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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 43
[Docket No. OCC–2013–0010]
RIN 1557–AD40

FEDERAL RESERVE SYSTEM
12 CFR Part 244
[Docket No. R–1411]
RIN 7100–AD70

FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 373
RIN 3064–AD74

FEDERAL HOUSING FINANCE
AGENCY
12 CFR Part 1234
RIN 2590–AA43

SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 246
[Release No. 34–73407; File No. S7–14–11]
RIN 3235–AK96

DEPARTMENT OF HOUSING AND
URBAN DEVELOPMENT
24 CFR Part 267
RIN 2501–AD53

Credit Risk Retention
Office of the Comptroller of
the Currency, Treasury (OCC); Board of
Governors of the Federal Reserve
System (Board); Federal Deposit
Insurance Corporation (FDIC); U.S.
Securities and Exchange Commission
(Commission); Federal Housing Finance
Agency (FHFA); and Department of
Housing and Urban Development
(HUD).
ACTION: Final rule.
AGENCIES:

The OCC, Board, FDIC,
Commission, FHFA, and HUD (the
agencies) are adopting a joint final rule
(the rule, or the final rule) to implement
the credit risk retention requirements of
section 15G of the Securities Exchange
Act of 1934, as added by section 941 of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the Act or
Dodd-Frank Act). Section 15G generally
requires the securitizer of asset-backed

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SUMMARY:

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securities to retain not less than 5
percent of the credit risk of the assets
collateralizing the asset-backed
securities. Section 15G includes a
variety of exemptions from these
requirements, including an exemption
for asset-backed securities that are
collateralized exclusively by residential
mortgages that qualify as ‘‘qualified
residential mortgages,’’ as such term is
defined by the agencies by rule.
DATES: Effective date: The final rule is
effective February 23, 2015.
Compliance dates: Compliance with
the rule with respect to asset-backed
securities collateralized by residential
mortgages is required beginning
December 24, 2015. Compliance with
the rule with regard to all other classes
of asset-backed securities is required
beginning December 24, 2016.
FOR FURTHER INFORMATION CONTACT:
OCC: Kevin Korzeniewski, Attorney,
Legislative and Regulatory Activities
Division, (202) 649–5490, for persons
who are deaf or hard of hearing, TTY,
(202) 649–5597, Office of the
Comptroller of the Currency, 400 7th
Street SW., Washington, DC 20219.
Board: April C. Snyder, Senior
Counsel, (202) 452–3099; Brian P.
Knestout, Counsel, (202) 452–2249;
Flora H. Ahn, Counsel, (202) 452–2317;
David W. Alexander, Senior Attorney,
(202) 452–2877; or Matt Suntag,
Attorney, (202) 452–3694, Legal
Division; Thomas R. Boemio, Manager,
(202) 452–2982; Donald N. Gabbai,
Senior Supervisory Financial Analyst,
(202) 452–3358; or Sean M. Healey,
Senior Financial Analyst, (202) 912–
4611, Division of Banking Supervision
and Regulation; Karen Pence, Adviser,
Division of Research & Statistics, (202)
452–2342; or Nikita Pastor, Counsel,
(202) 452–3667, Division of Consumer
and Community Affairs, Board of
Governors of the Federal Reserve
System, 20th and C Streets NW.,
Washington, DC 20551.
FDIC: Rae-Ann Miller, Associate
Director, (202) 898–3898; George
Alexander, Assistant Director, (202)
898–3718; Kathleen M. Russo,
Supervisory Counsel, (703) 562–2071; or
Phillip E. Sloan, Counsel, (703) 562–
6137, Federal Deposit Insurance
Corporation, 550 17th Street NW.,
Washington, DC 20429.
Commission: Arthur Sandel, Special
Counsel; David Beaning, Special
Counsel; Lulu Cheng, Special Counsel;
or Katherine Hsu, Chief, (202) 551–
3850, in the Office of Structured
Finance, Division of Corporation
Finance, U.S. Securities and Exchange
Commission, 100 F Street NE.,
Washington, DC 20549–3628.

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FHFA: Ronald P. Sugarman, Principal
Legislative Analyst, Ron.Sugarman@
fhfa.gov, (202) 649–3208; Phillip
Millman, Principal Capital Markets
Specialist, Phillip.Millman@fhfa.gov,
(202) 649–3080; or Thomas E. Joseph,
Associate General Counsel,
Thomas.Joseph@fhfa.gov, (202) 649–
3076; Federal Housing Finance Agency,
Constitution Center, 400 7th Street SW.,
Washington, DC 20024. The telephone
number for the Telecommunications
Device for the Hearing Impaired is (800)
877–8339.
HUD: Michael P. Nixon, Office of
Housing, Department of Housing and
Urban Development, 451 7th Street SW.,
Room 10226, Washington, DC 20410;
telephone number 202–402–5216 (this
is not a toll-free number). Persons with
hearing or speech impairments may
access this number through TTY by
calling the toll-free Federal Information
Relay Service at 800–877–8339.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background
B. Overview of the Revised Proposal and
Public Comment
C. Overview of the Final Rule
D. Post-Adoption Interpretation and
Guidance
II. General Definitions and Scope
III. General Risk Retention Requirement
A. Minimum Risk Retention Requirement
B. Permissible Forms of Risk Retention—
Menu of Options
1. Standard Risk Retention
2. Master Trusts: Revolving Pool
Securitizations
3. Representative Sample
4. Asset-Backed Commercial Paper
Conduits
5. Commercial Mortgage-Backed Securities
6. Government-Sponsored Enterprises
7. Open Market Collateralized Loan
Obligations
8. Municipal Bond ‘‘Repackaging’’
Securitizations
C. Allocation to the Originator
D. Hedging, Transfer, and Financing
Restrictions
E. Safe Harbor for Certain Foreign-Related
Securitizations
F. Sunset on Hedging and Transfer
Restrictions
IV. General Exemptions
A. Exemption for Federally Insured or
Guaranteed Residential, Multifamily,
and Health Care Mortgage Loan Assets
B. Exemption for Securitizations of Assets
Issued, Insured, or Guaranteed by the
United States or any Agency of the
United States and Other Exemptions
C. Federal Family Education Loan Program
and Other Student Loan Securitizations
D. Certain Public Utility Securitizations
E. Seasoned Loan Securitizations
F. Federal Deposit Insurance Corporation
Securitizations
G. Exemption for Certain Resecuritization
Transactions

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H. Other Exemptions from Risk Retention
Requirements
1. Legacy Loan Securitizations
2. Corporate Debt Repackagings
3. Securitizations of Servicer Advance
Receivables
V. Reduced Risk Retention Requirements and
Underwriting Standards for ABS
Interests Collateralized by Qualifying
Commercial, Commercial Real Estate, or
Automobile Loans
A. Qualifying Commercial Loans
B. Qualifying Commercial Real Estate
Loans
1. Definition of Commercial Real Estate
Loan
2. Single Borrower Underwriting Standard
3. Proposed QCRE Loan Criteria
4. Ability to Repay Criteria and Term
5. Loan-to-Value Requirement
6. Collateral
7. Risk Management and Monitoring
C. Qualifying Automobile Loans
1. Ability to Repay Criteria
2. Loan Terms
3. Reviewing Credit History
4. Down Payment Requirement
VI. Qualified Residential Mortgages
A. Background
B. Overview of the Reproposed Rule
C. Overview of Public Comments
1. Comments Received on the Reproposed
QRM Definition
2. Comments Received on the Alternative
Approach to QRM
D. Summary and Analysis of Final QRM
Definition
1. Alignment of QRM with QM
2. Periodic Review of the QRM Definition
3. Definition of QRM
E. Certification and Other QRM Issues
F. Repurchase of Loans Subsequently
Determined to be Non-Qualified After
Closing
VII. Additional Exemptions
VIII. Severability
IX. Plain Language
X. Administrative Law Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Commission Economic Analysis
D. OCC Unfunded Mandates Reform Act of
1995 Determination
E. FHFA: Considerations of Differences
between the Federal Home Loan Banks
and the Enterprises

I. Introduction
The agencies are adopting a final rule
to implement the requirements of
section 941 of the Dodd–Frank Act.1
Section 15G of the Exchange Act, as
added by section 941(b) of the DoddFrank Act, generally requires the Board,
the FDIC, the OCC (collectively, the
Federal banking agencies), the
Commission, and, in the case of the
securitization of any ‘‘residential
mortgage asset,’’ together with HUD and
1 Public

Law 111–203, 124 Stat. 1376 (2010).
Section 941 of the Dodd-Frank Act amends the
Securities Exchange Act of 1934 (the Exchange Act)
and adds a new section 15G of the Exchange Act.
15 U.S.C. 78o–11.

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FHFA, to jointly prescribe regulations
that (i) require a securitizer to retain not
less than 5 percent of the credit risk of
any asset that the securitizer, through
the issuance of an asset-backed security
(ABS), transfers, sells, or conveys to a
third party, and (ii) prohibit a
securitizer from directly or indirectly
hedging or otherwise transferring the
credit risk that the securitizer is
required to retain under section 15G and
the agencies’ implementing rules.2
Compliance with the final rule with
respect to securitization transactions
involving asset-backed securities
collateralized by residential mortgages
is required beginning one year after the
date of publication in the Federal
Register and with respect to
securitization transactions involving all
other classes of asset-backed securities
is required beginning two years after the
date of publication in the Federal
Register. References in this
Supplemental Information and the rule
itself to the effective date of the rule (or
similar references to the date on which
the rule becomes effective) are to the
date on which compliance is required.
Section 15G of the Exchange Act
exempts certain types of securitization
transactions from these risk retention
requirements and authorizes the
agencies to exempt or establish a lower
risk retention requirement for other
types of securitization transactions. For
example, section 15G specifically
provides that a securitizer shall not be
required to retain any part of the credit
risk for an asset that is transferred, sold,
or conveyed through the issuance of
ABS interests by the securitizer, if all of
the assets that collateralize the ABS
interests are ‘‘qualified residential
mortgages’’ (QRMs), as that term is
jointly defined by the agencies, which
definition can be ‘‘no broader than’’ the
definition of a ‘‘qualified mortgage’’
(QM) as that term is defined under
section 129C of the Truth in Lending
Act (TILA),3 as amended by the DoddFrank Act, and regulations adopted
thereunder.4 In addition, section 15G
provides that a securitizer may retain
less than 5 percent of the credit risk of
commercial mortgages, commercial
loans, and automobile loans that are
transferred, sold, or conveyed through
the issuance of ABS interests by the
securitizer if the loans meet
underwriting standards established by
the Federal banking agencies.5
2 See 15 U.S.C. 78o–11(b), (c)(1)(A) and
(c)(1)(B)(ii).
3 15 U.S.C. 1639c.
4 See 15 U.S.C. 78o–11(c)(1)(C)(iii), (e)(4)(A) and
(B).
5 See id. at sections 78o–11(c)(1)(B)(ii) and (2).

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Section 15G allocates the authority for
writing rules to implement its
provisions among the agencies in
various ways. As a general matter, the
agencies collectively are responsible for
adopting joint rules to implement the
risk retention requirements of section
15G for securitizations that are
collateralized by residential mortgage
assets and for defining what constitutes
a QRM for purposes of the exemption
for QRM-backed ABS interests.6 The
Federal banking agencies and the
Commission, however, are responsible
for adopting joint rules that implement
section 15G for securitizations
collateralized by all other types of
assets,7 and are authorized to adopt
rules in several specific areas under
section 15G.8 In addition, the Federal
banking agencies are jointly responsible
for establishing, by rule, underwriting
standards for non-QRM residential
mortgages, commercial mortgages,
commercial loans, and automobile loans
(or any other asset class established by
the Federal banking agencies and the
Commission) that would qualify
sponsors of ABS interests collateralized
by these types of loans for a risk
retention requirement of less than 5
percent.9 Accordingly, when used in
this final rule, the term ‘‘agencies’’ shall
be deemed to refer to the appropriate
agencies that have rulewriting authority
with respect to the asset class,
securitization transaction, or other
matter discussed.
For ease of reference, the final rule of
the agencies is referenced using a
common designation of section 1 to
section 21 (excluding the title and part
designations for each agency). With the
exception of HUD, each agency is
codifying the rule within its respective
title of the Code of Federal
Regulations.10 Section 1 of each
6 See id. at sections 78o–11(b)(2), (e)(4)(A) and
(B).
7 See id. at section 78o–11(b)(1).
8 See, e.g. id. at sections 78o–11(b)(1)(E) (relating
to the risk retention requirements for ABS
collateralized by commercial mortgages);
(b)(1)(G)(ii) (relating to additional exemptions for
assets issued or guaranteed by the United States or
an agency of the United States); (d) (relating to the
allocation of risk retention obligations between a
securitizer and an originator); and (e)(1) (relating to
additional exemptions, exceptions or adjustments
for classes of institutions or assets).
9 See id. at section 78o–11(b)(2)(B).
10 Specifically, the agencies codify the rule as
follows: 12 CFR part 43 (OCC); 12 CFR part 244
(Regulation RR) (Board); 12 CFR part 373 (FDIC); 17
CFR part 246 (Commission); 12 CFR part 1234
(FHFA). As required by section 15G, HUD has
jointly prescribed the final rule for a securitization
that is collateralized by any residential mortgage
asset and for purposes of defining a qualified
residential mortgage. Because the final rule exempts
the programs and entities under HUD’s jurisdiction

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agency’s rule identifies the entities or
transactions subject to such agency’s
rule.
Consistent with section 15G of the
Exchange Act, the risk retention
requirements will become effective, for
securitization transactions collateralized
by residential mortgages, one year after
the date on which the final rule is
published in the Federal Register, and
two years after the date on which the
final rule is published in the Federal
Register for any other securitization
transaction.
In April 2011, the agencies published
a joint notice of proposed rulemaking
that proposed to implement section 15G
of the Exchange Act (the ‘‘original
proposal’’).11 The agencies invited and
received comment from the public on
the original proposed rule. In September
2013, the agencies published a second
joint notice of proposed rulemaking (the
‘‘revised proposal’’ or ‘‘reproposal’’) that
proposed significant modifications to
the original proposal and that again
invited comment from the public.12 As
described in more detail below, the
agencies are adopting the revised
proposal with some changes in response
to comments received.
As discussed further below, the final
rule retains the framework of the revised
proposal. Unless an exemption under
the rule applies, sponsors of
securitizations that issue ABS interests
must retain risk in accordance with the
standardized risk retention option (an
eligible horizontal residual interest (as
defined in the rule) or an eligible
vertical interest (as defined in the rule)
or a combination of both) or in
accordance with one of the risk
retention options available for specific
types of asset classes, such as assetbacked commercial paper (ABCP). The
final rule includes, with some
modifications, those exemptions set
forth in the revised proposal, including
for QRMs. In addition, in response to
comments and for the reasons discussed
in Part VII of this Supplementary
Information, the agencies are providing
an additional exemption from risk
retention for certain types of
community-focused residential
mortgages that are not eligible for QRM
status under the final rule and are
exempt from the ability-to-pay rules
under the TILA.13 The agencies are not
exempting managers of certain
from the requirements of the final rule, HUD does
not codify the rule into its title of the Code of
Federal Regulations.
11 Credit Risk Retention; Proposed Rule, 76 FR
24090 (April 29, 2011).
12 Credit Risk Retention; Proposed Rule, 78 FR
57928 (September 20, 2013).
13 15 U.S.C. 1639c.

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collateralized loan obligations (CLOs)
from risk retention, as requested by
commenters, for the reasons discussed
in Part III.B.7 of this Supplementary
Information.
The agencies have made adjustments
and modifications to the risk retention
and underwriting requirements, as
discussed in further detail below. Of
particular note, under the final rule, the
agencies are not adopting the proposed
requirement that a sponsor holding an
eligible horizontal residual interest be
subject to the cash flow restrictions in
the revised proposal or any similar cash
flow restrictions. In addition, the
agencies accepted commenters’ views
that a fair value calculation was not
necessary for vertical retention and are
not requiring the eligible vertical
interest to be measured using fair value.
The agencies are also making some
adjustments to the disclosure
requirements associated with the fair
value calculation for an eligible
horizontal residual interest. The final
rule also includes a provision that
requires the agencies to periodically
review the definition of QRM, the
exemption for certain communityfocused residential mortgages, and the
exemption for certain three-to-four unit
residential mortgage loans and consider
whether they should be modified, as
discussed further below in Parts VI and
VII of this Supplementary Information.
The final rule also includes several
adjustments and modifications to the
proposed risk retention options for
specific asset classes in order to address
specific functional concerns and avoid
unintended consequences.
A. Background
As the agencies observed in the
preambles to the original and revised
proposals, the securitization markets are
an important link in the chain of entities
providing credit to U.S. households and
businesses, and state and local
governments.14 When properly
structured, securitization provides
14 Securitization may reduce the cost of funding,
which is accomplished through several different
mechanisms. For example, firms that specialize in
originating new loans and that have difficulty
funding existing loans may use securitization to
access more-liquid capital markets for funding. In
addition, securitization can create opportunities for
more efficient management of the asset–liability
duration mismatch generally associated with the
funding of long-term loans, for example, with shortterm bank deposits. Securitization also allows the
structuring of securities with differing maturity and
credit risk profiles from a single pool of assets that
appeal to a broad range of investors. Moreover,
securitization that involves the transfer of credit
risk allows financial institutions that primarily
originate loans to particular classes of borrowers, or
in particular geographic areas, to limit concentrated
exposure to these idiosyncratic risks on their
balance sheets.

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economic benefits that can lower the
cost of credit.15 However, when
incentives are not properly aligned and
there is a lack of discipline in the credit
origination process, securitization can
result in harmful consequences to
investors, consumers, financial
institutions, and the financial system.
During the financial crisis,
securitization transactions displayed
significant vulnerabilities arising from
inadequate information and incentive
misalignment among various parties
involved in the process.16 Investors did
not have access to the same information
about the assets collateralizing assetbacked securities as other parties in the
securitization chain (such as the
sponsor of the securitization transaction
or an originator of the securitized
loans).17 In addition, assets were
resecuritized into complex instruments,
which made it difficult for investors to
discern the true value of, and risks
associated with, an investment in the
securitization, as well as exercise their
rights in the instrument.18 Moreover,
some lenders loosened their
underwriting standards, believing that
the loans could be sold through a
securitization by a sponsor, and that
both the lender and sponsor would
retain little or no continuing exposure to
the loans.19 Arbitrage between various
markets and market participants, and in
particular between the Enterprises and
the private securitization markets,
resulted in lower underwriting
standards which undermined the
quality of the instruments collateralized
by such loans and ultimately the health
of the financial markets and their
participants.20
Congress intended the risk retention
requirements mandated by section 15G
to help address problems in the
securitization markets by requiring that
securitizers, as a general matter, retain
an economic interest in the credit risk
of the assets they securitize. By
requiring that a securitizer retain a
portion of the credit risk of the
securitized assets, the requirements of
section 15G provide securitizers an
incentive to monitor and ensure the
quality of the securitized assets
15 Report to the Congress on Risk Retention,
Board of Governors of the Federal Reserve System,
at 8 (October 2010), available at http://
federalreserve.gov/boarddocs/rptcongress/
securitization/riskretention.pdf (Board Report).
16 See Board Report at 8–9.
17 See S. Rep. No. 111–176, at 128 (2010).
18 See id.
19 See id.
20 See, e.g., Viral V. Acharya, Governments as
Shadow Banks: The Looming Threat to Financial
Stability, at 32 (Sept. 2011), available at http://
www.federalreserve.gov/events/conferences/2011/
rsr/papers/Acharya.pdf.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
underlying a securitization transaction,
and, thus, help align the interests of the
securitizer with the interests of
investors. Additionally, in
circumstances where the securitized
assets collateralizing the ABS interests
meet underwriting and other standards
designed to help ensure the securitized
assets pose low credit risk, the statute
provides or permits an exemption.21
Accordingly, the credit risk retention
requirements of section 15G are an
important part of the legislative and
regulatory efforts to address weaknesses
and failures in the securitization process
and the securitization markets. Section
15G also complements other parts of the
Dodd-Frank Act intended to improve
the securitization markets. Such other
parts include provisions that strengthen
the regulation and supervision of
nationally recognized statistical rating
organizations (NRSROs) and improve
the transparency of credit ratings; 22
provide for issuers of registered assetbacked securities offerings to perform a
review of the securitized assets
underlying the asset-backed securities
and disclose the nature of the review; 23
require issuers of asset-backed securities
to disclose the history of the requests
they received and repurchases they
made related to their outstanding assetbacked securities; 24 prevent sponsors
and certain other securitization
participants from engaging in material
conflicts of interest with respect to their
securitizations; 25 and require issuers of
asset-backed securities to disclose, for
each tranche or class of security,
information regarding the assets
collateralizing that security, including
asset-level or loan-level data, if such
data is necessary for investors to
independently perform due diligence.26
Additionally, various efforts regarding
mortgage servicing should also have
important benefits for the securitization
markets.27
The original proposal provided
several options from which sponsors
could choose to meet section 15G’s risk
retention requirements, including
retention of either a 5 percent ‘‘vertical’’
interest in each class of ABS interests
issued in the securitization or a 5
21 See

15 U.S.C. 78o–11(c)(1)(B)(ii), (e)(1)–(2).
e.g. sections 932, 935, 936, 938, and 943
of the Dodd-Frank Act (15 U.S.C. 78o–7, 78o–8).
23 See section 945 of the Dodd-Frank Act (15
U.S.C. 77g).
24 See section 943 of the Dodd-Frank Act (15
U.S.C. 78o–7).
25 See section 621 of the Dodd-Frank Act (15
U.S.C. 77z–2a).
26 See section 942(b) of the Dodd-Frank Act (15
U.S.C. 77g(c)).
27 See, e.g., Mortgage Servicing Rules Under the
Real Estate Settlement Act (Regulation X); Final
Rule, 78 FR 10696 (Feb. 14, 2013).

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percent ‘‘horizontal’’ first-loss interest
in the securitization, and other options
designed to reflect market practice in
asset-backed securitization transactions.
The original proposal also included a
special ‘‘premium capture’’ mechanism
designed to prevent a sponsor from
structuring a securitization transaction
in a manner that would allow the
sponsor to offset or minimize its
retained economic exposure to the
securitized assets.
As required by section 15G, the
original proposal provided a complete
exemption from the risk retention
requirements for asset-backed securities
that are collateralized solely by QRMs
and established the terms and
conditions under which a residential
mortgage would qualify as a QRM.28
The original proposal would generally
have prohibited QRMs from having
product features that were observed to
contribute significantly to the high
levels of delinquencies and foreclosures
since 2007 and included underwriting
standards associated with lower risk of
default. The original proposal also
provided that sponsors would not have
to hold risk retention for securitized
commercial, commercial real estate, and
automobile loans that met proposed
underwriting standards. In the original
proposal, the agencies specified that
securitization transactions sponsored by
the Federal National Mortgage
Association (Fannie Mae) and the
Federal Home Loan Mortgage
Corporation (Freddie Mac) (jointly, the
Enterprises) would meet risk retention
requirements for as long as the
Enterprises operated under the
conservatorship or receivership of
FHFA with capital support from the
United States.
In response to the original proposal,
the agencies received comments from
over 10,500 persons, institutions, or
groups. A significant number of
comments supported the proposed
menu-based approach of providing
sponsors flexibility to choose from a
number of permissible forms of risk
retention, although several requested
more flexibility in selecting risk
retention options, including using
multiple options simultaneously. Many
commenters expressed significant
concerns with the proposed standards
for horizontal risk retention and the
‘‘premium capture’’ mechanism. Other
commenters expressed concerns with
respect to standards in the original
proposal for specific asset classes and
underwriting standards for nonresidential asset classes and the
28 See Original Proposal, 76 FR at 24117–24129
and 24164–24167.

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application of the original proposal to
managers of certain CLO transactions. A
majority of commenters opposed the
agencies’ proposed QRM standard, and
several asserted that the agencies should
align the QRM definition with the QM
definition, then under development by
the Consumer Financial Protection
Bureau (CFPB).29
The agencies considered the many
comments received on the original
proposal and engaged in additional
analysis of the securitization and
lending markets in light of the
comments. The agencies subsequently
issued the reproposal in September
2013, modifying significant aspects of
the original proposal and again inviting
public comment on the revised design
of the risk retention regulatory
framework to help determine whether
the revised framework was
appropriately structured.
B. Overview of the Revised Proposal and
Public Comment
The agencies proposed in 2013 a risk
retention rule that would have retained
much of the structure of the original
proposal, but with more flexibility in
how risk retention could be held and
with a broader definition of QRM.30
Among other things, the revised
proposal provided a variety of options
for complying with a minimum 5
percent risk retention requirement, an
exemption from risk retention for
residential mortgage loans meeting the
QRM standard, and exemptions from
risk retention for auto, commercial real
estate, and commercial loans that met
proposed underwriting standards. With
respect to the standard risk retention
option, the revised proposal provided
sponsors with additional flexibility in
complying with the regulation. The
revised proposal permitted a sponsor to
satisfy its obligation by retaining any
combination of an ‘‘eligible vertical
interest’’ with a pro rata interest in all
ABS interests issued and a first-loss
‘‘eligible horizontal residual interest’’ to
meet the 5 percent minimum
requirement. A sponsor using solely the
vertical interest option would retain a
single security or a portion of each class
of ABS interests issued in the
securitization equal to at least 5 percent
of all interests, regardless of the nature
of the interests themselves (for example,
whether such interests were senior or
subordinated). The agencies also
proposed that the eligible horizontal
residual interest be measured using fair
29 See 78 FR 6407 (January 30, 2013), as amended
by 78 FR 35429 (June 12, 2013), 78 FR 44686 (July
24, 2013), and 78 FR 60382 (October 1, 2013)
(collectively, ‘‘Final QM rule’’).
30 See Revised Proposal, 78 FR 57928.

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value. The agencies proposed a
mechanism designed to limit payments
to holders of an eligible horizontal
residual interest, in order to prevent a
sponsor from structuring a transaction
so that the holder of the eligible
horizontal residual interest could
receive disproportionate payments with
respect to its interest. In the revised
proposal, sponsors were required to
make a one-time cash flow projection
based on fair value and certify to
investors that its cash payment recovery
percentages were not projected to be
larger than the recovery percentages for
all other ABS interests on any future
payment date. The agencies also invited
comment on an alternative proposal
relating to the amount of principal
payments received by the eligible
horizontal residual interest. Under that
alternative, the cumulative amount paid
to an eligible horizontal residual interest
on any payment date would not have
been permitted to exceed a
proportionate share of the cumulative
amount paid to all ABS interests in the
transaction.
The revised proposal also included
asset class-specific options for risk
retention with some modifications from
the original proposal to better reflect
existing market practices and
operations. For example, with respect to
revolving pool securitizations, the
agencies removed a restriction from the
original proposal that prohibited the use
of the seller’s interest risk retention
option for master trust securitizations
collateralized by non-revolving assets.
With respect to ABCP conduits, the
agencies made a number of
modifications intended to allow the
ABCP option to accommodate certain
market practices discussed in the
comments and to permit more flexibility
on behalf of the originator-sellers and
their majority-owned affiliates that
finance through ABCP conduits.
Similarly, the agencies modified the risk
retention option designed for
commercial mortgage-backed securities
(CMBS) to allow for up to two thirdparty purchasers to retain the required
risk retention interest, each taking a pari
passu interest in an eligible horizontal
residual interest.
Also responding to commenters’
concerns, the revised proposal did not
include the premium capture cash
reserve account mechanism and
‘‘representative sample’’ option
included in the original proposal. With
respect to the premium capture cash
reserve account mechanism, the
agencies considered that using fair value
to measure the standard risk retention
amount would meaningfully mitigate
the ability of a sponsor to evade the risk

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retention requirement through the use of
improper deal structures intended to be
addressed by the premium capture cash
reserve account. With respect to the
representative sample option in the
original proposal, the agencies
considered the comments received and
eliminated the option in the revised
proposal on the basis that such an
option would be difficult to implement
in a way that would not result in costs
that outweighed its benefits.
The agencies retained, to a significant
degree, standards for the expiration of
the hedging and transfer restrictions in
the regulation. The agencies decided in
the reproposal to limit the sponsor’s
ability to have all or a portion of the
required retention held by its affiliates
to only a sponsor’s majority-owned
affiliates rather than all consolidated
affiliates as would have been allowed in
the original proposal. The agencies have
included this approach in the final rule
because it ensures that any loss suffered
by the holder of risk retention will be
suffered by either the sponsor or an
entity in which the sponsor has a
substantial economic interest. The
agencies also largely carried over the
terms of the original proposal with
respect to securitizations collateralized
by qualifying commercial, commercial
real estate, or automobile loans,
although modifications were proposed
to reflect commenter observations and
concerns, such as permitting junior
liens to collateralize qualifying
commercial loans, increasing the
amortization period on commercial real
estate loans to 30 years for multifamily
residential qualified commercial real
estate (QCRE) loans and 25 years for
other QCRE loans, and amending the
amortization standards for qualifying
automobile loans.
The agencies also invited comment on
new exemptions from risk retention for
certain resecuritizations, seasoned
loans, and certain types of securitization
transactions with low credit risk. In
addition, the agencies proposed a new
risk retention option for CLOs, similar
to the allocation to originator concept
proposed for sponsors generally.
The agencies proposed to broaden and
simplify the scope of the definition of a
QRM in the revised proposal to align the
definition with the definition of a QM
under section 129C of the TILA 31 and
its implementing regulations, as
adopted by the CFPB.32 As discussed in
the revised proposal, the agencies
concluded that a QRM definition that
31 15

U.S.C. 1639c.
78 FR 6407 (January 30, 2013), as amended
by 78 FR 35429 (June 12, 2013) and 78 FR 44686
(July 24, 2013).
32 See

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was aligned with the QM definition
would meet the statutory goals and
directive of section 15G of the Exchange
Act to limit credit risk and preserve
access to affordable credit, while at the
same time facilitating compliance.
Along with this proposed approach to
defining QRM, the agencies also invited
comment on an alternative approach
that would require that the borrower
meet certain credit history criteria and
that the loan be for a principal dwelling,
meet certain lien requirements, and
have a certain loan to value ratio.
The revised proposal included a
provision excluding certain foreign
sponsors of ABS interests from the risk
retention requirements of section 15G of
the Exchange Act, which did not differ
materially from the corresponding
provision in the original proposal.
In response to the revised proposal,
the agencies received comments from
more than 250 persons, institutions, or
groups, including nearly 150 unique
comment letters. The agencies received
comments and observations on many
aspects of the reproposed rule.
Numerous commenters supported most
aspects of the rule, but many suggested
or asked for further modifications. As
discussed in further detail below, a
significant number of commenters
commented on the agencies’ use of fair
value to measure risk retention.
Commenters’ key concerns included the
timing of any fair value measurement
and potential alternative methodologies
to measuring risk retention. Many
commenters also expressed concern
about the proposed disclosure
requirements for fair value, and some
asked for a ‘‘safe harbor’’ from liability
with respect to the disclosures.
As with the original proposal, a
number of commenters on the revised
proposal asserted that managers of open
market CLOs are not ‘‘securitizers’’
within the definition in section 15G of
the Exchange Act and should not be
required to retain risk. In addition,
commenters asked for an exemption
from risk retention for CLOs that would
meet certain structural criteria and for a
new option to allow third-party
investors in CLOs to hold risk retention
instead of CLO managers. Commenters
also generally opposed the agencies’
proposed alternative for risk retention
for open market CLOs in which a lead
arranger in a syndicated loan was
allowed to satisfy the risk retention
requirement, asserting that this option
was inconsistent with current market
practice and that lead arranger banks
would be hesitant to retain risk as
proposed in the revised proposal
without being allowed to hedge or
transfer that risk because they would be

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concerned about criticism from bank
regulators.
The agencies’ proposed definition of a
QRM was also the subject of significant
commentary. Overall, commenters
supported the agencies’ proposal to
align the QRM definition with the QM
definition. Several commenters asked
that the QRM definition accommodate
the use of blended pools of QRM and
non-QRM loans. Other commenters
sought more specific expansions of the
definition, including an exemption for
loans originated by community
development financial institutions and
other community-focused lenders that
are exempt from the ability-to-repay
requirements (and, as a result, do not
qualify to be QMs under TILA),
imposition of a less than 5 percent risk
retention requirement for some loans
that did not qualify for QM, and the
inclusion of non-U.S. originated loans.
Several commenters expressed concern
with both the alignment of the QRM
definition with the QM definition as
well as the alternative, more restrictive,
definition of QRM for which the
agencies had invited comment,
suggesting that the agencies use the
definition of QRM in the original
proposal.
Commenters expressed concerns on
certain other aspects of the rule.
Numerous commenters opposed the
cash flow restrictions on the eligible
horizontal residual interest option,
making various assertions on
impracticalities and impacts on
different asset classes that could result
from the restrictions. Commenters also
expressed concerns about the scope of
the seller’s interest option for revolving
pool securitization arrangements and
whether it would comport with current
market practices. With respect to CMBS,
some commenters were concerned that
the third-party purchaser options were
too expansive, while other commenters
asked for further reductions in the
restrictions on B-piece risk retention.
Commenters also asked for a number of
modifications to the proposed
underwriting standards for qualifying
commercial, commercial real estate, and
automobile loans, including an
exemption for CMBS transactions where
all the securitized assets are extensions
of credit to one borrower or its affiliates.
C. Overview of the Final Rule
After considering all comments
received in light of the purpose of the
statute and concerns from investors and
individuals seeking credit, and after
engaging in additional analysis of the
securitization and lending markets, the
agencies have adopted the revised
proposal with some modifications, as

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discussed below. The agencies are
adopting the final QRM definition, as
proposed, to mean a QM, as defined in
section 129C of TILA 33 and its
implementing regulations, as amended
from time to time.34 The agencies
continue to believe that a QRM
definition that aligns with the definition
of a QM meets the statutory goals and
directive of section 15G of the Exchange
Act to protect investors and enhance
financial stability, in part by limiting
credit risk, while also preserving access
to affordable credit and facilitating
compliance. As discussed in further
detail below, the agencies will review
the definition of QRM periodically—
beginning not later than four years after
the effective date of the rule with
respect to securitizations of residential
mortgages, and every five years
thereafter. These timeframes are
designed to coordinate the agencies’
review of the QRM definition with the
timing of the CFPB’s statutorily
mandated assessment of QM, as well as
to better ensure that the QRM definition
continues to meet the goals and
directive of section 15G. The final rule
also provides that any of the agencies
may request a review of the definition
of QRM at any time as circumstances
warrant.
In addition, the agencies are adopting
the minimum risk retention requirement
and risk retention options, with some
modifications to address specific
commenter concerns. As discussed in
more detail below, and consistent with
the revised proposal, the final rule
applies a minimum 5 percent base risk
retention requirement to all
securitization transactions that are
within the scope of section 15G of the
Exchange Act and prohibits the sponsor
from hedging or otherwise transferring
its retained interest prior to the
applicable sunset date. The final rule
also allows a sponsor to satisfy its risk
retention obligation by retaining an
eligible vertical interest, an eligible
horizontal residual interest, or any
combination thereof as long as the
amount of the eligible vertical interest
and the amount of the eligible
horizontal residual interest combined is
no less than 5 percent. The amount of
the eligible vertical interest is equal to
the percentage of each class of ABS
interests issued in the securitization
transaction held by the sponsor as
eligible vertical risk retention. The
amount of eligible horizontal residual
interest is equal to the fair value of the
eligible horizontal residual interest
divided by the fair value of all ABS
33 15

U.S.C. 1639c.
Final QM rule.

34 See

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interests issued in the securitization
transaction. After considering the
numerous comments received, the
agencies have concluded that the
proposed cash flow restriction on the
eligible horizontal residual interest (as
well as the alternative described in the
reproposal) could lead to unintended
consequences or have a disparate
impact on some asset classes. The
agencies have therefore decided not to
include such restrictions under the final
rule.
With respect to the proposed
disclosure requirements related to the
fair value calculation of eligible
horizontal residual interests, the
agencies continue to believe that it is
important to the functioning of the final
rule to ensure that investors and the
markets, as well as regulators, are
provided with key information about
the methodologies and assumptions that
are used by sponsors under the final
rule to calculate the amount of their
eligible horizontal residual interests in
accordance with fair value standards.
Because the agencies believe that
disclosures of the assumptions inherent
in fair value calculations are necessary
to enable investors to make informed
investment decisions, the agencies are
generally retaining the proposed fair
value disclosure requirements, with
some modifications in response to
commenter concern, as further
discussed below.
Furthermore, as discussed in more
detail below, the agencies are adopting
the revised proposal’s provisions for
CMBS third-party purchasers with some
modifications to respond to specific
commenter concerns. In addition, the
agencies are retaining the proposed fiveyear period during which transfer
among qualified third-party purchasers
of CMBS eligible horizontal residual
interests that are retained in satisfaction
of the final rule will not be permitted.
The agencies are also adopting the
proposed underwriting standards for
commercial, commercial real estate, and
automobile loans, with some minor
adjustments to the commercial real
estate underwriting standards as
described below. The agencies are also
adopting the revised proposal’s
treatment of allocation to originators,
tender option bonds, and ABCP
conduits, with some limited
modifications, as described below. With
respect to revolving pool
securitizations—described in the
reproposal as revolving master trusts—
the agencies are adopting the reproposal
with several refinements designed to
expand availability of the seller’s
interest option. The final rule also
contains the various proposed

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exemptions for government-related
transactions and certain
resecuritizations from the revised
proposal.
The agencies also, as proposed, are
applying risk retention to CLO managers
as ‘‘securitizers’’ of CLO transactions
under section 15G of the Exchange Act
and, as discussed in further detail
below, are not adopting structural
exemptions or third-party options as
suggested by some commenters. After
carefully considering comments, the
suggested exemptions and alternatives,
the purposes of section 15G of the
Exchange Act, and the features and
dynamics of CLOs and the leveraged
loan market, the agencies have
concluded that risk retention is
appropriately applied to CLO managers
and a structural exemption or thirdparty option would likely undermine
the consistent application of the final
rule. Furthermore, the agencies are
retaining in the final rule the proposed
alternative for open market CLOs
whereby, for each loan purchased by the
CLO, risk may be retained by a lead
arranger. The agencies appreciate that
this option may not reflect current
practice, but have concluded that the
option may provide a sound method for
meaningful risk retention for the CLO
market in the future.
D. Post-Adoption Interpretation and
Guidance
The preambles to the original and
revised proposals described the
agencies’ intention to jointly approve
certain types of written interpretations
concerning the scope of section 15G and
the final rule issued thereunder. Several
commenters on the original proposal,
and some commenters on the
reproposal, expressed concern about the
agencies’ process for issuing written
interpretations jointly and the possible
uncertainty about the interpretation of
the rule that may arise due to this
process.
The agencies have endeavored to
provide specificity and clarity in the
final rule to avoid conflicting
interpretations or uncertainty. In the
future, if the agencies determine that
further guidance would be beneficial for
market participants, the agencies may
jointly publish interpretive guidance, as
the Federal banking agencies have done
in the past. In addition, the agencies
note that market participants can, as
always, seek guidance concerning the
rule from their primary Federal banking
regulator or, if such market participant
is not a depository institution, the
Commission. In light of the joint nature
of the agencies’ rule writing authority,
the agencies continue to view the

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consistent application of the final rule
as a benefit and intend to consult with
each other when adopting staff
interpretations or guidance on the final
rule that would be shared with the
public generally in order to attempt to
achieve full consensus on such
interpretations and guidance.35 In order
to facilitate this goal, the Federal
banking agencies and the Commission
intend to coordinate as needed to
discuss pending requests for such
interpretations and guidance, with the
participation of HUD and FHFA when
such agencies are among the appropriate
agencies for such matters.
II. General Definitions and Scope
The original proposal defined several
terms applicable to the overall rule. The
original proposal provided that the
proposed risk retention requirements
would have applied to sponsors in
securitizations that involve the issuance
of ‘‘asset-backed securities’’ and defined
the terms ‘‘asset-backed security’’ and
‘‘asset’’ consistent with the definitions
of those terms in the Exchange Act. The
original proposal noted that section 15G
does not appear to distinguish between
transactions that are registered with the
Commission under the Securities Act of
1933 (the Securities Act) and those that
are exempt from registration under the
Securities Act. It further noted that the
proposed definition of asset-backed
security, which would have been
broader than that in the Commission’s
Regulation AB,36 included securities
that are typically sold in transactions
that are exempt from registration under
the Securities Act, such as collateralized
debt obligations (CDOs) and securities
issued or guaranteed by an Enterprise.
As a result, pursuant to the definitions
in the original proposal, the proposed
risk retention requirements would have
applied to securitizers of offerings of
asset-backed securities regardless of
whether the offering was registered with
the Commission under the Securities
Act.
Under the original proposal, risk
retention requirements would have
applied to the securitizer in each
‘‘securitization transaction,’’ defined as
a transaction involving the offer and
sale of ABS interests by an issuing
entity. The original proposal also
explained that the term ‘‘ABS interest’’
35 These items do not include interpretation and
guidance in staff comment letters and other staff
guidance directed to specific institutions that is not
intended to be relied upon by the public generally.
Nor do they include interpretations and guidance
contained in administrative or judicial enforcement
proceedings by the agencies, or in an agency report
of examination or inspection or similar confidential
supervisory correspondence.
36 See 17 CFR 229.1100 through 17 CFR 229.1123.

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would refer to all types of interests or
obligations issued by an issuing entity,
whether or not in certificated form,
including a security, obligation,
beneficial interest, or residual interest,
but would not include interests, such as
common or preferred stock, in an
issuing entity that are issued primarily
to evidence ownership of the issuing
entity, and the payments, if any, which
are not primarily dependent on the cash
flows of the collateral held by the
issuing entity.
Section 15G stipulates that its risk
retention requirements be applied to a
‘‘securitizer’’ of an asset-backed security
and, in turn, that a securitizer is either
an issuer of an asset-backed security or
a person who organizes and initiates a
securitization transaction by selling or
transferring assets, either directly or
indirectly, including through an affiliate
or issuer. The original proposal
discussed the fact that the second prong
of this definition is substantially
identical to the definition of a
‘‘sponsor’’ of a securitization transaction
in the Commission’s Regulation AB 37
and defined the term ‘‘sponsor’’ in a
manner consistent with the definition of
that term in the Commission’s
Regulation AB.
As noted in the original proposal, the
agencies believe that applying the risk
retention requirement to the sponsor of
the ABS interests—as provided by
section 15G—is appropriate in light of
the active and direct role that a sponsor
typically has in arranging a
securitization transaction and selecting
the assets to be securitized. This role
best situates the sponsor to monitor and
control the credit quality of the
securitized assets. In some cases, the
transfer of assets by the sponsor will
take place through a wholly-owned
subsidiary of the sponsor that is often
referred to as the ‘‘depositor.’’ As noted
above, the definition of ‘‘securitizer’’ in
section 15G(a)(3)(A) includes the
‘‘issuer of an asset-backed security.’’
The term ‘‘issuer’’ when used in the
federal securities laws may have
different meanings depending on the
context in which it is used. For
example, for several purposes under the
federal securities laws, including the
Securities Act 38 and the Exchange
37 See Item 1101 of the Commission’s Regulation
AB (17 CFR 229.1101) (defining a sponsor as ‘‘a
person who organizes and initiates an asset-backed
securities transaction by selling or transferring
assets, either directly or indirectly, including
through an affiliate, to the issuing entity.’’).
38 Section 2(a)(4) of Securities Act (15 U.S.C.
77b(a)(4)) defines the term ‘‘issuer’’ in part to
include every person who issues or proposes to
issue any security, except that with respect to
certificates of deposit, voting-trust certificates, or
collateral trust certificates, or with respect to

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Act 39 (of which section 15G is a part)
and the rules promulgated under these
Acts,40 the term ‘‘issuer’’ when used
with respect to a securitization
transaction is defined to mean the
entity—the depositor—that deposits the
assets that collateralize the asset-backed
securities with the issuing entity. As
stated in the original proposal, the
agencies interpret the reference in
section 15G(a)(3)(A) to an ‘‘issuer of an
asset-backed security’’ as referring to the
‘‘depositor’’ of the securitization
transaction, consistent with how that
term has been defined and used under
the federal securities laws in connection
with asset-backed securities.41
As noted above, the rule generally
applies the risk retention requirements
of section 15G to a sponsor of the
securitization transaction. In many cases
the depositor and the sponsor are the
same legal entity; however, even in
cases where the depositor and the
sponsor are not the same legal entity,
the depositor is a pass-through vehicle
for the transfer of assets and is either
controlled or funded by the sponsor.
Therefore, under the rule, the definition
of sponsor effectively includes the
depositor of the securitization
transaction, and should identify the
party subject to the risk retention
requirements for every securitization
transaction. Therefore, in the agencies’
view, applying the risk retention
requirement to the sponsor, as defined
in the rule, substantively aligns with the
certificates of interest or shares in an
unincorporated investment trust not having a board
of directors (or persons performing similar
functions), the term issuer means the person or
persons performing the acts and assuming the
duties of depositor or manager pursuant to the
provisions of the trust or other agreement or
instrument under which the securities are issued.
39 See Exchange Act sec. 3(a)(8) (15 U.S.C.
78c(a)(8) (defining ‘‘issuer’’ under the Exchange
Act).
40 See, e.g., Securities Act Rule 191 (17 CFR
230.191) and Exchange Act Rule 3b–19 (17 CFR
240.3b–19).
41 For asset-backed securities transactions where
there is not an intermediate transfer of the assets
from the sponsor to the issuing entity, the term
depositor refers to the sponsor. For asset-backed
securities transactions where the person
transferring or selling the pool assets is itself a trust
(such as in an issuance trust structure), the
depositor of the issuing entity is the depositor of
that trust. See section 2 of the final rule. Securities
Act Rule 191 and Exchange Act Rule 3b–19 also
note that the person acting as the depositor in its
capacity as depositor to the issuing entity is a
different ‘‘issuer’’ from that person in respect of its
own securities in order to make clear—for
example—that any applicable exemptions from
Securities Act registration that person may have
with respect to its own securities are not applicable
to the asset-backed securities. That distinction does
not appear relevant here because the risk retention
rule would not be applicable to an issuance by such
person of securities that are not asset-backed
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definition of ‘‘securitizer’’ in section
15G of the Exchange Act.
Other than issues concerning CLOs,
which are discussed in Part III.B.7;
issues concerning ABCP, which are
discussed in Part III.B.4; and issues
concerning sponsors of municipal bond
repackagings, which are discussed in
Part III.B.8 of this Supplementary
Information, comments with regard to
the definition of securitizer or sponsor
were generally limited to requests that
the final rule provide that certain
specified persons—such as
underwriting sales agents—be expressly
excluded from the definition of
securitizer or sponsor for the purposes
of the risk retention requirements.
In response to comments received
relating to various transaction parties
requesting that the agencies either
designate as sponsors, or clarify would
meet the requirements of the definition
of sponsor, the agencies are providing
some guidance with respect to the
definition of sponsor. The statute and
the rule define a securitizer as a person
who ‘‘organizes and initiates an assetbacked securities transaction by selling
or transferring assets, either directly or
indirectly, including through an
affiliate, to the issuer.’’ 42 The agencies
believe that the organization and
initiation criteria in both definitions are
critical to determining whether a person
is a securitizer or sponsor. The agencies
are of the view that, in order to qualify
as a party that organizes and initiates a
securitization transaction and, thus, as a
securitizer or sponsor, the party must
have actively participated in the
organization and initiation activities
that would be expected to impact the
quality of the securitized assets
underlying the asset-backed
securitization transaction, typically
through underwriting and/or asset
selection. The agencies believe this
interpretation of the statutory language
‘‘organize and initiate’’ is reasonable
because it further accomplishes the
statutory goals of risk retention—
alignment of the incentives of the
sponsor of the securitization transaction
with the investors and improvement in
the underwriting and selection of the
securitized assets. Without this active
participation, the holder of retention
could be merely a speculative investor,
with no ability to influence
underwriting or asset selection. In
addition, the interests of a speculative
investor may not be aligned with those
of other investors. For example, another
asset-backed security issuer would not
meet the ‘‘organization and initiation’’
42 See 15 U.S.C. 78o–11(a)(3)(B) and section 2 of
the final rule, infra.

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criteria in the definition of ‘‘sponsor’’ as
such an entity could not be the party
that actively makes decisions regarding
asset selection or underwriting.
Additionally, the agencies believe that a
party who does not engage in this type
of active participation would be a thirdparty holder of risk retention, which
(with the narrow exception of a
qualified third-party purchaser in a
CMBS transaction) is not an acceptable
holder of retention under the rule
because the participation of such a party
does not result in the more direct
alignment of incentives achieved by
requiring the party with underwriting or
asset selection authority to retain risk.
Thus, for example, an entity that serves
only as a pass-through conduit for assets
that are transferred into a securitization
vehicle, or that only purchases assets at
the direction of an independent asset or
investment manager, only pre-approves
the purchase of assets before selection,
or only approves the purchase of assets
after such purchase has been made
would not qualify as a ‘‘sponsor’’. If
such a person retained risk, it would be
an impermissible third-party holder of
risk retention for purposes of the rule,
because such activities, in and of
themselves, do not rise to the level of
‘‘organization and initiation’’. In
addition, negotiation of underwriting
criteria or asset selection criteria or
merely acting as a ‘‘rubber stamp’’ for
decisions made by other transaction
parties does not sufficiently distinguish
passive investment from the level of
active participation expected of a
sponsor or securitizer.
The original proposal would have
defined the term ‘‘originator’’ in the
same manner as section 15G, namely, as
a person who, through the extension of
credit or otherwise, creates a financial
asset that collateralizes an asset-backed
security, and sells the asset directly or
indirectly to a securitizer (i.e., a sponsor
or depositor). The original proposal
went on to note that because this
definition refers to the person that
‘‘creates’’ a loan or other receivable,
only the original creditor under a loan
or receivable—and not a subsequent
purchaser or transferee—would have
been an originator of the loan or
receivable for purposes of section 15G.
The revised proposal kept the definition
from the original proposal.
The original proposal referred to the
assets underlying a securitization
transaction as the ‘‘securitized assets,’’
meaning assets that are transferred to a
special purpose vehicle (SPV) that
issues the ABS interests and that stand
as collateral for those ABS interests.
‘‘Collateral’’ was defined as the property
that provides the cash flow for payment

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of the ABS interests issued by the
issuing entity. Taken together, these
definitions were meant to include the
loans, leases, or similar assets that the
depositor places into the issuing entity
at the inception of the transaction,
though it would have also included
other assets such as pre-funded cash
reserve accounts. Commenters to the
original proposal stated that, in addition
to this property, the issuing entity may
hold other assets. For example, the
issuing entity may acquire interest rate
derivatives to convert floating rate
interest income to fixed rate, or the
issuing entity may accrete cash or other
liquid assets in reserve funds that
accumulate cash generated by the
securitized assets. As another example,
commenters stated that an ABCP
conduit may hold a liquidity guarantee
from a bank on some or all of its
securitized assets. The agencies retained
these definitions of securitized assets
and collateral in the revised proposal.
Some commenters expressed concern
with respect to the scope of the terms of
the definitions of asset-backed
securities, securitization transactions,
and ABS interests in the original
proposal and suggested specific
exemptions or exclusions from their
application. Similarly, a number of
commenters requested clarification of
the scope of the definition of ‘‘ABS
interest,’’ or suggested narrowing the
definition, while other commenters
suggested an expansion of the scope of
the ‘‘securitization transaction’’
definition. Comments with regard to
definitions of securitizer and sponsor in
the original proposal were generally
limited to requests that specified
persons be expressly excluded from, or
included in, the definition of securitizer
or sponsor for the purposes of the risk
retention requirements. The agencies
determined to leave the definitions of
securitizer and sponsor substantially
unchanged in the revised proposal.
After consideration of all the comments
on the original proposal, the agencies
did not believe that significant changes
to most definitions applicable
throughout the proposed rule were
necessary and, in the revised proposal,
retained most definitions as originally
proposed.
The agencies did add some
substantive definitions to the revised
proposal, including proposing a
definition of ‘‘servicing assets,’’ which
would be any rights or other assets
designed to assure the servicing, timely
payment, or timely distribution of
proceeds to security holders, or assets
related or incidental to purchasing or
otherwise acquiring and holding the
issuing entity’s securitized assets. The

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agencies noted in the revised proposal
that such assets may include cash and
cash equivalents, contract rights,
derivative agreements of the issuing
entity used to hedge interest rate and
foreign currency risks, or the collateral
underlying the securitized assets. As
provided in the reproposed rule,
‘‘servicing assets’’ also include proceeds
of assets collateralizing the
securitization transactions, whether in
the form of voluntary payments from
obligors on the assets or otherwise (such
as liquidation proceeds). The agencies
are adopting this definition
substantially as reproposed in order to
ensure that the provisions appropriately
accommodate the need, in
administering a securitization
transaction on an ongoing basis, to hold
various assets other than the loans or
similar assets that are transferred into
the asset pool by the securitization
depositor. In this way, the definition is
similar to the definition of ‘‘eligible
assets’’ in Rule 3a–7 under the
Investment Company Act of 1940,
which specifies conditions under which
the issuer of non-redeemable fixedincome securities collateralized by selfliquidating financial assets will not be
deemed to be an investment company.
In light of the agencies’ adoption of
the QRM definition from the reproposal
and the exemption for certain three-tofour unit residential mortgages (as
discussed in section VII below), the
agencies are modifying the proposed
definition of ‘‘residential mortgage’’ to
clarify that all loans secured by 1–4 unit
residential properties will be
‘‘residential mortgages’’ for the purposes
of the final rule and subject to the rule’s
provisions regarding residential
mortgages (such as the sunset on
hedging and transfer restrictions
specific to residential mortgages) if they
do not qualify for an exemption. Under
the final rule, a residential mortgage
would mean a residential mortgage that
is a ‘‘covered transaction’’ as defined in
the CFPB’s Regulation Z; 43 any
transaction that is specifically exempt
from the definition of ‘‘covered
transaction’’ under the CFPB’s
Regulation Z; 44 and, as a modification
to the proposed definition, any other
loan secured by a residential structure
that contains one to four units, whether
or not that structure is attached to real
property, including condominiums, and
if used as residences, mobile homes and
trailers.45 Therefore, the term
43 See

12 CFR 1026.43.
12 CFR 1026.43.
45 This addition to the definition is substantially
similar to the CFPB’s definition of ‘‘dwelling’’ in
Regulation Z. See 12 CFR 1026.2(19).
44 See

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‘‘residential mortgage’’ would include
home equity lines of credit, reverse
mortgages, mortgages secured by
interests in timeshare plans, temporary
loans, and certain community-focused
residential mortgages further discussed
in Part VII of this Supplementary
Information. It would also include
mortgages secured by 1–4 unit
residential properties even if the credit
is deemed for business purposes under
Regulation Z.
Many comments on the revised
proposal were similar to, or repeated,
the comments on the original proposal.
Some commenters asked that specific
definitions be added to the rule, such as
eligible participation interest, owner’s
interest, and participant’s interest. With
respect to the definitions of securitizer
and sponsor, several commenters on the
revised proposal requested that the final
rule expressly exempt, or include,
certain categories or groups of persons—
such as underwriting sales agents,
multiple sponsors of transactions,
affiliated entities, or, in the case of
tender-option bonds and ABCP, brokers
who acquire and securitize assets at the
direction of a third party. Other
commenters requested confirmation that
certain categories of transactions would
not qualify as a sale or transfer of an
interest for purposes of the rule.
Three commenters requested that the
agencies reconsider their decision to
treat non-economic residual interests in
real estate investment conduits
(REMICS) as ABS interests, noting the
potential negative tax consequences for
sponsors of REMICS. Another
commenter requested that lower-tier
REMIC interests in tiered structures be
exempted from treatment as ABS
interests, and a separate commenter
requested an express exclusion of
REMIC residual interests entirely. One
commenter again asserted that the
definition of ‘‘securitization
transaction’’ was overly broad because it
would include a variety of corporate
debt repackagings, which the
commenter asserted should be expressly
exempt from risk retention. One
commenter requested clarification that
issuers of securities collateralized by
qualifying assets could hold hedging
agreements, insurance policies, and
other forms of credit enhancement as
permitted by the Commission’s
Regulation AB. One commenter asked
that the definition of commercial real
estate be revised to include land loans,
including loans made to owners of fee
interests in land leased to third parties
who own improvements on the land.
While the final rule generally retains
the definitions in the revised proposal,
to address the concerns raised by

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commenters with respect to REMICs,46
the agencies have modified the
definition of ABS interest to exclude (i)
a non-economic residual interest issued
by a REMIC and (ii) an uncertificated
regular interest in a REMIC that is held
only by another REMIC, where both
REMICs are part of the same structure
and a single REMIC issues ABS interests
to investors. The agencies do not believe
that significant changes to the general
definitions are necessary or appropriate
in light of the purposes of the statute.
All adjustments to the general
definitions are discussed below in this
Supplementary Information in the
context of relevant risk retention
options.

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III. General Risk Retention
Requirement
A. Minimum Risk Retention
Requirement
Section 15G of the Exchange Act
generally requires that the agencies
jointly prescribe regulations that require
a securitizer to retain not less than 5
percent of the credit risk for any asset
that the securitizer, through the
issuance of ABS interests, transfers,
sells, or conveys to a third party, unless
an exemption from the risk retention
requirements for the securities or
transaction is otherwise available (e.g.,
if the ABS interests are collateralized
exclusively by QRMs). Consistent with
the statute, the reproposal generally
would have required that a sponsor
retain an economic interest equal to at
least 5 percent of the aggregate credit
risk of the assets collateralizing an
issuance of ABS interests (the base risk
retention requirement). For
securitizations where two or more
entities would each meet the definition
of sponsor, the reproposal would have
required that one of the sponsors retain
the credit risk of the securitized assets
in accordance with the requirements of
the rule. Under the reproposal, the base
risk retention requirement would have
been available as an option to sponsors
of all securitization transactions within
the scope of the rule, regardless of
whether the sponsor was an insured
depository institution, a bank holding
company or subsidiary thereof, a
registered broker-dealer, or another type
of entity.
Some comments addressed the
proposed minimum risk retention
requirement. One commenter expressed
46 Some commenters expressed concern that
including REMICs in the ABS interest definition
would create tax liabilities unrelated to the credit
risk of the underlying collateral and would likely
reduce the intended impact of the risk retention
rules since non-economic residual interests usually
have a negative value.

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support for the proposed minimum
requirement of 5 percent risk retention,
asserting that such a requirement would
promote higher quality lending, protect
investor interests, and limit the
originate-to-distribute business model.
Other commenters requested a higher
minimum risk retention requirement
depending on asset quality. One
commenter asserted that 5 percent
should be the minimum and that the
purpose of risk retention would be
defeated by applying 5 percent to
situations in which assets are sold at a
discount from par. That commenter
proposed that the requirement should
be either (i) the greater of 5 percent or
the expected losses on the assets or (ii)
the greater of 5 percent or the
conditional expected losses on the
assets or asset class under a moderate
economic stress environment. Another
commenter stated that some sponsors
hold less than 5 percent because of the
high quality of some assets, and
requiring 5 percent retention could
potentially double costs in some
instances. Another commenter asserted
that retaining 5 percent may not be
sufficient as many sponsors held more
than 5 percent credit risk in their
securitizations before the crisis. That
same commenter stated that investors
were likely to insist that originators
retain some credit risk. One commenter
proposed a minimum risk retention
requirement of 20 percent, while
another commenter requested that
sponsors be required to hold 100
percent risk retention for a specified
period of time. For securitizations
where multiple entities each meet the
definition of sponsor, one commenter
stated that multiple sponsors should be
permitted to allocate the required
amount of risk retention among
themselves, so long as the aggregate
amount retained satisfies the
requirements of the risk retention rules.
Other commenters requested a lower
minimum for pools that blend assets
that would be exempt from risk
retention by meeting the proposed
underwriting standards with assets not
meeting the standards, which is
discussed in further detail in Part V of
this Supplementary Information.
After careful consideration of the
comments received, the agencies are
adopting the minimum risk retention
requirement as proposed. Consistent
with the reproposal and the general
requirement in section 15G of the
Exchange Act, the final rule applies a
minimum 5 percent base risk retention
requirement to all securitization
transactions within the scope of section
15G, unless an exemption under the

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77611

final rule applies.47 The agencies
believe that this requirement will
provide sponsors with an incentive to
monitor and control the underwriting of
securitized assets and help align the
interests of the sponsor with those of
investors in the ABS interests. The
agencies note that, while Congress
directed that the rule include a risk
retention requirement of no less than 5
percent of the credit risk for any asset,
parties to a securitization transaction
may agree that more risk will be
retained. While some commenters asked
that the rule calibrate the credit risk on
an asset class basis (i.e., make a
determination that the credit risk
associated with certain asset classes is
lower than for other asset classes), the
agencies are declining to do that at this
time because the data provided by
commenters do not provide a sufficient
basis for the calibration of credit risk on
an asset class basis.48 For securitizations
where two or more entities would each
meet the definition of sponsor, the final
rule requires that one of the sponsors
complies with the rule, consistent with
the original and revised proposals. The
final rule does not prohibit multiple
sponsors from retaining credit risk as
long as one of those sponsors complies
with the requirements of the final rule.
The agencies are not allowing sponsors
to divide the required risk retention
generally because allowing multiple
sponsors to divide required risk
retention among themselves would
dilute the economic risk being retained
and, as a result, reduce the intended
alignment of interest between the
sponsor and the investors.
The agencies do not believe that it is
necessary or appropriate to attempt to
vary the amount of risk retention based
on the quality of the assets or other
factors and believe that attempting to do
so would unnecessarily complicate
compliance with the rule. As discussed
below, the agencies are adopting the
requirement that an eligible horizontal
47 See final rule at sections 3 through 10. Similar
to the proposal, the final rule, in some instances,
permits a sponsor to allow another person to retain
the required amount of credit risk (e.g., originators,
third-party purchasers in CMBS transactions, and
originator-sellers in ABCP conduit securitizations).
However, in such circumstances, the final rule
includes limitations and conditions designed to
ensure that the purposes of section 15G continue to
be fulfilled. Further, even when another person is
permitted to retain risk, the sponsor still remains
responsible under the rule for compliance with the
risk retention requirements, as discussed below.
48 As required by section 15G, the agencies have
established automobile, commercial real estate, and
commercial loan asset classes and related
underwriting standards designed to ensure a low
credit risk for assets originated to those standards.
The agencies provided for zero risk retention for
loans meeting the prescribed underwriting
standards.

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B. Permissible Forms of Risk
Retention—Menu of Options
Section 15G of the Exchange Act
expressly provides the agencies the
authority to determine the permissible
forms through which the required
amount of risk retention must be held.49
Accordingly, the reproposal, like the
original proposal, would have provided
sponsors with multiple options to
satisfy the risk retention requirements of
section 15G. The flexibility provided in
the reproposal’s menu of options for
complying with the risk retention
requirement was designed to take into
account the heterogeneity of
securitization markets and practices and
to reduce the potential for the proposed
rules to negatively affect the availability
and costs of credit to consumers and
businesses. As proposed, the menu of
options approach was designed to be
consistent with the various ways in
which a sponsor or other entity, in
historical market practices, may have

retained exposure to the credit risk of
securitized assets.50 Historically,
whether or how a sponsor retained
exposure to the credit risk of the assets
it securitized was determined by a
variety of factors including the rating
requirements of the NRSROs, investor
preferences or demands, accounting and
regulatory capital considerations, and
whether there was a market for the type
of interest that might ordinarily be
retained (at least initially by the
sponsor).
Commenters generally supported the
menu-based approach of providing
sponsors with the flexibility to choose
from a number of permissible forms of
risk retention. While commenters were
generally supportive of a menu-based
approach, several commenters requested
that the final rule provide additional
options and increased flexibility for
sponsors to comply with the risk
retention requirement. In this regard,
several commenters asserted that the
final rule should permit third-party
credit support as additional forms of
risk retention, including insurance
policies, guarantees, liquidity facilities,
and standby letters of credit. One
commenter stated that such unfunded
forms of credit support are permitted by
the European risk retention framework
and allowing similar options would
provide greater consistency between the
U.S. and European rules. This
commenter further contended that the
final rule, at a minimum, should permit
such forms of unfunded risk retention
for a subset of sponsors, such as
regulated banks. A few commenters
requested that overcollateralization be
permitted as an alternative method of
risk retention. Further, the agencies
received several comments requesting
that the final rule include an option
allowing retention to be held in the form
of interests in the securitized assets
themselves. Along these lines, several
commenters sought additional
flexibility under the rule to hold risk
retention as loan participation interests
or companion notes instead of an ABS
interest. One commenter stated that,
while the use of participations in
securitization transactions may not
currently be customary, sponsors may
find such a structure advantageous in
connection with the risk retention
requirements. A few commenters said
that pari passu participation interests
and structures using pari passu
companion notes have been used in

49 See 15 U.S.C. 78o–11(c)(1)(C)(i); see also S.
Rep. No. 111–176, at 130 (2010) (‘‘The Committee
[on Banking, Housing, and Urban Affairs] believes
that implementation of risk retention obligations
should recognize the differences in securitization
practices for various asset classes.’’).

50 See Board Report; see also Macroeconomic
Effects of Risk Retention Requirements, Chairman of
the Financial Stability Oversight Counsel (January
2011), available at http://www.treasury.gov/
initiatives/wsr/Documents/
Section946RiskRetentionStudy(FINAL).pdf.

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residual interest be measured at fair
value using a fair value methodology
acceptable under U.S. generally
accepted accounting principles (GAAP).
The agencies believe that generally
requiring that retention be 5 percent of
the fair value of the ABS interests issued
in the securitization transaction will
sufficiently calibrate the actual amount
of retention to the value of the assets,
including how that value may be
affected by expected losses. In addition,
subject to limited exceptions, such as
that applicable to transfers of CMBS
interests among qualified third-party
purchasers after five years, transfers to
majority-owned affiliates, and certain
permitted hedging activities, the final
rule prohibits the sponsor from hedging
or otherwise transferring its retained
interest prior to the applicable sunset
date, as discussed in Part IV.F of this
Supplementary Information.
The agencies note that the base risk
retention requirement is a regulatory
minimum and not a limit on what
investors or other market participants
may require. The sponsor, originator, or
other party to a securitization may
retain additional exposure to the credit
risk of assets that the sponsor,
originator, or other party helps
securitize beyond that required by the
rule, either on its own initiative or in
response to the demands or
requirements of private market
participants.

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certain types of CMBS transactions.
Other commenters requested that the
final rule allow for subordinated
participation interests. These
commenters said pari passu
participations should qualify as vertical
risk retention and subordinate
participation interests should qualify as
horizontal risk retention. The main
reason cited by these commenters for
expanding the forms of risk retention
recognized under the rule to include
this form of retention, other than future
flexibility as to form, was the possibility
that the sponsor could hold the same
economic exposure it would have as an
ABS interest form of risk retention,
while at the same time incurring lower
regulatory capital charges for that
exposure by holding it as a loan, and
avoiding consolidation of the structure
onto its balance sheet. Another
commenter suggested that the
availability of a participation option
may be important for commercial banks
because of their existing infrastructure
to share risk on a pari passu basis.
One commenter stated that the final
rule should provide more flexibility by
allowing sponsors to satisfy their risk
retention requirement through a
combination of means and that the rule
should not mandate forms of risk
retention for specific types of asset
classes or specific types of transactions.
The agencies have carefully
considered the comments and are
adopting the proposed menu of options
approach to risk retention largely as
proposed. The agencies continue to
believe that providing options for risk
retention is appropriate in order to
accommodate the variety of
securitization structures that will be
subject to the final rule and that the
menu of options, as proposed, provides
sufficient flexibility for sponsors to
satisfy their risk retention obligations.
After carefully considering the
comments requesting loan interests,
such as loan participations, as an
option, the agencies have decided not to
expand the recognized legal forms of
risk retention under the rule beyond
ABS interests by including pari passu
participation interests, subordinated
participation interests, pari passu
companion notes, or subordinated
companion notes. The agencies are
permitting specialized forms of
participations for two particular asset
classes as discussed below in
connection with CLO securitizations
and tender option bonds, subject to
several requirements under the rule.
However, the agencies believe that the
rule already provides sufficient
flexibility as to the economic forms of
risk retention and an additional form of

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risk retention is not necessary. The
agencies are concerned that offering
different legal forms, such as
participation interests or companion
loans, as a standard option would
introduce substantial complexity to the
rule in order to ensure that these forms
of retention were implemented in a way
that ensured that the holder had the
same economic exposure as the holder
of an ABS interest. In addition, given
the commenters’ reasons for requesting
that these options be made available, the
agencies are concerned that permitting
these types of interests to be held as
retention could raise concerns about
regulatory capital arbitrage.
The agencies do not believe it would
be appropriate to allow sponsors to
satisfy risk retention obligations through
third-party credit support, such as
insurance policies, guarantees, liquidity
facilities, or standby letters of credit. As
discussed in the reproposal, such forms
of credit support generally are not
funded at closing and therefore may not
be available to absorb losses at the time
they occur. Except in the case of the
guarantees from the Enterprises under
the conditions specified, which include
the Enterprises’ operating in
conservatorship or receivership with
capital support from the United States,
the agencies continue to believe that
unfunded forms of risk retention fail to
provide sufficient alignment of
incentives between sponsors and
investors and are not including them as
eligible forms of risk retention.
The final rule does not permit
overcollateralization as a standard
method of risk retention. While
overcollateralization may provide credit
enhancement to a securitization, the
agencies do not believe that a credit risk
retention option based solely on a
comparison of the face value 51 of the
securitized assets and the face value of
the ABS interests would provide
meaningful risk retention consistent
with the goals and intent of section 15G
because the face value of both the
securitized assets and the face value of
the ABS interests can materially differ
from their relative value and/or cost to
the sponsor.52 Moreover, the fair value

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51 The

agencies are using the term ‘‘face value’’
to mean the outstanding principal balance of a loan
or other receivable or an ABS interest and, with
respect to an asset that does not have a stated
principal balance, it means an equivalent value
measurement, such as securitization value.
52 The agencies have adopted a risk retention
option for revolving pool securitizations that relies
heavily on a comparison of the face value of the
securitized assets and the face value of the ABS
interests. However, reliance on the seller’s interest
option is limited to revolving pool securitizations
that include certain structural features and
alignment of incentives to address many of the

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of an eligible horizontal residual interest
takes into consideration the
overcollateralization and excess spread
in a securitization transaction as
adjusted by expected loss and other
factors. Further, for the reasons
discussed in Part III.B.3 of this
Supplementary Information, the final
rule does not include a representative
sample option.
As in the reproposal, the permitted
forms of risk retention in the final rule
are subject to terms and conditions that
are intended to help ensure that the
sponsor (or other eligible entity) retains
an economic exposure equivalent to 5
percent of the credit risk of the
securitized assets at a minimum. As
described below, the final rule includes
several modifications to the various
forms of risk retention, as well as the
terms and conditions that were
proposed, to help ensure that sponsors
have a meaningful stake in the overall
performance and repayment of the
assets that they securitize. Each of the
forms of risk retention permitted by the
final rule and the measures intended to
ensure that sponsors retain meaningful
credit risk are described below.
1. Standard Risk Retention
a. Structure of Standard Risk Retention
Option
Under the revised proposal, standard
risk retention could have been used by
a sponsor for any securitization
transaction.53 Standard risk retention
could have taken the form of: (i) Vertical
risk retention; (ii) horizontal risk
retention; and (iii) any combination of
vertical and horizontal risk retention.54
Under the reproposal, a sponsor would
have been permitted to satisfy its risk
retention obligation by retaining an
eligible vertical interest, an eligible
horizontal residual interest, or any
combination thereof, in a total amount
equal to no less than 5 percent of the
fair value of all ABS interests in the
issuing entity that are issued as part of
the securitization transaction.
Through the vertical option, the
reproposal would have allowed a
sponsor to satisfy its risk retention
concerns the agencies had with respect to the
reliance on face value to measure required credit
risk retention. See Part III.B.2 of this Supplementary
Information.
53 As discussed above, in the original proposal, a
sponsor using standard risk retention would have
had to choose between a 5 percent horizontal
interest, 5 percent vertical interest, or a
combination of horizontal and vertical interests that
was approximately half horizontal and half vertical.
The agencies reproposed standard risk retention
with a more flexible structure in response to
concerns raised by commenters on the original
proposal. See Revised Proposal, 78 FR at 57937.
54 See Revised Proposal, 78 FR at 57937.

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obligation with respect to a
securitization transaction by retaining at
least 5 percent of the fair value of each
class of ABS interests issued as part of
the securitization transaction. This
would provide the sponsor with an
interest in the entire securitization
transaction. As an alternative, the
reproposal would have allowed a
sponsor to satisfy its risk retention
requirement under the vertical option
by retaining a single vertical security.
As discussed in the reproposal, a single
vertical security would be an ABS
interest entitling the holder to a
specified percentage (e.g., 5 percent) of
the principal and interest paid on each
class of ABS interests in the issuing
entity (other than such single vertical
security) that result in the security
representing the same percentage of fair
value of each class of ABS interests.
Under the reproposal, a sponsor also
would have been permitted to satisfy its
risk retention obligation by retaining an
eligible horizontal residual interest in
the issuing entity in an amount equal to
no less than 5 percent of the fair value
of all ABS interests in the issuing entity
that are issued as part of the
securitization transaction. In lieu of
holding all or part of its risk retention
in the form of an eligible horizontal
residual interest, the reproposal would
have allowed a sponsor to cause to be
established and funded, in cash, a
reserve account at closing (eligible
horizontal cash reserve account) in an
amount equal to the same dollar amount
(or corresponding amount in the foreign
currency in which the ABS interests are
issued, as applicable) as would be
required if the sponsor held an eligible
horizontal residual interest.55
As reproposed, an interest would
have qualified as an eligible horizontal
residual interest only if it was an
interest in a single class or multiple
classes in the issuing entity with respect
to which, on any payment date on
which the issuing entity would have
insufficient funds to satisfy its
obligation to pay all contractual interest
or principal due, any resulting shortfall
would reduce amounts paid to the
eligible horizontal residual interest prior
to any reduction in the amounts paid to
any other ABS interest until the amount
of such ABS interest is reduced to zero.
The eligible horizontal residual interest
would have been required to have the
most subordinated claim to payments of
both principal and interest by the
issuing entity.
Many commenters generally
supported the reproposal to allow a
sponsor to meet its risk retention
55 See

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obligation by retaining an eligible
vertical residual interest, an eligible
horizontal residual interest, or any
combination of such interests. Such
commenters generally approved of the
flexibility that the reproposal would
provide to sponsors in structuring their
risk retention. Further, one commenter
expressed support for the single vertical
security option, asserting that it would
simplify compliance and monitoring
obligations of the sponsor. One
commenter, however, expressed
concern that the definition of single
vertical security could be read as though
the security could have different
percentage interests in each class and
requested that the definition be
amended to clarify that the specified
percentages must result in the fair value
of each interest in each such class being
identical.
The agencies received several
comments regarding the proposed
method by which a sponsor may satisfy
its risk retention requirement by holding
an eligible horizontal residual interest.
One commenter sought clarification as
to whether advance rates and
overcollateralization, equipment
residual values, reserve accounts and
third-party credit enhancement would
constitute eligible horizontal residual
interests. Another commenter sought
clarification as to whether the eligible
horizontal residual interest would be
required to have the most subordinated
claim to principal collections.56 Further,
one commenter expressed concern that
the eligible horizontal residual interest
option would create a conflict of interest
between the sponsor and the holders of
the other classes of securities, to the
extent that the servicer would have
control over decisions that could
optimize the value of the interest at the
expense of other tranches.
Regarding the horizontal cash reserve
account, one commenter requested that
the final rule permit a broader range of
investments to align with market
practice regarding standard investments
used for funds held in collection,
reserve and spread accounts. Another
commenter requested that the final rule
permit funds from eligible horizontal
cash reserve accounts to be used to pay
critical expenses, so long as such
expense payments are made for
specified priorities and are disclosed to
investors. The commenter further
proposed that no disclosure or
calculations should be required for such
56 In response to a similar comment, the agencies
confirm that a structure under which the interest is
at the bottom of the priority of payments provisions,
or last in line for payment, would satisfy this
requirement whether or not the interest is ‘‘legally’’
subordinated.

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payments that are senior to amounts
owed to holders of third-party ABS
interests or that are made to transaction
parties unaffiliated with the securitizer.
The agencies invited comment on
whether the rule should require a
minimum proportion of risk retention
held by a sponsor under the standard
risk retention option to be composed of
a vertical component or a horizontal
component. Further, the agencies
invited comment on whether a sponsor
should be required to hold a higher
percentage of risk retention if the
sponsor retains only an eligible vertical
interest or very little horizontal interest.
The agencies did not receive any
comments in favor of these options. One
commenter expressed opposition to any
requirement for a minimum vertical or
horizontal component, claiming that
such a requirement would increase
compliance costs and increase the risk
that sponsors would, as a result of
accounting standards, have to
consolidate securitization entities into
their financial statements. In addition,
two commenters expressed opposition
to any higher risk retention requirement
for sponsors retaining only a vertical
interest.
Several commenters expressed
opinions on the effect that the proposed
standard risk retention option would
have on decisions by sponsors regarding
whether they are obligated by
accounting standards to consolidate a
securitization vehicle into their
financial statements. Two commenters
asserted that, because of the flexibility
of the proposed standard risk retention
option, in and of itself, the option
would not cause a sponsor to have to
consolidate its securitization vehicles.
One of these commenters observed that
case-by-case analyses would be required
and that the likelihood of consolidation
would increase as a sponsor retains a
greater portion of its required interest as
a horizontal interest. Another
commenter asserted that, if potential
investors require the sponsor to hold a
horizontal rather than a vertical interest,
or a combination, the consolidation risk
will increase. This same commenter
stated that forthcoming updated
guidance from the Financial Accounting
Standards Board may modify the way
sponsors analyze their consolidation
requirements. One commenter asserted
that consolidation concerns may cause
broker-dealers to limit their secondary
market support, with respect to certain
affiliate transactions, for the duration of
the risk retention period and that such
decisions may have an effect on
secondary market liquidity. As a way of
reducing consolidation risk, one
commenter stated that securitization

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agreements should be required to give
securitization trusts the right to claim
5 percent of losses from securitizers as
they occur. Such losses, the commenter
asserted, should be held as contingent
liabilities on securitizers’ balance
sheets, against which reserves would
need to be held.
The agencies have carefully
considered comments on the reproposed
structure of the standard risk retention
option and, for the reasons discussed
below and in the reproposal, have
decided to adopt the approach as set
forth in the revised proposal with some
modifications. However, in the final
rule the agencies are adopting several
changes to the manner in which risk
retention must be measured and are
eliminating the restrictions on cash flow
to the eligible horizontal residual
interest. These changes are discussed in
Part III.B.1 of this Supplementary
Information.
Consistent with the reproposal, the
final rule allows a sponsor to satisfy its
risk retention obligation by retaining an
eligible vertical interest, an eligible
horizontal residual interest, or any
combination thereof, as long as the
percentage of the eligible vertical
interest claimed as retention under the
rule, when added to the percentage of
the fair value of the eligible horizontal
residual interest claimed as retention for
purposes of the rule equals no less than
five. The final rule does not mandate a
minimum or specific percentage of
horizontal or vertical interest that
sponsors must hold when they choose
to satisfy their risk retention obligation
by holding a combination of vertical and
horizontal interests, nor does the final
rule require sponsors to hold a higher
percentage of risk retention if the
sponsor retains only an eligible vertical
interest. The agencies added language to
the final rule clarifying that the requisite
percentage of eligible vertical interest,
eligible horizontal residual interest, or
combination thereof retained by the
sponsor must be determined as of the
closing date of the securitization
transaction.57
57 For example, a sponsor electing to hold risk
retention in the form of a combined horizontal and
vertical interest could determine the minimum
amount required to be retained pursuant to the rule
by determining the percentage of fair value
represented by the sponsor’s eligible horizontal
residual interest, and then supplementing that
amount with a vertical interest of a sufficient
percentage so that the sum of the two percentage
numbers equals five. To illustrate: If a sponsor
holds an eligible horizontal residual interest with
a fair value of 3.25 percent of the fair value of all
the ABS interests in the issuing entity, the sponsor
must also hold (at a minimum) a vertical interest
equal to 1.75 percent of each class of ABS interests
in the issuing entity. Alternatively, the sponsor may
retain a single vertical security representing 1.75

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
The final rule allows a sponsor to
satisfy its risk retention obligation under
the vertical option by retaining a portion
of each class of the ABS interests issued
in the transaction or a single vertical
security which represents an interest in
each class of the ABS interests issued in
the securitization. The rule specifies the
minimum retention to be held by a
sponsor. As such, the fact that
provisions such as the definition of
eligible vertical interest and single
vertical security require the sponsor to
hold the same proportion of or interest
in each class of ABS interests does not
preclude the sponsor from holding
different proportions of or in each class.
However, it does preclude the sponsor
from claiming risk retention credit
under the rule for any proportional
interest in a class that is not the same
across all classes. For example, a
sponsor which holds a vertical interest
of 5 percent of the most junior class and
3 percent of all other classes issued by
the entity can only claim credit for a
3 percent vertical interest.
A sponsor choosing to satisfy its
retention obligation solely through the
retention of an interest in each class of
ABS interest issued will be required to
retain at least 5 percent of each class of
ABS interests issued as part of the
securitization transaction. A sponsor
using this approach will be required to
retain at least 5 percent of each class of
ABS interests issued in the
securitization transaction regardless of
the nature of the class of ABS interests
(e.g., senior or subordinated) and
regardless of whether the class of
interests has a face or par value, was
issued in certificated form, or was sold
to unaffiliated investors. For example, if
four classes of ABS interests are issued
by an issuing entity as part of a
securitization—a senior-rated class, a
subordinated class, an interest-only
class, and a residual interest—a sponsor
using this approach with respect to the
transaction will have to retain at least
5 percent of each such class or interest.
If a class of interests has no face value,
the sponsor will have to hold an interest
in 5 percent of the cash flows paid on
that class.
If a sponsor opts to satisfy its risk
retention requirement solely by
retaining a single vertical security, that
ABS interest must entitle the holder to
5 percent of the cash flows paid on each
class of ABS interests in the issuing
entity (other than such single vertical
security). This will provide sponsors an
percent of the cash flows paid on each class of ABS
interests in the issuing entity (other than the single
vertical security itself). The rule does not prohibit
the sponsor from retaining additional amounts of
horizontal interests, vertical interests, or both.

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option that is simpler than carrying
multiple securities representing a
percentage share of every series,
tranche, and class issued by the issuing
entity, each of which might need to be
valued by the sponsor on its financial
statements every financial reporting
period. The single vertical security
option will provide the sponsor with the
same principal and interest payments
(and losses) as a 5 percent ownership of
each series, class, or tranche of the
securitization, in the form of one
security to be held on the sponsor’s
books.
Also consistent with the revised
proposal, the final rule allows a sponsor
to satisfy its risk retention obligation
exclusively through the horizontal
option by retaining a first loss eligible
horizontal residual interest in the
issuing entity in an amount equal to no
less than 5 percent of the fair value of
all ABS interests in the issuing entity
that are issued as part of the
securitization transaction. The eligible
horizontal residual interest may consist
of either a single class or multiple
classes in the issuing entity, provided
that each interest qualifies, individually
or in the aggregate, as an eligible
horizontal residual interest.58 In the
case of multiple classes, this
requirement will mean that the classes
must be in consecutive order based on
subordination level. For example, if
there are three levels of subordinated
classes and the two most subordinated
classes have a combined fair value equal
to 5 percent of all ABS interests, the
sponsor will be required to retain these
two most subordinated classes if it is
going to satisfy its risk retention
obligation by holding only eligible
horizontal residual interests.
In lieu of holding all or part of its risk
retention in the form of an eligible
horizontal residual interest, the final
rule will allow a sponsor to cause to be
established and funded, in cash, an
eligible horizontal cash reserve account,
at closing, in an amount equal to the
same dollar amount (or corresponding
amount in the foreign currency in which
the ABS interests are issued, as
applicable) as would be required if the
sponsor held an eligible horizontal
residual interest. As described in the
reproposal, the eligible horizontal cash
reserve account will have to be held by
a trustee (or person performing
functions similar to a trustee) for the
benefit of the issuing entity. Consistent
with the reproposal, the final rule
includes several important restrictions
and limitations on the eligible
58 See section 2 of the final rule (definition of
‘‘eligible horizontal residual interest’’).

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horizontal cash reserve account to
ensure that a sponsor that establishes an
eligible horizontal cash reserve account
will be exposed to the same amount and
type of credit risk on the securitized
assets as would be the case if the
sponsor held an eligible horizontal
residual interest. The intention of these
restrictions is to ensure amounts in the
account would be available to absorb
losses to the same extent as an eligible
horizontal residual interest. Therefore,
investments of funds in the account and
uses of the account are limited. The
agencies are not following commenters’
suggestion to broaden the range of
permissible investments of funds in the
horizontal cash reserve account because
that could undermine the capacity of
the account to absorb losses as they
occur to the same extent as an eligible
horizontal residual interest. Any use of
funds other than loss coverage could
result in fewer funds to absorb losses
later. The types of permissible
investments likewise are restricted to
cash and cash equivalents in order to
ensure that the account will not incur
investment losses and reduce the
capacity of the account to absorb losses
of the securitization transaction. The
agencies view ‘‘cash equivalents’’ to
mean high-quality, highly-liquid shortterm investments the maturity of which
corresponds to the securitization’s
expected maturity or potential need for
funds and that are denominated in a
currency that corresponds to either the
securitized assets or the ABS interests.
Depending on the specific funding
needs of a particular securitization,
‘‘cash equivalents’’ might include
deposits insured by the FDIC,
certificates of deposit issued by a
regulated U.S. financial institution,
obligations backed by the full faith and
credit of the United States, investments
in registered money market funds, and
commercial paper. For securitization
transactions whose securitized assets or
ABS interests are denominated in a
foreign currency, cash equivalents
would include cash equivalents
denominated in the foreign currency.
The agencies believe that the permitted
investment options provide sufficient
flexibility to sponsors that choose to
create an eligible horizontal cash reserve
account, while ensuring that such
sponsors will be exposed to the same
amount and type of credit risk as would
be the case if the sponsor held an
eligible horizontal residual interest.
In response to commenter concerns,
the agencies believe that it would not
violate the requirements of the eligible
horizontal cash reserve account if as a
result of a shortfall in the available cash

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flow, critical expenses of the trust
unrelated to credit risk, such as
litigation expenses or trustee or servicer
expenses, are paid from an eligible
horizontal cash reserve account, so long
as such payments, in the absence of
available funds in the eligible horizontal
cash reserve account, would be paid
prior to any payments to holders of ABS
interests and such payments are made to
parties that are not affiliated with the
sponsor.
The agencies believe the standard risk
retention option, as adopted, provides
sponsors with flexibility in choosing
how to structure their retention of credit
risk in a manner that is compatible with
current practices in the securitization
markets. For example, in securitization
transactions where the sponsor would
typically retain less than 5 percent of an
eligible horizontal residual interest, the
standard risk retention option will
permit the sponsor to hold the balance
of the risk retention as a vertical
interest. Each sponsor will have to
separately analyze whether the
particular option the sponsor selects
under the rule requires the sponsor to
consolidate the assets and liabilities of
a securitization vehicle onto its own
balance sheet for accounting purposes.
The rule itself does not provide
guidance on performing the
consolidation analysis, either in support
of deconsolidation or in requirement of
consolidation.
b. Risk Retention Measurement and
Disclosures
As explained in the revised proposal,
to provide greater clarity for the
measurement of risk retention and to
help prevent sponsors from structuring
around their risk retention requirement
by negating or reducing the economic
exposure they are required to maintain,
the agencies proposed to require
sponsors to measure their risk retention
requirement using fair valuation
methodologies acceptable under
GAAP.59
Several commenters supported the
proposed requirement that sponsors
measure their risk retention requirement
using fair value. These commenters
expressed the view that the use of fair
value would be a more prudent
approach than using face value and
would be consistent with market
practice. Other commenters, however,
expressed general concern with the
proposed method by which sponsors
would be required to measure their risk
retention. One commenter asserted that
59 Cf. Financial Accounting Standards Board,
Accounting Standards Codification Topic 820—Fair
Value Measurement.

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using fair value instead of face value
would require sponsors to hold higher
risk retention levels and attract
additional investor capital, leading to
higher borrowing costs. Two
commenters explained that many
sponsors who consolidate their issuing
entities or keep their securitizations on
their balance sheets do not currently
utilize fair value calculations, and that
requiring such sponsors to measure
their risk retention with fair value
would create significant burden and
expense.
Commenters expressed several
specific accounting concerns regarding
the use of fair value to measure risk
retention. Two commenters asserted
that calculation of fair value under
GAAP is not designed to provide a
definitive value, but a range of values.
In this regard, they expressed concerns
about how the requirements could be
met if a sponsor calculates multiple
possible fair values. One commenter
asserted that requiring sponsors to
determine fair value in accordance with
GAAP would be burdensome for
securitization transactions where the
sponsor (or other retaining entity) is
established outside the United States,
giving rise to additional work and costs.
For such transactions, the commenter
urged the agencies to allow sponsors to
measure fair value using local (nonU.S.) GAAP or International Financial
Reporting Standards (IFRS). One
commenter asserted that GAAP does not
prescribe use of a single valuation
technique, but allows entities to use
various techniques, including market,
income and cost approaches. The
commenter stated, however, that the
reproposal implied that sponsors would
be limited to specific valuation
techniques and requested that the final
rule clarify that sponsors are not so
restricted. The commenter also asserted
that the reproposal equated intrinsic
value with fair value, which are distinct
standards of value. In this regard, the
commenter stated that reference to
intrinsic value should either be
excluded from the final rule or the
agencies should clarify that intrinsic
and fair value are two separate concepts.
The agencies invited comment in the
reproposal on whether accountants
would be asked to perform agreed upon
procedures reports related to
measurement of the fair value of
sponsors’ retained ABS interests. One
commenter responded that such
requests would be unlikely and
requested that the agencies not mandate
agreed upon procedures in the final
rule.
One commenter stated that sponsors
should be permitted to measure their

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risk retention requirement by using
either fair value or securitization value
(the value specified in the operative
documents for the securitization
transaction, subject to certain
limitations) methodology. The
commenter stated that securitization
value is familiar to sponsors and
investors, and permitting its use would
accommodate a range of current
industry practices. The commenter also
stated that securitization value would be
easier to compute than fair value.
One commenter asserted that any
required risk retention amount for ABCP
conduits should be calculated by
reference to the principal balance, and
not the fair value, of the ABS interests
and asserted that using fair value will be
difficult, expensive and unnecessary,
especially given the revolving nature of
the asset pool. Commenters also
requested clarification as to whether,
when they are calculating the fair value
with respect to revolving pool of assets,
they can make static pool assumptions.
Having considered the comments
described above, the agencies are
adopting a fair value framework
substantially similar to the reproposal
for calculating eligible horizontal
residual interests in the final rule. As
discussed in the reproposal, this
measurement uses methods consistent
with valuation methodologies familiar
to market participants and provides a
consistent framework for calculating
residual risk retention across different
securitization transactions. It also takes
into account various economic factors
that may affect the securitization
transaction, which should aid investors
in assessing the degree to which a
sponsor is exposed to the risk of the
securitized assets. As discussed below,
in response to commenters the agencies
are not adopting the proposed fair value
measurement requirement for eligible
vertical interests because such
measurement is not necessary to ensure
that the sponsor has retained 5 percent
of the credit risk of the ABS interests
issued.
Consistent with the reproposal, the
agencies are not modifying the final rule
to allow for calculation of fair value
using the fair value measurement
framework under local GAAP or IFRS
for securitization transactions where the
sponsor is established outside the
United States. The agencies believe that,
as of the time the final rule is adopted,
these alternative valuation frameworks
and GAAP have common requirements
for measuring fair value, which should
minimize the burden to sponsors
established outside the United States of
measuring fair value using the GAAP
framework. The agencies believe that

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the benefits of being able to easily
compare the fair value of risk retention
in two separate issuances of ABS
interests regardless of where the
sponsors are established outweigh any
minimal burden imposed by the
requirement to use GAAP fair value.
In response to commenters’ concerns
about the burden of repeatedly
calculating fair value for a constantly
changing pool of securitized assets, the
agencies believe that no change to the
reproposed rule is required. Under the
final rule, only those securitization
transactions in which the issuing entity
issues ABS interests more than once
need to calculate the fair value of the
eligible horizontal residual interest
multiple times. The final rule provides
specific risk retention options for most
sponsors of securitizations that issue
multiple series of ABS interests,
including revolving pool securitizations,
tender option bond programs and ABCP
conduits. The agencies also note that
those securitization structures which
issue ABS interests on a frequent basis,
primarily ABCP conduits and tender
option bond programs, typically issue
short-term securities for which the fair
value calculation should be less
complex. The agencies are clarifying
that, to the extent that a sponsor uses a
valuation methodology that calculates
fair value based on the pool of
securitized assets as of a certain date,
the sponsor of a securitization of a
revolving or dynamic pool of securitized
assets would be able to calculate the fair
value of the ABS interests using data
with respect to the securitized assets as
of a cut-off date or similar date, as
described below, which the agencies
believe should alleviate some of the
concerns expressed by commenters
about the burden of repeatedly
calculating the fair value of the ABS
interests issued. The agencies believe
that this approach appropriately
balances commenters’ concerns with the
agencies’ policy goals of providing
appropriate transparency into a
sponsor’s calculation of the fair value of
ABS interests under the final rule.
Additionally, the agencies have
concerns that the alternative suggested
by commenters of calculating fair value
no more than once per month would
create unintended consequences. For
instance, the calculation of fair value of
ABS interests up to a month before the
issuance of those ABS interests or up to
a month after the issuance of those ABS
interests could result in disclosure to
investors based on unreliable
assumptions about pricing and the
expected volume of ABS interests to be
issued and possibly the issuance of ABS

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interests in violation of the sponsor’s
risk retention requirements.
Under the final rule, to the extent a
sponsor uses a valuation methodology
that calculates fair value based on the
pool of securitized assets as of a certain
date, a sponsor would be permitted to
use a cut-off date for establishing the
composition and characteristics of the
pool of securitized assets collateralizing
the asset-backed securities (or similar
date) that is not more than 60 days prior
to the date of first use of the fair value
calculation with investors, except in the
case of a securitization transaction that
makes distributions to investors on a
quarterly or less frequent basis, in
which case the sponsor may use a cutoff date or similar date not more than
135 days prior to the date of first use of
the fair value calculation with
investors.60 The final rule requires that
disclosures to investors be based on
information about the asset pool (such
as the characteristics of and
assumptions regarding the pool that will
be used to determine fair value) as of the
cut-off date or similar date specified by
the sponsor. The actual balance of the
securitized assets (and the calculation of
fair value) may include anticipated
additions to and removals of assets that
the sponsor will make between the cutoff date or similar date and the closing
date. For purposes of the fair value
calculation, the ABS interests must
include all ABS interests issued prior to,
and expected to be issued in, the
pending offering of ABS interests.61 The
agencies believe this will accommodate
the reporting described by commenters
and the evaluation of pool assets
suggested by commenters with respect
to fair value calculations. The agencies
recognize that not all securitization
transactions update information about
securitized assets on a monthly basis.
The final rule permits sponsors to rely
on information about the securitized
assets based on a date not more than 135
days prior to the date of first use with
investors for subsequent issuances of
ABS interests by the same issuing entity
with the same sponsor for which the
securitization transaction distributes
amounts to investors on a quarterly or
less frequent basis.62
60 The agencies expect that a sponsor will include
disclosure about the cut-off date as an aspect of the
fair valuation methodology it used.
61 The sponsor may include adjustments to the
balance of ABS interests that are expected to occur
in the ordinary course of events, such as scheduled
principal reductions and planned issuances
expected to occur after the pending offering of ABS
interests.
62 The 135-day period provides sponsors with
approximately 45 days after the end of any quarter
in which to provide the required information to
investors if the issuing entity makes distributions to

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As discussed in the reproposal, fair
value is a measurement framework that
requires an extensive use of judgment
for certain types of financial
instruments, for which significant
unobservable inputs are necessary to
determine their fair value. To provide
transparency to investors, regulators and
others on how the sponsor calculates
fair value in order to determine its
eligible horizontal residual interest, and
to ensure that this calculation
adequately reflects the amount of a
sponsor’s economic ‘‘skin in the game,’’
the agencies proposed to require
disclosure of the sponsor’s fair value
methodology and all significant inputs
used to measure its eligible horizontal
residual interest. Under the reproposal,
sponsors that elected to utilize the
horizontal risk retention option would
have been required to disclose the
reference data set or other historical
information used to develop the key
inputs and assumptions intended to
meaningfully inform third parties of the
reasonableness of the key cash flow
assumptions underlying the measure of
fair value. Such key assumptions could
include default, prepayment, and
recovery. As discussed in the
reproposal, the agencies believed that
these valuation inputs would help
investors assess whether the fair value
measure used by the sponsor to
determine the amount of its risk
retention is comparable to investors’
expectations.
Specifically, with respect to eligible
horizontal residual interests, the
reproposal would have required that
sponsors provide (or cause to be
provided) to potential investors a
reasonable time prior to the sale of ABS
interests in the issuing entity and, upon
request, to the Commission and its
appropriate Federal banking agency (if
any) disclosure of:
• The fair value (expressed as a
percentage of the fair value of all ABS
interests issued in the securitization
transaction and dollar amount (or
corresponding amount in the foreign
currency in which the ABS interests are
issued, as applicable)) of the eligible
horizontal residual interest that would
be retained (or was retained) by the
sponsor at closing, and the fair value
(expressed as a percentage of the fair
value of all ABS interests issued in the
securitization transaction and dollar
amount (or corresponding amount in the
foreign currency in which the ABS
interests are issued, as applicable)) of
investors no more frequently than quarterly. This
period parallels timeframes for prospectus and
static pool information under Regulation AB. See
Items 1104 and 1105 of Regulation AB.

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the eligible horizontal residual interest
required to be retained by the sponsor
in connection with the securitization
transaction;
• A description of the material terms
of the eligible horizontal residual
interest to be retained by the sponsor;
• A description of the methodology
used to calculate the fair value of all
classes of ABS interests;
• The key inputs and assumptions
used in measuring the total fair value of
all classes of ABS interests and the fair
value of the eligible horizontal residual
interest retained by the sponsor
(including the range of information
considered in arriving at such key
inputs and assumptions and an
indication of the weight ascribed
thereto) and the sponsor’s technique(s)
to derive the key inputs; and
• The historical data that would
enable investors and other stakeholders
to assess the reasonableness of the key
cash flow assumptions underlying the
fair value of the eligible horizontal
residual interest. Examples of key cash
flow assumptions may include default,
prepayment, and recovery.
The agencies received significant
comment on the proposed disclosure
requirements with respect to the eligible
horizontal residual interest, particularly
regarding the proposed timing of
disclosures and fair value calculations.
Commenters expressed a number of
concerns regarding the pre-sale
disclosure requirement. Several
commenters stated that there is an
inherent conflict between the proposed
requirement that fair value disclosures
be made a reasonable time prior to the
sale of ABS interests and the
requirement that fair value be
determined as of the day on which the
price of the ABS interests to be sold to
third parties is determined. Further,
several commenters asserted that the
most objective and accurate way to
calculate fair value is to base the
valuation on an observable market price,
but this option is unavailable to
sponsors in advance of pricing. In order
to comply with the pre-sale disclosure
requirement, they contended that
sponsors would be required to make
material assumptions, based on less
reliable secondary sources, regarding
interest, default, recovery and
prepayment rates, as well as timing of
reinvestments for revolving pools. Doing
so, they asserted, would often result in
differences between the pre-sale and
final fair value and would confuse
investors.
One commenter raised a concern
about the proposed requirement that fair
value be calculated as of the day on
which the price of ABS interests sold to

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third-party investors is determined. The
commenter, asserting that pricing for
different classes in single-securitization
transactions often occurs on different
days, urged the agencies to clarify that
the determination of fair value should
be done for all classes of asset-backed
securities at a single time after a
specified percentage threshold of classes
of asset-backed securities have priced.
As a proposed solution to the timing
concerns summarized above, two
commenters recommended that the final
rule should require fair value
determinations to be made after pricing
but before closing of the transaction.
The commenters stated that this would
allow sponsors to more accurately
determine fair value based on pricing of
the securitization transaction. The
commenters further stated that sponsors
could still be required to disclose the
expected form of risk retention prior to
sale, but they should only be required
to determine the fair value of those
interests shortly after pricing.
In addition to timing concerns, many
commenters expressed concerns about
the proposed requirement that sponsors
disclose the key inputs and assumptions
used in measuring fair value and the
sponsor’s technique(s) used to derive
the key inputs. Two commenters
specifically stated that requiring such
disclosures may mislead investors by
making such inputs and assumptions
seem authoritative. Further, several
commenters asserted that the proposal
would require sponsors to disclose
information that is proprietary, highly
confidential and commercially
sensitive. Such information, they
contended, could be used by third
parties to the competitive disadvantage
of the sponsor. One commenter raised
specific concerns regarding the
disclosure of reference data sets, noting
that disclosure of such information
could allow the reverse-engineering of
proprietary models.
While two commenters expressed
support for the reproposal’s
requirements that sponsors disclose the
various components that were used to
make fair value determinations, many
others requested significant
modifications to the disclosure
requirements. Several commenters
asserted that the rule should only
require a simple disclosure to the effect
that risk retention has been measured as
required by the final rule. Several
commenters stated that sponsors should
only be required to make disclosures to
the Commission and banking agencies,
rather than to investors. Two such
commenters proposed that issuers
should be required to retain the
documentation about assumptions and

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methodology used in calculating their
risk retention obligations for a specified
period of time and make such
information available for inspection by
the Commission and banking agencies,
if requested. Further, one commenter
proposed that sponsors should only be
required to provide the agencies with a
post-securitization fair value report
within a reasonable time after the issue
date.
Significant concern was raised
regarding potential liability and
litigation that commenters stated may
result when fair value projections,
assumptions and calculations disclosed
to investors turn out to be incorrect. A
few commenters expressed the view that
liability risk would be particularly high
from incorrect loss projections. Several
commenters asserted that litigation risks
may undermine the horizontal option by
convincing many sponsors to rely
instead on the vertical option. Another
commenter asserted such concerns may
convince sponsors to hold risk retention
closer to the 5 percent minimum than
they otherwise would because it is
easier to demonstrate that a projected 5
percent risk retention would be
accomplished than it would be for a
larger percentage. Several commenters
urged the agencies to provide a safe
harbor from liability for all fair value
calculations, which would protect
sponsors as long as the methodology
and assumptions used to make such
calculations are reasonable and made in
good faith.
Two commenters proposed that for
simple structures, sponsors should not
be required to make fair value
determinations or related disclosures,
nor should the cash flow restriction (as
described below) apply. The
commenters requested that such relief
be provided to structures with the
following characteristics: (1) The
principal amount of the ABS interests
sold to third parties is less than 95
percent of the principal amount of the
securitized assets (and, in the case of
pre-funded transactions, any cash held
in a pre-funded account); (2) the
weighted average interest rate (for
leases, the implicit interest rate used to
calculate the lease payments) on the
securitized assets (or the discount rate
in the case of a securitization value
calculation) is not expected to be less
than the time-weighted average interest
rate on the ABS interests sold to third
parties (for revolving and pre-funded
transactions, this condition would be
satisfied upon the completion of each
addition of additional assets); (3) all of
the ABS interests sold to third parties
are traditional interest-bearing debt
securities; and (4) the residual interest

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
retained by the sponsor or other holder
of a retained interest otherwise meets
the requirements of an eligible
horizontal residual interest.
The agencies have carefully
considered the concerns of commenters
with respect to the proposed disclosure
requirements related to the fair value
calculation of eligible horizontal
residual interests. The agencies
continue to believe that it is important
to the functioning of the final rule to
ensure that investors and the markets, as
well as regulators, are provided with
key information about the methodology
and assumptions used by sponsors
under the final rule to calculate the
amount of their eligible horizontal
residual interests using the fair value
measurement framework under GAAP.
As the agencies have previously
observed, fair value is a measurement
framework that for certain types of
instruments requires an extensive use of
judgment. In situations where
significant unobservable inputs are used
to determine fair value, disclosures of
those assumptions are necessary to
enable investors to effectively evaluate
the fair value calculation. Therefore, the
agencies are generally retaining the
proposed fair value disclosure
requirements with some modifications
in response to commenter concerns, as
further discussed below.
The agencies have considered the
concerns raised by commenters about
the potential conflict between pre-sale
disclosure and timing of the fair value
measurement. The agencies believe that
it is important that investors be
provided with information that would
allow them to better evaluate how
sponsors will measure the fair value of
the eligible horizontal residual interest
to be retained and that such information
be provided prior to the investor’s
investment decision. The final rule
continues to require certain fair value
disclosures to be provided to investors
a reasonable period of time prior to the
sale of an asset-backed security.
Nonetheless, the agencies recognize that
any valuation information given prior to
sale may often be preliminary.
Therefore, the agencies have revised the
final rule to address these concerns. The
final rule allows sponsors, for
disclosures provided prior to sale, to
disclose the sponsor’s determination of
a range of fair values for the eligible
horizontal residual interest that the
sponsor expects to retain at the close of
the securitization transaction. Under the
final rule, a sponsor may provide a
range of fair values for the eligible
horizontal residual interest only if the
specific prices, sizes or rates of interest
of each tranche of the securitization are

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not available. Additionally, this range of
fair values must be based on a range of
bona fide estimates or specified prices,
sizes, or rates of interest of each tranche
of the securitization. The agencies note
that in practice this will allow the
sponsor to provide fair value disclosures
based on the pricing guidance
traditionally provided to investors prior
to sale.63 The sponsor must also disclose
the method by which it determined any
range of bona fide estimates or specified
prices, tranche sizes or rates of interest.
The final rule also requires the
sponsor to provide to investors a
reasonable time after the closing of the
securitization transaction the actual fair
value measurement of the ABS interests
and the eligible horizontal residual
interest that the sponsor is required to
retain, expressed as a dollar amount and
percentage. This post-closing disclosure
must be based on actual sale prices and
finalized tranche sizes and
corresponding interest rates at the
closing of the securitization transaction.
The agencies continue to believe that
the fair value of the eligible horizontal
residual interest held by the sponsor as
calculated post-closing must not be less
than the amount required under the rule
to be held by the sponsor. Although
commenters expressed some concern
about possible adjustments to the
transaction occurring prior to closing
that may impact the fair value of the
eligible horizontal residual interest, the
agencies expect that, if necessary, as
part of the pricing process, the sponsor
will make adjustments to tranche sizes,
increase the percentage of vertical
interest retained by the sponsor, or
otherwise take actions to ensure that the
actual fair value of the eligible
horizontal residual interest held by the
sponsor satisfies the sponsor’s risk
retention obligations.
The sponsor also must disclose at that
time any material differences between
the inputs and assumptions that had
been disclosed by the sponsor to
potential investors prior to sale (as
required by the final rule) and the actual
methodology, inputs, and assumptions
used by the sponsor to measure fair
value for purposes of the final rule. The
agencies believe that this bifurcated
63 The agencies expect that the range of bona fide
estimates or specified prices, tranche sizes or rates
of interest should be reasonably narrow, reflecting
then current market conditions and the relationship
between the sponsor’s range of bona fide estimates
or specified prices, tranche sizes or rates of interest
and the historical data or other information used to
derive the range of bona fide estimates or specified
prices, tranche sizes or rates of interest. The
agencies also expect that in most instances the
range of assumed sale prices and tranche sizes will
correspond closely to any pricing guidance
provided to potential purchasers prior to sale.

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77619

approach to the timing of disclosures, as
well as clarification that the pre-closing
disclosures are based on a sponsor’s
range of bona fide estimates or specified
prices, tranche sizes or rates of interest
with relation to the fair value
measurement of the ABS interests,
should effectively balance the benefits
investors and others receive from the
disclosures against the concerns of
sponsors.
The final rule generally retains the
proposed requirement that the sponsor
disclose a description of the
methodology it uses to measure the fair
value of the ABS interests and its
eligible horizontal residual interest. For
example, under the final rule sponsors
are required to disclose the valuation
methodology the sponsor used to
determine fair value, such as discounted
cash flow analysis, comparable market
data, vendor pricing, or internal-model
based analysis.
As discussed above, a number of
commenters expressed concern about
heightened legal risk and other risks due
to the proposed requirement to disclose
quantitative information about key
inputs and assumptions, and various
commenters requested that the agencies
not require these disclosures to be
provided to investors. The agencies
continue to believe that disclosure of
descriptive information with respect to
key inputs and assumptions used in fair
value measurement is important for
helping investors to assess whether the
fair value measure used by the sponsor
to determine its eligible horizontal
residual interest is comparable to
market expectations. However, in
response to commenter concerns, the
agencies are modifying these
requirements to take into account the
preliminary and estimated nature of
pricing information that may need to be
used to calculate fair value prior to the
sale of an asset-backed security.
The agencies believe that the
disclosure required by the accounting
standards that gives investors and others
an understanding of how companies
measure fair value is also pertinent to
investors’ and regulators’ understanding
how sponsors calculate the fair value of
their eligible horizontal residual
interests under the rule. Therefore, the
final rule requires that the sponsor
disclose, at a minimum, a description of
all the inputs and assumptions it uses
to calculate the fair value of the ABS
interests and its eligible horizontal
residual interest, including, as
applicable and relevant to the
calculation, disclosures on discount
rates, loss given default (recovery rates),
prepayment rates, default rates, the lag
time between default and recovery, and

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the basis of forward interest rates used.
The agencies have not prescribed the
exact format of the description of key
inputs and assumptions that sponsors
are required to provide under the final
rule. The agencies expect that the format
of the required description will be
tailored to the key inputs and
assumptions and the reference data sets
or other historical information
underlying those key inputs and
assumptions being described. The
agencies believe that the descriptions
may be disclosed in quantitative or
narrative form or in a graphical or
tabular format, as appropriate.
The sponsor is required to provide
descriptions of all inputs and
assumptions that either could have a
material impact on the fair value
calculation or would be material to a
prospective investor’s ability to evaluate
the sponsor’s fair value calculations.
The required description of the material
terms of the eligible horizontal residual
interest to be retained by the sponsor
should include a description of the rate
of interest and other payment terms,
including contractually pre-determined
events that would reasonably be likely
to result in a materially disproportionate
payment of principal to the holder of
the residual interest, as well as any
reductions in overcollateralization. To
the extent the required disclosure
includes a description of a curve or
curves in connection with the sponsor’s
fair value calculations, the sponsor must
disclose a description of the
methodology that was used to derive
each curve and a description of any
aspects or features of each curve that
could materially impact the fair value
calculation or the ability of a
prospective investor to evaluate the
sponsor’s fair value calculation. The
agencies expect that a description of the
material aspects of a curve would
include any aspects of the curve that
could be reasonably expected to have a
material impact on the timing and
amounts of distributions expected to be
paid to the holder of the eligible
horizontal residual interest (or released
from the eligible horizontal cash reserve
account).
For example, if the sponsor uses
curves with respect to certain key inputs
and assumptions in the fair value
calculations, the agencies expect that
the description of those key inputs and
assumptions would not assume straight
lines (e.g., zero-loss assumptions). As a
further example, if the sponsor uses a
prepayment curve to calculate the fair
value of the ABS interests and its
eligible horizontal residual interest for a
residential mortgage securitization
transaction, the disclosure might

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indicate that estimated annual
prepayments are expected to range from
X percent to Y percent, notably
increasing after 36 months of
amortization and peaking after 84
months of amortization. Furthermore, to
the extent the inputs and assumptions
are observable and based on market
prices or other public information, the
sponsor should disclose those inputs
and assumptions or their source in order
to fulfill its requirement under the final
rule.
The post-closing fair value disclosure,
which is required a reasonable time
after the closing, obligates the sponsor
to disclose any material differences
between the range of bona fide estimates
or specified prices, tranche sizes or rates
of interests disclosed previously, as the
case may be, and the actual prices,
tranche sizes or rates of interest used by
the sponsor in its calculation of the fair
value under the rule for the ABS
interests sold at closing. This permits
sponsors to use the actual pricing of the
ABS interests as the basis for their final
disclosure requirement, which
addresses certain of the concerns raised
by commenters discussed above.
The agencies believe that the
revisions made to the rule appropriately
balance the agencies’ concerns that fair
value disclosure requirements
adequately allow an investor to analyze
the amount of a sponsor’s economic
‘‘skin in the game’’ with commenters’
concerns about the level of detail
required by the fair value disclosure
requirements.
The agencies observe that financial
companies commonly provide company
or portfolio-level disclosure in their
financial statements about estimated
ranges (and weighted averages) for
certain inputs, such as interest rates and
prepayment rates. Furthermore,
sponsors of recent publicly-offered
securitization transactions have
disclosed modeling assumptions for
prepayment rates based on the
characteristics of securitized loans. The
agencies believe that the disclosures
required under the final rule are similar
in nature, albeit more detailed, than
these public disclosures already being
made for financial reporting and similar
purposes. The agencies understand that
some types of inputs and assumptions
have generally not been publicly
disclosed, and that most sponsors have
disclosed certain inputs at the balance
sheet or portfolio level for different
types of assets, with varying degrees of
granularity that have generally not
included disclosures for individual
transactions. However, the agencies
observe that some of the concerns that
commenters have raised about potential

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liability for disclosure of inputs and
assumptions at the transactional level
could also be pertinent at the portfolio
level if the inputs and assumptions were
later proved incorrect. Furthermore, the
agencies believe that the modifications
to the disclosure requirement that
permit the sponsor to disclose a range
of fair values based on assumptions
about pricing, appropriately balances
commenters’ concerns with the
agencies’ policy goals of providing
appropriate transparency into a
sponsor’s calculation of the fair value of
ABS interests and eligible horizontal
residual interest under the final rule. In
response to commenters’ concerns about
the proposed requirement to disclose
the reference data set or other historical
information used to develop the key
inputs and assumptions used in the fair
value measurement of the ABS interests,
the agencies have modified significantly
that requirement in the final rule. The
agencies understand there may be
significant legal concerns with
disclosing this data, including the
proprietary nature and value of the data
and contractual restrictions with respect
to disclosure when the data is provided
by third parties. The agencies believe
that investors may in many cases
independently obtain representative
data sets for evaluating the ABS
interests offered for purposes of
evaluating the sponsor’s fair value
measurement, including the disclosures
on the sponsor’s inputs and
assumptions required by the final rule
and described above.
The final rule requires that the
sponsor provide a summary description
of the reference data set or other
historical information used to develop
the key inputs and assumptions used in
the sponsor’s calculation of the fair
value of the ABS interests, including
loss given default and default rates. This
disclosure should meaningfully inform
third parties of the reasonableness of the
key cash flow assumptions underlying
the sponsor’s measurement of fair value.
Relevant information may include the
number of data points, the time period
covered by the data set, the identity of
the party that collected the data, the
purpose for which the data was
collected and, if the data is publicly
available, how the data may be
accessed. The agencies believe that this
represents an appropriate balance
between the information required for an
investor to evaluate the sponsor’s fair
value disclosure and commenter’s
concerns about the disclosure of the
reference data set or other historical
information. In response to commenters’
requests that the agencies provide a safe

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
harbor from liability for all fair value
calculations, as long as the methodology
and assumptions used to make such
calculations are reasonable and made in
good faith, the agencies do not believe
a new safe harbor is necessary. The final
rule does not alter any existing antifraud
liability provisions of the Federal
securities laws. Furthermore, sponsors
may provide additional disclosure to
take advantage of the existing safe
harbor for forward-looking statements
under section 27A of the Securities
Act,64 if applicable, and the ‘‘bespeaks
caution’’ defense developed through
case law.65
To this end, the sponsor should
consider carefully the disclosure
requirements under the Federal
securities laws. The sponsor should be
cognizant of surrounding disclosure and
should determine if the disclosure of
such fair value methodology and related
assumptions requires additional
statements or information.66
To the extent the assumptions made
in connection with the methodology
used to measure fair value are not
entirely consistent with other disclosure
regarding the securitization structure
and the transaction parties, the sponsor
may need to include additional
statements or information that reduce
the potential confusion among
investors. Alternatively, to the extent
allowed under the fair value
measurement framework under GAAP, a
sponsor could use a methodology and
assumptions that are more consistent
with the sponsor’s other disclosures
regarding the securitization structure
and the transaction parties.
The agencies did not provide an
option for ‘‘simple structures’’ based on
the face value of the securitized assets
and the face value of the ABS interests.
The agencies believe that the face value
of both the securitized assets and the
face value of the ABS interests do not
necessarily reflect the actual value of
the securitized assets or the ABS
interests, respectively. For certain assets
such as leases, the ‘‘face value’’ of the
underlying assets is a number calculated
solely for purposes of the securitization
transaction and the calculation involves
64 See

15 U.S.C. 77z–2.
e.g., Polin v. Conductron Corp., 552 F.2d
797, 806 n.28 (8th Cir. 1977); Luce v. Edelstein, 802
F.2d 49, 56 (2d Cir. 1986); In re Donald J. Trump
Casino Sec. Litig., 7 F.3d 357, 364 (3d Cir. 1993);
P. Stolz Family P’ship L.P. v. Daum, 355 F.3d 92,
96–97 (2d Cir. 2004); and Iowa Pub. Emps.’ Ret. Sys.
v. MF Global Ltd., 620 F.3d 137, 141–142 (2d Cir.
2010).
66 See, e.g., Rule 408 under the Securities Act;
Sections 11, 12(a)(2) and 17(a) of the Securities Act;
Section 10(b) of the Exchange Act; Rule 10b–5
under the Exchange Act; and Rule 12b–20 under the
Exchange Act.

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65 See,

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many of the inputs and assumptions
discussed above in relation to fair value.
The face value of certain ABS interests
such as the CMBS B-piece does not
reflect the substantial discount to face
value at which such ABS interests are
often sold to investors. As the face value
of both the securitized assets and the
face value of the ABS interests can
materially differ from their relative
value and cost to the sponsor, the
agencies do not believe that a credit risk
retention option based solely on a
comparison of the face value of the
underlying assets and the face value of
the ABS interests would provide
meaningful risk retention consistent
with the goals and intent of section
15G.67
In addition to the measurement and
disclosure requirements applicable to
eligible horizontal residual interests, the
reproposal would have required
sponsors holding their risk retention
through eligible vertical interests to
measure such interests using fair value
and to comply with certain disclosure
requirements. With respect to the
vertical option, the reproposal would
have required that sponsors provide (or
cause to be provided) to potential
investors a reasonable time prior to the
sale of ABS interests in the issuing
entity and, upon request, to the
Commission and its appropriate Federal
banking agency (if any) disclosure of:
• Whether any retained vertical
interest is retained as a single vertical
security or as separate proportional
interests in each ABS interest;
• Each class of ABS interests in the
issuing entity underlying the single
vertical security at the closing of the
securitization transaction and the
percentage of each class of ABS interests
in the issuing entity that the sponsor
would have been required to retain if
the sponsor held the eligible vertical
interest as a separate proportional
interest in each class of ABS interest in
the issuing entity;
• The fair value (expressed as a
percentage of the fair value of all ABS
interests issued in the securitization
transaction and dollar amount (or
corresponding amount in the foreign
currency in which the ABS interests are
issued, as applicable)) of any single
vertical security or separate
proportional interests that would be (or
was retained) by the sponsor at closing,
and the fair value (expressed as a
percentage of the fair value of all ABS
interests issued in the securitization
transaction and dollar amount (or
corresponding amount in the foreign
currency in which the ABS interests are
67 See

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77621

issued, as applicable)) of the single
vertical security or separate
proportional interests required to be
retained by the sponsor in connection
with the securitization transaction;
• A description of the methodology
used to calculate the fair value of all
classes of ABS interests; and
• The key inputs and assumptions
used in measuring the total fair value of
all classes of ABS interests (including
the range of information considered in
arriving at such key inputs and
assumptions and an indication of the
weight ascribed thereto) and the
sponsor’s technique(s) to derive the key
inputs.
Several commenters asserted that the
final rule should not require sponsors to
measure and disclose the fair value of
eligible vertical interests, so long as the
underlying ABS interests have either a
principal or notional balance. The
commenters stated that a 5 percent
interest in the cash flow of each class
would always be equivalent to 5 percent
of each class. In this regard, the
commenters stated that requiring fair
value measurement and disclosures for
the vertical option would be
unnecessary for ensuring compliance
with the rule.
The agencies agree that calculation of
fair value for eligible vertical interests is
unnecessary. The agencies note that
only those sponsors that rely
exclusively on an eligible vertical
interest to meet their risk retention
requirements would not have to
calculate the fair value of the ABS
interests and make the related
disclosures. A sponsor that wishes to
receive credit for any residual interest
that meets the requirements of an
eligible horizontal residual interest
(other than any portion of the residual
retained as part of an eligible vertical
interest) would be required to calculate
the fair value of the ABS interests and
make the related disclosures.
c. Restriction on Projected Cash Flows
to Eligible Horizontal Residual Interest
The reproposal would have placed
limits on projected payments to holders
of the eligible horizontal residual
interest. Specifically, the reproposal
included a restriction on projected cash
flows to be paid to the eligible
horizontal residual interest that would
have limited how quickly the sponsor
would have been able to recover the fair
value amount of the eligible horizontal
residual interest in the form of cash
payments from the securitization (or, if
an eligible horizontal cash reserve
account were established, released to
the sponsor or other holder of such
account). The sponsor would have been

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prohibited from structuring a deal
where it was projected to receive such
amounts at a faster rate than the rate at
which principal was projected to be
paid to investors on all ABS interests in
the securitization. The restriction was
designed with an intention of enabling
sponsors to satisfy their risk retention
requirements with the retention of an
eligible horizontal residual interest in a
variety of ABS structures, including
those structures that do not distinguish
between principal and interest
payments and between principal losses
and other losses. The restriction was
discussed in detail in the reproposal.68
The agencies invited comment in the
reproposal on whether an alternative
provision should be adopted relating to
the amount of principal payments that
could be received by the eligible
horizontal residual interest. Under this
alternative, on any payment date, in
accordance with the transaction’s
governing documents, the cumulative
amount paid to an eligible horizontal
residual interest would not be permitted
to exceed a proportionate share of the
cumulative amount paid to all holders
of ABS interests in the transaction. The
proportionate share would equal the
percentage, as measured on the date of
issuance, of the fair value of all of the
ABS interests issued in the transaction
that is represented by the fair value of
the eligible horizontal residual
interest.69
The agencies received a significant
number of comments regarding the
proposed cash flow restrictions as well
as the alternative approach on which
they invited comment. Several
commenters requested that the proposed
cash flow restriction to the eligible
horizontal residual interest and related
certification be eliminated, either
entirely or for specific asset classes,
while one commenter proposed that the
restriction be eliminated at sunset.
Several commenters suggested that
the proposed restriction on cash flow
distributions would be incompatible
with a variety of securitization
structures, such as those organized to
have increasing overcollateralization
over time, large amounts of excess
spread at closing, or bullet maturities.
Commenters stated that the reproposal’s
failure to distinguish between payments
of interest and principal on the eligible
horizontal residual interest would be
particularly problematic for many
transactions. Such structures
highlighted by commenters included
CMBS, where monthly cash flow comes
predominantly from interest payments
68 Revised
69 See

Proposal, 78 FR at 57938.
Revised Proposal, 78 FR at 57941.

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for much of the life of the securitization,
with the result that these existing
structures would not meet the test and
would not have an economically
attractive eligible horizontal residual
interest (or B-piece) if they did meet the
test. Several commenters also stated that
the proposed cash flow restriction
would be problematic for CLOs and
other structures that use principal
proceeds to reinvest in additional assets,
but continue to pay interest, for
significant reinvestment periods. One
such commenter suggested that the final
rule should specify that the use of
proceeds to acquire new assets and
reinvest does not constitute a payment
with respect to the eligible horizontal
residual interest.
Commenters raised a number of
specific concerns regarding the
calculations and projections that would
be required by the proposed cash flow
restriction. One commenter stated that
the calculations that sponsors would be
required to compare in order to
determine whether restrictions are
required would be too different to make
effective comparison possible. Several
commenters asserted that the
calculations, disclosures, and
certifications required by the proposed
cash flow restriction were incompatible
with revolving structures, since the
asset pools of revolving structures
change over time and the time at which
the amortization period will commence
is not always known at the closing date.
These commenters suggested an
alternative certification and calculation
method for revolving structures.
Another commenter suggested that
when the ABS interest is a variable
funding note that may have periodic
increases and decreases in principal
amount, the date of any increase or
decrease should be treated as a new
issue date for purposes of calculating
the proposed cash flow restriction.
A few commenters asserted that the
proposed cash flow restriction would
significantly change the nature of the
residual structure, since, for many
structures, it would eliminate or
severely restrict the payment of interest
or yield to holders of the eligible
horizontal residual interest. One
commenter stated that if the holder of
an eligible horizontal residual interest is
not able to receive a return
commensurate with the risk of the
interest, the fair value of the interest
will decrease, requiring that it represent
a significantly greater portion of the
capital structure of the securitization in
order to reach 5 percent of the fair value
of all ABS interests issued. Another
commenter asserted that the proposed
cash flow restriction would discourage

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sponsors from structuring offerings of
ABS interests with excess spread
exceeding 5 percent of the fair value of
the transaction because the restriction
would effectively prevent sponsors from
reducing such excess spread to 5
percent during the life of the
transaction.
The certifications and disclosures to
investors that would have been required
by the proposed cash flow restriction
were also a focus of concern for
commenters. Several commenters
expressed concern about potential
liability that could result from the
proposed requirement that sponsors
certify to investors that they had
performed the required calculations and
to certify their expectations regarding
the cash flow to the eligible horizontal
residual interest as compared to more
senior ABS interests. Commenters stated
that sponsors could be subject to
liability, if their projections and
assumptions differed from actual
results. One commenter specifically
contended that the difficulty in
accurately modeling prepayment risks
heightens the risk of liability. Two
commenters suggested that a safe harbor
should be granted to protect sponsors
from such liability risk. One such
commenter requested limiting the safe
harbor to sponsors who utilize
reasonable methodologies in making the
required calculations. A different
commenter suggested that, rather than
requiring the sponsor to make the
certifications to investors, the sponsor
should only have to maintain a record
of the closing date calculations,
including the methodology and material
assumptions underlying them, and
make those records available to the
Commission and banking agencies upon
request for five years. One commenter
suggested that the proposed certification
to investors should be replaced with a
requirement that the sponsor disclose to
investors, in the offering documents,
that it has performed and met the cash
flow restriction test.
The agencies also received comments
regarding the proposed requirement that
sponsors would have to disclose their
past performance in respect to the cash
flow calculations. One commenter
raised concern that requiring such
disclosures could create potential
liability issues concerning false
disclosures. Two commenters suggested
a modification to the proposed
requirement such that the sponsor
would have to disclose the number of
payment dates on which the actual
payments made to the sponsor under
the eligible horizontal residual interest
exceeded the amounts projected to be
paid to the sponsor on such payment

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
dates. These commenters asserted that
the focus of this disclosure should be on
the cumulative amount of payments
made to the holder of the eligible
horizontal residual interests, rather than
the cash flow projected to be paid to the
sponsor on the payment dates.
Several commenters offered qualified
support for the alternative proposal on
which the agencies invited comment.
Such support was largely based on the
fact that the alternative proposal would
have required the comparison of all
forms of payment to both the eligible
horizontal residual interest and the
investor interests, while the proposed
cash flow restriction would have
required the comparison of all forms of
payment to the eligible horizontal
residual interest and only principal
payments to the investor interests. Two
commenters asserted that, without a
detailed proposal, it is difficult to
determine what type of cash flow
comparisons the agencies intended to
cover with the alternative proposal and
that they would not support any
proposal that does not allow for market
rates of return to be paid to the eligible
horizontal residual interest. One
commenter would support the
alternative proposal if it were modified
to clarify that a residual interest, in
order to be considered an eligible
horizontal residual interest, be limited
in the amount of principal repayments
it may receive, such that the cumulative
amount of payments applied to reduce
its principal or notional balance as of
any payment date is proportionate to (or
less than) the cumulative amount of
payments applied to reduce the
principal or notional balance of all ABS
interests in the transaction as of such
payment date. One commenter
requested a modified version of the
alternative proposal that the commenter
said would be more appropriate for
CMBS transactions. The commenter
asserted that, since CMBS bonds
associated with the horizontal risk
retention interest are sold at a discount,
the alternative proposal should allow
the percentage of cash flow paid to the
horizontal risk retention holder to be
based on the face value, rather than the
fair value, of their purchased interest.
Commenters also offered various
alternative proposals to the proposed
cash flow restriction. One commenter
requested that a sponsor be considered
to have met its risk retention obligation
if it satisfies one of the following tests
on the closing date based on projections
or assumptions of timely payment: (1)
The projected fair value of the amount
retained as of each payment date will
not be less than the required 5 percent;
(2) the level of overcollateralization

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calculated based on the amortizing
balance of the ABS interests as of each
payment date, is not projected to
decline below 5 percent over the life of
the transaction; or (3) the projected
principal payments to be paid to the
eligible horizontal residual interest, as
of each payment date, will not exceed
its pro rata share of all payments made
to ABS interest holders on such
payment date. One commenter
suggested that the test should be limited
to a projection that the retained risk will
be equal to at least 5 percent of the sum
of the projected aggregate fair value of
all ABS interests in the issuing entity,
other than the eligible horizontal
residual interest, and the projected fair
value of the eligible horizontal residual
interest.
After careful consideration of the
comments, the agencies agree that the
restrictions on projected cash flow to
the eligible horizontal residual interest
included in the proposed rule would
not operate without significant risk of
unintended consequences. Furthermore,
the agencies have not identified a cash
flow restriction mechanism that would
function effectively across asset classes
without having an unduly restrictive
impact on particular asset classes. While
the agencies could consider different
tests for different classes, the agencies
believe that would lead to a more
complicated rule that could be difficult
to administer and that would likely
engender more opportunity to
undermine the impact of the final rule
on the alignment of interests between
the sponsor and investors. Additionally,
the agencies believe that alternatives
suggested by commenters that proposed
to restrict cash flows based on a
comparison of projections of the face
value of securitized assets and the face
value of outstanding ABS interests
(which do not capture expected credit
losses, among other things) and
alternatives that focused only on
repayment of principal either would be
easily evaded or would not effectively
further the statutory goals and directive
of section 15G of the Exchange Act to
limit credit risk and promote sound
underwriting. Accordingly, the agencies
are not including in the final rule the
proposed cash flow restriction, the
alternative described in the reproposal,
or the alternatives suggested by
commenters.
The agencies are concerned that risk
retention may become less meaningful
when a sponsor quickly recovers the
value of risk retention through
distributions. However, the agencies
note that the final rule requires
disclosure regarding the material terms
of the risk retention interest, and the

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timing of cash flows and determination
of fair value, which is designed to
facilitate investor determination of
whether the risk retention interest to be
held by the sponsor remains meaningful
over time. In addition, while the rule
requires that the sponsor measure an
eligible horizontal residual interest only
as of the closing of a transaction (and,
under certain circumstances, if
additional ABS interests are issued
thereafter), the rule also restricts the
ability of a sponsor to transfer or hedge
any interest in the credit risk of the
securitized assets it is required to retain
until the expiration of specified periods.
Therefore, the rule is designed so that
the sponsor remains exposed to the
credit risk of securitized assets, up to
the amount required to be retained. If
the agencies observe that either the
assumptions and methodologies used to
calculate the fair value of horizontal risk
retention or the structuring of
securitization transactions—including
structuring of payments to the residual
interest—tends to undermine the ability
of the risk retention to align the interests
of sponsor and investors, the agencies
will consider whether modifications to
the rule should be made to address
these issues.
2. Master Trusts: Revolving Pool
Securitizations
a. Overview of the Reproposal and
Public Comments
Many securitization sponsors face a
mismatch between the maturities of the
assets they seek to securitize and the
maturities of bonds sought by investors
in the market. In order to obtain best
execution for a securitization of those
assets—or in other cases, in order to
obtain any investor interest in the
market of any kind—the sponsor must
use a structure that transforms the
available cash flow from the assets into
debt with a maturity and repayment
type (amortizing or bullet) sought by
investors. Furthermore, if the sponsor’s
business generates an ongoing stream of
assets to be securitized under these
circumstances, especially (but not
always) if the assets are receivables
generated from revolving credit lines,
the sponsor faces unique challenges in
structuring its securitization.
One solution to these issues, which
has evolved over the last 25 years, is a
type of revolving pool securitization
commonly known as a ‘‘master trust’’
securitization. Master trusts generally
issue multiple series of asset-backed
securities over time, collateralized by a
common pool of securitized assets. The
transaction documentation requires the
sponsor to maintain the collateral

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balance at an amount that is at all times
sufficient to back the aggregate amount
of outstanding investor ABS interests
with a specified amount of collateral
above that amount. The amount of
outstanding investor ABS interests
changes over time as new series are
issued or existing series are paid down.
Moreover, as each series is issued, it
begins with a revolving period (typically
for some number of years), during
which the holders of investor ABS
interests receive only interest, and cash
from borrower principal repayments on
the securitized assets are used to buy
additional assets for the pool from the
sponsor. This provides the sponsor with
ongoing funding for its operations, and
maintains the level of securitized assets
over time. Then, at a date specified
under the terms of the series, the
revolving phase for the series comes to
an end, and cash from borrower
principal repayments on securitized
assets is used to repay investors and
retire that series of investor ABS
interests.
Separately from the issue of credit
enhancement for the investor ABS
interests, which is discussed below,
investors are concerned that the total
amount and quality of securitized assets
does not decline unacceptably during
the revolving period of the series. If that
were to happen, the master trust could
face difficulties repaying investors
months or years later when the series
matures. To protect against this, the
sponsor is typically required, at various
intervals, to measure the amount by
which the aggregate principal balance of
the securitized assets exceeds the
aggregate principal balance of the
outstanding investor ABS interests. If
this ‘‘cushion’’ of securitized assets falls
below a target level, the sponsor has a
specified cure period in which it may
add more assets to restore the pool to its
required target size.70 Credit quality
problems with the securitized assets
would lead to elevated charge-offs of
securitized assets, which in turn could
cause the pool to fall below the target
level.71
If the sponsor cannot restore the pool
balance to its required target level
within the cure period, the master trust
commences an ‘‘early amortization
mode.’’ Once that occurs, the sponsor
may no longer use borrower payments
70 Instead of adding assets, the sponsor might also
avail itself of options described in the transaction
documents to reduce or repay outstanding investor
ABS interests.
71 The level of securitized assets in the pool might
also fall if securitized assets are repaid according
to their terms and the master trust does not use the
repaid principal to acquire replacement securitized
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on the securitized assets to purchase
additional loans to transfer to the
securitization, and interest and
principal payments on the securitized
assets are used to begin paying down
outstanding investor ABS interests as
rapidly as practicable. The
consequences to the sponsor are
significant, since early amortization of
the master trust means the sponsor will
no longer have access to securitized
funding through the master trust for
future securitized assets generated in
connection with the sponsor’s
operations.
The agencies’ reproposal would have
recognized the ‘‘seller’s interest’’
retained by a master trust sponsor as an
acceptable form of risk retention to meet
the sponsor’s obligations under the rule.
In many master trusts, the ‘‘seller’s
interest’’ is the amount by which the
outstanding principal balance (or
equivalent measurement) of the assets
held by the master trust exceeds the
outstanding principal balance of the
outstanding ABS interests and is
required by the series transaction
documents to be maintained at or above
a specified percentage of the aggregate
outstanding investor ABS interests,
measured monthly (e.g., the seller’s
interest in the principal balance of pool
collateral is required to equal at least 5
percent of the principal balance of all
outstanding investor ABS interests). The
seller’s interest is not attached to
specific pool collateral; it is an
undivided interest in the entire pool
akin to a participation interest,
representing the sponsor’s entitlement
to a percentage of the total principal and
interest or finance charge payments
received on the pooled securitized
assets for every payment period
(typically monthly). Investors in the
various series of ABS interests issued by
the master trust have claims on the
remaining principal and interest or
finance charge payments, as the source
of repayment for the ABS interests they
purchased from the master trust. The
seller’s interest in these structures is
generally pari passu with the investor
ABS interests, resulting in the sponsor
incurring a pro rata share of credit
losses on securitized assets, in a
percentage amount equal to the
percentage amount of the seller’s
interest as calculated under the terms of
the transaction documents.72
The agencies’ reproposal would have
treated a pari passu seller’s interest as
a separate form of risk retention. The
reproposal would have allowed this
option to be used only by issuing
72 A 5 percent pari passu seller’s interest is
commonly required in credit card master trusts.

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entities organized as master trusts,
established to issue on multiple
issuance dates one or more series of
ABS interests, all of which are
collateralized by a common pool of
assets that will change in composition
over time. The reproposal would have
required distributions to the sponsor on
the seller’s interest to be pari passu with
each series of investor ABS interests,
prior to an early amortization event as
defined in the transaction documents.
The sponsor would have been required
to meet the 5 percent threshold for its
seller’s interest at the closing of each
issuance of ABS interests by the master
trust, and at each seller’s interest
measurement date specified in the
transaction documents, but no less often
than monthly. The reproposal would
have required the seller’s interest to be
retained by the sponsor or by a whollyowned affiliate of the sponsor.
For so-called ‘‘legacy master trusts’’—
which hold revolving pools of collateral
and issue a certificate that entitles the
holder to distributions on that collateral
to another one of the sponsor’s master
trusts, which in turn securitizes those
distributions into investor ABS
interests—the reproposal would have
allowed the seller’s interest with respect
to the legacy trust assets to be held by
the sponsor at the level of either trust,
in proportion to their differing asset
pools. The agencies also proposed to
allow an offset against the required
seller’s interest, on a dollar-for-dollar
basis, for so-called ‘‘excess funding
accounts.’’ These accounts receive
distributions that would otherwise be
paid to the holder of the seller’s interest
if the sponsor fails to meet the
minimum seller’s interest requirement.
In the event of an early amortization of
the master trust, funds from the excess
funding account would be used to make
distributions to outstanding investor
ABS interests, in the same manner as
distributions on pool collateral during
early amortization.
In the reproposal, the agencies also
observed that some of the master trusts
in the market are not structured to
include a pari passu seller’s interest of
a sufficient size to meet the proposed
rule’s 5 percent trust-wide requirement.
In an effort to accommodate sponsors of
these trusts, the reproposal would have
allowed the sponsor to reduce its 5
percent pari passu seller’s interest
requirement by whatever corresponding
percentage of horizontal ABS interest
the sponsor held in the structure. The
reproposal would have given the
sponsor credit for an eligible horizontal
residual interest under section 4 for
these purposes, as well as an alternative
form of horizontal risk retention based

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on excess spread (described below). The
sponsor would have been required to
determine the percentages of horizontal
retention on a fair value basis,
consistent with the reproposal’s
treatment of other subordinated forms of
risk retention. Furthermore, any gap
between the amount of trust-wide pari
passu seller’s interest held by the
sponsor and the 5 percent minimum
requirement would have been required
to be offset with an equivalent fair value
percentage of the permitted horizontal
interests for every outstanding series
issued by the master trust.
Another alternative form of horizontal
risk retention that would have been
recognized by the reproposal was
designed to allow sponsors to receive
risk retention credit for excess spread,
which constitutes a significant portion
of the credit enhancement in master
trusts collateralized by credit card
receivables. These master trusts are
structured with two separate cash
waterfalls, one for principal repayments
collected from borrowers and one for
interest and fees (finance charges)
collected from borrowers. Interest and
fees collected from borrowers each
payment period are used to cover the
master trust’s expenses and to pay
interest due on outstanding investor
ABS interests for the period, and the
remaining interest and fee collections
are then made available to cover
principal charge-offs on securitized
assets. The sponsor is then entitled to
collect whatever interest and fee
collections remain. Absent application
of the excess interest and fee collections
to cover principal charge-offs, the
principal charge-offs would result in the
balance of outstanding investor ABS
interests being reduced. Accordingly,
the reproposal would have recognized
the sponsor’s interest in the residual
interest and fees (excess spread) as a
subordinated form of horizontal risk
retention, if it was structured in the
manner described in this paragraph, so
long as the master trust continued to
revolve, and the sponsor determined
and disclosed the fair value of the
residual interest and fees on the same
monthly basis as its pari passu seller’s
interest.
The reproposal also included
provisions clarifying that a master trust
entering early amortization and winding
down would not, as a result, violate the
rule’s requirement that the seller’s
interest be pari passu. During early
amortization, distributions on this form
of seller’s interest typically become
subordinated to investor interests, to
allow for the repayment of the
outstanding investor ABS interests more
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The agencies received extensive
comments on the overall design and the
details of the reproposal’s option for
master trusts. Commenters stated that
the agencies needed to make numerous
revisions to the mechanics of the
reproposal for master trusts or the
seller’s interest option would not be
useable by most revolving pool
securitization structures in the market.
Moreover, commenters stated that most
revolving pool securitizations in the
market would be left with no
mechanism for horizontal risk retention
under the rule whatsoever, because the
requirements in section 4 of the
reproposed rule for an eligible
horizontal residual interest conflicted
with key provisions of those revolving
pool securitizations. Commenters
pointed out that revolving pool
securitization structures have evolved
beyond credit cards and automobile
dealer floorplan financing, to
encompass numerous specialized asset
classes important to the U.S. economy.
Examples they cited included a wide
variety of floorplan and trade receivable
financing for commercial manufacturing
firms, other non-revolving short-term
assets such as insurance premium loans
and servicer advance receivables, a
broad variety of equipment leasing
programs, and home equity line
receivables. Commenters identified two
overarching concerns with the
reproposal, and also made numerous,
more detailed recommendations for
revisions to the mechanics of the rule.
The first area of overarching concern
for commenters centered on the
agencies’ proposed treatment of
subordinated forms of risk retention in
the master trust context. In the
reproposal, the agencies noted the
existence of subordinated forms of
seller’s interests in the market. The
agencies invited comment on whether
subordinated seller’s interests should be
given risk retention credit under the
rule, but also pointed out that the
agencies were inclined to require it to be
measured on a fair value basis,
consistent with the treatment of other
forms of subordinated risk retention
under the reproposal. Commenters said
many revolving pool securitizations in
the market relied on subordinated
seller’s interests as the principal source
of credit enhancement and, therefore, it
was critical for the agencies to include
it in the rule.73 Commenters also said
73 One group of commenters said the typical pari
passu seller’s interest in a floorplan securitization
was zero percent, and they were aware of no
floorplan securitization with one higher than 2
percent. These commenters said that a subordinated
seller’s interest was, like a pari passu seller’s
interest, typically calculated as a set percentage of

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77625

that monthly calculations of fair value,
as suggested by the agencies in the
reproposal, would be immensely
burdensome. Commenters said this
burden was especially unwarranted in
the case of revolving pool
securitizations, which do not monetize
excess spread and, therefore, do not
present the risks of evasion through deal
structures that motivated the agencies’
restrictions on other forms of horizontal
risk retention. Commenters also said
that the agencies’ concerns about
sponsor manipulation and evasion were
misplaced, because revolving pool
securitization sponsors rely on the
funding they thereby obtain as a
principal source of ongoing funding for
their business operations. Commenters
said this creates an alignment of
interests between sponsors and
investors that is the opposite of the
originate-to-distribute model.74
The other areas of concern for
commenters were differences between
the reproposal’s requirements for the
eligible horizontal residual interest and
the terms of existing revolving pool
securitizations in the market. First,
commenters said the cash flow recovery
percentage calculations were
structurally incompatible with revolving
pool securitizations.75 Second,
commenters expressed heightened
concerns about their potential liability
for disclosing predictions and
assumptions about the future
performance of a revolving pool
securitization, in connection with
making the fair value determination
additional assets required to be held in the
collateral pool, over and above an amount equal to
the total amount of outstanding investor ABS
interests (though this percentage is often
determined on a series-by-series basis rather than a
trust-wide basis). Principal and interest payments
made with respect to this subordinated seller’s
interest are distributed to the sponsor, after they are
first applied to cover any charge-offs of securitized
assets that would otherwise reduce the principal
amount of outstanding investor ABS interests. The
sponsor’s share of principal and interest
distributions is also available to cover shortfalls in
payments of principal and interest due to investors.
74 Commenters representing automobile,
equipment, and dealer floorplan manufacturers
were among those advocating for a simplified risk
retention alternative, without fair value
requirements and cash flow restrictions, for
‘‘simple’’ securitization structures that issue only
‘‘traditional’’ interest bearing asset-backed
securities with 5 to 10 percent overcollateralization
on a face value basis and weighted average interest
rates on the issued asset-backed securities in line
with that of the securitized assets. The agencies
note that the elimination of the cash flow
restrictions from section 4 of the rule, accompanied
by the treatment of subordinated seller’s interests
adopted in the final rule, should significantly
address the source of commenters’ concerns in this
regard.
75 The agencies note that the elimination of the
cash flow restrictions from section 4 of the rule
addresses commenters’ concerns in this regard.

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required by the rule. Third, commenters
asserted that the requirement for the
eligible horizontal residual interest to be
the most subordinated claim to
payments of both principal and interest
could not be achieved when the sponsor
is also entitled to collect residual
interest and fees, because there are
separate interest and principal
waterfalls and the subordinated junior
bond in the series held by the sponsor
(whether or not it is certificated or
rated) is usually structured to be paid
interest before the allocation of interest
and fee collections to cover charge-offs
otherwise allocable to senior bonds (and
in some cases, charge-offs allocable to
the junior interests held by the sponsor
as well).
Commenters said that sponsors sought
the ability to continue incorporating
subordinated seller’s interest or residual
ABS interest in excess interest and fees
into their deal structures and
simultaneously retain a junior bond,
while still having the flexibility to
choose which combination of those
interests the sponsor would use to
comply with the risk retention
requirements. Commenters placed
particular importance on retaining the
flexibility to do this without being
required to engage in fair value
determinations for the interests the
sponsor does not count for purposes of
regulatory compliance.
In addition, commenters expressed
concerns about paragraphs (2) and (3) of
the eligible horizontal residual interest
definition in connection with the serieslevel allocations and delinked structures
used in revolving pool securitizations.
Commenters also asked the agencies
to modify the rule’s subordination
requirements to allow a subordinated
tranche held as an eligible horizontal
residual interest to be repaid prior to
later-maturing senior tranches, noting
that, in delinked structures, a
subordinated tranche which enhances
one or more senior tranches may mature
before the senior tranche. In these
circumstances, commenters said the
securitization transaction documents
contain terms requiring the
subordinated tranche to be replaced to
the extent the remaining senior tranches
still require credit enhancement under
the terms of the transaction documents.
In addition to these concerns,
commenters requested numerous
changes they said were necessary to
recognize the risk retention existing in
revolving pool securitizations in the
current market.
Commenters said many revolving
securitization structures that are
commonly referred to as ‘‘master trusts’’
do not, in fact, use issuing entities

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organized in the form of a trust, and
their organizational documents do not
necessarily state that they are
established to issue multiple series.
Commenters also expressed concern
about whether sponsors universally
hold their seller’s interests in the form
of an ‘‘ABS interest’’ as defined in the
reproposed rule.
Commenters requested clarification as
to whether the requirement that the
master trust be collateralized by a
common pool of securitized assets
means that every series must be secured
by every asset held by the issuing entity.
Commenters explained that some
revolving pool securitizations may use
collateral groupings, and further that
principal accumulation and interest
reserve accounts may be held only for
the benefit of an identified series.
Commenters also requested clarification
as to whether the common pool
requirement prevents the issuing entity
from holding assets that are not eligible
to support issuance of additional ABS
interests to investors (such as excess
concentration receivables), but are
nonetheless pledged as collateral to the
structure, with proceeds from these
ineligible assets being allocated to the
sponsor, sometimes with varying
extents of subordination to one or more
series of outstanding investor ABS
interests.
In the reproposal, the agencies invited
comment on whether, if a sponsor is
relying on the seller’s interest as its
required credit risk retention under the
rule, the final rule should preclude the
master trust from monetizing excess
spread, in exchange for allowing the
seller’s interest to be calculated on the
basis of the principal balance of
outstanding investor ABS interests
instead of the fair value of outstanding
investor ABS interests. Commenters
questioned the agencies’ rationale for
this restriction, asserting that revolving
pool securitizations that generate excess
spread do not monetize it through the
issuance of interest-only securities or
premium bonds. Commenters said
revolving pool securitizations do exactly
the opposite, making excess spread
available to cover losses that would
otherwise reduce the principal
repayments to outstanding investor ABS
interests.76
Commenters questioned why the
reproposal would, as a general rule,
permit a majority-owned affiliate of a
securitizer to hold the securitizer’s risk
retention interest required by the rule,
76 Commenters also expressed concern as to how
the agencies could define the difference between
premium bonds and bonds that price above par due
to investor enthusiasm for a particular bond.

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but in the case of revolving pool
securitizations would only permit the
seller’s interest or special horizontal
interest to be held by the securitizer or
a wholly-owned affiliate of the
securitizer.
Commenters also requested that the
agencies revise the rule to permit risk
retention in legacy master trusts to be
held at the legacy master trust level, not
only for seller’s interests, as the agencies
proposed, but also for horizontal forms
of risk retention permitted under the
rule.
Commenters requested that the
agencies make changes to the details of
the definition of seller’s interest
concerning the requirement that the
sponsor’s distributions on the seller’s
interest be pari passu prior to an early
amortization event. Commenters
pointed out that principal distributions
on the seller’s interest are subordinated
to a series of outstanding investor ABS
interests in a controlled accumulation
phase or amortization, because the
transaction documents typically fix the
proportions for allocation of principal
distributions to the series at the start of
the accumulation phase or amortization
period.77
With respect to the reproposal’s
requirement for master trusts to measure
the seller’s interest on the measurement
date specified in the transaction
documents, no less than monthly,
commenters requested two changes.
First, commenters stated that some
revolving pool securitizations require
measurements of the seller’s interest on
a more frequent basis, and that they
should not be required to measure the
seller’s interest for regulatory
compliance purposes more often than
monthly (and at the closing of each
issuance of ABS interests).78 Second,
commenters requested the agencies to
recognize the cure period afforded them
under their transaction documents.
Commenters also requested changes to
the specifics of the disclosure
requirements with respect to the cut-off
dates for disclosing the amount of
seller’s interest retained by the sponsor.
Commenters also requested changes
to the details of the reproposed rule’s
77 Moreover, some revolving pool securitizations
allocate principal during an accumulation phase
pursuant to a formula that captures all available
principal collections from the assets that are not
otherwise needed for other principal accumulation
accounts and acquisition of new pool collateral.
78 Commenters said that the measurement
referred to by the agencies in the reproposal, for
purposes of determining whether the sponsor must
add more assets to the collateral pool, generally
takes place monthly. However, the seller’s interest
is measured more frequently (as often as daily) for
other purposes, such as verifying whether cash may
be released to the sponsor.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
treatment of excess funding accounts
and the provisions on early
amortization, to better reflect the way
early amortization triggers are currently
structured.
Commenters supported the
reproposal’s inclusion of residual
interest and fees as a recognized form of
risk retention for revolving pool
securitizations. They recognized the
rationale for requiring sponsors using
the option to measure it on a fair value
basis, but expressed concern that the
burdens of performing the valuation
monthly would be so substantial as to
dissuade all but a few revolving pool
securitizations from using the option.
Commenters also requested some
changes and clarifications to the
mechanics of the rule language in the
reproposal, to accommodate established
structures being used in the market.
They also requested that the agencies
eliminate the requirement for separate
interest and principal waterfalls.
Commenters supported the
reproposal’s inclusion of provisions
allowing revolving pool securitizations
to offset and reduce their 5 percent
seller’s interest with corresponding
amounts of horizontal interests. They
objected to the agencies’ requirement
that the offsetting amount be held with
respect to every series in the trust, and
requested that the agencies permit the
offset to be determined on a weighted
average basis across all series of
outstanding investor ABS interests.
Commenters also requested that, if a
sponsor held the horizontal interest
jointly with an investor, the sponsor be
allowed to take credit for its
proportional holding in that horizontal
interest.
Commenters agreed with the agencies
that it is not practicable to create a
grandfathered status for seller’s interest,
since it represents the sponsor’s
undivided interest in, and exposure to,
the common pool of securitized assets
in the trust, on a trust-wide basis.
Commenters suggested that a revolving
pool securitization relying on horizontal
interests to offset any portion of the
seller’s interest should be allowed to do
so on a grandfathered basis, whereby the
sponsor would only be required to hold
that horizontal element with respect to
series issued after the applicable
effective date of the rule.
Commenters also described a type of
revolving pool securitization that
securitizes mortgage servicer advance
receivables, in which the seller’s
interest is fully subordinated to all
expenses and investor obligations.
These commenters requested inclusion
of these subordinated interests as part of
the master trust option, and inclusion of

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certain series-specific interest reserve
accounts as an offset to the minimum
seller’s interest.
b. Description of the Final Rule
The agencies are revising the master
trust option in the final rule in order to
make the option available to more
commercial firms that currently rely on
revolving pool securitizations as an
important component of their funding
base. These revisions recognize and
accommodate the meaningful exposure
to credit risk currently held by sponsors
of these vehicles, in light of the
heightened alignment of incentives
between sponsors and investors that
attaches to their revolving nature. The
agencies are also making a number of
other refinements in the final rule in
order to align it more closely with the
mechanics of revolving pool
securitizations as they are structured in
the market today.
The pari passu seller’s interest option
proposed by the agencies represents a
special form of over-collateralization for
the ABS interests issued by a revolving
pool securitization. Under the final rule,
sponsors must maintain the size of the
seller’s interest position, which they
most commonly do through the ongoing
addition of assets to the pool or
repayment of investor ABS interests, if
the existing pool is diminished by
charge-offs exceeding expected loss
rates.
The agencies are also adopting an
additional change requested by
commenters to accommodate other
revolving pool securitizations that are
common in the market and rely on overcollateralization in a different manner,
which varies between asset classes.
Commenters described two different
structures, one of which the agencies are
persuaded should be recognized as an
eligible form of risk retention under the
final rule. This form was described by
commenters as a common feature of
some asset classes, such as equipment
leasing and floorplan financing. In these
revolving pool securitizations, the
sponsor is obligated, as is the case in the
pari passu seller’s interest structure, to
maintain an undivided interest in the
securitized assets in the collateral pool,
in an amount equal to a specified
percentage of the trust’s outstanding
investor ABS interests. Whereas the pari
passu seller’s interest is a trust-level
interest equal to a minimum percentage
of the revolving pool securitization’s
combined outstanding investor ABS
interests, the minimum percentage in
these structures may be tied to the
outstanding investor ABS interests in
each separate series. While the
sponsor’s right to receive distributions

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on the seller’s interest included in the
reproposal was required to be pari
passu, the sponsor’s right to receive its
share of distributions on its
subordinated seller’s interest may be
subordinated to varying extents to the
series’ share of credit losses.
Importantly, notwithstanding these
differences with the pari passu seller’s
interest, the sponsor of this form of
revolving pool securitization is still
required under the transaction
documents to maintain the specified
minimum percentage amount of
securitized assets in the pool if the
securitization is to continue revolving,
through the ongoing addition of extra
securitized assets to the pool if
necessary. The agencies believe this
requirement to maintain the specified
minimum percentage amount creates
incentives for the sponsor to monitor
the quality of the securitized assets
added to the pool in both structures. If
the sponsor replaces depleted pool
collateral with poorly underwritten
assets, those assets will, in turn,
underperform, and the sponsor will be
obligated to add even more assets. If this
cycle is perpetuated and the specified
minimum percentage amount is
breached, the deal will enter early
amortization, and the sponsor’s access
to future funding from the structure will
be terminated. In consideration of this,
the agencies have made modifications
so that the final rule recognizes this
subordinated form of seller’s interest as
an eligible form of risk retention for
revolving pool securitizations, because
the agencies believe this form aligns the
interests of sponsors and investors in a
manner similar to other forms of risk
retention recognized pursuant to the
final rule.
The second form of revolving pool
securitization described by commenters
as used in some asset classes, such as
equipment leasing and floorplan
financing, represents various types of
excess securitized assets. The
transaction documents for revolving
pool securitizations typically impose
eligibility requirements on the
securitized assets that are allowed to be
included as collateral for purposes of
calculating the total amount of
outstanding investor ABS interests that
may be issued by the revolving trust.
According to commenters, these
eligibility requirements include
concentration limits on securitized
assets with common characteristics,
such as those originating from a
particular manufacturer or dealer or a
particular geographic area. The sponsor
places assets in the revolving pool
securitization that do not meet these
requirements (excess concentration

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receivables), but these ineligible assets
are not included when calculating the
total amount of outstanding investor
ABS interests the revolving pool
securitization may issue. Commenters
asserted that these ineligible assets are
often subject to the pledge of collateral
to the ABS investors, but distributions
on these assets are typically allocated to
the sponsor. Depending on the terms of
the securitization, the sponsor’s claim to
the cash flow from these excess assets
may be partially or fully subordinated to
investor interests, and these
subordination features may be at the
trust level, at the series level, or some
combination of both.
The agencies are not persuaded that
the sponsor’s interest in these
receivables should be included as
eligible risk retention. By their terms,
these are assets that are not
representative of the assets that stand as
the principal repayment source for
investor ABS issued by the revolving
pool securitization.
To accommodate revolving pool
securitizations with subordinated
seller’s interest, the agencies have
revised the distribution language in the
definition of seller’s interest to include
seller’s interests that are pari passu with
each series of investor ABS interests, or
partially or fully subordinated to one or
more series in identical or varying
amounts with respect to the allocation
of all distributions and losses on the
securitized assets. This language retains
the vertical nature of the proposed
seller’s interest, since the sponsor must
receive at least its pro rata share of
losses on securitized assets through the
pari passu aspect of the distribution.
The sponsor is also free to use its pari
passu share of distributions from
securitized assets to provide loss
protection to outstanding investor ABS
interests, thereby subordinating its
interest. The final rule provides that
these levels of subordination may be
varied, thereby affording the sponsor
flexibility with regard to the extent of
this subordination. For example, the
sponsor may provide varying levels of
subordination to different series, or
provide different levels of subordination
depending on the occurrence of triggers
specified in the transaction documents.
Commenters stated that structures
with pari passu seller’s interest also
often include elements of conditional
subordination that are included to
accommodate investor or rating agency
concerns that vary from transaction to
transaction. These are also permitted
pursuant to the final rule. The agencies
believe this flexibility is necessary to
accommodate the kinds of variations in
current market practice from deal to

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deal that commenters described in their
comment letters. Nevertheless, the
flexibility afforded under the rule does
not permit the sponsor to participate in
distributions to any extent greater than
pari passu. Therefore, the seller’s
interest may not be senior to any series
of investor ABS interests with respect to
allocation of distributions pursuant to
the seller’s interest.
Commenters asserted that revolving
pool securitizations typically provide
different distribution regimes for seller’s
interests if the securitization moves into
early amortization. The reproposed rule
contained language reflecting this,
relieving the seller’s interest from the
pari passu distribution requirement
only after an ‘‘early amortization event.’’
In response to these comments, the
agencies have removed the technical
reference to a triggering event and
substituted functional language
describing a revolving pool
securitization in early amortization, as
specified in the securitization
transaction documents.79
In addition, the agencies have
modified slightly the operational
portion of the final rule text allowing
retention of a seller’s interest to satisfy
a sponsor’s risk retention obligation.
Whereas the reproposal obligated the
sponsor to ‘‘retain a seller’s interest of
not less than 5 percent,’’ the final rule
requires the sponsor to ‘‘maintain a
seller’s interest of not less than
5 percent’’ (emphasis added). The
agencies believe that the sponsor’s
obligation to replenish the seller’s
interest underlies the alignment of
interests unique to the revolving pool
securitization structure. Commenters
indicated that there are some forms of
subordinated seller’s interest that the
sponsor is not required to replenish.
These do not qualify for the seller’s
interest option under the final rule.
The definition of seller’s interest in
the final rule provides that ineligible
assets—specifically, assets which are
not eligible under the terms of the
securitization transaction to be included
when making periodic determinations
whether the revolving pool
securitization holds aggregate
securitized assets in the required
specified proportions to aggregate
outstanding investor ABS interests
issued by the revolving pool
securitization (e.g., excess concentration
receivables)—are not to be considered a
component of the seller’s interest.80 By
79 As discussed above, the definition of seller’s
interest has also been revised to allow, prior to early
amortization, subordinated distributions.
80 One group of commenters recommended that
the agencies simply modify the seller’s interest

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the terms of the transaction documents,
these are assets that are typically not
representative of the assets that stand as
the principal repayment source for
investor ABS interests issued by the
revolving pool securitization, and the
agencies are declining to grant
commenter’s request that they be
recognized as a form of risk retention
comparable to the forms of seller’s
interest recognized under the rule. The
agencies have also clarified the
proposed exclusion from seller’s interest
of assets that have been allocated as
collateral only for a specific series. As
the agencies discussed in the
reproposal, this exclusion was designed
to accommodate limited forms of
exclusion in connection with
administering the trust, accumulating
principal, and reserving interest.81 To
reflect this condition within the rule
text itself, the agencies have revised the
exclusion so it applies only to servicing
assets.
To address certain comments about
the application of the definition of
eligible horizontal residual interest to
revolving pool securitizations, the
agencies have modified paragraph (2) of
the definition of eligible horizontal
residual interest to refer to allocation
dates as well as payment dates.82 The
agencies also confirm that, in applying
the eligible horizontal residual interest
definition to a revolving securitization
with multiple series, the requirements
in paragraphs (2) and (3) specifying
priority of payment with respect to
amounts due to other interest holders
and requiring subordination are to be
applied with respect to the series
supported by the particular eligible
horizontal residual interest (including,
where applicable, certain delinked
structures), and should only be
construed to refer to all outstanding
investor ABS interests if the eligible
horizontal residual interest is, in fact,
structured to function as an
enhancement to all outstanding investor
ABS interests issued by that revolving
pool securitization. To accommodate
delinked structures, commenters
requested that the agencies allow
replacement of a subordinate tranche
before maturity of the senior tranches it
supports. The agencies are not adopting
definition to exclude assets within the revolving
pool securitization that secure less than all of the
ABS interests. The agencies are implementing this
approach in a more targeted way by identifying the
particular categories of assets to be excluded.
81 Revised Proposal, 78 FR at 57943, n.52.
82 Commenters stated that the reproposal’s
definition of eligible horizontal residual interest
refers to loss allocations occurring on ABS interest
payment dates, whereas revolving pool
securitizations allocate losses periodically, in
advance of ABS interest payment dates.

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this requested modification. The
agencies note that, to serve as risk
retention pursuant to the rule, the
sponsor must retain an eligible
horizontal retention interest for the life
of the securitization it supports, and the
agencies believe sponsors can readily
structure their retained residual
interests to achieve this outcome.83
The risk retention options described
in section 5 of the final rule are
available only to a specific category of
securitization vehicles, originally
defined as ‘‘revolving master trusts’’ but
now defined as ‘‘revolving pool
securitizations.’’ 84 The option is not
available to an issuing entity that issues
series of ABS interests at different times
collateralized by segregated
independent pools of securitized assets
within the issuing entity such as a series
trust, or an issuing entity that issues
shorter-term ABS interests collateralized
by a static pool of securitized assets, or
an issuing entity with a predetermined
re-investment period that precedes an
ultimate amortization period.
Commenters expressed concern that
language in the revolving pool
securitization definition requiring the
issuing entity to be ‘‘established to issue
on multiple issuance dates one or more
series’’ would require them to reconstitute their issuing entities. The
agencies note that the rule does not
require specific statements of intention
to issue multiple series in the issuing
entity’s organizational documents. That
being said, the agencies believe that the
ability to issue more than one series of
ABS interests is one of the defining
characteristics of the structure.85 In light
83 The agencies are also concerned that the
approach suggested by commenters is inconsistent
with the rule’s approach to the timing of the fair
value determination for retained eligible horizontal
residual interests under the standard risk retention
option, under which the fair value ratio of residual
to ABS interests issued is measured at the time of
issuance. Although sponsors noted that the terms of
a delinked revolving pool securitization transaction
include requirements for minimum levels of
subordination to be maintained in connection with
the maturity and replacement of subordinated
interests, these measures do not necessarily ensure
equivalent fair value for a replacement
subordination interest. Commenters did not suggest
any alternatives to address this area of concern.
84 The agencies made this change, and eliminated
language in the definition requiring the issuing
entity to be a ‘‘master trust,’’ in response to
comments indicating sponsors sometimes organize
the issuing entity as a different type of legal entity.
85 Although ‘‘series’’ could be considered a term
of art in securitization, it is not a defined term in
the rule. The rule text in this regard refers to ‘‘more
than one series, class, subclass, or tranche.’’ Section
5(a) of the final rule. The agencies believe the text
is sufficiently flexible to accommodate, regardless
of transaction labels used, the concept of a discrete
issuance of ABS interests of a certain maturity,
albeit one with a renewable or renegotiated
maturity, as well as delinked structures. However,
in the same vein, the rule’s reference to a class,

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of this, the agencies are replacing the
‘‘one or more’’ language with rule text
requiring the issuing entity to be
established to issue ‘‘more than one’’
series. While the rule requires no
specialized documentation of this
intention to be made in connection with
the issuing entity’s legal organization,
the sponsor must be able to establish
that, under the constituent legal powers
of the entity pursuant to applicable law,
the issuing entity has the authority to
issue more than one series. The agencies
also recognize that a business
organization might establish a revolving
pool securitization vehicle and, after
issuing one series, changes in
circumstances could prevent the
sponsor from seeking to issue any
additional series, with the structure
ceasing to revolve and amortizing out.
The agencies typically would not
dispute this issuing entity’s eligibility
under section 5 of the rule in hindsight,
absent facts and circumstances
indicating the sponsor sought to use the
structure to improperly avoid the
standard risk retention obligations of
section 4 of the rule. A business
organization that did so more than once
would face a heightened burden to
establish that its reliance on section 5 of
the rule was not a violation of its
obligations under the rule.
The final rule retains the reproposal’s
requirement that the issuing entity’s
ABS interests are collateralized by a
common pool of securitized assets that
will change in composition over time.
This is another defining characteristic of
a revolving pool securitization eligible
to use section 5 of the rule. Under these
structures, principal collections on the
securitized assets (net of funds required
to amortize the principal of outstanding
investor ABS interests or to accumulate
such funds) are used to purchase
additional assets to collateralize existing
and future investor ABS interests in the
securitization on a revolving basis, with
no predetermined end date.86 Revolving
pool securitizations allow sponsors to
restructure the cash flows on the
securitized assets not only for credit
enhancement, but for mismatches
between the maturities of the
securitized assets and the maturities of
subclass, or tranche, which are terms commonly
used to describe subsets within a series, is not an
invitation to sponsors to assert that subdivisions of
an issuance qualify as multiple issuances for these
purposes.
86 The agencies also recognize that the extent to
which the sponsoring organization utilizes investor
funding to fund the securitized assets may vary
according to business need, as well as the
availability of alternate sources of funds at more
favorable rates.

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ABS interests that are sought by the
market on attractive terms.87
Commenters requested further
clarification about the common pool
requirement. One concern centered on
the presence of ineligible assets,
including so-called ‘‘excess
concentration’’ receivables. The
agencies observe that, on the one hand,
these ineligible assets are part of the
asset pool, and proceeds from them may
even be used to cover losses that would
otherwise be allocated to investors. On
the other hand, the bulk, or in many
cases all, of the proceeds from the
ineligible assets are directed to the
sponsor, and the receivables are not
eligible to be included when
determining the revolving pool’s limit
on outstanding investor ABS interests.
The agencies do not consider these
arrangements to violate the common
pool requirement, though as noted
above the final rule does not permit
these assets to be included when
calculating the size of the seller’s
interest.
Notwithstanding the agencies’
willingness to accommodate these
ineligible assets that are allocated to the
sponsor, if a revolving pool
securitization designated a collateral
group as the securitized assets for a
specific series, the arrangement would
not meet the common pool requirement.
In this vein, commenters requested
clarification as to whether a revolving
pool securitization with collateral
groups meets the common pool
requirement. Commenters did not
provide details about these grouping
practices, and the agencies believe the
use of collateral groups may not satisfy
the common pool requirement. If the
arrangement were analogous to a
construct with multiple revolving pool
securitizations being operated out of a
single issuing entity, and the sponsor
could demonstrate that each group
would comply with the rule’s
requirements on an independent basis,
the arrangement could meet the
common pool standard. On the other
hand, if the arrangement is analogous to
a revolving pool securitization in one
group and a series trust in another
87 In referring to maturities in this aspect of the
discussion, the agencies do not focus on legal
maturity, or to effective maturity or duration, as
those terms are used in finance, but to the actual
lifespan of the assets and interests. For example, in
many revolving pool securitizations, such as credit
card, automobile floor plan, construction loan, and
trade receivable deals, the maturity of the
securitized assets is so short that the structure is
used to lengthen the maturity of the asset-backed
securities to attract investors. In other revolving
pool securitizations, such as UK residential
mortgage deals, the structure is used to create
shorter maturity bullet asset-backed securities to
attract investors.

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group, the arrangement would be
extremely unlikely to satisfy the
common pool standard. If distributions
and losses from any ‘‘group’’ are
designated to a single outstanding
series, the arrangement would not meet
the common pool standard.88 To
accommodate the possibility of a
multiple group arrangement, the
agencies have modified the rule text of
the common pool requirement slightly
to eliminate the requirement that the
common pool collateralize ‘‘all’’ series
issued by the revolving pool
securitization, as well as a similar
requirement in the definition of seller’s
interest. Nevertheless, a sponsor that
relies on section 5 of the rule for a
multiple group arrangement bears
ultimate responsibility to demonstrate
full compliance with the rule’s common
pool requirement.
As discussed above, the reproposal
also noted that revolving pool
securitizations do not monetize excess
spread, and the agencies invited
comment as to whether the rule should
be modified to expressly prohibit
structures that rely on the seller’s
interest option from issuing senior
interest-only bonds or premium
bonds.89 In light of commenters’
concerns about the feasibility of
incorporating this restriction into a
regulatory requirement and attendant
grandfathering issues with respect to
structures that have classes of bonds
previously issued with idiosyncratic
interest rates, the agencies are taking a
different approach. The agencies have
added to the definition of a revolving
pool securitization the requirement that
the sponsor does not monetize excess
spread from its securitized assets. The
ability of a sponsor to meet this
standard with respect to its outstanding
investor ABS interests depends on the
facts and circumstances of the issuance,
including whether the revolving pool
securitization issues ABS interests that
price materially above par in light of all
88 The use by a revolving pool securitization of
excess cash flows resulting from allocations of
distributions to one series of ABS interests as credit
enhancement to cover shortfalls in periodic interest
obligations, periodic losses, and similar exposures
experienced by other specified series of ABS
interests (but not all other series of ABS interests)
does not violate the common pool requirement. The
agencies do not believe this sharing of allocations
of distributions among ‘‘groups’’ of outstanding
series raises the same concerns as separate groups
of collateral. Similarly, principal accumulation
formulas would not violate the common pool
requirement. As discussed above, some revolving
pool securitizations allocate principal collections
from pool assets during an accumulation phase
pursuant to a formula that captures all available
principal collections from pool assets that are not
otherwise needed for other principal accumulation
accounts and acquisition of new pool collateral.
89 Revised Proposal, 78 FR at 57944.

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the features of the ABS interests and
market conditions, or the revolving pool
securitization issues ABS interests that
pay investors interest on notional
principal absent issuance of a
corresponding issuance of principalonly bonds to support the revolving
pool securitization.
Consistent with the reproposal, the
final rule requires the seller’s interest to
be not less than 5 percent of the
aggregate unpaid principal balance of all
outstanding investor ABS interests in
the issuing entity. The phrase ‘‘all
outstanding investor ABS interests
issued’’ refers to ABS interests issued to
persons other than the sponsor and
wholly-owned affiliates of the sponsor.
Although the reproposal suggested that
ABS interests held by the sponsor
would still be treated as outstanding
investor ABS interests if those assetbacked securities were ‘‘issued under a
series,’’ the agencies are simplifying the
final rule to eliminate this distinction,
which could raise associated
interpretive issues as to whether certain
retained interests met that description.
Accordingly, in determining the 5
percent ratio, a sponsor is not required
to include in the denominator the
amount of ABS interests that are held by
the sponsor or its wholly-owned
affiliates, but only if the sponsor (or its
wholly-owned affiliates) retains them
for the life of the ABS interests. This
treatment applies for ABS interests held
by the sponsor and its wholly-owned
affiliates for purposes of complying with
the risk retention rule, or held for other
reasons.90 In order to maintain
consistency with a sponsor’s disclosures
as to the manner of its compliance with
the seller’s interest requirement, which
are communicated to investors in
connection with the issuance of a series
of ABS interests, the sponsor must make
a threshold determination as to whether
it intends to retain excluded ABS
interests for their life and disclose this
election to investors. If a sponsor wishes
to retain the flexibility to transfer an
ABS interest in the future, the sponsor
must, from the time of the issuance of
90 There are several circumstances in which a
sponsor might retain additional ABS interests.
Investors may not be inclined to purchase investor
ABS interests unless the sponsor holds a greater
interest in the securitization transaction. The
sponsor’s cost of funds to place a subordinated
tranche of a series may be greater than the sponsor’s
cost to fund that tranche through other means, or
the sponsor’s overall cost of funds may be lower
than the funding that can be obtained by issuance
of a new series. If the ABS interest is being retained
by the sponsor as part of its required risk retention
pursuant to the rule, the interest is subject to
hedging and transfer restrictions of section 12 of the
rule.

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the ABS interest onward, include such
ABS interest in the denominator.91
The agencies have also added
language clarifying that, if the
transaction documents set minimum
required seller’s interest as a proportion
of the unpaid principal balance of the
outstanding investor ABS interests in
one or more identified series, rather
than all outstanding investor ABS
interests of the revolving pool
securitization as a whole, seller’s
interest may be measured on that basis.
However, the percentage of each series’
specific seller’s interest must (when
combined with the percentage of
securitization-wide seller’s interest, if
any) equal at least 5 percent other than
for any series issued prior to the
applicable effective date. For example,
the final rule does not permit a sponsor
to include in the numerator of the
seller’s interest ratio a reserve account
that only covers shortfalls of principal
and interest payments to holders of a
specific series of investor ABS interests.
The final rule requires the 5 percent
minimum seller’s interest test to be
determined and satisfied at the closing
of each issuance of ABS interests to
investors by the issuing entity, and at
least monthly. The agencies have made
several adjustments to the measurement
details, in response to comments.
Sponsors must measure the seller’s
interest at a seller’s interest
measurement date specified in the
transaction documents at least monthly.
If the seller’s interest does not meet the
minimum percentage requirement on
any measurement date and the
transaction documents specify a cure
period, the minimum percentage
requirement must be satisfied within the
cure period, but no later than one month
after the original measurement date.
For purposes of determining the size
of the seller’s interest at the closing of
each issuance of ABS interests to
investors, the final rule permits the
sponsor to use a specified ‘‘as of’’ date
or cut-off date for data in establishing
the outstanding value of the revolving
pool securitization’s securitized assets
and an ‘‘as-of’’ date or cut-off date for
data in establishing the value of the
revolving pool securitization’s
outstanding ABS interests. The agencies
expect that sponsors of revolving pool
securitizations will, as a practical
91 An ABS interest retained in this manner and
that is not being used to satisfy the minimum risk
retention requirements under the rule, and that is
excluded from the denominator, is not subject to
the restrictions of the final rule that apply to ABS
interests retained to meet the risk retention
obligations under the final rule. For instance, the
sponsor would be permitted to hedge the risks
related to holding such an interest.

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matter, continue their past practice of
using cut-off dates or similar dates as
the basis for disclosures about the
amount of securitized assets held by the
issuing entity, and similarly using
investor reporting or distribution dates
as the basis for disclosures about the
amount of outstanding investor ABS
interests. The final rule accommodates
this, both for disclosure purposes and
for determining compliance with the
regulatory minimum seller’s interest
requirement. The sponsor is required to
describe its use of specified dates for
these purposes in connection with the
associated investor disclosures for the
issuance of ABS interests by the
revolving pool securitization. In
addition, in the interests of ensuring
sponsors use up-to-date information, the
rule requires the specified dates to be no
more than 60 days prior to the date of
first use with investors. To
accommodate revolving pool
securitizations that only make investor
distributions quarterly (or less
frequently), rather than monthly, the
final rule permits the specified dates to
be up to 135 days prior to the date of
first use with investors.92
In addition, the final rule’s disclosure
requirements require the sponsor to
provide pre-sale descriptions of the
percentage of seller’s interest the
sponsor expects to retain at closing. To
accommodate this, the final rule permits
sponsors to describe adjustments to
their specified-date data reflecting
increases or decreases for additions or
removals of assets the sponsor expects
to make before the closing date.93 The
sponsor, in describing the amount of
additional investor ABS interest that are
expected to be added by the
securitization transaction, may also
describe other adjustments to the
issuing entity’s outstanding investor
ABS interest data resulting from
expected increases and decreases of
those interests under the control of the
sponsor, such as additional issuances,
or scheduled principal payments on
outstanding investor ABS interests that
the sponsor expects will be made before
the closing date. If the amount of seller’s
interest the sponsor determines that it
retains at the closing of the
securitization transaction is materially
different from the amount described in
92 See

supra note 62.
providing the sponsor this operational
flexibility, the final rule does not allow the sponsor
to adjust the asset total for changes other than
additions or removals of assets made by the sponsor
itself. Accordingly, the rule does not permit the
sponsor to adjust the asset total to take into account
seasonal changes in borrowers’ revolving credit
drawdown rates, expected changes in borrower
repayment rates, or other estimated factors.

the pre-closing disclosures, the sponsor
must disclose the amount as of closing,
within a reasonable time after the
closing.
Consistent with the reproposal, the
seller’s interest amount is the unpaid
principal balance of the seller’s interest
in the common pool of receivables or
loans. The minimum required seller’s
interest cannot be less than 5 percent of
the aggregate unpaid principal balance
of all outstanding investor ABS interests
issued by the issuing entity. The
agencies have added language clarifying
the measurement of this ratio.
Consistent with the definition of seller’s
interest, the final rule also clarifies that
the sponsor may not include in the
numerator of the seller’s interest ratio
ineligible assets, or those servicing
assets allocated as collateral for a
particular series. The agencies have also
added language permitting the sponsor
to take a deduction from the
denominator (the principal of
outstanding investor ABS interests)
equal to the amount of funds held in a
segregated principal accumulation
account for the repayment of
outstanding investor ABS interests,
subject to certain conditions specified in
the rule.94 For securitized assets without
a principal or stated balance, such as
royalty payments or leases, the amount
of the securitized assets is the value of
the collateral as determined under the
transaction documents for purposes of
measuring the seller’s interest required
for the revolving pool securitization.
The requirements from the reproposal
are unchanged with respect to the
holding of the seller’s interests. The rule
permits wholly-owned affiliates of the
sponsor to retain the seller’s interest
(and the horizontal interests described
in section 5 of the rule, described
below). The agencies decline to permit
holding by majority-owned affiliates, as
requested by commenters. The agencies
are affording the treatment provided to
seller’s interest in section 5 of the rule
because of the special alignment of
incentives created by the sponsor’s
interest in maintaining access to
continued funding through the
revolving pool securitization, and the
agencies seek to maintain this alignment
through this stricter holding
requirement under the final rule. The
final rule includes changes to the other
affiliate-holding provisions within

93 In

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94 The terms of the securitization documents must
prevent funds in the accumulation account from
being applied for any purpose other than the
repayment of the unpaid principal of outstanding
investor ABS, and the funds in the account may
only be invested in the types of assets permitted for
a horizontal cash reserve account pursuant to
section 4 of the rule.

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section 5 to maintain consistency with
this approach. The final rule also
clarifies the provisions allowing seller’s
interest for ‘‘legacy trust’’ assets to be
held at either the legacy trust level or
the issuing entity level. The final rule,
like the reproposal, limits the amount of
seller’s interest that may be held at the
legacy trust level to its proportional
share of the combined securitized assets
of the two trusts. The text has been
clarified to indicate that this
proportional share is determined based
on the principal balance of the
securitized assets in each trust. The
final rule also clarifies that the
proportion of seller’s interest held at the
legacy trust level must be equal to this
proportion.95 Commenters requested the
agencies permit legacy trusts to retain
horizontal forms of risk retention at
either level, but the comments did not
provide details of these structures.
Without more details about the
structures commenters seek to
accommodate, the agencies have not
made changes to section 5 of the rule in
this regard.
The agencies made changes requested
by commenters to allow for dollar-fordollar offset from the 5 percent seller’s
interest requirement for funds
maintained in a segregated excess
funding account that is funded from
distributions otherwise payable to the
holder of the seller’s interest. The
agencies expanded the funding trigger
requirements for the account to include
the sponsor’s failure to meet the
minimum seller’s interest requirement,
and the failure to meet other minimum
securitized asset balance tests under the
transaction documents.96 The agencies
agree with the commenters that losses
would not be allocated to an excess
funding account, and have removed a
pari passu requirement on the priority
of such distributions to the account.97 In
order to expand the issuing entity’s
flexibility slightly to hold the account in
a form other than cash deposits, the
agencies have also decided to add
language permitting investments in the
same assets permitted for a horizontal
95 The reproposal indicated that the legacy trust
must hold at least that proportion of seller’s
interest, but also suggested the sponsor would be
permitted to hold a greater proportion of seller’s
interest at the legacy trust. The final rule clarifies
that the proportion must be the same.
96 Commenters described a common test requiring
the principal balance of the securitized assets to be
not less than the sum of the numerators used for
each series’ calculation of its seller’s interest ratio
to allocate principal collections to the investor ABS
interests.
97 As in the reproposal, the account must, in the
event of early amortization, pay out to outstanding
investor ABS interest holders in the same manner
as distributions on the securitized assets.

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cash reserve account pursuant to section
4 of the rule.
The final rule retains the reproposal’s
provisions allowing the sponsor to
reduce its seller’s interest to a
percentage lower than 5 percent to the
extent that, for all series of investor ABS
interests issued by the revolving pool
securitization, the sponsor retains, at a
minimum, a corresponding fair value
percentage of subordinated risk
retention. This treatment is available
with respect to the same two forms of
subordinated risk retention the agencies
included in the reproposal. As
discussed in more detail below, the
agencies have revised the requirements
of each type slightly, in light of sponsor
comments stating that existing
structures would not be able to comply
with the reproposed rule. An example of
the reduction in seller’s interest
permitted by the final rule is as follows:
a revolving pool securitization sponsor
holds a seller’s interest in the issuing
entity’s common collateral pool equal to
2 percent of the aggregate balance of
outstanding investor ABS interests
issued by the securitization. The
securitization has two outstanding
series; for one series the sponsor retains
a residual interest in excess interest and
fees with a fair value of 5 percent of the
fair value of outstanding investor ABS
interests in that series, and for the other,
the sponsor retains a horizontal interest
with a fair value of 3 percent of the fair
value of outstanding investor ABS
interests in that series. This revolving
pool securitization holds adequate risk
retention to comply with section 5 of
the rule. So long as the structure in this
example only holds 2 percent seller’s
interest, every future series issued to
investors will be required to be
supported by at least a 3 percent fair
value subordinated interest.
For revolving pool securitizations
relying on both seller’s interest and
subordinated risk retention, commenters
requested the agencies grandfather all
series issued prior to the applicable
effective date of the rule with respect to
the subordinated portion of risk
retention. For example, for a revolving
pool securitization in which the sponsor
holds 2 percent seller’s interest, these
commenters urged the agencies to
permit the structure to come into
compliance with the rule by continuing
to maintain the 2 percent seller’s
interest and supplement it with at least
a 3 percent horizontal interest to
support each series issued to investors
after the applicable effective date of the
rule. Commenters said that, unless the
agencies permit this grandfathering
approach, a revolving pool
securitization with less than 5 percent

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seller’s interest would have no option
other than to increase its seller’s interest
to 5 percent. Commenters asserted it
was not feasible to grandfather existing
series issued before the applicable
effective date of the rule with respect to
a seller’s interest, since a seller’s interest
is an interest in the securitization’s
entire collateral pool, and this factor
raises serious obstacles to implementing
it on a series-by-series basis. The
agencies agree that the grandfathering
approach requested by commenters
should achieve meaningful risk
retention in ABS interests issued in a
revolving pool securitization after the
applicable effective date of the rule, and
the approach is reflected in the final
rule text.98
In the reproposal, the agencies sought
to give revolving pool securitizations
the above-described offset credit against
a seller’s interest for two different forms
of horizontal risk retention. The first
form was based on the sponsor’s interest
in excess interest and fees, as described
above, made available to the sponsor
periodically after covering the trust’s
expenses, interest due on more senior
ABS interests in the series for that
payment date, and charge-offs for that
period that would otherwise be
allocated to more senior ABS interests.
Some revolving pool securitizations
allocate each series its ratable share of
interest and fee collections from the
pool collateral and apply the interest
and fee collections only within each
series, while others permit sharing of
excess interest and fee collections to
cover shortfalls in another series after
application of its share of interest and
fee collections. The agencies proposed
to allow sponsors to use the fair value
of this residual ABS interest in excess
interest and fees, as a percentage of the
fair value of outstanding investor ABS
interests, to reduce their 5 percent
minimum seller’s interest. As discussed
above, commenters said they
anticipated the burden of calculating the
fair value of these excess interest and
fees on a monthly basis would be so
high that few, if any, sponsors would
avail themselves of the option. The
agencies note that this is a residual
interest comprised of a stream of future
cash flows, and no commenter
suggested any other reasonable
methodology to assign a value to it for
purposes of determining the required
amount of risk retention. To address this
burden, the final rule does not require
98 Specifically, section 5(f) of the rule provides
that the seller’s interest requirement would be
reduced by the subordinated portion of risk
retention support for all series of ABS interests
issued by the revolving pool securitization after the
applicable effective date of the rule.

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the sponsor to disclose its fair value
determination to investors monthly. The
sponsor also must continue to calculate
the fair value of the residual ABS
interest in excess interest and fees at the
same time the sponsor calculates the
seller’s interest, to verify that it
continues to hold at least the minimum
required amount of risk retention.99
The agencies have made two
clarifying changes to the text of the final
rule. First, at the request of commenters,
the agencies have eliminated the
requirement that the sponsor’s residual
claim to the interest and fee cash flows
for any interest payment period be
subordinated to all accrued and payable
principal due on the payment date to
more senior ABS interests in the series
for that period. Commenters asserted
this requirement was correct for interest
due (as the rule provides), but not for
principal.100 The agencies have
eliminated the ‘‘and principal’’ language
contained in the interest subordination
paragraph, and have also eliminated the
requirement that the residual have the
most subordinated claim to any part of
the series’ share of principal repayment
cash flows.101 In addition, the agencies
have clarified that, in applying interest
and fees to reduce the series’ share of
99 To reduce burden further, the rule permits the
periodic determinations of this residual interest’s
fair value percentage to be made without redetermining the fair value of the outstanding
investor ABS interests in the denominator. The
sponsor may, at its option, carry forward the fair
values of the outstanding investor ABS interests
from the determinations made for the closings of
the transactions in which those outstanding
investor ABS interests were issued (which are likely
to be based on observable market data at that time).
Only the fair value of the residual ABS interest in
the numerator of the ratio needs to be determined
every period. The agencies recognize that, for
revolving pool securitizations with one or more
amortizing series, this approach may result in a
larger denominator and thus a larger residual ABS
interest in excess interest and fees. The final rule
permits a sponsor to elect to make monthly
redeterminations of the fair value of such
amortizing series in connection with their periodic
determinations.
100 One group of commenters also said the
obligation to pay default-rate interest is typically
subordinated to payment of the contract-rate
interest and coverage for allocated charge-offs. The
agencies regard this as desirable in that it uses
available excess spread first to protect investors
from losses. At any rate, the arrangement described
by commenters in this regard means that the
sponsor only claims excess interest and fee
collections remaining after covering both types of
‘‘interest,’’ which is in compliance with the rule
text.
101 Commenters requested the agencies eliminate
the separate waterfall requirement from the option,
citing concern that single-waterfall revolving pool
securitizations could not utilize the structure.
Commenters did not elaborate on how the residual
ABS interest in excess interest and fees would be
separately identified or valued in such an approach.
Since the separate waterfall requirement is a central
element of the option, the agencies have retained
it.

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losses for the applicable period, these
losses must include charge-offs that
were not covered by available interest
and fees in previous periods. The
agencies believe this clarification is
appropriate to prevent sponsors from
receiving payments of excess spread on
a period-by-period basis for pools that
have suffered un-covered losses on
securitized assets in previous
periods.102
The second form of subordinated risk
retention the agencies would have
recognized in the reproposal for
purposes of reducing the required
amount of seller’s interest would have
been an eligible horizontal residual
interest the sponsor simultaneously
held in the securitization’s outstanding
series of ABS interests. The reproposal
required these interests to meet all the
requirements for the standard form of
eligible horizontal residual interest
pursuant to section 4 of the reproposed
rule. Commenters asserted that
revolving pool securitizations that retain
a residual ABS interest in excess
interest and fees could not
simultaneously satisfy the requirement
pursuant to section 4 that the eligible
horizontal residual interest have the
most subordinated claim to interest and
principal. Commenters said a residual
ABS interest in excess interest and fees
is typically structured first to apply a
series’ share of excess interest and fees
each period to cover the series’ share of
trust expenses and the interest due to
each tranche of ABS interests in the
series; second to apply remaining excess
interest and fees to cover charge-offs
allocated to more senior ABS interests
in the series; and third to make the
remainder available to the sponsor (net
of portions shared with other series, in
some structures). Commenters said that
this subordinated interest is typically
structured to pay interest to the holder
before excess interest and fee collections
are applied to cover the series’ share of
charge-offs. Accordingly, this residual
interest would not have the most
subordinated claim to interest.103 The
agencies note that, now that the final
rule recognizes subordinated forms of
seller’s interest, the residual interest
may not be the most subordinated claim
to principal distributions to the sponsor
from the seller’s interest, depending on
the particulars of the transaction.
102 This eliminates possible incentives for
sponsors to attempt to cluster charge-offs into
particular periods.
103 Commenters also said the cash flow
restrictions in section 4 were not workable for
revolving pool securitizations. As discussed
elsewhere in this Supplementary Information, these
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In order to permit sponsors to offset
their seller’s interest with either of the
two forms of horizontal risk retention
included in the reproposal, the agencies
have modified the subordination
requirements that would be required for
eligible horizontal residual interest, to
accommodate the issues described in
the preceding paragraph. The final rule
provides that a sponsor may take the
seller’s interest offset for ABS interests
that would meet the definition of
eligible horizontal residual interest in
section 2 of the rule but for the
sponsor’s simultaneous holding of
subordinated seller’s interests, residual
ABS interest in excess interest and fees,
or a combination thereof. In connection
with this approach, the sponsor’s fair
value determination for this horizontal
residual interest must not incorporate
any value attributable to the sponsor’s
holdings of subordinated seller’s
interest or residual ABS interest in
excess interest and fees.
Under the final rule, if the sponsor is
also taking risk retention credit for its
residual ABS interest in excess interest
and fees, the sponsor may not include
any of the interest payments to itself on
this offset eligible horizontal residual
interest (‘‘offset EHRI’’) in determining
the fair value of the offset EHRI.
Similarly, if the sponsor is taking risk
retention credit for subordinated seller’s
interest that is used to reduce chargeoffs that would otherwise be allocated to
reduce the principal of the offset EHRI,
the sponsor may not include any
principal payments on the offset EHRI
in determining the fair value of the
offset EHRI. The agencies believe this
bright-line rule provides an appropriate
compromise between flexibility for
sponsors and clarity for investors and
regulators as to the nature of the risk
retention interests upon which a
sponsor relies to comply with the final
rule.
Under the final rule, if the sponsor
seeks to rely on offset EHRI as part of
its risk retention interest for purpose of
compliance with the rule, any
subordinated seller’s interest or residual
ABS interest in excess interest and fees
retained by the sponsor must also
comply with the applicable
requirements of section 5 of the rule.
This is true even if the sponsor is not
asserting reliance on these subordinated
seller’s interests or residual ABS
interests in excess interest and fees as
part of its retained risk retention
interests to comply with the rule.
Commenters said that sponsors sought
the ability to continue incorporating
subordinated seller’s interest or residual
ABS interest in excess interest and fees
into their deal structures and

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simultaneously retain a junior bond,
while still having the flexibility to
choose which combination of those
interests the sponsor would use to
comply with the risk retention
requirements. Commenters placed
particular importance on retaining the
flexibility to do this without being
required to engage in fair value
determinations for the interests the
sponsor does not count for purposes of
regulatory compliance. Taken together,
the agencies believe that these rules for
offset EHRI provide an appropriate
framework to accommodate that
flexibility.104
The final rule requires the sponsor to
make the percentage fair value
determination for offset EHRI, and to
make investor disclosures, at the same
time and in the same manner as is
required for the standard form of
eligible horizontal residual interest
pursuant to section 4 of the rule.
Consistent with the treatment of the
standard form of eligible horizontal
residual interest pursuant to section 4 of
the rule, the sponsor is only required to
perform the fair value determination for
offset EHRI with respect to the initial
issuance of the ABS interests supported
by the offset eligible horizontal residual
interest. The final rule similarly requires
a sponsor using a residual ABS interest
in excess interest and fees to disclose
the fair value of the interest in the same
manner as required for eligible
horizontal residual interests pursuant to
section 4. To accommodate the
fluctuating nature of securitized assets
and outstanding investor ABS interests
present in revolving pool
securitizations, the final rule’s valuation
and disclosure provisions for offset
EHRI and residual ABS interests in
excess interest and fees allow the use of
specific dates for data on securitized
assets and outstanding investor ABS
interests, and adjustments to these
amounts in connection with pre-sale
disclosures. These provisions are the
same as those governing the
determination of minimum seller’s
interest, as described above.
Consistent with the agencies’
reproposal, the final rule also makes
104 As an example, a sponsor could rely on a pari
passu seller’s interest and supplement it with the
fair value of principal payments on an offset EHRI,
at the same time the sponsor retained a residual
interest in excess spread but did not rely on that
interest for purposes of satisfying its risk retention
requirements. Or for a revolving pool securitization
of assets that do not generate significant excess
spread, the sponsor might rely on a subordinated
seller’s interest and supplement it with the fair
value of interest payments on an offset EHRI, since
its residual interest in excess interest and fee
collections would provide a lesser contribution to
satisfying the sponsor’s risk retention obligations.

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clear that there is no sunset date for
revolving pool securitization risk
retention interests. The basis for the
agencies’ decision to propose a sunset
date for risk retention was that sound
underwriting is less likely to be
effectively promoted by risk retention
after a certain period of time has passed
and a peak number of delinquencies for
an asset class has occurred. In the case
of a revolving pool securitization, this
rationale does not apply, since the
sponsor continually transfers additional
assets into the common pool of
collateral.105 For a seller’s interest, the
rule text continues to specify that the
seller’s interest must be measured and
satisfied at least monthly until no ABS
interest in the issuing entity is held by
any person which is not a whollyowned affiliate of the sponsor.106 For
other forms of risk retention employed
by a revolving pool securitization
sponsor, the applicable provision on
sunset is in section 12(f) of the rule.
Notably, this provision only lifts the
transfer and hedging restrictions of
section 12 of the rule at ‘‘the latest of’’
amortization of the securitized assets to
33 percent of the original balance,
amortization of the principal amount of
the ABS interests to 33 percent of their
original balance, or two years after
closing. Since the common pool of
securitized assets continually revolves
and the ABS interests typically are not
paid principal until maturity, neither
the securitized assets nor the ABS
interests amortize down to 33 percent of
the original unpaid balance (absent an
early amortization).
Commenters requested several
additional changes concerning the rules
for holding and measuring a seller’s
interest. One commenter requested the
agencies strike the element of the
definition of seller’s interest that
describes it as an ABS interest. The
commenter requested the agencies allow
sponsors to hold anything that was the
economic equivalent of the seller’s
interest, regardless of form. The
agencies are not making this change
because they believe the rule’s
definition of ‘‘ABS interest’’ provides
sufficient flexibility, balanced against
the agencies’ interest in certainty and
clarity regarding how a sponsor
achieves compliance with the rule. With
respect to the form requirements for an
105 Even

if the pool consists of receivables created
by revolving accounts, successful underwriting of
revolving account credits is an ongoing process for
the life of the credit line.
106 The agencies have modified the rule text to
clarify that holding by an affiliate for these
purposes means holding by a wholly-owned
affiliate. This is consistent with the other affiliation
requirements of section 5 of the rule.

