# Credit Risk Retention > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2013-21677 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** September 20, 2013 - **Citation:** 78 FR 57928 ## Text DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Part 43 [Docket No. OCC-2013-0010] RIN 1557-AD40 FEDERAL RESERVE SYSTEM 12 CFR Part 244 [Docket No. R-1411] RIN 7100-AD70 FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 373 RIN 3064-AD74 FEDERAL HOUSING FINANCE AGENCY 12 CFR Part 1234 RIN 2590-AA43 SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 246 [Release Nos. 34-70277] RIN 3235-AK96 DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT 24 CFR Part 267 RIN 2501-AD53 Credit Risk Retention AGENCY: Office of the Comptroller of the Currency, Treasury (OCC); Board of Governors of the Federal Reserve System (Board); Federal Deposit Insurance Corporation (FDIC); U.S. Securities and Exchange Commission (Commission); Federal Housing Finance Agency (FHFA); and Department of Housing and Urban Development (HUD). ACTION: Proposed rule. SUMMARY: The OCC, Board, FDIC, Commission, FHFA, and HUD (the agencies) are seeking comment on a joint proposed rule (the proposed rule, or the proposal) to revise the proposed rule the agencies published in the Federal Register on April 29, 2011, and to implement the credit risk retention requirements of section 15G of the Securities Exchange Act of 1934 (15. U.S.C. 78o-11), as added by section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Section 15G generally requires the securitizer of asset-backed securities to retain not less than 5 percent of the credit risk of the assets collateralizing the asset-backed securities. Section 15G includes a variety of exemptions from these requirements, including an exemption for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as “qualified residential mortgages,” as such term is defined by the agencies by rule. DATES: Comments must be received by October 30, 2013. ADDRESSES: Interested parties are encouraged to submit written comments jointly to all of the agencies. Commenters are encouraged to use the title “Credit Risk Retention” to facilitate the organization and distribution of comments among the agencies. Commenters are also encouraged to identify the number of the specific request for comment to which they are responding. Office of the Comptroller of the Currency: Because paper mail in the Washington, DC area and at the OCC is subject to delay, commenters are encouraged to submit comments by the Federal eRulemaking Portal or email, if possible. Please use the title “Credit Risk Retention” to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods: • Federal eRulemaking Portal—“Regulations.gov”: Go to http://www.regulations.gov. Enter “Docket ID OCC-2013-0010” in the Search Box and click “Search”. Results can be filtered using the filtering tools on the left side of the screen. Click on “Comment Now” to submit public comments. Click on the “Help” tab on the Regulations.gov home page to get information on using Regulations.gov. • Email: regs.comments@occ.treas.gov. • Mail: Legislative and Regulatory Activities Division, Office of the Comptroller of the Currency, 400 7th Street SW., Suite 3E-218, Mail Stop 9W-11, Washington, DC 20219. • Fax: (571) 465-4326. • Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218, Mail Stop 9W-11, Washington, DC 20219. Instructions: You must include “OCC” as the agency name and “Docket Number OCC-2013-0010” in your comment. In general, OCC will enter all comments received into the docket and publish them on the Regulations.gov Web site without change, including any business or personal information that you provide such as name and address information, email addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure. You may review comments and other related materials that pertain to this proposed rulemaking by any of the following methods: • Viewing Comments Electronically: Go to http://www.regulations.gov. Enter “Docket ID OCC-2013-0010” in the Search box and click “Search”. Comments can be filtered by agency using the filtering tools on the left side of the screen. Click on the “Help” tab on the Regulations.gov home page to get information on using Regulations.gov, including instructions for viewing public comments, viewing other supporting and related materials, and viewing the docket after the close of the comment period. • Viewing Comments Personally: You may personally inspect and photocopy comments at the OCC, 400 7th Street SW., Washington, DC. For security reasons, the OCC requires that visitors make an appointment to inspect comments. You may do so by calling (202) 649-6700. Upon arrival, visitors will be required to present valid government-issued photo identification and submit to security screening in order to inspect and photocopy comments. • Docket: You may also view or request available background documents and project summaries using the methods described above. Board of Governors of the Federal Reserve System: You may submit comments, identified by Docket No. R-1411, by any of the following methods: • Agency Web site: http://www.federalreserve.gov. Follow the instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm. • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. • Email: regs.comments@federalreserve.gov. Include the docket number in the subject line of the message. • Fax: (202) 452-3819 or (202) 452-3102. • Mail: Address to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW., Washington, DC 20551. All public comments will be made available on the Board's Web site at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons. Accordingly, comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper in Room MP-500 of the Board's Martin Building (20th and C Streets, NW) between 9:00 a.m. and 5:00 p.m. on weekdays. Federal Deposit Insurance Corporation: You may submit comments, identified by RIN number, by any of the following methods: • Agency Web site: http://www.FDIC.gov/regulations/laws/federal. Follow instructions for submitting comments on the agency Web site. • Email: Comments@FDIC.gov. Include RIN 3064-AD74 in the subject line of the message. • Mail: Robert E. Feldman, Executive Secretary, Attention: Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429. • Hand Delivery/Courier: Guard station at the rear of the 550 17th Street Building (located on F Street) on business days between 7:00 a.m. and 5:00 p.m. • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. Instructions: All comments will be posted without change to http://www.fdic.gov/regulations/laws/federal , including any personal information provided. Paper copies of public comments may be ordered from the Public Information Center by telephone at (877) 275-3342 or (703) 562-2200. Securities and Exchange Commission: You may submit comments by the following method: Electronic Comments • Use the Commission's Internet comment form ( http://www.sec.gov/rules/proposed.shtml ); or • Send an email to rule-comments@sec.gov. Please include File Number S7-14-11 on the subject line; or • Use the Federal eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments. Paper Comments • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090 • All submissions should refer to File Number S7-14-11. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. Federal Housing Finance Agency: You may submit your written comments on the proposed rulemaking, identified by RIN number 2590-AA43, by any of the following methods: • Email: Comments to Alfred M. Pollard, General Counsel, may be sent by email at RegComments@fhfa.gov. Please include “RIN 2590-AA43” in the subject line of the message. • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. If you submit your comment to the Federal eRulemaking Portal, please also send it by email to FHFA at RegComments@fhfa.gov to ensure timely receipt by the agency. Please include “RIN 2590-AA43” in the subject line of the message. • U.S. Mail, United Parcel Service, Federal Express, or Other Mail Service: The mailing address for comments is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA43, Federal Housing Finance Agency, Constitution Center, (OGC) Eighth Floor, 400 7th Street SW., Washington, DC 20024. • Hand Delivery/Courier: The hand delivery address is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA43, Federal Housing Finance Agency, Constitution Center, (OGC) Eighth Floor, 400 7th Street SW., Washington, DC 20024. A hand-delivered package should be logged in at the Seventh Street entrance Guard Desk, First Floor, on business days between 9:00 a.m. and 5:00 p.m. All comments received by the deadline will be posted for public inspection without change, including any personal information you provide, such as your name and address, on the FHFA Web site at http://www.fhfa.gov. Copies of all comments timely received will be available for public inspection and copying at the address above on government-business days between the hours of 10 a.m. and 3 p.m. at the Federal Housing Finance Agency, Constitution Center, 400 7th Street SW., Washington, DC 20024. To make an appointment to inspect comments please call the Office of General Counsel at (202) 649-3804. Department of Housing and Urban Development: Interested persons are invited to submit comments regarding this rule to the Regulations Division, Office of General Counsel, Department of Housing and Urban Development, 451 7th Street SW., Room 10276, Washington, DC 20410-0500. Communications must refer to the above docket number and title. There are two methods for submitting public comments. All submissions must refer to the above docket number and title. • Submission of Comments by Mail. Comments may be submitted by mail to the Regulations Division, Office of General Counsel, Department of Housing and Urban Development, 451 7th Street SW., Room 10276, Washington, DC 20410-0500 . • Electronic Submission of Comments. Interested persons may submit comments electronically through the Federal eRulemaking Portal at www.regulations.gov. HUD strongly encourages commenters to submit comments electronically. Electronic submission of comments allows the commenter maximum time to prepare and submit a comment, ensures timely receipt by HUD, and enables HUD to make them immediately available to the public. Comments submitted electronically through the www.regulations.gov Web site can be viewed by other commenters and interested members of the public. Commenters should follow the instructions provided on that site to submit comments electronically. • Note: To receive consideration as public comments, comments must be submitted through one of the two methods specified above. Again, all submissions must refer to the docket number and title of the rule. • No Facsimile Comments. Facsimile (FAX) comments are not acceptable. • Public Inspection of Public Comments. All properly submitted comments and communications submitted to HUD will be available for public inspection and copying between 8 a.m. and 5 p.m. weekdays at the above address. Due to security measures at the HUD Headquarters building, an appointment to review the public comments must be scheduled in advance by calling the Regulations Division at 202-708-3055 (this is not a toll-free number). Individuals with speech or hearing impairments may access this number via TTY by calling the Federal Information Relay Service at 800-877-8339. Copies of all comments submitted are available for inspection and downloading at www.regulations.gov. FOR FURTHER INFORMATION CONTACT: OCC: Kevin Korzeniewski, Attorney, Legislative and Regulatory Activities Division, (202) 649-5490, Office of the Comptroller of the Currency, 400 7th Street SW., Washington, DC 20219. Board: Benjamin W. McDonough, Senior Counsel, (202) 452-2036; April C. Snyder, Senior Counsel, (202) 452-3099; Brian P. Knestout, Counsel, (202) 452-2249; David W. Alexander, Senior Attorney, (202) 452-2877; or Flora H. Ahn, Senior Attorney, (202) 452-2317, Legal Division; Thomas R. Boemio, Manager, (202) 452-2982; Donald N. Gabbai, Senior Supervisory Financial Analyst, (202) 452-3358; Ann P. McKeehan, Senior Supervisory Financial Analyst, (202) 973-6903; or Sean M. Healey, Senior Financial Analyst, (202) 912-4611, Division of Banking Supervision and Regulation; Karen Pence, Assistant Director, Division of Research & Statistics, (202) 452-2342; or Nikita Pastor, Counsel, (202) 452-3667, Division of Consumer and Community Affairs, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. FDIC: Rae-Ann Miller, Associate Director, (202) 898-3898; George Alexander, Assistant Director, (202) 898-3718; Kathleen M. Russo, Supervisory Counsel, (703) 562-2071; or Phillip E. Sloan, Counsel, (703) 562-6137, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429. Commission: Steven Gendron, Analyst Fellow; Arthur Sandel, Special Counsel; David Beaning, Special Counsel; or Katherine Hsu, Chief, (202) 551-3850, in the Office of Structured Finance, Division of Corporation Finance, U.S. Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-3628. FHFA: Patrick J. Lawler, Associate Director and Chief Economist, Patrick.Lawler@fhfa.gov , (202) 649-3190; Ronald P. Sugarman, Principal Legislative Analyst, Ron.Sugarman@fhfa.gov , (202) 649-3208; Phillip Millman, Principal Capital Markets Specialist, Phillip.Millman@fhfa.gov , (202) 649-3080; or Thomas E. Joseph, Associate General Counsel, Thomas.Joseph@fhfa.gov , (202) 649-3076; Federal Housing Finance Agency, Constitution Center, 400 7th Street SW., Washington, DC 20024. The telephone number for the Telecommunications Device for the Hearing Impaired is (800) 877-8339. HUD: Michael P. Nixon, Office of Housing, Department of Housing and Urban Development, 451 7th Street SW., Room 10226, Washington, DC 20410; telephone number 202-402-5216 (this is not a toll-free number). Persons with hearing or speech impairments may access this number through TTY by calling the toll-free Federal Information Relay Service at 800-877-8339. SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction A. Background B. Overview of the Original Proposal and Public Comment C. Overview of the Proposed Rule II. General Definitions and Scope A. Overview of Significant Definitions in the Original Proposal and Comments 1. Asset-Backed Securities, Securitization Transactions, and ABS Interests 2. Securitizer, Sponsor, and Depositor 3. Originator 4. Servicing Assets, Collateral B. Proposed General Definitions III. General Risk Retention Requirement A. Minimum Risk Retention Requirement B. Permissible Forms of Risk Retention—Menu of Options 1. Standard Risk Retention 2. Revolving Master Trusts 3. Representative Sample 4. Asset-Backed Commercial Paper Conduits 5. Commercial Mortgage-Backed Securities 6. Government-Sponsored Enterprises 7. Open Market Collateralized Loan Obligations 8. Municipal Bond “Repackaging” Securitizations 9. Premium Capture Cash Reserve Account C. Allocation to the Originator D. Hedging, Transfer, and Financing Restrictions IV. General Exemptions A. Exemption for Federally Insured or Guaranteed Residential, Multifamily, and Health Care Mortgage Loan Assets B. Exemption for Securitizations of Assets Issued, Insured, or Guaranteed by the United States or Any Agency of the United States and Other Exemptions C. Exemption for Certain Resecuritization Transactions D. Other Exemptions From Risk Retention Requirements 1. Utility Legislative Securitizations 2. Seasoned Loans 3. Legacy Loan Securitizations 4. Corporate Debt Repackagings 5. “Non-Conduit” CMBS Transactions 6. Tax Lien-Backed Securities Sponsored by a Municipal Entity 7. Rental Car Securitizations E. Safe Harbor for Foreign Securitization Transactions F. Sunset on Hedging and Transfer Restrictions G. Federal Deposit Insurance Corporation Securitizations V. Reduced Risk Retention Requirements and Underwriting Standards for ABS Backed by Qualifying Commercial, Commercial Real Estate, or Automobile Loans A. Qualifying Commercial Loans B. Qualifying Commercial Real Estate Loans 1. Ability To Repay 2. Loan-to-Value Requirement 3. Collateral Valuation 4. Risk Management and Monitoring C. Qualifying Automobile Loans 1. Ability To Repay 2. Loan Terms 3. Reviewing Credit History 4. Loan-to-Value D. Qualifying Asset Exemption E. Buyback Requirement VI. Qualified Residential Mortgages A. Overview of Original Proposal and Public Comments B. Approach to Defining QRM 1. Limiting Credit Risk 2. Preserving Credit Access C. Proposed Definition of QRM D. Exemption for QRMs E. Repurchase of Loans Subsequently Determined To Be Non-Qualified After Closing F. Alternative Approach to Exemptions for QRMs VII. Solicitation of Comments on Use of Plain Language VIII. Administrative Law Matters A. Regulatory Flexibility Act B. Paperwork Reduction Act C. Commission Economic Analysis D. OCC Unfunded Mandates Reform Act of 1995 Determination E. Commission: Small Business Regulatory Enforcement Fairness Act F. FHFA: Considerations of Differences Between the Federal Home Loan Banks and the Enterprises I. Introduction The agencies are requesting comment on a proposed rule that re-proposes with modifications a previously proposed rule to implement the requirements of section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act, or Dodd-Frank Act). 1 Section 15G of the Exchange Act, as added by section 941(b) of the Dodd-Frank Act, generally requires the Board, the FDIC, the OCC (collectively, referred to as the Federal banking agencies), the Commission, and, in the case of the securitization of any “residential mortgage asset,” together with HUD and FHFA, to jointly prescribe regulations that (i) require a securitizer to retain not less than 5 percent of the credit risk of any asset that the securitizer, through the issuance of an asset-backed security (ABS), transfers, sells, or conveys to a third party, and (ii) prohibit a securitizer from directly or indirectly hedging or otherwise transferring the credit risk that the securitizer is required to retain under section 15G and the agencies' implementing rules. 2 1 Public Law 111-203, 124 Stat. 1376 (2010). Section 941 of the Dodd-Frank Act amends the Securities Exchange Act of 1934 (the Exchange Act) and adds a new section 15G of the Exchange Act. 15 U.S.C. 78o-11. 2 See 15 U.S.C. 78o-11(b), (c)(1)(A) and (c)(1)(B)(ii). Section 15G of the Exchange Act exempts certain types of securitization transactions from these risk retention requirements and authorizes the agencies to exempt or establish a lower risk retention requirement for other types of securitization transactions. For example, section 15G specifically provides that a securitizer shall not be required to retain any part of the credit risk for an asset that is transferred, sold, or conveyed through the issuance of ABS by the securitizer, if all of the assets that collateralize the ABS are qualified residential mortgages (QRMs), as that term is jointly defined by the agencies. 3 In addition, section 15G provides that a securitizer may retain less than 5 percent of the credit risk of commercial mortgages, commercial loans, and automobile loans that are transferred, sold, or conveyed through the issuance of ABS by the securitizer if the loans meet underwriting standards established by the Federal banking agencies. 4 3 See 15 U.S.C. 78o-11(c)(1)(C)(iii), (e)(4)(A) and (B). 4 See id. at section 78o-11(c)(1)(B)(ii) and (2). In April 2011, the agencies published a joint notice of proposed rulemaking that proposed to implement section 15G of the Exchange Act (original proposal). 5 The proposed rule revises the original proposal, as described in more detail below. 5 Credit Risk Retention; Proposed Rule, 76 FR 24090 (April 29, 2011) (Original Proposal). Section 15G allocates the authority for writing rules to implement its provisions among the agencies in various ways. As a general matter, the agencies collectively are responsible for adopting joint rules to implement the risk retention requirements of section 15G for securitizations that are backed by residential mortgage assets and for defining what constitutes a QRM for purposes of the exemption for QRM-backed ABS. 6 The Federal banking agencies and the Commission, however, are responsible for adopting joint rules that implement section 15G for securitizations backed by all other types of assets, 7 and are authorized to adopt rules in several specific areas under section 15G. 8 In addition, the Federal banking agencies are jointly responsible for establishing, by rule, the underwriting standards for non-QRM residential mortgages, commercial mortgages, commercial loans, and automobile loans that would qualify ABS backed by these types of loans for a risk retention requirement of less than 5 percent. 9 Accordingly, when used in this Notice of Proposed Rulemaking, the term “agencies” shall be deemed to refer to the appropriate agencies that have rulewriting authority with respect to the asset class, securitization transaction, or other matter discussed. 6 See id. at section 78o-11(b)(2), (e)(4)(A) and (B). 7 See id. at section 78o-11(b)(1). 8 See, e. g. id. at sections 78o-11(b)(1)(E) (relating to the risk retention requirements for ABS collateralized by commercial mortgages); (b)(1)(G)(ii) (relating to additional exemptions for assets issued or guaranteed by the United States or an agency of the United States); (d) (relating to the allocation of risk retention obligations between a securitizer and an originator); and (e)(1) (relating to additional exemptions, exceptions or adjustments for classes of institutions or assets). 9 See id. at section 78o-11(b)(2)(B). For ease of reference, the re-proposed rules of the agencies are referenced using a common designation of § __.1 to § __.21 (excluding the title and part designations for each agency). With the exception of HUD, each agency will codify the rules, when adopted in final form, within each of their respective titles of the Code of Federal Regulations. 10 Section __.1 of each agency's rule identifies the entities or transactions subject to such agency's rule. 10 Specifically, the agencies propose to codify the rules as follows: 12 CFR part 43 (OCC); 12 CFR part 244 (Regulation RR) (Board); 12 CFR part 373 (FDIC); 12 CFR part 246 (Commission); 12 CFR part 1234 (FHFA). As required by section 15G, HUD has jointly prescribed the proposed rules for a securitization that is backed by any residential mortgage asset and for purposes of defining a qualified residential mortgage. Because the proposed rules would exempt the programs and entities under HUD's jurisdiction from the requirements of the proposed rules, HUD does not propose to codify the rules into its title of the CFR at the time the rules are adopted in final form. The preamble to the original proposal described the agencies' intention to jointly approve any written interpretations, written responses to requests for no-action letters and general counsel opinions, or other written interpretive guidance (written interpretations) concerning the scope or terms of section 15G of the Exchange Act and the final rules issued thereunder that are intended to be relied on by the public generally. The agencies also intended for the appropriate agencies to jointly approve any exemptions, exceptions, or adjustments to the final rules. For these purposes, the phrase “appropriate agencies” refers to the agencies with rulewriting authority for the asset class, securitization transaction, or other matter addressed by the interpretation, guidance, exemption, exception, or adjustment. Consistent with section 15G of the Exchange Act, the risk retention requirements would become effective, for securitization transactions collateralized by residential mortgages, one year after the date on which final rules are published in the Federal Register , and two years after that date for any other securitization transaction. A. Background As the agencies observed in the preamble to the original proposal, the securitization markets are an important link in the chain of entities providing credit to U.S. households and businesses, and state and local governments. 11 When properly structured, securitization provides economic benefits that can lower the cost of credit to households and businesses. 12 However, when incentives are not properly aligned and there is a lack of discipline in the credit origination process, securitization can result in harmful consequences to investors, consumers, financial institutions, and the financial system. 11 Securitization may reduce the cost of funding, which is accomplished through several different mechanisms. For example, firms that specialize in originating new loans and that have difficulty funding existing loans may use securitization to access more-liquid capital markets for funding. In addition, securitization can create opportunities for more efficient management of the asset-liability duration mismatch generally associated with the funding of long-term loans, for example, with short-term bank deposits. Securitization also allows the structuring of securities with differing maturity and credit risk profiles from a single pool of assets that appeal to a broad range of investors. Moreover, securitization that involves the transfer of credit risk allows financial institutions that primarily originate loans to particular classes of borrowers, or in particular geographic areas, to limit concentrated exposure to these idiosyncratic risks on their balance sheets. 12 Report to the Congress on Risk Retention, Board of Governors of the Federal Reserve System, at 8 (October 2010), available at http://federalreserve.gov/boarddocs/rptcongress/securitization/riskretention.pdf (Board Report). During the financial crisis, securitization transactions displayed significant vulnerabilities to informational and incentive problems among various parties involved in the process. 13 Investors did not have access to the same information about the assets collateralizing ABS as other parties in the securitization chain (such as the sponsor of the securitization transaction or an originator of the securitized loans). 14 In addition, assets were resecuritized into complex instruments, such as collateralized debt obligations (CDOs) and CDOs-squared, which made it difficult for investors to discern the true value of, and risks associated with, an investment in the securitization. 15 Moreover, some lenders using an “originate-to-distribute” business model loosened their underwriting standards knowing that the loans could be sold through a securitization and retained little or no continuing exposure to the loans. 16 13 See Board Report at 8-9. 14 See S. Rep. No. 111-176, at 128 (2010). 15 See id. 16 See id. Congress intended the risk retention requirements added by section 15G to help address problems in the securitization markets by requiring that securitizers, as a general matter, retain an economic interest in the credit risk of the assets they securitize. By requiring that the securitizer retain a portion of the credit risk of the assets being securitized, the requirements of section 15G provide securitizers an incentive to monitor and ensure the quality of the assets underlying a securitization transaction, and, thus, help align the interests of the securitizer with the interests of investors. Additionally, in circumstances where the assets collateralizing the ABS meet underwriting and other standards that help to ensure the assets pose low credit risk, the statute provides or permits an exemption. 17 17 See 15 U.S.C. 78o-11(c)(1)(B)(ii), (e)(1)-(2). Accordingly, the credit risk retention requirements of section 15G are an important part of the legislative and regulatory efforts to address weaknesses and failures in the securitization process and the securitization markets. Section 15G complements other parts of the Dodd-Frank Act intended to improve the securitization markets. Such other parts include provisions that strengthen the regulation and supervision of national recognized statistical rating organizations (NRSROs) and improve the transparency of credit ratings; 18 provide for issuers of registered ABS offerings to perform a review of the assets underlying the ABS and disclose the nature of the review; 19 and require issuers of ABS to disclose the history of the requests they received and repurchases they made related to their outstanding ABS. 20 18 See, e. g. sections 932, 935, 936, 938, and 943 of the Dodd-Frank Act (15 U.S.C. 78o-7, 78o-8). 19 See section 945 of the Dodd-Frank Act (15 U.S.C. 77g). 20 See section 943 of the Dodd-Frank Act (15 U.S.C. 78o-7). B. Overview of the Original Proposal and Public Comment In developing the original proposal, the agencies took into account the diversity of assets that are securitized, the structures historically used in securitizations, and the manner in which securitizers 21 have retained exposure to the credit risk of the assets they securitize. 