[Federal Register Volume 79, Number 247 (Wednesday, December 24, 2014)]
[Rules and Regulations]
[Pages 77601-77766]
[FR Doc No: 2014-29256]

Vol. 79

Wednesday,

No. 247

December 24, 2014

Part II

Department of the Treasury

Office of the Comptroller of the Currency

12 CFR Part 43

Federal Reserve System

12 CFR Part 244

Federal Deposit Insurance Corporation

12 CFR Part 373

Federal Housing Finance Agency

12 CFR Part 1234

Securities and Exchange Commission

17 CFR Part 246

Department of Housing and Urban Development

24 CFR Part 267

Credit Risk Retention; Rule

Federal Register / Vol. 79 , No. 247 / Wednesday, December 24, 2014 /
Rules and Regulations

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 43

[Docket No. OCC-2013-0010]
RIN 1557-AD40

FEDERAL RESERVE SYSTEM

12 CFR Part 244

[Docket No. R-1411]
RIN 7100-AD70

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 373

RIN 3064-AD74

FEDERAL HOUSING FINANCE AGENCY

12 CFR Part 1234

RIN 2590-AA43

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 246

[Release No. 34-73407; File No. S7-14-11]
RIN 3235-AK96

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 267

RIN 2501-AD53

Credit Risk Retention

AGENCIES: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); U.S. Securities and Exchange
Commission (Commission); Federal Housing Finance Agency (FHFA); and
Department of Housing and Urban Development (HUD).

ACTION: Final rule.

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SUMMARY: The OCC, Board, FDIC, Commission, FHFA, and HUD (the agencies)
are adopting a joint final rule (the rule, or the final rule) to
implement the credit risk retention requirements of section 15G of the
Securities Exchange Act of 1934, as added by section 941 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (the Act or Dodd-
Frank Act). Section 15G generally requires the securitizer of asset-
backed securities to retain not less than 5 percent of the credit risk
of the assets collateralizing the asset-backed securities. Section 15G
includes a variety of exemptions from these requirements, including an
exemption for asset-backed securities that are collateralized
exclusively by residential mortgages that qualify as ``qualified
residential mortgages,'' as such term is defined by the agencies by
rule.

DATES: Effective date: The final rule is effective February 23, 2015.
    Compliance dates: Compliance with the rule with respect to asset-
backed securities collateralized by residential mortgages is required
beginning December 24, 2015. Compliance with the rule with regard to
all other classes of asset-backed securities is required beginning
December 24, 2016.

FOR FURTHER INFORMATION CONTACT:
    OCC: Kevin Korzeniewski, Attorney, Legislative and Regulatory
Activities Division,<PHONE_NUMBER>, for persons who are deaf or hard
of hearing, TTY,<PHONE_NUMBER>, Office of the Comptroller of the
Currency, 400 7th Street SW., Washington, DC 20219.
    Board: April C. Snyder, Senior Counsel,<PHONE_NUMBER>; Brian P.
Knestout, Counsel,<PHONE_NUMBER>; Flora H. Ahn, Counsel, (202) 452-
2317; David W. Alexander, Senior Attorney,<PHONE_NUMBER>; or Matt
Suntag, Attorney,<PHONE_NUMBER>, Legal Division; Thomas R. Boemio,
Manager,<PHONE_NUMBER>; Donald N. Gabbai, Senior Supervisory Financial
Analyst,<PHONE_NUMBER>; or Sean M. Healey, Senior Financial Analyst,
(202) 912-4611, Division of Banking Supervision and Regulation; Karen
Pence, Adviser, Division of Research & Statistics,<PHONE_NUMBER>; or
Nikita Pastor, Counsel,<PHONE_NUMBER>, Division of Consumer and
Community Affairs, Board of Governors of the Federal Reserve System,
20th and C Streets NW., Washington, DC 20551.
    FDIC: Rae-Ann Miller, Associate Director,<PHONE_NUMBER>; George
Alexander, Assistant Director,<PHONE_NUMBER>; Kathleen M. Russo,
Supervisory Counsel,<PHONE_NUMBER>; or Phillip E. Sloan, Counsel,
(703) 562-6137, Federal Deposit Insurance Corporation, 550 17th Street
NW., Washington, DC 20429.
    Commission: Arthur Sandel, Special Counsel; David Beaning, Special
Counsel; Lulu Cheng, Special Counsel; or Katherine Hsu, Chief, (202)
551-3850, in the Office of Structured Finance, Division of Corporation
Finance, U.S. Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-3628.
    FHFA: Ronald P. Sugarman, Principal Legislative Analyst,
<EMAIL_ADDRESS>(202) 649-3208; Phillip Millman, Principal
Capital Markets Specialist<EMAIL_ADDRESS>(202) 649-3080;
or Thomas E. Joseph, Associate General Counsel<EMAIL_ADDRESS>
(202) 649-3076; Federal Housing Finance Agency, Constitution Center,
400 7th Street SW., Washington, DC 20024. The telephone number for the
Telecommunications Device for the Hearing Impaired is<PHONE_NUMBER>.
    HUD: Michael P. Nixon, Office of Housing, Department of Housing and
Urban Development, 451 7th Street SW., Room 10226, Washington, DC
20410; telephone number<PHONE_NUMBER> (this is not a toll-free number).
Persons with hearing or speech impairments may access this number
through TTY by calling the toll-free Federal Information Relay Service
at<PHONE_NUMBER>.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
    A. Background
    B. Overview of the Revised Proposal and Public Comment
    C. Overview of the Final Rule
    D. Post-Adoption Interpretation and Guidance
II. General Definitions and Scope
III. General Risk Retention Requirement
    A. Minimum Risk Retention Requirement
    B. Permissible Forms of Risk Retention--Menu of Options
    1. Standard Risk Retention
    2. Master Trusts: Revolving Pool Securitizations
    3. Representative Sample
    4. Asset-Backed Commercial Paper Conduits
    5. Commercial Mortgage-Backed Securities
    6. Government-Sponsored Enterprises
    7. Open Market Collateralized Loan Obligations
    8. Municipal Bond ``Repackaging'' Securitizations
    C. Allocation to the Originator
    D. Hedging, Transfer, and Financing Restrictions
    E. Safe Harbor for Certain Foreign-Related Securitizations
    F. Sunset on Hedging and Transfer Restrictions
IV. General Exemptions
    A. Exemption for Federally Insured or Guaranteed Residential,
Multifamily, and Health Care Mortgage Loan Assets
    B. Exemption for Securitizations of Assets Issued, Insured, or
Guaranteed by the United States or any Agency of the United States
and Other Exemptions
    C. Federal Family Education Loan Program and Other Student Loan
Securitizations
    D. Certain Public Utility Securitizations
    E. Seasoned Loan Securitizations
    F. Federal Deposit Insurance Corporation Securitizations
    G. Exemption for Certain Resecuritization Transactions

    H. Other Exemptions from Risk Retention Requirements
    1. Legacy Loan Securitizations
    2. Corporate Debt Repackagings
    3. Securitizations of Servicer Advance Receivables
V. Reduced Risk Retention Requirements and Underwriting Standards
for ABS Interests Collateralized by Qualifying Commercial,
Commercial Real Estate, or Automobile Loans
    A. Qualifying Commercial Loans
    B. Qualifying Commercial Real Estate Loans
    1. Definition of Commercial Real Estate Loan
    2. Single Borrower Underwriting Standard
    3. Proposed QCRE Loan Criteria
    4. Ability to Repay Criteria and Term
    5. Loan-to-Value Requirement
    6. Collateral
    7. Risk Management and Monitoring
    C. Qualifying Automobile Loans
    1. Ability to Repay Criteria
    2. Loan Terms
    3. Reviewing Credit History
    4. Down Payment Requirement
VI. Qualified Residential Mortgages
    A. Background
    B. Overview of the Reproposed Rule
    C. Overview of Public Comments
    1. Comments Received on the Reproposed QRM Definition
    2. Comments Received on the Alternative Approach to QRM
    D. Summary and Analysis of Final QRM Definition
    1. Alignment of QRM with QM
    2. Periodic Review of the QRM Definition
    3. Definition of QRM
    E. Certification and Other QRM Issues
    F. Repurchase of Loans Subsequently Determined to be Non-
Qualified After Closing
VII. Additional Exemptions
VIII. Severability
IX. Plain Language
X. Administrative Law Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    C. Commission Economic Analysis
    D. OCC Unfunded Mandates Reform Act of 1995 Determination
    E. FHFA: Considerations of Differences between the Federal Home
Loan Banks and the Enterprises

I. Introduction

    The agencies are adopting a final rule to implement the
requirements of section 941 of the Dodd-Frank Act.\1\ Section 15G of
the Exchange Act, as added by section 941(b) of the Dodd-Frank Act,
generally requires the Board, the FDIC, the OCC (collectively, the
Federal banking agencies), the Commission, and, in the case of the
securitization of any ``residential mortgage asset,'' together with HUD
and FHFA, to jointly prescribe regulations that (i) require a
securitizer to retain not less than 5 percent of the credit risk of any
asset that the securitizer, through the issuance of an asset-backed
security (ABS), transfers, sells, or conveys to a third party, and (ii)
prohibit a securitizer from directly or indirectly hedging or otherwise
transferring the credit risk that the securitizer is required to retain
under section 15G and the agencies' implementing rules.\2\ Compliance
with the final rule with respect to securitization transactions
involving asset-backed securities collateralized by residential
mortgages is required beginning one year after the date of publication
in the Federal Register and with respect to securitization transactions
involving all other classes of asset-backed securities is required
beginning two years after the date of publication in the Federal
Register. References in this Supplemental Information and the rule
itself to the effective date of the rule (or similar references to the
date on which the rule becomes effective) are to the date on which
compliance is required.
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    \1\ Public Law 111-203, 124 Stat. 1376 (2010). Section 941 of
the Dodd-Frank Act amends the Securities Exchange Act of 1934 (the
Exchange Act) and adds a new section 15G of the Exchange Act. 15
U.S.C. 78o-11.
    \2\ See 15 U.S.C. 78o-11(b), (c)(1)(A) and (c)(1)(B)(ii).
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    Section 15G of the Exchange Act exempts certain types of
securitization transactions from these risk retention requirements and
authorizes the agencies to exempt or establish a lower risk retention
requirement for other types of securitization transactions. For
example, section 15G specifically provides that a securitizer shall not
be required to retain any part of the credit risk for an asset that is
transferred, sold, or conveyed through the issuance of ABS interests by
the securitizer, if all of the assets that collateralize the ABS
interests are ``qualified residential mortgages'' (QRMs), as that term
is jointly defined by the agencies, which definition can be ``no
broader than'' the definition of a ``qualified mortgage'' (QM) as that
term is defined under section 129C of the Truth in Lending Act
(TILA),\3\ as amended by the Dodd-Frank Act, and regulations adopted
thereunder.\4\ In addition, section 15G provides that a securitizer may
retain less than 5 percent of the credit risk of commercial mortgages,
commercial loans, and automobile loans that are transferred, sold, or
conveyed through the issuance of ABS interests by the securitizer if
the loans meet underwriting standards established by the Federal
banking agencies.\5\
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    \3\ 15 U.S.C. 1639c.
    \4\ See 15 U.S.C. 78o-11(c)(1)(C)(iii), (e)(4)(A) and (B).
    \5\ See id. at sections 78o-11(c)(1)(B)(ii) and (2).
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    Section 15G allocates the authority for writing rules to implement
its provisions among the agencies in various ways. As a general matter,
the agencies collectively are responsible for adopting joint rules to
implement the risk retention requirements of section 15G for
securitizations that are collateralized by residential mortgage assets
and for defining what constitutes a QRM for purposes of the exemption
for QRM-backed ABS interests.\6\ The Federal banking agencies and the
Commission, however, are responsible for adopting joint rules that
implement section 15G for securitizations collateralized by all other
types of assets,\7\ and are authorized to adopt rules in several
specific areas under section 15G.\8\ In addition, the Federal banking
agencies are jointly responsible for establishing, by rule,
underwriting standards for non-QRM residential mortgages, commercial
mortgages, commercial loans, and automobile loans (or any other asset
class established by the Federal banking agencies and the Commission)
that would qualify sponsors of ABS interests collateralized by these
types of loans for a risk retention requirement of less than 5
percent.\9\ Accordingly, when used in this final rule, the term
``agencies'' shall be deemed to refer to the appropriate agencies that
have rulewriting authority with respect to the asset class,
securitization transaction, or other matter discussed.
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    \6\ See id. at sections 78o-11(b)(2), (e)(4)(A) and (B).
    \7\ See id. at section 78o-11(b)(1).
    \8\ See, e.g. id. at sections 78o-11(b)(1)(E) (relating to the
risk retention requirements for ABS collateralized by commercial
mortgages); (b)(1)(G)(ii) (relating to additional exemptions for
assets issued or guaranteed by the United States or an agency of the
United States); (d) (relating to the allocation of risk retention
obligations between a securitizer and an originator); and (e)(1)
(relating to additional exemptions, exceptions or adjustments for
classes of institutions or assets).
    \9\ See id. at section 78o-11(b)(2)(B).
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    For ease of reference, the final rule of the agencies is referenced
using a common designation of section 1 to section 21 (excluding the
title and part designations for each agency). With the exception of
HUD, each agency is codifying the rule within its respective title of
the Code of Federal Regulations.\10\ Section 1 of each

