Tara Castillo is a senior associate in Alston & Bird’s Finance Group who concentrates her practice on securities transactions, complex structured finance and securitization transactions, as well as securities compliance and regulatory matters for financial institutions, corporations and credit rating agencies. She regularly counsels clients regarding the SEC’s proposal for sweeping changes to Regulation AB (Reg AB II), which governs registered offerings of asset-backed securities.
Below, Tara shares some of her insights into the SEC’s proposed Reg AB II rules.
When can we expect the SEC to adopt the final Reg AB II rules?
Tara Castillo: In April 2010, the SEC proposed significant revisions to Regulation AB and other rules regarding the offering process, disclosure and reporting for asset-backed securities (“Reg AB II”). It is not clear when the SEC is going to adopt the final Reg AB II rules, especially in light of subsequent congressional mandates prescribed under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), the SEC’s July 2011 re-proposal of certain Reg AB II rule proposals and the upcoming November elections.
Although the SEC’s re-proposal did not indicate when the Reg AB II rules would be finalized, the SEC noted that the compliance date should occur within a year after the adoption of the final rules.
What was the driving force behind the initial Reg AB II rule proposals?
Tara: The Reg AB II rule proposals were adopted by the SEC in light of the recent financial crisis. Many observers, including some industry participants, have attributed the financial crisis, among other things, to a lack of transparency in the securitization market, particularly securitizations of sub prime residential real estate. From the SEC’s perspective, Reg AB II represents a fundamental revision to the current regulatory framework governing virtually all asset-backed securities with the stated goal of increasing investor protection through additional disclosure.
What impact are the final Reg AB II rules likely to have on liquidity in the securitization market?
Tara: The initial impact of the final Reg AB II rules will depend on how closely the final rules mirror the initial proposal and re-proposal. Without question, compliance with Reg AB II will add expense to both public and private securitization transactions. Large- and medium- size issuers will be more apt to sustain the impact of increased compliance costs. On the other hand, the final Reg AB II rules may have the unintended consequence of pushing smaller issuers and non-fungible asset classes out of the securitization market. In the long term, however, if the additional disclosures and procedures that may be mandated by Reg AB II successfully promote meaningful transparency—and and as a result boost investor confidence in the U.S. private securitization market, then—then liquidity in these markets should increase over time.
What aspects of the Reg AB II rule proposals are likely to impact servicers?
Tara: One aspect of the Reg AB II rule proposals is the expansion of the scope of the Form 10-K disclosure relating to a servicer’s lack of compliance with the servicing criteria set forth in Item 1122 of Regulation AB. Currently, a servicer is only required to disclose noncompliance with respect to all asset-backed transactions involving the same asset class (or platform) as the transaction for which the Form 10-K relates. Under Reg AB II, a servicer would be required to disclose whether its noncompliance affected the servicing of the underlying assets for the particular asset-backed security to which the Form 10-K relates.
In addition, the proposed rules relating to shelf eligibility and disclosure of asset-level data will also indirectly impact servicers and other counterparties by increasing such parties reporting and disclosure obligations with respect to the underlying assets. For example, continued shelf eligibility will be conditioned on the issuer’s compliance with all SEC filing requirements. As a result, issuers are going to have to rely upon servicers and other counterparties to provide data, and in some cases, prepare disclosure documents and other deal- related information, in a timely fashion so that all SEC filing deadlines can be met. As was the case with the adoption of the rules requiring disclosure of requests for repurchases of securitized assets due to breaches of representations and warranties (Exchange Act Rule 15Ga-1), we may find servicers seeking to protect themselves by attempting to further expand indemnification provisions and to provide more nuanced reporting and information delivery mechanics.
A year from now, will we be waiting on Reg AB III? What’s next?
Tara: Reg AB III - not likely. I suspect that in the year after Reg AB II’s effective date, the SEC will need to issue additional clarifying guidance on some of the Reg AB II rules. The SEC and other federal regulators are already behind on some of the rulemaking mandates prescribed under the Act. Given the robust nature of the Reg AB II rule proposals, I think it will take several years or another financial crisis before the SEC or the U.S. government determines that there is a need to overhaul or substantively readjust the regulatory framework governing asset-backed securities. Additional regulation and market practice will mostly like be shaped by state and local actors. We will continue to see an increase in proposed rulemaking and related regulatory actions relating to financial and consumer protection on a state or local level. A clear example is the recent proposed use of eminent domain actions and local ordinances with respect to residential mortgage loans.