capital support from the United States would satisfy the risk retention
requirements of section 15G of the Exchange Act with respect to the
mortgage-backed securities issued by the Enterprises. Similarly, an
equivalent guarantee provided by a limited-life regulated entity that
has succeeded to the charter of an Enterprise, and that is operating
under the authority and oversight of FHFA under section 1367(i) of the
Federal Housing Enterprises Financial Safety and Soundness Act of 1992,
would satisfy the risk retention requirements, provided that the entity
is operating with capital support from the United States. The original
proposal also provided that the hedging and finance provisions would
not apply to an Enterprise while operating under conservatorship or
receivership with capital support from the United States, or to a
limited-life regulated entity that

has succeeded to the charter of an Enterprise and is operating under
the authority and oversight of FHFA with capital support from the
United States. Under the original proposal, a sponsor (that is, the
Enterprises) utilizing this option would have been required to provide
to investors, in written form under the caption ``Credit Risk
Retention'' and, upon request, to FHFA and the Commission, a
description of the manner in which it met the credit risk retention
requirements.
    As the agencies explained in the original proposal, if either an
Enterprise or a successor limited-life regulated entity began to
operate other than as described, the Enterprise or successor entity
would no longer be able to avail itself of the credit risk retention
option provided to the Enterprises and would have become subject to the
related requirements and prohibitions set forth elsewhere in the
proposal.
    In the original proposal, the agencies explained what factors they
took into account regarding the treatment of the Enterprises while they
were in conservatorship or receivership with capital support from the
United States.\75\ First, the agencies observed that because the
Enterprise fully guaranteed the timely payment of principal and
interest on the mortgage-backed securities they issued, the Enterprises
were exposed to the entire credit risk of the mortgages that
collateralize those securities. The agencies also highlighted that the
Enterprises had been operating under the conservatorship of FHFA since
September 6, 2008, and that as conservator, FHFA had assumed all powers
formerly held by each Enterprise's officers, directors, and
shareholders and was directing its efforts as conservator toward
minimizing losses, limiting risk exposure, and ensuring that the
Enterprises priced their services to adequately address their costs and
risk. Finally, the agencies described how each Enterprise, concurrent
with being placed in conservatorship, entered into a Senior Preferred
Stock Purchase Agreement (PSPA) with the United States Department of
the Treasury (Treasury) and that the PSPAs provided capital support to
the relevant Enterprise if the Enterprise's liabilities had exceeded
its assets under GAAP.\76\
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    \75\ See Original Proposal, 76 FR at 24111-24112.
    \76\ Under each PSPA as amended, Treasury purchased senior
preferred stock of each Enterprise. In exchange for this cash
contribution, the liquidation preference of the senior preferred
stock that Treasury purchased from the Enterprise under the
respective PSPA increases in an equivalent amount. The senior
preferred stock of each Enterprise purchased by Treasury is senior
to all other preferred stock, common stock or other capital stock
issued by the Enterprise.
    Treasury's commitment to each Enterprise is the greater of: (1)
$200 billion; or (2) $200 billion plus the cumulative amount of the
Enterprise's net worth deficit as of the end of any calendar quarter
in 2010, 2011 and 2012, less any positive net worth as of December
31, 2012. Under amendments to each PSPA signed in August 2012, the
fixed-rate quarterly dividend that each Enterprise had been required
to pay to Treasury was replaced, beginning on January 1, 2013, with
a variable dividend based on each Enterprise's net worth, helping to
ensure the continued adequacy of the financial commitment made under
the PSPA and eliminating the need for an Enterprise to borrow
additional amounts to pay quarterly dividends to Treasury. The PSPAs
also require the Enterprises to reduce their retained mortgage
portfolios over time.
---------------------------------------------------------------------------

    The agencies received a number of comments on the original proposal
with respect to the Enterprises, including comments from banks and
other financial businesses, trade organizations, public interest and
public policy groups, members of Congress and individuals. A majority
of the commenters supported allowing the Enterprises' guarantee to be
an acceptable form of risk retention in accordance with the original
proposal.
    Many of the comments that supported the original proposal noted
that the capital support by the United States government, coupled with
the Enterprises' guarantee, equated to 100 percent risk retention by
the Enterprises. Others believed the treatment of the Enterprises in
the original proposal was important to support the mortgage market and
to ensure adequate credit in the mortgage markets, especially for low
down payment loans. One commenter representing community banks stated
that, without the provision for the Enterprises in the original
proposal, many community banks would have difficulty allocating capital
to support risk retention and, by extension, continued mortgage
activity. A few commenters specifically supported the original
proposal's exception for the Enterprises from the prohibitions on
hedging. These commenters asserted that preventing the Enterprise from
hedging would be unduly burdensome, taking into consideration the 100
percent guarantee of the Enterprises, while other sponsors would only
be required to meet a 5 percent risk retention requirement. At least
one commenter noted that applying the hedging prohibition to the
Enterprises could have negative consequences for taxpayers, given the
capital support from the United States.
    A number of the commenters said that, even though they supported
the original proposal, they believed that it could create an advantage
for the Enterprises over private lenders. These commenters recommended
that the agencies adopt a broader definition for QRM to address any
potential disadvantages for private lenders, rather than change the
risk retention option proposed for the Enterprises.\77\
---------------------------------------------------------------------------

    \77\ The comments that relate to the QRM definition are
addressed in Part VI of this Supplementary Information, which
discusses the proposed QRM definition.
---------------------------------------------------------------------------

    Those commenters that opposed the treatment of the Enterprises in
the original proposal generally believed that it would provide the
Enterprises with an unfair advantage over private capital, and asserted
that it would be inconsistent with the intent of section 15G of the
Exchange Act. Many of these commenters stated that this aspect of the
original proposal, if adopted, would prevent private capital from
returning to the mortgage markets and would otherwise make it difficult
to institute reform of the Enterprises. One commenter believed the
original proposal interfered with free market competition and placed
U.S. government proprietary interests ahead of the broader economic
interests of the American people. Other comments suggested that the
original proposal's treatment of the Enterprises could have negative
consequences for taxpayers.
b. Proposed Treatment
    The agencies have carefully considered the comments received with
respect to the original proposal's provision for the Enterprises. While
the agencies understand the issues involved with the Enterprises'
participation in the mortgage market, the agencies continue to believe
that it is appropriate, from a public policy perspective, to recognize
the guarantee of the Enterprises as fulfilling their risk retention
requirement under section 15G of the Exchange Act, while in
conservatorship or receivership with the capital support of the United
States. The authority and oversight of the FHFA over the operations of
the Enterprises or any successor limited-life regulated entity during a
conservatorship or receivership,\78\ the full guarantee provided by
these entities on the timely payment of principal and interest on the
mortgage-backed securities that they issue, and the capital support
provided

by Treasury under the PSPAs \79\ provide a reasonable basis consistent
with the goals and intent of section 15G for recognizing the Enterprise
guarantee as meeting the Enterprises' risk retention requirement.
---------------------------------------------------------------------------

    \78\ In this regard, FHFA is engaged in several initiatives to
contract the Enterprises presence in the mortgage markets, including
increasing and changing the structure of the guarantee fees charged
by the Enterprises and requiring the Enterprises to develop risk-
sharing transactions to transfer credit risk to the private sector.
See, e.g., FHFA 2012 Annual Report to Congress, at 7-11 (June 2013),
available at http://www.FHFA.gov (FHFA 2012 Report).
    \79\ By its terms, a PSPA with an Enterprise may not be
assigned, transferred, inure to the benefit of, any limited-life,
regulated entity established with respect to the Enterprise without
the prior written consistent of Treasury.
---------------------------------------------------------------------------

    Accordingly, the agencies are now proposing the same treatment for
the Enterprises as under the original proposal, without modification.
Consistent with the original proposal, if any of the conditions in the
proposed rule cease to apply, the Enterprises or any successor
organization would no longer be able to rely on its guarantee to meet
the risk retention requirement under section 15G of the Exchange Act
and would need to retain risk in accordance with one of the other
applicable sections of this risk retention proposal.
    For similar reasons, the restrictions and prohibitions on hedging
and transfers of retained interests in the proposal (like the original
proposal) would not apply to the Enterprises or any successor limited-
life regulated entities, as long as the Enterprise (or, as applicable,
successor entity) is operating consistent with the conditions set out
in the rule. In the past, the Enterprises have sometimes acquired pool
insurance to cover a percentage of losses on the mortgage loans
comprising the pool.\80\ FHFA also has made risk-sharing through a
variety of alternative mechanisms to be a major goal of its Strategic
Plan for the Enterprise Conservatorships.\81\ Because the proposed rule
would require each Enterprise, while in conservatorship or
receivership, to hold 100 percent of the credit risk on mortgage-backed
securities that it issues, the prohibition on hedging in the proposal
related to the credit risk that the retaining sponsor is required to
retain would limit the ability of the Enterprises to require such pool
insurance in the future or take other reasonable actions to limit
losses that would otherwise arise from the Enterprises' 100 percent
exposure to the credit risk of the securities that they issue. Because
the proposal would apply only so long as the relevant Enterprise
operates under the authority and control of FHFA and with capital
support from the United States, the agencies continue to believe that
the proposed treatment of the Enterprises as meeting the risk retention
requirement of section 15G of the Exchange Act should be consistent
with the maintenance of quality underwriting standards, in the public
interest, and consistent with the protection of investors.\82\
---------------------------------------------------------------------------

    \80\ Typically, insurers would pay the first losses on a pool of
loans, up to 1 or 2 percent of the aggregate unpaid principal
balance of the pool.
    \81\ See, e.g., FHFA 2012 Report at 7-11.
    \82\ See Original Proposal, 76 FR at 24112.
---------------------------------------------------------------------------

    As explained in the original proposal and noted above, the agencies
recognize both the need for, and importance of, reform of the
Enterprises, and expect to revisit and, if appropriate, modify the
proposed rule after the future of the Enterprises and of the statutory
and regulatory framework for the Enterprises becomes clearer.
7. Open Market Collateralized Loan Obligations
a. Overview of Original Proposal and Public Comment
    In the original proposal, the agencies observed that, in the
context of CLOs, the CLO manager generally acts as the sponsor by
selecting the commercial loans to be purchased by the CLO issuing
entity (the special purpose vehicle that holds the CLO's collateral
assets and issues the CLO's securities) and then manages the
securitized assets once deposited in the CLO structure.\83\
Accordingly, the original proposal required the CLO manager to satisfy
the minimum risk retention requirement for each CLO securitization
transaction that it manages. The original proposal did not include a
form of risk retention designed specifically for CLO securitizations.
Accordingly, CLO managers generally would have been required to satisfy
the minimum risk retention requirement by holding a sufficient amount
of standard risk retention in horizontal, vertical, or L-shaped form.
---------------------------------------------------------------------------

    \83\ See id. at 24098 n. 42.
---------------------------------------------------------------------------

    Many commenters, including several participants in CLOs, raised
concerns regarding the impact of the proposal on certain types of CLO
securitizations, particularly CLOs that are securitizations of
commercial loans originated and syndicated by third parties and
selected for purchase on the open market by asset managers unaffiliated
with the originators of the loans (open market CLOs). Some commenters
asserted that most asset management firms currently serving as open
market CLO managers do not have the balance sheet capacity to fund 5
percent horizontal or vertical slices of the CLO. Thus, they argued,
imposing standard risk retention requirements on these managers could
cause independent CLO managers to exit the market or be acquired by
larger firms, thereby limiting the number of participants in the market
and raising barriers to entry. According to these commenters, the
resulting erosion in market competition could increase the cost of
credit for large, non-investment grade companies represented in CLO
portfolios above the level that would be consistent with the credit
quality of these companies.
    Certain commenters also asserted that open market CLO managers are
not ``securitizers'' under section 15G of the Exchange Act. These
commenters argued that because the CLO managers themselves would never
legally own, sell, or transfer the loans that comprised the CLO's
collateral pool, but only direct which assets would be purchased by the
CLO issuing entity, they should not be ``securitizers'' as defined in
section 15G. Thus, these commenters argued that the agencies' proposal
to impose a sponsor's risk retention requirement on open market CLO
managers is contrary to the statute.\84\
---------------------------------------------------------------------------

