Regulation AB: Episode II – the long-awaited sequel
On August 27, 2014, the U.S. Securities and Exchange Commission (the SEC) unanimously adopted final rules (the Final Rules), with respect to regulations commonly referred to as Regulation AB II, which revises disclosure requirements, reporting requirements, registration and the offering process for asset-backed securities (ABS). The responses below are based upon a draft of the Final Rules.
1) Who is impacted by the Regulation AB II Final Rules?
The Final Rules will apply specifically to SEC-registered public offerings of ABS. Where the underlying assets consist of residential mortgages, commercial mortgages, auto loans, auto leases or debt securities (Relevant Assets), or the offering is a resecuritization of ABS where the underlying assets consist of Relevant Assets, the Final Rules set forth enhanced asset-level disclosure requirements.
The Final Rules will not apply to unregistered ABS offerings relying upon Rule 144A at this time; however, as discussed further below, standardization of disclosure is a recurring theme in the draft commentary of the Final Rules and it is possible that the SEC will, at some point in the future, adopt rules requiring that unregistered ABS offerings relying upon Rule 144A provide the same level of disclosure required under the Final Rules.
2) What is being adopted in the Regulation AB II Final Rules?
Significant changes to SEC-registered public offerings of ABS resulting from the Final Rules include the following:
- Standardized asset-level disclosure requirements for ABS where the underlying assets consist of Relevant Assets or the offering is a resecuritization of ABS where the underlying assets consist of Relevant Assets.
- Amendments to prospectus disclosure requirements, including enhanced disclosure regarding transaction parties, static pool information and modification of underlying assets and a requirement to file the transaction documents by the date of the final prospectus.
- Cooling-off period requirements whereby ABS issuers using a shelf registration statement must file a preliminary prospectus indicating transaction-specific information at least three business days prior to the first sale of securities in the offering.
- Modification of shelf registration eligibility and offering requirements for ABS issuers, including: (i) the requirement that the chief executive officer of the depositor certify that the securitization as described in the prospectus has been structured to produce cash flows from the underlying assets in amounts sufficient to service anticipated payments on the securities; (ii) the inclusion of provisions that provide for a review of the underlying assets for compliance with the representations and warranties upon the occurrence of certain post-securitization trigger events; (iii) the inclusion of dispute resolution provisions; and (iv) disclosure of investors' requests to communicate with other investors. In addition, the requirement that the securities have an investment-grade rating in order to be eligible for shelf registration has been removed.
- Other changes to the shelf offering provisions including a pay-as-you-go registration fee alternative, new Forms SF-1 and SF-3 for ABS issuers and the requirement that a single prospectus be filed for each takedown.
- Changes to reporting requirements in Form 10-D, Form 10-K and Form 8-K, including requiring disclosure of delinquency information and any material changes in the sponsor's interest in the ABS in Form 10-D, and requiring disclosure about identified material instances of non-compliance with existing Regulation AB servicing criteria in Form 10-K.
3) Which Proposed Rules are not being adopted in the Final Rules?
Following the implementation of the Final Rules, several rules that were proposed by the Commission in the Proposed Rules are not being implemented at this time and remain outstanding. Key proposals in the Proposed Rules that are not being adopted as part of the Final Rules include the following:
- Requiring issuers to provide the same disclosure for unregistered offerings of "structured finance products" made in reliance on Rule 144A as would be required for SEC-registered offerings (see Question 4 below for more information on this topic).
- Applying the asset-level or grouped account disclosure requirements to other assets including equipment loans and leases, student loans, floorplan financings and credit card and charged card ABS.
- Requiring issuers to file a computer program of the "waterfall" of contractual cash flow provisions relating to the securities.
- Requiring the transaction documents to be filed by the date of the preliminary prospectus, rather than the date of the final prospectus.
While these and other proposals are not being adopted at this time, in adopting the Final Rules certain of the SEC commissioners expressed a desire for these proposals to also be addressed and implemented in a timely fashion. We note that further details regarding the substance and timing of the adoption of any additional proposals have not been provided.
4) Do unregistered offerings relying on the Rule 144A safe harbor from the registration requirements of the Securities Act of 1933 have to comply with the Final Rules?
