August 7, 2013 Newsletter
Problem viewing this email? Click here for our online version.


Issue Spotlight

Recent Developments



On August 6, 2013, President Obama delivered a major address on the future of U.S. housing finance. SFIG supports the efforts by the President and the Congress to overhaul our nation’s housing finance system by reducing the role of the government in the mortgage market.With the right structural and regulatory reforms in place, the private mortgage securitization market can quickly grow and assume an increasing role in financing sustainable homeownership while limiting taxpayer exposure.We look forward to working with the Administration and Congress to facilitate a robust private securitization market that best serves the interests of all parts of the mortgage market, including borrowers, lenders, and investors.

SFIG is preparing special coverage of President Obama's announcement in Phoenix yesterday of his five step plan to achieve "Responsible Homeownership." You will receive an ISSUE ALERT with SFIG's analysis of the plan and commentary from the SFIG Residential Mortgage Committee.



SFIG is finalizing a position paper on the potential use of eminent domain by municipalities to seize and refinance “underwater” mortgages on local properties. The paper was initially drafted by members of SFIG’s Residential Mortgage Committee which then sought and received comments from a broad group of industry participants, including investors, servicers and trustees.

In related news, on July 30, 2013, the mayor of Richmond, California, announced that Richmond had adopted a plan to utilize eminent domain to seize underwater mortgages on properties in that city. Commenters have noted that the successful implementation of Richmond’s plan and widespread adoption by other cities is unlikely because rising home prices are undercutting the city’s rationale for the program, most cities will likely find the plan unattractive, and the plan is expected to face legal challenges by market participants.

If you are interested in participating in SFIG's Residential Mortgage Committee, please contact SFIG at




The launch by Freddie Mac of its “risk-sharing” transactions, with Fannie Mae’s similar transactions expected to follow soon, may provide an opportunity to revisit certain of the questions posed for comment by the Securities and Exchange Commission (SEC) in its proposed rule regarding conflicts of interest in securitizations, particularly those questions relating to hedging, disclosure and the definition of “synthetic asset-backed securities.”


Section 621 of the Dodd-Frank Act added a new provision, Section 27B, to the Securities Act of 1933 (1933 Act), entitled “Conflicts of Interest Relating to Certain Securitizations” (Conflicts Rule). The Dodd-Frank Act provided that the Conflicts Rule shall take effect when the SEC has issued the related final rules and they have become effective.

The Conflicts Rule provides, in relevant part:

  1. IN GENERAL. – An underwriter, placement agent, initial purchaser, or sponsor, or any affiliate or subsidiary of any such entity, of an asset-backed security…which for purposes of this section shall include a synthetic asset-backed security, shall not, at any time for a period ending on the date that is one year after the date of the first closing of the sale of the asset-backed security, engage in any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity.
  2. RULEMAKING. – Not later than 270 days after the date of enactment of this section, the Commission shall issue rules for the purpose of implementing subsection (a).
  3. EXCEPTION. – The prohibitions of subsection (a) shall not apply to –

(1) risk-mitigating hedging activities in connection with positions or holdings arising out of the underwriting, placement, initial purchase, or sponsorship or an asset-backed security, provided that such activities are designed to reduce the specific risks to the underwriter, placement agent, initial purchaser, or sponsor associated with positions or holdings arising out of such underwriting, placement, initial purchase, or sponsorship…

Pursuant to paragraph (b) above, the SEC proposed Rule 127B in September of 2011 (Proposed Rule 127B). The comment period on Proposed Rule 127B was finally closed on February 13, 2012. Since that time, the SEC has taken no further action with respect to Proposed Rule 127B.

The principal legislative proponents of Section 621 of the Dodd-Frank Act were U.S. Senators Jeff Merkley (D-OR) and Carl Levin (D-MI). These two Senators were also the sponsors of Section 619 of the Dodd-Frank Act, the so-called “Volcker Rule” provision. Senator Levin additionally serves as the chair of the U.S. Senate’s Permanent Subcommittee on Investigations, which on April 13, 2011 issued a report entitled “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse” (Senate Report).

The Conflicts Rule together with Proposed Rule 127B would affirmatively prohibit certain types of securitization transactions. However, as noted above, the SEC has substantial leeway in its rulemaking for Proposed Rule 127B. In addition, even though the Conflicts Rule may prohibit certain transactions, the SEC has the authority to adopt exemptive rules or regulations “to the extent such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.” In its request for comment on Proposed Rule 127B, the SEC asked whether such exemptive authority should be invoked with respect to certain types of transactions that otherwise would be prohibited, or under certain circumstances.

Synthetic Risk-Sharing Transactions

The period since the end of the comment period for Proposed Rule 127B has seen the commencement of a series of synthetic risk-sharing transactions by the Government-sponsored entities (GSEs), Freddie Mac and Fannie Mae. The first such transaction, Freddie Mac’s Structured Agency Credit Risk (STACR) Debt Notes, Series 2013-DNI, closed in late July of 2013.

The STACR transaction was not structured as what would commonly be considered by the industry as a “synthetic asset-backed security.” Rather, the STACR notes were unsecured corporate debt of Freddie Mac that were structured to be subject to the performance of a reference pool of residential mortgage loans that were included in prior Freddie Mac Participation Certificate securitizations. The STACR notes are subject to principal write-downs based on the occurrence of specified “credit events” with respect to the reference pool.

The STACR transaction is the first in an expected series of capital markets risk-sharing transactions to be undertaken by the GSEs at the direction of their conservator, the Federal Housing Finance Agency (FHFA). The transactions have, among other objectives, the reduction of the risks to the GSEs of honoring claims on their guaranties issued in their respective securitization programs, and the encouragement of private capital back into the RMBS market as their goal.


The offering circular for the STACR notes (Offering Circular) states that “[t]he transaction is designed to furnish credit protection to Freddie Mac, with respect to Reference Obligations that become 180 days or more delinquent or as to which certain other Credit Events occur.” It is unarguable that Freddie Mac is long mortgage risk. Accordingly, Freddie Mac is attempting to hedge the credit risk associated with the reference obligations.

Proposed Rule 127B’s language regarding the hedging exception mirrors the language of paragraph (c) of Section 27B, quoted above.

In the SEC’s discussion of Proposed Rule 127B, the SEC notes that the purpose of the hedging exception is to allow certain hedging activities that are designed to reduce or mitigate risk for the underwriter, placement agent or sponsor of an asset-backed securities offering. The SEC goes on to state that if a securitizer is assembling a pool of assets in anticipation of securitizing them, and hedges “the specific risk of a price decline” in those assets pre-securitization, that activity would fall within the scope of the hedging exemption.

According to the SEC’s commentary, and similar to the provisions of the proposed Volcker Rule, under Proposed Rule 127B “risk mitigating hedging” does not include trading to establish new positions “designed to earn a profit.” Nor would Proposed Rule 127B permit overhedging – situations in which the hedge is significantly greater than the exposure to the underlying assets. Further, the hedge should be correlated with the risk, such that “losses (gains) on the position being hedged are offset by gains (losses) on the hedge without appreciable differences.”

The SEC asked for specific comments on whether the term “risk-mitigating hedging activities” should be defined, as well as comments on the proposed application of the hedging exception to the pre-securitization warehouse period.

As part of the SEC’s guidance in its commentary on Proposed Rule 127B, it offers a series of examples of transactions that it believes may, or may not, involve potential conflicts of interest. The SEC cautions that these examples are “merely illustrative, and even minor differences in the facts and circumstances could change the result.”

To the extent that the STACR notes are considered “synthetic asset-backed securities,” the transaction arguably may run afoul of “Example 3B” in the SEC’s discussion of the material conflicts of interest test for Proposed Rule 127B.

In Example 3B, a securitization participant enters into a CDS provided by a synthetic securitization structure to offset the securitization participant’s long exposure to the assets underlying the synthetic asset-backed securities issued in connection with the securitization. The SEC explains:

For instance, the securitization participant might be seeking to reduce its long investment exposure to the relevant assets because it has come to believe that the assets will perform poorly. If the firm accomplishes this result by transferring the risk of its long positions to ABS investors through a synthetic ABS – while marketing the ABS securities to investors as a good investment opportunity – it could be viewed as benefiting from a decline in the ABS at the expense of the ABS investors, who now have exposure to the underlying assets.

