The United States Securities and Exchange Commission (the “SEC”) adopted revisions to Regulation AB on August 27, 2014, after a four year process of proposals and review. Regulation AB is the rule that governs the offering disclosure and periodic reporting obligations of issuers of asset-backed securities (“ABS”).
Insofar as covered bonds are concerned, several things are clear. First, covered bonds are not included in the definition of “asset-backed security.” Item 1101 of Regulation AB provides that:
Asset-backed security means a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases.
It is clear that covered bonds are not “primarily serviced by the cash flows of a discrete pool of receivables or other financial assets.” Instead, covered bonds are senior obligations of the issuing financial institution and are expected to be repaid from the general funds of the institution. Accordingly, covered bonds should not be asset-backed securities and Regulation AB should not apply generally to covered bonds.
Second, although the Commission had proposed extending the disclosure requirements of Form SF-1 and Regulation AB to privately placed ABS, the Commission did not adopt the proposed change. The Commission stated, however, that the proposal remained outstanding.
Thus, for most issuers of covered bonds, Regulation AB II will not be applicable. Most covered bonds issued in the U.S. are issued under Rule 144A as private placements, to which Regulation AB does not currently apply. Moreover, even if the SEC were to extend Regulation AB to private placements, since covered bonds are not asset-backed securities, Regulation AB would still not apply to Rule 144A offerings of covered bonds.
For the Canadian issuers with SEC registered covered bond programs, however, there still remains the question of whether they will be required to make loan-level disclosure for the mortgage loans in their cover pools in accordance with the requirements of Regulation AB. Each of the Canadian issuers requested a no-action letter from the SEC staff to enable it to register its covered bond program. (See, e.g., the RBC no-action letter.) Each issuer stated in its letter that it would provide offering disclosure and periodic reporting in connection with its covered bond offerings consistent with the requirements of Items 1111 and 1121 of Regulation AB. These two provisions of Regulation AB have now been revised by the SEC’s amendment of Regulation AB to require disclosure of 270 data fields for each residential mortgage loan. Whether the SEC staff will extend the new loan-level disclosure requirements of revised Items 1111 and 1121 to these Canadian covered bond issuers is a question.
If the SEC decides to require the Canadian banks to disclose loan-level information for each residential mortgage loan in their cover pools in accordance with Items 1111 and 1121 of Regulation AB, this could prove troublesome. These provisions require the disclosure of information that raised concerns under U.S. consumer privacy laws. In the end, the SEC needed to obtain a letter from the Consumer Finance Protection Bureau stating that the disclosure of information as required by the SEC under Regulation AB would not result in a violation of consumer financial privacy laws. However, this protection for issuers is only protection from violation of U.S. laws. Non-U.S. issuers do not benefit from this protection if they disclose information about consumers in the issuers' home jurisdictions.
Additionally, because residential mortgage loan products are different in Canada, many of the requested fields are simply inapplicable. And the extensive disclosure required under the SEC's template would require the collection of information that Canadian banks do not currently collect in their residential mortgage business and retain in their computer systems. Modifying existing computer systems and business processes to collect and retain this information could be expensive and disruptive.
The bottom line may be that compliance with Regulation AB by foreign financial institutions is impractical. This would mean that the registered ABS market in the U.S. would be reserved for securitization of U.S. assets only.