On 27 March 2023 both SIFMA and AFME submitted letters of comment to the US Securities and Exchange Commission (the SEC) responding to the SEC’s Release No. 33-11151 proposing new Rule 192 (Rule 192), seeking to implement a prohibition as required by Section 27B of the Securities Act of 1933 (as inserted in that Act by Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act). The SIFMA letter contains the bulk of the substantive comments and runs to 76 pages. The AFME letter is considerably shorter at 16 pages, but it does raise some issues of significant concern for UK and EU securitisation participants.
SEC Release No. 33-11151 (the text of Rule 192 can be found on pages 182 to 189 of that document) can be found here. The SIFMA letter can be found here and the AFME letter can be found here. The terms “securitization participant”, “affiliate”, “sponsor”, “initial purchaser”, “conflicted transaction” and “material conflict of interest” are all defined in Rule 192 (and those definitions are discussed in the SIFMA and AFME letters).
This note does not aim to set out a complete analysis of all aspects of Rule 192. Rather, we would like to bring to our readers’ attention certain aspects of Rule 192 that might, if it is not modified prior to being adopted, cause significant effects on the UK and EU securitisation markets.
Rule 192 contains no provisions that limit its effect to US territory. A purely UK or EU deal (i.e. one where all parties to the transaction and all investors in the transaction were based in the UK, the EU or otherwise outside the US) would have little reason to be concerned about Rule 192 or its impact. However, if such transaction involved or ended up with a US investor, it would be caught by the operation of Rule 192. Rule 192 could therefore apply even in respect of Regulation S only issuances as such issuances could end up with US investors once the relevant distribution compliance period had elapsed. Similarly, Rule 192 applies to privately placed securitisations as well as public ones (see the definition of initial purchaser).
Further, it is not only the relevant securitisation participants that are caught by the prohibitions contained in Rule 192. Any affiliate of such securitisation participant will also be caught by Rule 192 and obliged to comply with the prohibitions set out in the rule. This is the case whether or not the relevant affiliate has any knowledge of the securitisation (including where it is prohibited from having such knowledge due to the operation of information barriers). In addition to Rule 192 potentially capturing a non-US affiliate of a US securitisation participant, it could also catch non-US affiliates of non-US securitisation participants where one or more US persons becomes an investor in a securitisation executed by such non-US securitisation participants.
It should also be noted that there is a significant difference between the US and UK/EU definitions of securitisation. Accordingly, transactions which are not regarded as securitisations for UK/EU regulatory purposes (such as repackagings) may well amount to securitisations for US purposes and thus be subject to Rule 192. There is also concern that the expanded definition of sponsor in Rule 192 might lead to parties that would not typically regard themselves as sponsors of securitisations being deemed to be sponsors (and thus subject to Rule 192).
There are also concerns that Rule 192 is insufficiently clear that only dealings external to the relevant securitisation (i.e. sales and purchases of the bonds issued or to be issued under it or unrelated hedgings of the asset portfolio backing it) are caught by Rule 192. AFME’s letter reveals a concern that synthetic SRT transactions (noting that many investors in SRT transactions are based in the US) could also be caught within Rule 192 by virtue of actions taken in relation to the execution of a synthetic SRT transaction. If this were the case, then UK and EU banks may find it difficult to continue to carry out such transactions and this would significantly reduce their options for capital adequacy management (particularly in relation to SME financing exposures).
There are concerns that the third limb of the definition of conflicted transactions is overly wide and ambiguous and may capture a range of legitimate risk hedging transactions. UK and EU market participants are concerned that this in turn may limit their ability to manage risk in respect of their balance sheets.
Finally, the AFME comment letter raises some technical issues regarding the drafting of Rule 192. In particular, that the materiality threshold is set by reference to a disclosure standard, but disclosure is not permitted as a means of curing conflicts. Similarly, given the nature of Rule 192 and its basic principle being the avoidance of the creation of conflicts of interest, AFME noted that it is odd that information barriers are not seen as a potential cure or mitigant to conflicted transactions (given that a party that is not aware that it has a conflict of interest will not be in a position to deliberately take advantage of such conflict). It was noted that such barriers are seen as sufficient to cure or mitigate conflicts of interest risks in a number of other regulatory contexts. AFME also noted that the exceptions to prohibited activities in Rule 192 are narrower than those in the version of the equivalent rule proposed in 2011.
Securitisation participants in the UK and EU should be aware of Rule 192 and its potential, if introduced without amendment, to have a significant impact on their securitisation and repackaging businesses. In this regard, we would note that the previous iteration of the equivalent rule proposed in 2011 never ultimately came into force. By the same token, the proposing of Rule 192 indicates that the SEC has not lost sight of its intention to enact a rule under Section 27B of the Securities Act of 1933. It is to be hoped that the comments of SIFMA and AFME are taken into account and reflected in any revised rule, particularly with respect to territorial effect. However, securitisation participants outside the US should be cognisant of the requirements of Rule 192 (in whatever form it finally comes into force) and of the need to adapt their businesses as required to comply with the same.