agency's rule identifies the entities or transactions subject to such
agency's rule.
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    \10\ Specifically, the agencies codify the rule as follows: 12
CFR part 43 (OCC); 12 CFR part 244 (Regulation RR) (Board); 12 CFR
part 373 (FDIC); 17 CFR part 246 (Commission); 12 CFR part 1234
(FHFA). As required by section 15G, HUD has jointly prescribed the
final rule for a securitization that is collateralized by any
residential mortgage asset and for purposes of defining a qualified
residential mortgage. Because the final rule exempts the programs
and entities under HUD's jurisdiction from the requirements of the
final rule, HUD does not codify the rule into its title of the Code
of Federal Regulations.
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    Consistent with section 15G of the Exchange Act, the risk retention
requirements will become effective, for securitization transactions
collateralized by residential mortgages, one year after the date on
which the final rule is published in the Federal Register, and two
years after the date on which the final rule is published in the
Federal Register for any other securitization transaction.
    In April 2011, the agencies published a joint notice of proposed
rulemaking that proposed to implement section 15G of the Exchange Act
(the ``original proposal'').\11\ The agencies invited and received
comment from the public on the original proposed rule. In September
2013, the agencies published a second joint notice of proposed
rulemaking (the ``revised proposal'' or ``reproposal'') that proposed
significant modifications to the original proposal and that again
invited comment from the public.\12\ As described in more detail below,
the agencies are adopting the revised proposal with some changes in
response to comments received.
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    \11\ Credit Risk Retention; Proposed Rule, 76 FR 24090 (April
29, 2011).
    \12\ Credit Risk Retention; Proposed Rule, 78 FR 57928
(September 20, 2013).
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    As discussed further below, the final rule retains the framework of
the revised proposal. Unless an exemption under the rule applies,
sponsors of securitizations that issue ABS interests must retain risk
in accordance with the standardized risk retention option (an eligible
horizontal residual interest (as defined in the rule) or an eligible
vertical interest (as defined in the rule) or a combination of both) or
in accordance with one of the risk retention options available for
specific types of asset classes, such as asset-backed commercial paper
(ABCP). The final rule includes, with some modifications, those
exemptions set forth in the revised proposal, including for QRMs. In
addition, in response to comments and for the reasons discussed in Part
VII of this Supplementary Information, the agencies are providing an
additional exemption from risk retention for certain types of
community-focused residential mortgages that are not eligible for QRM
status under the final rule and are exempt from the ability-to-pay
rules under the TILA.\13\ The agencies are not exempting managers of
certain collateralized loan obligations (CLOs) from risk retention, as
requested by commenters, for the reasons discussed in Part III.B.7 of
this Supplementary Information.
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    \13\ 15 U.S.C. 1639c.
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    The agencies have made adjustments and modifications to the risk
retention and underwriting requirements, as discussed in further detail
below. Of particular note, under the final rule, the agencies are not
adopting the proposed requirement that a sponsor holding an eligible
horizontal residual interest be subject to the cash flow restrictions
in the revised proposal or any similar cash flow restrictions. In
addition, the agencies accepted commenters' views that a fair value
calculation was not necessary for vertical retention and are not
requiring the eligible vertical interest to be measured using fair
value. The agencies are also making some adjustments to the disclosure
requirements associated with the fair value calculation for an eligible
horizontal residual interest. The final rule also includes a provision
that requires the agencies to periodically review the definition of
QRM, the exemption for certain community-focused residential mortgages,
and the exemption for certain three-to-four unit residential mortgage
loans and consider whether they should be modified, as discussed
further below in Parts VI and VII of this Supplementary Information.
The final rule also includes several adjustments and modifications to
the proposed risk retention options for specific asset classes in order
to address specific functional concerns and avoid unintended
consequences.

A. Background

    As the agencies observed in the preambles to the original and
revised proposals, the securitization markets are an important link in
the chain of entities providing credit to U.S. households and
businesses, and state and local governments.\14\ When properly
structured, securitization provides economic benefits that can lower
the cost of credit.\15\ However, when incentives are not properly
aligned and there is a lack of discipline in the credit origination
process, securitization can result in harmful consequences to
investors, consumers, financial institutions, and the financial system.
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    \14\ Securitization may reduce the cost of funding, which is
accomplished through several different mechanisms. For example,
firms that specialize in originating new loans and that have
difficulty funding existing loans may use securitization to access
more-liquid capital markets for funding. In addition, securitization
can create opportunities for more efficient management of the asset-
liability duration mismatch generally associated with the funding of
long-term loans, for example, with short-term bank deposits.
Securitization also allows the structuring of securities with
differing maturity and credit risk profiles from a single pool of
assets that appeal to a broad range of investors. Moreover,
securitization that involves the transfer of credit risk allows
financial institutions that primarily originate loans to particular
classes of borrowers, or in particular geographic areas, to limit
concentrated exposure to these idiosyncratic risks on their balance
sheets.
    \15\ Report to the Congress on Risk Retention, Board of
Governors of the Federal Reserve System, at 8 (October 2010),
available at http://federalreserve.gov/boarddocs/rptcongress/securitization/riskretention.pdf (Board Report).
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    During the financial crisis, securitization transactions displayed
significant vulnerabilities arising from inadequate information and
incentive misalignment among various parties involved in the
process.\16\ Investors did not have access to the same information
about the assets collateralizing asset-backed securities as other
parties in the securitization chain (such as the sponsor of the
securitization transaction or an originator of the securitized
loans).\17\ In addition, assets were resecuritized into complex
instruments, which made it difficult for investors to discern the true
value of, and risks associated with, an investment in the
securitization, as well as exercise their rights in the instrument.\18\
Moreover, some lenders loosened their underwriting standards, believing
that the loans could be sold through a securitization by a sponsor, and
that both the lender and sponsor would retain little or no continuing
exposure to the loans.\19\ Arbitrage between various markets and market
participants, and in particular between the Enterprises and the private
securitization markets, resulted in lower underwriting standards which
undermined the quality of the instruments collateralized by such loans
and ultimately the health of the financial markets and their
participants.\20\
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    \16\ See Board Report at 8-9.
    \17\ See S. Rep. No. 111-176, at 128 (2010).
    \18\ See id.
    \19\ See id.
    \20\ See, e.g., Viral V. Acharya, Governments as Shadow Banks:
The Looming Threat to Financial Stability, at 32 (Sept. 2011),
available at http://www.federalreserve.gov/events/conferences/2011/rsr/papers/Acharya.pdf.
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    Congress intended the risk retention requirements mandated by
section 15G to help address problems in the securitization markets by
requiring that securitizers, as a general matter, retain an economic
interest in the credit risk of the assets they securitize. By requiring
that a securitizer retain a portion of the credit risk of the
securitized assets, the requirements of section 15G provide
securitizers an incentive to monitor and ensure the quality of the
securitized assets

underlying a securitization transaction, and, thus, help align the
interests of the securitizer with the interests of investors.
Additionally, in circumstances where the securitized assets
collateralizing the ABS interests meet underwriting and other standards
designed to help ensure the securitized assets pose low credit risk,
the statute provides or permits an exemption.\21\
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    \21\ See 15 U.S.C. 78o-11(c)(1)(B)(ii), (e)(1)-(2).
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    Accordingly, the credit risk retention requirements of section 15G
are an important part of the legislative and regulatory efforts to
address weaknesses and failures in the securitization process and the
securitization markets. Section 15G also complements other parts of the
Dodd-Frank Act intended to improve the securitization markets. Such
other parts include provisions that strengthen the regulation and
supervision of nationally recognized statistical rating organizations
(NRSROs) and improve the transparency of credit ratings; \22\ provide
for issuers of registered asset-backed securities offerings to perform
a review of the securitized assets underlying the asset-backed
securities and disclose the nature of the review; \23\ require issuers
of asset-backed securities to disclose the history of the requests they
received and repurchases they made related to their outstanding asset-
backed securities; \24\ prevent sponsors and certain other
securitization participants from engaging in material conflicts of
interest with respect to their securitizations; \25\ and require
issuers of asset-backed securities to disclose, for each tranche or
class of security, information regarding the assets collateralizing
that security, including asset-level or loan-level data, if such data
is necessary for investors to independently perform due diligence.\26\
Additionally, various efforts regarding mortgage servicing should also
have important benefits for the securitization markets.\27\
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    \22\ See, e.g. sections 932, 935, 936, 938, and 943 of the Dodd-
Frank Act (15 U.S.C. 78o-7, 78o-8).
    \23\ See section 945 of the Dodd-Frank Act (15 U.S.C. 77g).
    \24\ See section 943 of the Dodd-Frank Act (15 U.S.C. 78o-7).
    \25\ See section 621 of the Dodd-Frank Act (15 U.S.C. 77z-2a).
    \26\ See section 942(b) of the Dodd-Frank Act (15 U.S.C.
77g(c)).
    \27\ See, e.g., Mortgage Servicing Rules Under the Real Estate
Settlement Act (Regulation X); Final Rule, 78 FR 10696 (Feb. 14,
2013).
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    The original proposal provided several options from which sponsors
could choose to meet section 15G's risk retention requirements,
including retention of either a 5 percent ``vertical'' interest in each
class of ABS interests issued in the securitization or a 5 percent
``horizontal'' first-loss interest in the securitization, and other
options designed to reflect market practice in asset-backed
securitization transactions. The original proposal also included a
special ``premium capture'' mechanism designed to prevent a sponsor
from structuring a securitization transaction in a manner that would
allow the sponsor to offset or minimize its retained economic exposure
to the securitized assets.
    As required by section 15G, the original proposal provided a
complete exemption from the risk retention requirements for asset-
backed securities that are collateralized solely by QRMs and
established the terms and conditions under which a residential mortgage
would qualify as a QRM.\28\ The original proposal would generally have
prohibited QRMs from having product features that were observed to
contribute significantly to the high levels of delinquencies and
foreclosures since 2007 and included underwriting standards associated
with lower risk of default. The original proposal also provided that
sponsors would not have to hold risk retention for securitized
commercial, commercial real estate, and automobile loans that met
proposed underwriting standards. In the original proposal, the agencies
specified that securitization transactions sponsored by the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac) (jointly, the Enterprises) would
meet risk retention requirements for as long as the Enterprises
operated under the conservatorship or receivership of FHFA with capital
support from the United States.
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    \28\ See Original Proposal, 76 FR at 24117-24129 and 24164-
24167.
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    In response to the original proposal, the agencies received
comments from over 10,500 persons, institutions, or groups. A
significant number of comments supported the proposed menu-based
approach of providing sponsors flexibility to choose from a number of
permissible forms of risk retention, although several requested more
flexibility in selecting risk retention options, including using
multiple options simultaneously. Many commenters expressed significant
concerns with the proposed standards for horizontal risk retention and
the ``premium capture'' mechanism. Other commenters expressed concerns
with respect to standards in the original proposal for specific asset
classes and underwriting standards for non-residential asset classes
and the application of the original proposal to managers of certain CLO
transactions. A majority of commenters opposed the agencies' proposed
QRM standard, and several asserted that the agencies should align the
QRM definition with the QM definition, then under development by the
Consumer Financial Protection Bureau (CFPB).\29\
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    \29\ See 78 FR 6407 (January 30, 2013), as amended by 78 FR
35429 (June 12, 2013), 78 FR 44686 (July 24, 2013), and 78 FR 60382
(October 1, 2013) (collectively, ``Final QM rule'').
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    The agencies considered the many comments received on the original
proposal and engaged in additional analysis of the securitization and
lending markets in light of the comments. The agencies subsequently
issued the reproposal in September 2013, modifying significant aspects
of the original proposal and again inviting public comment on the
revised design of the risk retention regulatory framework to help
determine whether the revised framework was appropriately structured.

