As indicated in a previous piece, Item 1 of the proposed CSA rules deals with the various parties to a transaction and requires clear identification of each role that they play and the specific functions and responsibilities being performed in connection with each role. In the following, we continue to discuss issues raised by certain of the required disclosure elements relating to the parties to a securitized products transaction.
In Reg AB, disclosure is required in respect of “any provisions or arrangements included to address any one or more of the following issues:
- Whether any security interests granted in connection with the transaction are perfected, maintained and enforced.
- Whether declaration of bankruptcy, receivership or similar proceeding with respect to the issuing entity can occur.
- Whether in the event of a bankruptcy, receivership or similar proceeding with respect to the sponsor, originator, depositor or other seller of the pool assets, the issuing entity’s assets will become part of the bankruptcy estate or subject to the bankruptcy control of a third party.
- Whether in the event of a bankruptcy, receivership or similar proceeding with respect to the issuing entity, the issuing entity’s assets will become subject to the bankruptcy control of a third party.”
In the equivalent CSA proposals, the introductory wording is restricted to (a) above while the equivalent of (b), (c) and (d) are left as unqualified line items. As a result, rather than just requiring a description of the contractual provisions, if any, meant to address bankruptcy issues, the CSA seem to be requiring discussion of the substantive issues themselves. These are really the proper subject-matter of the legal opinions provided in the transaction which are lengthy and qualified in various ways in accordance with accepted practice. They are not appropriate subject-matters for prospectus disclosure with its associated liability.
Reg AB requires a description of the “creation (and perfection and priority status) of any security interest in favour of the issuing entity, the asset-backed security holders or others, including the material terms of any agreement providing for such … creation of a security interest.” Although not absolutely explicit, taken as a whole it is fairly clear that this requirement is meant to apply to the creation of security interests pursuant to the transaction in question. This is not so clear in respect of the CSA proposal as the result of the cropping of the language to simply require a description of “the creation, perfection and priority status of any security interest in a pool asset, and each person or company who holds a security asset in a pool asset.” On its face this language could be read so as to extend the scope of the requirement to include security interests in the pool assets given to the originator by the underlying obligors, which of necessity would need to be provided on an asset-level basis. Since such a reading is patently ludicrous and runs contrary to the entire thrust of the CSA proposals which intentionally avoid the asset level disclosure being proposed under Reg AB II, it must be assumed not to have been intended. The issuer relies on the representations and warranties of the originator in respect of these matters.
If multiple servicers service the pool assets then, in addition to each master servicer, each servicer that services at least 10% of the asset pool must be identified and more detailed disclosure is required if it services 20% or more of the pool assets. In some transactions, especially RMBS transactions, a sub-servicer may be appointed in respect of the entire pool. It is unclear whether such a sub-servicer is meant to be captured by this requirement but there is at least an argument that it is not, given that one of the specific line items is “the material terms of any relationship or arrangement with another party by which the servicer may subcontract or delegate some or all of its functions to that party.” If the sub-servicer was already caught, such disclosure would seem to be unnecessary given that the material terms of the servicing agreement applicable to each servicer is already required disclosure. On the other hand, the requirement to disclose information about each master servicer and each 10% servicer casts a certain degree of doubt on what is intended here. The servicer primarily obligated is usually the originator who could be said to be a master servicer and the sub-servicer could be caught by the 10% threshold.
If such a sub-servicer is caught there are a couple of line items which might cause some concern, both on the part of the sub-servicer and on the part of the issuer who must rely upon information provided to it by the sub-servicer. First, disclosure is required in respect of the servicer’s “procedures for servicing assets of the type included in the securitized product transaction” and its “process for handling delinquencies and losses”. A servicer’s collection policies are often extremely lengthy and detailed and may, to a certain extent, be considered to be proprietary. Second, information would need to be provided “regarding the servicer’s financial condition to the extant that there is a significant risk that the effect on one or more aspects of the servicing resulting from such financial condition could have a material impact on pool performance or performance of the securitized product”.
In Reg AB, disclosure is required if “any special or unique factors are involved in servicing particular types of assets included in the current transaction, such as subprime assets, and the servicer’s processes and procedures designed to address such factors”. In the CSA proposals, this is rendered as “any factors involved in servicing the types of assets included in the securitized product transaction that are particularly relevant to assets of that type. For example, describe the factors that are particularly relevant to subprime assets and loans with deferred payments, and the servicer’s processes and procedures designed to address those factors”. The deletion of the words “special or unique” is not helpful and only serves to introduce a degree of doubt about what is being required.
This point also illustrates a general concern deriving from the opening instructions to the form: “This Form sets out specific disclosure requirements relating to securitized products that are in addition to the general requirement under securities legislation to provide full, true and plain disclosure of all material facts relating to the securities to be distributed. Issuers must comply with the specific instructions or requirements in this Form if the instruction or requirement is applicable”. Thus, unless the specific requirement is limited by a materiality threshold, it appears that all applicable facts, however immaterial, are expected to be discussed. As a result, what precisely is being required here has been obscured rather than clarified.
One element of the bankruptcy-related disclosure discussed above in the context of issuers reappears here where a description is required in respect of “whether in the event of a bankruptcy, receivership or similar proceeding with respect to the servicer, any of the issuer’s assets will secure part of the bankruptcy estate or subject to the bankruptcy, receivership or similar control of a third party”. It is unclear in what circumstances the issuer’s assets would ever become subject to a bankruptcy proceeding with respect to servicer. Nevertheless the wording of this requirement seems to imply that at least a negative statement is expected.
Affiliates and Certain Relationships and Certain Transactions
In both Reg AB and the equivalent CSA proposals, disclosure is required in respect of related party relationships, agreements or transactions which exist at the time of the offering or during the two years before the date of the prospectus between any of the parties discussed in the prospectus. In Reg AB, the types of related-party arrangement which are of interest are (1) those entered into outside of the ordinary course of business or on non-arm’s length terms, apart from the asset-backed securities transaction and (2) those relating to the asset backed securities transaction or the pool assets.
In the equivalent CSA rule, however, the former category is also made subject to the requirement that the relationship, agreement or understanding be “related to the securitized products being distributed or the pool assets”. Accordingly, there does not seem to be any real distinction between the two categories under the CSA rule with the result that, unlike in the U.S., non-arms length dealings among the parties involved in the securitized product transaction which are not related to the securitized products or the pool assets need not be disclosed.
One final line item which may turn out to be the most controversial of all is the requirement to disclose “whether any person described in the prospectus[which includes arrangers or underwriters]or any of its affiliates are engaged in, or have in the 12 months before the date of the prospectus been engaged in, any transaction that would involve or result in any material conflict of interest with respect to any investor in the securitized product being distributed.” The possible implications of this requirement are unsettling to say the least. For instance, just on a practical level, does it really mean that the specific investors have to be identified? Clearly this information would not be available for the preliminary prospectus and may not be known until the prospectus has been finalized or until after it has been issued and receipted. In fact, can it be said that are there really any investors at all until after the final prospectus has been delivered or even until after the rescission period has elapsed? Would an amendment be required after the investors are confirmed and would that be just the start of a vicious circle?
Apart from technical difficulties, this requirement also raises significant substantive issues as it would appear that the obligation to provide the required information presupposes the ability on the part of the issuer to investigate, determine and understand the activities of all other participants, including the underwriters and the investors, over the last 12 months. It is not clear what the original intent here was but it seems safe to assume that there has been somewhat of a failure to translate it effectively. Clearly some further work is necessary here.