Commission Guidance Regarding Definitions of Mortgage Related Security and Small Business Related Security
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Interpretation; solicitation of comment.
CFR Part: "17 CFR Part 241"
Citation: "77 FR 42980"
Document Number: "Release No. 34-67448; File No. S7-06-12"
"Rules and Regulations"
SUMMARY:
EFFECTIVE DATE: Effective Date:
Comments: Comments should be received on or before
FOR FURTHER INFORMATION CONTACT:
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
* Use the Commission's Internet comment form (http://www.sec.gov/rules/interp.shtml); or
* Send an email to [email protected]. Please include File Number S7-06-12 on the subject line; or
* Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
* Send paper comments in triplicate to
All submissions should refer to File Number S7-06-12. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/interp.shtml). Comments also are available for Web site viewing and printing in the
SUPPLEMENTARY INFORMATION: Section 3(a)(41) of the Exchange Act defines the term "mortgage related security" as, among other things, a security that is rated in one of the two highest rating categories by at least one NRSRO. /1/ Section 3(a)(53)(A) of the Exchange Act defines the term "small business related security" as, among other things, a security that is rated in one of the four highest rating categories by at least one NRSRO. /2/ A "rating category" refers to a distinct level in an NRSRO's rating scale represented by a unique symbol, number, or score. For example, a rating scale consisting of AAA, AA, A, BBB, BB, B, CCC,
FOOTNOTE 1 See 15 U.S.C. 78c(a)(41). END FOOTNOTE
FOOTNOTE 2 See 15 U.S.C. 78c(a)(53)(A). END FOOTNOTE
Section 939(e) of the Dodd-Frank Act strikes the text in sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act that reference NRSRO credit ratings and in its place inserts text providing that a "mortgage related security" and a "small business related security" means a security that "meets standards of creditworthiness as established by the Commission." /3/ The effective date of these amendments to the Exchange Act is
FOOTNOTE 3 See Public Law 111-203
FOOTNOTE 4 See Public Law 111-203
The Commission previously discussed and requested comment on section 939(e) of the Dodd-Frank Act and potential standards of creditworthiness that could be used for purposes of the terms "mortgage related security" and "small business related security." /5/ The Commission is continuing to work on rule proposals to establish standards of creditworthiness to implement section 939(e) of the Dodd-Frank Act. However, as explained below, these definitions are referenced in numerous statutes and regulations--the majority of which are not Commission authorizing statutes or regulations administered by the Commission. Consequently, the new standards of creditworthiness established by the Commission under section 939(e) of the Dodd-Frank Act will impact different types of persons and transactions, including persons and transactions for which the Commission does not have oversight authority. This impact adds a layer of complexity to the process of developing and establishing a standard or standards of creditworthiness for each definition. The considerations involved in undertaking this difficult task include seeking to accommodate, to the extent practicable, the varied uses of the definitions of "mortgage related security" and "small business related security" in statutes and regulations without lowering protections for investors, disrupting the markets for these securities, increasing risk to financial institutions, or imposing undue burdens and costs to market participants.
FOOTNOTE 5 See Removal of Certain References to Credit Ratings under the Securities Exchange Act of 1934, Exchange Act Release No. 64352 (
Furthermore, as explained below, the Commission and other Federal agencies are continuing their efforts to remove references to credit ratings in regulations they administer as mandated by section 939A of the Dodd-Frank Act. /6/ In the case of some proposed amendments under section 939A, commenters--as explained below--have raised concerns that replacing the benchmark of credit ratings with another standard could, among other things, be harmful to investors, increase risk to financial institutions, distort financial markets, and increase burdens and costs.
