Proposed Rule2023-02003
Prohibition Against Conflicts of Interest in Certain Securitizations
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Published
February 14, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("SEC" or "Commission") is reissuing and revising a proposal that was initially published in September 2011 that would implement a provision under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act") prohibiting an underwriter, placement agent, initial purchaser, or sponsor of an asset-backed security (including a synthetic asset-backed security), or any affiliate or subsidiary of any such entity, from engaging in any transaction that would involve or result in certain material conflicts of interest.
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<title>Federal Register, Volume 88 Issue 30 (Tuesday, February 14, 2023)</title>
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[Federal Register Volume 88, Number 30 (Tuesday, February 14, 2023)]
[Proposed Rules]
[Pages 9678-9727]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-02003]
[[Page 9677]]
Vol. 88
Tuesday,
No. 30
February 14, 2023
Part III
Securities and Exchange Commission
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17 CFR Part 230
Prohibition Against Conflicts of Interest in Certain Securitizations;
Proposed Rule
Federal Register / Vol. 88 , No. 30 / Tuesday, February 14, 2023 /
Proposed Rules
[[Page 9678]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 230
[Release No. 33-11151; File No. S7-01-23]
RIN 3235-AL04
Prohibition Against Conflicts of Interest in Certain
Securitizations
AGENCY: Securities and Exchange Commission.
ACTION: Supplemental proposed rule.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is reissuing and revising a proposal that was initially
published in September 2011 that would implement a provision under the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(``Dodd-Frank Act'') prohibiting an underwriter, placement agent,
initial purchaser, or sponsor of an asset-backed security (including a
synthetic asset-backed security), or any affiliate or subsidiary of any
such entity, from engaging in any transaction that would involve or
result in certain material conflicts of interest.
DATES: Comments should be received on or before March 27, 2023.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/submitcomments.htm">http://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#483a3d242d652b2725252d263c3b083b2d2b662f273e"><span class="__cf_email__" data-cfemail="91e3e4fdf4bcf2fefcfcf4ffe5e2d1e2f4f2bff6fee7">[email protected]</span></a>. Please include
File Number S7-01-23 on the subject line.
Paper Comments
<bullet> Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-01-23. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's website (<a href="http://www.sec.gov/rules/proposed.shtml">http://www.sec.gov/rules/proposed.shtml</a>).
Comments also are available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. Operating conditions may limit access to the Commission's Public
Reference Room. All comments received will be posted without change.
Persons submitting comments are cautioned that we do not edit personal
identifying information from comment submissions. You should submit
only information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such items
will be made available on our website. To ensure direct electronic
receipt of such notifications, sign up through the ``Stay Connected''
option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Benjamin Meeks, Special Counsel, or
Brandon Figg, Attorney-Adviser, in the Office of Structured Finance,
Division of Corporation Finance at (202) 551-3850, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are proposing to add the following rule
under 15 U.S.C. 77a et seq. (``Securities Act''):
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Commission reference CFR citation
(17 CFR)
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General Rules and Regulations, Rule 192............ Sec. 230.192
Securities Act of 1933.
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Table of Contents
I. Introduction
A. Background
B. Overview
II. Discussion of Proposed Rule 192
A. Scope: Transactions With Respect to ABS
B. Scope: Securitization Participants
1. Placement Agent, Underwriter, and Initial Purchaser
2. Sponsor
a. Sponsor in Regulation AB
b. Contractual Rights Sponsor and Directing Sponsor
c. Federal Government Entities and Certain Other Entities Backed
by the Federal Government Would Not Be Defined To Be a Sponsor of
Fully Insured or Fully Guaranteed ABS
i. United States Government and Agencies
ii. Enterprises
3. Affiliates and Subsidiaries
C. Timeframe of Prohibition
D. Prohibition
1. Prohibited Conduct
2. Anti-Circumvention
E. Exception for Risk-Mitigating Hedging Activities
1. Specific Risk Identification and Calibration Requirements
2. Compliance Program Requirement
F. Exception for Liquidity Commitments
G. Exception for Bona Fide Market-Making Activities
1. Requirement To Routinely Stand Ready To Purchase and Sell
2. Limited to Client, Customer, or Counterparty Demand
Requirement
3. Compensation Requirement
4. Registration Requirement
5. Compliance Program Requirement
H. General Request for Comment
II. Economic Analysis
A. Introduction
B. Economic Baseline
1. Overview of the Securitization Markets
2. Affected Parties
3. Current Relevant Statutory Provisions, Regulations, and
Practices
C. Broad Economic Considerations
D. Costs and Benefits
1. Benefits
2. Costs
E. Anticipated Effects on Efficiency, Competition, and Capital
Formation
F. Reasonable Alternatives
1. Scope
2. Information Barriers
3. ``Sponsor'' Exceptions
4. Conditions of the Exceptions
G. Request for Comments
IV. Paperwork Reduction Act
A. Summary of the Collection of Information
B. Respondents Subject to Rule
C. Burden and Cost Estimates
D. Request for Comment
V. Small Business Regulatory Enforcement Fairness Act
VI. Initial Regulatory Flexibility Analysis
A. Reason for and Objections of the Proposed Action
B. Legal Basis
C. Small Entities Subject to Proposed Rule 192
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
G. Request for Comment
Statutory Authority
I. Introduction
A. Background
Section 621 of the Dodd-Frank Act \1\ added Section 27B to the
Securities Act (``Section 27B''). Section 27B(a) provides that an
underwriter, placement agent, initial purchaser, or sponsor, or any
affiliate or subsidiary of any such entity (collectively,
``securitization
[[Page 9679]]
participants''),\2\ of an asset-backed security, including a synthetic
asset-backed security (``ABS''), shall not, at any time for a period
ending on the date that is one year after the date of the first closing
of the sale of the asset-backed security, engage in any transaction
that would involve or result in any material conflict of interest with
respect to any investor in a transaction arising out of such
activity.\3\ Section 27B(b) further requires that the Commission issue
rules for the purpose of implementing the prohibition in Section
27B(a).\4\ Section 27B(c) provides exceptions from the prohibition in
Section 27B(a) for certain risk-mitigating hedging activities,
liquidity commitments, and bona fide market-making activities.\5\
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\1\ Sec. 621, Public Law 111-203, 124 Stat. 1376, 1632.
\2\ The proposed definition of ``securitization participant''
for purposes of the re-proposed rule is discussed below in Section
II.B.
\3\ 15 U.S.C. 77z-2a(a).
\4\ 15 U.S.C. 77z-2a(b).
\5\ 15 U.S.C. 77z-2a(c).
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In September 2011, the Commission proposed for comment a rule
designed to implement Section 27B.\6\ The 2011 proposed rule was based
substantially on the text of Section 27B and would have made it
unlawful for a securitization participant to engage in any transaction
that would involve or result in any material conflict of interest
between the securitization participant and any investor in an ABS that
the securitization participant created or sold at any time for a period
ending on the date that is one year after the date of the first closing
of the sale of the ABS.\7\ Consistent with Section 27B, the 2011
proposed rule would have provided exceptions for risk-mitigating
hedging activities, liquidity commitments, and bona fide market-making
activities.
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\6\ See Prohibition against Conflicts of Interest in Certain
Securitizations, Release No. 34-65355 (Sept. 19, 2011) [76 FR 60320
(Sept. 28, 2011)] (``2011 Proposing Release'' or ``2011 proposed
rule''). Section 27B is not effective until the adoption of final
rules issued by the Commission. Section 621(b) of the Dodd-Frank Act
states that ``Section 27B of the Securities Act of 1933, as added by
this section, shall take effect on the effective date of final rules
issued by the Commission . . . .''
\7\ See 2011 Proposing Release at 60320.
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B. Overview
We are proposing new Rule 192 (the ``re-proposed rule'') pursuant
to Section 27B(b), which requires the Commission to issue rules for the
purpose of implementing the prohibition in Section 27B(a).\8\ Senator
Carl Levin stated that the ``conflict of interest prohibition . . . is
intended to prevent firms that assemble, underwrite, place or sponsor
these instruments from making proprietary bets against those same
instruments.'' \9\ The re-proposed rule targets transactions that
effectively represent a bet against a securitization and focuses on the
types of transactions that were the subject of regulatory and
Congressional investigations and were among the most widely cited
examples of ABS-related misconduct during the lead up to the financial
crisis of 2007-2009.\10\ For example, according to a Senate report,
Goldman Sachs used net short positions to benefit from the downturn in
the mortgage market, and designed, marketed, and sold collateralized
debt obligation (``CDO'') securities in ways that created conflicts of
interest with the firm's clients.\11\ In the 2011 Proposing Release,
the Commission recognized that securitization participants may in some
circumstances engage in a range of different activities and
transactions that give rise to potential conflicts of interest.\12\
Securitization markets have undergone various changes since that time,
including as a result of other rules that regulate securitization
activity that the Commission adopted following the publication of the
2011 Proposing Release.\13\ As discussed below in Section III.B.3.,
while we do not have data on the extent of such conduct following the
financial crisis of 2007-2009, we believe that securitization
transactions continue to present securitization participants with the
opportunity to engage in the conduct that is prohibited by Section 27B.
Implementing the prohibition in Section 27B would provide an important
safeguard against the misconduct that led up to the 2007-2009 financial
crisis. The re-proposed rule would complement the existing Federal
securities laws that specifically apply to securitization, as well as
the general anti-fraud and anti-manipulation provisions of the Federal
securities laws, by explicitly protecting ABS investors against
material conflicts of interest.
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\8\ The numbering of the proposed rule under the 2011 Proposing
Release was Rule 127B. Under this re-proposal, the numbering of the
re-proposed rule is Rule 192.
\9\ See 156 Cong. Rec. S3470 (daily ed. May 10, 2010) (statement
of Sen. Levin).
\10\ See, e.g., 156 Cong. Rec. S3470 (daily ed. May 10, 2010)
(statement of Sen. Levin) (``Goldman Sachs assembled and sold
mortgage-related financial instruments, then placed large bets, for
the firm's own accounts, against those very same instruments.'');
see also 156 Cong. Rec. S1363 (daily ed. Mar. 10, 2010) (statement
of Sen. Levin) (``As has been widely reported, some institutions at
the height of the boom in asset-backed securities were creating
these securities, selling them to investors, and then placing bets
that their product would fail. Phil Angelides, the chairman of the
Financial Crisis Inquiry Commission, has likened this practice to
selling customers a car with faulty brakes, and then buying life
insurance on the driver.'').
\11\ See Wall Street and The Financial Crisis: Anatomy of a
Financial Collapse, Majority and Minority Staff Report, Permanent
Subcommittee on Investigations, United States Senate (Apr. 13, 2011)
(``Senate Financial Crisis Report'') (describing the role of Goldman
Sachs in various transactions, including Abacus 2007-AC1 where
``Goldman did not take the short position, but allowed a hedge fund
. . . that planned on shorting the CDO to play a major but hidden
role in selecting the assets'' and that ``Goldman marketed Abacus
securities to its clients, knowing the CDO was designed to lose
value'').
\12\ See 2011 Proposing Release at 60324.
\13\ See, e.g., discussion of other rules applicable to
securitization transactions in Sections II.A. and III.B.3.
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The re-proposed rule takes into account developments in the ABS
market since 2011 and the comments received in response to the 2011
proposed rule to provide greater clarity regarding the scope of
prohibited and permitted conduct.\14\ Fundamentally, the re-proposed
rule is intended to prevent the sale of ABS that are tainted by
material conflicts of interest. It seeks to accomplish this goal by
prohibiting securitization participants \15\ from engaging in certain
transactions that could incentivize a securitization participant to
structure an ABS in a way that would put the securitization
participant's interests ahead of those of ABS investors. By focusing on
transactions that represent a ``bet'' against the performance of an
ABS, the re-proposed rule seeks to provide an explicit standard for
determining which types of transactions would be prohibited. We believe
this standard would provide strong protection against material
conflicts of interest while not unnecessarily hindering routine
securitization activities that do not give rise to the risks that
Section 27B was intended to address.
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\14\ Comments received on the 2011 proposed rule are available
on our website at <a href="https://www.sec.gov/comments/s7-38-11/s73811.shtml">https://www.sec.gov/comments/s7-38-11/s73811.shtml</a>.
\15\ See Section II.B.
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To achieve these objectives, the re-proposed rule would:
<bullet> Prohibit, for a specified period, a securitization
participant from engaging in any transaction that would result in a
``material conflict of interest'' between the securitization
participant and an investor in the relevant ABS. A securitization
participant could not, for a period ending on the date that is one year
after the date of the first closing of the sale of an ABS, directly or
indirectly engage in any transaction that would involve or result in
any material conflict of interest between the securitization
participant and an investor in such ABS. Under the re-proposed rule,
such transactions would be ``conflicted transactions'' and would
include, for example, a short sale of the relevant ABS or the purchase
of a credit default
[[Page 9680]]
swap or other credit derivative that entitles the securitization
participant to receive payments upon the occurrence of specified credit
events in respect of the ABS; \16\
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\16\ The proposed definition of ``conflicted transaction'' would
also include any purchase or sale of any other financial instrument
(other than the relevant ABS) or entry into a transaction through
which the securitization participant would benefit from certain
actual, anticipated, or potential adverse events with respect to the
relevant ABS or its underlying asset pool. See Section II.D.
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<bullet> Define the persons that would be subject to the re-
proposed rule. The terms ``underwriter,'' ``placement agent,''
``initial purchaser,'' and ``sponsor'' (collectively, together with
their affiliates and subsidiaries, ``securitization participants'')
would capture the persons subject to the re-proposed rule and would be
functional definitions based on a person's activities in connection
with a securitization, which would generally be based on existing
definitions of such terms under the Federal securities laws and the
rules thereunder to ease compliance with the re-proposed rule; \17\
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\17\ The proposed definition of the term ``sponsor'' would not
include the United States or an agency of the United States with
respect to any asset-backed security that is fully insured or fully
guaranteed as to the timely payment of principal and interest by the
United States. The proposed definition of ``sponsor'' would also not
include the Federal National Mortgage Association (``Fannie Mae'')
or the Federal Home Loan Mortgage Corporation (``Freddie Mac'' and,
together with Fannie Mae, the ``Enterprises'') while operating under
conservatorship or receivership of the Federal Housing Finance
Agency (``FHFA'') with capital support from the United States with
respect to any asset-backed security that is fully insured or fully
guaranteed as to the timely payment of principal and interest by
such entity. See Section II.B.
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<bullet> Define asset-backed securities that would be subject to
the prohibition. Prohibited transactions would be those with respect to
an ``asset-backed security.'' An ``asset-backed security'', for
purposes of the re-proposed rule, would be defined based on the Section
3 definition of asset-backed security in the Securities Exchange Act of
1934 (``Exchange Act'') \18\ and also would specifically include
synthetic ABS, as well as hybrid cash and synthetic ABS,\19\ which is
consistent with Section 27B; \20\ and
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\18\ 15 U.S.C. 78a et seq.
\19\ For purposes of this release, we use the term ``cash ABS''
to refer to ABS where the underlying pool consists of one or more
financial assets. We use the term ``hybrid cash and synthetic ABS''
to refer to ABS where the underlying pool consists of one or more
financial assets as well as synthetic exposure to other assets.
\20\ See Section II.A.
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<bullet> Provide certain exceptions to the prohibition. The re-
proposed rule would implement certain exceptions for risk-mitigating
hedging activities, bona fide market-making activities, and liquidity
commitments as specified in Section 27B. The proposed exceptions would
focus on distinguishing the characteristics of such activities from
speculative trading. The proposed exceptions would also seek to avoid
disrupting current liquidity commitment, market-making, and balance
sheet management activities that we do not believe would give rise to
the risks that Section 27B was intended to address.\21\
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\21\ For example, the proposed exceptions for risk-mitigating
hedging activities and bona fide market-making activities are
similar to the equivalent exceptions under other rules applicable to
certain securitization participants and other financial
institutions. See discussion below in Sections II.E. through II.G.
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We believe that the re-proposed rule would help to prevent the
abusive conduct that Section 27B is designed to prevent by reducing the
incentive for a securitization participant to structure an ABS in a way
that would put the securitization participant's interests ahead of
those of ABS investors.
II. Discussion of Proposed Rule 192
A. Scope: Transactions With Respect to ABS
Under proposed Rule 192(a)(1), a securitization participant would
be prohibited, for a specified time period with respect to an asset-
backed security, from engaging in any transaction that would involve or
result in a material conflict of interest between such securitization
participant and an investor in such asset-backed security. For purposes
of the re-proposed rule, the term ``asset-backed security'' would be
defined in proposed Rule 192(c) to have the same meaning as set forth
in Section 3 of the Exchange Act \22\ (``Exchange Act ABS'') (which, by
extension, means that the re-proposed rule would cover both registered
and unregistered offerings) and also would include synthetic ABS as
well as hybrid cash and synthetic ABS. This approach is consistent with
Section 27B \23\ and the views of certain commenters who supported the
2011 proposed rule's definition of asset-backed security, which was
based on the Exchange Act ABS definition \24\ and also included
synthetic ABS.\25\ The Exchange Act ABS definition captures fixed-
income and other securities that are collateralized by any type of
self-liquidating asset,\26\ regardless of whether the ABS is registered
with the Commission under the Securities Act. We are proposing a
definition of the term ``asset-backed security'' that includes Exchange
Act ABS primarily for consistency with Section 27B(a). Additionally, we
believe that it is appropriate for the definition to apply both to ABS
sold in offerings registered with the Commission and ABS sold in
offerings that are exempt from registration because both types of
offerings could present securitization participants with the
opportunity to engage in the conduct that is prohibited by Section 27B.
In particular, we note that a number of the transactions that were the
subject of regulatory and Congressional investigations in the wake of
the financial crisis of 2007-2009 involved unregistered ABS
offerings.\27\
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\22\ 17 U.S.C. 78c(a)(79).
\23\ Section 27B applies to an ``asset-backed security (as such
term is defined in section 3 of the Securities and Exchange Act of
1934 . . . which for purposes of this section shall include a
synthetic asset-backed security).''
\24\ See comment letter from Better Markets, Inc. (Feb. 13,
2012) (``Better Markets Letter'') at 4; comment letter from U.S.
Senators Jeff Merkley and Carl Levin (Jan. 12, 2012) (``Merkley-
Levin Letter'') at 4.
\25\ See Merkley-Levin Letter at 4.
\26\ The Commission has described a ``self-liquidating asset''
as an asset that by its terms converts into cash payments within a
finite time period. See Section III.A.2. of Asset-Backed Securities,
Release No. 33-8518 (Dec. 22, 2004) [70 FR 1506 (Jan. 7, 2005)]
(``2004 Regulation AB Adopting Release'').
\27\ See supra note 10.