    \84\ See Part II.A.2 of this Supplementary Information for a
discussion of the definition of ``securitizer'' under section 15G of
the Exchange Act.
---------------------------------------------------------------------------

    One commenter argued that CLO underwriters (typically investment
banks) are ``securitizers'' for risk retention purposes and agent banks
of the underlying loans are ``originators.'' This commenter noted that
the CLO underwriter typically finances the accumulation of most of the
initial loan assets until the CLO securities are issued. According to
this commenter, the CLO manager selects the loans, but the CLO
underwriter legally transfers them and takes the market value risk of
the accumulating loan portfolio should the CLO transaction fail to
close. However, other commenters argued that no party within the open
market CLO structure constitutes a ``securitizer'' under section 15G.
These commenters stated that they did not view the underwriter as a
``securitizer'' because it does not select or manage the loans
securitized in a CLO transaction or transfer them to the issuer. These
commenters requested that the agencies establish an exemption from the
risk retention requirement for certain open market CLOs.
    In addition to the above comments, a commenter proposed that
subordinated collateral management fees and incentive fees tied to the
internal rate of return received by investors in the CLO's equity
tranche be counted towards the CLO manager's risk retention
requirement, as receipt of these fees is contingent upon the
satisfactory performance of the CLO and

timely payment of interest to CLO bondholders, thereby aligning the
interest of CLO managers and investors.
b. Proposed Requirement
    The agencies have considered the concerns raised by commenters with
respect to the original proposal and CLOs. As explained in the original
proposal, the agencies believe that the CLO manager is a
``securitizer'' under section 15G of the Exchange Act because it
selects the commercial loans to be purchased by the CLO issuing entity
for inclusion in the CLO collateral pool, and then manages the
securitized assets once deposited in the CLO structure. The agencies
believe this is consistent with part (B) of the definition of
securitizer which includes ``a person who organizes and initiates an
asset-backed securities transaction by selling or transferring assets,
either directly or indirectly, including through an affiliate, to the
issuer.'' \85\ The CLO manager typically organizes and initiates the
transaction as it has control over the formation of the CLO collateral
pool, the essential aspect of the securitization transaction. It also
indirectly transfers the underlying assets to the CLO issuing entity
typically by selecting the assets and directing the CLO issuing entity
to purchase and sell those assets.
---------------------------------------------------------------------------

    \85\ See 15 U.S.C. 78o-11(a)(3)(B).
---------------------------------------------------------------------------

    The agencies believe that reading the definition of ``securitizer''
to include a typical CLO manager or other collateral asset manager that
performs such functions is consistent with the purposes of the statute
and principles of statutory interpretation. The agencies believe that
the text itself supports the interpretation that a CLO manager is a
securitizer because, as explained above, the agencies believe that the
CLO manager organizes and initiates a securitization transaction by
indirectly transferring assets to the issuing entity. However, in the
case that any ambiguity exists regarding the statutory meaning of
``transfer'' and whether or not it means a legal sale or purchase, the
agencies may look to the rest of the statute, including the context,
when interpreting its meaning. Furthermore, as stated by the Supreme
Court, ``a statute should be construed so that effect is given to all
its provisions, so that no part will be inoperative or superfluous,
void or insignificant.'' \86\
---------------------------------------------------------------------------

    \86\ See, e.g. Corley v. United States, 556 U.S. 303, 129 S.Ct
1558, 1566, 173 L.Ed.2d 443 (2009).
---------------------------------------------------------------------------

    It is clear from the statutory text and legislative history of
section 15G of the Exchange Act that Congress intended for risk
retention to be held by collateral asset managers (such as CLO or CDO
managers), who are the parties who determine the credit risk profile of
securitized assets in many types of securitization transactions and
therefore should be subject to a regulatory incentive to monitor the
quality of the assets they cause to be transferred to an issuing
entity.\87\ Additionally, the agencies believe a narrow reading could
enable market participants to evade the operation of the statute by
employing an agent to select assets to be purchased and securitized.
This could potentially render section 15G of the Exchange Act
practically inoperative for any transaction where this structuring
could be achieved, and would have an adverse impact on competition and
efficiency by permitting market participants to do indirectly what they
are prohibited from doing directly.
---------------------------------------------------------------------------

    \87\ S. Rep. No. 111-176 (April 30, 2010).
---------------------------------------------------------------------------

    The agencies also recognize that the standard forms of risk
retention in the original proposal could, if applied to open market CLO
managers, result in fewer CLO issuances and less competition in this
sector. The agencies therefore have developed a revised proposal that
is designed to allow meaningful risk retention to be held by a party
that has significant control over the underwriting of assets that are
typically securitized in CLOs, without causing significant disruption
to the CLO market. The agencies' goal in proposing this alternative
risk retention option is to avoid having the general risk retention
requirements create unnecessary barriers to potential open market CLO
managers sponsoring CLO securitizations. The agencies believe that this
alternate risk retention option could benefit commercial borrowers by
making additional credit available in the syndicated loan market.
    Under the proposal, an open market CLO would be defined as a CLO
whose assets consist of senior, secured syndicated loans acquired by
such CLO directly from sellers in open market transactions and
servicing assets, and that holds less than 50 percent of its assets by
aggregate outstanding principal amount in loans syndicated by lead
arrangers that are affiliates of the CLO or originated by originators
that are affiliates of the CLO. Accordingly, this definition would not
include CLOs (often referred to as ``balance sheet'' CLOs) where the
CLO obtains a majority of its assets from entities that control or
influence its portfolio selection. Sponsors of balance sheet CLOs,
would be subject to the standard risk retention options in the proposed
rule because the particular considerations for risk retention relevant
to an open market CLO (as discussed above) should not affect sponsors
of balance sheet CLOs in the same manner. Furthermore, as commenters on
the original proposal indicated, sponsors of balance sheet CLOs should
be able to obtain sufficient support to meet any risk retention
requirement from the affiliate that is the originator of the
securitized loans in a balance sheet CLO.
    Under the proposal, in addition to the standard options for
vertical or horizontal risk retention, an open market CLO could satisfy
the risk retention requirement if the firm serving as lead arranger for
each loan purchased by the CLO were to retain at the origination of the
syndicated loan at least 5 percent of the face amount of the term loan
tranche purchased by the CLO. The lead arranger would be required to
retain this portion of the loan tranche until the repayment, maturity,
involuntary and unscheduled acceleration, payment default, or
bankruptcy default of the loan. This requirement would apply regardless
of whether the loan tranche was purchased on the primary or secondary
market, or was held at any particular time by an open market CLO
issuing entity.
    The sponsor of an open market CLO could presumably negotiate that
the lead arranger of each loan tranche purchased for the CLO portfolio
retain a portion of the relevant loan tranche at origination. However,
the sponsors of open market CLOs have frequently arranged for the
purchase of loans in the secondary market as well as from originators.
For purchases on the secondary market, negotiation of risk retention in
connection with such purchases would likely be impractical.
Accordingly, the proposal contemplates that specific senior, secured
term loan tranches within a broader syndicated credit facility would be
designated as ``CLO-eligible'' at the time of origination if the lead
arranger committed to retain 5 percent of each such CLO-eligible
tranche, beginning on the closing date of the syndicated credit
facility.
    A CLO-eligible tranche could be identical in its terms to a tranche
not so designated, and could be sized based on anticipated demand by
open market CLOs. For the life of the facility, loans that are part of
the CLO-eligible tranche could then trade in the secondary market among
both open market CLOs and other investors. The agencies acknowledge
that this approach may result in the retention by loan originators of
risk associated with assets that are no longer held in securitizations,
but have narrowly

tailored this option to eliminate that result as much as possible.
    In order to ensure that a lead arranger retaining risk had a
meaningful level of influence on loan underwriting terms, the lead
arranger would be required to have taken an initial allocation of at
least 20 percent of the face amount of the broader syndicated credit
facility, with no other member of the syndicate assuming a larger
allocation or commitment. Additionally, a retaining lead arranger would
be required to comply with the same sales and hedging restrictions as
sponsors of other securitizations until the repayment, maturity,
involuntary and unscheduled acceleration, payment default, or
bankruptcy default of the loan tranche.
    Under the proposal, a lead arranger retaining a ``CLO-eligible''
loan tranche must be identified at the time of the syndication of the
broader credit facility, and legal documents governing the origination
of the syndicated credit facility must include covenants by the lead
arranger with respect to satisfaction of requirements described above.
    Voting rights within the broader syndicated credit facility must
also be defined in such a way that holders of the ``CLO-eligible'' loan
tranche had, at a minimum, consent rights with respect to any waivers
and amendments of the legal documents governing the underlying CLO-
eligible loan tranche that can adversely affect the fundamental terms
of that tranche. This is intended to prevent the possible erosion of
the economic terms, maturity, priority of payment, security, voting
provisions or other terms affecting the desirability of the CLO-
eligible loan tranche by subsequent modifications to loan documents.
Additionally, the pro rata provisions, voting provisions and security
associated with the CLO-eligible loan tranche could not be materially
less advantageous to the holders of that tranche than the terms of
other tranches of comparable seniority in the broader syndicated credit
facility.
    Under the proposal, the sponsor of an open market CLO could avail
itself of the option for open market CLOs only if: (1) The CLO does not
hold or acquire any assets other than CLO-eligible loan tranches
(discussed above) and servicing assets (as defined in the proposed
rule); (2) the CLO does not invest in ABS interests or credit
derivatives (other than permitted hedges of interest rate or currency
risk); and (3) all purchases of assets by the CLO issuing entity
(directly or through a warehouse facility used to accumulate the loans
prior to the issuance of the CLO's liabilities) are made in open market
transactions. The governing documents of the open market CLO would
require, at all times, that the assets of the open market CLO consist
only of CLO-eligible loan tranches and servicing assets.
    The proposed option for open market CLOs is intended to allocate
risk retention to the parties that originate the underlying loans and
that likely exert the greatest influence on how the loans are
underwritten, which is an integral component of ensuring the quality of
assets that are securitized. In developing the proposed risk retention
option for open market CLOs, the agencies have considered the factors
set forth in section 15G(d)(2) of the Exchange Act.\88\ Section 15G
permits the agencies to allow an originator (rather than a sponsor) to
retain the required amount of credit risk and to reduce the amount of
credit risk required of the sponsor by the amount retained by the
originator.\89\
---------------------------------------------------------------------------

    \88\ 15 U.S.C. 78o-11(d)(2). These factors are whether the
assets sold to the securitizer have terms, conditions, and
characteristics that reflect low credit risk; whether the form or
volume of transactions in securitization markets creates incentives
for imprudent origination of the type of loan or asset to be sold to
the securitizer; and the potential impact of risk retention
obligations on the access of consumers and business to credit on
reasonable terms, which may not include the transfer of credit risk
to a third party.
    \89\ See id. at Section 78o-11(c)(G)(iv) and (d) (permitting the
Commission and Federal banking agencies to allow the allocation of
risk retention from a sponsor to an originator).
---------------------------------------------------------------------------

