Legal and Regulatory Issues Facing
Esoteric ABS

Abstract

Panel participants made the point that in some instances regulatory changes can be supportive of new esoteric ABS, but that some regulatory initiatives in fact provide headwinds to esoterics. Rule 17g-5 requires NRSROs (nationally recognized statistical rating organizations) to obtain representations from securitization arrangers that they will provide access (via a password-protected website) to information relating to the initial rating and ongoing surveillance of an ABS deal, so that non-hired NRSROs can access the same data furnished to the hired agencies. Rule 17g-5 appears to be a regulatory headwind for esoteric ABS unless certain enhancements are adopted and the establishment of a proposed credit rating agency review board (CRAB) is precluded. Rule 17g-7 requires NRSROs to include in their ABS credit reports a description of the representations, warranties, events of default and remedies in the rated transaction, and to list them alongside supposed benchmark terms and conditions for similar transactions. Unless the rating analyst carefully works through the document provisions, it is possible that the hired NRSRO may produce a report that inaccurately claims that some benchmark provisions are missing, when in fact they may be embedded in other elements of the documents. However, 17g-7 disclosure may have a positive effect of conditioning the marketplace as to the reps, warranties, and remedies that future deals should include, thereby reducing some of the guesswork which otherwise might accompany those later transactions. The emergence of “REO to Rental” securitization is another example of regulatory developments serving as a tailwind and a catalyst for an esoteric, emerging asset class, although in this case, the regulatory effect is indirect. The Consumer Financial Protection Bureau’s “ability-to-repay” qualified mortgage (QM) rule has made mortgage financing difficult for many consumers and thereby increased consumer demand for rental housing. This in turn has increased the demand for financing at the commercial level for institutional owners of REO properties. Property assessed clean energy (PACE) is a new method for facilitating renewable energy and energy efficiency through securitization that may now be ready for implementation. Property owners receive PACE financing from their county or municipality’s program to fund the purchase of eligible improvements and then repay the related “loans” over a 15–20 year period via an annual assessment added to their property tax bill. Some objections have been raised by lenders and other credit providers to the mortgage market, including Fannie Mae, Freddie Mac and the Federal Housing Finance Authority that as a priority claim, the assessments would be paid first if the borrower defaults.