> NPR 2 represents significant improvement over NPR 1, but still leaves open many issues

Transcription

1 October 2013 A Roadmap to the Second Notice of Proposed Rulemaking regarding U.S. Credit Risk Retention Requirements ( RRRs ) under Section 15G of the Securities Exchange Act of 1934 (added by Section 941 of the Dodd-Frank Act). Key Takeaways > NPR 2 represents significant improvement over NPR 1, but still leaves open many issues > Risk can be retained in any combination of eligible vertical and horizontal interests rather than only in the specified 5% vertical, 5% horizontal, 5% L- shaped or representative sample mechanisms found in NPR 1 > With a few exceptions, the 5% risk retention requirement is to be measured against fair value (determined under U.S. GAAP) > Special risk retention mechanisms are available to certain market participants for certain product types, including, among others, open market CLO transactions, revolving master trusts, ABCP conduits and CMBS > Certain assets meeting certain underwriting criteria are exempt from the RRRs > These requirements apply to all securitization transactions (registered or unregistered) and will become effective two years from the publication date of the final rules for all asset classes other than RMBS in respect of which they will become effective one year from the publication date of the final rules > Restrictions on transfer and hedging are now subject to sunset provisions > Sponsor may share the retained risk with originators subject to certain conditions, and if there are multiple sponsors, each of them is responsible for ensuring that at least one of them satisfies the RRRs > Exemptions for certain types of products satisfying various underwriting criteria remain, but have been modified from NPR 1 > Narrow exemptions for resecuritizations and foreign securitizations are also included in NPR 2 Contents Background... 2 NPR 2 s Structure... 3 Standard Risk Retention Approach... 3 Non-standard Risk Retention... 3 Special Products Excluded... 3 Restrictions on hedging and transfer... 4 Exemptions and safe harbors... 4 The Roadmap Timing Scope Standard risk retention Non-standard risk retention Restrictions on hedging and transfer Special products excluded Exemptions Foreign Securitizations Additional exemptions NPR 2 and Non- U.S. securitizations

2 Background The Relevant Regulators 1 recently adopted for publication in the Federal Register a second notice of proposed rulemaking (the NPR 2 ) 2 in respect of risk retention under Section 15G of the Securities Exchange Act of 1934 (as amended, the 34 Act ), as added by Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the DFA ). 3 Section 15G requires securitizers to retain 5% of the credit risk of the assets being securitized in a securitization, but leaves open, for the Relevant Regulators to fill-in, the majority of details necessary for implementation. The first notice of proposed rulemaking (the NPR 1, 4 and together with NPR 2, the NPRs ) was published in the Federal Register on April 29, Comments on NPR 2 are due by October 30, Section 15G was added to the 34 Act in an attempt to address the perceived problems of the so-called originate to distribute model by requiring securitizers to retain risk or skin in the game in the assets they securitize. The statute prescribes certain outer boundaries for the RRRs, but leaves it to the Relevant Regulators to adopt rules filling-in the specific details. In some cases, the statute directs rulemaking specifically to address certain items, e.g., carve-outs for various asset types satisfying underwriting criteria to be established. Only nine months elapsed from the time DFA became law on July 21, 2010 until NPR 1 was published on April 29, NPR 2 was published in the Federal Register on September 20, 2013, which is more than two years after NPR 1 was published and more than three years after DFA became law. The significant amount of time between NPR 1 and NPR 2 reflects the high volume of commentary and resistance that the Relevant Regulators received in respect of NPR 1. NPR 1 was, in the eyes of many commentators, severely lacking as it did not reflect market practice or provide sufficient flexibility in implementation. Although NPR 2 retains much from NPR 1, including many of its flaws, NPR 2 does reflect significant improvements from NPR 1. This includes, most notably, more flexibility and greater recognition of market practice. Even taking into account these improvements, however, NPR 2 is still too prescriptive and too rigid. For example, the open-market CLO transaction carve-out is too narrow. Likewise, the elimination of the representative sample option precludes, except in very limited instances, satisfying the RRRs by retaining a direct interest in the securitized assets rather than in the issuing entity s ABS interests or an The NPRs, pursuant to the DFA, have been proposed by, as applicable, Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; U.S. Securities and Exchange Commission; Federal Housing Finance Agency; and Department of Housing and Urban Development (collectively, the Relevant Regulators ). Credit Risk Retention; Proposed Rule, 76 FR (September 20, 2013) available at Public Law , 124 Stat (2010) available at Credit Risk Retention; Proposed Rule, 76 FR (April 29, 2011) available at Id. 2