The SEC added that because the transaction in Example 3B may provide a hedge for an existing long investment position, it did not provide a hedge for assets associated with underwriting activities and thus Proposed Rule 127B’s risk-mitigating hedging exception would not be available. It is unclear to what extent, if any, the securitization participant’s belief “that the assets will perform poorly” is a factor in the SEC’s conclusion that the exemption is unavailable in this case.

The Rule of Disclosure in Mitigating Conflicts of Interest

Section 27B prohibits specified securitization participants from engaging in certain transactions that “would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity.” The provision does not reference disclosure. The SEC notes this in its discussion of Proposed Rule 127B, and specifically asked for comment as to the role of disclosure in the context of the proposed rule.

As part of the test to determine whether a material conflict of interest exists, the SEC has proposed a formulation that would require “a substantial likelihood that a reasonable investor would consider the conflict important to his or her investment decision.” The SEC adds:

Although the proposed interpretation uses a materiality formulation that is also used under the federal securities laws for determining whether disclosure is necessary – i.e., whether there is a substantial likelihood that a reasonable investor would consider the issue important to his or her investment decision – the use of this phrase in this context is not intended to suggest that a transaction otherwise prohibited under the proposed rule would be permitted if there were adequate disclosure by the securitization participant.

During the debate on the Dodd-Frank Act, Senator Levin suggested that disclosure would not be sufficient in the context of certain types of transactions. Senator Levin stated on July 15, 2010, that:

…a firm that underwrites an asset-backed security would run afoul of the provision if it also takes the short position in a synthetic asset-backed security that references the same assets it created. In such an instance, even a disclosure to the purchaser of the underlying asset-backed securities that the underwriter has on right in the future bet against the security will not cure the material conflict of interest.

Senators Levin and Merkley echoed that same sentiment – that disclosure would not be adequate in certain conflict of interest situations – in the comment letter they submitted on Proposed Rule 127B on January 12, 2012 (Merkley-Levin Comment Letter).

The STACR transaction in and of itself does not appear at first blush to be the type of transaction which Senators Levin and Merkley reference as having a material conflict of interest that cannot be cured by disclosure. However, were an underwriter of STACR notes to provide credit protection to the buyer of STACR notes within the one-year window, the application of the provision to that transaction may be somewhat less clear.

The Offering Circular contains fairly extensive disclosure regarding potential conflicts of interest in the STACR transaction, under the caption “The Interests of Freddie Mac, the Dealers and Others May Conflict with and be Adverse to the Interests of the Noteholders.”

To the extent, however, the STACR transaction involves the issuance of “synthetic asset-backed securities,” it would seem to be a prohibited transaction, categorized as a hedging transaction similar to the one described in Example 3B. As a result, even if disclosure were deemed sufficient to cure the material conflict of interest, an exemptive order would need to be issued by the SEC under Section 28 of the 1933 Act for the transaction to be permitted.

Definition of “Synthetic Asset-Backed Security”

Proposed Rule 127B would only apply to the STACR transaction if the STACR notes were considered a “synthetic asset-backed security” within the meaning of Proposed Rule 127B. The phrase “synthetic asset-backed security” is used in Section 27B and is carried over into Proposed Rule 127B. The SEC in its discussion stated “[w]e are not proposing to define the term ‘synthetic asset-backed security’ for purposes of proposed Rule 127B, because we understand that this term is commonly used and understood by market participants.” However, the SEC did invite comment on whether this understanding is correct. Generally, credit-linked notes issued as corporate debt would not be considered “synthetic asset-backed securities” by “market participants.”

In the Merkley–Levin Comment Letter, the Senators offered this suggestion on the issue of defining “synthetic asset-backed security:”

The proposed rule also clearly encompasses synthetic ABS products, a term that currently has no statutory definition. The proposed rule does not offer its own definition of “synthetic asset-backed securities,” instead noting that the term is commonly understood by market participants. While that may be true, the rule should not rely exclusively on the understandings of market participants, as those may vary and shift over time. Instead, the rule should provide its own definition, and ensure that it is sufficiently broad to cover any synthetic product that creates an economic exposure equivalent to one or more ABS. A possible definition in line with Section 3(a)(77) Securities Exchange Act of 1934 would be a “fixed-income or other security that references any type of financial asset (including a loan, a lease, a mortgage, a secured or unsecured receivable, or index), and allows the holder of the security to receive payments that depend primarily on the value or performance of the referenced assets.”

