The US Securities and Exchange Commission altered new rules for asset-backed securities to ease privacy concerns, but investors want more disclosure.

Final rules for asset-backed securities (ABS) were approved by the US Securities and Exchange Commission (SEC) with a unanimous vote at the end of August. While issuers were satisfied by a dilution of requirements compared with earlier drafts, investors and some of the commissioners themselves are still hoping that the SEC will ultimately go further.

The central purpose of these rules, commonly known as Regulation ABII, is to improve the quality of disclosures made available to investors about the underlying assets in a securitisation pool. This is intended to prevent any repeat of the subprime crisis, where residential mortgage-backed securities (RMBS) performed significantly worse than expected by most investors, with many underlying mortgages bedevilled by fraudulent paperwork provided by the borrowers.

The rules require issuers and sponsors of ABS deals to provide loan-by-loan data for all public registered issues of securities backed by mortgages or auto loans. The SEC will consider at a later date whether to extend this requirement to other categories of ABS. These changes are particularly significant for auto loan ABS, where data provision was previously sparser than for RMBS.

“Until now, for auto loan ABS deals we have been given weighted averages, or at best, stratifications for each metric rather than loan-by-loan data. That makes it impossible to tell how many borrowers are weak on more than one metric such as low credit scores, longer loan term, and high loan-to-value ratio,” says Michael Canter, director of securitised products at $480bn US asset manager AllianceBernstein.

Unregistered exemption

One of the central concerns among the issuer community was that greater disclosure might breach privacy rules for retail borrowers, as data could be detailed enough to allow users to identify individual borrowers. SEC staff produced a study that suggested the revised Regulation ABII reduces that risk to about 20%, representing a compromise between privacy rights and the transparency needs of investors.

Most importantly, the SEC also sought reassurance from the Consumer Financial Protection Bureau (CFPB), which is responsible for administering the Fair Credit Reporting Act (FCRA). In a letter to SEC chair Mary Jo White in August 2014, David Silberman of the CFPB confirmed that the disclosures required from issuers under ABS rules would not cause an issuer to be classified as a consumer credit reporting agency under the FCRA. This laid to rest the concern that disclosures on a registered deal would breach customer privacy rights, but it still leaves unanswered questions.

“The CFPB’s letter provides comfort for issuers, but if issuers provide more information than specified in Regulation ABII, as some investors may ask them to, then they would not be covered by the CFPB’s letter, so there is an interesting tension,” says Jerry Marlatt, a partner in the capital markets practice of law firm Morrison & Foerster.

Investors may well seek more information from issuers than is required by the SEC, especially in view of a major exemption added into the final rules. The SEC decided that unregistered transactions (issued under rule 144a of the Securities Act) would not be subject to the new disclosure requirements. In the first draft, the SEC had proposed that issuers and sponsors must make equivalent disclosure on unregistered transactions if requested by investors.

“This was something that the issuer and sponsor community had strongly opposed. In their view, there are sometimes good reasons for unregistered transactions, for instance the underlying obligors in a commercial mortgage-backed security might not want to disclose information about commercially confidential arrangements,” says Christopher Killian, managing director of securitisation at the Securities Industry and Financial Markets Association.

An interim measure

SEC commissioner Luis Aguilar, however, made clear in his statement before the vote that he regards this exemption as an interim measure only. He said it was “crucial” that the disclosure requirements should be extended to 144a offerings, and to other ABS classes such as credit cards, student loans and vehicle leasing. This is a stance shared by many investors, including Mr Canter.

“If the data is available and there is no legal impediment to providing it, then investors deserve to see it – they are taking the risk by making the investment, after all,” he says.

What remains to be seen is whether, as deals compete for investor attention, there will be pressure to issue in a registered format and provide investors with the additional disclosure. The answer may partly depend on deal size and the priority of sponsors.

“The market for registered deals is more liquid and has a broader investor base. Some investors restrict their fund managers from investing in private deals, although managers could request a change to their mandate to address this,” says Mr Marlatt.

The deeper market for registered deals should appeal to frequent issuers. But Mr Canter is not entirely optimistic. “I would like to think that issuers would have to pay up for unregistered transactions with less disclosure, but history shows there tends to be a marginal buyer who is willing to take ABS paper even without the additional data, especially in a low interest rate environment,” he says.

Unfinished business

In the RMBS market, the choice between registered or unregistered deals is likely to be a secondary consideration. The most pressing problem is the future of government-supported entities Fannie Mae and Freddie Mac, and the need to wean the market off dependence on their mortgage guarantees.

Federally insured mortgages are not included in the new Regulation ABII, and yet SEC commissioner Daniel Gallagher pointed out at the hearing that they constitute 90% of outstanding US residential mortgages. Both the Republican commissioners on the SEC – Mr Gallagher and Michael Piwowar – expressed the view that ABS reform would be incomplete without settling the future role of Fannie and Freddie.

“While I still have significant concerns about the continued domination of the residential mortgage-backed securities market by Fannie Mae and Freddie Mac – and the potential for more taxpayer-funded bailouts – that will be a challenge to address on another day,” Mr Piwowar told the hearing.

Mr Marlatt sees something of a vicious cycle for RMBS at present. To revive the private market, the role of Fannie and Freddie needs to be scaled back. But policy-makers will be anxious about such a pull-back if the private market is insufficient to take their place.

“At the moment, the market for private RMBS deals without a guarantee from Fannie Mae or Freddie Mac is very small, so it is difficult to know if people will be willing to invest in the technology and staff to file the information required by the SEC for registered deals and keep it up to date,” says Mr Marlatt.

Continued uncertainty

There are a number of other questions that will need to be answered before the rules enter force in two years’ time. One of the most important challenges faces foreign ABS issuers tapping the US market, which is the largest in the world. Foreign industry bodies such as the Association for Financial Markets in Europe had expressed concern about the effect of the ABS rules on non-US issuers launching transactions into the US market. Privacy laws in jurisdictions such as the UK are different from those in the US, and may not be compatible with Regulation ABII.

“The industry in Europe had sought some form of mutual recognition. The SEC declined to provide that, but the exemption for 144a offerings should help, because that covers the majority of cross-border issuance,” says Mr Killian.

Additionally, Regulation ABII will interact with new rules on credit ratings agencies that were approved by the SEC on the same day. Most of those focus on the internal governance of the ratings agencies themselves. One late addition to the new ratings agency rules, however, was a requirement under rule 193 that issuers disclose details of any third-party due diligence on the underlying assets in a securitisation. This would also entail liability for the firm conducting due diligence. If the third party does not provide consent, then the issuer remains liable instead.

“There will be technical questions around what this means and how it works, but it is not a totally unexpected rule-making because it was mentioned in section 945 of the Dodd-Frank Act,” says Mr Killian.

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