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We received comment in response to the 2011 proposed rule
requesting clarification whether certain products, such as certain
types of municipal securities, would be Exchange Act ABS.\28\ Municipal
securitizations \29\ that are collateralized by any type of self-
liquidating financial asset that allows the holder of the security to
receive payments that depend primarily on the cash flow from such self-
liquidating financial asset fall within the Exchange Act ABS definition
and are, for example, already subject to the rules adopted in 2011 to
implement Section 943 of the Dodd-Frank Act \30\ and the
[[Page 9681]]
rules adopted in 2014 to implement the credit risk retention
requirements of Section 941 of the Dodd-Frank Act.\31\ In this regard,
we believe that market participants are familiar with analyzing whether
such a security meets the Exchange Act ABS definition as the Commission
has adopted other rules and regulations under the Securities Act and
the Exchange Act that use the Exchange Act ABS definition or a
substantially similar definition.\32\ Therefore, we believe that the
re-proposed rule's definition of ``asset-backed security'' is
sufficiently clear. We seek comment below on whether the re-proposed
rule should provide additional specificity regarding the types of ABS
that would be covered by the re-proposed rule.
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\28\ See comment letter from The Securities Industry and
Financial Markets Association (Feb. 13, 2012) (``SIFMA Letter'') at
17.
\29\ Most municipal entities do not typically issue ABS
directly. Under the re-proposed rule, a municipal entity would be a
sponsor of municipal ABS if the municipal entity met the proposed
definition of ``sponsor.'' Further, a municipal entity would be
subject to the re-proposed rule's prohibition to the extent the
municipal entity was a sponsor and the municipal ABS were Exchange
Act ABS. See Section II.B. for discussion of the proposed definition
of ``sponsor'' and its application to municipal entities. See also
request for comment 9 regarding other parties related to a municipal
securitization that could be ``securitization participants'' under
the re-proposed rule.
\30\ See Sections II.A.1. and II.A.3. of Disclosure For Asset-
Backed Securities Required by Section 943 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act, Release No. 33-9175 (Jan.
20, 2011) [76 FR 4489 (Jan. 26, 2011)] (stating the broader
definition of Exchange Act ABS and its application to municipal
securities, such as student loan bonds, housing, and mortgage
bonds). For a discussion of municipal securitizations, see generally
Robert A. Fippinger, The Securities Law of Public Finance, Chapter 4
(3rd. ed. Practicing Law Institute, Sept. 2011, Supplement Oct.
2022).
\31\ 17 CFR 246 (``Regulation RR''). See Credit Risk Retention,
Release No. 34-73407 (Oct. 22, 2014) [79 FR 77602 (Dec. 24, 2014)]
(``RR Adopting Release'') at 77661 (adopting certain provisions that
apply to municipal tender option bonds). See also Section IV.A.D.6.
of Credit Risk Retention, Release No. 34-70277 (Aug. 28, 2013) [78
FR 57928 (Sept. 20, 2013)] (explaining why an exemption from risk
retention for securitizations of tax lien-backed securities
sponsored by municipal entities was not proposed). Also, an ABS that
is backed by a single asset or one or more obligations of a single
borrower (often referred to as ``single asset, single borrower'' or
``SASB'' transactions) meets the definition of an Exchange Act ABS.
See RR Adopting Release at 77680 (explaining why separate loan
underwriting criteria for single borrower or single credit
commercial mortgage transactions were not adopted).
\32\ See, e.g., 17 CFR 240.15Ga-1(a), 17 CFR 240.17g-
7(a)(1)(ii)(N), and 17 CFR 246.2. Similarly, regarding a commenter's
request that we also specify whether mutual funds, exchange traded
funds, or certain other products would be Exchange Act ABS (see
SIFMA Letter at 17), we believe that there is a common market
understanding of whether such products are Exchange Act ABS and
whether other rules that use the definition of Exchange Act ABS,
such as Regulation RR, apply to them.
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We also received comment suggesting an exclusion from the rule for
certain types of ABS, including ABS with underlying assets for which
information is readily available or where the investor is involved in
asset selection.\33\ However, even if an investor is involved in asset
selection or has access to information regarding the underlying assets,
such investor may not know of the involvement of other parties with a
potential conflict of interest. Such an investor would not necessarily
know to be alert for potential selection of assets or structuring of an
ABS that might disadvantage such investor.\34\ Also, the participation
of one investor in asset selection would not necessarily protect any
other investors. Accordingly, the Commission does not believe that such
an exclusion would be appropriate.
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\33\ See, e.g., SIFMA Letter at 37-38.
\34\ Moreover, even if an investor were aware of a potential
conflict of interest, the re-proposed rule does not include an
exception based on disclosure of material conflicts of interest, as
discussed below in Section II.D.
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We also received comment on the 2011 proposed rule recommending
that the rule should only cover synthetic ABS because greater risk
arises out of synthetic ABS.\35\ However, Section 27B specifies that
the prohibition applies to both Exchange Act ABS and synthetic ABS, and
the misconduct that Section 27B is designed to prevent can occur with
respect to both synthetic ABS and non-synthetic ABS. For example, a
securitization participant could enter into a bilateral credit default
swap (``CDS'') contract referencing a non-synthetic ABS in order to bet
against the performance of the ABS. Therefore, excluding non-synthetic
ABS from the re-proposed rule would be inconsistent with the conflict
of interest protection intended by Section 27B.
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\35\ See comment letter from Association of Institutional
Investors (Feb. 13, 2012) (``AII Letter'') at 4-5.
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With regard to synthetic ABS, we received comment suggesting that
the term ``synthetic ABS'' should be defined.\36\ In contrast, we also
received comment that a definition of the term ``synthetic ABS'' is not
warranted because the term is well understood.\37\ The re-proposed rule
does not define ``synthetic ABS.'' We have previously described
synthetic securitizations, in general, as securitizations that are
designed to create exposure to an asset that is not transferred to or
otherwise part of the asset pool.\38\ These synthetic transactions are
generally effectuated through the use of derivatives such as a CDS or a
total return swap, or an ABS structure that replicates the terms of
such a swap. We believe that our previous descriptions of synthetic
securitizations are well understood by market participants and
adequately address the key issues raised by commenters, and that market
participants have been able to readily distinguish synthetic ABS from
other types of transactions. We are concerned that any particular
definition of ``synthetic ABS'' that we might propose would be
susceptible to potential overinclusiveness or underinclusiveness.
Because of the inherent complexity of the transactions involved in a
synthetic ABS, we are also concerned that a securitization participant
might attempt to evade the re-proposed rule's prohibition by
structuring such transactions around any particular definition of
``synthetic ABS'' while nonetheless creating a product that would be a
synthetic ABS within the commonly-understood meaning of the term, which
would weaken the re-proposed rule's conflict of interest protection for
investors.
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\36\ See comment letter from Americans for Financial Reform
(Feb. 13, 2012) (``AFR Letter'') at 7; comment letter from Chris
Barnard (Sept. 28, 2011) (``Barnard Letter'') at 2; Better Markets
Letter at 4; Merkley-Levin Letter at 5 (suggesting as a possible
definition a ``fixed-income or other security that references any
type of financial assets . . . and allows the holder of the security
to receive payments that depend primarily on the value or
performance of the referenced assets'').
\37\ See comment letter from American Securitization Forum (Feb.
13, 2012) (``ASF Letter'') at 23.
\38\ For a general discussion of synthetic securitizations, see
Section III.A.2. of 2004 Regulation AB Adopting Release.
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We received comment in response to the 2011 proposed rule that the
rule should explicitly cover hybrid ABS that contain a mix of financial
and synthetic assets.\39\ Given that Section 27B specified that the
prohibition applies to both Exchange Act ABS and synthetic ABS, it
would be inconsistent for the rule not to apply to a hybrid ABS that
has characteristics of both cash ABS and synthetic ABS. Furthermore,
the ability and incentive for a person to engage in the type of conduct
that Section 27B is intended to prevent are present with respect to
hybrid ABS. Therefore, the definition of the term ``asset-backed
security'' in the re-proposed rule would explicitly cover hybrid cash
and synthetic ABS that contain a mix of underlying financial and
synthetic assets.
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\39\ See Merkley-Levin Letter at 5.
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We also received comment recommending that the rule include a
catch-all provision to cover any product that functions as the economic
equivalent of a cash ABS, synthetic ABS, or hybrid ABS.\40\ However,
Section 27B prohibits material conflicts of interest with respect to
Exchange Act ABS and synthetic ABS, and consistent with Section 27B,
the re-proposed rule covers Exchange Act ABS as well as synthetic ABS
and hybrid ABS. A security that functions as the economic equivalent of
a cash ABS, synthetic ABS, or hybrid ABS, as contemplated by these
comments, should already meet the re-proposed rule's definition of ABS.
Therefore, we do not believe a catch-all provision to capture other
products beyond the proposed definition of ``asset-backed security'' is
necessary.
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\40\ See Better Markets Letter at 4; Merkley-Levin Letter at 5.
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We received comment on the 2011 proposed rule from portfolio
managers
[[Page 9682]]
at large banks \41\ and collateralized loan obligation (``CLO'')
investors \42\ that suggested an exception for certain synthetic
balance sheet CLOs to retain the use of such CLOs as a risk management
tool and an investment.\43\ We are concerned that an exception for such
a product has the potential to weaken conflict of interest protections
for ABS investors because the relevant securitization participant could
structure synthetic ABS products that entitle the securitization
participant to receive cash payments in the event that the referenced
ABS, which the securitization participant also structured and sold to
investors, fails. Therefore, we have not included such an exception.
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\41\ See, e.g., comment letter from The International
Association of Credit Portfolio Managers (Feb. 6, 2012) (``IACPM 1
Letter'') at 2.
\42\ See, e.g., comment letter from Orchard Global Asset
Management (June 28, 2012) (``Orchard Letter'').
\43\ See, e.g., comment letter from Deutsche Bank AG (Feb. 9.
2012) (``Deutsche Bank Letter'') at 1-8; comment letter from The
International Association of Credit Portfolio Managers (June 28,
2012) (``IACPM 2 Letter'') at 1-4; and comment letter from PGGM
Investments (June 20, 2012) (``PGGM Letter'') at 1-3.
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Finally, we received comment on the 2011 proposal stating that not
excluding Enterprise or Ginnie Mae ABS from the scope of the rule would
have significant economic and market impacts.\44\ As discussed below,
the re-proposed rule does not include an exception for Enterprise or
Ginnie Mae ABS.\45\ However, the proposed definition of ``sponsor''
does include an exception that, subject to certain conditions, would
apply to the Enterprises and Ginnie Mae with respect to an ABS that is
fully insured or fully guaranteed as to the timely payment of principal
and interest by such entity.
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\44\ See SIFMA Letter at 18-21.
\45\ See Section II.B.2.
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Request for Comment
1. We seek comment on the proposed definition of asset-backed
security for purposes of proposed Rule 192. Is it necessary to further
clarify components of the proposed definition?
2. Are market participants familiar with which securities products
fall under the definition of Exchange Act ABS? Should the re-proposed
rule provide more specificity regarding the types of ABS that would be
subject to the re-proposed rule?
3. Should we add a catch-all provision to the proposed definition
of asset-backed security to cover any product that functions as the
economic equivalent of a cash ABS, synthetic ABS, or hybrid cash and
synthetic ABS? Please comment on the advantages or disadvantages. If
so, what additional types of securities or transactions should be
included that would not be covered by the definition of asset-backed
security in the re-proposed rule?
4. The re-proposed rule does not define ``synthetic ABS,'' and we
are not providing specific guidance regarding whether any particular
products are ``synthetic ABS.'' As stated above, we have described
synthetic securitizations as securitizations that are designed to
create exposure to an asset that is not transferred to or otherwise
part of an asset pool, such as through a CDS or a total return swap.
Should we define ``synthetic ABS'' to incorporate that description or
otherwise define such term as a fixed-income or other security that
references any type of financial asset and allows the holder of the
security to receive payments that depend primarily on the value or
performance of the referenced assets? Are there particular products (1)
where additional clarity is necessary as to whether such products are
``synthetic ABS'' or (2) that the rule should expressly state are not
``synthetic ABS''? Please identify any such products and explain why
additional clarification is needed. Furthermore, is additional
clarification needed regarding what is or is not a hybrid cash and
synthetic asset-backed security?
5. Should proposed Rule 192(b) contain an additional exception from
the prohibition on material conflicts of interest for certain synthetic
balance sheet CLOs, as suggested by commenters to the 2011 proposed
rule,\46\ that would permit a securitization participant that is a
lender to hedge a portfolio of its originated loans and extensions of
credit by purchasing a CDS contract from the special purpose entity
that issues a synthetic ABS? If so, please explain what types of
synthetic balance sheet CLOs should not be covered by the rule, and
what conditions should have to be satisfied in order to ensure that
such CLOs would be used solely as a risk mitigation tool rather than a
speculative investment. Please also explain how such an exception would
be consistent with Section 27B.
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\46\ See, e.g., IACPM 1 Letter at 2; Orchard Letter.
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6. As stated above, municipal securitizations that are Exchange Act
ABS would fall within the definition of asset-backed security for
purposes of the re-proposed rule. Should we clarify in rule text or
through guidance the types of municipal securitizations that would be
covered by the re-proposed rule? If so, please identify those types of
municipal securitizations that you believe require clarification and
explain why. Are there types of municipal securitizations that should
be exempt from the re-proposed rule? If so, please explain why they
should be exempt, including whether the opportunity exists for
securitization participants to engage in the type of conduct the re-
proposed rule is designed to prohibit with respect to such municipal
securitizations.
7. Are there types of government-guaranteed securities that should
be exempt from the re-proposed rule? Please explain why they should be
exempt, including whether the opportunity exists for securitization
participants to engage in the type of conduct that the re-proposed rule
is designed to prohibit with respect to such securities.
B. Scope: Securitization Participants
Consistent with Section 27B(a), the prohibition in the re-proposed
rule would apply to transactions entered into by certain key
participants involved in the creation and sale of an ABS, namely an
underwriter, placement agent, initial purchaser, or sponsor, each of
which would be a ``securitization participant'' as defined in proposed
Rule 192(c). The functions performed by such persons are essential to
the design, creation, marketing, and/or sale of an ABS. The re-proposed
rule focuses on transactions that could give such persons the incentive
to market or structure ABS and/or construct underlying asset pools in a
way that would position them to benefit from the actual, anticipated,
or potential adverse performance of the relevant ABS or its underlying
asset pool. Also, consistent with Section 27B(a) and to help prevent
potential evasion, the prohibition in the re-proposed rule would apply
to the transactions entered into by the affiliates and subsidiaries of
any such person. Subject to certain exceptions discussed below, each of
the foregoing entities would be captured by the definition of
``securitization participant'' in the re-proposed rule.
The Commission did not propose definitions of the terms
``underwriter,'' ``placement agent,'' ``initial purchaser,'' and
``sponsor'' in the 2011 proposed rule, and we received comment to the
2011 proposed rule that we should refrain from providing definitions
for certain persons.\47\ However, certain other commenters to the 2011
proposed rule expressed support for defining these terms to specify the
persons
[[Page 9683]]
covered by the rule.\48\ In order to facilitate compliance, as
discussed below, we are proposing definitions for the terms
``underwriter,'' ``placement agent,'' ``initial purchaser,'' and
``sponsor'' that, with a few exceptions, are generally based on
existing definitions and are designed to reflect the functions of such
market participants in ABS transactions and not merely their formal
labels.
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\47\ See, e.g., comment letter from Akshat Tewary, Esq. (Dec. 2,
2011) (``Tewary Letter 1'') at 4.
\48\ See, e.g., SIFMA Letter at 10-11; Merkley-Levin Letter at
3.
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Request for Comment
8. Should we modify the proposed definition of the term
``securitization participant,'' and if so, how? Are any modifications
necessary or advisable to mitigate any unintended consequences?
9. As discussed above in Section II.A., municipal securitizations
that are Exchange Act ABS would fall within the definition of asset-
backed security for purposes of the re-proposed rule. Therefore,
parties related to a municipal securitization that are ``securitization
participants'' would be subject to the re-proposed rule. For example,
under the re-proposed rule a ``municipal advisor'' under 17 CFR
240.15Ba1-1(d)(1) could be a ``securitization participant'' under the
re-proposed rule based on the functions that it performs in connection
with a municipal securitization. Should certain parties related to a
municipal securitization be excluded from the scope of the re-proposed
rule? If so, how would those exclusions be consistent with Section 27B?
Are there any special considerations related to municipal advisors that
should be considered in applying the re-proposed rule?
1. Placement Agent, Underwriter, and Initial Purchaser
Proposed Rule 192(c) would define a ``placement agent'' or
``underwriter'' as a person who has agreed with an issuer or selling
security holder to:
<bullet> Purchase securities from the issuer or selling security
holder for distribution;
<bullet> Engage in a distribution for or on behalf of such issuer
or selling security holder; or
<bullet> Manage or supervise a distribution for or on behalf of
such issuer or selling security holder.
The terms ``placement agent'' and ``underwriter'' would have the same
definition in the re-proposed rule because the functional roles of the
persons who act as a placement agent or an underwriter are the same.
These definitional prongs are focused on the functional role of a
person in connection with a distribution of securities and should cover
the activities of a placement agent or underwriter that has agreed with
an issuer or selling security holder to facilitate an offering of
securities.\49\ These definitional prongs are also used for purposes of
the definition of the term ``underwriter'' under 17 CFR 255 (``Volcker
Rule'') \50\ and 17 CFR 242.100 through 105 (``Regulation M''); \51\
however, the Volcker Rule's definition of ``underwriter'' includes an
additional prong that is intended to capture selling group members that
may not have an agreement with the issuer or selling security
holder.\52\ The definition that we are proposing for purposes of the
re-proposed rule would be limited to persons that have agreed with an
issuer or a selling security holder to perform such functions, and
selling group members who have no agreement with an issuer or selling
security holder to engage in such functions would not be a ``placement
agent'' or ``underwriter'' for purposes of the re-proposed rule.
Although selling group members may help facilitate a successful
distribution of securities to a wider variety of purchasers, such as
regional purchasers that the underwriter or placement agent may not be
able to access as easily, selling group members do not have a direct
relationship with the issuer or selling security holder and are
therefore unlikely to have the same ability to influence the design of
the relevant ABS.
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\49\ We also believe that the prongs included in the proposed
definition would mitigate concerns raised by a commenter on the 2011
proposed rule about the potential overinclusiveness of the
definition of ``underwriter'' in Section 2(a)(11) of the Securities
Act, which could potentially include entities that do not have an
agreement with the issuer or the selling security holder and have no
ability to influence the design of the relevant ABS. See SIFMA
Letter at 10-11. The definition of underwriter for purposes of the
re-proposed rule would have no impact on the definition,
responsibility, or liability of an underwriter under Section
2(a)(11).