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ABS interest, the definition applies to
any type of interest, whether certificated
or uncertificated, and includes
beneficial interests and residual
interests. This provides flexibility for
sponsors and imposes no specific
requirements as to form or
documentation, but at the same time
maintains a basic requirement for the
sponsor to be able to demonstrate that
the legal source of its entitlement to
payments from, and its obligation to
share losses of, the securitized assets are
consistent with the rule’s requirements
for a risk retention interest.
Another group of commenters
requested the agencies modify the
holding requirements for sponsors
reducing their 5 percent seller’s interest
requirement with offsetting horizontal
interests. As described above, the
sponsor must demonstrate that it holds
the offset percentage as a minimum
percentage for every series of
outstanding investor ABS interests.107
Commenters requested the agencies
permit sponsors to determine they
satisfied the requirement on a weighted
average basis taken across all
outstanding series. The agencies decline
to incorporate this approach because it
would result in at least some series of
outstanding investor ABS interests with
less than 5 percent risk retention.
Commenters also requested sponsors be
permitted to take partial risk retention
credit for horizontal interests the
sponsor holds jointly with another
party, on a pro rata basis. The agencies
note this is not permitted for the
standard form of eligible horizontal
residual interest, and commenters did
not provide sufficient justification for
treating offset EHRI any differently.
The agencies revised the disclosure
requirements of section 5 of the rule in
a manner consistent with the agencies’
revisions to the disclosure requirements
throughout the rule, with appropriate
variations for valuation of seller’s
interest and offsetting subordinated
interests as described above.
The reproposal also included
provisions clarifying that a master trust
107 Commenters also expressed the view that the
reproposal did not provide sponsors with the
flexibility to offset their minimum seller’s interest
percentage with a form of horizontal risk retention
that supported more than one outstanding series. In
this regard, the agencies note that the final rule
requires the sponsor to satisfy the minimum floor
for every series issued after the applicable effective
date of the rule, but that it does not require them
to hold that risk retention in each series. The rule
does not prevent sponsors from incorporating
residual ABS interest in excess interest and fees or
offset EHRI that are structured to support more than
one series, or structured to support delinked
structures, so long as the sponsor demonstrates the
structure satisfies the rule’s requirements as to the
terms of those horizontal interests.

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entering early amortization and winding
down would not, as a result, violate the
rule’s requirement that the seller’s
interest be pari passu. Commenters
requested changes to the details of these
provisions, to reflect more accurately
the way early amortization triggers are
actually structured. In response to
commenter concerns, the agencies have
revised the rule text to apply when the
securitization has entered early
amortization, rather than focusing on
the technical trigger events that result in
an early amortization commencing.108
Nevertheless, the agencies also believe
that the revisions permitting
subordination of the seller’s interest
make this portion of the final rule less
significant than it was when the
agencies would have required the
seller’s interest to be pari passu.
For servicing advance receivables, the
agencies note that the final rule permits
sponsors of revolving pool
securitizations to rely on subordinated
forms of seller’s interest to meet their
risk retention requirements, which
largely addresses the source of the
commenters’ concerns.
3. Representative Sample
a. Overview of Reproposal and Public
Comment
The original proposal would have
allowed a sponsor to satisfy its risk
retention requirement for a
securitization transaction by retaining
ownership of a randomly selected
representative sample of assets. To
ensure that the sponsor retained
exposure to substantially the same type
of credit risk as investors in the
securitized transaction, the sponsor
electing to use the representatives
sample option would have been
required to construct a ‘‘designated
pool’’ of assets consisting of at least
1,000 separate assets from which the
securitized assets and the assets
comprising the representative sample
would be drawn. The original proposal
also would have required a number of
other measures in calculating the
representative sample to ensure the
integrity of the process of selection,
including a requirement to obtain a
report regarding agreed-upon
procedures from an independent public
accounting firm.109
108 The agencies have also eliminated the
paragraph limiting the provision to pools of
revolving assets. The language was included in the
reproposal based on concerns about potential
evasive structures, but the agencies have now
directly addressed that issue in the discussion of
revolving pool securitizations that amortize without
issuing a second series of investor ABS interests
collateralized by the common pool of assets.
109 See Original Proposal, 76 FR at 24104.

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Many commenters opposed the
representative sample in the original
proposal, noting that it would be
impractical to implement this option for
a variety of reasons, including that it
would be unworkable with respect to
various asset classes, would be subject
to manipulation, and was too
burdensome with respect to its
disclosure requirements. Due to these
concerns and a conclusion that the
representative sample option would
likely be too difficult to implement, the
agencies did not include a
representative sample option in the
reproposed rule. Instead, the agencies
invited comment on whether a
representative sample option should be
included as a form of risk retention,
and, if so, how should such an option
be constructed, and what benefits such
an option might provide.
The agencies received several
responses to this request for comment.
While some commenters were
supportive of the reproposal’s
elimination of the representative sample
option, many commenters urged the
agencies to reconsider including the
option in a simplified form. Several
commenters recommended a simplified
version of a representative sample
option similar to the representative
sample option included in the FDIC’s
safe harbor for securitizations, which
(prior to the applicable effective date of
the final rule) requires that the retained
sample be representative of the
securitized asset pool, but does not
specify the requirements for establishing
that the sample is representative and,
accordingly, does not itemize specific
items, such as servicing, accountant
reports or other requirements.110
Commenters asserted that the
representative sample option is one of
the two permitted forms of risk
retention under the existing FDIC safe
harbor and that the approach has been
working effectively for several banks
that issue asset-backed securities. One
commenter stated that its sponsor
members would strongly prefer to have
a representative sample method as an
alternative option, even if the final rule
is more burdensome than they would
prefer.
Commenters indicated that the
representative sample is one of the
alternative methods of risk retention
permitted under Article 122a of the
European Union’s Capital Markets
Directive, and that if the representative
sample is not included it may place U.S.
issuers at a competitive disadvantage
against asset-backed securities issuers
from outside the United States, and
110 See

12 CFR 360.6.

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could make it more difficult for global
offerings of asset-backed securities
originated outside the United States to
be sold to investors in the United States.
Many commenters indicated that a
revised representative sample option
would be particularly useful for
automobile loan and lease
securitizations. Commenters also stated
that the option would be useful more
generally for large pools of consumer or
retail assets, such as student loans, and
for sponsors that do not securitize all of
their assets. In order to facilitate use by
sponsors for these types of
securitizations, commenters generally
agreed that the agencies should revise
the option so that (i) a sponsor selects
a designated pool of assets for
securitization (ii) then uses a random
selection process to select a ‘sample’ of
assets with an aggregate unpaid
principal balance equal to 5 percent of
the pool and (iii) that the pool should
be sufficiently large to ensure that the
sample is representative of the assets in
the pool. To accomplish (iii),
commenters suggested that a pool size
of 5,500 or 6,000 loans would be
sufficient to achieve a high confidence
level that the sample shares significant
asset characteristics with the securitized
pool.
A commenter suggested that
additional criteria could be added such
as documentation of material asset
characteristics and a description of the
policies and procedures that the sponsor
used to ensure that the sample
identification process complies with the
risk retention requirement. The
commenter also recommended that
documentation identifying the
representative sample be maintained for
the same duration required for a vertical
risk retention interest and that the assets
be excluded from the securitization pool
and from any other securitization for
such time period. Other commenters
favored simpler disclosures, such as a
statement that the composition of the
sample was prepared in accordance
with the rule’s requirements, and a
description of the method used to
randomly select assets.
A few commenters suggested that
additional criteria could be added
specifically to address smaller pool
sizes, such as the criteria above, or a
‘resampling’ requirement if the sample
is not sufficiently similar to the
securitized pool. Other commenters
expressed the view that a sponsor
should not be required to ‘rework’ the
pool based on a post hoc examination of
the performance of the sample pool
compared to the securitized pool.

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77635

b. Response to Comments and Final
Rule
Having considered the comments, the
agencies have concluded that adopting
the recommendations made by
commenters would be insufficient to
address concerns about the practicality
of obtaining an adequate and truly
representative sample, while providing
sufficient flexibility for use of the option
in more than extremely limited
scenarios. Furthermore, the agencies
concur with commenters’ views that, at
a minimum, a large number of loans
would be required depending on the
variability of asset characteristics in
order to ensure an adequate sample,
which greatly reduces the number of
asset classes that would be able to
utilize the option.
The agencies do not believe that
adopting the disclosure, servicing, and
independent review requirements as
recommended by commenters would be
sufficiently robust to ensure the
effectiveness of the representative
sample option and to minimize the
ability of sponsors to ‘‘cherry pick’’
assets favorable to them, which would
result in the risk retention sample
having a better risk profile than the
assets collateralizing the ABS issued to
investors. In addition, unless large pools
of loans are already largely
homogeneous, a random sample will not
necessarily be a representative sample.
The agencies do not believe that
effective pool consistency standards
would be any less burdensome or
objectionable than the sample validation
standards. Even if an approach that met
the requirements of section 15G of the
Exchange Act could be developed, the
agencies acknowledge that the costs of
such requirements could be overly
burdensome for sponsors. Furthermore,
in light of the revisions that have been
made to other aspects of the rule, the
agencies believe that the final rule’s risk
retention options should provide a
workable risk retention option for
various asset classes including auto
loan, auto lease, and student loan
securitizations. The agencies believe
these additional risk retention options
will be more cost effective than the
representative sample option in the
original proposal and will more
effectively align the interests of
sponsors and investors. Therefore, the
final rule does not include a
representative sample option.

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4. Asset-Backed Commercial Paper
Conduits
a. Overview of the Reproposal and
Public Comments
As explained in the original proposal
and reproposal, ABCP is a type of
liability that is typically issued to
investors by a special purpose vehicle
(commonly referred to as a ‘‘conduit’’)
sponsored by a financial institution or
other sponsor. The commercial paper
issued by the ABCP conduit is
collateralized by a pool of asset-backed
securities, which may change over the
life of the entity. Depending on the type
of ABCP conduit, the securitized assets
collateralizing the ABS interests that
support the ABCP may consist of a wide
range of assets including securitized
automobile loans, commercial loans,
trade receivables, credit card
receivables, student loans, and other
loans. Historically, these programs came
about as a way for banks to extend
commercial firms credit at a lower cost
than bank-funded working capital lines
or trade receivable financing. Like other
types of commercial paper, the term of
ABCP typically is short, and the
liabilities are ‘‘rolled,’’ or refinanced, at
regular intervals. Thus, ABCP conduits
generally fund longer-term assets with
shorter-term liabilities.111 During the
financial crisis, however, ABCP
conduits experienced acute distress,
which revealed significant structural
weaknesses in certain ABCP conduit
structures, particularly those ABCP
conduits that did not have 100 percent
liquidity commitments, and exposed
investors and the financial system to
significant risks.112
In a typical ABCP conduit, the
sponsor approves the originators whose
loans or receivables will collateralize
the ABS interests that support the ABCP
issued by the conduit. Banks can use
ABCP conduits that they sponsor to
meet the borrowing needs of a bank
customer and offer that customer a more
attractive cost of funds than a
commercial loan or a traditional debt or
equity financing. In such a transaction,
the customer (an ‘‘originator-seller’’)
may sell loans or receivables to an
intermediate, bankruptcy remote SPV.
The credit risk of the loans or
receivables transferred to the
intermediate SPV then typically is
separated into two classes—a senior
ABS interest that is acquired by the
111 See

section 9 of the Original Proposal.
112 Daniel M. Covitz, Nellie Liang, and Gustavo A.
Suarez, ‘‘The Evolution of a Financial Crisis: Panic
in the Asset-Backed Commercial Paper Market,’’
Finance and Economics Discussion Series 2009–36
(Washington: Board of Governors of the Federal
Reserve System, August 2009).

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ABCP conduit and a residual ABS
interest that absorbs first losses on the
loans or receivables and that is retained
by the originator-seller. The residual
ABS interest retained by the originatorseller typically is sized with the
intention that it be sufficiently large to
absorb all losses on the securitized
assets.
In this structure, the ABCP conduit, in
turn, issues short-term ABCP that is
collateralized by the senior ABS
interests purchased from one or more
intermediate SPVs (which are supported
by the subordination provided by the
residual ABS interests retained by the
originator-sellers). The sponsor of this
type of ABCP conduit, which is usually
a bank or other regulated financial
institution or an affiliate or subsidiary of
a bank or other regulated financial
institution, also typically provides (or
arranges for another regulated financial
institution or group of financial
institution to provide) 100 percent
liquidity coverage on the ABCP issued
by the conduit. This liquidity coverage
typically requires the support provider
to provide funding to, or purchase assets
or ABCP from, the ABCP conduit in the
event that the conduit lacks the funds
necessary to repay maturing ABCP
issued by the conduit.
The agencies’ original proposal
included an ABCP option that
incorporated several conditions
designed to ensure that the ABCP option
would have been available only to the
type of single-seller or multi-seller
ABCP conduits described above. The
proposed ABCP option would only have
been available to ABCP conduits that
issued ABCP with a maximum maturity
at the time of issuance of nine months.
Under the original proposal, a sponsor
of an ABCP conduit program would
have been eligible for the proposed
ABCP option if a ‘‘regulated liquidity
provider’’ (defined in the rule generally
to mean banks and certain bank
affiliates) provided 100 percent liquidity
support to the ABCP conduit and the
originator-sellers retained a 5 percent
horizontal residual interest in each
intermediate special purpose vehicle
containing the assets they finance
through the ABCP conduit. Under the
original proposal, this risk retention
option would have been available to
ABCP conduits collateralized by ABS
interests that were issued or initially
sold by intermediate SPVs that sold
ABS interests exclusively to ABCP
conduits and would not have been
available to ABCP conduits that
purchased securities in the secondary

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market or operated securities arbitrage
programs.113
In the reproposal, the agencies
maintained an option tailored for ABCP
securitization transactions that retained
the basic structure of the original
proposal with modifications based in
part on comments. The modifications
were intended to accommodate certain
market practices referred to by
commenters, while maintaining a
meaningful risk retention requirement.
The reproposal would have permitted
the sponsor of an eligible ABCP conduit
to satisfy its risk retention requirement
if, for each ABS interest the ABCP
conduit acquired from an intermediate
SPV, the intermediate SPV’s sponsor
(the ‘originator-seller’ with respect to
the ABCP conduit) retained an exposure
to the assets collateralizing the
intermediate SPV in the appropriate
form and amount under the rule,
provided that all other conditions to this
option were satisfied. The agencies
reaffirmed the view expressed in the
original proposal that such an approach
is appropriate in light of the
considerations set forth in section
15G(d)(2) of the Exchange Act.114
In response to comments, the
reproposal would have included
additional flexibility not present in the
original proposal to permit affiliated
groups of originator-sellers to finance
credits through a single intermediate
SPV. Under the reproposal, both an
originator-seller and a ‘‘majority-owned
originator-seller affiliate’’ (majorityowned OS affiliate) could have sold or
transferred assets that these entities had
originated to an intermediate SPV. A
majority-owned OS affiliate was defined
as an entity that, directly or indirectly,
majority controls, is majority controlled
by, or is under common majority control
with, an originator-seller. For purposes
of this definition, majority control
would have meant ownership of more
than 50 percent of the equity of an
entity or ownership of any other
controlling financial interest in the
entity, as determined under GAAP.
However, consistent with the original
proposal, intermediate SPVs would not
be permitted to acquire assets from nonaffiliates.
The reproposal required the ABCP
conduit sponsor to: (i) Approve each
originator-seller and majority-owned OS
affiliate permitted to sell or transfer
113 Such ABCP conduits purchase securities in
the secondary market and typically either lack such
liquidity facilities or have liquidity coverage that is
more limited than those of the ABCP conduits
eligible to rely on this option for purposes of the
proposed rule.
114 See Revised Proposal, 78 FR at 57949; Original
Proposal, 76 FR at 24107.

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assets, directly or indirectly, to an
intermediate SPV from which an
eligible ABCP conduit acquires ABS
interests; (ii) approve each intermediate
SPV from which an eligible ABCP
conduit is permitted to acquire ABS
interests; (iii) establish criteria
governing the ABS interests, and the
assets underlying the ABS interests,
acquired by the ABCP conduit; (iv)
administer the ABCP conduit by
monitoring the ABS interests acquired
by the ABCP conduit and the assets
supporting those ABS interests,
arranging for debt placement, compiling
monthly reports, and ensuring
compliance with the ABCP conduit
documents and with the ABCP
conduit’s credit and investment policy;
and (v) maintain and adhere to policies
and procedures for ensuring that the
requirements described above have been
met.
The reproposal also permitted there to
be one or more intermediate SPVs
between an originator-seller and/or any
majority-owned OS affiliate and the
intermediate SPV that issues ABS
interests purchased by the ABCP
conduit.115 The reproposal redefined
‘‘intermediate SPV’’ as a direct or
indirect wholly-owned affiliate 116 of the
originator-seller that is bankruptcy
remote or otherwise isolated for
insolvency purposes from the eligible
ABCP conduit, the originator-seller, and
any majority-owned OS affiliate that,
directly or indirectly, sells or transfers
assets to such intermediate SPV.117
Consequently, an intermediate SPV was
permitted to acquire assets originated by
the originator-seller or one or more of its
majority-owned OS affiliates, or it could
also have acquired assets from another
intermediate SPV or asset-backed
securities from another intermediate
SPV collateralized solely by securitized
assets originated by the originator-seller
or one or more of its majority-owned OS
affiliate and servicing assets.118 ABS
interests collateralized by assets not
originated by the originator-seller or by
a majority-owned OS affiliate would
115 As indicated in the comments on the original
proposal, there are instances where, for legal or
other purposes, there is a need for multiple
intermediate SPVs.
116 See section 2 of the Revised Proposal
(definition of ‘‘affiliate’’).
117 See section 2 of the Revised Proposal
(definition of ‘‘Intermediate SPV’’).
118 The reproposal required each intermediate
SPV in structures with one or more multiple
intermediate SPVs that do not issue asset-backed
securities collateralized solely by ABS interests to
be a pass-through entity that either transfers assets
to another SPV in anticipation of securitization
(e.g., a depositor) or transfer ABS interests to the
ABCP conduit or another intermediate SPV.

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have been ineligible as collateral for the
ABCP conduit.
The reproposal also would have
relaxed activity restrictions on
intermediate SPVs, by permitting an
intermediate SPV to sell asset-backed
securities that it issues to third parties
other than ABCP conduits.119
The reproposal would have clarified
and expanded (as compared to the
original proposal) the types of collateral
that an eligible ABCP conduit could
acquire from an originator-seller and its
majority-owned affiliates.120 Under the
revised reproposal definition of
‘‘eligible ABCP conduit’’, an ABCP
conduit could acquire any of the
following types of assets: (1) ABS
interests collateralized by securitized
assets originated by an originator-seller
or one or more majority-owned OS
affiliates of the originator-seller and
servicing assets; (2) special units of
beneficial interest or similar interests in
a trust or special purpose vehicle that
retains legal title to leased property
underlying leases that are transferred to
an intermediate SPV in connection with
a securitization collateralized solely by
such leases originated by an originatorseller or one or more majority-owned
OS affiliates and servicing assets; and
(3) interests in a revolving master trust
collateralized solely by assets originated
by an originator-seller or one or more
majority-owned OS affiliates and
servicing assets.121 Under the proposal,
the ABCP option would have been
available only for ABCP conduits that
were bankruptcy remote or otherwise
isolated from insolvency of the sponsor
and from any intermediate SPV. Assets
other than the ABS interests and
servicing assets, such as loans or
receivables purchased directly by an
ABCP conduit or loans or receivables
acquired by an originator-seller, its
majority-owned OS affiliates or an
intermediate SPV in the secondary
119 As explained in the reproposal, the agencies
believe that some originator-sellers operate a
revolving master trust to finance extensions of
credit the originator-seller creates in connection
with its business operations. The master trust
sometimes issues a series of asset-backed securities
collateralized by an interest in those credits directly
to investors through a private placement transaction
or registered offering, and other times issues an
interest to an eligible ABCP conduit. The reproposal
was designed to accommodate such practices.
120 The purpose of this clarification was to allow
originator-sellers certain additional flexibility in
structuring their participation in eligible ABCP
conduits, while retaining the core principle that the
assets being financed have been originated by the
originator-seller or a majority-controlled OS
affiliate, not purchased in the secondary market and
aggregated.
121 The definition of ‘‘servicing assets’’ is
discussed in Part II.B of this Supplementary
Information. The agencies are allowing an ABCP
conduit to hold servicing assets.

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market, would have been expressly
disqualified.
The reproposal also would have
expanded the risk retention options
available to an originator-seller, in its
capacity as sponsor of the underlying
ABS interests issued by the intermediate
SPV, by allowing an eligible ABCP
conduit to purchase interests for which
the originator-seller or a majority-owned
OS affiliate retained risk using the
standard risk retention or seller’s
interest options.
The reproposal also would have
required a regulated liquidity provider
to enter into a legally binding
commitment to provide 100 percent
liquidity coverage of all the ABCP
issued by the issuing entity and would
have clarified that 100 percent liquidity
coverage means that, in the event that
the ABCP conduit is unable for any
reason to repay maturing ABCP issued
by the issuing entity, the total amount
for which the liquidity provider may be
obligated is equal to 100 percent of the
amount of ABCP outstanding plus
accrued and unpaid interest. In
response to commenters on the original
proposal, the reproposal clarified that
the required liquidity coverage would
not be subject to credit performance of
the ABS interests held by the ABCP
conduit or reduced by the amount of
credit support provided to the ABCP
conduit and that liquidity coverage that
only funds performing assets will not
meet the requirements of the ABCP
option.
Consistent with the original proposal,
under the reproposal the sponsor of an
eligible ABCP conduit would have
retained responsibility for ensuring
compliance with the requirements of the
ABCP option.122
With respect to disclosures, the
reproposal did not include a
requirement that the sponsor of the
ABCP conduit disclose the names of the
originator-sellers who sponsored the
ABS interests held by the ABCP conduit
and instead included a requirement that
an ABCP conduit sponsor promptly
notify investors, the Commission, and
its appropriate Federal banking agency,
if any, in writing of (1) the name and
form of organization of any originatorseller that fails to maintain its risk
retention as required and the amount of
asset-backed securities issued by an
intermediate SPV of such originator122 In response to commenters on the original
proposal who requested that the agencies replace
the monitoring obligation with a contractual
obligation of an originator-seller to maintain
compliance, the agencies noted their belief that the
sponsor of an ABCP conduit is in the best position
to monitor compliance by originator-sellers and
majority-owned OS affiliates.

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seller and held by the ABCP conduit; (2)
the name and form of organization of
any originator-seller or majority-owned
OS affiliate that hedges, directly or
indirectly through an intermediate SPV,
its risk retention in violation of its risk
retention requirements and the amount
of asset-backed securities issued by an
intermediate SPV of such originatorseller or majority-owned OS affiliate
and held by the ABCP conduit; and (3)
and any remedial actions taken by the
ABCP conduit sponsor or other party
with respect to such asset-backed
securities. Consistent with the original
proposal, the reproposal would have
required the sponsor of an ABCP
conduit to provide to each purchaser of
ABCP information regarding the
regulated liquidity provider, a
description of the liquidity coverage,
and notice of any failure to fund. The
reproposal also retained the requirement
that a sponsor provide information
regarding the collateral underlying ABS
interests held by the ABCP conduit and
entities holding risk retention, as well as
a description of the risk retention
interests. The reproposal also retained
the requirement that a sponsor provide
to the appropriate Federal regulators,
upon request, all of the information
required to be provided to investors, as
well as the name and form of
organization of each originator-seller or
majority-owned OS affiliate retaining an
interest in the underlying securitization
transactions.123
Finally, under the reproposal, the
sponsor of an ABCP conduit would have
been required to take other appropriate
steps upon learning of a violation by an
originator-seller or majority-owned OS
affiliate of its risk retention obligations,
and listed, as examples of steps that
may be taken, curing any breach of the
requirements, or removing from the
eligible ABCP conduit any asset-backed
security that does not comply with the
applicable requirements.
Many commenters expressed general
support for the revisions made to the
ABCP option and stated that the
reproposal provided significantly more
flexibility than the original proposal.
However, commenters also indicated
that additional revisions would be
necessary in order to ensure that the
ABCP option is available to the types of
ABCP programs predominantly
available in the current market.
Many commenters requested that the
agencies permit additional forms of risk
retention within the ABCP option.
Commenters encouraged the agencies to
recognize standby letters of credit,
guarantees, liquidity facilities,
123 See

Revised Proposal, 78 FR at 57948.

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unfunded liquidity, asset purchase
agreements, repurchase agreements, and
other similar support arrangements and
credit enhancements to satisfy the risk
retention requirement. Commenters
expressed the view that allowing such
additional forms of risk retention would
reduce the inconsistency between the
European Union risk retention regime
and the U.S. proposal, thus improving
the possibility of cross border
offerings.124 Commenters asserted that
these ABCP conduit features serve the
purpose of credit risk retention by
allocating credit risk between asset
originators and ABCP conduit sponsors,
and aligning incentives between ABCP
conduit sponsors and investors. For
example, one commenter asserted that
under existing market practice,
transferors of assets into ABCP conduits
routinely retain credit risk in the
financed assets in an amount equal to
not less than 5 percent of the related
subordinated ABCP notes, so that there
is no need for the rule to impose
duplicative risk retention requirements
on ABCP conduit managers.
Another commenter asserted that the
reproposed rule would increase the
costs of ABCP conduits and
substantially reduce the market for
ABCP financing, and that the rules were
not necessary to promote high-quality
underwriting of ABCP, which the
commenter asserted is already present
in the multi-seller ABCP conduits
operating in the current markets. This
commenter proposed that sponsors of
ABCP collateralized by originator-seller
asset pools that are underwritten to high
credit quality standards should be
permitted to fund 5 percent risk
retention either through a cash reserve
or through a cash substitute (e.g.,
irrevocable unconditional letter of credit
or credit facility) and should be
permitted to rely on committed liquidity
facilities that are limited to financing
only performing assets.
One commenter expressed the view
that the risk retention requirement
should not apply to ABCP conduits
collateralized by repurchase agreements
because the repurchase agreements
provide liquidity. One commenter
stated that some conduits do not apply
asset collections to the payment of
ABCP issued by such conduits but
instead, in the ordinary course, pay
their maturing notes directly from funds
provided by their liquidity support

providers. This commenter stated that,
although the agencies have to date
declined to recognize unfunded loan
commitments to ABCP conduits as valid
risk retention, a repurchase
counterparty is contractually obligated
from the outset to repurchase the assets
from the ABCP conduit, and therefore
retains credit risk throughout the term
of the transaction.125
Many commenters requested a full
exemption from risk retention under
section 15G of the Exchange Act for
ABCP conduits with certain features or
structures. For example, one commenter
asserted that fully-supported banksponsored conduits should be exempt
from risk retention, regardless of
whether the conduit satisfied other
criteria set forth in the rule, because 100
percent of the credit risk is retained by
the bank sponsor, and the only risk to
investors would be the risk of the
sponsoring institution itself.
Some commenters asserted that
arrangers and managers of ABCP
conduits are not ‘‘sponsors,’’ and
claimed that there is no valid basis for
imposing risk retention requirements on
these parties. One commenter asked for
clarification as to who will be deemed
a sponsor of ABCP issued by an ABCP
conduit. One of these commenters
disagreed with the agencies’ position
that in selecting the assets, one can be
characterized as ‘‘transferring’’ those
assets to the issuer. This commenter
expressed the view that the word
‘‘transfer,’’ as used in section 15G and
in the reproposal, cannot reasonably be
interpreted to include a conduit
manager’s selection of the assets that its
conduit will purchase. This commenter
cited to case law that the term ‘‘transfer’’
should be defined by reference to its
‘‘commonly accepted meaning’’; and a
conduit manager does not itself sell,
assign or deliver any assets to the
conduit, so that it has not engaged in a
‘‘transfer.’’
Several commenters expressed the
view that the proposed nine-month
restriction on the maximum maturity at
issuance for ABCP would be
unnecessarily restrictive. Commenters
asserted that while historical
commercial paper maturities may have
been shorter, many aspects of the
international liquidity standards for
banking organizations established by the
Basel Committee on Banking
Supervision’s ‘‘Basel liquidity

124 The European Union credit risk retention
regime consists of Articles 405–410 of the Capital
Requirements Regulation developed by the
European Banking Authority, and is available at
https://www.eba.europa.eu/regulation-and-policy/
single-rulebook/interactive-single-rulebook/-/
interactive-single-rulebook/toc/504.

125 The agencies do not believe there is sufficient
basis to distinguish an ABCP conduit collateralized
by repurchase agreements from other issuances of
ABS interests. As a result, the sponsor of an ABCP
conduit collateralized by repurchase agreements
would be required to satisfy the requirements of the
final rule.

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standards,’’ including the liquidity
coverage ratio and the proposed net
stable funding ratio may combine to
push average maturities out further. To
address these concerns, commenters
suggested that the maximum maturity
for ABCP held by an eligible ABCP
conduit be extended to 397 days, which
is the maximum remaining maturity for
securities that are eligible for purchase
by money market mutual funds
pursuant to Rule 2a–7 under the
Investment Company Act of 1940, as
amended.126
The agencies received several
comments regarding the definition of
‘‘eligible ABCP conduit.’’ Several
commenters expressed concern that
limitations on assets that may be
acquired by ABCP conduits were too
restrictive. Commenters stated that
many ABCP conduits hold assets that
are not asset-backed securities, such as
loans or receivables purchased directly
from originators under a deferred
purchase price note, which the
commenters asserted is a customary
structure by which conduits now
finance originator-seller’s assets, not the
originator-seller securitization structure
required by the reproposal. Commenters
also expressed concern that ABCP
conduits often hold asset-backed
securities that are acquired from various
sources, including other ABCP conduits
and in the secondary market. One
commenter asserted that there is no
need to limit permitted investments of
fully supported conduits, because
investors in ABCP issued by fullysupported conduits base their
investment decisions on the liquidity
provider’s financial strength and
reputation (rather than relying on asset
quality). A few commenters requested
that the ABCP option be modified to
permit originator-sellers to convey to
intermediate SPVs, in addition to assets
originated by them, assets acquired in
business combinations and asset
purchases.
Another commenter asserted that the
proposed limitation on eligible
collateral would not permit conduits to
acquire assets through an assignment
from another ABCP conduit. One
commenter requested that the final rules
permit transfers between conduits with
a common liquidity provider and
transfers of positions between one
funding agent/liquidity provider/
conduit group and another such group.
Several commenters expressed
concern regarding the proposed
definition of 100 percent liquidity
coverage, noting that a significant
percentage of existing conduits are
126 See

17 CFR 270.2a7.

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partially-supported or do not have 100
percent liquidity coverage as defined by
the proposal. Most of these commenters
suggested that the definition of 100
percent liquidity coverage be revised to
include coverage in a structure under
which the liquidity provider’s funding
obligation is reduced by non-performing
or defaulted assets, if the conduit
includes some form of credit
enhancement equal to at least 5 percent
of the outstanding ABCP. One
commenter requested that the agencies
align the 100 percent liquidity coverage
requirement with the regulatory capital
treatment applicable to unfunded credit
enhancements under the Basel
regulatory capital framework for
banking organizations, which generally
calculates a banking organization’s
exposure to an eligible ABCP liquidity
facility based on the maximum potential
amount that the banking organization
could be required to fund given the
ABCP program’s current underlying
assets (calculated without regard to the
current credit quality of those assets).
Several commenters interpreted the
reproposal’s requirement that an eligible
ABCP conduit obtain from a regulated
liquidity provider a legally binding
commitment to provide 100 percent
liquidity coverage to all the ABCP
issued by the ABCP conduit as limiting
an ABCP conduit to one regulated
liquidity provider. Commenters
opposed the requirement in the
definition of ‘‘eligible ABCP conduit’’
that requires liquidity support from a
single liquidity provider. One of these
commenters suggested that, although
most fully-supported multi-seller
conduits currently have 100 percent
liquidity support from an affiliate of the
conduit manager, the final rule permit
conduits to have multiple liquidity
providers.
Other commenters stated that
syndication of backstop liquidity is
market practice, and that there is no
reason to limit the number of liquidity
providers. One commenter
recommended that the agencies revise
the definition of ‘‘eligible ABCP
conduit’’ to clarify that eligible liquidity
facilities may include facilities entered
into by an affiliate of a regulated
liquidity provider, if the regulated
liquidity provider unconditionally
guarantees its affiliate’s obligations.
Commenters generally supported the
proposed definition of majority-owned
OS affiliate. One commenter observed
that the rule text in the reproposal only
referred to the originator-seller as the
risk retainer, but does not mention its
majority-controlled affiliates. This
commenter requested that the final rules
conform to the preamble of the original

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proposal by stating that majoritycontrolled originator-seller affiliates
(including an SPV) can satisfy the
originator-seller’s risk retention
requirements.
The agencies received several
comments on the proposed definition of
intermediate SPV. One commenter
stated that in certain circumstances an
intermediate SPV is not a direct or
indirect wholly owned affiliate of the
originator-seller but instead is an
‘‘orphan’’ SPV that is owned by a
corporate service provider or a
charitable trust.
One commenter stated that it was not
clear under the reproposal whether an
ABCP conduit sponsor would no longer
be able to rely on the option if a single
asset held by its conduit does not
comply with the rule. This commenter
requested that the rule prescribe cure
periods (of not less than 30 days) and
threshold amounts (1 percent of the
conduit’s assets), so that the conduit
will not be forced to unwind based on
a single noncompliant asset.
Commenters raised several concerns
with respect to the reproposal’s
disclosure requirements for the ABCP
option. One commenter indicated that
the asset disclosures in ABCP programs
are collectively negotiated and agreedupon by ABCP investors and conduit
arrangers, and the reproposal’s
calculation and reporting requirements
would deter borrowers from financing
assets through ABCP conduits.
One commenter indicated that the
scope of the proposed disclosure
requirements set forth in section 4(c) of
the reproposal is unclear, and the
proposed requirement to disclose fair
value calculations and supporting
information would not be feasible. This
commenter said that because the
conduits typically treat their extensions
of credit as loans for accounting
purposes, and do not periodically
revalue the assets, a requirement to
disclose fair value would not conform to
existing accounting practices. This
commenter stated that many ABCP
financings are revolving transactions in
which the principal balance of the
outstanding notes may change every
business day. This commenter also
asserted that, because investors in fully
supported conduits do not rely on the
market value of the assets in their
investment decisions, there would be no
need to require fully supported conduits
to provide asset-level disclosures. The
commenter also asserted that to the
extent a conduit finances assets for
many different originator-sellers, the
volume and frequency of disclosures
under this requirement would be
substantial and unreasonable. This

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commenter expressed the view that the
agencies should not impose
unnecessarily broad disclosure
requirements that would result in a
narrowing of the short-term financing
options available to businesses. Another
commenter said that the requirement to
report the fair value of each of the
conduit’s interests is unduly
burdensome to a sponsor, given the
dynamic nature of a conduit’s assets.
This commenter proposed that a
sponsor be required to report only
certain items.
Some commenters stated that
investors in ABCP fully supported by
liquidity facilities do not want or need
disclosure from conduit managers of an
originator-seller’s failure to comply with
risk retention requirements. One of
these commenters stated that the
disclosure requirement would
discourage originators from financing
assets through ABCP conduits. This
commenter stated that since the
reproposal did not generally require
sponsors of an ABS interests to notify
investors of the failure to comply with
risk retention requirements, and it was
not clear why this obligation was
imposed solely for fully-supported
ABCP conduits.
One commenter asserted that a
sponsor should not be required to
develop separate policies or procedures
to actively monitor each originatorseller; instead a sponsor should be
allowed to rely on an originator-seller’s
representations and warranties in
satisfying its compliance and
monitoring requirements. This
commenter also proposed that a sponsor
be required to notify only regulators
upon the actual discovery or knowledge
of an originator-seller’s failure to
comply.
One commenter asserted that
investors have generally not requested
any significant changes to ABCP
disclosure requirements in recent years,
and that reports currently being made
contain sufficient information for ABCP
investors to monitor their investments,
especially since the most important
economic factors will continue to be the
performance of the assets themselves,
the 100 percent liquidity coverage, and
(in the case of partially supported ABCP
conduits) the sponsor’s 5 percent or
more credit enhancement—but not
continued risk retention on the part of
the originator-sellers.
Some commenters requested a
complete exemption from the credit risk
retention requirements for conduits
with underlying assets that were
originated before the applicable
effective date of the rule that may be
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One commenter claimed that it would
be impractical to impose credit risk
retention on an originator-seller that has
already entered into a financing
transaction with a conduit, because the
conduits would not be able to timely
renegotiate terms.
b. Overview of the Final Rule
The final rule includes a specific
option for ABCP securitization
transactions that retains the basic
structure of the reproposed ABCP
option, with modifications intended to
address issues raised by commenters. As
with the reproposal, the final rule
provides that an eligible ABCP conduit
sponsor will satisfy the base risk
retention requirement if, for each ABS
interest the ABCP conduit acquires from
an intermediate SPV, the intermediate
SPV’s originator-seller 127 retains an
economic interest in the credit risk of
the assets collateralizing the ABS
interest acquired by the eligible ABCP
conduit using either standard risk
retention or the revolving pool
securitization risk retention option (as
revised in the final rule).128 As noted in
the reproposal, the use of the ABCP
option by the sponsor of an eligible
ABCP conduit does not relieve the
originator-seller from its independent
obligation to comply with its own risk
retention obligations as a sponsor of an
ABS interest under the revised proposal,
if any. The originator-seller will be the
sponsor of the asset-backed securities
issued by an intermediate SPV and will
therefore be required under the final
rule to hold an economic interest in the
credit risk of the assets collateralizing
the asset-backed securities issued by the
intermediate SPV.
Under the final rule, a sponsor of an
ABCP conduit is not limited to using the
ABCP option to satisfy its risk retention
127 See

infra footnote 130.
originator-seller will be subject to the same
requirements and have the same benefits under the
risk retention rule as any other sponsor that retains
risk, including restrictions on transferring or
hedging the retained interest to a third party as
applied to sponsors. See section 5(b)(1) of the final
rule (intermediate SPV’s originator-seller to retain
an economic interest in the credit risk of the
securitized assets in the amount and manner
required under section 4 or 5 of the rule). For
example, an originator-seller retaining risk in its
intermediate SPV in the same amount and manner
required under section 4 of the rule, as an eligible
horizontal residual interest, would be permitted to
transfer that interest to a majority-owned affiliate as
permitted under section 3 of the rule, subject to the
additional restrictions of section 12 of the rule, but
an originator-seller retaining risk in its intermediate
SPV in the same amount and manner permitted
under section 5 of the rule, as a revolving pool
securitization seller’s interest, could only transfer it
to a wholly-owned affiliate, as required by section
5(e)(1) of the rule. See infra note 130 for a
discussion of the definition of the term ‘‘originatorseller.’’
128 An

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requirements. An ABCP conduit
sponsor may rely on any of the risk
retention options described in section 4
of the rule, provided it meets the criteria
for such option. Consistent with the
reproposal, standby letters of credit,
guarantees, repurchase agreements,
asset purchase agreements, and other
unfunded forms of credit enhancement
cannot be used to satisfy the risk
retention requirement.
In response to comments questioning
the application of the rule’s
requirements to an ABCP conduit
arranger or manager, the agencies are
affirming their view that an arranger or
manager of an ABCP conduit is a
sponsor or ‘‘securitizer’’ under section
15G of the Exchange Act. The agencies
believe this is consistent with part (B)
of the definition of securitizer which
includes ‘‘a person who organizes and
initiates an asset-backed securities
transaction by selling or transferring
assets, either directly or indirectly,
including through an affiliate, to the
issuer.’’ 129 The arranger or manager of
an ABCP conduit typically organizes
and initiates the transaction as it selects
and approves the originators whose
loans or receivables will collateralize
the ABS interests that support the ABCP
issued by the conduit. It also indirectly
transfers the securitized assets to the
ABCP issuing entity by selecting and
directing the ABCP issuing entity to
purchase ABS interests collateralized by
the securitized assets. The agencies
believe that reading the definition of
securitizer to include a typical arranger
or manager of an ABCP conduit is
consistent with the purposes of the
statute and principles of statutory
interpretation. Furthermore, the
agencies believe that the narrow reading
of ‘‘securitizer’’ supported by
commenters is not consistent with
Section 15G and could lead to results
that would appear contrary to
Congressional intent by opening the
statute to easy evasion.
A more detailed discussion of the
agencies’ interpretation of the term
‘‘securitizer,’’ including analysis of the
statutory text and legislative history can
be found in Part III.B.7 of this
Supplementary Information.
The agencies have revised the
definition of ‘‘eligible ABCP conduit’’ in
the final rule to accommodate certain
business combinations and to clarify the
requirements for the types of assets that
can be acquired by an eligible ABCP
conduit. Other elements of the
definition, such as the requirement that
an ABCP conduit must be bankruptcy
remote or otherwise isolated for
129 See

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insolvency purposes from the sponsor of
the ABCP conduit and from any
intermediate SPV, and that an eligible
liquidity provider enter into a legally
binding commitment to provide 100
percent liquidity coverage to all the
ABCP issued by the ABCP conduit
remain unchanged from the reproposal.
The final rule definition of eligible
ABCP conduit requires that the ABS
interests acquired by the ABCP conduit
are: (i) ABS interests collateralized
solely by assets originated by an
originator-seller and by servicing assets;
(ii) special units of beneficial interest (or
similar ABS interests) in a trust or
special purpose vehicle that retains
legal title to leased property underlying
leases originated by an originator-seller
that were transferred to an intermediate
SPV in connection with a securitization
collateralized solely by such leases and
by servicing assets; (iii) ABS interests in
a revolving pool securitization
collateralized solely by assets originated
by an originator-seller and by servicing
assets; or (iv) ABS interests that are
collateralized, in whole or in part, by
assets acquired by an originator-seller in
a business combination that qualifies for
business combination accounting under
GAAP, and, if collateralized in part, the
remainder of such assets meet the
criteria in items (i) through (iii). The
ABS interests must be acquired by the
ABCP conduit in an initial issuance by
or on behalf of an intermediate SPV: (1)
Directly from the intermediate SPV, (2)
from an underwriter of the ABS
interests issued by the intermediate
SPV, or (3) from another person who
acquired the ABS interests directly from
the intermediate SPV. Finally, the rule
requires that an eligible ABCP conduit
is collateralized solely by ABS interests
acquired from intermediate SPVs and
servicing assets.
The agencies continue to believe that
a limitation on the types of assets that
may be acquired by an eligible ABCP
conduit is appropriate. Although some
commenters suggested eligible ABCP
conduits should be permitted to
purchase assets directly from originatorsellers under arrangements such as
deferred purchase price notes, which
commenters argued impose continuing
risk of loss on originator-sellers that
would be comparable to risk retention,
the agencies are not incorporating this
approach. The agencies believe such an
approach would add complexity to the
rule, and that requiring originatorsellers to retain risk in the same way as
the rule requires for other securitizers
provides investors and regulators with
better clarity and transparency as to the
nature of the originator-seller’s retention
of risk in the transaction.

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The agencies disagree with
commenter assertions that, in the
context of ABCP conduits, loans or
receivables originated before the
applicable effective date of the rule
should not be subject to risk retention.
Section 15G of the Exchange Act applies
to any issuance of asset-backed
securities after the effective date of the
rules, regardless of the date the assets in
the securitization were originated. The
agencies note, however, that loans or
receivables meeting the seasoned loan
exemption in section 19 of the rule
would not be subject to risk retention
requirements, and an originator-seller
that sponsors a securitization of
seasoned loans would not need to retain
risk with respect to a securitization of
such assets under the ABCP option.
With respect to ABS interests, the
agencies believe that in certain
circumstances described by
commenters, acquisition of ABS
interests from sources other than an
intermediate SPV or originator-seller
may be accomplished in a manner
consistent with the purposes of section
15G of the Exchange Act. The overview
of the final rule discusses two revisions
to collateral criteria for eligible ABCP
conduits: one that would permit limited
transfers between certain ABCP
conduits, and another that would permit
securitization of assets acquired as the
result of certain business combinations.
The agencies are adopting as
reproposed the requirements that an
ABCP conduit sponsor (i) approve each
originator-seller permitted to sell or
transfer assets, directly or indirectly, to
an intermediate SPV from which an
eligible ABCP conduit acquires ABS
interests; (ii) approve each intermediate
SPV from which an eligible ABCP
conduit is permitted to acquire ABS
interests; (iii) establish criteria
governing the ABS interests, and the
assets underlying the ABS interests,
acquired by the ABCP conduit; (iv)
administer the ABCP conduit by
monitoring the ABS interests acquired
by the ABCP conduit and the assets
supporting those ABS interests,
arranging for debt placement, compiling
monthly reports, and ensuring
compliance with the ABCP conduit
documents and with the ABCP
conduit’s credit and investment policy;
and (v) maintain and adhere to policies
and procedures for ensuring that the
requirements described above have been
met.
The final rule retains the concept that
a majority-owned affiliate of an
originator-seller may contribute assets it
originates to the originator-seller’s
intermediate SPV. To simplify the rule
text for most purposes, the final rule

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consolidates the reproposal’s definition
of ‘‘majority-owned OS affiliate’’ into
the definition of originator-seller
itself.130 In response to comments, the
agencies seek to clarify that the
originator-seller is the sponsor of a
securitization transaction in which an
intermediate SPV of such-originatorseller issues ABS interests that are
acquired by an eligible ABCP conduit,
and that the originator-seller may
allocate risk retention to its majority
owned-affiliates (or wholly-owned
affiliates) as permitted in accordance
with the sections 3, 4, and 5 of the rule,
as applicable. The sponsor of an ABCP
conduit must fulfill the compliance
requirements of the ABCP option with
respect to the originator-seller that is the
sponsor of the intermediate SPV.
The agencies have carefully
considered commenters’
recommendations regarding the
definition of 100 percent liquidity
coverage and are adopting the rule as
proposed. The agencies understand the
concern raised by commenters that a
significant number of existing partiallysupported conduits will likely not be
able to use the ABCP option to satisfy
the risk retention requirement, because
they are covered by a liquidity facility
that adjusts the funding obligation of the
liquidity provider according to the
performance of the assets collateralizing
the ABS interests held by the ABCP
conduit.131 However, the agencies
observe that a liquidity facility of the
type described by commenters, that
reduces the obligation of the liquidity
provider to provide funding based on a
formula that takes into consideration the
amount of non-performing assets could
serve to insulate the liquidity provider
from the credit risk of non-performing
assets in the securitization transaction.
The ABCP option is designed to
accommodate conduits that expose the
liquidity provider to the full credit risk
of the assets in the securitization, with
the expectation that exposure to the
credit risk of such assets will provide
the liquidity providers with incentive to
undertake robust credit underwriting
and monitoring.
The final rule adopts as proposed the
requirement that a regulated liquidity
130 In order to provide clarity in maintaining the
distinction between originator-sellers and majorityowned originator-seller affiliates, the agencies have
included a provision in the definition of
‘‘originator-seller’’ indicating that the majorityowned originator-seller affiliate may not be a
sponsor of the originator-seller’s intermediate SPV.
131 In response to commenters on the reproposal,
the agencies acknowledge that liquidity coverage
that does not require the regulated liquidity
provider to pay in the event of a bankruptcy of the
ABCP conduit would meet the requirements of the
ABCP option adopted in the final rule.

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provider enter into a legally binding
commitment to provide 100 percent
liquidity coverage (in the form of a
lending facility, an asset purchase
agreement, a repurchase agreement, or
other similar arrangement) to all the
ABCP issued by the ABCP conduit by
lending to, purchasing ABCP issued by,
or purchasing assets from, the ABCP
conduit in the event that funds are
required to repay maturing ABCP issued
by the ABCP conduit.
While the final rule continues to
require that there be only one registered
liquidity provider with responsibility to
make payment in respect of the
commercial paper notes, the regulated
liquidity provider is not prohibited from
hedging its liquidity obligation or from
backstopping the obligation by entering
into sub-participations or other
arrangements in respect of this
commitment, so long as one regulated
liquidity provider remains directly
responsible to all holders of ABCP
issued by the conduit. To the extent that
the regulated liquidity provider that
provides liquidity support to the ABCP
conduit is exposed to the credit risk of
the assets covered by such liquidity
support, the agencies believe the
incentives that encourage robust
underwriting remain appropriately
aligned.
The agencies continue to believe that
unfunded risk retention is not
consistent with the regulatory goal of
meaningful risk retention. As such, the
requirement in the ABCP credit risk
retention option for 100 percent nonasset tested liquidity is not a substitute
for risk retention by the ABCP sponsor,
but rather a recognition of an integral
part of the overall ABCP conduit
securitization structure. As the liquidity
support is not an ABS interest retained
to satisfy a risk retention requirement
under the rule, the liquidity provider is
not subject to the prohibitions on
transfer and hedging in section 12 of the
rule with respect to the liquidity
support.
The agencies were persuaded by
commenters views regarding the
likelihood that many conduits will need
to issue ABCP with a longer maturity in
the future in order to accommodate the
needs of regulated institutions that are
subject to new liquidity requirements
under the Basel liquidity standards.
Accordingly, the final rule extends the
nine month maximum maturity and
defines ABCP as asset-backed
commercial paper that has a maturity at
the time of issuance not exceeding 397
days, exclusive of grace periods, or any
renewal thereof the maturity of which is
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The agencies did not receive any
comments regarding the reproposal’s
definition of ABCP conduit.
Accordingly, as with the reproposal, the
final rule defines an ABCP conduit as an
issuing entity with respect to ABCP.
In response to comments, the final
rule permits eligible ABCP conduits to
acquire ABS interests from other eligible
ABCP conduits with the same regulated
liquidity provider. Under the final rule,
an eligible ABCP conduit may acquire
an ABS interest from another eligible
ABCP conduit if: (i) The sponsors of
both eligible ABCP conduits are in
compliance with section 6 of the rule;
and (ii) the same regulated liquidity
provider has entered into one or more
legally binding commitments to provide
100 percent liquidity coverage to all of
the ABCP issued by both eligible ABCP
conduits.
However, because the agencies
continue to be concerned about asset
aggregators that acquire loans and
receivables from multiple sources in the
market, place them in an intermediate
SPV, and issue interests to ABCP
conduits the agencies have declined to
extend the ABCP option to ABCP
conduits that purchase ABS interests
other than in an initial issuance by or
on behalf of an originator-seller’s
intermediate SPV.
In order to accommodate certain
market practices, as referred to in the
comments to the reproposal, the
agencies are revising the definition of
‘‘intermediate SPV’’ in the final rule.
The final rule revises this provision to
include a special purpose vehicle, often
referred to as an ‘‘orphan SPV,’’ that has
nominal equity owned by a trust or
corporate service provider that
specializes in providing independent
ownership of special purpose vehicles,
and such trust or corporate service
provider is not affiliated with any other
transaction parties. For purposes of the
final rule, ‘‘owned by a trust’’ includes
‘‘held by a trustee in trust’’ and ‘‘issued
to a trustee.’’ In addition, the corporate
service provider will not be affiliated
solely because it provides professional
directors or administrative services to
the orphan SPV or the trust. Finally, the
nominal equity in the orphan SPV will
not be entitled to a share of the profits
and losses or any other economic
indicia of ownership.
Consistent with the reproposal, the
final rule allows an intermediate SPV to
sell ABS interests that it issues to third
parties other than ABCP conduits.
However, the agencies emphasize that,
except as otherwise provided for loans
or receivables acquired as part of certain
business combinations, the ABS
interests acquired by the conduit cannot

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not be collateralized by securitized
assets otherwise purchased or acquired
by the intermediate SPV’s originatorseller, the originator-seller’s majorityowned affiliates, or by the intermediate
SPV from unaffiliated originators or
sellers. Commenters requested the
addition of a cure period, expressing
concern as to whether a conduit would
be considered to be in violation of the
rule any time one of its originator-sellers
failed to comply, and the agencies have
addressed this issue. The final rule
includes the reproposal’s provisions
obligating the sponsor to monitor
originator-sellers’ compliance, notify
investors of any failure of compliance
by an originator-seller, and take
appropriate steps to cure the breach. A
sponsor of an eligible ABCP conduit
that notifies investors and takes
appropriate steps in accordance with
the terms of the rule will be in
compliance with its obligations under
the rule, and, accordingly, no ‘‘cure
period’’ is necessary. Although
commenters objected to the requirement
to identify originator-sellers by name in
these circumstances, the agencies
believe it is an important part of
incentivizing the originator-seller and
ABCP conduit sponsor to comply with
the requirements of the ABCP option.
The final rule requires an ABCP
conduit sponsor to provide, or cause to
be provided, certain disclosures to
ABCP investors. In response to
commenters’ concerns, the disclosure
requirement requires that the
information about the underlying ABS
interests be updated at least monthly,
rather than updated in connection with
each issuance of ABCP. The final rule
requires that disclosures be provided
before or contemporaneously with the
first sale of ABCP to the investor and
must be provided on at least a monthly
basis to all conduit investors. In order
to implement this requirement, the
agencies have required that the
disclosures to investors must be based
on information as of a date not more
than 60 days prior to the date of first use
with investors in order to accommodate
variations in reporting timelines and
incorporation of information received
from originator-sellers.
The agencies are persuaded by
commenters who expressed concern
that the reproposal’s disclosure
requirements for the details of each
originator-seller’s risk retention interest,
together with the same information as
the originator-seller would be required
to provide direct investors pursuant to
the rule, provides more information
than necessary. Accordingly, the final
rule revises this disclosure to simplify it
significantly. The disclosure must

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contain the following information as of
a date not more than 60 days prior to the
date of first use with investors:
(i) The name and form of organization
of the regulated liquidity provider that
provides liquidity coverage to the
eligible ABCP conduit, including a
description of the material terms of such
liquidity coverage, and notice of any
failure to fund;
(ii) The asset class or brief description
of the underlying securitized assets;
(iii) The standard industrial category
code (SIC Code) for the originator-seller
that will retain (or has retained)
pursuant to this section an interest in
the securitization transaction; and
(iv) A description of the percentage
amount of risk retention by the
originator-seller, and whether it is in the
form of an eligible horizontal residual
interest, vertical interest, or revolving
pool securitization seller’s interest, as
applicable, pursuant to the rule.
The final rule also requires that an
ABCP sponsor provide, or cause to be
provided, upon request, to the
Commission and its appropriate Federal
banking agency, if any, in writing, all of
the information required to be provided
to investors, and the name and form of
organization of each originator-seller
that will retain (or has retained) a rulecompliant interest in the securitization
transaction. As investors in ABCP
initially will have significantly less
information about the risk retention
held by the originator-sellers that
sponsor ABS interests collateralizing the
ABCP than investors in other forms of
ABS interests, the requirement that
sponsors disclose a breach by an
originator-seller will provide them with
relevant information about the
originator-seller upon the occurrence of
a breach.
5. Commercial Mortgage-Backed
Securities

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a. Overview of the Reproposal and
Public Comments
Section 15G(c)(1)(E) of the Exchange
Act 132 provides that, with respect to
CMBS, the regulations prescribed by the
agencies may provide for retention of
the first-loss position by a third-party
purchaser that specifically negotiates for
the purchase of such first-loss position,
holds adequate financial resources to
back losses, provides due diligence on
all individual assets in the pool before
the issuance of the asset-backed
securities, and meets the same standards
for risk retention as the Federal banking
agencies and the Commission require of
the securitizer. In light of this provision
132 15

U.S.C. 78o–11(c)(1)(E).

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and the historical market practice of
third-party purchasers acquiring firstloss positions in CMBS transactions, the
agencies proposed to permit a sponsor
of ABS interests that is collateralized by
commercial real estate loans to meet its
risk retention requirements if thirdparty purchasers acquired eligible
horizontal residual interests in the
issuing entity.133 The reproposal would
have permitted one or two third-party
purchasers to satisfy the risk retention
requirement, so long as their eligible
horizontal residual interests were pari
passu with each other, so that neither
third-party purchaser’s losses were
subordinate to the other’s losses. The
eligible horizontal residual interest held
by the third-party purchasers would
have been permitted to be used to
satisfy the risk retention requirements
either by itself as the sole credit risk
retained, or in combination with a
vertical interest held by the sponsor.
The CMBS risk retention option in the
reproposal would have been available
only for securitization transactions
collateralized solely by commercial real
estate loans and servicing assets. In
addition, the following eight
requirements would have been required
to be met:
(1) Each third-party purchaser retains
an eligible horizontal residual interest
in the securitization in the same form,
amount, and manner as would have
been required of the sponsor under the
horizontal risk retention option;
(2) Each third-party purchaser pays
for the first-loss subordinated interest in
cash at the closing of the securitization;
(3) No third-party purchaser obtains
financing, directly or indirectly, from
any other person party to the
securitization transaction (including,
but not limited to, the sponsor,
depositor, or an unaffiliated servicer),
other than a person that is a party solely
by reason of being an investor;
(4) Each third-party purchaser
performs a review of the credit risk of
each asset in the pool prior to the sale
of the asset-backed securities;
(5) Except for an affiliation with the
special servicer in the securitization
transaction or an originator of less than
10 percent of the unpaid principal
balance of the securitized assets, no
third-party purchaser can be affiliated
with any other party to the
securitization transaction (other than
investors);
(6) The transaction documents
provide for the appointment of an
133 Such third-party purchasers are commonly
referred to in the CMBS market as ‘‘B-piece buyers’’
and the eligible horizontal residual interest is
commonly referred to as the ‘‘B-piece.’’

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operating advisor (Operating Advisor),
subject to certain terms and conditions;
(7) The sponsor provides, or causes to
be provided, to potential purchasers
certain information concerning the
third-party purchasers and other
information concerning the transaction;
and
(8) Any third-party purchaser
acquiring an eligible horizontal residual
interest under the CMBS option
complies with the hedging, transfer and
other restrictions applicable to such
interest under the reproposed rule as if
such third-party purchaser was a
sponsor who had acquired the interest
under the horizontal risk retention
option.
Generally, commenters supported the
CMBS risk retention option described in
the reproposal. One commenter
cautioned against further modifications
to the proposed CMBS option,
expressing its view that CMBS
underwriting standards were beginning
to deteriorate.
Another commenter, however,
pointed out that risk retention is better
implemented where the sponsor retains
some ‘‘skin in the game.’’ This
commenter suggested that the rule
require the sharing of risk retention
between the sponsor and the third-party
purchasers. This commenter suggested
that third-party purchasers not be
allowed to hold more than 2.5 percent
of the risk retention requirements, and
that they be required to hold the firstloss position for more than 5 years
before being allowed to transfer the
position even to another qualified thirdparty purchaser (barring an earlier
sunset). Another commenter requested
clarification as to whether multiple
sponsors can divide a vertical interest
among themselves, on a pro rata basis,
based on their contribution to the
transaction, with no minimum retention
for any one sponsor. Another
commenter requested clarification as to
whether a sponsor holding an eligible
vertical interest in a CMBS transaction
would need to retain a portion of the
eligible horizontal residual interest as
part of that vertical interest, expressing
the preference of its CMBS sponsor
members that the eligible horizontal
residual interest not be included as part
of the eligible vertical interest.
After considering these comments, the
agencies do not believe it is necessary
to require that the sponsor retain or
share with third-party purchasers the
credit risk in CMBS transactions
because third-party purchasers, under
the framework of the final rule, must
hold the risk and independently review
each securitized asset. The agencies
observe that under the final rule, the

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sponsor remains responsible for
compliance with the CMBS option and
risk retention and must monitor a thirdparty purchaser’s compliance with the
CMBS option.134 The agencies also do
not believe it is necessary to limit the
amount of risk retention held by the
third-party purchaser in an L-shaped
structure. This approach provides
parties to CMBS transactions with
flexibility to choose how to structure
their retention of credit risk in a manner
compatible with the practices of the
CMBS market. Further, consistent with
the reproposal, the agencies continue to
believe that the interests of the thirdparty purchaser and other investors are
aligned through other provisions of the
proposed CMBS option, such as the
Operating Advisor provisions and the
sponsor’s disclosure requirements
discussed below. The agencies also do
not believe it is necessary to extend the
five-year holding period after which the
third-party purchaser may transfer the
eligible horizontal residual interest to
another third-party purchaser. As stated
in the reproposal, the agencies selected
five years as a holding period that was
sufficiently long to enable underwriting
defects to manifest themselves. The
agencies did not receive sufficient data
or information demonstrating that a
longer holding period was warranted.
Additionally, the agencies have
determined that it would unduly dilute
the credit risk being retained in the
CMBS transaction if multiple sponsors
were allowed to divide the vertical
interest. Consistent with the standard
risk retention option generally where
multiple sponsors are not permitted to
divide the requisite 5 percent credit
retention among themselves, in a CMBS
transaction with multiple sponsors, if
any portion of the required 5 percent
retention is to be held by a sponsor (i.e.,
if any portion of the eligible horizontal
residual interest is not sold to a
qualified third-party purchaser or an
eligible vertical interest is being used to
meet the 5 percent retention
requirement), that portion of the 5
percent required retention must be held
by a single sponsor (and its majorityowned affiliates).
As the agencies stated in the
reproposal, the eligible horizontal
residual interest held by the third-party
purchasers can be used to satisfy the
risk retention requirements in
combination with a vertical interest
held by a sponsor. Consistent with this
approach, where the eligible horizontal
residual interest is held by a third-party
purchaser, and the sponsor holds a
vertical interest, the sponsor must, as
134 See

section 7(c) of the final rule.

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part of that vertical interest, also retain
a portion of the eligible horizontal
residual interest, as the vertical interest
must constitute 5 percent of the cash
flows of each tranche, including the
eligible horizontal residual interest.135
The agencies also received many
comments with respect to the more
specific aspects of the CMBS option in
the reproposal. These comments and the
final rule for these aspects of the CMBS
option are discussed below.
b. Third-Party Purchasers
i. Number of Third-Party Purchasers and
Retention of Eligible Horizontal
Residual Interest
While commenters generally
supported allowing up to two thirdparty purchasers to hold risk retention,
one commenter recommended
expanding the number of third-party
purchasers to allow participation by
more than two B-piece investors.
Several commenters recommended
allowing the third-party purchasers to
hold the interests in a seniorsubordinated structure, rather than pari
passu, provided that the holder of the
subordinated interest retains at least
half of the requisite eligible horizontal
residual interest, and that both thirdparty purchasers independently satisfy
all of the requirements and obligations
imposed on third-party purchasers.
These commenters suggested that a
senior-subordinated structure would
better allow the market to appropriately
and efficiently price the interests in a
manner that is commensurate with the
risk of loss of each interest, and to
address the different risk tolerance
levels of each third-party purchaser.
One of these commenters asserted that
the pari passu requirement would
reduce the capacity of third-party
purchasers to invest in the eligible
horizontal residual interest. However,
two commenters strongly opposed
allowing third-party purchasers to
satisfy the risk retention requirements
through a senior-subordinated structure,
commenting that such a change would
significantly dilute and render
ineffective the risk retention
requirements.
As stated in the reproposal, the
agencies provided additional flexibility
for the CMBS option by allowing up to
two third-party purchasers to satisfy the
risk retention requirement. The agencies
do not believe it would be appropriate
to allow more than two third-party
135 If there is no third-party purchaser and the
sponsor holds all of the required retention in the
form of a vertical interest, the sponsor must hold
5 percent of each tranche including the most
subordinated tranche in the structure.

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purchasers in a single transaction,
because it could dilute the incentives
generated by the risk retention
requirement to monitor the credit
quality of the commercial mortgages in
the pool. Similarly, the agencies agree
that allowing the third-party purchasers
to satisfy the risk retention requirement
through a senior-subordinated structure
would significantly dilute the
effectiveness of the risk retention
requirements. Accordingly, the agencies
therefore are adopting as proposed the
pari passu requirement with respect to
the retained interests held by third-party
purchasers in a CMBS transaction.
ii. Third-Party Purchaser Qualifying
Criteria
The agencies did not propose any
qualifying criteria for third-party
purchasers in the original proposal or
the reproposal.
In response, one commenter requested
that third-party purchasers be
‘‘qualified’’ based on predetermined
criteria of experience, financial analysis
capability, capability to direct the
special servicer, and capability to
sustain losses. Another commenter
requested that if a third-party
purchaser’s affiliate contributes more
than 10 percent of the securitized assets
to a CMBS transaction, that third-party
purchaser should be precluded from
holding the eligible horizontal residual
interest.
Another commenter stated its belief
that it is common for several funds
within a fund complex that are managed
by the same or affiliated investment
adviser to purchase eligible horizontal
residual interests in the same CMBS
transaction and, to be consistent with
practice, the definition of third-party
purchaser should be expanded to
include multiple funds that are
managed by the same or affiliated
investment advisers.
Consistent with the reproposal, the
agencies are not adopting specific
qualifying criteria for third-party
purchasers. The agencies believe that
investors in the business of purchasing
first-loss positions or ‘‘B-piece’’ interests
in CMBS transactions have the requisite
experience and capabilities to make an
informed decision regarding their
purchases. B-piece interests are not
offered or sold through registered
offerings—typically a B-piece interest
will be sold in reliance on Securities
Act Rule 144A, which requires
purchasers to be qualified institutional
buyers. The agencies observed that Bpiece CMBS investors are typically real
estate specialists who use their
knowledge about the underlying assets
and mortgages in the pools to conduct

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extensive due diligence on new deals.
The agencies also observed that the Bpiece market has very few participants.
According to Commercial Mortgage
Alert data, in 2009–2013, there were 38
different B-piece buyers with nine of
them participating in 70 percent of
CMBS deals. Furthermore, as discussed
below, the agencies believe that the
reproposed rule’s disclosure
requirements with respect to the
identity and CMBS investment
experience of third-party purchasers are
sufficient to allow investors in a CMBS
transaction to assess the investment
experience and other qualifications of
third-party purchasers and other
material information necessary to make
an informed investment decision. If, in
the future, the agencies observe adverse
changes in the experience and
capabilities of third-party purchasers in
CMBS transactions, the agencies may
consider whether modifications to the
rule should be made to address these
issues.
Also consistent with the reproposal,
the final rule retains the requirement
that third-party purchasers be
independent from originators of more
than 10 percent of the securitized assets.
The agencies believe that the
independence requirement will help
ensure a new review by the third-party
purchaser of the underwriting of the
securitized loans and do not believe that
the requirement will adversely affect the
number of third-party purchasers
willing to assume the risk retention
obligations in CMBS transactions. Last,
the agencies are not expanding the
definition of third-party purchaser to
include multiple funds that are
managed by the same or affiliated
investment adviser. The agencies
introduced the concept of a ‘‘majorityowned affiliate’’ in the reproposal,
which would permit risk retention to be
retained by a third-party purchaser or its
majority-owned affiliate. The final rule
retains the reproposal’s provisions
allowing sponsors and third-party
purchasers to transfer retained risk to
their majority-owned affiliates. The final
rule does not allow sponsors or thirdparty purchasers to transfer retained risk
to parties other than majority-owned
affiliates, as the agencies believe the
rule being adopted today already
includes flexibility with respect to risk
retention held by an entity that is a
majority-owned affiliate of a third-party
purchaser, and that further expansion of
the definition of third-party purchaser is
not necessary and would dilute the risk
required to be retained by a sponsor or
third-party purchaser.

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c. Operating Advisor
i. Applicability of the Operating Advisor
Requirement
The reproposal included a
requirement that all CMBS transactions
that use the third-party purchaser
option to satisfy the risk retention
requirement must appoint an Operating
Advisor that is not affiliated with other
parties to the securitization transaction.
The reproposal would have prohibited
the Operating Advisor from having,
directly or indirectly, any financial
interest in the securitization transaction,
other than fees from its role as
Operating Advisor, and would have
required the Operating Advisor to act in
the best interest of, and for the benefit
of, investors as a collective whole.
Multiple commenters expressed
support for the Operating Advisor
requirement, noting that it was a helpful
governance mechanism and reflective of
current market practice. One of these
commenters advocated expanding the
Operating Advisor requirement to all
CMBS transactions, and not simply
those relying on the CMBS option.
Another commenter recommended that
the Operating Advisor be prohibited
from having any direct or indirect
financial interest in, or financial
relationship with, the special servicer.
After considering the comments
received, the agencies have decided not
to expand the Operating Advisor
requirement to CMBS transactions that
do not rely on the third-party purchaser
CMBS option. As stated in the
reproposal, the agencies believe that
there is generally a strong connection
between third-party purchasers and the
special exercise of the servicing rights in
CMBS transactions. In CMBS
transactions where credit risk is being
retained by a third-party purchaser, the
agencies believe there is a particular
need to provide a check on third-party
purchasers by limiting their ability to
manipulate cash flows through the
exercise of the special servicing rights.
The agencies are providing this check
by requiring an Operating Advisor in
CMBS transaction where the third-party
purchaser is holding the risk retention.
The agencies note that the requirement
that there be an Operating Advisor for
any transaction relying on the CMBS
option means that the Operating
Advisor must be in place at any time
that a third-party purchaser holds any
portion of the required risk retention.
Accordingly, whether the B-piece is
initially sold to a third-party purchaser
or sold to a third-party purchaser after
the initial five year holding period
expires, the transaction must have an
Operating Advisor in place at all times

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that a third-party purchaser holds any
portion of the required risk retention.
Consistent with the reproposal, the
agencies are adopting the requirement
that the Operating Advisor be a party
that is not affiliated with other parties
to the securitization transaction, and
does not have, directly or indirectly, any
financial interest in the securitization
transaction other than fees from its role
as Operating Advisor. The agencies
continue to believe that this
requirement sufficiently establishes the
independence of the Operating Advisor
and protects investors’ interests.
ii. Qualifications of the Operating
Advisor
The agencies included in the
reproposal certain general qualifications
for the Operating Advisor. The
reproposal would have required
underlying transaction documents in a
CMBS transaction to provide standards
with respect to the Operating Advisor’s
experience, expertise and financial
strength to fulfill its duties and
obligations under the applicable
transaction documents over the life of
the securitization transaction.
One commenter cautioned against the
requirement that qualification standards
for the Operating Advisor be specified
in the transaction documents. This
commenter asserted that the
requirements must ensure that a
sufficient number of qualified and
independent Operating Advisors will be
available to fill the role. Additionally,
this commenter encouraged the agencies
to clarify the mechanism by which the
acceptability of the Operating Advisor
may be determined.
The agencies do not believe that the
rule should mandate the mechanism by
which the acceptability of the Operating
Advisor is determined, but that the
CMBS transaction parties should have
the flexibility to establish the
appropriate standards for the Operating
Advisor in each transaction. As a result,
the agencies are adopting the
qualification requirements as proposed.
iii. Role of the Operating Advisor
Under the reproposal, once the
eligible horizontal residual interest held
by third-party purchasers reaches a
principal balance of 25 percent or less
of its initial principal balance, the
special servicers would have been
required to consult with the
independent Operating Advisor in
connection with, and prior to, any major
investing decisions related to the
servicing of the securitized assets. The
reproposal would have required that the
Operating Advisor be provided with
adequate and timely access to

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information and reports necessary to
fulfill its duties under the transaction
documents. It also would have required
that the Operating Advisor be
responsible for reviewing the actions of
the special servicer, reviewing all
reports made by the special servicer to
the issuing entity, reviewing for
accuracy and consistency in
calculations made by the special
servicer in accordance with the
transaction documents, and issuing a
report to investors and the issuing entity
on the special servicer’s performance.
One commenter supported this
requirement, but requested that the
agencies clarify the scope of the
decisions on which the special servicer
was to consult with the Operating
Advisor’s review, and the scope of the
reports to be provided to the Operating
Advisor. Several commenters requested
that the agencies clarify that the
calculation of the principal balance
could take into account appraisal
reductions and realized losses, in order
to be consistent with current market
practice. Another commenter
questioned the usefulness of the
consultation requirement, noting that
there is no meaningful connection
between the 25 percent threshold and
the goal of risk retention. This
commenter proposed either eliminating
this requirement or limiting the
consultation right to the period from the
closing of the transaction until the
holder of risk retention loses control
over the special servicing rights.
Another commenter believed that the 25
percent threshold should be reduced to
10 percent.
After considering the comments
received, the agencies are adopting the
proposed consultation requirement,
with some modifications in response to
comments. For purposes of determining
the principal balance, the agencies are
clarifying in the final rule that the
calculation should be performed in a
manner that is consistent with the
calculation as permitted under the
transaction documents, and take into
account any realized losses and
appraisal reduction amounts to the
extent permitted under the terms and
conditions of the transaction
documents. In terms of the scope of
reports made by the special servicer to
the issuing entity that the Operating
Advisor must review, the agencies are
clarifying in the final rule that the
Operating Advisor shall have adequate
and timely access to all reports
delivered to all classes of bondholders
as well as the holders of the eligible
horizontal residual interest. Finally, the
agencies believe that section 7(b)(6)(iv)
of the final rule sufficiently describes

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the types of decisions that are subject to
consultation—specifically, any material
decision in connection with the
servicing of the securitized assets which
includes, without limitation, any
material modification or waiver of any
provision of a loan agreement, any
foreclosure or similar conversion of the
ownership of a property, or any
acquisition of a property.
iv. Special Servicer Removal Provisions
The reproposal would have required
that the Operating Advisor have the
authority to recommend the removal
and replacement of the special servicer.
Under the reproposal, the removal of the
special servicer would have required the
affirmative vote of a majority of the
outstanding principal balance of all ABS
interests voting on the matter, and
required a quorum of 5 percent of the
outstanding principal balance of all ABS
interests.
The agencies received many
comments with respect to the Operating
Advisor’s ability to remove the special
servicer. Commenters generally
supported retaining the Operating
Advisor’s ability to recommend the
replacement of the special servicer,
especially when the special servicer had
not acted in the best interest of all
investors. However, commenters
differed on their views of the
appropriate voting quorum
requirements.
One commenter believed that the
special servicer removal provisions
should mirror current CMBS
transactions, which typically provide
that (i) the Operating Advisor may
recommend to remove the special
servicer only after the most senior
tranche of the B-piece has been reduced
to less than 25 percent of its initial
principal balance, and (ii) removal can
only take place if more than 50 percent
of the aggregate outstanding principal
balance of all classes affirmatively vote
for such removal.
One commenter recommended
providing Operating Advisors with a
safe harbor from liability, except in the
case of gross negligence, fraud or willful
misconduct, for recommending
replacement of the special servicer. This
commenter also recommended requiring
the maintenance of an investor registry,
so that investors can be easily contacted
if the Operating Advisor makes a
replacement recommendation that
requires a vote.
Commenters submitted a wide range
of comments on the quorum
requirement for removal of the special
servicer. Two commenters asserted that
the quorum requirement would be more
appropriately specified by the

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underlying transaction documents,
rather than in the final rule, in order to
accommodate any future changes in the
market. One commenter favored a
requirement that in order to reach a
quorum, no fewer than three
unaffiliated investors participate in the
vote. Another commenter recommended
two options: (i) Increasing the quorum
to 15 percent and requiring the
participation of three unaffiliated
investors, or (ii) increasing the quorum
to 20 percent with no minimum
unaffiliated investor-voting
requirement. This commenter opposed a
more substantive increase to the quorum
requirement, asserting that it would be
nearly impossible for interest holders to
remove the special servicer. Both of
these commenters recommended adding
a provision that specified that the thirdparty purchaser may not unilaterally reappoint the original special servicer or
its affiliate following a removal and
replacement process.
One commenter highlighted a split in
views among those parties who
contributed to its comments. Some
favored increasing the voting quorum
requirement to two-thirds of all
investors eligible to vote (before the
eligible horizontal residual interest has
been reduced below 25 percent), and to
one-third of all investors eligible to vote
(after the eligible horizontal residual
interest has been reduced below 25
percent). Others supported a quorum
requirement of at least 20 percent, with
at least three independent investors
participating in the vote.
After considering the comments
received, the agencies have decided to
permit CMBS transaction parties to
specify in the underlying transaction
documents the quorum required for a
vote to remove the special servicer.
However, the transaction documents
may not specify a quorum of more than
the holders of 20 percent of the
outstanding principal balance of all ABS
interests in the issuing entity, with such
quorum including at least three ABS
interest holders that are not affiliated
with each other. The agencies believe
that this balanced approach provides
CMBS transaction parties with the
flexibility to establish the quorum
required to remove the special servicer
in the applicable transaction
documents, as is commonly done, while
addressing commenter concerns that a
quorum requirement of more than 20
percent may make is difficult for
interest holders to remove the special
servicer.
The agencies do not believe that it
would be appropriate to include a safe
harbor for the Operating Advisor or a
requirement that there be an investor

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registry requirement in the final rule
since the agencies believe the Operating
Advisor’s indemnification rights and the
trustee’s investor communication
provisions should be set forth in, and
governed by, the transaction documents.
Finally, the agencies agree with
comments requesting that the thirdparty purchaser should not have the
unilateral ability to reappoint the
original special servicer or its affiliate.
The rule requires the replacement of the
special servicer following the
recommendation of the Operating
Advisor and an affirmative vote of the
requisite number of ABS holders. The
agencies believe that the independence
of the Operating Advisor as otherwise
required by the final rule sufficiently
ensures that the recommendation of the
replacement special servicer will be
made independent of third-party
purchasers, and that the voting and
enhanced quorum requirements being
adopted today provide additional
assurance in this regard. The quorum
and voting requirements effectively
require that the third-party purchasers
not have the unilateral ability to reappoint the original special servicer or
its affiliate.
d. Disclosures
The reproposal would have required
the sponsor to provide, or cause to be
provided, to potential purchasers and
federal regulators certain information
concerning the third-party purchasers
and other information concerning the
CMBS transaction, such as each thirdparty purchaser’s name and form of
organization, experience investing in
CMBS, and any other information about
the third-party purchaser deemed
material to investors in light of the
particular securitization transaction.
Additionally, it would have required
a sponsor to disclose to investors the
amount of the eligible horizontal
residual interest that each third-party
purchaser will retain (or has retained) in
the transaction (expressed as a
percentage of the fair value of all ABS
interests issued in the securitization
transaction and the dollar amount of the
fair value of such ABS interests); the
purchase price paid for such interest;
the material terms of such interest; the
amount of the interest that the sponsor
would have been required to retain if
the sponsor had retained an interest in
the transaction; the material
assumptions and methodology used in
determining the aggregate amount of
ABS interests of the issuing entity; the
representations and warranties
concerning the securitized assets; a
schedule of exceptions to these
representations and warranties; and

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information about the factors that were
used to make the determination that
such exceptions should be included in
the pool even though they did not meet
the representations and warranties.
In addition, the reproposal would
have required that certain material
information with respect to the
Operating Advisor be disclosed in the
applicable transaction documents,
including, without limitation, the name
and form of organization of the
Operating Advisor, the qualification
standards applicable to the Operating
Advisor, how the Operating Advisor
satisfies these qualification standards,
and the terms of the Operating Advisor’s
compensation.
The reproposal also would have
required the sponsor to maintain and
adhere to policies and procedures to
actively monitor the third-party
purchaser’s compliance with the CMBS
option, and to notify investors if the
sponsor learns that a third-party
purchaser no longer complies with such
requirements.
The agencies received a few
comments regarding the disclosure
requirements under the CMBS risk
retention option. Two commenters
opposed the disclosure of the purchase
price paid by third-party purchasers for
the eligible horizontal residual interest.
These commenters pointed out that
such information has traditionally been
viewed by all market participants as
highly confidential and proprietary, and
that the disclosure requirement would
deter B-piece buyers from retaining risk.
One of these commenters suggested that
the issuer or third-party purchaser could
instead provide the purchase price to
the appropriate regulatory agency on a
confidential basis, or disclose only that
it has fulfilled the risk retention
requirement.
The investment grade investor
members of an industry association
requested that two additional
disclosures be required with respect to
the Operating Advisor: (1) Any material
conflict of interest or potential conflict
of interest of the Operating Advisor; and
(2) additional information regarding the
formula for calculating the Operating
Advisor’s compensation.
The agencies are adopting the
disclosure requirements for the CMBS
option, with some modifications in
response to comments. As stated in the
reproposal, the agencies believe that the
importance of the disclosures to
investors with respect to third-party
purchasers outweighs potential issues
associated with the sponsor or thirdparty purchaser making such
information available. The agencies
believe that the disclosure requirements

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with respect to the identity and
experience of third-party purchasers in
the CMBS transaction that are being
adopted today will alert investors in the
transaction as to the experience of thirdparty purchasers and other material
information necessary to make an
informed investment decision. In this
regard, the rule retains the requirement
that the price at which the B-piece is
sold be disclosed. Disclosure of the
price of the B-piece is consistent with
other fair value disclosures. The
agencies believe these disclosures are
necessary to allow other investors to
assess the risk being retained, and that
the ability of investors to assess the
value of the retained risk outweighs the
preferences of some B-piece buyers to
keep the price confidential.
With respect to requests that the rule
require the disclosure of the method of
calculating the Operating Advisor’s
compensation, the agencies believe the
requirement to disclose the terms of the
Operating Advisor’s compensation
already encompasses disclosure as to
how such compensation is calculated.
Therefore, the agencies believe that no
change to the reproposed rule is
required in this respect.
With respect to the request that the
rule require disclosure of any material
conflicts of interest involving the
Operating Advisor, the agencies agree
that disclosure of any material or
potential material conflicts of interest of
the Operating Advisor with respect to
the securitization transaction should be
disclosed. Such disclosure will allow
transaction parties to better ensure that
the Operating Advisor will act
independently. Accordingly, the
agencies have added this disclosure
requirement to the final rule.
e. Transfer of B-Piece
As discussed above, consistent with
the reproposal, the rule allows a sponsor
of a CMBS transaction to meet its risk
retention requirement where a thirdparty purchaser acquires the B-piece,
and all other criteria and conditions for
this CMBS option as described are met.
The reproposal would have permitted,
as an exception to the transfer and
hedging restrictions in that reproposed
rule and section 15G of the Exchange
Act, the transfer of the retained interest
by any initial third-party purchaser to
another third-party purchaser at any
time after five years after the date of the
closing of the securitization transaction,
provided that the transferee satisfies
each of the conditions applicable to the
initial third-party purchaser under the
CMBS option in connection with such
purchase. Conditions that an initial
third-party purchaser was required to

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satisfy at or prior to the closing of the
securitization transaction would be
required to be satisfied by the transferee
at or prior to the time of the transfer to
the transferee. The reproposed rule also
would have permitted transfers by any
such subsequent third-party purchaser
to any other purchaser satisfying the
criteria applicable to initial third-party
purchasers. In addition, if the sponsor
retained the B-piece at closing, the
reproposed rule would have permitted
the sponsor to transfer such interest to
a purchaser satisfying the criteria
applicable to subsequent third-party
purchasers after a five-year period
following the closing of the
securitization transaction has expired.
The reproposed rule also would have
required that any transferring thirdparty purchaser provide the sponsor
with complete identifying information
as to the transferee third-party
purchaser.
Comments on the proposed rule
included objections that the five-year
holding period was too long and that a
sponsor that retained the B-piece at
closing should not be required to hold
the position for five years before transfer
to a qualifying third-party purchaser.
Concern was also expressed that
imposing the five-year holding period,
in tandem with the limitation that there
can be no more than two third parties
sharing the B-piece on a pari passu basis
only, could decrease the liquidity of the
B-piece and, therefore, disrupt the
CMBS market.
Many commenters stated that the fiveyear transfer restriction period should
be reduced, because it would
significantly impair the liquidity of
CMBS and render the B-piece interests
much less desirable. However, these
commenters differed on their suggested
alternative approaches. One commenter
recommended a tiered approach by
requiring a third-party purchaser to
retain its interest for one year, allowing
such third-party purchaser to transfer its
interest to a ‘‘qualified transferee’’ who
meets the same criteria as the thirdparty purchaser for the following four
years, and having no transfer or hedging
restrictions after that time. Another
commenter asserted that there should be
no minimum holding requirement as
long as the third-party purchaser
transfers the interest to a subsequent
third-party purchaser meeting the same
qualification requirements as the initial
third-party purchaser. Another
commenter recommended reducing the
transfer restriction period to three years
because performance and other pool
data are readily available from multiple
sources, and investors would have the
opportunity to determine loan

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performance and to identify loans that
are not performing as expected.
One commenter suggested reducing
the 5 percent risk retention requirement
if a five-year holding period is imposed,
or allowing the third-party purchaser to
transfer to a qualified transferee who
meets the same criteria as the thirdparty purchaser, a qualified institutional
buyer under Rule 144A under the
Securities Act, or an institutional
accredited investor under Rule 501
under the Securities Act. Another
commenter recommended allowing
sponsors to transfer the retained interest
to a qualified third-party purchaser
within 90 days after the date of closing
of the transaction. One commenter also
pointed out the five-year period
applicable to holders of eligible
horizontal residual interests and
contained in section 7 of the reproposal
is inconsistent with, and suggested that
it be harmonized with, the general
transfer restriction period that is
contained in section 12 of the
reproposal 136 and that it should apply
to vertical risk retention in a CMBS
transaction, and that both holding
periods should be reduced to three
years. Several commenters suggested
that, if a sponsor holds the B-piece, it
should not be subject to the five-year
holding period or should be allowed to
transfer the B-piece within some short
period after the transaction closing. One
commenter requested that the final rule
state that a sponsor’s risk retention
obligation be terminated with respect to
a CMBS transaction once all of the loans
have been defeased.
The final rule, as it relates to the
rights to transfer the B-piece, is
substantially the same as the reproposal,
in which the agencies attempted to
balance two overriding goals: (1) Not
disrupting the existing CMBS thirdparty purchaser structure and (2)
ensuring that risk retention promotes
good underwriting. In formulating the
reproposal, the agencies reasoned that,
after a five-year period, the quality of
the underwriting would be sufficiently
evident that the initial third-party
purchaser or, if there was no initial
136 Section 12(f)(1) of the reproposal sets forth the
hedging and transfer restriction period that would
be generally applicable to risk retention, which is
the latest of (i) the date on which the total unpaid
principal balance of the securitized assets that
collateralize the securitization transaction has been
reduced to 33 percent of the total unpaid principal
balance of the securitized assets 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 of the securitization transaction;
or (iii) two years after the date of the closing of the
securitization transaction.

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third-party purchaser, the sponsor,
would suffer the consequences of poor
underwriting in the form of a reduced
sales price for such interest. The
agencies also believe that the initial
holder of the B-piece, whether a thirdparty purchaser or the sponsor, would
need to assume that holding the B-piece
for a five-year period would result in
such holder bearing the consequences of
poor underwriting. Thus, by permitting
transfer after the five year-period, the
agencies do not believe that they are
creating a structure which would result
in the initial holder being less
demanding of the underwriting than if
it was required to retain the B-piece
until expiration of the full sunset period
applicable to CMBS securitizations. In
connection with this, the agencies view
the requirement (among other
conditions) that a subsequent purchaser,
like the initial third-party purchaser,
conduct an independent review of the
credit risk of each securitized asset to be
important, as this requirement will
emphasize to the initial B-piece holder
that the performance of the securitized
assets will be scrutinized by any
potential purchaser, thus exposing the
initial purchaser to the full risks of poor
underwriting.
The only change in the final rule from
the reproposal is that it allows the risk
retention obligation to terminate once
all of the loans in a CMBS transaction
are fully defeased. A loan is deemed to
be defeased if cash or cash equivalents
have been pledged to the issuing entity
as collateral for the loan and are in such
amounts and payable at such times as
necessary to timely generate cash
sufficient to make all remaining debt
service payments due on such loan and
the issuing entity has an obligation to
release its lien on the loan. Once the
collateral securing a loan is replaced
with cash or cash equivalent
instruments in the full amount
remaining due on the loan, thereby
defeasing the loan, any risk associated
with poor underwriting is eliminated
and there is no need to require risk
retention to continue to be held.
The standards for the agencies to
provide exemptions to the risk
requirements and prohibition on
hedging are outlined in section 15G.
The exemption allowing for a transfer of
the B-piece by one qualified third-party
purchaser to another qualified thirdparty purchaser after five years meets
these requirements. The agencies
decided that unless there was a holding
period that was sufficiently long enough
to enable underwriting defects to
manifest themselves, the original thirdparty purchaser might not be
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underwriting of the securitized assets.
The agencies believe that under 15
U.S.C. 78o–11(e)(2), a five-year retention
duration helps ensure high-quality
underwriting standards for the
securitizers and originators of assets that
are securitized or available for
securitization by forcing sponsors or
initial third-party purchasers to bear the
risk of losses related to underwriting
deficiencies. Furthermore, the agencies
believe that this exemption meets the
statute’s requirement that the exemption
encourage appropriate risk management
practices by the securitizers and
originators of assets, improve the access
of consumers and businesses to credit
on reasonable terms, or otherwise is in
the public interest and for the protection
of investors. The approach of requiring
the third-party purchaser to hold for at
least five years accommodates
continuing participation of B-piece
buyers in the market, in a way that
requires meaningful risk retention as an
incentive to good risk management
practices by securitizers in selecting
assets and addresses specific concerns
about maintaining consumers’ and
businesses’ access to commercial
mortgage credit.137
6. Government-Sponsored Enterprises

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a. Overview of the Reproposal and
Public Comment
The reproposal provided in section 8
that the full guarantee (for timely
payment of principal and interest) by
the Enterprises while they operate
under the conservatorship or
receivership of FHFA with capital
support from the United States would
have satisfied the risk retention
requirements of section 15G of the
Exchange Act with respect to the
mortgage-backed securities issued by
the Enterprises. Similarly, an equivalent
guarantee provided by a limited-life
regulated entity that succeeds to the
charter of an Enterprise, and that is
operating under the authority and
oversight of FHFA under section 1367(i)
of the Federal Housing Enterprises
Financial Safety and Soundness Act of
1992, would have satisfied the risk
retention requirements, provided that
the entity is operating with capital
support from the United States. The
reproposal also provided that the
hedging and finance provisions would
137 While more than one commenter suggested
that a sponsor who retains the B-piece be allowed
to transfer the B-piece within the five year-period,
the agencies do not agree that the sponsor should
be treated differently from a third-party purchaser
in this regard. The obligation to hold the B-piece
for the five year-period is designed to, and will
help, ensure high quality underwriting regardless of
whether it is held by the sponsor or a third party.

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not have applied to an Enterprise while
operating under conservatorship or
receivership with capital support from
the United States, or to a limited-life
regulated entity that succeeded to the
charter of an Enterprise and is operating
under the authority and oversight of
FHFA with capital support from the
United States. Under the reproposal, a
sponsor (that is, an Enterprise) utilizing
this option would have been required to
provide to investors, in written form
under the caption ‘‘Credit Risk
Retention’’ and, upon request, to FHFA
and the Commission, a description of
the manner in which it met the credit
risk retention requirements.
As the agencies emphasized, if either
an Enterprise or a successor limited-life
regulated entity began to operate other
than as described, the Enterprise or
successor entity would no longer be able
to avail itself of the credit risk retention
option provided by section 8 of the
reproposal and would have become
subject to the related requirements and
prohibitions set forth elsewhere in the
reproposal. The reproposal did not alter
the approach to the risk retention
requirements for the Enterprises in the
original proposal.
In explaining their reasons for this
approach, the agencies observed that
because the Enterprises fully guarantee
the timely payment of principal and
interest on the mortgage-backed
securities they issue, the Enterprises
were exposed to the entire credit risk of
the mortgages that collateralize those
securities.138 The agencies also
highlighted that the Enterprises had
been operating under the
conservatorship of FHFA since
September 6, 2008, and that as
conservator, FHFA had assumed all
powers formerly held by each
Enterprise’s officers, directors, and
shareholders and was directing its
efforts as conservator toward
minimizing losses, limiting risk
exposure, and ensuring that the
Enterprises priced their services to
adequately address their costs and risk.
Finally, the agencies described how
each Enterprise, concurrent with being
placed in conservatorship, entered into
a Senior Preferred Stock Purchase
Agreement (PSPA) with the United
States Department of the Treasury
(Treasury) and that the PSPAs provided
capital support to the relevant
Enterprise if the Enterprise’s liabilities
exceeded its assets under GAAP.139
138 See Original Proposal, 76 FR at 24111–24112;
Revised Proposal, 78 FR at 57959–57961.
139 Under each PSPA as amended, Treasury
purchased senior preferred stock of each Enterprise.
In exchange for this cash contribution, the

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The agencies received only a few
comments on proposed section 8, and
those commenters generally supported
allowing the Enterprises’ guarantee to be
an acceptable form of risk retention in
accordance with the conditions
proposed. As a consequence the
agencies have decided to adopt section
8 without any change.
While the agencies understand the
issues involved with the Enterprises’
participation in the mortgage market,
the agencies continue to believe that it
is appropriate, from a public policy
perspective, to recognize the guarantee
of the Enterprises as fulfilling their risk
retention requirement under section
15G of the Exchange Act, while in
conservatorship or receivership with the
capital support of the United States.140
The authority and oversight of the
FHFA over the operations of the
Enterprises or any successor limited-life
regulated entity during a
conservatorship or receivership, the full
guarantee provided by these entities on
the timely payment of principal and
interest on the mortgage-backed
securities that they issue, and the
capital support provided by Treasury
under the PSPAs 141 provide a
reasonable basis consistent with the
goals and intent of section 15G for
recognizing the Enterprise guarantee as
meeting the Enterprises’ risk retention
requirement.
For similar reasons, the agencies
believe that final rule’s restrictions and
prohibitions on hedging and transfers of
retained interests should not apply to an
Enterprise or any successor limited-life
regulated entity, as long as the
Enterprise (or limited-life successor
liquidation preference of the senior preferred stock
that Treasury purchased from the Enterprise under
the respective PSPA increases in an equivalent
amount. The senior preferred stock of each
Enterprise purchased by Treasury is senior to all
other preferred stock, common stock or other
capital stock issued by the Enterprise.
Treasury’s commitment to each Enterprise is the
greater of: (1) $200 billion; or (2) $200 billion plus
the cumulative amount of the Enterprise’s net worth
deficit as of the end of any calendar quarter in 2010,
2011 and 2012, less any positive net worth as of
December 31, 2012. Under amendments to each
PSPA signed in August 2012, the fixed-rate
quarterly dividend that each Enterprise had been
required to pay to Treasury was replaced, beginning
on January 1, 2013, with a variable dividend based
on each Enterprise’s net worth, helping to ensure
the continued adequacy of the financial
commitment made under the PSPA and eliminating
the need for an Enterprise to borrow additional
amounts to pay quarterly dividends to Treasury.
The PSPAs also require the Enterprises to reduce
their retained mortgage portfolios over time.
140 See Revised Proposal, 78 FR at 57960.
141 By its terms, a PSPA with an Enterprise may
not be assigned, transferred, inure to the benefit of,
any limited-life, regulated entity established with
respect to the Enterprise without the prior written
consent of Treasury.

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entity) is operating consistent with the
conditions set out in the rule. In the
past, the Enterprises have sometimes
acquired pool insurance to cover a
percentage of losses on the mortgage
loans comprising the pool.142 FHFA also
has made risk-sharing through a variety
of alternative mechanisms a major goal
of its Strategic Plan for the Enterprise
Conservatorships.143 Because each
Enterprise, while in conservatorship or
receivership and operating with capital
support from the United States, will
need to fully guarantee, and hold the
credit risk on, the mortgage-backed
securities that it issues for the
provisions of section 8 of the rule to
apply, the prohibition on hedging the
credit risk that a retaining sponsor is
otherwise required to retain would have
limited the ability of the Enterprises to
acquire such pool insurance in the
future or take other reasonable actions
to limit losses that would otherwise
arise from the Enterprises’ full exposure
to the credit risk of the securities that
they issue.
If any of the conditions in the rule
cease to apply, an Enterprise or any
successor organization will no longer be
able to rely on its guarantee to meet the
risk retention requirement under section
15G of the Exchange Act and will need
to retain risk in accordance with one of
the other applicable sections of this risk
retention rule. Because section 8 of the
rule applies only so long as the relevant
Enterprise operates under the authority
and control of FHFA and with capital
support from the United States, the
agencies continue to believe that the
rule’s approach with regard to the
Enterprises’ compliance with the risk
retention requirement of section 15G of
the Exchange Act is consistent with the
maintenance of quality underwriting
standards, in the public interest, and
consistent with the protection of
investors.144
The agencies recognize ongoing
activity related to reform of the
Enterprises, and expect to revisit and, if
appropriate, modify this and other
provisions after the future of the
Enterprises and of the statutory and
regulatory framework for the Enterprises
becomes clearer. The agencies will
continue to consider the impact of
potential arbitrage between various
markets and market participants, and in
particular between the Enterprises and
the private securitization markets, and
142 Typically, insurers would pay the first losses
on a pool of loans, up to 1 or 2 percent of the
aggregate unpaid principal balance of the pool.
143 See, e.g., FHFA 2012 Report at 7–11; FHFA
2013 Report at 7–11.
144 See Original Proposal, 76 FR at 24112; Revised
Proposal 78 FR at 57961.

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whether adjustments should be made to
enhance investor protection and
financial stability.
7. Open Market Collateralized Loan
Obligations
a. Background
A CLO is an asset-backed security that
is typically collateralized by portions of
tranches of senior, secured commercial
loans or similar obligations of borrowers
who are of lower credit quality or that
do not have a third-party evaluation of
the likelihood of timely payment of
interest and repayment of principal. As
discussed in the reproposal,
commenters distinguished between two
general types of CLOs: open market
CLOs and balance sheet CLOs. As
described by commenters, a balance
sheet CLO securitizes loans already held
by a single institution or its affiliates in
portfolio (including assets originated by
the institution or its affiliate) and an
open market CLO securitizes assets
purchased on the secondary market, in
accordance with investment guidelines.
CLOs are organized and initiated by a
CLO manager usually when the CLO
manager partners with a structuring
bank that assists in financing asset
purchases that occur before the legal
formation of the CLO.145 After the terms
of a CLO transaction, including
investment guidelines, are agreed upon
with key investors, the CLO manager
will usually have sole discretion under
the governing documents to select
portions of tranches of syndicated
commercial loans on the primary or
secondary market to be acquired by the
CLO in compliance with the investment
guidelines. An SPV (issuing entity) is
formed to issue the asset-backed
securities collateralized by commercial
loans that the CLO manager has selected
and directed the CLO issuing entity to
purchase. The CLO manager retains the
obligation to actively manage the asset
portfolio, in accordance with the
investment guidelines, and earns
management fees and performance
fees 146 for management services
provided.
CLOs are a type of CDO. Both are
organized and initiated by an asset
manager that also actively manages the
assets for a period of time after closing
in compliance with investment
guidelines. Typically, both CLOs and
CDOs are characterized by relatively
simple sequential pay capital structures
145 Board of Governors of the Federal Reserve
System, Report to the Congress on Risk Retention
22 (Oct. 2010).
146 In many cases, a portion of the manager’s fees
are subordinated or contingent upon asset
performance.

