The U.S. Securities and Exchange Commission (SEC) will decide today on whether to propose a rule related to conflicts of interest in the structuring and offering of ABS.
The proposal stems from Section 621 of the Dodd-Frank Act. The provision was originally proposed by Senators Jeffrey Merkley and Carl Levin, who sought to prevent the issuance of securitizations that are designed to fail.
The rule ensured that those who create and sell ABS cannot profit by betting against those same securities at the expense of those who buy them.
Consistent with the Dodd-Frank Act, the SEC proposal would prohibit entities that create and distribute ABS from engaging in any deal that would involve or result in a material conflict of interest with someone investing in the security. It would also apply to the entities’ affiliates and subsidiaries.
The rule would also offer exceptions for risk-mitigating hedging activities, as well as activity consistent with liquidity commitments and bona fide market-making. The SEC said that it has considered several different types of conflicts that could occur with securitizations.
"For instance, a firm might package an asset-backed security, sell that security to an investor, and then subsequently short the security to potentially profit as the investor incurs a loss," said the SEC in a statement today. "Or a firm might allow a third party to help assemble an asset-backed security in a way that creates an opportunity for the third party to short the security and reap a profit. The staff’s proposal addresses potential conflicts like these."
For the SEC's fact sheet on the issue, please see link below.
However, the American Securitization Forum (ASF) today warned against imposing a rule that would be over-inclusive and, as a result, create serious unintended consequences for securitization and prevent legitimate capital formation activities.
The definition of material conflict of interest, according to the ASF, must be tailored to strike the appropriate balance between meeting the specific goals of Congress sought to achieve and sought to achieve while also permitting the healthy functioning of the securitization market and capital formation.
“ASF strongly supports the intent of this provision, which is to eliminate incentives for market participants to intentionally design asset-backed securities to fail,” said Tom Deutsch, ASF executive director. “However, we hope that the rules proposed by the SEC are crafted to eliminate these incentives without unintentionally prohibiting appropriate hedging, market making and other legitimate transactions, and causing un-necessary adverse impacts on the markets for asset-backed securities. We also believe that disclosure of potential conflicts would be appropriate in certain circumstances in order to not cutoff investment choice by sophisticated investors. We look forward to reviewing a copy of the proposed rules and providing industry comment.”