SEC Re-Proposes New Shelf Eligibility Requirements for Asset-Backed Securities

Securities and Exchange Commission has voted unanimously to re-propose for public comment some rules requiring greater accountability and enhanced quality around asset-backed securities (ABS) when issuers seek to use an expedited registration process known as shelf registration.

The SEC initially proposed rules in April 2010 to significantly revise the regulatory regime for ABS. Subsequent to that proposal, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law 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.

“It is very important that we move forward with our new registration and reporting rules for the asset-backed securities market, but we also want to make sure we get it right,” said SEC Chairman Mary L. Schapiro. “This re-proposal will help us solicit the input and constructive comments we need to finalize this critically important project to protect investors in asset-backed securities.”

Public comments are due 60 days after publication of the re-proposed rules in the Federal Register.

Background

Asset-backed securities are created by buying and bundling loans – such as residential mortgage loans, commercial loans or student loans – and creating securities backed by those assets that 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 procedures known as “shelf offerings.”

During the financial crisis, ABS holders suffered significant losses and the securitization market, particularly the non-governmental mortgage-backed securities market, has been relatively dormant ever since. The crisis revealed that many investors were not fully aware of the risk in the underlying mortgages within the pools of securitized assets and over-relied on credit ratings assigned by rating agencies, which in many cases turned out to be wrong.

Previous SEC Proposals

In April 2010, the SEC proposed rules that would give investors the tools they need to more accurately assess risk and better align the interests of the issuer with those of the investor. In particular, the proposed rules would revise the disclosure, reporting and offering process for ABS to better protect investors in the securitization market.

After the SEC voted to propose its rules, Congress passed the Dodd-Frank Act, which among other things also sought to address concerns in the ABS market.

As a result, some of the previously proposed ABS rules are either no longer necessary or should be revised. In addition to updating its 2010 proposals, the SEC is requesting additional comment on certain portions of its earlier proposal to require asset-level information about pool assets.

Re-Proposal of Shelf Eligibility Requirements

Under 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 Commission 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. This proposal revises the April 2010 proposal regarding certification.

Representations and Warranties: The underlying transaction agreements must include provisions:

- Appointing a credit risk manager to review assets upon the occurrence of certain trigger events.

- Setting 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 some of the following ways:

Risk Retention: In 2010, the SEC proposed that the ABS sponsor hold five percent 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 – which are described above.

Ongoing Reporting: In 2010, the SEC proposed that the ABS issuer agree to file Exchange Act reports with the Commission on an ongoing basis (rather than stop reporting with the Commission 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 the Dodd-Frank Act.

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.

Proposing Updated Exhibit Filing Deadlines

Under the current shelf registration rules, issuers may sell ABS almost immediately, without providing investors with a minimum amount of time to review the disclosure in the offering materials.

In April 2010, the SEC proposed to give investors more time to review the disclosure in the offering materials, by requiring that a preliminary prospectus be given to investors a minimum period of time in advance of first sale.

Now the SEC is issuing a proposal – that dovetails with the previous proposal – requiring that ABS issuers file copies of the underlying transaction agreements, including all attached schedules, at the time of a preliminary prospectus.

Requesting Comment on Outstanding Proposal to Require Asset-Level Data

In April 2010, the SEC proposed new disclosure rules that would require ABS issuers to provide specific data for each loan in the asset pool both at the time of securitization and on an ongoing basis. The loan-level data would cover items such as the terms and underwriting of the loan, credit information about the borrower, and/or characteristics of the property securing the loan.

The SEC received many comment letters regarding the asset-level proposal, and is requesting further comment on a few possible additional approaches.

In addition, Section 942(b) of the Dodd-Frank Act requires the SEC to adopt regulations requiring an issuer of an ABS to disclose loan-level information, if it is necessary for investors to independently perform due diligence.

The SEC is requesting comment to assist it in considering whether the April 2010 proposal appropriately implements Section 942(b) and whether additional information may be required.

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