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and significant participation by key
investors in the negotiation of
investment guidelines.
As discussed in the reproposal and
below, the agencies believe that the risk
retention rules apply to CLOs because
CLO managers clearly fall within the
statutory definition of ‘‘securitizer’’ set
forth in Exchange Act section 15G.
Moreover, the agencies believe it is
consistent with the purpose of section
15G of the Exchange Act and principles
of statutory interpretation to apply the
risk retention rules to CLOs. There is no
indication that Congress sought to
exclude any specific type of
securitization structure from the
requirements of section 15G. Other than
mandating specific types of exemptions
based on underwriting quality and for
securitizations involving certain public
entities,147 Congress directed the
agencies to apply risk retention
generally with respect to all assetbacked securities. Subject only to
specific limitations, authority to
determine other exemptions was left to
the implementing agencies.
Moreover, contrary to commenters’
suggestions, as discussed below,
developments in the CLO and leveraged
loan market suggest that CLOs present
many of the same incentive alignment
and systemic risk concerns that the risk
retention requirements of section 15G
were intended to address. CLO issuance
has been increasing in recent years.148
Paralleling this increase has been rapid
growth in the issuance of leveraged
loans,149 which are the primary assets
purchased by most CLOs. Heightened
activity in the leveraged loan market has
been driven by search for yield and a
corresponding increase in risk appetite
by investors.150 The agencies note that
there is evidence that this increased
activity in the leveraged loan market has
coincided with widespread loosening of
underwriting standards.151 In fact, a
recent review of a sample of leveraged
loans by the Federal banking agencies
found that forty-two percent of
leveraged loans examined were
criticized by examiners.152 The agencies
147 15

U.S.C. 78o–11(e).
Policy Report, Board of Governors of
the Federal Reserve System, at 23 (July 2014).
149 Id. at 22; Semiannual Risk Perspective: Spring
2014, Office of the Comptroller of the Currency, at
29 (June 2014).
150 Monetary Policy Report, at 1–2, 22.
151 Id.; Semiannual Risk Perspective: Spring 2014,
at 5.
152 Shared National Credits Program: 2013
Review, Board of Governors of the Federal Reserve
System, Federal Deposit Insurance Corporation,
Office of the Comptroller of the Currency, at 3
(September 2013) (‘‘A focused review of leveraged
loans found material widespread weakness in
underwriting practices, including excessive
148 Monetary

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believe that increases in the origination
and pooling of poorly underwritten
leveraged loans could expose the
financial system to risks.153 The Federal
banking agencies have been monitoring
this market closely and have responded
to concerns by issuing updated
leveraged lending supervisory guidance,
which outlines principles related to safe
and sound leveraged lending activities,
including expectations that banks and
thrifts exercise prudent underwriting
standards when originating leveraged
loans, regardless of intent to hold or
distribute them.154 As discussed in
more detail below, these developments
in the leveraged loan and CLO market
represent similar dynamics to issues in
the originate-to-distribute model that
were a major factor in the recent
financial crisis and that section 15G was
intended to address.
For these reasons, and others
discussed below, the agencies believe it
is appropriate to apply risk retention
rules to open market CLOs as well as
balance sheet CLOs.

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b. Overview of Original Proposal and
Reproposal
In the original proposal, the agencies
observed that a CLO manager generally
acts as the sponsor by selecting the
commercial loans to be purchased by
the CLO issuing entity and managing
the securitized assets once deposited in
the CLO structure.155 Accordingly, the
original proposal would have required
the CLO manager to satisfy the
minimum risk retention requirement for
each CLO securitization transaction that
it managed by holding a sufficient
amount of standard risk retention. The
original proposal did not include a form
of risk retention designed specifically
for CLO securitizations.
As discussed in the reproposal, many
commenters on the original proposal
raised concerns regarding the impact of
the proposal on open market CLOs.
Some commenters asserted that most
asset management firms currently
serving as open market CLO managers
do not have the balance sheet capacity
to fund 5 percent horizontal or vertical
slices of the CLO. They asserted that
imposing standard risk retention
requirements on these managers could
cause independent CLO managers to
leverage, inability to amortize debt over a
reasonable period, and lack of meaningful financial
covenants.’’).
153 See, e.g., Semiannual Risk Perspective: Spring
2014, at 8.
154 See ‘‘Interagency Guidance on Leveraged
Lending,’’ Final Supervisory Guidance, 78 FR
17766 (March 22, 2013), at http://www.gpo.gov/
fdsys/pkg/FR-2013-03-22/pdf/2013-06567.pdf
(Leveraged Lending Guidance).
155 See Original Proposal, 76 FR at 24098 n. 42.

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exit the market or be acquired by larger
firms. According to these commenters,
the resulting erosion in market
competition could increase the cost of
credit for large companies that are of
lower credit quality or that do not have
a third-party evaluation of the
likelihood of timely payment of interest
and repayment of principal and that are
represented in CLO portfolios above the
level that otherwise would be consistent
with the credit quality of these
companies.
Certain commenters also asserted that
open market CLO managers are not
‘‘securitizers’’ under section 15G of the
Exchange Act and, therefore, the
agencies do not have the statutory
authority to subject them to risk
retention requirements. These
commenters asserted that CLO managers
are not ‘‘securitizers’’ as defined in
section 15G of the Exchange Act
because they do not own, sell, or
transfer the loans that comprised the
CLO’s collateral pool, but only direct
which assets would be purchased by the
CLO issuing entity.
In the reproposal, the agencies
discussed these comments and
explained that the definition of
‘‘securitizer’’ under section 15G of the
Exchange Act applied to open market
CLO managers.156 To help address
concerns raised by commenters to the
initial proposal, the agencies proposed
an alternative method for risk retention
compliance for CLOs that the agencies
believed would be consistent with the
purposes of risk retention. This alternate
approach would be available under the
reproposal to an open market CLO, the
assets of which consist primarily of
portions of senior, secured syndicated
loans acquired by the issuing entity
directly from sellers in open market
transactions and servicing assets, and
that holds less than 50 percent of its
assets by aggregate outstanding
principal amount in loans syndicated by
lead arrangers that are affiliates of the
CLO or CLO manager or originated by
originators that are affiliates of the CLO
or CLO manager (lead arranger option).
Under the reproposal, as an
alternative to the standard options for
vertical or horizontal risk retention, the
sponsor of an open market CLO could
avail itself of the lead arranger option
only if, among other requirements: (1)
The CLO did not hold or acquire any
assets other than CLO-eligible loan
tranches (discussed below) and
servicing assets (as defined in the
reproposed rule); (2) the CLO did not
invest in ABS interests or credit
derivatives (other than permitted hedges
156 See

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77651

of interest rate or currency risk); and (3)
all purchases of assets by the CLO
issuing entity (directly or through a
warehouse facility used to accumulate
the loans prior to the issuance of the
CLO’s liabilities) were made in open
market transactions on an arm’s length
basis. In addition, to be eligible for the
option, the governing documents of the
open market CLO would have to
require, at all times, that the assets of
the open market CLO consist only of
CLO-eligible loan tranches and servicing
assets.
Under the reproposal’s lead arranger
option, a term loan of a syndicated
credit facility to a commercial borrower
would have qualified as a CLO-eligible
loan tranche if the firm serving as lead
arranger for the term loan tranche were
to retain at least 5 percent of the face
amount of the term loan tranche. The
lead arranger would have been required
to retain this portion of the loan tranche
until the repayment, maturity,
involuntary and unscheduled
acceleration, payment default, or
bankruptcy default of the loan tranche.
This requirement would have applied
regardless of whether the loan tranche
was purchased on the primary or
secondary market, or was held at any
particular time by an open market CLO,
and was designed to allow meaningful
risk retention to be held by a party that
has significant control over the
underwriting of assets that are typically
securitized in CLOs, without causing
significant disruption to the CLO
market.
In order to ensure that a lead arranger
retaining risk had a meaningful level of
influence on loan underwriting terms,
the reproposal would have required that
the lead arranger be identified in the
legal documents governing the
origination, participation or syndication
of the syndicated loan or credit facility
and that such documents include
covenants by the lead arranger that it
will fulfill the requirement to retain a
minimum of 5 percent of the face
amount of the CLO-eligible loan
tranche. The lead arranger also would
be required to take on an initial
allocation of at least 20 percent of the
face amount of the broader syndicated
loan or credit facility, with no other
member of the syndicate assuming a
larger allocation or commitment.
Additionally, a retaining lead arranger
would have been required to comply
with the same sales and hedging
restrictions as sponsors of other
securitizations until the repayment,
maturity, involuntary and unscheduled
acceleration, payment default, or
bankruptcy default of the loan tranche.
Voting rights within the broader

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syndicated loan or credit facility would
also have to be defined in such a way
that holders of the ‘‘CLO-eligible’’ loan
tranche had, at a minimum, consent
rights with respect to any material
waivers and amendments of the legal
documents governing the underlying
CLO-eligible loan tranche. Additionally,
the pro rata provisions, voting
provisions, and security associated with
the CLO-eligible loan tranche could not
be materially less advantageous to the
holders of that tranche than the terms of
other tranches of comparable seniority
in the broader syndicated credit facility.
Under the reproposal’s lead arranger
option for open market CLOs, the
sponsor would have been required to
disclose a complete list of every asset
held by an open market CLO (or before
the CLO’s closing, in a warehouse
facility in anticipation of transfer into
the CLO at closing). This list would
have been required to include the
following information: (i) The full legal
name and Standard Industrial
Classification category code of the
obligor of the loan or asset; (ii) the full
name of the specific CLO-eligible loan
tranche held by the CLO; (iii) the face
amount of the CLO-eligible loan tranche
held by the CLO; (iv) the price at which
the CLO-eligible loan tranche was
acquired by the CLO; and (v) for each
loan tranche, the full legal name of the
lead arranger subject to the sales and
hedging restrictions. Second, the
sponsor would have been required to
disclose the full legal name and form of
organization of the CLO manager. This
information would have been required
to be disclosed a reasonable period of
time prior to the sale of the asset-backed
securities in the securitization
transaction (and at least annually with
respect to information regarding the
assets held by the CLO) and, upon
request, to the Commission and the
sponsor’s appropriate Federal banking
agency, if any. Further, the lead arranger
and CLO manager would be required to
certify or represent as to the adequacy
of the collateral and the attributes of the
borrowers of the senior, secured
syndicated loans acquired by the CLO
and certain other matters.
c. Overview of Public Comments
The agencies received many
comments asserting that the proposed
options for open market CLOs would be
unworkable under existing CLO
practices and would lead to a significant
reduction in CLO offerings and a
corresponding reduction in credit to
commercial borrowers. These
commenters asserted that the likelihood
of a significant number of lead arrangers
retaining 5 percent risk retention (in any

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of the forms permitted by the rule)
would be remote and only the largest
CLO managers would be able to finance
the proposed risk retention requirement
through the standard risk retention
option. While larger managers might
have sufficient financing, several
commented that the risk retention
requirements would make the
management of CLOs less profitable and
might cause many managers to decrease
their activity in the market. One
commenter highlighted a recently
issued paper by the Bank of England
and the European Central Bank to
suggest that risk retention rules in
Europe that apply to CLO managers
have contributed to a reduction in
European CLO issuance.157 Several
commenters asserted that if the risk
retention requirement causes a
reduction in participation by open
market CLOs in the leveraged loan
market, some of the resulting reduced
credit availability would be replaced by
non-CLO credit providers, but cost of
capital and instability in the market
would increase.
Some commenters expressed specific
concerns about the proposed lead
arranger option. These commenters
stated that having lead arrangers hold a
portion of the loan would increase the
costs of arranging loans, thus restricting
the availability of credit to borrowers or
increasing the cost of credit to
borrowers. In addition, commenters
expressed concern that few loans would
satisfy the definition of ‘‘CLO-eligible
loan tranche.’’ Furthermore, they
asserted that the additional voting rights
required by the reproposal would be
administratively unworkable and
commercially unacceptable. Several
commenters also raised concerns that
the proposed option would expose the
arranger to potential liability and
litigation risks that arrangers should not
be expected, and would not be willing,
to assume. Commenters raised
particular concern about the
requirement that a lead arranger
represent that the loans and collateral
meet specified criteria. They asserted
that such a representation would require
the lead arranger to make subjective and
difficult determinations regarding the
adequacy of collateral, and the
sufficiency of the security interest in the
collateral and certain other matters, and
could expose the lead arranger to
potential liability.
157 The Case for a Better Functioning
Securitisation Market in the European Union, Bank
of England and the European Central Bank (May
2014), available at https://www.ecb.europa.eu/pub/
pdf/other/ecb-boe_case_better_functioning_
securitisation_marketen.pdf.

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Another concern raised by several
commenters was that the proposed lead
arranger option would prevent prudent
risk management practices and thus
invite criticism from lead arrangers’
bank regulators because the hedging
restriction would prohibit arrangers
from actively managing the risks and
disposing of loan assets in response to
market conditions, and would limit lead
arrangers’ capacities to provide other
forms of credit to borrowers. Further,
commenters stated that use of the option
would increase the capital and FDIC
assessment charges for lead arranger
banks and cause corresponding
increases in the pricing of CLO-eligible
tranches. In addition, some commenters
raised concerns that the proposed
option’s creation of both CLO-eligible
loans and non-eligible loans with
otherwise comparable characteristics
would distort and restrict the initial
syndication process and the secondary
loan market, as the secondary loan
market would place a premium on CLOeligible loans and liquidity related to
non-eligible loans would be reduced.
Relative to a ‘‘normal’’ market, both
types of loans would be less liquid
because they would each reflect a
smaller, divided market.
As discussed in Part B.1 of this
Supplementary Information, a number
of commenters expressed concern that
the proposed restriction on cash flow
distributions to eligible horizontal
residual interests would make the
eligible horizontal residual interest an
unworkable option for CLOs. They
suggested that the cash flow distribution
restriction would significantly reduce
returns to equity investors, making
CLOs unattractive investments and
cause dramatically reduced CLO
issuances. Further, a few commenters
supported a phase-in period while
markets adjust to the final rule or a
grandfathering for certain legacy CLOs.
Two commenters also recommended
that the risk retention rules follow the
European risk retention rules with
respect to CLOs.158 One such
commenter expressed concerns that
inconsistent regulations would cause
bifurcation of the CLO market and
substantially reduce market liquidity.
Further, a few commenters asserted that
the costs of imposing risk retention on
CLO managers exceeds the benefits and
that the agencies have not performed an
adequate economic analysis in
connection with the CLO option.
158 The agencies note that Articles 404–410 of the
EU Capital Requirements Regulation significantly
amended Article 122a of the European Union’s
Capital Markets Directive with respect to the use of
third parties to retain risk.

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Some commenters continued to assert
that open market CLO managers are not
‘‘securitizers’’ and are, therefore, not
subject to section 15G. These
commenters asserted that under the
plain language of the statute, CLO
managers cannot ‘‘sell’’ or ‘‘transfer’’ the
assets securitized through the CLO
because they do not own, possess, or
control the assets. Additionally,
commenters asserted that the CLO
manager acts as an agent to the CLO
issuing entity in directing the purchase
of assets, so it could not sell or transfer
the assets to a third party to meet the
definition, because it would be
equivalent to selling or transferring the
assets to itself. They asserted that the
use of ‘‘indirectly’’ in the definition of
securitizer was intended to prevent the
party that originates a loan from
avoiding risk retention obligations by
passing the loan through an associated
intermediary that organized and
initiated the securitization.
The commenters also asserted that the
interpretation is not supported by the
legislative history or statutory purpose
of the Dodd-Frank Act. They suggested
that Congress primarily intended to
address problems with the originate-todistribute model and transparency
issues in securitization transactions, but
open market CLOs differ from the
originate-to-distribute model and are
more transparent than the products
Congress sought to regulate. The
commenters stated that in the originateto-distribute model originators receive
significant up-front fees for originating
loans, which they transfer into
securitization pools to promote the
business of creating additional loans.
They asserted that CLOs differ from this
model because the primary purpose of
CLOs is to provide investors with the
ability to gain exposure to commercial
loans on a diversified basis, not to
finance the creation of financial assets.
They also asserted that, unlike
originators in the originate-to-distribute
model, who receive their compensation
by originating and transferring the assets
to securitization pools, the bulk of CLO
managers’ compensation is based on
performance of the securitized assets in
the CLO. Regarding the transparency
issues that Congress sought to address,
the commenters suggested that the
primary concern of Congress was to
apply risk retention to highly opaque
and complex products like resecuritizations of asset-backed
securities. These commenters asserted
that CLOs are more transparent than
such products because they contain
fewer, larger, loans and the obligors of
such loans are typically known

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corporations on which investors can
perform extensive due diligence, and
the loans are traded in a liquid market
that assesses risks and underwriting
quality.
In addition to the above comments,
some commenters requested alternative
options for meeting risk retention or that
the agencies provide an exemption from
risk retention for managers of open
market CLOs where certain criteria
would be met because of the nature and
characteristics of open market CLOs. In
this regard, commenters asserted that
open market CLOs operate
independently of originators and are not
part of, and do not pose the same risks
as, the originate-to-distribute model.
They also suggested that CLO managers’
interests are fully aligned with CLO
investors’ interests because CLO
managers bear significant risk through
their deferred, contingent compensation
structure, which they asserted is based
heavily on performance of the
securitized assets. Further, commenters
stated that most CLO managers are
registered investment advisors with
associated fiduciary duties to their
investors. One commenter also referred
to other regulations and guidance,
asserting that they already provide
meaningful protections against
imprudent or inferior underwriting,
including the leveraged lending
guidance released by the Federal
banking agencies in 2013.159 Several
commenters also supported their
arguments by indicating that the assets
selected by CLO managers are evaluated
through multiple layers of underwriting
and market decisions and CLO loan
portfolios are actively managed for
much of the life of a CLO. Commenters
further asserted that CLO managers
select senior secured commercial loans
with investor protection features. Some
commenters asserted that, unlike many
other securitizations, CLOs are
securitizations of liquid assets and they
are structurally transparent. They also
stated that CLOs have historically
performed well and that this strong
performance is evidence that further
regulation is unnecessary and that
customary features of CLOs, including
overcollateralization and interests
coverage tests, protect investors. The
alternative options and exemption
requests are discussed in further detail
below.

159 See

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d. Response to Comments
i. Definition of ‘‘Securitizer’’ and
Legislative History of Section 15G
The agencies have considered the
concerns raised by commenters with
respect to the reproposal, including
with respect to open market CLOs. As
discussed above, commenters asserted
that CLO managers could not be
‘‘securitizers’’ within the definition
thereof in section 15G of the Exchange
Act, including the contention that they
do not legally own, possess, or control
the assets.
As explained in the reproposal, the
agencies believe that CLO managers are
clearly included within the statutory
definition of ‘‘securitizer’’ set forth in
section 15G of the Exchange Act.
Subpart (a)(3)(B) of section 15G begins
the definition of a ‘‘securitizer’’ by
describing a securitizer as a ‘‘person
who organizes and initiates an assetbacked securities transaction.’’ CLOs
clearly meet the definition of ‘‘assetbacked security’’ set forth in section 3
of the Exchange Act, which defines
‘‘asset-backed security’’ as ‘‘a fixed
income or other security collateralized
by any type of self-liquidating financial
asset (including a loan, a lease, a
mortgage, or a secured or unsecured
receivable) that allows the holder of the
security to receive payments that
depend primarily on the cash flow from
the asset.’’ 160 As discussed above, a
CLO is a fixed income or other security
that is typically collateralized by
portions of tranches of senior, secured
commercial loans or similar obligations.
The holder of a CLO is dependent upon
the cash flow from the assets
collateralizing the CLO in order to
receive payments. Accordingly, a CLO is
an asset-backed securities transaction
for purposes of the risk retention
rules.161
A CLO manager typically negotiates
the primary deal terms of the
transaction and the primary rights of the
issuing entity and uniformly directs
such entity to acquire the commercial
loans that comprise its collateral pool.
Under the plain language of the statute,
therefore, a CLO manager organizes and
initiates an asset-backed securities
transaction.162
The definition continues that the
organizer and initiator of a CLO does so
160 See

15 U.S.C. 78c(a)(79).
CDOs are specifically mentioned
as examples both in the definition of ‘‘asset-backed
security’’ and elsewhere in section 941 of the DoddFrank Act. See 15 U.S.C. 78c(a)(79)(A)(ii) and 78o–
11(c)(1)(F). As discussed above, CLOs are a type of
CDO and CLOs and CDOs have the same general
structure.
162 The definition of ‘‘sponsor’’ is discussed in
Part II of this Supplementary Information.
161 Furthermore,

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‘‘by selling or transferring assets, either
directly or indirectly, including through
an affiliate, to the issuer.’’ A CLO
manager indirectly transfers the assets
to the CLO issuing entity because the
CLO manager has sole authority to
select the commercial loans to be
purchased by the CLO issuing entity for
inclusion in the CLO collateral pool,
directs the issuing entity to purchase
such assets in accordance with
investment guidelines, and manages the
securitized assets once deposited in the
CLO structure. Most importantly, an
asset is not transferred to the CLO
issuing entity unless the CLO manager
has selected the asset for inclusion in
the CLO collateral pool and instructed
the CLO issuing entity to acquire it.
Although some commenters have
narrowly interpreted the term
‘‘transferring’’ to specifically require
legal ownership or possession of the
object being transferred, the agencies
observe that the plain meaning of
‘‘transfer’’ does not first require
ownership or possession and otherwise
is not as narrow as these commenters
assert.163 ‘‘Transfer’’ is commonly
defined as ‘‘to cause to pass from one to
another,’’ which is precisely what the
CLO manager does.164 The CLO
manager causes assets to be passed from
the seller to the issuing entity because
the CLO manager selects the assets for
the collateral pool and directs the
issuing entity to purchase such assets.
Therefore, the CLO manager ‘‘transfers’’
the assets according to a commonly
accepted definition of the word. There
is no indication in the statute that
Congress intended to interpret the word
‘‘transfer’’ as narrowly as commenters
have advocated. If Congress had desired
such an interpretation that would be
narrower than how the term is
commonly defined, the agencies believe
that additional limiting language would
have been included in the statute. CLO
managers, therefore, fall clearly within
the statutory definition of ‘‘securitizer’’
as set forth in Exchange Act section
15G.
Even if there were ambiguity as to
whether CLO managers are covered by
the definition of ‘‘securitizer,’’ the
agencies believe that the interpretation
of ‘‘securitizer’’ to include CLO
managers is reasonable. In addition to
163 See, e.g., Babbitt v. Sweet Home Chapter of
Communities for a Great Or., 515 U.S. 687, 697–98
(1995) (rejecting the argument that the word
‘‘harm,’’ defined ‘‘to cause hurt or damage to:
injure,’’ should be read so narrowly as to require
a showing of direct injury to something).
164 Merriam-Webster’s Collegiate Dictionary 1253
(10th ed. 1995); See also Random House Webster’s
College Dictionary 1366 (2nd ed. 1997); The New
Oxford American Dictionary 1797 (Elizabeth J.
Jewell & Frank Abate eds., 2001).

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being consistent with commonly used
definitions of ‘‘transfer,’’ as discussed
above, the interpretation is consistent
with the context, purposes and
legislative history of the statute. Further,
the alternative interpretation argued by
commenters would lead to results that
would be contrary to the purposes of
section 941 and Congressional intent.
The text surrounding the word
‘‘transfer’’ supports the agencies’
interpretation of the word. To read
‘‘transfer’’ narrowly to require
ownership or possession would make
the preceding word ‘‘sell’’ superfluous
because the act of selling necessarily
involves the legal transfer of the
asset.165 In addition, the agencies do not
believe that the phrase ‘‘including
through an affiliate’’ bolsters the
commenters’ claim that ‘‘transfer’’ was
intended to be interpreted in this
limited manner because the use of the
word ‘‘include’’ in a statute can signal
that what follows is meant to be
illustrative rather than exclusive.166 As
stated earlier, the agencies believe that
a CLO manager generally acts as the
sponsor by selecting the commercial
loans to be purchased by the CLO
issuing entity and managing the
securitized assets once deposited in the
CLO structure, which the agencies
believe is a transfer or indirect transfer
of the assets.
The agencies also disagree with the
commenters’ assertion that the CLO
manager does not transfer or sell assets
because, as an agent of the CLO, it is on
the same side of the transaction as the
purchaser (the special purpose issuing
entity). Under the same reasoning, one
could claim that an originator of assets
that creates a special purpose vehicle to
issue asset-backed securities and
transfers assets to that special purpose
vehicle could never be a securitizer,
because the originator also essentially
would be transferring the assets to itself.
If that were the case, then many types
of securitizations would not have an
entity that would be subject to risk
retention.
Moreover, the agencies disagree with
commenters’ assertions that Congress
165 Cf. Hibbs v. Winn, 542 U.S. 88, 101 (2004)
(stating that it is one of the most basic interpretive
canons, that ‘‘ ‘[a] statute should be construed so
that effect is given to all its provisions, so that no
part will be inoperative or superfluous, void or
insignificant. . . .’ ’’) (quoting 2A N. Singer,
Statutes and Statutory Construction § 46.06,
pp.181–186 (rev. 6th ed. 2000)).
166 See Samantar v. Yousuf, 560 U.S. 305, 316–
17 (2010). While Congress referred to transferring
through affiliates as an example of indirect transfer,
it did not preclude other forms of indirect transfer
in the definition of ‘‘securitizer,’’ nor did it
specifically limit the definition to parties in the
chain of title.

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intended section 15G to apply primarily
to securitizations within the originateto-distribute model. Congress did not
specify that the requirements of the
statute apply only to certain types of
securitization models or structures.
Indeed, section 15G specifies that risk
retention applies to all securitizers,167
unless they have a specific exemption
under the statute or the agencies
provide a specific exemption in
accordance with criteria set forth in the
statutory text.168 Congress did not
specifically exclude securitizations that
are not part of an originate-to-distribute
model—or any other particular market
model or structure of securitization—
from risk retention. Although the
legislative history indicates that
Congress was concerned about
securitizations within the originate-todistribute model, nowhere in the text or
legislative history did Congress indicate
that it intended for risk retention not to
apply to transactions that some may
assert are not ‘‘originate-to-distribute’’
securitizations.
Furthermore, the leveraged loan
market shares characteristics with the
‘‘originate-to-distribute’’ model that led
to the deterioration in underwriting
standards that were a major factor in the
recent financial crisis. Originators of
leveraged loans often retain little or no
interest in the assets they originate, and
originate and underwrite with the
intention of distributing the entire loan.
In this regard, leveraged loans
purchased by CLOs are often originated
as a fee-generating, rather than a lending
business, and originators do not have
the same incentive to underwrite
carefully as they would for loans they
intend to keep in portfolio. These
characteristics of the leveraged loan
market pose potential systemic risks
similar to those observed in the
residential mortgage market during the
crisis, whether the loans are placed with
CLOs or other types of institutional
investors.
Additionally, there is no evidence to
support the notion that Congress
expected ‘‘securitizer’’ to be read
narrowly so that risk retention
requirements would apply only to
sponsors of securitizations which have
a specific type of structure or only to
sponsors that fulfill a narrow and
specific structural role in a
167 See 15 U.S.C. 78o–11(b)(1) (‘‘[T]he Federal
banking agencies and the Commission shall jointly
prescribe regulations to require any securitizer to
retain an economic interest in a portion of the credit
risk for any asset that the securitizer, through the
issuance of an asset-backed security, transfers, sells,
or conveys to a third party.’’).
168 See 15 U.S.C. 78o–11(c)(1)(G)(i) and 15 U.S.C.
78o–11(e).

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securitization transaction. Furthermore,
the agencies believe that the narrow
reading of ‘‘securitizer’’ supported by
commenters could lead to results that
would appear contrary to Congressional
intent by opening the statute to easy
evasion. Under such an interpretation, it
would be feasible for many sponsors to
evade risk retention by hiring a thirdparty manager to ‘‘select’’ assets for
purchase by the issuing entity that have
been pre-approved by the sponsor. This
could result in a situation in which no
party to a securitization can be found to
be a ‘‘securitizer’’ because the party that
organizes the transaction and has the
most influence over the quality of the
securitized assets could avoid legally
owning or possessing the assets.169
Interpreting the term ‘‘securitizer’’ to
produce such an easily evaded rule
would be an unreasonable result that
cannot comport with the intent of
Congress in enacting section 15G of the
Exchange Act.
With respect to the issuance of assetbacked securities, there is always a
sponsor responsible for the organization
and initiation of the issuance of assetbacked securities.170 The issuing entity
for a CLO transaction is a special
purpose vehicle formed by some other
party solely for the express purpose of
issuing asset-backed securities.
However, some person or other entity—
namely, the sponsor—‘‘organized and
initiated’’ this special purpose vehicle
with the intent that this special purpose
vehicle would issue asset-backed
securities. The agencies do not believe
that the special purpose vehicle formed
to issue asset-backed securities in a CLO
transaction does so independent of the
actions of a sponsor. The agencies also
note that the commenters did not
identify another party to an open market
CLO transaction other than the CLO
manager that should be considered the
sponsor.
As indicated in the legislative history
of the Dodd-Frank Act, the broad
purpose of the statute was to ‘‘create
incentives that will prevent a recurrence
of the excesses and abuses that preceded
the crisis, restore investor confidence in
169 As discussed, Congress clearly expected this
rule to apply to sponsors of CDOs, but the
commenters’ claims, if credited, would also exclude
sponsors of CDOs from the requirements of risk
retention.
170 Similar to the agencies interpretation of
‘‘securitizer’’ to include CLO managers, the
definitions of ‘‘issuer’’ in both the Securities
Exchange Act of 1934 and Securities Act of 1933
include, with respect to certain kinds of vehicles,
‘‘the person or persons performing the acts and
assuming the duties of depositor or manager
pursuant to the provisions of the trust or other
agreement or instrument under which the securities
are issued.’’

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asset-backed finance, and permit
securitization markets to resume their
important role as sources of credit for
households and businesses.’’ 171 In
drafting section 941, Congress
recognized that it would be impractical
for many investors to adequately assess
and monitor the risks of assets
underlying complex securitization
products.172 As a result, Congress
sought to encourage monitoring and
assessment of such assets by the parties
better suited to do so, namely those who
organize and initiate the
securitizations.173 Like other
securitization sponsors, a CLO manager
is the party best positioned to
adequately monitor and assess the risk
of the securitized assets. For the reasons
discussed above, the agencies continue
to find that a CLO manager is a
‘‘securitizer’’ under section 15G of the
Exchange Act.174
ii. Exemption Requests and Alternative
Proposals
Many commenters suggested that the
risk retention rules should not be
applied to open market CLOs because,
as described above, they believe the
structural and other characteristics of
open market CLOs make risk retention
unnecessary. Among the primary
characteristics highlighted to justify an
exemption, commenters asserted that
CLO managers’ subordinated
compensation structure aligns their
interests with those of investors, CLOs
differ from the originate-to-distribute
model, and the underwriting of CLOs’
assets is subject to multiple levels of
scrutiny. As an alternative to an
exemption based solely on such
characteristics, several commenters
supported exemptions for open market
CLOs meeting certain qualifications.
One commenter proposed an exemption
from risk retention for open market
CLOs that met the following conditions:
(i) The asset manager must be a
registered investment adviser under the
Investment Advisers Act of 1940;175 (ii)
171 S.

Rep. No. 111–176, at 128.

172 Id.
173 Id. at 129 (‘‘When securitizers retain . . . risk,
they have ‘skin in the game,’ aligning their
economic interests with those of investors. . . .
Securitizers who retain risk have a strong incentive
to monitor the quality of the assets they purchase
from originators, package into securities, and sell.
. . . Originators . . . will come under increasing
market discipline because securitizers who retain
risk will be unwilling to purchase poor-quality
assets.’’).
174 Furthermore, the agencies believe that this
applies to other issuances of asset-backed securities
in which the securitized assets are selected by a
manager and no other transaction party meets the
definition of ‘‘sponsor.’’ See Parts III.B.4 and III.B.8
of this Supplementary Information.
175 15 U.S.C. 80b–3(b).

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all U.S. investors must be qualified
purchasers or knowledgeable
employees, consistent with reliance on
the section 3(c)(7) exemption from
investment company status under the
Investment Company Act; 176 (iii) the
pool of assets are permitted and
expected to be traded by the asset
manager on behalf of the issuer in
accordance with contractually agreed
restrictions; (iv) the asset management
agreement establishes a standard of care
that requires the asset manager to
employ a degree of skill and care no less
than it uses for its own investments and
consistent with industry standards for
asset managers that are acting on behalf
of comparable clients; and (v) the
investment adviser effects agency cross
trades on behalf of its advisory client
only in accordance with section
275.206(3)–2 of the Commission’s rules
under the Investment Advisers Act.177
The agencies also received several
comments in continued support of an
option that was suggested with respect
to the original proposal that the agencies
did not include in the revised proposal.
This suggestion would allow an open
market CLO manager to satisfy its risk
retention requirement by holding a
combination of notes issued by the CLO,
modeled to reflect the risks assumed by
CLO managers through their
subordinated compensation structure,
and equity securities issued by the CLO
and purchased by the CLO manager.
Several commenters supported an
option that would expand the above
proposal by allowing managers of
‘‘Qualified CLOs’’ to satisfy the risk
retention requirement by purchasing 5
percent of the CLO’s equity and
maintaining a subordinated
compensation structure. Commenters
proposed that, in order to be deemed a
Qualified CLO, the CLO’s governing
transaction documents would have to
include specific requirements in the
following areas: Asset quality; portfolio
composition; structural features;
alignment of the interests of the CLO
manager and investors in the CLO’s
securities; regulatory oversight; and
transparency and disclosure.
Commenters suggested requirements
under each of these categories that they
asserted would ensure high quality
underwriting and investor protection.
They also suggested that this proposal
should be adopted along with the thirdparty option and pro rata risk retention
reduction proposals described below, as
they do not feel that the option alone
would sufficiently address the projected
176 15
177 17

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effects that the rule will have on open
market CLOs.
Several commenters suggested that
the agencies could adopt the
commenters’ exemption proposals
under the agencies’ exemptive authority
provided by section 15G(e).178
Alternatively, commenters supporting
the Qualified CLO proposal suggested
the proposal could be adopted as a
construction of the statutory
requirement that a securitizer retain not
less than 5 percent of the ‘‘credit risk’’
of any asset. In this regard, the
commenters asserted that by acquiring 5
percent of the equity interest in the
CLO, and by bearing the subordinated
risk of non-payment embedded in the
compensation structure demanded by
investors, the CLO manager would be
retaining far more than 5 percent of the
credit risk associated with the CLO’s
assets. As support for this suggestion,
the commenters cited research
concluding that the majority of likely
losses for a typical CLO are borne by the
bottom 20 percent of the CLO capital
structure.
The agencies do not believe that it
would be appropriate to exempt open
market CLOs from the risk retention
requirement under section 15G(e). The
statute permits the agencies to adopt or
issue exemptions, if the exemption
would: (A) help ensure high quality
underwriting standards for the
securitizers and originators of assets that
are securitized or available for
securitization; and (B) encourage
appropriate risk management practices
by the securitizers and originators of
assets, improve the access of consumers
and businesses to credit on reasonable
terms, or otherwise be in the public
interest and for the protection of
investors.179 While the agencies
recognize that certain structural features
of CLOs contribute to aligning the
interests of CLO managers with
investors, the agencies do not believe
these structural features would support
a finding that the exemption would help
ensure high quality underwriting
standards and there are reasons why
such an exemption may run counter to
the public interest and protection of
investors.180
As discussed above, many of the
structural features that commenters
cited as mitigating risk factors for CLOs
were shared by other types of CDOs,
such as CDOs of asset-backed securities,
178 One commenter suggested that the Qualified
CLO proposal could also be exempted based on the
agencies’ authority under section 15G(c)(1)(G)(i).
179 15 U.S.C. 78o–11(e)(2).
180 For similar reasons, the agencies do not
believe an exemption would be appropriate under
section 15G(c)(1)(G)(i).

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that performed poorly during the
financial crisis. Although the structural
features can offer protection to investors
in senior tranches, such protections are
exhausted when a portfolio’s default
rate significantly exceeds anticipated
losses, as was the case for CDOs of assetbacked securities during the financial
crisis. In such a situation, the manager
may be incented to engage in even more
risky behavior to maintain cash flow
and ensure the payment of its
subordinated compensation. Although
CLOs performed better than other CDOs
during the financial crisis, the better
performance of leveraged loans after the
financial crisis in CLO portfolios could
be partially attributed to lowered
interest rates and other government
interventions. Some commenters
claimed that CLOs are composed of
higher quality assets that undergo
significant underwriting scrutiny and
that include investor protection
features, but the significant recent credit
deterioration in the leveraged loan
market, as described above,
demonstrates increasing risks in the
types of assets held by CLOs. The
agencies also note that while the final
rule does not include an exemption for
open market CLOs, the removal of the
proposed restriction on cash flow
distributions to the eligible horizontal
residual interest, as described in Part
B.1 of this Supplementary Information,
will provide greater flexibility for CLO
managers to satisfy the standard risk
retention option, which may reduce the
cost of the standard risk retention
option.
The agencies recognize that
management fees incorporate credit risk
sensitivity and may contribute to some
degree to aligning the interests of the
CLO manager and investors with respect
to the quality of the securitized loans.
On the other hand, as discussed above,
this subordinated compensation
structure could also lead to a
misalignment of interests between the
CLO manager and investors in certain
circumstances. Moreover, as discussed
in the reproposal, these fees do not
appear to provide an adequate substitute
for risk retention because they typically
have small expected value, especially
given that CLOs securitize leveraged
loans, which carry higher risk than
many other securitized assets. Even
combining the expected value of the
manager’s compensation with a 5
percent interest in the equity of the CLO
would be inadequate because, as
described by a commenter, such an
equity interest would also likely amount
to under one percent of the fair value of
the ABS interests issued to third parties

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(which is less than the 5 percent
required for an eligible horizontal
residual interest). Further, management
fees are not funded in cash at closing
and therefore may not be available to
absorb losses as expected. Generally, the
agencies have declined to recognize
such unfunded forms of risk retention
and the agencies are not persuaded that
an exception should be made for open
market CLOs.
Some commenters supported an
alternative approach that would reduce
the risk retention requirement for open
market CLOs, on a pro rata basis, to the
extent that the commercial loans
backing the issued CLO securities met
certain underwriting criteria. In order to
qualify for reduced risk retention, the
commercial loans would have to be
senior secured first lien loans that either
(i) have a ratio of first lien debt to total
capitalization of less than or equal to 50
percent; or (ii) have a total leverage ratio
of less than or equal to 4.5 times.181
Further, this approach would reduce the
risk retention requirement to the extent
that the CLO holds a subset of loans
requiring certain specialized treatment.
This approach would require
determination of whether a loan
qualifies for reduced risk retention
treatment to be made at the time of
origination. Further, this approach
provided that loans originated before
the applicable effective date of the rule
should not require risk retention when
securitized after such date.
The agencies are not persuaded that
the risk retention requirement should be
reduced to the extent commercial loans
backing the issued CLO securities meet
the criteria proposed by the
commenters. As discussed in Part V.A
of this Supplementary Information, the
final rule already provides exemptions
from the risk retention requirement for
qualifying commercial loans that meet
specific underwriting standards. The
agencies developed these standards to
be reflective of very high quality loans.
The commenters’ approach relies on
significantly weaker standards, and the
agencies do not believe that these
criteria, which would permit
securitization with no risk retention for
loans to borrowers who are of lower
credit quality or that do not have a
third-party evaluation of the likelihood
of timely payment of interest and
repayment of principal, would satisfy
the statutory requirements for an
exception to help ensure high quality
underwriting standards.
181 In this context, leverage ratio refers to the
borrower’s total debt divided by earnings before
interest, taxes, depreciation and amortization
(EBITDA).

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The agencies also disagree with the
proposition that, in the context of CLOs,
loans originated before the applicable
effective date of the rule should not be
subject to risk retention. Section 15G of
the Exchange Act applies to any
issuance of asset-backed securities after
the applicable effective date of the rule,
regardless of the date the assets in the
securitization were originated. The
agencies note, however, that
securitizations of loans meeting the
seasoned loan exemption in section
19(b)(7) of the rule would not be subject
to risk retention requirements.
The agencies also received a number
of comments in support of approaches
to allow a third party, rather than the
CLO manager, to retain some or all of
the required credit risk in certain
circumstances. To be eligible under
these approaches, the third party would
be required to have a role in setting the
selection criteria for the assets held by
a CLO and the power to veto any change
to asset selection criteria. Specifically,
the commenters’ proposal would
require: (i) Prior to the CLO’s
acquisition of the initial CLO assets, the
third party to review and assent to key
transaction portfolio terms, including
the asset eligibility criteria,
concentration limits, collateral quality
tests, and reinvestment criteria of the
CLO’s asset pool; and (ii) any material
change to the above parameters to
receive prior written consent by the
third party retaining the CLO credit risk.
Further, to enable the third party
retaining credit risk to evaluate, before
the CLO closes, whether the CLO
manager is able to meet the asset
selection criteria, the commenters
proposed that at least 50 percent of the
initial asset pool would have to be
acquired (or be under a commitment to
be acquired) by the closing date. One of
the approaches would also require that
the CLO manager be a registered
investment adviser and would permit
multiple parties to jointly satisfy the
CLO’s risk retention requirement.
Another commenter proposed a
different third-party retention option,
under which a sponsor’s risk retention
requirement would be satisfied if one or
more third parties agreed to hold the
required minimum risk retention. The
commenter’s suggested option would
only apply to CLOs that are
securitizations of corporate debt and
servicing assets; inclusion of other ABS
interests would be prohibited. The third
party or a party appointed by the third
party would be required to perform an
independent review of the credit risk of
each securitized asset. Further, the
proposal would require the CLO
manager to provide information to

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investors about the investment
experience of each third-party
purchaser.
While the agencies considered the
third-party retention proposals
carefully, they have concluded that the
proposals would not provide an
appropriate method of risk retention.
The proposed third-party retention
options would result in retention of the
credit risk by a third party that would
have less control over the CLO portfolio
than the CLO manager. These
alternatives would result in weaker
means of influencing the underwriting
quality in CLO portfolios and are
therefore inadequate substitutes for risk
retention.
While, as discussed in Part III.B.5 of
this Supplementary Information, the
final rule allows third-party purchasers
to retain credit risk in CMBS
transactions, CLO and CMBS
transactions vary in several significant
ways that make such an option more
challenging in the CLO context. For
example, differences between CMBS
and CLO transactions would make it
more challenging for third-party
investors to perform thorough
independent reviews of loans in CLO
portfolios, including the dynamic nature
of CLO portfolios and the larger number
of loans in typical CLO portfolios. In
CMBS transactions, the loan pool is
chosen and is static before issuance,
which permits loan-level due diligence
by the third-party investor. In CLOs, the
loan pool is typically not complete
before issuance, and the pool is
dynamic, limiting the ability of a thirdparty investor to conduct loan-level due
diligence before issuance. Under
proposals submitted by commenters, the
third-party purchaser would be limited
to evaluating investment criteria for the
CLO and would not conduct loan-level
due diligence. In this regard, the thirdparty purchaser would not be
conducting loan-level re-underwriting,
and consequently is not a reasonable
substitute for the original effort of the
sponsor in underwriting the loan pool.
Furthermore, the third-party retention
proposals would provide the third-party
purchaser with minimal power or
influence over the composition or
quality of the CLO’s collateral pool after
closing. In contrast to CMBS
transactions that generally give the
third-party purchaser the right to reject
loans from the pool, no similar authority
would be granted to CLO third-party
purchasers under commenters’
proposals.
Given the weakening of underwriting
and increase in risk in the leveraged
loan market, the agencies do not believe
that existing market practice is

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77657

sufficiently robust to substitute for risk
retention. Furthermore, the agencies do
not believe the alternative approaches
suggested by commenters would
significantly add protection to investors,
as investors in CLOs would presumably
already have the opportunity to review
and assent to key portfolio transaction
terms.182 For these reasons, the agencies
have decided against adopting the thirdparty risk retention option. While the
agencies considered whether further
parameters around a third-party risk
retention option for CLO sponsors
would be appropriate, the agencies were
not able to identify parameters that
would function well for CLOs or that
would further the regulatory purposes of
the risk retention rules.
The agencies have also carefully
considered commenters’ views about
the impact the proposed rules would
have on CLO issuance and the
commercial loan markets in general. As
discussed in the reproposal, the
agencies acknowledge that requiring
open market CLO managers to satisfy
the risk retention requirement could
result in fewer CLO issuances and less
competition in this market. However,
the agencies note that other entities,
such as hedge funds and loan mutual
funds, also purchase commercial loans
and believe that the market will adjust
to the rule and that lending to
creditworthy commercial borrowers, on
appropriate terms, will continue at a
healthy rate. The agencies also note that
commenters’ concerns about the impact
of European risk retention requirements
on European CLO issuance may be
misplaced, as economic conditions have
constrained the available supply of
potential collateral for European CLOs.
Furthermore, the agencies believe
projected impacts on the CLO market
are justified by the benefits that will be
produced by subjecting open market
CLOs to the risk retention rules. As
discussed, the agencies have significant
concerns about recent activity in the
leveraged loan market. The search for
yield in the low interest rate
environment has led investors to take on
more risk in this market by investing in
lower quality commercial loans that
contain fewer lender protections.183 The
agencies believe that valuations on
lower-rated corporate bonds and
182 The risk retention approaches for CLOs
suggested by commenters also reflect standard
market practices for certain other types of CDOs
(e.g., CDOs of asset-backed securities) that
performed poorly during the financial crisis in
which key investors negotiated asset selection
criteria and reinvestment criteria and changes to
those criteria required investor consent.
183 See, e.g., Monetary Policy Report, at 1–2, 22;
Semiannual Risk Perspective: Spring 2014, at 5.

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leveraged loans are stretched and
excesses in these markets could lead to
higher levels of future defaults and
losses.184 The origination and
securitization of such poorly
underwritten loans could generate
systemic financial risks.185
Increased appetite from investors for
higher yielding and higher risk assets in
the leveraged loan market creates an
environment susceptible to some of the
abuses and excesses that occurred in the
residential and commercial mortgage
markets that contributed to the financial
crisis. In particular, the agencies are
concerned that this environment could
create incentives to originate an
increased volume of loans, without
regard for quality or underwriting
standards, for the purpose of
distribution through securitization. The
agencies therefore have concluded that
requiring open market CLO managers or
lead arrangers to retain economic
exposure in the securitized assets will
help ensure the quality of assets
purchased by CLOs, promote discipline
in the underwriting standards for such
loans, and reduce the risk that such
loans pose to financial stability.
For the reasons discussed above, the
final rule requires open market CLO
managers to satisfy the minimum risk
retention requirement for each CLO
securitization transaction that it
manages by holding a sufficient amount
of standard risk retention or meet the
requirements of the alternative lead
arranger option. After considering all
comments, the agencies are adopting,
largely as proposed, the lead arranger
option for open market CLOs, under
which an open market CLO could
satisfy the risk retention requirement if
the firm serving as lead arranger for
each loan purchased by the CLO retains
at the origination of the syndicated loan
at least 5 percent of the face amount of
the term loan tranche purchased by the
CLO. The lead arranger is required to
retain this portion of the loan tranche
until the repayment, maturity,
involuntary and unscheduled
acceleration, payment default, or
bankruptcy default of the loan. This
requirement applies regardless of
whether the loan tranche was purchased
on the primary or secondary market, or

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184 See,

e.g., Monetary Policy Report, at 1–2.
e.g., Leveraged Lending Guidance at
17771 (‘‘[A] poorly underwritten leveraged loan that
is pooled with other loans or is participated with
other institutions may generate risk for the financial
system.’’); Shared National Credits Program: 2013
Review at 8 (‘‘Poorly underwritten or low quality
leveraged loans, including those that are pooled
with other loans or participated with other
institutions, may generate risks for the financial
system.’’).
185 See,

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was held at any particular time by an
open market CLO issuing entity.
Under the final rule’s lead arranger
option, the sponsor is required to
disclose a complete list of every asset
held by an open market CLO (or before
the CLO’s closing, in a warehouse
facility in anticipation of transfer into
the CLO at closing). This list requires
the following information (i) the full
legal name, Standard Industrial
Classification category code and legal
entity identifier (LEI) issued by a utility
endorsed or otherwise governed by the
Global LEI Regulatory Oversight
Committee or the Global LEI Foundation
(if an LEI has been obtained by the
obligor) of the obligor of the loan or
asset; (ii) the full name of the specific
CLO-eligible loan tranche held by the
CLO; (iii) the face amount of the CLOeligible loan tranche held by the CLO;
(iv) the price at which the CLO-eligible
loan tranche was acquired by the CLO;
and (v) for each loan tranche, the full
legal name of the lead arranger subject
to the sales and hedging restrictions.
Also, the final rule requires the sponsor
to disclose the full legal name and form
of organization of the CLO manager. The
sponsor is required to provide these
disclosures a reasonable period of time
prior to the sale of the asset-backed
securities in the securitization
transaction (and at least annually with
respect to information regarding the
assets held by the CLO) and, upon
request, to the Commission and the
sponsor’s appropriate Federal banking
agency, if any. Further, the CLO
manager is required to certify or
represent as to the adequacy of the
collateral and certain attributes of the
borrowers of the senior, secured
syndicated loans acquired by the CLO
and certain other matters.
The agencies have added to the
disclosure requirement the disclosure of
an obligor’s LEI issued by a utility
endorsed or otherwise governed by the
Global LEI Regulatory Oversight
Committee or the Global LEI
Foundation, if an LEI has been obtained
by the obligor. The agencies believe that
the LEI requirement allows investors in
open-market CLOs to better track the
performance of assets originated by
specific originators. The effort to
standardize a universal LEI has
progressed significantly over the last
few years.186 As LEI use becomes more
186 The Commission has prescribed the disclosure
of LEI in other rulemakings. See, e. g., Nationally
Recognized Statistical Rating Organizations; Final
Rule, 79 FR 55078 (Sept. 15, 2014) and Reporting
by Investment Advisers to Private Funds and
Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF; Final Rule, 76 FR
71128 (Nov. 16, 2011).

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mandated and widespread pursuant to
other rules, the agencies anticipate that
LEI disclosure by obligors under the
lead arranger option will become the
standard.
In response to commenter concerns,
the agencies have removed from the
lead arranger option for open market
CLOs the requirement that lead
arrangers and CLO managers certify as
to the adequacy of the collateral and the
attributes of the borrowers of the senior,
secured syndicated loans that they
purchase and certain other matters and
make certain covenants. Instead, a lead
arranger will be required to certify that
it has evaluated the effectiveness of its
internal supervisory controls with
respect to the process for ensuring that
loans included in a CLO-eligible tranche
meet all of the requirements set forth in
section 9 of the rule applicable to CLOeligible loan tranches and has
concluded that its internal supervisory
controls are effective. CLO managers
will be required to certify that they have
policies and procedures to evaluate the
likelihood of repayment and that they
have followed such policies and
procedures when determining the
adequacy of the collateral and attributes
of the borrowers of the loans that they
purchase. These certifications are
similar to those required of depositors
with respect to QRMs and other
qualifying asset classes. The agencies
believe these modifications will reduce
concerns about risks and challenges that
commenters asserted would be faced in
connection with the requirement that
there be representations that the loans
meet the rule’s criteria. The agencies
also note that the reference to
‘‘ensuring’’ that loans are CLO-eligible
loans should be interpreted in a manner
similar to such reference in this
Supplementary Information with
respect to QRMs and other qualifying
asset classes.
As the agencies noted in the
reproposal, the lead arranger option for
open market CLOs is intended to
allocate risk retention to the parties that
originate the underlying loans and that
likely exert the greatest influence on
how the loans are underwritten, which
is an integral component of ensuring the
quality of assets that are securitized.
Subject to considering certain factors,
section 15G permits the agencies to
allow an originator (rather than a
sponsor) to retain the required amount
of credit risk and to reduce the amount
of credit risk required of the sponsor by
the amount retained by the
originator.187 In developing the
187 15 U.S.C. 78o–11(c)(G)(iv), (d) (permitting the
Commission and Federal banking agencies to allow

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proposed lead arranger option, the
agencies considered the factors set forth
in section 15G(d)(2) and concluded that
it is consistent with the purposes of the
statute to allow lead arrangers of open
market CLOs to satisfy the risk retention
requirement.188
The agencies considered the
commenters’ views that the option will
not be widely adopted by lead arranger
banks, but the agencies believe the
option provides additional flexibility for
lead arranger banks and non-banks and
therefore may reduce disruption to the
market. The agencies also believe that
this option for open market CLOs will
meaningfully align the incentives of the
party most involved with the credit
quality of these loans—the lead
arranger—with the interests of investors.
Commenters raised concerns that banks
would likely not want to retain risk
without being allowed to hedge or
transfer that risk due to concern about
criticism from regulators. However, the
agencies note that these concerns were
not raised for balance sheet CLOs where
banks would be required similarly to
retain a portion of the loans’ risk
without selling or transferring that
retained risk. In addition, to the extent
the comments referred to supervisory
standards, the Federal banking agencies
note that supervisors take into account
many considerations when reviewing
loan portfolios, including applicable
regulations and guidance regarding
underwriting and risk management.
Alternatively, incentives would be
placed on the CLO manager to monitor
the credit quality of loans it securitizes,
if it retains risk under the standard risk
retention option.
For the reasons discussed above, open
market CLO managers clearly fall within
the statutory definition of ‘‘securitizer’’
in Section 15G and therefore are subject
to the risk retention requirement. The
agencies also believe that subjecting
open market CLOs and their managers
to the risk retention requirement is
within their authority and consistent
with the purposes of section 15G. The
agencies believe the final rule places
risk retention responsibility on the
parties most capable of ensuring and
monitoring the credit quality of the
the allocation of risk retention from a sponsor to an
originator).
188 15 U.S.C. 78o–11(d)(2). These factors are
whether the assets sold to the securitizer have
terms, conditions, and characteristics that reflect
low credit risk; whether the form or volume of
transactions in securitization markets creates
incentives for imprudent origination of the type of
loan or asset to be sold to the securitizer; and the
potential impact of risk retention obligations on the
access of consumers and business to credit on
reasonable terms, which may not include the
transfer of credit risk to a third party.

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assets collateralizing open market
CLOs—the CLO manager or the lead
arranger. Further, the agencies believe
these two options provide sufficient
flexibility to avoid significant
disruptions to the CLO and credit
markets.
8. Municipal Bond ‘‘Repackaging’’
Securitizations
a. Overview of the Reproposal and
Public Comments
Several commenters on the original
proposal requested that the agencies
exempt municipal bond repackaging
securitizations from risk retention
requirements, the most common form of
which are often referred to as ‘‘tender
option bonds.’’ 189 In order to reflect and
incorporate the risk retention
mechanisms currently implemented by
the market, the reproposal included two
additional risk retention options for
certain municipal bond repackagings.
The proposed rule closely tracked
certain requirements for these
repackagings, outlined in IRS Revenue
Procedure 2003–84, that are relevant to
risk retention.190 Specifically, in the
revised proposal, the agencies proposed
additional risk retention options for
municipal bond repackagings issued by
a ‘‘qualified tender option bond entity,’’
which would be defined as an issuing
entity of tender option bonds in which:
• Only two classes of securities are
issued: a tender option bond and a
residual interest;
• The tender option bond qualifies for
purchase by money market funds under
Rule 2a–7 under the Investment
Company Act of 1940; 191
• The holder of a tender option bond
has the right to tender such bonds to the
189 As described by one commenter, a typical
tender option bond transaction consists of the
deposit of a single issue of highly rated, long-term
municipal bonds in a trust and the issuance by the
trust of two classes of securities: floating rate,
puttable securities (the ‘‘floaters’’), and an inverse
floating rate security (the ‘‘residual’’). The holders
of floaters have the right, generally on a daily or
weekly basis, to put the floaters for purchase at par,
which put right is supported by a liquidity facility
delivered by a highly rated provider and causes the
floaters to be a short-term security. The floaters are
in large part purchased and held by money market
mutual funds. The residual is held by a longer term
investor (bank, insurance company, mutual fund,
hedge fund, etc.). The residual investor takes all of
the market and structural risk related to the tender
option bond structure, with the floaters investors
only taking limited, well-defined insolvency and
default risks associated with the underlying
municipal bonds, which risks are equivalent to
those associated with investing in such municipal
bonds directly.
190 Revenue Procedure 2003–84, 2003–48 I.R.B.
1159.
191 This requirement is in section 10 of the final
rule (definition of ‘‘tender option bond’’).

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77659

issuing entity for purchase at any time
upon no more than 30 days’ notice; 192
• The collateral consists solely of
municipal securities as defined in
section 3(a)(29) of the Securities
Exchange Act of 1934 and servicing
assets, and all the municipal securities
have the same municipal issuer and the
same underlying obligor or source of
payment;
• Each of the tender option bond, the
residual interest and the underlying
municipal security are issued in
compliance with the Internal Revenue
Code of 1986, as amended (the ‘‘IRS
Code’’), such that the interest payments
made on those securities are excludable
from the gross income of the owners;
• The issuing entity has a legally
binding commitment from a regulated
liquidity provider to provide 100
percent guarantee or liquidity coverage
with respect to all of the issuing entity’s
outstanding tender option bonds; 193
and
• The issuing entity qualifies for
monthly closing elections pursuant to
IRS Revenue Procedure 2003–84, as
amended or supplemented from time to
time.
Under the reproposal, the sponsor of
a qualified tender option bond entity
could satisfy its risk retention
requirements by retaining an interest
that, upon issuance, would meet the
requirements of an eligible horizontal
residual interest but that, upon the
occurrence of a ‘‘tender option
termination event’’ as defined in section
4.01(5) of IRS Revenue Procedure 2003–
84, as amended or supplemented from
time to time, would meet requirements
of an eligible vertical interest.194
192 This requirement is in section 10 of the final
rule (definition of ‘‘tender option bond’’).
193 The final rule defines a regulated liquidity
provider as a depository institution (as defined in
section 3 of the Federal Deposit Insurance Act (12
U.S.C. 1813)); a bank holding company (as defined
in 12 U.S.C. 1841) or a subsidiary thereof; a savings
and loan holding company (as defined in 12 U.S.C.
1467a) provided all or substantially all of the
holding company’s activities are permissible for a
financial holding company under 12 U.S.C. 1843(k)
or a subsidiary thereof; or a foreign bank (or a
subsidiary thereof) whose home country supervisor
(as defined in section 211.21 of the Board’s
Regulation K (12 CFR 211.21)) has adopted capital
standards consistent with the Capital Accord of the
Basel Committee on Banking Supervision, as
amended, provided the foreign bank is subject to
such standards.
194 Section 4.01(5) of IRS Revenue Procedure
2003–84 defines a tender option termination event
as: (1) a bankruptcy filing by or against a tax-exempt
bond issuer; (2) a downgrade in the credit-rating of
a tax-exempt bond and a downgrade in the credit
rating of any guarantor of the tax-exempt bond, if
applicable, below investment grade; (3) a payment
default on a tax-exempt bond; (4) a final judicial
determination or a final IRS administrative
determination of taxability of a tax-exempt bond for

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Under the reproposal, the sponsor of
a qualified tender option bond entity
could also satisfy its risk retention
requirements by holding municipal
securities from the same issuance of
municipal securities deposited in the
qualified tender option bond entity, the
face value of which retained municipal
securities would be equal to 5 percent
of the face value of the municipal
securities deposited in the qualified
tender option bond entity.
The proposed prohibitions on transfer
and hedging set forth in section 12 of
the reproposal applied to the holder of
a residual interest in, as well as any
municipal securities retained by the
sponsor of, a qualified tender option
bond entity, if those interests were held
in satisfaction of the sponsor’s risk
retention requirements under section 10
of the reproposal.
The reproposal also would have
allowed the sponsor of a qualified
tender option bond entity to satisfy its
risk retention requirements under
subpart B of the proposed rule using any
other risk retention option in the
reproposal, provided the sponsor meets
the requirements of that option.
The agencies received many
comments regarding the proposed
tender option bond options. Most of the
comments requested an exemption from
risk retention for tender option bonds
and, in the absence of an exemption,
recommended either technical
clarifications or adjustments to the
proposed options for tender option
bonds to cover a broader range of
transaction structures.
Several commenters recommended
that the final rule exclude issuance of
tender option bonds from the risk
retention requirements for a variety of
reasons, including:
• The originate-to-distribute model
that poses moral hazard risks in certain
securitization transactions is not present
in a tender option bond program;
• The tender option bond structure
does not create information gaps for
investors because tender option bond
programs do not involve pooling large
numbers of unrelated assets;
• The underlying bonds in a tender
option bond structure generally are from
one original issuance with the same
issuer and borrower/obligor;
• The fund that selects the municipal
bond to be deposited into a tender
option bond structure retains virtually
Federal default on the underlying municipal
securities and credit enhancement, where
applicable; (5) a credit rating downgrade below
investment grade; (6) the bankruptcy of the issuer
and, when applicable, the credit enhancer; or (7)
the determination that the municipal securities are
taxable.

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all of the risk related to such municipal
bonds, and the tender option bond
structure provides liquidity that is not
found with typical asset-backed security
products; and
• The industry generally does not
define tender option bonds as structured
finance products or asset-backed
securities.
Commenters urging exclusion of
tender option bonds from the risk
retention requirements also stated that
the current tender option bond market
provides municipal issuers with access
to a diverse investor base and a more
liquid market, and subjecting tender
option bonds to the risk retention
requirements would significantly
increase the costs of tender option bond
programs and adversely affect the state
and local governments that indirectly
receive funding through these programs.
They also commented that applying the
risk retention rules to these structures
would decrease the availability of taxexempt investments in the market for
money market funds, which are
continuing to face limited investment
options due to constraints imposed by
Rule 2a–7 under the Investment
Company Act.
A few commenters proposed that a
sponsor of tender option bonds could
satisfy its risk retention requirements if
the residual interest holder provides,
either directly or indirectly through an
affiliate (i) 100 percent liquidity
coverage on the floaters, (ii) a binding
reimbursement obligation to the
provider of the 100 percent liquidity
coverage, or (iii) 100 percent credit
enhancement on the underlying
municipal securities. A few commenters
took the position that any residual
interest in any tender option bond
structure should qualify as a risk
retention option under the rule if the
residual interest is held by an
unaffiliated entity that agrees to
subordinate its right to payment to the
floater holders and the liquidity
provider until the occurrence of a tender
option termination event.
One commenter recommended
broadening the exemption relating to
asset-backed securities issued or
guaranteed by a state or municipal
entity to include securities
collateralized by such exempt securities.
Several commenters proposed that only
municipal bond repackaging
transactions with initial closing dates
after the applicable effective date of the
rule be subject to the risk retention
requirements.
Other commenters advocated for a
broader tender option bond risk
retention option that would include
most or all currently existing tender

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option bond programs, including those
that issue tender option bonds with a
notice period for tender of up to 397
days, tender option bond programs that
hold assets other than tax-exempt
municipal securities and servicing
assets,195 tender option bond programs
that hold securities issued by more than
one issuer,196 and tender option bond
programs in which the required retained
interest is held by multiple beneficial
owners, so long as all such owners are
managed by a common regulated
entity.197
Several commenters suggested
technical clarifications, adjustments and
corrections, including: The definition of
qualified tender option bond entity
should clarify the requirements with
respect to the liquidity guarantee; 198 the
requirement that tender option bonds be
eligible securities under Rule 2a–7
under the Investment Company Act
should be removed because it is
unnecessary in the risk retention
context; the definition of tender option
bond should be revised so that the
purchase price is par or face value plus
accrued interest; the definition of
qualified tender option bond entity
should require that the tender right be
supported by a liquidity facility or
guarantee, except upon the occurrence
of specified tender option termination
events, and that such liquidity facility
or guarantee be enforceable against the
entity obligated to support or guarantee
the purchase of the bonds upon tender;
and the agencies should provide more
specific guidance on how the disclosure
195 One commenter explained that other
qualifying assets should include taxable municipal
securities, preferred stock of registered closed-end
investment companies that primarily invest in
municipal securities, tender option bonds or tender
option bond residual interests that are already
issued and outstanding, and custodial receipts
representing beneficial interests in any of the
foregoing. A second commenter’s alternative
proposal includes tender option bond programs that
hold taxable municipal securities and ‘‘securities
evidencing a beneficial ownership interest in
municipal securities.’’ A third commenter’s
alternative proposal included tender option bond
programs for which the ‘‘underlying collateral
consists solely of tax-exempt assets or beneficial
interests in such assets.’’
196 One commenter explained, in limited
instances, assets held by tender option bond trusts
consist of municipal securities from different issues
from the same issuer or of more than one issuer.
197 One commenter explained that this allocation
is common practice in large fund complexes, and
broadening this definition would not change the
alignment of interests of the trust holders. Another
commenter requested that the agencies allow
multiple investment companies to satisfy the
sponsor risk retention requirements.
198 One commenter explained that the liquidity
facility in a tender option bond program is typically
structured as a credit enhancement of the
underlying assets and not of the floaters themselves.

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requirements would apply to tender
option bonds.199
A few commenters expressed concern
that the option to retain the residual
interest only if it otherwise qualified as
an eligible horizontal residual interest
before, and an eligible vertical interest
after, the occurrence of a tender option
termination event was inconsistent with
the partnership tax analysis used to pass
through the tax-exempt interest on the
bonds because the residual interest in a
tender option bond structure is not
legally subordinated at any time.
However, another commenter stated that
a residual interest is substantially
equivalent to an eligible horizontal
residual interest prior to the occurrence
of a tender option termination event and
an eligible vertical interest after a tender
option termination event because (i)
prior to the occurrence of a tender
option termination event, the residual
holder bears all the market risk, and (ii)
after a tender option termination event,
any credit losses are shared pro rata
between the floaters and the residuals.
As part of a broader alternative
definition for a qualified tender option
bond entity, it was suggested that the
retained risk in a qualified municipal
repackaging entity should be either a
residual or legally subordinate ABS
interest equal to at least 5 percent of the
face value (or fair market value, if no
face value is available) of the assets of
the entity at closing.
A group of commenters suggested
that, if the agencies do not provide a full
exemption for tender option bonds, the
rule should state that retaining a
residual interest in a qualified tender
option bond entity equal to 5 percent of
the fair value (determined as of the date
of deposit) of the deposited assets
should satisfy the risk retention
requirements, without regard to the
requirements applicable to eligible
horizontal residual interest or eligible
vertical interest requirements.
Other commenters recommended that
the agencies permit the sponsor or the
residual holder to purchase and retain a
residual interest with an upfront cash
investment value equal to 5 percent of
the initial market value of the municipal
securities in the tender option bond
program. In addition, commenters asked
199 One commenter asked that the agencies clarify
that the disclosure requirements applicable to the
sponsor of a qualified municipal repackaging entity
be limited to: (i) the name and form of organization
of the qualified municipal repackaging entity, (ii) a
description of the form and material terms of the
retained interest, (iii) whether the qualified
municipal residual interest is held by the sponsor
or a qualified residual holder, and (iv) a description
of the face value or fair value of the qualified
municipal residual interest or the municipal
securities that are separately retained.

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that the rule allow a sponsor to
aggregate the amount of a tender option
bond residual interest it holds, with the
municipal securities it directly holds, as
of the date of deposit, in determining its
risk retention requirement.
It was also suggested that the value of
the collateral posted by a residual
holder for a liquidity facility should be
recognized, and that the residual
holder’s interest should be calculated as
the sum of (a) the face amount of the
residual certificate and (b) the market
value of the collateral posted by the
residual to secure the liquidity facility.
In terms of valuing the residual
interest, one commenter suggested that
the 5 percent market value retention
amount be calculated at the time of the
purchase of the municipal bond or the
issuance of securities, to better conform
to common industry practice and the
realities of the tender option bond
program, if the agencies decide not to
exempt tender option bonds. This
commenter explained that it would be
impractical and costly to constantly
monitor any fluctuation in the market
value of the municipal bonds, and that
no adjustments should have to be made
if, during the life of the tender option
bond trust, the market value of those
bonds fluctuates above or below the
market value that is initially calculated.
Several commenters requested that
the agencies permit a party other than
the sponsor of the issuing entity with
respect to tender option bonds to be the
risk retainer. Commenters stated that
such a party may include a third-party
investor that selects the underlying asset
for the transaction and obtains the
primary financing benefit of the
structure, the funds or other investors
that purchase residuals in the tender
option bond trust to satisfy the
sponsor’s risk retention obligations as
third-party purchasers, and a third-party
investor with respect to tender option
bond programs that are made available
by sponsors and used by such thirdparty investors.
A few commenters requested that the
final rule confirm that the ‘‘sponsor’’ is
the bank that creates the tender option
bond program. Commenters explained
that the residual holders do not perform
any of the traditional functions of a
sponsor. One commenter claimed that
deeming the funds that purchase
residuals to be the ‘‘sponsors’’ for
purposes of risk retention would have
implications under other rules that use
the term ‘‘sponsor,’’ including Rule 2a–
7 under the Investment Company Act
and proposed Securities Act Rule 127B.
In connection with the prohibition on
hedging in the reproposal, which
prohibits hedges that are ‘‘materially

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related to the credit risk’’ of the tender
option bond residual interests and
securitized assets, a group of
commenters requested that the agencies
clarify the meaning of that restriction to
ensure that sponsors can manage the
risks associated with up to 95 percent of
the assets held by a tender option bond
program. It was also requested that the
agencies exclude from the hedging
prohibition: (i) risk reducing and other
transactions with regard to the
underlying municipal security that are
entered into by the sponsor prior to the
establishment of the municipal bond
repackaging structure, and (ii)
transactions between the sponsor or its
affiliates and an unrelated third party
where the purpose of such transaction is
to provide financing to such unrelated
third party for such municipal securities
on connection with a municipal bond
repackaging structure.
b. Final Rule
After considering carefully the
comments received on the reproposal as
well as the purpose and language of
section 15G of the Exchange Act, the
agencies have adopted in the final rule
the proposed tender option bond
options with some modifications. In
response to specific commenter
concerns, the final rule incorporates
certain technical clarifications and
adjustments.
The final rule does not provide an
exemption from risk retention
requirements for sponsors of issuing
entities with respect to tender option
bonds. The agencies continue to believe
that tender options bonds are assetbacked securities under the definition in
section 15G because they are securities
collateralized by self-liquidating
financial assets and the holders of the
securities receive payments that depend
primarily on cash flow from the
securitized assets.200 Therefore, the
sponsors of the issuing entities with
respect to tender option bonds are
subject to section 15G and the credit
risk retention rules.
Consistent with the treatment of
sponsors of other asset-backed
securities, the holder of risk retention in
connection with the issuance of tender
option bonds may divide the ABS
interests or tax-exempt municipal
securities required to be retained under
the final rule among its majority-owned
affiliates, but may not do so among
unrelated entities that are managed by
the sponsor or managed by an affiliate
of the sponsor. Accordingly, the sponsor
of a tender option bond issuance under
the rule may not sell the ABS interests
200 15

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required to be retained under the rule to
a fund it manages unless such fund is
a majority-owned affiliate of the
sponsor. Otherwise, the credit risk
associated with holding the ABS
interest will be transferred to the
investors in the fund that purchased
those ABS interests, which would
undermine the purpose and intent of the
statute.
The agencies believe that, with
respect to some issuances of assetbacked securities, it is possible that
more than one party could meet the
definition of sponsor in the rule.201
With respect to those issuances, it is the
responsibility of the transaction parties
to designate which party is the sponsor
and that party is then subject to the
requirements of the risk retention
rules.202 The agencies note that various
commenters requested that the agencies
designate the bank that arranges and
organizes the issuance of tender option
bonds or the party that owns the
residual interest as the sponsor.
Regarding such requests, the agencies
note that the party required to comply
with the risk retention rules with
respect to a tender option bond issuance
is the party or parties that meet the
definition of ‘‘sponsor’’ in the rule 203
and, depending on the specific facts and
circumstances of the issuance and how
the parties structure the transaction,
either the arranging bank or the residual
holder could be designated as the
sponsor in accordance with the final
rule.204
201 The designation of a party as a sponsor of an
issuance of asset-backed securities for purposes of
the final rule is not related to whether or not such
party is the sponsor for purposes of other rules and
regulations, including for example Rule 2a–7 under
the Investment Company Act (including the
discussion of sponsor in the Money Market Fund
Reform, 79 FR at 47876) or section 13G of the Bank
Holding Company Act (Volcker Rule). Whether or
not a party is the sponsor under a particular rule
or regulation is determined by reference to that rule
or regulation and the related legal authority.
202 While this concern was specifically raised by
commenters in the context of tender option bonds,
the agencies note that it is possible that any
issuance of asset-backed securities could have more
than one party that meets the definition of sponsor,
and the analysis in this section would apply
regardless of the securitization structure or
securitized assets.
203 As noted in the discussion of the definition of
‘‘securitizer’’ with respect to CLOs in Part III.B.7 of
this Supplementary Information, the agencies do
not believe that a sponsor is required to have had
legal ownership or possession of the assets that
collateralize an issuance of asset-backed securities.
204 Nothing in the final rule prohibits the use by
a sponsor of agents in order to meet the sponsor’s
obligations under the final rule, including the use
of third-party service providers, such as an
underwriter or remarketing agent to distribute
required disclosures to investors in a timely
manner. However, the sponsor remains liable for
compliance with its obligations under the final rule.

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The purpose of the tender option
bond risk retention options was to
address existing market practice for
traditional tender option bond issuances
that are specifically structured such that
the interest payments made on those
securities are excludable from the gross
income of the owners in the same way
that the interest on the underlying
municipal securities is excludable.
Certain commenters suggested that the
requirement that a residual interest in a
tender option bond structure meet the
requirements of an eligible horizontal
residual interest before, and an eligible
vertical interest after, the occurrence of
a tender option termination event was
inconsistent with the partnership tax
analysis required to be used to ensure
the pass-through treatment of the taxexempt interest on the tender option
bonds and tender option bond residuals.
The agencies acknowledge that some
asset-backed securities are not legally
structured as debt and, in order to
address this, the reproposal included
and the final rule adopts a definition of
‘‘collateral’’ which explicitly applies
‘‘irrespective of the legal structure of
issuance’’ and includes ‘‘fractional
undivided property interests in the
assets or other property of the issuing
entity, or any other property interest in
such assets or other property.’’ The
agencies believe that a residual interest
in a qualified tender option bond entity
would meet the requirements of an
eligible horizontal residual interest
before, and an eligible vertical interest
after, the occurrence of a tender option
termination event if: (i) prior to the
occurrence of a tender option
termination event, the residual holder
bears all the market risk associated with
the underlying tax-exempt municipal
security; and (ii) after the occurrence of
a tender option termination event, any
credit losses are shared pro rata between
the tender option bonds and the
residual interest.
The agencies do not agree with
comments suggesting that tender option
bond structures with an initial closing
date prior to the date on which rule
becomes effective should be exempt
from the rule or ‘‘grandfathered.’’
Consistent with the statute, the agencies
believe that the sponsor of issuances of
asset-backed securities after the
applicable effective date should be
subject to risk retention requirements
regardless of when the structure that
issues those securities was formed. A
tender option bond structure may issue
additional asset-backed securities on
multiple dates and may often substitute
collateral. These features, and the broad
exemptive relief requested by

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commenters, would allow for
potentially limitless issuances of assetbacked securities which would not be
subject to any risk retention
requirements. Requiring tender option
bond structures to meet the credit risk
retention requirements regardless of
their closing date is consistent with
treatment of other securitization
structures that exist prior to and
continue to issue ABS interests after the
applicable effective date of the rule,
such as ABCP conduits and revolving
pool securitizations.
The agencies have determined not to
revise the definition of qualified tender
option bond entity to expand the types
of assets such structures can hold.205
The tender option bond option in
section 10 of the final rule is narrowly
drawn to address risk retention
practices in existing market structures
and limit potential for abuse that could
result from a broad exemption based
entirely on structural features.
Accordingly, under the final rule,
sponsors of issuances of asset-backed
securities that are subject to risk
retention and that are collateralized by
assets other than tax-exempt municipal
securities 206 with the same municipal
issuer and the same underlying obligor
or source of payment will need to
comply with the requirements of one of
the other credit risk retention options.
As a result, the final rule does not
permit a qualified tender option bond
entity to hold a residual interest in
another tender option bond program or
preferred stock in a closed-end
investment company that invests in
municipal securities.
The agencies have adopted the
definition of tender option bond with
one change and a clarification. After
considering comments, the agencies are
permitting tender option bonds with a
notice period of up to 397 days to
qualify for the specialized option. The
agencies note that this time frame
corresponds to the maximum remaining
205 As proposed, the final rule requires that the
collateral for a qualified tender option bond entity
to consist only of servicing assets and tax exempt
municipal securities.
206 The agencies believe that a beneficial interest
in a tax-exempt municipal security may be held by
a qualified tender option bond entity, but only if
such beneficial interest is a pass-through and pro
rata interest in the underlying tax-exempt
municipal security. Therefore, a qualified tender
option bond entity will be permitted to hold an
asset-backed security collateralized by a tax-exempt
municipal security only if such asset-backed
security is a pass-through and pro rata interest in
the underlying tax-exempt municipal security and
the cash flows supporting such asset-backed
security are not tranched. A qualified tender option
bond entity will not be permitted to hold credit
default swaps referencing municipal obligations or
tranched asset-backed securities, such as tender
option bonds.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
maturity of securities allowed to be
purchased by money market funds
under Rule 2a–7 under the Investment
Company Act. Consistent with the
reproposal, the final rule requires that
the tender option bond have features
which entitle the holder to tender the
bond for a purchase price equal to the
approximate amortized cost of the
security, plus accrued interest, if any.
The agencies believe that, in the context
of a tender option bond, ‘‘amortized cost
plus accrued interest’’ typically equals
face value or par value plus accrued
interest.
In response to commenters’
suggestions for valuation methodologies
to determine the fair value of a residual
interest in a tender option bond
issuance, to the extent that a particular
valuation methodology is appropriate in
the fair value measurement framework
under GAAP to determine the fair value
of a residual interest in a tender option
bond issuance, then such valuation
methodology would be permitted under
the final rule to determine the fair value
of a retained residual interest in a tender
option bond issuance. After careful
consideration of commenters’
suggestions for alternative valuation
methodologies, the agencies do not
believe there is a compelling reason to
treat tender option bond residual
interests differently from any other
eligible horizontal residual interest, and
the final rule requires that the sponsor
of a tender option bond calculate the
fair value of the residual interest.
Consistent with the reproposal, the
final rule requires the amount of taxexempt municipal securities held by the
sponsor or a majority-owned affiliate of
the sponsor outside of the qualified
tender option bond entity to be
determined by reference to the face
value of the municipal securities
deposited in the qualified tender option
bond entity. For instance, if the face
value of the tax-exempt municipal
securities deposited into a qualified
tender option bond entity is $100
million, the sponsor or a majorityowned affiliate of the sponsor will be
required to hold tax-exempt municipal
securities, identical to those deposited
in the tender option bond entity with
respect to legal maturity and coupon,
with a face value of $5 million in order
to satisfy its requirements under the
final rule. The agencies continue to
believe that this approach is an accurate
and easily verifiable means of
calculating 5 percent risk retention
because the retained municipal
securities are identical to and fungible
with the deposited municipal securities.
This approach should help to minimize

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operational costs, administrative
burdens and additional costs.
Regarding commenters’ requests that
the agencies give a sponsor of a tender
option bond credit for cash held as
collateral for the liquidity agreement,
the final rule does not allow such cash
collateral credit to be credited toward
satisfaction of the risk retention
requirements unless the cash is held in
an account that meets the requirements
for an eligible horizontal cash reserve
account. This result is consistent with
the approach regarding cash reserves
connected to issuances of asset-backed
securities under other options in the
final rule.
Regarding commenters’ requests for
certain adjustments to, and clarification
of, the hedging prohibitions with
respect to the tender option bond risk
retention options and with respect to
tender option bond issuances generally,
the agencies believe there is no reason
to treat sponsors of tender option bond
structures any differently from sponsors
of other asset-backed securities
issuances. Therefore, subject to
provisions of the rule regarding
permitted hedges and the agencies’
interpretation of the hedging restrictions
discussed elsewhere in this preamble,
the agencies believe that a hedging
transaction entered into prior to the
establishment of the tender option bond
trust should be subject to the hedging
prohibition. Permitting such hedges
would allow the sponsor of a tender
option bond issuance to hedge its credit
risk exposure to the tender option bond
issuance simply by hedging its expected
exposure to the underlying assets prior
to the initial issuance of the tender
option bonds, effectively eliminating the
hedging prohibition. Similarly,
regarding commenters’ requests for an
exclusion for hedging transactions
entered into between the sponsor of a
tender option bond issuance or its
affiliates and an unrelated party where
the purpose of such transaction is to
provide financing to such third party for
the municipal securities to be deposited
into a tender option bond structure, the
agencies believe that the holder of
retained credit risk should not be
permitted to hedge its exposure to the
retained credit risk. This approach is
consistent with the treatment of all
other credit risk retention options in the
final rule. The agencies further believe
that consideration of the purpose and
intent of transactions that effectively
hedge or reduce the risks associated
with credit risk retention would
undermine the hedging prohibition and
the purpose and intent of section 15G.
Regarding commenters’ requests to
clarify the phrase ‘‘materially related to

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the credit risk’’ in the hedging
prohibition, the agencies expect the
sponsor of a tender option bond
issuance to make that determination
based on the relevant facts and
circumstances. To the extent that the
sponsor of a tender option bond
issuance holds ABS interests or tax
exempt municipal securities in excess of
the minimum requirement under the
final rule, then such sponsor would be
permitted to hedge such excess
interests, but must hold ABS interests or
tax exempt municipal securities
unhedged in an amount that satisfies the
minimum risk retention requirements
applicable to such retained risk.
The final rule does not include the
requirement that the tender option
bonds issued by a qualified tender
option entity be eligible assets under
Rule 2a-7 under the Investment
Company Act. The agencies were
persuaded by commenters that
analyzing compliance with such a
requirement would involve an
assessment of information that might
not be available to sponsors and was
unnecessary given the other conditions
to the sponsors’ ability to rely on the
risk retention options specific to tender
option bonds.
The agencies are adopting the
proposed disclosure requirements for
qualified tender option bonds with
some clarification and a minor addition.
Based on comments, the agencies have
added specific disclosure requirements
for sponsors that retain municipal
securities outside of the qualified tender
option bond entity that are limited to
the name and form of organization of
the qualified tender option bond entity,
the identity of the issuer of the
municipal securities, the face value of
the municipal securities deposited into
the qualified tender option bond entity,
and the face value of the municipal
securities retained by the sponsor or its
majority-owned affiliates and subject to
the hedging prohibition.
Also, in response to commenters’
requests for clarification of the
disclosure obligations of a sponsor of a
tender option bond issuance, the
agencies believe that the sponsor of a
tender option bond that holds a residual
interest that meets the requirements of
section 10(c) of the final rule should
provide the disclosures required in
section 4(c) of the final rule for both an
eligible horizontal residual interest and
an eligible vertical interest.
Under the final rule, the issuing entity
of a qualified tender option bond must
have a legally binding commitment from
a regulated liquidity provider to provide
100 percent liquidity coverage with
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outstanding tender option bonds.207 In
response to commenters’ requests for
certain clarifications with respect to the
required liquidity coverage, the agencies
recognize that the liquidity coverage
may not be enforceable against the
regulated liquidity provider upon the
occurrence of a tender option
termination event. Liquidity coverage
subject to this condition would
nevertheless satisfy the liquidity
coverage requirement in the final rule.
As commenters requested, the final
rule also permits the sponsor of a
qualified tender option bond entity to
combine the tender option bond risk
retention options with each other and
the other risk retention options under
subpart B of the final rule. In any such
case, the sum of the percentages of risk
retention held under each option and
measured in accordance with that
option must total at least five. For
example, if a sponsor securitizes $100
million face value of bonds in a
qualified tender option bond entity and
holds bonds outside the tender option
structure whose face value is $3 million
or 3 percent of the face value of the
bonds in the qualified tender option
bond entity, it must hold a residual
interest in the structure that has a fair
value of at least 2 percent of the fair
value of all ABS interests issued by the
structure (the 3 percent plus the 2
percent when aggregated equal 5
percent of the fair value). The final rule
does not require a minimum amount of
risk retention in any specific risk
retention option, only that the sum of
the percentages of risk retention totals at
least 5 percent of the fair value. The
agencies believe that permitting this
flexibility better enables sponsors of
tender option bonds to use the options
afforded under the final rule.
The final rule requires the sponsor to
calculate the fair value of all ABS
interests issued upon an issuance of
tender option bonds that increases the
face amount of tender option bonds then
outstanding. The agencies believe that
this approach appropriately balances
the costs of determining the fair value
of the tender option bond residual
interest with the statutory requirement
for risk retention. This means that a
sponsor of an issuance of tender option
bonds that would like to receive credit
under the final rule for retaining a
207 The final rule does not require any specific
form of liquidity coverage. Provided that the
liquidity coverage will cover an amount sufficient
to pay 100 percent of the principal outstanding and
interest payable on the tender option bonds, the
final rule permits liquidity coverage structured as
a guarantee, credit enhancement or credit support
with respect to the underlying securities or the
floaters or an irrevocable put option.

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residual interest in the qualifying tender
option bond entity would calculate the
fair value of the residual interest in the
qualifying tender option bond entity in
connection with the initial issuance of
tender option bonds in accordance with
section 10 of the final rule and would
not be required to recalculate the fair
value of such residual interest unless
either the face value of tender option
bonds outstanding exceeds the face
value of bonds initially issued.
C. Allocation to the Originator
1. Overview of Proposal and Public
Comment
As a general matter, the original
proposal and reproposal were structured
so that the sponsor of a securitization
transaction would be solely responsible
for complying with the risk retention
requirements established under section
15G of the Exchange Act and the
implementing regulations, consistent
with that statutory provision. However,
subject to a number of considerations,
section 15G authorizes the agencies to
allow a sponsor to allocate at least a
portion of the credit risk it is required
to retain to the originator(s) of
securitized assets.208 Accordingly,
subject to conditions and restrictions,
the reproposal (like the original
proposal) would have permitted a
sponsor to reduce its required risk
retention obligations in a securitization
transaction by the portion of risk
retention obligations assumed by one or
more of the originators of the securitized
assets.
When determining how to allocate the
risk retention requirements, the agencies
are directed to consider whether the
assets sold to the sponsor have terms,
conditions, and characteristics that
reflect low credit risk; whether the form
or volume of the transactions in
securitization markets creates incentives
for imprudent origination of the type of
loan or asset to be sold to the sponsor;
and the potential impact of the risk
retention obligations on the access of
consumers and businesses to credit on
reasonable terms, which may not
include the transfer of credit risk to a
third party.209
208 As discussed above, 15 U.S.C. 78o–11(a)(4)
defines the term ‘‘originator’’ as a person who,
through the extension of credit or otherwise, creates
a financial asset that collateralizes an asset-backed
security; and who sells an asset directly or
indirectly to a securitizer (i.e., a sponsor or
depositor).
209 15 U.S.C. 78o–11(d)(2). The agencies note that
section 15G(d) appears to contain an erroneous
cross-reference. Specifically, the reference at the
beginning of section 15G(d) to ‘‘paragraph
(c)(1)(E)(iv)’’ is read to mean ‘‘paragraph
(c)(1)(G)(iv)’’, as the former paragraph does not
pertain to allocation, while the latter is the

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In the reproposal, the agencies
proposed a framework that would have
permitted a sponsor of a securitization
to allocate a portion of its risk retention
obligation to an originator that
contributed a significant amount of
assets to the underlying asset pool. The
agencies endeavored to create
appropriate incentives for both the
securitization sponsor and the
originator(s) to maintain and monitor
appropriate underwriting standards
without creating undue complexity,
which potentially could mislead
investors and confound supervisory
efforts to monitor compliance.
Importantly, the reproposal would not
have required allocation to an
originator. Therefore, it did not raise the
types of concerns about allocation of
burden and credit availability that might
arise if certain originators, such as
mortgage brokers or small community
banks (that may experience difficulty
obtaining funding to retain risk
positions), were required to fulfill a
sponsor’s risk retention requirement.
The allocation to originator option in
the reproposal was designed to work in
tandem with the standard risk retention
option. Additionally, the reproposal
would have permitted a securitization
sponsor to allocate a portion of its risk
retention obligation to any originator of
the underlying assets that originated at
least 20 percent of the underlying assets
in the pool. The amount of the retention
interest held by each originator that was
allocated credit risk in accordance with
the reproposal was required to be at
least 20 percent, but not in excess of the
percentage of the securitized assets it
originated. The originator would have
been required to hold its allocated share
of the risk retention obligation in the
same manner as would have been
required of the sponsor, and subject to
the same restrictions on transferring,
hedging, and financing the retained
interest. Thus, for example, if the
sponsor satisfied its risk retention
requirements by acquiring an eligible
horizontal residual interest, an
originator allocated risk would have
been required to acquire a portion of
that interest, in an amount not
exceeding the percentage of securitized
assets created by the originator. The
sponsor’s risk retention requirements
would have been reduced by the
amount allocated to the originator. The
sponsor would have had to provide, or
cause to be provided, to potential
investors (and the appropriate regulators
paragraph that permits the agencies to provide for
the allocation of risk retention obligations between
a securitizer and an originator in the case of a
securitizer that purchases assets from an originator.

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upon request) the name and form of
organization of any originator that will
acquire and retain (or has acquired and
retained) an interest in the transaction,
including a description of the form,
amount, and nature of the interest (e.g.,
senior or subordinated), as well as the
method of payment for such interest.
Finally, the reproposal would have
made the sponsor responsible for any
failure of an originator to abide by the
transfer, hedging, and financing
restrictions included in the proposed
rule.
Comments on the allocation to
originator proposal focused on the 20
percent threshold for allocation, the
requirement that an originator to which
risk retention was allocated share pro
rata in all of the losses allocated to the
type of interest (i.e., horizontal or
vertical) it holds rather than only the
losses on assets that it originated, and
the definition of originator. Some of the
commenters requested that the 20
percent minimum should be deleted
and that it would hurt smaller
originators while one commenter
supported the limit and asserted that it
protected smaller originators. Comments
as to the required pro rata sharing by the
originator included an analysis that
because securitization tranches are
developed so that tranche holders share
pari passu in losses, it would cause
unnecessary complexity to limit an
originator’s interests to the loans that it
had originated. Finally, a commenter
asserted that the definition of
‘‘originator’’ ought to include parties
that purchase assets from entities that
create the assets.
2. Final Rule
The agencies have carefully
considered the concerns raised by
commenters with respect to the
reproposal on allocation to originators.
For the reasons discussed below, the
agencies have concluded that the
changes to the reproposal suggested by
the commenters are not necessary or
appropriate. Therefore, the agencies are
adopting the proposed allocation to
originator provision with minor drafting
corrections and changes, as discussed
below.
The only modifications to this option
from that proposed in the reproposal are
a drafting correction and changes to the
formulation in section 11(a)(1)(ii) of the
rule of the limit on how much of its risk
retention obligation a sponsor may
allocate to an originator. These changes
to section 11(a)(1)(ii) of the rule reflect
that no fair value computation is
required for a vertical interest
(discussed above in Part III.B.1 of this
Supplementary Information) and,

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consequently, that in certain
circumstances the fair value of the
retained interest as a percentage of all
ABS interests issued in the
securitization transaction may not be
determined. This change to the text of
section 11(a)(1)(ii) of the rule does not
result in any substantive change to the
allocation to originator provisions
contained in the reproposal.
While section 11(a)(1)(iv) is
unchanged from the reproposal, it
should be noted that the amount that is
required to be paid by the originator
might need to be calculated differently
from how this amount would have been
calculated under the reproposal. In the
event that the fair value of all ABS
interests issued in a securitization
transaction is not calculated, which
would be the case if the sponsor opted
for all of its required risk retention to be
held as eligible vertical interests and
one or more classes of ABS interests
were not sold to investors, the amount
by which the sponsor’s risk retention is
reduced by the sale of a portion thereof
to an originator will not be determinable
from the calculations required by
section 4 of the rule. In this
circumstance, the agencies would
expect that the value of the retained
portion of any unsold tranches for
purposes of section 11 of the rule will
be determined on a reasonable basis by
the sponsor and the originator.
The agencies note that the reference
in section 11(a)(1)(ii) of the rule to the
interest retained by the sponsor refers to
the amount of the interest required to be
retained by the sponsor before giving
effect to any sale to an originator.
Similarly, the provision in section
11(a)(2) of the rule that a sponsor
disclose the percentage of the interest
sold to an originator is intended to
require calculation of such percentage
based on the sponsor’s risk retention
amount before any sale to an originator.
The rule, like the proposal, requires
that an originator to which a portion of
the sponsor’s risk retention obligation is
allocated acquire and retain eligible
vertical interests or eligible horizontal
residual interests in the same manner as
would have been retained by the
sponsor. As under the reproposed rule,
this condition will require an originator
to acquire horizontal and vertical
interests in the securitization
transaction in the same proportion as
the interests originally to be retained by
the sponsor. This requirement helps to
align the interests of originators and
sponsors, as both will face the same
likelihood and degree of losses if the
securitized assets begin to default. In
addition, if originators were permitted
to retain their share of the sponsor’s risk

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retention obligation in a proportion that
is different from the sponsor’s mix of
the vertical and horizontal interests,
investor and regulatory monitoring of
risk retention compliance could become
very complex.
As under the reproposal, the rule
requires a sponsor that uses an eligible
horizontal cash reserve account and
desires to allocate a portion of its risk
retention obligations to an originator to
allocate a portion of the interest the
sponsor holds in such account to the
originator. Such allocation may be
effected by any method that results in
the sponsor and each originator to
which any retention is allocated
sharing, directly or indirectly, on a pari
passu basis in one or more eligible
horizontal residual accounts. For
example, (1) the originator may deposit
into the sponsor-established account
funds in the amount of the originator’s
share of the sponsor’s risk retention
obligations, in replacement of a like
amount of the funds originally
deposited by the sponsor, or (2) the
originator may create a separate
horizontal reserve account in the
amount of its share of the sponsor’s risk
retention obligations, in substitution for
a like amount of funds in the sponsor’s
reserve account. If an originator
establishes a separate account, such
account must share pari passu with the
sponsor’s eligible horizontal reserve
account (and any other originator’s
eligible horizontal reserve account) in
amounts released to satisfy amounts due
on ABS interests.
The rule does not modify the
requirement that an originator to which
a sponsor may sell a portion of its
required risk retention must have
originated at least 20 percent of the asset
pool. As explained in the reproposal, by
limiting this option to originators that
originate at least 20 percent of the asset
pool, the agencies seek to ensure that
the originator retains risk in an amount
significant enough to function as an
actual incentive for the originator to
monitor the quality of all the securitized
assets (and to which it would retain
some credit risk exposure). In addition,
the 20 percent threshold serves to make
the allocation option available only for
entities whose assets form a significant
portion of a pool and who, thus,
ordinarily could be expected to have
some bargaining power with a sponsor.
By restricting originators to holding
no more than their proportional share of
the risk retention obligation, the rule
seeks to prevent sponsors from
circumventing the purpose of the risk
retention obligation by transferring an
outsized portion of the obligation to an
originator that may have been seeking to

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acquire a speculative investment. These
requirements are also intended to
reduce the rule’s potential complexity
and facilitate investor and regulatory
monitoring.
The rule does not incorporate the
commenter suggestion that an originator
be allocated retention in only the loans
that it originated. The operational
burden on both securitization sponsors
and federal supervisors to ensure that
retention is held by originators on the
correct individual loans would, for
many different asset classes, be
exceedingly high. Therefore, the rule
requires that originators allocated a
portion of the risk retention requirement
be allocated a share of the entire
securitization pool.
The rule does not modify the
definition of originator from that set
forth in the reproposal and does not
include persons that acquire loans and
transfer them to a sponsor. The agencies
continue to believe that the definition of
the term originator in section 15G 210
should not be interpreted to include
such persons. Section 15G defines an
originator to a person that ‘‘through the
extension of credit or otherwise, creates
a financial asset.’’ A person that
acquires an asset created by another
person would not be the ‘‘creator’’ of
such asset.
Finally, while the final rule omits the
proposed requirement that a sponsor
disclose the dollar amount of the
interests sold to originators because
such amount may not always be
calculated, the disclosure requirements
of the sponsor under section 4 of the
final rule remain applicable to the
sponsor and should be construed to
refer to the required interest originally
retained by the sponsor, even where the
sponsor sells some or all of its required
retained interests to originators.
D. Hedging, Transfer, and Financing
Restrictions

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1. Overview of the Reproposal and
Public Comment
Section 15G(c)(1)(A) provides that the
risk retention regulations shall prohibit
a securitizer from directly or indirectly
hedging or otherwise transferring the
credit risk that the securitizer is
required to retain with respect to an
asset. Consistent with this statutory
directive, the reproposal would have
prohibited a sponsor from (i)
transferring any interest or assets that it
was required to retain under the rule to
any person other than a majority-owned
affiliate of the sponsor, (ii) hedging the
credit risk the sponsor is required to
210 15

U.S.C. 78o–11(a)(4).

