As was reported last week, on October 4 the SEC issued a release to implement the provisions of the Dodd-Frank Act (the Act) relating to representations and warranties. In addition to the disclosure requirements imposed on securitizers, the Act also requires each nationally recognized statistical rating organization (NRSRO) to include in any report accompanying a credit rating with respect to an Exchange Act - ABS a description of (i) the representations, warranties and enforcement mechanisms available to investors, and (ii) how they differ from the representations, warranties and enforcement mechanisms of similar securities.
A few definitional points to begin with: First, this provision applies to all Exchange Act - ABS which, as we have seen, is very broad and applies to all private as well as public ABS. Second, it "applies to any report accompanying a credit rating for an ABS transaction, regardless of when or in which context such reports and credit ratings are issued". Third, a "credit rating" includes any expected or preliminary credit rating issued by an NRSRO. This would include a pre-sale report.
The SEC believes that "the proposed disclosures will enhance the comparability of information across issuers in a relatively efficient manner by centralizing this disclosure in NRSRO reports. As a result, these disclosures will possibly expand the information available to investors and improve transparency regarding the use of representations and warranties in ABS transactions". In addition, "the required comparisons of the representations, warranties and enforcement measures in a given ABS transaction to those available in similar transactions may provide an impetus to the development of more standardized representations, warranties and enforcement mechanisms across the ABS markets, which is likely to benefit the efficiency of these markets".
The SEC admits that, while rating agencies often issue pre-sale reports that include a summary of important features of a transaction, "they do not usually provide disclosure of how representations and warranties would differ from other similar securities". It anticipates that the rating agencies will establish "benchmarks" for various types of securities although it is "not prescribing how an NRSRO must fulfill its responsibility to compare the terms of a deal to those of similar securities".
It is not surprising that the SEC makes no such prescriptions. It seems that this release raises more questions than it answers. For instance, what is a similar security? An ABS backed by assets of the same asset class? How material must differences be before they are disclosed? In the same release it explicitly excluded a materiality threshold that it had previously proposed for the reason that the Act included no such standard. Similarly, why is there no discussion of the implications for off-shore sales of Exchange Act – ABS as in the other part of the release? Is there likely to be any spill-over in purely Canadian domestic transactions?
The task facing the NRSROs in light of these and other as yet not contemplated questions is a rather daunting one. In order to prevent it from becoming overwhelming, it seems almost inevitable that they will bring tremendous pressure upon issuers to conform representations, warranties and enforcement mechanisms to some uniform standard. Issuers of course have negotiated and settled the forms of these provisions individually to suit their own priorities, circumstances and positions and will be loathe to deviate from them. The transition to uniform provisions promises to be a gruelling process.
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