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REGULATION AB ~ AN OVERVIEW OF KEY CHANGES, INTERPRETIVE ISSUES AND ADDITIONAL SEC GUIDANCE Michael H. Mitchell Orrick, Herrington & Sutcliffe LLP January.

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Presentation on theme: "REGULATION AB ~ AN OVERVIEW OF KEY CHANGES, INTERPRETIVE ISSUES AND ADDITIONAL SEC GUIDANCE Michael H. Mitchell Orrick, Herrington & Sutcliffe LLP January."— Presentation transcript:

1 REGULATION AB ~ AN OVERVIEW OF KEY CHANGES, INTERPRETIVE ISSUES AND ADDITIONAL SEC GUIDANCE Michael H. Mitchell Orrick, Herrington & Sutcliffe LLP January 31, 2006 American Securitization Forum 2006

2 Overview Regulatory Framework – Pre-Reg AB and Post-Reg AB  Securities Act Registration  1984 – Shelf registration for “mortgage-related securities”  1992 – ABS definition adopted → gateway to shelf registration  2006 – ABS definition revised → gateway to entire ABS regime

3  Disclosure  Informal disclosure framework developed through industry practice and SEC staff comment process  Regulation AB – principles-based disclosure framework  Securities Act Registration  1984 – Shelf registration for “mortgage-related securities”  1992 – ABS definition adopted → gateway to shelf registration  2006 – ABS definition revised → gateway to entire ABS regime

4  Periodic Reporting  Modified reporting framework established through staff “no ‑ action letters”  Regulation AB – principles-based disclosure framework  Dedicated rules re filing protocols, use of Form 10-K, 10-D, 8-K

5  Communications Regulations  Rigid statutory scheme liberalized through staff no-action letters  Dedicated rules re use of “ABS informational and computational material”; ABS research reports  Statutory scheme has since been liberalized by SOR to permit use of free writing prospectuses

6  Communications Regulations  Rigid statutory scheme liberalized through staff no-action letters  Dedicated rules re use of “ABS informational and computational material”; ABS research reports  Statutory scheme has since been liberalized by SOR to permit use of free writing prospectuses

7  Regulation AB disclosure framework is generally referred to as “principles-based.”  To be more precise, specific disclosure regulations are principles-based, while others are in the nature of per se disclosure requirements.  Principles-based disclosure regulations are largely based on market-driven disclosure that was prevalent pre-Reg AB.  On the other hand, there are areas where the SEC sought a reevaluation by transaction participants of the manner and content of presented disclosure, where existing disclosure standards may not adequately capture certain categories of information that may be material in an ABS transaction.

8  Required, to the extent material, in periodic increments regarding, among other things, delinquencies, cumulative losses and prepayments, as applicable.  SEC adopted framework specifically outlined by the ASF, providing separate starting points for disclosure depending on whether transaction involves an amortizing asset pool or a revolving asset master trust and, in the case of amortizing asset pools, suggesting separate starting points depending on the sponsor’s seasoning.  Static Pool Information  Amortizing asset pools: Focus is on prior securitized pools, unless sponsor is unseasoned, in which case focus is on sponsor’s overall portfolio, sorted by vintage origination year.  Revolving asset master trusts: Focus is on the asset pool itself, sorted by account age (e.g., 12-month increments over the first 5 years of the account’s life).  Disclosure framework affords issuers flexibility to adopt alternative presentations – focusing on different data groups or even on parties other than the sponsor – if appropriate to provide material disclosure.

9  Reg AB establishes expanded disclosure requirements concerning the background, experience, performance, and roles and responsibilities of various transaction parties, including sponsors, servicers, trustees and originators.  Reg AB also establishes more standardized disclosure requirements for third-party credit and other support providers, which key off designated concentration thresholds.  Updated financial information concerning these third parties is required on a quarterly and annual basis in the ABS issuer’s periodic reports.  Disclosure re Transaction Parties, Enhancement and Other Support Providers

