Pursuant to Reg AB II, theDodd-Frank Act and the rules implementing that Act (the "U.S. Proposals"), U.S. authorities have proposed the most far-reaching substantive and procedural regulations ever applied to the ABS market. In Canada, the CSA have chosen not to propose similar rules at this time but have instead focused almost entirely upon enhanced disclosure; in essence merely bringing Canadian ABS regulations to the standard existing under Reg AB prior to the U.S. Proposals. The implicit rationale for taking this approach is reflected in the third of the general principles which the CSA have indicated have guided them in developing the proposed rules:
"The rules should take into account the particular features of the Canadian securitization markets. In particular, rules should be proportionate to the risks associated with particular types of securitized products available in Canada, and should not unduly restrict investor access to securitized products. Canada experienced significant turmoil in the ABCP market in August 2007. However, for a number of reasons, the Canadian securitization market did not experience a sub-prime mortgage securitization bubble."
Accordingly, the CSA have not adopted the more controversial aspects of the U.S. Proposals such as mandatory risk retention, asset-level disclosure and waterfall computer programs. Even in respect of those parts of the U.S. Proposals that have been broached by the CSA proposals, the contrasting regulatory approaches have yielded markedly different results.
The U.S. authorities have devoted much energy to the topic of repurchase requests, in part as a result of lawsuits over the enforcement of covenants to repurchase assets as a result of alleged breaches of representation and warranty and the difficulties encountered by investors in obtaining the necessary information from sponsors. In an effort to identify originators with clear underwriting deficiencies, the U.S. Proposals contain various rules ranging from the requirement to file periodic reports in respect of all fulfilled and unfulfilled repurchase requests to a requirement to obtain a third-party opinion in respect of any unfulfilled repurchase request.
The equivalent CSA proposal is limited to prospectus disclosure requirements. It applies to any offering where the underlying transaction documents contain an obligation to repurchase or replace assets due to a breach of representation and warranty (that is, virtually all ABS transactions). Disclosure is required in respect of each transaction in which (i) the originator under the present distribution or one of its affiliates was the originator, (ii) the assets involved were of the same class as those involved in the distribution and were themselves the subject of a public distribution and (iii) the assets were the subject of a demand to repurchase or replace for a breach of representation and warranty pursuant to the transaction agreements made at any time during the previous three years. In addition, disclosure is required as to the outcome of the demand and, if the demand has been rejected on the basis that the assets did not violate a representation and warranty, "whether an opinion of a third party not affiliated with the originator had been furnished to the trustee or issuer that confirmed that the assets did not violate the representation and warranty". The requirement that any demand to repurchase be made "pursuant to the transaction documents" is important. In the U.S. much comment has been devoted to whether arbitrary demands not based on the rights afforded under the documents need be reported. The answer seems to have been clarified under the CSA proposal.
Curiously, a separate but identical provision applies to "each party that is required to repurchase or replace a pool asset for breach of a representation and warranty". Given the breadth of this latter provision, the one discussed above, which applies solely to originators and their affiliates, seems redundant.
Finally, information regarding the financial condition of each party with a repurchase obligation must also be provided if there is "a significant risk that the party's financial condition could have a material impact on its ability to comply with the provisions relating to the repurchase obligations". The precise nature of the required disclosure is uncertain and should be clarified unless all that is intended in the traditional statement that there can be no assurances that the party will be able to meet its obligations.
The U.S. Proposals also require issuers of registered ABS to perform a review of the underlying assets and to make disclosure regarding the nature, findings and conclusions of the review. The CSA proposal simply requires disclosure as to (i) "whether the pool assets have been reviewed for compliance with selection criteria or are the subject of a report by a third party to verify the accuracy of the loan or other asset information disclosed in the prospectus" and (ii)"if the pool assets have been reviewed for compliance or are the subject of a report by third party, the identify of the reviewer or third party, the scope of the review or report, and the result of findings of the review or report".
Two days prior to the release of the CSA proposals, the SEC and various other federal banking regulators issued a massive set of proposed rules under the Dodd-Frank Act requiring securitization sponsors to retain an economic interest in the assets that they securitize. The proposed rules apply to virtually all securitizations whether public or private. They provide for several forms in which risk can be retained as well as limited exceptions for pools of assets that satisfy specified credit criteria and restrictions on hedging of the retained interests. The impact of these rules promises to be significant, imposing costs and burdens on the securitization industry which will inevitably be passed on to consumers in the form of a higher cost of credit. In stark contract to the U.S. Proposals, the CSA have chosen not to require minimum risk retention but, in keeping with the general thrust of its proposals, have restricted themselves to merely requiring disclosure as to whether any party to the transaction for whom disclosure has been provided under the prospectus "is retaining a portion of a tranche or tranches, and if so, ... the amount retained for each tranche [and] whether that person or company has directly or indirectly hedged, or taken any other action, that seeks to transfer in whole or in part the credit risk associated with a retained portion."
Although the CSA have not proposed the introduction of Dodd-Frank-style rules, they have asked for comments on certain features of the U.S. Proposals: "We have done so where we think that further feedback and analysis is required to determine (a) whether the proposed requirement will achieve its intended aims and, if so, how to appropriately design the requirement or (b) whether it is appropriate in the Canadian context. In particular, we are seeking comment on the following types of requirements:
- requirements that securitizations be structured in a particular manner, such as requiring that sponsors or other transaction parties retain a minimum tranche or tranches of the securitization (a "skin-in-the-game requirement");
- requirements for due diligence, such as requiring the issuer to review the pool assets;
- requiring or restricting the involvement of particular parties in a securitization, such as imposing independence requirements or restrictions on conflicts of interest; and
- requirements for new disclosure that we think would be a major departure from what is already being provided pursuant to transaction agreements, such as asset-or-loan-level disclosure, provision of a computer waterfall payment program, and requiring sponsors or originators to file reports on fulfilled and unfulfilled repurchase requests across all securitizations."
The introduction of any such requirements in Canada should be strongly resisted. The U.S. Proposals were made in response to specific industry conditions which by and large were not present in Canada. Contrary to what is apparently believed by the CSA (see their assertion that the model is "fundamental to securitized products"), the 'originate-to-distribute' model of securitization which has attracted so much adverse attention in the U.S. was not in fact prevalent in Canada (or, for that matter, in most asset classes in the U.S.), at least not in the manner or to the degree which is said to have caused so much damage. In transactions involving most asset classes, Canadian sponsors (mostly originators) in fact retained a significant amount of "skin-in-the-game" as a result of underwriting and rating agency requirements and industry standards and expectations. The financial crisis was arguably the product of the radical and unregulated application of this model in the RMBS sector alone and, as recognized by the CSA, there was no the subprime housing bubble in Canada. Nor have Canadian securitizations in general suffered anywhere near the level of losses that were experienced in the U.S. U.S. commentators have forewarned of the danger to the U.S. securitization market represented by the cumulative burdens which would be imposed by the implementation of the U.S. Proposals. Such burdens would be even less tolerable in the Canadian market which is much shallower than its U.S. counterpart. If they were to be imposed in Canada, it may prove fatal to both the ABS industry and any positive effect of the industry on the supply of credit, a benefit cited by the CSA itself.
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