Time is rapidly ticking away before an amendment that extends a longstanding Securities and Exchange Commission (SEC) rule to Rule 144A transactions goes into effect and reduces liquidity in the securitization market. A separate SEC proposal may put collateralized loan obligations (CLOs) in a pickle later in 2023.
In 2020, the SEC amended Rule 15c2-11, long applied to over-the-counter (OTC) equity securities, to enhance investor protections by requiring an issuer's financial information to be publicly available in order for broker-dealers to quote its securities. Regulatory enforcement had never been extended to fixed-income, but market participants interpreted the amendment as doing exactly that.
Despite industry complaints, the SEC clarified in a December 2021 no-action letter—just before the amended rule was to become effective at the start of 2022—that it would indeed begin enforcing the rule in the fixed-income market. However, transactions issued under Rule 144A deals—most securitizations—were given until the start of 2023 to comply.
The clock ticks on compliance
With less than six weeks to go, however, the SEC has yet to address the industry's concerns about subjecting fixed-income securities to the rule, including securitizations that pool loans from numerous borrowers. The Securities Finance Association (SFA) has argued that key financial information required by the rule, such as balance sheet and profit and loss, are simply "not germane to ABS" and so isn't currently produced. Instead, the SFA says, investors already receive the information they need from the trusts issuing the securities, including remittance reports that regularly update the performance of the pool of assets collateralizing the security.
If the rule's requirements can't be met, according to the amended rule, broker-dealers would no longer be able to quote those securities publicly. The SFA contends the market's inability to quote those securities will reduce liquidity, raise the bonds' liquidity premium, and increase financing costs for businesses.
The rule would also require information to be made public that currently is available only to qualified institutional buyers (QIBs) purchasing the issuer's bonds. Securitizations such as single-asset, commercial mortgage-backed security (CMBS) include highly detailed property information, and the rule could dissuade issuers from tapping the 144A securitization market in the future.
"We really need the SEC to act quickly, since there's less than two months left," said
Kristi Leo, president of the SFA.
The industry has had "productive" conversations with SEC staff about the amended rule's impact, Leo added.
"But they're not the decision makers," she said of the SEC staff. "At the end of the day the staff needs the SEC commissioners support."
The SFA has proposed two potential solutions. One would extend indefinitely the year-long relief granted to Rule 144A transactions since the since the start of 2022. That relief would require broker-dealers to confirm their "reasonable belief" that the information is readily available, rather than having to confirm its public availability.
"So we're asking for the current approach to continue in perpetuity," Kristi said, adding that another solution would be to define publicly available as "readily available to qualified buyers."
The SEC could accomplish either solution with an updated no-action letter, Kristi said, a much less arduous path than amending the rule again.
She added that corporate Rule 144A offerings are impacted less by the amended rule because many, such as banks, are exempted from its requirements, and because most are public companies that already publish the required information in their financial statements.
In a bipartisan effort, a group of 20 Congressmen was sent a letter to SEC Chairman Gary Gensler July 26 that highlighted concerns about private companies having to make such information public. The lawmakers requested extending the no-action letter indefinitely.
The impact on CLOs
Separately, the SEC has issued a proposal that is particularly problematic for collateralized loan obligations (CLOs). In February it proposed a rule under the Investment Advisors Act of 1940, titled "Private Fund Advisers; Documentation of Registered Investment Advisor Compliance Reviews," that impacts private fund advisers registered with the regulator.
The proposal is clearly aimed at private-equity and hedge funds but also covers CLOs, although they are rarely mentioned in proposal's text. It would require several new disclosures to investors, many of which would be burdensome for small and mid-size CLO managers, the industry has argued. Most problematic, however, is its lack of a grandfathering clause, according to the Loan Syndications and Trading Association (LSTA) and other industry members. This void requires managers to pursue difficult indenture amendments for existing deals and potentially opening them up to liabilities.
Comments on the proposal were originally due April 25. More than a dozen trade association requested the SEC to provide additional time, and the regulator postponed the deadline until June 13.
"We've requested that the SEC exclude CLOs from a large portion of the rule and grandfather existing deals," Kristi said, adding that the rule likely won't be finalized for at least another seven months.