10  The single-most significant change in reporting practices under Regulation AB is the requirement for assessment reports regarding compliance with stated servicing criteria from each “party participating in the servicing function,” with associated attestation reports from each such party’s registered public accountants.  The SEC has modified paragraph 5 of the certification required under the Sarbanes-Oxley Act, which must continue to be filed as Exhibit 31 to the Form 10-K, to require an attestation that, except as otherwise disclosed, reports required from all parties participating in the servicing function have been included as exhibits to the Form 10-K.  USAP criteria used in many transactions heretofore have been replaced with a single set of disclosure-based criteria, that cover the entire servicing function, including allocation and distribution of collections on pool assets.  Servicing compliance is to be determined at a servicing platform level, rather than at a transaction-specific level; thus, reports will assess compliance with respect to all ABS transactions involving such party, taken as a whole, that are backed by the same asset type.  Servicing Assessment and Attestation Reports

11  Collection and asset maintenance activities; and  Cash flow allocation and distribution functions.  Who is a “Servicer”?  Regulation AB employs a unified definition of “servicer” designed to capture “the entire spectrum of activity:”  Application of this principle involves a 3-step inquiry –  #1 Is the person a servicer under the definition?  #2 If so, is it a servicer for which disclosure is required?  Master servicers;  Affiliated servicers;  Unaffiliated servicers servicing > 20% of pool assets; and  Other material servicers managing material servicing function.

12  #3 If so, what disclosure is material?  How important is the function to the performance of the pool assets?  Is the entity’s performance monitored by another servicer and, if so, how thoroughly?  How easily can servicer be replaced?  In December 2005, the SEC staff provided additional guidance through “telephone interpretations” that - -  Confirm the definition of servicer is a principles-based definition;  Staff has also indicated that the determination will depend on whether the party is responsible for managing the cash stream at any point between obligor payment and remittance to security holders.  Emphasize function over form (i.e., focus is on responsibilities, regardless of titles (vendor, trustee, etc.)); and  Create implication that a lockbox provider may be a servicer, at least under some circumstances.

13  Who is an “Originator”?  Regulation AB provides no definition of “originator.”  Originator disclosure is clearly focused on the impact the origination process may have on asset performance.  Subject to further SEC guidance, it seems reasonable to focus on entity establishing the credit-granting/underwriting criteria (though thorough monitoring of, e.g., a correspondent lender would be important).  ASF model MLPA and servicing provisions advance this approach through the concept of a “qualified correspondent.”

14  When and by what method must concentration percentages be reassessed?  The SEC staff has clarified through interpretation, including through its telephone interpretations, that the measurement of concentration percentages should be undertaken as of the designated cut-off date for the transaction and again as of the end of each related reporting period (e.g., monthly, quarterly, annually) using a weighted average methodology over the period covered by the report.  The only exception to this rule is for significant obligors (since they are not transaction parties).

15  When does Item 1100(b) apply?  Item 1100(b) provides general guidance regarding, among other things, the presentation of historical delinquency information, and contemplates that such information will be disclosed in 30-day increments through the point that the assets are written off or charged off as uncollectible.  In response to ASF inquiries, the SEC staff has clarified through its telephone interpretations that historical delinquency information for an asset group other than the subject asset pool (such as a managed or total portfolio) is governed by general principles of materiality, and not Item 1100(b). The staff has also clarified that the presentation of static pool information is similarly governed by general principles of materiality, and not Item 1100(b).  This interpretation was generally viewed as addressing industry concerns on this topic. In an unexpected development, however, the staff also announced an interpretation of Item 1111(c) that suggests that historical delinquency information for the subject asset pool is always required.  In a principles-based disclosure regime, based in large part on market- driven disclosures, this interpretation of Item 1111(c) seems misguided. Further dialogue with the staff may be required.

16  When is a derivative instrument a “credit derivative” versus a “non-credit derivative?”  Regulation AB distinguishes between derivative instruments whose primary purpose is (versus is not) to provide credit enhancement for the ABS. In the case of a non-credit derivative, disclosure triggers are more relaxed, and key off of measurements of the derivative’s “significance percentage,” which represents a measurement of the significance of the derivative based on a reasonable good-faith estimate of “maximum probable exposure.”  A consensus among outside counsel seems to be developing to the effect that, where a derivative is structured to contribute payments based on non-credit events (e.g., interest rate movements), this would generally control the instrument’s characterization, and the priority of payments/allocations (e.g., where cash flow arising under the derivative might first be applied to cover credit losses) should not necessarily alter the characterization. At the same time, there was also general agreement among outside counsel that additional features/factors may need to be considered, such as whether the derivative is “in the money” from the outset and, if so, the reasons why.


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