As part of its ongoing efforts to better align the interests of participants in the RMBS market and address the issue of risk retention, the Asset Securitization Forum (ASF) has come out with some guidelines relating to the repurchase of RMBS.

The trade group is recommending that pooling and servicing agreements should include a provision for an independent reviewer as an enforcement mechanism for the representations and warranties related to loans. This reviewer should have adequate power to review the loans, including being given access to the loan files, upon the occurrence of a "review event," such as delinquency levels above a certain threshold.

The ASF repurchase proposals also recommended that if the parties involved - such as issuers, investors and originators - are not satisfied with the outcome of the third-party review, they could go in for a dispute resolution process that will be binding.

Tom Deutsch, ASF's executive director, said that these RMBS repurchase proposals are part of its ongoing Project RESTART effort and make up the enforcement mechanism for the model representations and warranties that the ASF had come up with in 2009.

He expects that the use of this enforcement mechanism will mean that "enforcement happens quicker, faster, stronger than previous types of transactions and reduce litigation costs on deals going forward."

The ASF believes that its RMBS repurchase principles will serve better at aligning the interests of market participants than the Dodd-Frank Act's proposals for risk retention, aimed at creating "skin in the game" for RMBS issuers.

"We think that the risk retention can be best served by better reps and warranties, and better repurchase provisions for those reps and warranties, rather than items like the premium capture cash reserve account that seem to go well beyond the mandate of Dodd-Frank," Deutsch noted.

Jordan Schwartz, a partner with Cadwalader, Wickersham & Taft, also believes that the Dodd-Frank proposals are an excessive approach to risk retention in terms of, for instance, the provision calling for issuers to retain risk in the form of a vertical slice of the issuance, as well as the provision for the premium capture cash reserve account.

"The premium capture reserve account was a creation of the regulators that implemented the Dodd-Frank provision, and not of the statute itself," according to Schwartz. "The statute itself simply requires a credit risk retention in an amount of not less than 5%."

Schwartz believes that strong reps and warranties, backed by good governance making for effective remedies to enforce them, are sufficient to ensure that the interests of various parties to a securitization are aligned without the need for credit risk retention.

"However, it seems that ship has sailed and some form of credit risk retention is inevitable, with certain exceptions set forth in the regulations for qualified residential mortgages ," he acknowledged. "In that way, strong reps and warranties and enforcement mechanisms can be considered a complementary feature of securitization to risk retention."

The current industry practice is that the parties to a transaction themselves determine if there is any breach of reps and warranties. While this worked well in the early days of securitization, when participants could rely on an honor system and the industry did not have many fly-by-night participants, there is a need for a more rigid enforcement mechanism now given the happenings during the market meltdown.

As for the question of who will serve as an independent third-party reviewer of transactions, it could be any third-party that does not have any kind of interest in the deal to be reviewed. Firms already undertaking collateral risk management, or due diligence firms, could be a good fit to take on this role. There is also scope for new firms to be set up to satisfy this newly created role of third-party reviewer, which calls for an understanding of the residential mortgage origination process and transaction documentation, along with the application of good judgment.

The ASF RMBS repurchase proposal also calls for recourse to a binding dispute resolution mechanism, as specified in the pooling and servicing agreement, in case the parties involved don't agree with the findings of the third-party reviewer.

One area where there is scope for disagreement between investors and issuers is as to what triggers a review event. While issuers believe that the trigger for the independent review should be completely objective and performance-based, investors also want the ability to trigger a review themselves if they feel that it is warranted.

Mani Sabapathi, a principal engaged in RMBS credit research with Prudential's fixed-income investment group, expects that it will be a continuing challenge to define what constitutes a review event for this purpose. According to him, the ASF has provided a high-level outline as to what constitutes a review event.

Sabapathi believes that this ASF proposal addresses the most pressing concerns of investors.

"This is a good starting point," he said. "Clearly a lot of details are yet to be resolved, but it lays out a pretty high-level framework that will improve the health of the securitization industry."

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