Agencies Re-Propose Rule Implementing Risk Retention Requirements of Dodd-Frank Act

by Goodwin

On August 28, 2013, the FDIC, OCC, FRB, SEC, Federal Housing Finance Agency, and Department of Housing and Urban Development (collectively, the “Agencies”) issued a second Notice of Proposed Rulemaking (the “revised proposal”) that would implement the risk retention requirements of Section 941 of the Dodd-Frank Act, which amended the Securities Exchange Act of 1934 (the “Exchange Act”) by adding a new Section 15G.  Section 15G requires the Agencies to issue rules that would generally require that a securitizer of asset-backed securities (“ABS”) retain an economic interest in not less than 5% of the credit risk of the assets collateralizing such ABS.  As discussed in the April 19, 2011 Financial Services Alert, the first Notice of Proposed Rulemaking (the “original proposal”) was jointly approved in April 2011 by the Agencies.  In response to numerous comments received on the original proposal, the Agencies collectively developed the revised proposal, which includes significant modifications.

Risk Retention Options

Section 15G(c)(1)(B) of the Exchange Act generally requires a securitizer of an ABS offering to retain not less than 5 percent of the credit risk of the assets collateralizing the ABS issuance.  The original proposal provided securitizers with various options to comply with this risk retention requirement.  The revised proposal generally maintains the original framework, but makes various changes to the options that are designed to provide additional flexibility to securitizers.  For example, the original proposal’s “vertical risk retention” (5 percent of each class of ABS interests), “horizontal risk retention” (5 percent as a first-loss position), and “L-shaped risk retention” (half of risk retention held on vertical basis and the other half of risk retention held as a first-loss horizontal position), have been combined into a single “standard risk retention” option, which requires the sponsor of a securitization transaction to retain a vertical interest or horizontal residual interest, or any combination thereof.  In addition, the original proposal’s unpopular “representative sample” option has been eliminated.  The revised proposal also requires use of fair value measurements rather than the original proposal’s par value methodology in determining compliance with the risk retention requirement.  The fair value of the amount retained by the sponsor must equal at least 5 percent of the fair value of all ABS interests in the issuing entity issued as part of the securitization transaction, determined in accordance with GAAP, as of the day on which the price of the ABS interests to be sold to third parties is determined.  In conjunction with the revised proposal’s use of fair value accounting, the requirement in the original proposal that securitizers hold a premium capture cash reserve has been eliminated.

In addition to the standard risk retention option, other risk retention options would be available for certain enumerated types of transactions.  These include revolving master trusts, certain issuers of asset-backed commercial paper, issuers of commercial mortgage-backed securities, open-market CLOs, and sponsors with respect to issuances of tender option bonds by a qualified tender option bond entity.

The various options, including the standard risk retention option, generally have specific disclosure and record-keeping requirements intended to provide investors with material information about the retained interest and to permit the Agencies to monitor compliance.

Although the revised proposal generally requires a sponsor to retain the required risk, a sponsor of a securitization transaction that is using the standard risk retention option is permitted to offset the amount of its risk retention requirements by the amount of eligible interests acquired by an originator of one or more of the securitized assets, provided that certain conditions are met, including that the originator must retain the eligible interests in the same manner as the sponsor did prior to the acquisition.

Selling and Hedging Prohibited

The revised proposal generally prohibits a sponsor from selling or otherwise transferring any interests or assets that it is required to retain to any person other than an entity that is and remains a majority-owned affiliate of the sponsor.  The retained interests also may not be pledged as collateral for any obligation, unless such obligation is with full recourse to the sponsor.  The sponsor and its affiliates are also prohibited from purchasing or selling a security or other financial instrument, or entering into an agreement or derivative, with any other person if (1) the payments on the security or other financial instrument or under the agreement or derivative are materially related to the credit risk of one or more of the ABS interests that the sponsor is required to retain or one or more of the securitized assets that collateralize the ABS issued in the securitization transaction and (2) the security, instrument, agreement, or derivative “in any way reduces or limits” the sponsor’s financial exposure to the credit risk.  Similar prohibitions apply to the issuer of a securitization transaction.

