The U.S. Congress and U.S. regulatory agencies have imposed or proposed broad-based and aggressive laws and rulemaking in response to the failure of securitizations directly or indirectly backed by U.S. subprime residential mortgage loans originated in the several years prior to the onset of the financial crisis in 2007. Notwithstanding this aggressive response, there is no empirical evidence that transactions backed by other types of assets, including asset-backed securities (ABS) of foreign issuers, have been prone to such failures or merit coverage in the same regulatory scheme as applies to securitizations backed by subprime residential mortgage loans.
Historically, the main U.S. securities law concerns of foreign issuers engaged in securitization offerings in the U.S. were (i) observing the offering and sales restrictions for private offerings exempt from the registration requirements of the Securities Act of 1933 for non-registered offerings and (ii) structuring the transactions to utilize one of the exemptions available under the U.S. Investment Company Act of 1940. More recently, however, there have been a number of new or proposed U.S. rules governing ABS that many foreign ABS issuers may not be aware may apply to them, even though they intend to access U.S. investors only by means of private offerings. These changes are summarized below.
Required NRSRO Information Access
Rule 17g-5 under the U.S. Securities Exchange Act of 1934 (the Exchange Act) prohibits any nationally recognized statistical rating organization (NRSRO) from issuing or maintaining a credit rating for a structured finance product if it is subject to conflicts of interest described in the Rule. One of the enumerated conflicts of interest applies to an NRSRO that is hired by an issuer, sponsor or underwriter of a structured finance product transaction on or after June 2, 2010, to determine an initial credit rating that fails to take certain steps designed to allow other NRSROs to be able to prepare and publish, and subsequently monitor, initial credit ratings on an unsponsored basis. Such steps require the NRSRO to maintain, on a password-protected Internet Web site, a list of each structured finance product security for which it is in the process of determining an initial credit rating on a sponsored basis (i.e., paid for by the issuer, sponsor or underwriter), the name of the related issuer and the Internet Web site address where the information provided to the hired NRSRO can be accessed by other NRSROs.
The broad definition of "structured finance product," which includes a non-exclusive list of enumerated product categories, leaves open for interpretation by the NRSROs the product categories that, although not specifically mentioned in the rule, are nevertheless within the scope of the term. The individual NRSROs have formulated informal interpretations for certain non-enumerated product categories. At present, one category of particular interest to foreign issuers in emerging markets - future flow transactions such as those dependent on bank-sponsored diversified payment rights (DPRs) - is being viewed differently by the major NRSROs: Standard & Poor's and Fitch Ratings do not consider future flow transactions to be a structured finance product and therefore would not treat such transactions as being subject to the requirements of Rule 17g-5(a)(3); however, Moody's Investors Service regards future flow transactions to involve a structured finance product and therefore would treat such transactions as subject to the requirements described above.
Since the effective date of the Rule, the market has adapted to its written materials posting requirements. The treatment of oral communications is more troublesome, as the Rule requires that summaries or transcripts thereof be posted. As a practical matter, this has had the effect of diminishing productive transaction dialogue that, prior to the effectiveness of the Rule, occurred spontaneously orally or in informal e-mails between transaction parties and their advisors and the NRSROs.
Although Rule 17g-5 does not limit the extraterritorial effect of its scope, the Securities and Exchange Commission (SEC) has, by order, conditionally exempted NRSROs from the requirements of Rule 17g-5 until December 2, 2011, where (i) the issuer of the security or money market instrument is not a U.S. Person and (ii) the NRSRO has a reasonable basis to conclude that the structured finance product will be offered and sold upon issuance and that any arranger linked to the structured finance product will effect transactions of the structured finance product after issuance only in sales that occur outside the U.S. to non-U.S. Persons.
Proposed Additional Information Requirements for Structured Finance Products
Under current law, the information disclosure and reporting requirements under Regulation AB (Reg AB) for issuers of ABS apply only to transactions that are publically offered pursuant to a registration statement filed with the SEC.
The regulations that comprise Reg AB were tailored to address the issues and circumstances pertaining to the offering of ABS backed by homogenous pools of consumer debt instruments such as residential mortgage loans, automobile loans and leases, and credit card receivables, which in terms of sheer volume historically comprised the bulk of the ABS market. However, these and other asset classes - particularly those involving transactions that were negotiated or too esoteric, small, new, illiquid and/or marketed exclusively to very large institutional buyers - were historically conducted in the private market. Thus, whether existing Reg AB was particularly well suited to such private offerings was not critical insofar as the private offering market constituted a viable alternative to the public markets.
The SEC has proposed a major revision to Reg AB referred to as Reg AB II. Most significantly for foreign issuers, it proposes to condition the availability of the resale exemption provided by Rule 144A under the Securities Act and the safe harbor exemption from registration pursuant to Regulation D (Reg D) under the Securities Act to those transactions where the issuer agrees to provide the same information to investors that the investors would have received in a registered public offering of such securities. Rule 144A is the resale exemption typically used by arrangers who underwrite book-entry ABS (and transferees of the arrangers during the one-year period for which selling restrictions relating to such restricted securities generally apply). Reg D provides a safe harbor from Securities Act registration and is less commonly used in the ABS market, although in transactions utilizing the general statutory exemption for private placements under Section 4(2) of the Securities Act many of Reg D's definitions and concepts have been incorporated into the offering process, including limiting sales to an institutional subset of accredited investors and restrictions on general advertising and solicitations. Those private placement transactions usually consist of direct sales by the issuer to a limited number of investors in the form of physical securities in agented "best efforts" transactions.