FOOTNOTE 6 See Public Law 111-203
For these reasons, the Commission needs additional time to analyze and understand the potential impact that could result from the establishment of new standards of creditworthiness in the definitions of the terms "mortgage related security" and "small business related security." At the same time, under section 939(e) of the Dodd-Frank Act, the use of NRSRO credit ratings in sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act will be stricken from the statutory text on
Therefore, until new standards of creditworthiness are established by final rules, the Commission is providing a transitional interpretation that will be applicable beginning on
* The standard of creditworthiness for purposes of the definition of the term "mortgage related security" in section 3(a)(41) of the Exchange Act is a security that is rated in one of the two highest rating categories by at least one NRSRO; and
* The standard of creditworthiness for purposes of the definition of the term "small business related security" in section 3(a)(53)(A) of the Exchange Act is a security that is rated in one of the four highest rating categories by at least one NRSRO.
The Commission is not interpreting any other provisions of sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act herein.
II. Background
A. Use of the Definitions of
1. Mortgage Related Security
FOOTNOTE 7 Public Law 98-440,
FOOTNOTE 8 Most mortgage-backed securities are issued or guaranteed by the
FOOTNOTE 9 The legislation was aimed at encouraging participation in the secondary mortgage market by investment banks, investment entities, mortgage bankers, private mortgage insurance companies, pension funds and other investors, depositary institutions, and federal credit unions.
FOOTNOTE 10 See 15 U.S.C. 77r-1. END FOOTNOTE
FOOTNOTE 11 See 12 U.S.C. 1464(c)(1), 12 U.S.C. 1757, and 12 U.S.C. 24. END FOOTNOTE
FOOTNOTE 12 See 15 U.S.C. 77d. For further discussion of SMMEA, see also
FOOTNOTE 13 See Pittman, p. 514. END FOOTNOTE
Currently, section 3(a)(41) of the Exchange Act defines the term "mortgage related security" as a "security that is rated in one of the two highest rating categories by at least one [NRSRO]" and that: (1) Represents ownership of one or more promissory notes, or interests therein, which notes are directly secured by a first lien on a single parcel of real estate upon which is located a dwelling or mixed residential and commercial structure, or on a residential manufactured home or one or more parcels of real estate upon which is located one or more commercial structures and were originated by a savings or banking institution or other similar institution approved for insurance by the Secretary of the
FOOTNOTE 14 See 15 U.S.C. 78c(a)(41). END FOOTNOTE
Table 1 identifies examples of Federal statutes and regulations that refer to the term "mortgage related security" as defined under the Exchange Act and indicates the type of entity that is subject to the statute or regulation.
Table 1 Citation Entities subject to requirement 11 U.S.C. 101(47) Participants in bankruptcy proceedings. 12 U.S.C. 24 National banking associations. 12 U.S.C. 1464 Federal savings associations. 12 U.S.C. 1757 Federal credit unions. 12 U.S.C. 1787 Federal credit unions. 12 U.S.C. 1821 Depository institutions insured by theFederal Deposit Insurance Corporation . 12 U.S.C. 4520Fannie Mae and any affiliate thereof orFreddie Mac and any affiliate thereof. 12 U.S.C. 4617Fannie Mae and any affiliate thereof orFreddie Mac and any affiliate thereof. 15 U.S.C. 77r-1 Any person, trust, corporation, partnership, association, business trust, or business entity created pursuant to or existing under the laws ofthe United States or any State. 15 U.S.C. 78g Broker-dealers. 15 U.S.C. 78k Broker-dealers. 12 CFR 1.2 National banks,District of Columbia banks, and federal branches of foreign banks, State banks that are members of theFederal Reserve System and foreign branches of national banks. 12 CFR Part 3, Appendix A National banking associations. 12 CFR Part 208, Appendix A State banks that are members of theFederal Reserve System . 12 CFR Part 225, Appendix A Bank holding companies. 12 CFR Part 325, Appendix A Depository institutions insured by theFederal Deposit Insurance Corporation . 12 CFR 567.1 Savings associations. 12 CFR 567.6 Savings associations. 12 CFR 703.2 Federal credit unions. 12 CFR 703.16(d) Federal credit unions. 12 CFR 704, Appendix C Corporate credit unions. 12 CFR Part 1750, Appendix A toFannie Mae and any affiliate thereof Subpart B andFreddie Mac and any affiliate thereof. 17 CFR 230.424 Persons filing a prospectus or prospectus supplement relating to an offering of mortgage related securities on a delayed basis. 17 CFR 240.15c3-1 Broker-dealers.
