I. Executive Summary
On October 6, 2017, the U.S. Department of the Treasury released a report on the regulation of U.S. capital markets (the Report).1 The Report addresses securitization markets (among many other subjects).
The Report recommends regulatory changes or review in four areas related to securitizations:
- Capital Requirements—Bank capital requirements should be reduced or, in certain cases, reviewed, in order to better align those requirements with underlying securitization risks.
- Liquidity Requirements—Regulators should consider allowing certain high-quality securitized obligations to be counted by banking organizations against bank liquidity requirements.
- Risk Retention Requirements—Risk retention requirements should be revised to expand the exemptions available for certain types of securitizations, and one federal agency should be designated by Congress for related rulemaking.
- Disclosure Requirements—Reporting requirements for publicly offered securitizations should be reviewed and recalibrated and should not be extended to Rule 144A offerings or additional asset classes.
The recommendations are consistent with the Report’s characterization of the “counterproductive” treatment of securitization as “high-risk.” The Report states that “securitization, when undertaken in an appropriate manner, can be a vital financial tool to facilitate growth in our domestic economy.”
II. Capital Requirements
The Report describes a number of ways that bank capital rules and related requirements disadvantage securitization transactions. The Report recommends:
- The capital requirements for securitization exposures should be no higher than the capital requirements that would apply if securitized assets were held directly. The Report notes that current capital requirements include a “surcharge” on holding underlying assets in securitized form, which should be addressed.
- Capital requirements should recognize the added credit enhancement that results when a bank holds a securitization at a discount to par value.
- The risk-weight floor for securitization exposures should be lowered to accord with a recent Basel recommendation.2
- Capital requirements that result from accounting consolidation of certain securitization structures should be reduced to take into account the related transfer of credit risk, rather than tying to full consolidation of the securitized assets.
- U.S. bank regulators should consider the impact on secondary market activity that may result from recently proposed capital standards for trading positions.3 In any case, any final requirements should be recalibrated to prevent required capital from exceeding the maximum economic exposure of the securitization trading positions.
- In connection with its stress testing, the Federal Reserve should consider adjustments to its market shock scenario for trading exposures, in order to more fully consider the credit quality of the underlying collateral and the reforms that have been implemented since the crisis.
III. Liquidity Requirements
The Report cites requirements related to the liquidity coverage ratio (LCR) and the proposed net stable funding ratio (NSFR), under which banking organizations must maintain certain levels of “high-quality liquid assets” (HQLA). It noted that all non-agency securitizations were excluded from qualifying as HQLA, even though “other asset classes that experienced similar, or worse, illiquidity during the crisis have been made eligible to count toward HQLA.”4 The Report recommends:
- Regulators should consider allowing high-quality securitized obligations with a proven track record to qualify as “level 2B” HQLA for purposes of the LCR and the NSFR.
IV. Risk Retention Requirements
The Report notes three issues related to U.S. risk retention rules:
- overly conservative conditions that must be met by sponsors of securitizations of “qualifying” non-residential mortgage loans (commercial loans, commercial real estate loans and automobile loans) in order to receive an exemption;
- overly conservative treatment of collateralized loan obligations (CLOs); and
- the length of the holding period for third-party purchasers (“B-piece” buyers) in commercial mortgage real estate transactions.
The Report recommends:
- Risk retention exemptions for securitizations of “qualifying” loans in eligible asset classes should be expanded through notice-and-comment rulemaking.
- A broad qualified exemption for CLO risk retention should be adopted through the creation of a set of loan-specific requirements.
- The mandatory five-year holding period for third-party purchasers and sponsors of CMBS transactions should be reviewed. If regulators determine that the “emergence period” for underwriting-related losses is shorter than five years, the associated restrictions on sale or transfer should be reduced.
- Congress should designate a lead agency, from among the six agencies that promulgated the risk retention rules, to be responsible for future actions related to the rulemaking, including issuing interpretative guidance and providing exemptive relief.
V. Disclosure Requirements
The Report describes the evolution of ABS disclosure requirements, from those under Regulation AB to those under Regulation AB II, emphasizing the “inherently difficult balancing act [of] weighing the need to provide investors sufficient transparency into the risk profile of the underlying assets against the burden placed upon issuers to furnish detailed, asset-specific information.”5 The Report recommends:
- The scope of asset-level data required by Regulation AB II warrants review and recalibration.
- The number of required data fields for registered securitizations should be reduced, and the SEC should continue to refine its definitions to better standardize the reporting requirements on the remaining required fields.
- The SEC should review the requirement that there be at least three days between when offering disclosures are made and when sales are confirmed.
- The SEC should “signal” that it will not extend Regulation AB II disclosure requirements to unregistered Rule 144A offerings or to additional securitized asset classes.