    The terms of the proposed option for eligible open market CLOs
include conditions designed to provide incentive to lead arrangers to
monitor the underwriting of loans they syndicate that may be sold to an
eligible open market CLO by requiring that lead arrangers retain risk
on these leveraged loans that could be securitized through CLOs. The
agencies believe that this proposed risk retention option for open
market CLOs would meaningfully align the incentives of the party most
involved with the credit quality of these loans--the lead arranger--
with the interests of investors. Alternatively, incentive would be
placed on the CLO manager to monitor the credit quality of loans it
securitizes if it retains risk under the standard risk retention
option.
    In response to commenter requests that the agencies recognize
incentive fees as risk retention, the agencies recognize that
management fees incorporate credit risk sensitivity and contribute to
aligning the interests of the CLO manager and investors with respect to
the quality of the securitized loans. However, these fees do not appear
to provide an adequate substitute for risk retention because they
typically have small expected value (estimated as equivalent to a
horizontal tranche of less than 1 percent), especially given that CLOs
securitize leveraged loans, which carry higher risk than many other
securitized assets. Additionally, these fees are not funded in cash at
closing and therefore may not be available to absorb losses as
expected. Generally, the agencies have declined to recognize unfunded
forms of risk retention for purposes of the proposal (such as fees or
guarantees), except in the case of the Enterprises under the conditions
specified with regard to their guarantees.
    Under the option for open market CLOs, the sponsor relying on the
option would be required to provide, or cause to be provided, certain
disclosures to potential investors. The sponsor would be required to
disclose this information a reasonable period of time prior to the sale
of the asset-backed securities in the securitization transaction (and
at least annually with respect to information regarding the assets held
by the CLO) and, upon request, to the Commission and its appropriate
Federal banking agency, if any. First, a sponsor relying on the CLO
option would need to disclose a complete list of every asset held by an
open market CLO (or before the CLO's closing, in a warehouse facility
in anticipation of transfer into the CLO at closing). This list would
need to include the following information (i) the full legal name and
Standard Industrial Classification category code of the obligor of the
loan or asset; (ii) the full name of the specific loan tranche held by
the CLO; (iii) the face amount of the loan tranche held by the CLO;
(iv) the price at which the loan tranche was acquired by the CLO; and
(v) for each loan tranche, the full legal name of the lead arranger
subject to the sales and hedging restrictions of Sec.  ----.12 of the
proposed rule. Second, the sponsor would need to disclose the full
legal name and form of organization of the CLO manager.
Request for Comment
    50(a). Does the proposed CLO risk retention option present a
reasonable allocation of risk retention among the parties that
originate, purchase, and sell assets in a CLO securitization? 50(b).
Are there any changes that should be made in order to better align the
interests of CLO sponsors and CLO investors?
    51. Are there technical changes to the proposed CLO option that
would be needed or desirable in order for lead arrangers to be able to
retain the risk as proposed, and for CLO sponsors to be able to rely on
this option?

    52(a). Who should assume responsibility for ensuring that lead
arrangers comply with requirement to retain an interest in CLO-eligible
tranches? 52(b). Would some sort of ongoing reporting or periodic
certification by the lead arranger to holders of the CLO-eligible
tranche be feasible? 52(c). Why or why not?
    53(a). The agencies would welcome suggestions for alternate or
additional criteria for identifying lead arrangers. 53(b). Do loan
syndications typically have more than one lead arranger who has
significant influence over the underwriting and documentation of the
loan? 53(c). If so, should the risk retention requirement be permitted
to be shared among more than one lead arranger? 53(d). What practical
difficulties would this present, including for the monitoring of
compliance with the retention requirement? 53(e). How could the rule
assure that each lead arranger's retained interest is significant
enough to influence its underwriting of the loan?
    54(a). Is the requirement for the lead arranger to take an initial
allocation of 20 percent of the broader syndicated credit facility
sufficiently large to ensure that the lead arranger can exert a
meaningful level of influence on loan underwriting terms? 54(b). Could
a smaller required allocation accomplish the same purpose?
    55(a). The proposal permits lead arrangers to sell or hedge their
retained interest in a CLO-eligible loan tranche if those loans
experience a payment or bankruptcy default or are accelerated. Would
the knowledge that it could sell or hedge a defaulted loan in those
circumstances unduly diminish the lead arranger's incentive to
underwrite and structure the loan prudently at origination? 55(b).
Should the agencies restrict the ability of lead arrangers to sell or
hedge their retained interest under these circumstances? 55(c). Why or
why not?
    56(a). Should the lead arranger role for ``CLO-eligible'' loan
tranches be limited to federally supervised lending institutions, which
are subject to regulatory guidance on leveraged lending? 56(b). Why or
why not?
    57(a). Should additional qualitative criteria be placed on CLO-
eligible loan tranches to ensure that they have lower credit risk
relative to the broader leveraged loan market? 57(b). What such
criteria would be appropriate?
    58(a). Should managers of open market CLOs be required to invest
principal in some minimal percentage of the CLO's first loss piece in
addition to meeting other requirements for open market CLOs proposed
herein? 58(b). Why or why not?
    59(a). Is the requirement that all assets (other than servicing
assets) consist of CLO-eligible loan tranches appropriate? 59(b). To
what extent could this requirement impede the ability of a CLO sponsor
to diversify its assets or its ability to rely on this option? 59(c).
Does this requirement present any practical difficulties with reliance
on this option, particularly the ability of CLO sponsors to accumulate
a sufficient number of assets from CLO-eligible loan tranches to meet
this requirement? 59(d). If so, what are they? 59(e). Would it be
appropriate for the agencies to provide a transition period (for
example, two years) after the effective date of the rule to allow some
investment in corporate or other obligations other than CLO-eligible
loan tranches or servicing assets while the market adjusts to the new
standards? 59(f). What transition would be appropriate? 59(g). Would
allowing a relatively high percentage of investment in such other
assets in the early years following the effective date (such as 10
percent), followed by a gradual reduction, facilitate the ability of
the market to utilize the proposed option? 59(h). Why or why not?
59(i). What other transition arrangements might be appropriate?
    60(a). Should an open market CLO be allowed permanently to hold
some de minimis percentage of its collateral assets in corporate
obligations other than CLO-eligible loan tranches under the option?
60(b). If so, how much?
    61(a). Is the requirement that permitted hedging transactions be
limited to interest rate and currency risks appropriate? 61(b). Are
there other derivative transactions that CLO issuing entities engage in
to hedge particular risks arising from the loans they hold and not as
means of gaining synthetic exposures?
    62(a). Is the requirement that the holders of a CLO-eligible loan
tranche have consent rights with respect to any material waivers and
amendments of the underlying legal documents affecting their tranche
appropriate? 62(b). How should waivers and amendments that affect all
tranches (such as waivers of defaults or amendments to covenants) be
treated for this purpose? 62(c). Should holders of CLO-eligible loan
tranches be required to receive special rights with respect those
matters, or are their interests sufficiently aligned with other
lenders?
    63. How would the proposed option facilitate (or not facilitate)
the continuance of open market CLO issuances?
    64(a). What percentage of currently outstanding CLOs, if any, have
securitized assets that consist entirely of syndicated loans? 64(b).
What percentage of securitized assets of currently outstanding CLOs
consist of syndicated loans?
    65(a). Should unfunded portions of revolving credit facilities be
allowed in open market CLO collateral portfolios, subject to some
limit, as is current market practice? 65(b). If yes, what form should
risk retention take? 65(c). Would the retention of 5 percent of an
unfunded revolving commitment to lend (plus 5 percent of any
outstanding funded amounts) provide the originator with incentives
similar to those provided by retention of 5 percent of a funded term
loan? 65(d). Why or why not?
    66(a). Would a requirement for the CLO manager to retain risk in
the form of unfunded notes and equity securities, as proposed by an
industry commenter, be a reasonable alternative for the above proposal?
66(b). How would this meet the requirements and purposes of section 15G
of the Exchange Act?
8. Municipal Bond ``Repackaging'' Securitizations
    Several commenters on the original proposal requested that the
agencies exempt municipal bond repackagings securitizations from risk
retention requirements, the most common form of which are often
referred to as ``tender option bonds'' (TOBs).\90\ These commenters
argued that these transactions should be exempt from risk retention for
the following reasons:
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    \90\ As described by one commenter, a typical TOBs transaction
consists of the deposit of a single issue of highly rated, long-term
municipal bonds in a trust and the issuance by the trust of two
classes of securities: A floating rate, puttable security (the
``floaters''), and an inverse floating rate security (the
``residual''). No tranching is involved. The holders of floaters
have the right, generally on a daily or weekly basis, to put the
floaters for purchase at par, which put right is supported by a
liquidity facility delivered by a highly rated provider and causes
the floaters to be a short-term security. The floaters are in large
part purchased and held by money market mutual funds. The residual
is held by a longer term investor (bank, insurance company, mutual
fund, hedge fund, etc.). The residual investors take all of the
market and structural risk related to the TOBs structure, with the
floaters investors only taking limited, well-defined insolvency and
default risks associated with the underlying municipal bonds, which
risks are equivalent to those associated with investing in such
municipal bonds directly.
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     Securities issued by municipal entities are exempt, so
securitizations involving these securities should also be exempt;
     Municipal bond repackagings are not the type of
securitizations that prompted Congress to enact section 15G of the
Exchange Act, but rather are

securitizations caught in the net cast by the broad definition of ABS.
In fact, the underlying collateral of TOBs has very lower credit risk
and is structured to meet the credit quality requirements of Rule 2a-7
under the Investment Company Act of 1940; \91\
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    \91\ 17 CFR 270.2a-7.
---------------------------------------------------------------------------

     Imposing risk retention in the TOBs market would reduce
the liquidity of municipal bonds, which would lead to an increase in
borrowing costs for municipalities and other issuers of municipal
bonds, as well a decrease the short-term investments available for tax-
exempt money market funds; and
     TOB programs are financing vehicles that are used because
more traditional forms of securities financing are inefficient in the
municipal securities market; TOB programs are not intended to, and do
not, transfer material investment risk from the securitizer to
investors. The securitizer in a TOB program (whether the TOB program
sponsor or a third-party investor) has ``skin in the game'' by virtue
of (i) the nature of the TOB inverse floater interest it owns, which
represents ownership of the underlying municipal securities and is not
analogous to other types of ABS programs, or (ii) its provision of
liquidity coverage or credit enhancement, or its obligation to
reimburse the provider of liquidity coverage or credit enhancement for
any losses.

Another commenter asserted that TOBs and other types of municipal
repackaging transactions continue to offer an important financing
option for municipal issuers by providing access to a more diverse
investor base, a more liquid market and the potential for lower
interest rates. According to this commenter, if TOBs were subject to
the risk retention requirements of the proposal, the cost of such
financing would increase significantly, sponsor banks would likely
scale back the issuance of TOBs, and as a result the availability of
tax-exempt investments in the market would decrease.
    In order to reflect and incorporate the risk retention mechanisms
currently implemented by the market, the agencies are proposing to
provide two additional risk retention options for certain municipal
bond repackagings. The proposed rule closely tracks certain
requirements for these repackagings, outlined in IRS Revenue Procedure
2003-84, that are relevant to risk retention.\92\ Specifically, the re-
proposed rule proposes additional risk retention options for certain
municipal bond repackagings in which:
---------------------------------------------------------------------------

    \92\ Revenue Procedure 2003-84, 2003-48 I.R.B. 1159.
---------------------------------------------------------------------------

     Only two classes of securities are issued: A tender option
bond and a residual interest;
     The tender option bond qualifies for purchase by money
market funds under Rule 2a-7 under the Investment Company Act of 1940;
     The holder of a tender option bond must have the right to
tender such bonds to the issuing entity for purchase at any time upon
no more than 30 days' notice;
     The collateral consists solely of servicing assets and
municipal securities as defined in Section 3(a)(29) of the Securities
Exchange Act of 1934 and all of those securities have the same
municipal issuer and the same underlying obligor or source of payment;
     Each of the tender option bond, the residual interest and
the underlying municipal security are issued in compliance with the
Internal Revenue Code of 1986, as amended (the ``IRS Code''), such that
the interest payments made on those securities are excludable from the
gross income of the owners;
     The issuing entity has a legally binding commitment from a
regulated liquidity provider to provide 100 percent guarantee or
liquidity coverage with respect to all of the issuing entity's
outstanding tender option bonds; \93\ and
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    \93\ The agencies received very few comments with respect to the
definition of regulated liquidity provider included in the original
proposal with respect to the proposed ABCP option. The proposed rule
includes the same definition and defines a regulated liquidity
provider as a depository institution (as defined in section 3 of the
Federal Deposit Insurance Act (12 U.S.C. 1813)); a bank holding
company (as defined in 12 U.S.C. 1841) or a subsidiary thereof; a
savings and loan holding company (as defined in 12 U.S.C. 1467a)
provided all or substantially all of the holding company's
activities are permissible for a financial holding company under 12
U.S.C. 1843(k) or a subsidiary thereof; or a foreign bank (or a
subsidiary thereof) whose home country supervisor (as defined in
Sec.  211.21 of the Federal Reserve Board's Regulation K (12 CFR
211.21)) has adopted capital standards consistent with the Capital
Accord of the Basel Committee on Banking Supervision, as amended,
provided the foreign bank is subject to such standards.
---------------------------------------------------------------------------

     The issuing entity qualifies for monthly closing elections
pursuant to IRS Revenue Procedure 2003-84, as amended or supplemented
from time to time.

