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From Securities Regulation Daily, October 22, 2014

SEC adopts risk retention rules in a split vote

By Jacquelyn Lumb

The SEC today adopted, by a three-to-two vote, final risk retention rules for the asset-backed securities markets as mandated by the Dodd-Frank Act. The OCC and the FDIC announced the adoption of the joint rulemaking yesterday, ahead of votes by the SEC, the Federal Reserve Board, the Department of Housing and Urban Development, and the Federal Housing Finance Agency. The rules, which require lenders to retain no less than 5 percent of the credit risk of the assets they securitize, respond to some of the most serious issues that were exposed during the financial crisis.

SEC Chair Mary Jo White explained in opening remarks at today’s meeting that the rules will provide sponsors with a number of options with respect to the risk retention requirements. Sponsors will be required to disclose information about the interest they retain in a transaction, the fair value amount, and, with respect to certain options, the identity of the legal entity that is involved.

QRM definition. White emphasized the importance of a provision in the final rules that requires a review of the definition of a qualified residential mortgage (QRM) at regular intervals. The rules provide an exemption from the risk retention requirements for asset-backed securities that are collateralized solely by QRMs. The six federal agencies chose to adopt a definition of QRM that reflects the Consumer Financial Protection Bureau’s definition of a qualified mortgage under the Truth in Lending Act.

The agencies must review the QRM definition four years after the effective date of the rules and every five years thereafter, but any of the agencies may call for a review at any time. White has directed the staff to monitor the market for any changes in circumstances, including any changes to the structure and framework of the government-sponsored enterprises, two of which account for 78 percent of all residential mortgage-backed securities.

Risk retention requirements. The final rules apply a minimum 5 percent base risk retention requirement to all securitization transactions that are within the scope of Section 15G of the Exchange Act and prohibit the sponsor from hedging or otherwise transferring its retained interest prior to the applicable sunset date. The final rules also allow a sponsor to satisfy its risk retention obligation by retaining an eligible vertical interest, an eligible horizontal residual interest, or any combination thereof, as long as the amount of the eligible vertical interest and the amount of the eligible horizontal residual interest combined is no less than 5 percent.

The amount of the eligible vertical interest is equal to the percentage of each class of asset-backed securities interests issued in the securitization transaction held by the sponsor as eligible vertical risk retention. The amount of eligible horizontal residual interest is equal to the fair value of the eligible horizontal residual interest divided by the fair value of all asset-backed securities interests issued in the securitization transaction.

Effective date. The rules take effect one year after publication in the Federal Register with respect to asset-backed securities collateralized by residential mortgages and two years after publication with respect to all other classes of asset-backed securities.

Commissioner Luis Aguilar. Commissioner Luis Aguilar, who supported the final rulemaking, said it corrects the misalignment of interests between mortgage originators and investors. Given the involvement of multiple government agencies, he said, the rules reflect much deliberation and compromise. He doubted that any of the commissioners were completely satisfied with the final product, but said that 51 months after the Dodd-Frank Act mandated the adoption of the rules, it was time to act. The SEC’s work is not complete, he added: It must still adopt disclosure requirements regarding asset-level information across other asset classes.

Commissioner Daniel Gallagher. Commissioner Daniel Gallagher, who opposed the final rules, also dissented to last year’s proposing release. He said the adoption of the QRM definition disgracefully abdicated the agencies’ responsibility to the CFPB. Of all of the dissents he has cast over the years, Gallagher said this one was the most painful. Today’s adoption makes GSE reform all the more important, he added. Gallagher also expressed great disappointment with the rulemaking process, since it provided no opportunity for individual commissioners to make their views known. He also slammed the agency that released the final rules yesterday before all of the agencies had voted.

Commissioner Kara Stein. Commissioner Kara Stein, who voted to adopt the final rules, strongly supported the disclosure of the legal identity involved in the asset-backed securities transaction. She said it reflects a partnership between regulators and the industry and suggested that the SEC consider the disclosure in other rules going forward. Stein also called on the SEC to move forward with the incentive pay reforms, since certain compensation structures may incentivize firms and their employees to engage in poor securitization practices.

Commissioner Michael Piwowar. Commissioner Michael Piwowar, who dissented to the adoption of the final rules, faulted the other government agencies for failing to perform an economic analysis. He criticized the agencies for failing to consider risk retention alternatives posed by commenters. Piwowar also cited troubling news last week that FHFA is pushing Fannie Mae and Freddie Mac to make it easier for borrowers to obtain mortgages with down payments as low as 3 percent.

Rep. Jeb Hensarling. Jeb Hensarling, chair of the House Financial Services Committee, released a statement following the rules adoption, in which he said if risk retention is a good idea, it should be established by the market rather than by government mandate. He said a better solution would be to repeal the Dodd-Frank Act’s risk retention provision, end the government’s domination over the housing finance market, and place private capital at the center of the mortgage system, as provided under the PATH Act. The Act, which was approved by his committee last year, would end the bailout for Fannie Mae and Freddie Mac, remove barriers to private capital, and give home buyers more informed choices about their mortgage options.

SIFMA President. SIFMA President and CEO Kenneth Bentsen, Jr. issued a statement in favor of the final rules. He said the adoption of final rules will bring relief to the regulatory uncertainty hanging over non-government-guaranteed mortgage securitizations. However, he expressed disappointment that the agencies did not respond to commenters’ requests to tailor the risk retention rules for collateralized loan obligations, which are a key source of funding for Main Street businesses and other corporate borrowers.

The release is No. 34-73407.

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