Numerous State laws also contain references to the definition of the term "mortgage related security" in section 3(a)(41) of the Exchange Act. /15/ The entities subject to these laws include insurance companies, banks, and trusts. /16/
FOOTNOTE 15 See, e.g., ALA. CODE SUBSEC 10A-10-1.10 and 11-81-21; ARIZ. REV. STAT. ANN.
FOOTNOTE 16 Id. END FOOTNOTE
2. Small Business Related Security
FOOTNOTE 17 Public Law 103-325,
FOOTNOTE 18 See Conf. Rep. on H.R. 3474, 140 Cong. Rec. H6685, H6690 (
FOOTNOTE 19 Id. See also Remarks of
Currently, section 3(a)(53)(A) defines the term "small business related security" as "a security that is rated in one of the four highest rating categories by at least one [NRSRO]" and that either: (1) Represents an interest in one or more promissory notes or leases of personal property evidencing the obligation of a small business concern and originated by an insured depository institution or other similar institution which is supervised and examined by federal or state authority or certain other regulated types of issuers; or (2) is secured by an interest in one or more promissory notes or leases of personal property (with or without recourse to the issuer or lessee) and provides for payments of principal in relation to payments, or reasonable projections of payments, on notes or leases of the type described in the preceding clause. /20/
FOOTNOTE 20 See 15 U.S.C. 78c(a)(53)(A). END FOOTNOTE
Table 2 identifies examples of Federal statutes and regulations that use the term "small business related security" and indicates the type of entity that is subject to the statute or regulation.
Table 2 Citation Entities subject to requirement 12 U.S.C. 24 National banking associations. 12 U.S.C. 1464 Federal savings associations. 12 U.S.C. 1757 Federal credit unions. 15 U.S.C. 77r-1 Any person, trust, corporation, partnership, association, business trust, or business entity created pursuant to or existing under the laws ofthe United States or any State. 15 U.S.C. 78g Broker-dealers. 15 U.S.C. 78k Broker-dealers. 12 CFR 1.2 National banks,District of Columbia banks, and federal branches of foreign banks, State banks that are members of theFederal Reserve System and foreign branches of national banks. 12 CFR 1.3 National banking associations. 12 CFR 703.2 Federal credit unions. 12 CFR 703.16 Federal credit unions. 12 CFR 704.2 Corporate credit unions. 12 CFR 704.5 Corporate credit unions.
Several State laws also contain references to the definition of the term "small business related security" in section 3(a)(53)(A) of the Exchange Act. /21/ Banks and trust companies are subject to these laws. /22/
FOOTNOTE 21 See, e.g., LA. REV. STAT. ANN.
FOOTNOTE 22 Id. END FOOTNOTE
3. Use of the Definitions by the Commission and Other Agencies
As identified in the tables set forth above, rules administered by the Commission and other Federal agencies reference the terms "mortgage related security" and "small business related security," as those terms are defined in Exchange Act Sections 3(a)(41) and 3(a)(53)(A), respectively. Since the Dodd-Frank Act was adopted, several Federal agencies have proposed to continue to rely on the Exchange Act definitions of these terms. For example, the
FOOTNOTE 23 See Alternatives to the Use of External Credit Ratings in the Regulations of the OCC, 76 FR 73526, 73529 (
FOOTNOTE 24 See Removing References to Credit Ratings in Regulations; Proposing Alternatives to the Use of Credit Ratings, 76 FR 11164, 11166 (
FOOTNOTE 25 Id. END FOOTNOTE
B. Regulatory Initiatives To Remove References to Credit Ratings
1. Introduction
The use of NRSRO credit ratings in statutes and regulations has been criticized as fostering undue reliance by investors on credit ratings. /26/ In addition, concerns have been raised that using NRSRO credit ratings in statutes and regulations impedes competition in the credit rating industry by giving NRSROs an unfair advantage over credit rating agencies that do not operate as NRSROs because entities subject to the statutes and regulations, or seeking favorable treatment under the statutes and regulations, must use NRSRO credit ratings. /27/
FOOTNOTE 26 Id.; see also H.R. Rep. No. 111-517, Joint Explanatory Statement of the
FOOTNOTE 27 See, e.g., Introduction of the Consumer Protection and Regulatory Enhancement Act, 155 Cong. Rec. E1965, E1965-67 (
The Commission has for many years studied the issue of using NRSRO credit ratings in its rules and is engaged in an extensive rulemaking initiative to remove references to NRSRO credit ratings from its rules that commenced prior to enactment of the Dodd-Frank Act. The development of alternatives to NRSRO credit ratings raises complex issues as indicated by comments received by the Commission and other Federal agencies.
2. Regulatory Initiatives
In 1975, the Commission adopted the term "nationally recognized statistical rating organization" as part of amendments to the "net capital rule" for broker-dealers (Rule 15c3-1). /28/ The Commission's initial regulatory use of the term was intended to provide a method for determining net capital charges on different grades of debt securities under Rule 15c3-1. /29/ The Commission eventually inserted references to NRSRO credit ratings in other rules under the Securities Act of 1933 (the "Securities Act"), the Exchange Act, and the Investment Company Act of 1940 (the "Investment Company Act"). /30/ In addition, credit ratings by NRSROs have been used as benchmarks in Federal and State legislation, rules administered by other Federal agencies, and foreign regulatory schemes. /31/
FOOTNOTE 28 See Adoption of Uniform Net Capital Rule and an Alternative Net Capital Requirement for Certain Brokers and Dealers, Exchange Act Release No. 11497 (
FOOTNOTE 29 See 17 CFR 240.15c3-1. END FOOTNOTE
FOOTNOTE 30 See, e.g., Report on Review of Reliance on Credit Ratings: As Required by Section 939A(c) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Commission Staff (
FOOTNOTE 31 See, e.g., Report to
Concerns about the use of NRSRO credit ratings in statutes and regulations have prompted the Commission to study whether this use should be eliminated and whether there are practical alternatives to NRSRO credit ratings that could be used as benchmarks in regulations. For example, in 1994, the Commission published a concept release soliciting comment on whether references to NRSRO credit ratings should be eliminated from its rules. /32/ Commenters generally supported the continued use of NRSRO credit ratings. /33/ As summarized by the Commission, one commenter noted that the use of NRSRO credit ratings provides an objective, simple standard. /34/ Some commenters suggested that internal models could be used for purposes of determining net capital charges under the Commission's broker-dealer net capital rule. /35/
FOOTNOTE 32 See Nationally Recognized Statistical Rating Organizations, Exchange Act Release No. 34616 (
FOOTNOTE 33 See Capital Requirements for Brokers or Dealers Under the Securities Exchange Act of 1934, Exchange Act Release No. 39457 (
FOOTNOTE 34 Id. END FOOTNOTE
FOOTNOTE 35 Id. END FOOTNOTE
In 2003, the Commission again sought comment on whether to eliminate the use of NRSRO credit ratings from Commission rules, and, if so, what alternative benchmarks could be used to meet the Commission's regulatory objectives. /36/ Commenters raised concerns about alternatives to credit ratings, highlighting the challenge of replacing credit ratings, though some commenters stated that alternatives such as internally developed credit ratings could be used. /37/
FOOTNOTE 36 See Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws, Exchange Act Release No. 47972 (
FOOTNOTE 37 The comment letters are available on the Commission's Internet Web site at the following address: http://www.sec.gov/rules/concept/s71203.shtml. See, e.g., letter dated
In
FOOTNOTE 38 See References to Ratings of Nationally Recognized Statistical Rating Organizations, Exchange Act Release No. 58070 (
FOOTNOTE 39 The comment letters are available on the Commission's Internet Web site at the following addresses: http://www.sec.gov/comments/s7-18-08/s71808.shtml (Securities Act rules); http://www.sec.gov/comments/s7-19-08/s71908.shtml (Investment Company Act rules); and http://www.sec.gov/comments/s7-17-08/s71708.shtml (Exchange Act rules). See, e.g., letter dated
FOOTNOTE 40 See References to Ratings of Nationally Recognized Statistical Rating Organizations, Exchange Act Release No. 60789 (
FOOTNOTE 41 The comment letters are available on the Commission's Internet Web site at the following address: http://www.sec.gov/comments/s7-17-08/s71708.shtml. See, e.g., letter dated