B. Overview of the Revised Proposal and Public Comment

    The agencies proposed in 2013 a risk retention rule that would have
retained much of the structure of the original proposal, but with more
flexibility in how risk retention could be held and with a broader
definition of QRM.\30\
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    \30\ See Revised Proposal, 78 FR 57928.
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    Among other things, the revised proposal provided a variety of
options for complying with a minimum 5 percent risk retention
requirement, an exemption from risk retention for residential mortgage
loans meeting the QRM standard, and exemptions from risk retention for
auto, commercial real estate, and commercial loans that met proposed
underwriting standards. With respect to the standard risk retention
option, the revised proposal provided sponsors with additional
flexibility in complying with the regulation. The revised proposal
permitted a sponsor to satisfy its obligation by retaining any
combination of an ``eligible vertical interest'' with a pro rata
interest in all ABS interests issued and a first-loss ``eligible
horizontal residual interest'' to meet the 5 percent minimum
requirement. A sponsor using solely the vertical interest option would
retain a single security or a portion of each class of ABS interests
issued in the securitization equal to at least 5 percent of all
interests, regardless of the nature of the interests themselves (for
example, whether such interests were senior or subordinated). The
agencies also proposed that the eligible horizontal residual interest
be measured using fair

value. The agencies proposed a mechanism designed to limit payments to
holders of an eligible horizontal residual interest, in order to
prevent a sponsor from structuring a transaction so that the holder of
the eligible horizontal residual interest could receive
disproportionate payments with respect to its interest. In the revised
proposal, sponsors were required to make a one-time cash flow
projection based on fair value and certify to investors that its cash
payment recovery percentages were not projected to be larger than the
recovery percentages for all other ABS interests on any future payment
date. The agencies also invited comment on an alternative proposal
relating to the amount of principal payments received by the eligible
horizontal residual interest. Under that alternative, the cumulative
amount paid to an eligible horizontal residual interest on any payment
date would not have been permitted to exceed a proportionate share of
the cumulative amount paid to all ABS interests in the transaction.
    The revised proposal also included asset class-specific options for
risk retention with some modifications from the original proposal to
better reflect existing market practices and operations. For example,
with respect to revolving pool securitizations, the agencies removed a
restriction from the original proposal that prohibited the use of the
seller's interest risk retention option for master trust
securitizations collateralized by non-revolving assets. With respect to
ABCP conduits, the agencies made a number of modifications intended to
allow the ABCP option to accommodate certain market practices discussed
in the comments and to permit more flexibility on behalf of the
originator-sellers and their majority-owned affiliates that finance
through ABCP conduits. Similarly, the agencies modified the risk
retention option designed for commercial mortgage-backed securities
(CMBS) to allow for up to two third-party purchasers to retain the
required risk retention interest, each taking a pari passu interest in
an eligible horizontal residual interest.
    Also responding to commenters' concerns, the revised proposal did
not include the premium capture cash reserve account mechanism and
``representative sample'' option included in the original proposal.
With respect to the premium capture cash reserve account mechanism, the
agencies considered that using fair value to measure the standard risk
retention amount would meaningfully mitigate the ability of a sponsor
to evade the risk retention requirement through the use of improper
deal structures intended to be addressed by the premium capture cash
reserve account. With respect to the representative sample option in
the original proposal, the agencies considered the comments received
and eliminated the option in the revised proposal on the basis that
such an option would be difficult to implement in a way that would not
result in costs that outweighed its benefits.
    The agencies retained, to a significant degree, standards for the
expiration of the hedging and transfer restrictions in the regulation.
The agencies decided in the reproposal to limit the sponsor's ability
to have all or a portion of the required retention held by its
affiliates to only a sponsor's majority-owned affiliates rather than
all consolidated affiliates as would have been allowed in the original
proposal. The agencies have included this approach in the final rule
because it ensures that any loss suffered by the holder of risk
retention will be suffered by either the sponsor or an entity in which
the sponsor has a substantial economic interest. The agencies also
largely carried over the terms of the original proposal with respect to
securitizations collateralized by qualifying commercial, commercial
real estate, or automobile loans, although modifications were proposed
to reflect commenter observations and concerns, such as permitting
junior liens to collateralize qualifying commercial loans, increasing
the amortization period on commercial real estate loans to 30 years for
multifamily residential qualified commercial real estate (QCRE) loans
and 25 years for other QCRE loans, and amending the amortization
standards for qualifying automobile loans.
    The agencies also invited comment on new exemptions from risk
retention for certain resecuritizations, seasoned loans, and certain
types of securitization transactions with low credit risk. In addition,
the agencies proposed a new risk retention option for CLOs, similar to
the allocation to originator concept proposed for sponsors generally.
    The agencies proposed to broaden and simplify the scope of the
definition of a QRM in the revised proposal to align the definition
with the definition of a QM under section 129C of the TILA \31\ and its
implementing regulations, as adopted by the CFPB.\32\ As discussed in
the revised proposal, the agencies concluded that a QRM definition that
was aligned with the QM definition would meet the statutory goals and
directive of section 15G of the Exchange Act to limit credit risk and
preserve access to affordable credit, while at the same time
facilitating compliance.
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    \31\ 15 U.S.C. 1639c.
    \32\ See 78 FR 6407 (January 30, 2013), as amended by 78 FR
35429 (June 12, 2013) and 78 FR 44686 (July 24, 2013).
---------------------------------------------------------------------------

    Along with this proposed approach to defining QRM, the agencies
also invited comment on an alternative approach that would require that
the borrower meet certain credit history criteria and that the loan be
for a principal dwelling, meet certain lien requirements, and have a
certain loan to value ratio.
    The revised proposal included a provision excluding certain foreign
sponsors of ABS interests from the risk retention requirements of
section 15G of the Exchange Act, which did not differ materially from
the corresponding provision in the original proposal.
    In response to the revised proposal, the agencies received comments
from more than 250 persons, institutions, or groups, including nearly
150 unique comment letters. The agencies received comments and
observations on many aspects of the reproposed rule. Numerous
commenters supported most aspects of the rule, but many suggested or
asked for further modifications. As discussed in further detail below,
a significant number of commenters commented on the agencies' use of
fair value to measure risk retention. Commenters' key concerns included
the timing of any fair value measurement and potential alternative
methodologies to measuring risk retention. Many commenters also
expressed concern about the proposed disclosure requirements for fair
value, and some asked for a ``safe harbor'' from liability with respect
to the disclosures.
    As with the original proposal, a number of commenters on the
revised proposal asserted that managers of open market CLOs are not
``securitizers'' within the definition in section 15G of the Exchange
Act and should not be required to retain risk. In addition, commenters
asked for an exemption from risk retention for CLOs that would meet
certain structural criteria and for a new option to allow third-party
investors in CLOs to hold risk retention instead of CLO managers.
Commenters also generally opposed the agencies' proposed alternative
for risk retention for open market CLOs in which a lead arranger in a
syndicated loan was allowed to satisfy the risk retention requirement,
asserting that this option was inconsistent with current market
practice and that lead arranger banks would be hesitant to retain risk
as proposed in the revised proposal without being allowed to hedge or
transfer that risk because they would be

concerned about criticism from bank regulators.
    The agencies' proposed definition of a QRM was also the subject of
significant commentary. Overall, commenters supported the agencies'
proposal to align the QRM definition with the QM definition. Several
commenters asked that the QRM definition accommodate the use of blended
pools of QRM and non-QRM loans. Other commenters sought more specific
expansions of the definition, including an exemption for loans
originated by community development financial institutions and other
community-focused lenders that are exempt from the ability-to-repay
requirements (and, as a result, do not qualify to be QMs under TILA),
imposition of a less than 5 percent risk retention requirement for some
loans that did not qualify for QM, and the inclusion of non-U.S.
originated loans. Several commenters expressed concern with both the
alignment of the QRM definition with the QM definition as well as the
alternative, more restrictive, definition of QRM for which the agencies
had invited comment, suggesting that the agencies use the definition of
QRM in the original proposal.
    Commenters expressed concerns on certain other aspects of the rule.
Numerous commenters opposed the cash flow restrictions on the eligible
horizontal residual interest option, making various assertions on
impracticalities and impacts on different asset classes that could
result from the restrictions. Commenters also expressed concerns about
the scope of the seller's interest option for revolving pool
securitization arrangements and whether it would comport with current
market practices. With respect to CMBS, some commenters were concerned
that the third-party purchaser options were too expansive, while other
commenters asked for further reductions in the restrictions on B-piece
risk retention. Commenters also asked for a number of modifications to
the proposed underwriting standards for qualifying commercial,
commercial real estate, and automobile loans, including an exemption
for CMBS transactions where all the securitized assets are extensions
of credit to one borrower or its affiliates.

