Efforts to require 5 percent credit retention on ABS to be tested.
With the comment period for the SEC’s proposed changes to Reg AB closing today, the SEC will have to begin in earnest efforts to finalize rulemaking on securitization.
Getting clarity on new rulemaking, and better interpretation of accounting guidance, will be critical to revitalizing a market that, pre-crisis, financed over half of all business and consumer lending. As will the problem of required ratings. To help sort his out, the SEC set up a new office in July within the Division of Corporate Finance to focus on disclosure reviews and policy-making for asset-backed securities and other structured finance products.
Under Dodd-Frank, federal banking agencies and the SEC must jointly prescribe new regulations for securitization within 270 days of enactment to become effective one year later (for residential MBS) or two years later (for other types of MBS).
These rules are expected to require securitizers of asset-backed securities, by default, to maintain 5 percent of the credit risk in assets transferred, sold or conveyed through the issuance of asset-backed securities, except conforming residential mortgages. A lower retention requirement could be instituted, however, if underwriting/diligence meets high underwriting standards specific to the class of the securitized asset; plus regulators could allocate the risk-retention obligation between securitizers and originators.
A preview of what these rules might look like from the SEC perspective came with its proposed changes to Reg AB released last April. The comments also show how market participants seek to convince regulators to back off from a hard retention requirement across all asset classes.
Commenters pushing for relief
As comment letters to the SEC’s proposed changes come in, so far it is clear that many are pushing back on the 5 percent retention requirement. Chief among these is SIFMA’s securitization group, which as the Financial Times reported, seeks technical corrections to Dodd-Frank to clarify that different retention amounts will be allowed for different types of loans, which would seem consistent with the language in the law.
Other commenters are focused on the reps and warrant requirements of the proposed rules (also called for in Dodd-Frank). For example, Ford Motor Credit has a presentation that outlines its ABS financing process, where it makes the case that capital market reputation and quality of issue/marketing documentation are as important, if not more so, than levels of retention.
In the end, there seems room for compromise, whereby securitizers that adhere to best-practice underwriting standards (and otherwise demonstrate in their history and reps and warranties of having interests in line with investors) would be allowed a less onerous retention requirement. What remains to be seen is what sort of hoops securitizers will have to jump through to avoid a default 5 percent retention requirement.