The Dodd-Frank Act--enacted in 2010--includes section 939A. /42/ This section requires Federal agencies to "review any regulation issued by such agency that requires the use of an assessment of the creditworthiness of a security or money market instrument and any references to or requirements in such regulations regarding credit ratings." /43/ Once the agency has completed that review, the statute provides that the agency "remove any reference to or requirement of reliance on credit ratings, and to substitute in such regulations such standard of creditworthiness" as the agency determines to be appropriate. /44/
FOOTNOTE 42 See Public Law 111-203
FOOTNOTE 43 See Public Law 111-203
FOOTNOTE 44 See Public Law 111-203
In response to section 939A of the Dodd-Frank Act, the Commission proposed amendments in 2011 to remove references to NRSRO credit ratings in its rules and forms under the Securities Act, the Exchange Act, and the Investment Company Act. In particular, in
FOOTNOTE 45 See Security Ratings, Securities Act Release No. 9186 (
FOOTNOTE 46 See References to Credit Ratings in Certain Investment Company Act Rules and Forms, Securities Act Release No. 9193 (
FOOTNOTE 47 See Removal of Certain References to Credit Ratings under the Securities Exchange Act of 1934, 76 FR 26550. In particular, the Commission requested public comment on proposed amendments to Exchange Act Rule 15c3-1 (17 CFR 240.15c3-1), 15c3-3 (17 CFR 240.15c3-3), 17a-4 (17 CFR 240.17a-4), 101 and 102 of Regulation M (17 CFR 242.101 and 242.102), and 10b-10 (17 CFR 240.10b-10), and one Exchange Act form--Form X-17A-5, Part IIB (17 CFR 249.617)--to remove references to credit ratings and, in certain cases, substitute alternative standards of creditworthiness. END FOOTNOTE
FOOTNOTE 48 Id. END FOOTNOTE
FOOTNOTE 49 See comment letters to the proposals available on the Commission's Internet Web site at the following addresses: (1) http://www.sec.gov/comments/s7-18-08/s71808.shtml (letters commenting on Security Ratings, 76 FR 8961); (2) http://sec.gov/comments/s7-07-11/s70711.shtml (letters commenting on References to Credit Ratings in Certain Investment Company Act Rules and Forms, 76 FR 12896); and (3) http://sec.gov/comments/s7-15-11/s71511.shtml (letters commenting on Removal of Certain References to Credit Ratings under the Securities Exchange Act of 1934, 76 FR 26550). See, e.g., letter dated
FOOTNOTE 50 See, e.g., Alternatives to the Use of External Credit Ratings in the Regulations of the OCC,
FOOTNOTE 51 See, e.g., comments submitted in response to Alternatives to the Use of External Credit Ratings in the Regulations of the OCC, 76 FR 73526, available at http://www.regulations.gov/#!searchResults;a=OCC;rpp=25;po=0;dktid=OCC-2011-0019. END FOOTNOTE
As noted above, in its
FOOTNOTE 52 See Removal of Certain References to Credit Ratings under the Securities Exchange Act of 1934, 76 FR at 26566. END FOOTNOTE
FOOTNOTE 53 Id. END FOOTNOTE
FOOTNOTE 54 See letter dated
FOOTNOTE 55 See the SIFMA Letter. END FOOTNOTE
FOOTNOTE 56 Id. END FOOTNOTE
FOOTNOTE 57 See the CFA Letter. END FOOTNOTE
FOOTNOTE 58 Id. ("With respect to objective measures that could be used to determine whether securities qualify as mortgage-related securities or small business-related securities, we suggest consideration of the following factors: Average loan-to-value for borrowers in secured borrowings; Term to maturity of the security; Regional concentrations of loans within the pools; Loan category concentration of loans within the pools, such as loans secured with either commercial or residential real estate, commercial and industrial loans, or small business credit card loans; Average debt-to-equity ratios for the loan pools supporting small business-related securities; Guarantees for bond guarantors."). END FOOTNOTE
FOOTNOTE 59 See the Better Markets Letter. END FOOTNOTE
FOOTNOTE 60 Id. END FOOTNOTE
FOOTNOTE 61 See the Barnard Letter. END FOOTNOTE
III. Solicitation of Comment