An issuing entity that meets these qualifications would be a Qualified
Tender Option Bond Entity.
    The sponsor of a Qualified Tender Option Bond Entity may satisfy
its risk retention requirements under section 10 of the proposed rule
if it retains an interest that upon issuance meets the requirements of
an eligible horizontal residual interest but that upon the occurrence
of a ``tender option termination event'' as defined in section 4.01(5)
of IRS Revenue Procedure 2003-84, as amended or supplemented from time
to time, will meet requirements of an eligible vertical interest.\94\
The agencies believe that the proposed requirements for both an
eligible horizontal residual interest and an eligible vertical interest
adequately align the incentives of sponsors and investors.
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    \94\ Section 4.01(5) of IRS Revenue Procedure 2003-84 defines a
tender option termination event as: (1) A bankruptcy filing by or
against a tax-exempt bond issuer; (2) a downgrade in the credit-
rating of a tax-exempt bond and a downgrade in the credit rating of
any guarantor of the tax-exempt bond, if applicable, below
investment grade; (3) a payment default on a tax-exempt bond; (4) a
final judicial determination or a final IRS administrative
determination of taxability of a tax-exempt bond for Federal default
on the underlying municipal securities and credit enhancement, where
applicable; (5) a credit rating downgrade below investment grade;
(6) the bankruptcy of the issuer and, when applicable, the credit
enhancer; or (7) the determination that the municipal securities are
taxable.
---------------------------------------------------------------------------

    The sponsor of a Qualified Tender Option Bond Entity may also
satisfy its risk retention requirements under this Section if it holds
municipal securities from the same issuance of municipal securities
deposited in the Qualified Tender Option Bond Entity, the face value of
which retained municipal securities is equal to 5 percent of the face
value of the municipal securities deposited in the Qualified Tender
Option Bond Entity. The prohibitions on transfer and hedging set forth
in section 12 of the proposed rule would apply to any municipal
securities retained by the sponsor of a Qualified Tender Option Bond
Entity in satisfactions of its risk retention requirements under this
section.
    The sponsor of a Qualified Tender Option Bond Entity could also
satisfy its risk retention requirements under subpart B of the proposed
rule using any of the other risk retention options in this proposal,
provided the sponsor meets the requirements of that option.
Request for Comment
    67(a). Do each of the additional options proposed with respect to
repackagings of municipal securities accommodate existing market
practice for issuers and sponsors of tender option bonds? 67(b). If
not, are there any technical adjustments that need to be made in order
to accommodate existing market practice?
    68(a). Do each of the additional options proposed with respect to
repackagings of municipal securities adequately align the incentives of
sponsors and investors? 68(b). If not, are

there any additional requirements that should be added in order to
better align those incentives?
9. Premium Capture Cash Reserve Account
a. Overview of Original Proposal and Public Comment
    In the original proposal, the agencies were concerned with two
different forms of evasive behavior by sponsors to reduce the
effectiveness of risk retention. First, in the context of horizontal
risk retention, it could have been difficult to measure how much risk a
sponsor was retaining where the risk retention requirement was measured
using the ``par value'' of the transaction. In particular, a first loss
piece could be structured with a face value of 5 percent, but might
have a market value of only cents on the dollar. As the sponsor might
not have to put significant amounts of its own funds at risk to acquire
the horizontal interest, there was concern that the sponsor could
structure around its risk retention requirements and thereby evade a
purpose of section 15G.
    Second, in many securitization transactions, particularly those
involving residential and commercial mortgages, conducted prior to the
financial crisis, sponsors sold premium or interest-only tranches in
the issuing entity to investors, as well as more traditional
obligations that paid both principal and interest received on the
underlying assets. By selling premium or interest-only tranches,
sponsors could thereby monetize at the inception of a securitization
transaction the ``excess spread'' that was expected to be generated by
the securitized assets over time and diminish the value, relative to
par value, of the most subordinated credit tranche. By monetizing
excess spread before the performance of the securitized assets could be
observed and unexpected losses realized, sponsors were able to reduce
the impact of any economic interest they may have retained in the
outcome of the transaction and in the credit quality of the assets they
securitized. This created incentives to maximize securitization scale
and complexity, and encouraged unsound underwriting practices.
    In order to achieve the goals of risk retention, the original
proposal would have increased the required amount of risk retention by
the amount of proceeds in excess of 95 percent of the par value of ABS
interests, or otherwise required the sponsor to deposit the difference
into a first-loss premium capture cash reserve account. The amount
placed into the premium capture cash reserve account would have been
separate from and in addition to the sponsor's base risk retention
requirement, and would have been used to cover losses on the underlying
assets before such losses were allocated to any other interest or
account. As a likely consequence to those proposed requirements, the
agencies expected that few, if any, securitizations would require the
establishment of a premium capture cash reserve account, as sponsors
would simply adjust by holding more risk retention.
    The agencies requested comment on the effectiveness and
appropriateness of the premium capture cash reserve account and sought
input on any alternative methods. Several commenters were supportive of
the concept behind the premium capture cash reserve account to prevent
sponsors from structuring around the risk retention requirement.
However, most commenters generally objected to the premium capture cash
reserve account. Many commenters expressed concern that the premium
capture cash reserve account would prevent sponsors and originators
from recouping the costs of origination and hedging activities, give
sponsors an incentive to earn compensation in the form of fees from the
borrower instead of cash from deal proceeds, and potentially cause the
sponsor to consolidate the entire securitization vehicle for accounting
purposes.
    Commenters stated that these potential negative effects would
ultimately make securitizations uneconomical for many sponsors, and
therefore would have a significant adverse impact on the cost and
availability of credit. Some commenters also argued that the premium
capture cash reserve account exceeded the statutory mandate and
legislative intent of the Dodd-Frank Act.
b. Proposed Treatment
    After careful consideration of all the comments regarding the
premium capture cash reserve account, and in consideration of the use
of fair value in the measurement of the standard risk retention amount
in the proposed rule (as opposed to the par value measurement in the
original proposal), the agencies have decided not to include a premium
capture cash reserve account provision in the proposed rule. The
agencies still consider it important to ensure that there is meaningful
risk retention and that sponsors cannot effectively negate or reduce
the economic exposure they are required to retain under the proposed
rule. However, the proposal to use fair value to measure the amount of
risk retention should meaningfully mitigate the ability of a sponsor to
evade the risk retention requirement through the use of deal
structures. The agencies also took into consideration the potential
negative unintended consequences the premium capture cash reserve
account might cause for securitizations and lending markets. The
elimination of the premium capture cash reserve account should reduce
the potential for the proposed rule to negatively affect the
availability and cost of credit to consumers and businesses.
Request for Comment
    69(a). Should the proposed rule require a sponsor to fund all or
part of its risk retention requirement with own funds, instead of using
proceeds from the sale of ABS interests to investors? 69(b). Would risk
retention be more effective if sponsors had to fund it entirely with
their own funds? 69(c). Why or why not?
    70(a). Should the agencies require a higher amount of risk
retention specifically for transaction structures which rely on premium
proceeds, or for assets classes like RMBS and CMBS which have relied
historically on the use of premium proceeds? 70(b). If so, how should
this additional risk requirement be sized in order to ensure risk
retention achieves the right balance of cost versus effectiveness?

C. Allocation to the Originator

1. Overview of Original Proposal and Public Comment
    As a general matter, the original proposal was structured so that
the sponsor of a securitization transaction would be solely responsible
for complying with the risk retention requirements established under
section 15G of the Exchange Act and the proposed implementing
regulations, consistent with that statutory provision. However, subject
to a number of considerations, section 15G authorizes the agencies to
allow a sponsor to allocate at least a portion of the credit risk it is
required to retain to the originator(s) of securitized assets.\95\
Accordingly, subject to conditions and restrictions discussed below,
the original proposal would have permitted a sponsor to reduce its
required risk retention obligations in a securitization transaction by
the portion of risk

retention obligations assumed by the originators of the securitized
assets.
---------------------------------------------------------------------------

    \95\ As discussed above, 15 U.S.C. 78o-11(a)(4) defines the term
``originator'' as a person who, through the extension of credit or
otherwise, creates a financial asset that collateralizes an asset-
backed security; and who sells an asset directly or indirectly to a
securitizer (i.e., a sponsor or depositor).
---------------------------------------------------------------------------

    When determining how to allocate the risk retention requirements,
the agencies are directed to consider whether the assets sold to the
sponsor have terms, conditions, and characteristics that reflect low
credit risk; whether the form or volume of the transactions in
securitization markets creates incentives for imprudent origination of
the type of loan or asset to be sold to the sponsor; and the potential
impact of the risk retention obligations on the access of consumers and
businesses to credit on reasonable terms, which may not include the
transfer of credit risk to a third party.\96\
---------------------------------------------------------------------------

    \96\ 15 U.S.C. 78o-11(d)(2). The agencies note that section
15G(d) appears to contain an erroneous cross-reference.
Specifically, the reference at the beginning of section 15G(d) to
``subsection (c)(1)(E)(iv)'' is read to mean ``subsection
(c)(1)(G)(iv)'', as the former subsection does not pertain to
allocation, while the latter is the subsection that permits the
agencies to provide for the allocation of risk retention obligations
between a securitizer and an originator in the case of a securitizer
that purchases assets from an originator.
---------------------------------------------------------------------------

