SEC Adopts Rule to Prohibit Conflicts of Interest in Certain Securitizations

Following a corresponding consultation earlier this year (please see EventID 19373 in this context), the U.S. Securities and Exchange Commission has announced the adoption of a final rule to enhance the conflicts of interest requirements pertaining to securitizations.
To recall, the Commission sought to implement a new rule under the Securities Act of 1933, namely 17 CFR Part 230 § 230.192, to prohibit sponsors, underwriters, placement agents, or initial purchasers of securitizations (securitization participants) to engage in certain transactions, if such transactions „involve or result in any material conflict of interest between themselves and an investor“ in an asset-backed security (ABS), including synthetic securities. The SEC thereby proposed to prohibit transactions involving short sales on ABS, the purchase of a CDS or other credit derivatives entitling its holder to payments upon the occurrence of credit events on the underlying ABS, or transactions in financial instruments that benefit from the decline in value of an ABS. Exempt would be certain transactions for market making, liquidity, and hedging purposes.
In its final rule now, the SEC implements – in large – the rule as proposed. Certain targeted amendments have been made, however, to account for comments received and concerns raised by market participants. These changes are briefly discussed below.
(1) Changes in the scope of prohibited transactions: To ensure that transactions involving interest rate and currency hedging in relation to ABS may be performed, the final catch-it-all prohibition of transactions benefiting from a decline in value of the ABS has been removed.
(2) Refinement of the term „Securitization Participant“: To provide more clarity as to which parties are considered „securitization participants“, the SEC has clarified various terms, including „Contractual Rights Sponsors“, which excludes long-holding investors acting solely based on their ABS ownership rights or „Sponsors“ which does not include ABS servicers engaged in ongoing administrative tasks or managing the asset pool composition.
(3) Provision of a safe harbor for certain foreign transactions: The final rule provides a safe harbor for foreign ABS transactions so long as the ABS‘ are not issued by U.S. persons and the „offer and sale of the asset-backed security (as defined by this section) is in compliance with 17 CFR 230.901 through 905“ (Regulation S) which requires securities sold in the U.S. to be registered with the SEC unless certain exemption provisions apply.
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The final rule will come into force on February 5, 2024 and apply 16 months thereafter.