Were the Senators’ proposed definition of “synthetic asset-backed security” to be adopted by the SEC, the question of whether transactions such as STACR are covered under Rule 127B might become more difficult. Some commenters on Proposed Rule 127B previously raised this issue in connection with insurance-linked securities, which may also be issued in the form of corporate debt.

Relationship to Volcker Rule

The SEC observes in its discussion of Proposed Rule 127B that there are similarities between certain provisions of Section 619 [Volcker Rule] and Section 621 of the Dodd-Frank Act and that, as a result, states that it will consider whether aspects of the implementing rules under Section 619 should also be applied to the securitization conflicts of interest rules. This is particularly the case with respect to the hedging exception.

Generally speaking, most industry observers would probably conclude that the SEC and the other agencies responsible for the Volcker Rule have placed a greater emphasis on that rule than on the securitization Conflicts Rule.

However, as a review of the STACR transaction may illustrate, there are aspects of securitization that are particular to securitization, perhaps even in the context of the hedging issue common to both the Volcker Rule and Proposed Rule 127B. As recently as August 6, 2013, President Obama spoke about the need to wind down Fannie Mae and Freddie Mac, and the further need to encourage the return of private capital to the RMBS markets – citing the risk-sharing transactions in particular. It is probably not an overstatement to characterize those objectives of the President, which in general are shared by both parties in both Houses of Congress, as rising to the level of “national priorities.”

To the extent that it is the considered judgment of the FHFA to require the GSEs to engage in risk-sharing transactions such as STACR, those transactions can be seen as promoting the achievement of those national priorities, at least currently and in the absence of further Congressional action.

It may be unfortunate for the securitization industry if the consideration of the securitization conflicts of interest rules become an afterthought to consideration of the Volcker Rule provisions. As the GSE risk-sharing transactions become a program, if not in fact a new “asset class” for securitizations, the role of securitization to advance important national priorities will hopefully become (re-)apparent, and the securitization conflicts of interest rules will receive the policymaker attention they deserve.

If you are interested in joining SFIG’s Conflicts of Interest Task Force, please contact SFIG at

Click here for Section 621 of the Dodd-Frank Act. Click here for Proposed Rule 127B. Click here for the Senate Report. Click here for the Merkley–Levin Comment Letter. Click here for the Offering Circular.




On August 1, 2013, the Senate confirmed by unanimous consent the President’s nomination of Kara Stein (Democrat) and Michael Piwowar (Republican) as commissioners for the Securities and Exchange Commission (SEC). Stein served as an aide to Senator Jack Reed (D-RI), and Piwowar served as an aide to Senator Mike Crapo (R-ID). There are five SEC commissioners in total. Existing SEC commissioner and chairman since April of 2013, Mary J o White, was confirmed for an additional five year term.



On cross motions for summary judgment, Judge Richard Leon of the District Court of the District of Columbia (District Court) ruled on July 31, 2013 in favor of the plaintiffs in NACS v. Board of Governors of the Federal Reserve System (Fed). The case is a challenge by a group of merchants and trade associations to the regulation (Regulation II) promulgated by the Fed pursuant to the Durbin Amendment to the Dodd-Frank Act. The Court determined that the Fed has “clearly disregarded Congress’s statutory intent by inappropriately inflating all debit card transaction fees by millions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit card transaction.” The merchants asserted that Regulation II’s debit interchange fee limitation was not calculated to be “reasonable and proportional” to the cost incurred by the issuer of the card, as required by the legislation. In addition, the merchants successfully argued that the Fed disregarded the plain meaning of the Durbin Amendment and misconstrued the statute by adopting a network non-exclusivity rule required all debit cards – rather than all debit transactions – the ability to run over at least two unaffiliated networks.

