A long-standing Securities and Exchange Commission (SEC) rule amended a year and a half ago could significantly reduce liquidity in the asset-backed securities (ABS) market starting next year, which would have a negative impact on both investors in securitizations and borrowers of securitized loans. The changes came into effect on January 3 for strictly private transactions and, unless revised, will impact Rule 144A transactions from January 2023.
That was the message from the Structured Finance Association (SFA) in a December 9, 2021 letter to the SEC regarding the regulator’s amendments to Rule 15c2-11 which it adopted on September 16, 2020. The rule was originally put in place to protect investors in over-the-counter (OTC) equity securities by prohibiting brokers from posting quotes for a security for which current issuer information is not publicly available.
The amendments effectively expand the rule’s impact to include fixed income securities, prompting several major industry associations, including the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI), to address the issue. September 23, 2021. Letter to SEC Chairman Gary Gensler. She argues that the structural differences between the bond market and the equity market make compliance with the amended rule difficult and costly and would have a negative impact on liquidity.
In response to industry concerns, SEC staff issued a no-action letter on September 24, 2021, stating that it would not recommend enforcement action under the amended rule until January 3, 2022. .
The SFA’s letter in December said concerns about the rule’s impact on the fixed income market are heightened for ABS because “Rule 15c2-11’s disclosure requirements are not material”. for securitizations and that it is often impossible for brokers to comply with them. This is partly because the issuer is an independent trust that holds the financial assets and executes the transaction to maturity, but does not provide investors with the information required by the rule.
“SFA investor members believe that the key financial information required under Rule 15c2-11, the issuer’s ‘balance sheet’, ‘profit and loss’ statement and calculation of ‘retained earnings’ are not relevant to ABS and therefore such information is not being produced,” the letter states.
For ABS investors, the letter says, the relevant information instead comes from trust and rebate reports that regularly update the performance of the pool of assets providing security.
As a result, the amended rule would impede brokers’ ability to provide quotes for ABS securities, “directly reducing liquidity and trading,” the letter states, and inhibiting investment by institutional investors who must adhere to regulatory standards and practices. risk managers. Lower liquidity would in turn increase the cost of issuing ABS and using it as a financing tool for consumer and business loans.
“For example,” the letter states, “homebuyers in the mortgage market represent the primary indirect beneficiaries of financing provided by ABS.”
Subsequently, SEC staff released a Dec. 16 letter outlining how it will apply the rule in stages to give brokers more time to implement the necessary changes. The first stage began Jan. 3 and lasts for a year, exempting transactions that provide investors with offering documents. These transactions include Rule 144A transactions, which make up the vast majority of private ABS transactions by volume, said Paul Forrester, partner at Mayer Brown.
Strictly private transactions for more esoteric assets do not use Rule 144A and have therefore been subject to the rule’s listing bans.
“They’re usually sold to buy-and-hold investors, so they won’t need the rating system, although a number might,” he said.
The most significant impact comes after January 3, 2023, when Rule 144A agreements will have to meet additional requirements, including having a class of securities listed on a national securities exchange, which will be difficult, if not impossible, to respect.
So far, there has been no indication from the SEC that it is considering an exemption for securitizations. Forrester noted that bond market representatives have been slow to voice their concerns – a year after the SEC approved the changes – and that there is a “powerful case” for brokers to provide enough information to investors to support the ratings they provide.
“I think a better argument is that there’s really no benefit to forcing brokers to ensure that this information is available before providing quotes to sophisticated institutional investors,” he said. , noting that investors in Rule 144A agreements must be eligible institutions that have discretionary investments. authority for at least $100 million in securities.
Forrester added that concerns could arise this year for investors in strictly private transactions, as portfolio management and similar issues can be difficult to resolve without quotes, and so far there has been little overt consternation. as to the wider impact of the rule next January.
“When we get to the middle of the year or the third quarter, with no visible relief, I think it will become a bigger deal,” Forrester said. “Brokers will need to put systems in place to make those decisions and provide quotes. They will probably answer that they will be able to do it, but it will be expensive and investors will end up paying for it.