Among the many hurdles any return of the private-label securitized market will likely have to overcome are conflict of interest measures in Section 619 of Dodd-Frank and the Volcker Rule, which as noted in a recent American Securitization Forum seminar, are hitting some key deadlines this month and next year.
The deadline for comments for the proposed conflict of interest rule is Dec. 19, according to a presentation by law firm Orrick, Herrington, & Sutcliffe at a recent American Securitization Forum seminar on the topic.
Meanwhile, the Volcker Rule continues to be as Barclays' U.S. equity portfolio strategist Barry Knapp noted at a press conference on the outlook for 2012 last week, one of the “big unanswered questions” for Wall Street. Clarity on it and some other key issues could “go a long way to stabilize markets,” he said.
As ASF executive director Tom Deutsch noted during his group's recent meeting, the Volcker Rule in particular is “exceptionally complex.” Several press accounts indicate its namesake, former Fed chairman Paul Volcker Jr., has complained about how complicated it has gotten.
The conflict of interest proposal would create what Michael Mitchell, partner, Orrick, Herrington, & Sutcliffe, described to attendees at the ASF meeting as an “interpretative framework, if you will.” This framework determines when the rule might apply based on definitions of covered persons, covered products, timeframes, conflicts and when conflicts are material. Some aspects of these are still vague.
It looks like the proposed rule would apply to any securitization. It would cover conflicts between a securitization participant and investor, as a result of or in connection with a securitization and in connection with a securitization party engaging in a transaction. It has a two-pronged test for whether a conflict is material. The first part involves a test for whether a securitization participant benefits directly or indirectly from a short transaction or whether a securitization participant who controls the securitization benefits from creating an opportunity for a third party to benefit from a short transaction. The second part involves a test for whether there is a “substantial” likelihood that a “reasonable” investor would consider the conflict important to his or her investment decision. Three exceptions to the proposed rules involve risk-mitigating hedging activities (as opposed to ones aimed at profit), liquidity commitments and bona fide market-making activities.
The Volcker Rule also is concerned with conflicts of interests and has similar exceptions. The SEC has sought comment on the potential interplay between the two. As noted in a Chapman and Cutler LLP presentation at the ASF meeting, the Volcker Rule would prohibit banking entities from engaging in proprietary trading, acquiring and retaining an ownership interest in “covered funds” and entering into covered transactions with such funds that the banking entity sponsors or to which it provides investment advice or investment management services.
This could include securitization issuers because covered funds are defined to include all entities that use a certain section of the Investment Company Act of 1940 for relief from registration requirements under the act and this includes some securitization issuers. Loan securitization is permitted under covered fund activities, but commentary suggests credit derivatives and synthetic securitizations are not. Retention of interests in covered funds to meet risk retention requirements would be permitted.