The Commission solicits comment on section 939(e) of the Dodd-Frank Act and potential standards of creditworthiness that could be used for the definition of the terms "mortgage related security" in section 3(a)(41) of the Exchange Act and "small business related security" in section 3(a)(53)(A) of the Exchange Act in order to assist the Commission in developing proposed standards of creditworthiness to replace NRSRO credit ratings. The Commission seeks comment from all interested parties, including: (1) Persons that are subject to, or rely on, Federal or State statutes and/or regulations that use these definitions; (2) Federal and State agencies that oversee persons that are subject to, or rely on, Federal or State statutes and/or regulations that use these definitions; (3) Federal and State agencies that administer regulations that use these definitions; (4) persons that participate in the markets for mortgage related securities and/or small business related securities, including issuers, underwriters, investors, and NRSROs; (5) originators of mortgages and/or small business loans that are securitized into mortgage related securities and/or small business related securities; and (6) any other interested persons, including persons that will need to rely on the standards of creditworthiness the Commission establishes to replace the use of NRSRO credit ratings.
The Commission invites commenters to provide their views and recommendations on all aspects of section 939(e) of the Dodd-Frank Act, including identifying approaches for developing new standards and creditworthiness to be used in the definitions and the benefits, costs, and competitive impacts of such approaches. To supplement the
FOOTNOTE 62 See Removal of Certain References to Credit Ratings under the Securities Exchange Act of 1934, 76 FR 26550. END FOOTNOTE
1. To help the Commission obtain relevant market information, commenters are invited to provide data and statistics on the nature of the market for "mortgage related securities" as defined in section 3(a)(41) of the Exchange Act, including the size of the market in terms of the number and aggregate principal amount of issuances per year.
3. With respect to establishing a standard of creditworthiness to be used in the definition of the term "mortgage related security," would any of the proposals or final rules by the Commission and other Federal agencies under section 939A of the Dodd-Frank Act serve as a model to develop a practical and workable new standard of creditworthiness in section 3(a)(41) of the Exchange Act? If so, identify the proposal and explain how it may accommodate the varied uses of the definition of the term "mortgage related security" in statutes and regulations as well as how it may impact protections for investors, the market for these securities, risk to the financial system, and burdens and costs to market participants. Are there other approaches that could serve as models for developing a practical and workable new standard of creditworthiness in section 3(a)(41) of the Exchange Act? If so, identify the approach and explain how it would meet the Commission's objective.
4. With respect to establishing a standard of creditworthiness to be used in the definition of "small business related security," would any of the proposals or final rules by the Commission and other Federal agencies under section 939A of the Dodd-Frank Act serve as a model to develop a practical and workable new standard of creditworthiness in section 3(a)(53)(A) of the Exchange Act? If so, identify the proposal and explain how it may accommodate the varied uses of the definition of the term "small business related security" in statutes and regulations as well as how it may impact protections for investors, the market for these securities, risk to the financial system, and burdens and costs to market participants. Are there other approaches that could serve as models for developing a practical and workable new standard of creditworthiness in section 3(a)(53)(A) of the Exchange Act? If so, identify the approach and explain how it would meet the Commission's objective.