3 entity feeding into the issuing entity. A wide array of other criticisms and issues raised by commentators and others in respect of NPR 1 have not been addressed in NPR 2. NPR 2 applies to all securitization transactions (as discussed in more detail below) and, by virtue of that fact and various other features of the proposed rules, it raises a host of unique issues for non-u.s. securitizations, which we address in Section 10 below. NPR 2 s Structure Some categorical lines can be drawn through NPR 2, although they are not always neat and tidy. Generally speaking, NPR 2 breaks down into (i) standard risk retention, (ii) non-standard risk retention, (iii) special products, (iv) hedging and transfer restrictions and (v) general exemptions and safe harbors. We describe each of these briefly below and then address them in more granularity in the sections that follow. 6 Standard Risk Retention Approach NPR 2 articulates a standard approach to satisfying the RRRs, which involves the sponsor holding a 5% (calculated based upon U.S. GAAP fair value) horizontal (i.e., a first loss position), vertical (i.e., a pari passu or vertical interest in each class of the issuer s securities) or any combination of such eligible horizontal and vertical interests. The standard risk retention approach must be used unless one of the non-standard risk retention approaches is available or there is another exemption. If both a non-standard approach and a standard approach are available, then the sponsor may use either. Non-standard Risk Retention In addition to the standard risk retention approach, NPR 2 identifies various products and asset classes in respect of which the RRRs may be satisfied in a different fashion and/or by a different person retaining some or all of the relevant risk. The most relevant of these include (i) open market CLOs; (ii) revolving master trusts; (iii) CMBS; and (iv) ABCP conduits. The non-standard approaches available for these asset classes require satisfying a variety of conditions, including specific structural features and additional disclosure requirements (beyond those applicable to the standard risk retention approach). Special Products Excluded In respect of securitization transactions where collateral comprises certain special products meeting certain minimum underwriting criteria, NPR 2 provides that the 6 This document does not address every detail of NPR 2. In some cases we have glossed over or excluded elements and in others we have changed or deleted words and/or summarized provisions. We have also changed the order in which various items appear. This note is for general informational purposes and should not be construed as legal advice. Please be sure to consult the actual text of NPR 2 along with counsel. 3

4 RRRs will not apply. 7 The theory being that such high quality assets do not require skin in the game. Although we do not focus on them here, some of these are actually quite contentious. Restrictions on hedging and transfer In addition to the general restrictions on hedging and transfer, which we discuss below, certain products have specific additional or different restrictions. The restrictions on hedging and transfer end or sunset after certain periods of time expire. Once these restrictions cease to apply, hedging and transfer are permitted. Exemptions and safe harbors In addition to the other exemptions listed in Section 7 below, there are also narrow safe harbors for foreign securitizations 8 and for resecuritizations. The Roadmap 1 Timing The RRRs will become effective for RMBS one year from the date the final rules are published in the Federal Register and two years from the date the final rules are published in the Federal Register for all other asset classes. 2 Scope The RRRs apply to all securitization transactions 9 (whether or not required to be registered with the U.S. Securities and Exchange Commission) with limited exemptions based upon, among other things, asset type and quality (discussed in more detail below). 3 Standard risk retention The sponsor of a securitization transaction must retain an eligible vertical interest or an eligible horizontal residual interest or any combination thereof equal to at least 5% of the fair value (determined under U.S. GAAP as of the pricing date) of all ABS interests in the issuing entity issued as part of the securitization transaction, and which cannot be transferred or hedged prior to certain sunset dates Blended pools of the same category (but not different categories) of these special products where some meet the underwriting criteria and others do not may have the RRRs reduced on a blended basis. 8 See infra Section 8. 9 Transactions which do not involve the issuance of asset-backed securities (as defined below) are not securitization transactions (as defined below) and are thus not within the scope of Section 15G. See infra note 13. Various other exemptions are discussed below including for foreign securitizations and pass-through resecuritizations. 10 NPR This represents a significant deviation from NPR 1 as it allows any combination of vertical and horizontal risk retention rather than one or the other or an even split. Likewise, it eliminates the representative sample option and various other items that were included in NPR 1. It also incorporates sunset provisions that were not in NPR 1. 4

