The ABS Vegas conference bills itself as “largest capital markets conference in the world.” Speaking at that event, a gathering of professionals in the asset-backed securities space, the Securities and Exchange Commission’s Michael Piwowar agreed with that characterization, but quipped that banking regulators—unfortunately, in his view—might be inclined to call it the “largest shadow banking conference in the world.”
“The ABS market serves as a critical source of capital, providing funding for home and automobile loans, credit cards, and many other purposes,” Commissioner Piwowar said. “Yet, as shown during the recent financial crisis, investors may abandon the ABS market if they do not believe they possess sufficient information to evaluate the risks associated with a particular asset-backed security and to price it accordingly.” In particular, the financial crisis revealed that many market participants and regulators were not fully aware of the risks underlying residential mortgage-backed securities.
During the financial crisis, Piwowar served at the White House as a senior economist for the President’s Council of Economic Advisers. “In that role, I personally observed the difficulties in obtaining reliable data about the quality and performance of underlying RMBS assets,” he said. “This lack of transparency also contributed to the overreliance on credit ratings by market participants and regulators.”
Since the 2008, especially with passage of the Dodd-Frank Act, the SEC has undertaken several rulemakings intended to improve the regulatory framework governing ABS transactions. In 2011, it adopted rules requiring ABS issuers to disclose the history of the requests they received and repurchases made by them related to their outstanding asset-backed securities. The Commission also adopted rules requiring ABS issuers to conduct a review of the assets underlying those securities and make disclosures about those reviews. In September 2014, the SEC adopted amendments to revise Regulation AB and other rules governing the offering process, disclosure, and reporting for asset-backed securities. Beyond the SEC, the Financial Industry Regulatory Authority implemented changes to its Trade Reporting and Compliance Engine (TRACE) to provide the public with post-trade price information for transactions involving asset-backed securities.
There was also the adoption of a six-agency joint rule requiring mandatory risk retention by the SEC, the Office of the Comptroller of the Currency, the Federal Reserve Board of Governors, the Federal Deposit Insurance Corporation, the Department of Housing and Urban Development, and the Federal Housing Finance Agency.
“Unfortunately, the majority of SEC commissioners and the prudential bureaucrats adopted the rules over my objections,” Piwowar, who voted against the credit risk retention rules, said. Those rules require a securitizer to retain a minimum 5 percent credit risk of any securitization transaction and generally prohibit the sponsor from hedging its retained interest. He was “particularly dismayed by the ‘one-size-fits-all’ approach taken by the regulators to create a flat 5 percent risk retention requirement for all asset classes, except for securitizations involving so-called ‘qualified residential mortgages’ for which the risk retention level is zero,” calling the rule a series of “arbitrary choices.”
“Residential mortgages, commercial mortgages, credit card receivables, and automobile loans each have distinct and different attributes associated with their underlying borrowers,” Piwowar said. “Rather than carefully examining these attributes to determine an optimal credit risk retention rate for each asset class, prudential regulators in Washington, D.C., took the easy way out—they simply set it at the maximum statutory rate and ignored the authorization from Congress to create lower risk retention requirements or use alternative methods to align interests.” Bureaucratic self-preservation, he said, “might explain the decision to adopt as broad of an exemption for QRMs as possible, so as to minimize any political fallout from the real estate and housing industries.”
What does the future hold for asset-backed securities? The SEC needs to evaluate the cumulative impact of all of these new rules on the securitization markets, Piwowar said, noting that the amount of securitizations in registered public offerings has declined between 2014 and 2015. In 2015, approximately $155 billion was raised in registered offerings, a $22 billion decrease from the prior year.
“We must appropriately regulate securitization offerings, including rules that adequately align the incentives of investors and sponsors,” he said. “However, we must keep in mind that unnecessary or inappropriate regulation of securitizations may lead to less availability of capital, increased borrowing rates, and a more limited supply of credit. These effects are likely to be passed on to borrowers, either in terms of increased borrowing costs or loss of access to credit, and thus will cut directly against the benefits of securitization.”
Piwowar is “concerned that the relative costs have made ABS issuances in the private markets significantly more attractive than registered ABS offerings in the public markets” and “skeptical that the solution offered by some in Washington is to increase the regulatory costs associated with private offerings.”
The full speech, including Piwowar’s thoughts on credit rating agencies and European securitizations, can be found here.