On July 26, 2011, the SEC re-proposed rules containing new shelf eligibility requirements for asset-based securities (ABS). The SEC initially proposed rules in April 2010 to significantly revise the regulatory regime for ABS. Subsequent to that proposal, the Dodd-Frank Act was enacted and addressed some of the same ABS concerns. In light of those Dodd-Frank Act provisions, and comments received from the public, the SEC re-evaluated its initial proposals.
Under currently existing rules, an ABS offering is not eligible for an expedited shelf offering unless the securities are rated investment-grade by a credit rating agency. In 2010, the SEC proposed new ABS “shelf” eligibility criteria to enhance the type of securities that are being offered and enhance the accountability of participants in that securitization chain.
The SEC is now proposing rules that would require the following as conditions for shelf eligibility:
- Certification: An executive officer of the ABS issuer would be required to certify, among other things, the accuracy of the disclosure and that the securitization is designed to produce cash flows at times and in amounts sufficient to service expected payments on the asset-backed securities being offered and sold.
- Representations and Warranties: The underlying transaction agreements must include provisions that:
- appoint a credit risk manager to review assets upon the occurrence of certain trigger events
- set forth dispute resolution procedures that outline the way in which pending or disputed requests to repurchase potentially non-compliant assets in the pool can be resolved
- Investor Communications: The underlying transaction agreements must include a provision requiring the issuer to provide a notice in a public filing that an investor requests to communicate with other investors.
These actions regarding shelf eligibility build upon the April 2010 proposals and the Dodd-Frank Act in the following ways:
- Risk Retention: In 2010, the SEC proposed that the ABS sponsor hold 5% of each class of asset-backed securities and not hedge those holdings. Risk retention is now mandated by Section 941 of the Dodd-Frank Act, and the SEC has proposed rules under this provision jointly with the other financial regulators.
- Confirmation of Reps and Warranties: In 2010, the SEC proposed that the ABS issuer provide a mechanism whereby the investors will be able to confirm that the assets comply with the issuer’s representations and warranties, such as representations and warranties that the loans in the ABS pool were underwritten in a manner consistent with the lenders’ underwriting standards. This is being replaced in the re-proposal with an alternative mechanism to strengthen the enforceability of representation and warranty provisions – the credit risk manager and repurchase request dispute resolution procedures – described above.
- Ongoing Reporting: In 2010, the SEC proposed that the ABS issuer agree to file Exchange Act reports with the SEC on an ongoing basis (rather than stop reporting with the SEC in the first year, which at the time of the proposal the Exchange Act permitted many ABS issuers to do). This shelf eligibility condition is not being re-proposed because Congress subsequently mandated ongoing Exchange Act reporting for registered ABS offerings as part of Section 942(a) of Dodd-Frank.
While ratings would continue to be allowed for ABS offerings, the proposed rules would eliminate the ratings requirement from the SEC’s expedited shelf eligibility test.
Comments on the proposed rules are due 60 days after publication of the rule release in the Federal Register.