The Investor Protection and Securities Reform Act of 2010 (the Act), adopted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, includes provisions that will affect asset-backed securities. The changes generally require:

  • Risk retention by securitizers
  • Disclosure and reporting for asset-backed securities

Risk Retention

Definition of Asset-Backed Security. The Securities Exchange Act of 1934 is amended to define the term "asset-backed security" to mean any fixed-income or other security collateralized by any type of self-liquidating financial asset that allows the holder of the security to receive payments that depend primarily on cash flow from the asset. Specific examples are provided, including collateralized mortgage obligations, collateralized debt obligations, and collateralized bond obligations.

Risk Retention Regulations. The federal banking agencies and Securities and Exchange Commission are directed to jointly adopt regulations to require any securitizer to retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers or sells to a third party. The term "securitizer" is defined to mean an issuer of an asset-backed security, or a person who organizes and initiates an asset-backed security transaction by selling or transferring assets. The regulations are to be adopted not later than 270 days after the date of the Act.

5 Percent Risk Retention. The Act prescribes specific standards for the regulations to be adopted by the federal banking agencies and SEC. As a general rule, a securitizer will be required to retain not less than 5 percent of the credit risk for any asset transferred in connection with a securitization. Securitizers will not be permitted to hedge or otherwise transfer the retained risk. The regulations may allow for retention of less than 5 percent of the credit risk for certain assets, such as:

  • Qualified residential mortgages
  • Assets that meet underwriting standards established by the federal banking agencies

Regulatory Standards. The regulations adopted by the federal banking agencies and SEC must specify:

  • The permissible forms of risk retention
  • The minimum duration of the risk retention
  • The particular types, forms, and amounts of risk retention for commercial mortgages

Total or Partial Exemptions for Government Securities. The regulations will provide a total or partial exemption for the securitization of an asset issued or guaranteed by the United States or an agency of the United States. However, for these purposes, the Federal National Mortgage Association and Federal Home Loan Mortgage Corporation are not considered agencies of the United States. A total or partial exemption will also be provided for any asset-backed security that is issued or guaranteed by any state or by any political subdivision of a state or territory, by a public instrumentality of a state or territory, or a qualified scholarship funding corporation.

Asset Originators. The regulations will address the allocation of risk retention between a securitizer and an asset originator in the case of a securitizer that purchases assets from an originator. The percentage of risk retention obligations required of a securitizer will be reduced by the percentage of risk retention obligations required of the originator.

Underwriting Standards. The regulations will establish asset classes with separate rules for securitizers of different classes of assets. Underwriting standards will be established by the federal banking agency that specify the terms, conditions, and characteristics of a loan within each asset class that indicate a low credit risk with respect to the loan.

Qualified Residential Mortgages. Qualified residential mortgages are to be exempt from risk retention requirements of the legislation. Regulations are to be adopted to define the term "qualified residential mortgage," taking into consideration underwriting and product features indicating a lower risk of default.

Effective Date of Regulations. The regulations are to become effective:

  • With respect to securitizers and originators of asset-backed securities backed by residential mortgages, one year after the date on which final rules are published in the Federal Register
  • With respect to securitizers and originators of all other classes of asset-backed securities, two years after the date on which the final rules are published in the Federal Register

Disclosure and Reporting

Suspension of Duty to File. The SEC is directed to adopt regulations to provide special rules for the suspension or termination of the duty to file periodic reports with the SEC under Section 15(d) of the Securities Exchange Act with respect to asset-backed securities.

Disclosure Requirements. The SEC is directed to adopt regulations requiring each issuer of an asset-backed security to disclose information regarding the assets backing that security. The regulations will set standards for the format of the data to be provided by issuers, and will require issuers of asset-backed securities, at a minimum, to disclose asset level or loan level data, if such data is necessary for investors to independently perform due diligence.

Representations and Warranties in Asset-Backed Offerings.  Not later than 180 days after the date of the Act, the SEC is directed to prescribe regulations on the use of representations and warranties for asset-backed securities that:

  • Require each rating agency to include in any report accompanying a credit rating a description of the representations, warranties, and enforcement mechanisms available to investors, and how they differ from representations, warranties, and enforcement mechanisms in issuances of similar securities
  • Require securitizers to disclosure any fulfilled and unfulfilled repurchase requests made to the issuer so that investors may identify asset originators with clear underwriting deficiencies

Due Diligence Analysis. The SEC is directed to issue rules relating to the registration statement to be filed by an issuer of asset-backed securities that require the issuer to perform a review of the assets underlying the asset-backed security and disclose the nature of the review.

Ballard Spahr's Financial Institutions Reform Task Force will continue to monitor these and other portions of the Dodd-Frank Act, and its members are available to assist clients as they prepare to address the new requirements. Please feel free to contact Patrick R. Gillard at 215.864.8536 or gillard@ballardspahr.com; Thomas A. Hauser at 410.528.5691 or hauser@ballardspahr.com; or Jere G. Thompson at 215.864.8501 or thompson@ballardspahr.com.

Return to the Dodd-Frank Act Brings Sweeping Regulatory Changes alert.


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