SEC Proposals on ABS: Representations and Warranties, Part I

Author:Mr Michael Rumball
Profession:Stikeman Elliott LLP

The SEC has indentified, as a significant contributing factor to the RMBS collapse, the paucity of adequate information which would have allowed investors to make informed investment decisions and the resulting overreliance upon ratings. In a previous piece, we touched upon the SEC's proposal to require significant asset level disclosure in shelf offerings. Today we will consider a further proposal which the SEC believes to be "an appropriate partial substitute for the investment grade ratings requirement."

In the aftermath of the RMBS collapse, disgruntled investors attempted to probe the degree to which securitizers may have failed to comply with their representations and warranties relating to the assets in the pool and, more specifically, compliance with underwriting policies. The investors suspected that there must have been widespread breaches of the representations and warranties but in some cases they were frustrated by what they perceived to be the stonewalling of those parties who were the only available source of the information.

In order to enhance the protective nature of the representations and warranties, the SEC has proposed to require the deal documentation to contain a requirement for the representing and warranting party to furnish, on a quarterly basis, a non-affiliated third party's opinion relating to any asset in respect of which the securitization vehicle's trustee has asserted a breach of any representation and warranty and which was not repurchased or replaced as a result of such assertion.

The SEC has indicated that this requirement is "designed to help ensure that representations and warranties about the assets provide meaningful protection to investors, which should encourage sponsors to include higher quality assets in the asset pool".

It seems to me that there are several problems with this proposal. First, it only requires delivery of the opinion after a refused assertion of a breach. This does not address the lack of transparency at the heart of the problem since the trustee may not have sufficient knowledge at the asset level to assert a breach.

Second, it is not clear that any qualified third party could be found to give such an opinion. It would need not only to make a technical assessment that the representation and warranty has been breached, but, in most cases, also the less objective determination of whether the breach is material and adverse. Given the factual and subjective elements involved, these...

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