Thank you, Chairman Schapiro.
It is widely recognized that securitization helps spur the real economy. Most notably, securitization expands the availability of credit so that homeowners, consumers, and small and large businesses alike can tap into financing more efficiently to fund their needs. Without securitization, credit becomes harder to come by, and those who do obtain credit may have to pay more to borrow. Without securitization, it becomes more burdensome for people to buy homes; for consumers to shop; and for businesses to finance their operations.
The financial crisis has raised many questions about securitization's viability as a means of finance and credit expansion. With the proposal before us today, the Commission is offering its attempt to address certain concerns with securitization that the crisis has brought into focus.
The Commission staff has worked diligently in trying to fashion a regulatory response that is intended to reinvigorate the securitization market. A central feature of the proposal is to require new disclosures for public offerings of asset-backed securities (ABS). New asset-level disclosures, for example, would be coupled with a new waterfall computer program to promote investors' ability to evaluate an ABS offering and thus to price the securities more appropriately. The expectation is that such enhanced disclosures — which I support — will bring greater market discipline to the securitization chain. Indeed, the private sector already is considering disclosure improvements to facilitate informed investor decision making and to promote a more efficient securitization process that encourages capital to flow throughout the economy. In addition to thinking about mandatory disclosure from traditional perspectives of securities regulation — namely, investor protection and capital formation — one also has to take notice of certain personal privacy interests that could be compromised as more detailed asset-level information is made publicly available. I look forward to the comments we will receive as we look to ensure that the disclosure mandates are properly tailored to fit the needs of securitization.
I do, however, have significant reservations about other key features of this rulemaking. The following captures the core of three of my primary concerns.
First, I am concerned about the proposal's approach to "skin in the game." The proposal conditions shelf eligibility upon the sponsor of an ABS offering retaining an unhedged five percent "vertical slice" of the issuance. The goal of better aligning the incentives of originators and sponsors with the interests of investors is valid. However, more rigorous analysis is required than has been offered before concluding that a particular percentage or form of risk retention is appropriate to entrench in the Commission's rules. Even if it is optimal for a sponsor to retain a five percent vertical slice of the deal in some ABS offerings, it does not necessarily follow that a one-size-fits-all approach to skin in the game for shelf eligibility makes sense. Different asset classes and different deal structures may argue for different degrees and forms of risk retention.
In addition, many financial institutions, along with many investors, suffered considerable losses when the financial crisis hit precisely because they had skin in the game. Accordingly, how confident should we be that requiring a sponsor to hold a five percent vertical slice will appreciably improve the quality of asset-backed securities?
Moreover, risk retention can have accounting, regulatory capital, and true sale implications that could jeopardize the economics and underlying rationale of asset securitization. These risks to securitization as an effective means of finance recommend caution before too readily concluding that risk retention is a solution for what has ailed the securitization market.
All of this introduces a more fundamental question: Especially given that no consensus has yet been reached regarding the optimal approach to risk retention, is it even appropriate for the SEC to advance rules under the '33 Act that could determine the substance of securitization? Should the Commission independently fashion a substantive skin-in-the-game requirement to reflect its own assessment of the incentives of participants in the securitization chain? Whatever the merits of risk retention may be, I question whether greater risk retention should be effectuated by incorporating a skin-in-the-game requirement into the Commission's shelf-eligibility conditions.
Second, repurchase obligations triggered by a representation or warranty breach in pooling and servicing or other transaction agreements are themselves a form of risk retention. To lend repurchase obligations more bite, the proposal further conditions shelf eligibility on receipt of a periodic third-party opinion to the effect that there has been no representation or warranty breach as to any asset that has been put back and not repurchased (or replaced). The logic of this shelf-eligibility condition is sensible, but I question whether the opinion will be forthcoming in practice given the research, due diligence, and other steps it seems a third party would have to undertake to determine if a breach had occurred. On the other hand, a highly-qualified and circumscribed opinion, although more feasible for a third party to give, may not be particularly valuable.