22 The original proposal provided several options from which sponsors could choose to meet section 15G's risk retention requirements, including, for example, retention of a 5 percent “vertical” interest in each class of ABS interests issued in the securitization, retention of a 5 percent “horizontal” first-loss interest in the securitization, and other options designed to reflect the way in which market participants have historically structured credit card receivable and asset-backed commercial paper conduit securitizations. The original proposal also included a special “premium capture” mechanism designed to prevent a sponsor from structuring a securitization transaction in a manner that would allow the sponsor to offset or minimize its retained economic exposure to the securitized assets by monetizing the excess spread created by the securitization transaction. 21 As discussed in the original proposal and further below, the agencies propose that a “sponsor,” as defined in a manner consistent with the definition of that term in the Commission's Regulation AB, would be a “securitizer” for the purposes of section 15G. 22 Both the language and legislative history of section 15G indicate that Congress expected the agencies to be mindful of the heterogeneity of securitization markets. See, e.g., 15 U.S.C. 78o-11(c)(1)(E), (c)(2), (e); S. Rep. No. 111-76, at 130 (2010) (“The Committee believes that implementation of risk retention obligations should recognize the differences in securitization practices for various asset classes.”). The original proposal also included disclosure requirements that were specifically tailored to each of the permissible forms of risk retention. The disclosure requirements were an integral part of the original proposal because they would have provided investors with pertinent information concerning the sponsor's retained interests in a securitization transaction, such as the amount and form of interest retained by sponsors. As required by section 15G, the original proposal provided a complete exemption from the risk retention requirements for ABS that are collateralized solely by QRMs and established the terms and conditions under which a residential mortgage would qualify as a QRM. In developing the proposed definition of a QRM, the agencies considered the terms and purposes of section 15G, public input, and the potential impact of a broad or narrow definition of QRM on the housing and housing finance markets. In addition, the agencies developed the QRM proposal to be consistent with the requirement of section 15G that the definition of a QRM be “no broader than” the definition of a “qualified mortgage” (QM), as the term is defined under section 129C(b)(2) of the Truth in Lending Act (TILA) (15 U.S.C. 1639C(b)(2)), as amended by the Dodd-Frank Act, 23 and regulations adopted thereunder. 24 23 See 15 U.S.C. 78o-11(e)(4)(C). As adopted, the text of section 15G(e)(4)(C) cross-references section 129C(c)(2) of TILA for the definition of a QM. However, section 129C(b)(2), and not section 129C(c)(2), of TILA contains the definition of a “qualified mortgage.” The legislative history clearly indicates that the reference in the statute to section 129C(c)(2) of TILA (rather than section 129C(b)(2) of TILA) was an inadvertent technical error. See 156 Cong. Rec. S5929 (daily ed. July 15, 2010) (statement of Sen. Christopher Dodd) (“The [conference] report contains the following technical errors: the reference to `section 129C(c)(2)' in subsection (e)(4)(C) of the new section 15G of the Securities and Exchange Act, created by section 941 of the [Dodd-Frank Act] should read `section 129C(b)(2).' In addition, the references to `subsection' in paragraphs (e)(4)(A) and (e)(5) of the newly created section 15G should read `section.' We intend to correct these in future legislation.”). 24 See 78 FR 6408 (January 30, 2013), as amended by 78 FR 35430 (June 12, 2013). These two final rules were preceded by a proposed rule defining QM, issued by the Board and published in the Federal Register . See 76 FR 27390 (May 11, 2011). The Board had initial responsibility for administration and oversight of TILA prior to transfer to the Consumer Financial Protection Bureau. The original proposal would generally have prohibited QRMs from having product features that were observed to contribute significantly to the high levels of delinquencies and foreclosures since 2007. These included features permitting negative amortization, interest-only payments, or significant interest rate increases. The QRM definition in the original proposal also included other underwriting standards associated with lower risk of default, including a down payment requirement of 20 percent in the case of a purchase transaction, maximum loan-to-value ratios of 75 percent on rate and term refinance loans and 70 percent for cash-out refinance loans, as well as credit history criteria (or requirements). The QRM standard in the original proposal also included maximum front-end and back-end debt-to-income ratios. As explained in the original proposal, the agencies intended for the QRM proposal to reflect very high quality underwriting standards, and the agencies expected that a large market for non-QRM loans would continue to exist, providing ample liquidity to mortgage lenders. Consistent with the statute, the original proposal also provided that sponsors would not have to hold risk retention for securitized commercial, commercial real estate, and automobile loans that met proposed underwriting standards that incorporated features and requirements historically associated with very low credit risk in those asset classes. With respect to securitization transactions sponsored by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (jointly, the Enterprises), the agencies proposed to recognize the 100 percent guarantee of principal and interest payments by the Enterprises on issued securities as meeting the risk retention requirement. However, this recognition would only remain in effect for as long as the Enterprises operated under the conservatorship or receivership of FHFA with capital support from the United States. In response to the original proposal, the agencies received comments from over 10,500 persons, institutions, or groups, including nearly 300 unique comment letters. The agencies received a significant number of comments regarding the appropriate amount and measurement of risk retention. Many commenters generally supported the proposed menu-based approach of providing sponsors flexibility to choose from a number of permissible forms of risk retention, although several argued for more flexibility in selecting risk retention options, including using multiple options simultaneously. Comments on the disclosure requirements in the original proposal were limited. Many commenters expressed significant concerns with the proposed standards for horizontal risk retention and the premium capture cash reserve account (PCCRA), which were intended to ensure meaningful risk retention. Many commenters asserted that these proposals would lead to significantly higher costs for sponsors, possibly discouraging them from engaging in new securitization transactions. However, some commenters supported the PCCRA concept, arguing that the more restrictive nature of the account would be offset by the requirement's contribution to more conservative underwriting practices. Other commenters expressed concerns with respect to standards in the original proposal for specific asset classes, such as the proposed option for third-party purchasers to hold risk retention in commercial mortgage-backed securitizations instead of sponsors (as contemplated by section 15G). Many commenters also expressed concern about the underwriting standards for non-residential asset classes, generally criticizing them as too conservative to be utilized effectively by sponsors. Several commenters criticized application of the original proposal to managers of certain collateralized loan obligation (CLO) transactions and argued that the original proposal would lead to more concentration in the industry and reduce access to credit for many businesses. An overwhelming majority of commenters criticized the agencies' proposed QRM standard. Many of these commenters asserted that the proposed definition of QRM, particularly the 20 percent down payment requirement, would significantly increase the costs of credit for most home buyers and restrict access to credit. Some of these commenters asserted that the proposed QRM standard would become a new “government-approved” standard, and that lenders would be reluctant to originate mortgages that did not meet the standard. Commenters also argued that this proposed standard would make it more difficult to reduce the participation of the Enterprises in the mortgage market. Commenters argued that the proposal was inconsistent with legislative intent and strongly urged the agencies to eliminate the down payment requirement, make it substantially smaller, or allow private mortgage insurance to substitute for the requirement within the QRM standard. Commenters also argued that the agencies should align the QRM definition with the definition of QM, as implemented by the Consumer Financial Protection Bureau (CFPB). 25 25 See 78 FR 6407 (January 30, 2013), as amended by 78 FR 35429 (June 12, 2013) and 78 FR 44686 (July 24, 2013). Various commenters also criticized the agencies' proposed treatment of the Enterprises. A commenter asserted that the agencies' recognition of the Enterprises' guarantee as retained risk (while in conservatorship or receivership with capital support from the United States) would impede the policy goal of reducing the role of the Enterprises and the government in the mortgage securitization market and encouraging investment in private residential mortgage securitizations. A number of other commenters, however, supported the proposed approach for the Enterprises. The preamble to the original proposal described the agencies' intention to jointly approve certain types of written interpretations concerning the scope of section 15G and the final rules issued thereunder. Several commenters on the original proposal expressed concern about the agencies' processes for issuing written interpretations jointly and the possible uncertainty about the rules that may arise due to this process. The agencies have endeavored to provide specificity and clarity in the proposed rule to avoid conflicting interpretations or uncertainty. In the future, if the heads of the agencies determine that further guidance would be beneficial for market participants, they may jointly publish interpretive guidance documents, as the federal banking agencies have done in the past. In addition, the agencies note that market participants can, as always, seek guidance concerning the rules from their primary federal banking regulator or, if such market participant is not a depository institution or a government-sponsored enterprise, the Commission. In light of the joint nature of the agencies' rule writing authority, the agencies continue to view the consistent application of the final rule as a benefit and intend to consult with each other when adopting staff interpretations or guidance on the final rule that would be shared with the public generally. The agencies are considering whether to require that such staff interpretations and guidance be jointly issued by the agencies with rule writing authority and invite comment. 26 26 These items would not include interpretation and guidance in staff comment letters and other staff guidance directed to specific institutions that is not intended to be relied upon by the public generally. Nor would it include interpretations and guidance contained in administrative or judicial enforcement proceedings by the agencies, or in an agency report of examination or inspection or similar confidential supervisory correspondence. The specific provisions of the original proposal and public comments received thereon are discussed in further detail below. C. Overview of the Proposed Rule The agencies have carefully considered the many comments received on the original proposal as well as engaged in further analysis of the securitization and lending markets in light of the comments. As a result, the agencies believe it would be appropriate to modify several important aspects of the original proposal and are issuing a new proposal incorporating these modifications. The agencies have concluded that a new proposal would give the public the opportunity to review and provide comment on the agencies' revised design of the risk retention regulatory framework and assist the agencies in determining whether the revised framework is appropriately structured. The proposed rule takes account of the comments received on the original proposal. In developing the proposed rule, the agencies consistently have sought to ensure that the amount of credit risk required of a sponsor would be meaningful, consistent with the purposes of section 15G. The agencies have also sought to minimize the potential for the proposed rule to negatively affect the availability and costs of credit to consumers and businesses. As described in detail below, the proposed rule would significantly increase the degree of flexibility that sponsors would have in meeting the risk retention requirements of section 15G. For example, the proposed rule would permit a sponsor to satisfy its obligation by retaining any combination of an “eligible vertical interest” and an “eligible horizontal residual interest” to meet the 5 percent minimum requirement. The agencies are also proposing that horizontal risk retention be measured by fair value, reflecting market practice, and are proposing a more flexible treatment for payments to a horizontal risk retention interest than that provided in the original proposal. In combination with these changes, the agencies propose to remove the PCCRA requirement. 27 The agencies have incorporated proposed standards for the expiration of the hedging and transfer restrictions and proposed new exemptions from risk retention for certain resecuritizations, seasoned loans, and certain types of securitization transactions with low credit risk. In addition, the agencies propose a new risk retention option for CLOs that is similar to the allocation to originator concept proposed for sponsors generally. 