Because the Fed’s rule is “fundamentally deficient,” the District Court took the unusual step of first vacating the problematic provisions of Regulation II (12 CFR 235.3(b) and 12 CFR 235.7(a)(2)) before ordering the Fed to completely re-write these portions of the regulation. The District Court recognized that because the Fed’s rule has been in place since October 1, 2011, vacating the standards of Regulation II would be very disruptive to the debit card system. Therefore, the District Court agreed to a brief stay of its own decision to provide the Fed with “months, not years” to provide valid replacement provisions.

The Fed has not yet stated whether it will appeal the District Court’s decision. Click here for the District Court’s decision.



The Internal Revenue Service (IRS) is working on final regulations for the new 3.8% net investment income tax. As reported by BNA Daily Tax Report on July 31, 2013, Dan McCall, special counsel to the IRS deputy Associate Chief Counsel (International), speaking at a New York seminar of the International Fiscal Association USA Branch, said that “the goal is still to put out final regs in 2013.” Proposed regulations on the net investment income tax were published in the Federal Register on December 5, 2012.

The proposed regulations provide detailed rules and examples for determining net investment income, including the threshold income amount for application of the net investment tax, for individuals, estates and certain trusts. For securitizations, U.S. holders of securities that are individuals, estates, and certain trusts are subject to the net investment income tax on all or a portion of their net investment income, which can include interest, dividends, and any gain realized with respect to the disposition of securities.

Click here for the proposed regulations. Click here for the BNA Daily Tax Report article (subscription required).

If you are interested in participating in SFIG’s Tax Committee, please contact SFIG at



On July 30, 2013, the International Organization of Securities Commissions (IOSCO) published its final report on the establishment and preliminary operation of independent supervisory colleges for credit rating agencies (CRAs). The CRA colleges would be collaborative arrangements among CRA supervisors to promote information sharing, consultation, and cooperation to enhance risk assessment of internationally active CRAs and to support effective supervision of those CRAs.

The CRA colleges are proposed only for internationally active CRAs that have significant cross-border operations, have affiliates or branches subject to multiple supervisory programs, and whose credit ratings are relied upon by investors and other users of credit ratings in multiple jurisdictions. The CRA colleges could increase costs of CRAs as information sharing increases oversight and the CRA colleges become additional parties requesting information from the CRAs.

IOSCO’s members include more than 120 securities regulators from all over the world and 80 other market participants (such as stock exchanges, and regional and international organizations). IOSCO’s members cooperate in developing and implementing consistent regulatory standards.

Click here for IOSCO’s final report on Supervisory Colleges for Credit Rating Agencies.

If you are interested in participating in SFIG’s Credit Rating Agency Force, please contact SFIG at



The Loan Syndications and Trading Association (LSTA), in its July 29, 2013 comment letter concerning risk retention and the implementation of Section 941 of the Dodd-Frank Act (Risk Retention Rules), referenced the results of a survey of 35 collateralized loan obligation (CLO) managers on the expected impact to them of the proposed Risk Retention Rules. The LSTA’s letter predicts a precipitous contraction of the U.S. CLO market as CLO managers struggle to find ways to finance their required retention of 5% of the CLO’s notes. This is the LSTA’s fourth set of supplemental comments to the Risk Retention Rules.

Observers of the joint rulemaking process among six federal agencies are predicting a release of the final Risk Retention Rule as soon as Labor Day.

In previously submitted comments, the LSTA has taken the position that:

Section 941’s definition of “securitizer” does not cover Open Market CLO managers or any relevant CLO entity, and thus the risk retention requirement does not apply to them. Most fundamentally and consistent with the scope of Section 941, Open Market CLOs simply do not present the risk of the originate-to-distribute business model that the statue addresses and did not give rise to the 2008 Financial Crisis which Section 941 seeks to ensure will not recur.

Nevertheless, if the final Risk Retention Rules were to include CLOs, 22 of the 35 surveyed CLO managers predicted that they would stop issuing CLOs.