\50\ 17 CFR 255.4(a)(4). The re-proposed rule would have no
impact on the definition of ``underwriter'' in the Volcker Rule.
\51\ 17 CFR 242.100(b). The re-proposed rule would have no
impact on the definition of ``underwriter'' in Regulation M.
\52\ 17 CFR 255.4(a)(4).
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Proposed Rule 192(c) would define ``distribution'' as used in the
proposed definitions of ``underwriter'' or ``placement agent'' to mean:
<bullet> An offering of securities, whether or not subject to
registration under the Securities Act, that is distinguished from
ordinary trading transactions by the presence of special selling
efforts and selling methods; or
<bullet> An offering of securities made pursuant to an effective
registration statement under the Securities Act.
This proposed definition is the same as the definition of
``distribution'' under the Volcker Rule, which is focused on the
presence of special selling efforts and selling methods. We believe
that focusing on special selling efforts and selling methods would help
to distinguish an offering of ABS from secondary trading and helps to
target the re-proposed rule to persons engaged in selling an ABS
offering to investors once such ABS is created. Activities generally
indicative of special selling efforts and selling methods include, but
are not limited to, greater than normal sales compensation
arrangements, delivering a sales document (such as a prospectus), and
conducting road shows.\53\ A primary offering of an ABS made pursuant
to an effective registration statement under the Securities Act would
also be captured under the proposed definition of ``distribution''
because, in the context of Section 27B, such an offering would be a
primary issuance by an issuer immediately following the creation of the
relevant ABS, which would be clearly distinguishable from an ordinary
secondary trading transaction and, therefore, an identification of
special selling efforts or selling method would be unnecessary in this
context.
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\53\ See Review of Anti-manipulation Regulation of Securities
Offerings, Release No. 34-33924 (Apr. 19, 1994) [59 FR 21681 (Apr.
26, 1994)] at 21685; see also Trading Practices Concerning
Securities Offerings, Release No. 34-37094 (Apr. 11, 1996) [61 FR
17108 (Apr. 18, 1996)], Anti-manipulation Rules Concerning
Securities Offerings, Release No. 34-38067 (Dec. 20, 1996) [62 FR
520 (Jan. 3, 1997)], and Securities Offering Reform, Release No. 33-
8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)].
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Proposed Rule 192(c) would define ``initial purchaser'' in a manner
consistent with the Commission's prior use of that term in the context
of ABS.\54\ Specifically, the re-proposed rule would define the term
``initial purchaser'' as ``a person who has agreed with an issuer to
purchase a security from the issuer for resale to other purchasers in
transactions that are not required to be registered under the
Securities Act in reliance upon Rule 144A or that are otherwise not
required to be registered because they do not involve any public
[[Page 9684]]
offering.'' This definition is also consistent with industry use of the
term ``initial purchaser'' in the context of private placement
transactions to mean a person (typically a broker-dealer) who, pursuant
to an agreement with the issuer, performs the function of acquiring
securities from an issuer in a private placement and reselling those
securities to qualified institutional buyers in reliance on Rule 144A
or to purchasers in sales that otherwise do not involve any public
offering.\55\ Proposing to define the term ``initial purchaser'' in a
manner consistent with the Commission's prior use of that term in the
context of ABS and also the common industry understanding of the term
should ease compliance with the re-proposed rule because market
participants are familiar with that usage of the term and should
already have mechanisms in place to determine when the proposed
definition is met.
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\54\ While not defined in rules adopted by the Commission, the
Commission has used the term when describing the distribution of an
asset-backed security. See, e.g., Asset-Backed Securities, Release
No. 33-9117 (Apr. 7, 2010) [75 FR 23328 (May 3, 2010)] at 23332
(stating that CDOs are typically sold by the issuer in a private
placement to one or more initial purchaser or purchasers in reliance
upon the Section 4(2) private offering exemption in the Securities
Act, which is available only to the issuer, followed by resales of
the securities to ``qualified institutional buyers'' in reliance
upon Rule 144A); id. at 23393 (stating that the initial purchaser is
typically a registered broker-dealer). The definition of ``initial
purchaser'' in the re-proposed rule would have no impact on the
application of Rule 144A.
\55\ See comment letter from The Investment Company Institute
(Feb. 13, 2012) (``ICI Letter'') at 3; SIFMA Letter at 11. These
commenters suggested that the definition incorporate a specific
reference to the functions of an underwriter in connection with a
Rule 144A transaction. As the proposed definition refers to a person
agreeing to acquire a security from an issuer in a private placement
for purposes of resales pursuant to Rule 144A, this proposed
definition is appropriate and should capture the common industry
understanding of ``underwriting'' a Rule 144A transaction.
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The proposed definitions of the terms ``underwriter,'' ``placement
agent,'' and ``initial purchaser'' in the re-proposed rule would
identify persons by their function in connection with a securitization
as suggested by certain commenters to the 2011 proposed rule.\56\ We
believe that function-based definitions would encompass those persons
who have a key role in the creation or sale of an ABS transaction,
which would help prevent evasion by persons seeking to avoid the re-
proposed rule's prohibitions by using a different title to refer to
themselves, even though they perform the function described in the
definition. These function-based definitions should address evasion
concerns raised by certain commenters.\57\
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\56\ See, e.g., Better Markets Letter at 3; Merkley-Levin Letter
at 3-4.
\57\ See, e.g., Better Markets Letter at 3-4.
---------------------------------------------------------------------------
The proposed definitions of the terms ``underwriter,'' ``placement
agent,'' and ``initial purchaser'' do not exclude an underwriter,
placement agent, or initial purchaser that was not directly involved in
structuring an ABS transaction or selecting the assets underlying the
ABS, as requested by a commenter to the 2011 proposed rule.\58\ As
discussed above, the proposed definitions of those terms in the re-
proposed rule are functional definitions that are based on such a
person entering into an agreement with the relevant ABS issuer to
perform specific functions. Such specific functions are essential to
the successful issuance of the relevant ABS and, even if, for example,
the relevant ``sponsor'' is the person most directly involved in the
selection of assets, the relevant underwriter, placement agent, or
initial purchaser would also be in a position to influence the
structure of the relevant ABS given its role in the transaction.
Therefore, we do not believe that including the requested exclusion
would be appropriate.
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\58\ See SIFMA Letter at 10.
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Request for Comment
10. Are the proposed definitions of the terms ``initial
purchaser,'' ``placement agent,'' and ``underwriter'' overinclusive or
underinclusive, and why? If you believe that any of the proposed
definitions are overinclusive or underinclusive, please provide an
alternative definition and explain why you believe it is appropriate.
11. Should we modify the proposed definition of the terms
``placement agent'' and ``underwriter,'' and if so, how should the
proposed definition be modified and why? Specifically, is it
appropriate to use the same definition for such terms? If not, please
explain why and suggest revisions. Should we modify the proposed
definition to provide for functions in addition to the functions
specified in the proposed definition?
12. As discussed above, the proposed definition of the terms
``placement agent'' and ``underwriter'' would be limited to persons
that have agreed with an issuer or a selling security holder to perform
the functions detailed in the proposed definition. Should the proposed
definition be expanded to include selling group members who have no
such agreement with an issuer or selling security holder? Why or why
not?
13. Should the proposed definition of the term ``distribution'' be
modified? If so, please explain why and provide an alternative
definition. In particular, should ``the presence of special selling
efforts and selling methods'' be included in the proposed definition?
Additionally, should the magnitude of the offering be considered as
part of the proposed definition? \59\ Why or why not? If so, please
describe the factors that should be considered when determining the
magnitude of an offering (e.g., the aggregate principal or notional
amount of ABS to be sold, either in absolute terms or relative to the
aggregate outstanding principal or notional amount of ABS issued by the
issuer of the ABS and/or the normal trading volume of the ABS).
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\59\ The definition of ``distribution'' in Regulation M
considers the magnitude of the offering, in addition to the presence
of special selling efforts and selling methods. See 17 CFR
242.100(b).
---------------------------------------------------------------------------
14. Should we modify the proposed definition of the term ``initial
purchaser,'' and if so, how should the proposed definition be modified
and why?
2. Sponsor
Proposed Rule 192(c) would, subject to certain exceptions,\60\
define the term ``sponsor'' as:
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\60\ As discussed below in Section II.B.2.b., the proposed
definition of ``sponsor'' excludes a person that performs only
administrative, legal, due diligence, custodial, or ministerial acts
related to the structure, design, or assembly of an asset-backed
security or the composition of the pool of assets underlying the
asset-backed security. As discussed below in Section II.B.2.c., the
proposed definition of ``sponsor'' also excludes certain U.S.
Federal government entities and the Enterprises, subject to certain
conditions.
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<bullet> Any person who organizes and initiates an asset-backed
securities transaction by selling or transferring assets, either
directly or indirectly, including through an affiliate, to the entity
that issues the asset-backed security; or
<bullet> Any person:
[cir] With a contractual right to direct or cause the direction of
the structure, design, or assembly of an asset-backed security or the
composition of the pool of assets underlying the asset-backed security;
or
[cir] That directs or causes the direction of the structure,
design, or assembly of an asset-backed security or the composition of
the pool of assets underlying the asset-backed security.
Thus, a person who organizes and initiates an ABS transaction, or who
directs or causes the direction of the structure, design, or assembly
of an ABS or the composition of the pool of assets underlying the ABS
(or who has the contractual right to do so), would, subject to the
exceptions described below, be a sponsor for purposes of the re-
proposed rule. This would include, for example, a portfolio selection
agent for a CDO transaction, a collateral manager for a CLO transaction
with the contractual right to direct asset purchases or sales on behalf
of the CLO, or a hedge fund manager or other private fund manager who
directs the structure of the ABS or the composition of the pool of
assets underlying the ABS as described in the definition. Whether other
parties to a securitization transaction, such as servicers, would
[[Page 9685]]
meet the re-proposed rule's definition of ``sponsor'' is a
determination that would be based upon the specific facts and
circumstances of the ABS transaction, including whether such a party
would qualify for the exclusion in paragraph (ii)(C) of the proposed
definition of ``sponsor'' for a person that performs only
administrative, legal, due diligence, custodial, or ministerial acts
related to the structure, design, or assembly of the ABS or the
composition of the pool of assets underlying the ABS, as discussed
below in Section II.B.2.b.
Similar to the other proposed definitions discussed above, the
proposed definition of the term ``sponsor'' is a functional definition
that would apply regardless of the title bestowed upon the person
(e.g., an ``issuer'' of a municipal securitization would be a
``sponsor'' if its activities meet the re-proposed rule's
definition).\61\
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\61\ See Section II.A. for discussion of the proposed definition
of ``asset-backed security'' and its application to municipal
securitizations.
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a. Sponsor in Regulation AB
Paragraph (i) of the proposed definition of ``sponsor'' in proposed
Rule 192(c), which is derived from the definition of the term
``sponsor'' in Regulation AB,\62\ includes any person who organizes and
initiates an asset-backed securities transaction by selling or
transferring assets, either directly or indirectly, including through
an affiliate, to the entity that issues the asset-backed security.
However, the definition in the re-proposed rule is not limited to the
Regulation AB definition.\63\ The Regulation AB definition was adopted
to define who a sponsor is for purposes of the Regulation AB
registration and reporting regime, and accordingly, that definition was
intended to identify the party or one of the parties that is
responsible for complying with the offering and reporting requirements
of Regulation AB.\64\ Moreover, the Regulation AB definition of
``sponsor'' was adopted for the limited purpose and scope applicable
only to those ABS eligible for registration under Regulation AB, and
would not be appropriate to cover the full range of ABS that would be
covered by the re-proposed rule, including those that are
unregistered.\65\ Accordingly, the proposed definition of ``sponsor''
in the re-proposed rule would include, but would not be limited to, a
sponsor as defined in Regulation AB. As discussed below, we are
proposing a definition of ``sponsor'' that would apply more broadly to
also cover, subject to certain exceptions, any person that directs or
causes the direction of the structure, design, or assembly of an ABS or
the composition of the pool of assets underlying the ABS or has the
contractual right to do so. This is because such a person is in a
unique position to structure the ABS and/or construct the underlying
asset pool or reference pool in a way that would position the person to
benefit from the actual, anticipated, or potential adverse performance
of the relevant ABS or its underlying asset pool if such person were to
enter into a conflicted transaction.
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\62\ 17 CFR 229.1101(l). Under the Regulation AB definition, a
sponsor is the person who organizes and initiates an asset-backed
securities transaction by selling or transferring assets, either
directly or indirectly, including through an affiliate, to the
issuing entity.
\63\ Some commenters to the 2011 proposed rule supported
adopting the Regulation AB definition of the term ``sponsor.'' See
SIFMA Letter at 11 (suggesting that the term ``sponsor'' be defined
as ``a person who organizes and initiates an ABS transaction by
selling or transferring assets, either directly or indirectly,
including through an affiliate, to the issuer.''); see also ASF
Letter at 22-23 n.36 (supporting the Regulation AB definition of
sponsor and stating that ``[w]e do not believe the definition of
`sponsor' should cover servicers, custodians or collateral managers,
since those who merely service or manage the assets underlying an
ABS, by definition, do not play a role in structuring an ABS and are
not, therefore, in a position to design the ABS to default or
fail''); comment letter from American Bar Association (Feb. 13,
2012) (``ABA Letter'') at 4 (supporting the Regulation AB definition
of the term ``sponsor'').
\64\ See 2004 Regulation AB Adopting Release.
\65\ Not all ABS are eligible for the specialized registration
and reporting regime under Regulation AB. For example, because
synthetic securitizations are primarily based on the performance of
assets or indices not included in the ABS, synthetic securitizations
are not eligible for the Regulation AB registration and reporting
regime. See 2004 Regulation AB Adopting Release at 1513-14 (stating
that in instances where ABS are not eligible, additional or
different disclosures and/or registration and reporting treatment
may be more appropriate and stating that synthetic securitizations
do not meet the Regulation AB definition of ABS). Also as discussed
in Section II.A., the definition of ABS for purposes of the re-
proposed rule is broader than the definition of ABS in Regulation
AB. For example, the re-proposed rule's definition of ABS includes
synthetic ABS as required by Section 27B, whereas Regulation AB's
definition of ABS does not.
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b. Contractual Rights Sponsor and Directing Sponsor
Consistent with our concerns about the potential underinclusiveness
of the Regulation AB definition of ``sponsor'' for purposes of the re-
proposed rule, paragraph (ii) of the proposed definition of ``sponsor''
in proposed Rule 192(c) would apply more broadly to also cover, subject
to certain exceptions, any person that directs or causes the direction
of the structure, design, or assembly of an ABS or the composition of
the pool of assets underlying the ABS or has the contractual right to
do so.
First, paragraph (ii)(A) of the proposed definition of ``sponsor''
would include, subject to certain exceptions, any person with a
contractual right to direct or cause the direction of the structure,
design, or assembly of an ABS or the composition of the pool of assets
underlying the ABS (a ``contractual rights sponsor'').\66\ The
definition of sponsor in the re-proposed rule refers to a contractual
right to direct or cause the direction of ``the structure, design, or
assembly of an asset-backed security or the composition of the pool of
assets underlying the asset-backed security'' because we believe that
the structure of the ABS and the composition of the underlying asset
pool are the factors that will most impact the performance of the ABS.
Additionally, a person with the contractual right to direct or cause
the direction of these aspects of an ABS that enters into a conflicted
transaction would have the incentive and ability to engage in the
conduct that is prohibited by Section 27B. For example, participating
in asset selection for an ABS provides the opportunity for a person to
benefit through a bet against the ABS or the underlying assets by
selecting assets that such person believes will perform poorly.\67\
Therefore, the definition that we are proposing would cover various
parties with a significant role in asset selection for an ABS
transaction, whether before or after the initial issuance of the
relevant ABS, such as a portfolio selection agent for a CDO
transaction, a collateral manager for a CLO transaction with the
contractual right to direct asset purchases or sales on behalf of the
CLO, or a hedge fund manager or other private fund manager with
substantial involvement in the selection of the assets underlying an
ABS (other than in connection with its acquisition of a long position
in the relevant ABS).
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\66\ This approach is consistent with a commenter's suggestion
in response to the 2011 proposed rule to define the term ``sponsor''
broadly for purposes of Section 27B in order to ensure that the
prohibition would apply to a broad range of persons with
``significant influence in the structure, composition, and
management of an ABS.'' See Merkley-Levin Letter at 3-4.
\67\ See Section II.D. for a discussion of what would be a
``conflicted transaction'' under the re-proposed rule.
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The re-proposed rule does not provide that an actual exercise of
contractual rights would be necessary for purposes of the proposed
definition of ``sponsor.'' Our understanding of general industry
practices based on our oversight of ABS markets is that there are a
relatively small number of parties in a given ABS transaction with such
contractual rights,
[[Page 9686]]
and that in most instances a party with such contractual rights (e.g.,
a portfolio selection agent or collateral manager) would in fact
exercise (and often has a contractual duty to exercise) those
contractual rights with respect to the ABS. Accordingly, we believe it
is appropriate for the proposed definition of ``sponsor'' to capture
contractual rights sponsors without requiring a factual determination
of whether a contractual rights sponsor has exercised its contractual
right to direct or cause the direction of the structure, design, or
assembly of an ABS or the composition of the pool of assets underlying
the ABS.
We understand that there may be instances where a person that does
not have a contractual right to do so may nevertheless direct or cause
the direction of the structure, design, or assembly of an ABS or the
composition of the pool of assets underlying the ABS. For example, in
connection with certain well-known examples of synthetic CDOs that were
issued in the lead up to the financial crisis of 2007-2009, hedge funds
that desired to take short positions in synthetic CDO securities (i.e.,
so that the hedge fund could benefit if the synthetic CDO securities
performed adversely) would direct or cause the direction of the
composition of the portfolio assets in ways that would increase the
likelihood of realizing an ultimate gain on their short position.\68\
Paragraph (ii)(B) of the proposed definition of ``sponsor'' would
therefore also include any person that directs or causes the direction
of the structure, design, or assembly of an ABS or the composition of
the pool of assets underlying the ABS even if that person does not have
a contractual right to do so (a ``directing sponsor''). A determination
that a person meets the definition of sponsor for this reason would be
based upon the specific facts and circumstances.
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\68\ See Senate Financial Crisis Report.
