SEC targets conflicted sales in ABS products
26 January 2023 US
Image: AdobeStock/intheskies
The US Securities and Exchange Commission (SEC) has proposed rule changes designed to prevent firms, when structuring or marketing an asset-backed security (ABS), from acting in a way that puts their interests ahead of investors in the instrument.
This rule, intended to prevent sale of ABS that are tarnished by material conflicts of interest, is outlined in new Securities Act Rule 192 and relates to a provision added by Section 621 of the Dodd-Frank Act.
This acts on concerns identified by financial regulators in the US and Europe in the lead up to the 2008 financial crisis, when some ABS sponsors or structuring parties were felt to have traded against their ABS investors or otherwise acted in ways that were not in investors’ best interests.
The SEC indicates that it originally proposed a rule to prevent the sale of “tainted ABS” – that is ABS that are tainted by material conflicts of interest – in September 2011, when it put forward rules changes embedded in Section 27b of the Securities Act of 1933.
The Commission explains that, if adopted, “new Securities Act Rule 192 would prohibit an underwriter, placement agent, initial purchaser or sponsor of an ABS … from engaging direct or indirectly in any transaction that would involve or result in a material conflict of interest between the securitisation participant and the ABS investor”.
For example, this might include short selling the ABS or buying a credit default swap or other credit derivative that allows the securitisation participant to benefit from specified credit events linked to the ABS and its components.
Recognising that a securitisation participant may employ these actions for legitimate risk management objectives, the SEC has suggested exceptions in the proposed rule for bona fide risk management and market making activities, along with selected commitments by the securitisation participant to provide liquidity for the ABS product.
“The proposed exceptions would focus on distinguishing the characteristics of such activities from speculative trading,” explains the Commission. “[These] also seek to avoid disrupting current liquidity commitment, market making and balance sheet management activities.”
The SEC has advanced its proposal for public comment, with the consultation period continuing for 60 days from date of publication on the SEC website on 25 January 2023, or 30 days from its announcement in the Federal Register.
Commenting on the proposed rule, SEC chair Gary Gensler says: “I am pleased to support this re-proposed rule as it fulfils Congress’s mandate to address conflicts of interests in the securitisation market. This re-proposed rule is designed to help address conflicts of interest arising with market participants taking positions against investors’ interests […] These changes, taken together, would benefit investors and our markets.”
This rule, intended to prevent sale of ABS that are tarnished by material conflicts of interest, is outlined in new Securities Act Rule 192 and relates to a provision added by Section 621 of the Dodd-Frank Act.
This acts on concerns identified by financial regulators in the US and Europe in the lead up to the 2008 financial crisis, when some ABS sponsors or structuring parties were felt to have traded against their ABS investors or otherwise acted in ways that were not in investors’ best interests.
The SEC indicates that it originally proposed a rule to prevent the sale of “tainted ABS” – that is ABS that are tainted by material conflicts of interest – in September 2011, when it put forward rules changes embedded in Section 27b of the Securities Act of 1933.
The Commission explains that, if adopted, “new Securities Act Rule 192 would prohibit an underwriter, placement agent, initial purchaser or sponsor of an ABS … from engaging direct or indirectly in any transaction that would involve or result in a material conflict of interest between the securitisation participant and the ABS investor”.
For example, this might include short selling the ABS or buying a credit default swap or other credit derivative that allows the securitisation participant to benefit from specified credit events linked to the ABS and its components.
Recognising that a securitisation participant may employ these actions for legitimate risk management objectives, the SEC has suggested exceptions in the proposed rule for bona fide risk management and market making activities, along with selected commitments by the securitisation participant to provide liquidity for the ABS product.
“The proposed exceptions would focus on distinguishing the characteristics of such activities from speculative trading,” explains the Commission. “[These] also seek to avoid disrupting current liquidity commitment, market making and balance sheet management activities.”
The SEC has advanced its proposal for public comment, with the consultation period continuing for 60 days from date of publication on the SEC website on 25 January 2023, or 30 days from its announcement in the Federal Register.
Commenting on the proposed rule, SEC chair Gary Gensler says: “I am pleased to support this re-proposed rule as it fulfils Congress’s mandate to address conflicts of interests in the securitisation market. This re-proposed rule is designed to help address conflicts of interest arising with market participants taking positions against investors’ interests […] These changes, taken together, would benefit investors and our markets.”
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