A longstanding Securities and Exchange Commission rule amended a year and a half ago could significantly reduce liquidity in the asset-backed securities (ABS) market starting next year, negatively impacting both investors in securitizations and borrowers of securitized loans. The amendments went into effect January 3 for strictly private transactions and, unless revised, will impact Rule 144A deals starting January 2023.
That was the Structured Finance Association’s message in a Dec. 9, 2021, letter to the SEC regarding the regulator’s amendments to Rule 15c2-11 that it adopted Sept. 16, 2020. The rule was originally put in place to protect investors in over-the-counter (OTC) equity securities by prohibiting broker-dealers from publishing quotes for a security in which current issuer information is not publicly available.
The amendments effectively broaden the rule’s impact to include fixed-income securities, prompting several major industry associations, including the Securities Industry and Financial Markets Association and the Investment Company Institute, to address the matter in a Sept. 23, 2021, letter to SEC Chairman Gary Gensler. It argues that the bond market’s structural differences from the equity market make compliance with the amended rule difficult and costly and would adversely impact liquidity.
In response to industry concerns, SEC staff issued a no-action letter Sept. 24, 2021, that stated it would not recommend enforcement action under the amended rule until Jan. 3, 2022.
The SFA’s letter in December said that concerns about the rule’s impact on the fixed-income market are heightened for ABS because “the informational requirements of Rule 15c2-11 are not material” to securitizations and it is often impossible for broker-dealers to comply with them. Partly that’s because the issuer is an independent trust that holds the financial assets and executes the transaction through maturity but does not provide the information to investors required by the rule.
“SFA investor members believe the key financial information that is required under Rule 15c2-11, the ‘balance sheet,’ the statement of ‘profit and loss,’ and the calculation of ‘retained earnings,’ of the issuer is not germane to ABS and therefore such information is not produced,” the letter says.
For ABS investors, the letter says, the relevant information instead comes from trust and remittance reports that regularly update the performance of the pool of assets collateralizing the security.
As a result, the amended rule would impede broker-dealers’ ability to provide quotes for ABS securities, “directly reducing liquidity and trading,” the letter says, and inhibiting investment by institutional investors that must meet regulatory standards and responsible risk management practices. Less liquidity would in turn increase the cost to issue ABS and its use as a financing tool for consumer and business loans.
“For instance,” the letter says, “home buyers in the mortgage market represent the largest indirect beneficiaries of the financing provided by ABS.”
Subsequently, SEC staff issued a Dec. 16 letter explaining how it will enforce the rule in stages to provide broker-dealers with more time to implement the necessary changes. The first stage began January 3 and lasts a year, exempting transactions that provide investors with offering documents. Those transactions include Rule 144A deals, which make up the vast majority of private ABS transactions in terms of volume, said Paul Forrester, a partner at Mayer Brown.
Strictly private deals for more esoteric assets do not use Rule 144A and so have been subject to the rule’s quote prohibitions.
“They’re usually sold to buy-and-hold investors, so they won’t need the quotation system, although some number might,” Forrester said.
The bigger impact arrives after Jan. 3, 2023, when Rule 144A deals will have to meet additional requirements, including having a class of securities that is listed on a national securities exchange, that will be difficult if not impossible to meet.
So far there’s been no indication from the SEC that it is considering an exemption for securitizations. Forrester noted that bond-market representatives were slow to express their concerns—a year after the SEC approved the amendments—and that there is a “powerful argument” for broker-dealers to provide sufficient information to investors to support the quotes they provide.
“I think a better argument is that there’s really no benefit to making broker-dealers ensure this information is available before they provide quotes to sophisticated institutional investors,” he said, noting that investors in Rule 144A deals must be qualifying institutions that have discretionary investing authority for at least $100 million in securities.
Forrester added concerns may arise this year for investors in the strictly private deals, since portfolio management and similar issues may be difficult to address without quotes, and so far there’s been little overt consternation about the rule’s broader impact next January.
“When we get to mid-year or third quarter, without some visible relief, I think this will become a bigger deal,” Forrester said. “Broker-dealers will have to put in place systems to make these determinations and offer quotes. They’re likely to respond that they’ll be able to do it, but it will be expensive and investors will end up paying for it.”