27 The proposal would also eliminate the “representative sample” option, which commenters had argued would be impractical. Furthermore, the agencies are proposing revised standards with respect to risk retention by a third-party purchaser in commercial mortgage-backed securities (CMBS) transactions and an exemption that would permit transfer (by a third-party purchaser or sponsor) of a horizontal interest in a CMBS transaction after five years, subject to standards described below. The agencies have carefully considered the comments received on the QRM standard in the original proposal as well as various ongoing developments in the mortgage markets, including mortgage regulations. For the reasons discussed more fully below, the agencies are proposing to revise the QRM definition in the original proposal to equate the definition of a QRM with the definition of QM adopted by the CFPB. 28 28 See 78 FR 6407 (January 30, 2013), as amended by 78 FR 35429 (June 12, 2013) and 78 FR 44686 (July 24, 2013). The agencies invite comment on all aspects of the proposed rule, including comment on whether any aspects of the original proposal should be adopted in the final rule. Please provide data and explanations supporting any positions offered or changes suggested. II. General Definitions and Scope A. Overview of Significant Definitions in the Original Proposal and Comments 1. Asset-Backed Securities, Securitization Transactions, and ABS Interests The original proposal provided that the proposed risk retention requirements would have applied to sponsors in securitizations that involve the issuance of “asset-backed securities” and defined the terms “asset-backed security” and “asset” consistent with the definitions of those terms in the Exchange Act. The original proposal noted that section 15G does not appear to distinguish between transactions that are registered with the Commission under the Securities Act of 1933 (the Securities Act) and those that are exempt from registration under the Securities Act. It further noted that the proposed definition of ABS, which would have been broader than that of the Commission's Regulation AB, 29 included securities that are typically sold in transactions that are exempt from registration under the Securities Act, such as CDOs and securities issued or guaranteed by an Enterprise. As a result, the proposed risk retention requirements would have applied to securitizers of ABS offerings regardless of whether the offering was registered with the Commission under the Securities Act. 29 See 17 CFR 229.1100 through 17 CFR 229.1123. Under the original proposal, risk retention requirements would have applied to the securitizer in each “securitization transaction,” defined as a transaction involving the offer and sale of ABS by an issuing entity. The original proposal also explained that the term “ABS interest” would refer to all types of interests or obligations issued by an issuing entity, whether or not in certificated form, including a security, obligation, beneficial interest, or residual interest, but would not include interests, such as common or preferred stock, in an issuing entity that are issued primarily to evidence ownership of the issuing entity, and the payments, if any, which are not primarily dependent on the cash flows of the collateral held by the issuing entity. With regard to these three definitions, some commenters were critical of what they perceived to be the overly broad scope of the terms and advocated for express exemptions or exclusions from their application. Some commenters expressed concern that the definition of “asset-backed securities” could be read to be broader than intended and requested clarification as to the precise contours of the definition. For example, certain commenters were concerned that the proposed ABS definition could unintentionally include securities that do not serve the same purpose or present the same set of risks as “asset-backed securities,” such as securities which are, either directly or through a guarantee, full-recourse corporate obligations of a creditworthy entity that is not a special-purpose vehicle (SPV), but are also secured by a pledge of financial assets. Other commenters suggested that the agencies provide a bright-line safe harbor that defines conditions under which risk retention is not required even if a security is collateralized by self-liquidating assets and advocated that certain securities be expressly excluded from the proposed rule's definition of ABS. Similarly, a number of commenters requested clarification with regard to the scope of the definition of “ABS interest,” stating that its broad definition could potentially capture a number of items not traditionally considered “interests” in a securitization, such as non-economic residual interests, servicing and special servicing fees, and amounts payable by the issuing entity under a derivatives contract. With regard to the definition of “securitization transaction,” a commenter recommended that transactions undertaken solely to manage financial guarantee insurance related to the underlying obligations not be considered “securitizations.” 2. Securitizer, Sponsor, and Depositor Section 15G stipulates that its risk retention requirements be applied to a “securitizer” of an ABS and, in turn, that a securitizer is both an issuer of an ABS or a person who organizes and initiates a securitization transaction by selling or transferring assets, either directly or indirectly, including through an affiliate or issuer. The original proposal noted that the second prong of this definition is substantially identical to the definition of a “sponsor” of a securitization transaction in the Commission's Regulation AB. 30 Accordingly, the original proposal would have defined the term “sponsor” in a manner consistent with the definition of that term in the Commission's Regulation AB. 31 30 See Item 1101 of the Commission's Regulation AB (17 CFR 229.1101) (defining a sponsor as “a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity.”). 31 As discussed in the original proposal, when used in the federal securities laws, the term “issuer” may have different meanings depending on the context in which it is used. For the purposes of section 15G, the original proposal provided that the agencies would have interpreted an “issuer” of an asset-back security to refer to the “depositor” of an ABS, consistent with how that term has been defined and used under the federal securities laws in connection with an ABS. Other than issues concerning CLOs, which are discussed in Part III.B.7 of this Supplementary Information, comments with regard to these terms were generally limited to requests that the final rules provide that certain specified persons—such as underwriting sales agents—be expressly excluded from the definition of securitizer or sponsor for the purposes of the risk retention requirements. 3. Originator The original proposal would have defined the term “originator” in the same manner as section 15G, namely, as a person who, through the extension of credit or otherwise, creates a financial asset that collateralizes an ABS, and sells the asset directly or indirectly to a securitizer ( i.e., a sponsor or depositor). The original proposal went on to note that because this definition refers to the person that “creates” a loan or other receivable, only the original creditor under a loan or receivable—and not a subsequent purchaser or transferee—would have been an originator of the loan or receivable for purposes of section 15G. 4. Securitized Assets, Collateral The original proposal referred to the assets underlying a securitization transaction as the “securitized assets,” meaning assets that are transferred to the SPV that issues the ABS interests and that stand as collateral for those ABS interests. “Collateral” would be defined as the property that provides the cash flow for payment of the ABS interests issued by the issuing entity. Taken together, these definitions were meant to suggest coverage of the loans, leases, or similar assets that the depositor places into the issuing SPV at the inception of the transaction, though it would have also included other assets such as pre-funded cash reserve accounts. Commenters pointed out that, in addition to this property, the issuing entity may hold other assets. For example, the issuing entity may acquire interest rate derivatives to convert floating rate interest income to fixed rate, or the issuing entity may accrete cash or other liquid assets in reserve funds that accumulate cash generated by the securitized assets. As another example, commenters noted that an asset-backed commercial paper conduit may hold a liquidity guarantee from a bank on some or all of its securitized assets. B. Proposed General Definitions The agencies have carefully considered all of the comments raised with respect to the general definitions of the original proposal. The agencies do not believe that significant changes to these definitions are necessary and, accordingly, are proposing to maintain the general definitions in substantially the same form as they were presented in the original proposal, with one exception. 32 32 Regarding comments about what securities constitutes an ABS interest under the proposed definition, the agencies preliminarily believe that non-economic residual interests would constitute ABS interests. However, as the proposal makes clear, fees for services such as servicing fees would not fall under the definition of an ABS interest. To describe the additional types of property that could be held by an issuing entity, the agencies are proposing a definition of “servicing assets,” which would be any rights or other assets designed to assure the servicing, timely payment, or timely distribution of proceeds to security holders, or assets related or incidental to purchasing or otherwise acquiring and holding the issuing entity's securitized assets. These may include cash and cash equivalents, contract rights, derivative agreements of the issuing entity used to hedge interest rate and foreign currency risks, or the collateral underlying the securitized assets. As noted in the rule text, it also includes proceeds of assets collateralizing the securitization transactions, whether in the form of voluntary payments from obligors on the assets or otherwise (such as liquidation proceeds). The agencies are proposing this definition in order to ensure that the provisions of the proposal appropriately accommodate the need, in administering a securitization transaction on an ongoing basis, to hold various assets other than the loans or similar assets that are transferred into the asset pool by the securitization depositor. The proposed definition is similar to elements of the definition of “eligible assets” in Rule 3a-7 under the Investment Company Act of 1940, which specifies conditions under which the issuer of non-redeemable fixed-income securities backed by self-liquidating financial assets will not be deemed to be an investment company. To facilitate the agencies revised proposal for the QRM definition, the agencies are proposing to define the term “residential mortgage” by reference to the definition of “covered transaction” to be found in the CFPB's Regulation Z. 33 Accordingly, for purposes of the proposed rule, a residential mortgage would mean a consumer credit transaction that is secured by a dwelling, as such term is also defined in Regulation Z 34 (including any real property attached to a dwelling) and any transaction that is exempt from the definition of “covered transaction” under the CFPB's Regulation Z. 35 Therefore, the term “residential mortgage” would include home equity lines of credit, reverse mortgages, mortgages secured by interests in timeshare plans, and temporary loans. By defining residential mortgage in this way, the agencies seek to ensure that relevant definitions in the proposed rule and in the CFPB's rules on and related to QM are harmonized to reduce compliance burden and complexity, and the potential for conflicting definitions and interpretations where the proposed rule and the QM standard intersect. Additionally, the agencies are proposing to include those loans excluded from the definition of “covered transaction” in the definition of “residential mortgage” for purposes of risk retention so that those categories of loans would be subject to risk retention requirements that are applied to residential mortgage securitizations under the proposed rule. 33 See 78 FR 6584 (January 30, 2013), to be codified at 12 CFR 1026.43. 34 12 CFR 1026.2(a)(19). 35 Id. III. General Risk Retention Requirement A. Minimum Risk Retention Requirement Section 15G of the Exchange Act generally requires that the agencies jointly prescribe regulations that require a securitizer to retain not less than 5 percent of the credit risk for any asset that the securitizer, through the issuance of an ABS, transfers, sells, or conveys to a third party, unless an exemption from the risk retention requirements for the securities or transaction is otherwise available ( e.g., if the ABS is collateralized exclusively by QRMs). Consistent with the statute, the original proposal generally required that a sponsor retain an economic interest equal to at least 5 percent of the aggregate credit risk of the assets collateralizing an issuance of ABS (the base risk retention requirement). Under the original proposal, the base risk retention requirement would have applied to all securitization transactions that are within the scope of section 15G, regardless of whether the sponsor were an insured depository institution, a bank holding company or subsidiary thereof, a registered broker-dealer, or other type of entity. 36 36 Synthetic securitizations and securitizations that meet the requirements of the foreign safe harbor are examples of securitization transactions that are not within the scope of section 15G. The agencies requested comment on whether the minimum 5 percent risk retention requirement was appropriate or whether a higher risk retention requirement should be established. Several commenters expressed support for the minimum 5 percent risk retention requirement, with some commenters supporting a higher risk retention requirement. However, other commenters suggested tailoring the risk retention requirement to the specific risks of distinct asset classes. Consistent with the original proposal, the proposed rule would apply a minimum 5 percent base risk retention requirement to all securitization transactions that are within the scope of section 15G, regardless of whether the sponsor is an insured depository institution, a bank holding company or subsidiary thereof, a registered broker-dealer, or other type of entity, and regardless of whether the sponsor is a supervised entity. 37 The agencies continue to believe that this exposure should provide a sponsor with an incentive to monitor and control the underwriting of assets being securitized and help align the interests of the sponsor with those of investors in the ABS. In addition, the sponsor also would be prohibited from hedging or otherwise transferring its retained interest prior to the applicable sunset date, as discussed in Part III.D of this SUPPLEMENTARY INFORMATION . 