The Securities and Exchange Commission today adopted revisions to rules governing the disclosure, reporting, and offering process for asset-backed securities (ABS) to enhance transparency, better protect investors, and facilitate capital formation in the securitization market.
The new rules, among other things, require loan-level disclosure for certain assets, such as residential and commercial mortgages and automobile loans. The rules also provide more time for investors to review and consider a securitization offering, revise the eligibility criteria for using an expedited offering process known as “shelf offerings,” and make important revisions to reporting requirements.
“These are strong reforms to protect America’s investors by enhancing the disclosure requirements for asset-backed securities and by making it easier for investors to review and access the information they need to make informed investment decisions,” said SEC Chair Mary Jo White. “Unlike during the financial crisis, investors will now be able to independently conduct due diligence to better assess the credit risk of asset-backed securities.”
ABS are created by buying and bundling loans, such as residential and commercial mortgage loans, and auto loans and leases, and creating securities backed by those assets for sale to investors. A bundle of loans is often divided into separate securities with varying levels of risk and returns. Payments made by the borrowers on the underlying loans are passed on to investors in the ABS.
ABS holders suffered significant losses during the 2008 financial crisis. The crisis revealed that many investors in the securitization market were not fully aware of the risks underlying the securitized assets and over-relied on ratings assigned by credit rating agencies, which in many cases did not appropriately evaluate the credit risk of the securities. The crisis also exposed a lack of transparency and oversight by the principal officers in the securitization transactions. The revised rules are designed to address these problems and to enhance investor protection.
The revised rules become effective 60 days after publication in the Federal Register. Issuers must comply with new rules, forms, and disclosures other than the asset-level disclosure requirements no later than one year after the rules are published in the Federal Register. Offerings of ABS backed by residential and commercial mortgages, auto loans, auto leases, and debt securities (including resecuritizations) must comply with the asset-level disclosure requirements no later than two years after the rules are published in the Federal Register.
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Asset-backed securities are created by buying and bundling loans – such as residential mortgage loans, commercial mortgage loans or auto loans and leases – and creating securities backed by those assets that are then sold to investors.
Often a bundle of loans is divided into separate securities with different levels of risk and returns. Payments on the loans are distributed to the holders of the lower-risk, lower-interest securities first, and then to the holders of the higher-risk securities. Most public offerings of ABS are conducted through expedited SEC procedures known as “shelf offerings.”
During the financial crisis, ABS holders suffered significant losses and areas of the securitization market–particularly the non-governmental mortgage-backed securities market–have been relatively dormant ever since. The crisis revealed that many investors were not fully aware of the risk in the underlying mortgages within the pools of securitized assets and unduly relied on credit ratings assigned by rating agencies, and in many cases rating agencies failed to accurately evaluate and rate the securitization structures. Additionally, the crisis brought to light a lack of transparency in the securitized pools, a lack of oversight by senior management of the issuers, insufficient enforcement mechanisms related to representations and warranties made in the underlying contracts, and inadequate time for investors to make informed investment decisions.
In April 2010, the SEC proposed rules to revise the offering process, disclosure and reporting requirements for ABS. Subsequent to that proposal, the Dodd-Frank Act was signed into law and addressed some of the same ABS concerns. In light of the Dodd-Frank Act and comments received from the public in response to the 2010 proposal, the SEC re-proposed some of the April 2010 proposals in July 2011. In February 2014, the Commission re-opened the comment period on the proposals to permit interested persons to comment on an approach for the dissemination of loan-level data. The proposals sought to address the concerns highlighted by the financial crisis by, among other things, requiring additional disclosure, including the filing of tagged computer-readable, standardized loan-level information; revising the ABS shelf-eligibility criteria by replacing the investment grade ratings requirement with alternative criteria; and making other revisions to the offering and reporting requirements for ABS.
The Final Rules:
Requiring Certain Asset Classes to Provide Asset-Level Information in a Standardized, Tagged Data Format
To provide increased transparency about the underlying assets of a securitization and to implement Section 942(b) of the Dodd-Frank Act, the final rules require issuers to provide standardized asset-level information for ABS backed by residential mortgages, commercial mortgages, auto loans, auto leases, and debt securities (including resecuritizations). The rules require that the asset-level information be provided in a standardized, tagged data format called eXtensible Mark-up Language (XML), which allows investors to more easily analyze the data. The rules also standardize the disclosure of the information by defining each data point and delineating the scope of the information required. Although specific data requirements vary by asset class, the new asset-level disclosures generally will include information about:
- Credit quality of obligors.
- Collateral related to each asset.
- Cash flows related to a particular asset, such as the terms, expected payment amounts, and whether and how payment terms change over time.
Asset-level information will be required in the offering prospectus and in ongoing reports. Providing investors with access to standardized, comprehensive asset-level information that offers a more complete picture of the composition and characteristics of the pool assets and their performance allows investors to better understand, analyze and track the performance of ABS. The Commission continues to consider the best approach for requiring information about underlying assets for the remaining asset classes covered by the 2010 proposal.
Providing Investors With More Time to Consider Transaction-Specific Information
The final rules require ABS issuers using a shelf registration statement to file a preliminary prospectus containing transaction-specific information at least three business days in advance of the first sale of securities in the offering. This requirement gives investors additional time to analyze the specific structure, assets, and contractual rights for an ABS transaction.
Removing Investment Grade Ratings for ABS Shelf Eligibility
The final rules revise the eligibility criteria for shelf offerings of ABS. The new proposed transaction requirements for ABS shelf eligibility replace the prior investment grade requirement and require:
- The chief executive officer of the depositor to provide a certification at the time of each offering from a shelf registration statement about the disclosure contained in the prospectus and the structure of the securitization.
- A provision in the transaction agreement for the review of the assets for compliance with the representations and warranties upon the occurrence of certain trigger events.
- A dispute resolution provision in the underlying transaction documents.
- Disclosure of investors’ requests to communicate with other investors.
The final rules also require other changes to the procedures and forms related to shelf offerings, including:
- Permitting a pay-as-you-go registration fee alternative, allowing ABS issuers to pay registration fees at the time of filing the preliminary prospectus, as opposed to paying all registration fees upfront at the time of filing the registration statement.
- Creating new Forms SF-1 and SF-3 for ABS issuers to replace current Forms S-1 and S-3 in order to distinguish ABS filers from corporate filers and tailor requirements for ABS offerings.
- Revising the current practice of providing a base prospectus and prospectus supplement for ABS issuers and instead requiring that a single prospectus be filed for each takedown (however, it is permissible to highlight material changes from the preliminary prospectus in a separate supplement to the preliminary prospectus 48 hours prior to first sale).
Amendments to Prospectus Disclosure Requirements
The Commission approved amendments to the prospectus disclosure requirements for ABS, which include:
- Expanded disclosure about transaction parties, including disclosure about a sponsor’s retained economic interest in an ABS transaction and financial information about parties obligated to repurchase assets.
- A description of the provisions in the transaction agreements about modification of the terms of the underlying assets.
- Filing of the transaction documents by the date of the final prospectus, which is a clarification of the current rules.
Revisions to Regulation AB
The Commission also approved other revisions to Regulation AB, including:
- Standardization of certain static pool disclosure.
- Revisions to the Regulation AB definition of an “asset-backed security.”
- Specifying, in addition to the asset-level requirements, the disclosure that must be provided on an aggregate basis relating to the type and amount of assets that do not meet the underwriting criteria that is described in the prospectus.
- Several changes to Forms 10-D, 10-K, and 8-K, including requiring explanatory disclosure in the Form 10-K about identified material instances of noncompliance with existing Regulation AB servicing criteria.