Speech by SEC Chairman:
Statement Regarding Credit Risk Retention
Chairman Mary L. Schapiro
SEC Open Meeting
March 30, 2011
Good morning. This is an open meeting of the U.S. Securities and Exchange Commission on March 30, 2011.
Today, the Commission will consider two proposals, both of which stem from the Dodd-Frank Wall Street Reform and Consumer Protection Act.
First, we will consider joining with other regulators to propose rules implementing section 941 of the Dodd-Frank Act. That section generally requires that certain parties involved in non-exempted asset-backed securities, retain a minimum amount of economic interest in the credit risk of the assets being securitized.
Second, we will consider proposing rules to implement section 952 of the Dodd-Frank Act. That section requires the Commission to adopt rules concerning the disclosure of a compensation consultant’s potential conflicts of interest. It also calls for rules directing the exchanges to adopt certain listing standards addressing compensation committee independence.
Risk Retention in the ABS Market
We begin with the risk retention proposal.
As we know, securitization – which is the buying and bundling of assets such as housing, student, car or commercial loans – played a key role in the financial crisis.
Like many investment products, securitization has both benefits and risks. The benefits to our national economy include lowering the cost of credit to households and businesses, enabling lenders to make loans and credit available to a wide range of borrowers and companies seeking financing. From an investors’ perspective, securitization can provide an attractive yield and an important opportunity to diversify risk. For these reasons, at one time, the securitization market provided trillions of dollars of liquidity to virtually every sector of the economy.
However, these benefits are not without costs. For example, many parties in the securitization chain, such as loan originators, may have access to information not readily available to investors of asset-backed securities or ABS. This could include information that may affect the future credit worthiness of a borrower.
In addition, participants in this chain may be able to affect the value of the securities in ways that are not fully transparent to investors. This could happen, for instance, when an originator includes the most poorly underwritten loans through a securitization and retains for itself only those loans very likely to fully perform.
This misalignment of incentives and information are contrary to fair and efficient markets. And, as we have learned repeatedly, when investors don’t trust the fairness of a market, they often withdraw their capital. In the securitization market, this has had a dramatic impact on businesses and households across America.
Addressing the various lessons that we have learned about the ABS market is a multi-pronged effort. In fact, this is the fourth major ABS proposal that the Commission has undertaken in just the past 12 months.
Previous SEC Proposals
As many of you may recall, last April, the Commission proposed rules that sought to level the information playing field among different parties in the securitization chain. Among other things, these rules would require issuers of ABS to file loan-level information in a specific computer-readable format. The proposal also would require issuers to file on the SEC website a computer program that would show the so-called “waterfall,” allowing investors to see and analyze how borrowers’ loan payments are being distributed.
Additionally, the April 2010 proposal included a provision that sought to realign economic incentives in the ABS market. Specifically, it would have required, as a condition of shelf eligibility, that ABS sponsors retain some of the credit risk associated with the underlying assets.
However, after our April 2010 proposal, Congress passed the Dodd-Frank Act which directed the Commission, as well as other financial regulators, to address many of the weaknesses in the ABS market that the financial crisis brought to light.
As a result, earlier this year the Commission adopted two other sets of ABS rules, both of which enhance transparency and thereby further minimize the information gap that has existed in this market.
The first requires issuers of asset-backed securities to provide greater disclosure about their representations and warranties, as well as the history of loan repurchases. All of this data will help investors identify originators that may have underwriting deficiencies.
The second requires issuers of ABS that are registered with the SEC to conduct a review, either themselves or with the help of third parties, of the bundled assets that underlie the ABS, and then to disclose information about that review.
The proposal we consider today impacts a broader class of issuers than did our April 2010 proposal regarding credit risk retention. As directed by Dodd-Frank, today’s proposed rules have been jointly developed by the staffs of several agencies. Specifically, our staff worked with staff at the Federal Reserve Board, the Office of the Comptroller of the Currency, the FDIC, the Federal Housing Finance Agency, and the Department of Housing and Urban Development. Yesterday, those other agencies approved the joint proposal that we are now considering.
As I mentioned earlier, our April proposal was narrowly crafted to only impose risk retention requirements upon sponsors of asset-backed securities seeking to use the “shelf” registration process. This was due to limitations to the Commission’s statutory authority. However, with enactment of the Dodd-Frank Act, the Commission (jointly with our fellow regulators) is not only authorized to write rules requiring risk retention in all non-exempted ABS transactions – whether “shelf” eligible or not – but is required to do so.
In a moment I will ask Meredith Cross, Director of the Division of Corporation Finance, to provide the details about the recommendation before us. But before I do, I’d like to thank the staff members who have put in countless hours working on this project.
From Corp Fin, thank you to Meredith, Paula Dubberly, Kathy Hsu, Jay Knight, Rolaine Bancroft, Paul Dudek, Amy Starr, and Stephanie Hunsaker. From the Division of Trading & Markets, thanks to Gregg Berman. Thanks also to our colleagues in the General Counsel’s Office, specifically Rich Levine, David Fredrickson and Bryant Morris. From the Division of Risk, Strategy and Financial Innovation, thank you to Stas Nikolova and Emre Carr. Thanks also to Paul Beswick and Wes Bricker from the Office of Chief Accountant, and to David Grim from the Division of Investment Management
Finally, I would like to thank the staffs of our fellow regulatory agencies, as well as my colleagues on the Commission and our counsels for their work and thoughtful comments.
Now I'll turn the meeting over to Meredith Cross to hear more about the Division’s recommendations.