C. Overview of the Final Rule

    After considering all comments received in light of the purpose of
the statute and concerns from investors and individuals seeking credit,
and after engaging in additional analysis of the securitization and
lending markets, the agencies have adopted the revised proposal with
some modifications, as discussed below. The agencies are adopting the
final QRM definition, as proposed, to mean a QM, as defined in section
129C of TILA \33\ and its implementing regulations, as amended from
time to time.\34\ The agencies continue to believe that a QRM
definition that aligns with the definition of a QM meets the statutory
goals and directive of section 15G of the Exchange Act to protect
investors and enhance financial stability, in part by limiting credit
risk, while also preserving access to affordable credit and
facilitating compliance. As discussed in further detail below, the
agencies will review the definition of QRM periodically--beginning not
later than four years after the effective date of the rule with respect
to securitizations of residential mortgages, and every five years
thereafter. These timeframes are designed to coordinate the agencies'
review of the QRM definition with the timing of the CFPB's statutorily
mandated assessment of QM, as well as to better ensure that the QRM
definition continues to meet the goals and directive of section 15G.
The final rule also provides that any of the agencies may request a
review of the definition of QRM at any time as circumstances warrant.
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    \33\ 15 U.S.C. 1639c.
    \34\ See Final QM rule.
---------------------------------------------------------------------------

    In addition, the agencies are adopting the minimum risk retention
requirement and risk retention options, with some modifications to
address specific commenter concerns. As discussed in more detail below,
and consistent with the revised proposal, the final rule applies a
minimum 5 percent base risk retention requirement to all securitization
transactions that are within the scope of section 15G of the Exchange
Act and prohibits the sponsor from hedging or otherwise transferring
its retained interest prior to the applicable sunset date. The final
rule also allows a sponsor to satisfy its risk retention obligation by
retaining an eligible vertical interest, an eligible horizontal
residual interest, or any combination thereof as long as the amount of
the eligible vertical interest and the amount of the eligible
horizontal residual interest combined is no less than 5 percent. The
amount of the eligible vertical interest is equal to the percentage of
each class of ABS interests issued in the securitization transaction
held by the sponsor as eligible vertical risk retention. The amount of
eligible horizontal residual interest is equal to the fair value of the
eligible horizontal residual interest divided by the fair value of all
ABS interests issued in the securitization transaction. After
considering the numerous comments received, the agencies have concluded
that the proposed cash flow restriction on the eligible horizontal
residual interest (as well as the alternative described in the
reproposal) could lead to unintended consequences or have a disparate
impact on some asset classes. The agencies have therefore decided not
to include such restrictions under the final rule.
    With respect to the proposed disclosure requirements related to the
fair value calculation of eligible horizontal residual interests, the
agencies continue to believe that it is important to the functioning of
the final rule to ensure that investors and the markets, as well as
regulators, are provided with key information about the methodologies
and assumptions that are used by sponsors under the final rule to
calculate the amount of their eligible horizontal residual interests in
accordance with fair value standards. Because the agencies believe that
disclosures of the assumptions inherent in fair value calculations are
necessary to enable investors to make informed investment decisions,
the agencies are generally retaining the proposed fair value disclosure
requirements, with some modifications in response to commenter concern,
as further discussed below.
    Furthermore, as discussed in more detail below, the agencies are
adopting the revised proposal's provisions for CMBS third-party
purchasers with some modifications to respond to specific commenter
concerns. In addition, the agencies are retaining the proposed five-
year period during which transfer among qualified third-party
purchasers of CMBS eligible horizontal residual interests that are
retained in satisfaction of the final rule will not be permitted. The
agencies are also adopting the proposed underwriting standards for
commercial, commercial real estate, and automobile loans, with some
minor adjustments to the commercial real estate underwriting standards
as described below. The agencies are also adopting the revised
proposal's treatment of allocation to originators, tender option bonds,
and ABCP conduits, with some limited modifications, as described below.
With respect to revolving pool securitizations--described in the
reproposal as revolving master trusts--the agencies are adopting the
reproposal with several refinements designed to expand availability of
the seller's interest option. The final rule also contains the various
proposed

exemptions for government-related transactions and certain
resecuritizations from the revised proposal.
    The agencies also, as proposed, are applying risk retention to CLO
managers as ``securitizers'' of CLO transactions under section 15G of
the Exchange Act and, as discussed in further detail below, are not
adopting structural exemptions or third-party options as suggested by
some commenters. After carefully considering comments, the suggested
exemptions and alternatives, the purposes of section 15G of the
Exchange Act, and the features and dynamics of CLOs and the leveraged
loan market, the agencies have concluded that risk retention is
appropriately applied to CLO managers and a structural exemption or
third-party option would likely undermine the consistent application of
the final rule. Furthermore, the agencies are retaining in the final
rule the proposed alternative for open market CLOs whereby, for each
loan purchased by the CLO, risk may be retained by a lead arranger. The
agencies appreciate that this option may not reflect current practice,
but have concluded that the option may provide a sound method for
meaningful risk retention for the CLO market in the future.

D. Post-Adoption Interpretation and Guidance

    The preambles to the original and revised proposals described the
agencies' intention to jointly approve certain types of written
interpretations concerning the scope of section 15G and the final rule
issued thereunder. Several commenters on the original proposal, and
some commenters on the reproposal, expressed concern about the
agencies' process for issuing written interpretations jointly and the
possible uncertainty about the interpretation of the rule that may
arise due to this process.
    The agencies have endeavored to provide specificity and clarity in
the final rule to avoid conflicting interpretations or uncertainty. In
the future, if the agencies determine that further guidance would be
beneficial for market participants, the agencies may jointly publish
interpretive guidance, as the Federal banking agencies have done in the
past. In addition, the agencies note that market participants can, as
always, seek guidance concerning the rule from their primary Federal
banking regulator or, if such market participant is not a depository
institution, the Commission. In light of the joint nature of the
agencies' rule writing authority, the agencies continue to view the
consistent application of the final rule as a benefit and intend to
consult with each other when adopting staff interpretations or guidance
on the final rule that would be shared with the public generally in
order to attempt to achieve full consensus on such interpretations and
guidance.\35\ In order to facilitate this goal, the Federal banking
agencies and the Commission intend to coordinate as needed to discuss
pending requests for such interpretations and guidance, with the
participation of HUD and FHFA when such agencies are among the
appropriate agencies for such matters.
---------------------------------------------------------------------------

    \35\ These items do not include interpretation and guidance in
staff comment letters and other staff guidance directed to specific
institutions that is not intended to be relied upon by the public
generally. Nor do they include interpretations and guidance
contained in administrative or judicial enforcement proceedings by
the agencies, or in an agency report of examination or inspection or
similar confidential supervisory correspondence.
---------------------------------------------------------------------------

II. General Definitions and Scope

    The original proposal defined several terms applicable to the
overall rule. The original proposal provided that the proposed risk
retention requirements would have applied to sponsors in
securitizations that involve the issuance of ``asset-backed
securities'' and defined the terms ``asset-backed security'' and
``asset'' consistent with the definitions of those terms in the
Exchange Act. The original proposal noted that section 15G does not
appear to distinguish between transactions that are registered with the
Commission under the Securities Act of 1933 (the Securities Act) and
those that are exempt from registration under the Securities Act. It
further noted that the proposed definition of asset-backed security,
which would have been broader than that in the Commission's Regulation
AB,\36\ included securities that are typically sold in transactions
that are exempt from registration under the Securities Act, such as
collateralized debt obligations (CDOs) and securities issued or
guaranteed by an Enterprise. As a result, pursuant to the definitions
in the original proposal, the proposed risk retention requirements
would have applied to securitizers of offerings of asset-backed
securities regardless of whether the offering was registered with the
Commission under the Securities Act.
---------------------------------------------------------------------------

    \36\ See 17 CFR 229.1100 through 17 CFR 229.1123.
---------------------------------------------------------------------------

    Under the original proposal, risk retention requirements would have
applied to the securitizer in each ``securitization transaction,''
defined as a transaction involving the offer and sale of ABS interests
by an issuing entity. The original proposal also explained that the
term ``ABS interest'' would refer to all types of interests or
obligations issued by an issuing entity, whether or not in certificated
form, including a security, obligation, beneficial interest, or
residual interest, but would not include interests, such as common or
preferred stock, in an issuing entity that are issued primarily to
evidence ownership of the issuing entity, and the payments, if any,
which are not primarily dependent on the cash flows of the collateral
held by the issuing entity.
    Section 15G stipulates that its risk retention requirements be
applied to a ``securitizer'' of an asset-backed security and, in turn,
that a securitizer is either an issuer of an asset-backed security or a
person who organizes and initiates a securitization transaction by
selling or transferring assets, either directly or indirectly,
including through an affiliate or issuer. The original proposal
discussed the fact that the second prong of this definition is
substantially identical to the definition of a ``sponsor'' of a
securitization transaction in the Commission's Regulation AB \37\ and
defined the term ``sponsor'' in a manner consistent with the definition
of that term in the Commission's Regulation AB.
---------------------------------------------------------------------------

    \37\ See Item 1101 of the Commission's Regulation AB (17 CFR
229.1101) (defining a sponsor as ``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 issuing entity.'').
---------------------------------------------------------------------------

    As noted in the original proposal, the agencies believe that
applying the risk retention requirement to the sponsor of the ABS
interests--as provided by section 15G--is appropriate in light of the
active and direct role that a sponsor typically has in arranging a
securitization transaction and selecting the assets to be securitized.
This role best situates the sponsor to monitor and control the credit
quality of the securitized assets. In some cases, the transfer of
assets by the sponsor will take place through a wholly-owned subsidiary
of the sponsor that is often referred to as the ``depositor.'' As noted
above, the definition of ``securitizer'' in section 15G(a)(3)(A)
includes the ``issuer of an asset-backed security.'' The term
``issuer'' when used in the federal securities laws may have different
meanings depending on the context in which it is used. For example, for
several purposes under the federal securities laws, including the
Securities Act \38\ and the Exchange

Act \39\ (of which section 15G is a part) and the rules promulgated
under these Acts,\40\ the term ``issuer'' when used with respect to a
securitization transaction is defined to mean the entity--the
depositor--that deposits the assets that collateralize the asset-backed
securities with the issuing entity. As stated in the original proposal,
the agencies interpret the reference in section 15G(a)(3)(A) to an
``issuer of an asset-backed security'' as referring to the
``depositor'' of the securitization transaction, consistent with how
that term has been defined and used under the federal securities laws
in connection with asset-backed securities.\41\
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    \38\ Section 2(a)(4) of Securities Act (15 U.S.C. 77b(a)(4))
defines the term ``issuer'' in part to include every person who
issues or proposes to issue any security, except that with respect
to certificates of deposit, voting-trust certificates, or collateral
trust certificates, or with respect to certificates of interest or
shares in an unincorporated investment trust not having a board of
directors (or persons performing similar functions), the term issuer
means the person or persons performing the acts and assuming the
duties of depositor or manager pursuant to the provisions of the
trust or other agreement or instrument under which the securities
are issued.
    \39\ See Exchange Act sec. 3(a)(8) (15 U.S.C. 78c(a)(8)
(defining ``issuer'' under the Exchange Act).
    \40\ See, e.g., Securities Act Rule 191 (17 CFR 230.191) and
Exchange Act Rule 3b-19 (17 CFR 240.3b-19).
    \41\ For asset-backed securities transactions where there is not
an intermediate transfer of the assets from the sponsor to the
issuing entity, the term depositor refers to the sponsor. For asset-
backed securities transactions where the person transferring or
selling the pool assets is itself a trust (such as in an issuance
trust structure), the depositor of the issuing entity is the
depositor of that trust. See section 2 of the final rule. Securities
Act Rule 191 and Exchange Act Rule 3b-19 also note that the person
acting as the depositor in its capacity as depositor to the issuing
entity is a different ``issuer'' from that person in respect of its
own securities in order to make clear--for example--that any
applicable exemptions from Securities Act registration that person
may have with respect to its own securities are not applicable to
the asset-backed securities. That distinction does not appear
relevant here because the risk retention rule would not be
applicable to an issuance by such person of securities that are not
asset-backed securities.
---------------------------------------------------------------------------