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retain under the rule, unless the hedge
positions are expressly permitted or not
materially related to the credit risk of
the particular ABS interests or
exposures required to be retained by the
sponsor, or (iii) pledging as collateral for
any obligation any interest or asset that
the sponsor is required to retain, unless
the pledge collateralizes an obligation
with full recourse to the sponsor or a
consolidated affiliate.
The agencies did not receive any
comments directly addressing the
financing restrictions in the reproposal.
Several commenters addressed the
hedging and transfer provisions.
While some commenters supported
the proposed restrictions on hedging,
others opposed the provisions as being
overly restrictive, and certain
commenters requested clarification as to
the scope of the proposed restrictions.
One commenter advocated a blanket
exception from the hedging restriction
for pool and asset level credit insurance
reasoning that such insurance reduces
credit risk for the benefit of all holders
of ABS interests, and does not eliminate
the retaining sponsor’s exposure to
credit risk or change the ‘‘relative
distribution of risk among interest
holders.’’ Another commenter expressed
the view that issuers of securities
collateralized by ‘‘qualifying assets’’
should be able to hold hedges,
insurance policies and other forms of
credit enhancement as discussed in
Items 1114 and 1115 of the
Commission’s Regulation AB, and
asserted that ‘‘interest rate hedges, bond
insurance policies, pool insurance
policies and other forms of credit
enhancement form an important
component of many securitization
structures and provide clear benefits to
investors.’’
Several commenters requested that
the agencies clarify that the term
‘‘servicing assets’’ (which are generally
permitted to be held by issuers)
includes hedge instruments. One of
these commenters asserted that the
preamble to the reproposal indicated
that the term was intended to be defined
broadly and included ‘‘interest rate and
foreign currency risk’’ hedges, but the
definition of the term in the proposed
regulation did not reflect that breadth.
The commenter expressed concern that,
without clarification, issuers that used
other types of hedges would not be able
to avail themselves of exemptions from
risk retention, with the result that costs
would be borne by investors (in the
form of less credit enhancement) and
borrowers (in the form of higher interest
rates). Another commenter requested
that permitted hedging activities
include ‘‘purchasing or selling a

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security or other financial instrument to
protect or mitigate credit risk in
servicing assets for the protection of all
investors.’’ This commenter requested
that hedges to mitigate risk with respect
to amounts due for services that are not
financed as well as vehicle leases be
allowed.
One commenter suggested that the
agencies consider whether the
restriction prohibiting the sponsor from
transferring, selling, or otherwise
encumbering its interest for a period of
time after establishing the securitization
entity may have the unintended
consequence of creating a de facto
agency relationship between the
sponsor and the other investors in the
securitization entity under GAAP. The
commenter asserted that a de facto
agency relationship between the
sponsor and the other investors in a
securitization entity results in a higher
likelihood that the sponsor would be
required to consolidate the
securitization entity.
2. Final Rule
The agencies have carefully
considered the comments received with
respect to the reproposal’s hedging,
transfer, and financing restrictions, and
for the reasons discussed below, do not
believe that any significant changes to
the reproposal’s restrictions are
necessary or appropriate. Accordingly,
the final rule contains hedging, transfer,
and financing restrictions that are
substantially the same as those
contained in the reproposal.211
The final rule prohibits a sponsor or
any affiliate from hedging the credit risk
the sponsor is required to retain under
the rule or from purchasing or selling a
security or other financial instrument,
or entering into an agreement (including
an insurance contract), derivative or
other position, with any other person if:
(i) Payments on the security or other
financial instrument or under the
agreement, derivative, or position are
materially related to the credit risk of
one or more particular ABS interests
that the retaining sponsor is required to
retain, or one or more of the particular
securitized assets that collateralize the
asset-backed securities; and (ii) the
security, instrument, agreement,
derivative, or position in any way
reduces or limits the financial exposure
of the sponsor to the credit risk of one
or more of the particular ABS interests
or one or more of the particular
211 The sunset on hedging and transfer
restrictions is discussed in Part III.F of this
Supplementary Information.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
securitized assets that collateralize the
asset-backed securities.212
As in the reproposal, because the
agencies believe it would not be
‘‘materially related’’ to the particular
interests or assets that the sponsor is
required to retain, holding a security
tied to the return of an index (such as
the subprime ABX.HE index) is not a
prohibited hedge so long as: (1) any
class of ABS interests in the issuing
entity that were issued in connection
with the securitization transaction and
that are included in the index represent
no more than 10 percent of the dollarweighted average of all instruments
included in the index, and (2) all classes
of ABS interests in all issuing entities
that were issued in connection with any
securitization transaction in which the
sponsor was required to retain an
interest pursuant to the rule and that are
included in the index represent, in the
aggregate, no more than 20 percent of
the dollar weighted average of all
instruments included in the index. Such
permitted positions include hedges
related to overall market movements,
such as movements of market interest
rates (but not the specific interest rate
risk, also known as spread risk,
associated with the ABS interest that is
otherwise considered part of the credit
risk), currency exchange rates, home
prices, or the overall value of a
particular broad category of assetbacked securities.
In response to comments, the agencies
also note that they do not believe that
the rule prohibits the retaining sponsor
from benefiting from credit
enhancements or risk mitigation
products that are designed to benefit all
investors in the securitization in which
the sponsor is required to retain risk.
For example, the retaining sponsor may
benefit from private mortgage insurance
provided that the proceeds of such
insurance are subject to the priority of
payments for all investors.
The agencies caution that a sponsor
would not be in compliance with the
rule if it were to engage in, direct or
control a series of transactions designed
to add credit enhancement to assets
ultimately securitized by it in a manner
that indirectly achieved what the
sponsor is prohibited from doing
directly. The agencies believe that the
hedging and transfer prohibitions in the
statute are intended to ensure that the
sponsor retains meaningful credit
exposure to the securitized assets rather
two-part test requires that a position be
both ‘‘materially related to the credit risk’’ and
actually offset credit risk. These concepts are often
interrelated and, if significant amounts of credit risk
are offset, this may indicate a material relationship
to the retained ABS interests.

than credit exposure to a third party. As
a result, the agencies believe that the
hedging prohibition would impose
limits on a sponsor benefitting from
asset-level or pool-level insurance that
covered 100 percent of the credit risk of
the securitized assets, unless the
sponsor’s right to recover insurance
proceeds from such hedges is
subordinated to the payment in full of
all other investors.
A different approach is applicable
when risk reducing transactions or
instruments cover either the ABS
interests required to be retained by the
sponsor, such as bond insurance, or 100
percent of the credit risk of the
securitized assets, such as municipal
bond insurance. Under this approach,
the retaining sponsor would be
precluded from receiving distributions
that, but for the proceeds from the
insurance, would not be available for
distribution to that retaining sponsor
unless, at the time of distribution, all
other amounts due at that time to be
paid to all other holders of outstanding
ABS interests have been paid in full.
Accordingly, until all other holders of
obligations issued as part of the
securitization transaction are paid all
amounts then due to them, a holder of
an eligible vertical interest would not be
permitted to benefit from bond
insurance on a senior class or tranche
and, thus, would be required to
subordinate its interest in any bond
insurance proceeds to the payment of all
amounts due to all other ABS interests.
Similarly, a sponsor would not be
entitled to benefit from a pool insurance
policy that references amounts payable
to a specific tranche or class of ABS
interest unless, at the time of
distribution, all other ABS interests had
been paid all amounts due to them at
the time.
The agencies are clarifying that the
liquidity support provided by a
regulated liquidity provider in
satisfaction of the requirements set forth
in the tender option bond risk retention
option described in section 10 of the
final rule or in satisfaction of the
requirements set forth in the ABCP risk
retention option described in section 6
of the final rule is not subject to the
prohibition on hedging and transfer.213
In both cases, the liquidity support is an
important aspect of the existing market
practice and alignment of interests in
these transactions. The agencies note
that, to the extent that a sponsor of an
ABCP conduit or tender option bond

212 The

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213 Because a liquidity facility is required for the
ABCP option and the qualified tender option bond
entity options, but does not itself constitute
required risk retention, it is not subject to the
transfer or hedging restrictions.

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program is also the liquidity provider, a
liquidity agreement or credit guarantee
would not violate the prohibition on
hedging because such an agreement
would not hedge the sponsor’s credit
risk retention. Additionally, with
respect to an eligible ABCP conduit, the
originator-seller in its capacity as
sponsor of the intermediate SPV is
subject to the hedging prohibition and
would remain exposed to the credit risk
of the collateral supporting the ABS
interests issued by the intermediate
SPV.
As under the reproposal, because the
agencies believe that they would not be
‘‘materially related’’ to the particular
interests or assets that the sponsor is
required to retain, hedges tied to
securities that are collateralized by
similar assets originated and securitized
by other sponsors would not be
prohibited. On the other hand, a
security, instrument, derivative or
contract generally would be ‘‘materially
related’’ to the particular interests or
assets that the sponsor is required to
retain if the security, instrument,
derivative or contract refers to those
particular interests or assets or requires
payment in circumstances where there
is or could reasonably be expected to be
a loss due to the credit risk of such
interests or assets (e.g., a credit default
swap for which the particular interest or
asset is the reference asset).
In response to comments requesting
clarification as to whether servicing
assets could be hedged, the agencies are
of the view that cash equivalents that
are servicing assets should be
specifically limited so that they do not
create additional risk for a securitization
transaction and they should not require
hedging.214 As for whether servicing
assets may include hedge instruments,
the agencies note that interest rate and
foreign currency hedges are not
prohibited hedges under section 12 of
the final rule. As noted earlier, the term
‘‘servicing assets’’ is similar to the
definition of the term ‘‘eligible assets’’
under Rule 3a–7 of the Investment
Company Act.
Regarding commenters’ concerns that
the rule’s transfer and hedging
restrictions may create a de facto agency
relationship between the sponsor and
the other investors in the securitization
entity under GAAP, the Commission
notes, and the other agencies concur,
that a de facto agency relationship
214 One notable exception might arise for cash
held in a currency different than the currency of
obligation for the securitization, where the amount
of currency and time to payment obligation are
material from the standpoint of the securitization;
however this foreign exchange risk is more
commonly hedged at the securitized asset level.

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under GAAP will not be created by the
transfer, hedging, or financing
restrictions in the final rule, and note
that the definition of a de facto agency
relationship in GAAP relates to an
agreement between variable interest
holders in an entity that restricts one
variable interest holder from selling,
transferring, or encumbering its interest
in the entity without the prior approval
of other variable interest holders. A de
facto agency relationship does not exist
solely as a result of a regulatory
restriction imposed on an investor that
prohibits its ability to transfer, sell, or
otherwise encumber its interest in an
entity. As such, the Commission
confirms, and the other agencies concur,
that the restriction in the final rule
prohibiting the sponsor from
transferring, selling, or otherwise
encumbering its interest for a period of
time after establishing the securitization
entity does not create under GAAP a de
facto agency relationship between the
sponsor and the other investors in the
securitization entity.
E. Safe Harbor for Certain ForeignRelated Securitizations
Like the original proposal, the
reproposal included a ‘‘safe harbor’’
provision for certain securitization
transactions with limited connections to
the United States and U.S. investors.215
The safe harbor was intended to exclude
from the risk retention requirements
transactions in which the effects on U.S.
interests are sufficiently remote so as
not to significantly impact underwriting
standards and risk management
practices in the United States or the
interests of U.S. investors. Accordingly,
reliance on the safe harbor is
conditioned upon limited involvement
by persons in the United States with
respect to both securitized assets and
the ABS interests sold in connection
with the transaction. The safe harbor
would not have been available for any
transaction or series of transactions that,
although in technical compliance with
the conditions of the safe harbor, is part
of a plan or scheme to evade the
requirements of section 15G of the
Exchange Act and these rules.
Under the reproposal, the risk
retention requirement would not have
applied to a securitization transaction if:
(1) the securitization transaction is not
required to be and is not registered
215 As the agencies noted in the original proposal,
the safe harbor is intended solely to provide clarity
that the agencies will not apply the requirements
of the final rule to transactions that meet all of the
conditions of the safe harbor. The safe harbor
should not be interpreted as reflecting the views of
any agency as to the potential scope of transactions
or persons subject to section 15G or the final rule.

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under the Securities Act; (2) no more
than 10 percent of the dollar value (or
equivalent if denominated in a foreign
currency) of all classes of ABS interests
in the securitization transaction are sold
or transferred to U.S. persons or for the
account or benefit of U.S. persons; 216
(3) neither the sponsor of the
securitization transaction nor the
issuing entity is (i) chartered,
incorporated, or organized under the
laws of the United States, or a U.S. state,
the District of Columbia, Puerto Rico,
the Virgin Islands or any other
possession of the United States (any
such state, other jurisdiction or
possession, a ‘‘U.S. state’’), (ii) an
unincorporated branch or office
(wherever located) of an entity
chartered, incorporated or organized
under the laws of the United States or
any U.S. state, or (iii) an unincorporated
branch or office located in the United
States or any U.S. state (an
‘‘unincorporated U.S.-located entity’’) of
an entity not chartered, incorporated, or
organized under the laws of the United
States, or a U.S. state; and (4) no more
than 25 percent of the assets
collateralizing the ABS interests sold in
the securitization transaction were
acquired by the sponsor or issuing
entity, directly or indirectly, from (i) a
majority-owned affiliate of the sponsor
or issuing entity that is chartered,
incorporated or organized under the
laws of the United States or a U.S. state,
or (ii) an unincorporated U.S.-located
entity of the sponsor or issuing entity.
Commenters on the reproposal
generally supported the existence of a
safe harbor for certain foreign
securitizations. A few commenters
suggested increasing the 10 percent
limit on the value of ABS interests
permitted to be sold to or for the
account of U.S. persons. These
commenters also requested that the
agencies clarify that the 10 percent limit
applies only at the time of initial
issuance and does not include
secondary market transfers. Commenters
also proposed to exclude from the 10
percent limitation (A) securitization
transactions with a sponsor or issuing
entity that is a U.S. person which makes
no offers to U.S. persons and (B)
issuances of asset-backed securities that
comply with Regulation S of the
Securities Act.
Several commenters requested that
the rule provide for coordination of the
rule’s risk retention requirement with
foreign risk retention requirements,
216 The agencies note that the value of an ABS
interest for this purpose would be its fair value on
the date of sale, determined using the fair value
measurement framework under GAAP.

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including by permitting a foreign issuer
to comply with home country or other
applicable foreign risk retention rules.
In this regard, comment was made that
U.S. risk retention rules may be
incompatible with foreign risk retention
requirements, such as the European
Union risk retention requirements and,
accordingly, that sponsors required to
comply with U.S. as well as foreign risk
retention regulations could be subject to
conflicting rules. Commenters also
requested that the agencies clarify how
the dollar value of ABS interests should
be determined and that satisfaction of
conditions to the safe harbor be tested
as of the date of issuance only and not
on an ongoing basis.
The final rule sets forth a foreign safe
harbor that is substantially similar to
that included in the reproposal. The
agencies have retained the 10 percent
limit on the value of ABS interests sold
to U.S. persons for safe harbor
eligibility. The agencies continue to
believe that the 10 percent limit
appropriately aligns the safe harbor with
the objective of the rule, which is to
exclude only those transactions with
limited effect on U.S. interests,
underwriting standards, risk
management practices, or U.S. investors.
The agencies wish to make clear that,
in general, the rule is intended to
include in the calculation of the 10
percent limit only ABS interests sold in
the initial distribution of ABS interests.
Secondary sales to U.S. persons would
not normally be included in the
calculation. However, secondary sales
into the U.S. under circumstances that
indicate that such sales were
contemplated at the time of the issuance
(and not included for purposes of
calculating the 10 percent limit) might
be viewed as part of a plan or scheme
to evade the requirements of the rule.
The 10 percent limit as applied to the
sale or transfer of any ABS interest
would need to be computed only on the
date of initial distribution of that ABS
interest, not an ongoing basis following
such initial distribution. If different
classes or portions of the same class of
ABS interests are distributed by or on
behalf of the issuing entity or a sponsor
on different dates, the 10 percent limit
would need to be calculated on each
such distribution date.
Under the rule, interests retained by
the sponsor may be included, as part of
the aggregate ABS interests in the
securitization transaction, in calculating
the percentage of those ABS interests
sold to U.S. persons or for the account
or benefit of U.S. persons.
The agencies considered the
comments requesting a mutual
recognition framework and observe that

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such a framework has not been
generally adopted in non-U.S.
jurisdictions with risk retention
requirements. As explained in the
preamble to the proposed rule, given the
many differences between jurisdictions,
such as securitization frameworks that
place the obligation to comply with risk
retention requirements upon different
parties in the securitization transaction,
different requirements for hedging, risk
transfer, or unfunded risk retention, and
other material differences, the agencies
believe that it would likely not be
practicable to construct such a ‘‘mutual
recognition’’ system that would meet all
the requirements of section 15G of the
Exchange Act. Moreover, in several such
jurisdictions, the risk retention
framework recognizes unfunded forms
of risk retention, such as standby letters
of credit, which the agencies do not
believe provide sufficient alignment of
incentives and have rejected as eligible
forms of risk retention under the U.S.
framework. Finally, the agencies believe
that the rule incorporates sufficient
flexibility for sponsors with respect to
forms of eligible risk retention to permit
foreign sponsors seeking a significant
U.S. investor base to retain risk in a
format that satisfies applicable foreign
and U.S. regulatory requirements, even
though such dual compliance
requirements might cause a sponsor to
structure a transaction differently than it
would have chosen had it not been
subject to such multiple requirements.
The agencies do not agree that
securitizations with U.S. persons,
sponsors or issuing entities with no U.S.
offerees, or that conduct all sales
pursuant to Regulation S of the
Securities Act, should be exempt from
the 10 percent limit. If the rule excluded
such securitizations or sales from the 10
percent limit, a market for poorly
underwritten assets could evolve and
negatively impact U.S. underwriting
standards and risk management
practices.
Improving underwriting standards is
one of the goals of risk retention and, for
the rule to be effective, the rule should
be applied in a manner that maintains
underwriting standards and risk
management practices in the United
States. The agencies’ adoption of the
foreign safe harbor incorporates the
agencies’ understanding of current
securitization markets and market
trends, including the importance of U.S.
investors in global securitization
markets. As securitization markets
evolve, the agencies will be alert to
ensuring any such changes do not
undermine the effectiveness of the rule
in achieving the purposes of section
15G. Accordingly, the agencies will

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monitor compliance with the safe
harbor and the contexts in which the
safe harbor is relied upon. Should it
become apparent that reliance on the
safe harbor has resulted in market shifts
that are detrimental to investors or
securitization markets, for example
where significant amounts of
securitizations collateralized by U.S.
assets are conducted in reliance on the
safe harbor and such reliance
undermines underwriting standards and
risk management practices in the United
States, the agencies will consider the
applicability of the anti-evasion
provisions of the safe harbor or will
consider modifications to the safe
harbor.
F. Sunset on Hedging and Transfer
Restrictions
As discussed in Part III.D of this
Supplementary Information, section
15G(c)(1)(A) of the Exchange Act
provides that sponsors may not hedge or
transfer the risk retention interest they
are required to hold.217 However, the
statute also provides that the agencies
shall specify the minimum duration of
risk retention. As explained in the
reproposal, the agencies believe that the
primary purpose of risk retention—
sound underwriting—is less likely to be
effectively promoted by risk retention
requirements after a certain period of
time has passed and a peak number of
delinquencies for an asset class has
occurred. Therefore, the agencies
proposed two categories of duration for
the transfer and hedging restrictions—
one for RMBS and one for other types
of ABS interests.
For RMBS, the transfer and hedging
restrictions under the proposed rule
would expire on or after the date that is
(1) the later of (a) five years after the
date of the closing of the securitization
or (b) the date on which the total unpaid
principal balance of the securitized
assets is reduced to 25 percent of the
original unpaid principal balance as of
the date of the closing of the
securitization, but (2) in any event no
later than seven years after the date of
the closing of the securitization.
For all ABS interests other than
RMBS, the transfer and hedging
restrictions under the reproposed rule
would expire on or after the date that is
the latest of (1) the date on which the
total unpaid principal balance of the
securitized assets that collateralize the
securitization is reduced to 33 percent
of the original unpaid principal balance
217 15 U.S.C. 78o–11(c)(1)(A). As with other
provisions of risk retention, the agencies could
provide an exemption under section 15G(e) of the
Exchange Act if certain findings were met. See id.
at section 78o–11(e).

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as of the date of the closing of the
securitization, (2) the date on which the
total unpaid principal obligations under
the ABS interests issued in the
securitization is reduced to 33 percent
of the original unpaid principal
obligations at the closing of the
securitization transaction, or (3) two
years after the date of the closing of the
securitization transaction.218
The reproposal also included a
provision that the proposed rule’s
restrictions on transfer and hedging
would end if a conservator or receiver
of a sponsor or other holder of risk
retention is appointed pursuant to
federal or state law.
The agencies invited comment on the
sunset provisions and asked whether
they were appropriately calibrated for
RMBS and all other asset classes, and
whether it was appropriate to provide a
sunset provision for all RMBS. Several
commenters expressed general support
for the sunset provisions but others
requested shorter time period
restrictions. One commenter suggested
longer time period restrictions on
certain asset classes, while others
proposed shortening the time periods
and adding more flexibility. One
commenter suggested that there should
be an outside time limit of no more than
five years for asset classes other than
RMBS and CMBS, including student
loans, aircraft leases, shipping container
leases, railcar leases, and structured
settlements of personal injury awards,
lottery winnings, and other assets. A
few commenters requested clarification
for transactions that do not typically
have a nominal ‘‘principal balance’’ and
one commenter requested that the test
use the cut-off date instead of the
closing date for measurement.
For RMBS, a few commenters
requested that sunset occur three to four
years after closing, while another
commenter requested a sunset of two
years after the security is issued. One
commenter recommended that the
agencies adopt a flat five-year sunset for
RMBS and eliminate the 25 percent
remaining unpaid balance test. In
support of a three-year sunset after
closing, some commenters requested
that the RMBS sunset provision be
analogous to the FHFA framework for
218 As described in Part III.B.5 of this
Supplementary Information, the agencies also
included in the reproposal, as an exception to the
transfer and hedging restrictions, the ability to
transfer the retained B-piece interest in a CMBS
transaction (whether held by the sponsor or a thirdparty purchaser) to a third-party purchaser five
years after the date of the closing of the
securitization transaction, provided that the
transferee satisfies each of the conditions applicable
to an initial third-party purchaser under the CMBS
option.

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representations and warranties whereby
lenders are relieved of certain
repurchase obligations for loans after 36
months of on-time payments. One
commenter requested that the sunset
provisions be calibrated differently
depending on the risk associated with
the underlying RMBS.
A few commenters recommended a
two-year sunset provision for open
market CLOs, noting that anything
longer would provide no relief given the
fact that these pools allow for
reinvestment. Two commenters
requested alternative sunset provisions
for student, vehicle, and equipment
loans where sunset would occur on the
earlier of (i) two years after the closing
date, and (ii) the later of (A) the
reduction of the unpaid principal
balance of the securitized assets to 33
percent or less of the cut-of date balance
and (B) the reduction of the unpaid
principal balance of the ABS interests
sold to third parties to 33 percent or less
of the closing date balance.
The agencies have carefully
considered the comments and are
adopting the sunset provisions as
proposed. In reviewing the reproposal
and the comments, the agencies
considered the duration for which the
rule should maintain the sponsor’s
exposure to the performance of the
assets, balancing the time it might take
for weaker underwriting to manifest
itself against the competing
consideration that, as that time period
extends, other factors may be more
influential triggers of asset default.
Although the time periods proposed by
the agencies are longer than commenters
generally asserted were necessary in
striking this balance, the agencies seek
to establish a conservative approach. It
is expected that this approach will
cause sponsors to focus on underwriting
criteria on the front end, at the time of
securitization, and the agencies believe
that requiring them to be mindful of
their exposure for the periods the
agencies proposed will improve the
sponsor’s alignment of incentives and
reinforce their focus on the performance
of their assets beyond their initial
creation. Accordingly, with respect to
the proposed risk retention duration
requirements for RMBS and for nonresidential mortgage ABS interests, the
agencies are concerned that reducing
the risk retention periods further would
weaken the incentive for sponsors to
ensure sound underwriting.
With respect to the proposed risk
retention duration requirement for
RMBS, as the agencies discussed in the
reproposal, because residential
mortgages typically have a longer
duration than other assets, weaknesses

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in underwriting may manifest
themselves later than in other asset
classes and can be masked by strong
housing markets. Moreover, residential
mortgage pools are uniquely sensitive to
adverse selection through prepayments:
if market interest rates fall, borrowers
refinance their mortgages and prepay
their existing mortgages, but refinancing
is not available to borrowers whose
credit has deteriorated, so mortgages to
less creditworthy borrowers become
concentrated in the RMBS pool in later
years. Accordingly, the agencies are
maintaining a different sunset provision
for RMBS collateralized by residential
mortgages that are subject to risk
retention.
In response to commenters who, in
the context of assets other than
residential mortgage loans, asked for
clarification as to how the sunset
provisions apply if the securitized assets
do not have a principal balance, the
agencies have revised the rule to clarify
that the sunset criterion relating to
principal balance would not apply to
securitized assets that do not have a
principal balance, if applicable. Thus,
for such securitized assets, the rule
provides that the transfer and hedging
restrictions may terminate upon the
later of two years after the date of the
closing of the securitization transaction
or the date on which the total unpaid
principal balance of the issued ABS
interests is reduced to 33 percent of
their original balance.
In addition, the agencies continue to
believe the exemptions to the
prohibitions on transfer for CMBS
eligible horizontal residual interests
proposed in the reproposal would help
ensure high quality underwriting
standards for the securitizers and
originators of non-residential mortgage
ABS interests and CMBS, would
improve the access of consumers and
businesses to credit on reasonable
terms, and are in the public interest and
for the protection of investors.219
IV. General Exemptions
Sections 15G(c)(1)(G) and 15G(e) of
the Exchange Act require the agencies to
provide a total or partial exemption
from the risk retention requirements for
certain types of asset-backed securities
or securitization transactions.220
In addition, section 15G(e)(1) permits
the agencies jointly to adopt or issue
additional exemptions, exceptions, or
adjustments to the risk retention
requirements of the rule, including
exemptions, exceptions, or adjustments
for classes of institutions or assets, if the
219 15

U.S.C. 78o–11(e)(2).
15 U.S.C. 78o–11(c)(1)(G) and (e).

220 See

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exemption, exception, or adjustment
would: (A) help ensure high quality
underwriting standards for the
securitizers and originators of assets that
are securitized or available for
securitization; and (B) encourage
appropriate risk management practices
by the securitizers and originators of
assets, improve the access of consumers
and businesses to credit on reasonable
terms, or otherwise be in the public
interest and for the protection of
investors.
Consistent with these provisions, the
reproposal would have exempted
certain types of asset-backed securities
or securitization transactions from the
credit risk retention requirements of the
rule. Each of these exemptions, along
with the comments and the final rule
that the agencies are adopting, are
discussed below. The agencies have
determined that each of the exemptions
adopted pursuant to section 15G(e)(1),
including for the reasons described
below and in the reproposal, satisfy the
requirements described in the preceding
paragraph.
A. Exemption for Federally Insured or
Guaranteed Residential, Multifamily,
and Health Care Mortgage Loan Assets
Section 15G(e)(3)(B) of the Exchange
Act provides that the agencies, in
implementing risk retention regulations,
shall not apply risk retention to any
residential, multifamily, or health care
facility mortgage loan asset, or
securitization based directly or
indirectly on such an asset, that is
insured or guaranteed by the United
States or an agency of the United
States.221 To implement this provision,
the reproposal would have exempted
from the risk retention requirements any
securitization transaction collateralized
solely by residential, multifamily, or
health care facility mortgage loan assets
if the assets are insured or guaranteed as
to the payment of principal and interest
by the United States or an agency of the
United States.222
Several commenters expressed
support for the exemption for
securitization transactions collateralized
solely by assets that are insured or
guaranteed as to the payment of
principal and interest by the United
States or its agencies. One commenter
urged the agencies to extend the
government-backed exemptions to assetbacked securities backed by foreign
governments. Another commenter
requested that the agencies clarify that
Enterprise securitizations of multifamily
221 See
222 See

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loans are exempt from the risk retention
requirements.
After considering the comments
received, the agencies are adopting as
proposed the exemption from the risk
retention requirements for any
securitization transaction that is
collateralized solely by residential,
multifamily, or health care facility
mortgage loan assets if the assets are
insured or guaranteed in whole or in
part as to the payment of principal and
interest by the United States or an
agency of the United States.
The agencies are not adopting an
exemption from risk retention for
securitizations of assets issued,
guaranteed or insured by foreign
government entities. As the agencies
noted in the reproposal, the agencies
continue to believe that it would not be
appropriate to exempt such transactions
from risk retention if they were offered
in the United States to U.S. investors.
Nor are the agencies expanding this (or
any other exemption) to include all
securitizations of multifamily loans by
the Enterprises. Such securitizations
require risk retention under the rule
unless they meet the requirements of
section 8 of the rule.

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B. Exemption for Securitizations of
Assets Issued, Insured, or Guaranteed
by the United States or any Agency of
the United States and Other Exemptions
Section 15G(c)(1)(G)(ii) of the
Exchange Act requires that the agencies,
in implementing risk retention
regulations, provide for a total or partial
exemption from risk retention for
securitizations of assets that are issued
or guaranteed by the United States or an
agency of the United States, as the
agencies jointly determine appropriate
in the public interest and the protection
of investors.223 The reproposal would
have provided full exemption from risk
retention for any securitization
transaction in which the ABS interests
issued in the transaction were (1)
collateralized solely by obligations
issued by the United States or an agency
of the United States and servicing
assets; (2) collateralized solely by assets
that are fully insured or guaranteed as
to the payment of principal and interest
by the United States or an agency of the
United States (other than residential,
multifamily, or health care facility
mortgage loan securitizations discussed
above) and servicing assets; or (3) fully
guaranteed as to the timely payment of
principal and interest by the United
States or any agency of the United
States.
223 See

id. at section 78o–11(c)(1)(G).

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Consistent with section 15G(e)(3)(A)
of the Exchange Act, the reproposal also
would have provided an exemption
from risk retention for any securitization
transaction collateralized solely by
loans or other assets made, insured,
guaranteed, or purchased by any
institution that is subject to the
supervision of the Farm Credit
Administration, including the Federal
Agricultural Mortgage Corporation, and
servicing assets.224 Additionally, the
reproposal would have provided an
exemption from risk retention,
consistent with section 15G(c)(1)(G)(iii)
of the Exchange Act,225 for securities (1)
issued or guaranteed by any state 226 of
the United States, or by any political
subdivision of a state, or by any public
instrumentality of a state that is exempt
from the registration requirements of the
Securities Act by reason of section
3(a)(2) of the Securities Act, or (2)
defined as a qualified scholarship
funding bond in section 150(d)(2) of the
IRS Code.
One commenter requested that the
final rule retain the full exemption for
securities issued by a state (including a
political subdivision or public
instrumentality of a state), and for
securities that meet the definition of a
qualified scholarship funding bond.
This commenter requested clarification
that the exemption for state and
municipal securitizations would apply
to both securities issued on a federally
taxable basis and securities issued on a
federal tax-exempt basis. A few
commenters urged that the agencies
clarify that all securities issued by
housing finance agencies and other state
government agencies and collateralized
by loans financed by housing finance
agencies are exempted.
After considering the comments
received, the agencies are adopting as
proposed the exemption from the risk
retention requirements for any
securitization transaction that is (1)
collateralized solely by obligations
issued by the United States or an agency
of the United States and servicing
assets; (2) collateralized solely by assets
that are fully insured or guaranteed as
to the payment of principal and interest
by the United States or an agency of the
United States (other than residential,
multifamily, or health care facility
mortgage loan securitizations discussed
224 See

15 U.S.C. 78o–11(e)(3)(A).
id. at section 78o–11(c)(1)(G)(iii).
226 Section 2 of the rule defines ‘‘state’’ as having
the same meaning as in section 3(a)(16) of the
Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(16)), which includes a state of the United
States, the District of Columbia, Puerto Rico, the
Virgin Islands, or any other possession of the
United States.
225 See

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77671

above) and servicing assets; (3) insured
or guaranteed as to the payment of
principal and interest by the United
States or an agency of the United States;
(4) collateralized solely by loans or
other assets made, insured, guaranteed,
or purchased by any institution that is
subject to the supervision of the Farm
Credit Administration, including the
Federal Agricultural Mortgage
Corporation, and servicing assets; (5)
issued or guaranteed by any state of the
United States, or by any political
subdivision of a state, or by any public
instrumentality of a state that is exempt
from the registration requirements of the
Securities Act by reason of section
3(a)(2) of the Securities Act; or (6)
defined as a qualified scholarship
funding bond in section 150(d)(2) of the
IRS Code.
Regarding whether the exemption for
state and municipal securitizations
would apply to both securities issued on
a federally taxable basis and securities
issued on a federal tax-exempt basis, the
agencies note that the text of the
exemption does not specifically make a
distinction between taxable and taxexempt securities. To the extent that a
security otherwise satisfies the
requirements of the state and municipal
securitizations exemption, such security
is exempt from the risk retention rule.
The agencies are exempting loans that
are exempt from the ability-to-repay
requirements (such as loans made
through state housing finance agency
programs and certain community
lending programs) that were not
separately included in the definition for
QRM (which under the statute cannot be
broader than QM) and would only be
QRMs if they otherwise met the
qualifying criteria for QMs. This
exemption is discussed more fully
below.
C. Federal Family Education Loan
Program and Other Student Loan
Securitizations
The reproposal would have exempted
any securitization transaction that is
collateralized solely (excluding
servicing assets) by student loans made
under the Federal Family Education
Loan Program (‘‘FFELP’’) that are
guaranteed as to 100 percent of
defaulted principal and accrued interest
(i.e., FFELP loans with first
disbursement prior to October 1993, or
pursuant to certain limited
circumstances where a full guarantee
was required). A securitization
transaction that is collateralized solely
(excluding servicing assets) by FFELP
loans that are guaranteed as to at least
98 percent (but less than 100 percent) of
defaulted principal and accrued interest

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would have its risk retention
requirement reduced to 2 percent. Any
other securitization transaction that is
collateralized solely (excluding
servicing assets) by FFELP loans would
have its risk retention requirement
reduced to 3 percent.
Several commenters urged the
agencies to expand the proposed
exemption for securitization
transactions collateralized by FFELP
loans to a full exemption from risk
retention requirements. These
commenters asserted that a risk
retention requirement ranging from zero
percent to 3 percent for FFELP loan
securitizations that are subject to a
guaranty ranging from 97 percent to 100
percent means risk retention is required
in an amount greater than the loss
exposure on the loans. These
commenters stated that other
securitization products would receive a
full exemption under the reproposal
even if they are only partially insured or
guaranteed. A few of these commenters
also asserted that risk retention would
have no effect on the underwriting
standards since these loans have already
been funded and the program is no
longer underwriting new loans. One of
these commenters urged the agencies to
apply the risk retention requirement
only to the portion of the FFELP loans
that are not guaranteed.227
Commenters also recommended that
the agencies accept alternative forms of
risk retention for FFELP loan
securitizations. The suggested
alternative forms of risk retention
include a simplified representative
sample method, an exemption for onbalance sheet transactions where the
structure clearly demonstrates at least 5
percent risk retention, initial equity
contribution, overcollateralization, and
unfunded forms of risk retention. One of
these commenters cited the European
Union risk retention regime which
recognizes certain unfunded forms of
risk retention.
One commenter asked that the
agencies extend the FFELP loan
securitization exemption to include
student loan-backed securities issued by
entities exempt from registration under
section 3(a)(4) of the Securities Act and
by entities that have received taxexempt designations under section
501(c)(3) of the IRS Code. This
commenter asserted that these issuers
are constrained in their ability to raise
sufficient capital to meet the risk
227 This commenter suggested, as an example,
that if only 3 percent of a FFELP loan is uninsured,
the 5 percent risk retention requirement should
only apply to the 3 percent uninsured portion,
resulting in a 0.15 percent risk retention
requirement with respect to such loan.

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retention requirements. One other
commenter requested that student loan
revenue bonds issued by nonprofit
issuers that are supported by third-party
credit enhancement be exempted. This
commenter asserted that investors in
these bonds are not making their
investment decisions based on the
credit risk and performance of the asset
pool, and that these bonds are assessed
based on the creditworthiness and
structure of the third-party credit
enhancement. Another commenter
requested that all nonprofit public
purpose student loan providers be fully
exempted from risk retention
requirements. This commenter asserted
that the structure of the securitizations
issued by these entities, and the history
of investor interest in security issuances
by nonprofit organizations, reflect the
strong alignment of interests between
the investors and sponsors of these
types of securitization transactions.
Another commenter requested
clarification that the exemption for
qualified scholarship funding bonds
apply to both securities issued on a
federally taxable basis and securities
issued on a federal tax-exempt basis.
After considering the comments
received, the agencies are adopting the
reductions in the amount of required
risk retention for FFELP loan
securitization as reproposed. The
agencies do not believe that providing a
full exemption to partially insured or
guaranteed FFELP loans is warranted.
The agencies believe that the reductions
in risk retention for FFELP loan
securitizations described in the
reproposal reflect the appropriate level
of ‘‘skin in the game’’ for these
transactions, encouraging high quality
underwriting generally in the selection
of assets for securitization and
appropriate risk management practices
in post-default servicing. The agencies
also reiterate that they have generally
declined to recognize unfunded forms of
risk retention and continue to do so for
purposes of the final rule.
Consistent with the reproposal, the
agencies are not expanding the
proposed exemptions to cover student
loans other than FFELP student loans,
including student loan-backed securities
issued by entities exempt from
registration under section 3(a)(4) of the
Securities Act or entities that have
received tax exempt designations under
section 501(c)(3) of the IRS Code,
because comments received on the
reproposal did not provide a basis to
allow the agencies to conclude that the
structures or underwriting practices of
these securitizations align the interests
of securitizers with the interests of
investors such that an exemption would

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be appropriate under section
15G(c)(1)(G) or section 15G(e) of the
Exchange Act. The agencies are
concerned that an exemption for
sponsors of student loan-backed
securities issued by entities exempt
from registration under section 3(a)(4) of
the Securities Act or entities that receive
tax exempt designations under section
501(c)(3) of the IRS Code would permit
evasion of the rule through the use of an
entity that meets the requirements of
such exemption, but whose sole
purpose is the issuance of ABS interests.
Regarding whether the exemption for
qualified scholarship funding bonds
would apply to both securities issued on
a federally taxable basis and securities
issued on a federal tax-exempt basis, the
agencies note that the text of the
exemption does not specifically make a
distinction between taxable and taxexempt securities. To the extent a
security satisfies the requirements of the
qualified scholarship funding bond
exemption in the rule, such security is
exempt from the risk retention rule. The
agencies believe that there is not
sufficient justification to provide an
exemption for bonds that may have
some similarities to a qualified
scholarship funding bond, but do not
meet the statutory definition.
D. Certain Public Utility Securitizations
The reproposal would have provided
an exemption from risk retention for
utility legislative securitizations.
Specifically, the reproposal would have
exempted any securitization transaction
where the ABS interests are issued by
an entity that is wholly owned, directly
or indirectly, by an investor-owned
utility company that is subject to the
regulatory authority of a state public
utility commission or other appropriate
state agency. Additionally, ABS
interests issued in an exempted utility
legislative securitization transaction
would have been required to be secured
by the intangible property right to
collect charges for the recovery of
specified costs and such other assets of
the issuing entity. The reproposal would
have defined ‘‘specified cost’’ to mean
any cost identified by a state legislature
as appropriate for recovery through
securitization pursuant to ‘‘specified
cost recovery legislation,’’ which is
legislation enacted by a state that:
• Authorizes the investor-owned
utility company to apply for, and
authorizes the public utility commission
or other appropriate state agency to
issue, a financing order determining the
amount of specified costs the utility will
be allowed to recover;
• Provides that pursuant to a
financing order, the utility acquires an

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intangible property right to charge,
collect, and receive amounts necessary
to provide for the full recovery of the
specified costs determined to be
recoverable, and assures that the charges
are non-bypassable and will be paid by
customers within the utility’s historic
service territory who receive utility
goods or services through the utility’s
transmission and distribution system,
even if those customers elect to
purchase these goods or services from a
third party; and
• Guarantees that neither the state nor
any of its agencies has the authority to
rescind or amend the financing order, to
revise the amount of specified costs, or
in any way to reduce or impair the value
of the intangible property right, except
as may be contemplated by periodic
adjustments authorized by the specified
cost recovery legislation.228
The agencies received no comments
on the utility legislative securitization
exemption, and are adopting the
exemption as reproposed.

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E. Seasoned Loan Securitizations
In the reproposal, the agencies
proposed to exempt from risk retention
any securitization transaction that is
collateralized solely by servicing assets
and seasoned loans that (1) have not
been modified since origination and (2)
have never been delinquent for 30 days
or more. With respect to residential
mortgages, the reproposal would have
defined ‘‘seasoned loan’’ to mean a
residential mortgage loan that either (1)
has been outstanding and performing for
the longer of (i) five years or (ii) the
period until the outstanding principal
balance of the loan has been reduced to
25 percent of the original principal
balance; or (2) has been outstanding and
performing for at least seven years. For
all other asset classes, the reproposal
would have defined ‘‘seasoned loan’’ to
mean a loan that has been outstanding
and performing for the longer of (1) two
years, or (2) the period until the
outstanding principal balance of the
loan has been reduced to 33 percent of
the original principal balance.
The agencies received a number of
comments on the seasoned loan
exemption from financial entities and
financial trade organizations.
Commenters generally favored
expanding the seasoned loan
228 The eligibility standards for the exemption are
similar to certain requirements for these
securitizations outlined in IRS Revenue Procedure
2005–62, 2005–2 C.B. 507, that are relevant to risk
retention. This Revenue Procedure outlines the
Internal Revenue Service’s requirements in order to
treat the securities issued in these securitizations as
debt for tax purposes, which is the primary
motivation for states and public utilities to engage
in such securitizations.

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exemption, although they differed in
how to expand the exemption. One
commenter proposed that ‘‘seasoned
loans’’ be redefined to accommodate
auto loans that have been outstanding
and performing for the shorter of (1) two
years, or (2) the period until the
outstanding principal balance of the
loan has been reduced to 33 percent of
the original principal balance. Other
commenters proposed that the
exemption be expanded to
accommodate certain previously
modified residential mortgage loans that
have not had past delinquency events.
One commenter requested that loans
with delinquencies up to 60 days
qualify, and another suggested that
loans that have been delinquent and
then brought current qualify if they
perform for 36 months after the
delinquency. Another commenter asked
that the exception include loans that
had no more than three 30-day
delinquencies if the loan is otherwise
performing for five years and not
delinquent at the time of securitization.
Other commenters asked that the
agencies permit blended securitizations
of seasoned loans with other loans that
require risk retention, with the amount
of risk retention reduced accordingly.
These commenters expressed concern of
potentially fragmenting the market for
these loans. However, the investor
members of one commenter questioned
the need to blend pools of seasoned and
‘‘non-seasoned’’ loans because ABS
interests collateralized by these types of
assets are unlikely to appeal to the same
types of investors.
After considering the comments
received, the agencies are adopting the
seasoned loan exemption as reproposed.
The agencies believe that there is
insufficient data to justify expanding the
seasoned loan exemption and that the
alignment of the seasoned loan
exemption with the sunset provisions
on hedging and transfer enhances
consistency across the provisions of the
rule and better aligns the incentives of
sponsors and investors. The agencies do
not believe that the period of time
during which a loan is required to have
been outstanding to qualify as a
seasoned loan should be different from
the period after which the transfer and
hedging restrictions sunset. Nor do they
believe that loans that have at any time
been more than 30 days delinquent
should qualify. And, while
modifications of loans for reasons other
than loss mitigation might be wellunderwritten loans, it would be difficult
if not impossible to verify the
underlying reasons for a modification.
Commenters did not provide examples
of securitization transactions

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77673

collateralized by newly originated and
seasoned loans or data or reasoned
analysis to support the assertion that
such transactions would fill existing
needs for financing. Because the
agencies are not persuaded that market
fragmentation would result, the agencies
are not permitting blended pools of
seasoned loans and loans that would not
satisfy the seasoned loan exemption.
F. Federal Deposit Insurance
Corporation Securitizations
In the reproposal, the agencies
proposed an exemption from risk
retention for securitization transactions
that are sponsored by the FDIC, acting
as conservator or receiver under any
provision of the Federal Deposit
Insurance Act or Title II of the DoddFrank Act. For the reasons discussed in
the reproposal,229 the agencies continue
to believe that this exemption would
help ensure high quality underwriting,
and is in the public interest and for the
protection of investors.230 These
receivers and conservators perform a
function that benefits creditors in
liquidating and maximizing the value of
assets of failed financial institutions for
the benefit of creditors. Accordingly,
their actions are guided by sound
underwriting practices, and the quality
of the assets will be carefully monitored
in accordance with the relevant
statutory authority.
One commenter expressly supported
this exemption, noting, among other
things, that it would help the FDIC
maximize the value of assets in
conservatorship and receivership. For
the reasons noted above, the agencies
are adopting the FDIC securitization
exemption as reproposed.
G. Exemption for Certain
Resecuritization Transactions
In the reproposal, the agencies
proposed two different exemptions from
risk retention for certain ABS interests
issued in resecuritization transactions
(resecuritization ABS interests).231 The
first of these exemptions would have
applied to resecuritizations of asset
backed securities that met certain
specific conditions set forth in proposed
section 19(b)(5) (pass-through
resecuritizations). The second one
would have applied only to
resecuritizations of certain first pay
classes of mortgage backed securities
that met the requirements in proposed
229 See

Revised Proposal, 78 FR at 57978.
15 U.S.C. 78o–11(e).
231 See Revised Proposal, 78 FR at 57972–57974.
In a resecuritization transaction, the asset pool
collateralizing the ABS interests issued in the
transaction comprises one or more asset-backed
securities.
230 See

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations

section 19(b)(6) (first-pay-class
resecuritization). Under the reproposal,
sponsors of resecuritizations that were
not structured to meet the terms of one
of these two exemptions would have
been required to meet the credit risk
retention requirements with respect to
the resecuritization transaction unless
another exemption for the transaction
was available.
Under the section 19(b)(5) of the
reproposal, the resecuritization ABS
interests would have to be collateralized
solely by servicing assets and existing
ABS interests issued in a securitization
transaction for which credit risk was
retained as required under the original
proposal, or which was otherwise
exempted from credit risk retention
requirements (compliant ABS interests).
Second, the transaction would have to
be structured so that it involved the
issuance of only a single class of ABS
interests and provided for a pass
through of all principal and interest
payments received on the underlying
asset-backed securities (net of expenses
of the issuing entity) to the holders of
such class of ABS interests. The
agencies explained that because the
holder of a resecuritization ABS interest
structured as a single-class pass-through
security would have had a fractional
undivided interest in the pool of
underlying asset-backed securities and
in the distributions of principal and
interest (including prepayments) from
these underlying asset-backed
securities, a resecuritization ABS
interest meeting these requirements
would not alter the level or allocation of
credit and interest rate risk on the
underlying asset-backed securities. The
agencies had proposed this exemption
in the original proposal and did not
substantively alter it in the reproposal.
The agencies proposed to adopt this
exemption under the general exemption
provisions of section 15G(e)(1) of the
Exchange Act. The agencies noted that
a resecuritization transaction that
created a single-class pass-through
would neither increase nor reallocate
the credit risk inherent in the
underlying compliant ABS interests,
and that the transaction could allow for
the combination of asset-backed
securities collateralized by smaller
pools, and the creation of asset-backed
securities that may be collateralized by
more geographically diverse pools than
those that can be achieved by the
pooling of individual assets.
Under the first-pay-class
resecuritization exemption in proposed
section 19(b)(6), the agencies proposed
a limited resecuritization exemption
that would apply to certain
resecuritizations of residential

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mortgage-backed securities structured to
address prepayment risk, but that would
not apply to a structure that re-allocated
credit risk by tranching and
subordination. To qualify for this
proposed exemption, the transaction
would have to have been a
resecuritization of first-pay classes of
ABS interests, which were themselves
collateralized by first-lien residential
mortgages on property located in a
state,232 and which were issued in
transactions that complied with the risk
retention rules or were exempt from the
rule.233 The reproposal also would have
allowed a pool collateralizing the
exempted first-pay-class resecuritization
to contain servicing assets.
In addition, to qualify for the
exemption, any ABS interest issued in
the resecuritization would have had to
share pro rata in any realized principal
losses with all other ABS interests
issued in the resecuritization based on
the unpaid principal balance of such
interest at the time the loss was realized.
The transaction would have had to be
structured to reallocate prepayment risk,
and the proposed exemption
specifically would have prohibited any
structure which re-allocated credit risk
(other than credit risk reallocated only
as a consequence of reallocating
prepayment risk). The reproposal also
would have prohibited the issuance of
an inverse floater or any similarly
structured class of ABS interest as part
of the exempt resecuritization
transaction.234
232 Section 2 of the reproposed rule defined
‘‘state’’ as having the same meaning as in section
3(a)(16) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(16)). Thus, the ABS interests that
would be resecuritized in a transaction exempted
under this provision would have been required to
be collateralized by mortgages on properties located
in a state of the United States, the District of
Columbia, Puerto Rico, the Virgin Islands, or any
other possession of the United States. See Revised
Proposal, 78 FR at 57973.
233 The reproposal defined ‘‘first-pay class’’ as a
class of ABS interests for which all interests in the
class were entitled to the same priority of principal
payments and that, at the time of closing of the
transaction, were entitled to repayments of
principal and payments of interest prior to or prorata, except for principal-only and interest only
tranches that are prior in payment, with all other
classes of securities collateralized by the same pool
of first-lien residential mortgages until such class
has no principal or notional balance remaining. A
single class of pass-through ABS interests under
which an investor would have a fractional,
undivided interest in the pool of mortgages
collateralizing the ABS interests would have
qualified as a ‘‘first pay class’’ under this definition.
234 The reproposal defined ‘‘inverse floater’’ as an
ABS interest issued as part of a securitization
transaction for which interest or other income is
payable to the holder based on a rate or formula that
varies inversely to a reference rate of interest. The
exclusion from the proposed exemption of
transactions involving the issuance of an inverse
floater class addressed concerns with the high risk

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The agencies proposed the first-payclass resecuritization exemption in
response to comments on the original
proposal about liquidity in underlying
markets and access to credit on
reasonable terms.235 The agencies noted
that residential mortgage-backed
securities tend to have longer maturities
than other types of asset-backed
securities and to have high prepayment
risk. The agencies reasoned that the
exemption would help provide
investors with protection against
prepayment risk and greater certainty as
to expected life. The proposed
exemption, however, did not divide the
credit risk of the underlying assetbacked securities and therefore did not
give rise to the same concerns as CDOs
and other resecuritizations that involved
tranching of credit risk.236
The agencies proposed the first-payclass resecuritization exemption under
the general exemption provisions of
section 15G(e)(1) of the Exchange Act.
The agencies determined that the
provision was consistent with the
requirements of this section, given the
conditions established for the
exemption. In particular, the agencies
noted that the provision limited the
exemption to resecuritizations of firstpay classes of residential mortgagebacked securities, and that it applied
specific prohibitions on structures that
re-allocate credit risk, so it minimized
credit risk associated with the
resecuritized residential mortgagebacked securities and prevented the
transaction from reallocating existing
credit risk while addressing some of the
commenters’ concerns with regard to
liquidity and access to credit.237
The agencies received a number of
comments on the proposed
resecuritization exemptions. The
comments did not raise specific
objections or concerns with either of the
two proposed exemptions, but generally
urged regulators to expand the
exemptions to other types of structures
including those that re-tranche credit
risk. Commenters asserted that applying
risk retention to resecuritization of
asset-backed securities that are already
in the market, especially where the
interests are compliant ABS interests,
cannot alter the incentives for the
original sponsor of asset-backed
securities to ensure high-quality assets.
Other commenters stated that the lack of
a broad resecuritization exemption
would negatively affect markets by
of loss that has been associated with these
instruments. See Id. at 57974.
235 Id. at 57973.
236 Id.
237 Id.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
making it harder for investors to restructure and sell existing asset-backed
securities. A number of commenters
stated that the agencies should provide
an exemption for resecuritizations of
asset-backed securities that were issued
prior to the applicable effective date of
the rule. Still others expressed the view
that the agencies could develop an
exemption that would allow credit
tranching in resecuritized asset-backed
securities while limiting the scope of
such exemption, such as by excluding
actively managed pools, to address
agencies’ concerns regarding CDOs and
similar structures. The comments were
generally similar to comments received
on the original proposal.
The agencies have carefully
considered the comments received in
conjunction with the purposes and
requirements of the statute. As the
agencies noted in the reproposal,
sponsors of resecuritization transactions
have considerable flexibility in choosing
what ABS interests to include in the
underlying pool of securitized assets as
well as in creating the specific
structures. This choice of securities is a
type of underwriting choice with
respect to those securities for inclusion
in the underlying pool of securitized
assets. The agencies continue to
consider it appropriate, therefore, to
adopt rules that will provide sponsors
with sufficient incentive to choose ABS
interests that have lower levels of credit
risk and to not use a resecuritization to
obscure what might have been sub-par
credit performance of certain ABS
interests. The agencies also continue to
consider it appropriate to apply the risk
retention requirements to
resecuritization transactions generally
because resecuritization transactions
can result in a re-allocation of the credit
risk of the underlying ABS interest.
Such considerations are present
whether or not the original underlying
asset-backed securities were issued
prior to the applicable effective date of
these risk retention rules or are
compliant with the rule.238 The agencies
also note that section 15G of the
Exchange Act specifically contemplates
applying risk retention to
resecuritizations.239

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238 Section

15G of the Exchange Act would not
apply to asset-backed securities issued before the
applicable effective date of the agencies’ final rule,
and that as a practical matter, private-label assetbacked securities issued before the applicable
effective date of the final rule would typically not
be compliant ABS interests. Asset-backed securities
issued before the applicable effective date that meet
the terms of an exemption from the rule or that are
guaranteed by the Enterprises, however, could
qualify as compliant ABS interests.
239 See 15 U.S.C. 78o–11(a).

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Taking into account these
considerations, the agencies continue to
believe that requiring additional risk
retention as the standard for most
resecuritization transactions is
consistent with the intent of section 15G
of the Exchange Act, both in light of
recent history and the specific statutory
requirement that the agencies adopt risk
retention standards for CDOs, and
similar instruments collateralized by
asset-backed securities.240 The
comments received in response to the
reproposal did not raise any issues to
cause the agencies to expand the scope
of the exemptions for resecuritizations.
In particular, the agencies do not believe
that suggestions for distinguishing
‘‘typical’’ resecuritizations from CDOs
or other higher risk transactions could
be applied consistently across
transactions.
As a consequence, the agencies are
adopting the pass-through
resecuritization exemption in section
19(b)(5), as proposed in the reproposal.
This exemption will apply only if the
resulting resecuritization ABS interests
consist of only a single class of interests
and provides for a pass through of all
principal and interest payments
received on the underlying ABS
interests (net of expenses of the issuing
entity). The new ABS interests have to
be collateralized solely by servicing
assets and existing ABS interests issued
in a securitization transaction for which
credit risk was retained as required
under the rule, or which are otherwise
exempted from credit risk retention
requirements in the rule.
The agencies are also adopting as
proposed the exemption in section
19(b)(6). Thus, to qualify for this
exemption, the ABS interests issued in
the resecuritization must share pro rata
in any realized principal losses with all
other holders of ABS interests issued in
the resecuritization based on the unpaid
principal balance of such interest at the
time the loss is realized. The transaction
must be structured to reallocate
prepayment risk, and cannot re-allocate
credit risk (other than credit risk
reallocated as a collateral consequence
of reallocating prepayment risk). While
the agencies specifically invited
comment on whether the issuance of an
inverse floater as part of a first-pay class
resecuritization exemption would be
necessary to provide adequate
prepayment protection for investors, the
agencies received no specific response
to this question or comments on the
prohibition proposed on the issuance of
an inverse floater or any similarly
structured class of ABS interests as part
240 See

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of an exempt transaction under section
19(b)(6), and are adopting this
prohibition as part of the final rule.
H. Other Exemptions From Risk
Retention Requirements
1. Legacy Loan Securitizations
Some commenters on the original
proposal recommended an exemption
from risk retention for securitizations
and resecuritizations of loans made
before the applicable effective date of
the final rule, or ‘‘legacy loans,’’
asserting that risk retention would not
affect the underwriting standards used
to create those loans. After considering
the comments received on the original
proposal, the agencies did not propose
to provide an exemption from risk
retention for legacy loan securitizations
in the reproposal. The agencies did not
believe that such securitizations should
be exempt from risk retention, because
risk retention requirements are designed
to incentivize securitizers to select wellunderwritten loans, regardless of when
those loans were underwritten.
Furthermore, the agencies did not
believe that exempting securitizations of
legacy loans from risk retention would
satisfy the statutory criteria for an
exemption under section 15G(e) of the
Exchange Act.241
On the reproposal, the agencies
received comments from one financial
trade organization that again
recommended exempting securitizations
of legacy loans. This commenter
requested that the agencies provide a
legacy loan exemption, because in the
case of loans that were originated prior
to the adoption of the final risk
retention rules, it would not have been
possible to create those assets in
compliance with a regulatory scheme
whose precise terms were unknown at
the time of origination.
As the agencies stated in the
reproposal, the agencies do not believe
it is appropriate to exempt legacy loans
because the risk retention requirements
affect the quality of loans that are
selected for a securitization transaction.
Therefore, the agencies are not adopting
an exemption from risk retention for
legacy loan securitizations in the final
rule.
2. Corporate Debt Repackagings
Some commenters on the reproposal
urged the agencies to adopt an
exemption from risk retention for
‘‘corporate debt repackagings.’’ 242 One
241 See

15 U.S.C. 78o–11(e).
to commenters, corporate debt
repackagings are created by the deposit of corporate
debt securities purchased by the sponsoring
242 According

15 U.S.C. 78o–11(c)(1)(F).

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of these commenters recommended that,
as an alternative, the agencies create a
limited exemption for corporate debt
repackaging transactions that repackage
securities that could be sold directly to
investors without risk retention, and
that do not involve credit tranching.
This commenter also proposed
additional means of satisfying the risk
retention requirements in corporate debt
repackaging transactions, including the
retention of 5 percent of the underlying
securities in the repackaging
transaction, or the retention of 5 percent
of any class of securities issued in the
repackaging that is pari passu with the
securities being issued to the investors
in the transaction.
Consistent with the reproposal and for
the reasons discussed therein,243 the
agencies are not adopting an exemption
for corporate debt repackagings. As
stated in the reproposal, the agencies do
not believe an exemption is warranted
because the underlying assets (the
corporate bonds) are not asset-backed
securities. As the agencies stated in the
reproposal, regardless of the level of
credit risk a corporate debt issuer
believes it holds on its underlying
corporate bonds, the risk retention
requirement would apply at the
securitization level, and the sponsor of
the securitization should be required to
hold 5 percent of the credit risk of the
securitization transaction. The agencies
continue to believe that risk retention at
the securitization level for corporate
debt repackagings is necessary in order
to align the interest of the sponsor in
selecting the bonds in the pool and
structuring the terms of the ABS
interests with the interests of the
investors in the securitization.
One commenter requested a general
exemption for securitization
transactions in which collateral consists
primarily of unsecured direct
obligations of the sponsor or its
affiliates. The agencies are not adopting
any such exemption as this commenter
did not provide sufficient detail on
which to base such exemption.

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3. Securitizations of Servicer Advance
Receivables
Some commenters requested that the
agencies provide an exemption for
servicer advance receivables.244
According to these commenters, the
institution in the secondary market into a trust
which issues certificates collateralized by cash
flows on the underlying corporate debt securities.
243 See Revised Proposal, 78 FR at 57975.
244 According to this commenter, servicer
advance receivables are contractual rights that
entitle a servicer to reimbursement for advances
that it is required, under the terms of the servicing
agreements, to make for purposes of liquidity
enhancement.

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servicer advance facilities (‘‘SAFs’’)
pursuant to which these servicer
advance receivables are securitized
create the requisite levels of credit
enhancement through overcollateralization in the form of an equity
interest in the issuing entity, that is
subordinated to all other classes of ABS
interests issued by the issuing entity.
These commenters indicated that
securitizations of servicer advance
receivables should be exempted from
the risk retention requirements because
servicer advances are payments that a
servicer is required to make under the
terms of the servicing agreements, and
are not originated for purposes of
distribution in a securitization
transaction. These commenters also said
that the fundamental goal of risk
retention—the alignment of interests in
order to produce higher quality
underwriting standards—is not relevant
in these servicer advance receivable
securitizations, because these servicer
advance receivables do not represent an
extension of credit by a lender to a
borrower, and that there is no
underwriting criteria.
If the agencies declined to provide an
exemption, these commenters requested
that the agencies allow the equity
interests held by servicer-sponsors of
the SAFs to satisfy the risk retention
requirement, and to allow the equity
interest (in an SAF structured as a
revolving master trust) that supports all
series of ABS interests to qualify as a
risk retention option for revolving
master trusts.
The agencies are not adopting an
exemption from risk retention for SAFs.
The agencies believe that there is
insufficient data to justify granting this
specific exemption. Furthermore, the
agencies do not believe that there are
particular features of this type of
securitization that would warrant an
exemption under the factors that the
agencies must consider in section
15G(e) of the Exchange Act. However, as
discussed in Part III.B.2 of this
Supplementary Information, an SAF
that meets the final rule’s eligibility
requirements for the seller’s interest
option for revolving pool securitizations
may avail itself of that option.
Alternately, the sponsor of an SAF may
structure its equity interest in the trust
as an eligible horizontal residual
interest.

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V. Reduced Risk Retention
Requirements and Underwriting
Standards for ABS Interests
Collateralized by Qualifying
Commercial, Commercial Real Estate,
or Automobile Loans
As contemplated by section 15G of
the Exchange Act, the reproposal
included a zero risk retention
requirement, or exemption, for
securitizations consisting solely of
commercial loans, commercial real
estate (CRE) loans, and automobile loans
that met specific proposed underwriting
standards (qualifying assets). The
reproposal also would have allowed
sponsors to commingle qualifying and
non-qualifying assets of a similar type to
receive up to a 50 percent reduction in
the minimum required risk retention
amount.
While many commenters supported
the ability to blend pools of qualifying
and non-qualifying assets to obtain a
reduced risk retention amount,
commenters also requested that the
agencies reduce or remove the 50
percent limit on the reduction for
blended pools of commercial, CRE, or
automobile loans. Some commenters
claimed that the limit would be a
disincentive for sponsors to include
more qualifying assets in blended pools
(and thereby improve the overall quality
of the pool) once the 50 percent
threshold had been reached. In addition,
a comment was made that, because the
agencies would be imposing a risk
retention requirement on qualifying
assets if they exceeded 50 percent of the
pool, this would be contrary to the
overall proposed exemption for
qualifying assets. Other commenters
supported the limit on blended pools or
generally opposed allowing blended
pools of qualifying and non-qualifying
assets because of the concern that a
blended pool could facilitate the ability
of sponsors to obscure the credit quality
of the non-qualifying assets.
Under the reproposal, a sponsor of a
transaction with a blended pool would
have to provide disclosures to investors,
its primary Federal regulator, and the
Commission the manner in which the
sponsor determined the aggregate risk
retention requirement for the pool after
including qualifying assets, a
description of the qualifying and nonqualifying assets, and material
difference between them. Furthermore,
the reproposal would have required a
sponsor to either repurchase out of the
pool any qualifying asset found not to
meet the proposed underwriting criteria
after securitization or to cure the defects
to bring the loan into conformity with
the criteria. A few commenters

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
expressed concerns about the
repurchase and certification
requirements in the reproposal with
respect to pools containing qualifying
assets. A few commenters suggested
that, because of liability concerns,
sponsors should not be required to make
the proposed disclosures about
qualifying assets to investors. One of
these commenters also claimed that the
statutory language was drafted such that
such certifications should only be
applied to residential mortgages. The
commenter further asserted that
investors already receive sufficient
information about underlying collateral
in the other asset classes, such that the
proposed disclosures and certifications
would be an unnecessary burden, and
that investors were additionally
protected by the proposed buy back or
cure requirement for assets found to be
non-qualifying post securitization. The
commenter also asked for clarification
about how long a sponsor must
maintain records related to the proposed
disclosure and certification
requirements. A commenter also
requested that with respect to
automobile loan securitizations that the
proposed internal control certification
requirements be allowed to be
performed less frequently to reduce
burden.
The final rule retains the 50 percent
limit for blended pools for these three
asset classes. The agencies are
concerned that reducing the minimum
risk retention for blended pools to less
than 2.5 percent of the value of the ABS
interests would significantly weaken the
economic incentive for the sponsor to
ensure that the non-qualifying loans in
the pool are appropriately underwritten.
However, the agencies are allowing a
limited amount of blending, as
proposed, to increase the liquidity of
both qualifying and non-qualifying
assets by allowing these assets to be
securitized in the same pool.
The agencies are also adopting the
disclosure and certification
requirements with regard to
securitizations including qualifying
assets as proposed in the revised
proposal. As discussed in the revised
proposal,245 the agencies believe that
the disclosure and certification
requirements are important to
facilitating investors’ ability to evaluate
and monitor the overall credit quality of
securitized collateral, especially where
qualifying and non-qualifying assets are
combined. The agencies believe that
these transparency goals are essential to
the integrity of the exemption from risk
retention for qualifying assets. The
245 Revised

Proposal, 78 FR at 57986.

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agencies note that the record retention
requirement for certification and
disclosure in other parts of the rule is
three years after all ABS interests are no
longer outstanding.246 The agencies are
adopting the same standard for
certification and disclosures with
respect to the qualifying commercial,
CRE, and automobile loan exemptions
to remain consistent throughout the
rule. The agencies believe this
timeframe will allow for a sufficient
period for review by the Commission or
the sponsor’s Federal banking agency, as
appropriate.
The agencies note the concern
expressed by some commenters with
respect to all three of these asset classes
that, for the residential mortgage asset
class and QRM, a significant portion of
the existing market would qualify for an
exemption from risk retention, whereas
in proposing the underwriting standards
for qualifying commercial loans,
commercial real estate loans, and
automobile loans, the agencies proposed
conservative underwriting criteria that
would not capture an equivalent portion
of the respective markets. The agencies
observe that there is a homogeneity in
the securitized residential mortgage loan
market that does not exist for
commercial loan or commercial real
estate loan asset classes. Commercial
loans and commercial real estate loans
typically focus on a common set of
borrower and collateral metrics, but
they are individually underwritten and
tailored to a specific borrower or
property, and often contain terms
developed in view not only of the
borrower’s financial position but also
the general business cycle, industry
business cycle, and standards for
appropriate leverage in that industry
sub-sector. The agencies believe the
additional complexity needed to create
underwriting standards for every major
type of business in every economic
cycle would be so great that originators
would almost certainly be dissuaded
from attempting to implement them or
attempting to stay abreast of the
numerous regulatory revisions the
agencies would need to issue from time
to time to keep up with the changing
economic cycles or industries.
The reproposed underwriting
standards established a single set of
requirements, which are necessary to
enable originators, sponsors, and
investors to be certain as to whether any
particular loan meets the rule’s
requirements for an exemption. For the
agencies to expand the underwriting
criteria in the fashion suggested by some
commenters, the rule would need to
246 Sections

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accommodate numerous relative
standards. The resulting uncertainty of
market participants as to whether any
particular loan was qualified for an
exemption could undermine the
market’s willingness to rely on the
exemption.
While there may be more
homogeneity in the securitized
automobile loan class, the agencies are
concerned that attempting to
accommodate a significantly large share
of the current automobile loan
securitization market would require
weakening the underwriting standards
to the point where the agencies are
concerned that they would permit the
inclusion of low quality loans. For
example, the agencies note that current
automobile lending practices often
involves no or small down payments,
financing in excess of the value of the
automobile (which is itself an asset of
quickly declining value) to
accommodate taxes and fees, and a
credit score in lieu of an analysis of the
borrower’s ability to repay. These
concerns as to credit quality are
evidenced by the high levels of credit
support automobile securitization
sponsors build into their securitization
transactions, even for so-called ‘‘prime’’
automobile loans. Moreover, securitizers
from the automobile sector who
commented on the original proposal and
reproposal expressed no interest in
using any underwriting-based
exemptive approach that did not
incorporate the industry’s current
model, which relies almost exclusively
on matrices of consumer credit scores,
loan-to-value (LTV) ratios, and ‘‘on the
spot’’ borrower approval. One
commenter stated that the entire
underwriting process must occur while
the customer is at the dealership. As
was discussed in the reproposal, the
agencies are not persuaded that it would
be appropriate for the underwritingbased exemptions under the rule to
incorporate a credit score metric.247
Finally, commenters requested that
the agencies clarify that the requirement
that a depositor certify as to the
effectiveness of its internal supervisory
controls with respect to the process for
ensuring that assets that collateralize the
asset-backed securities are eligible for
an exemption does not impose an
obligation on sponsors to guarantee that
all assets meet all of the requirements to
be eligible for 0 percent risk retention.
As is indicated by the final rule’s
provision of a buyback option for noncompliant assets, the agencies do not
view the requirement as requiring that
the controls guarantee compliance.
247 Revised

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Rather, the process must be robust and
sufficient to enable the sponsor to
carefully evaluate eligibility.
A. Qualifying Commercial Loans

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The reproposal included definitions
and underwriting standards for
qualifying commercial loans (QCLs),
that, when securitized, would be
exempt from the risk retention
requirements. The proposed definition
of commercial loan generally would
have included any loan for business
purposes that was not a commercial real
estate loan or one-to-four family
residential real estate loan.
The proposed criteria for a QCL
included determining compliance with
the following financial tests based on
two years of past data and two years of
projections: a total liabilities ratio less
than or equal to 50 percent; a leverage
ratio 248 of less than or equal to 3.0x; a
debt service coverage (DSC) ratio of
greater than or equal to 1.5x. A QCL
would need to base loan payments on a
straight-line amortization schedule over
no more than a 5-year term. Additional
standards were proposed for QCLs that
are collateralized, including lien
perfection and collateral inspection
standards.249
Commenters generally asserted the
proposed criteria were too strict in one
or more areas. One commenter claimed
that the QCL exemption would have no
relevance for securitizations of
commercial loans because loans that
would satisfy the proposed QCL criteria
typically would not be securitized and
that the agencies did not seriously
attempt to consider the historical
performance of the asset class. Some
commenters also supported the
submission by other commenters to
allow syndicated loans meeting certain
criteria, when held by CLOs meeting
certain other structural criteria, to be
exempt from risk retention, as discussed
above in Part III.B.7 of this
Supplementary Information.
Some commenters requested that the
agencies create multiple types of QCL
underwriting criteria to address
different industries or different types of
commercial loans, for example,
establishing separate criteria for vehicle
fleet loans or equipment loans in order
to exempt loans meeting such criteria
from risk retention. These commenters
248 Under the reproposal, the leverage ratio would
have been defined as the borrower’s total debt
divided by the borrower’s annual income of a
business before expenses for interest, taxes,
depreciation and amortization are deducted, as
determined in accordance with GAAP. See section
14 of the revised proposal (definition of ‘‘leverage
ratio’’).
249 See Revised Proposal, 78 FR at 57979.

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asserted that the securitizations of
equipment loans have performed well
before, during, and after the financial
crisis and that such loans should
therefore have their own asset class and
underwriting criteria to qualify for an
exemption.
Commenters also suggested that the
agencies relax the proposed QCL
standards in various ways, including by:
Removing the straight-line amortization
criterion; increasing the maximum
amortization period beyond 5 years (up
to 15 or 20 years); allowing payment-inkind loans; reducing retention for
debtor-in-possession situations and
loans resulting from Chapter 11 exit
financings; increasing the leverage ratio
to 4.5 or less; and replacing the leverage
ratio with a 60 percent or 50 percent
debt-to-capitalization ratio. One
commenter also urged the agencies to
require a valuation such as a qualified
appraisal for all collateralized QCLs,
noting that other proposed criteria—
such as requiring a perfected security
interest for secured commercial loans—
would be of limited utility without a
valuation requirement.
For the subsequently discussed
reasons, the agencies are adopting the
QCL standards as proposed. While the
agencies recognize that there are many
types of commercial loans to serve many
types of industries and companies, it
would be impracticable to accommodate
each category of loan and industry with
a unique set of underwriting criteria.
Even applying a different set of criteria
to a broader category within commercial
loans, such as equipment loans, would
be under- and over-inclusive and could
have unintended consequences for the
alignment of interests of sponsors and
investors. Furthermore, as the different
industries and economic conditions in
which they operate change over time,
such regulatory underwriting criteria
could influence originations in
unintended ways. In developing the
underwriting standards for the
reproposal, the agencies intended for
the standards to be reflective of very
high quality loan characteristics for
most commercial borrowers. To the
extent that a commercial loan is
securitized, the agencies believe that
risk retention provides an appropriate
incentive to sponsors to carefully
consider the underwriting quality of the
loans being securitized; therefore, only
those commercial loans that are of very
high quality should be exempt from risk
retention. The agencies have concluded
that the proposed high quality
underwriting standards are appropriate
for QCLs generally, even if the standards
do not correspond to the profile of loans
generally securitized in CLOs. While

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some commercial loans are structured as
bullet or interest-only loans, the
agencies determined that such loans are
not appropriate for QCL given the
deferral of principal repayment until
maturity, which can overstate the
borrower’s repayment capacity as
measured by the DSC ratio (due to a lack
of principal payments) and increase
default risk related to having to
refinance a larger principal amount at
maturity.
While commercial loans do exist with
longer terms than the maximum
permitted under the underwriting
criteria, the agencies do not believe such
long-term commercial loans are
common, and they involve more
uncertainty about continued repayment
ability, particularly when loans are
made without collateral. With respect to
payment-in-kind loans, the agencies
observe that these loans are generally
riskier loans, as borrowers may not be
paying any interest in cash over part or
all of the loan term. Therefore, the
agencies do not believe it is appropriate
to incorporate the changes requested by
commenters with respect to term and
payment-in-kind in the QCL
underwriting criteria.
The agencies also continue to favor
the reproposed earnings-based leverage
ratio, as opposed to a capitalization
ratio, to measure the ability of a
borrower to service the debt and thus
help determine the consequent riskiness
of a loan. Finally, while a commercial
lender should consider the accuracy of
valuation of collateral to the extent it is
a factor in the repayment of the
obligation, the agencies are declining to
impose a requirement of a qualifying
appraisal or other particular valuation
for collateral securing a QCL. The
agencies observe that many types of
collateral could be pledged to secure a
commercial loan and, therefore,
mandating particular valuation methods
could be very complex and
unintentionally exclusive, thereby
discouraging secured loans, which are
frequently safer as credits than
unsecured loans and therefore provide
additional avenues for funding for many
borrowers. Additionally, a valuation
requirement would increase the burden
associated with underwriting a QCL.
In addition to the underwriting
criteria discussed above, in the
reproposal, the agencies proposed that
all QCLs must be funded prior to the
securitization and that the securitization
not allow for any reinvestment periods.
In addition, if a loan was subsequently
found not to have met the QCL criteria,
the sponsor would have been required
to effect a cure or buyback of the loan.

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One commenter requested that the
agencies allow QCL loans to be funded
up to six months after the issuance of
the securitization. Some commenters
also requested that the agencies allow
QCL securitizations to have
reinvestment periods, so long as the
new loans added to the pool would
either be QCLs or not reduce the QCL/
non-QCL blended pool ratio below 50
percent. Finally, some commenters
opposed the buyback provision, noting
that open market CLO managers
designated as sponsors under the rule
are thinly capitalized and generally
would not have significant financial
resources available to buy back loans in
the pools they manage.
The agencies are not adopting these
commenter suggestions in the final rule.
The agencies believe that only funded
loans should be recognized as QCLs for
purposes of exemption from risk
retention, as there could be an adverse
change in circumstances between the
closing date of the securitization and a
subsequent funding date for the loan
that could disadvantage investors.
Furthermore, changes in circumstances
could mean the loan may not meet the
quantitative QCL requirements upon
funding. The agencies also decline to
allow reinvestment periods for
securitizations including QCLs. As
discussed herein and in the revised
proposal, there are increased concerns
about transparency when qualifying and
non-qualifying assets are mixed in a
pool and an exemption from risk
retention applies to the qualifying
assets. Allowing reinvestment in
addition to allowing blending of
qualified and non-qualified assets could
exacerbate these concerns and could
allow sponsors to increase the risk of an
initial pool that had a significant
portion of QCLs in ways that would be
difficult for investors to discern postclosing. Finally, the agencies are not
removing the buyback requirement
where QCLs are subsequently found not
to have met the underwriting criteria at
origination. The agencies do not believe
that lack of financial resources of the
sponsor should excuse the sponsor from
meeting its obligations to ensure a loan
labelled a QCL at origination met the
QCL requirements. In addition, the rule
allows certain underwriting errors to be
addressed through cure, which would
not require repurchase of the entire loan
out of the pool and thus could be less
financially burdensome for the sponsor.
B. Qualifying Commercial Real Estate
Loans
Both the original and the revised
proposals included underwriting
standards for CRE loans that would be

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exempt from risk retention if the loans
met those standards (qualifying CRE
loans, or QCRE loans). As discussed in
the revised proposal, the agencies made
a number of changes to the QCRE
standard in the reproposal to address
concerns raised by commenters with
respect to the original proposal. The
proposed standards focused
predominantly on the following criteria:
The borrower’s capacity to repay the
loan; the value of, and the originator’s
security interest in, the collateral; the
LTV ratio; and, whether the loan
documentation includes the appropriate
covenants to protect the value of the
collateral.
1. Definition of Commercial Real Estate
Loan
In the reproposal, a CRE loan would
have been defined as any loan secured
by a property of five or more residential
units or by non-residential real
property, where the primary source of
repayment would come from the
proceeds of sale or refinancing of the
property or underlying rental income
from entities not affiliated with the
borrower. The definition would have
specifically excluded land loans.
Some commenters questioned the
exclusion of certain land loans from the
definition of CRE in the original and
revised proposals. Specifically, these
commenters stated that numerous
CMBS securitizations include loans to
owners of a fee interest in land that is
ground leased to a third party who owns
the improvements and whose ground
lease payments are a source of income
for debt service payments on the loan.
These commenters suggested that the
agencies clarify that the exclusion did
not apply to such loans, because these
loans are included in many existing
CMBS securitizations and the entire
securitization would be unable to use
CMBS risk retention option due to these
loans being excluded from the CRE
definition.
As explained in the revised proposal,
the agencies did not take commenters
suggestion to include some land loans
in the definition of commercial real
estate because of concerns, among other
things, that separation of ownership
between land and buildings could
complicate servicing and foreclosure.250
However, having carefully considered
comments on this point following the
reproposal, the agencies have decided to
modify the definition of commercial real
estate in the final rule to address
commenters’ concerns about these land
loans. The agencies have concluded that
excluding these ground-leased land
250 See

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77679

loans on improved property from the
definition is not warranted and so have
explicitly included them in the
definition of commercial real estate so
that these loans may qualify as QCRE
loans if they otherwise meet the
qualifying criteria, or alternatively, may
be included with pools of other CRE
loans to allow the sponsor to use the
third-party purchaser form of risk
retention discussed in Part III.B.5 of this
Supplementary Information.
2. Single Borrower Underwriting
Standard
Commenters generally supported the
reproposed exemption from risk
retention for QCRE loans. However, as
discussed further below, many
commenters stated that the proposed
underwriting criteria were too strict and
requested that the agencies modify the
QCRE loan criteria to allow more loans
to qualify for the exemption. In
addition, some commenters requested
that the agencies expand the QCRE loan
criteria for, or provide an additional
QCRE loan exemption for, singleborrower or single-credit (SBSC)
transactions involving a securitization
of cross-collateralized loans provided to
one or more related borrowers.
Commenters stated that these
transactions warranted an exemption
because they typically have had stronger
historical performance than non-SBSC
CMBS transactions and due to market
practice, few or none would qualify as
a QCRE loan. In addition, commenters
asserted that B-piece buyers have not
historically been involved in these
transactions because of the limited
number of loans involved. Commenters
also asserted that these transactions are
particularly transparent to investors
because they involved only a few, large
loans (as compared to other CMBS
transactions) and investors typically
receive granular information with
respect to the loans. Commenters
asserted that risk retention for these
structures would cause costs to increase
and possibly reduce access to credit for
some companies without a
commensurate increase in investor
protection, given the nature of the loans
involved and transparency to investors.
One commenter proposed that the SBSC
exemption rely exclusively on extensive
disclosure about the securitization
structure and loans in the structure
rather than quantitative underwriting
criteria. Commenters also proposed that
only larger SBSC deals (over $200
million in ABS interests issued) be
exempted from risk retention to reduce
the possibility that the exemption
would be used to effectively exempt a
significant section of the market.

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The agencies have carefully
considered the commenters’ requests for
separate QCRE loan criteria for SBSC
transactions. Having reviewed
information provided by commenters as
well as other information related to this
market, the agencies have concluded
that it would not be appropriate to
adopt separate QCRE loan underwriting
criteria for SBSC transactions. An SBSC
transaction may qualify for an
exemption from risk retention, like
other CMBS transactions, to the extent
the securitized loans qualify as QCRE
loans, and the regulators do not believe
there is sufficient support to justify
establishing separate underwriting
criteria for SBSC transactions. The
agencies have not concluded that SBSC
transactions as a category are of
sufficiently low risk to warrant a special
exemption from risk retention. While
most CMBS transactions involve
diversifying risk across types of
properties, SBSC transactions generally
focus on one specific type of property
(for example, loans on properties related
to one brand of hotel), which potentially
concentrates and increases credit risk as
compared with a diversified CMBS
securitization. In addition, because of
the cross-collateralization or crossdefault provisions in these deals and the
reliance on a single borrower, the failure
of one loan in a deal could cause a
default of the entire securitization.
Furthermore, the agencies are
concerned that it would be difficult to
construct a definition that captures an
SBSC transaction in a way that would
address the commenters’ concerns while
also being sufficiently limited in scope
to prevent widespread use of the option
in a manner that would undermine
consistent application of the rule for
CMBS transactions. The agencies are
further concerned that using a deal size
threshold to reduce inappropriate use of
the option could be unnecessarily
arbitrary and restrictive for smaller
borrowers without providing sufficient
regulatory benefit. Additionally, the
agencies are concerned that such a
definition would inadvertently lead to
exempting from risk retention CMBS
transactions with lower quality
underwriting than intended by the
exemption and less stringent crosscollateralization or cross-default
features, as well as other criteria
historically associated with SBSC
transactions.
In addition, the agencies have
concerns that the commenters’
suggested conditions for which
transactions would qualify as a singleborrower transaction or as a singlecredit transaction would allow for
widespread structural evasion of the

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rule. A sponsor could easily structure a
CMBS transaction in which the single
asset is a mortgage loan secured by
multiple properties or in which the
single borrower is an SPV formed by an
entity that wants to finance a portfolio
of unrelated properties.
Finally, the agencies note, as
discussed further below, that the criteria
for QCRE loans has been modified in the
final rule to provide some additional
flexibility.
3. Proposed QCRE Loan Criteria
As discussed above, the agencies
adjusted some of the QCRE loan
underwriting criteria as set forth in the
original proposal in response to
commenter concerns. The agencies
generally reproposed the original
structure of the qualifying criteria,
divided into four categories: ability to
repay, loan-to-value requirement,
valuation of the collateral, and risk
management and monitoring. These
sections and their associated comments
are discussed below.
The agencies received some
comments that were generally
supportive of the QCRE loan criteria in
the reproposal and that requested that
the agencies not loosen the criteria
further because of concerns of the effect
that could have on lender behavior, to
the detriment of investors in CMBS
transactions. One commenter in
particular supported the collateral
valuation requirements with respect to
appraisers.
A number of commenters said the
QCRE loan criteria were generally too
conservative, noting that only a small
number of commercial real estate loans
would meet the criteria and that the
exemption from risk retention for QCRE
loans would be rendered impractical for
most sponsors, thereby eliminating
incentives to originate QCRE loans and
possibly causing funding problems,
including for multifamily loans if the
Enterprises were to stop providing
funding. One commenter claimed that
because the QCRE loan criteria is
narrow and many CMBS transactions
would be subject to risk retention, this
could cause rents to rise in the
multifamily sector and slow down job
creation.
Some commenters asserted that a
much lower percentage of commercial
real estate loans would qualify as QCRE
loans than residential mortgages would
qualify as QRMs under the reproposal,
and generally recommended that the
QCRE loan criteria be crafted to capture
a portion of the market similar to that
portion of the residential mortgage
market captured by the QRM definition.
Another commenter suggested that the

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agencies modify the QCRE loan criteria
to follow metrics ‘‘more typical’’ of
balance sheet lenders such as insurance
companies and commercial banks.
Another commenter asserted that the
proposed QCRE loan criteria would
introduce interest rate sensitivity into
the CMBS market where it does not
currently exist. A few commenters
requested that the agencies consider
distinct QCRE loan underwriting
standards for different commercial real
estate sectors. For example, a
commenter urged the agencies to allow
for a higher loan-to-value ratio for
multifamily loans than allowed under
the reproposed QCRE loan criteria.
Many of the commenters who
generally opposed the proposed QCRE
loan definition had specific critiques or
suggestions related to each of the
categories of QCRE loan criteria, as
discussed below.
4. Ability To Repay Criteria and Term
Like the original proposal, the
reproposal included a number of criteria
that would relate to the borrower’s
ability to repay in order for a loan to
qualify as a QCRE loan. The borrower
would have been required to have a DSC
ratio of at least 1.25x for qualifying
multi-family property loans,251 1.5x for
qualifying leased QCRE loans,252 and
1.7x for all other commercial real estate
loans. The reproposed standards also
would have required reviewing two
years of historical financial data and
two years of prospective financial data
of the borrower. The loan would have
been required to have either a fixed
interest rate or a floating rate that was
effectively fixed under a related swap
agreement. The loan documents also
would have had to prohibit any deferral
of principal or interest payments and
any interest reserve fund, resulting in
excluding interest-only loans from
qualifying as QCRE loans.
The reproposal included a maximum
amortization period of 25 years for most
commercial real estate loans, and 30
years for qualifying multi-family loans,
with payments made at least monthly
for at least 10 years of the loan’s term.
Furthermore, payments made under the
251 Under the reproposal, a ‘‘qualifying multifamily loan’’ would be, generally, a commercial real
estate loan secured a residential property with five
or more residential dwellings and where at least 75
percent of the net operating income is derived from
residential units and tenant amenities, but not other
uses. See Revised Proposal, 78 FR at 58038.
252 Under the reproposal, a qualifying leased
commercial real estate loan generally means a
commercial real estate loan secured by nonfarm real
property (other than multi-family and hotel
properties) that is occupied by tenants meeting
certain criteria. See Revised Proposal, 78 FR at
58038.

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loan agreement would be required to be
based on a straight-line amortization of
principal and interest over the
amortization period (up to the
maximum allowed amortization period,
noted above). The minimum loan term
could be no less than 10 years and no
deferral of repayment of principal or
interest could be permitted.
A number of commenters objected to
the agencies’ reproposed DSC ratios as
too conservative, or suggested
eliminating or changing the DSC ratio
criteria. Some commenters suggested
lowering qualifying DSC ratios to a
range between 1.25x and 1.5x, or
establishing criteria similar to those
used by Fannie Mae or Freddie Mac to
fund multifamily real estate loans.
However, a commenter expressed
concern that the reproposed QCRE loan
criteria unduly loosened the standard
and supported increasing the DSC ratio
to 2.4x. A commenter claimed that the
DSC and LTV criteria, without taking
into consideration other characteristics
of a property, would lead to an
inappropriate assessment of risk, and
that each commercial real estate
property has a unique risk profile.
Some commenters supported
removing the proposed requirement to
examine two years of past borrower data
or replacing it with two years of
property data, as they stated that many
new CRE loans involve stabilized
properties purchased by new SPVs and
the SPVs would not have two years of
historical data. In addition, as these
loans are generally non-recourse (or are
made to SPVs whose only asset is the
subject real estate), only the property
and income stream from the property
are available to satisfy the loan
obligation.
Many commenters supported the
requirement for fixed interest rate loans
for QCRE loans. However, some
commenters suggested expanding the
types of derivatives allowed to convert
a floating rate into a fixed rate through
a rate cap derivative. Some commenters
also supported the restrictions on
deferrals of principal and interest.
However, other commenters supported
allowing interest-only loans if those
loans had a lower LTV ratio (such at 50
percent).
Many commenters objected to the
minimum length and amortization of
QCRE loans. These commenters said
that 3, 5, and 7-year CRE loans have
become common in the industry, and
therefore asserted that the proposed
minimum 10-year term criterion would
inappropriately disqualify numerous
loans without much regulatory benefit.
A commenter asserted, for example, that
default and delinquency data

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demonstrates that loan term does not
materially factor into or increase the
likelihood of loss for CMBS investors.
Another commenter asserted that the
loss rate for shorter term loans is better
than for 10-year loans. For similar
reasons, these commenters also
supported a longer amortization period
for QCRE loans, up to 30 years. Other
commenters, however, requested that
the agencies continue to disqualify
interest-only loans from QCRE loans
and also to maintain the minimum term
at 10 years.
After carefully considering the
comments on the underwriting criteria
for QCRE loans, the agencies are
adopting in the final rule QCRE loan
criteria similar to those in the
reproposal, with some modifications to
address some commenter concerns. The
agencies are not changing the DSC ratios
from the reproposal, because the
agencies believe reducing these
requirements would inappropriately
allow riskier loans to qualify for a
complete exemption from risk retention.
As noted in the reproposal, these
criteria are consistent with the Federal
banking agencies’ historical standards
for conservative CRE lending.253
The agencies are also retaining the
requirement not to include interest-only
loans or loans with interest-only periods
as QCRE loans. The agencies believe
that interest-only loans or interest-only
periods distort assessment of repayment
ability, increase risk at maturity due to
lack of principal reduction, and may
present increased credit risk, even with
a lower LTV ratio and, accordingly,
would be inappropriate for qualifying
CRE loan treatment.
With respect to maximum
amortization periods, the agencies are
aware that there are many nonmultifamily CRE loans with
amortization periods in excess of 25
years. However, allowing a longer
amortization period for these loans
reduces the amount of principal paid
each month on the loan before maturity,
which can increase risks related to
having to refinance a larger principal
amount than would be the case for a
loan with a shorter amortization period.
Because the agencies believe that loans
with a maximum 25-year maturity
reflect more stringent underwriting, and
believe that exemptions from risk
retention should be available only for
the most prudently underwritten CRE
loans, the agencies are adopting an
amortization period of 30 years for
253 These standards include the ‘‘Interagency
Guidelines for Real Estate Lending.’’ 12 CFR part
34, subpart D, Appendix A (OCC); 12 CFR part 208,
subpart C, Appendix A (FRB); 12 CFR part 365,
Appendix A (FDIC).

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multifamily residential QCRE loans and
25 years for all other QCRE loans. The
agencies are also making a technical
change from requiring straight-line
amortizing payments to level payments
of principal and interest.
The agencies are also adopting a 10year minimum maturity for QCRE loans.
The agencies believe that loans with
terms shorter than 10 years, such as
three, five, or seven years, may create
underwriting incentives not
commensurate with the high credit
quality and low risk necessary for a loan
to qualify as a QCRE loan. For example,
when making a shorter term loan, an
originator may focus only on a short
timeframe in evaluating the stability of
the real estate underlying the loan in an
industry that might be at or near the
peak of its business cycle. In contrast, a
10-year maturity CRE loan requires
underwriting through a longer business
cycle for the property, including
downturns that may not be captured
appropriately when underwriting to a
shorter time horizon.
In response to comments on lack of
data availability for new loans to SPVs
that recently purchased property, the
agencies are making modest adjustments
to the QCRE loan criteria to facilitate
loans to such borrowers. Therefore, the
final rule allows originators to use two
years of historical data from the
property, when the property has two
years of operating history.254 Under this
revised standard, properties with less
than two years of operating history
would still be excluded from the QCRE
loan standards because new properties
present significant additional risks and
loans on those properties generally
should not be exempt from risk
retention.
Similar to the reproposal, the final
rule requires that the interest rate on a
QCRE loan be fixed or convertible into
a fixed rate using a derivative product.
However, in the final rule, the agencies
have expanded the allowable
derivatives to include interest rate cap
derivatives, provided that the loan is
underwritten based on the maximum
interest rate allowable under the cap,
even if the loan is originated at a lower
rate. The agencies are not proposing to
allow other types of derivatives because
they have concluded they are
insufficiently transparent for a QCRE
loan standard.
5. Loan-to-Value Requirement
The revised proposal would have
required that the combined loan-to254 In the CRE lending context, a sponsor is the
party that ultimately controls the property, such as
by owning an SPV, which in turn owns the CRE.

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value (CLTV) ratio for first and junior
loans for QCRE loans be less than or
equal to 70 percent and the LTV ratio
for the first-lien loan be less than or
equal to 65 percent; or that the CLTV
and LTV ratios be less than or equal to
65 and 60 percent, respectively, for
loans with valuation using a
capitalization rate below a certain
threshold, as set forth in the
reproposal.255 As discussed in the
reproposal, the agencies concluded that
these criteria would be appropriate for
high quality commercial real estate
loans and to help protect securitization
investors against losses from declining
property values and potential defaults
on the CRE loans.256
Many commenters recognized that
LTV standards are important to ensuring
high quality CRE loan underwriting.
While some commenters supported the
agencies’ proposed ratios, others
asserted that they were too conservative.
Some commenters suggested that higher
LTV ratios (generally up to 70 percent)
should be allowed in the QCRE loan
standards, that the CLTV ratio cap be
removed, and that the reduction in LTV
and CLTV ratios for loans with certain
valuation assumptions be removed.
Others, however, suggested more
conservative maximum LTV ratio
criteria, including a 50 percent LTV
ratio suggestion for interest-only loans,
if they were to be permitted in the QCRE
loan criteria by the agencies. One
commenter indicated that the highest
quality loans secured in CMBS tended
to have lower LTV ratios than would be
permitted for the QCRE loan standard,
and expressed concern that the agencies
may not have been conservative enough
in the reproposal.
The agencies have considered the
comments on LTV and CLTV ratio
requirements for QCRE loans and are
adopting the standards as reproposed.
The agencies agree with those
commenters who generally supported a
65 percent LTV ratio requirement.
While the agencies are not adopting a 70
percent LTV ratio requirement, the 65
percent LTV ratio requirement still
allows for 70 percent debt financing
with up to 5 percent subordinated
financing. As discussed in the
reproposal, the agencies observe that the
more equity a borrower has in a CRE
project, the lower the lender or
investor’s exposure to credit risk and
the greater the incentive for the
borrower to perform on the loan.
Overreliance on excessive subordinated
financing instead of equity financing for
a CRE property (which increases CLTV
255 Revised
256 Revised

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Proposal, 78 FR at 57982.

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ratios) can significantly reduce the cash
flow available to the property, as
investors in subordinated finance often
require high rates of return to offset the
increased risk of their subordinate
position. The agencies have concluded
that a 70 percent CLTV ratio cap is
generally appropriate for a low risk
QCRE loan standard, which would
require the borrower to have at least 30
percent equity in the project to help
protect securitization investors against
losses from declining property values
and potential defaults.
The agencies decline the commenters’
suggestion to reduce the maximum LTV
ratio requirement for all QCRE loans, as
65 percent is sufficiently conservative
for a QCRE loan standard given the
other conservative underwriting
requirements in the rule. The agencies
also decline to adopt a 50 or 55 percent
LTV ratio requirement for interest-only
loans. As discussed above, the agencies
believe interest-only loans, even at
lower LTV ratios, present significant
risks that would not meet an
appropriately conservative QCRE loan
underwriting standard.
The agencies are also retaining the
requirement that the maximum LTV and
CLTV ratios be lowered by 5 percent
under certain appraisal conditions, as in
the reproposal, with minor technical
modifications to address commenter
concerns. The ratios are only reduced if
the appraisal used to qualify the CRE
loan as a QCRE loan used an income
approach with a direct capitalization
rate, and that rate was lower than the
rate permitted by the final rule. The
final rule text clarifies that the appraisal
used to qualify the CRE loan is not
required to use a direct capitalization
rate. Generally, as direct capitalization
rates decline, values increase. In a lower
cap rate environment there is an
increase in the amount that can be
borrowed given a fixed LTV or CLTV
ratio, which is why the lower LTV and
CLTV ratios would apply. In addition,
to address concerns about appraisals
using excessively high cap rates, the
agencies are requiring that if a direct
capitalization rate was used in an
appraisal to qualify the loan as a QCRE
loan, the rate must be disclosed to
investors in the securitizations.
6. Collateral
The agencies proposed to require an
appraisal and environmental risk
assessment for every property serving as
collateral for a QCRE loan. Commenters
strongly supported both the appraisal
and environmental risk assessment for
all QCRE loan properties. Many
commenters indicated this is already
standard industry practice. A few

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commenters expressed the view that the
agencies were too strict in requiring
specific types of appraisals, such as an
income-based appraisal using a
discounted cash flow and an appraisal
using a direct capitalization rate, rather
than allowing a certified appraiser to
determine the appropriate valuation
method. As noted above, the agencies
have made clarifications in the final rule
to provide originators and appraisers
with more flexibility in determining the
appropriate appraisal approaches for a
specific property that would be used to
meet the QCRE loan standards, while
not restricting appraisers from using
other valuation methods that they
believe are appropriate for the property.
The agencies also made a technical
change in the final rule to reflect the
common appraisal terminology and
Uniform Standards of Professional
Appraisal Practice terminology for the
income approach that is required to be
in the written appraisal.
7. Risk Management and Monitoring
The reproposal would have required
lenders to obtain a first lien in the
property and limited the ability to
pledge the property as collateral for
other loans. While many commenters
supported the first-lien requirement,
one commenter supported allowing
unlimited junior liens to finance energyefficient improvements on the CRE
property subject to the loan. A
commenter requested that the agencies
modify the proposed QCRE loan criteria
to take into account pari passu and
junior lien loans, noting that such
modifications would not increase the
risk of QCRE loans. Some commenters
supported the requirement that a
borrower obtain insurance on the
property up to the property value, while
other commenters requested that the
requirement be changed to require
insurance up to the lesser of the
replacement cost of the property
improvements or the loan balance.
The agencies are adopting the lien
requirements as proposed. While
energy-efficient improvements may
reduce utility expenses associated with
the property, the agencies do not wish
the rule to facilitate structures whereby
additional financing, even if
subordinate, is obtained and thus
increases leverage on the property.
Regarding the insurance amount, the
agencies have concluded that a strong
QCRE loan standard would be
maintained if the insurance limit in the
criteria was changed to no less than the
replacement cost of property
improvements, in accordance with more
customary market practice. After
reviewing the related comment, the

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agencies determined that loan balance
was not an appropriate measurement as,
in some jurisdictions, a lender may be
required to make insurance proceeds
available to a borrower and, in those
circumstances, a prudent lender would
wish to make sure that the proceeds are
sufficient to fully repair or replace the
insured property.
C. Qualifying Automobile Loans
Similar to the original proposal, the
revised proposal included underwriting
standards for automobile loans that
would be individually exempt from risk
retention (qualifying automobile loans,
or QALs) if securitized. As in the
original proposal, the definition of
automobile loan in the reproposal
generally would have included only
first-lien loans on light passenger
vehicles employed for personal use. It
specifically excluded loans for vehicles
for business use, medium or heavy
vehicles (such as commercial trucks and
vans), lease financing, fleet sales, and
recreational vehicles including
motorcycles. As explained in the
reproposal, the agencies did not follow
recommendations to propose including
loans on vehicles more frequently used
for recreational purposes, such as
motorcycles or business purposes,
because the risks and underwriting of
those loans would be different than that
for vehicles used for personal use. In
addition, the reproposed definition did
not include automobile leases because,
as the agencies explained, leases
represent a different set of risks to
securitization investors than purchase
loans. For example, automobile resale
price at the end of the lease period can
affect the securitization cash flow,
which is not the case for purchase loan
securitizations.257
While some commenters supported
the reproposed definition of automobile
loan, others asserted that it continued to
be too narrow. Several commenters
suggested expanding the definition to
include motorcycles, because often they
are not used solely as recreational
vehicles but as primary transportation
and because, as these commenters
asserted, motorcycle loans perform as
well as auto loans. The commenters
asserted that there would be no reason
to categorically exclude motorcycles
from the QAL definition, even if they
could otherwise meet the QAL criteria,
by excluding motorcycles from the
definition of automobile loan. They also
contended that the fact some
motorcycles are used for recreational
use does not lead to adverse motorcycle
loan performance.
257 See

Revised Proposal, 78 FR at 57983.