5. Should the new standards of creditworthiness in sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act be modeled on Commission proposals under section 939A of the Dodd-Frank Act that would replace the use of NRSRO credit ratings with definitional standards? For example, as discussed above, the Commission proposed to remove references to NRSRO credit ratings in the net capital rule for purposes of determining whether lower haircuts apply to certain debt instruments. /63/ In place of credit ratings, the Commission proposed a new standard of creditworthiness; namely, that the debt instrument has only "a minimal amount of credit risk" as determined by the broker-dealer pursuant to written policies and procedures the broker-dealer establishes, maintains, and enforces to assess creditworthiness. Would such a definitional approach be a practical and workable standard of creditworthiness for sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act? In this regard, the Commission seeks comment in response to the following questions:
FOOTNOTE 63 See Removal of Certain References to Credit Ratings under the Securities Exchange Act of 1934, 76 FR at 26552-54. END FOOTNOTE
a. Would there need to be different creditworthiness definitions for the terms "mortgage related security" and "small business related security" given that the current standard in section 3(a)(41) of the Exchange Act is a security that is rated in one of the two highest rating categories by at least one NRSRO and the current standard in section 3(a)(53)(A) of the Exchange Act is a security that is rated in one of the four highest rating categories by at least one NRSRO? For example, should the standard of creditworthiness for purposes of the definition of the term "mortgage related security" require a more stringent level of creditworthiness than the standard of creditworthiness in the definition of the term "small business related security"? If so, should the Commission use the "minimal amount of credit risk" standard proposed for the net capital rule for a small business related security and a different, more stringent standard of creditworthiness for a mortgage related security?
b. Under the Commission's net capital rule proposal, the broker-dealer holding the security would be required to determine whether the security has a "minimal amount of credit risk." As noted above, the statutes and regulations using the definitions of "mortgage related security" and "small business related security" implicate a range of market participants. Consequently, who could be responsible for making the determination that a security meets the definitional creditworthiness standard used for purposes of sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act? For example, could the issuer or underwriter represent that the security meets the definitional standard? If so, should the representation be made as of a point in time (e.g., at or before issuance of the security) and/or would it need to be updated throughout the term of the debt security? Alternatively, if the investor in the security is subject to oversight and inspection by a Federal or State agency, could the investor be required to make the determination (subject to review by the agency) as to whether the security meets the definitional standard of creditworthiness in order to obtain favorable treatment under an applicable statute or regulation using the definition of "mortgage related security" or "small business related security"? Could the issuer or underwriter be required to make the representation that the security meets the definitional standard at issuance and, thereafter, the investor be responsible for determining on an on-going basis whether the security continues to meet the definitional standard? Issuers, underwriters, and investors may have incentives to determine that a security meets the definitional standard in order to get favorable treatment under statutes and regulations using the terms "mortgage related security" or "small business related security." Given this potential conflict, could a third-party be required to verify that the security meets the definitional standard? If so, what type of entity could perform the verification and who would be responsible for compensating the third-party for this work?
c. The following examples of different possible definitional standards are designed to provide context to assist commenters in responding to the questions above:
Mortgage Related Security
Example 1
For purposes of section 3(a)(41) of the Act (15 U.S.C. 78c(a)(41)), a "mortgage related security" means a security that has virtually no credit risk, including virtually no vulnerability to changes in business or economic circumstances.
Example 2
For purposes of section 3(a)(41) of the Act (15 U.S.C. 78c(a)(41)), a "mortgage related security" means a security that the issuer or underwriter of the security represents has virtually no credit risk, including virtually no vulnerability to changes in business or economic circumstances.
Example 3
For purposes of section 3(a)(41) of the Act (15 U.S.C. 78c(a)(41)), a "mortgage related security" means a security that the issuer or underwriter of the security represents at the time of issuance has virtually no credit risk, including virtually no vulnerability to changes in business or economic circumstances, and thereafter has virtually no credit risk, including virtually no vulnerability to changes in business or economic circumstances.
Example 4
For purposes of section 3(a)(41) of the Act (15 U.S.C. 78c(a)(41)), a "mortgage related security" means a security that the issuer or underwriter of the security represents has virtually no credit risk, including virtually no vulnerability to changes in business or economic circumstances. The representation of the issuer or underwriter must be verified by an independent third party that is in the business of performing credit analysis.