As noted above, the Final Rules do not at this time adopt certain changes that were included in the Proposed Rules requiring issuers to provide the same disclosure for unregistered offerings of "structured finance products" made in reliance on Rule 144A as would be required for SEC-registered offerings. However, in adopting the Final Rules, certain of the SEC commissioners, without providing guidance as to details and/or timing, stated that implementation of a requirement for issuers to provide the same disclosure for unregistered ABS offerings relying upon Rule 144A as is required for SEC-registered ABS offerings should be a priority.
While the Final Rules are not applicable to unregistered ABS offerings relying upon Rule 144A at this time, it is important to note that the new requirements under the Final Rules may influence disclosure practices in unregistered ABS offerings relying upon Rule 144A involving Relevant Assets. The extent of any changes to current market practices remains uncertain and will most likely depend on the facts and circumstances of any particular offering. In addition, it is unclear how the cooling-off period (as described in Question 2 above), which requires that ABS issuers using a shelf registration statement file a preliminary prospectus containing transaction-specific information at least three business days in advance of the first sale of related securities, will influence (if at all) market practice with respect to the timing of unregistered ABS offerings relying upon Rule 144A.
5) When do the requirements under the Final Rules take effect?
The effective date of the Final Rules will be 60 days after publication in the Federal Register. The Commission has adopted a bifurcated approach with respect to implementation of the overall proposals in the Final Rules. Issuers must comply with all-new requirements, other than asset-level disclosures requirements, within one year from the effective date of the Final Rules. However, with respect to the new asset-level disclosure requirements, issuers are required to provide asset-level information no later than two years after the effective date of the Final Rules.
It should be noted that, with respect to resecuritizations of ABS, if the underlying ABS was issued prior to the compliance date for the asset-level disclosure requirements (ie prior to the date that is two years after the effective date of the Final Rules), there is an exemption from the new requirement to provide asset-level disclosure about the underlying ABS.
6) Do the Final Rules recognize asset-level disclosure requirements of other prudential regulators in other jurisdictions such as those of the European Central Bank and the Bank of England?
The Final Rules do not allow for the recognition of the asset-level disclosure requirements developed by foreign authorities that are specific to assets originated outside of the U.S. While the Commission has acknowledged that prudential regulators in other jurisdictions, such as the European Central Bank and the Bank of England, do require asset-level disclosure with respect to certain ABS in certain circumstances, the Commission has stated that it is of the view that asset-level data is generally of limited value unless the data is standardized and that the adoption of other disclosure regimes for foreign- asset ABS would reduce such standardization, thereby impairing the comparability of ABS backed by assets originated outside of the U.S. and ABS backed by assets originated within the U.S.
7) How have the Final Rules addressed re-identification risk and privacy concerns?
Originators and sponsors expressed concerns with the privacy implications of asset-level disclosure, particularly the risk that the information could be combined with other publicly available information to discover, or "re-identify," the identities of the obligors in ABS pools, thereby revealing potentially sensitive personal and financial information about an obligor (such as credit score, monthly income and monthly debt). This issue is especially pronounced for securitizations backed by residential mortgages. The Final Rules seek to strike a balance between the investor's need for asset-level data and concerns that the data could lead to identification of individual underlying obligors. Changes were made to the required asset-level data fields for residential mortgage-backed securities and securities backed by auto loans and leases in the Final Rules in order to seek to address these privacy concerns by providing somewhat less granularity as to potentially sensitive data fields. However, as stated above, all asset-level data required under the Final Rules will be publicly filed on EDGAR, in a machine-readable XML format, despite calls for sensitive asset-level data to be provided on a restricted issuer website.
Data fields required in the Proposed Rules that are not required in the Final Rules include unique broker identifier, sales price, origination date, first payment date, certain information about an obligor's bankruptcy and foreclosure history, income and debt, liquid/cash reserves, number of mortgaged properties, percentage of down payment from the obligor's own funds, self-employment status, current other monthly payments, mortgage insurance certificate number, non-pay reason, and eviction end date.
In a letter issued to the Commission dated August 26, 2014, the Consumer Financial Protection Bureau stated that the Fair Credit Reporting Act will not apply to asset-level disclosures that exclude direct identifiers where the Commission determines that disclosure of such information is "necessary for investors to independently perform due diligence." While this will be helpful to issuers subject to U.S. regulation, foreign issuers may not have similar comfort from their relevant regulator. As the Commission itself acknowledged, the Final Rules do not completely eliminate the risk of obligor re-identification, and there may be costs associated with providing certain sensitive information required by the Final Rules, including the cost of consulting with privacy experts to understand the impact of providing these disclosures.