Finally some good news. It may be recalled that in April the SEC released its proposals for Reg AB II including proposals relating to risk retention. These proposals generated heated responses from industry participants mostly due to the requirement that securitizers (other than in credit card transactions) retain a 5% interest in each tranche of offered securities (a so-called “vertical slice”). The stated purpose of this proposal was to realign incentives among market participants in response to the abuses associated with the “originate–to–distribute” transaction model. It was rightly remarked that several market sectors, most notably auto and equipment finance, never employed this model but did employ alternative risk retention models which performed as expected during the crisis.

Then on July 15 the Dodd-Frank Act was passed. It also dealt with risk retention but only required the applicable rule-makers to adopt regulations setting the minimum level of risk retention at not less than 5%. It did not mandate the form that the risk retention should take but did require the regulators to adopt regulations to establish asset classes with separate rules for each.

The Act also required the Federal Reserve Board to study and report on the cumulative impact of the Act’s risk retention requirements. This report was issued in October. It recommends that, in order to achieve the aim of the Act, which was to reduce the potential incentives of an originator or securitizer to securitize poor quality assets, rule-makers should craft credit risk requirements that are tailored specifically to each major asset class. Echoing the comments of other industry participants, it states that “such an approach could recognize differences in market practices and conventions, which in many instances exist for sound reasons related to the inherent nature of the type of asset being securitized”.

In its own thinly-veiled assessment of the SEC proposals, it specifically states that “simple credit risk retention rules, applied uniformly across assets of all types, are unlikely to achieve the stated objective of the Act” and may unnecessarily reduce the supply or increase the cost of credit and thus “curtail credit availability in certain sectors of the securitization market.”

One assumes, or at least hopes, that the next development will involve significant revisions to the SEC’s proposals, which would be a welcome relief from the cumulative constrictive effect of its other proposals.