At an open meeting this morning, the SEC voted to propose a comprehensive revision to Reg AB, which covers the offering process, disclosure and reporting for asset-backed securities, such as securitized pools of sub-prime mortgages, as well as equipment leases, student loans and credit card receivables, among other things. The 667-page release has already been posted to the SEC's website. The proposal is of general interest because, as you know, problems in the asset-securitization markets were a major contributing factor, to put it euphemistically, in the financial crisis. The release recites that, at the end of 2007, there were outstanding more than $7 trillion of mortgage-backed securities alone, and many of these mortgage-backed securities were then used to collateralize other debt obligations, such as collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs), types of asset-backed securities that are sold in private placements. (And then many of these CDOs were used to collateralize other securities and so on and on).

The new proposal recognizes that, under the existing rules, investors in the securitization market "did not have the necessary tools to be able to fully understand the risk underlying those securities and did not value those securities properly or accurately." (Some of you might remember that it wasn't until 2004 that there were any regulations at all that were specific to asset-backed securities). In addition, some of the current regulations are tied to ratings for asset-backed securities provided by the ratings agencies, the failings (another euphemism) of which have been well-publicized. The SEC also notes that market participants have expressed a desire for more time to analyze the securities and expanded disclosure relating to the assets underlying securitizations and have complained about the weakness of enforcement mechanisms regarding reps and warranties. The lack of visibility (and transparency) is even more pronounced in the private markets.

The proposal includes a number of changes to the offering process, disclosure and reporting for asset-backed securities, generally consistent with global initiatives that seek to improve practices in the securitization market. Interestingly, while the 2004 rules were more principles-based, they would now be replaced by rules that are prescriptive. The proposed revisions include the following:

  • revisions to the shelf offering process and criteria and prospectus delivery requirements;
  • Securities Act and Exchange Act disclosure requirements, including new requirements to disclose standardized asset-level information or grouped asset data and a computer program that gives effect to the cash flow provisions of the transaction agreement (often referred to as the "waterfall"); and 
  • changes to the Securities Act safe harbors for exempt offerings and exempt resales for asset-backed securities.

For example, in connection with registrations, shelf eligibility would be based, instead of on ratings by credit rating agencies, on items such as these:

  • A certification by the CEO that the assets in the pool have characteristics that provide a reasonable basis to believe that they will produce cash flows to service any payments due on the securities as described in the prospectus; and
  • Retention by the sponsor of a minimum of 5% of each tranche of the securitization, net of the sponsor's hedging, on the theory that securitizations with sponsors that have continuing risk exposure would likely be higher quality than those without.

With regard to disclosure, for each loan or asset in the asset pool, the rules would require disclosure of specified data relating to the terms of the asset, obligor characteristics and underwriting of the asset, including filing of a "waterfall" computer program of the contractual cash flow provisions of the securities and aggregated, as well as loan-level data relating to the type and amount of assets that do not meet the underwriting criteria that is specified in the prospectus. (I know all the disclosure mavens, mired in the minutiae of information required in proxy statements, are wondering how this information had ever not been required to be disclosed in the first place).

With regard to the private markets, the proposal would require enhanced disclosure by asset-backed issuers seeking to take advantage of the safe harbor. To provide additional transparency, the SEC is proposing amendments to Rule 144A to require a structured finance product issuer to file a public notice on EDGAR of the initial placement of structured finance products that are eligible for resale under Rule 144A.

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