5 Sponsor = person who organizes and initiates a securitization transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity 12 Securitization transaction = transaction involving the offer and sale of assetbacked securities by an issuing entity 13 Securitized assets = asset (i.e., a selfliquidating financial asset (including but not limited to a loan, lease, mortgage or receivable)) transferred, sold or conveyed to an issuing entity that collateralizes the ABS interests issued by that issuing entity Issuing entity = respecting a securitization transaction, the trust or other entity that (1) owns or holds the pool of assets to be securitized and (2) in whose name the assetbacked securities are issued Asset-backed securities ( ABS ) = 14 a fixed-income or other security collateralized by any type of selfliquidating financial asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset, including CMOs, CDOs, CBOs, CDOs of ABS, CDOs of CDOs and anything else the SEC determines by rule ABS interest = any interest or obligation issued by an issuing entity, whether or not certificated, payments on which are primarily dependent on the cash flows of the collateral owned or held by the issuing entity 15 Eligible vertical interest = with respect to any securitization transaction, a single vertical security 16 or an interest in each class of ABS interests in the issuing entity issued as part of the securitization transaction that constitutes the same portion of the fair value of each such class Eligible horizontal residual interest = with respect to a securitization transaction, an ABS interest 17 in the issuing entity that is a first loss position (n.b., sponsor may instead fund a horizontal reserve account with cash in an amount equal to the eligible horizontal residual interest, subject to the account satisfying certain conditions) Disclosure Requirements for Standard Risk Retention Horizontal Sponsors using the standard risk retention approach and holding an eligible horizontal residual interest must satisfy certain disclosure requirements by providing to potential 12 If there are multiple sponsors, each of them is responsible for ensuring that at least one of them satisfies the RRRs. The sponsor may also allocate retained risk to one or more originators subject to certain criteria, including limiting such allocation to the portion of the pool originated by such originator and requiring that any such originator have originated at least 20% of the pool as well as requiring advance notice to potential investors of the originator s identity and form, and the form, amount and nature of the interest and the method of payment for such interest. Additionally, even when allocating retained risk to one or more originators, the sponsor remains responsible for ensuring that the RRRs are satisfied. If the sponsor determines any originator is not in compliance, the sponsor must notify the holders of the ABS interests of such noncompliance by the originator. NPR Synthetic securitizations and foreign securitizations satisfying the foreign securitization safe harbor are examples of securitization transactions that are outside the scope of Section 15G. FN 36 of NPR See 3(a)(79) of the 34 Act. This excludes synthetic securitizations. Id.; see also supra note Excludes items (i) issued primarily to evidence ownership of the issuing entity; and (ii) whose payments are not primarily dependent on the securitized assets cash flows. Also excludes service providers rights to receive payments for services. 16 The single vertical security option is not substantively different than the eligible vertical interest option, but rather as a matter of convenience allows the eligible vertical interest to be held in the form of a single security rather than multiple securities. 17 That is an interest in a single class or multiple classes in the issuing entity, provided that each interest meets, individually or in the aggregate, all of the requirements of this definition. 18 See NPR 2.4(c)(1)-(3) for those conditions. 5

6 investors a reasonable period of time prior to the sale of the ABS in the securitization transaction written disclosures, including, among other things: (i) (ii) (iii) (iv) (v) (vi) key inputs and methodologies for determining fair value; fair value of all the ABS interests issued in the securitization transaction; the dollar amount of the ABS interests retained by the sponsor; description of the material terms of the eligible horizontal residual interest to be retained by the sponsor; the reference data set or other historical information used to develop the key inputs and assumptions; and historical cash flow information about amounts paid to the sponsor in other securitizations in which the sponsor retained an eligible horizontal residual interest pursuant to this section Vertical Where the sponsor retains an eligible vertical interest, such disclosure must also contain, among other things: (i) (ii) (iii) (iv) whether the sponsor will retain it in the form of a single vertical security or as a separate proportional interest in each class of ABS interests in the issuing entity issued as part of the securitization transaction; fair value of the amount of the single vertical security retained by the sponsor and required to be retained by the sponsor; details of what the sponsor would have been required to retain if it did so through multiple ABS interests rather than a single vertical security; and if retaining an eligible vertical interest through multiple ABS interests, the percentage of each class that is required to be retained by the sponsor and that the sponsor will retain See NPR 2.4(d) for a more complete list. See also NPR 2.4(e) (requiring records and certifications required under 4(b) and 4(d) be kept in writing and be provided on request to the SEC and the appropriate Federal Banking agency, if any, until three years after no ABS interests remain outstanding). Additional elements apply where the sponsor retains risk through the funding of a horizontal reserve account. NPR 2.4(d)(1)(vii). 20 See NPR 2.4(d)(2) for further details and additional information. 6

7 3.2.3 Written records Sponsors using the standard risk retention method must make various calculations and certifications to investors and maintain written records of same, including with respect to the disclosure requirements discussed above. 21 The non-standard risk retention approaches discussed below require compliance with additional product/asset type specific disclosure provisions, as applicable. 4 Non-standard risk retention As we discuss in more detail in this section, certain participants in some securitizations may avail themselves of alternative or non-standard approaches to risk retention to satisfy the RRRs. 4.1 Open market CLOs With respect to open market CLO transactions, as more fully described below, the RRRs may be satisfied if the arranger of the securitized loans (rather than the manager, as sponsor, as would be required under the standard risk retention approach) retains 5% of the face value of each eligible loan tranche included in the CLO. This mechanism is quite narrow in its requirements and applicable conditions, as the language of the rule and the defined terms below reflect. If this non-standard approach is not available for a particular CLO, then the manager of that CLO, as sponsor, will be required to satisfy the RRRs under the standard risk retention approach NPR 2 provides in pertinent part that a sponsor satisfies the RRRs with respect to an open market CLO transaction if: (i) (ii) (iii) (iv) the open market CLO ( OCLO ) acquires/holds only CLOeligible loan tranches and servicing assets; the OCLO s governing documents require that, at all times, its assets consist of senior, secured syndicated Loans that are CLO-eligible loan tranches and servicing assets; the OCLO does not invest in ABS interests or in credit derivatives other than hedging transactions that are servicing assets to hedge risks of the open market CLO; all purchases of CLO-eligible loan tranches and other assets by the OCLO issuing entity or through a warehouse facility used to accumulate the loans prior to the issuance of the CLO s ABS interests are made in open market transactions on an arm s length basis; 21 See NPR 2.4(b)(2)(i)-(iii); see also NPR 2.4(e) supra note 19. 7