    As noted above, the rule generally applies the risk retention
requirements of section 15G to a sponsor of the securitization
transaction. In many cases the depositor and the sponsor are the same
legal entity; however, even in cases where the depositor and the
sponsor are not the same legal entity, the depositor is a pass-through
vehicle for the transfer of assets and is either controlled or funded
by the sponsor. Therefore, under the rule, the definition of sponsor
effectively includes the depositor of the securitization transaction,
and should identify the party subject to the risk retention
requirements for every securitization transaction. Therefore, in the
agencies' view, applying the risk retention requirement to the sponsor,
as defined in the rule, substantively aligns with the definition of
``securitizer'' in section 15G of the Exchange Act.
    Other than issues concerning CLOs, which are discussed in Part
III.B.7; issues concerning ABCP, which are discussed in Part III.B.4;
and issues concerning sponsors of municipal bond repackagings, which
are discussed in Part III.B.8 of this Supplementary Information,
comments with regard to the definition of securitizer or sponsor were
generally limited to requests that the final rule provide that certain
specified persons--such as underwriting sales agents--be expressly
excluded from the definition of securitizer or sponsor for the purposes
of the risk retention requirements.
    In response to comments received relating to various transaction
parties requesting that the agencies either designate as sponsors, or
clarify would meet the requirements of the definition of sponsor, the
agencies are providing some guidance with respect to the definition of
sponsor. The statute and the rule define a securitizer as 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.'' \42\ The agencies
believe that the organization and initiation criteria in both
definitions are critical to determining whether a person is a
securitizer or sponsor. The agencies are of the view that, in order to
qualify as a party that organizes and initiates a securitization
transaction and, thus, as a securitizer or sponsor, the party must have
actively participated in the organization and initiation activities
that would be expected to impact the quality of the securitized assets
underlying the asset-backed securitization transaction, typically
through underwriting and/or asset selection. The agencies believe this
interpretation of the statutory language ``organize and initiate'' is
reasonable because it further accomplishes the statutory goals of risk
retention--alignment of the incentives of the sponsor of the
securitization transaction with the investors and improvement in the
underwriting and selection of the securitized assets. Without this
active participation, the holder of retention could be merely a
speculative investor, with no ability to influence underwriting or
asset selection. In addition, the interests of a speculative investor
may not be aligned with those of other investors. For example, another
asset-backed security issuer would not meet the ``organization and
initiation'' criteria in the definition of ``sponsor'' as such an
entity could not be the party that actively makes decisions regarding
asset selection or underwriting. Additionally, the agencies believe
that a party who does not engage in this type of active participation
would be a third-party holder of risk retention, which (with the narrow
exception of a qualified third-party purchaser in a CMBS transaction)
is not an acceptable holder of retention under the rule because the
participation of such a party does not result in the more direct
alignment of incentives achieved by requiring the party with
underwriting or asset selection authority to retain risk. Thus, for
example, an entity that serves only as a pass-through conduit for
assets that are transferred into a securitization vehicle, or that only
purchases assets at the direction of an independent asset or investment
manager, only pre-approves the purchase of assets before selection, or
only approves the purchase of assets after such purchase has been made
would not qualify as a ``sponsor''. If such a person retained risk, it
would be an impermissible third-party holder of risk retention for
purposes of the rule, because such activities, in and of themselves, do
not rise to the level of ``organization and initiation''. In addition,
negotiation of underwriting criteria or asset selection criteria or
merely acting as a ``rubber stamp'' for decisions made by other
transaction parties does not sufficiently distinguish passive
investment from the level of active participation expected of a sponsor
or securitizer.
---------------------------------------------------------------------------

    \42\ See 15 U.S.C. 78o-11(a)(3)(B) and section 2 of the final
rule, infra.
---------------------------------------------------------------------------

    The original proposal would have defined the term ``originator'' in
the same manner as section 15G, namely, as a person who, through the
extension of credit or otherwise, creates a financial asset that
collateralizes an asset-backed security, and sells the asset directly
or indirectly to a securitizer (i.e., a sponsor or depositor). The
original proposal went on to note that because this definition refers
to the person that ``creates'' a loan or other receivable, only the
original creditor under a loan or receivable--and not a subsequent
purchaser or transferee--would have been an originator of the loan or
receivable for purposes of section 15G. The revised proposal kept the
definition from the original proposal.
    The original proposal referred to the assets underlying a
securitization transaction as the ``securitized assets,'' meaning
assets that are transferred to a special purpose vehicle (SPV) that
issues the ABS interests and that stand as collateral for those ABS
interests. ``Collateral'' was defined as the property that provides the
cash flow for payment

of the ABS interests issued by the issuing entity. Taken together,
these definitions were meant to include the loans, leases, or similar
assets that the depositor places into the issuing entity at the
inception of the transaction, though it would have also included other
assets such as pre-funded cash reserve accounts. Commenters to the
original proposal stated that, in addition to this property, the
issuing entity may hold other assets. For example, the issuing entity
may acquire interest rate derivatives to convert floating rate interest
income to fixed rate, or the issuing entity may accrete cash or other
liquid assets in reserve funds that accumulate cash generated by the
securitized assets. As another example, commenters stated that an ABCP
conduit may hold a liquidity guarantee from a bank on some or all of
its securitized assets. The agencies retained these definitions of
securitized assets and collateral in the revised proposal.
    Some commenters expressed concern with respect to the scope of the
terms of the definitions of asset-backed securities, securitization
transactions, and ABS interests in the original proposal and suggested
specific exemptions or exclusions from their application. Similarly, a
number of commenters requested clarification of the scope of the
definition of ``ABS interest,'' or suggested narrowing the definition,
while other commenters suggested an expansion of the scope of the
``securitization transaction'' definition. Comments with regard to
definitions of securitizer and sponsor in the original proposal were
generally limited to requests that specified persons be expressly
excluded from, or included in, the definition of securitizer or sponsor
for the purposes of the risk retention requirements. The agencies
determined to leave the definitions of securitizer and sponsor
substantially unchanged in the revised proposal. After consideration of
all the comments on the original proposal, the agencies did not believe
that significant changes to most definitions applicable throughout the
proposed rule were necessary and, in the revised proposal, retained
most definitions as originally proposed.
    The agencies did add some substantive definitions to the revised
proposal, including proposing a definition of ``servicing assets,''
which would be any rights or other assets designed to assure the
servicing, timely payment, or timely distribution of proceeds to
security holders, or assets related or incidental to purchasing or
otherwise acquiring and holding the issuing entity's securitized
assets. The agencies noted in the revised proposal that such assets may
include cash and cash equivalents, contract rights, derivative
agreements of the issuing entity used to hedge interest rate and
foreign currency risks, or the collateral underlying the securitized
assets. As provided in the reproposed rule, ``servicing assets'' also
include proceeds of assets collateralizing the securitization
transactions, whether in the form of voluntary payments from obligors
on the assets or otherwise (such as liquidation proceeds). The agencies
are adopting this definition substantially as reproposed in order to
ensure that the provisions appropriately accommodate the need, in
administering a securitization transaction on an ongoing basis, to hold
various assets other than the loans or similar assets that are
transferred into the asset pool by the securitization depositor. In
this way, the definition is similar to the definition of ``eligible
assets'' in Rule 3a-7 under the Investment Company Act of 1940, which
specifies conditions under which the issuer of non-redeemable fixed-
income securities collateralized by self-liquidating financial assets
will not be deemed to be an investment company.
    In light of the agencies' adoption of the QRM definition from the
reproposal and the exemption for certain three-to-four unit residential
mortgages (as discussed in section VII below), the agencies are
modifying the proposed definition of ``residential mortgage'' to
clarify that all loans secured by 1-4 unit residential properties will
be ``residential mortgages'' for the purposes of the final rule and
subject to the rule's provisions regarding residential mortgages (such
as the sunset on hedging and transfer restrictions specific to
residential mortgages) if they do not qualify for an exemption. Under
the final rule, a residential mortgage would mean a residential
mortgage that is a ``covered transaction'' as defined in the CFPB's
Regulation Z; \43\ any transaction that is specifically exempt from the
definition of ``covered transaction'' under the CFPB's Regulation Z;
\44\ and, as a modification to the proposed definition, any other loan
secured by a residential structure that contains one to four units,
whether or not that structure is attached to real property, including
condominiums, and if used as residences, mobile homes and trailers.\45\
Therefore, the term ``residential mortgage'' would include home equity
lines of credit, reverse mortgages, mortgages secured by interests in
timeshare plans, temporary loans, and certain community-focused
residential mortgages further discussed in Part VII of this
Supplementary Information. It would also include mortgages secured by
1-4 unit residential properties even if the credit is deemed for
business purposes under Regulation Z.
---------------------------------------------------------------------------

    \43\ See 12 CFR 1026.43.
    \44\ See 12 CFR 1026.43.
    \45\ This addition to the definition is substantially similar to
the CFPB's definition of ``dwelling'' in Regulation Z. See 12 CFR
1026.2(19).
---------------------------------------------------------------------------

    Many comments on the revised proposal were similar to, or repeated,
the comments on the original proposal. Some commenters asked that
specific definitions be added to the rule, such as eligible
participation interest, owner's interest, and participant's interest.
With respect to the definitions of securitizer and sponsor, several
commenters on the revised proposal requested that the final rule
expressly exempt, or include, certain categories or groups of persons--
such as underwriting sales agents, multiple sponsors of transactions,
affiliated entities, or, in the case of tender-option bonds and ABCP,
brokers who acquire and securitize assets at the direction of a third
party. Other commenters requested confirmation that certain categories
of transactions would not qualify as a sale or transfer of an interest
for purposes of the rule.
    Three commenters requested that the agencies reconsider their
decision to treat non-economic residual interests in real estate
investment conduits (REMICS) as ABS interests, noting the potential
negative tax consequences for sponsors of REMICS. Another commenter
requested that lower-tier REMIC interests in tiered structures be
exempted from treatment as ABS interests, and a separate commenter
requested an express exclusion of REMIC residual interests entirely.
One commenter again asserted that the definition of ``securitization
transaction'' was overly broad because it would include a variety of
corporate debt repackagings, which the commenter asserted should be
expressly exempt from risk retention. One commenter requested
clarification that issuers of securities collateralized by qualifying
assets could hold hedging agreements, insurance policies, and other
forms of credit enhancement as permitted by the Commission's Regulation
AB. One commenter asked that the definition of commercial real estate
be revised to include land loans, including loans made to owners of fee
interests in land leased to third parties who own improvements on the
land.
    While the final rule generally retains the definitions in the
revised proposal, to address the concerns raised by

commenters with respect to REMICs,\46\ the agencies have modified the
definition of ABS interest to exclude (i) a non-economic residual
interest issued by a REMIC and (ii) an uncertificated regular interest
in a REMIC that is held only by another REMIC, where both REMICs are
part of the same structure and a single REMIC issues ABS interests to
investors. The agencies do not believe that significant changes to the
general definitions are necessary or appropriate in light of the
purposes of the statute. All adjustments to the general definitions are
discussed below in this Supplementary Information in the context of
relevant risk retention options.
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    \46\ Some commenters expressed concern that including REMICs in
the ABS interest definition would create tax liabilities unrelated
to the credit risk of the underlying collateral and would likely
reduce the intended impact of the risk retention rules since non-
economic residual interests usually have a negative value.
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III. General Risk Retention Requirement

