Asset-Backed Securities: Disclosure Regulation or Substantive Legislation?
In addition to improving asset-backed securities disclosure (using XBRL perhaps?), SEC Chairman Mary Schapiro called for substantive ABS regulation in a speech Tuesday to SIFMA, the parent organization of the American Securitization Forum (link to colorful Michael Lewis description):
ABS Regulation
In one final example, I believe there may be gaps that should be filled in the asset-backed securities (ABS) market. I have asked the staff to broadly review our regulation of ABS including disclosures, offering process, and reporting of asset-backed issuers. The staff is considering a number of proposed changes, which are designed to enhance investor protection in this vital part of the market.
However, not all problems with ABS can be addressed under our current rulemaking authority. So, I believe that legislative action is also necessary to deal with some of the issues that have been highlighted by the credit crisis.
As you know, the statutes governing the offer and sale of securities were written decades before asset backed securities were even dreamed of. The laws were written for corporations or other entities with active management attempting to grow a business.
In contrast, asset-backed securities are generally securities that are backed by a discrete pool of self-liquidating financial assets. And asset-backed securitization is a financing technique in which financial assets, in many cases themselves less liquid, are pooled and converted into instruments that may be offered and sold in the capital markets.
Most legislative proposals aimed at improving securitization, suggest amendments to the securities laws that are focused on the disclosure of material information. But substantive protections beyond disclosure requirements are needed for the ABS arena.
That’s because of the unique character of securitization and the role it plays in the national economy. Creating a new act directed solely at securitizations would allow Congress to specifically tailor solutions for these investment vehicles — much like the Investment Company Act of 1940. And, it could be done without compromising or changing the fundamental structure and underpinnings of existing statutes.
Similar to the Investment Company Act, the ABS Act could have substantive restrictions or requirements for the trust that issues the securities and for related parties. Such a statute could set minimum requirements for the pooling and servicing agreements, such as requiring strong representations and warranties about the assets being securitized and procedures for ensuring those representations and warranties are followed. That’s in addition to the disclosure requirements of the Securities Act, which would continue to apply when ABS securities were offered and sold.
The primary danger of substantive legislation, as opposed to disclosure regulation, is that substantive legislation
could enhance the ability of market participants to establish cartel powers by strengthening barriers to entry, competition, and innovation. For example, it took more than 60 years for ETF’s to create lower-cost competition to mutual fund managers enjoying high fees protected by barriers to entry under the Investment Company Act.
The ABS industry would like nothing more than a similar regulatory structure giving it decades of enhanced pricing power and profits. After all,
Wall Street ultimately turned to ABS because the SEC limited excess profits from dealing in public company securities with the end of fixed commissions in the 70s and enhanced public company disclosure in the 80s, 90s, and in this decade. If the ABS market became similarly competitive and transparent, Wall Street would need to look elsewhere for opacity to exploit for excess profits — or settle for more modest profits, such as those earned in the competitive and transparent sectors of today’s capital markets.
Leadership to pierce self-interested arguments about so-called ABS complexity is essential. After all, what’s so complex about analyzing an interest in a future stream of payments? Both company securities and ABS are subject to risk, but groups of similar cash flows must be considerably easier to evaluate than the value of a share in a public company — particularly if information about cash flow obligations, actual performance-to-date, and other empirical data is available in an industry standard computer language like XBRL.
One fact that might be disclosed in XBRL with no need for additional legislation: The amount of credit risk permanently borne by securities issuers and loan originators. You want me to buy an ABS to which you contributed assets or that you assembled? Maybe it makes sense as part of a diversified portfolio, but you need to be in it with me and I need to understand exactly how we’re going to share the risk and the reward. Crank up the taxonomy machine — or another taxonomy machine — or another taxonomy machine — and get to work.