8 (v) the CLO Manager is not entitled to receive any management fee or gain on sale at the time the open market CLO issues its ABS interests. Note that the risk retention component, which is not immediately apparent from these five numbered items, is embedded in the definition of CLO-eligible loan tranche which is summarized below. Otherwise, the CLO manager must itself retain the risk to satisfy the RRRs under the standard risk retention approach There are also special disclosure requirements with respect to this option. 22 Senior, secured syndicated loan = commercial loan that: (1) is not subordinate to any of borrower s other borrowed money obligations; (2) is secured by a valid first priority security interest or lien in the collateral underlying the loan; and (3) the value of such collateral together with the obligor s other attributes is adequate (in the commercially reasonable judgment of the CLO manager exercised at the time of investment) to repay the loan in accordance with its terms and all other indebtedness of equal seniority secured by such collateral, and the CLO manager certifies same to investors in regular periodic disclosures. CLO-eligible loan tranche = commercial term loan of a syndicated facility having the following features: (1) lead arranger retains at least 5% percent of tranche s face amount; (2) holders of the CLO-eligible loan tranche have consent rights with respect to any material waivers and amendments; and (3) the pro rata provisions, voting provisions, and similar provisions applicable to the security associated with such CLO-eligible loan tranches are not materially less advantageous to the obligor than the terms of other tranches of comparable seniority in the broader syndicated credit facility. open market CLO = a CLO: (1) whose assets consist of senior, secured syndicated loans acquired by such CLO directly from the sellers thereof in open market transactions and of servicing assets, (2) that is managed by a CLO manager, and (3) That holds less than 50% of its assets, by aggregate outstanding principal amount, in loans syndicated by lead arrangers that are affiliates of the CLO or originated by originators that are affiliates of the CLO. Open market transaction = (1) either an initial loan syndication transaction or a secondary market transaction in which a seller offers senior, secured syndicated loans to prospective purchasers in the loan market on market terms on an arm s length basis, which prospective purchasers include, but are not limited to, entities that are not affiliated with the seller, or (2) a reverse inquiry from a prospective purchaser of a senior, secured syndicated loan through a dealer in the loan market to purchase a senior, secured syndicated loan to be sourced by the dealer in the loan market. CLO Manager = entity managing a CLO that is a registered investment adviser under the Investment Advisers Act of 1940, as amended, or is an affiliate of such an entity and is itself managed by such a registered investment adviser. Servicing assets = rights or other assets designed to assure the timely distribution of proceeds to ABS interest holders and assets that are related or incidental to purchasing or otherwise acquiring and holding the issuing entity s securitized assets. Includes amounts received by the issuing entity as proceeds of rights or other assets, whether as remittances by obligors or as other recoveries. CLO = special purpose entity that: (1) issues debt and equity interests, and (2) whose assets consist primarily of loans that are securitized assets and servicing assets. 4.2 Revolving master trusts NPR 2 allows the RRRs to be satisfied for a securitization where the issuing entity is a revolving master trust if the sponsor (or one 22 See NPR 2.9(d)(2) for these requirements. 23 NPR

