In the US, securitization is regulated both under the Dodd-Frank Act and by bank regulators under separate rulemaking. Regulators have proposed and in some cases finalized a framework of ABS disclosure, conflict-of-interest and other rules under the Dodd-Frank Act designed to mitigate risk and increase transparency in the securitization markets (see Practice Note, Summary of the Dodd-Frank Act: Securitization). These rules have already begun to make securitization more cumbersome, increasing the costs of ABS issuance. Bank regulators have also independently implemented regulations targeting securitization, such as the FDIC assessments on bank securitization holdings. These became effective on April 1, 2013, though the ultimate impact of these charges remains unclear (see Legal Update, April 1, 2013: FDIC Assessments on Bank CLO Holdings Take Effect).

But the centerpiece of Dodd-Frank ABS regulation is, of course, risk retention. The Consumer Financial Protection Bureau (CFPB) recently finalized the "Qualified Mortgage" (QM) definition, on which the "Qualified Residential Mortgage" (QRM) definition that will underpin the Dodd-Frank risk retention rules will be based. Securitizations composed entirely of QRMs (high quality residential mortgage loans) will be exempt from the risk retention requirement. There are also QRM equivalents for other asset classes including commercial loans, commercial mortgage loans, auto loans and other types of securitized assets. For details on the Dodd-Frank risk retention proposal, see Practice Note, ABS Risk Retention under Dodd-Frank.

With the QM definition now in place, Dodd-Frank risk retention is expected to be finalized later this year. However, market participants have pointed out that transactions backed entirely by securitized assets that meet the QRM (or an equivalent) definition, and are therefore exempt from retention, are likely to be uncommon. Banking industry groups have claimed that a narrow QRM definition could shut down the residential mortgage market because non-QRM loans (and equivalents in other asset classes) will not be able to be securitized without retention.

However, market participants appear prepared to account for this development in ABS transaction structures. Even absent regulation, historically it has not been uncommon for issuers or arrangers to retain a portion of an ABS issuance, though that has traditionally been a residual equity piece rather than a representative slice of the transaction's overall credit risk, as required by Dodd-Frank risk retention rules. Some commenters have noted that risk retention has not proven a historical indicator of a successful ABS transaction, and is not likely to align the interests of investors and originators as intended.

On April 1, 2013, the LSTA submitted its third comment letter to regulators on risk retention, seeking exemptions for some CLOs from Dodd-Frank risk retention requirements. The LSTA has been maintaining for years that CLOs performed well during the financial crisis, and do not have some of the features common to defaulted ABS. For instance, the LSTA points out that the compensation structure for CLO managers aligns with incentivizing the CLO to perform well and CLO asset pools are by definition composed of transparent assets that have undergone extensive diligence prior to their origination. The LSTA has also noted that open market CLO managers are not "sponsors" of CLOs as defined under Dodd-Frank.

Perhaps most daunting to market participants of all of the pending securitization regulations is the Basel Securitisation Framework (BSF), to which recent modifications have been made. Because Basel is primarily a consultative body that reaches accords on bank capital and other international regulatory requirements, it is implemented separately in each of its member jurisdictions including the US. In the US, regulators have committed to implementing regulations that are at least as stringent as Basel, some of which will be implemented under Dodd-Frank and others which will not.

Basel rules affect securitization because global regulators crafting Basel bank rules view ABS as risky and therefore have created rules that effectively penalize banks for holding ABS on their balance sheets. Many market participants have voiced concerns that these rules, as proposed, treat securitization unfairly. The market has focused its recent attention on two newly revised proposals from the Basel Committee on Banking Supervision (BCBS) in particular, the proposed:

It is generally recognized that, despite its flaws, real or perceived, securitization facilitates an active credit market by dispersing the risk of loans held on bank balance sheets into the marketplace, replenishing bank capital and providing banks with the ability to make more loans. Banking and ABS industry groups maintain that if implemented as currently proposed, Dodd-Frank risk retention would all but eliminate securitization and the creation of credit opportunities currently provided by the ABS markets, limiting the availability of credit and presenting obstacles to a broader economic recovery.

Nevertheless, as discussed, many ABS markets remain strong and others continue to gain momentum. It is therefore often not clear the degree to which these warnings are posturing by advocacy groups in an attempt to soften rules prior to their implementation, and to what extent these proposed regulations pose a real threat to market viability. Then again, market participants may be racing to get transactions completed before the regulations become effective.

In any event, neither Dodd-Frank risk retention rules nor the BSF has been finalized. The Basel LCR rules, for example, as proposed, would not begin to be phased in until 2015 as follows:

The Dodd-Frank Act also specifies that final risk retention rules do not become effective until:

Some expect the rules to ultimately be re-proposed, which would further delay implementation. The risk retention rules would apply only to securitization transactions completed after the effective date of the final rules.

As a result, it would appear that ABS issuance is poised to remain strong over the intermediate term, particularly among CLOs, auto loan and credit card ABS and, to a lesser extent, CMBS. The recovery of ABS such as private-label RMBS and CDOs, still struggling to attract investor confidence after their well-publicized roles in the financial crisis, remains nascent, and a full recovery of these markets appears unlikely in 2013.

The fact remains that the most important factor in ABS issuance is market demand. As long as investor appetite for ABS is healthy, issuers will find a way to work within the regulations to get ABS transactions to market. The problem is that proposed regulations like the BSF and the FDIC assessments directly target bank ABS holdings through regulatory capital or similar rules that come at a time when banks are already facing drastic increases in required regulatory capital holdings. Because banks and other financial institutions have traditionally been critical drivers of ABS demand, the longer-term outlook for securitization has to be viewed as opaque.

For more information on the basic function, mechanics and benefits of securitization generally, see Practice Note, Securitization: US Overview.

For details on the regulation of securitization in the US, both under the Dodd-Frank Act and otherwise, see Practice Note, Summary of the Dodd-Frank Act: Securitization.

For more information on Basel, see: