On May 19, 2010, the SEC conditionally exempted until December 2, 2010 national recognized statistical rating organizations (NRSROs) from certain requirements in Rule 17g-5(a)(3) of the Securities Exchange Act of 1934 (the Rule), which had a compliance date of June 2, 2010. Under that May 19th order, the SEC provided that an NRSRO is not required to comply with the Rule until December 2, 2010 with respect to credit ratings where: (1) the issuer of the structured finance product is a non-U.S. person and (2) the NRSRO has a reasonable basis to conclude that the structured finance product will be offered and sold, upon issuance, and that any arranger linked to the structured finance product will effect transactions of the structured finance product after issuance, only in transactions that occur outside the U.S. On November 23, 2010, the SEC extended the temporary conditional exemption exempting NRSROS from complying with the Rule with respect to such non-U.S. transactions until December 2, 2011. Whereas some commentators had been hoping for a permanent exemption from application of the Rule for non-U.S. transactions, Canadian structured finance participants (arrangers in particular) now have an extra year to contemplate the operational, technical and legal ramifications of the Rule when applied to new rated transactions.
Our readers will recall that the Rule provided, among other things, that NRSROs must maintain on a password-protected Internet Web site a list of each structured finance product for which it currently is in the process of determining an initial credit rating and identifying the type of structured finance product, the name of the issuer, the date the rating process was initiated and the Internet Web site address where the arranger of the subject issuance provides information to the hired NRSRO for the subject issuance that can be accessed by other NRSROs. One of the goals of the foregoing Rule was to provide information accessible to NRSROs that were not hired for a subject structured finance issuance so as to enable such other NRSROs to be able to complete alternate or shadow ratings or review of the issuance. The Rule is part of the broader U.S. reform initiative that is seeking to manage perceived conflicts of interest in the rating retainer arrangements and processes between asset originators and credit rating agencies. The underlying logic is that by providing access to all interested rating agencies to information about a proposed rated structured finance product, rating agencies might be in an informed position to assess the ratings ascribed to structured finance issuances generated by other rating agencies and thus avoid rating agency determinations that are not capable of review, criticism or confirmation by others. Whether in fact the rating agencies and their processes (and allegations of conflict of interest) are to blame for the failures in U.S. securitization is a subject that I believe requires a nuanced and careful examination but in any event the U.S. Congress certainly doesn't need to be convinced that the credit rating agencies are at least partly responsible for the excesses and failures in the structured finance market in recent years. But that's the subject for another blog...
Our anecdotal information suggests that many structured finance arrangers in Canada were not prepared in June of this year to have due diligence and similar information available on dedicated web sites for non-hired NRSROs as required under the Rule and many would not have been ready to meet the previous effective date for the Rule as of this coming December 2nd. One of the issues that structured finance arrangers were struggling with is how to manage, collect and record exchanges with rating agencies so as to be able to be in a position to effectively populate the required dedicated Internet Web site with information shared with the hired rating agency about the structured finance product in question. Some commentators have suggested that the requirement to have the information about the rated product available for scrutiny on a dedicated site may have a chilling effect on the tone, manner and scope of exchanges among the arranger, the rating agency and the originator. We'd see, so the argument goes, less candid and informal exchanges among participants engaged with the proposed issuance to help develop the product criteria or attributes, fewer oral communications and more scripted responses.
The SEC is seeking comments from interested parties on the Rule and particularly its application to non-U.S. structured finance transactions. The extra-territoriality of the US financial reform legislation (including the Dodd-Frank securitization reforms) has been a subject of previous blog posts by my partner, Mike Rumball, and the application of this Rule in the future to Canadian deals is another example of the potential broad application of current US reforms. We will be watching the application of this Rule to Canadian deals and will report back on this blog on future related developments.