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As stated above, participating in asset selection for an ABS
provides the opportunity for a person to benefit through a bet against
the ABS or the underlying assets by selecting assets that such person
believes will perform poorly. Therefore, the definition that we are
proposing would cover a person, such as a private fund manager, who
selects all or a portion of the assets underlying the ABS by directing
the relevant person with the contractual right to do so and, based on
its ability to select assets that are expected to perform poorly,
enters into a transaction to short the ABS. The facts and circumstances
regarding the actions of such a person would be distinguishable from
that of an ABS investor that is acquiring a long position in the
relevant ABS. An ABS investor that is acquiring a long position in the
relevant ABS would be expected to provide input with respect to the
structure of the ABS investment or the underlying pool of assets for
the purpose of maximizing the expected value of its ABS investment. For
example, investors in certain ABS markets may have stipulations
regarding general characteristics of the composition of the underlying
pool of an ABS that must be satisfied in order for that investor to
agree to acquire the relevant securities, including to ensure that the
ABS investment would comply with its investment guidelines. Therefore,
an ABS investor that is interested in acquiring a long position in an
ABS would not be considered to direct the composition of assets merely
because such investor expresses its preferences regarding the assets
that would collateralize its ABS investment. Paragraph (ii)(B) of the
proposed definition of ``sponsor'' is not intended to capture such
investors as a ``sponsor'' and is intended to capture only those
persons--such as the hedge fund managers in the examples referred to
above--that direct or cause the direction of the structure, design, or
assembly of an ABS or the composition of the pool of assets underlying
the ABS other than in connection with their acquisition of a long
position in the ABS.
The proposed definition of ``sponsor'' is a functional definition
that would apply regardless of the title bestowed upon such person.
Accordingly, a person would be a sponsor for purposes of the re-
proposed rule if such person organized and initiated the ABS
transaction or directed or had the contractual right to direct the
structure, design, or assembly of the ABS or the composition of the
pool of assets underlying the ABS, regardless of whether the person is
referred to as the sponsor of the ABS or by some other title (e.g.,
issuer, depositor, originator, or collateral manager),\69\ and even if
the person does not have a named role in the ABS transaction and is not
a party to any of the transaction agreements. This is consistent with a
commenter's suggestion in response to the 2011 proposed rule to define
the term ``sponsor'' broadly for purposes of Section 27B in order to
ensure that the prohibition would apply to a broad range of
securitization participants, including collateral managers and other
parties with significant influence in the structure, composition, and
management of an ABS.\70\
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\69\ For example, if a person is designated an ``issuer'' of a
transaction, the person could also be a ``sponsor'' if the person
performs the functions specified in the proposed definition.
\70\ See Merkley-Levin Letter at 3-4.
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To avoid having the scope of the proposed definition of ``sponsor''
extend beyond those persons with the incentive and ability to engage in
the conduct that is prohibited by Section 27B, paragraph (ii)(C) of the
proposed definition of ``sponsor'' would exclude a person that performs
only administrative, legal, due diligence, custodial, or ministerial
acts related to the structure, design, or assembly of the ABS or the
composition of the pool of assets underlying the ABS. Whether a person
performs only such functions is a determination that would be based
upon the specific facts and circumstances of an ABS transaction. For
example, we believe that the activities customarily performed by
accountants, attorneys, and credit rating agencies with respect to the
creation and sale of an ABS, and the activities customarily performed
by trustees, custodians, paying agents, calculation agents, and other
contractual service providers relating to the ongoing management and
administration of the entity that issues the ABS, are the sorts of
activities that would typically fall within the exclusion from the
definition of the proposed definition of the term ``sponsor.'' This
exclusion should address the concerns of a commenter that the persons
defined to be subject to the prohibition of the re-proposed rule should
not inadvertently include trustees, servicers, law firms, accountants,
and diligence providers.\71\ This exclusion should also mitigate
concerns about the potential overinclusiveness of a definition of the
term ``sponsor,'' including concerns raised by certain commenters on
the 2011 proposed rule about a definition that is broader than the
Regulation AB definition.\72\ While we received comment to the 2011
proposed rule that the definition of ``sponsor'' should include a
catch-all to cover ``any other person that makes a material
contribution to the design, composition, assembly, sale, or management
of an asset-backed security,'' \73\ we believe that such a catch-all
provision would be overly broad as it could potentially include
trustees, attorneys, or others that, for the reasons discussed above,
should not be treated as ``sponsors'' under the re-proposed rule.
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\71\ See SIFMA Letter at 9.
\72\ See ASF Letter at 23 n.36; and ABA Letter at 4-5.
\73\ See, e.g., Better Markets Letter at 3; Merkley-Levin Letter
at 3-4.
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[[Page 9687]]
c. Federal Government Entities and Certain Other Entities Backed by the
Federal Government Would Not Be Defined To Be a Sponsor of Fully
Insured or Fully Guaranteed ABS
Paragraph (iii)(A) of the proposed definition of ``sponsor'' in
proposed Rule 192(c) would provide that the United States or an agency
of the United States would not be a ``sponsor'' for purposes of the re-
proposed rule with respect to an ABS that is fully insured or fully
guaranteed as to the timely payment of principal and interest \74\ by
the United States. Additionally, under paragraph (iii)(B) of the
proposed definition of ``sponsor,'' Fannie Mae or Freddie Mac operating
under the conservatorship or receivership of FHFA with capital support
from the United States \75\ would not be a ``sponsor'' for purposes of
the re-proposed rule with respect to an ABS that is fully insured or
fully guaranteed as to the timely payment of principal and interest by
such entity.\76\
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\74\ The re-proposed rule does not define what ``fully insured
or fully guaranteed as to the timely payment of principal and
interest'' means in this context as we believe that concept is
commonly understood by market participants with respect to the
relevant security.
\75\ This would also include any limited-life regulated entity
succeeding to the charter of either Fannie Mae or Freddie Mac
pursuant to section 1367(i) of the Federal Housing Enterprises
Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617(i)),
provided that such entity is operating with capital support from the
United States.
\76\ One commenter to the 2011 proposal stated that not
excluding Enterprise or Ginnie Mae ABS from the scope of the rule
would have significant economic and market impacts. See SIFMA Letter
at 18-21.
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As discussed below, with respect to the types of fully insured or
fully guaranteed securities of which the United States, an agency of
the United States, or the Enterprises might otherwise be a sponsor
absent these proposed exclusions, it is the United States that is
exposed to the credit risk of the underlying assets. Therefore, if
these entities were to enter into the types of conflicted transactions
that this rule is intended to address, investors would ultimately not
be exposed to credit risks stemming from such transactions.
Each of these exclusions would apply only to the entities specified
in the relevant exclusion, and any other securitization participants
involved with an ABS issued or guaranteed by such entity (e.g., an
underwriter or a non-governmental sponsor) would be subject to the re-
proposed rule. Additionally, each of these exclusions is subject to
certain conditions. If those conditions are not satisfied with respect
to certain ABS (e.g., an ABS is not fully insured or fully guaranteed
by the relevant entity), then any securitization participant with
respect to such ABS would still be subject to the prohibition of the
re-proposed rule.
i. United States Government and Agencies
With respect to an ABS that is fully insured or fully guaranteed as
to the timely payment of principal and interest by the United States,
the United States or an agency of the United States would not be a
``sponsor'' under paragraph (iii)(A) of the proposed definition of
``sponsor'' in proposed Rule 192(c). These ABS would include mortgage-
backed securities (``MBS'') guaranteed by the Government National
Mortgage Association (``Ginnie Mae''), a wholly owned U.S. Government
corporation that guarantees investors the timely payment of principal
and interest on MBS backed by Federally insured or guaranteed loans,
including mortgage loans insured by the Federal Housing Administration
or guaranteed by the Department of Veterans Affairs. As a result of the
proposed exception in paragraph (iii)(A) of the proposed definition of
``sponsor,'' Ginnie Mae would not be a ``sponsor'' with respect to its
guaranteed ABS. Ginnie Mae's guarantee is backed by the full faith and
credit of the United States. Given that Ginnie Mae sets certain
guidelines and serves as guarantor for the MBS that it guarantees,\77\
Ginnie Mae would, absent the proposed exception, be a sponsor of the
ABS that it guarantees for purposes of the re-proposed rule.
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\77\ See, e.g., 24 CFR 320 and the Ginnie Mae MBS Guide,
available at <a href="https://www.ginniemae.gov/issuers/program_guidelines/Pages/mbs_guide.aspx">https://www.ginniemae.gov/issuers/program_guidelines/Pages/mbs_guide.aspx</a>.
---------------------------------------------------------------------------
As guarantor, the United States is exposed to the full credit risk
related to the underlying assets. In turn, investors in ABS that are
fully backed by the United States government rely on the support
provided by the full faith and credit of the United States and not on
the creditworthiness of the obligors on the underlying assets, and
therefore are not exposed to the credit risk of the underlying assets.
As a result, investors in such ABS are not exposed to the risk that was
present in certain ABS transactions prior to the financial crisis of
2007-2009 where investors suffered credit-based losses due to the poor
performance of the relevant asset pool while key securitization parties
entered into transactions to profit from such poor performance.
ii. Enterprises
Similar to the reasons for excepting the United States government
and agencies thereof, under paragraph (iii)(B) of the proposed
definition of ``sponsor'' in proposed Rule 192(c), Fannie Mae and
Freddie Mac, in each case, for so long as the applicable Enterprise is
operating under conservatorship or receivership \78\ of FHFA with
capital support from the United States,\79\ would not be defined as a
``sponsor'' for purposes of the re-proposed rule with respect to an ABS
that is fully insured or fully guaranteed as to the timely payment of
principal and interest by such Enterprise.
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\78\ Under the Federal Housing Enterprises Safety and Soundness
Act of 1992, FHFA may be appointed as the conservator or receiver
for an Enterprise. Although Fannie Mae and Freddie Mac have been
operating under the conservatorship of FHFA since September 6, 2008,
the re-proposed rule includes the reference to ``receivership'' in
order to align with the statutory authority of FHFA under the
Federal Housing Enterprises Safety and Soundness Act of 1992.
\79\ This would also include any limited-life regulated entity
succeeding to the charter of either Enterprise pursuant to the
authority of FHFA as conservator or receiver in respect of such
Enterprise under the Federal Housing Enterprises Safety and
Soundness Act of 1992, provided that such successor entity is
operating with capital support from the United States.
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The Enterprises act as mortgage loan seller, master servicer, and,
at times, trustee for collateralized mortgage obligations and other
MBS. The Enterprises select and manage the assets in the asset pools
underlying the securities and set the selection criteria and servicing
guidelines for the securities. The Enterprises serve as guarantors for
MBS, and, as guarantors, they are required to make principal and
interest payments on the securities regardless of credit losses on the
underlying mortgages.
Because some of these activities fall within the proposed
definition of ``sponsor,'' Fannie Mae or Freddie Mac (or a successor
limited-life regulated entity) would, absent an exception, be the
sponsor of the ABS that it issues for purposes of the re-proposed rule.
However, because such entities would be excluded from the definition of
``sponsor'' under, and subject to the conditions of, paragraph (iii) of
the proposed definition of ``sponsor,'' neither Enterprise would be
subject to the rule's prohibition with respect to the relevant
Enterprise-guaranteed ABS. We believe that this is appropriate where
Fannie Mae and Freddie Mac operate with capital support from the United
States and fully guarantee the timely payment of principal and interest
on their guaranteed ABS. This is because Fannie Mae and Freddie Mac are
exposed to the entire credit risk of the mortgages that collateralize
such ABS instead of investors, and an Enterprise's
[[Page 9688]]
guarantee would protect investors fully against the risk of credit
losses on the underlying assets, at least for so long as the Enterprise
remains in conservatorship with capital support from the United States
as discussed below.
Both Fannie Mae and Freddie Mac have been operating under the
conservatorship of FHFA since September 6, 2008. Concurrently with
being placed in conservatorship under Section 1367 of the Federal
Housing Enterprises Financial Safety and Soundness Act of 1992, each
Enterprise entered into a Senior Preferred Stock Purchase Agreement
(``PSPA'') with the United States Department of the Treasury
(``Treasury''). Under each PSPA, Treasury provided capital support to
the Enterprises through the purchase of senior preferred stock of each
Enterprise.\80\ While the Enterprises are in conservatorship, due to
the unique nature of the authority and oversight of FHFA over their
operations as a result of such status, the Enterprises are not expected
to act in a manner that would result in conflicted transactions that
would benefit private parties, and, thus, are not expected to engage in
the adverse selection of assets for their ABS. Moreover, because of the
capital support provided by Treasury under the PSPAs, each Enterprise's
guarantee fully protects investors against the risk of credit losses on
the underlying assets consistent with the goals and intent of Section
27B. Accordingly, we are proposing to exclude the Enterprises from the
definition of ``sponsor'' with respect to Enterprise-guaranteed ABS
while the Enterprises are in conservatorship or receivership with
capital support from the United States. We recognize the ongoing
activity related to reform of the Enterprises and, if appropriate, we
may revisit and modify the proposed exception if and when the future of
the Enterprises and of the statutory and regulatory framework post-
conservatorship for the Enterprises becomes clearer.\81\
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\80\ For a discussion of Enterprise operations under
conservatorship or receivership with capital support from the United
States, see RR Adopting Release at 77649.
\81\ The RR Adopting Release similarly states that the
application of the credit risk retention rules to the Enterprises
will be revisited and, if appropriate, modified after the future of
the Enterprises and of the statutory and regulatory framework for
the Enterprises becomes clearer. See id. at 77650.
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One commenter to the 2011 proposed rule also suggested an exception
for the Enterprises' security-based credit risk transfer (``CRT'')
transactions to allow for efficient mitigation of the Enterprises'
retained credit risk associated with their holdings of residential and
commercial mortgages and MBS.\82\ A security-based CRT transaction
typically involves the issuance of unguaranteed ABS by a special
purpose trust where the performance of such ABS is linked to the
performance of a reference pool of mortgage loans that collateralize
Enterprise guaranteed-MBS.\83\ As a part of a security-based CRT
transaction structure, the relevant Enterprise enters into an agreement
with the special purpose trust pursuant to which the trust has a
contractual obligation to pay the Enterprise upon the occurrence of
certain adverse events with respect to the referenced mortgage
loans.\84\
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\82\ See comment letter from Fannie Mae and Freddie Mac (Dec.
21, 2015) (``Fannie Mae/Freddie Mac Letter'') at 3-8.
\83\ See, e.g., the relevant legal documentation and other
related information about Freddie Mac's single-family transactions,
available at <a href="https://capitalmarkets.freddiemac.com/crt/securities/deal-documents">https://capitalmarkets.freddiemac.com/crt/securities/deal-documents</a>.
\84\ See id.
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The proposed exclusion of the Enterprises, subject to certain
conditions, from the definition of ``sponsor'' with respect to
Enterprise-guaranteed ABS should address concerns that, absent such an
exception, an Enterprise might be prohibited from engaging in a
security-based CRT transaction, which could be a ``conflicted
transaction'' under the re-proposed rule with respect to an
Enterprise's guaranteed ABS.\85\ Again, the investors in ABS fully
insured or fully guaranteed by an Enterprise would not be subject to
credit risk so long as an Enterprise's guarantee is backed by the full
faith and credit of the United States. As such, we do not believe that
such investors bear significant risk of conflicted transactions.
Accordingly, under the re-proposed rule, the relevant Enterprise,
subject to the conditions discussed above, would not be defined as a
``sponsor'' of its Enterprise-guaranteed ABS and would, therefore, not
be a ``securitization participant'' under the re-proposed rule with
respect to its Enterprise-guaranteed ABS.
---------------------------------------------------------------------------
\85\ See Section II.D. for a discussion of what would be a
``conflicted transaction'' for purposes of the re-proposed rule.
---------------------------------------------------------------------------
We note, however, that because a CRT security issued in a security-
based CRT transaction is not guaranteed by the relevant Enterprise,
investors in a CRT security would bear credit risk. Furthermore,
because the CRT security is not fully insured or fully guaranteed by an
Enterprise, the proposed exclusion from the definition of ``sponsor''
for the Enterprises with respect to Enterprise-guaranteed ABS would not
apply to a CRT security itself. Therefore, the Enterprises would be
``sponsors'' of CRT securities for purposes of the re-proposed rule and
would be prohibited from engaging in conflicted transactions that would
be prohibited by the re-proposed rule with respect to investors in such
CRT securities.
Request for Comment
15. Is the proposed definition of the term ``sponsor''
overinclusive or underinclusive? Please explain why or why not.
16. We seek comment on the concept in the definition of the term
``sponsor'' of a person directing or causing the direction of the
structure, design, or assembly of an ABS or the composition of the pool
of assets underlying the ABS. Is this concept, in the context of a
person that does not have a contractual right to exercise such
direction, overinclusive or underinclusive, and why? In particular, is
the reference to ``causes the direction of'' necessary in order to
capture direction given through a third party, or is the reference
unnecessary because of the inclusion of the anti-circumvention
provision in proposed Rule 192(d)? Why or why not? Are there additional
indicia that should be included or referenced for purposes of the facts
and circumstances that would be relevant to this determination? What
parties that have a role in a securitization could fall within the
proposed definition of ``sponsor'' because they direct or cause the
direction of the structure, design, or assembly of an ABS or the
composition of the pool of assets underlying an ABS? Should all of
these parties be included? Should other parties be included in the
definition of ``sponsor''? Which of these parties would not be a
sponsor because of the exclusion in paragraph (ii)(C) of the proposed
definition of ``sponsor'' for a person that performs only
administrative, legal, due diligence, custodial, or ministerial acts
related to the structure, design, or assembly of the ABS or the
composition of the pool of assets underlying the ABS? The proposed
definition of the term ``sponsor'' includes, but is not limited to, a
sponsor as defined in Regulation AB. If the rule were limited to the
Regulation AB definition of ``sponsor,'' would that make the rule
underinclusive? Would it be clear how to determine which party or
parties would be a sponsor when applying the Regulation AB definition
of ``sponsor'' to the wider population of ABS that are not subject to
Regulation AB, but are
[[Page 9689]]
subject to the prohibitions of Section 27B? \86\
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\86\ See discussion in Section II.A.
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17. We seek comment on an alternative definition of the term
``sponsor'' where paragraph (ii) of the proposed definition of
``sponsor'' would include a contractual rights sponsor described in
paragraph (ii)(A) of the proposed definition of ``sponsor'' but would
not include a directing sponsor described in paragraph (ii)(B) of the
proposed definition of ``sponsor.'' Would this alternative definition
better address concerns of commenters on the 2011 proposed rule about
potential overinclusiveness of the definition of the term ``sponsor''
by covering only persons with a contractual relationship with the
entity that issues the ABS (or with one or more of the other
securitization participants)? Would this alternative definition be
underinclusive because it would not cover all the parties that could
direct or cause the direction of the structure, design, or assembly of
an ABS or the composition of the pool of assets underlying the ABS,
such as a hedge fund manager or other private fund manager that would
have an opportunity to benefit from a bet against the performance of
the ABS or the underlying assets? If paragraph (ii) of the definition
of ``sponsor'' were limited to a contractual rights sponsor, even if it
might not cover the full range of potentially culpable parties, would
it nonetheless prevent most conflicted transactions from occurring
because of its interaction with other provisions of the rule? Further,
should the definition of the term ``sponsor'' be limited to refer to
only a contractual rights sponsor that has actually exercised its
relevant contractual rights?