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Other commenters supported
allowing automobile leases to qualify as
QALs and recommended certain
technical changes to the proposed QAL
criteria. In particular, one commenter
supported expanding the definition to
include fleet purchases or fleet leasing,
on the basis that these leases or sales are
generally with corporations or
government entities with strong
repayment histories.
Another comment on the definition of
automobile loan raised concerns that it
would be difficult for an originator to
determine whether an automobile
purchase was for consumer or nonconsumer use.
The agencies have carefully
considered these comments and are
adopting the definition of automobile
loans for QAL underwriting standards
as reproposed. The agencies believe it
continues to be appropriate to restrict
the definition of automobile loan to
light passenger vehicles employed for
personal use, not including motorcycles
and other vehicles that are commonly
used for recreational purposes, as well
as everyday personal transportation.
While the agencies acknowledge some
motorcycle loans may have strong
underwriting and risk characteristics
similar to those of automobile loans, the
agencies have concluded that overall
risk profile of motorcycles as a class
remains distinct from that of
automobiles and, like other recreational
vehicles, exhibit overall a higher risk
profile. Certain recreational vehicles
may also be highly customized before or
after purchase, which may reduce resale
or recovery value in case of borrower
default.
The agencies also have decided not to
expand the definition of automobile
loan to include vehicles used for
business purposes through fleet loans,
as the risks and underwriting of such
loans differ from those of vehicles used
for personal transportation. For
example, a car or truck used in a
business may endure significantly more
wear and depreciate much faster than a
vehicle used only for normal household
use.
Similarly, for the reasons discussed in
the reproposal, the agencies are not
expanding the definition of automobile
loan to include automobile leases. The
agencies remain concerned that the
credit risks posed by leases are different
than automobile purchase loans, in part
(as discussed above) due to resale price
risk associated with returned vehicles.
Regarding the comment on difficulties
determining consumer purpose, the
agencies believe originators or dealers
will be able to differentiate between
types of customers based on the existing

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process dealers and lenders must use to
comply with TILA, which requires
disclosures be provided to borrowers
purchasing vehicles for personal use.
The QAL underwriting criteria in the
reproposal included requirements
regarding a borrower’s ability to repay
an automobile loan, including with
respect to verification of borrower
income and a borrower debt-to-income
(DTI) ratio of no more than 36 percent.
The loan term criteria included a first
lien security interest on the vehicle,
maximum maturity date, fixed rate
interest, and level monthly payments
with full amortization of the loan, as
well as strict limits on deferral of
payments and deferral of initiation of
payments. The credit history criteria
included verification and minimum
credit history standards (such as no
bankruptcy or repossession within the
previous 3 years). The LTV criteria
impose a borrower down payment
requirement equal to fees, warranties
and 10 percent of the purchase price.258
The agencies received a number of
comments on the proposed QAL
underwriting criteria. Generally the
comments expressed concern that very
few automobile loans would meet the
QAL criteria because they would not fit
existing market practices. Some
commenters asserted that because the
QAL criteria would not be met in
existing market practice, the resulting
risk retention requirements on
automobile securitizations could
discourage new issuances and impede
liquidity and consumer credit. Others
asserted this result would be unduly
punitive to automobile securitizations
as strong performers during the crisis,
especially as compared to the proposed
definition of QRM, which would
exempt most residential mortgages from
risk retention. Some commenters also
offered particular suggestions to change
the criteria, as discussed further below
with respect to each category of criteria.
Additionally, some commenters
requested that the agencies apply the
quantitative portions of the
underwriting standards on a pool basis
(which would assess underwriting
standards on a pool-wide, rather than
loan by loan, basis) rather than to
individual loans, noting that the
homogeneity of securitized automobile
loans and their typical characteristics
(not subject to interest rate fluctuations
or refinancings) would make an
exemption from risk retention based on
pool level criteria appropriate. The
agencies are not adopting this
suggestion in the final rule and the final
rule only permits the exemption to
258 See

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apply to individual loans that meet the
QAL criteria. The agencies observe that
section 15G of the Exchange Act
indicates that the reduction from risk
retention for a qualifying asset is limited
to the asset itself that is securitized, and
does not suggest an exemption for a
pool of assets that meets pool-wide
underwriting criteria.259 Accordingly,
the final rule provides that the
underwriting standards for QAL must be
met by each loan for that loan to be
exempt from risk retention.
Furthermore, the agencies do not
believe providing risk retention on a
pool basis would further the goals of
risk retention and could lead to some of
the transparency concerns discussed
with respect to unlimited blending of
non-qualifying assets with qualifying
assets. For example, an exemption based
on pool-level underwriting criteria
could obscure the true credit quality of
the pool in a way that would be difficult
for investors to discern because of the
potential for wide variation (and varying
degrees of document verification) of the
underwriting quality of those assets in
a pool that did not meet a QAL standard
on an individual basis.
1. Ability To Repay Criteria
As noted above, the ability-to-repay
criteria for QALs in the reproposal
included a DTI ratio not in excess of 36
percent of a borrower’s monthly gross
income. Under the proposed QAL
criteria, originators would also have
been required to verify a borrower’s
income and debt payments using
standard methods.
Commenters generally disagreed with
the proposed ability-to-repay criteria
and requested a higher maximum DTI
ratio or elimination of the ratio
criterion, on the basis that it is not
typically used in current automobile
loan underwriting and not using it has
not adversely affected automobile loan
performance because (commenters
claimed) borrowers often prioritize
payment of their automobile loans over
other debt obligations. Some
commenters offered a number of
suggested adjustments to the proposed
DTI and verification requirements.
Other commenters suggested using a
payment-to-income (PTI) ratio instead of
a DTI ratio because, they claimed, a PTI
ratio is a stronger predictor of vehicle
loan performance than a DTI ratio and
does not involve as many operational
burdens as a DTI ratio in providing
quick approval of automobile loans, a
practice expected by automobile
consumers. A commenter also asserted
that the proposed DTI requirements
259 See

15 U.S.C. 78o–11(c)(1)(B)(ii).

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would put lenders that rely on the
securitization markets for funding at a
disadvantage to lenders that do not.
Regarding the verification requirements,
commenters suggested that if
verification of debt and income would
be retained as a criterion, originators
should only be required to verify those
debts listed on a borrower’s credit report
and rely on borrower stated income
without verification.
The agencies have carefully
considered these comments, but have
concluded that the reproposed DTI
criteria, including verification
requirements, is essential to
determining a borrower’s ability to
repay, which in turn is essential to a
strong consumer underwriting standard.
As discussed in the original and revised
proposals, the agencies believe that a
total exemption from risk retention
should be applied only to those loans
that meet underwriting criteria
associated with strong credit
performance. A DTI ratio is a
meaningful and comprehensive method
for calculating a borrower’s ability to
repay a loan, while a PTI ratio does not
include other potentially significant
debts that may reduce a borrower’s
ability to repay the automobile loan.
The agencies have continued to find a
36 percent DTI ratio to be an
appropriately conservative measure of
ability to repay commensurate with a
high quality automobile loan with low
credit risk. Regarding verification, the
agencies are concerned that not all of a
borrower’s liabilities may be listed on a
credit report and therefore are adopting
the verification standards as proposed.
In addition, relying on borrower stated
income in assessing ability to repay
could lead to overstatement of income
by the borrower to obtain the loan or by
the originator to qualify the loan as a
QAL. For these reasons, as well as those
discussed in the reproposal, the
agencies are adopting the DTI and
verification requirements as reproposed.
2. Loan Terms
As noted above, the reproposal
included a number of criteria relating to
the automobile loan, including that the
loan term be calculated based on the
origination date and loan payments
could not be contractually deferred.
A commenter requested that the loan
term be calculated from the date of first
payment rather than the origination
date. Commenters also requested that
loan deferrals be allowed to assist
borrowers with hardship events.
The agencies observe that the loan
origination date and date of first
payment should usually be within a few
weeks of each other, which would not

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materially affect the loan term. The
agencies do not view a long period prior
to the first payment date as consistent
with a strong QAL standard, as it could
extend the total loan term for months
beyond the limits for maturity the
agencies have identified as appropriate
for a QAL. While the agencies are
retaining the requirement that the
contract not allow borrower-initiated
payment deferrals, this requirement
would not affect subsequent servicerinitiated deferrals that may be triggered
by borrower hardships described by the
commenters. For these reasons and
those discussed in the revised proposal,
the agencies are finalizing the loan term
criteria as proposed.
3. Reviewing Credit History
In the reproposal, the QAL criteria
included an originator verification,
within 30 days of originating a QAL,
that the borrower was not 30 days or
more past due on any obligation; was
not more than 60 days past due over the
past two years on any obligation; and
was not a judgment debtor or in
bankruptcy in the past three years. The
agencies also proposed a safe harbor
enabling the originator to rely on a
borrower’s credit report showing the
borrower complies with the standards.
Also, the agencies proposed a
requirement that all QALs be
contractually current at the closing of
the securitization.
Several commenters opposed the
proposed credit history criteria and
requested that the agencies use instead
a credit scoring system based on FICO
or a similar system of rating potential
borrowers based on credit history,
generally using proprietary models.
Commenters pointed out that the
automobile lending industry has used
credit scoring as a primary underwriting
tool and would be unable under the
QAL criteria to continue to rely on that
method for qualifying its best borrowers,
and therefore would not be able to use
the criteria in order not to lose those
borrowers as customers.
Commenters further asserted that the
proposed credit history verification
criteria would be more burdensome
than credit scoring systems, thereby
increasing costs for lenders and
consumers. A commenter suggested that
the criteria would result in conclusions
possibly less objective than credit
scoring systems. In addition, a few
commenters claimed that the QAL
credit history standards would exclude
many consumers of good credit quality
while failing to identify risky
consumers, whereas credit scoring
models used in the industry would
more accurately discriminate between

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high and low-credit quality borrowers.
These commenters asserted that this
result would occur because the
proposed criteria do not capture many
aspects of credit history that are
captured by credit scoring models. The
commenters also recommended that the
agencies adopt a ‘‘vendor-neutral’’
approach to incorporating the use of
credit scores in the QAL criteria to
ensure that there would be no undue
reliance on a particular vendor and that
credit models are already subject to
regulatory oversight (including being
the subject of the banking agencies’
guidance on model validation) and are
rigorously validated. A commenter
pointed to the FDIC’s large bank
assessment rule 260 as an example of
how the agencies could adopt a vendorneutral credit score criterion into the
QAL criteria. Some commenters also
requested that the agencies define
‘‘contractually current’’ and base
compliance on the securitization cut-off
date rather than the closing date.
The agencies have carefully
considered the comments regarding the
proposed QAL criteria and the requests
to use credit scoring in the criteria. The
agencies recognize that much of the
current automobile lending industry
relies heavily or solely on an internally
or externally developed credit scoring
system to approve automobile loans.
However, the agencies do not believe
that a credit score alone is sufficient
underwriting for a conservative
automobile loan with a low risk of
default. Furthermore, the agencies do
not believe it is appropriate for purposes
of risk retention to establish regulatory
requirements that rely on a credit
scoring system or combination of
proprietary credit scoring systems. The
agencies are concerned that, over time,
market pressures around meeting QAL
criteria or other factors could lead to
distortions in the scoring systems that
do not appropriately reflect credit risk.
Additionally, the agencies have broad
policy concerns with linking regulatory
underwriting criteria for risk retention
purposes to proprietary credit analyses
using privately developed models.
Additionally, the agencies believe that
a borrower must be contractually
current on the loan obligation prior to
securitization in order to have a robust
underwriting requirement. However, the
agencies do not believe it is necessary
to establish a definition of contractually
current, instead leaving this decision to
the contract between the originator and
borrower. While the agencies believe a
securitization exempt from risk
retention should contain only current
260 12

CFR part 327.

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automobile loans, the agencies will
adopt the commenters’ suggestion to
require evaluation of a loan’s status
based on the cut-off date or similar date
for establishing the composition of the
asset pool collateralizing asset-backed
securities issued pursuant to a
securitization transaction rather than
the closing date of the securitization.
For these reasons, the agencies are
adopting the credit history criteria as set
forth in the revised proposal.
4. Down Payment Requirement
As noted above, the proposed QAL
criteria included a down payment
requirement whereby automobile loan
borrowers would have been required to
pay 100 percent of the taxes, fees, and
extended warranties in addition to 10
percent of the net purchase price
(negotiated price less manufacturer
rebates and incentive payments) of the
car.
Most comments on the QAL criteria
opposed the proposed down payment
requirements. The commenters
proposed eliminating the down
payment entirely, eliminating the down
payment requirement for the taxes, fees,
and extended warranties, or reducing
the down payment requirement on the
net purchase price. One of these
commenters asserted that prime
automobile loans do not require down
payments generally because vehicles
depreciate rapidly and therefore,
lenders generally do not rely
significantly on the value of the
collateral when underwriting.
Furthermore, the commenter asserted
that depreciation makes strategic
defaults highly unlikely and the short
term of most automobile loans makes
down payments unnecessary. As with
the verification requirements discussed
above, the commenter claimed that the
down payment requirement in the QAL
criteria could put automobile lenders
that use securitization financing at a
disadvantage as compared to others
because of increased burden on
consumers in meeting the QAL criteria
or having more costs due to risk
retention. The commenter also asserted
that down payments have far less
relevance to the credit risk of
automobile loans than they do to
residential loans, and that having such
a requirement in the QAL criteria would
not be consistent with the agencies’
position on the QRM definition.
As discussed in the reproposal, the
agencies do not believe that an
automobile loan with an LTV ratio over
90 percent would be low-risk, and that
a customer should put some of the
customer’s own cash or trade-in value
into the deal to reduce risks for strategic

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default and incent repayment of the
loan. The agencies recognize that down
payment requirements for prime
borrowers are not common in
automobile lending, but note that down
payments provide an additional level of
protection to lenders and investors in
automobile securitizations that ensures
a low level of credit risk over time as
market conditions change.
For the reasons discussed above, the
agencies are adopting the QAL criteria
as set forth in the reproposal. As
explained above, the criteria ensure that
QAL loans (that are fully exempt from
risk retention) are of very high quality
and low credit risk, as required by
section 15G of the Exchange Act.261 The
agencies recognize that the QAL
standards are in some respects more
conservative than those of the QRM
definition. The agencies observe,
however, that the statutory standards for
establishing QAL criteria and the QRM
definition are different.262 Furthermore,
as discussed in the reproposal and Part
VI of this Supplementary Information,
the agencies’ decisions with regard to
the QRM definition take into
consideration the particular dynamics
in the residential mortgage market and
the effect of that market on the
economy. The dynamics in the
automobile market are different, as are
the effects of the automobile market on
the broader financial system and
economy, and the agencies have
therefore considered the automobile and
residential markets separately, together
with the differences in the relevant
statutory requirements, in establishing
the QRM and QAL standards.
VI. Qualified Residential Mortgages
After carefully considering comments
received on the reproposed definition of
QRM, as well as comments received on
the alternative approach to defining
QRM, the agencies are adopting, as
reproposed, the definition of QRM that
aligns with the definition of QM, as
defined in section 129C of TILA 263 and
the regulations thereunder. The agencies
are also providing an exemption from
risk retention requirements for certain
mortgage loans secured by three-to-four
unit residential properties that meet the
criteria for QM other than being a
consumer credit, as well as an
exemption to permit sponsors to blend
these exempted mortgage loans with
QRMs.
The final rule also includes a separate
exemption from risk retention
261 See

15 U.S.C. 78o–11(c)(2)(B).
id. at sections 78o–11(c)(2)(B) and 78–
11(e)(4)(B).
263 15 U.S.C. 1639c.
262 See

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requirements for certain types of
community-focused residential
mortgages that are not eligible for QRM
status under the rule, similar to the
exemptions provided from Regulation
Z’s ability-to-repay requirement.264
The agencies are also including a
provision in the final rule that will
require the agencies to periodically
review the definition of QRM and its
effect on the mortgage securitization
market, as well as the exemptions
provided for the three-to-four unit
residential properties and the
community-focused residential
mortgages. Each of these aspects of the
final rule is discussed more fully below.
A. Background

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Section 15G of the Exchange Act
exempts sponsors of securitizations
from the risk retention requirements if
all the assets that collateralize the
securities issued in the transaction are
QRMs.265 In defining QRM, the statute
requires that the agencies take into
consideration underwriting and product
features that historical loan performance
data indicate result in a lower risk of
default. In addition, the statute requires
that the definition of QRM be ‘‘no
broader than’’ the definition of QM.266
In the original proposal, the agencies
proposed to define QRM to mean a
covered closed-end credit transaction
that meets the statutory QM
standards 267 as well as additional
underwriting criteria. These additional
underwriting criteria included
minimum LTV and down payment
requirements, DTI requirements, and
credit history criteria.268 These
additional criteria were developed after
the agencies examined extensive data on
loan performance from several
sources,269 and were based on several
264 See Part VII of this Supplementary
Information.
265 See 15 U.S.C. 78o–11(c)(1)(C)(iii).
266 See id. at section 78o–11(e)(4).
267 Under the original proposal, QRM was limited
to a closed-end first-lien mortgage to purchase or
refinance a one-to-four family property, at least one
unit of which is the principal dwelling of a
borrower. In addition, consistent with the QM
requirement under section 129C(b)(2) of TILA, the
maturity date of a QRM could not exceed 30 years
and QRMs would have been prohibited from
having, among other features, payment terms that
allow interest-only payments, negative
amortization, ‘‘balloon payments,’’ or prepayment
penalties. See Original Proposal, 76 FR at 24122.
268 See Original Proposal, 76 FR at 24117.
269 The agencies reviewed data supplied by
McDash Analytics, LLC, a wholly owned subsidiary
of Lender Processing Services, Inc., on prime fixedrate loans originated from 2005 to 2008, which
included underwriting and performance
information on approximately 8.9 million
mortgages; data from the 1992 to 2007 waves of the
triennial Survey of Consumer Finances, which
focused on respondents who had purchased their

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goals and principles the agencies
articulated in the original proposal.270
The agencies also sought to implement
the statutory requirement that the
definition of QRM be no broader than
the definition of a QM, as mandated by
the Dodd-Frank Act. 271 At the time of
the original proposal, the definition of
QM had not been adopted in a final
rule.
The majority of commenters opposed
the QRM definition in the original
proposal, expressing concerns over the
20 percent down payment requirement
in particular. These commenters stated
that the proposed definition of QRM
was too narrow and would constrain
credit availability, especially for lowand moderate-income (LMI) borrowers
or first-time homebuyers. Many of these
commenters urged the agencies to
postpone finalizing the QRM definition
until after the QM definition was
finalized by the CFPB.272
As discussed in the reproposal, in
deciding to propose a broader QRM
definition, the agencies carefully
considered the concerns raised by
commenters with respect to the original
proposed definition, the cost of risk
retention, current and historical data on
mortgage lending and performance, and
the provisions of the final QM
definition. The agencies examined
updated loan performance information
and considered the historical
performance of residential mortgage
loans with respect to the QM criteria.273
Further, the agencies considered the
potential effects of a QRM definition on
credit pricing and access under
prevailing market conditions, as well as
homes either in the survey year or the previous
year, and included information on approximately
1,500 families; and data regarding loans purchased
or securitized by the Enterprises from 1997 to 2009,
which consisted of more than 78 million mortgages,
and included data on loan products and terms,
borrower characteristics (e.g., income and credit
score), and performance data through the third
quarter of 2010. See Original Proposal, 76 FR at
24152.
270 First, the agencies stated that QRMs should be
of very high credit quality, given that Congress
exempted QRMs completely from the credit risk
retention requirements. Second, the agencies
recognized that setting fixed underwriting rules to
define a QRM could exclude many mortgages to
creditworthy borrowers. Third, the agencies sought
to preserve a sufficiently large population of nonQRMs to help enable the market for securities
collateralized by non-QRM mortgages to be
relatively liquid. Fourth, the agencies sought to
implement standards that would be transparent and
verifiable to participants in the market. See Original
Proposal, 76 FR at 24117.
271 See 15 U.S.C. 78o–11(e)(4)(C). At the time of
issuance of the original proposal on April 29, 2011,
the Board had sole rulemaking authority for
defining QM, which authority transferred to CFPB
on July 21, 2011, the designated transfer date under
the Dodd-Frank Act.
272 See Final QM Rule.
273 See Revised Proposal, 78 FR at 57989–57990.

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direct and indirect costs of lending that
could be passed on to borrowers and
restrict credit availability.274
The agencies decided in the
reproposal to align the QRM definition
with the QM definition for several key
reasons, which include meeting the
statutory goals and directive under
section 15G of the Exchange Act to limit
credit risk, preserving access to
affordable credit, and reducing
compliance burden. Among other
factors related to credit risk, the
agencies discussed in the reproposal
observations that loans that meet the
QM criteria have a lower probability of
default than mortgages that do not, most
notably for loans originated near the
peak of the housing bubble that
preceded the financial crisis.275 In
addition, the agencies observed that a
QRM definition aligned with QM
should limit the scope of information
asymmetry between sponsors and
investors because the QM definition
requires, among other things,
documentation and verification of
income and debt.276 In addition, the
agencies expressed concern about
imposing further constraints on
mortgage credit availability under the
prevailing tight mortgage lending
conditions, including through
additional criteria that could reduce the
credit risk of QRMs further, such as LTV
and credit history-related criteria. The
agencies also observed that the indirect
costs of the interaction of QRM with
existing regulations and market
conditions is difficult to quantify and
has the potential to be large, and that
aligning the QRM definition with the
QM definition should minimize these
costs.277 Finally, the agencies noted
with concern that a QRM definition not
aligned with the QM definition could
compound the segmentation in the
securitization market that may already
occur between QMs and non-QMs. It
was acknowledged that, while the
agencies recognized that the alignment
of QRM with QM could also further
solidify the non-QM/QM segmentation
in the market, the consequences of
segmentation due to non-alignment
were judged to be more severe.278
In reproposing to align the QRM
definition with QM, the agencies
expressed an intention to review the
advantages and disadvantages of this
decision as the market evolves, to
ensure the risk retention rule best meets
274 See

id. at 57991.
id. at 57989.
276 See id. at 57990.
277 See id. at 57991.
278 See id.
275 See

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the statutory objectives of section 15G of
the Exchange Act.279
B. Overview of the Reproposed Rule
The reproposal would have
implemented the statutory exemption
for QRMs by defining ‘‘qualified
residential mortgage’’ to mean
‘‘qualified mortgage’’ as defined in
section 129C of TILA 280 and the
regulations issued thereunder.281 The
agencies proposed to align the
definition of QRM with QM to minimize
potential conflicts between the two
definitions and minimize burden in
meeting both QM and QRM criteria.
Therefore, under the reproposal, a QRM
would have been a loan that
(i) Met the general criteria for a QM
under section 1026.43(e)(2);
(ii) Met the special criteria of the
temporary QM definition under section
1026.43(e)(4);
(iii) Met the criteria for small creditor
portfolio loans under section
1026.43(e)(5) or (e)(6); or
(iv) Met the criteria for rural or
underserved creditor balloon loans
under section 1026.43(f).
This reproposed definition of QRM
included any closed-end loan secured
by any dwelling (e.g., home purchase,
refinances, home equity loans, second
or vacation homes), whether a first or
subordinate lien. However, the
reproposed definition of QRM would
not have included any loan exempt from
the ability-to-repay requirements and
not eligible to be a QM, such as homeequity lines of credit (HELOCs) or
reverse mortgages.282 In addition, loans
exempt from the ability-to-repay
requirements (such as loans made
through state housing finance agency
programs and certain community
lending programs) were not separately
included in the definition of QRM,
which under the statute cannot be
broader than QM.
The agencies invited comment on all
aspects of the reproposed definition of
QRM. In particular, the agencies asked
whether the reproposed definition
would reasonably balance the goals of
helping to ensure high quality
underwriting and appropriate risk
management with the public interest in
continuing access to credit for
creditworthy borrowers. The agencies
also asked whether the definition of
QRM should be limited to certain QM
loans, such as loans that qualify for the
QM safe harbor under 12 CFR
1026.43(e)(1), and if the reproposed
id.
U.S.C. 1639c.
281 See Final QM Rule.
282 See 12 CFR 1026.43(a) and 1026.43(c).

definition of QRM should include loans
secured by subordinate liens. In
addition, the agencies invited comment
on an alternative approach to defining
QRM (QM-plus approach). Consistent
with the statutory requirement that
QRM be no broader than QM, the QMplus approach would have taken the
CFPB’s definition of QM as a starting
point, including the requirements for
product type, loan term, points and fees,
underwriting, income, and debt
verification, and DTI,283 and added four
additional factors: the loan would have
had to be a first-lien mortgage loan, be
secured by a one-to-four family
principal dwelling, and have an LTV
ratio of 70 percent or less, and the
borrower would have had to meet
specific credit history criteria.284 Under
this approach, significantly fewer loans
likely would have qualified as QRMs.
The agencies asked a number of
questions about the QM-plus approach,
including whether the benefits of the
QM-plus approach would exceed the
benefits of the reproposed approach to
align the QRM definition to QM, taking
into consideration financial stability,
credit access, and regulatory burden.285
C. Overview of Public Comments
1. Comments Received on the
Reproposed QRM Definition
The agencies received a significant
number of comments with respect to the
reproposed QRM definition, with most
commenters expressing support for the
reproposal that would align the QRM
definition with the QM definition.
Generally, these commenters stated that
aligning the two definitions would
comply with statutory requirements,
minimize negative impact on the
availability and cost of credit to
borrowers (especially LMI borrowers,
minority borrowers, and first-time
homebuyers), and reduce potential
costs, regulatory uncertainty, and
compliance burden. Some commenters
specifically expressed support for
retaining the proposed full alignment
with QM so that the proposed QRM
definition would not distinguish
between loans that receive a ‘‘safe
harbor’’ or a ‘‘rebuttable presumption’’
of compliance under the QM provisions.
Some commenters requested
clarifications, expressed concerns, or
suggested modifications to the proposed
QRM definition, including with respect
to loans exempted from the ability-torepay rules under TILA, which are
discussed and addressed in more detail

279 See
280 15

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283 See

Revised Proposal, 78 FR at 57993–57996.
Revised Proposal, 78 FR at 57993.
285 See id. at 57995.
284 See

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in Part VII of this Supplementary
Information.
Several commenters opposed aligning
the QRM definition with the QM
definition, asserting that such an
approach would be contrary to statutory
intent. These commenters asserted that
the definitions of QRM and QM have
distinct and different purposes, with the
former addressing risk posed to
investors and the latter addressing
consumer protection. These commenters
further stated that broadening the QRM
definition would reduce the effect of the
risk retention rule with respect to
residential mortgages, which comprised
one of the main securitization markets
that led to the financial crisis. These
commenters also expressed concern that
the proposed QRM definition would be
insufficient to support the credit quality
on which a stable mortgage market
depends.
Most commenters that opposed the
revised definition of QRM supported
most, if not all, aspects of the QRM
definition in the original proposal and
recommended that the agencies adopt
that QRM definition instead. These
commenters asserted that LTV and
credit history requirements are key
criteria to ensure that QRMs represent a
lower risk of default and the risk
retention rules offer some protection to
RMBS investors. One commenter
asserted that the reproposed QRM
definition is based on the same credit
reporting requirements used prior to the
financial crisis and continues to lack
credit reporting verification safeguards
to ensure completeness and accuracy.
Another commenter suggested that the
agencies require a loan-level credit
enhancement when QM loans exceed a
stated LTV ratio.
A few commenters expressed concern
about the potential effects the
reproposed QRM definition might have
on the market, in that QMs and QRMs
could become the only type of mortgage
loans made and accepted on the
secondary market, or that the market
may shift more towards federally
insured or guaranteed mortgages.
Finally, commenters requested that
the agencies clarify that the requirement
that a depositor certify as to the
effectiveness of its internal supervisory
controls with respect to the process for
ensuring that mortgages included in a
pool of QRM assets qualify as QRMs
does not impose an obligation on
sponsors to guarantee that all assets are,
in fact, QRMs. As is indicated by the
final rule’s provision of a buyback
option for non-compliant assets, the
agencies do not view the certification as
requiring that the controls guarantee
compliance. Rather, the process must be

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robust and sufficient to enable the
sponsor to carefully evaluate eligibility.
2. Comments Received on the
Alternative Approach to QRM
The agencies also received numerous
comments on the alternative QM-plus
approach. Commenters generally
opposed the QM-plus approach,
asserting that it would be too restrictive,
impose additional compliance costs,
and have a negative effect on the
availability of affordable credit,
especially to LMI borrowers, minority
borrowers, and first-time homebuyers.
In addition, many commenters
expressed concern that a QM-plus
approach would slow the return of
private capital in the mortgage market
because it would increase government
and agency involvement in the mortgage
market and would make it more difficult
for sponsors to assemble a critical mass
of QRMs necessary for a securitization.
Commenters also expressed concern
that mortgages meeting the QM-plus
standard would effectively become the
primary mortgage product available,
thus pushing out other mortgage loans
that would qualify as QMs from the
mortgage market. Some commenters
supported a narrow definition of QRM
as reflected in the QM-plus approach,
but generally recommended that the
agencies adopt the original proposed
QRM definition rather than the QM-plus
approach.
One commenter specifically
expressed concern about the exclusion
of secondary liens from the QM-plus
approach, asserting that secondary liens
facilitate credit to borrowers and benefit
the economy. Another commenter
asserted that because the QM-plus
approach was described only in the
preamble, there was insufficient
information to determine how the QMplus approach would be implemented.
Some commenters requested specific
changes if the agencies were to go
forward with the QM-plus approach,
including a lower down payment
requirement, the exclusion of piggyback
loans, and the inclusion of credit scores.
D. Summary and Analysis of Final QRM
Definition

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1. Alignment of QRM With QM
After carefully considering the
comments received, the agencies are
adopting a definition of QRM that is
aligned with the definition of QM, with
some modifications. Accordingly, the
final rule defines a QRM to mean a QM,
as defined under section 129C of TILA
and the regulations issued thereunder,
as may be amended from time to time.
The agencies also believe it is necessary

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to periodically review the QRM
definition to take into account
developments in the residential
mortgage market, as well as the results
of the CFPB’s five-year review of the
ability-to-repay rules and the QM
definition, which is required under
section 1022(d) of the Dodd-Frank
Act.286 Therefore, the final rule also
includes a provision that requires the
agencies to conduct a periodic review of
the definition of QRM, which is
discussed more fully below.
The agencies have declined to adopt
the QM-plus approach or the approach
from the original proposal. While the
additional requirements in those two
approaches may include useful factors
in determining the probability of
mortgage default, these additional credit
overlays may have ramifications for the
availability of credit that many
commenters asserted were not
outweighed by the corresponding
reductions in the likelihood of default
from including these determinants in
the QRM definition. The agencies are
concerned about the prospect of
imposing potential additional
constraints on mortgage credit
availability at this time, especially as
such constraints might
disproportionately affect LMI, minority,
or first-time homebuyers.
The agencies continue to believe that
a QRM definition aligned with the
definition of QM meets the statutory
goals and directive of section 15G of the
Exchange Act to limit credit risk and
promote sound underwriting. At the
same time, the agencies believe this
definition will also meet the important
goals of preserving access to affordable
credit for various types of borrowers and
facilitating the return of private capital
to the mortgage market. Furthermore,
the agencies believe this definition
appropriately minimizes regulatory
compliance burdens in the origination
of residential mortgage loans. The final
definition of QRM does not incorporate
either an LTV ratio requirement or
standards related to a borrower’s credit
history, such as those in the alternative
QM-plus approach discussed in the
reproposal. As the agencies explained in
the reproposal, although credit history
and LTV ratio are significant factors in
determining the probability of mortgage
default and are important aspects of
prudent underwriting, on balance, the
agencies believe policy considerations
weigh in favor of aligning QRM with
QM at this time.
Consistent with the discussion in the
reproposal, the agencies believe that a
QRM definition that is aligned with the
286 See

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QM definition meets the statutory
requirement to take into consideration
underwriting and product features that
historical loan performance data
indicate result in a lower risk of
default.287 The criteria of the QM
definition support this determination.
The QM criteria are structured to help
ensure that borrowers are offered and
receive residential mortgage loans that
borrowers can afford. For example, the
QM definition requires full
documentation and verification of
consumers’ debt and income, and
generally requires borrowers to meet a
DTI threshold of 43 percent or less,
which helps to address certain
underwriting deficiencies, such as the
existence of subordinate liens, and may
help to reduce incidents of mortgage
fraud. The QM definition also restricts
the use of certain product features, such
as negative amortization, interest-only
and balloon payments (except as
provided under special definitions
available only to small portfolio
creditors) that historical data have
shown correlate to higher rates of
default. As discussed in the reproposal,
formal statistical models indicate that
borrowers with mortgages that do not
meet these aspects of the QM definition
rule exhibit higher probabilities of
default.288 Consistent with these
statistical models, historical data
indicate that borrowers with mortgages
that meet the QM criteria have lower
probabilities of default than those with
mortgages that do not meet the
criteria.289
The agencies continue to believe that
aligning the QRM and QM definitions at
this time will help promote access to
affordable credit by minimizing
additional regulatory burden and
compliance cost and facilitating the
return of private capital to the mortgage
market. Although mortgage lending
conditions appear to have been easing
gradually for several quarters, standards
overall remain tight, especially for
borrowers with lower credit scores or
fewer funds for a down payment. In the
July 2014 Senior Loan Officer Opinion
Survey of Bank Lending Practices,
approximately a fourth of all banks
surveyed reported that they had eased
their standards for prime residential
287 15

U.S.C. 78o–11(e)(4).
Shane M. Sherlund, ‘‘The Past, Present,
and Future of Subprime Mortgages,’’ Finance and
Economics Discussion Series, Paper 2008–63
available at http://www.federalreserve.gov/pubs/
feds/2008/200863/200863pap.pdf; Ronel Elul,
Nicholas S. Souleles, Souphala Chomsisengphet,
Dennis Glennon, and Robert Hunt. ‘‘What ‘Triggers’
Mortgage Default?’’ American Economic Review 100
(May 2010): 490–494.
289 For further detail, see Revised Proposal, 78 FR
at 57989–57990.
288 See

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mortgages in the second quarter of
2014.290 However, approximately half of
the banks surveyed reported that their
standards for prime conforming
residential mortgages were tighter than
the midpoint of their longer-term
ranges. Even more lenders reported
levels of standards that were tighter
than historical averages for jumbo,
nontraditional, and subprime mortgages.
Likewise, the Mortgage Bankers
Association’s index of mortgage credit
availability—designed to capture the
credit risk profile of mortgages being
offered in the market place—edged up
over the first few months of 2014,
suggesting that mortgage credit
conditions continue to improve.
Nonetheless, comparisons of this index
to a roughly equivalent proxy for
lending conditions in 2004 suggest that
credit availability is quite restricted.
An additional manifestation, in part,
of tight credit standards is the subdued
level of mortgage and housing activity.
Mortgage applications in the first six
months of 2014, as measured by the
Mortgage Bankers Association
application indexes, were at the lowest
levels since the 1990s. Existing home
sales rose only 3.5 percent in the first
six months of 2014 and are still roughly
25 percent below their 2004 level. In
addition, the private-label RMBS market
remains extremely small and limited to
mortgages of very high credit quality. In
the second quarter of 2014, less than 1
percent of mortgage originations were
funded through private-label RMBS.291
The securitizations that were issued
were collateralized by mortgages with a
weighted average loan-to-value ratio of
around 70 percent and, in most cases,
weighted average credit scores greater
than 750.
At the same time, several mortgage
and securitization regulatory changes
have been put in place that increase the
amount of information available to
investors, improve mortgage
underwriting, and increase investors’
ability to exercise their rights and obtain
recoveries in the event of mortgage
default. For example, the CFPB has
implemented regulations governing
mortgage servicing and loan originator
compensation in addition to the abilityto-repay rule and QM standards. The
ability-to-repay rule is particularly
noteworthy for requiring loan
290 Senior Loan Officer Opinion Survey of Bank
Lending Practices, Board of Governors of the
Federal Reserve System (July 2014), available at
http://www.federalreserve.gov/boarddocs/
SnLoanSurvey/201408/default.htm.
291 Mortgage Bankers Association, Quarterly
Mortgage Originations Estimates as of July 2014;
Intex Solutions, Inc., and Asset-Backed Alert, prime
non-agency RMBS issued in second quarter of 2014.

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originators to document income, debts,
and other underwriting factors, which
should in turn provide investors a more
complete set of information on which to
base their investment decision. The
Commission recently adopted revisions
to Regulation AB that, among other
things, require disclosure in registered
RMBS transactions of detailed loanlevel information at the time of issuance
and on an ongoing basis. These
revisions also require that securitizers
provide investors with this information
three business days prior to the first sale
of securities so that they can analyze
this information when making their
investment decision.292 The
Commission also has proposed rules
required by section 621 of the DoddFrank Act 293 that would prevent
sponsors and certain other
securitization participants from
engaging in material conflicts of interest
with respect to their securitizations.294
Additionally, the Board, the FDIC, the
OCC, the FHFA and the Commission,
among other federal agencies, have
jointly proposed rules required by
section 956 of the Dodd-Frank Act 295
that would enhance reporting and
oversight of incentive-based
compensation practices and prohibit
compensation arrangements that
encourage inappropriate risk taking by
financial institutions.296 These
regulatory actions are further
complemented by efforts on the part of
the Enterprises and the industry to
improve standards for due diligence,
representations and warranties,
appraisals, and loan information.297
Although additional changes may be
necessary, taken together, these changes
and the other changes to be completed
provide additional support for aligning
the definition of QRM with that of QM.
2. Periodic Review of the QRM
Definition
The agencies recognized that aligning
the QRM definition with the QM
definition could have potential
problematic effects on securitization
markets, such as increasing of
bifurcation in the mortgage market
between QM and non-QM loans.
Although the agencies continue to
believe the benefits of the alignment at
292 See Asset-Backed Securities Disclosure and
Registration; Final Rule, 79 FR 57184 (Sept. 24,
2014).
293 15 U.S.C. 77z–2a.
294 See Prohibition Against Conflicts of Interest in
Certain Securitizations; Proposed Rule, 76 FR 60320
(Sept. 28, 2011).
295 12 U.S.C. 5641.
296 See Incentive-Based Compensation
Arrangements; Proposed Rule, 76 FR 21170 (Apr.
14, 2011).
297 See Revised Proposal, 78 FR at 57990.

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this time outweigh these potential risks,
the agencies stated in the reproposal
that they intended to review the
advantages and disadvantages of
aligning the QRM and QM definitions as
the market evolves.298
The agencies are adopting the
reproposed QRM definition, but also
recognize that mortgage and
securitization market conditions and
practices change over time, and
therefore, believe it would be beneficial
to periodically review the QRM
definition. Thus, the agencies are
committing in the final rule to review
the QRM definition at regular intervals
to consider, among other things,
changes in the mortgage and
securitization market conditions and
practices (which may include, for
example, the structures of
securitizations, the relationship
between, and roles undertaken by, the
various transaction parties, implications
for investor protection and financial
stability arising from the relationship
between Enterprise markets and private
label markets, and trends in mortgage
products in various markets and
structures), as well as how the QRM
definition is affecting residential
mortgage underwriting and
securitization of residential mortgage
loans under evolving market conditions.
The agencies also want the opportunity
to consider the results of future reviews
of, and any changes made to, the QM
definition by the CFPB, any additional
regulatory changes affecting
securitization that are adopted by the
agencies, as well as any changes to the
structure and framework of the
Enterprises and those markets. As a
result of these reviews, the agencies may
or may not decide to modify the
definition of QRM. Any such
modification would occur through
notice and comment rulemaking.
Otherwise, any changes the CFPB makes
to the QM definition automatically will
modify the QRM definition.
As provided in the final rule, the
agencies will commence a review of the
definition of QRM not later than four
years after the effective date of this rule
with respect to securitizations of
residential mortgages, five years after
the completion of that initial review,
and every five years thereafter. In
addition, the agencies will commence a
review at any time upon the request of
any one of the agencies. The agencies
will jointly publish in the Federal
Register notice of the commencement of
a review, including the reason for the
review if it has been initiated upon the
request of one of the agencies. In the
298 See

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notice, the agencies will seek public
input on the review. The agencies
intend to complete each review no later
than 6 months after initial notice of the
review, subject to extension by the
agencies as conditions warrant.
Following the review, the agencies will
jointly publish a notice that includes
their conclusions from the review and,
as part of such review, take whatever
action is required by applicable law,
including the Administrative Procedure
Act. If, as a result of the review, the
agencies decide to modify the definition
of QRM, the agencies will complete
such rulemaking within 12 months of
publication in the Federal Register of
the notice disclosing the determination
of their review, unless extended by the
agencies.
The agencies intend for their initial
review of the QRM definition to be
completed after the publication of the
report of the CFPB’s assessment of the
ability-to-repay rules, including the QM
definition, which the CFPB is required
to publish within five years of the
effective date of the ability-to-repay rule
(i.e., January 10, 2019).299 However, as
noted above, the agencies’ initial review
will start no later than four years after
the effective date of this final rule with
respect to residential mortgages. The
agencies believe this timing helps to
ensure the initial review of the QRM
definition benefits from the CFPB’s
review and course of action regarding
the definition of QM, and will help the
agencies in determining whether the
QRM definition should continue to
align fully with the QM definition in all
aspects. Furthermore, the agencies
expect additional information on the
housing and mortgage market will be
available at the time the initial review
is conducted that would be important in
determining whether the then-current
QRM definition remains appropriate
under prevailing market conditions and
continues to meet the requirements and
policy purposes of section 15G of the
Exchange Act.

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3. Definition of QRM
Under the final rule, QRM is defined
by aligning it to the definition of QM in
the CFPB regulations under section
129C of TILA. A QRM is a loan that is
a ‘‘covered transaction’’ 300 that meets
the general definition of a QM. The
299 See

12 U.S.C. 5512.
12 CFR 1026.43(b)(1), which defines
‘‘covered transaction’’ as a consumer credit
transaction that is secured by a dwelling, as defined
in section 1026.2(a)(19), including any real property
attached to a dwelling, other than a transaction
exempt from coverage under section 1026.43(a) (i.e.,
HELOCs, time shares, reverse mortgages, temporary
or ‘‘bridge’’ loans of 12 months or less, and certain
construction loans).
300 See

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general definition of a QM provides that
the loan must have:
• Regular periodic payments that are
substantially equal;
• No negative amortization, interest
only or balloon features;
• A maximum loan term of 30 years;
• Total points and fees that do not
exceed 3 percent of the total loan
amount, or the applicable amounts
specified for small loans up to $100,000;
• Payments underwritten using the
maximum interest rate that may apply
during the first five years after the date
on which the first regular periodic
payment is due;
• Consideration and verification of
the consumer’s income and assets,
including employment status if relied
upon, and current debt obligations,
mortgage-related obligations, alimony
and child support; and
• Total DTI ratio that does not exceed
43 percent.301
In addition, in the final rule, the
definition of QRM includes loans that
meet one of the special types of QMs.
One special QM is a covered transaction
that meets the CFPB’s temporary
government QM definition.302 A loan
eligible under the temporary QM
definition must satisfy the loan-feature
limitations of the general definition of a
QM: the loans must have substantially
equal periodic payments, with no
interest-only, negative amortization or
balloon features; must have a maximum
30-year term; and must comply with the
points and fees limitations.303 However,
the loans are not subject to the
underwriting provisions of the general
QM definition, such as the total DTI
ratio requirement of 43 percent or less.
To be eligible under the CFPB’s
temporary government QM definition,
loans must be eligible for purchase,
guarantee or insurance by an Enterprise,
U.S. Department of Agriculture (USDA),
or Rural Housing Services (RHS).304
As discussed in the reproposal, the
temporary QM definition with respect to
an Enterprise expires once the
Enterprise exits conservatorship, but in
any case no later than January 21,
2021.305 Additionally, the temporary
QM definition with respect to USDA
and RHS expires when USDA and RHS
issue their own QM rules or, in any
case, no later than January 21, 2021.306
Lastly, a QRM is a loan that meets the
definitions of QM issued by HUD, the
Department of Veterans Affairs (VA),
301 See

12 CFR 1026.4(e)(2).
12 CFR 1026.43(e)(4).
303 See 12 CFR 1026.43(e)(2) and 1026.43(e)(4).
304 See 12 CFR 1026.43(e)(4)(ii).
305 See 12 CFR 1026.43(e)(4)(iii).
306 See id.
302 See

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USDA, and RHS under section 129C of
TILA. HUD, VA, USDA, and RHS each
have authority under the Dodd-Frank
Act to define QM for their own loans.
Specifically, section 129C(a)(3) of TILA
authorizes these agencies to issue rules
implementing the QM requirements
under section 129C(a)(2) of TILA. USDA
and RHS have not yet issued rules
under section 129C of TILA
On December 11, 2013, HUD adopted
a final rule to define QM for the single
family residential loans that it insures,
guarantees or administers and which
took effect on January 10, 2014.307 In
addition, the VA issued an interim final
rule to define QM for loans that it
insures or guarantees, with an effective
date of May 9, 2014.308 Accordingly, the
final definition of QRM now includes
any loan insured, guaranteed or
administered as a QM under either the
HUD or VA definition of QM, as
applicable.
In the final rule, the definition of
QRM also includes a loan that meets
any of the special QM definitions
designed to facilitate credit offered by
small creditors.309 To qualify as a
‘‘small creditor’’ eligible under one of
these special QM definitions, however,
the entity must meet certain asset and
threshold criteria and hold the QM
loans in portfolio for at least three years,
with certain exceptions.310 Thus, loans
meeting these special small creditor QM
definitions would generally be ineligible
for securitization as QRMs for three
years following consummation.
A loan eligible under these special
‘‘small creditor’’ QM definitions must
meet the general requirements of a
QM,311 except that these loans receive
greater underwriting flexibility (i.e., do
not need to meet the quantitative DTI
threshold of 43 percent or less).312
Additionally, a loan originated by a
qualifying small creditor may contain a
balloon feature if the loan is originated
during the two-year transition period,
which expires January 10, 2016,
provided the loan meets certain other
criteria, such as a 5-year minimum
term.313 After January 10, 2016, the
ability to write a balloon QM will be
limited to small creditors that operate
307 See Qualified Mortgage Definition for HUD
Insured and Guaranteed Single Family Mortgages,
78 FR 75215 (Dec. 11, 2013).
308 See Loan Guaranty: Ability-to-Repay
Standards and Qualified Mortgage Definition Under
the Truth in Lending Act, 79 FR 26620 (May 9,
2014).
309 See 12 CFR 1026.43(e)(5) and (e)(6).
310 See 12 CFR 1026.43(e)(5), (e)(6), and (f).
311 See 12 CFR 1026.43(e)(2).
312 See 12 CFR 1026.43(e)(5), (e)(6), and (f).
313 See 12 CFR 1026.43(e)(6).

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
primarily in rural or underserved
areas.314
Consistent with the reproposed
definition described above, the final
definition of QRM includes any closedend loan secured by any dwelling (e.g.,
home purchase, refinances, home equity
loans, second or vacation homes, and
mobile homes, and trailers used as
residences), whether a first or
subordinate lien.315 The final definition
of QRM does not include any loan
exempt from the ability-to-repay
requirements under TILA and the
ability-to-repay rules, such as HELOCs,
reverse mortgages, timeshares or
temporary or ‘‘bridge’’ loans of 12
months or less.316 In addition, the final
definition of QRM does not include
those loans that were provided a
regulatory exemption from the abilityto-repay rules, such as loans made
through state housing finance agency
programs and certain community
lenders. If a loan is not subject to TILA
because it is deemed to be extended for
a business purpose, it is also not
included in the definition of QM (and
therefore, is not a QRM). The agencies
believe this approach is consistent with
the language and intent of section 15G
of the Exchange Act, whereby a QRM
can be no ‘‘broader than’’ a QM.
To provide relief from risk retention
for mortgage loans that are collateralized
by three-to-four unit residential
properties and are not included in the
QRM definition because they are
deemed not to be covered transactions
in the QM definition, but that otherwise
meet all the criteria to be a QM, the final
rule includes a separate exemption, as
discussed further below in Part VII of
this Supplementary Information.
Several commenters requested that
the agencies clarify that the
incorporated QM definition include all
statutory provisions, the regulation, the
314 See

12 CFR 1026.43(f).
12 CFR 1026.43(e)(2), which provides that
QM is a covered transaction that meets the criteria
set forth in 12 CFR 1026.43(e)(2), (4), (5), (6) or (f).
A ‘‘covered transaction’’ is defined to mean ‘‘a
consumer credit transaction that is secured by a
dwelling, as defined in § 1026.2(a)(19), including
any real property attached to a dwelling, other than
a transaction exempt from coverage under
[§ 1026.43(a)].’’
316 The Dodd-Frank Act excludes from the term
‘‘residential mortgage loan’’ an open-end credit plan
or an extension of credit secured by an interest in
a timeshare plan. See 15 U.S.C. 1602(cc)(5) and
1639c(i). The Dodd-Frank Act does not apply the
ability-to-repay provisions of TILA to reverse
mortgages and temporary or ‘‘bridge’’ loans with a
term of 12 months or less. See 15 U.S.C. 1639c(a)(8).
Therefore they are also exempt from the ability-topay rules. Also excluded are most loan
modifications, unless the transaction meets the
definition of refinancing set forth in section
1026.20(a) of the Final QM rule. For a complete list,
see 12 CFR 1026.43(a).

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315 See

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regulation’s commentary and appendix,
and future supporting guidance to
prevent any difficult interpretive
questions about whether it is possible
for a loan to be a QM and not a QRM.
As noted above, the agencies are
defining QRM by cross-reference to the
definition of QM under section 129C of
TILA, and any regulations issued
thereunder, to avoid potential conflicts
between the definitions of QRM and QM
and to facilitate compliance. By crossreferencing to the definition of QM, the
final rule incorporates any rules issued
under section 129C of TILA that define
QM, including any Official
Interpretation that interprets such rules.
The rule provides that QRM means
QM as amended by the CFPB from time
to time. As such, the rule presumes that
each amendment to the definition of
QM will automatically be incorporated
into the definition of QRM unless the
agencies act to amend the definition of
QRM. However, in exercising their
responsibility under section 15G, the
agencies will evaluate and collectively
consider each amendment to QM to
decide whether that amendment meets
the requirements of section 15G, and
take such action, if any, as is required
under applicable law, including the
Administrative Procedure Act. The
agencies note that they will have notice
of proposed CFPB changes to the
definition of QM and, thus, will be in
a position to commence consideration of
possible changes to the QM definition
before the CFPB issues a final rule. As
noted above, section 13(d) of the rule
also requires the agencies to conduct
periodic reviews of the definition of
QRM.
One commenter requested
clarification that all QM definitions
would be included in the revised QRM
definition and there would be full
alignment of QRM and QM throughout
the life cycle of a loan. As discussed
more fully above, QRM is defined to
include a loan that meets any of the
definitions of QM issued under section
129C of TILA. The agencies also note
that the determination of whether a loan
meets the QM definition occurs at
consummation; post-consummation
events that cannot be reasonably
anticipated are not relevant.317
Some commenters requested revisions
to provisions that are set forth in the
QM definition, such as the cap on
points and fees or the 43 percent DTI
ratio limit. The agencies are required to
implement the statutory requirement
that the definition of QRM be no
broader than the definition of a QM, and
317 See 12 CFR 1026.43(c)(1) and corresponding
official staff commentary.

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77691

therefore cannot expand the definition
of QRM in this manner.
Some commenters expressed concern
with the reproposal to allow higherpriced QMs to be pooled and securitized
with non-higher priced QMs. These
commenters asserted that higher-priced
means higher risk. The commenters
asserted, however, that excluding
higher-priced QMs from the definition
of QRM would unduly restrict LMI
access, and in that case, it may be
appropriate to treat these loans as QRMs
but that the agencies should prohibit
their inclusion in securitizations that
consisted of non-higher-priced QMs.
The requirements for QMs are the same
whether they are higher-priced or lowerpriced, and those QM criteria are one of
the reasons the agencies defined QRM to
mean QM. A higher-priced QM under
the CFPB’s rule must generally meet the
43 percent DTI ratio requirement, have
verified income and assets, generally
have points and fees that do not exceed
the 3 percent cap, have regular periodic
payments, and contain no negative
amortization, interest only or balloon
features (with exceptions for certain
small creditors). Accordingly, the final
rule does not distinguish between nonhigher priced and higher-priced QMs,
and both are eligible to be QRMs
without distinction, and therefore, can
be pooled together in the same
securitization.
A few commenters expressed concern
that the reproposed QRM definition
would still contain in its practical
implementation an implicit bias in favor
of a single credit scoring brand, FICO,
to the exclusion of others. These
commenters stated that the Enterprises
exclusively use the credit scoring brand
FICO when underwriting and
determining eligibility of loans for
purchase. These commenters claimed
that because the QRM definition
incorporates the temporary QM
definition by reference, which permits
loans that are eligible for purchase,
guarantee or insurance by an Enterprise
to be QRMs (such loans must also still
generally meet the general definition of
a QM), there is an implicit bias towards
the FICO scoring brand. One commenter
further asserted that the unintended bias
in favor of a single credit scoring brand
could be fixed while still ensuring the
QM and QRM definitions are aligned by
having FHFA require the Enterprises to
revise their policies and practices to
accept mortgages underwritten with
other validated credit scoring models in
addition to the single scoring brand
currently permitted.
The agencies note that, under the final
rule, the definition of QRM is a loan that
meets any of the definitions of QM

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issued under section 129C of TILA.
Accordingly, the agencies note that a
loan is not required to be eligible for
purchase by the Enterprises to meet the
definition of QRM.318 Thus, the
agencies do not believe the alignment of
the QRM definition with the QM
definition includes an implicit bias in
favor of a single credit scoring brand as
there is no requirement in the QM
definition that a consolidated credit
score be used or obtained.319 Therefore,
the agencies do not believe that any
changes to the QRM definition are
needed.
A few commenters expressed concern
about the potential bifurcation effect on
the market if the definitions of QRM to
QM were to be aligned, asserting that a
QM/QRM loan may become the only
type of residential mortgage made and
securitized. Some commenters
suggested that the agencies provide
flexibility for creditors to continue
originating non-QM and non-QRM loans
by allowing certain loans to qualify for
a lower than 5 percent risk retention
requirement. As noted in the reproposal,
the agencies recognize that aligning the
QRM and QM definitions has the
potential to intensify any existing
bifurcation in the mortgage market that
may occur between QM and non-QM
loans, as securitizations collateralized
by non-QMs could have higher funding
costs due to risk retention requirements
in addition to potential risk of legal
liability under the ability-to-repay rule.
The agencies acknowledge this risk but
believe that not aligning the QRM and
QM definitions would likely result in
even more segmentation in the
securitization market and higher costs
for consumers. Securitization typically
is a more cost-effective source of
funding when the underlying pool
includes a large number of loans.
However, QM and non-QM loans are
less likely to be combined in a pool
because of the different risk profiles and
legal liabilities associated with these
loans, and QRM and non-QRM loans
cannot be combined in a pool under the
restrictions of the rule. Accordingly, if
318 Some commenters also called on FHFA to
require the Enterprises to apply prime loan criteria
in the automatic underwriting system so that the
combination of aligning the definitions of QRM and
QM and temporary QM definition applicable to
loans that qualify for purchase or guarantee by the
Enterprises does not cause a decline in
underwriting standards and assures high
underwriting standards. The agencies view this
issue to be outside the scope of this joint
rulemaking.
319 The underwriting requirements under the
general QM definition and the small creditor QM
definitions do not include a requirement for a credit
score or an explicit requirement to consider credit
history. However, credit history may be included in
underwriting for debt and DTI.

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the QRM and QM definitions are not
aligned and lenders have difficulty
amassing a critical number of loans for
an asset pool to provide cost effective
funding, they may choose a source of
funding other than securitization or
charge higher mortgage rates to
consumers.
A few other suggestions and concerns
expressed by commenters include: (i) a
request that the agencies acknowledge
that first mortgages secured by real
property in priority lien states are
encompassed within the QRM
definition; (ii) caution that the QRM and
credit risk retention rule not evolve into
a safety and soundness standard in
terms of evaluating an individual
lender’s real estate portfolio; (iii) a
request that the QRM definition reflect
the value of Homeownership Education
and Counseling in reducing default; and
(iv) a request to allow non-U.S.
originated transactions to benefit from
the QRM exemption. The agencies’
definition of QRM is adopted as a
component of the broader credit risk
retention rule that helps address
underwriting and incentive alignment
concerns in the securitization market
and is not a safety and soundness,
standard. The agencies’ adoption of the
QRM definition does not limit or change
the definition of QM and, thus, the
application of the definition of QM in
priority lien states and to non-U.S.
originated transactions is limited by the
applicability of the QM definition under
TILA and not the adoption of the
definition of QRM. Similarly, the
agencies are not expressly requiring or
including as criteria to meet the QRM
definition homeownership education
and counseling. The agencies also will
evaluate a lender’s mortgage portfolio
on its own merits and do not expect to
judge the safety and soundness of a loan
or portfolio on whether or not it meets
the definition of QRM.
A few commenters also expressed
concern about including subordinate
liens in the scope of the QRM
definition. These commenters were
concerned that permitting subordinate
liens to be eligible for the QRM
exemption would introduce a layer of
additional risk, especially where the
QRM definition did not contain a LTV
ratio requirement. One commenter
specifically requested that the agencies
reconsider the inclusion of subordinate
lien loans in the definition of QRM,
noting that second lien holders have
been blamed for holding up short sales
and complicating efforts to resolve
defaulted loans.
The agencies appreciate these
commenters’ concerns. However,
similar to the reasons discussed in the

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reproposal, the agencies believe aligning
the definition of QRM to the QM
definition, which includes loans
secured by any dwelling, as well as
subordinate liens, is appropriate to
minimize potential conflicts between
the two definitions. The agencies
believe allowing subordinate liens to
qualify for the QRM exemption also will
help preserve credit access. Last, as
noted above, the QM definition requires
full documentation and verification of
consumers’ debt and income on all
loans, which the agencies believe helps
to address risks that may accompany
subordinate liens.
E. Certification and Other QRM Issues
In order for a QRM to be exempted
from the risk retention requirement, the
rule includes evaluation and
certification conditions related to QRM
status, consistent with statutory
requirements and similar to the
reproposal. One commenter requested
that the requirement for measuring
performance data be as of the cut-off
date, and not the closing date. In
response to commenters’ requests, the
agencies have modified the performance
measurement date from the closing date
to the cut-off date or similar date.
While some commenters supported
the proposed certification requirements,
others suggested that the certification be
submitted to the appropriate Federal
banking agency or the Commission, and
not to the investors, which the
commenters said would create
additional liability and be functionally
burdensome. One commenter suggested
that the agencies make clear that these
certifications must be retained by the
sponsor for a period of no more than
five years.
The agencies believe that the
certification by the depositor for the
securitization is important information
that should be disclosed to investors
and therefore are not persuaded by the
commenters’ requests to require that
certification be submitted only to the
Commission and the appropriate
Federal banking agency, if any.
Several commenters expressed the
belief that allowing for blended pools of
QRMs and non-QRMs would help
ensure that a greater variety of loans
could be securitized and reduce market
fragmentation between QRMs and nonQRMs. These commenters requested
that the agencies permit the blending of
non-QRMs and QRMs, with the QRMs
being exempt from risk retention and
the non-QRMs being subject to risk
retention (unless otherwise exempt).
Under this approach, the sponsor would
be required to hold credit risk in
proportion to the non-qualifying assets

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in the pool. These commenters
expressed the belief that the exemption
authority under section 15G(e)(1) and
(2) of the Exchange Act was sufficiently
broad to permit the agencies to provide
a partial exemption for securitizations
collateralized by QRMs and non-QRMs.
Another approach suggested was that
the agencies permit blending exempt
mortgage assets (e.g., seasoned loans)
and QRMs, with all such securitized
assets remaining exempt from risk
retention. Under this approach the
sponsor would not be required to hold
any credit risk since all of the assets in
the pool would qualify for an
exemption.
Except as described in Part VII of this
Supplementary Information with
respect to certain mortgage loans
secured by three-to-four unit properties
that meet the QM criteria other than
being an extension of consumer credit,
the agencies are not adopting the
requested exemption for blended pools
of QRMs and non-QRMs. The agencies
believe that the breadth of the QRM
definition in the final rule, as well as the
additional mortgage exemptions
discussed in Part VII of this
Supplementary Information, should
facilitate the return of private capital to
the mortgage market and preserve access
to affordable credit for various types of
borrowers while the mortgage market
continues to stabilize. Furthermore, the
agencies observe that differences in
product features, underwriting
standards, and other factors associated
with QRMs and non-QRMs generally
could tend to reduce the likelihood of
investors preferring combined pools.
The agencies also note that a reduction
in a risk retention requirement for the
pool based on inclusion of QRMs would
add complexity to the risk retention
regime for residential mortgages without
evidence of any significant benefit.
Finally, the agencies are concerned,
given the breadth of the QRM definition,
that allowing reduced risk retention for
combined pools of QRMs and nonQRMs will not provide sponsors with
sufficient incentives to ensure high
quality underwriting of the non-QRM
mortgages.320

320 The agencies are not addressing the
permissibility of exempting pools blending QRMs
and non-QRMs at this time. The agencies note that
section15G of the Exchange Act refers to an
exemption from risk retention requirements with
respect to an asset-backed security if all the assets
that collateralize the asset-backed security are
QRMs. See 15 U.S.C. 78o–11(c)(1)(C)(iii).

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F. Repurchase of Loans Subsequently
Determined To Be Non-Qualified After
Closing
The reproposal provided that, if after
the closing of a QRM securitization
transaction, it was discovered that a
mortgage did not meet all of the criteria
to be a QRM due to inadvertent error,
the sponsor would be obligated to
repurchase the mortgage.321 While some
commenters expressed support for the
proposed requirement, one commenter
asserted that investors have historically
preferred substitution over repurchase,
especially when the required repurchase
would impact the value of the
investment.
Similar to the reproposal, the final
rule includes a buyback requirement for
mortgages that are determined not to
meet the QRM definition by inadvertent
error after the closing of the
securitization transaction, provided that
the conditions set forth in section 13(c)
of the rule are met. These conditions are
intended to provide a sponsor with the
opportunity to correct inadvertent errors
by promptly repurchasing any nonqualifying mortgage loans from the pool.
In addition, this requirement helps
ensure that sponsors have a strong
economic incentive to ensure that all
mortgages collateralizing a QRM
securitization satisfy all of the
conditions applicable to QRMs prior to
closing of the transactions. As long as
the loan met the QRM requirements at
the closing of the securitization
transaction, however, subsequent nonperformance of the loan does not trigger
the proposed buyback requirement. For
the reasons described above, the
agencies are not allowing substitution
instead of repurchase in the final rule.
VII. Additional Exemptions
As discussed in Part VI of this
Supplementary Information, under the
final rule, a loan is eligible for the QRM
exemption if it meets one of the QM
definitions issued under section 129C of
TILA, as may be amended from time to
time. Meeting the QM criteria is also
one of several ways that a lender can
choose to satisfy the minimum
underwriting standards for the abilityto-repay requirements under TILA.
Because QM loans may provide greater
protection from potential legal liability
under TILA, many lenders are
incentivized to make QMs.322
321 Sponsors may choose to repurchase a loan
from securitized pools even if there is no
determination that the loan is not a QRM. The
agencies would not view such repurchases as
determinative of whether or not a loan meets the
QRM standard.
322 HELOCs and timeshares are also not subject to
any ATR requirement, but not because of a statutory

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Community-Focused Lending
Exemption
In addition to the classes of
transactions exempt from the ability-torepay requirement under the DoddFrank Act, such as HELOCs, reverse
mortgages, timeshares or temporary or
‘‘bridge’’ loans of 12 months or less, the
CFPB exempted certain additional
categories of loans made by certain
lenders from the ability-to-repay rules,
under its regulatory authority to exempt
classes of transactions to help ensure
borrowers continue to have access to
affordable mortgage credit. The CFPB
used its regulatory authority to exempt
these lenders because they typically use
flexible and unique underwriting
standards that differ from the minimum
underwriting standards of the ability-torepay or QM criteria, and the types of
loans exempted are important sources of
credit for LMI, minority and first-time
homebuyers.323 Loans exempt from the
ability-to-repay requirement fall into the
following categories:
• An extension of credit made
pursuant to a program administered by
a Housing Finance Agency, as defined
under 24 CFR 266.5 (HFA).324
• An extension of credit made by an
entity creditor designated by the U.S.
Treasury as Community Development
Financial Institution, as defined under
12 CFR 1805.104(h) (CDFI).
• An extension of credit made by a
HUD-designated Downpayment
Assistance through Secondary
Financing Provider (DAP), pursuant to
24 CFR 200.194(a), operating in
accordance with HUD regulations.
• An extension of credit made by a
HUD-designated Community Housing
Development Organization, as defined
under 24 CFR 92.2 (CHDO), provided it
has entered into a commitment with a
participating jurisdiction and is
undertaking a project pursuant to HUD’s
HOME Investment Partnership Program,
pursuant to 24 CFR 92.300(a).
• An extension of credit made by
certain non-profit organizations that
extend credit no more than 200 times
or regulatory exemption. Rather, these loans were
never included in the scope of loans defined to be
subject to the ATR requirement (i.e., residential
mortgage loans).
323 See 15 U.S.C. 1604(f). See also 78 FR 35430
(June 12, 2013).
324 Housing Finance Agency means any public
body, agency, or instrumentality created by a
specific act of a State legislature or local
municipality empowered to finance activities
designed to provide housing and related facilities,
through land acquisition, construction or
rehabilitation. The term State includes the several
States, Puerto Rico, the District of Columbia, Guam,
the Trust Territory of the Pacific Islands, American
Samoa and the Virgin Islands.

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annually,325 provide credit only to LMI
consumers, and follow their own
written procedures to determine that
consumers have a reasonable ability to
repay their loans (Eligible Nonprofits)
• An extension of credit made
pursuant to a program authorized by
sections 101 and 109 of the Emergency
Economic Stabilization Act of 2008
(EESA).326
As a result, loans made by these
entities do not need to comply with the
ability-to-repay requirement, for which
QM is one way to comply.
The agencies received several
comments regarding some of the above
extensions of credit. One commenter
requested that the agencies clarify that
the proposed exemption from risk
retention for asset-backed securities
issued or guaranteed by states,
municipalities, and public
instrumentalities of states (state and
municipal securitization exemption) 327
would include asset-backed securities
issued by HFAs and other state agencies
and collateralized by loans financed by
HFAs. This commenter also asked for
clarification on whether the use of
private servicers in those transactions
would affect the availability of the
exemption. A few commenters
requested that the agencies
automatically classify all state HFA
loans as QRMs. One commenter
observed that the CFPB granted HFA
loans an exemption from the ability-torepay requirement because of a strong
record of lending to LMI borrowers, so
that compliance with the ability-torepay requirement would be of little
benefit and could impede access to
credit by LMI borrowers. Another
commenter also asserted that strong
credit performance from HFA loans
would mean that risk retention is not
necessary to protect investors. This
commenter further expressed concern
that if any HFA loans were subject to
risk retention, other securitization
structures employed by the HFA that
may not technically qualify for the state
and municipal securitizations
exemption would then be subject to risk
retention, with negative consequences
for access to credit for underserved
borrowers.
Several commenters similarly
observed that CDFIs and nonprofit
lenders are an important source of
mortgage credit for LMI borrowers and
play a key role in neighborhood
325 See 79 FR 25730 (May 6, 2014). The CFPB’s
proposed rule would exclude from the 200
originations count certain forgivable or deferred
second lien loans.
326 12 U.S.C. 5211; 5219.
327 15 U.S.C. 78o–11(c)(1)(G)(iii). See also Part
IV.B of this Supplementary Information.

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stabilization and community
development. These commenters stated
that loans made by these entities
frequently would not fit the QM criteria
because they use flexible underwriting
standards that consider an individual
borrower’s unique circumstances and
use homebuyer education and housing
counseling to support homeowners
throughout the mortgage process. These
commenters raised the concern that the
risk retention requirement would
impose disproportionate compliance
burdens on these entities and could be
a significant barrier to obtaining
investment in these lending programs.
Commenters also indicated that
exempting these entities from the risk
retention requirement would be within
the spirit of aligning QRM with QM.
A few other commenters also
requested that the agencies similarly
consider including under the definition
of QRM the other categories of loans
exempted by the CFPB from the abilityto-repay rules, or otherwise provide
them with an exemption from risk
retention. Commenters observed that
CDFIs and nonprofit mortgage lenders
are an important source of mortgage
credit for LMI borrowers and play a key
role in neighborhood stabilization and
community development. The loans
made by these entities are not covered
transactions under the ability-to-repay
rules (and therefore would not be
classified as QMs in any case) but also
frequently would not independently
meet the type of underwriting standards
in the CFPB’s QM criteria because they
use flexible features that consider an
individual borrower’s unique
circumstances. At the same time, these
lenders use homebuyer education and
housing counseling to support
homeowners throughout the mortgage
process. These commenters raised the
concern that the risk retention
requirements would be a
disproportionate compliance burden for
these entities and could be a significant
barrier to obtaining investment in these
lending programs if an exemption was
not provided.
Under section 15G of the Securities
Act, the definition of a QRM can be ‘‘no
broader than’’ the definition of a QM.
Because there are various and unique
underwriting practices used to make the
loans described above that are exempted
from the ability-to-repay requirement,
including significant variations in DTI
ratios and other underwriting criteria, it
is not possible for the agencies to
determine that these loans generally are
not ‘‘broader than’’ QM. Therefore, the
agencies have concluded that they
cannot include these community-

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focused residential mortgages in the
definition of QRM.
As discussed previously with respect
to other exemptions (or requests for
exemptions) from risk retention,
however, the agencies may provide an
exemption from risk retention if the
exemption would: (i) help ensure highquality underwriting standards for the
securitizers and originators of assets that
are securitized or available for
securitization; and (ii) encourage
appropriate risk management practices
by the securitizers and originators of
assets, improve the access of consumers
and businesses to credit on reasonable
terms, or otherwise be in the public
interest and for the protection of
investors.328
For the reasons discussed below, and
in response to concerns raised by
commenters, the agencies are providing
an exemption from risk retention under
section 15G(e) of the Exchange Act for
the categories of loans described above
(community-focused exempted loans),
other than extensions of credit made
pursuant to a program authorized by
sections 101 and 109 of the EESA.
Generally, the agencies have concluded
that the loans made by lenders
identified above and covered by this
exemption meet the requirements for an
exemption under section 15G(e) because
they are either government-certified, or
originated by government-administered
programs, or small non-profit programs
that have a specific community mission.
As the primary mission of these lenders
is building and strengthening at-risk
communities, or building wealth for
LMI families, strong underwriting
procedures to maximize affordability
and borrower success in keeping their
homes has been integral to the programs
that originate the community-focused
exempted loans. Because the stated
mission is integral to the lending
programs administered by these lenders,
the agencies believe these entities have
the incentive to maintain strong
underwriting standards to help ensure
that they offer affordable loans to the
borrowers they serve. The stated
mission also helps to protect investors
because of the incentives to maintain
high underwriting standards and ensure
that borrowers are given appropriate
and affordable loans. Additionally,
exemptions from risk retention for loans
made by the above-listed entities serve
the public interest because these entities
have stated public mission purposes to
make safe, sustainable loans available
primarily to LMI communities, which
helps to improve access to credit on
reasonable terms for borrowers and is in
328 15

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the public interest. The agencies further
observe that these programs are a
significant source of credit to LMI
communities. To the extent these loans
are or will be securitized, an exemption
helps to ensure that a risk retention
requirement would not impede
financing on reasonable terms for such
borrowers.
In addition, the agencies below
respond to concerns raised by
commenters with respect to the
exemption under section 15G of the
Exchange Act and the final rule for
asset-backed securities issued or
guaranteed by states and their
instrumentalities, or by municipal
entities.
i. Housing Finance Agency Program
Loans
State HFAs are state lending programs
established to help meet the affordable
housing needs of the residents of their
states. Although their characteristics
vary widely, such as their relationship
to the state government, most HFAs are
independent entities that operate under
the direction of a board of directors
appointed by each state’s governor.
They typically administer a wide range
of affordable housing and community
development programs, including
providing first-time homebuyers with
loans for existing and new construction
and providing financing to build and
revitalize affordable housing units,
revitalize older neighborhoods and
communities, and build shelters and
transitional and supportive housing.
If an HFA is a public instrumentality
of a state, then an asset-backed security
issued or guaranteed by such HFA (or
otherwise issued or guaranteed by the
state that established the HFA or one of
its public instrumentalities) is exempt
from the registration requirements
under section 3(a)(2) of the Securities
Act 329 and should be exempt from risk
retention under the state and municipal
securitization exemption provided in
section 19(b)(3) of the final rule.
Further, the use of a private-sector
entity to service loans that collateralize
such asset-backed securities would not,
in and of itself, invalidate this
exemption. If an HFA is not a public
instrumentality of a state whose
securities are exempt from the
registration requirements under section
3(a)(2) of the Securities Act, then
securitizations issued or guaranteed by
the HFA would not automatically be
exempt from risk retention unless
another exemption applied.
Securitizations of loans made by HFAs
through private-sector sponsors also
329 15

U.S.C. 77c(a)(2).

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would not have an exemption from risk
retention. The agencies understand that
it is unclear whether there are any HFA
securitizations currently occurring that
are not covered under that state and
municipal securitizations exemption in
section 19(b)(3) of the final rule.
However, the agencies believe it may be
possible that some future securitizations
of HFA loans would not be covered and
that an exemption under section 15G(e)
of the Exchange Act would help ensure
that HFA lending programs continue to
have access to the financial markets,
which in turn should help to ensure
affordable access to credit for the
borrowers that they serve.
Many HFA underwriting standards
are similarly stringent or more stringent
than those of the Enterprises or Federal
government agencies thorough their
program analyses of a consumer’s ability
to repay.330 The agencies believe that an
exemption under section 15G(e) would
encourage HFAs to continue providing
sound underwriting and access to
affordable credit for their communities.
In addition, as discussed above, the
state HFA programs are established
under public oversight under a specific
state legal framework and provide a key
source of affordable mortgage credit for
LMI and first-time borrowers that is
important to sustaining homeownership
(and the public benefits that flow
therefrom) in many communities.
ii. Community Development Financial
Institution Loans
Creditors designated as CDFIs, as
defined under Treasury regulations,331
include such entities as regulated banks,
savings associations and credit unions
as well as nonprofit funds and
institutions.332 The Community
Development Banking and Financial
Institutions Act of 1994,333 defines a
CDFI as an entity that (1) has a primary
mission of promoting community
development; (2) serves an investment
area or targeted population; (3) provides
development services in conjunction
with equity investments or loans
directly or through a subsidiary or
affiliate; (4) maintains, through
representation on its governing board
accountability to residents of its area or
target population; and (5) is a
nongovernmental entity. Treasury’s
CDFI certification and application
regulations incorporate the statutory
definition requirements and contain
78 FR 35430, 35432–33 (June 12, 2013).
CFR 1805.104(h).
332 There were 874 CDFIs as of June 30, 2014.
CDFI Fund, CDFI Certification, visited August 1,
2014, available at: http://www.cdfifund.gov/what_
we_do/programs_id.asp?programID=9#certified.
333 12 U.S.C. 1401 et seq.

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additional requirements for eligibility
verification, applications, matching
funds, and other standards. These
requirements include that a CDFI must
be certified by Treasury’s CDFI Fund
Program.334 Additionally, at least 60
percent of the financing activities of a
CDFI must be targeted to one or more
LMI or underserved communities.
Although CDFI securitization volume
data is not available, at least one CDFI,
the Community Reinvestment Fund, has
issued securitizations in the past.
Access to the securitization market for
CDFIs may help to ensure that these
entities can continue to focus on their
mission of providing community
development and helping LMI
borrowers by preserving access to the
securitization market. In determining
that these entities warranted an
exemption from the ability-to-repay
rules, the CFPB found that, although
these entities do not have standardized
underwriting criteria, they use a variety
of compensating factors and compare
the strength of different underwriting
factors, such as credit history and
income, to determine if the LMI
consumer qualified.335 Similar to state
HFAs, an exemption from risk retention
would assist CDFIs in continuing their
mission of providing affordable credit to
various communities by allowing them
to access securitization markets without
risk retention requirements if they were
to seek such funding in the future.
Furthermore CDFIs have a stated
mission requirement to serve the
community which requires them to
maintain strong underwriting standards
to protect the individual borrower and
the organization, thus lowering risk for
the public and investors.
iii. Community Housing Development
Organizations and Downpayment
Assistance Programs
To be a CHDO, an organization must
qualify under HUD’s regulations for
such designation and re-qualify every
time it receives additional set-asides
through the HOME program. HUD’s
HOME Investment Partnership
Program 336 requires the allocation of 15
percent of funds to a CHDO to undergo
HOME activities. A CHDO has 5 years
to allocate the funds and its activities
must be in compliance with both HUD’s
and the awarding jurisdiction’s
requirements for use of the HOME

330 See
331 12

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334 12

CFR 1805.201.
FR at 35433, 35461 (June 12, 2013).
336 There are 353 creditors certified by HUD as
CHDOs. OneCPD, HUD Exchange, visited on August
1, 2014, available at: https://www.onecpd.info/
search.
335 78

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funds.337 HUD’s requirements for being
a CHDO and eligible for an award
include: (1) being a private nonprofit
organization; (2) having among its
purposes the provision of decent
housing that is affordable to LMI
persons, as evidenced in its charter,
articles of incorporation, resolutions or
by-laws; (3) having a demonstrated
capacity for carrying out housing
projects assisted with HOME funds; and
(4) having a history of serving the
community within which housing to be
assisted with HOME funds is to be
located. Data indicates that lending at
CHDOs totaled $64 million in 2011 with
just under 500 loans.338
As with CDFIs, although CHDOs do
not have standardized underwriting
criteria, CHDOs use a variety of
compensating factors, including an
ability-to-repay analysis,339 in
underwriting mortgage loans to ensure
that the loan is appropriate for the
borrower.340 CHDOs use these factors in
addition to standard underwriting
factors, such as credit history and
income, to determine if the LMI
consumer qualifies.341 CHDOs’ stated
mission to serve LMI persons and
requirements to qualify under the HUD
program helps to ensure strong, but
flexible underwriting of loans to sustain
their mission.
For its loans to qualify for an
exemption from the ability-to-repay
rules, a Downpayment Assistance
Provider must operate in accordance
with applicable HUD regulations.342
Consequently, a DAP must be listed on
HUD’s nonprofit organization roster by
applying every two years and specifying
the FHA activities it proposes to carry
out.343 The organization must comply
with all requirements stated in the
specific applicable provision of the
single family regulations applicable to
the FHA activity it undertakes. Similar
to CHDOs, DAPs also use underwriting
requirements that are tailored to the
target LMI populations.344 The DAPs’
mission requires them to tailor their
programs to provide lending for LMI
populations, but they must also follow
HUD and program-specific requirements
which encourage sound lending.
337 24

CFR 92.254.
FR at 35434, 35461 (June 12, 2013).
339 24 CFR 92.254.
340 Id.
341 Id.
342 12 CFR 1026.43(a)(3)(v)(B).
343 There are currently 205 organizations certified
as DAPs. HUD, Nonprofits, visited on August 1,
2014, available at: https://entp.hud.gov/idapp/html/
f17npdata.cfm.
344 See 78 FR 35430, 35464 (June 12, 2014).

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iv. Exempt Nonprofit Organizations
To be exempt from the ability-torepay rules, a nonprofit organization
must have an IRS tax-exempt ruling or
determination letter as a 501(c)(3)
organization, and meet the following
additional criteria: 345 (1) during the
preceding calendar year, the
organization extended a maximum of
200 dwelling-secured loans; 346 (2)
during the preceding calendar year,
extended credit only to consumers with
income that did not exceed the LMI
household limit; (3) the extension of
credit must be made to consumers with
income that does not exceed the LMI
household limit; and (4) the creditor has
and uses written procedures to
determine the consumer’s reasonable
ability to repay. Similar to the other
categories of lenders exempted from risk
retention because of their communityfocused lending, as discussed above,
these entities serve LMI consumers, and
as non-profits, seek to provide
borrowers with loans that will be
affordable to lower risk to the borrower
and the non-profit. Additionally, such
entities must maintain a written policy
on determining ability to repay for the
LMI consumers it serves.
For the reasons discussed above,
under section 15G(e) of the Exchange
Act, the agencies are exempting from
risk retention loans made by the above
entities that are also exempt from the
ability-to-repay rules under the CFPB’s
Regulation Z. As discussed above, the
agencies have concluded that the
history of sound underwriting of
affordable mortgage credit to LMI and
similar communities by these entities,
government oversight and program
requirements, as well as the public
mission of these entities generally
supports findings that these exemptions
from risk retention would help ensure
high-quality underwriting and be in the
public interest and for the protection of
investors.
The agencies have not concluded that
an exemption is warranted for
extensions of credit under EESA
programs. Unlike the communityfocused lending exemption, the EESA
exemption covers special, temporary
homeownership stabilization and
foreclosure prevention programs that
were specially enacted in the wake of
the financial crisis to promote the
recovery and prevent foreclosures. The
EESA programs exempted from the
345 12

CFR 1026.43(a)(3)(v)(D),
CFPB has proposed an amendment to
exclude from the 200 originations count certain
forgivable or deferred second lien loans. See 79 FR
25730 (May 6, 2014). Update if CFPB adopts change
before this rule is finalized.
346 The

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ability-to-repay rule are those
authorized under the ‘‘Making Home
Affordable’’ (MHA) provision and the
Hardest Hit Fund (HHF), which
includes programs such as the Home
Affordable Modification Program and
the Home Affordable Foreclosure
Alternatives Program. Currently the
MHA programs are scheduled to expire
on December 31, 2015, and the HHF
programs are scheduled to expire on
December 31, 2017. The rehabilitative
purpose of these programs and their
limited duration distinguish these
programs from the community-focused
lending programs. Consequently, the
agencies are not exempting these
programs from risk retention.
Under the final rule, an exemption is
provided if the asset-backed securities
issued in the transaction are
collateralized solely by communityfocused residential mortgages and by
servicing assets. Alternatively, if the
community-focused residential
mortgages are included in a pool with
other non-QRMs, the amount of risk
retention required under section 4(a) of
the rule is reduced by a ratio of the
unpaid principal balance of the
community-focused residential
mortgages to the total unpaid principal
balance of residential mortgages that are
included in the pool of assets
collateralizing the asset-backed
securities issued pursuant to the
securitization transaction (the
community-focused residential
mortgage asset ratio). This communityfocused residential mortgage asset ratio
must be measured as of the cut-off date
or similar date for establishing the
composition of the securitized assets
collateralizing the asset-backed
securities issued pursuant to the
securitization transaction. In addition,
under the final rule, if the communityfocused residential mortgage asset ratio
exceeds 50 percent, it is treated as 50
percent, which provides the same
ability to pool exempt communityfocused residential mortgages with other
non-QRMs, as permitted for qualifying
and non-qualifying commercial loans,
CRE loans, and automobile loans.
Additionally, the agencies are
committing in the final rule to review
the community-focused lending
exemption at the same time the agencies
review the QRM definition (i.e., no later
than four years after the effective date of
this rule with respect to securitizations
of residential mortgages, five years after
the completion of that initial review,
and every five years thereafter.) In
addition, the agencies will commence a
review of the exemption at any time
upon the request of any one of the
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Exemption for Certain Mortgage Loans
Secured by Three-to-Four Unit
Residential Properties
Under Regulation Z, only loans that
are ‘‘covered transactions’’ are QMs
under the definitions adopted by the
CFPB.347 A ‘‘covered transaction’’ under
Regulation Z means a consumer credit
transaction that is secured by a dwelling
(including any real property attached to
a dwelling) other than those consumer
credit transactions exempted from the
ability-to-repay rules by the CFPB.348 A
‘‘dwelling’’ is defined under the CFPB
rules as a residential structure that
contains one-to-four units (and can
include various types of properties such
as mobile homes and
condominiums).349 However, the
Regulation Z Official Interpretations
specify that credit extended to acquire
a rental property that is or will be
owner-occupied within the coming year
and that has more than two housing
units is deemed to be for business
purposes.350 In that case, the loan is not
a consumer credit transaction or
covered transaction under Regulation Z,
and therefore does not appear to meet
the definition of QM.
In aligning the QRM definition with
QM, the agencies understood that
covered transactions could include
owner-occupied, one-to-four unit
residential properties.351 The agencies
also understand that market practice is
generally to categorize residential
mortgage securitizations as those
collateralized by one-to-four unit
properties, with mortgages of three-tofour unit properties frequently
combined in a single collateral pool
with one- or two-unit properties.352
Enterprise guidelines for residential
mortgage securitizations also categorize
residential mortgages by one-to-four
family units.353 From a credit risk

perspective, mortgages secured by threeto-four unit residential properties
generally have the same characteristics
as mortgages secured by two-unit
properties, which are covered
transactions under Regulation Z and
may qualify as QMs, and therefore
QRMs.
The agencies are concerned that the
categorical exclusion of some mortgage
loans secured by three-to-four unit
mortgages from the definition of
‘‘covered transaction’’ under Regulation
Z (in accordance with the Official
Interpretations) and the consequence
that such loans appear not to be QMs
even if they otherwise meet all of the
other QM criteria, would
inappropriately constrain funding from
the securitization markets for these
types of residential mortgages. This in
turn could significantly impact the
availability of credit to finance the
purchase of such properties by owneroccupiers. While the overall volume of
mortgage lending secured by three-tofour unit residential properties is small
in relation to all residential mortgage
lending, there are some metropolitan
areas that contain a significant stock of
such properties, including in many lowand-moderate income areas.354
At the same time, the agencies believe
that owner-occupied, three-to-four unit
mortgages that meet the same
underwriting qualifications under the
QM rule as two unit residential
mortgages that meet the QM definition
have similar risk characteristics. In
order to ensure that such mortgage loans
have the same access to securitization
markets as similar loans secured by oneto-two unit properties, pursuant to the
authority in section 15G(e)(1) of the
Exchange Act, the agencies are
exempting from risk retention
requirements owner-occupied mortgage
loans secured by three-to-four unit
residential properties that meet all the
criteria for QM in Regulation Z except
for being a ‘‘consumer credit

347 See 12 CFR 1026.43(e)(2), (e)(4), (e)(5), and
(e)(6).
348 12 CFR 1026.43(b)(1).
349 See 12 CFR 1026.2(a)(19).
350 See 12 CFR part 1026 Supplement I, paragraph
3(a)–5.i.
351 See, for example, the discussion in the
preamble to the 2013 proposal at 57991 (78 FR
57928, 57991 (September 20, 2013)) and the
proposed definition of commercial loan, which
excluded any loan to a company or an individual
for business purposes to purchase or refinance a
one-to-four family residential property (78 FR
57928, 58037 (September 20, 2013)).
352 See, for example, https://
www.americansecuritization.com/uploadedFiles/
RMBS%20Outline.pdf
353 The agencies also note that other regulations
categorize mortgages on one-to-four unit (or family)
properties as residential mortgages. See, for

example, the definition of ‘‘residential mortgage
exposure’’ in the banking agency capital regulations
(12 CFR 3.2, 12 CFR 217.2; 12 CFR 324.2). See also
similar definitions in 12 CFR 37.2; 12 CFR part 30,
appendix C; 12 CFR part 208, appendix C.
354 In a review mortgages originated from 2005 to
2013, with respect to each vintage, mortgages
collateralized by two-to-four unit properties
accounted for between 1 percent and 3 percent of
the count of residential mortgages and to one to four
percent of the dollar volume (at origination). Data
sources reviewed do not generally separately
identify one-to-four unit properties. (Data reviewed
was from Black Knight Data and Analytics (formerly
known as McDash)). It is noted that there are some
metropolitan statistical areas across the country in
which the share of housing units located in 3 and
4 unit properties is significantly higher than the
national average of 4.5 percent, based on data from
the U.S. Census, 2013 American Community
Survey, 1-year estimates.

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of the exemption over time and as the
market evolves.

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transaction,’’ as determined under
Regulation Z and the Official
Interpretations. These mortgages are
referred to in the final rule as
‘‘qualifying three-to-four unit residential
mortgage loans.’’ To qualify for the
exemption, a mortgage loan secured by
a three-to-four unit residential property
must be owner-occupied and must
comply with all of the requirements for
qualified mortgages as set forth in
sections 1026.43(e) and (f) of Regulation
Z as if the mortgage were a covered
transaction for purposes of that
section.355
The agencies recognize that in order
for qualifying three-to-four unit
residential mortgage loans to benefit
from the exemption from risk retention
as intended and maintain access to
securitization markets and mortgage
credit similar to residential mortgages
that are QRMs, it must be possible for
sponsors to combine these loans with
QRMs in a single collateral pool.
Therefore, pursuant to their exemptive
authority in section15G (e)(1), the
agencies are also providing an
exemption from risk retention for
securitizations that contain both QRMs
and qualifying three-to-four unit
residential mortgage loans.
To qualify for these combined pools,
the final rule requires that depositors
comply with the certification
requirements for these exempt
securitization transactions on the same
basis as qualifying residential mortgage
securitization transactions that are
exempted from risk retention. That is,
the depositor must certify that all the
assets in the pool meet either the QRM
definition or are qualifying three-to-four
unit residential mortgage loans that
meet the requirements of section
1026.43(e) (other than being deemed a
consumer credit transaction).
Additionally, a sponsor must comply
with the repurchase requirements for
these exempt securitization transactions
on the same basis as qualifying
residential mortgage securitization
transactions that are exempted from risk
retention, if it is determined after
closing that a loan does not meet all of
the criteria to be either a QRM or a
qualifying three-to-four unit residential
mortgage loan.
As discussed previously with respect
to other exemptions from risk retention
pursuant to section 15G(e)(1) of the
Exchange Act, the agencies may issue
exemptions, exceptions or adjustments
to the risk retention rules, including for
classes of institutions or assets relating
to the risk retention requirement, if the
exemption would: (i) Help ensure high355 12

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quality underwriting standards for the
securitizers and originators of assets that
are securitized or available for
securitization; and (ii) encourage
appropriate risk management practices
by the securitizers and originators of
assets, improve the access of consumers
and businesses to credit on reasonable
terms, or otherwise be in the public
interest and for the protection of
investors.356
The agencies believe that an
exemption from risk retention for
securitization transactions collateralized
by qualifying three-to-four unit
residential mortgage loans and an
exemption for combining qualifying
three-to-four unit residential mortgage
loans and QRMs (as well as servicing
assets) in a single securitization pool
meets these statutory standards for an
exemption under section 15G(e)(1). The
exemptions will help ensure highquality underwriting standards for
securitizers and originators of assets that
are securitized or available for
securitization because all the collateral
will have to be mortgage loans secured
by owner-occupied, one-to-four family
residential properties that met all the
requirements to be a QM (other than
being deemed a loan for business
purposes, and therefore not a covered
transaction, under the Official
Interpretations of Regulation Z (12 CFR
part 1026, Supplement I, paragraph
3(a)(5)(i)). As discussed above with
respect to the alignment of the QRM and
QM definitions, the agencies believe
that the underwriting and product
standards for QMs limit credit risk and
promote sound underwriting.
The agencies also believe that the
exemptions will improve the access of
consumers and businesses to credit on
reasonable terms because they will help
preserve access to securitization funding
for mortgage loans to owner-occupied
three-to-four unit residential properties
on the same basis as other one-to-four
unit residential properties. The
exemptions are also in the public
interest and for the protection of
investors because they require all the
loans in a securitization transaction that
benefit from the exemption to meet the
underwriting and product standards of
QM, which, for the reasons discussed
above in Section VI, appropriately limit
credit risk for residential mortgages
exempted from risk retention.
The agencies also believe that,
because the qualifying three-to-four unit
residential mortgage loans will meet all
QM criteria other than being a consumer
credit transaction, these exemptions are
not inconsistent with the provisions of
356 15

U.S.C. 78o–11(e)(1) and (2).

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section 15G of the Exchange Act that,
absent an exemption, require the
agencies to apply risk retention to
transactions collateralized by both
QRMs and non-QRMs.357 The agencies
have separately retained the exemption
mandated in section 15G for risk
retention for securitization transactions
collateralized solely by QRMs,
including the certification requirements
also specified in the statute.358
Moreover, the exemption the agencies
are providing for securitizations
collateralized by both QRMs and
qualifying three-to-four unit residential
mortgage loans is limited in scope and
only permits the mixing of QRMs and
non-QRM loans that are subject to the
exact same underwriting and product
type standards that limit credit risk and
define QM. For these reasons, the
agencies are adopting the above
described exemption from risk retention
in the final rule.
Additionally, the agencies are
committing in the final rule to review
the exemption for qualifying three-tofour unit residential mortgage loans at
the same time the agencies review the
QRM definition (i.e., no later than four
years after the effective date of this rule
with respect to securitizations of
residential mortgages, five years after
the completion of that initial review,
and every five years thereafter.) In
addition, the agencies will commence a
review of the exemption at any time
upon the request of any one of the
agencies. This will allow the agencies to
assess the advantages and disadvantages
of the exemption over time and as the
market evolves.
VIII. Severability
If any provision of this rule, or the
application thereof to any person or
circumstance, is held to be invalid, such
invalidity shall not affect other
provisions or application of such
provisions to other persons or
circumstances that can be given effect
without the invalid provision or
application.
IX. Plain Language
Section 722 of the Gramm-LeachBliley Act, Public Law 106–102, sec.
722, 113 Stat. 1338, 1471 (Nov. 12,
1999), requires the Federal banking
agencies to use plain language in all
proposed and final rules published after
January 1, 2000. The Federal banking
agencies invited comments on how to
357 The agencies do not otherwise address the
permissibility of exemptions for pools blending
QRMs and non-QRMs at this time. See note 322,
supra, and accompanying text.
358 See 15 U.S.C. 78o–11(e)(5) and (e)(6).

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make the reproposal easier to
understand.
X. Administrative Law Matters
A. Regulatory Flexibility Act
OCC: The Regulatory Flexibility Act
(RFA) generally requires that, when
promulgating a final rule, an agency
publish a final regulatory flexibility
analysis that describes, among other
items, the impact of the final rule on
small entities.359 However, a regulatory
flexibility analysis is not required if the
head of the agency certifies that the rule
will not have a significant economic
impact on a substantial number of small
entities 360 and publishes the
certification and a statement of the
factual basis for such certification.361
As discussed in the Supplementary
Information, the final rule generally
requires a securitizer to retain not less
than 5 percent of the credit risk of any
asset that the securitizer, through the
issuance of an asset-backed security
(ABS), transfers, sells, or conveys to a
third party; and prohibits a securitizer
from directly or indirectly hedging or
otherwise transferring the credit risk
that the securitizer is required to retain.
In certain situations, the final rule
allows securitizers to allocate a portion
of the risk retention requirement to the
originator(s) of the securitized assets, if
an originator contributes at least 20
percent of the assets in the
securitization. The final rule also
provides an exemption for ABS
collateralized exclusively by QRM
loans.
In determining whether the final rule
would have a significant economic
impact on a substantial number of small
national banks and Federal savings
associations, the OCC reviewed
December 31, 2013 Call Report data 362
to evaluate the securitization activity
and approximate the number of small
banking organizations that potentially
could retain credit risk under the final
rule primarily through the allocation to
originator provisions.
As of December 31, 2013, the OCC
regulated approximately 1,231 small
national banks and Federal savings
associations that would be subject to
359 5

U.S.C. 604.
Small Business Administration defines
small entity to include national banks or Federal
savings associations with assets of $550 million or
less. 13 CFR 121.201.
361 5 U.S.C. 605(b).
362 Call Report Schedule RC–S provides
information on the servicing, securitization, and
asset sale activities of banking organizations. For
purposes of the RFA analysis, the OCC evaluated
data regarding residential mortgage loan origination
for securitization, as this is the primary
securitization activity by small banking
organizations.
360 The

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this rule. The Call Report data indicates
that approximately 155 small national
banks and Federal savings associations
originate loans for securitization,
predominantly one-to-four family
residential mortgages. Using a threshold
of 5 percent of small regulated
institutions, the final rule could impact
a substantial number of small national
banks and Federal savings associations.
The vast majority of securitization
activity by small banks is in the
residential mortgage sector. Many of
these banks originate and sell
residential mortgage loans to the
Enterprises, which satisfy risk retention
under the final rule when they
securitize those loans and would not
allocate risk retention to the originating
banks under the final rule. Small banks
that originate mortgages for
securitization through other channels
likely would be exempt from risk
retention by another provision in the
rule, such as that the loans meet the
QRM definition or meet the community
focused lending securitization
exemption. For these reasons, the OCC
concludes that the final rule would not
have a significant economic impact on
a substantial number of small national
banks and Federal savings
associations.363
Board: In general, section 4 of the
Regulatory Flexibility Act (5 U.S.C. 604)
requires an agency to prepare a final
regulatory flexibility analysis for a final
rule unless the agency certifies that the
rule will not, if promulgated, have a
significant economic impact on a
substantial number of small entities
(defined as of July 14, 2014, to include
banking entities with total assets of $550
million or less) (‘‘small banking
entities’’).364 Pursuant to section 505(b)
of the Regulatory Flexibility Act, a final
regulatory flexibility analysis is not
required if an agency certifies that the
final rule will not have a significant
economic impact on a substantial
number of small entities. The Board has
considered the potential economic
impact of the final rule on small
banking entities supervised by the
Board in accordance with the
Regulatory Flexibility Act. The Board
363 The OCC previously concluded that the
reproposed rule, if finalized, would not have a
significant economic impact on a substantial
number of small national banks and Federal savings
associations. See Section VIII.A, 78 FR 57928
(September 20, 2013). The OCC requested comment
and received no responsive comments on that
conclusion.
364 See 13 CFR 121.201; See also 13 CFR
121.103(a)(6) (noting factors that the Small Business
Administration considers in determining whether
an entity qualifies as a small business, including
receipts, employees, and other measures of its
domestic and foreign affiliates).

