Securities

Navigating Securitization Reforms through the EU & US

by Elana Hahn, Kenneth Kohler, Nimesh Christie and Melissa Beck

This EIA is a guide to the principal EU and US securitization regulatory developments and the challenges and prospects for transatlantic securitization issuers and investors.

Excerpt:

The frequency and volume of new securitization regulation being introduced in the US and the EU presents challenges. For issuers and investors, there are hidden dangers - and opportunities - that lie in divergent approaches and extraterritorial effects of the new and emerging rules. In this Emerging Issues Analysis, we provide a guide to the principal EU and US securitization regulatory developments and the challenges and prospects for transatlantic securitization issuers and investors. We also include a helpful summary chart.

Reforming the Residential Mortgage Securitization Industry

Targeted US Residential Mortgage Industry Reform: The US is introducing a series of sweeping regulatory measures designed to specifically address US residential mortgage products, originators, underwriters and servicers. These are designed to improve the quality of US mortgage loans and change the systemic infrastructure of the US residential mortgage industry. These include:

  • Title XIV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which requires federal regulators to: 
    • establish a licensing regime for mortgage originators;
    • promulgate rules limiting pre-payment penalties on certain types of mortgages; and
    • approve regulations that would prohibit originators from approving certain types of mortgages without reasonable proof that the borrower can afford to pay off the loan.
  • Proposed rules issued by US regulators in March 2011 to implement section 941 of the Dodd-Frank Act - the so-called "risk retention" proposal - will inevitably change the loan origination and underwriting business in the US. Stringent origination and underwriting standards are built into the Qualified Residential Mortgage ("QRM") exemption set forth in the proposed credit risk retention rules. The QRM exemption exempts from the 5% risk retention requirement securitizations of QRMs, which are mortgage loans that, among other requirements:
    • are subject to strict limitations on adjustable rates, loan-to-value, debt-to-income ratio, points and fees; and
    • require a downpayment of at least 20%.
  • In late 2010 the Federal Deposit Insurance Corporation (the "FDIC") substantially revised its "safe harbor" securitization rule (12 CFR § 360.6) setting forth conditions that must be met by US bank securitizers to qualify for essential comfort to the rating agencies and investors that the FDIC will respect the securitization upon the receivership of the bank. In the case of residential mortgage-backed securities ("RMBS") these conditions include required adherence to sub-prime underwriting guidelines, limitations on securitization structures to 6 tranches, prohibition of most forms of third party external credit enhancement, and the establishment of a 5% reserve fund to back representations and warranties. These rules place US bank issuers at a significant competitive disadvantage to European bank issuers.

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Elana Hahn is a partner at Morrison & Foerster LLP. Elana Hahn advises financial institutions as lenders and structurers/arrangers and represents investors, originators and investment managers in UK, pan-European and international financings. She principally advises on fund and structured debt deals across a wide range of asset classes (including master trust, structured investment vehicle, secured loan, true sale, conduit financing, and warehousing structures).

Kenneth Kohler is senior of counsel at Morrison & Foerster LLP. Mr. Kohler's practice involves a broad range of corporate and capital markets work, including public offerings and private placements of equity and debt securities, mergers and acquisitions of public and private companies, and disclosure and reporting matters under the federal securities laws.

Nimesh Christie is an associate in Morrison & Foerster's Capital Markets practice, in the London office. His experience includes advising on debt and equity capital markets and structured finance transactions involving listed EMTN programmes, convertible and exchangeable bonds and structured notes, acting for amongst others financial institutions, corporates, private equity firms and sovereign issuers.

Melissa Beck is an associate in the Capital Markets Group of the New York office of Morrison & Foerster. Ms. Beck's practice is focused on the insurance industry, where she specializes in the life settlement sector. She has advised clients on the establishment of proprietary programs, the drafting of transaction documents, the development of policies and procedures, and the oversight of ongoing operations, including state licensing filings, and has performed audits on third-party providers for clients. Ms. Beck has experience in catastrophe bonds, sidecars, and CDO and CLO transactions. She has used her insurance regulatory knowledge to assist in M&A and litigation projects.