18. We seek comment on an alternative definition of the term
``sponsor'' that would include an additional catch-all prong that would
include ``any other person that makes a material contribution to the
design, composition, assembly, sale, or management of an asset-backed
security'' as suggested by certain commenters to the 2011 proposed
rule.\87\ Would this catch-all better capture all parties that could
engage in conduct prohibited by Section 27B? What parties that have a
role in a securitization would be captured by this catch-all that would
not otherwise be subject to the re-proposed rule? Should such parties,
if any, be subject to the re-proposed rule's prohibition on material
conflicts of interest? Please explain why or why not. Would such a
catch-all be overinclusive, or would it unduly burden parties that
would not have the incentive or ability to engage in conduct prohibited
by Section 27B? Please also explain whether and how such a catch-all
would be consistent with Section 27B.
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\87\ See, e.g., Better Markets Letter at 3; Merkley-Levin Letter
at 3-4.
---------------------------------------------------------------------------
19. Is the exclusion in paragraph (ii)(C) of the proposed
definition of ``sponsor'' for a person that performs only
administrative, legal, due diligence, custodial, or ministerial acts
related to the structure, design, or assembly of the ABS or the
composition of the pool of assets overinclusive or underinclusive, and
why? Are there additional administrative activities and functions in
the context of ABS that should be addressed? Is it clear whether
servicers or other contractual service providers with ongoing
managerial or administrative roles with respect to the securitization,
but limited discretion over the structure, design, or assembly of the
ABS or the composition of the pool of assets underlying the ABS, would
qualify for the proposed exclusion? Please explain why or why not.
Should the exclusion be modified to provide more detail on the types of
activities that can be provided by a party while continuing to qualify
for the exclusion from the proposed definition of ``sponsor''? If so,
please explain how the exclusion should be modified, including which
types of activities the exclusion should reference.
20. Should we modify the proposed exception from the definition of
``sponsor'' for the United States or an agency of the United States
with respect to an ABS that is fully insured or fully guaranteed by the
United States? If so, describe any suggested modifications or deletions
to the exception and explain why they would be necessary and how they
would be consistent with Section 27B.
21. Should we modify the proposed exception from the definition of
``sponsor'' for the United States or an agency of the United States to
apply not only with respect to an ABS that is fully insured or fully
guaranteed by the United States but also an ABS that is not fully
insured or fully guaranteed by the United States? If so, describe any
suggested modifications or deletions to the exception and explain why
they would be necessary and how they would be consistent with Section
27B.
22. The proposed exceptions from the definition of ``sponsor'' in
paragraph (iii) of the proposed definition of ``sponsor'' are premised
on the fact that the United States, and not investors in such ABS, is
exposed to the credit risk of the underlying assets because of the
credit support provided by the United States. Are there other types of
non-credit-related risks, such as interest rate risk or prepayment
risk, that we should also address in the context of such fully insured
or fully guaranteed ABS transactions for purposes of the prohibition,
and if so, how should these proposed exceptions be modified to address
such risks?
23. Should we modify the proposed exception from the definition of
``sponsor'' in paragraph (iii)(B) of the proposed definition of
``sponsor'' for the Enterprises with respect to an ABS that is fully
insured or fully guaranteed by the relevant entity? Please describe any
suggested modifications or deletions to the exception and explain why
they would be necessary and how they would be consistent with Section
27B.
24. The proposed exception from the definition of ``sponsor'' for
the Enterprises in paragraph (iii)(B) of the proposed definition of
``sponsor'' would apply only for so long as the applicable Enterprise
is operating under conservatorship or receivership of FHFA with capital
support from the United States. Should it apply beyond that time
period? If so, why, and how would that be consistent with Section 27B?
25. If so, then investors in Enterprise-guaranteed ABS would be
relying solely on the Enterprise guarantee due to the lack of the
capital support from the United States. If the exception were to extend
beyond conservatorship, then are there any ways that the rule could
address the credit risk related to the Enterprise guarantee and the
conflicts that could arise from securitization participants engaging in
conflicted transactions? Should the exception for the Enterprises be
subject to any other conditions?
26. In addition to or in lieu of the proposed exceptions from the
definition of ``sponsor'' in paragraph (iii) of the proposed definition
of ``sponsor'' discussed above, should there be an exception for ABS
that is fully insured or fully guaranteed by, or collateralized solely
by obligations issued, fully insured, or fully guaranteed by, the
United States or an agency of the United States? If so, should it be an
exception to the definition of ``asset-backed security,'' or should it
be an exception to the re-proposed rule's prohibition? Please explain
why any such exception would be necessary and what conditions, if any,
should apply to the application of that exception. How would such an
exception be consistent with Section 27B?
27. In addition to or in lieu of the proposed exceptions from the
definition of ``sponsor'' in paragraph (iii) of the
[[Page 9690]]
proposed definition of ``sponsor'' discussed above, should there be an
exception to the definition of ``asset-backed security'' for an ABS
that is fully insured or fully guaranteed as to the timely payment of
principal and interest by the Enterprises while operating under the
conservatorship or receivership of FHFA with capital support from the
United States? If so, please explain why such an exception would be
necessary, how such an exception would be consistent with Section 27B,
and if any conditions should apply to the application of such an
exception.
28. Are there any other types of government entities, including
municipal entities, that should be exempt from the re-proposed rule?
Please explain why they should be exempt and how such an exemption
would be consistent with Section 27B. If the relevant ABS are not fully
insured or fully guaranteed by a government or government-controlled
entity, then please explain why securitization participants that would
be covered by the re-proposed rule should be exempt, including whether
the opportunity exists to engage in the type of conduct prohibited by
the re-proposed rule.
3. Affiliates and Subsidiaries
Consistent with Section 27B(a), the proposed definition of
``securitization participant'' in proposed Rule 192(c) would extend to
affiliates and subsidiaries of an underwriter, placement agent, initial
purchaser, or sponsor of an ABS. Including affiliates and subsidiaries
in the re-proposed rule would help to prevent affiliates and
subsidiaries from being used to evade the rule's prohibitions and would
also be consistent with Section 27B.
Proposed Rule 192 is being proposed under the Securities Act, and
the rule refers to the definitions of the terms ``affiliate'' and
``subsidiary'' under 17 CFR 230.405 (``Securities Act Rule 405'').
Under Securities Act Rule 405, an ``affiliate'' of a specified person
is a person that directly, or indirectly through one or more
intermediaries, controls or is controlled by, or is under common
control with, the person specified, and a ``subsidiary'' of a specified
person means an affiliate controlled by such person directly, or
indirectly through one or more intermediaries.\88\ Also, under
Securities Act Rule 405, the term ``control'' is defined to mean the
possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of a person, whether through
the ownership of voting securities, by contract, or otherwise.\89\
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\88\ 17 CFR 230.405.
\89\ Id.
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We believe that these definitions are commonly understood by market
participants and would help to prevent evasion of the re-proposed rule.
The re-proposed rule is designed to prevent securitization participants
from entering into transactions that are bets against the ABS that they
create or sell to investors, and it would be inconsistent with the
intent of the re-proposed rule if the prohibition did not extend to
cover a transaction structure where a securitization participant
directs, either directly or through one or more intermediaries, an
affiliate or subsidiary to enter into such a bet against the relevant
ABS. We believe that, to cover the various ways in which an affiliate
or subsidiary relationship may be effectuated, the re-proposed rule
should cover such a scenario whether the securitization participant's
ability to direct the management and policies of the relevant entity
are through the ownership of voting securities, by contract, or
otherwise.
The inclusion of affiliates and subsidiaries in the re-proposed
rule means that persons in addition to underwriters, placement agents,
initial purchasers, or sponsors of an ABS would be securitization
participants for purposes of the re-proposed rule if they are an
affiliate or subsidiary of an underwriter, placement agent, initial
purchaser, or sponsor of an ABS. For example, a servicer that is a
sponsor's affiliate would fall within the scope of the re-proposed rule
even if the servicer's role in connection with the securitization would
not meet the re-proposed rule's definition of the term ``sponsor.''
\90\
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\90\ We understand that servicers are often affiliated with the
sponsor of an ABS. See, e.g., 2004 Regulation AB Adopting Release at
1511 (stating that because the issuing entity is designed to be a
passive entity, one or more ``servicers,'' often affiliated with the
sponsor, are generally necessary to collect payments from obligors
of the pool assets, to carry out the other important functions
involved in administering the assets, and to calculate and pay the
amounts net of fees due to the investors that hold the ABS to the
trustee, which actually makes the payments to investors).
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We received comments to the 2011 proposed rule that including
affiliates and subsidiaries would be overinclusive and that it would
impose an unduly burdensome impact on certain persons.\91\ Certain
commenters to the 2011 proposed rule suggested that the use of
information barriers would mitigate the re-proposed rule's potential
overinclusion of affiliates and subsidiaries of securitization
participants.\92\ One commenter to the 2011 proposed rule specifically
supported the use of an information barriers regime with respect to
investment companies and investment advisers that are affiliates or
subsidiaries of securitization participants.\93\ However, other
commenters opposed the use of information barriers to manage material
conflicts of interest in connection with the 2011 proposed rule for
reasons such as perceived permeability, limited utility, and
difficulties associated with monitoring and enforcing information
barriers in addition to their weakening impact on the prohibition set
forth in Section 27B.\94\
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\91\ See, e.g., ABA Letter at 11-12; SIFMA Letter at 12-15.
\92\ See, e.g., ABA Letter at 11-12; ASF Letter at 10-11;
comment letter from The Financial Services Roundtable (Feb. 13,
2012) (``Roundtable Letter'') at 10; SIFMA Letter at 14-15.
\93\ See, e.g., ICI Letter at 5-7.
\94\ See Barnard Letter at 2 (stating that, although information
barriers and disclosure may be useful to mitigate conflicts of
interest, short transactions should be absolutely prohibited);
Better Markets Letter at 9 n.23 (stating that history had proved
that information barriers are not reliable and are difficult for
regulators to monitor and enforce); comment letter from Public
Citizen (Feb. 13, 2012) (``Public Citizen Letter'') at 1, 4-5
(stating that information barriers invite abuse and present major
enforcement problems); Tewary Letter 1 at 13-14 (stating that
academic studies have found that, even where information barriers
are erected, regulators are routinely unaware of when such barriers
have been breached).
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Information barriers, in the form of written, reasonably designed
policies and procedures, have been recognized in others areas of the
Federal securities laws and the rules thereunder. For example, brokers
and dealers have used information barriers to manage the potential
misuse of material non-public information to adhere to Section 15(g) of
the Exchange Act.\95\ Also, Regulation M contains an exception for
affiliated purchasers if, among other requirements, the affiliate
maintains and enforces written policies and procedures reasonably
designed to prevent the flow of information to or from the affiliate
that might result in a violation of Regulation M.\96\
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\95\ 17 U.S.C. 78o(g).
\96\ 17 CFR 242.100-105; 17 CFR 242.100(b).
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The re-proposed rule does not include the use of information
barriers as an exception for affiliates and subsidiaries because we are
concerned about the potential to use an affiliate or subsidiary to
evade the re-proposed rule's prohibition. However, we seek comment
below on whether an exception utilizing information barriers to exclude
affiliates and subsidiaries could be implemented in a way that would be
consistent with Section 27B. Responses to such questions would provide
further insight
[[Page 9691]]
on commenters' views on the 2011 proposed rule that supported the use
of information barriers, including whether such an approach would be
appropriate with respect to investment companies and investment
advisers that are affiliates or subsidiaries of certain securitization
participants.\97\
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\97\ See, e.g., ICI Letter at 5-7.
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An information barriers exception could contain conditions that
must be met to qualify for such exception, which would help ensure that
the relevant affiliates or subsidiaries of a securitization participant
would not engage in transactions that would involve or result in a
material conflict of interest. For example, an information barrier-
based exception could contain a condition requiring that an
underwriter, placement agent, initial purchaser, or sponsor of an ABS
establish, implement, maintain, enforce, and document written policies
and procedures to prevent the flow of information to and from such
underwriter, placement agent, initial purchaser, or sponsor and its
affiliates and subsidiaries that might result in a violation of the re-
proposed rule. Such written policies and procedures could aid the
underwriter, initial purchaser, placement agent, and sponsor in
monitoring and enforcing the applicable information barriers. For
example, the policies and procedures could include a physical
separation of personnel which could help to restrict information flow,
for example, between a securitization participant and its affiliates
and subsidiaries, and could promote a barrier between activities
related to securitization and other activities that are unrelated to
the creation and distribution of ABS. Additionally, policies and
procedures could restrict the activities of an underwriter, placement
agent, initial purchaser, or sponsor in the context of an ABS
transaction to only those activities necessary for it to act in such
capacity, such that the securitization participant would be further
limited in its ability to engage in activity that Section 27B is
designed to prevent.
A second condition to an information barriers exception could be to
require that an underwriter, placement agent, initial purchaser, or
sponsor of an ABS establish, implement, maintain, enforce, and document
a written internal control structure governing the implementation and
adherence to the policies and procedures required under the information
barriers exception. An internal control condition would aid the
underwriter, initial purchaser, placement agent, and sponsor in
monitoring, identifying, and remediating non-compliance with the
applicable information barriers. For example, an internal control
structure would help identify whether policies and procedures would
need to be modified so that they achieve their intended purpose.
A third condition could be that the securitization participant
obtains an annual, independent assessment of the operation of the
policies and procedures and internal control structure required under
the information barriers exception. This condition would also aid the
underwriter, initial purchaser, placement agent, and sponsor in
monitoring, identifying, and remediating non-compliance with the
applicable information barriers that are not identified by the internal
control structure.
A fourth condition could be that the affiliate or subsidiary has no
officers (or persons performing similar functions) or employees (other
than clerical, ministerial, or support personnel) in common with the
underwriter, initial purchaser, placement agent, or sponsor and was not
involved in the creation, distribution, origination of the assets, or
otherwise providing services with respect to the related ABS. For
example, originators and servicers that are affiliates or subsidiaries
of an underwriter, placement agent, initial purchaser, or sponsor would
not meet the elements of this condition. This condition would recognize
that it would be nearly impossible to have an effective information
barrier to prevent the flow of information if the affiliates or
subsidiary shared common officers or employees, was involved in the
creation, distribution, or origination of the assets, or is otherwise
providing services related to the ABS.
A fifth condition could be that the information barriers exception
would not be available if, in the case of any specific securitization,
the underwriter, initial purchaser, placement agent, or sponsor knows
or reasonably should know that, notwithstanding meeting the conditions
described above, the transaction would involve or result in a material
conflict of interest. We seek commenters' views on an information
barriers exception with the conditions described above. We also seek
comment on other or different conditions below.
Request for Comment
29. Is it appropriate for the Securities Act Rule 405 definitions
of the terms ``affiliate,'' ``subsidiary,'' and ``control'' to apply
for purposes of the re-proposed rule? If not, please explain why and
provide alternative definitions of these terms that should be used.
30. If a securitization participant that is an investment adviser
``controls'' a fund that it manages for purposes of the re-proposed
rule, then such fund would be an ``affiliate'' or ``subsidiary'' of
such investment adviser and subject to the re-proposed rule. Is this
appropriate? If not, please explain why, provide alternative
definitions of the relevant terms that should be used, and explain how
the modifications would be consistent with Section 27B.
31. The proposed definitions of the terms ``affiliate'' and
``subsidiary'' could include a securitization participant's non-U.S.
affiliates and subsidiaries. Would the inclusion of affiliates and
subsidiaries within the scope of the re-proposed rule result in the
rule having an unnecessary and highly burdensome global reach, as
suggested by one commenter to the 2011 proposed rule? \98\ Why or why
not?
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\98\ See SIFMA Letter at 15.
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32. As discussed above, information barriers are used as tools to
manage conflicts of interest in other areas of the Federal securities
laws and the rules thereunder.\99\ We seek comment on whether
information barriers could be designed to effectively mitigate
prohibited conflicts of interest and provide adequate protection in
this context, whether the use of such barriers would effectively
implement Section 27B, and whether internal information barriers are
vulnerable to breach. If the re-proposed rule were to include the use
of information barriers, should there be an exception for an affiliate
or subsidiary of an underwriter, placement agent, initial purchaser, or
sponsor of an ABS if each of the following conditions is satisfied: (1)
the underwriter, placement agent, initial purchaser, or sponsor of the
ABS establishes, implements, maintains, enforces, and documents written
policies and procedures to prevent the flow of information to and from
the affiliate or subsidiary that might result in a violation of the re-
proposed rule; (2) the underwriter, placement agent, initial purchaser,
or sponsor of the ABS establishes, implements, maintains, enforces, and
documents a written internal control structure governing the
implementation of, and adherence to, the written policies and
procedures; (3) the underwriter, placement agent, initial purchaser, or
sponsor of the ABS obtains an annual, independent assessment of the
operation of such policies and procedures and internal control
structure; (4) the affiliate or subsidiary has no officers (or persons
performing similar functions) or
[[Page 9692]]
employees (other than clerical, ministerial, or support personnel) in
common with the underwriter, placement agent, initial purchaser, or
sponsor of the ABS, and was not involved in the creation or
distribution of, or otherwise involved in providing services with
respect to, the related ABS; and (5) a person may not rely on the
exception if, in the case of any specific securitization, the person
knows or reasonably should know that notwithstanding satisfying the
conditions, a transaction would involve or result in a material
conflict of interest? How would this exception be consistent with
Section 27B?
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\99\ See Section II.B.3.
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33. Please identify any additional conditions that would be
appropriate for a potential information barriers exception to include
in order to help maintain strong conflict of interest protection while
permitting normal course business activities for certain affiliates and
subsidiaries, and how those conditions would be consistent with Section
27B.
34. Should any of the conditions described in question 32 be
modified if the final rule were to include an information barriers
exception? For example, should condition (1) be modified to specify
that policies and procedures such as physical separation of personnel
and functions and limitations on the types of permissible activities of
an underwriter, initial purchaser, placement agent, or sponsor (and its
affiliates and subsidiaries) could satisfy this condition? Should
condition (1) be modified to specify that the policies and procedures
must take into consideration the nature of the entity's business?
Should any of the conditions be deleted? If so, explain why, including
why the removal of any such conditions would be consistent with Section
27B if the final rule were to include an information barriers
exception.
35. Should the potential information barriers exception described
in question 32 include a condition that the offering document for the
ABS must disclose the types of transactions that the affiliate or
subsidiary could engage in as part of its normal, ordinary course of
business? How could any such disclosure condition be structured so that
the resulting disclosure would not contain vague boilerplate language?
