During the most recent financial crisis, many investors in asset-backed securities claimed that they did not have the necessary information and time to fully analyze the structures and, therefore, underestimated the risks inherent in these securities. Regulation AB II is intended to address those shortcomings.
Regulation AB II represents the response of the US SEC to a public perception that inadequate regulation of asset-backed securities (ABS) was a significant driver of the credit crisis. In an effort to remedy the perceived inadequate oversight and security-level opacity, Regulation AB II establishes important procedures that significantly affect the offering process. Specifically, the rule mandates that before issuance, most publicly offered ABS will need to offer additional asset pool transparency, increased disclosures, and CEO certification.
How Is This Research Useful to Practitioners?
After the 2008 financial crisis, investors claimed that they did not have the necessary information to properly value and evaluate the risks associated with ABS. Moreover, there was a perception that faulty oversight and regulation of ABS offerings was a significant driver of the credit crisis. As such, the SEC proposed and ultimately adopted Regulation AB II in response to the claims. The regulation revises previous regulations for ABS and offers additional safeguards. The most prominent new addendums require asset pool transparency and increased disclosures as well as CEO certification, all of which must be provided in advance of the issuance.
Regarding asset pool transparency for resecuritizations and publicly offered ABS backed by residential mortgages, commercial mortgages, automobile loans, automobile leases, or debt securities, the regulation requires the issuer to file a comprehensive set of standardized asset-level datapoints about the underlying pool assets. Data include both general information and data geared specifically toward each asset class as well as detailed information about the individual assets in the pools.
The increased disclosure requirement stipulates that ABS issuers must include certain financial information about the sponsor and any 20% originator. Previously, originators that originated less than 10% were not identified. But under certain circumstances, the new rules do require that they be identified. An additional disclosure requires the presentation of delinquencies and losses for amortizing asset pools to be made in 30–31 day increments through no less than 120 days. Finally, because of complaints from investors after the financial crisis that asset repurchase demands were not being enforced consistently, the new regulations provide for the appointment of an unaffiliated “asset representations reviewer,” which will review the pool assets on the occurrence of specified trigger events.
Because the Dodd–Frank Act removed the investment-grade rating requirement from ABS issuance, Regulation AB II requires depositor CEO certification. The CEO must state and certify that he or she has reviewed and approved the underlying loan structure and the characteristics of the pool assets as well as verify that the prospectus contains all relevant information.
Other important changes to ABS offerings include a dedicated registration form for ABS offerings, a repurchase request dispute resolution provision, an integrated prospectus instead of a base prospectus, and prospectus supplements, as well as an annual evaluation for shelf registrations. Importantly, these disclosures must be provided to prospective investors three days before issuance, which will give investors much more time to review the documentation and fully vet the ABS structures.
The new rules became effective on 1 November 2014. All of the rules must be complied with by 23 November 2015, except for the new asset-level disclosure requirements, which must be complied with no later than 23 November 2016. The SEC announced a pilot program for ABS issuers to have the additional disclosure requirements reviewed. The SEC will make all draft registration statements and related staff comment letters from the pilot program publicly available prior to the compliance date.
Prospective ABS investors will most certainly applaud the new regulations because they offer much more transparency to a fairly opaque asset class. The new asset pool–level disclosure requirement will allow investors to have a much greater understanding of the underlying assets in the pool. The requirement for CEO certification should provide investors with some assurance that someone will be held directly liable for any fraudulent activities. Although investors will have additional asset-level transparency, there is some concern that additional disclosure introduces privacy concerns regarding consumer information. Additionally, although the regulations seem to address the issues investors had from the previous crisis, there is no guarantee they will address future issues.