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Derivatives

SEC Proposes Comprehensive Rules For Asset-Backed Securities

The huge increase in credit derivatives referenced to asset-backed securities means changes in ABS rules will affect the derivatives markets.

 

The huge increase in credit derivatives referenced to asset-backed securities means changes in ABS rules will affect the derivatives markets. Last month the Securities and Exchange Commission proposed a comprehensive set of rules to address the registration, disclosure and reporting requirements for asset-backed securities under the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended. This article highlights some of the proposal's concepts.

 

1933 Act Registration

Definition of Asset-Backed Security

The proposal broadens the definition of the term "asset-backed security" or "ABS" to include leases that convert to cash partially from the proceeds of the disposition of the physical assets underlying the leases. It limits the percentage of cash that may be derived from such residual values to less than 60% of dollar volume for autos and, in the case of shelf offerings (offerings on Form S-3), to less than 20% for other assets.

Under the proposal, no "non-performing assets" may be included in the asset pool at the time of issuance. For Form S-3 offerings, up to 20% of the assets may be delinquent at the time of issuance. Assets with a payment 30 or more days past due or that are re-aged without a formal workout plan would be deemed to be delinquent.

The proposed definition of ABS requires a "discrete pool" of assets, but permits (i) master trusts without limits on amount of assets or duration of expansion, (ii) for Form S-3 offerings, prefunding accounts of up to 25% of the offering proceeds for up to a year and (iii) for Form S-3 offerings, revolving periods for up to one year in which up to 25% of the offering proceeds may be used to acquire new assets. It is unclear whether the prefunding and revolving limits are separate or combined limits.

 

1933 Act Registration Statements

The proposal limits registration of ABS to Form S-3 or, if the eligibility requirements for Form S-3 are not met, Form S-1. Continued use of Form S-3 will require that both the sponsor and the depositor have been in strict compliance with their 1934 Act reporting obligations for ABS securities for the previous 12 months. The proposal clarifies that the depositor is the "issuer" for the offering, provides guidance on preparation of the registration statement and who signs it, and restricts use of the prospectus supplement to modify or supplement the base prospectus.

Registration of Underlying Pool Assets

The proposal would require separate registration of underlying non-exempt securities, unless the depositor could publicly sell those securities without registration and neither the issuer of the underlying securities nor its affiliates (i) has an agreement or understanding relating to such securities or the ABS transaction or (ii) is an affiliate of the sponsor, depositor, issuing entity or underwriter of the ABS transaction.

 

Disclosure--Regulation AB

The proposal includes new Regulation AB, which provides principles-based disclosure for ABS offerings rather than an exhaustive list of disclosure requirements for each asset class.

Disclosure Of Static Pool Information

Under Regulation AB, disclosure of static pool performance data for the sponsor's overall portfolio, prior pools or the specific pool is required if material to the transaction.

Disclosure Of Servicer Information

Regulation AB would significantly expand disclosure requirements for any servicer affiliated with the sponsor, any unaffiliated servicer that services 10% or more of the pool assets and any master servicer or special servicer. Servicer is defined to include both traditional servicers and administrators responsible for making allocations or distributions to holders of ABS,

Disclosure Concerning Other Transaction Participants

Disclosure would be required relating to originators, significant obligors (relating to 10% or more of the asset pool) and credit enhancers. The required level of disclosure increases as the percentage of assets or securities related to such participant increases. Incorporation by reference to the 1934 Act reports of these entities may be permissible if required conditions are met. In a change from current practice, disclosure would be required regarding enhancement providers based on payments that the enhancement provider is liable or contingently liable to provide.

Other Disclosure Requirements

Regulation AB also requires expanded disclosure relating to the depositor, the sponsor and the trustee, more complete disclosure of the terms of underlying contracts, disclosure of the amount paid by the issuing entity for the pooled assets and the principles used to determine such amount, disclosure of material legal proceedings (including pending or threatened actions) against the sponsor, the depositor, the trustee or the servicer, and disclosure of fees and expenses of the transaction in tabular format.

 

Communications During the Offering Process

The proposal codifies existing safe harbors and provides additional relief for the use of computational materials and research reports.

