Four years in the making, the Securities and Exchange Commission on Wednesday adopted revised rules governing the disclosure, reporting, and offering process for asset-backed securities. In a separate, but related, action it also finalized several new requirements for credit rating agencies registered with the SEC as nationally recognized statistical rating organizations.
The new asset-backed securities rules require loan-level disclosure for certain assets, such as residential and commercial mortgages and automobile loans. The rules also provide more time for investors to review and consider a securitization offering, alter the eligibility criteria for using an expedited offering process known as “shelf offerings,” and make important revisions to reporting requirements.
Asset-backed securities (ABS) are created by buying and bundling loans to create investment products backed by those assets for sale to investors. Loan bundles are typically 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.
ABS holders suffered significant losses during the 2008 financial crisis and it was revealed that many investors in the securitization market were not fully aware of the risks underlying the securitized assets and over-relied on ratings assigned by credit rating agencies which, critics say, did not appropriately evaluate the credit risk.
The SEC first proposed changes to the regulations that govern ABS, known as Regulation AB, in 2010. The Dodd-Frank Act, signed later that year, included additional demands for asset-level disclosures. The SEC combined the proposals into what became known as Regulation AB II, but the proposal lingered while stakeholders haggled over how issuers could provide more details on underlying assets without revealing sensitive consumer information.
The new rules require issuers to provide standardized asset-level information for ABS backed by residential mortgages, commercial mortgages, auto loans, auto leases, and debt securities (including resecuritizations). Asset-level information must be provided in a standardized, tagged data format so that investors can more readily analyze the data. Although specific data requirements vary by asset class, the new asset-level disclosures generally will include information about: the credit quality of obligors; the collateral related to each asset; and cash flows related to a particular asset, including terms, expected payment amounts, and whether and how payment terms change over time.
The final rules also require ABS issuers using a shelf registration statement to file a preliminary prospectus containing transaction-specific information at least three business days in advance of the first sale of securities in the offering.
A fact sheet detailing all the new requirements, and the implementation timeline, can be found here. The new rules do not include risk-retention requirements for issuers, a controversial Dodd-Frank Act requirement that will involve multiple regulators.
Speaking before the vote, SEC Commissioner Luis Aguilar referred to “the magnitude of the crisis in the ABS market.” At the end of 2007, the market consisted of more than $7 trillion of mortgage-backed securities and nearly $2.5 trillion of other outstanding ABS. In 2008, private-label residential mortgage-backed security issuance dropped to $9 billion.
Aguilar said he wants to see the SEC broaden the scope of the new rules in the near future to require issuers to provide asset-level information across more asset classes, including equipment loans and leases, student loans, and inventory financings.
Commissioner Michael S. Piwowar supported the rule. “Unlike a number of provisions in the Dodd-Frank Act that were drafted by politically-connected special interest groups well before the recent global financial crisis – such as conflict minerals, resource extraction, mine safety, and median pay ratio – reforms tackling the overreliance on credit ratings and the opacity of asset-backed securities directly address two interrelated areas that actually contributed to the crisis,” he said.
“Interactive data will be indispensable, for instance, when a single automotive securitization contains in excess of 50,000 individual car loans or leases,” Piwowar added. “The ability to use interactive data will also permit investors to lessen their reliance on credit ratings.”
The new requirements for credit rating agencies address internal controls, conflicts of interest, disclosure of credit rating performance statistics, procedures to protect the integrity and transparency of rating methodologies, disclosures to promote the transparency of credit ratings, and standards for training, experience, and competence of credit analysts. The requirements also require an annual certification by the CEO as to the effectiveness of internal controls and additional certifications to accompany credit ratings attesting that the rating was not influenced by other business activities. A fact sheet detailing the new rules can be found here.
“Instead of acting as gatekeepers and protecting investors, as they were supposed to do, the rating agencies allowed issuers of structured products to prey on investors,” Aguilar said.
Piwowar, however, voted against the final rule. Requiring the CEO of each NRSRO annually sign a statement regarding the effectiveness of the entity’s internal control structure “will accomplish nothing other than to create potential personal liability” and “line the pocketbooks of plaintiffs’ lawyers than… make credit ratings more informative and useful or to protect the investors that utilize them,” he said. Commisioner Daniel Gallagher also dissented.