37 See proposed rule at §§ __.3 through __.10. Similar to the original proposal, the proposed rule, in some instances, would permit a sponsor to allow another person to retain the required amount of credit risk ( e.g., originators, third-party purchasers in commercial mortgage-backed securities transactions, and originator-sellers in asset-backed commercial paper conduit securitizations). However, in such circumstances, the proposal includes limitations and conditions designed to ensure that the purposes of section 15G continue to be fulfilled. Further, even when a sponsor would be permitted to allow another person to retain risk, the sponsor would still remain responsible under the rule for compliance with the risk retention requirements. The agencies note that the base risk retention requirement under the proposed rule would be a regulatory minimum. The sponsor, originator, or other party to a securitization may retain additional exposure to the credit risk of assets that the sponsor, originator, or other party helps securitize beyond that required by the proposed rule, either on its own initiative or in response to the demands or requirements of private market participants. B. Permissible Forms of Risk Retention—Menu of Options Section 15G expressly provides the agencies the authority to determine the permissible forms through which the required amount of risk retention must be held. 38 Accordingly, the original proposal provided sponsors with multiple options to satisfy the risk retention requirements of section 15G. The flexibility provided in the original proposal's menu of options for complying with the risk retention requirement was designed to take into account the heterogeneity of securitization markets and practices and to reduce the potential for the proposed rules to negatively affect the availability and costs of credit to consumers and businesses. The menu of options approach was designed to be consistent with the various ways in which a sponsor or other entity, in historical market practices, may have retained exposure to the credit risk of securitized assets. 39 Historically, whether or how a sponsor retained exposure to the credit risk of the assets it securitized was determined by a variety of factors including the rating requirements of the NRSROs, investor preferences or demands, accounting and regulatory capital considerations, and whether there was a market for the type of interest that might ordinarily be retained (at least initially by the sponsor). 38 See 15 U.S.C. 78o-11(c)(1)(C)(i); see also S. Rep. No. 111-176, at 130 (2010) (“The Committee [on Banking, Housing, and Urban Affairs] believes that implementation of risk retention obligations should recognize the differences in securitization practices for various asset classes.”). 39 See Board Report; see also Macroeconomic Effects of Risk Retention Requirements, Chairman of the Financial Stability Oversight Counsel (January 2011), available at http://www.treasury.gov/initiatives/wsr/Documents/Section 946 Risk Retention Study (FINAL).pdf. The agencies requested comment on the appropriateness of the menu of options in the original proposal and the permissible forms of risk retention that were proposed. Commenters generally supported the menu-based approach of providing sponsors with the flexibility to choose from a number of permissible forms of risk retention. Many commenters requested that sponsors be permitted to use multiple risk retention options in any percentage combination, as long as the aggregate percentage of risk retention would be at least 5 percent. The agencies continue to believe that providing options for risk retention is appropriate in order to accommodate the variety of securitization structures that would be subject to the proposed rule. Accordingly, subpart B of the proposed rule would maintain a menu of options approach to risk retention. Additionally, the agencies have considered commenters' concerns about flexibility in combining forms of risk retention and are proposing modifications to the various forms of risk retention, and how they may be used, to increase flexibility and facilitate different circumstances that may accompany various securitization transactions. Additionally, the permitted forms of risk retention in the proposal would be subject to terms and conditions that are intended to help ensure that the sponsor (or other eligible entity) retains an economic exposure equivalent to at least 5 percent of the credit risk of the securitized assets. Each of the forms of risk retention being proposed by the agencies is described below. 1. Standard Risk Retention a. Overview of Original Proposal and Public Comments In the original proposal, to fulfill risk retention for any transactions (standard risk retention), the agencies proposed to allow sponsors to use one of three methods: (i) Vertical risk retention; (ii) horizontal risk retention; and (iii) L-shaped risk retention. Under the vertical risk retention option in the original proposal, a sponsor could satisfy its risk retention requirement by retaining at least 5 percent of each class of ABS interests issued as part of the securitization transaction. As discussed in the original proposal, this would provide the sponsor with an interest in the entire securitization transaction. The agencies received numerous comments supporting the vertical risk retention option as an appropriate way to align the interests of the sponsor with those of the investors in the ABS in a manner that would be easy to calculate. However, some commenters expressed concern that the vertical risk retention option would expose the sponsor to substantially less risk of loss than if the sponsor had retained risk under the horizontal risk retention option, thereby making risk retention less effective. Under the horizontal risk retention option in the original proposal, a sponsor could satisfy its risk retention obligations by retaining a first-loss “eligible horizontal residual interest” in the issuing entity in an amount equal to at least 5 percent of the par value of all ABS interests in the issuing entity that were issued as part of the securitization transaction. In lieu of holding an eligible horizontal residual interest, the original proposal allowed a sponsor to cause to be established and funded, in cash, a reserve account at closing (horizontal cash reserve account) in an amount equal to at least 5 percent of the par value of all the ABS interests issued as part of the transaction ( i.e., the same dollar amount (or corresponding amount in the foreign currency in which the ABS are issued, as applicable) as would be required if the sponsor held an eligible horizontal residual interest). Under the original proposal, an interest qualified as an eligible horizontal residual interest only if it was an ABS interest that was allocated all losses on the securitized assets until the par value of the class was reduced to zero and had the most subordinated claim to payments of both principal and interest by the issuing entity. While the original proposal would have permitted the eligible horizontal residual interest to receive its pro rata share of scheduled principal payments on the underlying assets in accordance with the relevant transaction documents, the eligible horizontal residual interest generally could not receive any other payments of principal made on a securitized asset (including prepayments) until all other ABS interests in the issuing entity were paid in full. The agencies solicited comment on the structure of the eligible horizontal residual interest, including the proposed approach to measuring the size of the eligible horizontal residual interest and the proposal to restrict unscheduled payments of principal to the sponsor holding horizontal risk retention. Several commenters expressed support for the horizontal risk retention option and believed that it would effectively align the interests of the sponsor with those of the investors in the ABS. However, many commenters raised concerns about the agencies' proposed requirements for the eligible horizontal residual interest. Many commenters requested clarification as to the definition of “par value” and how sponsors should calculate the eligible horizontal residual interest when measuring it against 5 percent of the par value of the ABS interests. Moreover, several commenters recommended that the agencies use different approaches to the measurement of the eligible horizontal residual interest. A few of these commenters recommended the agencies take into account the “fair value” of the ABS interests as a more appropriate economic measure of risk retention. Several commenters pointed out that the restrictions in the original proposal on principal payments to the eligible horizontal residual interest would be impractical to implement. For example, some commenters expressed concern that the restriction would prevent the normal operation of a variety of ABS structures, where servicers do not distinguish which part of a monthly payment is interest or principal and which parts of principal payments are scheduled or unscheduled. The original proposal also contained an “L-shaped” risk retention option, whereby a sponsor, subject to certain conditions, could use an equal combination of vertical risk retention and horizontal risk retention to meet its 5 percent risk retention requirement. 40 40 Specifically, the original proposal would have allowed a sponsor to meet its risk retention obligations under the rules by retaining: (1) Not less than 2.5 percent of each class of ABS interests in the issuing entity issued as part of the securitization transaction (the vertical component); and (2) an eligible horizontal residual interest in the issuing entity in an amount equal to at least 2.564 percent of the par value of all ABS interests in the issuing entity issued as part of the securitization transaction, other than those interests required to be retained as part of the vertical component (the horizontal component). The agencies requested comment on whether a higher proportion of the risk retention held by a sponsor under this option should be composed of a vertical component or a horizontal component. Many commenters expressed general support for the L-shaped option, but recommended that the agencies allow sponsors to utilize multiple risk retention options in different combinations or in any percentage combination as long as the aggregate percentage of risk retained is at least 5 percent. Commenters suggested that the flexibility would permit sponsors to fulfill the risk retention requirements by selecting a method that would minimize the costs of risk retention to sponsors and any resulting increase in costs to borrowers. b. Proposed Combined Risk Retention Option The agencies carefully considered all of the comments on the horizontal, vertical, and L-shaped risk retention with respect to the original proposal. In the proposed rule, to provide more flexibility to accommodate various sponsors and securitization transactions and in response to comments, the agencies are proposing to combine the horizontal, vertical, and L-shaped risk retention options into a single risk retention option with a flexible structure. 41 Additionally, to provide greater clarity for the measurement of risk retention and to help prevent sponsors from structuring around their risk retention requirement by negating or reducing the economic exposure they are required to maintain, the proposal would require sponsors to measure their risk retention requirement using fair value, determined in accordance with U.S. generally accepted accounting principles (GAAP). 42 41 See proposed rule at § __.4. 42 Cf. Financial Accounting Standards Board Accounting Standards Codification Topic 820. The proposed rule would provide for a combined standard risk retention option that would permit a sponsor to satisfy its risk retention obligation by retaining an “eligible vertical interest,” an “eligible horizontal residual interest,” or any combination thereof, in a total amount equal to no less than 5 percent of the fair value of all ABS interests in the issuing entity that are issued as part of the securitization transaction. The eligible horizontal residual interest may consist of either a single class or multiple classes in the issuing entity, provided that each interest qualifies, individually or in the aggregate, as an eligible horizontal residual interest. 