Through its proposals on Regulation AB, the Securities and Exchange Commission (SEC) will be subjecting privately sold ABS to the disclosure requirements applicable to securities offered in registered public offerings.
Private placement market ABS players have to adjust these proposals once implemented because they have been operating under long-established Safe Harbors from public registration requirements under Rule 144A and Regulation D.
Like Rule 144A, Regulation D has three rules providing exemptions from the registration requirements. These three rules allow some firms to offer and sell their securities without having to register the securities with the SEC.
"In its proposed Regulation AB II, the [SEC] is attempting to provide specific rules to govern the asset-backed securities markets, to implement the spirit of the Dodd- Frank financial regulatory reform act,” Thomas Y. Hiner, partner in the business practice group at Hunton & Williams, responding to the SEC’s proposed revisions of the Regulation AB disclosure rules for ABS, for which comments were due yesterday. "The SEC, in the same spirit as the Dodd Frank act, is looking at the financial meltdown and what caused it and is looking for things that could be changed that might help to prevent the crisis from happening again.”
He added that these private markets are the primary source of financing for many businesses, particularly smaller businesses. Since these private markets allow companies to structure financing arrangements with a limited number of institutional lenders, without the added cost and time involved to comply with public registration requirements, these private markets have become the "cradle of innovative corporate finance," Hiner said.
The imposition of public offering disclosure rules in this market, Hiner said, could force many issuers, particularly smaller businesses, to abandon the securitization markets and go back to more expensive, less efficient secured loans.
One of the things, he said, that the SEC did was to look at deals that performed the worst such as privately placed CDOs backed by subprime RMBS, and explore whether requiring greater disclosure might help future investors to better assess the risks that they might not have fully appreciated before the crisis.
However, there are many types of ABS that are not directly tied to residential mortgages, and that performed quite well through the crisis. Many of these types of ABS have never been traded publicly, but are more akin to carefully negotiated lending arrangements between a company and a small group of institutional lenders, than securities offered for consumption by the general public, he said.
"The proposed regulation's definition of 'structured finance product' is overly broad," Hiner said. “An enhanced disclosure regime is not necessary or appropriate for all types of ABS. Unintended negative consequences could follow from imposing the regulation's requirements on all types of ABS."
“The securities laws have long recognized the private securities market and that secondary trading of these securities among institutional investors has financed large segments of the U.S. economy,” Hiner said. “The SEC historically established these Safe Harbors to allow issuers and sophisticated investors to structure deals not for sale to the general public and not subject to the same filing and mandated disclosure requirements as public offerings. Rule 144A is only available to deals marketed and sold to the most sophisticated institutional investors.”
The premise, he said, was that these investors can conduct their own due diligence and that they could ask or negotiate for the type of disclosure that they want from their issuers.
Private offerings, Hiner said, are typically less expensive and much more efficient to execute. He added that sophisticated investors typically like to do their own analysis when investing in structured finance products and do not need the regulation.
For many companies, the private ABS markets serve the same purpose as lines of credit, and their relationship with their investors is much like that of a corporate borrower with its lenders. The borrower and the lenders know each other. The investors often prefer the financing to be structured as ABS rather than a secured loan because structured finance products can mitigate the risk to the investors if the issuer goes bankrupt. This is why the ABS markets have historically offered lower-risk investments for the institutional lending community, and consequently lower cost financing for the issuers, than more traditional corporate finance markets.
“The imposition of public offering disclosure requirements on these private markets can make the ABS markets cost prohibitive for many companies,” Hiner said. “This can exacerbate the credit problems the country is facing, as more companies will find it more difficult and more costly to finance their businesses.”
Trade Groups Air Concerns
The American Securitization Forum submitted yesterday a comment letter to the SEC with it collective concerns regarding the regulator’s proposal to require public disclosures, upon request, in all private 144A transactions.
Although the trade group supports the SEC’s goal of ensuring that sophisticated investors are able to consider and understand the risks of their investments, a number of concerns are presented with its proposal to condition the availability of Safe Harbors for privately-issued structured finance products on an issuer’s undertaking to provide investors the same information as would be required in a registered transaction.
In light of these concerns, the trade organization offered what it called a “more balanced approach,” which they called ASF ‘SQIB Proposal.’ This approach ensures that only sophisticated investors participate in the private market for structured finance products. It also creates incentives for investors to consider and understand the risks of their investments. The ASF said that although the proposal is supported by many of its members, a number of ASF investor members still have concerns with some of the SQIB features.
The Securities Industry and Financial Markets Association’s (SIFMA) comment letter to the SEC said that its dealer and sponsor members as well as its investor members have different views on the SEC’s proposals for regulation of private offerings of structured finance products.
SIFMA’s investor members agree with the principle that disclosure in 144A/Regulation D deals should not be different from that of offerings executed under the Regulation AB regime, and thus support the SEC’s approach.
But, SIFMA’s dealer and sponsor members have expressed considerable concern regarding the impact of the proposed rule changes on the viability of the 144A and Regulation D markets, as well as the resulting impact these might have on the provision of credit previously funded through the securitization process.
Additionally, SIFMA raised important issues regarding proposed Rule 192 and the SEC’s proposed definition of structured finance product. The association requested the SEC to offer clarification on the use of this term.
In its comment letter, SIFMA urged the SEC not to change its interpretation of what constitutes an underwriter as well as not to impose added conditions on the availability of the Regulation S Safe Harbor. Regulation S covers the rules that govern offerings and sales made outside the U.S. without registration under the Securities Act of 1933.
The SIMFA also requested the SEC not to impose added restrictions on private offerings, including limiting the total number of investors or imposing a minimum holding period before securities may be resold under Rule 144A.