Until now, when an issuer proposed to sell mortgage- or asset-backed securities in the public markets, the issuer’s counsel had to rely on an incredible hodgepodge of rulings, no-action letters and other interpretive material in order to know what the securities laws required in the way of disclosure, filings and periodic reporting. All that is changing with the adoption, in mid-December 2004, of final regulations governing asset-backed securities.
These regulations were proposed earlier in 2004 based on careful study and analysis by the SEC staff. Many participants in the asset-backed securities markets took the time to comment on the proposals, and the SEC gave consideration to this input. (Among the commenters was an ABA committee that included a Manatt representative.) The result is a set of regulations that is, on the whole, fairly responsive to the concerns of both issuers and investors, that retains substantive rules of existing practice in most respects, and that provides transitional time periods that should accommodate most industry participants, provided that they are attentive now to the future requirements.
Summary of New Regulations
- Application of New Regulations
The new regulations will apply to securitizations of all types of receivables. Although the term “asset-backed securities” or “ABS” is used throughout the regulations, the term is used in the broad sense that includes mortgage-backeds, as well as securities backed by such things as credit card receivables, auto loans, debt securities, equipment purchase receivables, home equity loans and medical receivables. They also include securities that are backed by pools of leases, such as auto leases and equipment leases.
The new regulations will apply to securitizations of foreign receivables, as well as domestic receivables. Although some market participants were hoping that synthetic securities would be made eligible for Regulation AB and the other new provisions, this was not done. The SEC continues to view synthetic, credit linked, index linked and managed securities as being outside the scope of ABS.
- Things That Stay the Same
The new regulations mostly codify existing practices that were already accepted by the SEC through various rulings and interpretations. These include:
The codification of these rules in one place is a great improvement. Moreover, the SEC’s articulation, in its preamble to the final regulation, of the current practices contains many clarifications of the details of the SEC’s position, even where not changed, and information about the bases upon which those practices are premised, all of which will be quite useful in future applications of the rules.
- Availability of shelf registration and Form S-3 for investment grade securities.
- Required disclosures based on the principle of materiality, not a prescribed set of specifics.
- Disclosures about asset pool’s attributes and credit enhancers’ financial condition, but not about the finances of the sponsoring entity or depositor.
- Scope and detail of disclosure of paydown scenarios.
- Use of computational materials, in addition to the prospectus.
- Filing of monthly distribution reports in lieu of quarterly reports on Form 10-Q.
- Deregistration after one year if purchasers are not numerous.
- Things That Will Change
There are, however, some respects in which the new regulations make substantial changes in the current practices. Here are some of the more significant changes:
Changes in the contents of the prospectus:
New limitations on asset pools:
Other changes in registration process:
Periodic reporting changes:
- Sponsor - More disclosure is required about the sponsor of the transaction, including a description of the sponsor’s securitization program and historical information about other pools of assets of the same type.
- Static Pool Data—Static pool information must be disclosed for the five years preceding the issuance. This can be provided on a website, rather than in the prospectus itself. But either way, it carries liability as if included in the prospectus. Required disclosures include prepayment as well as delinquency and loss information.
- Servicing Functions—There is new required disclosure about the allocation of servicing responsibilities among the parties.
- Servicing Policies—Expanded disclosure is required about servicing policies. These include the charge-off policy used for assets in the pool, and any material changes in the servicer’s servicing policies in the last three years. There is one standard for servicers of between 10% and 20% of the pool; more disclosures for servicers of 20% or more of the pool.
- Originator—Expanded disclosure is required about originators. There is one standard for originators of between 10% and 20% of the pool; more disclosures for originators of 20% or more of the pool.
- Fees—All fees imposed during the life of the deal must be disclosed in a new tabular format.
- Credit Enhancements and Derivatives—Disclosures about credit enhancements and derivatives used as hedges are specified, based on the extent to which they affect cash flow. For credit enhancements, the amounts are measured on the basis of the maximum payout. But significantly (and different from the proposed regulations), for derivatives, the amounts are measured on the basis of the maximum probable exposure.