43 In the case of multiple classes, this requirement would mean that the classes must be in consecutive order based on subordination level. For example, if there were three levels of subordinated classes and the two most subordinated classes had a combined fair value equal to 5 percent of all ABS interests, the sponsor would be required to retain these two most subordinated classes if it were going to discharge its risk retention obligations by holding only eligible horizontal residual interests. As discussed below, the agencies are proposing to refine the definitions of the eligible vertical interest and the eligible horizontal residual interest as well. 43 See proposed rule at § __.2 (definition of “eligible horizontal residual interest”). This standard risk retention option would provide sponsors with greater flexibility in choosing how to structure their retention of credit risk in a manner compatible with the practices of the securitization markets. For example, in securitization transactions where the sponsor would typically retain less than 5 percent of an eligible horizontal residual interest, the standard risk retention option would permit the sponsor to hold the balance of the risk retention as a vertical interest. In addition, the flexible standard risk retention option should not in and of itself result in a sponsor having to consolidate the assets and liabilities of a securitization vehicle onto its own balance sheet because the standard risk retention option does not mandate a particular proportion of horizontal to vertical interest or require retention of a minimum eligible horizontal residual interest. Under the proposed rule, a sponsor would be free to hold more of an eligible vertical interest in lieu of an eligible horizontal residual interest. The inclusion of more of a vertical interest could reduce the significance of the risk profile of the sponsor's economic exposure to the securitization vehicle. The significance of the sponsor's exposure is one of the characteristics the sponsor evaluates when determining whether to consolidate the securitization vehicle for accounting purposes. As proposed, a sponsor may satisfy its risk retention requirements with respect to a securitization transaction by retaining at least 5 percent of the fair value of each class of ABS interests issued as part of the securitization transaction. A sponsor using this approach must retain at least 5 percent of the fair value of each class of ABS interests issued in the securitization transaction regardless of the nature of the class of ABS interests ( e.g., senior or subordinated) and regardless of whether the class of interests has a par value, was issued in certificated form, or was sold to unaffiliated investors. For example, if four classes of ABS interests were issued by an issuing entity as part of a securitization—a senior AAA-rated class, a subordinated class, an interest-only class, and a residual interest—a sponsor using this approach with respect to the transaction would have to retain at least 5 percent of the fair value of each such class or interest. A sponsor may also satisfy its risk retention requirements under the vertical option by retaining a “single vertical security.” A single vertical security would be an ABS interest entitling the holder to a specified percentage ( e.g., 5 percent) of the principal and interest paid on each class of ABS interests in the issuing entity (other than such single vertical security) that result in the security representing the same percentage of fair value of each class of ABS interests. By permitting the sponsor to hold the vertical form of risk retention as a single security, the agencies intend to provide sponsors an option that is simpler than carrying multiple securities representing a percentage share of every series, tranche, and class issued by the issuing entity, each of which might need to be valued by the sponsor on its financial statements every financial reporting period. The single vertical security option provides the sponsor with the same principal and interest payments (and losses) as the vertical stack, in the form of one security to be held on the sponsor's books. The agencies considered the comments on the measurement of the eligible horizontal residual interest in the original proposal and are proposing a fair value framework for calculating the standard risk retention because it uses methods more consistent with market practices. The agencies' use of par value in the original proposal sought to establish a simple and transparent measure, but the PCCRA requirement, which the agencies proposed to ensure that the eligible horizontal residual interest had true economic value, tended to introduce other complexities. In addition, the use of fair value as defined in GAAP provides a consistent framework for calculating standard risk retention across very different securitization transactions and different classes of interests within the same type of securitization structure. However, fair value is a methodology susceptible to yielding a range of results depending on the key variables selected by the sponsor in determining fair value. Accordingly, as part of the agencies' proposal to rely on fair value as a measure that will adequately reflect the amount of a sponsor's economic “skin in the game,” the agencies propose to require disclosure of the sponsor's fair value methodology and all significant inputs used to measure its eligible horizontal residual interest, as discussed below in this section. Sponsors that elect to utilize the horizontal risk retention option must disclose the reference data set or other historical information which would meaningfully inform third parties of the reasonableness of the key cash flow assumptions underlying the measure of fair value. For the purposes of this requirement, key assumptions may include default, prepayment, and recovery. The agencies believe these key metrics will help investors assess whether the fair value measure used by the sponsor to determine the amount of its risk retention are comparable to market expectations. The agencies are also proposing limits on payments to holders of the eligible horizontal residual interest, but the limits differ from those in the original proposal, based on the fair value measurement. The agencies continue to believe that limits are necessary to establish economically meaningful horizontal risk retention that better aligns the sponsor's incentives with those of investors. However, the agencies also intend for sponsors to be able to satisfy their risk retention requirements with the retention of an eligible horizontal residual interest in a variety of ABS structures, including those structures that, in contrast to mortgage-backed securities transactions, do not distinguish between principal and interest payments and between principal losses and other losses. The proposed restriction on projected cash flows to be paid to the eligible horizontal residual interest would limit how quickly the sponsor can recover the fair value amount of the eligible horizontal residual interest in the form of cash payments from the securitization (or, if a horizontal cash reserve account is established, released to the sponsor or other holder of such account). The proposed rule would prohibit the sponsor from structuring a deal where it receives such amounts at a faster rate than the rate at which principal is paid to investors in all ABS interests in the securitization, measured for each future payment date. Since the cash flows projected to be paid to sponsors (or released to the sponsor or other holder of the horizontal cash reserve account) and all ABS interests would already be calculated at the closing of the transactions as part of the fair value calculation, it should not be unduly complex or burdensome for sponsors to project the cash flows to be paid to the eligible horizontal residual interest (or released to the sponsor or other holder of the horizontal cash reserve account) and the principal to be paid to all ABS interests on each payment date. To compute the fair value of projected cash flows to be paid to the eligible horizontal residual interest (or released to the sponsor or other holder of the horizontal cash reserve account) on each payment date, the sponsor would discount the projected cash flows to the eligible horizontal residual interest on each payment date (or released to the sponsor or other holder of the horizontal cash reserve account) using the same discount rate that was used in the fair value calculation (or the amount that must be placed in an eligible horizontal cash reserve account, equal to the fair value of an eligible horizontal residual interest). To compute the cumulative fair value of cash flows projected to be paid to the eligible horizontal residual interest through each payment date, the sponsor would add the fair value of cash flows to the eligible horizontal residual interest (or released to the sponsor or other holder of the horizontal cash reserve account) from issuance through each payment date (or the termination of the horizontal cash reserve account). The ratio of the cumulative fair value of cash flows projected to be paid to the eligible horizontal residual interest (or released to the sponsor or other holder of the horizontal cash reserve account) at each payment date divided by the fair value of the eligible horizontal residual interest (or the amount that must be placed in an eligible horizontal cash reserve account, equal to the fair value of an eligible horizontal residual interest) at issuance (the EHRI recovery percentage) measures how quickly the sponsor can be projected to recover the fair value of the eligible horizontal residual interest. To measure how quickly investors as a whole are projected to be repaid principal through each payment date, the sponsor would divide the cumulative amount of principal projected to be paid to all ABS interests through each payment date by the total principal of ABS interests at issuance (ABS recovery percentage). In order to comply with the proposed rule, the sponsor, prior to the issuance of the eligible horizontal residual interest (or funding a horizontal cash reserve account), or at the time of any subsequent issuance of ABS interests, as applicable, would have to certify to investors that it has performed the calculations required by section 4(b)(2)(i) of the proposed rule and that the EHRI recovery percentages are not expected to be larger than the ABS recovery percentages for any future payment date. 44 In addition, the sponsor would have to maintain record of such calculations and certifications in written form in its records and must provide disclosure upon request to the Commission and its appropriate Federal banking agency, if any, until three years after all ABS interests are no longer outstanding. If this test fails for any payment date, meaning that the eligible horizontal residual interest is projected to recover a greater percentage of its fair value than the percentage of principal projected to be repaid to all ABS interests with respect to such future payment date, the sponsor, absent provisions in the cash flow waterfall that prohibit such excess projected payments from being made on such payment date, would not be in compliance with the requirements of section 4(b)(2) of the proposed rule. For example, the schedule of target overcollateralization in an automobile loan securitization might need to be adjusted so that the sponsor's retained interest satisfies the eligible horizontal residual interest repayment restriction. 44 See proposed rule at § __.4(b). The cash flow projection would be a one-time calculation performed at issuance on projected cash flows. This is in part to limit operational burdens and to allow for sponsors to receive the upside from a transaction performing above expectations in a timely fashion. It should also minimize increases in the cost of credit to borrowers as a result of the risk retention requirement. At the same time, the restriction that a sponsor cannot structure a transaction in which the sponsor is projected to recover the fair value of the eligible horizontal residual interest any faster than all investors are repaid principal should help to maintain the alignment of interests of the sponsor with those of investors in the ABS, while providing flexibility for various types of securitization structures. Moreover, the restriction would permit a transaction to be structured so that the sponsor could receive a large, one-time payment, which is a feature common in deals where certain cash flows that would otherwise be paid to the eligible horizontal residual interest are directed to pay other classes, such as a money market tranche in an automobile loan securitization, provided that such payment did not cause a failure to satisfy the projected payment test. On the other hand, the restriction would prevent the sponsor from structuring a transaction in which the sponsor is projected to be paid an amount large enough to increase the leverage of the transaction by more than the amount which existed at the issuance of the asset-backed securities. In other words, the purpose of the restriction is to prevent sponsors from structuring a transaction in which the eligible horizontal residual interest is projected to receive such a disproportionate amount of money that the sponsor's interests are no longer aligned with investors' interests. For example, if the sponsor has recovered all of the fair value of an eligible horizontal residual interest, the sponsor effectively has no retained risk if losses on the securitized assets occur later in the life of the transaction. In addition, in light of the fact that the EHRI recovery percentage calculation is determined one time, before closing of the transaction, based on the sponsor's projections, the agencies are proposing to include an additional disclosure requirement about the sponsor's past performance in respect to the EHRI recovery percentage calculation. For each transaction that includes an EHRI, the sponsor will be required to make a disclosure that looks back to all other EHRI transactions the sponsor has brought out under the requirements of the risk retention rules for the previous five years, and disclose the number of times the actual payments made to the sponsor under the EHRI exceeded the amounts projected to be paid to the sponsor in determining the Closing Date Projected Cash Flow Rate (as defined in section 4(a) of the proposed rule). Similar to the original proposal, the proposed rule would allow a sponsor, in lieu of holding all or part of its risk retention in the form of an eligible horizontal residual interest, to cause to be established and funded, in cash, a reserve account at closing (horizontal cash reserve account) in an amount equal to the same dollar amount (or corresponding amount in the foreign currency in which the ABS are issued, as applicable) as would be required if the sponsor held an eligible horizontal residual interest. 45 45 See proposed rule at § __.4(c). This horizontal cash reserve account would have to be held by the trustee (or person performing functions similar to a trustee) for the benefit of the issuing entity. Some commenters on the original proposal recommended relaxing the investment restrictions on the horizontal cash reserve account to accommodate foreign transactions. The proposed rule includes several important restrictions and limitations on such a horizontal cash reserve account to ensure that a sponsor that establishes a horizontal cash reserve account would be exposed to the same amount and type of credit risk on the underlying assets as would be the case if the sponsor held an eligible horizontal residual interest. For securitization transactions where the underlying loans or the ABS interests issued are denominated in a foreign currency, the amounts in the account may be invested in sovereign bonds issued in that foreign currency or in fully insured deposit accounts denominated in the foreign currency in a foreign bank (or a subsidiary thereof) whose home country supervisor (as defined in section 211.21 of the Board's Regulation K) 46 has adopted capital standards consistent with the Capital Accord of the Basel Committee on Banking Supervision, as amended, provided the foreign bank is subject to such standards. 47 In addition, amounts that could be withdrawn from the account to be distributed to a holder of the account would be restricted to the same degree as payments to the holder of an eligible horizontal residual interest (such amounts to be determined as though the account was an eligible horizontal residual interest), and the sponsor would be required to comply with all calculation requirements that it would have to perform with respect to an eligible horizontal residual interest in order to determine permissible distributions from the cash account. 