Were the Reg AB II proposal to be adopted, it would largely eliminate the regulatory distinction between U.S. public and private offerings in connection with disclosures of information, unless issuers determined to effect their initial sales under Section 4(2) without the benefit of the Regulation D safe harbor and resales were made pursuant to the widely recognized so-called "4(1-1/2)" concept, whereby resales made in the same manner as an initial 4(2) private placement are not deemed to be an impermissible unregistered public offering.
With respect to asset-backed commercial paper (ABCP), the proposed information delivery requirements would be particularly onerous, since substantially all ABCP programs provide for resales of ABCP in reliance upon the Rule 144A safe harbor, and ABCP conduits continually finance large quantities of diverse and constantly changing underlying assets, which would make compliance with the comprehensive asset-level data disclosure contemplated by the proposed information delivery requirements of Reg AB II highly impractical.
As drafted, this proposal does not draw any distinction between foreign issuers and domestic issuers. Prior to proceeding further with the proposal, the SEC will need to review and consider the many comment letters that have been submitted with respect to the proposal, and may tailor its final rules based on the comments received. The timetable for any final rules is also affected by the SEC's need to focus its attention on the proposal and adoption of rules under the Dodd-Frank Act, which in part overlap with some of the topics it had intended to cover in Reg AB II.
A number of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) apply to securitization transactions and follow the pattern set under Rule 17g-5 and proposed Reg AB II in disregarding the distinction between public and private ABS transactions, and therefore, absent any special exceptions discussed below, would include foreign ABS transactions sold in the U.S. Those provisions proposed or implemented to date are discussed below.
Disclosure of Repurchase
Requests - Rule 15Ga-1.
Effective March 28, 2011, the SEC has adopted Rule 15Ga-1 under the Exchange Act, which, implementing Section 943 of the Dodd-Frank Act, requires securitizers of ABS to disclose fulfilled and unfulfilled repurchase requests, and requires NRSROs to include information regarding the representations, warranties and enforcement mechanisms available to investors in an ABS offering in any report accompanying a credit rating issued in connection with such offering, including a preliminary credit rating. Pursuant to Rule 15Ga-1, any securitizer that issued or issues an ABS as defined under the Exchange Act during the three-year period ending December 31, 2011, that includes a covenant to repurchase or replace an underlying asset for breach of a representation or warranty would be required to file Form ABS-15G with the SEC by February 14, 2012, if the securitizer has ABS outstanding held by non-affiliates as of December 31, 2011. Such filing would report any repurchase activity relating to applicable outstanding ABS during the applicable period, and thereafter the securitizer would be required to file quarterly reports with respect to such activity for the related period.
Disclosure of Asset
In October 2010, the SEC proposed Rule 15Ga-2 under the Exchange Act to implement Section 932 of the Dodd-Frank Act. Proposed Rule 15Ga-2 would require any issuer registering the offer and sale of any ABS to perform a review of the assets underlying the ABS and to disclose the nature of its review of the assets and its findings and conclusions as a result of such review. If the issuer has engaged a third party to perform this review, the issuer would be required to disclose the third party's findings and conclusions, as well as certain other information regarding the third-party due diligence provider. On January 20, 2011, at the same time that it implemented rules for public ABS under Section 945 of the Dodd-Frank Act, the SEC decided to postpone consideration of Section 932, as it would apply to unregistered transactions. Finally, on June 8, 2011, the SEC published a Notice of Proposed Rulemaking to include a disclosure obligation for due diligence reports in private ABS. This disclosure will have to be made either by filing a Form ABS-15G on the EDGAR System or by the issuer or underwriter obtaining a representation from each NRSRO rating the issuance that it will publicly disclose the findings of such report within five days prior to the first sale in the offering.
On April 29, 2011, six regulatory agencies published a Notice of Proposed Rulemaking to implement Section 941 of the Dodd-Frank Act on risk retention in ABS. It sets forth a general rule of 5% risk retention by the sponsor, subject to certain exemptions for assets that the agencies view as posing a lower default risk due to their creditworthy obligors (U.S. government obligations or guarantees) or their underwriting characteristics (which have been criticized for not taking into account the low-risk origination practices applicable to a number of asset types). Of most interest to foreign ABS issuers, a safe harbor excludes transactions that (1) are not required to be registered, (2) have not more than 10% of their securities sold to U.S. persons, (3) have a foreign sponsor and (4) have not more than 25% of their assets (measured by unpaid principal balance) acquired by the sponsor in the U.S., directly or indirectly.
This article is excerpted from a longer client memorandum on the same topic published by their firm.