The authors review regulation, both proposed and enacted, in the United States and the European Union. In particular, they focus on the impact of such reforms on the process of securitization.
Regulation has been proposed and enacted in the United States and the European Union that affects several critical areas of the financial industry. The authors specifically look at the effect of the regulations on securitization transactions.
How Is This Research Useful to Practitioners?
The 2007–09 Great Recession has produced numerous regulatory developments in both the United States and the European Union. The authors analyze the impact on securitization across the regulatory domains of risk retention, due diligence, and disclosure as well as on the role of credit rating agencies. They compare and contrast proposed and enacted regulation from both areas and conclude with an overview of several important U.S. reforms that do not have EU equivalents but may still affect the regulatory treatment of securitization transactions in Europe.
Risk retention is a critical area because the practice should result in higher underwriting standards for originators. In the United States, much of the reform is proposed; the sole risk-retention requirement is the Federal Deposit Insurance Corporation (FDIC) safe-harbor rule, which mandates a 5% risk retention for a valid bank transfer of financial assets in a securitization. In contrast, Europe’s rules have been in effect since 1 January 2011. A key difference between Europe’s rules and the U.S. rules is that the former are targeted at financial institutional investors whereas the latter are aimed at securitizers (issuers). U.S. provisions seem to offer a greater number of methods to satisfy retention requirements than the European reforms. They also offer a greater number of exemptions to the requirements.
Regarding due diligence and disclosure, the applicability of provisions to securitizers in the United States and investors in the EU continues to be valid. In general, both regulatory regimes require proper research and disclosure of the assets underlying asset-backed securities; due diligence requirements also vary based on the type of assets in question. Information has to be sufficient enough to make a material investment decision. Loan-level due diligence and disclosure requirements are significantly more developed in Europe than in the United States, where much regulation that would mandate loan-specific disclosures and due diligence is still only proposed.
Concerning the credit rating agencies, the Dodd–Frank Act requires U.S. SEC review of the rating process applied to structured products as well as to issuer-pay and subscriber-pay conflicts of interest. European Regulation under Credit Rating Agency Regulation (CRA Regulation) seeks greater disclosure of ratings methodology and conflicts of interest. CRA 3, a draft amendment, seeks reduced risk of conflict and improvement of overall disclosure requirements. In particular, the amendment mandates that structured product issuers seek ratings from at least two agencies and strive to improve rating industry competition and processes.
Finally, the authors review additional critical provisions of Dodd–Frank for which no European regulatory equivalent exists but that may impact prospective regulation in the EU. They focus on how the provisions relate to securitization. The provisions they examine relate to disclosure of repurchases, third-party due diligence reports, rating agency requirements for a description of representations and warranties in reports, impact of the Volcker Rule, commodity pool issues, and conflicts of interest between covered products and persons.
How Did the Authors Conduct This Research?
The authors draw extensively on relevant provisions of the Dodd–Frank Act to study regulatory impact in the United States and various reforms in the EU, which include the Basel II and Basel III Accords, the Capital Requirements Directive (CRD), the CRA Regulation, and the Solvency II proposals. The authors compare and contrast provisions relating to the areas of risk retention, due diligence, and disclosure as well as the role of the credit rating agencies. They conclude with a review of key provisions contained in Dodd–Frank for which no European equivalent exists.
The process by which regulation has been implemented in the wake of the financial crisis has been an arduous one and has included many vested interests that may antagonize reformers. The authors carefully review the relevant regulatory provisions pertaining to securitization in the United States and the EU. The impact of the financial crisis was far-reaching; in response, regulation must also be far-reaching to address the most egregious violations, which contributes to regulatory complexity and an uneven pace of development. Because sovereign credit woes have followed the global financial debacle, it would be interesting to consider how proposed regulations may be finalized by taking into account recent events and the global nature of securitization. Finally, one would hope for greater accord between regulatory regimes in the United States and in Europe.