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Federal agencies adopt credit risk retention requirements

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Oct 23, 2014

The SEC and five other federal agencies (the Office of the Comptroller of the Currency in the Department of the Treasury; the Board of Governors of the Federal Reserve System; the Federal Deposit Insurance Corporation; the Federal Housing Finance Agency; and the Department of Housing and Urban Development) have adopted Final Rule Release No. 34-73407, “Credit Risk Retention,” which requires securitizers, under certain conditions, to retain a portion of the credit risks associated with the assets collateralizing an asset-based security (ABS). The final rule is being issued in response to a mandate of Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which added new credit risk retention requirements to Section 15G of the Securities Exchange Act of 1934.

The final rule addresses what some believed to be a critical weakness in the securitization market that led to the financial crisis — namely, that certain meaningful risks need to be retained to ensure that securitizers have the incentives to monitor the quality of the securities. Therefore, under the final rule, securitizers would be:

    • Required to retain no less than 5 percent of the credit risk of assets within an ABS.
    • Prohibited from hedging or transferring the credit risk they are required to retain.

In addition, the final rule permits securitizers to select a form of risk retention obligation from a menu of specified options. The options available include (1) an eligible vertical interest, (2) an eligible horizontal residual interest, or (3) a combination of both when the combined interest is no less than 5 percent of the fair value of all ABSs issued.

ABSs that are collateralized solely by “qualified residential mortgages” (QRMs) are exempt from the risk retention requirements. The final rule alters the definition of a QRM to align it with the Consumer Financial Protection Bureau’s definition of a “qualified mortgage.”

For more information, see the press release, final rule, and the speeches by SEC Chair Mary Jo White and commissioners Luis A. Aguilar, Michael S. Piwowar, Kara M. Stein, and Daniel M. Gallagher on the SEC’s Web site.

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