46 12 CFR 211.21. 47 Otherwise, as in the original proposal, amounts in a horizontal cash reserve account may only be invested in: (1) United States Treasury securities with remaining maturities of one year or less; and (2) deposits in one or more insured depository institutions (as defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813)) that are fully insured by federal deposit insurance. See proposed rule at § __.4(c)(2). Disclosure requirements would also be required with respect to a horizontal cash reserve account, including the fair value and calculation disclosures required with respect to an eligible horizontal residual interest, as discussed below. The original proposal included tailored disclosure requirements for the vertical, horizontal, and L-shaped risk retention options. A few commenters recommended deleting the proposed requirement that the sponsor disclose the material assumptions and methodology used in determining the aggregate dollar amount of ABS interests issued by the issuing entity in the securitization. In the proposed rule, the agencies are proposing disclosure requirements similar to those in the original proposal, with some modifications, and are proposing to add new requirements for the fair value measurement and to reflect the structure of the proposed standard risk retention option. The proposed rule would require sponsors to provide or cause to be provided to potential investors a reasonable time prior to the sale of ABS interests in the issuing entity and, upon request, to the Commission and its appropriate Federal banking agency (if any) disclosure of: • The fair value (expressed as a percentage of the fair value of all ABS interests issued in the securitization transaction and dollar amount (or corresponding amount in the foreign currency in which the ABS are issued, as applicable)) of the eligible horizontal residual interest that will be retained (or was retained) by the sponsor at closing, and the fair value (expressed as a percentage of the fair value of all ABS interests issued in the securitization transaction and dollar amount (or corresponding amount in the foreign currency in which the ABS are issued, as applicable)) of the eligible horizontal residual interest required to be retained by the sponsor in connection with the securitization transaction; • A description of the material terms of the eligible horizontal residual interest to be retained by the sponsor; • A description of the methodology used to calculate the fair value of all classes of ABS interests; • The key inputs and assumptions used in measuring the total fair value of all classes of ABS interests and the fair value of the eligible horizontal residual interest retained by the sponsor (including the range of information considered in arriving at such key inputs and assumptions and an indication of the weight ascribed thereto) and the sponsor's technique(s) to derive the key inputs; • For sponsors that elect to utilize the horizontal risk retention option, the reference data set or other historical information that would enable investors and other stakeholders to assess the reasonableness of the key cash flow assumptions underlying the fair value of the eligible horizontal residual interest. Examples of key cash flow assumptions may include default, prepayment, and recovery; • Whether any retained vertical interest is retained as a single vertical security or as separate proportional interests; • Each class of ABS interests in the issuing entity underlying the single vertical security at the closing of the securitization transaction and the percentage of each class of ABS interests in the issuing entity that the sponsor would have been required to retain if the sponsor held the eligible vertical interest as a separate proportional interest in each class of ABS interest in the issuing entity; and • The fair value (expressed as a percentage of the fair value of all ABS interests issued in the securitization transaction and dollar amount (or corresponding amount in the foreign currency in which the ABS are issued, as applicable)) of any single vertical security or separate proportional interests that will be retained (or was retained) by the sponsor at closing, and the fair value (expressed as a percentage of the fair value of all ABS interests issued in the securitization transaction and dollar amount (or corresponding amount in the foreign currency in which the ABS are issued, as applicable)) of the single vertical security or separate proportional interests required to be retained by the sponsor in connection with the securitization transaction. Consistent with the original proposal, a sponsor electing to establish and fund a horizontal cash reserve account would be required to provide disclosures similar to those required with respect to an eligible horizontal residual interest, except that these disclosures have been modified to reflect the different nature of the account. Request for Comment 1(a). Should the agencies require a minimum proportion of risk retention held by a sponsor under the standard risk retention option to be composed of a vertical component or a horizontal component? 1(b). Why or why not? 2(a). The agencies observe that horizontal risk retention, as first-loss residual position, generally would impose the most economic risk on a sponsor. Should a sponsor be required to hold a higher percentage of risk retention if the sponsor retains only an eligible vertical interest under this option or very little horizontal risk retention? 2(b). Why or why not? 3. Are the disclosures proposed sufficient to provide investors with all material information concerning the sponsor's retained interest in a securitization transaction and the methodology used to calculate fair value, as well as enable investors and the agencies to monitor whether the sponsor has complied with the rule? 4(a). Is the requirement for sponsors that elect to utilize the horizontal risk retention option to disclose the reference data set or other historical information that would enable investors and other stakeholders to assess the reasonableness of the key cash flow assumptions underlying the fair value of the eligible horizontal residual interest useful? 4(b). Would the requirement to disclose this information impose a significant cost or undue burden to sponsors? 4(c). Why or why not? 4(d). If not, how should proposed disclosures be modified to better achieve those objectives? 5(a). Does the proposal require disclosure of any information that should not be made publicly available? 5(b). If so, should such information be made available to the Commission and Federal banking agencies upon request? 6. Are there any additional factors that the agencies should consider with respect to the standard risk retention? 7. To what extent would the flexible standard risk retention option address concerns about a sponsor having to consolidate a securitization vehicle for accounting purposes due to the risk retention requirement itself, given that the standard risk retention option does not require a particular proportion of horizontal to vertical interest? 8(a). Is the proposed approach to measuring risk retention appropriate? 8(b). Why or why not? 9(a). Would a different measurement of risk retention be more appropriate? 9(b). Please provide details and data supporting any alternative measurement methodologies. 10(a). Is the restriction on certain projected payments to the sponsor with respect to the eligible horizontal residual interest appropriate and sufficient? 10(b). Why or why not? 11(a). The proposed restriction on certain projected payments to the sponsor with respect to the eligible horizontal residual interest compares the rate at which the sponsor is projected to recover the fair value of the eligible horizontal residual interest with the rate which all other investors are projected to be repaid their principal. Is this comparison of two different cash flows an appropriate means of providing incentives for sound underwriting of ABS? 11(b). Could it increase the cost to the sponsor of retaining an eligible horizontal residual interest? 11(c). Could sponsors or issuers manipulate this comparison to reduce the cost to the sponsor of retaining an eligible horizontal residual interest? How? 11(d). If so, are there adjustments that could be made to this requirement that would reduce or eliminate such possible manipulation? 11(e). Would some other cash flow comparison be more appropriate? 11(f). If so, which cash flows should be compared? 11(g). Does the proposed requirement for the sponsor to disclose, for previous ABS transactions, the number of times the sponsor was paid more than the issuer predicted for such transactions reach the right balance of incremental burden to the sponsor while providing meaningful information to investors? 11(h). If not, how should it be modified to better achieve those objectives? 12(a). Does the proposed form of the single vertical security accomplish the agencies' objective of providing a way for sponsors to hold vertical risk retention without the need to perform valuation of multiple securities for accounting purposes each financial reporting period? 12(b). Is there a different approach that would be more efficient? 13(a). Is three years after all ABS interests are no longer outstanding an appropriate time period for the sponsors' record maintenance requirement with respect to the calculations and other requirements in section 4? 13(b). Why or why not? 13(c). If not, what would be a more appropriate time period? 14(a). Would the calculation requirements in section 4 of the proposed rule likely be included in agreed upon procedures with respect to an interest retained pursuant to the proposed rule? 14(b). Why or why not? 14(c). If so, what costs may be associated with such a practice? c. Alternative Eligible Horizontal Residual Interest Proposal The agencies have also considered, and request comment on, an alternative provision relating to the amount of principal payments received by the eligible horizontal residual interest. Under this alternative, on any payment date, in accordance with the transaction's governing documents, the cumulative amount paid to an eligible horizontal residual interest may not exceed a proportionate share of the cumulative amount paid to all holders of ABS interests in the transaction. The proportionate share would equal the percentage, as measured on the date of issuance, of the fair value of all of the ABS interests issued in the transaction that is represented by the fair value of the eligible horizontal residual interest. For purposes of this calculation, fees and expenses paid to service providers would not be included in the cumulative amounts paid to holders of ABS interests. All other amounts paid to holders of ABS would be included in the calculations, including principal repayment, interest payments, excess spread and residual payments. The transaction documents would not allow distribution to the eligible horizontal residual interest any amounts payable to the eligible horizontal residual interest that would exceed the eligible horizontal residual interest's permitted proportionate share. Such excess amounts could be paid to more senior classes, placed into a reserve account, or allocated in any manner that does not otherwise result in payments to the holder of the eligible horizontal residual interest that would exceed the allowed amount. By way of illustration, assume the fair value of the eligible horizontal residual interest for a particular transaction was equal to 10 percent of the fair value of all ABS interests issued in that transaction. In order to meet the requirements of the proposal, the cumulative amount paid to the sponsor in its capacity as holder of the eligible horizontal residual interest on any given payment date could not exceed 10 percent of the cumulative amount paid to all holders of ABS interests, excluding payment of expenses and fees to service providers. This would allow large payments to the eligible horizontal residual interest so long as such payments do not otherwise result in payments to the holder of the eligible horizontal residual interest that would exceed the allowed amount. The agencies request comment on this alternative mechanism for allowing the eligible horizontal residual interest to receive unscheduled principal payments, including whether the agencies should adopt the alternative proposal instead of the proposed mechanism for these payments described above. Request for Comment 15(a). Other than a cap in the priority of payments on amounts to be paid to the eligible horizontal residual interest and related calculations on distribution dates and related provisions to allocate any amounts above the cap, would there be any additional steps necessary to comply with the alternative proposal? 15(b). If so, please describe those additional steps and any associated costs. 16. Would the cost and difficulty of compliance with the alternative proposal, including monitoring compliance, be higher or lower, than with the proposal? 17(a). Does the alternative proposal accommodate more or less of the current market practice than the proposal? 17(b). If there is a difference, please provide data with respect to the scale of that difference. 18. With respect to the alternative proposal, should amounts other than payment of expenses and fees to service providers be excluded from the calculations? 19(a). Does the alternative proposal adequately accommodate structures with unscheduled payments of principal, such as scheduled step downs? 19(b). Does the alternative adequately address structures which do not distinguish between interest and principal received from underlying assets for purposes of distributions? 20(a). Are there asset classes or transaction structures for which the alternative proposal would not be economically viable? 20(b). Are there asset classes or transaction structures for which the alternative proposal would be more economically feasible than the proposal? 21. Should both the proposal and the alternative proposal be made available to sponsors? 22(a). The proposal includes a restriction on how payments on an eligible horizontal residual interest must be structured but does not restrict actual payments to the eligible horizontal residual interest, which could be different than the projected payments if losses are higher or lower than expected. The alternative proposal for payments on eligible horizontal residual interests does not place restrictions on structure but does restrict actual payments to the eligible horizontal residual interest. Does the proposal or the alternative proposal better align the sponsor's interests with investors' interests? 