    In the original proposal, the agencies proposed a framework that
would have permitted a sponsor of a securitization to allocate a
portion of its risk retention obligation to an originator that
contributed a significant amount of assets to the underlying asset
pool. The agencies endeavored to create appropriate incentives for both
the securitization sponsor and the originator(s) to maintain and
monitor appropriate underwriting standards without creating undue
complexity, which potentially could mislead investors and confound
supervisory efforts to monitor compliance. Importantly, the original
proposal did not require allocation to an originator. Therefore, it did
not raise the types of concerns about credit availability that might
arise if certain originators, such as mortgage brokers or small
community banks (that may experience difficulty obtaining funding to
retain risk positions), were required to fulfill a sponsor's risk
retention requirement.
    The allocation to originator option in the original proposal was
designed to work in tandem with the base vertical or horizontal risk
retention options that were set forth in that proposal. The provision
would have made the allocation to originator option available to a
sponsor that held all of the retained interest under the vertical
option or all of the retained interest under the horizontal option, but
would not have made the option available to a sponsor that satisfied
the risk retention requirement by retaining a combination of vertical
and horizontal interests.
    Additionally, the original proposal would have permitted a
securitization sponsor to allocate a portion of its risk retention
obligation to any originator of the underlying assets that contributed
at least 20 percent of the underlying assets in the pool. The amount of
the retention interest held by each originator that was allocated
credit risk in accordance with the proposal was required to be at least
20 percent, but not in excess of the percentage of the securitized
assets it originated. The originator would have been required to hold
its allocated share of the risk retention obligation in the same manner
as would have been required of the sponsor, and subject to the same
restrictions on transferring, hedging, and financing the retained
interest. Thus, for example, if the sponsor satisfied its risk
retention requirements by acquiring an eligible horizontal residual
interest, an originator allocated risk would have been required to
acquire a portion of that horizontal first-loss interest, in an amount
not exceeding the percentage of pool assets created by the originator.
The sponsor's risk retention requirements would have been reduced by
the amount allocated to the originator. Finally, the original proposal
would have made the sponsor responsible for any failure of an
originator to abide by the transfer and hedging restrictions included
in the proposed rule.
    Several commenters opposed the original proposal on allocation to
originators in its entirety for a variety of reasons. A common reason
stated was that originators would be placed in an unequal bargaining
position with sponsors. Other commenters supported the proposed
provision, but many urged that it be revised. Several commenters stated
that requiring that the originator use the same form of risk retention
as the sponsor should be removed, while one commenter proposed that if
a sponsor desired to allocate a portion of risk retention to an
originator, only the horizontal retention option should be used. Many
commenters stated that the proposed 20 percent origination threshold
required in order for the option to be used was too high. One commenter
urged that an originator that originated more than 50 percent of the
securitized assets be required to retain at least 50 percent of the
required retention. Another commenter suggested that an originator
retaining a portion of the required interest be allocated only a
percentage of the loans it originated, rather than an allocation of the
entire pool, as proposed. The agencies also received comments that the
definition of ``originator'' ought to include parties that purchase
assets from entities that create the assets and that allocation to
originators should be permitted where the L-shaped option or horizontal
cash reserve account option was used as a form of risk retention.
2. Proposed Treatment
    The agencies have carefully considered the concerns raised by
commenters with respect to the original proposal on allocation to
originators. The agencies do not believe, however, that a significant
expansion of the allocation to originator option would be appropriate
and that allocation limits on originators are necessary to realize the
agencies' goal of better aligning securitizers' and investors'
interests.
    Therefore, the agencies are proposing an allocation to originator
provision that is substantially similar to the provision in the
original proposal. The only modifications to this option would be
technical changes that reflect the proposed flexible standard risk
retention (discussed above in Part III.B.1 of this SUPPLEMENTARY
INFORMATION). The rule, like the original proposal, would require that
an originator to which a portion of the sponsor's risk retention
obligation is allocated acquire and retain ABS interests or eligible
horizontal residual interests in the same manner as would have been
retained by the sponsor. Under the proposed rule, this condition would
require an originator to acquire horizontal and vertical interests in
the securitization transaction in the same proportion as the interests
originally established by the sponsor. This requirement helps to align
the interests of originators and sponsors, as both face the same
likelihood and degree of losses if the collateralized assets begin to
default.
    In addition, the proposed rule would permit a sponsor that uses a
horizontal cash reserve account to use this option. Finally, consistent
with the change in the general risk retention from par value to fair
value (discussed above in Part III.B.1 of this Supplementary
Information) in determining the maximum amount of risk retention that
could be allocated to an originator, the current NPR refers to the fair
value, rather than the dollar amount (or corresponding amount in the
foreign currency in which the ABS are issued, as applicable), of the
retained interests.
    As explained in the original proposal, by limiting this option to
originators that originate at least 20 percent of the asset pool, the
agencies seek to ensure that the originator retains risk in an amount
significant enough to function as an actual incentive for the
originator

to monitor the quality of all the assets being securitized (and to
which it would retain some credit risk exposure). In addition, by
restricting originators to holding no more than their proportional
share of the risk retention obligation, the proposal seeks to prevent
sponsors from circumventing the purpose of the risk retention
obligation by transferring an outsized portion of the obligation to an
originator that may have been seeking to acquire a speculative
investment. These requirements are also intended to reduce the
proposal's potential complexity and facilitate investor and regulatory
monitoring.
    The re-proposal again requires that an originator hold retained
interests in the same manner as the sponsor. As noted, the proposed
rule provides the sponsor with significant flexibility in determining
the mix of vertical and horizontal interests that it would hold to meet
its risk retention requirement. In addition, unlike the original
proposal, the proposed rule would permit a sponsor that holds a
combination of vertical and horizontal interests to utilize the
allocation to originator option. If originators were permitted to
retain their share of the sponsor's risk retention obligation in a
proportion that is different from the sponsor's mix of the vertical and
horizontal interests, investor and regulatory monitoring could become
very complex.
    The re-proposal does not incorporate commenters' suggestion that an
originator be allocated retention in only the loans that it originated.
The operational burden on both securitization sponsors and federal
supervisors to ensure that retention is held by originators on the
correct individual loans would be exceedingly high. Therefore, the
proposal continues to require that originators allocated a portion of
the risk retention requirement be allocated a share of the entire
securitization pool.
    The agencies are not proposing a definition of originator modified
from the original proposal and are not proposing to include persons
that acquire loans and transfer them to a sponsor. The agencies
continue to believe that the definition of the term originator in
section 15G \97\ does not provide the agencies with flexibility to make
this change. This definition limits an originator to a person that
``through the extension of credit or otherwise, creates a financial
asset.'' A person that acquires an asset created by another person
would not be the ``creator'' of such asset.
---------------------------------------------------------------------------

    \97\ 15 U.S.C. 78o-11(a)(4).
---------------------------------------------------------------------------

    The agencies are not proposing to eliminate the allocation to
originator provision, as some commenters suggested. Although the
agencies are sensitive to concerns that smaller originators might be
forced to accept allocations from sponsors due to unequal bargaining
power, the 20 percent threshold would make the allocation option
available only for entities whose assets form a significant portion of
a pool and who, thus, ordinarily could be expected to have some
bargaining power with a sponsor.
    Finally, the agencies do not believe that it is necessary, as some
commenters suggested, to require retention by a non-sponsor originator
which provides more than half of the securitized asset pool. In most
circumstances, such an originator would be a sponsor. In any
circumstance where such an originator was not the sponsor, the agencies
believe that risk retention goals would be adequately served by
retention by the sponsor, if allocation to the originator did not
otherwise occur.
Request for Comment
    71(a). If originators were allocated risk only as to the loans they
originate, would it be operationally feasible to allocate losses on a
loan-by-loan basis? 71(b). What would be the degree of burden to
implement such a system and accurately track and allocate losses?

D. Hedging, Transfer, and Financing Restrictions

1. Overview of the Original Proposal and Public Comment
    Section 15G(c)(1)(A) provides that the risk retention regulations
prescribed shall prohibit a securitizer from directly or indirectly
hedging or otherwise transferring the credit risk that the securitizer
is required to retain with respect to an asset. Consistent with this
statutory directive, the original proposal prohibited a sponsor from
transferring any interest or assets that it was required to retain
under the rule to any person other than an affiliate whose financial
statements are consolidated with those of the sponsor (a consolidated
affiliate). An issuing entity, however, would not be deemed a
consolidated affiliate of the sponsor for the securitization even if
its financial statements were consolidated with those of the sponsor
under applicable accounting standards.
    In addition to the transfer restrictions, the original proposal
prohibited a sponsor or any consolidated affiliate from hedging the
credit risk the sponsor was required to retain under the rule. However,
hedge positions that are not materially related to the credit risk of
the particular ABS interests or exposures required to be retained by
the sponsor or its affiliate would not have been prohibited under the
original proposal. The original proposal also prohibited a sponsor and
a consolidated affiliate from pledging as collateral for any obligation
any interest or asset that the sponsor was required to retain unless
the obligation was with full recourse to the sponsor or consolidated
affiliate.
    Commenters generally expressed support for the proposed
restrictions in the original proposal as they felt that the
restrictions were appropriately structured. However, several commenters
recommended that sponsors only be required to maintain a fixed
percentage of exposure to a securitization over time rather than a
fixed amount of exposure. Some commenters also recommended that the
transfer restriction be modified so that not only could sponsors
transfer retained interests or assets to consolidated affiliates, but
consolidated affiliates could hold the risk retention initially as
well.
2. Proposed Treatment
    The agencies have carefully considered the comments received with
respect to the original proposal's hedging, transfer, and financing
restrictions, and the agencies do not believe that any significant
changes to these restrictions would be appropriate (other than the
exemptions provided for CMBS and duration of the hedging and transfer
restrictions, as described in Part IV.F of this Supplementary
Information).
    The agencies are, however, proposing changes in connection with the
consolidated affiliate treatment. As noted above, the ``consolidated
affiliate'' definition would be operative in two respects. First, the
original proposal would have permitted transfers of the risk retention
interest to a consolidated affiliate. The agencies proposed this
treatment under the rationale that financial losses are shared equally
within a group of consolidated entities; therefore, a sponsor would not
``avoid'' losses by transferring the required risk retention asset to
an affiliate. Upon further consideration, the agencies are concerned
that, under current accounting standards, consolidation of an entity
can occur under circumstances in which a significant portion of the
economic losses of one entity will not, in economic terms, be suffered
by its consolidated affiliate.
    To avoid this outcome, the current proposal introduces the concept
of a

``majority-owned affiliate,'' which would be defined under the proposal
as an entity that, directly or indirectly, majority controls, is
majority controlled by, or is under common majority control with,
another entity For purposes of this definition, majority control would
mean ownership of more than 50 percent of the equity of an entity or
ownership of any other controlling financial interest in the entity (as
determined under GAAP). The agencies are also, in response to
commenters, revising the proposal to allow risk retention to be
retained as an initial matter by a majority-owned affiliate; in other
words, it would not be necessary for the sponsor to go through the
steps of holding the required retention interest for a moment in time
before moving it to the affiliate.
    Second, the original proposal prohibited a consolidated affiliate
of the sponsor from hedging a risk retention interest required to be
retained under the rule. Again, the rationale was that the sponsor's
consolidated affiliate would obtain the benefits of the hedging
transaction and they would offset any losses sustained by the sponsor.
In the current proposal, the agencies are eliminating the concept of
the ``consolidated'' affiliate and instead applying the hedging
prohibition to any affiliate of the sponsor.
    In all other respects, the agencies are again proposing the same
hedging, transfer, and financing restrictions as under the original
proposal, without modification. The proposal would prohibit a sponsor
or any affiliate from hedging the credit risk the sponsor is required
to retain under the rule or from purchasing or selling a security or
other financial instrument, or entering into an agreement (including an
insurance contract), derivative or other position, with any other
person if: (i) Payments on the security or other financial instrument
or under the agreement, derivative, or position are materially related
to the credit risk of one or more particular ABS interests that the
retaining sponsor is required to retain, or one or more of the
particular securitized assets that collateralize the asset-backed
securities; and (ii) the security, instrument, agreement, derivative,
or position in any way reduces or limits the financial exposure of the
sponsor to the credit risk of one or more of the particular ABS
interests or one or more of the particular securitized assets that
collateralize the asset-backed securities.
    Similar to the original proposal, under the proposed rule holding a
security tied to the return of an index (such as the subprime ABX.HE
index) would not be considered a prohibited hedge by the retaining
sponsor so long as: (1) Any class of ABS interests in the issuing
entity that were issued in connection with the securitization
transaction and that are included in the index represented no more than
10 percent of the dollar-weighted average of all instruments included
in the index, and (2) all classes of ABS interests in all issuing
entities that were issued in connection with any securitization
transaction in which the sponsor was required to retain an interest
pursuant to the proposal and that are included in the index represent,
in the aggregate, no more than 20 percent of the dollar-weighted
average of all instruments included in the index.
    Such positions would include hedges related to overall market
movements, such as movements of market interest rates (but not the
specific interest rate risk, also known as spread risk, associated with
the ABS interest that is otherwise considered part of the credit risk),
currency exchange rates, home prices, or of the overall value of a
particular broad category of asset-backed securities. Likewise, hedges
tied to securities that are backed by similar assets originated and
securitized by other sponsors, also would not be prohibited. On the
other hand, a security, instrument, derivative or contract generally
would be ``materially related'' to the particular interests or assets
that the sponsor is required to retain if the security, instrument,
derivative or contract refers to those particular interests or assets
or requires payment in circumstances where there is or could reasonably
be expected to be a loss due to the credit risk of such interests or
assets (e.g., a credit default swap for which the particular interest
or asset is the reference asset).
    Consistent with the original proposal, the proposed rule would
prohibit a sponsor and any affiliate from pledging as collateral for
any obligation (including a loan, repurchase agreement, or other
financing transaction) any ABS interest that the sponsor is required to
retain unless the obligation is with full recourse to the sponsor or a
pledging affiliate (as applicable). Because the lender of a loan that
is not with full recourse to the borrower has limited rights against
the borrower on default, and may rely more heavily on the collateral
pledged (rather than the borrower's assets generally) for repayment, a
limited recourse financing supported by a sponsor's risk retention
interest may transfer some of the risk of the retained interest to the
lender during the term of the loan. If the sponsor or affiliate pledged
the interest or asset to support recourse financing and subsequently
allowed (whether by consent, pursuant to the exercise of remedies by
the counterparty or otherwise) the interest or asset to be taken by the
counterparty to the financing transaction, the sponsor will have
violated the prohibition on transfer.
    Similar to the original proposal, the proposed rule would not
prohibit an issuing entity from engaging in hedging activities itself
when such activities would be for the benefit of all investors in the
asset-backed securities. However, any credit protection by or hedging
protection obtained by an issuing entity could not cover any ABS
interest or asset that the sponsor is required to retain under the
proposed rule. For example, if the sponsor retained a 5 percent
eligible vertical interest, an issuing entity may purchase (or benefit
from) a credit insurance wrap that covers up to 95 percent of the
tranches, but not the 5 percent of such tranches required to be
retained by the sponsor.
Request for Comment
    72(a). Is the scope of the proposed restriction relating to
majority-owned affiliates, and affiliates generally, appropriate to
prevent sponsors from avoiding losses arising from a risk retention
asset? 72(b). Should the agencies, instead of the majority-owned
affiliate approach, increase the 50 percent ownership requirement to a
100 percent ownership threshold under a wholly-owned approach?