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believes that the final rule will not have
a significant economic impact on a
substantial number of small banking
entities supervised by the Board for the
reasons described below.
For the reasons discussed in Part II of
this Supplementary Information, the
final rule defines a securitizer as a
‘‘sponsor’’ in a manner consistent with
the definition of that term in the
Commission’s Regulation AB and
provides that the sponsor of a
securitization transaction is generally
responsible for complying with the risk
retention requirements established
under section 15G. The Board is
unaware of any small banking
organization under the supervision of
the Board that has acted as a sponsor of
a securitization transaction 365 (based on
December 31, 2013 data).366 As of
December 31, 2013, there were
approximately 5,051 small banking
organizations supervised by the Board,
which includes 4,009 bank holding
companies, 298 savings and loan
holding companies, 651 state member
banks, 23 Edge and agreement
corporations and 70 U.S. offices of
foreign banking organizations.
The final rule permits, but does not
require, a sponsor to allocate a portion
of its risk retention requirement to one
or more originators of the securitized
assets, subject to certain conditions
being met. In particular, a sponsor may
offset the risk retention requirement by
the amount of any eligible vertical risk
retention interest or eligible horizontal
residual interest acquired by an
originator of one or more securitized
assets if certain requirements are
satisfied, including, the originator must
originate at least 20 percent of the
securitized assets.367 A sponsor using
this risk retention option remains
responsible for ensuring that the
originator has satisfied the risk retention
requirements. In light of this option, the
Board has considered the impact of the
final rule on originators that are small
banking organizations.
365 For purposes of the proposed rules, this would
include a small bank holding company; savings and
loan holding company; state member bank; Edge
corporation; agreement corporation; foreign banking
organization; and any subsidiary of the foregoing.
366 Call Report Schedule RC–S; Data based on the
Reporting Form FR 2866b; Structure Data for the
U.S. Offices of Foreign Banking Organizations; and
Aggregate Data on Assets and Liabilities of U.S.
Branches and agencies of Foreign Banks based on
the quarterly form FFIEC 002.
367 With respect to an open market CLO
transaction, the risk retention retained by the
originator must be at least 20 percent of the
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The December 31, 2013 regulatory
report data 368 indicates that
approximately 757 small banking
organizations, 102 of which are small
banking organizations that are
supervised by the Board, originate loans
for securitization, namely ABS
issuances collateralized by one-to-four
family residential mortgages. The
majority of these originators sell their
loans to the Enterprises, which retain
credit risk through agency guarantees
and would not be able to allocate credit
risk to originators under this proposed
rule. Additionally, based on publiclyavailable market data, it appears that
most residential mortgage-backed
securities offerings are collateralized by
a pool of mortgages with an unpaid
aggregate principal balance of at least
$500 million.369 Accordingly, under the
final rule a sponsor could potentially
allocate a portion of the risk retention
requirement to a small banking
organization only if such organization
originated at least 20 percent ($100
million) of the securitized mortgages. As
of December 31, 2012, only one small
banking organization supervised by the
Board reported an outstanding principal
balance of assets sold and securitized of
$100 million or more.370
For residential mortgage-backed
securitizations, the draft final rule is
expected to have minimal impact on the
cost of credit for sponsors of nonEnterprise mortgage-backed
securitizations that currently retain less
than the draft final rule’s base risk
retention requirement. The markets for
those residential mortgages exempted
under the draft final rule should be very
large, and result in significant liquidity,
economies of scale, little to no impact
for these securitizations.
368 Call Report Schedule RC–S provides
information on the servicing, securitization, and
asset sale activities of banking organizations. For
purposes of the RFA analysis, the agencies gathered
and evaluated data regarding (1) the outstanding
principal balance of assets sold and securitized by
the reporting entity with servicing retained or with
recourse or other seller-provided credit
enhancements, and (2) assets sold with recourse or
other seller-provided credit enhancements and not
securitized by the reporting bank.
369 Based on the data provided in Table 1, page
29 of the Board’s ‘‘Report to the Congress on Risk
Retention’’, it appears that the average MBS
issuance is collateralized by a pool of
approximately $620 million in mortgage loans (for
prime MBS issuances) or approximately $690
million in mortgage loans (for subprime MBS
issuances). For purposes of the RFA analysis, the
agencies used an average asset pool size of $500
million to account for reductions in mortgage
securitization activity following 2007, and to add an
element of conservatism to the analysis.
370 The FDIC notes that this finding assumes that
no portion of the assets originated by small banking
organizations were sold to securitizations that
qualify for an exemption from the risk retention
requirements under the proposed rule.

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Commercial loans that have in recent
years been securitized through open
market CLOs may experience a modest
incremental impact in the cost of credit,
as mangers of open market CLOs
increase their credit exposure to 5
percent using the horizontal risk
retention option under the draft final
rule. There could also be consolidation
in the asset manager industry as a result.
The alternative option for lead arrangers
to hold risk in the final rule should have
minimal impact on the cost of credit
(approximately 0–10 basis points)
because it would be a vertical interest.
An estimate for the incremental increase
in the cost of credit for CLO managers
is approximately 10–20 basis points, but
because risk retention would affect the
current business model, costs may be
higher than expected.
The draft final rule will also likely
have an effect on CMBS transactions.
The typical market practice of holding
horizontal risk retention of 2.5 percent
for conduit transactions will double to
5 percent under the draft rule. The
Board estimates that the rule will have
a small incremental impact on cost of
credit (of up to 10 basis points,
approximately) for sponsors subject to
the rule, but reducing the leverage of
third-party purchasers could
significantly improve issuer incentives,
and other requirements in the rule could
mitigate existing conflicts of interest
between third-party purchasers and
sponsors who hold residual interests
and senior investors. Single-Borrower
CMBS, despite a lack of current risk
retention in practice, should experience
a modest incremental impact on cost of
credit (of up to approximately 25 basis
points). The rule should have little to no
effect on the cost of credit for credit
card, prime and non-prime auto, student
loan, and less common (esoteric)
securitizations, because the amount of
credit risk retention typical to these
securitizations already being held in the
market is generally adequate to satisfy
the requirements in the final rule.
In light of the foregoing, the Board
does not believe, for the banking entities
subject to the Board’s jurisdiction, that
the final rule would have a significant
economic impact on a substantial
number of small entities.
FDIC: The Regulatory Flexibility Act,
5 U.S.C. 601 et seq. (RFA), requires an
agency, in connection with a final rule,
to prepare a Final Regulatory Flexibility
Act analysis describing the impact of
the rule on small entities (defined by the
Small Business Administration for
purposes of the RFA to include banking
entities with total assets of $550 million
or less) or to certify that the rule will not
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a substantial number of small
entities.371
As of June 30, 2014, there were 3,573
small FDIC-supervised institutions,
which include 3,267 state nonmember
banks and 306 state-chartered savings
institutions. For the reasons provided
below, the FDIC certifies that the final
rule will not have a significant
economic impact on a substantial
number of small entities, which in this
context are small banking organizations
supervised by the FDIC with total assets
of $550 million or less. Accordingly, a
regulatory flexibility analysis is not
required.
As discussed in the Supplementary
Information above, section 941 of the
Dodd-Frank Act 372 generally requires
the Federal banking agencies and the
Commission, and, in the case of the
securitization of any residential
mortgage asset, together with HUD and
FHFA, to jointly prescribe regulations,
that (i) require a securitizer to retain not
less than 5 percent of the credit risk of
any asset that the securitizer, through
the issuance of an asset-backed security
(ABS), transfers, sells, or conveys to a
third party; and (ii) prohibit a
securitizer from directly or indirectly
hedging or otherwise transferring the
credit risk that the securitizer is
required to retain under section 15G.
Although the final rule will apply
directly only to securitizers, subject to
certain considerations section 15G
authorizes the agencies to permit
securitizers to allocate at least a portion
of the risk retention requirement to the
originator(s) of the securitized assets.
Section 15G provides a total
exemption from the risk retention
requirements for securitizers of certain
securitization transactions, such as an
ABS issuance collateralized exclusively
by QRMs, and further authorizes the
agencies to establish a lower risk
retention requirement for securitizers of
ABS issuances collateralized by other
asset types, such as commercial,
commercial real estate (CRE), and
automobile loans, which satisfy
underwriting standards established by
the Federal banking agencies and the
Commission. The risk retention
requirements of section 15G apply
generally to a ‘‘securitizer’’ of ABS,
where securitizer is defined to mean (i)
an issuer of an ABS; or (ii) a person who
organizes and initiates an asset-backed
transaction by selling or transferring
assets, either directly or indirectly,
including through an affiliate, to the
issuer. Section 15G also defines an
371 See

5 U.S.C. 601 et seq.
at section 15G of the Exchange Act,
17 U.S.C. 78o–11.
372 Codified

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‘‘originator’’ as a person who (i) through
the extension of credit or otherwise,
creates a financial asset that
collateralizes an asset-backed security;
and (ii) sells an asset directly or
indirectly to a securitizer. The final rule
implements the credit risk retention
requirements of section 15G. The final
rule, as a general matter, requires that a
‘‘sponsor’’ of a securitization transaction
retain the credit risk of the securitized
assets in the form and amount required
by the final rule. The agencies believe
that imposing the risk retention
requirement on the sponsor of the
ABS—as permitted by section 15G—is
appropriate in view of the active and
direct role that a sponsor typically has
in arranging a securitization transaction
and selecting the assets to be
securitized. The FDIC is aware of only
22 small banking organizations that
currently sponsor securitizations (three
of which are national banks, eight of
which are state member banks, eight of
which are state nonmember banks, and
three of which are savings associations,
based on June 30, 2014 information)
and, therefore, the risk retention
requirements of the final rule, as
generally applicable to sponsors, will
not have a significant economic impact
on small banking organizations. Under
the final rule a sponsor may offset the
risk retention requirement by the
amount of any eligible vertical interest
or eligible horizontal residual interest
acquired by an originator of one or more
securitized assets if certain
requirements are satisfied, including,
the originator must originate at least 20
percent of the securitized assets, as
measured by the aggregate unpaid
principal balance of the asset pool.373 In
determining whether the allocation
provisions of the final rule will have a
significant economic impact on a
substantial number of small banking
organizations, the Federal banking
agencies reviewed June 30, 2014,
consolidated reports of condition and
income (‘‘Call Report’’) data to evaluate
the securitization activity and
approximate the number of small
banking organizations that potentially
could retain credit risk under allocation
provisions of the final rule.374 As of
373 With respect to an open market CLO
transaction, the risk retention retained by the
originator must be at least 20 percent of the
aggregate principal balance at origination of a CLOeligible loan tranche.
374 Call Report Schedule RC–S provides
information on the servicing, securitization, and
asset sale activities of banking organizations. For
purposes of the RFA analysis, the agencies gathered
and evaluated data regarding (1) the outstanding
principal balance of assets sold and securitized by
the reporting entity with servicing retained or with
recourse or other seller-provided credit

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June 30, 2014, the Call Report data
indicates that approximately 763 small
banking organizations, 493 of which are
state nonmember banks, originate loans
for securitization which are largely ABS
issuances collateralized by one-to-four
family residential mortgages. Many of
these originators sell their loans either
to Fannie Mae or Freddie Mac, which
retain credit risk through agency
guarantees, and therefore will not be
allocated credit risk under the final rule.
Additionally, based on publicly
available market data, it appears that
most residential mortgage-backed
securities offerings are collateralized by
a pool of mortgages with an unpaid
aggregate principal balance of at least
$500 million.375 Accordingly, under the
final rule a sponsor could potentially
allocate a portion of the risk retention
requirement to a small banking
organization only if such organization
originated at least 20 percent ($100
million) of the securitized mortgages. As
of June 30, 2014, only nine small
banking organizations supervised by the
FDIC reported an outstanding principal
balance of assets sold and not
securitized by the reporting bank of
$100 million or more.376
Therefore, the FDIC does not believe
that the final rule will result in a
significant economic impact on a
substantial number of small banking
organizations under its supervisory
jurisdiction. The FDIC certifies that the
final rule will not have a significant
economic impact on a substantial
number of small FDIC-supervised
institutions.
Commission: The Regulatory
Flexibility Act of 1980 requires the
Commission, in promulgating rules, to
consider the impact of those rules on
small entities. An initial Regulatory
Flexibility Act Analysis was prepared in
accordance with the Regulatory
Flexibility Act and included in the reenhancements, and (2) assets sold with recourse or
other seller-provided credit enhancements and not
securitized by the reporting bank.
375 Based on the data provided in Table 1, page
29 of the Board’s October 2010 Report covering
2002 through 2010 entitled, ‘‘Report to the Congress
on Risk Retention,’’ it appears that the average
RMBS issuance is collateralized by a pool of
approximately $620 million in mortgage loans (for
prime RMBS issuances) or approximately $690
million in mortgage loans (for subprime RMBS
issuances). For purposes of the RFA analysis, the
agencies used an average asset pool size of $500
million to account for reductions in mortgage
securitization activity following 2007, and to add an
element of conservatism to the analysis.
376 The FDIC notes that this finding assumes that
all assets originated by small banking organizations
reported on RC–S as being sold, whether or not
securitized by the reporting bank, would be subject
to the 5 percent risk retention requirement (and
would not qualify for an exemption from the risk
retention requirements under the final rule).

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proposing release. The Commission
certified in the re-proposing release,
pursuant to 5 U.S.C. 605(b), that the
proposed rule, if adopted, would not
have a significant economic impact on
a substantial number of small entities.
The Commission received one
comment 377 on this certification.
The final rule implements the risk
retention requirements of section 15G of
the Exchange Act, which, in general,
requires the securitizer of asset-backed
securities (ABS) to retain not less than
5 percent of the credit risk of the assets
collateralizing the ABS.378 Under the
final rule, the risk retention
requirements apply to ‘‘sponsors’’, as
defined in the final rule. Based on the
analysis set forth in the original
proposal and the reproposal, the
Commission continues to believe that
the final rule would not have a
significant economic impact on a
substantial number of small entities.
Some commenters on the re-proposal
expressed concern that the re-proposed
risk retention requirements could
indirectly affect the costs and
availability of credit to small businesses
and the availability of mortgage credit to
low- to moderate-income buyers. The
Regulatory Flexibility Act only requires
an agency to consider regulatory
alternatives for those small entities
subject to the final rule. The
Commission has considered the broader
economic impact of the final rule,
including their potential effect on
efficiency, competition and capital
formation, in the Commission’s
Economic Analysis below.
For the reasons described above, the
Commission again hereby certifies,
pursuant to 5 U.S.C. 605(b), that the
final rule will not have a significant
economic impact on a substantial
number of small entities.
FHFA: FHFA has considered the
impact of the final rule on the entities
that it regulates, none of which come
within the meaning of small entities as
defined in the Regulatory Flexibility Act
(RFA). See 5 U.S.C. 601(6). Pursuant to
section 605(b) of the RFA, FHFA hereby
certifies that the final rule will not have
a significant economic impact on a
substantial number of small entities.
B. Paperwork Reduction Act
1. Background
Certain provisions of the final rule
contain ‘‘collection of information’’
377 One commenter urged the agencies to develop
the required Regulatory Flexibility Act analysis to
accurately assess the impact on small entities of the
QM-plus approach to define QRM, if the agencies
adopt such approach. The agencies are not adopting
the QM-plus approach to define QRM.
378 See 17 U.S.C. 78o–11.

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requirements within the meaning of the
Paperwork Reduction Act of 1995
(‘‘PRA’’), 44 U.S.C. 3501–3521. In
accordance with the requirements of the
PRA, the agencies may not conduct or
sponsor, and the respondent is not
required to respond to, an information
collection unless it displays a currently
valid Office of Management and Budget
(OMB) control number. The agencies
published a notice requesting comment
on the collection of information
requirements in the Original Proposal
and the Revised Proposal, and the
information collection requirements
contained in this joint final rule have
been submitted by the FDIC, OCC, and
the Commission to OMB for approval
under section 3507(d) of the PRA and
section 1320.11 of OMB’s implementing
regulations (5 CFR part 1320). The
Board reviewed the rule under the
authority delegated to the Board by
OMB. While commenters provided
qualitative comments on the possible
costs of the rule, the agencies did not
receive any quantitative comments on
the PRA analysis.
2. Information Collection
Title of Information Collection: Credit
Risk Retention.
Frequency of response: Event
generated; annual.
Affected Public: 379
FDIC: Insured state non-member
banks, insured state branches of foreign
banks, state savings associations, and
certain subsidiaries of these entities.
OCC: National banks, Federal savings
associations, Federal branches or
agencies of foreign banks, or any
operating subsidiary thereof.
Board: Insured state member banks,
bank holding companies, savings and
loan holding companies, Edge and
agreement corporations, foreign banking
organizations, nonbank financial
companies supervised by the Board, and
any subsidiary thereof.
Commission: All entities other than
those assigned to the FDIC, OCC, or
Board.
Abstract: The rule sets forth
permissible forms of risk retention for
securitizations that involve issuance of
asset-backed securities, as well as
exemptions from the risk retention
requirements, and contains
requirements subject to the PRA. The
information requirements in the joint
regulations adopted by the three Federal
banking agencies and the Commission
379 The affected public of the FDIC, OCC, and
Board is assigned generally in accordance with the
entities covered by the scope and authority section
of their respective rule. The affected public of the
Commission is based on those entities not already
accounted for by the FDIC, OCC, and Board.

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are found in sections l.4, l.5, l.6,
l.7, l.8, l.9, l.10, l.11, l.13, l.15,
l.16, l.17, l.18, and l.19(g). The
agencies believe that the disclosure and
recordkeeping requirements associated
with the various forms of risk retention
will enhance market discipline, help
ensure the quality of the assets
underlying a securitization transaction,
and assist investors in evaluating
transactions. Compliance with the
information collections is mandatory.
Responses to the information collections
will not be kept confidential and, except
for the recordkeeping requirements set
forth in sections l.4(d), l.5(k)(3) and
l.15(d), there will be no mandatory
retention period for the collections of
information.
3. Section-by-Section Analysis
Section l.4 sets forth the conditions
that must be met by sponsors electing to
use the standard risk retention option,
which may consist of an eligible vertical
interest or an eligible horizontal
residual interest, or any combination
thereof. Sections l.4(c)(1) and l.4(c)(2)
specify the disclosures required with
respect to eligible horizontal residual
interests and eligible vertical interests,
respectively.
A sponsor retaining any eligible
horizontal residual interest (or funding
a horizontal cash reserve account) is
required to disclose: The fair value (or
a range of fair values and the method
used to determine such range) of the
eligible horizontal residual interest that
the sponsor expects to retain at the
closing of the securitization transaction
(§ l.4(c)(1)(i)(A)); the material terms of
the eligible horizontal residual interest
(§ l.4(c)(1)(i)(B)); the methodology used
to calculate the fair value (or range of
fair values) of all classes of ABS
interests (§ l.4(c)(1)(i)(C)); the key
inputs and assumptions used in
measuring the estimated total fair value
(or range of fair values) of all classes of
ABS interests (§ l.4(c)(1)(i)(D)); the
reference data set or other historical
information used to develop the key
inputs and assumptions
(§ l.4(c)(1)(i)(G)); the fair value of the
eligible horizontal residual interest
retained by the sponsor
(§ l.4(c)(1)(ii)(A)); the fair value of the
eligible horizontal residual interest
required to be retained by the sponsor
(§ l.4(c)(1)(ii)(B)); description of any
material differences between the
methodology used in calculating the fair
value disclosed prior to sale and the
methodology used to calculate the fair
value at the time of closing
(§ l.4(c)(1)(ii)(C)); and the amount
placed by the sponsor in the horizontal
cash reserve account at closing, the fair

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value of the eligible horizontal residual
interest that the sponsor is required to
fund through such account, and a
description of such account
(§ l.4(c)(1)(iii)).
For eligible vertical interests, the
sponsor is required to disclose: The
form of the eligible vertical interest
(§ l.4(c)(2)(i)(A)); the percentage that
the sponsor is required to retain
(§ l.4(c)(2)(i)(B)); a description of the
material terms of the vertical interest
and the amount the sponsor expects to
retain at closing (§ l.4(c)(2)(i)(C)); and
the amount of vertical interest retained
by the sponsor at closing
((§ l.4(c)(2)(ii)).
Section l.4(d) requires a sponsor to
retain the certifications and disclosures
required in paragraphs (a) and (c) of this
section in its records and must provide
the disclosure upon request to the
Commission and the sponsor’s
appropriate Federal banking agency, if
any, until three years after no ABS
interests are outstanding.
Section l.5 requires sponsors relying
on the master trust (or revolving pool
securitization) risk retention option to
disclose: The material terms of the
seller’s interest and the percentage of
the seller’s interest that the sponsor
expects to retain at the closing of the
transaction (§ l.5(k)(1)(i)); the
percentage of the seller’s interest that
the sponsor retained at closing
(§ l.5(k)(1)(ii)); the material terms of
any horizontal risk retention offsetting
the seller’s interest under § l.5(g),
§ l.5(h) and § l.5(i) (§ l.5(k)(1)(iii));
and the fair value of any horizontal risk
retention retained by the sponsor
(§ l.5(k)(1)(iv)). Additionally, a sponsor
must retain the disclosures required in
§ l.5(k)(1) in its records and must
provide the disclosure upon request to
the Commission and the sponsor’s
appropriate Federal banking agency, if
any, until three years after no ABS
interests are outstanding (§ l.5(k)(3)).
Section l.6 addresses the
requirements for sponsors utilizing the
eligible ABCP conduit risk retention
option. The requirements for the eligible
ABCP conduit risk retention option
include disclosure to each purchaser of
ABCP and periodically to each holder of
commercial paper issued by the ABCP
conduit of the name and form of
organization of the regulated liquidity
provider that provides liquidity
coverage to the eligible ABCP conduit,
including a description of the material
terms of such liquidity coverage, and
notice of any failure to fund; and with
respect to each ABS interest held by the
ABCP conduit, the asset class or brief
description of the underlying
securitized assets, the standard

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industrial category code for each
originator-seller that retains an interest
in the securitization transaction, and a
description of the percentage amount
and form of interest retained by each
originator-seller (§ l.6(d)(1)). An ABCP
conduit sponsor relying upon this
section shall provide, upon request, to
the Commission and the sponsor’s
appropriate Federal banking agency, if
any, the information required under
§ l.6(d)(1), in addition to the name and
form of organization of each originatorseller that retains an interest in the
securitization transaction (§ l.6(d)(2)).
A sponsor relying on the eligible
ABCP conduit risk retention option
shall maintain and adhere to policies
and procedures to monitor compliance
by each originator-seller (§ l.6(f)(2)(i)).
If the ABCP conduit sponsor determines
that an originator-seller is no longer in
compliance, the sponsor must promptly
notify the holders of the ABCP, and
upon request, the Commission and the
sponsor’s appropriate Federal banking
agency, in writing of the name and form
of organization of any originator-seller
that fails to retain, and the amount of
ABS interests issued by an intermediate
SPV of such originator-seller and held
by the ABCP conduit
(§ l.6(f)(2)(ii)(A)(1)); the name and form
of organization of any originator-seller
that hedges, directly or indirectly
through an intermediate SPV, its risk
retention in violation of the rule, and
the amount of ABS interests issued by
an intermediate SPV of such originatorseller and held by the ABCP conduit
(§ l.6(f)(2)(ii)(A)(2)); and any remedial
actions taken by the ABCP conduit
sponsor or other party with respect to
such ABS interests (§ l.6(f)(2)(ii)(A)(3)).
Section l.7 sets forth the
requirements for sponsors relying on the
commercial mortgage-backed securities
risk retention option, and includes
disclosures of: The name and form of
organization of each initial third-party
purchaser (§ l.7(b)(7)(i)); each initial
third-party purchaser’s experience in
investing in commercial mortgagebacked securities (§ l.7(b)(7)(ii)); other
material information (§ l.7(b)(7)(iii));
the fair value and purchase price of the
eligible horizontal residual interest
retained by each third-party purchaser,
and the fair value of the eligible
horizontal residual interest that the
sponsor would have retained if the
sponsor had relied on retaining an
eligible horizontal residual interest
under the standard risk retention option
(§ l.7(b)(7)(iv) and (v)); a description of
the material terms of the eligible
horizontal residual interest retained by
each initial third-party purchaser,
including the same information as is

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required to be disclosed by sponsors
retaining horizontal interests pursuant
to § l.4 (§ l.7(b)(7)(vi)); the material
terms of the applicable transaction
documents with respect to the
Operating Advisor (§ l.7(b)(7)(vii)); and
representations and warranties
concerning the securitized assets, a
schedule of any securitized assets that
are determined not to comply with such
representations and warranties, and the
factors used to determine that such
securitized assets should be included in
the pool notwithstanding that they did
not comply with the representations and
warranties (§ l.7(b)(7)(viii)). A sponsor
relying on the commercial mortgagebacked securities risk retention option is
also required to provide in the
underlying securitization transaction
documents certain provisions related to
the Operating Advisor (§ l.7(b)(6)), to
maintain and adhere to policies and
procedures to monitor compliance by
third-party purchasers with regulatory
requirements (§ l.7(c)(2)(A)), and to
notify the holders of the ABS interests
in the event of noncompliance by a
third-party purchaser with such
regulatory requirements (§ l.7(c)(2)(B)).
Section l.8 requires that a sponsor
relying on the Federal National
Mortgage Association and Federal Home
Loan Mortgage Corporation risk
retention option must disclose a
description of the manner in which it
has met the credit risk retention
requirements (§ l.8(c)).
Section l.9 sets forth the
requirements for sponsors relying on the
open market CLO risk retention option,
and includes disclosures of a complete
list of, and certain information related
to, every asset held by an open market
CLO (§ l.9(d)(1)), and the full legal
name and form of organization of the
CLO manager (§ l.9(d)(2)).
Section l.10 sets forth the
requirements for sponsors relying on the
qualified tender option bond risk
retention option, and includes
disclosures of the name and form of
organization of the qualified tender
option bond entity, a description of the
form and subordination features of the
retained interest in accordance with the
disclosure obligations in section l.4(d),
the fair value of any portion of the
retained interest that is claimed by the
sponsor as an eligible horizontal
residual interest, and the percentage of
ABS interests issued that is represented
by any portion of the retained interest
that is claimed by the sponsor as an
eligible vertical interest (§ l.10(e)(1)–
(4)). In addition, to the extent any
portion of the retained interest claimed
by the sponsor is a municipal security
held outside of the qualified tender

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option bond entity, the sponsor must
disclose the name and form of
organization of the qualified tender
option bond entity, the identity of the
issuer of the municipal securities, the
face value of the municipal securities
deposited into the qualified tender
option bond entity, and the face value
of the municipal securities retained
outside of the qualified tender option
bond entity by the sponsor or its
majority-owned affiliates (§ l.10(e)(5)).
Section l.11 sets forth the conditions
that apply when the sponsor of a
securitization allocates to originators of
securitized assets a portion of the credit
risk the sponsor is required to retain,
including disclosure of the name and
form of organization of any originator
that acquires and retains an interest in
the transaction, a description of the
form, amount and nature of such
interest, and the method of payment for
such interest (§ l.11(a)(2)). A sponsor
relying on this section is required to
maintain and adhere to policies and
procedures that are reasonably designed
to monitor originator compliance with
retention amount and hedging,
transferring and pledging requirements
(§ l.11(b)(2)(A)), and to promptly notify
the holders of the ABS interests in the
transaction in the event of originator
non-compliance with such regulatory
requirements (§ l.11(b)(2)(B)).
Sections l.13 and l.19(g) provide
exemptions from the risk retention
requirements for qualified residential
mortgages and qualifying 3-to-4 unit
residential mortgage loans that meet
certain specified criteria, including that
the depositor with respect to the
securitization transaction certify that it
has evaluated the effectiveness of its
internal supervisory controls and
concluded that the controls are effective
(§§ l.13(b)(4)(i) and l.19(g)(2)), and
that the sponsor provide a copy of the
certification to potential investors prior
to sale of asset-backed securities in the
issuing entity (§§ l.13(b)(4)(iii) and
l.19(g)(2)). In addition, §§ l.13(c)(3)
and l.19(g)(3) provide that a sponsor
that has relied upon the exemptions will
not lose the exemptions if, after closing
of the transaction, it is determined that
one or more of the residential mortgage
loans does not meet all of the criteria;
provided that the depositor complies
with certain specified requirements,
including prompt notice to the holders
of the asset-backed securities of any
loan that is required to be repurchased
by the sponsor, the amount of such
repurchased loan, and the cause for
such repurchase.
Section l.15 provides exemptions
from the risk retention requirements for
qualifying commercial loans that meet

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the criteria specified in Section l.16,
qualifying CRE loans that meet the
criteria specified in Section l.17, and
qualifying automobile loans that meet
the criteria specified in Section l.18.
Section l.15 also requires the sponsor
to disclose a description of the manner
in which the sponsor determined the
aggregate risk retention requirement for
the securitization transaction after
including qualifying commercial loans,
qualifying CRE loans, or qualifying
automobile loans with 0 percent risk
retention (§ l.15(a)(4)). In addition, the
sponsor is required to disclose
descriptions of the qualifying
commercial loans, qualifying CRE loans,
and qualifying automobile loans
(‘‘qualifying assets’’), and descriptions
of the assets that are not qualifying
assets, and the material differences
between the group of qualifying assets
and the group of assets that are not
qualifying assets with respect to the
composition of each group’s loan
balances, loan terms, interest rates,
borrower credit information, and
characteristics of any loan collateral
(§ l.15(b)(3)). Additionally, a sponsor
must retain the disclosures required in
§§ l.15(a) and (b) in its records and
must provide the disclosure upon
request to the Commission and the
sponsor’s appropriate Federal banking
agency, if any, until three years after no
ABS interests are outstanding
(§ l.15(d)).
Sections l.16, l.17 and l.18 each
require that: The depositor of the assetbacked security certify that it has
evaluated the effectiveness of its
internal supervisory controls and
concluded that its internal supervisory
controls are effective (§§ l.16(a)(8)(i),
l.17(a)(10)(i), and l.18(a)(8)(i)); the
sponsor is required to provide a copy of
the certification to potential investors
prior to the sale of asset-backed
securities in the issuing entity
(§§ l.16(a)(8)(iii), l.17(a)(10)(iii), and
l.18(a)(8)(iii)); and the sponsor must
promptly notify the holders of the assetbacked securities of any loan included
in the transaction that is required to be
cured or repurchased by the sponsor,
including the principal amount of such
loan and the cause for such cure or
repurchase (§§ l.16(b)(3), l.17(b)(3),
and l.18(b)(3)). Additionally, a sponsor
must retain the disclosures required in
§§ l.16(a)(8), l.17(a)(10) and
l.18(a)(8) in its records and must
provide the disclosure upon request to
the Commission and the sponsor’s
appropriate Federal banking agency, if
any, until three years after no ABS
interests are outstanding (§ l.15(d)).

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4. Estimated Paperwork Burden
Estimated Burden per Response:
§ l.4—Standard risk retention:
horizontal interests: recordkeeping—0.5
hours, disclosures—5.5 hours; vertical
interests: recordkeeping—0.5 hours,
disclosures—2.0 hours; combined
horizontal and vertical interests:
recordkeeping—0.5 hours, disclosures—
7.5 hours.
§ l.5—Revolving master trusts:
recordkeeping—0.5 hours; disclosures—
7.0 hours.
§ l.6—Eligible BCP conduits:
recordkeeping—20.0 hours;
disclosures—3.0 hours.
§ l.7—Commercial mortgage-backed
securities: recordkeeping—30.0 hours;
disclosures—20.75 hours.
§ l.8—Federal National Mortgage
Association and Federal Home Loan
Mortgage Corporation ABS:
disclosures—1.5 hours.
§ l.9—Open market CLOs:
disclosures—20.25 hours.
§ l.10—Qualified tender option
bonds: disclosures—6.0 hours.
§ l.11—Allocation of risk retention
to an originator: recordkeeping 20.0
hours; disclosures 2.5 hours.
§§ l.13 and l.19(g)—Exemption for
qualified residential mortgages and
qualifying 3-to-4 unit residential
mortgage loans: recordkeeping—40.0
hours; disclosures 1.25 hours.
§ l.15—Exemption for qualifying
commercial loans, commercial real
estate loans, and automobile loans:
disclosure—20.0 hours; recordkeeping—
0.5 hour.
§ l.16—Underwriting standards for
qualifying commercial loans:
recordkeeping—40.5 hours;
disclosures—1.25 hours.
§ __.17— Underwriting standards for
qualifying CRE loans: recordkeeping—
40.5 hours; disclosures—1.25 hours.
§ __.18—Underwriting standards for
qualifying automobile loans:
recordkeeping—40.5 hours;
disclosures—1.25 hours.
FDIC
Estimated Number of Respondents: 32
sponsors; 153 annual offerings per year.
Total Estimated Annual Burden:
3,235 hours.
OCC
Estimated Number of Respondents: 35
sponsors; 166 annual offerings per year.
Total Estimated Annual Burden:
3,444 hours.
Board
Estimated Number of Respondents: 22
sponsors; 102 annual offerings per year.
Total Estimated Annual Burden:
2,114 hours.
Commission

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Estimated Number of Respondents:
181 sponsors; 854 annual offerings per
year.
Total Estimated Annual Burden:
17,768 hours.
Commission’s explanation of the
calculation:
To determine the total paperwork
burden for the requirements contained
in this rule the agencies first estimated
the universe of sponsors that would be
required to comply with the disclosure
and recordkeeping requirements. The
agencies estimate that approximately
270 unique sponsors conduct ABS
offerings each year. This estimate was
based on the average number of ABS
offerings from 2004 through 2013
reported by the ABS database AssetBacked Alert for all non-CMBS
transactions and by Commercial
Mortgage Alert for all CMBS
transactions. Of the 270 sponsors, the
agencies have assigned 8 percent of
these sponsors to the Board, 12 percent
to the FDIC, 13 percent to the OCC, and
67 percent to the Commission.380
Next, the agencies estimated the
burden per response that is associated
with each disclosure and recordkeeping
requirement, and then estimated how
frequently the entities would make the
required disclosure by estimating the
proportionate amount of offerings per
year for each agency. In making this
determination, the estimate was based
on the average number of ABS offerings
from 2004 through 2013 and, therefore,
the agencies estimate the total number
of annual offerings per year to be
1,275.381 The agencies also made the
following additional estimates:
• 12 offerings per year will be subject
to disclosure and recordkeeping
requirements under § __.11, which are
divided equally among the four agencies
(i.e., 3 offerings per year per agency);
• 100 offerings per year will be
subject to disclosure and recordkeeping
requirements under §§ __.13
and __.19(g), which are divided
proportionately among the agencies
based on the entity percentages
described above (i.e., 8 offerings per
year subject to §§ __.13 and
__.19(g) for the Board; 12 offerings per
380 The allocation percentages among the agencies
have been adjusted based on the agencies’ latest
assessment of more recent data, including the
securitization activity reported by FDIC-insured
depository institutions in the June 30, 2014
Consolidated Reports of Condition.
381 Based on ABS issuance data from AssetBacked Alert on the initial terms of offerings,
supplemented with information from Commercial
Mortgage Alert. This estimate includes registered
offerings, offerings made under Securities Act Rule
144A, and traditional private placements. This
estimate is for offerings that are not exempted under
§§ _.19(a)–(f) and _.20 of the rule.

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year subject to §§ __.13 and __.19(g) for
the FDIC; 13 offerings per year subject
to §§ __.13 and __.19(g) for the OCC; and
67 offerings per year subject to §§ __.13
and __.19(g) for the Commission); and
• 120 offerings per year will be
subject to the disclosure requirements
under § __.15, which are divided
proportionately among the agencies
based on the entity percentages
described above (i.e., 10 offerings per
year subject to § __.15 for the Board, 14
offerings per year subject to § __.15 for
the FDIC; 16 offerings per year subject
to § __.15 for the OCC, and 80 offerings
per year subject to § __.15 for the
Commission. Of these 120 offerings per
year, 40 offerings per year will be
subject to disclosure and recordkeeping
requirements under §§ __.16, __.17, and
__.18, respectively, which are divided
proportionately among the agencies
based on the entity percentages
described above (i.e., 3 offerings per
year subject to each section for the
Board, 5 offerings per year subject to
each section for the FDIC; 5 offerings
per year subject to each section for the
OCC, and 27 offerings per year subject
to each section for the Commission).
To obtain the estimated number of
responses (equal to the number of
offerings) for each option in subpart B
of the rule, the agencies multiplied the
number of offerings estimated to be
subject to the base risk retention
requirements (i.e., 1,055) 382 by the
sponsor percentages described above.
The result was the number of base risk
retention offerings per year per agency.
For the Commission, this was calculated
by multiplying 1,055 offerings per year
by 67 percent, which equals 707
offerings per year. This number was
then divided by the number of base risk
retention options under subpart B of the
rule (i.e., nine) 383 to arrive at the
estimate of the number of offerings per
year per agency per base risk retention
option. For the Commission, this was
calculated by dividing 707 offerings per
year by nine options, resulting in 79
offerings per year per base risk retention
option.
The total estimated annual burden for
each agency was then calculated by
multiplying the number of offerings per
year per section for such agency by the
number of burden hours estimated for
the respective section, then adding these
382 Estimate of 1,275 offerings per year minus the
estimate of the number of offerings qualifying for
an exemption under §§ __.13, __.15, and 19(g) (220
total).
383 For purposes of this calculation, the
horizontal, vertical, and combined horizontal and
vertical risk retention methods under the standard
risk retention option are each counted as a separate
option under subpart B of the rule.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
subtotals together. For example, under
§ __.10, the Commission multiplied the
estimated number of offerings per year
for § __.10 (i.e., 79 offerings per year) by
the estimated annual frequency of the
response for § __.10 of one response,
and then by the disclosure burden hour
estimate for § __.10 of 6.0 hours. Thus,
the estimated annual burden hours for
respondents to which the Commission
accounts for the burden hours under
§ __.10 is 474 hours (79 × 1 × 6.0 hours
= 474 hours).
For disclosures made at the time of
the securitization transaction,384 the
Commission allocates 25 percent of
these hours (1,773 hours) to internal
burden for all sponsors. For the
remaining 75 percent of these hours,
(5,319 hours), the Commission uses an
estimate of $400 per hour for external
costs for retaining outside professionals
totaling $2,127,750. For disclosures
made after the time of sale in a
securitization transaction,385 the
Commission allocated 75 percent of the
total estimated burden hours (1,565
hours) to internal burden for all
sponsors. For the remaining 25 percent
of these hours (522 hours), the
Commission uses an estimate of $400
per hour for external costs for retaining
outside professionals totaling $208,650.
FHFA: The rule does not contain any
FHFA information collection
requirement that requires the approval
of OMB under the Paperwork Reduction
Act.
HUD: The rule does not contain any
HUD information collection
requirement that requires the approval
of OMB under the Paperwork Reduction
Act.
C. Commission Economic Analysis

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1. Introduction
Pursuant to Section 15G (Section 15G)
of the Securities Exchange Act of 1934
(Exchange Act), as added by Section
941(b) of the Dodd-Frank Act, the
agencies are jointly prescribing
regulations that (i) require a sponsor to
retain not less than 5 percent of the
credit risk of any asset that the sponsor,
through the issuance of an asset-backed
384 These are the disclosures required by §§ _.4
(c)(1)(i) and (iii), and (c)(2)(i) (as applicable to
horizontal interests, vertical interests, or any
combination of horizontal and vertical interests);
§§ _.5(k)(1)(i), (iii) and (iv) ; _.6(d); _.7(b)(7)(i)
through (viii); _.8(c); _.9(d); 10(e); _.11(a)(2);
_.13(b)(4)(iii); _.15(a)(4) and (b)(3); _.16(a)(8)(iii);
_.17(a)(10)(iii); _.18(a)(8)(iii); and __.19(g)(2).
385 These are the disclosures required by §§ _.4
(c)(1)(ii) and (c)(2)(ii) (as applicable to horizontal
interests, vertical interests, or any combination of
horizontal and vertical interests); §§ _.5(k)(1)(ii);
_.6(f)(2)(ii); _.7(c)(2)(B); _.9(d)(1); _.11(b)(2)(B);
_13(c)(3); _.16(b)(3); _17(b)(3); _.18(b)(3); and
__.19(g)(3).

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security, transfers, sells, or conveys to a
third party, and (ii) prohibit a sponsor
from directly or indirectly hedging or
otherwise transferring the credit risk
that the sponsor is required to retain
under Section 15G and the agencies’
implementing rules.386 Section 15G also
exempts certain types of securitization
transactions from these risk retention
requirements and authorizes the
agencies to exempt or establish a lower
risk retention requirement for other
types of securitization transactions.
The Commission is sensitive to the
economic impacts, including the costs
and benefits, of its rules. The discussion
below addresses the economic effects of
the final rule, including the likely
benefits and costs of the rule as well as
their effects on efficiency, competition
and capital formation. Some of the
economic effects stem from the statutory
mandate of Section 15G, whereas others
are affected by the discretion the
agencies have exercised in
implementing this mandate. These two
types of impacts may not be entirely
separable to the extent that the agencies’
discretion is exercised to realize the
goals of Section 15G.
Section 23(a)(2) of the Exchange Act
requires the Commission, when making
rules under the Exchange Act, to
consider the impact on competition that
the rules would have, and prohibits the
Commission from adopting any rule that
would impose a burden on competition
not necessary or appropriate in
furtherance of the Exchange Act.387
Further, Section 3(f) of the Exchange
Act requires the Commission,388 when
engaging in rulemaking where it is
required to consider or determine
whether an action is necessary or
appropriate in the public interest, to
consider, in addition to the protection of
investors, whether the action will
promote efficiency, competition and
capital formation.
While we make every reasonable
attempt to quantify the economic impact
of the rule that we are adopting, we are
unable to do so for several components
of the new rule due to the lack of
available data. We also recognize that
several components of the new rule are
designed to change existing market
practices and as a result, existing data
may not provide a basis to fully assess
the rule’s economic impact.
Specifically, the rule’s effects will
depend on how sponsors, issuers,
investors, and other parties to the
transactions (e.g., originators, trustees,
386 See 15 U.S.C. 78o–11(b), (c)(1)(A) and
(c)(1)(B).
387 15 U.S.C. 78w(a).
388 17 U.S.C. 78c(f).

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underwriters, and other parties that
facilitate transactions between
borrowers, issuers and investors) will
adjust on a long-term basis to this new
rule and the resulting evolving
conditions. The ways in which these
parties could adjust, and the associated
effects, are complex and interrelated. As
a result, we are unable to predict them
with specificity nor are we able to
quantify them at this time.
2. Broad Economic Considerations
a. Policy Goals of the Risk Retention
Requirement
Asset-backed securitizations play an
important role in the creation of credit
by increasing the amount of capital
available for the origination of loans and
other receivables 389 through the transfer
of those assets—in exchange for new
capital—to other market participants.
The intended benefits of the
securitization process include reduced
cost of credit and expanded access to
credit for borrowers, ability to match
risk profiles of securities to investors’
specific demands, and increased
secondary market liquidity for loans and
other receivables.390
Asset-backed securitizations can also
generate significant risks to the
economy. Indeed, many observers claim
that the ‘‘originate-to-distribute’’ model
underlying securitization for some asset
classes contributed to the onset of the
financial crisis.391 The informational
asymmetries in securitization markets
generated between the borrower and the
investors in the asset-backed securities,
who are the ultimate providers of credit,
give rise to the moral hazard problem of
loan originators or securitization
sponsors incurring risks in the
underwriting or securitization process
for which they did not bear the
consequence. Loan originators who
establish and enforce the underwriting
standards are best able to understand
the potential consequences of their
credit decisions. If loan originators hold
the loans they originated, then they are
more likely to exercise appropriate care
in evaluating the credit quality of the
loan, including the borrower’s ability to
389 While most securitized assets are loans or
other extensions of credit, other assets are routinely
securitized. This discussion focuses on loans
because they are the most commonly securitized
assets and their impact is more widespread. The
Commission believes that the impact on other kinds
of receivables should be similar.
390 See, e.g., Board of Governors of the Federal
Reserve System, ‘‘Report to the Congress on Risk
Retention’’ (October 2010) and Financial Stability
Oversight Committee, ‘‘Macroeconomic Effects of
Risk Retention Requirements’’ (January 2011).
391 Purnanandam, ‘‘Originate-to-Distribute Model
and the Sub-Prime Mortgage Crisis’’, 24(6) Rev. Fin.
Stud. 1881–1915 (2011).

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repay. However, if the originator can
sell the loan, the originator has less
incentive to screen borrowers carefully.
Likewise, sponsors have limited
incentives to accurately assess the
actual risks of the loans they purchase
from originators because the
consequences of their decisions are
passed on to the investors in the assetbacked securities. Further, because both
loan originators and asset-backed
securities sponsors are compensated on
the basis of volume rather than quality
of underwriting, there are economic
incentives to originate and securitize as
many loans as possible. Consequently,
default risk is less important to the
market participants originating and
securitizing loans.
In addition to this fundamental moral
hazard problem, other features of the
securitization market contribute to the
risks posed by these financing
transactions. The ultimate investors in
the securitized assets have access to less
information about the credit quality and
other relevant characteristics of the
borrowers than either the originator or
sponsor, and may not have effective
recourse when the assets do not perform
as expected. Moreover, in the early
2000s, demand from securitization
sponsors for additional assets to
securitize encouraged originators to
focus capital towards higher risk assets,
including the sub-prime residential
mortgage market, which serves the
mortgage needs of individuals who are
less creditworthy than typical home
buyers.392 The effects of these
incentives were compounded by the
entry of new market originators and
sponsors with varying amounts of
experience and capacity to effectively
evaluate credit risk.
The moral hazard problem may be
especially severe when there are
inadequate processes in place to elicit
sufficient transparency about the assets
or securitization structure to overcome
informational differences. In these
cases, the securitization process can
misalign incentives so that the welfare
of some participants is maximized at the
expense of other participants. Many of
these risks are not adequately disclosed
to investors in securitizations, an issue
compounded as sponsors introduce
increasingly complex structures.393 The
392 Dell’Ariccia, Deniz and Laeven, ‘‘Credit
Booms and Lending Standards: Evidence from the
Subprime Mortgage Market’’, Journal of Money,
Credit and Banking, vol. 44, no. 2–3, pp. 367–384,
March-April 2012; Mian and Sufi, ‘‘The
Consequences of Mortgage Credit Expansion:
Evidence from the 2007 Mortgage Default Crisis’’,
Quarterly Journal of Economics 2009, vol. 124, no.
4, pp. 1449–1496.
393 Furfine, Complexity and Loan Performance:
Evidence from the Securitization of Commercial

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financial crisis also revealed that credit
rating agencies had generally not
appropriately evaluated the credit risk
of certain asset-backed securities. In
particular, credit rating agencies
assigned high ratings on the senior
classes of RMBS or CDOs backed by
RMBS that were subsequently not
supported by the actual performance of
those securities.394
Requiring the retention of credit risk
by sponsors of asset-backed securities is
intended to address these misaligned
incentives by requiring originators and
sponsors of asset-backed securities to
internalize some of the same risks faced
by the investors in those asset-backed
securities. For example, risk-averse
sponsors will be reluctant to absorb the
uncertain payouts associated with highrisk loans. In order to limit their
exposure to loans with high default risk,
these sponsors will be incentivized to
scrutinize loan originators’ loans and
underwriting procedures more
carefully.395 Under the risk retention
requirements, securitized loans should
therefore be less subject to the lax
lending and credit enhancement
standards that imposed large losses on
asset-backed securities (in particular,
RMBS) investors during the financial
crisis. By requiring sponsors to retain
credit exposure to the securitized assets,
risk retention is intended to ensure that
sponsors have ‘‘skin in the game’’ and
thus are economically motivated to be
more judicious in their selection of
loans being securitized, thereby helping
to produce asset-backed securities
collateralized by loans with higher
underwriting standards. More generally,
when a sponsor or originator with better
Mortgages, Review of Corporate Finance Studies, v.
2, no. 2, March 2014, pp. 154–187; Ghent, Torous,
and Valkanov, Complexity in Structured Finance:
Financial Wizardry or Smoke and Mirrors? (2013,
Working Paper, available at http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=2325835).
394 See, e.g., Benmelech and Dlugosz, 2010, The
Credit Rating Crisis, Chapter 3 of NBER
Macroeconomics Annual 2009, Vol. 24, pp. 161–
207, Acemoglu, Rogoff and Woodford, eds.,
University of Chicago Press; Bolton, Freixas and
Shapiro, ‘‘The Credit Ratings Game’’, Journal of
Finance, vol. 67, no. 1, pp. 85–111, February 2012;
Griffin and Tang, ‘‘Did Subjectivity Play a Role in
CDO Credit Ratings?’’, Journal of Finance, vol. 67,
no. 4, pp. 1293–1328, August 2012.
395 Likewise, if the originator were required to
share in the pool’s risk, or were required to buy
back loans that did not meet pre-specified
underwriting standards, the originator could be
incentivized to exercise more care in making loans.
However, because such arrangements are unfunded,
they may not effectively mitigate the moral hazard
problem described above, and investors may not
benefit from the credit protection because the
obligor under the unfunded obligations may not be
able to fulfill those obligations when they come
due. Consequently, the agencies have not
recognized these arrangements as acceptable forms
of risk retention.

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information about the securitized loans
is required to hold some of the same
risks being transferred to asset-backed
securities investors, those investors
should be subject to lower risks. When
a sponsor shares the risk of the
securitized loans with asset-backed
securities investors, the sponsor is more
likely to be aware of the exact nature
and scope of the potential risks, and
therefore to be in a position to provide
those investors with more accurately
represented risks.
b. Potential Economic Effects of
Requiring Risk Retention
Mandatory risk retention reflects a
belief that sponsors of asset-backed
securities have a more accurate
assessment of the underlying assets’ risk
properties than can be attained by their
ultimate investors. This information
asymmetry can have adverse market
effects to the extent that sponsors seek
to profit from their differential
information. Some observers contend
that during the financial crisis, sponsors
sold assets that they knew to be very
risky, without conveying that
information to ABS investors. One way
to offset information asymmetries is to
require that sponsors retain some ‘‘skin
in the game,’’ through which loan
performance can affect sponsors’ profits
as much as—or more than—those of the
ABS investors.
The standard forms of risk retention
in the final rule include a vertical
option, a horizontal option, or a
combination of a vertical option and a
horizontal option. Sponsors’ choice of a
particular risk retention option will
depend on tradeoffs among direct costs,
the sponsors’ required returns on
capital, and investors’ uncertainty about
the quality of the underlying loan pool.
In turn, the overall economic impact of
requiring risk retention will depend on
the form in which it is held by
sponsors.396 A sponsor relying
exclusively on the vertical risk retention
option will hold 5 percent of every
tranche, from the senior tranche to the
residual interest, and shares the same
credit risk as investors in every tranche.
The retention of a 5 percent vertical
slice of ABS securities ties the sponsor’s
profits to the underlying assets’ default
rates. For any given securitization of
assets characterized by a fixed set of
underlying loan interest rates, the ABS
396 See Section 5.a of this Economic Analysis for
further detailed discussion of the economic effects
associated with the different options of standard
risk retention. Section 5.b discusses additional
forms of risk retention available to sponsors of
certain securitization structures, including
revolving pool securitizations, tender option bonds,
and asset-backed commercial paper conduits.

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sponsor earns less if the loans default at
a higher-than-expected rate. This gives
the sponsor an enhanced incentive to be
sure that the loan interest rates
accurately reflect the loans’ expected
default rates. ABS investors can
therefore be more confident that their
ABS interests will perform as promised
when the ABS sponsor retains a vertical
slide of risk. In other words, the
information asymmetry between
sponsor and investors is ameliorated by
the risk retention requirement, which
leads the sponsor to make sure that loan
interest rates reflect their expected
default probabilities.397
An eligible horizontal residual
interest, or EHRI, is the most
subordinated tranche(s) of a
securitization, which exposes the owner
to a disproportionate share of losses
from the securitized loans.398 A sponsor
holding an EHRI will suffer greater
default losses from a given percentage
investment than from an equal percent
investment in a vertical slice, making it
a more expensive form of risk retention.
Horizontal risk retention is nonetheless
the norm in some market segments
because ABS investors’ beliefs about the
quality of loans in the securitization are
influenced by the ABS sponsor’s
exposure to credit losses. Investors can
therefore be more confident that the
underlying assets are high-quality when
the sponsor retains a larger subordinate
exposure.399 In other words, the sponsor
‘‘signals’’ to ABS investors its belief that
defaults will be low by taking a larger,
but junior, claim on the portfolio’s cash
flows.
In general, although ABS investors
may find it difficult to assess the
securitized assets’ risks on their own,
sponsors can signal the quality of the
underlying assets by purchasing a first
loss position at a price that reflects its
fundamental value only if loan defaults
turn out to be low. Relatively larger
residual interest tranches may be
required when the assets being
securitized suffer from more acute
397 If sponsors are risk-averse, vertical risk
retention might also discourage them from
securitizing higher-risk loans. See below.
398 Sponsors also share credit risk in a horizontal
manner through overcollateralization, subordinated
management fees, or other arrangements. Many of
such arrangements are unfunded, however, and
consequently, the agencies have not recognized
them as acceptable forms of risk retention.
399 Two papers provide evidence that risk
retention by a lead underwriter affects the risks
perceived by other, less informed, members of the
syndicate. Victoria Ivashina, 2009, Asymmetric
information effects on loan spreads, Journal of
Financial Economics, vol. 92, no. 2, pp. 300–319;
Amir Sufi, 2007, Information Asymmetry and
Financing Arrangements: Evidence from Syndicated
Loans, The Journal of Finance, vol. 62, no. 2, pp.
629–668.

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information asymmetries or higher
uncertainty about their true default risk.
Horizontal risk retention forces the
sponsor to accept more default losses
than an equal investment in vertical
retention. But the increased risk
exposure permits a horizontal risk
position to signal the pool’s asset
quality and, in turn, permits the
securitization transaction to provide an
economically efficient source of funding
for the sponsor.
We anticipate that the ultimate market
impact of the credit risk retention
requirements will depend in part on the
individual sponsor’s level of risk
aversion and required return on
invested capital. Some sponsors may
find that holding relatively more risky
assets would adversely impact their
financial position. The risk retention
requirement will incentivize these
sponsors to securitize assets with lower
default risk. Securitizing assets with
lower anticipated losses would lessen
the resulting credit risk exposure for
asset-backed securities investors.
Higher-quality loan pools with more
homogenous risk characteristics would
give sponsors more incentive to provide
accurate information about the pool’s
risk characteristics. With less
uncertainty about the quality of
securitized assets, investors should be
willing to pay more or demand a lower
rate of return for bearing the credit risk,
which in turn could reduce borrowing
costs for underlying borrowers. Thus,
the net effect of reducing the moral
hazard in a securitization transaction
may be to reduce the cost of loans for
more creditworthy borrowers.
The risk retention requirements,
however, will not necessarily increase
the quality of all loan pools offered for
securitization. Asset-backed securities
investors may fund riskier pools
provided that they are properly
compensated (in the form of higher
promised tranche returns). The market’s
appetite for risk could lead sponsors to
package high-risk loans that can
generate high expected returns.
Sponsors with higher cost of capital
may also need to earn higher return on
their retained tranches, which requires
that the underlying loans have higher
interest rates, which tend to be riskier
loans. Less creditworthy borrowers
could be required to pay higher loan
interest rates than in the past to the
extent that the risk retention requires
sponsors to more accurately account for
the potential losses associated with
these riskier loans.
The effect of risk retention on
borrowing costs will also depend on
how securitization investors react to the
requirements of the final rule. If risk

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retention increases investor confidence
that incentives are properly aligned in
the securitization market, this should
increase their likelihood of participating
in the market, making more capital
available and increasing competition for
issuances of asset-backed securities. As
a result, the higher prices paid for
issuances will mitigate the costs
imposed on sponsors to retain credit
risk. In the past, asset-backed security
investors did not always have accurate,
timely or accessible information about
securitized asset quality and in certain
instances were misled about the quality
of those assets.400 If risk retention
results in the transmission of more
accurate information about loan quality
to investors (e.g., through pricing of
EHRIs, the level of horizontal risk
retention, or fair value disclosures) and
allows asset-backed security investors to
distinguish lower quality loans from
higher quality loans, then risk should be
more efficiently priced in asset-backed
security markets.
Quantifying the potential impact of
the credit risk retention on borrowing
rates of the loans underlying the assetbacked securities will depend on the
tradeoff between the costs associated
with financing the additional capital
required by sponsors to fund the
retained risk and its effect on the pricing
of the asset-backed securities. For
example, two studies by the Federal
Reserve Bank of New York estimate the
potential impact of risk retention on the
cost of residential mortgage borrowing
by estimating the change in interest
rates on securitized loans required to
compensate for the sponsors’ risk
retention requirements.401 The analyses
suggest that incremental increases to
sponsors’ rate of return requirements for
securitizations of residential mortgage
loans with higher levels of risk retention
are relatively modest, approximately 0–
30 basis points.402 These estimates
400 See Piskorski, Seru, and Witkin, 2013, Asset
Quality Misrepresentation by Financial
Intermediaries: Evidence from RMBS Market, NBER
Working Paper No. 18843; and Griffin and
Maturana, Who Facilitated Misreporting in
Securitized Loans? Journal of Finance, forthcoming.
Both papers find evidence of mortgage misreporting
in non-agency RMBS by both originators and
underwriters; this misreporting was not priced by
investors at issuance and yet strongly predicted
future RMBS losses.
401 See appendix A of the 2013 Reproposal, 78 FR
at 58019.
402 This assessment assumes that the underlying
loan pool characteristics are accurately disclosed
and with sufficient detail for investors to properly
assess the underlying risk. Such a scenario would
be reflective of the risk retention requirements
solving the moral hazard problem that might
otherwise result in the obfuscation of intrinsic risks
to the ultimate investors. These results also rely on

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suggest that the underlying loans would
need to have an interest rate
approximately 0.25 percent higher. As
discussed above, however, risk retention
will likely influence the composition of
loan pools. Although the New York Fed
studies do not incorporate this effect,
perceptibly higher quality loan pools
will require less costly financing or
lower yielding asset-backed securities.
Thus, the underlying loan interests rates
may rise (due to more risk being borne
by the sponsor or high opportunity cost
of capital for retained capital) or fall
(because the pool is higher quality). By
contrast, to the extent that riskier loans
continue to be securitized even with the
requirement to retain risk, the
underlying loan interest rates are likely
to rise. Developments that make riskier
loans more expensive, at a cost
commensurate to their intrinsic risk,
will improve the efficiency of capital
markets.
Requiring sponsors to retain risk in
the portfolios of assets they securitize
could impose significant costs on
financial markets. Currently, sponsors
who do not retain 5 percent of the
securitization deploy those funds to
other uses, such as repaying lines of
credit used to fund securitized loans,
holding other assets or making new
loans, which may earn a different
interest rate and have a different risk
exposure. Tying up capital as a result of
the imposition of risk retention
requirements could pose an opportunity
cost to sponsors who do not currently
retain risk and could limit the volume
of securitizations that they can sponsor.
These costs would likely be passed on
to borrowers, either in terms of
increased borrowing costs or loss of
access to credit. In particular, borrowers
whose loans do not qualify for an
exemption from risk retention (e.g.,
those loans that do not meet the
underwriting criteria for being deemed
a qualified asset) could face increased
borrowing costs, or be priced out of the
loan market, thus restricting their access
to credit. As a result, there could be a
negative impact on capital formation by
loan originators to the extent that it
impedes the flow of capital from ABS
investors, particularly if credit is denied
to creditworthy borrowers. More
generally, if the costs are deemed by
sponsors to be significant enough that
they would no longer be able to earn a
sufficiently high expected return by
sponsoring securitizations, this form of
supplying capital to lenders would
decline.
specific assumptions about the return on equity
demanded by different types of sponsors.

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The net impact of requiring credit risk
retention on capital markets and the
costs of credit will ultimately depend on
the availability of alternative
arrangements for transferring capital to
lenders and the costs of transferring
capital to sponsors. For example, the
impact of the potential decrease in the
use of securitizations in the residential
mortgage market would depend on the
cost and availability to lenders of
alternative mortgage funding sources,
and the willingness of these sponsors to
retain the full burden of the risks
associated with credit risk retention and
securitization. To the extent there are
funding alternatives, and these funding
alternatives can provide funding to
lenders on terms similar to those
available as a result of sponsors’ use of
the securitization markets, the impact of
the substitution of these alternatives for
securitizations would likely be minimal.
Similarly, to the extent that sponsors
can find sources of capital at costs
similar to the returns paid on retained
interests in securitizations, the impact
of risk retention requirements would
likely be minimal. Currently, there is no
relevant and available empirical
evidence to reliably estimate the cost
and consequence of either such
outcome.
c. The Impact of Asset-Level Disclosure
and Other Requirements of Revised
Regulation AB
On August 27, 2014, the Commission
adopted significant revisions to
Regulation AB and other rules
governing the offering process,
disclosure, and reporting for assetbacked securities.403 Among other
things, these revisions require that
prospectuses for registered offerings of
asset-backed securities backed by
residential and commercial mortgages,
auto loans and leases, or debt securities
(including resecuritizations), and
ongoing reports with respect to such
securities contain specified asset-level
information about each of the assets in
the pool.
Increased transparency for these
securitizations through the introduction
of enhanced disclosure requirements
and enhanced transactional safeguards
for ABS shelf offerings should help to
address the moral hazard problem that
contributed to the poor performance of
asset-backed securities during the
financial crisis.404 For registered
403 Asset-Backed Securities Disclosure and
Registration; Final Rule, 79 FR 57184 (Sept. 24,
2014).
404 See, Adam B. Ashcraft & Til Schuermann,
Understanding the Securitization of Subprime
Mortgage Credit (Staff Report, Fed. Reserve Bank of
N.Y., Working Paper No. 318, 2008) (identifying at

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offerings of asset-backed securities
subject to the new requirements, the
revisions to Regulation AB should
improve the amount of information
available to investors about the quality
of securitized assets. The availability of
detailed loan-level data in a machine
readable format will provide investors
with information needed to perform
their own assessments of the associated
risks and lessen the risk of overreliance
on third-party evaluations such as credit
ratings.
The new requirements for shelf
offerings of asset-backed securities
include additional safeguards to
improve the offering process, encourage
greater oversight of the structuring and
disclosure of the transaction and
provide additional recourse for
resolving potential problems by
providing stronger mechanisms to
enforce compliance with the sponsors’
representations and warranties.405
Combined, these rules should improve
investors’ willingness to invest in assetbacked securities and to help the
recovery in the asset-backed securities
market with attendant positive effects
on informational and allocative
efficiency, competition, and the level of
capital formation.
The amendments to Regulation AB
should significantly reduce the moral
hazard problem in the publicly offered
asset-backed securities market and offer
an important complement to, but not a
substitute for, the risk retention
requirement. In particular, there are
several ways in which the risk retention
requirement will further address the
moral hazard problem. As an initial
matter, the scope of the risk retention
requirement is significantly broader
than the asset-level disclosure
requirements of the revised Regulation
AB, which does not apply across all
least seven different frictions in the residential
mortgage securitization chain that can cause agency
and adverse selection problems in a securitization
transaction and explaining that given that there are
many different parties in a securitization, each with
differing economic interests and incentives, the
overarching friction that creates all other problems
at every step in the securitization process is
asymmetric information).
405 For example, the rules require a minimum
three-business day waiting period before the first
sale of securities in the offering to provide investors
with time to conduct analysis of the offering.
Additionally, as a shelf eligibility requirement, the
chief executive officer of the depositor must
provide a certification at the time of each takedown
about the disclosure contained in the prospectus
and the structure of the securitization. As another
shelf eligibility requirement, the underlying
transaction agreements must include provisions
that require a review of pool assets upon the
occurrence of a two-prong trigger based first upon
the occurrence of a specified percentage of
delinquencies in the pool and, if the delinquency
trigger is met, upon the direction of investors by
vote.

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asset classes or to unregistered offerings
(e.g., private sales of securities to
qualified institutional buyers pursuant
to Rule 144A under the Securities
Act).406 Hence, the impact of the assetlevel disclosure requirements under the
revised Regulation AB may be limited
by the extent to which market practices
for asset classes not covered by the
revised Regulation AB and privately
offered asset-backed securities do not
incorporate or develop similar
disclosure standards and sponsors
pursue private offerings instead of
registered offerings.407
There is reason to believe, however,
that the revised Regulation AB could
have positive spillover effects into the
private markets. With the adoption of
standardized loan-level disclosures and
increased investor confidence in the
registered market, similar practices may
develop in the private offering market,
particularly to the extent that sponsors
and investors participate in both
markets. At present, 37 percent of the
dollar volume of ABS transactions had
sponsors who issued both registered and
unregistered offerings.408 With respect
to asset classes and originators for
which these sponsors have conducted
registered offerings, the sponsors would
have relatively low incremental costs to
apply existing infrastructure developed
to comply with the new disclosure
requirements of Regulation AB in any
private market offerings that they may
conduct for those asset classes and those
originators.
These benefits will be further
supplemented with the overlay of the
risk retention requirements. Risk
retention forces sponsors to internalize
the costs of inappropriate behaviors
such as the obfuscation of the intrinsic
risks of the securitization and failure to
do appropriate diligence. This
internalization will occur
contemporaneously with the losses
incurred by investors. In contrast, even
with the additional disclosures and
transactional safeguards required under
the revised Regulation AB, sponsors
may misrepresent the characteristics of
the securitized assets and, in such cases,
investor recourse to the sponsor can
406 Using the Asset-Backed Alert and Commercial
Mortgage Alert databases, DERA staff calculated
that, during the 2009–2013 period, only 12.8
percent of non-U.S. agency asset-backed securities
deals (excluding ABCP and TOB), or 24.5 percent
by dollar volume, will be subject to asset-level
disclosure requirements under revised Regulation
AB.
407 The Commission continues to consider
whether asset-level disclosure would be useful to
investors across other asset classes as well as in
private offerings. See revised Regulation AB
Adopting Release, 79 FR at 57191 and 57197.
408 AB Alert.

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only occur after the fact of the losses,
such as through legal remedy. Analysis
from recent studies and details of
Commission enforcement cases show
that RMBS sponsors misrepresented the
quality of the securitized asset pool in
RMBS prospectuses leading up to the
financial crisis.409 The additional
disclosure requirements and
transactional safeguards mandated by
Regulation AB may not cause sponsors
of registered securitizations to
internalize the costs of such practices as
fully as if the sponsor retained a portion
of the credit risk. Thus, the risk
retention requirements for certain
registered offerings should be beneficial
even with the existence of Regulation
AB’s additional disclosure and
transactional requirements because
those disclosure requirements do not
create the same alignment of interests of
sponsors and investors that would serve
to reduce the prevalence of moral
hazard and improve underwriting in the
publicly offered securitization market.
The disclosure practices that evolve
in connection with revised Regulation
AB will work together with the credit
risk retention requirement to address
the moral hazard problem in the
publicly offered asset-backed securities
market, encourage better underwriting,
and better inform investors on the
nature of the retained risk. In particular,
revised Regulation AB may influence a
sponsor’s choice between the vertical
and (potentially more costly) horizontal
forms of risk retention. The revisions to
Regulation AB require public disclosure
of asset-level information for registered
offerings, and because investors in these
transactions will be able to better assess
the characteristics of the securitized
assets, they may be willing to invest in
more risky tranches of securitizations,
which could increase the ability of the
sponsor to rely on a larger vertical
interest. As a result, more sponsors
might choose to use the less costly
vertical risk retention option (or, if they
use a combination of the horizontal and
409 For example, in 2013, the Commission
charged Bank of America entities for failing to
disclose key risks and misrepresenting facts about
the mortgages underlying an RMBS securitization
that the firms underwrote, sponsored, and issued in
2008 (see Commission press release of August 6,
2013, available at http://www.sec.gov/News/
PressRelease/Detail/PressRelease/1370539751924).
Similarly, in 2014, the Commission charged Morgan
Stanley entities, with misleading investors and
misrepresenting the current or historical
delinquency status of mortgage loans underlying
two subprime RMBS securitizations that the firms
underwrote, sponsored, and issued in 2007 (see
Commission press release of July 24, 2014, available
at http://www.sec.gov/News/PressRelease/Detail/
PressRelease/1370542355594). See also footnote
400 for academic papers that find evidence of
mortgage misreporting in non-agency MBS by both
originators and underwriters.

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vertical forms of risk retention, they
might choose to reduce the relative
weight of the horizontal form and
increase the relative weight of the
vertical form), and if so, the
implementation of the revisions to
Regulation AB could reduce the costs of
risk retention to sponsors of registered
offerings.
After the implementation of both
revised Regulation AB and the risk
retention rules, asset-backed securities
offerings will be subject to varying
levels of compliance with asset-level
requirements and the risk retention
rules, which may result in differing
levels of incentive alignment and
transparency. Offerings would fall into
different groups 410 and these groups
may have different levels of exposure to
underwriting quality, moral hazard and
asymmetric information problems and
may attract different types of investors
because different risk tolerances among
investors will result in preferences for
different types of asset classes and
offering methods. Some of these offering
groups would be subject to higher
underwriting standards and lower risk
of default, but could be relatively more
exposed to the moral hazard problem
(e.g., an incentive to misrepresent the
characteristics of the securitized assets)
due to the lack of risk retention and
asset-level disclosures. Other offering
groups may contain lower quality assets,
but could be less exposed to the moral
hazard problem because of the risk
retention requirement. Such distinction
could create different demand for each
group commensurate with the level of
perceived asset underwriting quality
and moral hazard, with corresponding
implications for risk premium and cost
of capital.
3. Economic Baseline
The baseline the Commission uses to
analyze the economic effects of the risk
retention requirements mandated by
410 The groups are: (1) Those where the sponsor
is subject to risk retention and for which asset-level
disclosure is required (e.g., registered RMBS of
loans that are not qualified residential mortgages
(QRM), CMBS of loans that are not qualifying
commercial real estate (QCRE) loans, and registered
asset-backed securities backed by non-qualifying
automobile loans); (2) those for which only assetlevel disclosure is required (e.g., registered RMBS
of QRM loans, registered CMBS of QCRE loans, and
registered asset-backed securities backed by
qualifying automobile loans); (3) those for which
only risk retention is required (e.g., unregistered
RMBS of non-QRM loans, unregistered CMBS of
non-QCRE loans, unregistered asset-backed
securities backed by non-qualifying automobile
loans, and all unregistered asset-backed securities
backed by any other assets not otherwise exempt
from risk retention); and (4) those for which neither
asset-level disclosure nor risk retention is required
(e.g., unregistered non-U.S. agency RMBS backed by
QRM loans and U.S. agency RMBS).

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
extent to which the requirements affect
borrower access to credit and the cost of
capital for lenders. The discussion
below describes the Commission’s
understanding of the securitization
markets that are affected by the final
rule.411

Section 15G is the current set of rules,
regulations, and market practices that
may affect the amount of credit
exposure retained by sponsors. To the
extent not already encompassed by
current market practices, the risk
retention requirements being adopted
are expected to have a significant
impact on market practices of, and risks
faced by, asset-backed securities market
participants, including loan originators,
sponsors and investors in asset-backed
securities, and consumers and
businesses that seek access to credit
using financial products that are
securitized. The costs and benefits of
the risk retention requirements depend
largely on the current market practices
specific to each securitization asset
class—including current risk retention
practices—and corresponding asset
characteristics. The magnitude of the
potential effects of the risk retention
requirements depend on the overall size
of the securitization market and the

a. Size of Securitization Markets
The asset-backed securities market is
important for the U.S. economy and
comprises a large fraction of the U.S.
debt market. During the five-year period
from 2009 to 2013, 31.5 percent of the
$33.2 trillion in public and private debt
issued in the United States was in the
form of mortgage-backed securities
(MBS) or other asset-backed securities,
and 3.0 percent was in the form of nonU.S. agency backed (private label) MBS
or asset-backed securities. For
comparison, 32.9 percent of all debt
issued was U.S. Treasury debt, and 5.6
percent was municipal debt at the end
of 2013.412 Figure 1 shows the
percentage breakdown of total non-

agency issuances from 2009 to 2013 for
various asset classes excluding short
term asset-backed securities, such as
asset-backed commercial paper (ABCP)
or Tender Option Bonds (TOBs) and
excluding collateralized loan and debt
obligations (CLOs and CDOs).413
Consumer credit categories, including
asset-backed securities backed by
automobile loans and leases and credit
card receivables, comprise 37 percent
and 14 percent of the total annual
issuance volume, respectively. Nonagency RMBS and CMBS comprise 4
percent and 18 percent of the market,
respectively, while asset-backed
securities backed by student loans
account for 9 percent of the market.
Below the Commission analyzes the
variation in issuance among these five
largest asset classes. For several
categories, the Commission outlines
detailed information about issuance
volume and the number of active
sponsors (Tables 2 and 3).

Prior to the financial crisis of 2008,
the number of non-agency RMBS
issuances was substantial. For example,
new issuances totaled $760.3 billion in

2005 and peaked at $801.7 billion in
2006. Non-agency RMBS issuances fell
dramatically in 2008, to $34.5 billion, as
did the total number of sponsors, from

a high of 80 in 2006 to 27 in 2008. In
2013, there was only $25.2 billion in
new non-agency RMBS issuances by 22
separate sponsors.

411 The impact of the recently adopted but not yet
effective revisions to Regulation AB is discussed in
Section 2.c of this Economic Analysis.
412 Source: SIFMA Statistics available at http://
www.sifma.org/research/statistics.aspx, accessed on
July 11, 2014.

413 To estimate the size and composition of the
private-label securitization market, the Commission
uses data from the Securities Industry and Financial
Markets Association (SIFMA) and Asset-Backed
Alert. It is not clear how corporate debt
repackagings are classified in these databases. In the

following analysis, the Commission excludes all
securities guaranteed by U.S. government agencies.
ABCP is a short-term financing instrument and is
frequently rolled over; thus, its issuance volume is
not directly comparable to the issuance volume of
other asset classes of asset-backed securities.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations

TABLE 2—ANNUAL ISSUANCE VOLUME AND NUMBER OF SPONSORS BY OFFERING TYPE FOR ASSET-BACKED SECURITIES
BACKED BY CONSUMER LOANS
Credit Card ABS

Automobile ABS

Student Loan ABS

Year
SEC

144A

Private

Total

SEC

144A

Private

Total

SEC

144A

Private

Total

Panel A—Annual Issuance Volume by Offering Type ($ bn)
2005
2006
2007
2008
2009
2010
2011
2012
2013

................................................
................................................
................................................
................................................
................................................
................................................
................................................
................................................
................................................

61.2
60.0
88.1
56.7
34.1
5.3
10.0
28.7
32.0

1.8
12.5
6.4
5.0
12.5
2.1
4.8
10.5
3.1

0.0
0.0
0.0
0.0
0.0
0.0
1.5
0.0
0.0

62.9
72.5
94.5
61.6
46.6
7.5
16.3
39.2
35.1

85.1
68.0
55.8
31.9
33.9
37.9
41.9
65.6
62.5

8.7
12.2
6.8
5.7
15.4
15.3
14.4
13.9
12.8

0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0

93.9
80.2
62.6
37.6
49.2
53.2
56.3
79.5
75.2

54.1
54.9
41.7
25.8
8.3
2.8
2.5
6.6
6.5

8.1
10.9
16.0
2.4
12.5
16.2
13.9
23.2
14.9

0.4
0.5
0.6
0.0
0.0
1.2
1.1
0.0
0.0

62.6
66.2
58.3
28.2
20.8
20.2
17.5
29.9
21.4

38
30
28
21
22
27
25
36
32

13
8
7
3
3
2
1
1
1

7
17
17
6
6
18
19
26
22

1
1
1
0
0
1
1
0
0

19
24
22
8
6
19
20
26
22

Panel B—Annual Number of Sponsors by Offering Type
2005
2006
2007
2008
2009
2010
2011
2012
2013

................................................
................................................
................................................
................................................
................................................
................................................
................................................
................................................
................................................

13
10
12
9
9
5
5
7
9

5
11
8
3
6
5
7
9
5

0
0
0
0
0
0
1
0
0

17
18
16
11
11
9
12
13
14

30
23
23
16
13
19
14
18
17

9
12
9
8
13
15
16
24
19

0
0
0
0
0
0
0
0
0

Notes: The numbers in the table were calculated by staff from the Commission’s Division of Economic and Risk Analysis (DERA) using the
Asset-Backed Alert database. The deals are categorized by offering year, underlying asset type, and offering type (SEC registered offerings,
Rule 144A offerings, or traditional private placements). Automobile asset-backed securities include asset-backed securities backed by automobile
loans and leases, both prime and subprime, motorcycle loans, and truck loans. Panel A shows the total issuance amount in billions of dollars.
Panel B shows the number of unique sponsors (based on sponsor name) of ABS in each category (the number in the column ‘‘Total’’ may not be
the sum of the numbers in the columns ‘‘SEC’’, ‘‘144A’’ and ‘‘Private’’ because some sponsors may sponsor deals in several categories). Only
asset-backed securities classified by Asset-Backed Alert as deals sold in the U.S. and sponsors of such deals are counted.

TABLE 3—ANNUAL ISSUANCE VOLUME AND NUMBER OF SPONSORS BY OFFERING TYPE FOR REAL ESTATE-BACKED ABS
Non-agency RMBS

CMBS

Year
SEC

144A

Private

Total

SEC

144A

Private

Total

Panel A—Annual Issuance Volume by Offering Type ($ bn)
2005
2006
2007
2008
2009
2010
2011
2012
2013

738.5
727.1
634.8
12.2
0.0
0.2
0.7
1.9
4.0

21.7
74.6
80.4
22.3
48.1
67.2
40.8
27.0
21.1

0.0
0.0
0.0
0.0
0.0
12.8
9.7
0.0
0.0

760.3
801.7
715.3
34.5
48.1
80.3
51.3
29.0
25.2

136.23
161.76
190.57
10.71
0.00
0.00
8.45
32.56
53.07

34.44
41.05
40.58
1.49
6.86
19.54
26.05
18.68
33.27

0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00

170.68
202.81
231.15
12.20
6.86
19.54
34.50
51.24
86.35

42
40
29
2
13
25
31
33
57

0
0
0
0
0
0
0
0
0

61
57
54
21
13
25
31
56
83

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Panel B—Annual Number of Sponsors by Offering Type
2005
2006
2007
2008
2009
2010
2011
2012
2013

54
55
53
12
0
1
1
1
1

21
43
45
22
17
26
16
20
22

0
0
0
0
0
1
2
0
0

60
80
78
27
17
28
18
21
22

41
39
43
19
0
0
16
26
32

Notes: The numbers in the table were calculated by DERA staff using the Asset-Backed Alert and Commercial Mortgage Alert databases. The
deals are categorized by offering year, underlying asset type, and offering type (SEC registered offerings, Rule 144A offerings, or traditional private placement). Non-agency RMBS include residential, Alt-A, and subprime RMBS. Panel A shows the total issuance amount in billions of dollars. Panel B shows the number of unique sponsors (based on sponsor name) of asset-backed securities in each category (the number in the
column ‘‘Total’’ may not be the sum of the numbers in the columns ‘‘SEC’’, ‘‘144A’’ and ‘‘Private’’ because some sponsors may sponsor deals in
several categories). Only asset-backed securities deals classified by Asset-Backed Alert as sold in the U.S. and sponsors of such deals are
counted.

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Similar to the market for non-agency
RMBS, the market for CMBS also
experienced a decline following the
financial crisis. There were $231.15
billion in new issuances at the market’s
peak in 2007. New issuances fell to
$12.20 billion in 2008 and to $6.86
billion in 2009. In 2013, there were
$86.35 billion in new CMBS issuances.
While the markets for asset-backed
securities backed by credit card
receivables, automobile loans and
leases, and student loans experienced a
similar decline in issuances following
the financial crisis, the issuance trends
in Table 2 indicate that they have
rebounded substantially more than the
non-agency RMBS and CMBS markets.
Asset-backed securities collateralized by
automobile loans and leases currently
have the largest issuance volume and
the largest number of active sponsors of
asset-backed securities among all asset
classes. There were $75.2 billion in new
asset-backed securities issuances
collateralized by automobile loans and

leases in 2013 from 32 sponsors. This
amount of new issuances is
approximately twice the amount of new
issuances in 2008 ($37.6 billion) in this
asset class and is similar to the amount
of new issuances in this asset class from
2004 to 2007.
Although the amount of new
issuances of asset-backed securities
backed by credit card receivables has
not fully rebounded from pre-crisis
levels, it is currently substantially larger
than in recent years. There were $35.6
billion in new issuances of asset-backed
securities backed by credit card
receivables in 2013, a five-fold increase
over the amount of new issuances in
2010 ($7.5 billion). The number of
sponsors of such transactions has
remained steady over time, totaling 14
in 2013. The amount of new issuances
of asset-backed securities backed by
student loans has also not fully
rebounded from pre-crisis levels.414
There were $21.3 billion in new
issuances of asset-backed securities

backed by student loans in 2013,
compared to a range from $45.9 billion
to $58.3 billion between 2004 and 2007.
The number of sponsors of such
transactions has returned to pre-crisis
levels, totaling 22 in 2013.
In addition to these asset classes,
sponsors will have to retain risk for all
issuances of asset-backed securities,
including equipment loans and leases,
corporate debt repackagings, TOBs,
ABCP, CDOs and CLOs.
Information describing the amount of
issuances and the number of sponsors in
the ABCP markets is not readily
available. Information on the total
amount of issuances outstanding
indicates that the ABCP market has
decreased since the end of 2006, when
the total amount outstanding was
$1,081.4 billion, or 55 percent of the
entire commercial paper market.415 As
of the end of 2013, there were $254.7
billion of ABCP outstanding, accounting
for less than 25 percent of the
commercial paper market.

TABLE 4—COMMERCIAL PAPER (CP) OUTSTANDING ($BN)
Year
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

All CP
outstanding

ABCP

.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................

688.9
860.3
1,081.4
774.5
734.0
487.0
348.1
328.8
319.0
254.7

ABCP share
(%)

1,401.5
1,637.5
1,974.7
1,785.9
1,681.5
1,170.0
971.5
959.3
1,065.6
1,086.2

49.2
52.5
54.8
43.4
43.7
41.6
35.8
34.3
29.9
23.4

NOTES: Source—Federal Reserve.

Like other asset-backed securities
markets, the CLO market went through
the same cycle of high growth right
before the crisis in 2005–2007 followed
by steep decline in 2008–2010.

However, by 2013 the CLO market had
almost recovered to its pre-crisis level
(see Table 5), in terms of the number of
CLO deals per year, the aggregate dollar
volume of issuance, and the number of

active sponsors (CLO managers). It
should also be noted that, in most of the
years in the table below, the median
sponsor had only one CLO deal
sponsored per year.

TABLE 5—ANNUAL ISSUANCE VOLUME AND NUMBER OF SPONSORS FOR ARBITRAGE CLOS 416

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Year
2004
2005
2006
2007
2008
2009
2010
2011
2012

.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................
.............................................................................................................................................

414 The elimination of the Federal Family
Education Loan Program (FFELP), a federally
guaranteed student loan program, in March 2010
may be a significant contributor to the decline in

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Total volume,
$ bn

Deals

the issuance of asset-backed securities backed by
student loans as no subsequent loans were
permitted to be made under the program after June
2010.

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89
124
215
187
44
8
7
30
123

Unique CLO
managers

30.6
56.05
106.74
95.56
22.05
2.84
2.39
12.86
55.99

415 Based on information from the Federal
Reserve Bank of St. Louis FRED Economic Data
database.

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60
79
119
101
26
6
6
26
72

Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations

77713

TABLE 5—ANNUAL ISSUANCE VOLUME AND NUMBER OF SPONSORS FOR ARBITRAGE CLOS 416—Continued
Year

Total volume,
$ bn

Deals

2013 .............................................................................................................................................

179

Unique CLO
managers

85.83

97

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NOTES: The numbers in the table were calculated by DERA staff using the Asset-Backed Alert database. Only arbitrage CLOs backed by corporate loans and sold in the U.S. and sponsors of such deals are counted. The total issuance amount is in billions of dollars.

b. Current Risk Retention Market
Practices
As noted earlier, the potential
economic effects of the final risk
retention requirements will depend on
current market practices. Currently, risk
retention is not legally mandated in any
sector of the U.S. asset-backed securities
market (with the exception of the FDIC
safe harbor option discussed below
where risk retention is one of the
compliance options), although some
sponsors of different asset-backed
securities classes do remain exposed to
credit risk, at least at initial issuance, in
response to investors’ or rating agencies’
demand. The new risk retention
requirements will impose a cost on
sponsors that will depend on the
amount and form of risk currently
retained by a sponsor of asset-backed
securities and the length of time
sponsors remain exposed to such risk.
Market practices are different for
different sectors (to the extent that they
are applied at all) and there is no
uniform reporting of the types or
amounts of risk exposure. Because of
the lack of aggregated quantitative
information relating to the current risk
exposure practices of sponsors, the
Commission does not have full
information on the extent to which
sponsors remain exposed to risk. Below
the Commission describes current risk
exposure practices for various asset
classes based upon its understanding of
these markets and public comment
received to date.417 Almost all asset
classes include structural features in
which sponsors remain exposed to some
amount of credit risk, including RMBS,
CMBS, automobile loans and leases,
credit card receivables, equipment loans
and leases and automobile floorplan
loans. We note, however, that even if
some sponsors voluntarily retain risk in
the form of a combination of several
tranches, including residual interest that
adds up to 5 percent of the principal
amount of the deal, the sponsors
416 The agencies are adopting a risk retention
option for CLOs that meet certain criteria, described
herein as ‘‘open-market CLOs.’’ Arbitrage CLOs
have many of the features of open-market CLOs, but
as these requirements were not part of the market
prior to this rulemaking, there is no reasonable
means of determining which CLOs would have
qualified as an open-market CLO.

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typically do not contractually commit in
the transaction documents to holding
these interests after the initial sale
(however, a rating agency might
downgrade the entire securitization if
the residual is sold). Notable exceptions
include: TOBs, CLOs and CMBS where
depending on the specific structure and
the funding needs of the sponsor, either
the sponsor or a third party might
purchase a residual or equity interest;
and structures in which parties involved
in the securitization, other than the
sponsors, retain risk, such as ABCP
conduits, in which the seller of
receivables holds a pro rata or residual
interest in the receivables sold to the
ABCP conduit.
In 2010, the Federal Deposit
Insurance Corporation (FDIC) adopted
an amended rule regarding the
treatment by the FDIC, as receiver or
conservator of an insured depository
institution, of financial assets
transferred by the institution in
connection with a securitization.418 If
the FDIC does not deem a transfer of
assets to a securitization vehicle a true
sale, the FDIC could repudiate
transaction agreements for the
securitization, recover financial assets
that had been transferred, and thereby
compromise the ‘‘legal isolation,’’ as
determined by relevant accounting
standards, of the assets upon which the
securitization was predicated.419 The
FDIC’s rule imposes several new
conditions to qualify for a safe harbor
from such repudiation, with risk
417 See also the Board of Governors of the Federal
Reserve System’s ‘‘Report to the Congress on Risk
Retention’’ (October 2010), pp. 41–48, where other
mechanisms intended to align incentives and
mitigate risk are described, including alternatives
such as overcollateralization, subordination,
guarantees, representations and warranties, and
conditional cash flows as well as the retention of
credit risk. The report also contains a description
of the most common incentive alignment and credit
enhancement mechanisms used in the various
securitization asset classes. The report does not
establish the extent to which these alternatives
might be substitutes for the retention of credit risk.
418 See 12 CFR 360.6. Upon their effective date,
the final rule will replace the FDIC regulations and
shall exclusively govern the requirement to retain
credit risk for insured depository institutions.
419 The FDIC would have to pay damages to the
securitization vehicle for any repossessed assets;
however, those damages might be less than the full
amount of principal and interest due on
outstanding securities backed by such assets.

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retention being one of the new
conditions. Thus, in the absence of
other forms of ‘‘true sale’’ protection,
banking institutions that would like to
avoid the potential future FDIC
repudiation of a securitization could
retain credit risk. As discussed below in
Section 3.b.iii, some banks sponsoring
asset-backed securities comply with the
FDIC safe harbor rule by retaining risk
in the form of a representative sample
of the securitized assets—one of the
forms of risk retention permitted under
the FDIC’s rule.
Finally, sponsors that intend to
market their asset-backed securities in
both the United States and the European
Union and that issue securities after
January 1, 2014, may need to retain 5
percent credit risk to comply with E.U.
risk retention rules that, instead of
imposing a direct risk retention
obligation on sponsors, regulate the
types of securities that certain investors
can buy.420 The Commission does not
have data on the fraction or types of
asset-backed securities currently sold in
the U.S. that retain credit risk to comply
with these rules or asset-backed
securities sold by U.S. sponsors to
investors covered by E.U. risk retention
rules.
i. Residential Mortgage-Backed
Securities
The Commission understands that
sponsors of non-agency RMBS
historically did not generally retain a
portion of credit risk in the form and at
a level consistent with the rule being
adopted. One study 421 finds that, on
420 Article 122a of the Capital Requirements
Directive mandates that European Economic Arearegulated credit institutions and investment firms
and their affiliates may only invest in securitization
transactions if the original lender, originator or
sponsor of the securitization retains 5 percent of the
net economic interest of the transaction. Related EU
Alternative Investment Fund Manager’s Directive
imposes similar risk retention requirements on
securitizations that most private equity, real estate
investment services and hedge funds are allowed to
invest in.
421 Taylor Begley and Amiyatosh Purnanandam,
Design of Financial Securities: Empirical Evidence
from Private-label RMBS Deals (2014), University of
Michigan working paper. They find that the size of
the residual interest is proportional to the fraction
of no document loans—their proxy for increased
information asymmetry between sponsors and
investors.

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average, RMBS deals had a 1.2 percent
residual interest by face value that was
proportional to the perceived level of
information asymmetry between the
sponsor and ABS investors, although
the study could not determine whether
sponsors retained the residual interest
or, if retained, for how long it was held
after issuance. Thus, even if sponsors of
RMBS deals were holding the residual
interest and were not selling it to third
parties, they were not, on average,
retaining 5 percent of the credit risk by
face value.422 Consequently, as
discussed below, except in the case
where exemptions are applicable (e.g.,
the QRM exemption), the final risk
retention requirements likely will
impose new constraints on RMBS
sponsors.

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ii. Commercial Mortgage-Backed
Securities
The current risk retention practice in
the CMBS market is to retain at issuance
the ‘‘first loss piece’’ (riskiest tranche).
This tranche is typically sold to a
specialized category of CMBS investor,
known as a ‘‘B-piece buyer.’’ 423 The Bpiece investors in CMBS securitizations
often hold dual roles as bond investors,
if the assets remain current on their
obligations, and as holders of
controlling interests to appoint special
servicers, if the loans default and go into
special servicing. As holders of the
controlling interest, they will typically
appoint an affiliate as the special
servicer. The B-piece CMBS investors
are typically commercial real estate
specialists who use their knowledge
about the securitized assets in the pools
to conduct extensive due diligence on
new deals.424 The B-piece market has
very few participants.425 The B-pieces
are often ‘‘buy-and-hold’’ investments,
422 We also note that one of the largest sponsors
of registered RMBS has stated it currently retains
some interest in the RMBS transactions that it
sponsors. See Sequoia Mortgage Trust 2013–1, Final
Prospectus filed pursuant to Rule 424(b)(5), File No.
333–179292–06 filed January 16, 2013; http://
www.sec.gov/Archives/edgar/data/1176320/
000114420413002646/v332142_424b5.htm.
423 However, not every CMBS deal has a B-piece
buyer. According to Commercial Mortgage Alert, 46
percent of CMBS deals in 2009–2013 had a B-piece
buyer.
424 CMBS have much smaller number of
underlying loans in a pool (based on data from
Commercial Mortgage Alert, in 2009–2013, CMBS,
on average, had about 100 commercial properties in
a pool, whereas RMBS had about 3,000 assets in a
pool and automobile loan/lease ABS typically had
75,000 assets) and these loans are often not
standardized. Thus, direct management of
individual underperforming loans is often
necessary and is much more viable for CMBS than
for other asset classes.
425 Based on Commercial Mortgage Alert data, in
2009–2013, there were 38 different B-piece buyers
with 9 of them participating in 70 percent of CMBS
deals.

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and, based on the Commission’s
knowledge of the asset-backed securities
market, the secondary market for Bpieces is relatively illiquid at this time.
According to one comment letter, a
typical B-piece makes up 2.6 percent of
economic and 7 percent of the notional
balance of a CMBS. Thus, the
Commission believes the prevailing
market practice for risk retention in the
CMBS sector is to hold less than the
final rule’s risk retention option for
CMBS sponsors.
iii. Master Trusts (Revolving Pool
Securitizations)
Master trusts generally issue multiple
series of asset-backed securities over
time, backed by a common pool of
securitized assets. The transaction
agreements require the sponsor to
maintain the principal balance of the
securitized assets at an amount that is
at all times sufficient to back the
aggregate amount of asset-backed
securities outstanding to investors with
a specified amount of collateral above
that amount. The principal amount of
outstanding investor ABS interests
changes over time as new series are
issued or existing series are paid off.
Moreover, as each series is issued, it
begins with a revolving period (typically
for some number of years), during
which the investors receive only
interest, and cash from borrower
principal repayments on the pool assets
are used to buy additional assets for the
pool from the sponsor. This provides
the sponsor with ongoing funding for its
operations, and maintains the level of
pool assets over time. Then, at a date
specified under the terms of the series,
the revolving phase for the series comes
to an end, and cash from borrower
principal repayments on pool assets is
used to repay investors and retire that
series of investor ABS interests.
Sponsors of revolving master trusts
often maintain risk exposures through
the use of a seller’s interest which is
intended to be equivalent to the
sponsor’s interest in the receivables
underlying the asset-backed securities.
In current market practices, the amount
and form of risk exposure generally
depends on the asset class in the master
trust; there is typically more risk
exposure for assets with higher rates of
default or that are more difficult to
assess. For example, credit card master
trusts sponsors retain economic
exposure through excess spread and
fees, while dealer floorplan asset-backed
securities have significant residual
exposure. The Commission requested
additional information about current
practices and data from market
participants, but none was provided. As

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a result, the Commission does not have
reasonably accessible data about
revolving master trusts that would
permit it to estimate current market
practice about the amount of risk
exposure held by sponsors.
As discussed above, banks sponsoring
asset-backed securities that intend to
comply with the FDIC safe harbor rule
could retain 5 percent of credit risk of
the securitized pool. Some banks that
use trust structures to sponsor assetbacked securities backed by automobile
loans and leases use one of the allowed
options under the FDIC rule, the
representative sample option, to comply
with the safe harbor rule requirements.
Under this option, the sponsor
randomly selects a separate pool of
receivables that represents the
characteristics of the securitized pool of
assets and holds it on their balance
sheet.426
iv. Other Asset-Backed Securities
The current market practices for other
categories of asset-backed securities that
serve to align the interests of the
sponsor and investors vary across asset
classes. The Commission understands
that sponsors of automobile loans
typically maintain exposure to the
quality of their underwriting by
retaining a significant residual interest
in their securitization transactions.
However, there is insufficient data
available to the Commission to estimate
the fair value of these retained residual
interests. Also, as discussed above,
some banking institutions that are
affiliated with a sponsor of asset-backed
securities collateralized by automobile
loans and leases retain a 5 percent
representative sample to comply with
the FDIC safe harbor rule. As noted
above, the final rule does not include a
representative sample option. The
Commission also understands that many
sponsors of asset-backed securities
backed by student loans did not retain
credit risk as many were federally
guaranteed. Sallie Mae, the largest
sponsor of student loan asset-backed
securities, typically retains through an
affiliate a residual interest in the form
of overcollateralization in the
securitizations that it sponsors.
v. Asset-Backed Commercial Paper
ABCP is a type of asset-backed
security that is typically issued to
investors by a special purpose vehicle
(commonly referred to as a ‘‘conduit’’)
426 See, for example, Bank of America Auto Trust
2012–1 (http://www.sec.gov/Archives/edgar/data/
1488082/000119312512149853/d309744d42
4b3.htm) or Ally Auto Receivables Trust 2012–3
(http://www.sec.gov/Archives/edgar/data/1477336/
000119312512243201/d357186d424b5.htm).

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
sponsored by a financial institution. The
commercial paper issued by the conduit
is collateralized by a pool of assetbacked securities, which may change
over the life of the entity. ABCP
conduits generally purchase longer-term
assets financed by the issuance of
shorter-term liabilities, and the
liabilities are ‘‘rolled,’’ or refinanced, at
regular intervals.427
In a typical ABCP conduit transaction,
the sponsor’s customer (an ‘‘originatorseller’’) sells loans or receivables to an
intermediate, bankruptcy remote special
purpose vehicle (SPV). The credit risk of
the receivables transferred to the
intermediate SPV then typically is
separated into two classes—a senior
ABS interest that is acquired by the
ABCP conduit and a residual interest
that absorbs first losses on the
receivables and that is retained by the
originator-seller. The residual interest
retained by the originator-seller
typically is sized with the intention that
it be sufficiently large to absorb all
losses on the underlying receivables.
In this structure, the ABCP conduit
issues short-term ABCP that is
collateralized by the senior ABS
interests purchased from one or more
intermediate SPVs, which are, in turn,
supported by the subordination
provided by the residual ABS interests
retained by the originator-sellers (i.e.,
the sponsors of underlying ABS
interests would be subject to risk
retention requirements). The sponsor of
this type of ABCP conduit, which is
usually a bank or other regulated
financial institution or their affiliate,
also typically provides (or arranges for
another regulated financial institution
or group of financial institution to
provide) 100 percent liquidity coverage
on the ABCP issued by the conduit. This
liquidity coverage typically requires the
support provider to provide funding to,
or purchase assets or ABCP from, the
ABCP conduit in the event that the
conduit lacks the funds necessary to
repay maturing ABCP issued by the
conduit.
Commenting on the original proposal,
ABCP conduit sponsors noted that there
are structural features in ABCP
securitizations that align the interests of
the ABCP conduit sponsor and the
ABCP investors. For instance,
commenters stated that ABCP conduits
usually have some mix of credit support
and liquidity support equal to 100
percent of the ABCP outstanding. In the
view of commenters, this liquidity and
credit support exposes the ABCP
conduit sponsor to the quality of the
assets in an amount that far exceeds 5
427 See

Original Proposal at § __.9.