Certain hedging activities are permitted under the revised proposal.  These include hedging interest rate risk (except for spread risk that is otherwise considered part of the credit risk) and foreign exchange risk arising from one or more of the retained ABS interests.  Sponsors and issuers may also buy or sell securities or other financial instruments or enter into agreements and derivatives based on an index of instruments that includes the retained ABS interests, but only if certain rules are satisfied that are designed to ensure that the relevant ABS constitute only a small portion of the index.

In contrast to the original proposal, the revised proposal permits the prohibitions on sale and hedging to expire prior to the final maturity or termination of the issued securities.  Specifically, the prohibitions would generally expire on the latest of (i) the date on which the total unpaid principal balance of the collateral has been reduced to 33 percent of the total unpaid principal balance of the collateral as of the closing of the securitization transaction; (ii) the date on which the total unpaid principal obligations under the ABS interests issued in the securitization transaction has been reduced to 33 percent of the total unpaid principal obligations of the ABS interests at closing; or (iii) two years after the date of the closing.  Later dates apply to the expiration of such prohibitions with respect to residential mortgages with the minimum being 5 years after the date of the closing.  The expiration of the prohibitions on sale and hedging were introduced based on an analysis of historical credit defaults for various asset classes and based on the premise that sound underwriting, which the revised proposal calls “the primary purpose of risk retention,” is less likely to be effectively promoted after a certain period of time.

Exemptions from the Risk Retention Requirement

The revised proposal includes various exemptions from the risk retention requirement.  Most notably, a sponsor is exempt from the risk retention requirements if, among other conditions, all of the assets that collateralize the ABS are qualified residential mortgages (“QRMs”).  The original proposal’s QRM definition received many negative comments; the revised proposal abandons that definition and instead defines “QRM” to equate to the definition of  “qualified mortgage” in the Truth in Lending Act and the regulations issued thereunder by the Consumer Financial Protection Bureau (the “CFPB”).  The qualified mortgage definition does not include consideration of a borrower’s credit history, loan-to-value or down payment; instead it includes an analysis of, among other things, the borrower’s ability to repay and imposes a maximum debt-to-income ratio of 43 percent.  Additionally, the qualified mortgage definition excludes certain types of loans and loan features, including interest-only loans, balloon payments and negative amortization loans, while permitting exceptions for small creditors in rural and underserved areas.

The Agencies chose to define “QRM” as “qualified mortgage” after considering an alternative approach referred to in the release accompanying the proposed rule as “QM-plus.”  As described in the release, the QM-plus approach would begin by defining “QRM” based on the same factors adopted by the CFPB in the “qualified mortgage” definition, but would then add four additional factors.  Specifically, under this approach, classification as a QRM would only be available if, in addition to satisfying the factors identified by the CFPB, all the following conditions were met:

  • The loan secures a one-to-four family real property that constitutes the principal dwelling of the borrower.  Therefore, QRM status would not be available to mortgages on, for example, house boats and vacation homes.
  • The loan must be a first-lien mortgage.  Mortgages used to purchase a residence would only be eligible for QRM status if no other recorded or perfected liens exist on the property at closing, to the knowledge of the originator.  Junior liens are permitted for QRMs used for refinancing purposes, but must be included in the loan to value calculations described below.
  • The originator must determine that the borrower meets certain credit history criteria, including not currently being 30 or more days past due on any debt obligation and not having been a debtor in a bankruptcy proceeding within the preceding 36 months.
  • The loan to value ratio at closing must not exceed 70 percent.

Under the revised proposal, down payments are eliminated as an element required to fit within the definition of QRM.

The proposed rule release requests comments on various aspects of the QM-plus approach.

Interests in commercial loans, commercial real estate loans, and automobile loans that are transferred through a securitization transaction are also exempt from the risk retention requirement, provided that certain conditions are met.  In addition, the risk retention requirements would not apply to any securitization transaction collateralized solely by certain loan assets insured or guaranteed by the United States or an agency of the United States or that involve the issuance of ABS that are so insured or guaranteed; any securitization transaction collateralized solely by loans or other assets made, insured, guaranteed, or purchased by any institution subject to the supervision of the Farm Credit Administration; any ABS issued or guaranteed by any State or political subdivision of any State; certain securitization transactions collateralized by existing ABS for which credit risk was retained or that was exempted from the credit risk retention requirements; and certain other transactions.

Comments on the revised proposal are due no later than October 30, 2013.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Goodwin | Attorney Advertising

Written by:


Goodwin on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.