ABS Computational Material

Proposed new Rule 167 exempts the use of ABS computational materials, structural term sheets and collateral term sheets (ABS comp mats) provided any actions taken in connection with the exemption have neither the primary purpose nor the effect of conditioning the market. The proposal expressly permits loan level information to be distributed. ABS comp mats are written communications that describe the details of the transaction, including structure and size of the offering, identity of the issuer, information about the pool assets and about security classes under various scenarios and static pool data.

Under the proposal, issuers and underwriters are, for the first time, authorized to provide to third-party services such as Bloomberg and Intex collateral and structural inputs and models that allow investors to perform their own calculations and modeling.

ABS comp mats would be considered prospectuses and as such could not have disclaimers of accuracy and completeness or provide for confidentiality, nor could they state that the communication is not a prospectus. ABS comp mats would be subject to 1933 Act fraud rules even if not filed. The proposal, however, codifies the existing safe harbor for brokers/dealers publishing information, opinions, or recommendations with respect to an ABS issuer or its securities in reseach reports.

 

Ongoing Reporting Under The 1934 Act

New Form 10-D For Periodic Reporting

A new Form 10-D (signed by the depositor, the servicer, or the Master Servicer, but not the trustee) would replace Form 8-K for monthly reporting. Proposed disclosure for Form 10-D would consist of distribution information and pool performance information as well as certain non-financial disclosures, such as legal proceedings, that occurred during the reporting period and updated information relating to significant obligors and certain enhancement providers. Distribution statements now sent to investors would be attached as an exhibit to Form 10-D and would be required to have information about items such as cash flows, material modifications to pool assets, amount drawn on credit enhancements and breaches of material pool asset representations or transaction covenants.

10-K Annual Reports

A modified Form 10-K would require two important reports to be filed as exhibits: (i) a report of the responsible party concerning its assessment of servicing compliance with specified servicing criteria and (ii) a report of a public accounting firm concerning its examination of the responsible party's assertion of compliance with the servicing criteria without any restricted use language.

Report Of Servicer Compliance & Accountant's Attestation

Under the proposal, the responsible party for the issuing entity must provide a servicer compliance report assessing compliance with certain proposed servicing criteria. The responsible party would be either the depositor, if the depositor signs the report on Form 10-K, or the servicer, if the servicer signs the report on behalf of the issuing entity. If multiple servicers are involved and a master servicer signs the report on behalf of the issuing entity, the master servicer would be the responsible party. The proposal requires a registered public accounting firm to attest to, and report on, the assessment of compliance made by the responsible party.

Servicer's Statement Of Compliance With Servicing Agreement

The proposal would also require the Form 10-K to include, as an exhibit, a statement of compliance signed by an authorized officer of the servicer, regarding the servicer's obligations under the applicable servicing agreement. If multiple servicers were involved, a separate compliance statement would be required from the master servicer, each affiliated servicer, each unaffiliated servicer that services 10% or more of the pool assets, and any other servicer that performs a material aspect of the servicing of the pool assets.

Sarbanes-Oxley Certification

The proposal amends the Sarbanes Oxley certification to be filed by ABS issuers as an exhibit to the Form 10-K. The proposal provides alternative forms of certification depending on which entity (the depositor or the servicer/master servicer) is making the certification.

Current Reporting On Form 8-K

The Form 8-K would be used to disclose material, unusual events, such as (i) a change of servicer or trustee, (ii) a change in credit enhancement or other external support, (iii) a failure to make a required distribution, and (iv) sales of additional securities.

Definition Of Issuer/Signatories Of 1934 Act Reports

The proposal would clarify that the depositor is the issuer for purposes of 1934 Act reporting. Under the proposal, either the depositor or the servicer may sign the reports on Form 10-K, Form 10-D and Form 8-K, and the same party that signs the annual report on Form 10-K must also sign the Sarbanes-Oxley certification and make the proposed assertion of compliance.

 

This week's Learning Curve was written by Richard Fried, Allan Krinsman and Lois Weinroth, partners in the structured finance practice group of Stroock & Stroock & Lavan in New York.

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