Debate Over Securitization Reform Heats Up in Washington

In a development that could impact the commercial mortgage-backed securities (CMBS) market, government officials and lawmakers are tightening up their scrutiny of the regulatory system for asset-backed securities (ABS) as part of the ongoing debate in Washington regarding financial market reforms.
On October 27, House Financial Services Committee Chairman Barney Frank (D-MA) released a proposal intended to address "systemic risks" facing the financial system. The draft of the bill included measures calling for regulators to write rules requiring creditors to retain at least 10 percent of the credit risk related to loans that are transferred or sold to other parties, including securitizers. 
Under Frank's plan, regulators would be able to adjust the level of risk retention above or below 10 percent, but not lower than 5 percent. Securitizers would be required to retain all of the credit risk in cases in which they securitize assets that they did not originate.
At an October 29 House Financial Services Committee hearing on Frank's bill, Daniel K. Tarullo, a member of the Board of Governors of the Federal Reserve System, said the proposals "could help restore confidence in the securitization market and encourage the application of sound underwriting criteria to all loans." He also backed plans to enhance the transparency of ABS.
Also appearing at the hearing, Timothy Ryan, president and CEO of the Securities Industry and Financial Markets Association, questioned whether stronger credit risk-retention requirements for ABS sponsors would have the intended effect of aligning their economic interests with those of investors. At the same time, the new requirements would hamstring lenders' capacity to finance new transactions, according to Ryan.
"A 10 percent retention requirement will be, for many asset classes and institutions, an economically unmanageable level that is not correlated with the risk presented in those assets—for example, prime mortgage or credit card loan transactions," he said. "Such a blunt requirement will also reduce the ability of lenders to finance new transactions, as valuable capital will need to be maintained against the retained positions."
Securities and Exchange Commission (SEC) Chairman Mary Schapiro said in a speech given October 27 that her agency is exploring new proposals to better regulate asset-backed securities (ABS). She also called on Congress to produce new legislation to reform the securitization system.
The current rules governing ABS have become antiquated, according to Schapiro. Instead, she suggested that legislation specifically tailored to create a new regulatory framework for ABS, modeled along the lines of the Investment Company Act of 1940, is needed.
Schapiro noted that current legislative proposals designed to enhance disclosure requirements related to ABS don't go far enough.

"Similar to the Investment Company Act, the ABS Act could have substantive restrictions or requirements for the trust that issues the securities and for related parties," she said. "Such a statute could set minimum requirements for the pooling and servicing agreements, such as requiring strong representations and warranties about the assets being securitized and procedures for ensuring those representations and warranties are followed."