On Wednesday, April 7, 2010, the U.S. Securities and Exchange Commission (SEC) announced proposed revisions to Regulation AB and other rules, including Rule 144A and Regulation D, regarding the offering process, disclosure and reporting requirements for asset-backed securities (the Proposed Rule).

The Proposed Rule is intended to restore investor confidence in the U.S. securitization market and reduce reliance upon credit ratings by providing investors with timely and sufficient information to better assess the risks associated with their investment.

Accordingly, the SEC proposes to make significant revisions on three major fronts, the highlights of which are briefly summarized in turn below:

1. Securities Act Registration

The SEC is proposing a number of changes to the Securities Act registration process for asset-backed securities on Form S-1 and Form S-3. These changes include the following:

  • ABS issuances on Forms S-1 and S-3 will be replaced by new Forms SF-1 and SF-3, respectively, each of which will incorporate some new and revised line items.
  • Each registration statement must correspond to one depositor securitizing only one asset class. For example, the form of shelf registration statement filed with the SEC cannot contemplate multiple depositors, nor can it contemplate the ability to issue different types of ABS. The Proposed Rule would require issuers to use a single prospectus for each issuance based on that form of registration statement. Issuers will no longer be able to use a genericized base prospectus that contemplates differing transactions. A depositor is currently defined as the entity that receives and transfers the pool assets to the issuing entity.
  • The issuer must file a preliminary prospectus with transaction-specific information at least five business days before the first sale.
  • Shelf registration eligibility will no longer be subject to investment grade credit ratings on the ABS. Instead, the SEC proposes, among other things, the following four requirements to ensure asset quality:
  1. Risk retention: For a fixed pool of assets, the sponsor (or an affiliate) will be required to retain a minimum 5% interest in each tranche sold to investors, net of the sponsor's hedging. For a revolving pool of assets, the sponsor (or an affiliate) will be required to take a minimum 5% interest in the originator's interest in the pool of assets, net of the sponsor's hedging. A sponsor is currently defined as the entity that organizes and initiates an ABS transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity. Often times, the sponsor and the depositor will be the same entity.
  2. Third party review of repurchase demands: If the obligated party (i.e., the representing and warranty party) declines to repurchase upon an alleged breach of an asset representation or warranty, the obligated party will be required to furnish to the trustee a third party opinion confirming that the asset did not violate such representation or warranty.
  3. CEO certification on cash flows: The CEO of the depositor must certify that the assets have the characteristics that provide a reasonable basis to believe they will produce the cash flows necessary to make the payments described in the prospectus.
  4. Exchange Act reporting: The Proposed Rule would eliminate the current ability of issuers to suspend their ongoing obligation to file Exchange Act reports (e.g., Form 8-K). This ongoing reporting obligation would apply as long as non-affiliates of the depositor hold any of the issuer's securities that were sold in registered transactions.
  • The securities issued by master trust issuers backed by non-revolving assets (such as master trust structures backed by mortgages originated in the UK) will no longer qualify as "asset-backed securities". As a result, shelf registration will no longer be available to such issuers, and the disclosure requirements of Regulation AB would not apply. Such issuers would still be able to register transactions on Form S-1 and would remain subject to the general disclosure standard of materiality.

2. Disclosure Requirements Under Regulation AB

For registered offerings subject to Regulation AB, the SEC proposes to significantly enhance asset-level disclosure.

  • Depending on the asset class, the issuer must provide specified data relating to the terms of the asset, obligor characteristics and underwriting of the asset.
  • The data must be provided in a machine-readable, standardized format (XML) that enables the investor to analyze such data.
  • Issuers must provide asset-level data (or for credit card ABS, grouped account data) when new assets are added to the pool initially and on an ongoing basis.
  • The issuer must file with the SEC a "waterfall computer program" that will enable investors to input information from the asset data file (as required above) in order to analyze the cash flows on the asset pool.
  • Current disclosure requirements will be refined as follows:
  1. Aggregated and asset-level data relating to the type and amount of assets that do not meet the underwriting criteria will need to be disclosed.
  2. Sponsors (and in some cases, originators) must disclose the amount of its publicly securitized assets that have been the subject of a demand to repurchase or replace in the last three years.
  3. Additional information regarding originators and sponsors will be required.
  4. Further description about the static pool information, such as the methodology used in calculating pool performance, will need to be disclosed.
  5. A Form 8-K filing will be required if there has been a 1% or more change in any material pool characteristic (reduced from 5%).

3. Privately-Issued ABS

Currently, the registration safe harbors of Rule 144A and Regulation D under the Securities Act do not impose specific disclosure requirements. In an effort to ensure that even sophisticated investors in the private market have timely and sufficient information, the Proposed Rule would require the following for any offers, sales or resales of "structured finance products" in reliance on Rule 144A or Regulation D.

  • Issuers must covenant to provide to investors, upon request, the information that would be required if the transaction were registered with the SEC (i.e., full compliance with the disclosure requirements of Regulation AB).
  • Issuers must file a public notice of the securities that are eligible for resale pursuant to Rule 144A.
  • New Rule 192 would enable the SEC to bring an enforcement action against any issuer that fails to provide the information required under the Proposed Rule.

In order to capture the wide range of securitization products sold in the private market, "structured finance product" is more broadly defined than Regulation AB's definition of "asset-backed security". "Structured finance product" includes synthetic ABS, CDOs and any product that is commonly known as an asset-backed security or a structured finance product.

The public will have an opportunity to comment on the Proposed Rule for 90 days from the date the Proposed Rule is published in the Federal Register, which is expected to occur within 5-10 business days.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.