Background: Asset-backed securities (ABS) are created by buying and bundling loans – such as residential mortgage loans, commercial loans or student loans – and creating securities backed by those assets, which are then sold to investors. Often, a bundle of loans is divided into separate securities with different levels of risk and returns. Payments on the loans are distributed to the holders of the lower-risk, lower-interest securities first, and then to the holders of the higher-risk securities.
Most public offerings of ABS are conducted through expedited SEC registration procedures known as “shelf offerings.” ABS offerings also are sold as private placements which are exempt from SEC registration. Privately-issued ABS are typically sold to large institutional investors known as qualified institutional buyers or QIBs.
During the financial crisis, ABS holders suffered significant losses. The crisis revealed that many investors were not fully aware of the risk in the underlying mortgages within the pools of securitized assets.
In April 2010, the Commission proposed certain revisions to the existing rules applicable to ABS transactions, including:
- Requiring the filing of tagged, computer-readable, standardized information about the specific assets, or loans, in the pool. This so-called “loan-level information” would be provided at the time the asset is securitized and on an ongoing basis.
- Requiring the ABS issuer to file on the SEC website a computer program that provides investors with a tool to analyze information about specific loans within the pool of assets. This computer program would show the effect of the so-called “waterfall” so investors can analyze how the borrowers’ loan payments are distributed to investors in the ABS, how losses or lack of payment on those loans will be divided among the investors, and when administrative expenses, such as loan servicing fees, are paid to service providers.
- Providing investors with more time to consider information about the pool of securitized assets before they need to make an investment decision.
- Repealing an existing condition that issuers must receive an “investment grade” rating for an ABS in order to be granted “shelf” or expedited eligibility. Instead, the rules would establish new conditions for ABS shelf eligibility.
- Increasing transparency in the private ABS market by revising SEC safe harbors (which provide an exemption from SEC registration) to require ABS issuers to:
- File a notice of ABS offerings conducted in reliance on the SEC safe harbor.
- Represent in their transaction agreement that they will make available to investors the same information about the securities that would be provided if the offering were publicly registered.
The Dodd-Frank Wall Street Reform and Consumer Protection Act imposes new requirements on the ABS process. Specifically:
- Section 621 prohibits an underwriter, placement agent, initial purchaser, sponsor, or any affiliate or subsidiary of any such entity, of an asset-backed security from engaging in any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity for a period of one year after the date of the first closing of the sale of the asset-backed security.
- Section 941 requires the Commission, the Federal banking agencies, and, with respect residential mortgages, the Secretary of Housing and Urban Development and the Federal Housing Finance Agency to prescribe rules to require that a securitizer retain an economic interest in a material portion of the credit risk for any asset that it transfers, sells, or conveys to a third party. The chairperson of the Financial Stability Oversight Council is tasked with coordinating this regulatory effort.
- Section 942 contains disclosure and Exchange Act reporting requirements for ABS issuers.
- Section 943 requires the Commission to prescribe regulations on the use of representations and warranties in the market for ABS.
- Section 945 requires the Commission to issue rules requiring an asset-backed issuer in a Securities Act registered transaction to perform a review of the assets underlying the ABS, and disclose the nature of such review.
In light of the Dodd-Frank Act and comments received on the April 2010 proposals, on July 26, 2011, the SEC re-proposed for public comment some of the rules from April 2010 release — namely the proposals relating to ABS shelf eligibility. The SEC also requested comment on certain portions of its April 2010 proposal to require asset-level information to assist it in considering whether that requirement appropriately implements Section 942(b) of the Dodd-Frank Act, and whether additional information may be required. The comment period was reopened on February 25, 2014.
Implementation: On January 20, 2011, final rules were adopted implementing Section 943, requiring nationally recognized statistical rating organizations and issuers of asset-backed securities to provide certain disclosures on the use of representations and warranties in the market for asset-backed securities. Final rules also were adopted on January 20, 2011, to implement Section 945, requiring asset-backed securities issuers whose offerings are registered under the Securities Act to conduct a review of the assets underlying those securities and make certain disclosures about those reviews. The SEC also has adopted rules relating to the ongoing reporting of asset-backed issuers under the Exchange Act.
On March 30, 2011, the SEC proposed rules (jointly with other agencies) regarding risk retention by securitizers of asset-backed securities. These rules were proposed following two related studies that are also required by the Dodd-Frank Act.1 On August 28, 2013, the agencies re-proposed the risk retention rules. The comment period ended on October 30, 2013.
The SEC has also adopted rules relating to the ongoing reporting of asset-backed issuers under the Exchange Act.
On September 19, 2011, the Commission proposed rules to prohibit material conflicts of interest between those who package and sell asset-backed securities and those who invest in them. On December 23, 2011, the comment period was extended to February 13, 2012.
1 In October 2010, the Federal Reserve Board published its report, in coordination and consultation with others including the SEC, on certain effects of risk retention. In January 2011, as required by Section 946 of the Dodd-Frank Act, the Chairman of the Financial Stability Oversight Council issued a study on the macroeconomic effects of risk retention.