Fixing the Registered Mortgage-Backed Securities Market: Reducing Risk, Protecting Privacy, Reviving Markets

On December 1, SIFMA filed a letter with the SEC in response to its concept release on asset-backed securities regulation (Regulation AB). This ruleset governs disclosure and other requirements for registered issuances of asset-backed securities, including residential mortgage-backed securities (RMBS). In simplest terms, you can either issue a registered security or issue in the unregistered market, with the Rule 144A market being the most common one. There can be benefits to registered issuances, such as a potentially broader and deeper investor base.

In the concept release, the SEC asks for responses to 39 questions (with a few sub-questions for added fun) that cover loan-level disclosure requirements, privacy of confidential information, the definition of an asset-backed security, and other topics.

We think it is great that the SEC is doing this.

• Why is it great that the SEC is reviewing Reg AB? The last registered RMBS would almost be old enough to go to a PG-13 movie if it were human; there have been zero issuances since 2013. On the other hand, the 144A (private) market went from a side dish to the entire meal and has expanded gracefully to take up slack. As a general matter, regulators should be commended for reviewing the impact of their rules. While we wish this had come sooner, our focus is on improvement going forward and a fruitful conclusion to this new initiative.
• Why did the registered RMBS market go the way of the wooly mammoth? There are many reasons, but the most important one is that the last time the SEC updated Regulation AB in response to the problems in the late-2000s RMBS markets, they imposed very numerous, very prescriptive, not always clearly explained, and overall very litigation-risky loan level disclosure requirements. For RMBS, there are hundreds of required data points for each loan, each of which would need to be captured, collated, and filed with the SEC for the life of a transaction without a single error. Strict liability applies to errors in this market; there is no room for mistakes. Another major concern is the fact that SEC filings are generally public, and RMBS investors need information that presents reidentification risk if posted publicly (such as 5-digit zip codes). There are a number of other issues as well, but they are more along the lines of things that entertain lawyers than we want to post here. The bottom line is that an expensive liability & litigation risk-riddled framework was created, and potential RMBS issuers did the rational thing, which is to not issue in that market. While the intentions were good, the end result was unworkable.
• What is the potential benefit of the SEC’s effort? The problem here is that we need both a functioning 144A market and a functioning registered market for RMBS. There are investors who don’t or won’t invest in 144As, and there are investors who may have limits on the amount of 144A bonds they can buy. Given the current focus at the highest levels of government on resolving GSE conservatorships and making the mortgage market as affordable and inclusive as possible, we need to invite all sources of mortgage capital into the party.
• What did SIFMA recommend? Quite a few things. The bottom line is that we want a market that works for investors and issuers, protects the privacy of sensitive information, and incentivizes issuers to operate in the registered markets in addition to the Rule 144A market. This will have benefits to consumers, our members, and the economy as a whole.

Here’s a summary; SIFMA’s recommendations may be distilled into five key categories.

1. Substantially Reduce and Redesign Schedule AL Asset-Level Disclosure Requirements for RMBS to Better Align with the 144A Market

The current asset-level disclosure regime is a significant barrier to registered RMBS and is impractical or impossible to comply with. Required data fields should be aligned with those that are uniformly provided in the 144A market and are readily obtainable across product types. Our recommendations include:

• Issuers should be permitted to define each field since the meanings are often ambiguous or may vary between issuers (e.g., “cash-out refinance”).
• References to “any transaction party or its affiliates” should be removed from any data fields since it is impractical, if not impossible, to gather information from unrelated business lines.
• Flexible response codes should be included for each data field so that issuers can provide substantive responses as opposed to being forced to choose “Other” or “Not available”.

2. Allow Sensitive Data to be Filed in Restricted-Access Systems

Investors require certain loan-level data points that raise privacy concerns, such as five-digit zip codes. The public release of this information raises borrower re-identification risk. Our recommendations include:

• Only limited, non-sensitive data points should be publicly accessible.
• Sensitive data (e.g., five-digit zip code, credit score, income/asset data) should be provided only through a Commission-operated restricted website, analogous to 144A practices (redacted vs. unredacted tapes via confidentiality agreements).
• The SEC should specify in Regulation AB that receipt of sensitive asset-level data filed on the Commission’s restricted website does not create “material non-public information” or Regulation FD issues for issuers or investors.

3. Reduce the Burden of Ongoing Exchange Act Reporting

The lifetime reporting obligations required by the Exchange Act make the issuance of registered RMBS economically irrational. Since they are long-dated assets, the reporting requirements create decades of unpredictable compliance costs as “grandfathering” generally does not exist for any new reporting obligations created under the Exchange Act. To reinvigorate the registered markets, the Commission will need to take action to reduce the burden of Exchange Act reporting on issuers of asset-backed securities.

4. Modernize Eligibility Requirements to Align with Actual 144A RMBS Practice

The asset review provisions and the dispute resolution mechanics required by the SEC do not permit the detailed and effective mechanisms that have been developed in the 144A RMBS market. The eligibility requirements should be revised to permit registered transactions that incorporate those mechanisms that both issuers and investors have already determined are acceptable in the 144A market.

5. Conduct a Comprehensive Review and Reform of Regulation AB and Related Rules in Addition to the Issues Raised in the Concept Release

Regulation AB includes outdated disclosure requirements (e.g., mandatory identification of rating agencies even though this has not occurred since Rule 436(g) was repealed). In addition, overly prescriptive rules (e.g., Item 1100(b)) and rules that are not currently generating meaningful disclosures (e.g., Item 1104(f)) should be revised or eliminated.

Author

Chris Killian is Managing Director, Corporate Credit and Securitization for SIFMA.