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percent of the fair value of the
outstanding ABCP.428
vi. Collateralized Loan Obligations
A collateralized loan obligation (CLO)
is an asset-backed security that is
typically collateralized by portions of
tranches of senior, secured commercial
loans or similar obligations of noninvestment grade borrowers.429 CLOs
are organized and initiated by a CLO
manager, usually when the CLO
manager partners with a structuring
bank that assists in financing asset
purchases that occur before the
formation of the CLO.430 The CLO
manager actively manages the asset
portfolio and earns management fees
and performance fees for investment
management services provided to the
CLO.
The Commission understands that
CLO managers often retain a small
portion—significantly less than 5
percent—of the residual interest,
although the party retaining the risk
may vary depending on the CLO. Some
types of CLO managers are more likely
to hold a significant residual interest in
their CLO, while others are more likely
to secure a third-party equity investor to
purchase the residual interest.
According to one commenter, a common
CLO market practice is for the CLO
manager to hold 5 percent of the
residual interest, which is typically
around 8 percent of the value of the
CLO at issuance.431 This level of
retention equates to approximately 0.4
percent of the value of the CLO.
The Commission understands that
many CLO structures use
overcollateralization—the amount by
which the face value of the underlying
loan portfolio 432 exceeds the face value
of the outstanding asset-backed
securities—which many CLO managers
consider as a form of risk retention
because the value of the
overcollateralization is ascribed to the
residual interest. For example, the
current senior overcollateralization for
428 See footnote 395 for the general agencies
position on acceptability of unfunded arrangements
as forms of risk retention.
429 The term ‘‘CLO’’ is also used to refer to the
special purpose vehicle that issues the asset-backed
securities and the overall securitization structure.
430 Report to the Congress on Risk Retention,
Board of Governors of the Federal Reserve System,
at 22 (Oct. 2010), available at http://federalreserve.
gov/boarddocs/rptcongress/securitization/
riskretention.pdf.
431 In general, the size of the equity tranche
increases in downturns and decreases in booms.
See Updating the CLO Primer, Bank of America/
Merrill Lynch, July 2012.
432 The face value of the underlying loans may be
adjusted in accordance with the CLOs transaction
documents to reflect concentration limits,
delinquencies and/or discounted purchase prices.

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77715

older vintage CLO 1.0 deals (CLO
structure used before the crisis) is 132
percent, while for CLO 2.0 deals (the
structure used for newer CLO) it is 135
percent.433 This means that a CLO 1.0
deal has $132 supporting every $100 of
the most senior tranche outstanding.
The amount of overcollateralization for
the entire CLO structure would be much
lower because it would also include
mezzanine and subordinate bonds in
addition to the residual interest. The
agencies do not consider
overcollateralization by face value to be
an acceptable form of risk retention
because the face values of both the
securitized assets and of the ABS
interests can materially differ from their
relative value and/or cost to the
sponsor.434
The Commission requested comments
on whether any practices in the CLO
market reflected risk retention as
envisioned by the proposed rule. Many
commenters indicated that the proposed
rule requirements would change current
practices and therefore substantially
impact the CLO market. No commenter
indicated the presence of, or
development towards, risk retention
practices that would satisfy the
requirements of the proposed rule.
Some commenters described the amount
of risk retention currently held and how
managers of CLOs often retain a small
portion of the residual interest and
asserted that sponsors retain risk
through subordinated management and
performance fees that have performance
components that depend on the
performance of the overall pool or
junior tranches.435
vii. Tender Option Bonds
There are two typical tender option
bonds (TOBs) structures that generally
have different amounts of risk retention.
One type of TOB is a bank-sponsored
TOB where a single bank and its
affiliates serve as the sponsor, residual
holder and liquidity provider; in this
structure, the bank will typically hold
nominal equity. Commenters noted that
the bank’s credit exposure is
significantly greater than 5 percent
because it is the provider of 100 percent
433 Asset-Backed

Alert, July 11th, 2014.
discussed below, the final rule does give
sponsors credit for overcollateralization to the
extent the fair value of the horizontal form of risk
retention takes into consideration the fair value of
the overcollateralization.
435 The agencies have not recognized
subordinated management fees as an acceptable
form of risk retention in the final rule because, if
the CLO underperforms, subordinate management
fees may not align the interests of the manager with
those of investors. See also footnote 395 for the
general agencies position on acceptability of
unfunded arrangements as forms of risk retention.
434 As

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liquidity support. The second type of
TOB is one in which the bank that is the
liquidity provider does not hold the
residual interest; in this case the TOB
residual holder will retain a more
significant amount of risk. Other
features of TOBs include a put feature
as part of the bond that allows investors
to put the bond back to the sponsor and
a 100 percent liquidity support. The
Commission requested data on current
market levels of risk retention for TOBs
but received no data from commenters.
4. Analysis of Risk Retention
Requirements
As discussed above, the agencies are
adopting the rule requiring sponsors of
asset-backed securitizations to retain
risk. Each of the asset classes subject to
the final rule has its own particular
structure and, as a result, the
implementation and impact of risk
retention will vary across asset classes,
although certain attributes of risk
retention are common to all asset
classes. In this section, the Commission
discusses those aspects of the final rule
that apply across a broad range of asset
classes: The requirement that sponsors
hold 5 percent of the credit risk of a
securitization; the use of fair value of
the securitization to measure the
amount of horizontal risk retained by
the sponsor; and the length of time that
a sponsor will be required to hold its
risk exposure.
a. Level and Measurement of Risk
Retention

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i. Requirement To Hold Five Percent of
Risk
Section 15G requires the agencies to
jointly prescribe regulations that require
a sponsor to retain not less than 5
percent of the credit risk of any asset
that the sponsor, through the issuance of
ABS, transfers, sells, or conveys to a
third party, unless an exemption from
the risk retention requirements for the
securities or transaction is otherwise
available. The agencies reproposed a
requirement to hold a minimum 5
percent base risk retention for most ABS
transactions that are within the scope of
Section 15G, with some exemptions.
Commenters did not comment
specifically on the discussion of the 5
percent risk retention requirement in
the Commission’s Economic Analysis in
the 2013 reproposal. One commenter
did suggest the minimum amount of risk
retention be increased to 20 percent. As
discussed in more detail below,
increasing the minimum amount of risk
retention could increase the cost to
sponsors and impede capital formation
in the economy by preventing the more

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efficient reinvestment of the sponsors’
capital, while not necessarily providing
significant incremental benefit to
investors. In addition, several
commenters suggested risk retention
requirements be determined by
reference to asset quality.436
The agencies are adopting a 5 percent
risk retention requirement as
reproposed. The Commission lacks the
data—and commenters did not provide
quantitative information—to allow for
analysis of an optimal level of retained
risk, taking into account the goal of
aligning the incentives of the sponsors
and the investors in asset-backed
securities. As discussed above, barring
any exemption, the required level of risk
retention is set by statute at no less than
5 percent. Below is a discussion of the
trade-offs between setting the level of
required risk retention too high or too
low.
As a general matter, if the required
level of risk retention is set too low, it
may not adequately align the incentives
of investors and sponsors. While we
recognize that Congress prescribed a
minimum level of risk retention, the
Commission is also aware that, as
discussed in the Economic Baseline,
sponsors of asset-backed securities in
many asset classes retained less than 5
percent credit exposure to
securitizations in the past. Moral hazard
problems persisted at these lower levels.
In contrast, asset classes with relatively
higher levels of risk retention (e.g.,
asset-backed securities backed by auto
loans and leases) performed relatively
better throughout the financial crisis.
A level of risk retention that is set too
high, however, could lead to inefficient
deployment of capital by unduly
restricting a sponsor’s ability to
structure new deals. If sponsors are
436 The agencies do not believe that it is necessary
or appropriate to attempt to vary the amount of risk
retention based on the quality of the assets or other,
similar, factors. Doing so would unnecessarily
complicate compliance with the rule. Furthermore,
as discussed in the following section, the
Commission believes that requiring risk retention to
be measured by fair value adequately incorporates
the quality of the assets. Specifically, it would
calibrate the sponsor’s economic exposure to the
asset pool depending on quality of securitized
assets. For example, the Commission notes that if
the securitized asset pool consists of low-quality
assets, the value of the residual interest would be
relatively low and a sponsor would have to hold a
larger equity tranche to meet the five percent fair
value credit risk exposure requirement. On the
other hand, if the securitized asset pool consists of
high quality assets, the value of the residual interest
would be relatively higher and a sponsor would be
able to satisfy the requirement by holding smaller
residual interest. Use of face value or
overcollateralization to avoid the 5 percent risk
retention requirement will not be possible using fair
value methodologies acceptable under GAAP as it
would account for the expected losses associated
with the residual interest.

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limited in their ability to secure the
necessary financing to retain the
required amount of credit risk in their
intended offerings, then this could
adversely impact the flow of capital
from ABS investors to originators of the
assets intended for securitization.
Hence, excessive required risk retention
levels may lead to less capital available
to lenders, potentially increasing
borrowing rates as borrowers compete
for a more limited supply of credit. In
this scenario, the reduction in capital
formation would have a negative impact
on competition due to the increased cost
of securitizing non-qualified assets,
disadvantaging their ability to be
financed by ABS investors relative to
qualified assets and other sources of
capital.
ii. Measurement of Risk Retention Using
Fair Value
The agencies are adopting a
requirement for sponsors to measure
risk retention of an ‘‘eligible horizontal
residual interest’’ (EHRI) using a fair
value measurement framework
consistent with GAAP. As described in
the 2013 reproposal, the agencies
believe that measuring risk retention
with a fair value measurement
framework will align the measurement
more closely with the credit risk of a
securitization transaction than
alternative frameworks. The agencies
are not requiring vertical interests to be
measured using a fair value
measurement framework, as proposed,
because they were persuaded by
commenters that such measurement is
not necessary to ensure that the sponsor
has retained 5 percent of the credit risk
of the ABS interests issued.
Commenters generally supported
basing the measurement of the
horizontal risk retention requirement on
fair value. Some commenters raised
general concerns with the proposed
method by which sponsors would be
required to measure their risk retention
because some sponsors do not currently
use fair value calculations. Thus,
requiring such sponsors to measure
their risk retention with fair value
would create significant burden and
expense. Commenters also expressed
several specific accounting concerns
regarding use of fair value to measure
risk retention. Specifically, they
expressed concern regarding the timing
of the pre-sale fair value disclosure
requirement. Commenters noted that the
most objective and accurate way to
calculate the fair value of the residual
interest is to base the valuation on
observable market prices for the
remaining securities; however, because
the reproposal required that sponsors

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calculate the fair value of the residual
interest in advance of the final pricing
of the issued securities, the fair value of
the residual interest would have to be
calculated using estimates of final
pricing levels. Commenters asserted that
potential differences between the presale fair value calculated using
estimated pricing levels and the postclosing fair value calculated using
actual pricing levels would confuse
investors.
To provide investors with sufficient
information to allow them to evaluate
whether the sponsor’s estimated
calculation of fair value was reasonable,
the proposed rule would have required
sponsors to disclose the key inputs and
assumptions used in measuring fair
value and the sponsor’s technique(s)
used to derive the key inputs and
assumptions. Many commenters
expressed concerns about the proposed
requirement, indicating that the
proposal would require sponsors to
disclose information that is proprietary,
highly confidential and commercially
sensitive, which could be used by third
parties to the competitive disadvantage
of the sponsor. Other commenters
suggested significant modifications to
the disclosure requirements. For
example, several commenters asserted
that sponsors should only be required to
make disclosures to the Commission
and banking agencies, rather than to
investors. Significant concern was
raised regarding potential liability and
litigation that commenters indicated
may result when fair value projections,
assumptions and calculations disclosed
to investors turn out to be incorrect.
A few commenters asserted that for
simple structures, sponsors should not
be required to make fair value
determinations or related disclosures,
nor should the cash flow restriction (as
described below) apply. Several
commenters requested that the final rule
should not require sponsors to measure
and disclose the fair value of eligible
vertical interests, so long as the
underlying ABS interests have either a
principal or notional balance. The
commenters noted that a 5 percent
interest in the cash flow of each class
would always be equivalent to 5 percent
of the fair value of each class. In this
regard, the commenters asserted that
requiring fair value measurement and
disclosures for the vertical option would
be unnecessary for ensuring compliance
with the rule.
The final rule does not require
sponsors holding risk retention in a
vertical form to measure and disclose
the fair value of their vertical risk
retention. With the vertical form of risk
retention, requiring sponsors to measure

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and disclose the fair value would
impose additional cost on the sponsor
with little, if any, corresponding
enhancement of investors’ ability to
evaluate and understand the amount of
credit risk exposure of the sponsor. This
is because 5 percent of the fair value of
each tranche will be equal to 5 percent
of face value of each tranche. Therefore,
if investors know that a sponsor is
holding 5 percent of each tranche, they
will be able to assess the credit exposure
of the sponsor regardless of whether it
is face value or fair value.
Using a fair value measurement
framework acceptable under GAAP, as
applicable, to value the EHRI will
provide a number of benefits. First, it
allows investors and sponsors to
objectively measure and understand the
amount of credit risk exposure of the
sponsor. The use of fair value is
intended to prevent sponsors from
structuring around risk retention, as
may otherwise be the case when using
the face value of residual interests or
overcollateralization to measure the
amount of horizontal risk retention. For
example, if a sponsor issues $100
million in asset-backed securities at par
and retains a first-loss residual interest
with a face value of $5 million, that
residual interest could yield a market
value below $5 million given the
expected losses associated with the
securitized assets, in which case the
sponsor would be holding less than 5
percent of the deal’s value. Use of face
value or overcollateralization to avoid
the 5 percent risk retention requirement
will not be possible using fair value
methodologies acceptable under GAAP
as it would account for the expected
losses associated with the residual
interest. Moreover, and as a general
matter, most investors and sponsors
have experience with fair value
methodologies acceptable under GAAP
and therefore using it in this context
will help to minimize the costs of
evaluating the amount of risk retention
held by sponsors because it will be
consistent with other valuation
experiences.
There are also potential costs to
investors associated with the use of a
fair value measurement framework. Fair
value is a measurement framework that,
for certain types of instruments, where
significant unobservable inputs are used
to determine fair value, requires an
extensive use of judgment. Because of
this extensive use of judgment, an
investor may be unable to determine if
the sponsor’s fair value calculation uses
assumptions that are similar to the
investor’s assumptions. In order to help
mitigate this potential cost, the agencies
also are requiring, as proposed, that the

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sponsor disclose specified information
about how it calculates fair value. While
this requirement should discourage
manipulation, sponsors will incur
additional costs to prepare the necessary
disclosures. In addition, because the
final rule specifies that fair value must
be determined using a fair value
measurement framework consistent
with GAAP, sponsors will incur costs to
ensure that the reported valuations are
compliant with the valuation standard.
With respect to the disclosure
required in order to allow investors to
evaluate and understand the sponsor’s
fair value calculation, the reproposal
discussed the appropriate level of detail
to be provided to investors. One
approach would be to provide the same
model inputs (e.g., prepayment rate,
discount rates) that the sponsors used so
that investors could more precisely
evaluate the sponsor’s fair value
calculations. While sponsors already
have the model inputs they use to
calculate fair value, as commenters
noted, there may be costs to the
sponsors associated with providing
investors with sponsors’ proprietary
information. For example, sponsors may
base their model inputs on proprietary
information derived from the historical
performance data of their loan pools,
information that has commercial value
and is often compiled and sold to
market participants who purchase the
data in order to derive model inputs
similar to the ones that sponsors would
be required to disclose. Disclosure of the
model inputs could thus lower the
commercial value of the historical data.
Disclosing their inputs could also
provide competitors—with similar
access to historical performance data—
with insight into the sponsor’s
interpretation or selection of relevant
benchmark data. Access to this insight
could reveal proprietary valuation
methods or, as some commenters
suggested, give rise to litigation risk to
the extent that there are differences in
opinions on how to interpret the data.
Taken together, requiring sponsors to
disclose precise information about their
model inputs could increase the cost to
sponsors without necessarily providing
additional benefit to investors.
To help mitigate these potential costs,
the final rule permits the disclosure of
fair value based on estimated ranges for
tranche size, interest rates for each
tranche, and underwriting discount. The
information is required to be provided
a reasonable amount of time prior to the
sale of the asset-backed security. Also
required to be included are the
sponsor’s key inputs and assumptions
that may be described as a curve. The
rule requires that this disclosure be

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updated to reflect actual fair values of
the ABS interests sold at the closing
date. This approach may enable
investors to make meaningful
assessments of whether a sponsor’s fair
value calculations are reasonable prior
to making their investment decisions,
and at the same time may help to
address sponsors’ concerns about
disclosing what they believe to be
proprietary information and the timing
of the disclosure. The ranges of pricing
information will allow investors to
decide if the sponsor’s model input
curves are aggressive or conservative
compared to their own expectations
based on their experiences and
knowledge of the asset class.
In the case of revolving pool
securitizations, the agencies are
permitting the seller’s interest option to
be measured using face value. These
securitizations have unique structures
described further below that would
address the agencies’ concerns about the
use of face value of the ABS interests or
the face value of the securitized assets
to circumvent risk retention
requirements as described above. This
option recognizes the unique
characteristics of certain structures and
the impact of those structures on the
alignment of incentives for the
transaction parties. This option also
helps to minimize the burden of fair
value disclosure discussed in the
reproposal while still allowing certain
structures to have a meaningful amount
of risk retained and addressing some
commenters’ concerns about using a fair
value measurement framework to
measure risk retention. One unique
characteristic is that the vehicle will
engage in multiple issuances for the life
of the master trust. Because of this, if
the revolving pool securitization
contains poorly underwritten
receivables that are expected to default
then, in the future, this will impact the
ability of the sponsor to make future
issuances of asset-backed securities
using the revolving pool securitization.
The structure of revolving pool
securitizations aligns incentives
between sponsors and investors,
reduces the need for fair value
measurement that does not bring
benefits to investors, and allows for face
value measurement, which will help to
minimize costs for sponsors of revolving
pool securitizations.
b. Duration of the Risk Retention
Requirement
Under the reproposal, sponsors would
have been prohibited from selling or
otherwise transferring any interest or
assets that they would be required to
retain under the rule to any person other

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than a consolidated affiliate for
specified time periods. For all ABS
other than RMBS, the specified time
period would have been the later of two
years after the closing date of the
securitization or when the aggregate
unpaid balance of the ABS interests has
been reduced to 33 percent. For RMBS,
the specified time period would have
been the later of five years after the
closing of the securitization or when the
pool balance has been reduced to 25
percent, but in no event later than seven
years after the closing of the
securitization.
In response to the reproposal,
commenters recommended various
modifications to the length of risk
retention requirements. Some
commenters suggested lengthening the
non-RMBS duration to three years,
while other commenters questioned
why only RMBS and CMBS had asset
specific durations and suggested
lengthening or shortening periods of
time that were tied to a specific asset
class or securitized asset quality.
Finally, some commenters suggested
eliminating the alternative sunset period
contingent on the unpaid pool balance.
The agencies are adopting the sunset
provisions as reproposed. The
Commission lacks the data to determine
an optimal duration of these risk
retention requirements, and while
commenters supported their positions
based on relevant time periods that are
tied to securitized assets, no
commenters submitted relevant data or
other quantifiable information. In
particular, as stated in the reproposal,
these time periods were chosen to strike
a balance between retaining risk long
enough to align the sponsors’ and
investors’ incentives and allowing the
redeployment of retained capital for
other productive uses. A shorter
duration was chosen for non-mortgage
asset classes, because these loans tend
to have shorter maturities than
mortgages and thus it may not be
necessary to retain risk for a longer
period. The alternative sunset
component contingent on the reduction
of pool balance further calibrates the
required duration of risk retention based
on the remaining balances. By the time
the loan pool balance decreases to 33
percent, the information about the loan
pool performance will be largely
revealed, at which point the moral
hazard problem between the sponsor
and the investor is likely to be
significantly reduced.
We recognize that, in the case where
the loan pool balance drops below the
prescribed threshold (25 percent for
RMBS and 33 percent for other ABS)
before the prescribed number of years

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(five years for RMBS and two years for
other ABS), the additional required
duration might be costly to the sponsor.
A requirement that the sponsor continue
to retain exposure to the securitization
once the impact of the initial
uncertainty about the ABS is resolved
could potentially impede allocative
efficiency by limiting the sponsor’s
ability to redeploy capital to new
securitizations or other investment
opportunities. Moreover, as loan
balances are paid down, the sponsor
may hold more risk relative to other
investors because the size of the credit
risk retention piece is based on the
initial size of the securitization and does
not change with the current market
value. Thus, sponsors could face
increased levels of risk retention on a
percentage of outstanding basis at the
same time retained risk becomes less
necessary. While economic efficiency
might be increased in certain
circumstances by allowing sponsors to
withdraw their risk retention
investment to use in new securitizations
or other credit forming activities,437 the
minimum fixed duration of risk
retention is appropriate to prevent
structuring securitizations that would be
quickly paid off to the balance threshold
points (25 percent or 33 percent) for the
purposes of avoiding risk retention.
5. Forms of Risk Retention Menu of
Options
Rather than prescribe a single form of
risk retention, the final rule allows
sponsors to choose from a range of
options to satisfy their risk retention
requirements. As a standard form of risk
retention available to sponsors of all
securitizations, sponsors may choose
vertical risk retention, horizontal risk
retention, or any combination of those
two forms. Both the vertical and
horizontal forms of risk retention
require the sponsor to share the risk of
the securitized asset pool. The final rule
also includes options tailored to specific
asset classes and structures such as
revolving master trusts, CMBS, ABCP,
CLOs, and TOBs. Given the special
characteristics of certain asset classes,
some of these options permit the
sponsor to allocate a portion of the
shared risk to originators, allow the risk
to be held by specified third parties, or
437 See Hartman-Glaser, Piskorski and Tchistyi,
2012, Optimal Securitization with Moral Hazard.
Journal of Financial Economics, vol. 104, no. 1,
April 2012, pp. 186–202. They consider the optimal
design of MBS contracts between a mortgage
underwriter that can engage in costly hidden effort
to screen borrowers and investors and show, among
other things, that the maturity of the optimal
contract can be short.

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allow the risk to be held in an identical
asset outside of the securitization.
Commenters generally supported the
menu-based approach of providing
sponsors with the flexibility to choose
from a number of permissible forms of
risk retention. These commenters
believed that this provides sponsors
with the flexibility to structure their risk
retention requirements to accommodate
current market practices.
By adopting a rule that will allow
sponsors flexibility to choose how they
retain risk, the agencies seek to enable
sponsors to select the approach that is
most cost-effective for them, while still
fulfilling the purposes of Section 15G.
As discussed previously, the agencies
are sensitive to the need to balance the
goals of risk retention (reduction of the
moral hazard problem and better
underwriting) with the need to facilitate
the efficient deployment of capital. A
flexible approach to retaining risk will
permit sponsors to take into account a
variety of factors, as discussed in more
detail below.
Various factors are likely to impact
sponsors’ preferred method of retaining
risk, including size, funding costs,
financial condition, riskiness of the
securitized assets, potential regulatory
capital requirements, return on capital
requirements, risk tolerances, and
accounting conventions. All else being
equal, sponsors may prefer the option
that involves the least exposure to credit
risk. For example, the horizontal form of
standard risk retention creates a fully
subordinated residual interest that is
more exposed to the expected losses of
the deal than a similarly sized vertical
form, and therefore is more sensitive to
the deal’s credit risk. By contrast, a
vertical form of standard risk retention
is comparable to a stand-alone passthrough securitization, which when
held by the sponsor, is the form of risk
retention least exposed to a deal’s credit
risk. As discussed below, some sponsors
may choose to use the horizontal
method of risk retention or some
combination of the horizontal and
vertical method in order to meet the risk
retention requirement.
In particular, sponsors have an
incentive to calibrate the level of risk
exposure that minimizes their overall
cost of funding. For example, some
investors may be more likely to
purchase senior ABS interests if the
sponsor retains a larger residual interest
and thus has more ‘‘skin in the game.’’
Alternatively, the sponsor may be
unable to sell the residual interest on
terms that would minimize the
sponsor’s cost of funding. In both
instances, sponsors would prefer an
option with a higher level of exposure

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to credit risk. This might be particularly
true for securitizations that involve
riskier or more opaque assets or more
complicated securitization structures.
As discussed previously, the potential
need for retaining risk in a more costly
form because the sponsor could not sell
the residual interest on acceptable terms
could be attenuated for registered
offerings that are subject to the assetlevel disclosure requirements under
revised Regulation AB to the extent that
investors are able to quantify risks using
the required loan-level disclosures and
are willing to purchase more of the
residual interest on terms acceptable to
the sponsor.
As the Commission discusses below,
a number of the options also attempt to
correspond to current market practices.
By allowing sponsors to satisfy their risk
retention requirement while still
maintaining current market practices,
the proposed menu of options approach
should help to reduce additional costs
of the required regime. Moreover, the
flexibility sponsors have to design how
they hold credit risk will allow them to
calibrate and adjust their selections for
each transaction according to changing
market conditions.
On the other hand, because sponsors
will have a choice on how to retain risk,
their chosen structure may not always
align interests and mitigate risks for
investors in the same manner. Thus, to
the extent that some forms of risk
retention create disparate incentives for
sponsors and investors,438 the ability to
rely on those options may not fully
address some of the conflicts of interest
that contribute to the moral hazard
problem that characterize
securitizations. In addition, the
flexibility of this approach may increase
the complexity of implementation of
risk retention because of the wide range
of possible choices available to
sponsors.
a. Standard Risk Retention
The agencies are adopting the
standard risk retention option as
438 For example, if a sponsor is affiliated with a
servicer (or has another way to influence the
servicing of assets), then different forms of risk
retention may change how distressed assets are
serviced—more to the benefit of all investors or
more to the benefit of junior tranche holders’. In
most cases, investors in the more senior tranches
would favor liquidation because liquidation of the
securitized assets would reduce uncertainty and
eliminate the credit risk of a delinquent or
defaulted asset and because losses resulting from
such liquidation of the securitized assets would be
absorbed by investors in more subordinated
tranches. Alternatively, investors in more
subordinated tranches would favor a modification
of the terms of a defaulted or delinquent asset
because modification potentially could minimize
losses.

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reproposed. In the reproposal, the
Commission provided separate analyses
of the economic effects of vertical risk
retention, horizontal risk retention, or
any combination of these two forms.
Many commenters generally supported
the reproposal to allow a sponsor to
meet its risk retention obligation by
using the standard risk retention option
and approved of the flexibility that the
proposal would provide to sponsors in
structuring their risk retention. One
commenter specifically expressed
support for the single vertical security
option, asserting that it would simplify
compliance and monitoring obligations
of the sponsor.
The agencies continue to believe that
it is appropriate to provide flexibility to
sponsors. This approach allows
sponsors to minimize costs by selecting
a customized combination of vertical
and horizontal risk retention that suits
their individual situation and
circumstances, including relative
market demand for the various types of
interest that may be retained under the
rule. To the extent that the costs and
benefits of credit risk retention vary
across time, across asset classes, or
across sponsors, this approach would
implement risk retention in the broadest
possible manner such that sponsors may
choose the combination of vertical and
horizontal risk retention that they view
as optimal. For example, if investors are
unable to accurately estimate the risk of
the securitized asset, the sponsor may
be unable to sell the residual interest on
acceptable terms, which would mean
any excess vertical risk retention would
be an additional cost to such a sponsor.
Allowing flexibility will not only
benefit sponsors but also will allow
investors’ demands to be more easily
satisfied.
Below we discuss the economic
implications of particular risk retention
structures.
i. Eligible Horizontal Residual Interest
Under the eligible horizontal residual
interest (EHRI) option, sponsors would
hold the first loss piece, which as
described above, would reflect a larger
credit exposure than an equal
percentage of retained risk using a form
that included vertical retention. To the
extent that such a holding signals to
investors that the information about the
asset portfolio being securitized is
accurately represented and fairly priced,
having this option available to sponsors
may improve investor participation and
lead to enhanced capital formation.
However, horizontal risk retention used
without vertical risk retention may not
fully align sponsor incentives with the
incentives of investors in all of the

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tranches or classes. Investors who are
investing in the most senior tranches
will have different interests than the
sponsor holding the residual interest,
which is the most junior tranche,
especially concerning the servicing of
under-performing assets.439
There are several reasons why a
sponsor may choose to hold a residual
interest instead of a vertical interest.
Sponsors may be unable to sell the
residual interest or, if they are
securitizing riskier loans, may hold the
residual interest to increase investors’
interest in more senior tranches. In
particular, to the extent that a sponsor
is willing to incur exposure to the first
losses, investors may be willing to
purchase the senior tranches at higher
prices. Also, if sponsors have a cost of
capital that is higher than the return
provided by holding vertical risk
retention, sponsors may choose to hold
more subordinated tranches and more of
the credit risk to generate a return
sufficient to meet their required cost of
capital. The holder of the residual
interest generally receives a higher rate
of return than any other tranche of the
deal and therefore a sponsor may choose
to hold horizontal risk retention in order
to make the deal economically viable for
the sponsor. This would increase the
amount of capital available for riskier
loans as sponsors’ demand for loans of
a higher risk increases. In all these
cases, any requirement to retain a
vertical interest would only impose
additional costs on such sponsors.
In the reproposal, the agencies
included cash flow restrictions with
EHRI, reasoning that if sponsors can
structure securitizations in such a way
that the residual interest is able to
receive cash early on in the deal then
the sponsor’s incentive to select loans
with better underwriting may be
reduced because the sponsor may be
repaid all of their principal investment
(‘‘cash out of the deal’’) before losses
accumulate and the deal underperforms.
Many commenters supported
elimination of the cash flow restrictions.
They asserted that these restrictions are
incompatible with a variety of
securitization structures, that the
certifications and disclosures to
investors that would be required by the
proposed cash flow restriction would
create potential liability, and that there
are possible ways around these
restrictions such that they will not be
meaningful but only increase costs to
sponsors. Commenters also stated that
cash flow restrictions would prohibit
almost all securitizations from being
issued as they are designed to pay high
439 See

footnote 438.

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interest rates early on to the residual
holder as compensation for risk taken,
and that most of the structures in
previously issued asset-backed
securities would have failed the cash
flow restriction tests. According to these
commenters, imposing the cash flow
restrictions could thus require current
market participants to change their
current practices, which could lead to a
reduction or cessation of the
securitization markets, resulting in a
decrease in capital formation and
reduction in allocative efficiency.
After considering the numerous
comments received, the agencies have
concluded that the proposed cash flow
restrictions on the EHRI (as well as the
alternative described in the reproposal
and alternatives suggested by
commenters) could lead to unintended
consequences and impose unnecessary
burdens on some asset classes.
Therefore, the agencies have eliminated
the previously proposed restrictions
from the final rule. The revised
disclosure requirements being adopted
relating to the key inputs and
assumptions underlying fair value
calculations, however, should provide
investors with the information
necessary to analyze whether the
sponsor is being conservative or
aggressive in its estimate of the 5
percent risk retention holding. The rule
also requires disclosure of the material
terms of the residual interest. By
providing this information to investors,
the disclosure helps mitigate the
concern that sponsors may provide
accelerated returns to themselves
through the residual interest since
investors will be able assess the
likelihood of such scenario based on
this information. Eliminating the cash
flow restriction requirements would
eliminate the costs to sponsors
associated with changing their market
practice while potentially promoting
competition among the sponsors for
alternative structures that optimize their
retention and investor preferences.
ii. Eligible Vertical Interest
A sponsor relying solely on the
vertical option would hold a percentage
of each tranche, resulting in an
economic exposure of 5 percent of the
credit risk of the entire loan pool. The
primary benefit of vertical risk retention
as compared to other standard forms of
risk retention is that investor-sponsor
incentives will be equally aligned across
all ABS tranches.
Vertical risk retention is also subject
to less credit risk exposure, and thus it
will be a cheaper method for the
sponsor to satisfy the requirement both
in terms of cost of capital and in

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measurement and disclosure to
investors. There is no requirement for
sponsors to provide a fair value estimate
to investors, which could reduce the
cost of retaining risk relative to the costs
associated with the other risk retention
options. Vertical risk retention will be
relatively simple for investors to
evaluate because the sponsor will hold
a specified percentage of each tranche.
However, vertical risk retention may be
less optimal for sponsors who typically
hold a first loss piece with the intent of
signaling higher quality of the senior
tranches or for other reasons.
The benefits of the vertical form of
risk retention extend to other market
participants as well. By allowing
sponsors to choose a vertical form of
risk retention, there will be increased
flexibility to choose higher yielding
assets and provide greater access to
credit to viable but higher-risk
borrowers than would otherwise be
possible through only a horizontal form
of risk retention. Investors interested in
holding residual interests will benefit
from a vertical form of risk retention as
they will be able to purchase more
higher-yielding first loss pieces of
securitizations, while investors who
demand tranches above the first loss
piece will have less supply available
because the sponsor would hold 5
percent of each tranche instead of
holding all of its retained risk in the
residual interest.
The final rule also permits a single
vertical security, as proposed. All
economic considerations that apply to
vertical risk retention will apply to the
single vertical security except that the
single vertical security may allow
sponsors to comply with risk retention
in a less costly manner in terms of
administrative fees and accounting
costs. If the sponsors’ costs of risk
retention are lower while still providing
the same incentive alignment, then cost
of credit for borrowers may be lower.
iii. Combined Risk Retention Option
The final rule allows sponsors to
retain risk through any combination of
a vertical form and a horizontal form
provided that the total percentages of
retained forms in the securitization add
up to 5 percent. For example, a sponsor
can hold 3 percent in the vertical form
and 2 percent in the horizontal form in
reliance on a combination of the
horizontal and vertical forms of risk
retention.
As noted above, horizontal risk
retention allows sponsors to provide a
stronger signal about their private
information about asset quality than
vertical risk retention because of the
increased amount of credit exposure for

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
sponsors. Hence, a sponsor choosing to
retain risk in a more expensive
horizontal form over a vertical form
would have greater exposure to credit
risk, and that sponsor’s incentives
should be better aligned with investors’.
As previously described, by choosing a
higher cost method of retaining risk,
such as through the horizontal form, a
sponsor can signal to the market greater
certainty about the quality of assets and
the level of risk in the senior tranches
because the sponsor is willing to incur
the losses in the lower subordination.
However, the optimal size of the
residual interest for a sponsor that seeks
to maximize the proceeds and minimize
the sponsor’s overall cost of funding
from securitization may not be 5
percent.
Finally, sponsors may choose to hold
some residual interest in an attempt to
gain a higher return on capital. In this
case, again, the optimal size of the
residual interest to achieve sponsor’s
required return may not be 5 percent.
The combination of the horizontal and
vertical forms reduces costs to sponsors
by allowing them to hold some of their
risk retention in the cheaper vertical
form while still receiving credit for the
residual interest they retain. Moreover,
the vertical form of risk retention still
allows for a more equal alignment of
sponsors’ interests with all types of
investors because the sponsor will hold
a portion of all of the tranches in the
securitization.
Allowing a flexible combination of
the horizontal and vertical forms
accommodates various current market
practices. Some asset classes have been
able to monetize more of their exposure
to securitized assets than other asset
classes. Typically the range for RMBS
has been closer to 1–3 percent of
overcollateralization than to the 5
percent of fair value for the retained first
loss piece required by the final rule.
Thus, the flexible combination of
horizontal and vertical forms will allow
sponsors to continue to retain risk as
they have in the past while keeping the
cost of risk retention to a minimum.
The flexibility of the combination of
the horizontal and vertical forms also
allows sponsors to better meet demands
of investors. If investors want to hold
more of the residual tranche, the
sponsor can hold less risk in the
horizontal form and more risk in the
vertical form to be able to sell interests
in the residual tranche to investors.
Alternatively, if there is a larger demand
for more senior tranches, then sponsors
can hold more risk horizontally. This
flexibility will increase allocative
efficiency within the ABS market. The
flexible combination of the horizontal

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and vertical forms also increases
competition among sponsors because it
allows sponsors to adjust several
dimensions of the securitization: risk
retention costs, expected returns on
retained pieces, and supply of tranches
with different risk characteristics.
b. Options for Specific Asset Classes
and Structures
i. Seller’s Interest Option
The reproposed rule would have
allowed a sponsor of a revolving master
trust that is collateralized by loans or
other extensions of credit to meet its
risk retention requirement by retaining
a seller’s interest in an amount not less
than 5 percent of the unpaid principal
balance of the pool assets held by the
sponsor. Commenters stated that the
reproposed version of the seller’s
interest option would not accommodate
all the common market practices in the
master trust market. They suggested
methods to broaden the options
available to revolving master trusts to
allow a wider variety of market
practices to count as risk retention.
The agencies are revising the seller’s
interest option for revolving pool
securitizations (referred to as revolving
master trusts in the reproposal) in the
final rule in order to accommodate more
of the practices of sponsors that
currently rely on revolving pool
securitizations as an important
component of their funding. These
revisions recognize and accommodate
the meaningful exposure to credit risk
currently held by sponsors of these
revolving pool securitizations, in light
of the heightened alignment of
incentives between sponsors and
investors that attaches to their structural
features. The agencies are also making a
number of other refinements in the final
rule in order to align the seller’s interest
option more closely with the mechanics
of revolving pool securitizations as they
are structured in the market today.
The pari passu seller’s interest option
in the final rule represents a special
form of exposure to credit risk for the
asset-backed security issued by a
revolving pool securitization. Under this
option, the sponsor must maintain the
size of the seller’s interest position,
most commonly through the ongoing
addition of receivables to the pool or
repayment of investor ABS interests.
Commenters also requested that the
agencies accommodate other revolving
pool securitizations that are common in
the market and rely on a seller’s interest
that is structured in a different manner,
which varies among the revolving pool
securitizations used for certain asset
classes. Commenters described two

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different structures, which the agencies
believe should be recognized as an
eligible form of risk retention under the
final rule.
The agencies have recognized a series
subordinated seller’s interest in a
revolving pool securitization as eligible
risk retention in the final rule. As
described by commenters, a series
subordinated seller’s interest is a
common feature of revolving pool
securitizations for certain asset classes,
such as equipment leasing and floorplan
financing. In these revolving pool
securitizations, the sponsor is obligated,
as is the case with the pari passu seller’s
interest, to maintain an undivided
interest in the receivables in the
collateral pool, in an amount equal to a
specified percentage of the trust’s
outstanding investor ABS interests.
Whereas the pari passu seller’s interest
is a trust-level interest equal to a
minimum percentage of the combined
outstanding investor ABS interests, the
minimum percentage in subordinated
seller’s interest revolving pool
securitizations may be tied to the
outstanding investor ABS interests of
each separate series. While the
sponsor’s right to receive distributions
on the seller’s interest included in the
reproposal was required to be pari
passu, the sponsor’s right to receive
distributions on its share of
distributions in subordinated seller’s
interest revolving pool securitizations
may be subordinated to varying extents
to the series’ share of credit losses.
Importantly, commenters noted that
notwithstanding these differences with
the pari passu seller’s interest, the
sponsor of a series subordinated seller’s
interest revolving pool securitization is
still required to maintain the minimum
amount of securitized assets in the pool,
if the securitization is to continue
revolving, through the ongoing addition
of assets to the pool if necessary. The
sponsor has incentives to monitor the
quality of the assets added to the pool
in both structures. If the sponsor
replaces repaid or defaulted assets with
poorly underwritten assets, those assets
will, in turn, suffer losses, and the
sponsor will be obligated to add even
more assets. If this cycle is perpetuated
and the minimum asset target is
breached, the revolving pool
securitization will enter an early
amortization period, and the sponsor
will no longer have access to future
funding from the revolving pool
securitization. Because the
subordination of the seller’s interest
does not change this potential
consequence and provides similar
economic incentives as the pari passu
seller’s interest for the sponsor to

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monitor and maintain the quality of
securitized assets in the pool, the final
rule recognizes this ‘‘series
subordinated’’ form of seller’s interest as
an eligible form of risk retention for
revolving pool securitizations. Allowing
the series subordinated seller’s interest
accommodates existing market practice
and will therefore minimize costs to
certain revolving pool securitizations,
while providing the intended benefit of
aligning sponsor and investor incentives
which will encourage higher quality
underwriting.
Commenters also described another
form of seller’s interest used in
revolving pool securitizations for certain
asset classes, such as equipment leasing
and floorplan financing, which are often
collateralized by various types of
‘‘excess’’ receivables. The transaction
documents for revolving pool
securitizations typically impose
eligibility requirements on the
receivables that are allowed to be
included as collateral for purposes of
calculating the total amount of
outstanding investor ABS interests that
may be issued by the revolving trust.
These eligibility requirements include
concentration limits on receivables with
common characteristics, such as those
originating from a particular
manufacturer or dealer or a particular
geographic area. The sponsor places
assets that exceed these concentration
limits (ineligible assets) in the revolving
pool securitization, where they are often
subject to the pledge of collateral to the
holders of the ABS interests, but they
are not included when calculating the
amount of the seller’s interest under the
revolving pool securitization.
Distributions on these ineligible assets
are typically allocated to the sponsor,
but depending on the terms of the
securitization, the sponsor’s claim to the
cash flow from these assets may be
partially or fully subordinated to the
claims of investor ABS interests, and
these subordination features may be at
the trust level, at the series level, or
some combination of both.
While the agencies are persuaded that
revolving pool securitizations should be
allowed to hold these receivables
without violating the common pool
requirement, the final rule, consistent
with market practice described above,
does not allow these excess receivables
to be included in the measurement of
seller’s interest. Because these are assets
that by their terms are not representative
of the assets that stand as the principal
repayment source for investor ABS
interests issued by the revolving pool
securitization, the agencies believe, in
conformance with market practice, that
it would be inappropriate to include

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them in the calculation of the seller’s
interest. This accommodation for
existing market practice allows a greater
number of existing revolving pool
securitization structures to meet the risk
retention requirements, which should
reduce the costs of compliance with the
final rule and minimize disruption to
existing structures. The agencies also
recognize that some revolving pool
securitizations make distributions on
these receivables available to cover
losses on eligible pool assets, which
increases the amount of credit
enhancement available to investors.
The agencies are adopting the seller’s
interest option generally as reproposed
with certain modifications to
incorporate more existing revolving
pool securitizations. The Commission
believes that there are several benefits to
recognizing the existing seller’s interests
in revolving pool securitizations as an
eligible form of risk retention. Aligning
the rule’s requirements with current
market practice will reduce
implementation costs for sponsors using
the master trust structure while still
retaining the benefits that investors
receive through improved selection of
underlying assets by the sponsors of
revolving pool securitizations.
Accommodating current practice will be
transparent and easy for the market to
understand and will preserve current
levels of efficiency and help to maintain
investors’ willingness to invest in the
market. Accommodating current
practice will also provide clarity to
market participants and may encourage
additional investor participation given
the removal of previous uncertainty
about potential changes to current
practices, thereby helping to promote
capital formation. Under this option,
there would be a cost to sponsors of
measuring the seller’s interest amount
on an ongoing basis in accordance with
the final rule, but since ongoing
measurement is a current market
practice, the additional cost should be
low. Unlike more traditional
securitization transactions collateralized
by a static pool of assets, revolving pool
securitizations use a single issuing
entity to issue multiple series. These
accommodations should allow sponsors
of revolving pool securitizations to
continue to use the same issuing entity
and minimize the potential disruption
to the market that could be caused by
bifurcating the common pool of
securitized assets or any other
restructuring of the issuing entities, and
any of their outstanding asset-backed
securities issued prior to the applicable
effective date of the final rule.
As discussed above, the agencies are
modifying the seller’s interest option to

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accommodate more of the market
practices that currently exist.
Accommodating more market practices
will reduce costs for sponsors of
revolving pool securitizations that
otherwise would not been able to rely
on the reproposed version of the seller’s
interest option and thereby help to
promote competition within this
segment of the market.
ii. Representative Sample
The agencies also considered the
alternative option of risk retention held
through a representative sample of the
securitized assets that was proposed in
2011, but not included in the 2013
reproposal.
While some commenters were
supportive of the original proposal’s
inclusion of the representative sample
option, many commenters were critical
of the option, stating that it would be
impractical to implement this option for
a variety of reasons, including that it
would be unworkable for various asset
classes, it would be subject to
manipulation, and its disclosure
requirements were too burdensome.
Some commenters on the reproposal
asked for the representative sample to
be reinstated, asserting that a revised
representative sample option would be
particularly useful for automobile loan
and lease securitizations, and more
generally, for securitizations with large
pools of consumer or retail assets, such
as student loans. However, these
commenters did not specify the costs of
not including such an option in the final
rule.
The agencies continue to believe a
representative sample option should not
be included in the final rule because,
among other reasons, it would be
difficult and potentially costly for
investors and regulators to monitor or
verify that exposures were indeed
selected randomly, rather than in a
manner that favored the sponsor. In
order to allow sponsors to hold a
representative sample, a number of
material factors would need to be
considered for the sample to be truly
representative. However, even if many
factors are considered, a factor could
potentially be missed, and as a result,
sponsors would end up holding a
sample that differed in a material way
from the pool assets. This could lead to
ineffective alignment of incentives and
therefore fail to realize one of the
intended benefits of the rule. Due to
these concerns, the agencies have
decided not to include a representative
sample option in the final rule.
Sponsors using this structure will incur
costs to comply with the requirements
of the final rule because the final rule

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does not include a representative
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iii. Asset-Backed Commercial Paper
Conduits Option
Under the reproposal, sponsors of
ABCP conduits could either hold 5
percent of the risk using the standard
risk retention option, as discussed
above, or could rely on the ABCP
option. The proposed ABCP option
would not have required the sponsor of
the conduit, which is typically a special
purpose vehicle, to retain risk as long as
the assets held in the ABCP conduit,
which are often ABS interests in other
asset classes, are not purchased in the
secondary markets, and the sponsor of
every ABS interest held by the ABCP
conduit complies with the credit risk
retention requirements. Another
condition of the proposed conduit
option was the requirement that the
ABCP conduit have 100 percent
liquidity support from a regulated
institution.
Commenters generally repeated
earlier requests that the agencies
provide an exemption based on, or
otherwise recognize, unfunded risk
retention provided by banks in the form
of liquidity support, program wide
credit enhancement, unconditional
letters of credit, and similar features, as
satisfying the risk retention
requirements. Commenters also
requested that ABCP conduits relying
on this option be permitted to use a
broader range of transaction structures
and purchase a wider variety of assets.
Finally, some commenters suggested the
elimination or modification of the
proposed requirements to disclose fair
value calculations and supporting
information by conduit managers about
an originator-seller’s failure to comply
with risk retention requirements, stating
that such disclosure under current
market conditions could risk the
collapse of the particular ABCP conduit
and pose a contagion risk to the other
conduits.440
The agencies are adopting the ABCP
option substantially as reproposed
except for certain modifications based
on comments received to accommodate
a greater range of current market
practices for existing ABCP structures in
the ABCP option. The agencies have not
adopted commenters’ suggestion to
permit the application of the ABCP
option to certain types of assets not
covered by the reproposal or transaction
440 The Commission believes that the
diversification of ABS interests and the 100 percent
liquidity support requirement make this scenario
highly improbable.

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structures with less than 100 percent
liquidity support. Restricting the option
to ABCP conduits that hold only certain
ABS interests is a structural safeguard
that while possibly limiting the ability
raise capital through ABCP conduits,
will increase the alignment of incentives
between sponsors of ABCP conduits and
investors.
Under the final rule, eligible ABCP
conduits may only purchase ABS
interests in an initial issuance. By
limiting an eligible ABCP conduit to
holding ABS interests acquired in initial
issuances, a sponsor will be in a better
position to potentially influence the
terms of the deal and have an effect on
the quality of assets underlying the ABS
interests relative to if the ABS interests
were acquired in the secondary market
post issuance. However, by conditioning
ABCP conduit eligibility to rely on the
ABCP option on the purchase of ABS
interests in an initial issuance, the rule
could have a negative impact on
secondary markets, possibly resulting in
lower liquidity and potentially
decreasing the efficiency in the
secondary markets for ABS interests.
Additionally, the agencies understand
that ABCP conduit structures that
primarily relied on secondary market
purchases (arbitrage ABCP conduits)
performed poorly during the financial
crisis.
Allowing the ABCP option provides
incentive to improve underwriting
while minimizing the impact on ABCP
funding costs, thereby lessening the
potential burden on capital formation as
ABCP conduit sponsors will not need to
use their capital to retain 5 percent of
the ABS interest issued by the ABCP
conduit. The risk retention option for
ABCP conduits includes specific
requirements for a regulated liquidity
provider that provides liquidity support
with contractual terms that meet certain
requirements. We estimate that
approximately half of existing ABCP
conduit sponsors may need to adjust the
terms of their existing liquidity support
in order to comply with the
requirements of the final rule, and
therefore will incur costs to implement
the liquidity support necessary to meet
the new requirements. The liquidity
support requirements are largely
consistent with the exclusion from the
definition of covered fund for certain
ABCP conduits in the rules
implementing Section 619 of the DoddFrank Act. As a result, the Commission
believes ABCP conduits sponsored by
banks, which make up the bulk of the
ABCP market,441 already have or will

have liquidity support that will comply
with the final rule, and therefore the
new requirements will not materially
increase their costs.
Maintaining current practice and
requiring 100 percent liquidity coverage
without regard to asset performance will
be transparent and easy for investors to
understand and implement, and help to
maintain investor’s willingness to invest
in ABCP. Adoption of the liquidity
coverage requirement and removal of
previous uncertainty about liquidity
coverage (i.e. under what conditions
liquidity support would be provided)
should also provide clarity to investors
and may encourage additional
investment, thereby lowering the cost,
or increasing the amount, of capital
formation in ABCP and underlying
asset-backed securities markets.
However, the liquidity support could
have the effect of lowering the yields of
the ABS interests because investors will
face less risk compared to less than 100
percent liquidity support.
Other modifications that the agencies
are making will also permit more
existing market practices to be used
with the ABCP option. Accommodating
these market practices will reduce costs
to those ABCP conduits that were not
covered under the reproposed version of
the ABCP option and thereby help to
promote competition within this
segment of the market.

441 Asset-Backed Alert, March 28, 2014, lists the
20 largest ABCP conduit administrators. All but one

of them are large banks. The non-bank is Lord
Securities.

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iv. Commercial Mortgage-Backed
Securities Option
The agencies are adopting the CMBS
option largely as reproposed. The
Commission continues to believe that
the option provides a means to satisfy
the risk retention requirements that, for
the most part, will allow CMBS issuers
to continue current market practice
relating to techniques that align
incentives and improve underwriting
standards. Under the final rule, a
sponsor will be able to satisfy the risk
retention requirements by having up to
two third-party purchasers (provided
that each party’s interest is pari passu
with the other party’s interest) purchase
an eligible horizontal residual interest
(B-piece) in the issuing entity if it is
backed solely by commercial real estate
loans and servicing assets. The thirdparty purchaser(s) would be required to
acquire and retain an eligible horizontal
residual interest in the issuing entity in
the same form, amount, and manner as
the sponsor (with the same hedging,
transfer, and other restrictions) except
that after five years the third-party

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purchaser can sell the B-piece to
another eligible third-party purchaser.
As discussed in Section 3.b.ii of this
Economic Analysis, currently the Bpiece investors in CMBS often hold dual
roles as bond investors, if the assets
remain current on their obligations, and
as holders of controlling interests to
appoint special servicers, if the loans
default and go into special servicing.
The B-piece investors are typically real
estate specialists who use their
extensive knowledge about the
underlying assets and mortgages in the
pools to conduct extensive due
diligence on new deals. Such due
diligence is feasible because typically
CMBS have much smaller number of
underlying loans in a pool.442
Consequently, since B-piece buyers are
taking the credit risk and have an ability
to perform their own due diligence on
securitized assets before purchasing the
residual tranche, the third party holding
risk effectively serves as an independent
re-underwriter of the underlying loans,
achieving a quality of re-underwriting
consistent with the quality of
underwriting of a sponsor that would
retain credit risk on its own balance
sheet. B-piece buyers also have the
ability to affect the performance of the
securitization when problems arise.
Because they usually have expertise in
commercial real estate and are holders
of controlling interests to appoint
special servicers (and often have special
servicers affiliates), they facilitate
restructuring of underperforming loans
to maintain the structure of a CMBS. By
providing for the continued retention of
risk and strong incentive to the sponsor
to limit potential moral hazard problems
at the time the structure is put in place,
the effect of the CMBS risk retention
option on the moral hazard problem
will likely be similar to the effect of one
of the standard risk retention options.
Allowing the third-party purchaser to
sell the B-piece to another eligible thirdparty purchaser after a minimum
holding period should generate
secondary market liquidity, thereby
lessening the original purchaser’s cost of
retaining the risk and encourages greater
participation in the CMBS market by
eligible B-piece purchasers. The
resulting secondary market transactions
could generate additional benefits to
CMBS investors to the extent that Bpiece buyers have differential skills
with respect to assessing the risk at the
time of origination, monitoring
performance, and engaging in
restructuring activity when performance
issues arise. Allowing the transfer of the
B-piece will allow the transfer of the B442 See

also footnote 424.

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piece to a purchaser with specialized
skills appropriate to the particular
situations.
Under the final rule, use of the CMBS
option requires the appointment of an
independent operating advisor who,
among other obligations, has the
authority to recommend and call a vote
for removal of the special servicer under
certain conditions. This requirement
may serve to limit potential conflicts of
interest between the investors in senior
tranches and the B-piece buyer(s), thus
helping to ensure that the benefits of the
risk retention requirements are
preserved and extended to all investors.
There will be costs, however, related to
the appointment of the independent
operating advisor, including, but not
limited to, the payments to the
advisor.443
The primary benefit of allowing
sponsors to maintain their current
market practices is to effectively achieve
the intended objectives of risk retention
with minimized cost to the CMBS
market. Commenters generally
supported the CMBS option as
reproposed, with one investor
commenter cautioning against further
modifications to the proposed CMBS
option, expressing the view that CMBS
underwriting standards were beginning
to deteriorate. However, some comment
letters suggested changes from the
reproposal.
Commenters suggested increasing the
5 percent minimum quorum
requirement for a vote to replace the
special servicer to 15 percent or 20
percent, and adding a requirement that
no fewer than three unaffiliated
investors participate in the vote. The
agencies have decided to permit CMBS
transaction parties to specify in the
underlying transaction documents the
quorum required for a vote to remove
the special servicer, provided it is not
more than 20 percent of the outstanding
principal balance of all ABS interests in
the issuing entity, with such quorum
including at least three ABS interest
holders that are not affiliated with each
other.
The final rule includes these
suggested changes to address the
concern that a 5 percent quorum could
allow a B-piece buyer holding 5 percent
of the CMBS deal to replace the special
servicer alone without consent of other
investors. As discussed in Section 3.b.ii
443 According to CRE Finance World, Autumn
2012, Volume 14, No.3, pp. 47–50, the operating
advisor fee rate is ‘‘modest.’’ Other costs may
include delays in special servicer replacement due
to the need to call for investors’ vote, and a possible
loss of efficiency because operating advisors may be
less knowledgeable of the special servicing market
than B-piece buyers.

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of this Economic Analysis and in Part
III.B.5 of the Supplementary
Information, the B-piece investors in
CMBS often have an affiliate special
servicer and, as holders of controlling
interests, they can appoint that affiliated
entity if the loans default and go into
special servicing. An affiliate special
servicer could make decisions about
loan restructuring in the interest of its
affiliated B-piece holder that are
inconsistent with the interests of all
investors. Thus, requiring at least three
investors that are not affiliated with
each other for the quorum would ensure
that the economic interest of at least
some senior tranche investors would be
accommodated in the selection of the
special servicer and subsequent
restructuring.
Raising the maximum quorum
requirement to 20 percent from 5
percent in the final rule will further
ensure that other CMBS investors will
participate in the selection of the special
servicer. Limiting the maximum quorum
requirement to 20 percent also ensures
that investors do not face an undue
burden in coordinating with other
dispersed investors to call a vote to
change the special servicer. Currently,
transaction agreements can stipulate any
quorum threshold. If a transaction
agreement currently stipulates a
threshold that is too high, the
coordination costs attributed to
collective action could prevent
potentially efficient changes in the
special servicer. On the other hand,
with less ability to influence the
selection of the special servicer,
combined with an inability to disinvest
until the expiration of the sunset period,
B-piece buyers will have less incentive
to invest in B-pieces. Hence, relative to
current practices, mandating a lower
maximum quorum requirement could
generate benefits in some cases.
The agencies considered but did not
adopt the suggestion to allow third party
purchasers to hold their interests in a
senior/subordinate structure, rather than
pari passu, to match the risk of loss of
each B-piece interest and the risk
tolerances of each B-piece buyer.
Commenters asserted that a seniorsubordinated structure would better
allow the market to appropriately and
efficiently price the B-piece interests in
a manner that is commensurate with the
risk of loss of each interest, and to
address the different risk tolerance
levels of each third-party purchaser.
However, other commenters strongly
opposed allowing third-party
purchasers to satisfy the risk retention
requirements through a seniorsubordinated structure, commenting
that such a change would significantly

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dilute and render ineffective the risk
retention requirements. The agencies
have decided not to allow third-party
purchasers to satisfy the risk retention
requirement with a senior-subordinated
structure. As noted earlier, the purpose
of third-party risk retention is to create
a transaction participant that would
serve as an independent re-underwriter
of the underlying loans. A ‘‘senior’’ Bpiece holder in this structure might not
be appropriately compensated for
employing sufficient resources to reunderwrite a CMBS transaction because
its expected return would be too low to
compensate for the expenditure of
resources necessary for re-underwriting.
In addition, the pari passu requirement
better aligns the interests of the most
junior tranche buyer(s) with those of
more senior noteholders whereas the
senior/subordinated structure for the Bpiece would further separate the
interests of most junior tranche buyer(s)
(that in this case could hold the first loss
tranche that might be significantly
smaller than 5 percent) from those of the
senior noteholders, which could
exacerbate conflicts of interest issues in
this area.
Some commenters opposed the
disclosure of the purchase price paid by
third-party purchasers for the eligible
horizontal residual interest. These
commenters pointed out that such
information has traditionally been
viewed by all market participants as
highly confidential and proprietary, and
that the disclosure requirement would
deter B-piece buyers from retaining risk.
The Commission acknowledges that, if
B-piece buyers are deterred from
purchasing eligible residual horizontal
interests, this could lower the liquidity
of the junior tranches of CMBS and,
thus, potentially increase the sponsors’
cost of capital and the cost of credit for
borrowers. However, the agencies
continue to believe that requiring
disclosure of the price at which the Bpiece is sold is important to
understanding the value of the third
party’s risk retention (and therefore
whether the required amount has been
retained) and would be consistent with
other required fair value disclosures for
any eligible horizontal residual interest
retained by the sponsor that allow
investors to assess the amount of risk
being retained.444 Hence, the ability of
investors to quantify the amount of
credit risk exposure of the B-piece
buyer, and thus the level of incentive
alignment with other investors,
generates benefits that would not be
444 See

Section 4.a.ii of this Economic Analysis.

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v. Government Sponsored Entities
Option
The final rule allows the full
guarantee of the Enterprises under
conservatorship or receivership to count
as risk retention for purposes of the risk
retention requirements. Because of the
capital support provided by the U.S.
government for the Enterprises,
investors in Enterprise ABS are not
exposed to credit loss, and there is no
incremental benefit to be gained by
requiring the Enterprises to retain risk.
Commenters generally supported
allowing the Enterprises’ guarantee to be
an acceptable form of risk retention in
accordance with the conditions
proposed and did not suggest any
alternatives. The agencies are adopting
the Enterprise option as reproposed.
This option along with the
Enterprises’ capital support from the
U.S. government creates a competitive
advantage for the Enterprises over
private-sector sponsors when

purchasing non-QRM loans as long as
they are conforming to the Enterprises
underwriting standards. Recognizing the
Enterprises’ guarantee as fulfilling their
risk retention requirement and the
resulting additional competitive
advantage over sponsors of non-QRM
conforming loans has two significant
economic benefits. First, it will allow
the Enterprises to facilitate the
availability of capital to segments of the
population that might not otherwise
have access through private sector
channels. Second, it will provide stable
funding of home financing in periods
when lenders curb their lending due to
limited access to capital and privatesector sponsors are unable or unwilling
to meet excess demand.
A potential cost of recognizing the
Enterprises’ guarantee as fulfilling their
risk retention requirement is that it may
incentivize them to purchase loans that
do not meet the QRM criteria (i.e.,
expanding the Enterprises’ conforming
loans underwriting criteria), which
would introduce risk that the risk
retention requirement is intended to
mitigate. However, analysis of loans
originated between 1997 and 2009, a
period that spans the onset of the
financial crisis, shows that private label
loans had a much higher serious
delinquency rate than Enterprise
purchased loans, even after accounting
for different underlying loan
characteristics.446 Hence, this historical
performance-based evidence suggests
that Enterprise underwriting standards
may offset any incentive to incur excess
risk because of their capital support, at
least in relation to the incentives and
behaviors among private label sponsors
during the same period.
If the Enterprises’ conservatorship is
terminated, their securitizations will no
longer be exempt from risk retention
requirements unless the securitized
assets meet the QRM definition. This
will put the Enterprises on even footing
with private label securitizations in
terms of risk retention, but, as was the
case before the crisis, the Enterprises
still carry an implicit guarantee of the
U.S. government and, thus, will retain
some of their funding advantage for both
QRM and non-QRM securitizations.
Private label securitizations may still
have limited ability to be a significant
source of capital to conforming nonQRM loan originations until the
Enterprises wind down their activity or
the implicit guarantee is eliminated. As
is the case now, private label

445 Based on Commercial Mortgage Alert, out of
61 private label U.S. CMBS deals in 2013 that had
B-piece buyers, 50 had a single B-piece buyer, 12
had two B-piece buyers, and none of the deals had
more than two B-piece buyers.

446 See Joshua White and Scott Bauguess,
Qualified Residential Mortgage: Background Data
Analysis on Credit Risk Retention, (August 2013),
available at http://www.sec.gov/divisions/riskfin/
whitepapers/qrm-analysis-08-2013.pdf.

possible if B-piece buyers were able to
keep the price confidential.
The final rule provides additional
flexibility for the CMBS option by
allowing up to two third-party
purchasers to satisfy the risk retention
requirement. This provision
accommodates the current market
practice 445 and should facilitate
liquidity of the residual piece market,
contributing to a lower cost of capital
for sponsors and borrowers. While
commenters generally supported
allowing up to two third-party
purchasers to hold risk retention, one
commenter recommended expanding
the number of third-party purchasers to
allow participation by more than two Bpiece investors. The agencies do not
believe it would be appropriate to allow
more than two third-party purchasers in
a single transaction. While allowing
more than two purchasers could
increase B-piece market liquidity and,
in turn, reduce costs for CMBS
sponsors, it also could dilute the
incentives generated by the risk
retention requirement to monitor the
credit quality of the commercial
mortgages in the pool, thereby
undermining the intended benefits of
the rule. Each B-piece investor who has
exposure to significantly less than 5
percent credit risk, would have not
enough ‘‘skin in the game’’ to be
incentivized to monitor the quality of
underwriting as discussed in Section
4.a.i. of this Economic Analysis.

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securitizations would not have to
compete with the Enterprises for
securitizations of non-conforming loans
(e.g., riskier non-qualified mortgage
(non-QM) loans or jumbo loans), which
will still fall outside of the Enterprises
domain if current conforming loan
underwriting standards remain in place.
vi. Open Market Collateralized Loan
Obligations
A collateralized loan obligation (CLO)
is an asset-backed security that is
typically collateralized by portions of
tranches of senior, secured commercial
loans or similar obligations of borrowers
who are of lower credit quality or that
do not have a third-party evaluation of
the likelihood of timely payment of
interest and repayment of principal.
Commenters distinguished between two
general types of CLOs: open market
CLOs and balance sheet CLOs. As
described by commenters, a balance
sheet CLO securitizes loans already held
by a single institution or its affiliates in
portfolio (including assets originated by
the institution or its affiliate). An open
market CLO securitizes assets purchased
on the secondary market at the direction
of an asset manager, in accordance with
investment guidelines. Under the final
rule, sponsors of CLOs are required to
retain 5 percent of risk using the
standard form of risk retention and have
not been provided with an exemption
from the rule’s requirements. CLOs are
subject to the same sunset provisions as
other non-residential mortgage
securitizations.
As an alternative to this standard risk
retention, the agencies are adopting, as
proposed, an option for sponsors of
open market CLOs to satisfy the risk
retention requirement by holding only
‘‘CLO-eligible’’ tranches for which the
syndicated loan’s ‘‘lead arranger’’
retains (for the duration of the loan) at
least 5 percent of the tranche’s value. A
syndication’s ‘‘lead arranger’’ is defined
as a syndicated member that holds an
initial allocation of the overall
syndicated credit facility equal to (at
least) the greater of (a) 20 percent of the
aggregate principal balance and (b) the
largest allocation taken by any other
member (or members affiliated with
each other) of the syndication group.
The agencies have defined open market
CLOs for purposes of the lead arranger
option being adopted. The analysis
below considers the impact of the risk
retention requirements and the lead
arranger option on the market for open
market CLOs, which was the subject of
many comment letters.447
447 In balance sheet CLOs the originator of the
loan is the sponsor or an affiliate of the sponsor.

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Under the final rule, the risk retention
requirements for open market CLOs are
subject to the same sunset provisions as
other non-residential mortgage
securitizations. These provisions require
CLO sponsors to retain risk until the
latest of: (1) The date on which the
principal balance of the securitized
assets reduces to 33 percent of the
original unpaid principal balance as of
the cut-off date or similar date for
establishing the composition of the
securitized assets collateralizing the
asset-backed securities issued pursuant
to the securitization transaction, (2) the
date on which the unpaid principal
obligations of securities has been
reduced to 33 percent of the original
unpaid principal obligations at the
closing of the securitization transaction,
or (3) two years after the date of the
closing of the securitization transaction.
The loans backing CLOs typically
have maturities that can extend beyond
the term of the CLOs, particularly when
the loans are added to the pool after
issuance, which could mean that loan
balances of loans held by a CLO may not
necessarily decrease prior to the
maturity or redemption of the CLO.
Hence, the final rule may effectively
require the CLO manager (as the sponsor
of the CLO) to retain risk beyond the
minimum sunset period. This should
lessen the incentive for managers to
alter the composition of the loan
portfolio in a way that could harm
investors relative to what may be
present with a shorter sunset period.
A key difference between this lead
arranger option and those related to, for
example, commercial mortgage backed
securities is that the CLO manager must
rely on the lead arranger’s continuing 5
percent retention of risk in the CLOeligible loans, in order for the CLO
manager to satisfy its risk retention
obligations. Thus, unlike a portfolio of
commercial mortgages, the CLO
requirement extends beyond the
initiation date of the securitization so
that the status of the lead arrangers’
continuing participation may affect the
CLO manager.
The agencies received many
comments about the lead arranger
option, and the impact of risk retention
on the market for open market CLOs.
These comments can be categorized into
four main areas: (1) The impact of the
lead arranger option on the availability
and cost of leveraged loans; (2) the
unwillingness or inability of arrangers
to create CLO-eligible tranches; (3)
For balance sheet CLOs, economically there is no
difference between the lead arranger option and
standard risk retention when the sponsor is the
originator or its affiliate.

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alternative options for sponsors of open
market CLOs to retain risk; and (4)
general concerns about the impact of
risk retention on the CLO industry and
the syndicated loan market.
Regarding the impact of the lead
arranger option on borrowing costs,
commenters asserted that the proposed
option would be unworkable with
existing CLO practices and therefore the
risk retention requirements would result
in a significant reduction in CLO
issuances and a corresponding
reduction in credit to commercial
borrowers. Commenters further asserted
that the requirement that the lead
arranger retain at least 5 percent of an
eligible tranche would increase the
required capital and FDIC assessment
charges, thereby increasing the pricing
of CLO-eligible tranches, and adversely
impacting borrowing costs. Moreover,
some commenters noted that only a very
small number of arrangers can meet the
definition of ‘‘lead arranger’’ as
proposed, because the syndication of
leveraged loans is concentrated among a
small number of banks.448 According to
these commenters, requiring lead
arrangers to hold a relatively large piece
of these syndicated loans on their
balance sheets would cause a
substantial increase in their risk-based
capital requirement.449 Further,
commenters noted that the requirement
to retain 5 percent of the eligible
tranche, combined with the hedging and
transfer restrictions, is inconsistent with
sound risk management practices,
overly burdensome in light of regulatory
and lending limits and would reduce
the lead arranger’s ability to extend
credit. Commenters also stated that
these additional costs, imposed on the
lead arranger, would be passed on to the
corporate borrowers, restricting access
to and cost of capital.
One commenter observed that only a
handful of non-regulated entities have a
sufficient amount of available capital to
arrange and syndicate leveraged loans
and satisfy the proposed risk retention
requirements under the lead arranger
option. According to this commenter,
adopting the lead arranger option, as
448 Based on Bloomberg L.P. data, the largest five
banks arranged 47 percent of the syndicated
leveraged loans in 2013.
449 One commenter pointed out that banks and
other highly regulated financial entities represent
almost the entire market of originators of the loans
that comprise the assets collateralizing CLOs. This
commenter stated that the requirement for lead
arrangers to hold additional exposure to a borrower
that is unhedged until maturity of the loan is
generally inconsistent with prudent lending
practices and internal lending policies. Such a
requirement also, impacts the amount of other
banking products that such lead arrangers can
extend to other borrowers.

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proposed, would cause a severe
contraction in CLO-related activities by
regulated institutions and a significant
reduction in liquidity to a critical sector
of the U.S. economy. The Commission
notes, however, that this conclusion
assumes that other lenders will not
enter the market with sufficient capital
to compensate for the loss of bank
capital in the event that large banks
curtail their involvement in the CLO
sector. For example, other commenters
asserted that if the risk retention
requirement caused a reduction in
participation by open market CLOs in
the leveraged loan market, other
institutions would enter the market to
fill the unmet credit needs. Ultimately,
if this were to occur, the commenters
asserted that non-CLO credit providers
likely would incur higher costs than the
CLO credit providers that have operated
in the past, and these costs would be
passed along to the ultimate borrowers,
raising their cost of funding.
Commenters’ second main area of
concern was the practical ability and
willingness of originators to create and
retain CLO-eligible tranches. One
commenter stated that the lead arranger
option is not workable because the
implementation difficulties associated
with creating CLO-eligible tranches are
substantial and observed that surveyed
banks have indicated they would not be
willing to take on this endeavor. In
particular, to qualify for the option,
CLO-eligible tranches would be required
to carry separate voting rights, which
the same commenter asserted would be
administratively unworkable and
commercially unacceptable to the other
parties to the loan transaction.
Commenters also expressed concern
that it was unclear how a CLO would be
able to monitor whether the CLOeligible loan tranche continues to meet
the necessary criteria. Commenters
stated that the requirement that a lead
arranger represent that the loans
continue to meet the rule’s criteria
exposes the lead arranger to potential
liability that the lead arranger cannot
realistically bear. While the Commission
acknowledges these concerns, the
Commission also notes that, because
CLOs are a major source of funding for
leveraged loan originators, there is
significant economic incentive for
arrangers to use the lead arranger option
to ensure the continued participation of
CLO managers.
Other commenters argued that openmarket CLOs should be exempted from
the risk retention requirements
altogether because the organizational
structure of open market CLOs provides
investors with sufficient safeguards.
These commenters indicated that open

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market CLOs operate independently of
originators and are not part of, and do
not pose the same risks as, the originateto-distribute model. They also asserted
that CLO managers’ interests are fully
aligned with the interests of CLO
investors because CLO managers bear
significant risk through their deferred,
contingent compensation structure,
which they noted is based heavily on
performance of the underlying assets.
Commenters also noted that most CLO
managers are registered investment
advisers, with associated fiduciary
duties to their clients. Commenters also
noted that many CLO managers are
subject to existing regulations that
provide meaningful protections against
imprudent or inferior underwriting,
including the leveraged lending
guidance released by the Federal
banking agencies in 2013.450
Commenters further asserted that
existing industry best practices mitigate
risks, and that CLO assets are actively
managed and often include select senior
secured commercial loans with investor
protection features. More generally,
commenters asserted that: (1) unlike
many other securitizations, CLOs are
securitizations of liquid assets and are
structurally transparent, (2) CLOs have
historically performed well even during
the financial crisis, and (3) this strong
performance is evidence that risk
retention is unnecessary.
Some commenters proposed a new
option for ‘‘qualified CLOs’’ that would
codify many of the existing practices of
open-market CLOs and require CLO
managers to hold 5 percent of the equity
tranche of at least 8 percent of the value
of the CLO. As discussed below, the
Commission does not believe this
option would provide sufficient
incentive alignment for open-market
CLOs. Although some commenters
stated their belief that CLO managers
450 See Leveraged Lending Guidance. However, as
discussed above in Part III.B.7 of the
Supplementary Information, the Federal banking
agencies noted that there is evidence that increased
activity in the leveraged loan market has coincided
with widespread loosening of underwriting
standards and that many banks have not fully
implemented standards set forth in the guidance,
see Semiannual Risk Perspective: Spring 2014,
Office of the Comptroller of the Currency, at 5 (June
2014), available at http://www.occ.gov/
publications/publications-by-type/otherpublications-reports/semiannual-risk-perspective/
semiannual-risk-perspective-spring-2014.pdf,
Shared National Credits Program: 2013 Review,
Board of Governors of the Federal Reserve System,
Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency (September 2013),
available at http://www.federalreserve.gov/
newsevents/press/bcreg/bcreg20131010a1.pdf and
‘‘Fed Scrutiny of Leveraged Loans Grows Along
With Bubble Concern’’, Bloomberg News, October
1, 2014, available at http://www.bloomberg.com/
news/2014-10-01/fed-scrutiny-of-leveraged-loansgrows-along-with-bubble-concern.html.

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select and manage CLO assets free from
the potential conflicts and misaligned
incentives related to the originate-todistribute model, the Commission notes
that, without a risk retention
requirement, there is little economic
incentive to discourage practices
associated with an originate-todistribute model from developing.
The fourth category of comments
reflected a general concern about the
lead arranger option and the impact of
risk retention on the market for open
market CLOs. One commenter expressed
concern that designating one tranche of
a syndicated facility the CLO-eligible
loan tranche would significantly affect
the pricing of other tranches due to the
decreased liquidity of such tranches, as
such tranches would not be available for
securitization in the CLO market. The
same commenter noted that the universe
of CLO-eligible loan tranches would be
very limited and restrict the CLO
manager’s ability to invest in a diverse
number of loans. Further, several
commenters asserted that the costs of
imposing risk retention on CLO
managers exceeds the benefits and that
the agencies have not performed an
adequate economic analysis in
connection with the lead arranger
option.
One study by Oliver Wyman451
claimed that as a result of the proposed
requirements, credit spreads will
increase from 117 to 292 basis points
and costs to borrowers will increase
between $2.5 billion and $3.8 billion
per year because non-CLO lenders will
charge a higher interest rate to leveraged
loan borrowers than CLOs. To arrive at
these estimates, the study assumed that
CLO managers unaffiliated with a large
financial institution or market
participant will no longer be able to
provide capital to the leveraged loan
market and that credit would not be
provided to borrowers through other
channels.
In reaching these conclusions, the
study makes several assumptions that
are questionable. For instance, the study
assumes that CLO managers cannot or
will not be able to hold 5 percent risk
retention. However, the Commission
believes that there may be economically
feasible means for CLO managers to
meet the risk retention requirements,
particularly if there is economic
incentive of the magnitude described in
the study (i.e., predicted spread
increases ranging from 100 to 200 basis
points). Another assumption is that not
enough lead arrangers will use the lead
arranger option which will mean there
451 http://www.sec.gov/comments/s7-14-11/
s71411-535.pdf.

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will not be enough CLO-eligible
tranches for CLOs to be formed using
the lead arranger option. Given that
CLOs currently account for a significant
portion of the leveraged loan market,
there are significant economic
incentives for loan arrangers to create
CLO-eligible tranches particularly
because, by not doing so, originators
may not have enough demand for their
issuances. Hence, lead arrangers may
make CLO-eligible tranches available,
which would create enough
diversification and supply for CLOs to
rely on the lead arranger option.
The study’s third assumption relies
on an estimate of elasticity of supply of
credit in the leveraged loan market (i.e.,
the change in the availability of credit
associated with a given change in the
loan interest rate). The study proxied for
the elasticity of supply of credit with an
estimate of elasticity of demand for
credit in the leveraged loan market (i.e.,
the change in the borrowers’ demand for
credit associated with a given change in
the loan interest rate) published in
another (academic) study.452 However,
the commenter’s study does not justify
its assumption that the elasticity of
supply should be equal to the elasticity
of demand. Indeed, the commenter’s
study implicitly assumes that demand is
inelastic and would not change in
response to the change in interest rate
(i.e., that borrowers would demand the
same amount of credit regardless of the
level of interest rates). The commenter’s
study also assumes that the credit
supply curve would not shift in
response to the change in interest rate
(i.e., as a result of entrance of new
lenders).453 Taken together, the
Commission believes the assumptions
in the commenter’s study contribute to
an estimate of the cost to the leveraged
loan and the CLO industry that is likely
to be significantly inflated.
More generally, there are several
considerations that could affect the
extent of the rule’s impact on the
leveraged loan market, as described in
the commenter’s study. One
consideration is that non-CLO investors
might invest more capital given the right
incentives (higher yields or less risk).
These investors include hedge funds,
loan mutual funds, and insurance
452 Greg Nini, ‘‘Institutional Investors in
Corporate Loans’’, University of Pennsylvania
working paper, 2013, available at http://
papers.ssrn.com/sol3/papers.cfm?abstract_
id=2349840.
453 The study asks the question ‘‘How much
‘‘extra’’ yield would be needed to induce these nonCLO loan buyers to increase the amount of credit
they are willing to supply?’’ and proceeds to
estimate ‘‘the increase in credit quantity that nonCLO leveraged loan credit providers would have to
supply to fully replace lost CLO capacity.’’

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companies. Another possibility is that
these investors, instead of purchasing
leveraged loans on the secondary
market, would join in as part of the
syndication. Finally, CLO managers
with lower cost of funds and capability
to satisfy the risk retention requirements
may replace some of the supply of credit
lost due to exit from the market of CLO
managers with higher cost of funds. Any
of these possibilities would mitigate the
loss of CLO capital as other investors
invested more capital into the leveraged
loan market.
Although the Commission
acknowledges commenters’ concerns
about the lead arranger option, the
Commission does not believe there is an
economic justification for an exemption
from the standard 5 percent risk
retention requirement for CLOs. The
Commission believes that the amount of
risk retention included in the alternative
approach suggested by commenters of a
CLO option retaining 5 percent of the
equity tranche of at least 8 percent of
the value of the CLO transaction
(effectively amounting to as low as 0.4
percent risk retention in the entire
securitization) would not sufficiently
address the originate-to-distribute risks
in the leveraged loan market. In
particular, a CLO market absent of
meaningful risk retention may not have
the protections against future moral
hazard problems that the final rule is
designed to provide. The Commission
acknowledges that risk retention may
generate significant upfront costs to the
CLO and the leveraged loan market
relative to current practices or the
proposed alternatives provided by
commenters. However, the Commission
believes that these current practices and
the proposed alternatives would not do
enough to align incentives between
sponsors and investors which, in the
long term, could impose larger costs on
the market than the risk retention
requirements of the final rule.
The Commission is also sensitive to
the claim by commenters that the CLO
market performed well during the
financial crisis in comparison to other
asset classes and, in particular, to
RMBS. However, the Commission
believes that this claim has the benefit
of hindsight, and that during the
financial crisis, there were considerable
concerns with the ability of borrowers to
meet their financial obligations through
their collateralized loans.454 Ultimately,
454 See, e.g., Ng, S., and K. Haywood, 2009, ‘‘Rates
Low, Firms Race to Refinance Their Debts,’’ The
Wall Street Journal, June 26, 2009, http://
online.wsj.com/articles/SB124597520948957427.
They observe: ‘‘Bankers and borrowers alike worry
that the overhang could create serious problems in
the years ahead if financial markets don’t heal

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aggressive monetary policy resulted in
sharp declines in the interest rates
payable on floating-rate leveraged loans,
making it easier for borrowers to meet
their loan obligations. The Commission
believes that it is this extraordinary
influence on borrowing costs, and not
the underlying market practices of CLO
managers, which largely explains CLO
performance during the financial crisis.
Hence, CLO performance during the
financial crisis does not provide a sound
basis for an exemption from the rule’s
requirements.
The Commission believes that
commenters’ alternative suggestions do
not create sufficient incentive
alignment, or ‘‘skin in the game,’’ for
sponsors to ensure that originators
maintain high underwriting standards
in accordance with the purposes of
Section 15G. While the Oliver Wyman
study claims that risk retention will
have a large negative impact on the
leverage loan market and the CLO
industry, the Commission believes that
the assumptions underlying that
assessment are questionable. In
particular, the study assumes that CLO
managers, who currently hold 53
percent 455 of the leveraged loans sold
by originators, will no longer be able to
purchase leveraged loans and that a
significant proportion would otherwise
go unfunded. The Commission
acknowledges that this may increase
cost to leveraged loans borrowers, but,
for the reasons explained above, the
Commission believes these are likely to
be at a much lower level than the study
suggests. Originators may sell leveraged
loans to other purchasers, in which
case, as discussed below, smaller CLO
managers may be affected but there
would not be a significant impact on the
CLO market.
Under current practices in the
leveraged loan market, syndicates hold
the revolving piece of the origination,
which is a line of credit that allows the
borrower to drawdown additional
capital from the arranger. Hence, the
revolving piece of a leveraged loan
represents a potential future liability to
the lead arranger that could ultimately
increase the amount of risk retained.
The agencies did not create an option
for treating this future liability as
retained risk. In this way, the final rule
may result in the lead arranger holding
more exposure to the borrower of the
leveraged loan than what would be
required to satisfy the risk retention
enough to allow hundreds of non-investment-grade
companies to refinance their debt.’’
455 See Bloomberg Business Week, January 1,
2014, available at http://www.businessweek.com/
news/2014-01-31/leveraged-loan-trades-in-u-dot-sdot-rise-to-most-since-07-lsta-says.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
requirement. Therefore, allowing the
lead arranger to hold risk retention in
place of the CLO manager should not
diminish, and may increase, the
alignment of incentives between loan
arrangers and ultimate investors in the
CLO, by providing strong incentives for
the loan arranger to create loans with
high underwriting standards.
The impact of the lead arranger option
on the leveraged loan market will be
determined by the likelihood that lead
arrangers are willing to retain risk in the
manner required and CLO managers are
willing to rely on this commitment. As
commenters stated, there are frictions in
the market that may prevent CLO
managers from purchasing CLO-eligible
loans or originators from creating CLOeligible tranches. CLO managers may
not be able to ensure that the bank will
meet the CLO-eligible tranche
requirements for the length of the loan.
In addition, the special voting rights
attached to the CLO-eligible tranche
may prevent other parties from wanting
to create a CLO-eligible tranche.
Large commercial banks are the
primary source for leveraged loan
origination and may be reluctant to
retain ongoing exposure to leveraged
loans because the loans are typically
longer term and riskier than the other
assets banks usually hold on their
balance sheet. As such, they may not be
willing to serve as a lead arranger for the
purpose of creating a CLO-eligible
tranche. Should these banks choose to
create CLO-eligible tranches to facilitate
additional demand for their
originations, it is possible that they
would charge borrowers higher rates to
compensate for the additional capital
charge they could incur under existing
regulatory requirements, or because it
would impede a redeployment of capital
for other projects.
CLO managers that use the lead
arranger option will be relying on lead
arranger commitments to hold 5 percent
of the CLO-eligible tranche for the
duration of the loan. A CLO manager
relying on the lead arranger option
would need to sell any tranches that
cease to be CLO-eligible tranches due to
the failure of a loan arranger to hold the
required amount of risk, which could
generate an otherwise unnecessary loss
if the forced sale provides a buyer with
leverage to negotiate a discount.
However, a CLO manager should have
some level of confidence in a lead
arranger’s ongoing commitment to meet
the requirement because there will be
recourse against the lead arranger for
breach of contract, as the lead arranger
will warrant in the transaction
documents to hold 5 percent of the
CLO-eligible tranche for the duration of

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the loan. Any costs the CLO manager
incurs from the forced sale of the loan
could be part of their claim against the
loan arranger for breach of contract.
Moreover, failure of a lead arranger to
keep this commitment could harm their
reputation with respect to continued
participation in the leveraged loan
market because potential CLO managers
would be less willing to engage in their
transactions, leaving the lead arranger
unable to sell or face higher costs in
selling CLO-eligible loan tranches or
any other loans, in the future.
To accommodate potential demand
for CLO-eligible tranches and the
concomitant costs of the ongoing credit
exposure from the risk retention
requirement, lead arrangers may be
willing to charge higher rates to
borrowers and, as a result, continue
generating revenue from underwriting,
warehousing, and selling leveraged
loans. There is strong incentive for loan
arrangers to do so given that CLO
purchases of leveraged loans currently
represent about half of the total
investment in the leveraged loan
market.456 The prospect of CLO
managers declining to purchase non
CLO-eligible loan tranches should
encourage lead arrangers to hold enough
exposure to create CLO-eligible tranches
in order to meet current investor
demand. Hence, the Commission
believes that CLO managers have
significant influence over, and lead
arrangers will have increased incentive
to facilitate, the use of the lead arranger
option and the creation of CLO-eligible
tranches. Moreover, if non-CLO
investors perceive loans with CLOeligible tranches as higher quality loans,
this may create additional demand for
CLO-eligible tranches that would lead to
higher prices and lower interest rates for
such loans.
The Commission acknowledges the
concerns about the workability of the
option expressed in the comment letters
and, as described above, has considered
the attendant costs, but continues to
believe that adopting the lead arranger
option in the final rule will provide
CLOs with additional meaningful
456 See commentaries by Wells Capital
Management, ‘‘Global Opportunities in Bank
Loans’’, February 2014, available at http://
www.wellscap.com/docs/expert_commentary/
global_bank_loans_0214.pdf and by Loomis, Sayles
& Company, L.P. Investment, ‘‘The Myth of
Overcrowding in the Bank Loan Market’’, May
2014, available at http://www.loomissayles.com/
internet/internetdata.nsf/0/
CA96B70BA0BE8BB585257CD8004F1A03/$FILE/
The-Myth-of-Overcrowding-in-the-Bank-LoanMarket.pdf for the leveraged loan investor base
breakdown. Statistics from both of these sources are
based on data from Standard & Poor’s Capital IQ
Leveraged Commentary & Data.

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flexibility in satisfying the risk retention
requirements.
If the lead arranger option is not used,
then CLO managers will have to satisfy
the risk retention requirement using one
of the standard options. In this case, the
Commission recognizes that the final
rule may have differing impacts on CLO
managers, which could have a negative
effect on competition. The amount of
capital available to managers can vary
with the size and affiliations of the
manager. In particular, the availability
and cost of capital for managers with a
relatively smaller amount of capital
available to finance required risk
retention may be less favorable than for
managers with access to larger balance
sheets or sources of capital. This could
result in different funding costs between
smaller and larger managers and could
impact competition by creating an
advantage for managers with lower
funding costs, particularly larger
financial institutions and banks.
If smaller CLO managers do not have
sufficient available capital to hold 5
percent risk retention, then they will be
unable to sponsor CLO transactions
unless they are able to get funding from
another source. A reduction in CLO
managers may reduce the number of
CLOs, which may lead to a decrease in
capital formation, a decrease in price
efficiency for leveraged loans, and a
decrease in competition for leveraged
loans. If this impairs the supply of
capital to borrowers using leveraged
loans, such borrowers could expect to
pay higher rates or have less access to
financing. This potential impact on
capital formation is ameliorated to the
extent that larger CLO managers—or
other potential investors—are able to
replace smaller CLO managers as buyers
of leveraged loans. Such an outcome
would benefit these other investors at
the expense of smaller CLO managers.
A number of commenters asserted
that the final rule would force many
smaller CLO managers to exit the CLO
market. Because the Commission did
not have data with respect to the cost of
funds for each CLO manager or each
CLO manager’s desired return on
capital, the Commission was unable to
directly analyze the potential cost of the
additional capital necessary to satisfy
the risk retention requirements or the
relative portion of the current CLO
market managed by those smaller CLO
managers that would no longer sponsor
CLOs as a result of the increased costs.
In order to estimate the potential impact
of the exit of smaller CLO managers
from the market, the Commission
identified and categorized 111 CLO
managers known to have participated in
the CLO market between 2009 and 2013

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using categorizations that serve as a
proxy for the CLO managers’ access to
capital, whether internal or external,
and thus their potential capital capacity
and ability to satisfy the risk retention
requirements.457 The first category
included CLO managers that are not
subject to the periodic reporting
requirements of the Exchange Act and
do not appear to be subsidiaries of or
affiliated with other financial
institutions (banks, insurance
companies, diversified asset managers
that managed investment vehicles other
than CLOs, etc.), which the Commission
believes is the set of CLO managers that
may face the greatest burden in
obtaining capital to finance and retain
the 5 percent required risk retention.
These CLO managers were responsible
for 39 percent of the CLO market
issuances between 2009 and 2013, 37
percent by dollar volume, and
represented 48 percent of all CLO
managers analyzed.
The second category included CLO
managers who fall into at least one of
the following categories (A) subject to
the periodic reporting requirements of
the Exchange Act,458 or (B) also the
sponsor of asset-backed securities other
than CLOs, or (C) a bank or insurance
company, or (D) affiliated with, or
otherwise related to an entity described
in (A), (B) or (C). These CLO managers
were responsible for 61 percent of CLO
issuances between 2009 and 2013 by
number or 63 percent of CLO issuance
by dollar volume, and represented 52
percent of the population of CLO
managers analyzed. The Commission
believes that the second category of CLO
managers, given their affiliations,
diversified business lines and
demonstrated ability to raise capital in
public capital markets, would have
greater access to capital, whether
internal or external, and would face
fewer obstacles and lower funding costs
to obtain the capital necessary to satisfy
the risk retention requirements.
457 CLO market issuance data and the list of CLO
managers that were analyzed are from the AssetBacked Alert database. The Commission categorized
CLO sponsors that issued CLOs in the U.S. between
January 1, 2009 and December 31, 2013. In order
to estimate the possible impact of the risk retention
requirement we examine the fraction of the CLO
market that each group comprises. A sponsor’s
category was determined by using the 2014 Fitch
Ratings CLO Asset Manager Handbook, sponsors’
Web sites and other publicly available information.
If it was not immediately apparent which category
best described a manager, a conservative approach
was taken and such manager was included in the
category of managers with limited access to capital.
458 The second category of CLO managers would
also include those CLO managers that maintain a
listing of a class of securities on an exchange in a
non-U.S. jurisdiction.

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If the risk retention requirements
cause certain CLO managers to exit the
leveraged loan market, there could be a
commensurate decrease in the supply of
capital unless other investors
compensate for their exit. From the
above analysis, the Commission believes
it would be reasonable to estimate that
the exit of the first category of CLO
managers from the CLO market could
impact current levels of capital
formation by CLOs by 37 percent, which
is considerably less than Oliver Wyman
lower bound estimate of 60 percent.459
The Commission believes that a
significantly greater impact would be
unlikely without an exit from the
market of entities with potentially easier
access to capital.
The potential impact of the loss of
certain CLO managers will depend on
whether the CLO investors would
continue to supply credit to the
leveraged loan market through
alternative channels. If some senior CLO
tranches become unavailable, then,
because of their sensitivity to credit risk,
banks and other investors whose
investment guidelines require
purchasing of very high quality loans
(e.g., triple-A rated) and who buy senior
CLO tranches may be less likely to
provide direct investment into leveraged
loan market, which offers higher risk
(e.g., single-B rated) investments on
average. In contrast, CLO investors who
seek higher returns and tend to be less
sensitive to credit risk may decide to
participate directly in the leveraged loan
market or use other intermediaries to do
so because they have an appetite for that
level of credit risk. Both categories of
investors may channel their investments
into one of multiple existing
participants in the leveraged loan
market. Mutual funds, private equity
funds, private equity mezzanine loan
funds and credit funds (entities that are
generally formed as partnerships with
third-party capital and invest in loans or
make loans or otherwise extend the type
of credit that banks are authorized to
undertake on their own balance sheet)
currently invest directly in the
leveraged loan market and may increase
their direct purchase of leveraged loans
if smaller CLO managers exit the
market. Thus, there are multiple
existing sources of capital that could
compensate for any potential exit of
some CLO managers.
Based on estimates of the CLO
investor base in the Oliver Wyman
study (Exhibit 4 of the study),
459 The Oliver Wyman estimate is based on a
sample of the top 30 CLO managers and the
assumption that managers that could feasibly hold
the 5 percent risk retention make up 25 percent of
the CLO assets under management.

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approximately 20 percent of CLO
tranches are rated ‘‘BBB’’ or lower and
are held by asset managers and other
investors such as hedge funds, pension
funds, and structured credit funds. If
certain CLO deals were no longer
available, assuming that these investors
in lower rated tranches would be able to
find an alternative channel to invest in
the leveraged loan market and the
remaining 80 percent (the risk-sensitive
investors that purchase higher quality
tranches) would not, then the overall
estimated impact of a 37 percent decline
in the supply of credit from the
potential exit of certain CLO managers
would account for an approximately
14.8 percent reduction in supply of
capital to the leveraged loan market.460
This assumes CLO sponsors comprise
approximately 50 percent of the
leveraged loan market,461 and that any
resulting increase in the underlying loan
rates would not encourage the
emergence of other capital sources.
Because risk-sensitive CLO investors
have other relatively low risk means of
investing in the leveraged loan market
(e.g., mutual funds that concentrate on
leveraged loans), the Commission
believes that the actual impact may be
lower.
vii. Qualified Tender Option Bonds
The final rule includes two options
for tender option bonds (TOBs). Both
options require 100 percent liquidity
protection and provide for a mechanism
by which the sponsors’ incentives are
aligned with the investors. In the first
option, the sponsor maintains
horizontal risk retention unless there is
a tender option termination event
(TOTE), in which case the sponsor’s
interest converts to vertical risk
retention. After a TOTE, the sponsors
will receive a distribution pari passu
with tender option bond holders. In a
termination that is triggered by an event
that is not a TOTE the sponsor will
continue to hold horizontal risk
retention and will receive the remaining
balance after the distribution is paid to
the bond holders. The second option,
which is very similar to a representative
sample option, allows the sponsor to
sell the entire TOB but requires the
sponsor to hold municipal securities
from the same issuance with a face
460 14.8 percent is the product of the CLO market
share of the leveraged loan market, 50 percent, the
CLO managers market share of those CLO managers
that the Commission believe it would be reasonable
to assume could exit the CLO market, 37 percent,
and the fraction of risk-sensitive investors in such
CLOs that would not invest through other means,
80 percent (the percentage of risk-sensitive
investors assumed by the Oliver Wyman study).
461 See footnote 456 for references.

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Federal Register / Vol. 79, No. 247 / Wednesday, December 24, 2014 / Rules and Regulations
value of 5 percent of the deposited
municipal security.
Commenters suggested providing a
full exemption for TOBs, not counting
TOBs as a securitization, or allowing
third-party risk retention. Commenters
also requested an exemption or
recognition of unfunded risk retention
in the form of liquidity support. They
also commented on the cost to the TOB
market, however, no commenter
provided data to allow us to calculate
potential costs from requiring risk
retention to the TOB market. Requiring
TOBs to hold risk retention imposes a
cost on sponsors who were not currently
retaining exposure to credit risk in a
form permissible under the final rule.
After considering comments, the
agencies have decided to adopt the
reproposal options with some changes
to further accommodate market
practices. The agencies were not
persuaded to create a structural
exemption for TOBs, as commenters
requested, as this would exempt future
TOB structures, with unknown
incentive alignment, from risk retention.
Under the final rule, the agencies are
accommodating the bulk of those
structures currently issuing in the
market.
By accommodating current market
practice, these options help reduce the
cost of retaining risk but still effectively
align the incentives between sponsors
and investors. The first option, by
accommodating TOB tax requirements,
allows TOBs to hold horizontal risk
retention. In the absence of this
accommodation, any TOB that tried to
retain risk using the standard horizontal
form would be in violation of the IRS
tax code, invalidating the tax exemption
of the TOB structure. By allowing TOB
sponsors to hold horizontal risk
retention while maintaining their tax
exemption the first option provides
additional flexibility for TOB sponsors
to retain risk in a manner that better
suits their specific needs, thereby
reducing compliance costs. At the same
time, investor-sponsor incentive
alignment is maintained because
sponsors have horizontal risk retention
for the duration of the TOB unless a
TOTE occurs at which time the TOB is
terminated and the sponsor shares any
losses with the investors in a pro-rata
manner.
The agencies believe that the second
option described above is appropriate in
this specific context (as opposed to
other ABS markets where the agencies
do not adopt a representative sample
option) because most TOBs are made up
of one municipal bond, which is the
same bond held by the sponsor. Thus,
there are no characteristics of

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underlying assets that might make the
representative sample different from the
underlying assets, thereby skewing
incentives between the sponsor and
investor different. Consequently, the
second option does not pose the same
complexities and costs that make the
representative sample option not
feasible in other contexts. As with the
first option, permitting this additional
flexibility will help to reduce costs for
TOB sponsors without jeopardizing
investors’ interests. In addition, the
alignment of incentives may encourage
investors to invest in the TOB market,
which may increase capital formation. If
there are more investors, liquidity will
also increase, which may lead to
increased price efficiency and reduce
the cost of capital within the TOB
market.
As mentioned above, existing TOB
transactions typically have a 100
percent liquidity guarantee, which the
sponsor (or an affiliate) may be
providing. Thus requiring the sponsor to
retain 5 percent of the risk despite this
liquidity guarantee will impose
additional costs but helps to ensure that
the sponsor is selecting high-quality
municipal bonds and not selling off
their risk to a third party. The
Commission also acknowledges that
because these options are based on
current TOB structures it may be too
costly for new structures to be created.
This may impact competition by
creating a barrier to entry for future
novel types of TOB structures.
viii. Alternatives
In developing the forms of
permissible risk retention to be included
the final rule, the agencies considered a
number of alternative approaches. Some
of the alternatives were suggested by
commenters and considered by the
agencies following the previous rule
proposals.
In response to the reproposal, for
instance, several commenters requested
that the final rule recognize other forms
of, or substitutes for, risk retention such
as: third party credit support, including
insurance policies, guarantees, liquidity
facilities, and standby letters of credit;
5 percent participation interest in each
securitized asset; representations and
warranties; ‘‘contractual’’ risk retention;
private mortgage insurance;
overcollateralization; subordination;
and conditional cash flows. One
commenter requested that the final rule,
at a minimum, should permit such
forms of unfunded risk retention for a
sub-set of sponsors, such as regulated
banks. Another commenter asserted that
the final rule should provide more
flexibility by allowing sponsors to

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satisfy their risk retention requirement
through a combination of various means
and that the rule should not mandate
forms of risk retention for specific types
of asset classes or specific types of
transactions.
The agencies have generally declined
to recognize unfunded forms of risk
retention for the purposes of the final
rule, except in the case of the
Enterprises under the conditions
specified for their guarantees. The
Commission acknowledges that
recognizing unfunded forms of risk
retention could help to reduce the costs
of compliance, since many of thes