9 or more wholly-owned affiliates of the sponsor, including one or more depositors) 24 retains a seller s interest of not less than 5% 25 of the unpaid principal balance of all outstanding investors ABS interests issued by the issuing entity. Note that this is a different measure than the U.S. GAAP fair value determination under the standard risk retention approach There are special provisions for multi-level trusts, 26 credit for pool level excess funding accounts, 27 combined retention at the trust and series level 28 as well as in respect of early amortization. 29 Revolving master trust = issuing entity that is a master trust and established to issue on multiple issuance dates one or more series, classes, subclasses or tranches of ABS all of which are collateralized by a common pool of securitized assets that will change in composition over time. Seller s interest = an ABS interest or ABS interests: (1) collateralized by all of the issuing entity s securitized assets and servicing assets (other than assets collateralizing only specific series); (2) that are pari passu to each series of investors ABS interests issued by the issuing entity with respect to the allocation of all distributions and losses with respect to the securitized assets prior to an early amortization event (as defined in the securitization transaction documents); and (3) that adjusts for fluctuations in the outstanding principal balance of the securitized assets in the pool. Collateral = in respect of an issuance of ABS interests the assets or other property that provide the cash flow (including from foreclosures or sales of such assets or property) for the ABS interests regardless of issuance s legal structure, including security interests in assets or other property of the issuing entity or interests therein; and, assets or other property collateralize an issuance of ABS interests if they serve as collateral for such issuance There are also special disclosure requirements for sponsors using the seller s interest approach Eligible ABCP conduits NPR 2 allows an ABCP conduit sponsor to satisfy the RRRs with respect to the issuance of ABCP by an eligible ABCP 24 NPR 2.5(c)(2). 25 RRRs under this provision must be satisfied (i) at the time of each issuance of ABS interests by the issuing entity, (ii) every seller s interest measurement date specified in the securitization transaction documents, but (iii) no less than monthly (until only sponsor or sponsor affiliates hold ABS interests in the issuing entity). NPR 2.5(c)(1). 26 Under the multi-level trust provisions, if a revolving master trust issues collateral certificates representing a beneficial interest in some or all of its securitized assets to another revolving trust, which then issues ABS interests collateralized wholly or partially by such collateral certificates, a sponsor may satisfy the RRRs by retaining the seller's interest for the assets represented by the collateral certificates through either trust, subject to various conditions. NPR 2.5(d). 27 The 5% seller's interest required to be satisfied as of each seller measurement date may be reduced dollar-for-dollar by the balance, as of such date, of a segregated excess funding account satisfying certain criteria. NPR 2.5(e). 28 The combined retention at trust and series level provisions contemplate the 5% seller's interest requirement being reduced to the extent that for all series of ABS interests issued by the revolving master trust, the sponsor or wholly owned affiliate of the sponsor - retains at a minimum, a corresponding percentage of the fair value of all ABS interests issued in each series, in the form of an eligible horizontal residual interest, or, for so long as the revolving master trust continues to operate by issuing ABS collateralized by a revolving pool of securitized assets, a horizontal interest meeting certain other specified criteria. NPR 2.5(f). 29 Subject to various conditions being satisfied, the early amortization provisions contemplate that a sponsor relying on the revolving master trust approach will not be in violation of the rule if it fails to satisfy the RRRs due to the occurrence of an early amortization event (with respect to all ABS interests issued by the trust to persons that are not affiliates of the sponsor). NPR 2.5(h). 30 NPR 2.5(g). See id. for the full list of additional disclosures required in respect of this option. 31 NPR

10 conduit in a securitization transaction if, for each ABS interest the ABCP conduit acquires from an intermediate SPV: (i) the intermediate SPV s originator-seller retains an economic interest in the credit risk of the assets collateralizing the ABS interest acquired by the eligible ABCP conduit in accordance with the following requirements, 32 in the same form, amount, and manner as would be required to satisfy the RRRs under the standard risk retention approach or the revolving master trust approach; 33 and (ii) the ABCP conduit sponsor: (a) (b) (c) (d) (e) approves each originator-seller and any majorityowned OS affiliate permitted to sell or transfer assets, directly or indirectly, to an intermediate SPV from which an eligible ABCP conduit acquires ABS interests; approves each intermediate SPV from which an eligible ABCP conduit is permitted to acquire ABS interests; establishes criteria governing the ABS interests, and the assets underlying the ABS interests, acquired by the ABCP conduit; administers the ABCP conduit; and maintains and adheres to policies and procedures for ensuring that these conditions have been met The originator-seller that sponsors ABS interests acquired by an eligible ABCP conduit must still comply with the RRRs applicable to it. 32 The following requirements refers to those set forth in NPR 2.6(b)(2). 33 NPR 2.6(b)(1). 10

