On August 27, 2014, the Securities and Exchange Commission (SEC) adopted final revisions to Regulation AB (Reg AB II) that significantly revise Regulation AB as it relates to disclosure, reporting, and shelf registration of asset-backed securities (ABS).1 These final rules were adopted in part in response to the requirements of Sections 939A and 942(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and follow a series of earlier rule proposals issued by the SEC in 2010 and 2011. In addition, also on August 27, 2014, the SEC adopted a variety of rules relating to Nationally Recognized Statistical Rating Organizations (NRSROs), including those pertaining to third-party due diligence reporting,2 which follow an earlier proposal issued by the SEC in 2011.
Summary of principal Reg AB II requirements and changes
Regulation AB is a comprehensive set of rules that address the registration, disclosure, and reporting requirements for ABS under the Securities Act of 1933, as amended (Securities Act), and the Securities Exchange Act of 1934, as amended (Exchange Act). Reg AB II, as adopted, provides a number of amendments to these rules but did not incorporate a number of changes to Regulation AB included in the 2010 and 2011 proposals. Especially noteworthy exclusions from the original proposals are that (a) the adopted rules for Reg AB II do not require the issuer or registrant to file a waterfall computer program of the contractual cash flow provisions, and (b) Reg AB II only applies to registered public offerings and does not apply to offerings exempt from registration under Rule 144A or otherwise. However, the SEC noted in their release that certain proposed changes that remain outstanding may be implemented in the future.
Registrants must comply with the new rules and registration requirements (other than the asset-level disclosure requirements) no later than one year and 60 days from the date of publication of the final rules in the Federal Register and must comply with the new asset-level disclosure requirements for publicly offered ABS issued two years and 60 days after the publication of the final rules in the Federal Register.
Reg AB II requires ABS issuers to disclose standardized, asset-level information for ABS backed by residential mortgages, commercial mortgages, auto loans, auto leases, and debt securities (including resecuritizations). Although asset-level disclosure requirements for additional asset classes were included in earlier proposals of the rule changes, Reg AB II asset-level disclosure, as adopted, does not apply to ABS backed by equipment loans and leases, student loans, floorplan financings, managed pools such as CLOs, and synthetic transactions. However, the earlier proposals with respect to these assets have not been withdrawn and so they may be enacted in the future in some form.
Asset-level disclosure is required to be made at the time of the offering as part of the preliminary and final prospectuses, and on an ongoing basis as part of periodic Form 10-D filings. This asset-level information is also required to be provided in a standardized tagged data format called eXtensible Mark-up Language (XML) and posted on EDGAR so that it can be made publicly available.
The asset-level disclosure must also contain various enumerated data points. The number of data points required to be included in the asset-level data depends on the type of asset, and in some cases, such as ABS backed by residential mortgages, there are up to 270 different data points required to be included. Examples of the required asset-level data includes, among other items, (i) information related to the terms of the asset, (ii) a unique identifying asset number, (iii) the identity of the servicer and the servicing advance methodology, (iv) the characteristics of the obligor, (v) the underwriting of the asset, (vi) collateral related to each asset, and (vii) cash flows related to each asset, such as timing and amount of payments and expected changes to payment terms over time.
Securities Act registration
Under Reg AB II as it relates to shelf registrations, a complete preliminary prospectus must be filed under Rule 424(h)(1) at least three business days prior to the date of the first sale in an ABS offering that is issued under a shelf registration statement. This preliminary prospectus must contain all information required to be included in the final prospectus other than certain pricing and underwriting fee information. If there is any material change from the information set forth in the preliminary prospectus, the registrant must file a prospectus supplement at least 48-hours before the date and time of the first sale in the offering and such supplement must clearly state what material information has changed from the initial preliminary prospectus.
In order to distinguish the ABS registration system from the registration system for other securities, Reg AB II also establishes two new forms for registering ABS offerings: Form SF-1 for standalone ABS issuances and Form SF-3 for ABS shelf issuances. Unlike Form S-3 shelf registration statements that allow the use of a base prospectus and supplemental prospectus, in an attempt to require issuers to make periodic assessments of their continued eligibility to conduct shelf offerings, Reg AB II requires filings to be made under a single prospectus document in which the issuer will file an initial form prospectus at the time the registration statement filed on Form SF-3 becomes effective and an “integrated” prospectus at the time of each takedown.