Small Business Related Security
Example 1
For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 78c(a)(53)), a "small business related security" means a security that has only a minimal amount of credit risk.
Example 2
For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 78c(a)(53)), a "small business related security" means a security that the issuer or underwriter of the security represents has only a minimal amount of credit risk.
Example 3
For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 78c(a)(53)), a "small business related security" means a security that the issuer or underwriter of the security represents at the time of issuance has only a minimal amount of credit risk and thereafter has only a minimal amount of credit risk.
Example 4
For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 78c(a)(53)), a "small business related security" means a security that the issuer or underwriter of the security represents has only a minimal amount of credit risk. The representation of the issuer or underwriter must be verified by an independent third party that is in the business of performing credit analysis.
d. Provide additional examples of definitions that could be used as standards of creditworthiness. For any example provided, explain why it would be a practical and workable standard for purposes of the definitions of mortgage related security and small business related security.
6. Rather than using a definitional standard, could the new standards of creditworthiness in sections 3(a)(41) and 3(a)(53)(A) of the Exchange Act be based on objective criteria? For example, could the criteria be based on structural characteristics of securities that meet the current definitions of the terms "mortgage related security" and "small business related security" such as the features, underlying asset pool quality, and the performance of the underlying assets after issuance that are typical of such securities? If so, what characteristics could be used to develop the criteria? In this regard, the Commission seeks comment in response to the following questions:
a. What are the typical features of mortgage related securities that meet the current standard of creditworthiness in section 3(a)(41) of the Exchange Act (i.e., rated in the top two rating categories by at least one NRSRO)?
b. What are the characteristics of the loans underlying mortgage related securities that meet the current standard of creditworthiness in section 3(a)(41) of the Exchange Act (i.e., rated in the top two rating categories by at least one NRSRO)? Would the characteristics of a "qualified mortgage," as that term is defined under the Truth in Lending Act section 129C(b)(2), meet the current standard of creditworthiness in section 3(a)(41)? Could the criteria for a mortgage related security be tied to that definition? Could the criteria be tied to the definition of a "qualified residential mortgage," as is used in section 15G of the Exchange Act? /64/ If so, explain how.
FOOTNOTE 64 On
c. What is typical of the level of performance of the loans underlying mortgage related securities that meet the current standard of creditworthiness in section 3(a)(41) of the Exchange Act (i.e., rated in the top two rating categories by at least one NRSRO)?
d. What are the typical features of small business related securities that meet the current standard of creditworthiness in section 3(a)(53)(A) of the Exchange Act (i.e., rated in the top four rating categories by at least one NRSRO)?
e. What are the characteristics of the loans underlying small business related securities that meet the current standard of creditworthiness in section 3(a)(53)(A) of the Exchange Act (i.e., rated in the top four rating categories by at least one NRSRO)?
f. What is typical of the level of performance of the loans underlying small business related securities that meet the current standard of creditworthiness in section 3(a)(53)(A) of the Exchange Act (i.e., rated in the top four rating categories by at least one NRSRO)?
7. Could the requirements of
FOOTNOTE 65
FOOTNOTE 66 In
IV. Conclusion
For the foregoing reasons, the Commission is providing a transitional interpretation that will be applicable on and after
List of Subjects in 17 CFR Part 241
Securities.
Amendment to the Code of Federal Regulations
For the reasons set forth above, the Commission is amending title 17, chapter II of the Code of Federal Regulations as set forth below:
PART 241--INTERPRETIVE RELEASES RELATING TO THE SECURITIES EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER
Part 241 is amended by adding Release No. 34-67448 to the list of interpretive releases as follows:
Subject Release No. Date Federal Register vol. and page Commission 34-67448 July 17, 2012 75 FR [INSERT FR Guidance Regarding PAGE NUMBER]. Definitions of Mortgage Related Security and Small Business Related Security
By the Commission.
Dated:
Secretary.
[FR Doc. 2012-17763 Filed 7-20-12;
BILLING CODE 8011-01-P
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