IV. General Exemptions

    Section 15G(c)(1)(G) and section 15G(e) of the Exchange Act require
the agencies to provide a total or partial exemption from the risk
retention requirements for certain types of ABS or securitization
transactions.\98\ In addition, section 15G(e)(1) permits the agencies
jointly to adopt or issue additional exemptions, exceptions, or
adjustments to the risk retention requirements of the rules, including
exemptions, exceptions, or adjustments for classes of institutions or
assets, if the exemption, exception, or adjustment would: (A) Help
ensure high quality underwriting standards for the securitizers and
originators of assets that are securitized or available for
securitization; and (B) encourage appropriate risk management practices
by the securitizers and originators of assets, improve the access of
consumers and businesses to credit on reasonable terms, or otherwise be
in the public

interest and for the protection of investors.
---------------------------------------------------------------------------

    \98\ 15 U.S.C. 78o-11(c)(1)(G) and (e).
---------------------------------------------------------------------------

    Consistent with these provisions, the original proposal would have
exempted certain types of ABS or securitization transactions from the
credit risk retention requirements of the rule, each as discussed
below, along with the comments and the new or revised proposals of the
proposed rule.

A. Exemption for Federally Insured or Guaranteed Residential,
Multifamily, and Health Care Mortgage Loan Assets

    The original proposal would have implemented section 15G(e)(3)(B)
of the Exchange Act by exempting from the risk retention requirements
any securitization transaction that is collateralized solely by
residential, multifamily, or health care facility mortgage loan assets
if the assets are insured or guaranteed as to the payment of principal
and interest by the United States or an agency of the United
States.\99\ Also, the original proposal would have exempted any
securitization transaction that involves the issuance of ABS if the ABS
are insured or guaranteed as to the payment of principal and interest
by the United States or an agency of the United States and that are
collateralized solely by residential, multifamily, or health care
facility mortgage loan assets, or interests in such assets.
---------------------------------------------------------------------------

    \99\ Id. at section 78o-11(e)(3)(B).
---------------------------------------------------------------------------

    Commenters on the original proposal generally believed the agencies
had appropriately proposed to implement this statutory exemption from
the risk retention requirement. Some commenters remarked that the broad
exemptions granted to government institutions and programs, which are
unrelated to prudent underwriting, are another reason that transactions
securitizing loans with private mortgage insurance should be exempted
because, without including private mortgage insurance, the rule may
encourage excessive reliance on such exemption and undermine the
effectiveness of risk retention.
    Commenters also generally believed that the agencies were correct
in believing the federal department or agency issuing, insuring or
guaranteeing the ABS or collateral would monitor the quality of the
assets securitized. One commenter noted that, in its experience,
federal programs are sufficiently monitored to ensure the safety and
consistency of the securitization and public interest. One commenter
said that it would seem that any U.S. guarantee or insurance program
should be exempt if it provides at least the same amount of coverage as
the risk retention requirement, and another commenter said that the
exemption should be broad enough to cover all federal insurance and
guarantee programs. One commenter noted that the exemption seemed to
prevent the mixing of U.S. direct obligations and U.S. insured or
guaranteed obligations because the proposed rule would only allow an
exemption for transactions collateralized either solely by U.S. direct
obligations or solely by assets that are fully insured or guaranteed as
to the payment of principal and interest by the U.S. Certain commenters
urged the agencies to extend the government-backed exemptions to ABS
backed by foreign governments, similar to the European Union's risk
retention regime which includes a general exemption for transactions
backed by ``central government'' claims without restriction.
    Several commenters urged the agencies to revise the government
institutions and programs exemption to include an exemption for
securitizations consisting of student loans made under the Federal
Family Education Loan Program (``FFELP''). In particular, these
commenters believe an exemption is warranted because FFELP loans have a
U.S.-backed guarantee on 97 percent to 100 percent of defaulted
principal and interest under the FFELP guarantee programs administered
by the Department of Education. These commenters noted that FFELP loans
benefit from a higher level of federal government support than Veterans
Administration loans (25 percent to 50 percent) and Department of
Agriculture Rural Development loans (up to 90 percent). These
commenters also noted that risk retention would have no effect on the
underwriting standards since these loans have been funded already and
the program is no longer underwriting new loans. A securitizer of
student loans also noted that the Department of Education set the
standards by which FFELP loans were originated and serviced. Some
commenters said that, if the agencies do not entirely exclude FFELP
loan securitizations from the risk retention requirement, at a minimum
the agencies should only require risk retention on the non-FFELP
portion of the ABS portfolio.\100\
---------------------------------------------------------------------------

    \100\ One commenter requested an exemption for the sponsor of
short-term notes issued by Straight-A Funding, LLC. As Straight-A
Funding, LLC will not have ABS interests outstanding after January
19, 2014, such an exemption is not necessary.
---------------------------------------------------------------------------

    Two commenters on the original proposal urged the agencies to
include an exemption for ABS collateralized by any credit instrument
extended under the federal guarantee program for bonds and notes issued
for eligible community or economic development purposes established
under the Community Development Financial Institutions (``CDFI'') bond
program. Therefore, because credit risk retention was addressed and
tailored specifically for the CDFI program, it was this commenter's
view that the CDFI program transactions were designed to be exempt from
the final credit risk retention requirements of section 15G of the
Exchange Act in accordance with section 94l(b) of the Dodd-Frank Act.
    The agencies are again proposing, without changes from the original
proposal, the exemption from the risk retention requirements for any
securitization transaction that is collateralized solely by
residential, multifamily, or health care facility mortgage loan assets
if the assets are insured or guaranteed in whole or in part as to the
payment of principal and interest by the United States or an agency of
the United States. The agencies are also proposing, without changes
from the original proposal, the exemption from the risk retention
requirements for any securitization transaction that involves the
issuance of ABS if the ABS are insured or guaranteed as to the payment
of principal and interest by the United States or an agency of the
United States and that are collateralized solely by residential,
multifamily, or health care facility mortgage loan assets, or interests
in such assets.
    In addition, taking into consideration comments received on the
original proposal, the agencies are proposing a separate provision for
securitization transactions that are collateralized by FFELP loans.
Under the proposed rule, a securitization transaction that is
collateralized (excluding servicing assets) solely by FFELP loans that
are guaranteed as to 100 percent of defaulted principal and accrued
interest (i.e., FFELP loans with first disbursement prior to October
1993 or pursuant to certain limited circumstances where a full
guarantee was required) would be exempt from the risk retention
requirements. A securitization transaction that is collateralized
solely (excluding servicing assets) by FFELP loans that are guaranteed
as to at least 98 percent of defaulted principal and accrued interest
would have its risk retention requirement reduced to 2 percent.\101\
This means that if the lowest guaranteed

amount for any FFELP loan in the pool is 98 percent (i.e., a FFELP loan
with first disbursement between October 1993 and June 2006), the risk
retention requirement for the entire transaction would be 2 percent.
Similarly, under the proposed rule, a securitization transaction that
is collateralized solely (excluding servicing assets) by FFELP loans
that are guaranteed as to at least 97 percent of defaulted principal
and accrued interest (in other words, all other securitizations
collateralized solely by FFELP loans) would have its risk retention
requirement reduced to 3 percent. Accordingly, if the lowest guaranteed
amount for any FFELP loan in the pool is 97 percent (i.e., a FFELP loan
with first disbursement of July 2006 or later), the risk retention
requirement for the entire transaction would be 3 percent.
---------------------------------------------------------------------------

    \101\ The definition of ``servicing assets'' is discussed in
Part II.B of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------

    The agencies believe this reduction in the risk retention
requirement is appropriate because FFELP loans have a guarantee on 97
percent to 100 percent of defaulted principal and interest under the
FFELP guarantee programs backed by the U.S. Department of Education.
Further, fairly extensive post-default servicing must be properly
performed under FFELP rules as a prerequisite to guarantee payment.
Sponsors would therefore be encouraged to select assets for
securitization with high quality underwriting standards. Furthermore,
appropriate risk management practices would be encouraged as such
proper post-default servicing will be required to restore the loan to
payment status or successfully collect upon the guarantee.
    The agencies generally are not proposing to expand general
exemptions from risk retention for other types of assets, as described
in commenters' requests above. The agencies are not creating an
exemption for short-term promissory notes issued by the Straight-A
Funding program. The agencies do not believe such an exemption is
appropriate because of the termination of the FFELP program and the
presence in the market of other sources of funding for student lending.
Additionally, the agencies are not proposing to exempt securitization
transactions that employ a mix of government-guaranteed and direct
government obligations from risk retention requirements, because the
agencies have not found evidence that such securitization transactions
currently exist in the market and the agencies have concerns about the
development of such transactions for regulatory arbitrage purposes.
    The agencies are not proposing an exemption from risk retention for
securitizations of assets issued, guaranteed or insured by foreign
government entities. The agencies do not believe it would be
appropriate to exempt such transactions from risk retention if they
were offered in the United States to U.S. investors.
    Finally, the agencies are not proposing an exemption for the CDFI
program, because the agencies do not believe such an exemption is
necessary. It does not appear that CDFI program bonds are ABS. Although
the proceeds of the bonds flow to CDFIs for use in funding community
development lending, and the community development loans are ultimately
the source of repayment on the bond, they do not collateralize the
bonds. Furthermore, even if the bonds were ABS, the bonds are fully
guaranteed by the U.S. government and therefore would qualify for other
exemptions from risk retention contemplated by section 15G of the
Exchange Act, discussed below.