A. Minimum Risk Retention Requirement

    Section 15G of the Exchange Act generally requires that the
agencies jointly prescribe regulations that require a securitizer to
retain not less than 5 percent of the credit risk for any asset that
the securitizer, through the issuance of ABS interests, transfers,
sells, or conveys to a third party, unless an exemption from the risk
retention requirements for the securities or transaction is otherwise
available (e.g., if the ABS interests are collateralized exclusively by
QRMs). Consistent with the statute, the reproposal generally would have
required that a sponsor retain an economic interest equal to at least 5
percent of the aggregate credit risk of the assets collateralizing an
issuance of ABS interests (the base risk retention requirement). For
securitizations where two or more entities would each meet the
definition of sponsor, the reproposal would have required that one of
the sponsors retain the credit risk of the securitized assets in
accordance with the requirements of the rule. Under the reproposal, the
base risk retention requirement would have been available as an option
to sponsors of all securitization transactions within the scope of the
rule, regardless of whether the sponsor was an insured depository
institution, a bank holding company or subsidiary thereof, a registered
broker-dealer, or another type of entity.
    Some comments addressed the proposed minimum risk retention
requirement. One commenter expressed support for the proposed minimum
requirement of 5 percent risk retention, asserting that such a
requirement would promote higher quality lending, protect investor
interests, and limit the originate-to-distribute business model. Other
commenters requested a higher minimum risk retention requirement
depending on asset quality. One commenter asserted that 5 percent
should be the minimum and that the purpose of risk retention would be
defeated by applying 5 percent to situations in which assets are sold
at a discount from par. That commenter proposed that the requirement
should be either (i) the greater of 5 percent or the expected losses on
the assets or (ii) the greater of 5 percent or the conditional expected
losses on the assets or asset class under a moderate economic stress
environment. Another commenter stated that some sponsors hold less than
5 percent because of the high quality of some assets, and requiring 5
percent retention could potentially double costs in some instances.
Another commenter asserted that retaining 5 percent may not be
sufficient as many sponsors held more than 5 percent credit risk in
their securitizations before the crisis. That same commenter stated
that investors were likely to insist that originators retain some
credit risk. One commenter proposed a minimum risk retention
requirement of 20 percent, while another commenter requested that
sponsors be required to hold 100 percent risk retention for a specified
period of time. For securitizations where multiple entities each meet
the definition of sponsor, one commenter stated that multiple sponsors
should be permitted to allocate the required amount of risk retention
among themselves, so long as the aggregate amount retained satisfies
the requirements of the risk retention rules. Other commenters
requested a lower minimum for pools that blend assets that would be
exempt from risk retention by meeting the proposed underwriting
standards with assets not meeting the standards, which is discussed in
further detail in Part V of this Supplementary Information.
    After careful consideration of the comments received, the agencies
are adopting the minimum risk retention requirement as proposed.
Consistent with the reproposal and the general requirement in section
15G of the Exchange Act, the final rule applies a minimum 5 percent
base risk retention requirement to all securitization transactions
within the scope of section 15G, unless an exemption under the final
rule applies.\47\ The agencies believe that this requirement will
provide sponsors with an incentive to monitor and control the
underwriting of securitized assets and help align the interests of the
sponsor with those of investors in the ABS interests. The agencies note
that, while Congress directed that the rule include a risk retention
requirement of no less than 5 percent of the credit risk for any asset,
parties to a securitization transaction may agree that more risk will
be retained. While some commenters asked that the rule calibrate the
credit risk on an asset class basis (i.e., make a determination that
the credit risk associated with certain asset classes is lower than for
other asset classes), the agencies are declining to do that at this
time because the data provided by commenters do not provide a
sufficient basis for the calibration of credit risk on an asset class
basis.\48\ For securitizations where two or more entities would each
meet the definition of sponsor, the final rule requires that one of the
sponsors complies with the rule, consistent with the original and
revised proposals. The final rule does not prohibit multiple sponsors
from retaining credit risk as long as one of those sponsors complies
with the requirements of the final rule. The agencies are not allowing
sponsors to divide the required risk retention generally because
allowing multiple sponsors to divide required risk retention among
themselves would dilute the economic risk being retained and, as a
result, reduce the intended alignment of interest between the sponsor
and the investors.
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    \47\ See final rule at sections 3 through 10. Similar to the
proposal, the final rule, in some instances, permits a sponsor to
allow another person to retain the required amount of credit risk
(e.g., originators, third-party purchasers in CMBS transactions, and
originator-sellers in ABCP conduit securitizations). However, in
such circumstances, the final rule includes limitations and
conditions designed to ensure that the purposes of section 15G
continue to be fulfilled. Further, even when another person is
permitted to retain risk, the sponsor still remains responsible
under the rule for compliance with the risk retention requirements,
as discussed below.
    \48\ As required by section 15G, the agencies have established
automobile, commercial real estate, and commercial loan asset
classes and related underwriting standards designed to ensure a low
credit risk for assets originated to those standards. The agencies
provided for zero risk retention for loans meeting the prescribed
underwriting standards.
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    The agencies do not believe that it is necessary or appropriate to
attempt to vary the amount of risk retention based on the quality of
the assets or other factors and believe that attempting to do so would
unnecessarily complicate compliance with the rule. As discussed below,
the agencies are adopting the requirement that an eligible horizontal

residual interest be measured at fair value using a fair value
methodology acceptable under U.S. generally accepted accounting
principles (GAAP). The agencies believe that generally requiring that
retention be 5 percent of the fair value of the ABS interests issued in
the securitization transaction will sufficiently calibrate the actual
amount of retention to the value of the assets, including how that
value may be affected by expected losses. In addition, subject to
limited exceptions, such as that applicable to transfers of CMBS
interests among qualified third-party purchasers after five years,
transfers to majority-owned affiliates, and certain permitted hedging
activities, the final rule prohibits the sponsor from hedging or
otherwise transferring its retained interest prior to the applicable
sunset date, as discussed in Part IV.F of this Supplementary
Information.
    The agencies note that the base risk retention requirement is a
regulatory minimum and not a limit on what investors or other market
participants may require. The sponsor, originator, or other party to a
securitization may retain additional exposure to the credit risk of
assets that the sponsor, originator, or other party helps securitize
beyond that required by the rule, either on its own initiative or in
response to the demands or requirements of private market participants.

B. Permissible Forms of Risk Retention--Menu of Options

    Section 15G of the Exchange Act expressly provides the agencies the
authority to determine the permissible forms through which the required
amount of risk retention must be held.\49\ Accordingly, the reproposal,
like the original proposal, would have provided sponsors with multiple
options to satisfy the risk retention requirements of section 15G. The
flexibility provided in the reproposal's menu of options for complying
with the risk retention requirement was designed to take into account
the heterogeneity of securitization markets and practices and to reduce
the potential for the proposed rules to negatively affect the
availability and costs of credit to consumers and businesses. As
proposed, the menu of options approach was designed to be consistent
with the various ways in which a sponsor or other entity, in historical
market practices, may have retained exposure to the credit risk of
securitized assets.\50\ Historically, whether or how a sponsor retained
exposure to the credit risk of the assets it securitized was determined
by a variety of factors including the rating requirements of the
NRSROs, investor preferences or demands, accounting and regulatory
capital considerations, and whether there was a market for the type of
interest that might ordinarily be retained (at least initially by the
sponsor).
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    \49\ See 15 U.S.C. 78o-11(c)(1)(C)(i); see also S. Rep. No. 111-
176, at 130 (2010) (``The Committee [on Banking, Housing, and Urban
Affairs] believes that implementation of risk retention obligations
should recognize the differences in securitization practices for
various asset classes.'').
    \50\ See Board Report; see also Macroeconomic Effects of Risk
Retention Requirements, Chairman of the Financial Stability
Oversight Counsel (January 2011), available at http://www.treasury.gov/initiatives/wsr/Documents/Section946RiskRetentionStudy(FINAL).pdf.
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    Commenters generally supported the menu-based approach of providing
sponsors with the flexibility to choose from a number of permissible
forms of risk retention. While commenters were generally supportive of
a menu-based approach, several commenters requested that the final rule
provide additional options and increased flexibility for sponsors to
comply with the risk retention requirement. In this regard, several
commenters asserted that the final rule should permit third-party
credit support as additional forms of risk retention, including
insurance policies, guarantees, liquidity facilities, and standby
letters of credit. One commenter stated that such unfunded forms of
credit support are permitted by the European risk retention framework
and allowing similar options would provide greater consistency between
the U.S. and European rules. This commenter further contended that the
final rule, at a minimum, should permit such forms of unfunded risk
retention for a subset of sponsors, such as regulated banks. A few
commenters requested that overcollateralization be permitted as an
alternative method of risk retention. Further, the agencies received
several comments requesting that the final rule include an option
allowing retention to be held in the form of interests in the
securitized assets themselves. Along these lines, several commenters
sought additional flexibility under the rule to hold risk retention as
loan participation interests or companion notes instead of an ABS
interest. One commenter stated that, while the use of participations in
securitization transactions may not currently be customary, sponsors
may find such a structure advantageous in connection with the risk
retention requirements. A few commenters said that pari passu
participation interests and structures using pari passu companion notes
have been used in certain types of CMBS transactions. Other commenters
requested that the final rule allow for subordinated participation
interests. These commenters said pari passu participations should
qualify as vertical risk retention and subordinate participation
interests should qualify as horizontal risk retention. The main reason
cited by these commenters for expanding the forms of risk retention
recognized under the rule to include this form of retention, other than
future flexibility as to form, was the possibility that the sponsor
could hold the same economic exposure it would have as an ABS interest
form of risk retention, while at the same time incurring lower
regulatory capital charges for that exposure by holding it as a loan,
and avoiding consolidation of the structure onto its balance sheet.
Another commenter suggested that the availability of a participation
option may be important for commercial banks because of their existing
infrastructure to share risk on a pari passu basis.
    One commenter stated that the final rule should provide more
flexibility by allowing sponsors to satisfy their risk retention
requirement through a combination of means and that the rule should not
mandate forms of risk retention for specific types of asset classes or
specific types of transactions.
    The agencies have carefully considered the comments and are
adopting the proposed menu of options approach to risk retention
largely as proposed. The agencies continue to believe that providing
options for risk retention is appropriate in order to accommodate the
variety of securitization structures that will be subject to the final
rule and that the menu of options, as proposed, provides sufficient
flexibility for sponsors to satisfy their risk retention obligations.
    After carefully considering the comments requesting loan interests,
such as loan participations, as an option, the agencies have decided
not to expand the recognized legal forms of risk retention under the
rule beyond ABS interests by including pari passu participation
interests, subordinated participation interests, pari passu companion
notes, or subordinated companion notes. The agencies are permitting
specialized forms of participations for two particular asset classes as
discussed below in connection with CLO securitizations and tender
option bonds, subject to several requirements under the rule. However,
the agencies believe that the rule already provides sufficient
flexibility as to the economic forms of risk retention and an
additional form of

risk retention is not necessary. The agencies are concerned that
offering different legal forms, such as participation interests or
companion loans, as a standard option would introduce substantial
complexity to the rule in order to ensure that these forms of retention
were implemented in a way that ensured that the holder had the same
economic exposure as the holder of an ABS interest. In addition, given
the commenters' reasons for requesting that these options be made
available, the agencies are concerned that permitting these types of
interests to be held as retention could raise concerns about regulatory
capital arbitrage.
    The agencies do not believe it would be appropriate to allow
sponsors to satisfy risk retention obligations through third-party
credit support, such as insurance policies, guarantees, liquidity
facilities, or standby letters of credit. As discussed in the
reproposal, such forms of credit support generally are not funded at
closing and therefore may not be available to absorb losses at the time
they occur. Except in the case of the guarantees from the Enterprises
under the conditions specified, which include the Enterprises'
operating in conservatorship or receivership with capital support from
the United States, the agencies continue to believe that unfunded forms
of risk retention fail to provide sufficient alignment of incentives
between sponsors and investors and are not including them as eligible
forms of risk retention.
    The final rule does not permit overcollateralization as a standard
method of risk retention. While overcollateralization may provide
credit enhancement to a securitization, the agencies do not believe
that a credit risk retention option based solely on a comparison of the
face value \51\ of the securitized assets and the face value of the ABS
interests would provide meaningful risk retention consistent with the
goals and intent of section 15G because the face value of both the
securitized assets and the face value of the ABS interests can
materially differ from their relative value and/or cost to the
sponsor.\52\ Moreover, the fair value of an eligible horizontal
residual interest takes into consideration the overcollateralization
and excess spread in a securitization transaction as adjusted by
expected loss and other factors. Further, for the reasons discussed in
Part III.B.3 of this Supplementary Information, the final rule does not
include a representative sample option.
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    \51\ The agencies are using the term ``face value'' to mean the
outstanding principal balance of a loan or other receivable or an
ABS interest and, with respect to an asset that does not have a
stated principal balance, it means an equivalent value measurement,
such as securitization value.
    \52\ The agencies have adopted a risk retention option for
revolving pool securitizations that relies heavily on a comparison
of the face value of the securitized assets and the face value of
the ABS interests. However, reliance on the seller's interest option
is limited to revolving pool securitizations that include certain
structural features and alignment of incentives to address many of
the concerns the agencies had with respect to the reliance on face
value to measure required credit risk retention. See Part III.B.2 of
this Supplementary Information.
---------------------------------------------------------------------------