- Affiliation—Any affiliation between parties to the transaction must be disclosed.
- Delinquency Concentrations—New limitations are added as to the portion of the asset pool that may be contractually delinquent when the transaction begins.
- Leases—For pools of leases, new limitations are added as to the percentage of cash flow that comes from residuals.
- Foreign Securities—Foreign ABS may be registered using Form S-1 or S-3, just as domestic issues are.
- Market-Making Transactions—Prospectus delivery will no longer be required for market-making transactions in ABS. This means that it is not necessary to update the prospectus, or to avoid deregistering, in order to have an active secondary market in a particular issue.
- Computational Materials—Computational materials must be filed electronically, not in paper form.
- Exhibits to Registration Statements—All governing documents, including those between third parties, must be filed with the SEC as exhibits.
- Distribution Reports—New Form 10-D will be used to report on periodic distributions (in place of Form 8-K, which has been used until now for this purpose). It must be filed within 15 days after the end of the period, and must be signed by the depositor or the servicer.
- Signers—Annual reports on Form 10-K and current reports on Form 8-K must also be signed by either the depositor or the servicer.
- SOX Certification—The form of certification under section 302 of Sarbanes-Oxley has been modified, and it, too, will now be signed by the appropriate senior officer of the depositor or servicer.
- Annual Assessment and Attestation—Annual assessment and attestation reports will be required for all parties that participate in any part of the servicing. The details of attestation reports are generally similar to the USAP standards that are familiar in the mortgage servicing context. There are some requirements, however, that go beyond the USAP standards. Moreover, the requirements apply not only to the servicer itself, but to any other party performing functions of collection, allocation, calculation or distribution. This may include trustees, subservicers, and other participants in the process.
- Section 16 Exemption—ABS are entirely exempt from Section 16 reporting and liability.
The final regulations generally afford a minimum of one year’s grace period before the new rules will be applicable to transactions. Specifically, the new rules will be applicable as follows:
- The new regulations are effective for transactions that close after December 31, 2005.
- For offerings under a shelf registration, the new requirements can generally be satisfied in the prospectus supplement for registration statements filed on or before August 31, 2005. But for registration statements filed after that date, amendments to the registration statement itself will be required when the shelf registration is used after December 31, 2005. Thus, the SEC effectively encourages compliance starting September 1, 2005 for shelf registrations whose use is expected to continue after December 31, 2005.
While the timing to effectiveness is generous, issuers will need to commence some steps now in order to be prepared in time. In particular, advance preparation will be significant for compliance in the areas of static pool disclosures and servicing attestation reports.
In the case of static pool disclosures, the new rules are likely to require that pool sponsors revisit data from prior years and reformat the information for disclosure in compliance with the new rules. If possible, disclosure on a pool-by-pool basis is preferred. But if there were not comparable securitization pools in the relevant periods, data can instead be presented for the entire portfolio of similar assets, on a year-by-year basis. In any case, a decision must be made as to how the data will be presented. The data can be made available on a website or in the printed disclosure. If a website is used, it must have specified features, described in the new regulations. Conforming the website will take planning and time.
In the case of servicing attestation reports, compliance with the new rules is likely to require cooperation from parties who may not currently be contractually bound to provide the reports that are now needed. It will take time and discussion, and perhaps expenditure of money, to be in a position to provide the attestation reports that are required. It is therefore wise to start early to determine which parties are providing portions of the servicing functions (as defined by the SEC). It then may be necessary to review the governing agreements to ascertain the extent to which those entities are already required to provide them. Negotiation of additional provisions may be needed. Planning for the process of getting attestation by public accounting firms is something that cannot be started too soon.
Beyond the areas of static pool disclosure and attestation reports, there will be many practices and procedures that will be changed in large and small ways by the new rules. Participants in the securitization market are wise to take advantage of the long implementation period to prepare for these changes.