How could such disclosure be provided to investors if the transactions
occur after the offering but within the timeframe of the prohibition?
How would any such disclosure conditions be consistent with Section
27B?
36. Should the potential information barriers exception described
in question 32 provide an exception for specific types of businesses
that are unrelated to the creation and distribution of ABS such that
only affiliates and subsidiaries engaged in those specific businesses
would be eligible for the exception? If yes, please explain and provide
a list of specific businesses unrelated to the creation and
distribution of ABS that should be listed in any such exception (for
example, mutual fund asset-management, investment advisers acting on
behalf of clients, foreign trading desks facilitating customer trades).
Also, please explain how any such exceptions would be consistent with
Section 27B. If no, please explain.
37. Should the potential information barriers exception described
in question 32 provide an exception if the affiliate or subsidiary
already would be subject to existing rules and regulation that provide
for conflict management or restricting information flow as the
requirements of such rules and regulations could help to achieve the
policy objectives of the re-proposed rule? Please list specific rules
and regulations that provide for managing conflicts of interest or
restricting information flow at the affiliate or subsidiary as a
condition to qualifying for such exception.
38. Should the re-proposed rule include an information barriers
exception as described by one commenter to the 2011 proposed rule?
\100\ How would such an exception be consistent with Section 27B?
Should any conditions that were suggested by that commenter be added to
the information barriers exception described in question 32? In lieu of
condition (3) in question 32, should a potential information barriers
exception instead require periodic internal audits of compliance with
policies and procedures? If so, how often should that assessment be?
For example, should it be monthly, annually, or quarterly and why? Is
there a particular actor within an organization that should perform the
internal audit? If so, who would that be and why?
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\100\ See SIFMA Letter at 15 (describing a safe harbor that
would permit a financial institution to design its own information
barriers).
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C. Timeframe of Prohibition
We are proposing in Rule 192(a)(1) that the prohibition on
conflicted transactions would commence on the date on which a person
has reached, or has taken substantial steps to reach, an agreement
\101\ that such person will become a securitization participant
(``commencement point'') and would end one year after the date of the
first closing of the sale of the relevant ABS. This end point for the
covered timeframe is set forth in the statutory language of Section
27B, and the re-proposed rule incorporates that statutory language. The
prohibition in the 2011 proposed rule would have applied at any time
for a period ending on the date that is one year after the date of the
first closing of the sale of the ABS.
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\101\ For purposes of the re-proposed rule, an ``agreement''
need not constitute an executed written agreement, such as an
engagement letter. Oral agreements and facts and circumstances
constituting an agreement, even absent an executed engagement
letter, can be an agreement for purposes of the rule. We expect that
market participants would know and understand when an agreement has
been reached.
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The re-proposed rule's approach to the commencement point is
designed to reduce the circumstances in which a person could engage in
prohibited conduct prior to the issuance of the relevant ABS. We
preliminarily believe that the point at which a securitization
participant has reached, or has taken substantial steps to reach, an
agreement that such person will become a securitization participant is
the appropriate commencement point for the prohibition in the re-
proposed rule because that is the point at which a person may be
incentivized and/or can act on an incentive to engage in the misconduct
that Section 27B is designed to prevent.
Whether a person has taken substantial steps to reach an agreement
to become a securitization participant would be a facts and
circumstances determination based on the actions of such person in
furtherance of becoming a securitization participant. For example, a
person who has engaged in substantial negotiations over the terms of an
engagement letter or other agreement to become an underwriter,
placement agent, initial purchaser, or sponsor of an ABS would be
subject to the prohibition in the re-proposed rule by virtue of having
taken substantial steps to reach an agreement to become a
securitization participant. The re-proposed rule does not define
``agreement'' or ``substantial steps to reach . . . an agreement'' in
the context of the commencement point. However, we seek comment below
on indicia of whether a person has reached an agreement to become a
securitization participant, or taken substantial steps to reach such an
agreement, and whether such indicia should be specified in the rule.
Proposed Rule 192(a)(1) prohibits a securitization participant from
engaging in any transaction that would involve or result in any
material conflict of interest
[[Page 9693]]
between the securitization participant and an investor in the relevant
ABS. In order for the prohibition in proposed Rule 192(a)(1) to apply
to a potentially conflicted transaction, an ABS must have been created
and sold to one or more investors; in the absence of the creation and
sale of an ABS, there would be no investors in an ABS with respect to
which a potentially conflicted transaction could involve or result in a
material conflict of interest. Additionally, the prohibition in
proposed Rule 192(a)(1) applies only to a securitization participant
(i.e., an underwriter, placement agent, initial purchaser, or sponsor
of an ABS or any affiliate or subsidiary of any such person).
Therefore, under the re-proposed rule, the prohibition on material
conflicts of interest would not apply to a person that never reaches an
agreement to become an underwriter, placement agent, initial purchaser,
or sponsor of an ABS, even if such person were to take substantial
steps to reach such an agreement.\102\ However, once a person has
become a securitization participant and an ABS has been created and
sold, the re-proposed rule's prohibition would apply to such person
commencing on the date on which such person reached, or took
substantial steps to reach, an agreement to become a securitization
participant. As a practical matter, this means that if a person were to
enter into a potentially conflicted transaction prior to becoming a
securitization participant, e.g., while engaged in negotiations to
become a securitization participant, the person could avoid violating
the re-proposed rule by withdrawing from the transaction prior to
becoming a securitization participant. However, if the person were to
become a securitization participant with respect to an ABS after having
engaged in a potentially conflicted transaction, the person would be in
violation of the re-proposed rule by virtue of being a securitization
participant that had engaged in a conflicted transaction during the
period specified in proposed Rule 192(a)(1). We preliminarily believe
that this approach to the commencement point would help prevent conduct
that the re-proposed rule is designed to prohibit that occurs prior to
a person having reached an agreement to become a securitization
participant.
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\102\ We note, however, that if such person were to direct or
cause the direction of the structure, design, or assembly of an ABS
or the composition of the pool of assets underlying the ABS, such
person would be a directing sponsor under paragraph (ii)(B) of the
proposed definition of ``sponsor'' (which, by extension, means that
such person would be subject to the re-proposed rule's prohibition)
even if such person had no contractual right to do so. See Section
II.B.2.
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Certain commenters to the 2011 proposed rule supported specific
dates as the commencement point (e.g., the date of the first marketing
or offering materials for the ABS,\103\ the pricing date for the
ABS,\104\ or the point in time when an issuer engages those involved in
structuring and marketing the ABS \105\). We also received comment that
supported leaving the commencement point unspecified because, for
example, specific commencement points may be underinclusive.\106\ We
believe that a commencement point that begins on the date of the first
marketing or offering materials for the ABS, the pricing date for the
ABS, or the point in time when an issuer engages those involved in
structuring and marketing the ABS could be underinclusive because a
securitization participant could engage in the misconduct that Section
27B is designed to prevent just prior to such commencement points and
the rule would, as a result, not cover misconduct prior to those dates.
Therefore, we believe that the commencement point should begin at an
early point in time when a securitization participant may first have
the opportunity to engage in the misconduct that Section 27B is
designed to prevent.
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\103\ See ASF Letter at 24; SIFMA Letter at 23.
\104\ See SIFMA Letter at 23.
\105\ See ASF Letter at 24.
\106\ See AFR Letter at 7; Barnard Letter at 3; Better Markets
Letter at 5; Merkley-Levin Letter at 6.
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Request for Comment
39. We seek commenters' views regarding the approach to the covered
timeframe in the re-proposed rule. Should we modify the proposed
covered timeframe in the re-proposed rule, and if so, how and why?
40. In particular, we seek comment on the proposed commencement
point of the re-proposed rule's prohibition on material conflicts of
interest. Is it appropriate for the re-proposed rule's prohibition to
commence at the point at which a person has reached, or has taken
substantial steps to reach, an agreement that such person will become a
securitization participant, and why? Are there modifications to the
commencement point that might be necessary or advisable to mitigate any
unintended consequences? Should the rule specify when a person has
reached an agreement to become a securitization participant? For
example, should the rule specify that ``agreement'' refers to a formal,
written agreement to become a securitization participant, or should it
instead specify that ``agreement'' refers to an agreement in principle
as to the major terms of the arrangement by which such person will
become a securitization participant, and why? Should the rule identify
specific activities that would constitute ``substantial steps'' to
becoming an underwriter, placement agent, initial purchaser, or sponsor
of an ABS? Why or why not? Please provide comment on specific
activities that you believe constitute ``substantial steps'' to
becoming an underwriter, placement agent, initial purchaser, or sponsor
of an ABS, and whether any or all of such activities should be
specified in the rule.
41. We seek comment on whether we should specify additional factors
that would indicate when a person has reached an agreement to become a
securitization participant. Should an ``agreement'' arise only through
an executed engagement letter or the oral equivalent of an executed
engagement letter, or should the facts and circumstances of the
situation dictate when an agreement has been reached?
42. We seek comment on the implications of the commencement point
of the re-proposed rule's prohibition on affiliates and subsidiaries of
a person seeking to become an underwriter, placement agent, initial
purchaser, or sponsor of an ABS. How would an affiliate or a subsidiary
of such a person know that the person had taken substantial steps to
reach an agreement to become a securitization participant, such that a
conflicted transaction entered into by the affiliate or subsidiary
would be prohibited by the re-proposed rule if the person seeking to
become a securitization participant were to ultimately reach an
agreement to become a securitization participant? Are there existing
information barriers in place within certain regulated firms that would
prevent the person seeking to become a securitization participant from
informing its affiliates and subsidiaries that it had taken substantial
steps to reach an agreement to become a securitization participant? For
these or other reasons, should the re-proposed rule be modified to
prohibit conflicted transactions by affiliates or subsidiaries of a
person seeking to become an underwriter, placement agent, initial
purchaser, or sponsor of an ABS only after such person has reached an
agreement to become a securitization participant, and why? If so,
please explain how the re-proposed rule should be modified, and how
such
[[Page 9694]]
modifications would be consistent with Section 27B.
43. How should the rule treat a person that never reaches an
agreement to become an underwriter, placement agent, initial purchaser,
or sponsor of an ABS, despite having taken substantial steps to reach
such an agreement? As discussed above, the re-proposed rule's
prohibition generally would not apply to a person that does not reach
an agreement to become an underwriter, placement agent, initial
purchaser, or sponsor of an ABS, even if such person were to take
substantial steps to reach such an agreement. However, once a person
has become a securitization participant, the rule's prohibition would
apply to such person commencing on the date on which such person
reached, or took substantial steps to reach, an agreement to become a
securitization participant. Would this approach be underinclusive
because it would not cover parties that might have had a significant
role in determining the structure, design, or assembly of an ABS or the
composition of the pool of assets underlying the ABS? Why or why not?
Are any such concerns about potential underinclusiveness adequately
mitigated by the anti-circumvention provision in proposed Rule 192(d)?
D. Prohibition
Section 27B(a) provides that an underwriter, placement agent,
initial purchaser, or sponsor, or any affiliate or subsidiary of any
such entity, of an ABS, including a synthetic ABS, shall not, at any
time for a period ending on the date that is one year after the date of
the first closing of the sale of the asset-backed security, engage in
any transaction that would involve or result in any material conflict
of interest with respect to any investor in a transaction arising out
of such activity.\107\
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\107\ 15 U.S.C. 77z-2a(a).
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1. Prohibited Conduct
Consistent with Section 27B(a), the prohibition in proposed Rule
192(a)(1) provides that a securitization participant shall not, for a
period commencing on the date on which a person has reached, or has
taken substantial steps to reach, an agreement that such person will
become a securitization participant with respect to an asset-backed
security and ending on the date that is one year after the date of the
first closing of the sale of such asset-backed security, directly or
indirectly engage in any transaction that would involve or result in
any material conflict of interest between the securitization
participant and an investor in such asset-backed security. As set forth
in proposed Rule 192(a)(2), engaging in any transaction would involve
or result in any material conflict of interest between a securitization
participant and an investor if such transaction is a ``conflicted
transaction'' as defined in proposed Rule 192(a)(3). This formulation
is designed to effectuate Section 27B by prohibiting a securitization
participant from entering into a conflicted transaction that is, in
effect, a bet against the ABS that such securitization participant
created and/or sold to investors. We believe that this prohibition in
the re-proposed rule, along with the proposed definitions of
``conflicted transaction'' discussed below,\108\ would provide strong
investor protection against such misconduct, while also providing an
explicit standard for determining which types of transactions would be
prohibited by the re-proposed rule in order to address concerns
expressed by commenters to the 2011 proposed rule about not
unnecessarily prohibiting or restricting activities routinely
undertaken in connection with the securitization process, as well as
routine transactions in the types of financial assets underlying
covered securitizations.
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\108\ The proposed definitions of ``conflicted transaction'' and
``material conflict of interest'' would apply solely for purposes of
the re-proposed rule. See proposed Rule 192(a)(2) and (3).
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The prohibition in the re-proposed rule applies to a ``conflicted
transaction'' entered into by a securitization participant. This is
defined under proposed Rule 192(a)(3) to include two main components.
One component is whether the transaction is:
<bullet> A short sale of the relevant ABS;
<bullet> The purchase of a CDS or other credit derivative pursuant
to which the securitization participant would be entitled to receive
payments upon the occurrence of a specified adverse event with respect
to the relevant asset-backed security; or
<bullet> The purchase or sale of any financial instrument (other
than the relevant asset-backed security) or entry into a transaction
through which the securitization participant would benefit from the
actual, anticipated, or potential:
[cir] Adverse performance of the asset pool supporting or
referenced by the relevant ABS;
[cir] Loss of principal, monetary default, or early amortization
event on the relevant ABS; or
[cir] Decline in the market value of the relevant ABS.
The other component relates to materiality--i.e., whether there is
a substantial likelihood that a reasonable investor would consider the
relevant transaction important to the investor's investment decision,
including a decision whether to retain the ABS.
Paragraphs (i) and (ii) of the proposed definition of ``conflicted
transaction'' in proposed Rule 192(a)(3) would capture transactions
that constitute direct bets against the relevant ABS itself. In the
case of proposed Rule 192(a)(3)(i), such a direct bet against an ABS
would be a short sale where the securitization participant sells an ABS
that it does not own (or that it will borrow for purposes of delivery).
In such a situation, if the price of the ABS declines, then the short
selling securitization participant could buy the ABS at the lower price
to cover its short and make a profit. However, it is not relevant for
purposes of the re-proposed rule whether the securitization participant
makes a profit on the short sale. It is sufficient that the
securitization participant sells the ABS short. In the case of proposed
Rule 192(a)(3)(ii), a direct bet against an ABS would be entering into
a credit derivative that references such ABS and entitles the
securitization participant to receive a payment upon the occurrence of
an adverse event with respect to the ABS such as a failure to pay,
restructuring or any other adverse event that would trigger a payment
on the derivative contract. It would be irrelevant for the purpose of
proposed Rule 192(a)(3)(ii) whether the credit derivative is in the
form of a CDS or other credit derivative product because the focus is
on the economic substance of the credit derivative as a bet against the
relevant ABS without regard to the specific contractual form or
structure of the derivative. Proposed Rule 192(a)(3)(ii) would also
capture any credit derivative entered into by the securitization
participant with the special purpose entity issuer of a synthetic CDO
where that credit derivative would entitle the securitization
participant to receive payments upon the occurrence of a specified
adverse event with respect to an ABS that is referenced by such credit
derivative and with respect to which the relevant person is a
securitization participant under the re-proposed rule.
Clause (iii) of the proposed definition of ``conflicted
transaction'' would capture the purchase or sale of any other financial
instrument or entry into a transaction the terms of which are
substantially the economic equivalent of a direct bet against the
relevant ABS. Specifically, proposed Rule 192(a)(3)(iii) would capture
the purchase or sale of any financial instrument (other than the
relevant ABS) or entry into a transaction
[[Page 9695]]
through which the securitization participant would benefit from certain
actual, anticipated, or potential adverse events with respect to the
relevant ABS or its underlying asset pool. The events specified in
items (A) through (C) of proposed Rule 192(a)(3)(iii) would capture the
various situations pursuant to which an ABS or its underlying asset
pool could perform adversely, which would include the actual,
anticipated, or potential:
<bullet> Adverse performance of the asset pool supporting or
referenced by the relevant ABS;
<bullet> Loss of principal, monetary default, or early amortization
event on the relevant ABS; or
<bullet> Decline in the market value of the relevant ABS.
Each of these events would be adverse to investors in the ABS as it
would negatively impact the distributions on the relevant ABS and/or
its market value. Given that, for example, a security-based swap or
other contractual agreement could be structured to reference only one
of such events occurring, the proposed definition would capture any
such event being referenced as a payment trigger.
The financial instruments captured under proposed Rule
192(a)(3)(iii) would, for example, include entering into the short-side
of a derivative (with the special purpose entity issuer of a synthetic
CDO or otherwise) that references the performance of the pool of assets
underlying the ABS with respect to which the person is a securitization
participant under the re-proposed rule and pursuant to which the
securitization participant would benefit if the referenced asset pool
performs adversely. This is intended to address comments to the 2011
proposed rule in support of a definition of the term ``transaction''
that would include not only a short sale of the relevant ABS or the
purchase of CDS protection on the relevant ABS, but would also include
the purchase or sale of products that are linked to, or otherwise
create an opportunity to benefit from the actual, anticipated, or
potential adverse performance of, the pool of assets underlying the
relevant ABS.\109\ Furthermore, given the potential ability of market
participants to craft novel financial structures that can replicate the
economic mechanics of the types of transactions described in proposed
Rule 192(a)(3)(i) and (ii) without triggering those prongs, proposed
Rule 192(a)(3)(iii) should help alleviate the risk of any attempted
evasion of the rule that is premised on the form of the transaction
rather than its substance. For example, a security-based swap, such as
a total return swap, that, in economic substance, creates an
opportunity to benefit from the adverse performance of the relevant ABS
or the pool of assets underlying the relevant ABS would be captured by
proposed Rule 192(a)(3)(iii) regardless of whether the securitization
participant attempts to structure such security-based swap in a way to
avoid triggering proposed Rule 192(a)(3)(ii).
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\109\ See, e.g., Merkley-Levin Letter at 8 (expressing support
for approach that would capture a securitization participant
directly or indirectly benefiting from the adverse performance of
the relevant asset pool).