    As in the reproposal, the permitted forms of risk retention in the
final rule are subject to terms and conditions that are intended to
help ensure that the sponsor (or other eligible entity) retains an
economic exposure equivalent to 5 percent of the credit risk of the
securitized assets at a minimum. As described below, the final rule
includes several modifications to the various forms of risk retention,
as well as the terms and conditions that were proposed, to help ensure
that sponsors have a meaningful stake in the overall performance and
repayment of the assets that they securitize. Each of the forms of risk
retention permitted by the final rule and the measures intended to
ensure that sponsors retain meaningful credit risk are described below.
1. Standard Risk Retention
a. Structure of Standard Risk Retention Option
    Under the revised proposal, standard risk retention could have been
used by a sponsor for any securitization transaction.\53\ Standard risk
retention could have taken the form of: (i) Vertical risk retention;
(ii) horizontal risk retention; and (iii) any combination of vertical
and horizontal risk retention.\54\ Under the reproposal, a sponsor
would have been permitted to satisfy its risk retention obligation by
retaining an eligible vertical interest, an eligible horizontal
residual interest, or any combination thereof, in a total amount equal
to no less than 5 percent of the fair value of all ABS interests in the
issuing entity that are issued as part of the securitization
transaction.
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    \53\ As discussed above, in the original proposal, a sponsor
using standard risk retention would have had to choose between a 5
percent horizontal interest, 5 percent vertical interest, or a
combination of horizontal and vertical interests that was
approximately half horizontal and half vertical. The agencies
reproposed standard risk retention with a more flexible structure in
response to concerns raised by commenters on the original proposal.
See Revised Proposal, 78 FR at 57937.
    \54\ See Revised Proposal, 78 FR at 57937.
---------------------------------------------------------------------------

    Through the vertical option, the reproposal would have allowed a
sponsor to satisfy its risk retention obligation with respect to a
securitization transaction by retaining at least 5 percent of the fair
value of each class of ABS interests issued as part of the
securitization transaction. This would provide the sponsor with an
interest in the entire securitization transaction. As an alternative,
the reproposal would have allowed a sponsor to satisfy its risk
retention requirement under the vertical option by retaining a single
vertical security. As discussed in the reproposal, a single vertical
security would be an ABS interest entitling the holder to a specified
percentage (e.g., 5 percent) of the principal and interest paid on each
class of ABS interests in the issuing entity (other than such single
vertical security) that result in the security representing the same
percentage of fair value of each class of ABS interests.
    Under the reproposal, a sponsor also would have been permitted to
satisfy its risk retention obligation by retaining an eligible
horizontal residual interest in the issuing entity in an amount equal
to no less than 5 percent of the fair value of all ABS interests in the
issuing entity that are issued as part of the securitization
transaction. In lieu of holding all or part of its risk retention in
the form of an eligible horizontal residual interest, the reproposal
would have allowed a sponsor to cause to be established and funded, in
cash, a reserve account at closing (eligible horizontal cash reserve
account) in an amount equal to the same dollar amount (or corresponding
amount in the foreign currency in which the ABS interests are issued,
as applicable) as would be required if the sponsor held an eligible
horizontal residual interest.\55\
---------------------------------------------------------------------------

    \55\ See Revised Proposal, 78 FR 57939.
---------------------------------------------------------------------------

    As reproposed, an interest would have qualified as an eligible
horizontal residual interest only if it was an interest in a single
class or multiple classes in the issuing entity with respect to which,
on any payment date on which the issuing entity would have insufficient
funds to satisfy its obligation to pay all contractual interest or
principal due, any resulting shortfall would reduce amounts paid to the
eligible horizontal residual interest prior to any reduction in the
amounts paid to any other ABS interest until the amount of such ABS
interest is reduced to zero. The eligible horizontal residual interest
would have been required to have the most subordinated claim to
payments of both principal and interest by the issuing entity.
    Many commenters generally supported the reproposal to allow a
sponsor to meet its risk retention

obligation by retaining an eligible vertical residual interest, an
eligible horizontal residual interest, or any combination of such
interests. Such commenters generally approved of the flexibility that
the reproposal would provide to sponsors in structuring their risk
retention. Further, one commenter expressed support for the single
vertical security option, asserting that it would simplify compliance
and monitoring obligations of the sponsor. One commenter, however,
expressed concern that the definition of single vertical security could
be read as though the security could have different percentage
interests in each class and requested that the definition be amended to
clarify that the specified percentages must result in the fair value of
each interest in each such class being identical.
    The agencies received several comments regarding the proposed
method by which a sponsor may satisfy its risk retention requirement by
holding an eligible horizontal residual interest. One commenter sought
clarification as to whether advance rates and overcollateralization,
equipment residual values, reserve accounts and third-party credit
enhancement would constitute eligible horizontal residual interests.
Another commenter sought clarification as to whether the eligible
horizontal residual interest would be required to have the most
subordinated claim to principal collections.\56\ Further, one commenter
expressed concern that the eligible horizontal residual interest option
would create a conflict of interest between the sponsor and the holders
of the other classes of securities, to the extent that the servicer
would have control over decisions that could optimize the value of the
interest at the expense of other tranches.
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    \56\ In response to a similar comment, the agencies confirm that
a structure under which the interest is at the bottom of the
priority of payments provisions, or last in line for payment, would
satisfy this requirement whether or not the interest is ``legally''
subordinated.
---------------------------------------------------------------------------

    Regarding the horizontal cash reserve account, one commenter
requested that the final rule permit a broader range of investments to
align with market practice regarding standard investments used for
funds held in collection, reserve and spread accounts. Another
commenter requested that the final rule permit funds from eligible
horizontal cash reserve accounts to be used to pay critical expenses,
so long as such expense payments are made for specified priorities and
are disclosed to investors. The commenter further proposed that no
disclosure or calculations should be required for such payments that
are senior to amounts owed to holders of third-party ABS interests or
that are made to transaction parties unaffiliated with the securitizer.
    The agencies invited comment on whether the rule should require a
minimum proportion of risk retention held by a sponsor under the
standard risk retention option to be composed of a vertical component
or a horizontal component. Further, the agencies invited comment on
whether a sponsor should be required to hold a higher percentage of
risk retention if the sponsor retains only an eligible vertical
interest or very little horizontal interest. The agencies did not
receive any comments in favor of these options. One commenter expressed
opposition to any requirement for a minimum vertical or horizontal
component, claiming that such a requirement would increase compliance
costs and increase the risk that sponsors would, as a result of
accounting standards, have to consolidate securitization entities into
their financial statements. In addition, two commenters expressed
opposition to any higher risk retention requirement for sponsors
retaining only a vertical interest.
    Several commenters expressed opinions on the effect that the
proposed standard risk retention option would have on decisions by
sponsors regarding whether they are obligated by accounting standards
to consolidate a securitization vehicle into their financial
statements. Two commenters asserted that, because of the flexibility of
the proposed standard risk retention option, in and of itself, the
option would not cause a sponsor to have to consolidate its
securitization vehicles. One of these commenters observed that case-by-
case analyses would be required and that the likelihood of
consolidation would increase as a sponsor retains a greater portion of
its required interest as a horizontal interest. Another commenter
asserted that, if potential investors require the sponsor to hold a
horizontal rather than a vertical interest, or a combination, the
consolidation risk will increase. This same commenter stated that
forthcoming updated guidance from the Financial Accounting Standards
Board may modify the way sponsors analyze their consolidation
requirements. One commenter asserted that consolidation concerns may
cause broker-dealers to limit their secondary market support, with
respect to certain affiliate transactions, for the duration of the risk
retention period and that such decisions may have an effect on
secondary market liquidity. As a way of reducing consolidation risk,
one commenter stated that securitization agreements should be required
to give securitization trusts the right to claim 5 percent of losses
from securitizers as they occur. Such losses, the commenter asserted,
should be held as contingent liabilities on securitizers' balance
sheets, against which reserves would need to be held.
    The agencies have carefully considered comments on the reproposed
structure of the standard risk retention option and, for the reasons
discussed below and in the reproposal, have decided to adopt the
approach as set forth in the revised proposal with some modifications.
However, in the final rule the agencies are adopting several changes to
the manner in which risk retention must be measured and are eliminating
the restrictions on cash flow to the eligible horizontal residual
interest. These changes are discussed in Part III.B.1 of this
Supplementary Information.
    Consistent with the reproposal, the final rule allows a sponsor to
satisfy its risk retention obligation by retaining an eligible vertical
interest, an eligible horizontal residual interest, or any combination
thereof, as long as the percentage of the eligible vertical interest
claimed as retention under the rule, when added to the percentage of
the fair value of the eligible horizontal residual interest claimed as
retention for purposes of the rule equals no less than five. The final
rule does not mandate a minimum or specific percentage of horizontal or
vertical interest that sponsors must hold when they choose to satisfy
their risk retention obligation by holding a combination of vertical
and horizontal interests, nor does the final rule require sponsors to
hold a higher percentage of risk retention if the sponsor retains only
an eligible vertical interest. The agencies added language to the final
rule clarifying that the requisite percentage of eligible vertical
interest, eligible horizontal residual interest, or combination thereof
retained by the sponsor must be determined as of the closing date of
the securitization transaction.\57\
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    \57\ For example, a sponsor electing to hold risk retention in
the form of a combined horizontal and vertical interest could
determine the minimum amount required to be retained pursuant to the
rule by determining the percentage of fair value represented by the
sponsor's eligible horizontal residual interest, and then
supplementing that amount with a vertical interest of a sufficient
percentage so that the sum of the two percentage numbers equals
five. To illustrate: If a sponsor holds an eligible horizontal
residual interest with a fair value of 3.25 percent of the fair
value of all the ABS interests in the issuing entity, the sponsor
must also hold (at a minimum) a vertical interest equal to 1.75
percent of each class of ABS interests in the issuing entity.
Alternatively, the sponsor may retain a single vertical security
representing 1.75 percent of the cash flows paid on each class of
ABS interests in the issuing entity (other than the single vertical
security itself). The rule does not prohibit the sponsor from
retaining additional amounts of horizontal interests, vertical
interests, or both.

