In April, 2010 the SEC proposed a number of rules relating to shelf eligibility and various disclosure requirements in respect of asset-backed securities (the April 2010 Proposals). Among other proposals, the April 2010 Proposals contained certain eligibility requirements for use of a shelf prospectus including:
- A specified minimum amount of risk retention;
- A covenant to periodically furnish an opinion of an independent third party regarding instances in which securitized assets were not repurchased following a demand for repurchase based on an alleged breach of representations or warranty; and
- A certification by the chief executive officer of the depositor as to the adequacy of the cash flows generated by the securitized pool assets.
On July 26, 2011, the SEC issued a proposing release entitled Re-Proposal of Shelf Eligibility Conditions for Asset-Backed Securities and other Additional Requests for Comment (the July 2011 Re-Proposals) in which it addressed each of the foregoing eligibility requirements as well as certain of its proposals relating to disclosure.
As expected, the risk retention proposal has been dropped. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) was signed into law. Under the Dodd-Frank Act, a number of federal regulators, including the SEC, were tasked with jointly prescribing rules relating to risk retention requirements. On March 31, 2011 these regulators issued detailed proposals on the topic. The SEC’s decision to drop its own version of risk retention rules resulted from its view that “disparate risk retention requirements could be confusing and impose unnecessary burdens on the ABS market.”
In a previous posting, we commented upon the practical difficulties associated with the proposed requirement to obtain an opinion relating to repurchase requests and indicated that we felt that the alternative suggested by the Securities Industry and Financial Markets Association (SIFMA) would be a more workable, albeit costly, one. Apparently the SEC was also swayed by the SIFMA suggestion. Accordingly, the new shelf eligibility condition requires that the underlying transaction documents appoint a credit risk manager to review the underlying assets upon the occurrence of certain trigger events and provide its report to the trustee of the findings and conclusions of the review of assets. In addition, the documents are to contain certain provisions relating to the resolution of repurchase requests. While the new proposal does avoid a number of the pitfalls associated with the old one, we do not believe that the added complexity and cost involved in implementing the new proposal are warranted in the Canadian market which has not experienced the sort of problems relating to the enforcement of buy-back provisions which precipitated the regulatory response in the U.S.
In another posting we also discussed the certification requirement which, we argued, would have in essence required the issuer’s CEO to conduct a credit review of the ABS transaction and to assume an uncertain degree of securities law liability for such review. We concurred in the view expressed by many commentators that such a requirement would be inappropriate. A number of commentators were also concerned that the certification could be construed as a guarantee of the assets’ performance or be taken to cover classes of securities not offered, but described, in the prospectus. In response to these and other criticisms, the SEC has now modified the requirements relating to certification. Perhaps most notably, the certification relating to the adequacy of cash flow has been modified to state that “the structure of the securitization, including internal credit enhancements, ….is designed to produce, but is not guaranteed by this certification to produce, cash flows at times and in amounts sufficient to service expected payments on the asset-backed securities offered and sold pursuant to the registration statement”. While such a reformulation addresses certain of the criticisms levelled against the April 2010 Proposals, in our view it still fails to address the fundamental issue regarding the appropriateness of requiring certification relating to asset credit quality in any form whatsoever. In addition, while the re-proposal tightened the certification in certain respects, it expanded it in others relating to the certifying officer’s familiarity with the prospectus disclosure, the structure of the securitization, the relevant transaction documents, the underlying assets and the risks of ownership of the ABS.
As a final note on the shelf eligibility requirements, the SEC is now proposing a new one in keeping with its focus on the enforcement of rights contained in the transaction documents. According to this requirement, the documents must include a provision that requires the issuer to provide a notice in a public filing that an investor requests to communicate with other investors. The SEC believes that this will facilitate investors in directing the trustee to take certain actions on their behalf.
The SEC has not, at this time, revised the April 2010 Proposals relating to asset-level disclosure. It may be recalled from a previous posting that these were the subject of much criticism from commentators. That emanating from the auto sector was especially strong, complaining that the enormous burden of such disclosure, in a sector where the individual assets in a pool could number in the thousands, dwarfed the meagre benefits that could be gained by investors since the assets in the pool would be largely homogenous. As in the past, the SEC has found cover for its approach in the Dodd-Frank Act, in this case, the requirement imposed on the SEC to establish rules relating to asset-level disclosure. However, the specific wording of the statute only requires the disclosure of asset-level data “if such data are necessary for investors to independently perform due diligence” which, in our view, is not an adequate answer to the foregoing criticism. Nevertheless, at this time the SEC has chosen in the July 2011 Proposals to merely request additional comments relating to the substantive coverage and format of the previously proposed disclosure requirements.
In contrast, the SEC has indicated that it is reconsidering when, and how much, asset-level data disclosure should be required for privately issued structured products. In the April 2010 Proposals, the SEC required that an issuer deliver, to any investor who requested it, the same information required under the prospectus disclosure requirements which, of course, would now include asset-level data. Several commentators pointed out that the April 2010 Proposals do not specify clear information requirements for certain types of ABS that are not typically offered under Regulation AB, such as CDOs, CLOs, asset-backed commercial paper or synthetic ABS. Commentators also expressed concerns that any novel asset type or structure would face uncertainty regarding their disclosure obligations. In light of these and other comments, the SEC is considering limiting asset-level data disclosure in private placements to assets of an asset class for which there are asset-level reporting requirements in Regulation AB, namely RMBS, CMBS, automobile loans or leases, equipment loans or leases, student loans, floorplan financings, and resecuritizations.
One of the more contentious elements of the April 2010 Proposals was that requiring most ABS issuers to file a computer program that would permit investors to run various assumptions through the securitization’s flow of funds to analyze prospective performance in connection with evaluating an investment decision and to monitor actual performance of the ABS after issuance. Market participants, including the author, expressed many concerns with respect to this proposal including the fact that such a program would be inherently imperfect and incomplete, the potential for liability under federal securities laws based on the performance of the waterfall program under any set of variables supplied by investors and the expected cost burden on issuers. In light of the weight of commentary on this issue, the SEC has indicated that it plans to re-propose the waterfall computer program separately at a later date.
It should be apparent, given the range and the significance of the issues still at play, that there is a long way to go yet before we can expect any respite from regulatory uncertainty in this market.