Shelf eligibility – transaction requirements
In response to a general mandate under the Dodd-Frank Act to eliminate the mandatory use of ratings in various statutory schemes, another major change to Regulation AB that has been adopted under Reg AB II is that the requirement that ABS be rated investment grade in order to be eligible for shelf registration has been eliminated and has been replaced by the requirement that the following criteria be satisfied:
- CEO certification: The chief executive officer of the depositor must sign a certification as of the date of the final prospectus stating he/she has reviewed the prospectus and is familiar with the securitized asset, the structure, and the material transaction documents and that such information is accurately described therein. The chief executive officer must also certify that based on his/her knowledge, there is no untrue statement of material fact included or omitted from the prospectus and that taking the material aspects of the issuance, there is a reasonable basis to conclude that it is structured to produce, but not guaranteed to produce, expected cash flows at times and in amounts necessary to make timely payments of principal and interest. This certification is allowed to be qualified by a statement that it is being given subject to all available defenses under securities laws.
- Asset review: The transaction documents must provide for the selection and appointment of an independent asset representations reviewer that must be engaged at the time of issuance and identified in the prospectus. The reviewer’s responsibility will be to review the pool assets for compliance with the representations and warranties following specific trigger events, which must include at a minimum (i) a threshold percentage of delinquent assets being reached on a pool-wide basis and (ii) an investor vote to direct a review. Regarding investor direction, the minimum investor percentage to trigger a vote shall not be set above 5% of the total pool interest and the percentage of investors needed to require review cannot be more than a simple majority of voting investors.
- Dispute resolution: The transaction documents must contain provisions allowing a party making repurchase demands not resolved after 180-days to refer the dispute to mediation or third-party arbitration.
- Investor communication: The transaction documents must contain provisions under which the party responsible for the Form 10-D filings must include in the report any request from an investor to communicate with other investors.
Shelf eligibility – registrant requirements
Prior to filing a registration statement on Form SF-3, to the extent the depositor, any issuing entity previously established by the depositor or any affiliate of the depositor was required to comply with the proposed transaction requirements of Form SF-3 with respect to a previous offering of ABS involving the same asset class during the preceding twelve months, such depositor, issuing entity or affiliate must meet certain registrant requirements at the time the shelf registration statement is filed. These requirements include the timely filing of all reports required under the Exchange Act as well as the filing of all required certifications and transaction agreements stated above during the preceding 12 months. In addition, there is a separate registrant requirement whereby the depositor must disclose its compliance with the registrant requirements. Reg AB II provides for a 90-day cure period for late filings. An effective shelf on Form SF-3 will become ineffective if after 90-days following the depositor’s fiscal year end prior to the offering, the requirements above, as well as certain other requirements stated in Form SF-3 are not met.
Exchange Act reporting
Reg AB II has also modified several Exchange Act reporting requirements for ABS. With respect to Form 10-D, the final rules require pool level delinquency reporting in the periodic distribution report to be presented in 30-day increments for not less than 120-days, rather than monthly information through charge-off. Material changes in a sponsor’s interest in an ABS transaction resulting from a sale or purchase of the securities must also be reported. With respect to Form 10-K, added disclosure is required to be included if it has been determined that for any material noncompliance identified in the platform level assessment, such noncompliance involved the servicing of the assets in the pool. Any steps taken to remedy a material instance of noncompliance at the platform level must also be included.
Summary of third-party due diligence requirements
Rule 15Ga-2 requires that an issuer or underwriter of registered or unregistered ABS rated by an NRSRO make publicly available on EDGAR the findings and conclusions of any report of a third-party due diligence service provider (a TPDDS Provider) relating to “due diligence services” obtained by the issuer or underwriter. Under the new rules, “due diligence services” are defined as a review of the pool assets for the purposes of making findings with respect to (i) asset data accuracy, (ii) conformity of the assets with underwriting standards, (iii) the value of the assets, (iv) legal compliance by the originator, and (v) any other material factor related to the likelihood that the issuer will pay principal and interest as required.
The new rules include provisions on how NRSROs, issuers, underwriters and TPDDS Providers are to coordinate the required disclosure and certifications. Under Rule 15Ga-2, the issuer or underwriter will generally be required to furnish a Form ABS-15G to the SEC via EDGAR no later than five business days before the first sale of the offering. If the issuer or underwriters each obtain the same report, only one of them is required to file.
These reporting requirements will have a broad impact on the market as, unlike Reg AB II, they apply to both non-registered transactions (private placements) and transactions registered with the SEC. However, an ABS offering will be exempt from Rule 15Ga-2 if:
- the offering is not registered (or required to be registered) under the Securities Act;
- the issuer is not a U.S. person; and
- the securities will be offered and sold only in transactions that occur outside of the United States.
Rules 17g-7 and 17g-10
Rules 17g-7 and 17g-10 require a TPDDS Provider to provide a written certification to any NRSRO that produces a rating to which the due diligence services relate, if the TPDDS Provider was engaged by the NRSRO, an issuer, or underwriter. This delivery requirement will primarily be done by providing the certification to the issuer or underwriter for posting on its Rule 17g-5 website.
The above third-party due diligence reporting rules become effective nine months after the publication of the final rules in the Federal Register.