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In addition to the purchase or sale of such financial instruments,
proposed Rule 192(a)(3)(iii) would also capture the ``entry into a
transaction'' through which the securitization participant would
benefit from certain actual, anticipated, or potential adverse events
with respect to the relevant ABS or its underlying asset pool. This
should similarly help alleviate the risk of any attempted evasion of
the rule that is premised on the form of the transaction rather than
its substance. For example, in certain synthetic ABS structures, the
relevant agreement that the securitization participant enters into with
the special purpose entity that issues the synthetic ABS may in some
circumstances not be documented in the form of a swap; however, the
terms of such agreement are structured to replicate the terms of a swap
pursuant to which the special purpose entity that issues the synthetic
ABS is obligated to make a payment to the securitization participant
upon the occurrence of certain adverse events in respect of the ABS for
which the person is a securitization participant under the re-proposed
rule. Proposed Rule 192(a)(iii) would capture such an agreement based
on the economic substance of the transaction.
We received comment to the 2011 proposed rule that the scope of
prohibited transactions should be limited to transactions other than
those that are an integral part of the creation and sale of the
relevant ABS.\110\ We are not including such a standard in the re-
proposed rule. Under the re-proposed rule, entering into an agreement
to serve as a securitization participant with respect to an ABS would
not itself be a ``conflicted transaction.'' However, any transaction
that the securitization participant enters into with respect to the
creation or sale of such ABS (e.g., a transaction whereby a
securitization participant takes the short position in connection with
the creation of a synthetic ABS) would need to be analyzed to determine
if it would be a ``conflicted transaction'' under the re-proposed rule.
Proposed Rule 192(a)(3)(iii) would not capture the purchase or sale of
the ABS with respect to which the person is a securitization
participant under the re-proposed rule. The short sale of the relevant
ABS would be separately covered under proposed Rule 192(a)(3)(i), and
the sale of ABS to investors by an underwriter, placement agent, or
initial purchaser would not be captured as a conflicted transaction.
Also, the re-proposed rule is not intended to disincentivize a
securitization participant from retaining portions of an ABS that it
creates or sells.
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\110\ See ASF Letter at 17 (stating that the statutory reference
to engaging in ``any transaction'' was intended to mean a
transaction other than the ABS transaction itself, and accordingly,
that the rule should not prohibit a firm from taking the short
position in connection with the creation of a synthetic ABS).
---------------------------------------------------------------------------
Under proposed Rule 192(a)(3)(iii), it would not be necessary for
the securitization participant to actually benefit from a conflicted
transaction. Rather, it would be sufficient that the transaction
creates an opportunity for the securitization participant to benefit,
for example, from a decline in the market value of the ABS. The
relevant transaction would be a ``conflicted transaction'' even absent
such a decline in market value.
We received comments both in opposition to and in support of
including the modifier ``directly or indirectly'' as used in the
relevant interpretation in the 2011 proposed rule \111\ when describing
benefits accruing to the securitization participant. One commenter
stated that, given that the rule applies to affiliates and subsidiaries
and that there are many inherent conflicts of interest in
securitizations, it is difficult to determine many circumstances where
there are indirect benefits and that, if indirect benefits are to be
addressed, they should be limited to those that are known or reasonably
foreseeable.\112\ Another commenter stated that securitization
participants have no way to ascertain the scope or meaning of
benefiting indirectly from a specified short transaction.\113\ However,
another commenter stated that securitization participants should not be
allowed to perform indirectly what they are barred from doing
directly.\114\ For example, a
[[Page 9696]]
transaction structure could route CDS payments to the securitization
participant through a variety of different legal entities that are
structured to not be affiliates or subsidiaries of the securitization
participant or could attempt to recharacterize such payments in a way
so as to obscure the ultimate economics of a conflicted transaction.
Such a transaction structure would still be captured by proposed Rule
192(a)(3)(iii) because the securitization participant is receiving a
benefit that can be traced back to the actual, anticipated or potential
adverse performance of the relevant ABS or its underlying asset pool.
Accordingly, we have not included the modifier ``directly or
indirectly'' in proposed Rule 192(a)(3)(iii) when describing benefits
accruing to the securitization participant. We believe such reference
to be unnecessary because any transaction under which a securitization
participant would receive a benefit that can be traced back to the
actual, anticipated, or potential adverse performance of the relevant
ABS or its underlying asset pool would already be captured by proposed
Rule 192(a)(3)(iii). Moreover, we believe that the anti-circumvention
language in proposed Rule 192(d) would help to address concerns about
attempts to evade the re-proposed rule's prohibition if a
securitization participant were to route payments through multiple
transactions or recharacterize payments so as to obscure the economics
of a conflicted transaction.
---------------------------------------------------------------------------
\111\ See 2011 Proposing Release at 60330.
\112\ ABA Letter at 5-6.
\113\ SIFMA Letter at 28.
\114\ Tewary Letter 1 at 7.
---------------------------------------------------------------------------
In a change from the 2011 proposed rule, the re-proposed rule would
not define a conflicted transaction to include the scenario in which a
securitization participant would benefit directly or indirectly (e.g.,
from fees or other forms of remuneration, or the promise of future
business, fees, or other forms of remuneration) as a result of allowing
a third party, directly or indirectly, to structure the relevant ABS or
select assets underlying the ABS in a way that facilitates or creates
an opportunity for that third party to benefit from a short
transaction.\115\ Instead, we are taking a different approach to
address possible conflicts by proposing to define the term ``sponsor''
in a manner such that the re-proposed rule's prohibition on engaging in
conflicted transactions would apply directly to most of the parties
whose conduct would have been covered by the 2011 proposed rule. The
definition of the term ``sponsor'' is discussed in Section II.B.2.
above.
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\115\ See 2011 Proposing Release at 60331 (explaining that a
third party might directly or indirectly select assets underlying an
ABS through its relationship with a securitization participant and
that such third party, rather than the securitization participant,
may attempt to enter into a short transaction of the type that the
securitization participant would be prohibited from entering into
itself under the 2011 proposed rule).
---------------------------------------------------------------------------
Certain commenters to the 2011 proposed rule requested
clarification regarding how prohibited activity would be distinguished
from activity undertaken independently of, and not in connection with,
a securitization.\116\ Other commenters expressed concerns about
unnecessarily prohibiting or restricting activities routinely
undertaken in connection with the securitization process.\117\ The re-
proposed rule would address these concerns by providing additional
specificity about the scope of transactions that would be covered by
the rule through the proposed definition of the term ``conflicted
transaction.'' Because the proposed definition of ``conflicted
transaction'' is limited in scope to transactions that are effectively
a bet against the relevant ABS or its underlying pool of assets, the
re-proposed rule would not apply to transactions that are wholly
independent of, and not in connection to, the relevant securitization.
Moreover, as discussed above, those persons that only perform
activities that are administrative, legal, due diligence, custodial, or
ministerial in nature with respect to an ABS would be excluded from the
definition of ``sponsor.'' \118\
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\116\ See, e.g., comment letter from Commercial Real Estate
Financial Council (Feb. 13, 2012) (``CRE Letter'') at 4-5; SIFMA
Letter at 6, 25; ASF Letter at 8-10.
\117\ See, e.g., ASF Letter at 4-6; comment letter from
Association for Financial Markets in Europe, Asia Securities
Industry & Financial Markets Association, and International Capital
Market Association (Feb. 13, 2012) (``AFME/ASIFMA/ICMA Letter'') at
6; CRE Letter at 4-5; SIFMA Letter at 8, 18-21; comment letter from
Northwest Farm Credit Services, FLCA (Feb. 10, 2012) (``Northwest
Letter'') at 4; comment letter from Fannie Mae (Jan. 17, 2012)
(``Fannie Mae Letter'') at 2-8.
\118\ See Section II.B.2.
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Consistent with Section 27B's prohibition of conflicts of interest
that are ``material,'' the definition of ``conflicted transaction'' in
proposed Rule 192(a)(3) requires that there is a substantial likelihood
that a reasonable investor would consider the relevant transaction
important to the investor's investment decision whether to acquire the
asset-backed security. This is similar to the discussion in the release
for the 2011 proposed rule,\119\ which relied on the ``reasonable
investor'' standard of materiality articulated in Basic v.
Levinson.\120\
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\119\ See 2011 Proposing Release at 60331 (citing to Basic v.
Levinson and stating that, in considering whether there is a
substantial likelihood that a reasonable investor would consider the
conflict important to their investment decision, it is not possible
to designate in advance certain facts or occurrences as
determinative in every instance).
\120\ See Basic v. Levinson, 485 U.S. 224, 231-32 (1988) (citing
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
---------------------------------------------------------------------------
The use of this standard would not in this context imply that a
transaction otherwise prohibited under the re-proposed rule would be
permitted if there were adequate disclosure made by the securitization
participant to the relevant investor. The prohibition would apply to
transactions that are bets against the relevant ABS whether or not such
transactions are disclosed to investors in the ABS. While certain
commenters to the 2011 proposed rule supported the use of disclosure to
manage material conflicts of interest,\121\ other commenters opposed
the use of disclosure to manage material conflicts of interest.\122\
One commenter to the 2011 proposed rule stated that disclosure alone
could not cure material conflicts of interest with respect to synthetic
ABS but that disclosure would be sufficient to manage material
conflicts of interest in connection with non-synthetic ABS.\123\ We
have not included an exception to the re-proposed rule based on
disclosure of potential material conflicts of interest because we
believe that such disclosure would be insufficient in this context as
the re-proposed rule is designed to prevent the sale of ABS that are
tainted by material conflicts of interest by prohibiting a
securitization participant from entering into a conflicted transaction
with respect to ABS that it creates or sells to investors. If the re-
proposed rule were to include a disclosure-based exception, then
securitization participants would still be allowed to enter into a
transaction that constitutes a bet against the same ABS that they are
creating or selling to investors so long as such conflicted transaction
is disclosed. Even if disclosure of a conflicted transaction would
reduce the likelihood that an investor would invest in a tainted ABS,
the incentive for a securitization participant to enter into the
conflicted transaction would not be wholly
[[Page 9697]]
eliminated. Furthermore, a disclosure-based exception to the re-
proposed rule would fail to align with Section 27B given that the
proposed prohibition would apply for one year after the date of the
first closing of the sale of the relevant ABS.
---------------------------------------------------------------------------
\121\ See, e.g., ABA Letter at 6-8.
\122\ See, e.g., AFR Letter at 8; Barnard Letter at 2; Better
Markets Letter at 8-9; Public Citizen Letter at 2-3; Tewary Letter 1
at 15; Merkley-Levin Letter at 21. Certain of these commenters,
however, felt that if providing disclosure were nevertheless
permitted to manage conflicts, the disclosure should satisfy strict
requirements, including that it should: be in written form; be
delivered to investors a specific time period prior to investment;
contain particular information; require investor acknowledgment of
receipt of such disclosure and consent to the conflict; and be
prominent, clear, and comprehensive.
\123\ See AII Letter at 3-4.
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Similarly, the use of the reasonable investor standard would not
imply that a transaction otherwise prohibited by the re-proposed rule
would be permitted if an investor selected or approved the assets
underlying the ABS. Although certain commenters to the 2011 proposed
rule suggested that the rule should not prohibit conflicts of interest
between a securitization participant and an investor in an ABS if the
investor was involved in selecting the underlying assets or approving
the underlying portfolio,\124\ we do not believe that investor consent
would provide adequate protection against misconduct. Even if an
investor in an ABS is given accurate information about the pool of
assets underlying the ABS, and consents to the asset pool on the basis
of such information, a securitization participant could nonetheless
structure the ABS or construct the underlying asset pool in a way that
would position the securitization participant to benefit from the
adverse performance of the assets underlying the ABS. Additionally, we
are concerned that an exclusion on the basis of investor consent could
cause some securitization participants to pressure investors to provide
written consent to the portfolio of underlying assets as a condition to
participating in an ABS offering, which would undermine the
effectiveness and purpose of such disclosure and the meaningfulness of
the investor's consent. For these reasons, we are not including such an
exclusion in the re-proposed rule.
---------------------------------------------------------------------------
\124\ See Morgan Stanley Letter at 13, 15-17; SIFMA Letter at
24.
---------------------------------------------------------------------------
Also, although certain commenters to the 2011 proposed rule
supported limiting the scope of material conflicts of interest to ABS
transactions that are intentionally designed to fail,\125\ other
commenters to the 2011 proposed rule were opposed to an intentionally
designed-to-fail approach to determine what constitutes a material
conflict of interest.\126\
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\125\ See ASF Letter at 11; Fannie Mae Letter at 1-2; SIFMA
Letter at 27-28. For example, an ABS transaction in which one or
more securitization participants structure the ABS transaction or
select the underlying assets with the intent or expectation that the
ABS securities will default or decline in value would be
intentionally designed to fail.
\126\ See AFR Letter at 5; Better Markets Letter at 7; Merkley-
Levin Letter at 9-10.
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Under the re-proposed rule, a securitization participant would be
prohibited from designing an ABS to intentionally fail and then
entering into a conflicted transaction in order to profit from the
adverse performance of the ABS; however, the re-proposed rule would not
apply only to ABS that are intentionally designed to fail. We are not
proposing an intentionally designed-to-fail test to determine what
constitutes a material conflict of interest because we believe that
such a test could lead to attempts to evade the rule. Moreover, the
need to prove intent could make enforcement of the rule more difficult,
thereby potentially weakening investor protection. We believe that the
proposed definition of ``material conflict of interest'' in the re-
proposed rule is consistent with Section 27B, which is not limited only
to ABS that are intentionally designed to fail.
As discussed below, both the proposed risk-mitigating hedging
activities exception and the proposed bona fide market-making
activities exception to the re-proposed rule include a requirement that
a securitization participant have certain documented policies and
procedures in place related to its compliance with the requirements of
the relevant exception. However, the re-proposed rule does not include
a more generalized requirement that a securitization participant would
be required to have documented policies and procedures in place that
are reasonably designed to prevent the securitization participant from
violating the re-proposed rule's prohibition with respect to conflicted
transactions regardless of whether the securitization participant is
relying on an exception from the re-proposed rule. This is because,
unlike the exceptions that would include specific requirements that
would need to be satisfied in order for securitization participants to
meet such exceptions, the prohibition in the re-proposed rule is a
general prohibition on entering into conflicted transactions that
cannot be waived on the basis of certain documented policies and
procedures. We seek comment below on whether such a requirement should
be included in the re-proposed rule.
Request for Comment
44. Are there any changes we should make to clarify the application
of proposed Rule 192(a)? If so, what changes should we make and why?
Should we revise the approach to defining the unlawful activity that is
subject to the prohibition under the re-proposed rule? If you believe
that the approach should be different, please provide an alternative
approach and explain why such approach would be preferable and how it
would be consistent with the prohibition on material conflicts of
interest in Section 27B.
45. Does the re-proposed definition of ``material conflicts of
interest'' accurately capture the material conflicts of interest that
Section 27B is designed to address? If you believe that there is a
definition that better identifies the material conflicts of interest
that Section 27B is designed to address, please provide a revised
definition and an explanation for the revisions. For example, would it
clarify the application of proposed Rule 192(a) if the qualification
about the transaction being important to a reasonable investor's
investment decision were included in the definition of ``material
conflict of interest'' in proposed Rule 192(a)(2) rather than, or in
addition to, in the definition of ``conflicted transaction'' in
proposed Rule 192(a)(3)?
46. Proposed Rule 192(a)(1) refers to ``directly or indirectly''
engaging in a transaction involving or resulting in a material conflict
of interest. Is the reference to ``directly or indirectly'' necessary
in order to capture multi-step transactions or conflicted transactions
entered into by a securitization participant through a third party? Is
the reference to ``directly or indirectly'' unnecessary because any
such attempts to ``indirectly'' engage in a conflicted transaction
would be covered by the anti-circumvention provision in proposed Rule
192(d)? In your responses to each of these questions, please explain
why or why not.
47. Is there activity that securitization participants currently
engage in with respect to ABS that would fall within the definition of
``conflicted transaction''? If so, please provide a detailed
explanation of such activity, the securitization participants involved
with respect thereto, and the frequency as to which such activity is
engaged in by such securitization participants. Please describe how
that activity is or is not consistent with Section 27B.
48. Is there any activity that you believe would fall within the
scope of the proposed definition of ``conflicted transaction'' but is
not the type of transaction that Section 27B is intended to prohibit?
Please provide a detailed description of how the rule could define this
activity and those transactions, and the conditions that should attach
to any such exemption in order to protect investors from the misconduct
that is targeted by Section 27B.
49. Is there any activity that you believe would not fall within
the scope of the proposed definition of ``conflicted
[[Page 9698]]
transaction'' but that is the type of transaction that Section 27B is
intended to prohibit? If so, please explain why and provide a detailed
description of such activity or transactions.
50. Is it appropriate for proposed Rule 192(a)(3)(ii) to cover the
purchase of a credit default swap or any other credit derivative
pursuant to which the securitization participant would be entitled to
receive payments upon the occurrence of specified credit events in
respect of the relevant ABS? Should proposed Rule 192(a)(3)(ii) also
apply to the purchase of any security-based swap pursuant to which the
securitization participant would be entitled to receive payments upon
the occurrence of a decline in price of the relevant ABS? Would such an
approach be overinclusive or otherwise result in significant overlap
with the coverage of proposed Rule 192(a)(3)(iii)?
51. Are there any special considerations regarding the use of total
return swaps that should be addressed in the context of the proposed
definition of ``conflicted transaction''?
52. Please discuss the impact of the proposed definition of
``conflicted transaction'' on entities with multiple affiliates or
subsidiaries, particularly with respect to how a securitization
participant would benefit from certain actual, anticipated, or
potential adverse events with respect to the relevant ABS or its
underlying asset pool under proposed Rule 192(a)(3)(iii). Is the
proposed definition of ``conflicted transaction'' as applied to
entities with multiple affiliates or subsidiaries appropriate? If not,
please explain why and provide a description of any additional
qualifying language or alternative that would be more appropriate and
consistent with Section 27B.
53. The re-proposed rule does not include a disclosure-based or
investor approval-based exception for managing material conflicts of
interest. If you believe that the re-proposed rule should allow
securitization participants to manage potential conflicts of interest
using disclosure or through obtaining investor approvals, then please
explain how disclosure or investor approval of such potential conflicts
of interest would adequately protect investors against the risks
associated with such conflicts of interest, particularly in light of
the concerns expressed in this re-proposal. How could a disclosure
exception be structured so that the resulting disclosure would not
contain vague boilerplate language? Should the rule also require that a
securitization participant disclose that it entered into a transaction
that would be a conflicted transaction? How could this disclosure be
provided to investors if the securitization participants engage in
transactions that occur after the offering but within the timeframe of
the prohibition? Please also explain how disclosure or investor
approval would be consistent with Section 27B.
54. The re-proposed rule would not be limited to only capturing
designed-to-fail transactions and therefore would not include a
designed-to-fail standard for what constitutes a material conflict of
interest. If you believe that a designed-to-fail standard should be the
relevant standard instead of the one that is included in the re-
proposed rule, then please explain how such standard would adequately
protect investors against the risks associated with such conflicts of
interest, particularly in light of the concerns expressed in the re-
proposal. Please also explain how such a standard would be consistent
with Section 27B.
