The final version Regulation AB II could create a data overload in the asset backed securities (ABS) market.
The final amendments to the regulation were adopted on August 27 by the US Securities and Exchange Commission (SEC). This followed a second request for public comment to determine how best to increase disclosure without overly comprising privacy.
The new rules require asset level disclosure for certain ABS classes, periodic updates on the states of assets in the pool and certification of the information by the issuers CEO.
The amount of information required is anticipated to drive up the cost for securitizers of initial offerings. Investors will now also need to conduct more diligence to get the best sense of an offering’s value. This in turn is expected to create and grow a sub-industry designed to analyse and help investors visualise the data.
“It will probably create a new service sector,” said Jerry Marlatt, a partner with Morrison & Foerster in Washington DC. “Because not all fund managers will have the capacity to analyse this data and won’t have the capacity in terms of systems and people.”
The amendments
The SEC passed the rules in a unanimous vote and the final release is expected for some time in November.
Mortgage-backed securitisations, both residential and commercial, auto loan and auto lease ABS as well debt securitisations and re-securitisations all fall under the new rules. The regulators have said they plan to monitor whether other asset classes, such as student loans or equipment should be moved under these regulations too.
Increased analysis
The type of information required in disclosures will now be standard, so that investors can make better comparisons between offerings.
“The increased information won’t just impact the way investors buy and sell, it will also affect their stress-testing and risk analysis of the portfolios,” said Kevin Samborn of consulting firm Sapient Global Markets.
New third party reviewers will likely take on some liability, but will see significant growth as portfolio managers attempt to better understand ABS offerings. The analysis of these deals will likely become more sophisticated, explained Marlatt. “You will be able to index the value of the underlying property to the property sales in the geographical area, also you have more sense of the property value,” he added.
KEY TAKEAWAYS
- Amendments to regulation AB have been approved by the SEC. They increase the amount of asset level data issuers must provide;
- The increase in information is excepted to drive the creation of a new industry to analyse and review the data, separate from traditional rating agencies;
- The changes are expected to affect pricing and issuances as market participants determine how to deal with the new disclosure requirement and the bulk of information.
The changes require a credit risk manager to conduct a review of the assets pool if either certain delinquency measures are triggered or at the request of an investor. However, due to privacy concern about the underlying data, only a summary of the final review will be filed with the SEC.
Investors are expected to want their own reviews based on the asset level data provided in the disclosures. Both larger institutional investors and smaller investors, who lack the capacity to perform these analysis in-house, will want to take full advantage of third party information reviewers to better decided pricing and risk - further driving the creation of this new market.
“The arms race to use loan level data as part of the strategy will be short,” said Samborn. “What this should do is increase the overall quality and should help align the coupons of a security to better reflect their underlying assets.”
With investors able to perform their own analysis and comparisons, the role of rating agencies is expected to decrease. “There has already been blame placed on the rating agencies for the financial crisis,” said Amanda Baker a partner with Mayer Brown in New York. “Now that blame and consequently new responsibility is being passed to securitizers.”
Changes to securitizers
For smaller, less frequent or foreign issuers the new rules may push them out of the space entirely or to the private market where the new regulations, so far, do not apply. Even large issuers could face problems collecting some of the newly required asset-level information, which has not been part of Reg AB II.
“Some of the requirements are not typically obtained at origination, thereby making this information difficult for securitizers to collect and disclose,” said Baker. The auto industry has never provided the asset level details required in the new rules. The industry as a whole may ask for an exception rather than request the additional information.
Opt-out
Borrowers who do not want that information disclosed may now be offered the option to keep their loans out of any ABS pools. These opt-out loans would likely come at a higher price to borrowers.
If lower risk borrowers are more inclined to pay to protect their privacy it may change the nature of the ABS market. In industries such as auto loans, it could also mean certain higher end issuers no longer have enough loans to form substantial pools.
Regulator overload
Along with securitizers the SEC will be bombarded by a wave of information. The amount of data is far more than the agency has had to store in the past.
It will also take the regulator more time to go through the new filings, not only because they contain more information, but because of the suspected backlog at the start of the process, when many issuers re-file. When Reg AB initially came out, issuers dealt with a similar backlog. Reviews then could take 90 days as opposed to the typical 30.
Further reading
Analysis: Reg AB II transparency debate
China auto ABS revives securitisation optimism
Deal: Brazil first oil royalty securitisation