Section 946 Dodd-Frank Act requires the Financial Stability Oversight Council's (FSOC) chairman, who is Treasury Secretary Timothy Geithner, to issue a study on the act’s risk retention requirements within 180 days of its enactment.

Separately, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Securities and Exchange Commission are required to jointly prescribe rules implementing the risk retention requirements under Section 941 of the act. FSOC's study is independent of Section 941.

The Federal Housing Finance Agency and the Department of Housing and Urban Development, together with the above agencies should also jointly prescribe rules on risk retention regarding residential mortgages. ​

This risk retention study was delivered to Congress today. The study looks at ways that the "skin-in- the-game" concept can help reform the securitization sector, protect the public and the economy from irresponsible lending practices, as well as facilitate economic growth through safe and stable credit formation.

The study noted that ABS offers important economic benefits by improving credit availability and affordability to different consumers, businesses, and homeowners.

According to the study, however, without reform, the risks presented by the securitization process can limit these benefits as shown by the recent financial crisis. The study said that since originators had little interest in whether borrowers could repay the loans, underwriting standards deteriorated and excessively risky mortgages flourished, which drove the financial crisis.

To address this this pre-crisis securitization market problem, the Dodd-Frank Act generally requires that ABS originators have “skin in the game” by retaining at least 5% of the credit risk of an asset sold to investors via securitization, which should allow market participants to more accurately price credit risk and  more efficiently allocate capital.

The Dodd-Frank Act can help to make securitization a stable and reliable source of credit to by placing safeguards.

The study stated that risk retention is an important tool that, if properly structured, can lessen some of the risks seen in the past and promote safe and efficient lending.

The study said that a risk retention framework should seek to: align incentives without changing the basic structure and objectives of securitization deals; offer greater certainty and confidence among market participants; promote efficiency of capital allocation; preserve flexibility as markets and circumstances evolve; and allow the different market players to still engage in safe and sound lending activities.

There are a number of issues regulators must address. These are: the form of risk retention, allocation of risk retention to the different participants in the securitization chain, the risk retention amount, the allowances for risk management, and the exemptions from risk retention are all important variables in the design of any such framework.

While risk retention offers many potential benefits, it cannot by itself address all of the challenges in this market. This is why the Dodd-Frank Act includes a comprehensive set of reforms to help in improving the health and sustainability of the financial system, such as credit rating agency reform; improved transparency and issuer due diligence; the ability-to-pay mortgage requirements; critical new consumer protections; and improved risk monitoring throughout the financial system.

Aside from these, accounting and prudent capital standards are now being reformed to address problems made apparent by the financial crisis.

“The American Securitization Forum (ASF) believes properly aligning interests in the securitization process is critical to the successful functioning of the market and the ASF looks forward to working with regulators and the Council as policymakers sort thru the specific issues involved with appropriate risk retention." said ASF Executive Director Tom Deutsch FSOC's risk retention study.

He added that securitization is the key to getting credit flowing again to U.S. consumers and businesses. The ASF, Deustch said, is committed to properly balancing the right level of risk retention with issuers' ability to sell assets as well as recycle capital to ensure better and less expensive access to credit.

Separately, the Securities Industry and Financial Markets Association (SIFMA) also issued  a statement today.

“SIFMA supports risk retention measures which are calibrated to the risk profile and structural features of various asset classes," said SIFMA President and CEO Tim Ryan. "With any scenario, developing and implementing risk retention standards requires prudent analysis."

According to Ryan, SIFMA thinks that it is essential that regulators perform business or financial modeling that would clarify the effect weighting a given deal with 5% retention would have on lending and financial markets.  "We are pleased that Treasury took steps toward this approach in this study that was mandated by the Dodd-Frank Act," he said.

Ryan also urged regulators to ensure any proposed policies will align stakeholders interests yet do not have an unnecessarily negative effect on the availability of affordable consumer and small business credit, and ultimately credit to the overall economy.

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