11 ABCP = asset-backed commercial paper that has a maturity at the time of issuance not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited. Regulated liquidity provider means = (1) A depository institution; (2) A bank holding company, or a subsidiary; (3) A savings and loan holding company or a subsidiary thereof; or (4) A foreign bank whose home country supervisor has adopted capital standards consistent with the Capital Accord of the Basel Committee on Banking Supervision, as amended, and that is subject to such standards, or a subsidiary. Intermediate SPV = SPV that: (1) is a direct or indirect wholly-owned affiliate of the originator-seller; (2) is bankruptcy remote from the eligible ABCP conduit, the originator-seller, and any majority-owned OS affiliate that, directly or indirectly, sells or transfers assets to such intermediate SPV; (3) acquires assets that are originated by the originator-seller or its majorityowned OS affiliate from the originator-seller or majority-owned OS affiliate, or acquires ABS issued by another intermediate SPV or the original seller that are collateralized solely by such assets; and (4) issues ABS collateralized solely by such assets, as applicable. Majority-owned OS affiliate = an entity that, directly or indirectly, majority controls, is majority controlled by or is under common majority control with, an originator-seller participating in an eligible ABCP conduit. Majority control means ownership of more than 50 percent of an entity s equity, or ownership of any other controlling financial interest in the entity, as determined under GAAP. Originator-seller = an entity that originates assets and sells or transfers those assets directly, or through a majorityowned OS affiliate, to an intermediate SPV. ABCP conduit = an issuing entity with respect to ABCP. 100 percent liquidity coverage = means an amount equal to the outstanding balance of all ABCP issued by the conduit plus any accrued and unpaid interest without regard to the performance of the ABS interests held by the ABCP conduit and without regard to any credit enhancement. Eligible ABCP conduit = an ABCP conduit, provided that: (1) The ABCP conduit is bankruptcy remote from the sponsor and from any intermediate SPV; (2) The ABS acquired by the ABCP conduit are: (i) (ii) Collateralized solely by the following: (A) ABS collateralized solely by assets originated by an originator-seller or one or more majority-owned OS affiliates of the originator seller, and by servicing assets; (B) special units of beneficial interest or similar interests in a trust or special purpose vehicle that retains legal title to leased property underlying leases that were transferred to an intermediate SPV in connection with a securitization collateralized solely by such leases originated by an originator-seller or majority-owned OS affiliate, and by servicing assets; or (C) interests in a revolving master trust collateralized solely by assets originated by an originator-seller or majority-owned OS affiliate and by servicing assets; and not collateralized by ABS (other than those described in paragraphs (2)(i)(A) through (C) of this definition), otherwise purchased or acquired by the intermediate SPV, the intermediate SPV s originator-seller, or a majority-owned OS affiliate of the originator seller; and (iii) acquired by the ABCP conduit in an initial issuance by or on behalf of an intermediate SPV (A) directly from the intermediate SPV, (B) from an underwriter of the securities issued by the intermediate SPV, or (C) from another person who acquired the securities directly from the intermediate SPV; (3) the ABCP conduit is collateralized solely by ABS acquired from intermediate SPVs as described in paragraph (2) of this definition and servicing assets; and (4) a regulated liquidity provider has entered into a legally binding commitment to provide 100 percent liquidity coverage to all the ABCP issued by the ABCP and such coverage may not be conditional on. the credit performance of the ABCP s ABS or limited only to performing ABS interests. 11

12 4.3.3 There are also special disclosure requirements with respect to this option CMBS NPR 2 permits a sponsor to satisfy some or all of the RRRs with respect to CMBS if a third party purchaser (each, a TPP ) purchases and holds for its own account an eligible horizontal residual interest in the issuing entity in the same form, amount, and manner as would be held by the sponsor under the standard risk retention approach and various conditions are met, including, among others: (i) (ii) (iii) (iv) (v) max two TPPs (and, if two, their interests are pari passu); collateral solely commercial real estate loans and servicing assets; TPPs pay for their eligible horizontal residual interest(s) in cash at closing and do not receive financing from any party or any affiliate of any party to the securitization transaction (other than investors that are parties solely by being investors); TPPs independently review the credit risk of each securitized asset prior to the sale of the asset-backed securities; and no TPP is affiliated with any party to the securitization transaction (other than investors, the special servicer or one or more originators (as long as the assets they originated collectively comprise less than 10% of the unpaid principal balance of the securitized assets included at closing)) The securitization documents must provide for the appointment of an independent Operating Advisor meeting certain criteria and which is required to act in the best interest of, and for the benefit of, investors as a collective whole TPP must comply with the normal hedging and other transfer restrictions (as discussed below) as if it were the retaining sponsor that had acquired an eligible horizontal residual interest. An initial TPP or a sponsor that acquired an eligible horizontal residual interest at closing may, on or after the date that is five years after the date of the closing of a securitization 34 NPR 2.6(d)-(e). 35 NPR

13 transaction, transfer that interest to a subsequent TPP satisfying certain conditions The retaining sponsor is responsible for compliance by itself and each initial or subsequent TPP. A sponsor relying on this section must maintain and adhere to policies and procedures to monitor each TPP s compliance. If the sponsor determines a TPP is no longer in compliance, it must promptly notify, or cause to be notified, the holders of the ABS interests issued in the securitization transaction of such TPP s noncompliance There are also special disclosure requirements with respect to this option Federal National Mortgage Association and Federal Home Loan Mortgage Corporation ABS 38 NPR 2 provides that the RRRs will be satisfied where the sponsor fully guarantees timely payment of principal and interest on all ABS interests issued by the issuing entity in the securitization transaction and the sponsor is one of the entities enumerated Qualified tender option bonds 40 NPR 2 provides that in respect of certain types of municipal bond repackagings that the RRRs can be satisfied either through the standard risk retention approach or by the sponsor holding the relevant municipal bonds in an amount sufficient to satisfy the RRRs Restrictions on hedging and transfer The retaining sponsor is not permitted to sell or transfer its retained risk to anyone other than a majority-owned affiliate. A retaining sponsor and its affiliates cannot hedge the retained risk nor can the issuing entity do so. Pledging retained interests on a non-recourse basis is prohibited. Hedging interest rate risk (other than the specific spread risk associated with the ABS interest) and foreign exchange risk are permitted. Transactions linked to indices which include a relevant ABS interest are not prohibited subject to no class of ABS interests comprising more than 10% of the index and all classes of ABS interests in respect of a securitization not comprising more than 20% of the index. 5.2 Except in respect of securitization transactions 100% collateralized by RMBS (which are subject to longer sunset provisions) 43 these hedging, 36 NPR 2.7(b)(8)(ii)(C). Subsequent TPPs may also transfer to other subsequent TPPs subject to complying with NPR 2.7(b)(8)(ii)(C). See NPR 2.7(b)(8)(ii)(B). 37 NPR 2.7(b)(7). 38 NPR See NPR 2.8 for the list of entities. 40 NPR See NPR NPR