55. As discussed above, the re-proposed rule does not expressly
prohibit actions of third parties in the proposed definition of the
term ``material conflict of interest'' and takes a different approach
to address possible conflicts than the approach described in the
interpretations included in the 2011 Proposing Release by defining the
term ``sponsor'' in a manner that we believe would directly capture
most of the parties whose conduct would have been covered by the 2011
proposed rule.\127\ If you believe that, instead of the proposed
approach, we should revise the definition of the term ``material
conflict of interest'' to cover the actions of a third party consistent
with the 2011 proposed rule, please tell us what activities should or
should not be within the scope of ``allowing a third party, directly or
indirectly, to influence the structure, design, or assembly of the
relevant asset-backed security or the composition of the pool of assets
underlying the relevant asset-backed security in a way that facilitates
or creates an opportunity for that third party to benefit from a
conflicted transaction'' as described in the release for the 2011
proposed rule and why. Also tell us whether this alternative would
directly capture the conduct of parties that the re-proposed rule
intends to cover. If you support such a revised definition, please
explain whether and how it is consistent with Section 27B.
---------------------------------------------------------------------------
\127\ See 2011 Proposing Release at 60331 (describing Item 1(B)
of the material conflict of interest test).
---------------------------------------------------------------------------
56. Are there any unintended effects on securitizations from the
proposed definitions of the terms ``material conflicts of interest''
and ``conflicted transaction''? If so, please provide alternative
definitions designed to minimize such effects, and explain how those
alternative definitions would be consistent with Section 27B.
57. Under the re-proposed rule, the issuance of a synthetic ABS
where a securitization participant enters into the short side of the
transaction with the issuing entity of the synthetic ABS would be a
``conflicted transaction'' because the securitization participant would
be entitled to payment if the referenced assets, and thus the ABS,
perform poorly. Is this the appropriate result? Please explain why or
why not. Are there examples of synthetic ABS where a securitization
participant taking the short position in the referenced assets would
not necessarily benefit from the adverse performance of the underlying
asset pool, the loss of principal, monetary default, or early
amortization event, or decline in the market value of the relevant ABS?
If so, should the definition of ``conflicted transaction'' exclude the
issuance of such synthetic ABS? If so, please explain how such
exclusion would be consistent with Section 27B.
58. Are there transactions that would be ``conflicted
transactions'' under the re-proposed rule that occur with respect to
municipal ABS? If so, please describe those transactions, the relevant
persons that are parties thereto, and the frequency as to which they
are entered into by such persons.
59. Should the re-proposed rule include a requirement that a
securitization participant have documented policies and procedures in
place that are reasonably designed to prevent the securitization
participant from violating the re-proposed rule's prohibition with
respect to conflicted transactions? What should the consequences be for
a securitization participant that did not follow such procedures? Would
such a requirement provide effective protection for investors? Should
such a requirement be in addition to or in lieu of the proposed
compliance program requirements discussed below with respect to the
risk-mitigating hedging activities exception and the bona fide market-
making activities exception?
60. If a general compliance program requirement as described in
question 59 were to be included in the re-proposed rule, are there any
types of securitization participants that should be exempted from such
requirement? For example, should government entities (including
municipal entities) and/or smaller securitization participants be
exempt from such
[[Page 9699]]
requirement, or should the specific requirements or conditions of such
requirement vary based on the type of entity? Alternatively, should the
implementation of such requirement as applied to government entities
and/or smaller securitization participants be delayed in order to give
such entities more time to comply with the requirement? In your
responses, please explain how ``smaller securitization participant''
should be defined for purposes of any such exemption or delayed
implementation.
61. We seek comment on whether the re-proposed rule should include
a safe harbor whereby a person that meets the proposed definition of
``securitization participant'' but nonetheless has no involvement in
the structure, design, or assembly of an ABS or the composition of the
pool of assets underlying the ABS would be exempt from the re-proposed
rule's prohibition on material conflicts of interest. Would such a safe
harbor address concerns that the re-proposed rule might unduly burden
parties that would not have the incentive or ability to engage in
conduct prohibited by Section 27B? Would it weaken the conflicts of
interest protection of the re-proposed rule, and if so, how? Are there
specific conditions that could be included in the safe harbor in order
to address any such concerns? If so, please identify any such
conditions. Please also explain whether and how such a safe harbor
would be consistent with Section 27B.
62. We seek comment on whether the re-proposed rule should include
a safe harbor whereby a securitization participant could rely on the
judgment of a governance specialist as to whether a transaction would
be a ``conflicted transaction'' for purposes of the re-proposed rule,
in the manner suggested by one commenter to the 2011 proposed
rule.\128\ Would such a safe harbor minimize any market disruption that
might result from any potential ambiguity about whether a transaction
would be a ``conflicted transaction''? Would it undermine the
effectiveness of the re-proposed rule by permitting reliance on the
judgment of a third-party to determine compliance with the rule? How
could we help ensure the independence of a third-party specialist that
receives compensation directly or indirectly from securitization
participants to pass judgment on whether a transaction is a
``conflicted transaction''? Is this a workable framework to reduce
conflicts of interest? Please explain why or why not. If you believe
the re-proposed rule should include such a safe harbor, please address
the benefits of the safe harbor and identify any conditions that should
be included in the safe harbor (e.g., a limitation on the types of
entities that could serve as a governance specialist, any minimum
qualifications for an entity to qualify to serve in such capacity, and/
or a condition that the conclusion reached by the governance specialist
be reasonable in light of the facts and circumstances of the
transaction). Please provide an estimate of the anticipated costs
associated with retaining the services of a governance specialist for
this purpose. Please also explain whether and how such a safe harbor
would be consistent with Section 27B.
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\128\ See comment letter from Pentalpha Surveillance LLC (Sept.
1, 2021) (``Pentalpha Letter'') at 2.
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2. Anti-Circumvention
We received comment on the 2011 proposed rule that the rule should
address potential evasion of the rule's prohibition on material
conflicts of interest, and commenters noted a variety of ways in which
a securitization participant might attempt to evade the re-proposed
rule's prohibition.\129\ We agree with such commenters that potential
evasion of the re-proposed rule could weaken the re-proposed rule's
conflict of interest protection. Accordingly, we are proposing Rule
192(d), which provides that, if a securitization participant engages in
a transaction that circumvents the prohibition in proposed Rule
192(a)(1), the transaction will be deemed to violate proposed Rule
192(a)(1). For example, proposed Rule 192(a)(3) defines ``conflicted
transaction'' as three specific categories of transactions because they
are common types of transactions that a person might utilize in order
to ``bet'' against the performance of a financial asset. We believe
that the re-proposed rule's prohibition should be premised on the
substance of the transaction rather than on its form, label, or written
documentation. Proposed Rule 192(d) would address a securitization
participant circumventing the re-proposed rule's prohibition on
material conflicts of interest by structuring one or more transactions
to fall outside of the prohibition (including its permitted exceptions)
while nonetheless engaging in a transaction that is economically
equivalent to a type of transaction specified in the proposed
definition of ``conflicted transaction.''
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\129\ See, e.g., Better Markets Letter at 3-5 (stating that the
re-proposed rule should include functional definitions and
descriptions to prevent evasion of the rule through labeling or the
creation of novel financial instruments or novel categories of
securitization participants that appear to fall outside the purview
of the rule but in reality and substance should be subject to the
restrictions in Section 27B); Morgan Stanley Letter at 4 (stating
that anti-evasion principles could be applied where counterparties
enter into security based swap transactions solely to avoid
application of the prohibition); Tewary Letter 1 at 7 (stating that
the Commission would not want to enable securitization participants
to perform indirectly what they are barred from doing directly).
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Request for Comment
63. We seek commenters' views regarding the anti-circumvention
provision in proposed Rule 192(d). Is it appropriate for the re-
proposed rule to prohibit transactions that circumvent the prohibition
in proposed Rule 192(a)(1) by deeming such transactions to violate
proposed Rule 192(a)(1)? Why or why not?
64. Should proposed Rule 192(d) be modified such that a transaction
circumventing the re-proposed rule's prohibition will only be deemed to
violate proposed Rule 192(a)(1) if the securitization participant knows
or has reason to know that the transaction is undertaken for the
purpose of circumventing the re-proposed rule's prohibition? Please
explain why or why not.
65. Should proposed Rule 192(d) be modified in order to address
other ways in which a person might attempt to evade the prohibition in
the re-proposed rule, including with regard to the proposed exceptions
for risk-mitigating hedging activities, liquidity commitments, or bona
fide market-making activities? If so, how should proposed Rule 192(d)
be modified and why?
66. Would proposed Rule 192(d) be overinclusive or otherwise result
in potential uncertainty as to the coverage of the re-proposed rule's
prohibition, and if so, how should proposed Rule 192(d) be modified to
address such concerns? Are there examples of transactions that proposed
Rule 192(d) would prohibit but should not? Please explain how any such
modifications to proposed Rule 192(d) would be consistent with Section
27B.
67. We seek comment on whether the relationship between proposed
Rule 192(d) and the proposed exceptions for risk-mitigating hedging
activities, liquidity commitments, and bona fide market-making
activities should be clarified. If so, please explain what
clarifications are necessary, and why.
68. We seek comment on an alternative anti-circumvention provision
that would instead provide that, if a securitization participant
engages in a transaction or a series of related transactions as part of
a plan or scheme
[[Page 9700]]
to evade the prohibition in proposed Rule 192(a)(1), such transaction
or series of related transactions will be deemed to violate proposed
Rule 192(a)(1). Would this alternative anti-circumvention provision
address any concerns about potential overinclusiveness of proposed Rule
192(d), including the absence of a knowledge qualifier?
E. Exception for Risk-Mitigating Hedging Activities
Section 27B(c) provides that the prohibition in Section 27B(a) does
not apply to risk-mitigating hedging activities in connection with
positions or holdings arising out of the underwriting, placement,
initial purchase, or sponsorship of an ABS, provided that such
activities are designed to reduce the specific risks to the
underwriter, placement agent, initial purchaser, or sponsor associated
with positions or holdings arising out of such underwriting, placement,
initial purchase, or sponsorship.\130\ Consistent with Section
27B(c)(1), we are proposing that the prohibition not apply when a
securitization participant engages, subject to certain conditions, in
risk-mitigating hedging activities in connection with its
securitization activities. The proposed risk-mitigating hedging
activities exception would be conditioned on the securitization
participant satisfying all three proposed conditions included in
proposed Rule 192(b)(1)(ii), as discussed below.
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\130\ 15 U.S.C. 77z-2a(c)(1).
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Risk-mitigating hedging activities of a securitization participant
permitted under the proposed exception would include hedging conducted
in connection with and related to individual or aggregated positions,
contracts, or other holdings of the securitization participant arising
out of its securitization activities, including the origination or
acquisition of assets that it securitizes.\131\ Given that the
accumulation of assets prior to the issuance of an ABS is a fundamental
component of assembling an ABS prior to its sale, the proposed risk-
mitigating hedging activities exception would allow for a
securitization participant to not only hedge retained ABS positions (in
compliance, as applicable, with Regulation RR) but also hedge exposures
arising out of the assets that are originated or acquired by the
securitization participant in connection with warehousing assets in
advance of an ABS issuance. The proposed risk-mitigating hedging
activities exception would also allow for the relevant hedging activity
related to a securitization participant's securitization activity to be
done on an aggregated basis and would not require that the exempt
hedging be conducted on a trade-by-trade basis. Given the nature of the
ABS market and the types of assets that collateralize ABS (such as
receivables or mortgages), it may not be possible for a securitization
participant to enter into a hedge with respect to an ABS or any of its
underlying assets on an individualized basis. Therefore, we believe
that this approach to the risk-mitigating hedge exception should allow
securitization participants sufficient flexibility to design their
securitization-related hedging activities in a way that is not unduly
complicated or cost prohibitive.
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\131\ This standard would not broaden, limit, or otherwise
modify the requirements applicable to a securitization participant
pursuant to Regulation RR.
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In order to distinguish permitted risk-mitigating hedging activity
under the re-proposed exception from prohibited conflicted transactions
that would constitute a bet against the relevant ABS, we are proposing
certain conditions that would have to be satisfied in order for the
risk-mitigating hedging activity exception to apply. We believe that
this proposed approach is consistent with views of certain commenters
to the 2011 proposed rule that recommended a narrow risk-mitigating
hedging activities exception that is designed to reduce specific risks
and that includes robust conditions.\132\ Each of these conditions is
discussed in detail below.
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\132\ See Barnard Letter at 2; Better Markets Letter at 9-12;
Merkley-Levin Letter at 16-18; Tewary Letter 1 at 10.
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Under the re-proposed exception, the initial issuance of an ABS,
such as a synthetic ABS, would not be risk-mitigating hedging
activity.\133\ Although we received comment that securitization
participants should be permitted to enter into a synthetic ABS
transaction pursuant to the risk-mitigating hedging activities
exception because such transaction is the economic equivalent of a
bilateral CDS transaction where the counterparty to the CDS is not an
ABS issuer,\134\ the re-proposed rule prohibits a securitization
participant from creating and/or selling a new synthetic ABS to hedge a
position or holding. In these synthetic ABS transactions, a
securitization participant is typically a party to a CDS contract with
the issuing entity of the ABS. We are concerned that such activity
would weaken the conflicts of interest protection of the re-proposed
rule by allowing a securitization participant to engage in a
transaction (the CDS contract(s) with the issuer) where cash paid by
ABS investors to acquire the newly created synthetic ABS would fund the
relevant CDS contract(s) and be available to make a payment to the
securitization participant upon the occurrence of an adverse event.
This type of transaction was the focus of Congressional scrutiny in
connection with the financial crisis of 2007-2009.\135\ Moreover, the
securitization participant would perform a central role in creating,
structuring, and/or marketing the relevant synthetic ABS that is being
issued and, in connection with such role, would likely obtain
additional benefits such as arranger or manager compensation. These
factors would go beyond engaging in risk-mitigating hedging activity
that is designed to reduce specific risks to the securitization
participant in connection with positions or holdings arising out of its
securitization activities and could raise conflicts of interest with
investors in the new synthetic ABS that we believe Section 27B is
intended to prohibit.
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\133\ As discussed above in Section II.D., the proposed
definition of the term ``conflicted transaction'' does not exclude
the issuance of synthetic ABS.
\134\ See ASF Letter at 25-26; comment letter from Cadwalader,
Wickersham & Taft LLP (Feb. 13, 2012) (``Cadwalader Letter'') at 2-
6; SIFMA Letter at 22-23.
\135\ See Senate Financial Crisis Report.
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1. Specific Risk Identification and Calibration Requirements
We are proposing in Rule 192(b)(1)(ii)(A) that the first condition
of the exception be that, at inception of the hedging activity and at
the time of any adjustments to the hedging activity, the risk-
mitigating hedging activity of the securitization participant is
designed to reduce or otherwise significantly mitigate one or more
specific, identifiable risks arising in connection with and related to
identified positions, contracts, or other holdings of the
securitization participant arising out of its securitization
activities, based upon the facts and circumstances of the identified
underlying and hedging positions, contracts, or other holdings and the
risks and liquidity thereof. This condition would be the essential
requirement of the proposed exception that the relevant hedging
activity is risk-mitigating. Various activities of a securitization
participant, such as acquiring a portfolio of assets in anticipation of
issuing an ABS or retaining a portion of an ABS issuance with respect
to which it is a securitization participant, expose the securitization
participant to the risk that such positions could decline in value.
Permissible risk-mitigating hedging
[[Page 9701]]
activity, under the re-proposed rule, would be required to be designed
to reduce or significantly mitigate such risks \136\ and could not
``overhedge'' such risks in a way that would result in a net short
exposure to the relevant ABS. This proposed condition is designed to
preclude a securitization participant from engaging in speculative
activity that is designed to gain exposure to incremental risk by, for
example, entering into a CDS contract referencing a retained exposure
where the notional amount of the CDS exceeds the amount of the relevant
exposure intended to be hedged. Such a transaction would provide the
securitization participant with an opportunity to profit from a decline
in the value of the relevant retained exposure rather than simply to
reduce its risk to it. Therefore, although the relevant risks arising
from a securitization participant's securitization activity would be
permitted to be hedged on an aggregated basis to address more than one
exposure arising from such activity, such risks would need to be
specific and identifiable at the outset of the hedging activity. The
proposed requirement that the risks must be specific and identifiable
means that a securitization participant would not be permitted to rely
on the proposed risk-mitigating hedging activities exception if it were
to enter into a CDS contract referencing a retained ABS interest for
the purpose of hedging generalized risks that it believes to exist
based on non-position specific modeling or other considerations. In
order to make a determination of whether the hedge is designed so as
not to ``overhedge'' positions related to a securitization
participant's securitization activities, the hedge would need to be
tied to specific exposures that exist and are specifically
identifiable. Otherwise, it would be impractical or impossible to make
that determination, and the proposed exception should not apply.
Whether a risk is ``specific'' and ``identifiable'' depends on the
facts and circumstances of the positions, contracts, or other holdings
of the securitization participant, and these terms are not defined in
the re-proposed rule. However, we seek comment below on indicia of
whether a risk is specific and identifiable, and whether such indicia
should be specified in the rule.
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\136\ For example, such risks would include the market risk of
the price decline of warehoused assets or the interest rate risk
arising between the interest rate accruing on a retained ABS
position and any financing used to acquire it.
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We recognize that the risks of the relevant exposures are dynamic
and may change over time and that new risks may emerge in a way that
would make the hedging activity that was designed at inception less
effective. The prohibition of the re-proposed rule only applies for a
limited timeframe,\137\ and this proposed condition does not restrict
making adjustments to a hedge over time. However, in order to prevent
evasion, the requirements of this proposed condition would apply not
only at the inception of the hedging activity but also whenever such
hedging activity is subsequently adjusted during the time period in
which the prohibition applies.\138\ Therefore, any changed or new risks
that are being hedged would need to be specifically identified, and the
adjusted hedging activity would need to be tied to them.
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\137\ See Section II.C. for a discussion of the time period
during which the prohibition applies.
\138\ Id.
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Similarly, we are proposing in Rule 192(b)(1)(ii)(B) that the
second condition of the exception be that the risk-mitigating hedging
activity would be required to be subject, as appropriate, to ongoing
recalibration by the securitization participant to ensure that such
hedging activity satisfies the requirements applicable to the first
condition of the exception and does not facilitate or create an
opportunity to benefit from a conflicted transaction other than through
risk-reduction. For example, if a securitizat
[…truncated; see source link]Indexed from Federal Register on February 14, 2023.
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