Third, the proposal would treat private offerings of ABS substantially the same as public offerings of ABS in terms of the required disclosures. The release itself acknowledges that "[t]his will be the first time . . . that we would require an undertaking to provide information to accredited investors as a condition to the safe harbor in Rule 506 of Regulation D, and the first time we would require an undertaking to provide such specific information to QIBs in Rule 144A transactions."
The extent to which the proposal collapses the regulatory distinction between public and private offerings of ABS is disquieting. By effectively burdening an ABS private offering with public-offering-type disclosure mandates, the Commission's proposal risks compromising the essential function of the private placement market as a means of efficient capital formation. More to the point, to my mind, the proposal is at odds with the regulatory regime's longstanding regard for a meaningful private securities market that offers an alternative to the more heavily-regulated public offering process.
Furthermore, the proposed regulatory approach to private offerings of ABS finds the Commission treating ABS uniquely as compared to other types of securities. In other words, the Commission is passing substantive judgment on ABS and the securitization process. However, it is not self-evident that the Commission should be passing judgment of the substance of different types of securities offerings. Should private offerings of ABS be subjected to more demanding regulation because the Commission has determined that the merits of such an offering warrant more government oversight? Having started down this path, might the Commission decide that other types of securities also should be subject to more stringent safe harbor requirements under Rules 506 and 144A?
These and other concerns I have sum to my two overarching hesitations with the proposal. The first is the risk that, in the end, the totality of the new regulatory demands will unduly burden the securitization process. Historically, few ABS offerings have been completed using Form S-1. Instead, the more efficient process of a shelf offering or a private placement has been favored. Yet the proposed rule amendments would make both shelf offerings and private placements in reliance on relevant safe harbors more costly and perhaps infeasible under certain circumstances. Accordingly, it is premature to presume that the proposed tightening of the securities regulatory regime will restore a vibrant securitization market. To the contrary, a more targeted regulatory response — including a more balanced approach to Rules 506 and 144A that tempers the required disclosures under these safe harbors to account for the wherewithal of investors participating in private offerings to safeguard their own interests — may better facilitate securitization.
The second overarching hesitation concerns the housing market and Freddie Mac, Fannie Mae, and Ginnie Mae. The proposing release indicates that by "[i]ncreasing the costs of securitization" for private-label mortgage-backed issuances, the rule amendments "may give a competitive advantage to residential mortgage originators who can securitize through government sponsored enterprises and may increase the cost of non-conforming loans to borrowers." For reasons the release explains, the rule amendments could lead to a "reduction in the number of assets available for securitization by non-GSE ABS issuers and could provide GSEs with greater market power at the expense of conforming loan lenders and non-conforming borrowers." This is troubling, to say the least. I look forward to comments we may receive concerning the implications for the housing market and our financial system more generally if Freddie Mac, Fannie Mae, and Ginnie Mae benefit from this rulemaking as the release contemplates they could.
Ultimately, I am willing to support the proposal to move this rulemaking forward so that the Commission can benefit from the additional information and input we will receive through the notice-and-comment process. However, I do so with caution, mindful of the adverse impact the agency's actions could have on the real economy if the Commission does not properly calibrate these reforms.
As we seek to fashion a securities regulation regime that restarts and sustains the securitization market, not only must this agency carefully assess both the pros and cons of the proposal before us and whether alternatives to the Commission's proposal may strike a better balance; but it also is important that we cooperate and coordinate with other federal bodies considering their own securitization initiatives. If the relevant regulatory authorities, including the SEC, do not work together constructively, I am concerned that the cumulative impact of the regulatory changes could stifle securitization at the expense of individuals and businesses in need of credit.
In conclusion, I join my colleagues in thanking the Commission staff — particularly those from the Division of Corporation Finance, the Division of Risk, Strategy, and Financial Innovation, the Office of the General Counsel, and the Office of the Chief Accountant — for their tremendous effort to bring this rulemaking to where it stands today. I appreciate your hard work and commitment.