B. Exemption for Securitizations of Assets Issued, Insured, or
Guaranteed by the United States or Any Agency of the United States and
Other Exemptions

    Section 15G(c)(1)(G)(ii) of the Exchange Act requires that the
agencies, in implementing risk retention regulations, provide for a
total or partial exemption from risk retention for securitizations of
assets that are issued or guaranteed by the United States or an agency
of the United States, as the agencies jointly determine appropriate in
the public interest and the protection of investors.\102\ The original
proposal would have contained full exemptions from risk retention for
any securitization transaction if the ABS issued in the transaction
were (1) collateralized solely (excluding cash and cash equivalents) by
obligations issued by the United States or an agency of the United
States; (2) collateralized solely (excluding cash and cash equivalents)
by assets that are fully insured or guaranteed as to the payment of
principal and interest by the United States or an agency of the United
States (other than residential, multifamily, or health care facility
mortgage loan securitizations discussed above); or (3) fully guaranteed
as to the timely payment of principal and interest by the United States
or any agency of the United States.
---------------------------------------------------------------------------

    \102\ Id. at 78o-11(c)(1)(G).
---------------------------------------------------------------------------

    Consistent with section 15G(e)(3)(A) of the Exchange Act, the
original proposal also would have provided an exemption from risk
retention for any securitization transaction that is collateralized
solely (excluding cash and cash equivalents) by loans or other assets
made, insured, guaranteed, or purchased by any institution that is
subject to the supervision of the Farm Credit Administration, including
the Federal Agricultural Mortgage Corporation.\103\ Additionally, the
original proposal provided an exemption from risk retention, consistent
with section 15G(c)(1)(G)(iii) of the Exchange Act,\104\ for securities
(1) issued or guaranteed by any state of the United States, or by any
political subdivision of a state or territory, or by any public
instrumentality of a state or territory that is exempt from the
registration requirements of the Securities Act by reason of section
3(a)(2) of the Securities Act or (2) defined as a qualified scholarship
funding bond in section 150(d)(2) of the Internal Revenue Code of 1986.
---------------------------------------------------------------------------

    \103\ Id. at 78o-11(e)(3)(A).
    \104\ Id. at 78o-11(c)(1)(G)(iii).
---------------------------------------------------------------------------

    Commenters on the original proposal generally believed that the
proposed exemptions would appropriately implement the relevant
provisions of the Exchange Act. Two commenters requested that the final
rule clarify that this exemption extends to securities issued on a
federally taxable as well as on a federal tax-exempt basis. Similarly,
another commenter requested that the agencies make it clear that, in
order to satisfy the qualified scholarship funding bond exemption, it
is sufficient that the issuer be the type of entity described in the
definition of qualified scholarship funding bond. One commenter did not
support the broad exemption for municipal and government entities
because it believed the exemption would provide an unfair advantage to
public mortgage insurance that is not otherwise available to private
mortgage insurance. Three commenters requested that the municipal
exemption be broadened to include special purpose entities created by
municipal entities because such special purpose entities are fully
accountable to the public and are generally created to accomplish
purposes consistent with the mission of the municipal entity.
    Another commenter said that the exemption should be broadened to
cover securities issued by entities on behalf of municipal sponsors
because the Commission has historically, through no-action letters,
deemed such securities to be exempt under section 3(a)(2) of the
Securities Act. This commenter also asked that the final rule or
adopting release clarify that any ``separate security'' under Rule 131
under the Securities Act would also be exempt under the risk retention
rule.

One commenter stated that an exemption was appropriate in this
circumstance because state and municipal issuers are required by state
constitutions to carry out a ``public purpose,'' which excludes a
profit motive.
    Several commenters recommended the agencies broaden the exemption
so that all state agency and nonprofit student lenders (regardless of
section 150(d) qualification) would be exempt from the rule. In
general, these commenters stated that an exemption would be appropriate
because requiring risk retention by these entities would be unnecessary
and will cause them financial distress, thus impairing their ability to
carry out their public-interest mission. One commenter said that the
original proposal would make an erroneous distinction between nonprofit
lenders that use section 150(d) and those who do not because both types
of nonprofit student lenders offer the same level of retained risk.
Also, the group noted that nonprofit and state agency student lenders
are chartered to perform a specific public purpose--to provide
financing to prospective students who want to enroll in higher
education institutions. However, one commenter did not support a broad
exemption for nonprofit student lenders because there did not appear to
be anything inherent in a nonprofit structure that would protect
investors in securitizations. Further, this commenter noted that there
have been nonprofit private education lenders whose business model
differs little from for-profit lenders.
    After considering the comments received, the agencies are again
proposing the exemptions under section 15G(c)(1)(G)(ii) of the Exchange
Act without substantive modifications from the original proposal. The
agencies believe that broadening the scope of the exemption to cover
private entities that are affiliated with municipal entities, but that
are not themselves municipal entities, would go beyond the statutory
scope of section 15G(c)(1)(G)(iii) of the Exchange Act. Similarly, the
agencies are not expanding the originally proposed exemptions to cover
nonprofit student loan lenders. The agencies believe that nonprofit
student loan lending differs little from for-profit student loan
lending and that there does not appear to be anything inherent in the
underwriting practices of nonprofit student loan lending to suggest
that these securitizations align interests of securitizers with
interests of investors so that an exemption would be appropriate under
section 15G(c)(1)(G) or section 15G(e) of the Exchange Act.

C. Exemption for Certain Resecuritization Transactions

    Under the original proposal, certain ABS issued in resecuritization
transactions \105\ (resecuritization ABS) would have been exempted from
the credit risk retention requirements if they met two conditions.
First, the transaction had to be collateralized solely by existing ABS
issued in a securitization transaction for which credit risk was
retained as required under the original proposal, or which was
otherwise exempted from credit risk retention requirements (compliant
ABS). Second, the transaction had to be structured so that it involved
the issuance of only a single class of ABS interests and provided for a
pass through of all principal and interest payments received on the
underlying ABS (net of expenses of the issuing entity) to the holders
of such class of ABS. Because the holder of a resecuritization ABS
structured as a single-class pass-through security would have a
fractional undivided interest in the pool of underlying ABS and in the
distributions of principal and interest (including prepayments) from
these underlying ABS, the agencies reasoned that a resecuritization ABS
meeting these requirements would not alter the level or allocation of
credit and interest rate risk on the underlying ABS.
---------------------------------------------------------------------------

    \105\ In a resecuritization transaction, the asset pool
underlying the ABS issued in the transaction comprises one or more
asset-backed securities.
---------------------------------------------------------------------------

    In the original proposal, the agencies proposed to adopt this
exemption under the general exemption provisions of section 15G(e)(1)
of the Exchange Act.\106\ The agencies noted that a resecuritization
transaction that created a single-class pass-through would neither
increase nor reallocate the credit risk inherent in that underlying
compliant ABS, and that the transaction could allow for the combination
of ABS backed by smaller pools, and the creation of ABS that may be
backed by more geographically diverse pools than those that can be
achieved by the pooling of individual assets. As a result, the
exemption for this type of resecuritization could improve the access of
consumers and businesses to credit on reasonable terms.\107\
---------------------------------------------------------------------------

    \106\ As discussed above in Part IV of this SUPPLEMENTARY
INFORMATION, the agencies may jointly adopt or issue exemptions,
exceptions, or adjustments to the risk retention rules, if such
exemption, exception, or adjustment would: (A) Help ensure high
quality underwriting standards for the securitizers and originators
of assets that are securitized or available for securitization; and
(B) encourage appropriate risk management practices by the
securitizers and originators of assets, improve the access of
consumers and businesses to credit on reasonable terms, or otherwise
be in the public interest and for the protection of investors. 15
U.S.C. 78o-11(e)(1).
    \107\ See Original Proposal, 76 FR at 24138.
---------------------------------------------------------------------------

    Under the original proposal, sponsors of resecuritizations that
were not structured purely as single-class pass-through transactions
would have been required to meet the credit risk retention requirements
with respect to such resecuritizations unless another exemption for the
resecuritization was available. Thus, the originally proposed rule
would subject resecuritizations to separate risk retention requirements
that separate the credit or pre-payment risk of the underlying ABS into
new tranches.\108\
---------------------------------------------------------------------------

    \108\ For example, under the proposed rules, the sponsor of a
CDO would not meet the proposed conditions of the exemption and
therefore would be required to retain risk in accordance with the
rule with respect to the CDO, regardless of whether the underlying
ABS have been drawn exclusively from compliant ABS. See 15 U.S.C.
78o-11(c)(1)(F). In a typical CDO transaction, a securitizer pools
interests in the mezzanine tranches from many existing ABS and uses
that pool to collateralize the CDO. Repayments of principal on the
underlying ABS interests are allocated so as to create a senior
tranche, as well as supporting mezzanine and equity tranches of
increasing credit risk. Specifically, as periodic principal payments
on the underlying ABS are received, they are distributed first to
the senior tranche of the CDO and then to the mezzanine and equity
tranches in order of increasing credit risk, with any shortfalls
being borne by the most subordinate tranche then outstanding.
    Similarly, with regard to ABS structured to protect against pre-
payment risk or that are structured to achieve sequential paydown of
tranches, the agencies reasoned that although losses on the
underlying ABS would be allocated to holders in the resecuritization
on a pro rata basis, holders of longer duration classes in the
resecuritization could be exposed to a higher level of credit risk
than holders of shorter duration classes. See Original Proposal, 76
FR at 24138 n.193.
---------------------------------------------------------------------------

    The agencies received a number of comments on the resecuritization
exemption in the original proposal, principally but not exclusively
from financial entities and financial trade organizations. The
commenters, including investor members of one trade organization,
generally favored expanding the resecuritization exemption and allowing
greater flexibility in these transactions, although individual
commenters differed in how broad a new exemption should be. Further,
while many commenters generally supported the first criterion for the
proposed exemption that the ABS used in the resecuritization must be
compliant with, or exempt from, the risk retention rules, they did not
support the second criterion that only a single class pass-through be
issued in the resecuritization transaction for the proposed exemption
to apply. In particular, they did not believe that this condition would

further the goal of improving underwriting of the underlying assets,
although they believed that it would unnecessarily restrict a source of
liquidity in the market place.
    A few commenters asserted that applying risk retention to
resecuritization of ABS that are already in the market place, whether
or not the interests are compliant ABS, cannot alter the incentives for
the original ABS sponsor to create high-quality assets. Some commenters
also stated that resecuritizations allowed the creation of specific
tranches of ABS interests, such as planned asset class securities, or
principal or interest only strips, that are structured to meet specific
demands of investors, so that subjecting such transactions to
additional risk retention (possibly discouraging the issuance of such
securities) could prevent markets from efficiently fulfilling investor
needs. Commenters also noted that resecuritization transactions allow
investors to sell ABS interests that they may no longer want by
creating assets that are more highly valued by other investors, thereby
improving the liquidity of these assets. Another commenter advised that
the rule should encourage resecuritizations that provided additional
collateral or enhancements such as insurance policies for the
resecuritization ABS. Another commenter noted that resecuritizations of
mortgage backed securities were an important technical factor in the
recent run up in prices and that requiring additional risk retention
would chill the market unnecessarily.
    Some comments suggested that the agencies should expand the
exemption to some common types of resecuritizations, but not apply it
to CDOs. To distinguish which should be subject to the exemption,
commenters suggested not extending the exemption to transactions with
managed pools of collateral, or limiting the types or classes of ABS
that could be resecuritized, and the derivatives an issuing entity
could use. A few commenters specifically stated that the
resecuritization exemption should be extended to include sequential pay
resecuritizations or resecuritizations structured to address prepayment
risk, if they were collateralized by compliant ABS. Another commenter
recommended that the exemption include any tranched resecuritizations
(such as typical collateralized mortgage obligations) of ABS issued or
guaranteed by the U.S. government, the Government National Mortgage
Associations or the Enterprises, as these instruments were an important
source of liquidity for the underlying assets.
    Finally, one commenter requested clarification as to whether the
resecuritizations of Enterprise ABS, guaranteed by the Enterprises,
would be covered by the provision for Enterprises in the original
proposal. The agencies are clarifying that to the extent the
Enterprises act as sponsor for a resecuritization of their ABS, fully
guarantee the resulting securities as to principal and interest, and
meet the other conditions the agencies are again proposing, that
provision would apply to the Enterprise securitization
transaction.\109\
---------------------------------------------------------------------------

    \109\ See proposed rule at Sec.  ----.8. The wording of the
provision as proposed is not limited to just initial Enterprise-
sponsored securitization transactions but would also apply to ABS
created by Enterprise-sponsored resecuritizations, as long as all
the proposed conditions are met.
---------------------------------------------------------------------------

