Representatives from various parts of the financial industry gathered to discuss the consequences and effectiveness of new and proposed regulations in the asset-backed securities market. Panelists agreed on some issues, including the inadequacy of regulations to cure perceived problems, but they were divided on other issues.
What’s Inside?
Representatives from the Federal Reserve Bank, U.S. SEC, and U.S. Congress and financial industry participants (bankers and advisers) commented on and gave their personal views on recent regulations in the asset-backed securities (ABS) market regarding risk-based capital, risk retention, Regulation AB (disclosure and reporting), reform of government-sponsored enterprises (GSEs), and the Volker rule.
How Is This Article Useful to Practitioners?
The first topic of discussion was risk-based capital. Regulatory capital revisions have focused on understanding the quality and quantity of capital, improving the risk sensitivity of capital, incorporating systemic risks, reducing pro-cyclicality, and limiting risk capital arbitrage. Specifically for securitization, the following issues exposed by the crisis will be addressed by the revisions: illiquidity of securitization positions on trading books, weak performance of certain asset classes (inconsistent with assigned ratings), and preferential accounting treatment for risk transfer while retaining first-loss piece and servicing rights. First-loss piece is the debt class with the lowest payment priority in a senior/subordinated debt structure.
Under the revisions, banks are required to perform their own analysis of a securitization position before acquiring it, document the analysis in a timely manner, and perform ongoing analysis at least quarterly. The analysis needs to cover transaction structure, credit performance, and relevant market data.
Industry participants on the panel expressed concerns about the changes in due diligence requirements. They were apprehensive about the potential delays that could hinder trade decisions, the disadvantages that new issuers or assets and smaller banks could face, and the weight of the penalty for a lapse in due diligence.
Next, the panel discussed risk retention, premium cash capture reserve accounts (PCCRAs), and qualified residential mortgages (QRMs). The regulator on the panel thinks vertical risk retention is not sufficient to protect against poor underwriting and supports using PCCRAs to align sponsors’ interests. One industry participant argued that newly proposed risk retention requirements are inconsistent with the current functioning practice in the bank-sponsored asset-backed commercial paper (ABCP) conduit market. Currently, unfunded letters of credit provide program-wide credit enhancement, and multiple third-party assets are transferred to ABCP conduits.
Another industry participant argued that QRMs are narrowly defined, and together with PCCRAs, these restrictions add costs to private-label residential mortgage-backed securities and make them unable to compete with GSEs. The representatives from Congress and the SEC are aware of the potential impact (e.g., 20% down payment requirements for mortgage borrowers) and are working on ways to mitigate the issues (e.g., legal safe harbor provided by the Consumer Financial Protection Bureau).
In regard to Regulation AB2, the panelists generally welcomed requirements to disclose loan-level data and transaction waterfall computer programs along with holding private issuances to the same disclosure standards as public issuances. But they believe that disclosure alone will not reform the market and that the requirements are biased against resecuritizations as well as past issuances under the old rule.
In the discussion about the Volker rule and other concerns, the panelists agreed that the intersection of the Volker rule and the Commodity Futures Trading Commission definitions complicates the operations of ABCP and those securitizations with swaps.
The conclusion was that current regulations may still be insufficient to address the problems in the ABS market and are potentially overly complicated or misguided and could create unintended consequences.
Abstractor’s Viewpoint
Regulations have a profound impact on the ABS industry, directly affecting originators of and investors in securitized products (with banks being the focal point) and rippling through the wider public, such as in real estate markets and to other capital markets participants and home buyers. Regulators need to walk a fine line between not over-regulating and stifling efficient capital markets that benefit from financial innovation and effectively protecting the system against excessive risk taking.