11 May 2004
The Securities and Exchange Commission has recently proposed new rulesfor Asset-Backed Securities ("ABS") in the US market. A number of the proposed changes will affect foreign corporations, including Australian issuers.
The proposed rules were released on 3 May 2004 and the SEC is seeking industry comments over the following 60 days.
What will change?
The SEC currently regulates the ABS market via a complex arrangement of legislation, staff interpretations and no action letters. This has arisen because the legislative regime for ABS is the same as for other securities which are, though, by their nature significantly different instruments.
The proposed changes cover four regulatory areas:
Securities Act
Definition of Asset-backed Securities
Many of the changes to the Securities Act for ABS will be promulgated in a new Regulation AB. Securities that fall within the new definition of "asset backed securities" will be subject to the disclosure and other requirements under the proposed rules. All other securities will continue to be regulated under the current legislative regime.
The proposed definition of ABS, for the purposes of Regulation AB, is as follows:
"A security that is primarily serviced by cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underling such leases."
The SEC Release states that this definition will not include synthetic securitisations.
Expedited shelf registration for foreign ABS issuers
Foreign ABS issuers currently face a number of additional conditions and steps, leading to delays and possible impediments to their access of the US market. In particular, foreign ABS issuers are not permitted shelf registration until they have undertaken a number of registered issues. This is due to the SEC's concern that different legal systems could alter the basic principles underlying ABS in the US.
The SEC considers that many of their concerns can now be addressed through adequate disclosure. Accordingly, under the proposed rules shelf registration will be available to first time foreign issuers or issuers with foreign assets.
Form S-3 registration, which permits shelf registered securities, will be amended to indicate which ABS transactions will be eligible. In addition to allowing foreign ABS issuers to access shelf registration, the SEC will codify the periodic reporting obligations under the Exchange Act to maintain shelf registration eligibility.
The disclosure requirements for foreign issuers will be the same as for domestic issuers. Foreign issuers will, though, also have to disclose the following: "any pertinent governmental legal or regulatory or administrative matters and any pertinent tax matters, exchange controls, currency restrictions or other economic, fiscal, monetary or potential factors that could materially affect payments on[,] the performance of, or other matters relating to, the assets contained in the pool or the asset-backed securities".
At present Australian issuers address some of these subjects in their registration statements, but it remains to be seen whether the proposed rules will impose further disclosure obligations on them or maintain the status quo; and whether Australian issuers will be exposed to greater liability if they fail to meet the required disclosure standard.
The SEC proposes to hold pre-filing conferences where appropriate to discuss the home country legal and regulatory environment, the proposed transaction and the relevant disclosures that will be required.
Definition of "issuer"
The SEC intends a new Securities Act Rule 191 to clarify who the "issuer" will be for Securities Act purposes (with a similar rule for Exchange Act purposes). The SEC proposes that the issuer will be the "depositor". This expression in turn will be defined as the person who "receives or purchases and transfers or sells the pool assets to the issuing entity". For asset-backed securities where there is no intermediate transfer of the assets from the sponsor to the issuing entity (eg. for conduit programmes), the SEC intends that the term "depositor" will refer to the sponsor.
The SEC has previously accepted for Australian bank RMBS issues that the manager is the "issuer". The effect of the proposed change seems to be that the parent bank, rather than the manager, will now be regarded as the issuer. It will be interesting to see whether this position will change for Australian issuers and, if so, whether the banks will be subject to new liabilities which were previously borne by their subsidiaries or whether their position will remain roughly the same given the effect of section 15 of the Securities Act (entities liable for acts of persons they control).
We are also waiting for further guidance as to how the proposed rule will work for multi-seller structures.
Ongoing reporting under the Exchange Act
The SEC has not proposed any significant changes to the Exchange Act reporting structure, but it does believe that the current requirements in the Exchange Act do not elicit information that is entirely relevant for ABS investors. Through a series of exemptive orders, no action letters and other interpretations, SEC staff have allowed modified Exchange Act reporting for ABS issuers. The SEC proposes to codify these existing arrangements.
Under the proposed rules, Form 8-K will only be used for significant events that an ABS issuer is required to report. These will include the bankruptcy or insolvency of a servicer, a change to a credit enhancement, the modification or termination of a material agreement and other matters relevant to ABS. These events must be reported within four business days under rules recently adopted by the SEC.
A new Form 10-D has been proposed for periodic reporting regarding distributions, currently dealt with under Form 8-K. Every issuer that is subject to the Exchange Act reporting requirements must report on Form 10-D shortly after each distribution date.
The existing practice for Form 10-K reporting will be codified. The modified annual report on Form 10-K must include a servicer's statement of compliance with its servicing obligations and a report by an independent public accountant regarding compliance with particular servicing criteria. Issuers are also required to include a certification under Section 302 of the Sarbanes-Oxley Act with each Form 10-K.
In addition foreign issuers will need to provide ongoing disclosures in Forms 10-D and 10-K regarding any material impact caused by foreign legal and regulatory developments during the period covered by the report.
Disclosure
Currently, there are no disclosure items specifically tailored to ABS. The SEC proposes to establish in Regulation AB a body of principles-based disclosure items that will form the basis for disclosure in both Securities Act registration statements and Exchange Act reports. The SEC does not believe it would be practical or effective to draft detailed disclosure guides for each asset type that may be securitised. Instead the SEC has attempted to identify the "disclosure concept" required. Because of the broad nature of these disclosure concepts, the SEC has provided several illustrations that apply the concepts to a number of scenarios aimed at guiding ABS issuers on the appropriate level of disclosure.
The SEC also believes that the existing disclosure standards may not adequately capture certain categories of information that may be material to an ABS transaction. As a result, the SEC proposes new disclosure items relating to the background, experience, performance and roles of various transaction parties, including sponsors, originators, credit enhancement providers, servicers and trustees. To reduce the burden of this requirement, the proposed rules will permit "reasonable reliance" by the responsible person on information provided by an unaffiliated party.
Under the new rules, the issuer must, for example, provide for material disclosures of prior securitisations involving the servicer in which there has been a default, early amortisation or performance trigger event and provide information regarding the servicer's financial condition. Originators will be required to disclose, if material, a description of their securitisation program and underwriting criteria.
Some of the other key changes include:
Communications during the offering process
In the mid-1990s, the SEC issued a series of no action letters permitting the use of various written materials in an ABS offering, in addition to the statutory registration statement prospectus. These materials provide financial data on the assets being securitised and on the structure of the offering.
The proposed rules will codify the existing position.
At present the SEC has different requirements for various asset classes in relation to the timing for the filing of these materials. The proposed rules will codify the timing requirements and make them consistent across all ABS.
The rules relating to dissemination of ABS research reports as they relate to registered offerings of ABS will also be codified.
Conclusion
It is clear that many of these changes will affect foreign issuers. The impact of these will become more apparent once those involved in the industry have had an opportunity to digest the new rules.
The SEC has given industry 60 days to comment on these changes, and we urge Australian issuers to consider making a submission. If you would like to discuss the proposals further, please contact any of the partners listed below.