14 transfer and financing restrictions expire on or after the date that is the latest of: the date when the unpaid principal balance of the securitized assets is reduced to 33% of the unpaid principal balance of the securitized assets as of the securitization closing date; the date when total unpaid principal obligations under the ABS interests issued in the securitization transaction have been reduced to 33% of the total unpaid principal obligations of the ABS interests at closing of the securitization transaction; or two years after the date of the closing of the securitization transaction Special products excluded 6.1 Qualified Residential Mortgages Subject to various conditions, 45 the RRRs will not apply to RMBS collateralized 100% by qualified residential mortgages Qualifying commercial loans, CRE loans and auto loans Subject to various conditions, the RRRs will not apply to ABS collateralized 100% by qualifying commercial loans, qualifying CRE loans and qualifying auto loans. Blending qualifying assets with non-qualifying assets of the same type is now permissible, but the RRRs will still apply albeit on a reduced basis (i.e., 2.5% instead of 5%) Underwriting standards for Qualifying Commercial Loans, 48 CRE Loans 49 and Auto Loans 50 The underwriting standards for each of these asset classes are set forth in detail in NPR 2 and are better understood by reviewing the complete list rather than a summary Exemptions: 52 The following are exempt from the RRRs assuming they satisfy various requirements. Other than in the few most relevant instances, we have not 43 NPR 2.12(f)(2). 44 NPR 2.12(f)(1). 45 NPR 2.15(a)(1)-)(4). 46 What constitutes a qualified residential mortgage has been expanded in NPR 2. NPR 2.13(a). 47 NPR 2.15(b). 48 NPR NPR NPR NPR NPR

15 included below the granular details of those requirements, but the complete details of each can be found in NPR U.S. Government-backed securitizations Certain agricultural loan securitizations State and municipal securitizations Qualified scholarship funding bonds Pass-through resecuritizations Any securitization transaction that: (i) is collateralized solely by servicing assets, and by existing ABS: for which the RRRs were satisfied or that is exempt from the RRRs; (ii) involves the issuance of only a single class of ABS interests; and (iii) provides for the pass-through of all principal and interest payments received on the underlying ABS (net of expenses of the issuing entity) to the holders of such class First-pay-class securitizations Seasoned loans = (i) any securitization transaction that is collateralized solely by (x) servicing assets, and (y) by seasoned loans that meet the following requirements: (A) the loans have not been modified since origination; and (B) none of the loans have been delinquent for 30 days or more. (ii) For purposes of this paragraph, a seasoned loan means: (A) with respect to ABS backed by residential mortgages, a loan that has been outstanding and performing for the longer of: (1) five years; or (2) until the loan s outstanding principal balance has been reduced to 25 percent of the original principal balance. (3) Notwithstanding the above, any performing residential mortgage loan that has been outstanding for a period of at least seven years shall be deemed a seasoned loan. (B) For all other classes of ABS, a performing loan that has been outstanding for the longer of: (1) a period of at least two years; or (2) until the loan s outstanding principal balance has been reduced to 33% of the original principal balance Certain public utility securitizations Certain student loan transactions See NPR 2.19(b)(1). 54 See NPR 2.19(b)(2). 55 See NPR 2.19(b)(3). 56 See NPR 2.19(b)(4). 57 See NPR 2.19(b)(5). 58 See NPR 2.19(b)(6). 59 See NPR 2.19(b)(7). 60 See NPR 2.19(b)(8). 61 See NPR 2.19(e). 15