    The agencies continue to believe that the resecuritization
exemption from the original proposal is appropriate for the reasons
discussed in that proposal, and above. Accordingly, the agencies are
again proposing this provision without substantive change.
Additionally, the agencies have carefully considered comments asking
for expansion of the resecuritization exemption. In this respect, the
agencies have considered that sponsors of resecuritization transactions
would have considerable flexibility in choosing what ABS interests to
include in an underlying pool as well as in creating the specific
structures. This choice of securities is essentially the underwriting
of those securities for selection in the underlying pool. The agencies
consider it appropriate, therefore, to propose rules that would provide
sponsors with sufficient incentive to choose ABS that have lower levels
of credit risk and to not use a resecuritization to obscure what might
have been sub-par credit performance of certain ABS. It is also
appropriate to apply the risk retention requirements in
resecuritization transactions because resecuritization transactions can
result in re-allocating the credit risk of the underlying ABS interest.
Taking into account these considerations, the agencies believe that
requiring additional risk retention as the standard for most
resecuritization transactions is consistent with the intent of section
15G of the Exchange Act, both in light of recent history and the
specific statutory requirement that the agencies adopt risk retention
standards for CDOs, and similar instruments collateralized by ABS.\110\
---------------------------------------------------------------------------

    \110\ See 15 U.S.C. 78o-11(c)(1)(F).
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    The agencies note that to qualify for the proposed resecuritization
exemptions, the ABS that are resecuritized would have to be compliant
ABS. As the agencies noted in the original proposal, section 15G of the
Exchange Act would not apply to ABS issued before the effective date of
the agencies' final rules,\111\ and that as a practical matter,
private-label ABS issued before the effective date of the final rules
would typically not be compliant ABS. ABS issued before the effective
date that meet the terms of an exemption from the proposed rule or that
are guaranteed by the Enterprises, however, could qualify as compliant
ABS.
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    \111\ See id. at section 78o-11(i) (regulations become effective
with respect to residential mortgage-backed ABS one year after
publication of the final rules in the Federal Register, and two
years for all other ABS).
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    The agencies also do not believe that many of the commenters'
suggestions for distinguishing ``typical'' resecuritizations from CDOs
or other higher risk transactions could be applied consistently across
transactions. The agencies, however, are proposing a modification to
the original proposal in an effort to address comments about liquidity
provision to the underlying markets and access to credit on reasonable
terms while remaining consistent with the purpose of the statute.
Certain RMBS resecuritizations are designed to address pre-payment risk
for RMBS, because RMBS tend to have longer maturities than other types
of ABS and high pre-payment risk. In this market, investors often seek
securities structured to protect against pre-payment risk and have
greater certainty as to expected life. At the same time, these
resecuritizations do not divide again the credit risk of the underlying
ABS with new tranches of differing subordination and therefore do not
give rise to the same concerns as CDOs and similar resecuritizations
that involve a subsequent tranching of credit risk.
    Accordingly, the agencies are proposing a limited expansion of the
resecuritization exemption to include certain resecuritizations of RMBS
that are structured to address pre-payment risk, but that do not re-
allocate credit risk by tranching and subordination structures. To
qualify for this exemption, the transaction would be required to meet
all of the conditions set out in the proposed rule. First, the
transaction must be a resecuritization of first-pay classes of ABS,
which are themselves collateralized by first-lien residential mortgage
located in a state of the United States or its territories.\112\

The proposal would define ``first-pay class'' as a class of ABS
interests for which all interests in the class are entitled to the same
priority of principal payment and that, at the time of closing of the
transaction, are entitled to repayments of principal and payments of
interest prior to or pro-rata, except for principal-only and interest
only tranches that are prior in payment, with all other classes of
securities collateralized by the same pool of first-lien residential
mortgages until such class has no principal or notional balance
remaining.\113\ The proposed rule also would allow a pool
collateralizing an exempted resecuritization to contain servicing
assets.\114\
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    \112\ Section 2 of the proposed rule defines ``state'' as having
the same meaning as in section 3(a)(16) of the Securities Exchange
Act of 1934 (15 U.S.C. 78c(a)(16)). Thus, the mortgages underlying
the ABS interest that would be re-securitized in a transaction
exempted under this provision must be on property located in a state
of the United States, the District of Columbia, Puerto Rico, the
Virgin Islands, or any other possession of the United States.
    \113\ A single class pass-through ABS under which an investor
would have a fractional, undivided interest in the pool of mortgages
collateralizing the ABS would qualify as a ``first pay class'' under
this definition.
    \114\ The proposed definition of ``servicing assets'' is
discussed in Part II of this Supplementary Information.
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    In addition, the proposed rule would require that the first-pay
classes of ABS used in the resecuritization transaction consist of
compliant ABS. Further, to qualify for the exemption any ABS interest
issued in the resecuritization would be required to share pro rata in
any realized principal losses with all other ABS holders of ABS
interests issued in the resecuritization based on the unpaid principal
balance of such interest at the time the loss is realized.
    The proposed rule would also require the transaction to be
structured to reallocate pre-payment risk and specifically would
prohibit any structure which re-allocates credit risk (other than
credit risk reallocated only as a collateral consequence of
reallocating pre-payment risk). It would also prohibit the issuance of
an inverse floater or any similarly structured class of ABS as part of
the exempt resecuritization transaction. The proposal would define
``inverse floater'' as an ABS interest issued as part of a
securitization transaction for which interest or other income is
payable to the holder based on a rate or formula that varies inversely
to a reference rate of interest.
    The exclusion from the proposed exemption of transactions involving
the issuance of an inverse floater class would address the high risk of
loss that has been associated with these instruments.
    The agencies are proposing the expanded exemptions from risk
retention for resecuritizations of first-pay classes of RMBS under the
general exemption provisions of section 15G(e)(1) of the Exchange Act,
and believe that the provision is consistent with the requirements of
this section. The provisions that would limit the exemption to
resecuritizations of first-pay classes of RMBS, and the specific
prohibitions on structures that re-allocate credit risk, would also
help minimize credit risk associated with the resecuritization ABS and
prevent the transaction from reallocating existing credit risk.
Request for Comment
    73(a). Would the issuance of an inverse floater class of ABS be
necessary to properly structure other classes of ABS to provide
adequate pre-payment protection for investors as part of the
resecuritization transaction? 73(b). Would this prohibition frustrate
the goals of the proposed exemption?

D. Other Exemptions From Risk Retention Requirements

    In the original proposal, the agencies' requested comment about
whether there were other securitization transactions not covered by the
exemptions in the original proposal that should be exempted from risk
retention. The agencies received requests from commenters for
exemptions from risk retention for some types of assets, as discussed
below. After carefully considering the comments, the agencies are
proposing some additional exemptions from risk retention that were not
included in the original proposal.
1. Utility Legislative Securitizations
    Some commenters on the original proposal requested that the
agencies exempt ABS issued by regulated electric utilities that are
backed by stranded costs, transition property, system restoration
property and other types of property specifically created or defined
for regulated utility-related securitizations by state legislatures
(utility legislative securitizations). These commenters asserted that
risk retention for these transactions would not encourage better
underwriting or otherwise promote the purposes of the risk retention
requirement, because a utility legislative securitization can generally
only occur after findings by a state legislature and a public service
commission that it is desirable in the interest of utility consumers
and after utility executives representing the utility's investors seek
such financing. According to commenters, the structure is used to
minimize the costs of financing significant utility-related costs, and
the increase in the cost of such financing that would result from risk
retention would not be warranted, because it would not affect credit
quality of the underlying assets. Further, commenters asserted that
this type of financing avoids the risk of poor underwriting standards,
adverse selection and minimizes credit risk, because the utility
sponsor does not choose among its customers for inclusion or exclusion
from the transaction and because the financing order mechanism, or
choose order of repayment.
    The agencies have considered these comments and are proposing to
provide an exemption from risk retention for utility legislative
securitizations. Specifically, the re-proposed rule would exempt any
securitization transaction where the ABS are issued by an entity that
is wholly owned, directly or indirectly, by an investor-owned utility
company that is subject to the regulatory authority of a state public
utility commission or other appropriate state agency. Additionally, ABS
issued in an exempted transaction would be required to be secured by
the intangible property right to collect charges for the recovery of
specified costs and such other assets of the issuing entity. The
proposed rule would define ``specified cost'' to mean any cost
identified by a state legislature as appropriate for recovery through
securitization pursuant to ``specified cost recovery legislation,''
which is legislation enacted by a state that:
     Authorizes the investor-owned utility company to apply
for, and authorized the public utility commission or other appropriate
state agency to issue, a financing order determining the amount of
specified costs the utility will be allowed to recover;
     Provides that pursuant to a financing order, the utility
acquires an intangible property right to charge, collect, and receive
amounts necessary to provide for the full recovery of the specified
costs determined to be recoverable, and assures that the charges are
non-bypassable and will be paid by customers within the utility's
historic service territory who receive utility goods or services
through the utility's transmission and distribution system, even if
those customers elect to purchase these goods or services from a third
party; and
     Guarantees that neither the state nor any of its agencies
has the authority to

rescind or amend the financing order, to revise the amount of specified
costs, or in any way to reduce or impair the value of the intangible
property right, except as may be contemplated by periodic adjustments
authorized by the specified cost recovery legislation.\115\
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    \115\ The eligibility standards for the exemption are similar to
certain requirements for these securitizations outlined in IRS
Revenue Procedure 2005-62, 2005-2 C.B. 507, that are relevant to
risk retention. This Revenue Procedure outlines the Internal Revenue
Service's requirements in order to treat the securities issued in
these securitizations as debt for tax purposes, which is the primary
motivation for states and public utilities to engage in such
securitizations.
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    As a general matter, the agencies believe that, although it falls
somewhat short of being an explicit state guarantee, the financing
order mechanism typical in utility legislative securitizations (by
which, under state law, the state periodically adjusts the amount the
utility is authorized to collect from users of its distribution
network) would ensure to a sufficient degree that adequate funds are
available to repay investors.
2. Seasoned Loans
    Some commenters on the original proposal urged the agencies to
create an exemption for securitizations of loans that were originated a
significant period of time prior to securitization (seasoned loans) and
that had remained current, because underwriting quality would no longer
be as relevant to the credit performance of such loans. Commenters
representing different groups provided different suggestions on the
length of time required for a loan to be seasoned: sponsors
representing issuers suggested a two-year seasoning period for all
loans, whereas commenters representing investors suggested fully
amortizing fixed-rate loans should be outstanding and performing for
three years and for adjustable-rate loans the time period should depend
on the reset date of the loan.
    The agencies believe that risk retention as a regulatory tool to
promote sound underwriting is less relevant after loans have been
performing for an extended period of time. Accordingly, for reasons
similar to the sunset provisions in section 12(f) of the proposed rule
(as discussed in Part IV.F of this Supplementary Information), the
agencies are proposing an exemption from risk retention for
securitizations of seasoned loans that is similar to the sunset
provisions. The proposed rule would exempt any securitization
transaction that is collateralized solely (excluding servicing assets)
by seasoned loans that (1) have not been modified since origination and
(2) have never been delinquent for 30 days or more.\116\ With respect
to residential mortgages, the proposed rule would define ``seasoned
loan'' to mean a residential mortgage loan that either (1) has been
outstanding and performing for the longer of (i) five years or (ii) the
period until the outstanding principal balance of the loan has been
reduced to 25 percent of the original principal balance; or (2) has
been outstanding and performing for at least seven years. For all other
asset classes, the proposed rule would define ``seasoned loan'' to mean
a loan that has been outstanding and performing for the longer of (1)
two years, or (2) the period until the outstanding principal balance of
the loan has been reduced to 33 percent of the original principal
balance.
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    \116\ The definition of ``servicing assets'' is discussed in
Part II.B of this SUPPLEMENTARY INFORMATION.
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3. Legacy Loan Securitizations
    Some commenters on the original proposal recommended an exemption
from risk retention for securitizations and resecuritizations of loans
made before the effectiveness of the final rule, or legacy loans,
arguing that risk retention would not affect the underwriting standards
used to create those loans.
    The agencies are not proposing to provide an exemption from risk
retention for securitizations of loans originated before the effective
date of the rule (legacy loans). The agencies do not believe that such
securitizations should be exempt from risk retention because
underwriting occurred before the effective date of the rule. The
agencies believe that requiring risk retention does affect the quality
of the loans that are selected for a securitization transaction, as the
risk retention requirements are designed to incentivize securitizers to
select well-underwritten loans, regardless of when those loans were
underwritten. Furthermore, the agencies do not believe that exempting