22(b). Why or why not? 2. Revolving Master Trusts a. Overview Securitization sponsors frequently use a revolving master trust when they seek to issue more than one series of ABS collectively backed by a common pool of assets that change over time. 48 Pursuant to the original proposal, the seller's interest form of risk retention would only be available to revolving master trusts. 48 In a revolving master trust securitization, assets ( e.g., credit card receivables or dealer floorplan financings) are periodically added to the pool to collateralize current and future issuances of the securities backed by the pool. Often, but not always, the assets are receivables generated by revolving lines of credit originated by the sponsor. A major exception would be the master trusts used in the United Kingdom to finance residential mortgages. The seller's interest is an undivided interest held by the master trust securitization sponsor in the pool of receivables or loans held in the trust. It entitles the sponsor to a percentage of all payments of principal, interest, and fees, as well as recoveries from defaulted assets that the trust periodically receives on receivables and loans held in the trust, as well as the same percentage of all payment defaults on those assets. Investors in the various series of ABS issued by the trust have claims on the remaining principal and interest, as a source of repayment for the ABS interests they hold. 49 Typically, the seller's interest is pari passu to the investors' interest with respect to collections and losses on the securitized assets, though in some revolving master trusts, it is subordinated to the investors' interest in this regard. If the seller's interest is pari passu, it generally becomes subordinated to investors' interests in the event of an early amortization of the ABS interests held by investors, as discussed more below. Commenters representing the interests of securitization sponsors generally favored the seller's interest approach but requested certain modifications. 49 Generally, the trust sponsor retains the right to any excess cash flow from payments of interest and fees received by the trust that exceeds the amount owed to ABS investors. Excess cash flow from payments of principal is paid to the sponsor in exchange for newly generated receivables in the trust's existing revolving accounts. However, the specific treatment of excess interest, fees, and principal payments with respect to any ABS series within the trust is a separate issue, discussed in connection with the agencies' proposal to give sponsors credit for some forms of eligible horizontal risk retention at the series level, as explained in further detail below. The agencies are proposing to maintain the seller's interest as the specific risk retention option for master trusts, with changes from the original proposal that reflect many of the comments received, as discussed in further detail below. The modifications to this option are intended to refine this method of risk retention to better reflect the way revolving master trust securitizations operate in the current market. As discussed in greater detail below, among other things, the agencies are proposing to modify the original proposal with respect to master trusts by: • Allowing sponsors that hold a first-loss exposure in every series of ABS issued by a master trust to count the percent of such interest that is held consistently across all ABS series toward the minimum 5 percent seller's interest requirement; • Removing the restriction in the original proposal that prohibited the use of the seller's interest risk retention option for master trust securitizations backed by non-revolving assets; • Clarifying how the seller's interest can be used in connection with multi-level legacy trusts and master trusts in which some of the seller's interest corresponds to loans or receivables held in a legacy master trust; • Revising the calculation of the 5 percent seller's interest amount so it is based on the trust's amount of outstanding ABS rather than the amount of trust assets; • Clarifying the rules regarding the use of certain structural features, including delinked credit enhancement structures, where series-specific credit enhancements that do not support the seller's interest-linked structures, and the limited use of assets that are not part of the seller's interest to administer the features of the ABS issued to investors; and • Clarify how the rule would apply to a revolving master trust in early amortization. b. Definitions of Revolving Master Trust and Seller's Interest The seller's interest form of retention would only be available to revolving master trusts. These are trusts established to issue ABS interests on multiple issuance dates out of the same trust. In some instances the trust will issue to investors a series with multiple classes of tranched ABS periodically. In others, referred to as “delinked credit enhancement structures,” the master trust maintains one or more series, but issues tranches of ABS of classes in the series periodically, doing so in amounts that maintain levels of subordination between classes as required in the transaction documents. The revolving master trust risk retention option is designed to accommodate both of these structures. The agencies' original proposal would require that all securitized assets in the master trust must be loans or other extensions of credit that arise under revolving accounts. The agencies received comments indicating that a small number of securitizers in the United States, such as insurance premium funding trusts, use revolving trusts to securitize short-term loans, replacing loans as they mature with new loans, in order to sustain cash flow and collateral support to longer-term securities. In response to commenters, the agencies are proposing to expand the securitized asset requirement to include non-revolving loans. 50 Nevertheless, as with the original proposal, all ABS interests issued by the master trust must be collateralized by the master trust's common pool of receivables or loans. Furthermore, the common pool's principal balance must revolve so that cash representing principal remaining after payment of principal due, if any, to outstanding ABS on any payment date, as well as cash flow from principal payments allocated to seller's interest is reinvested in new extensions of credit at a price that is predetermined at the transaction and new receivables or loans are added to the pool from time to time to collateralize existing series of ABS issued by the trust. The seller's interest option would not be available to a trust that issues series of ABS at different times backed by segregated independent pools of securitized assets within the trust as a series trust, or a trust that issues shorter-term ABS interests backed by a static pool of long-term loans, or a trust with a re-investment period that precedes an ultimate amortization period. 50 Revolving master trusts are also used in the United Kingdom to securitize mortgages, and U.S. investors may invest in RMBS issued by these trusts. This proposed change would make it easier for these issuers to structure their securitizations in compliance with section 15G for such purpose. In general, the seller's interest represents the seller/sponsor's interest in the portion of the receivables or loans that does not collateralize outstanding investors' interests in ABS issued under series. Investor interests include any sponsor/seller's retained ABS issued under a series. As discussed above, a seller's interest is a typical form of risk retention in master trusts, whereby the sponsor of a master trust holds an undivided interest in the securitized assets. The original proposal defined “seller's interest” consistent with these features, as an ABS interest (i) in all of the assets that are held by the issuing entity and that do not collateralize any other ABS interests issued by the entity; (ii) that is pari passu with all other ABS interests issued by the issuing entity with respect to the allocation of all payments and losses prior to an early amortization event (as defined in the transaction documents); and (iii) that adjusts for fluctuations in the outstanding principal balances of the securitized assets. The proposal would define “seller's interest” similarly to the original proposal. However, in response to comments, the agencies have made changes to the definition from the original proposal to reflect market practice. The first change would modify the definition to reflect the fact that the seller's interest is pari passu with investors' interests at the series level, not at the level of all investors' interests collectively. The agencies are proposing this change because each series in a revolving master trust typically uses senior-subordinate structures under which investors are entitled to different payments out of that series' percentage share of the collections on the trust's asset pool, so some investors in subordinated classes are subordinate to the seller's interest. The second change would modify the definition to reflect the fact that, in addition to the receivables and loans that collateralize the trust's ABS interests, a master trust typically includes servicing assets. 51 To the extent these assets are allocated as collateral only for a specific series, these assets are not part of the seller's interest. 52 Furthermore, the proposal clarifies that the seller's interest amount is the unpaid principal balance of the seller's interest in the common pool of receivables or loans. The seller's interest amount must at least equal the required minimum seller's interest. 51 The definition of “servicing assets” is discussed in Part II.B of this Supplementary Information. 52 Although this language allows certain assets held by the trust to be allocated as collateral only for a specific series and excluded from the seller's interest, it does not allow a trust to claim eligibility for the seller's interest form of risk retention unless the seller's interest is, consistent with the revolving master trust definition, generally collateralized by a common pool of assets, the composition of which changes over time, and that securitizes all ABS interests in the trust. Absent broad exposure to the securitized assets, the seller's interest ceases to be a vertical form of risk retention. The proposed language is designed to accommodate limited forms of exclusion from the seller's interest in connection with administering the trust, dealing with the revolving versus amortizing periods for investor ABS series, implementation of interest rate features, and similar aspects of these securitization transactions. In addition, the agencies are considering whether they should make additional provisions for subordinated seller's interests. In some revolving master trusts, there is an interest similar to a seller's interest, except that instead of the interest being pari passu with the investors' interest with respect to principal collections and interest and fee collections, the sponsor's (or depositor's) share of the collections in the interest are subordinated, to enhance the ABS interests issued to investors at the series level. The agencies are considering whether to permit these subordinated interests to count towards the 5 percent seller's interest treatment, since they perform a loss-absorbing function that is analogous to a horizontal interest (whereas a typical seller's interest is analogous to a vertical interest, and typically is only subordinated in the event of early amortization). Because they are subordinated, however, the agencies are considering requiring them be counted toward the 5 percent requirement on a fair value basis, instead of the face value basis applied for regular, unsubordinated seller's interests. 53 The sponsor would be required to apply the same fair value standards as the rule imposes under the general risk retention requirement. 53 The fair value determination would be for purposes of the amount of subordinated seller's interest included in the numerator of the 5 percent ratio. The denominator would be the unpaid principal balance of all outstanding investors' ABS interests, as is proposed for regular, unsubordinated seller's interests. In addition to these definitional changes, the agencies are proposing modifications to the overall structure of the master trust risk retention option as it was proposed in the original proposal, in light of comments concerning the manner in which the seller's interest is held. In some cases, the seller's interest may be held by the sponsor, as was specified in the original proposal, but in other instances, it may be held by another entity, such as the depositor, or two or more originators may sponsor a single master trust to securitize receivables generated by both firms, with each firm holding a portion of the seller's interest. Accordingly, the agencies are proposing to allow the seller's interest to be held by any wholly-owned affiliate of the sponsor. 54 54 The requirement for the holder to be a wholly-owned affiliate of the sponsor is consistent with the restrictions on permissible transferees of risk retention generally required to be held by the sponsor under the rule. See Part III.D.2 of this Supplementary Information. In response to comments, the agencies are also proposing to allow the seller's interest to be retained in multiple interests, rather than a single interest. This approach is intended to address legacy trust structures and would impose requirements on the division of the seller's interest in such structures. In these structures, a sponsor that controls an older revolving master trust that no longer issues ABS to investors keeps the trust in place, with the credit lines that were designated to the trust over the years still in operation and generating new receivables for the legacy trust. The legacy trust issues certificates collateralized by these receivables to a newer issuing trust, which typically also has credit lines designated to the trust, providing the issuing trust with its own pool of receivables. The issuing trust issues investors' ABS interests backed by receivables held directly by the issuing trust and also indirectly in the legacy trust (as evidenced by the collateral certificates held by th [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2013-21677. Public record. Not legal advice.