16 7.10 Assets issued, insured or guaranteed by the United States FDIC in its capacity as receiver or conservator sponsoring a securitization transaction Foreign Securitizations Foreign securitizations satisfying certain conditions are exempt from the RRRs. Those conditions include: the securitization transaction is not required to be and is not registered under the Securities Act of 1933; no more than 10% of the dollar value of all classes of ABS interests in the securitization transaction are sold or transferred to U.S. persons or for the account or benefit of U.S. persons; neither the sponsor nor the issuing entity is: (i) chartered, incorporated, or organized under the laws of the United States or any State (or an unincorporated branch or office of such an entity); or (ii) an unincorporated branch or office located in the United States or any State of an entity that is chartered, incorporated, or organized under the laws of a jurisdiction other than the United States or any State; and if the sponsor or issuing entity is chartered, incorporated, or organized under the laws of a jurisdiction other than the United States or any State, no more than 25 percent (as determined based on unpaid principal balance) of the assets that collateralize the ABS interests sold in the securitization transaction were acquired by the sponsor or issuing entity, directly or indirectly, from: (i) a majority-owned affiliate of the sponsor or issuing entity that is chartered, incorporated, or organized under the laws of the United States or any State; or (ii) an unincorporated branch or office of the sponsor or issuing entity that is located in the United States or any State. 8.2 This safe harbor is not available for any transaction(s) that, although otherwise technically eligible, is part of a plan or scheme to evade the requirements of section 15G and the RRRs. Note that NPR 2 also includes an express definition of U.S. person, which we have reproduced in the footnote See NPR 2.19(c). 63 See NPR 2.19(d). 64 NPR NPR 2 does not expressly state whether this 10% requirement is in respect of initial sales or if it also encompasses secondary sales, but the most likely construction, although the matter is not free from doubt, is that it includes both. 66 U.S. person means: Any of the following: (i) Any natural person resident in the United States; (ii) Any partnership, corporation, limited liability company, or other organization or entity organized or incorporated under the laws of any State or of the United States; (iii) Any estate of which any 16

17 9 Additional exemptions 67 The regulators having authority with respect to particular types of assets are empowered to jointly provide a total or partial exemption for any securitization transaction as they may determine in the public interest and for the protection of investors. 68 Additionally, the Federal banking agencies and the SEC, in consultation with the Federal Housing Finance Agency and the Department of Housing and Urban Development, may jointly adopt or issue exemptions, exceptions or adjustments to the RRRs NPR 2 and Non-U.S. securitizations 10.1 One of the conditions which must be satisfied for a non-us securitization to be able to benefit from the safe harbor is that no more than 10% of the dollar value of ABS interests in the securitization are sold or transferred to US persons. It is not clear if this reference to transfers is intended merely to capture transfers from the issuing entity to initial investors or if it is meant to extend to transfers in the secondary market. The latter interpretation would make it almost impossible to rely on the safe harbor The size of any retained interest must be measured using fair value determined in accordance with US GAAP, 70 while most non-us sponsors will use their own local GAAP or International Financial Reporting Standards for accounting purposes. executor or administrator is a U.S. person; (iv) Any trust of which any trustee is a U.S. person; (v) Any agency or branch of a foreign entity located in the United States; (vi) Any non-discretionary account or similar account (other than an estate or trust) held by a dealer or other fiduciary for the benefit or account of a U.S. person; (vii) Any discretionary account or similar account (other than an estate or trust) held by a dealer or other fiduciary organized, incorporated, or (if an individual) resident in the United States; and (viii) Any partnership, corporation, limited liability company, or other organization or entity if: (A) Organized or incorporated under the laws of any foreign jurisdiction; and (B) Formed by a U.S. person principally for the purpose of investing in securities not registered under the Act; and U.S. person(s) does not include: (i) Any discretionary account or similar account (other than an estate or trust) held for the benefit or account of a non-u.s. person by a dealer or other professional fiduciary organized, incorporated, or (if an individual) resident in the United States; (ii) Any estate of which any professional fiduciary acting as executor or administrator is a U.S. person if: (A) An executor or administrator of the estate who is not a U.S. person has sole or shared investment discretion with respect to the assets of the estate; and (B) The estate is governed by foreign law; (iii) Any trust of which any professional fiduciary acting as trustee is a U.S. person, if a trustee who is not a U.S. person has sole or shared investment discretion with respect to the trust assets, and no beneficiary of the trust (and no settlor if the trust is revocable) is a U.S. person; (iv) An employee benefit plan established and administered in accordance with the law of a country other than the United States and customary practices and documentation of such country; (v) Any agency or branch of a U.S. person located outside the United States if: (A) The agency or branch operates for valid business reasons; and (B) The agency or branch is engaged in the business of insurance or banking and is subject to substantive insurance or banking regulation, respectively, in the jurisdiction where located; (vi) The International Monetary Fund, the International Bank for Reconstruction and Development, the Inter- American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies, affiliates and pension plans, and any other similar international organizations, their agencies, affiliates and pension plans. NPR 2.20(a). 67 NPR NPR 2.21(a). 69 NPR 2.21(b). 70 Note the actual text of the rule in NPR 2 refers only to GAAP, but the body of the proposing release makes clear that GAAP refers to U.S. GAAP. See NPR 2 at

18 10.3 Some of the proposed qualified asset definitions refer to US-specific criteria which it may prove difficult, or impossible, for non-us assets to comply with Structures typically used in some non-us jurisdictions (including Europe) for mortgage master trusts, ABCP conduits, arbitrage CLOs and CMBS transactions may struggle to fall within the specific provisions included in NPR 2 for those types of transactions, which have clearly been drafted with US deal structures in mind. 18

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