SEC and CSA restrictions on the exempt market for securitized products
.jpg)
-As reported earlier, the SEC has included in Reg AB II proposals relating to the private market. These would require that, in order for a reseller of a “structured finance product” to sell a security in reliance on Rule 144A or in order for an issuer of a “structured finance product” to sell a security in reliance on Rule 506 of Regulation D (the so-called “safe harbors”), the underlying transaction agreement must grant to initial investors and transferees, as applicable, the right to request, both initially and on an ongoing basis, the same information that would have been required had the transaction been registered.
As formulated, these proposals could create significant contingent closing risk for issuers leaving them with no practical options but to assume the worst by preparing the necessary disclosure. Given the enhanced disclosure requirements of Reg AB II, this could be a very difficult proposition, especially for issuers who have traditionally accessed the private market because they are unable to satisfy all public market requirements. These provisions could be especially problematic for ABCP issuers. It is hard to imagine how an issuer of ABCP would set about complying with many of the requirements of Reg AB II, such as asset level disclosure and waterfall computer programs, in respect of each originator.
It is important to note here, however, that, as of yet, there does not appear to be any restriction on investors agreeing not to request disclosure. Although this may not benefit issuers of ABCP, whose investors may change on a regular basis, for other issuers this may be the practical way to carry on with investors whom they know and trust.
As we have discussed in previous pieces, the CSA have also decided to more closely regulate the exempt market. When compared to Reg AB II, the CSA proposals are both less and more restrictive and thus problematic.
The CSA has proposed a new securitized product exemption available only to “eligible securitized product investors”. In order to qualify for the securitized product exemption, the issuer will be required to deliver an information memorandum to the purchaser which must (i) disclose sufficient information about the securitized product and securitized product transaction to enable a prospective purchaser to make an informed investment decision; (ii) describe the rights of action that the issuer will have against, among others, the issuer, the sponsor and the underwriter for any misrepresentations in the information memorandum; (iii) describe the relevant resale restrictions; and (iv) not contain a misrepresentation. For short term securitized products, the information memorandum must also be in the prescribed form.
The CSA proposals compare favourably to the Reg AB II proposals in that there is no specific disclosure requirements, at least for medium-term notes. This positive note is somewhat tempered by a residual concern that the combination of requiring sufficient information to enable a prospective purchaser to make an informed investment decision and that there be no misrepresentation may, in practice, not be far distant from the standard of full, true and plain disclosure. Nevertheless, even if, as we expect, prospectus level disclosure is adopted as the standard for information memoranda, compared to the Reg AB II requirements, the CSA proposals are relatively straight forward.
On the other hand, given the fact that the provision of an information memorandum is a precondition to accessing the exemption and thus cannot be waived, the situation is significantly worse than under Reg AB II. The new rules would create unsustainable burdens in both the mid-term and short-term note markets. A number of mid-term note transactions involve single seller trusts established by the originator which purchases or leases the underlying assets and then issues a medium-term note to, for example, an ABCP conduit. Under the proposals, the note issued to the ABCP conduit would be a securitized product for which an information memorandum would be required. This is patently ridiculous where the purchaser is someone whose business it is to structure and thus understand these products. This is the very model of a sophisticated purchaser who does not need regulatory protection and can, and should have the freedom to, fend for itself. The only effect of requiring the delivery of an information memorandum in such circumstances would be to increase the cost of doing business. Accordingly, we believe that it is essential that appropriate exceptions be created to this requirement for “highly sophisticated” investors such as financial institutions and entities administered by them.
The problems posed by the proposed rules for issuers of short-term securitized products are, if anything, even more serious. Under the proposed regime, ABCP conduits would need to provide detailed disclosure relating to asset pool characteristics and performance and other matters which by definition will change on a regular basis. The cumulative effect of the proposed rules would seem to require ABCP conduits to maintain current disclosure on a virtually daily basis. The strain on resources, not to mention the effect on costs which would ultimately be passed on to originators, may well be sufficient to effectively destroy an economic model which has been a crucial source of credit in the Canadian market.