Specifically, the survey asked how many CLOs the CLO manager could or would issue if the manager were required to retain 5% of the fair value of each new CLO. The survey predicted a 75% decline in the CLO market. This number is based on a comparison of the number of CLOs currently managed by the group of survey respondents (509 individual CLOs) against a predicted 69 new CLOs to be issued at any time in the future under the proposed Risk Retention Rules by this same group. This group of managers were also asked to explain the basis for their prediction of reduced future CLO issuances. The LSTA reported that the major limiting factor is capital constraints. In other words, the CLO managers did not believe that they could borrow or otherwise raise the funding necessary to purchase a 5% interest in the CLO notes.

To test the validity of the CLO managers’ expectations, the LSTA also surveyed commercial and investment banks to assess the likelihood that term lending or prime brokerage lending would be available to CLO managers.

Most term loan lenders who responded stated that they would lend against a percentage of the manager’s senior fee streams and 50%-75% of the value of the CLO senior securities held by the manager. Such loans would also typically be made only on a recourse basis. The LSTA stated in its comments that only a handful of the very largest and most credit worthy CLO managers would be able to obtain such financing.

Prime brokerage lenders who responded stated that they finance only highly liquid securities and only for short terms. The requirement that risk retained securities cannot be re-hypothecated would make them ineligible for this type of financing. Thus, the LSTA believes that bank financing is not a realistic solution to the CLO managers’ financing needs.

In recent press reports, CLO managers in Europe have similarly warned that they will not be able to find funding to retain 5% interests in their deals, as required by the European Banking Authority (EBA). The EBA recently announced that it would no longer allow CLO managers to count equity held by outside investors toward the EBA’s 5% retention requirement.

If you are interested in participating in SFIG’s Risk Retention Task Force or SFIG’s CLO Committee, please contact SFIG at

Click here for the LSTA comment letter.



On July 18, 2013, Howard Drossner, a certified public accountant, pleaded guilty in the United States District Court of New Jersey to one count of conspiracy to commit wire fraud. In return, the United States Attorney, District of New Jersey, agreed not to initiate any further criminal charges in connection with Drossner’s role in the scheme to defraud FirstPlus Financial Group, Inc. (FPFG), a publicly traded corporation, and its subsidiaries that conducted mortgage lending activities based in Texas. The indictment alleged that in June of 2007 the conspirators, certain of whom were alleged to be members of a mafia crime syndicate, seized control of FPFG through intimidation. After seizing control, the conspirators placed new management in control of FPFG and directed FPFG to acquire companies owned and controlled by the conspirators at greatly inflated values and to enter into fraudulent consulting agreements benefiting the conspirators. The indictment alleged that Drossner, in his capacity as FPFG’s accountant, was instrumental in the execution and concealment of the fraud from the Securities and Exchange Commission and other regulatory authorities and law enforcement.

Click here for a copy of Drossner’s Indictment. Click here for a copy of Drossner’s Plea.



The special liquidator of Anglo Irish Bank announced its intention to sell €22 billion of the bank’s loans. The Anglo Irish Bank was nationalized in 2009 by the Irish government and is now known as the Irish Bank Resolution Corp. Ltd. (IBRC). The loans are in four portfolios comprised respectively of the following assets: (i) Irish originated corporate loans, (ii) UK originated commercial real estate loans, (iii) Irish originated residential mortgage loans and (iv) Irish originated commercial real estate loans. The bank’s special liquidator intends to commence the sales in September and to complete them by year-end. It has not determined the exact manner in which the loans will be sold or any required bidder qualifications. Any loans remaining after the sale deadline would be transferred to the National Asset Management Agency, an agency established by the Irish government in 2009 to address the problems in Ireland’s banking sector.



ABS Vegas 2014 – January 21-24, Las Vegas, Nevada. Click here for more information.

SFIG is now accepting sponsorship contracts for this conference. If you are interested, please contact SFIG.



SFIG has a number of Committees and Task Forces meeting and working on many topics of interest to the securitization industry. Please visit our website for more information, including how to join.


SFIG is pleased to share this edition of its newsletter with our members, as well as our supporters in the structured finance community. To ensure that you receive future editions of the newsletter, please visit our website ( to learn about membership opportunities.


Contact us at


Structured Finance Industry Group
WebsiteEmail Us | Web Archive

To unsubscribe from this email listing, please click here.

Terms and Conditions | Privacy Policy