---------------------------------------------------------------------------

    The final rule allows a sponsor to satisfy its risk retention
obligation under the vertical option by retaining a portion of each
class of the ABS interests issued in the transaction or a single
vertical security which represents an interest in each class of the ABS
interests issued in the securitization. The rule specifies the minimum
retention to be held by a sponsor. As such, the fact that provisions
such as the definition of eligible vertical interest and single
vertical security require the sponsor to hold the same proportion of or
interest in each class of ABS interests does not preclude the sponsor
from holding different proportions of or in each class. However, it
does preclude the sponsor from claiming risk retention credit under the
rule for any proportional interest in a class that is not the same
across all classes. For example, a sponsor which holds a vertical
interest of 5 percent of the most junior class and 3 percent of all
other classes issued by the entity can only claim credit for a 3
percent vertical interest.
    A sponsor choosing to satisfy its retention obligation solely
through the retention of an interest in each class of ABS interest
issued will be required to retain at least 5 percent of each class of
ABS interests issued as part of the securitization transaction. A
sponsor using this approach will be required to retain at least 5
percent of each class of ABS interests issued in the securitization
transaction regardless of the nature of the class of ABS interests
(e.g., senior or subordinated) and regardless of whether the class of
interests has a face or par value, was issued in certificated form, or
was sold to unaffiliated investors. For example, if four classes of ABS
interests are issued by an issuing entity as part of a securitization--
a senior-rated class, a subordinated class, an interest-only class, and
a residual interest--a sponsor using this approach with respect to the
transaction will have to retain at least 5 percent of each such class
or interest. If a class of interests has no face value, the sponsor
will have to hold an interest in 5 percent of the cash flows paid on
that class.
    If a sponsor opts to satisfy its risk retention requirement solely
by retaining a single vertical security, that ABS interest must entitle
the holder to 5 percent of the cash flows paid on each class of ABS
interests in the issuing entity (other than such single vertical
security). This will provide sponsors an option that is simpler than
carrying multiple securities representing a percentage share of every
series, tranche, and class issued by the issuing entity, each of which
might need to be valued by the sponsor on its financial statements
every financial reporting period. The single vertical security option
will provide the sponsor with the same principal and interest payments
(and losses) as a 5 percent ownership of each series, class, or tranche
of the securitization, in the form of one security to be held on the
sponsor's books.
    Also consistent with the revised proposal, the final rule allows a
sponsor to satisfy its risk retention obligation exclusively through
the horizontal option by retaining a first loss eligible horizontal
residual interest in the issuing entity in an amount equal to no less
than 5 percent of the fair value of all ABS interests in the issuing
entity that are issued as part of the securitization transaction. The
eligible horizontal residual interest may consist of either a single
class or multiple classes in the issuing entity, provided that each
interest qualifies, individually or in the aggregate, as an eligible
horizontal residual interest.\58\ In the case of multiple classes, this
requirement will mean that the classes must be in consecutive order
based on subordination level. For example, if there are three levels of
subordinated classes and the two most subordinated classes have a
combined fair value equal to 5 percent of all ABS interests, the
sponsor will be required to retain these two most subordinated classes
if it is going to satisfy its risk retention obligation by holding only
eligible horizontal residual interests.
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    \58\ See section 2 of the final rule (definition of ``eligible
horizontal residual interest'').
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    In lieu of holding all or part of its risk retention in the form of
an eligible horizontal residual interest, the final rule will allow a
sponsor to cause to be established and funded, in cash, an eligible
horizontal cash reserve account, at closing, in an amount equal to the
same dollar amount (or corresponding amount in the foreign currency in
which the ABS interests are issued, as applicable) as would be required
if the sponsor held an eligible horizontal residual interest. As
described in the reproposal, the eligible horizontal cash reserve
account will have to be held by a trustee (or person performing
functions similar to a trustee) for the benefit of the issuing entity.
Consistent with the reproposal, the final rule includes several
important restrictions and limitations on the eligible horizontal cash
reserve account to ensure that a sponsor that establishes an eligible
horizontal cash reserve account will be exposed to the same amount and
type of credit risk on the securitized assets as would be the case if
the sponsor held an eligible horizontal residual interest. The
intention of these restrictions is to ensure amounts in the account
would be available to absorb losses to the same extent as an eligible
horizontal residual interest. Therefore, investments of funds in the
account and uses of the account are limited. The agencies are not
following commenters' suggestion to broaden the range of permissible
investments of funds in the horizontal cash reserve account because
that could undermine the capacity of the account to absorb losses as
they occur to the same extent as an eligible horizontal residual
interest. Any use of funds other than loss coverage could result in
fewer funds to absorb losses later. The types of permissible
investments likewise are restricted to cash and cash equivalents in
order to ensure that the account will not incur investment losses and
reduce the capacity of the account to absorb losses of the
securitization transaction. The agencies view ``cash equivalents'' to
mean high-quality, highly-liquid short-term investments the maturity of
which corresponds to the securitization's expected maturity or
potential need for funds and that are denominated in a currency that
corresponds to either the securitized assets or the ABS interests.
Depending on the specific funding needs of a particular securitization,
``cash equivalents'' might include deposits insured by the FDIC,
certificates of deposit issued by a regulated U.S. financial
institution, obligations backed by the full faith and credit of the
United States, investments in registered money market funds, and
commercial paper. For securitization transactions whose securitized
assets or ABS interests are denominated in a foreign currency, cash
equivalents would include cash equivalents denominated in the foreign
currency. The agencies believe that the permitted investment options
provide sufficient flexibility to sponsors that choose to create an
eligible horizontal cash reserve account, while ensuring that such
sponsors will be exposed to the same amount and type of credit risk as
would be the case if the sponsor held an eligible horizontal residual
interest.
    In response to commenter concerns, the agencies believe that it
would not violate the requirements of the eligible horizontal cash
reserve account if as a result of a shortfall in the available cash

flow, critical expenses of the trust unrelated to credit risk, such as
litigation expenses or trustee or servicer expenses, are paid from an
eligible horizontal cash reserve account, so long as such payments, in
the absence of available funds in the eligible horizontal cash reserve
account, would be paid prior to any payments to holders of ABS
interests and such payments are made to parties that are not affiliated
with the sponsor.
    The agencies believe the standard risk retention option, as
adopted, provides sponsors with flexibility in choosing how to
structure their retention of credit risk in a manner that is compatible
with current practices in the securitization markets. For example, in
securitization transactions where the sponsor would typically retain
less than 5 percent of an eligible horizontal residual interest, the
standard risk retention option will permit the sponsor to hold the
balance of the risk retention as a vertical interest. Each sponsor will
have to separately analyze whether the particular option the sponsor
selects under the rule requires the sponsor to consolidate the assets
and liabilities of a securitization vehicle onto its own balance sheet
for accounting purposes. The rule itself does not provide guidance on
performing the consolidation analysis, either in support of
deconsolidation or in requirement of consolidation.
b. Risk Retention Measurement and Disclosures
    As explained in the revised proposal, to provide greater clarity
for the measurement of risk retention and to help prevent sponsors from
structuring around their risk retention requirement by negating or
reducing the economic exposure they are required to maintain, the
agencies proposed to require sponsors to measure their risk retention
requirement using fair valuation methodologies acceptable under
GAAP.\59\
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    \59\ Cf. Financial Accounting Standards Board, Accounting
Standards Codification Topic 820--Fair Value Measurement.
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    Several commenters supported the proposed requirement that sponsors
measure their risk retention requirement using fair value. These
commenters expressed the view that the use of fair value would be a
more prudent approach than using face value and would be consistent
with market practice. Other commenters, however, expressed general
concern with the proposed method by which sponsors would be required to
measure their risk retention. One commenter asserted that using fair
value instead of face value would require sponsors to hold higher risk
retention levels and attract additional investor capital, leading to
higher borrowing costs. Two commenters explained that many sponsors who
consolidate their issuing entities or keep their securitizations on
their balance sheets do not currently utilize fair value calculations,
and that requiring such sponsors to measure their risk retention with
fair value would create significant burden and expense.
    Commenters expressed several specific accounting concerns regarding
the use of fair value to measure risk retention. Two commenters
asserted that calculation of fair value under GAAP is not designed to
provide a definitive value, but a range of values. In this regard, they
expressed concerns about how the requirements could be met if a sponsor
calculates multiple possible fair values. One commenter asserted that
requiring sponsors to determine fair value in accordance with GAAP
would be burdensome for securitization transactions where the sponsor
(or other retaining entity) is established outside the United States,
giving rise to additional work and costs. For such transactions, the
commenter urged the agencies to allow sponsors to measure fair value
using local (non-U.S.) GAAP or International Financial Reporting
Standards (IFRS). One commenter asserted that GAAP does not prescribe
use of a single valuation technique, but allows entities to use various
techniques, including market, income and cost approaches. The commenter
stated, however, that the reproposal implied that sponsors would be
limited to specific valuation techniques and requested that the final
rule clarify that sponsors are not so restricted. The commenter also
asserted that the reproposal equated intrinsic value with fair value,
which are distinct standards of value. In this regard, the commenter
stated that reference to intrinsic value should either be excluded from
the final rule or the agencies should clarify that intrinsic and fair
value are two separate concepts.
    The agencies invited comment in the reproposal on whether
accountants would be asked to perform agreed upon procedures reports
related to measurement of the fair value of sponsors' retained ABS
interests. One commenter responded that such requests would be unlikely
and requested that the agencies not mandate agreed upon procedures in
the final rule.
    One commenter stated that sponsors should be permitted to measure
their risk retention requirement by using either fair value or
securitization value (the value specified in the operative documents
for the securitization transaction, subject to certain limitations)
methodology. The commenter stated that securitization value is familiar
to sponsors and investors, and permitting its use would accommodate a
range of current industry practices. The commenter also stated that
securitization value would be easier to compute than fair value.
    One commenter asserted that any required risk retention amount for
ABCP conduits should be calculated by reference to the principal
balance, and not the fair value, of the ABS interests and asserted that
using fair value will be difficult, expensive and unnecessary,
especially given the revolving nature of the asset pool. Commenters
also requested clarification as to whether, when they are calculating
the fair value with respect to revolving pool of assets, they can make
static pool assumptions.
    Having considered the comments described above, the agencies are
adopting a fair value framework substantially similar to the reproposal
for calculating eligible horizontal residual interests in the final
rule. As discussed in the reproposal, this measurement uses methods
consistent with valuation methodologies familiar to market participants
and provides a consistent framework for calculating residual risk
retention across different securitization transactions. It also takes
into account various economic factors that may affect the
securitization transaction, which should aid investors in assessing the
degree to which a sponsor is exposed to the risk of the securitized
assets. As discussed below, in response to commenters the agencies are
not adopting the proposed fair value measurement requirement for
eligible vertical interests because such measurement is not necessary
to ensure that the sponsor has retained 5 percent of the credit risk of
the ABS interests issued.
    Consistent with the reproposal, the agencies are not modifying the
final rule to allow for calculation of fair value using the fair value
measurement framework under local GAAP or IFRS for securitization
transactions where the sponsor is established outside the United
States. The agencies believe that, as of the time the final rule is
adopted, these alternative valuation frameworks and GAAP have common
requirements for measuring fair value, which should minimize the burden
to sponsors established outside the United States of measuring fair
value using the GAAP framework. The agencies believe that

the benefits of being able to easily compare the fair value of risk
retention in two separate issuances of ABS interests regardless of
where the sponsors are established outweigh any minimal burden imposed
by the requirement to use GAAP fair value.
    In response to commenters' concerns about the burden of repeatedly
calculating fair value for a constantly changing pool of securitized
assets, the agencies believe that no change to the reproposed rule is
required. Under the final rule, only those securitization transactions
in which the issuing entity issues ABS interests more than once need to
calculate the fair value of the eligible horizontal residual interest
multiple times. The final rule provides specific risk retention options
for most sponsors of securitizations that issue multiple series of ABS
interests, including revolving pool securitizations, tender option bond
programs and ABCP conduits. The agencies also note that those
securitization structures which issue ABS interests on a frequent
basis, primarily ABCP conduits and tender option bond programs,
typically issue short-term securities for which the fair value
calculation should be less complex. The agencies are clarifying that,
to the extent that a sponsor uses a valuation methodology that
calculates fair value based on the pool of securitized assets as of a
certain date, the sponsor of a securitization of a revolving or dynamic
pool of securitized assets would be able to calculate the fair value of
the ABS interests using data with respect to the securitized assets as
of a cut-off date or similar date, as described below, which the
agencies believe should alleviate some of the concerns expressed by
commenters about the burden of repeatedly calculating the fair value of
the ABS interests issued. The agencies believe that this approach
appropriately balances commenters' concerns with the agencies' policy
goals of providing appropriate transparency into a sponsor's
calculation of the fair value of ABS interests under the final rule.
    Additionally, the agencies have concerns that the alternative
suggested by commenters of calculating fair value no more than once per
month would create unintended consequences. For instance, the
calculation of fair value of ABS interests up to a month before the
issuance of those ABS interests or up to a month after the issuance of
those ABS interests could result in disclosure to investors based on
unreliable assumptions about pricing and the expected volume of ABS
interests to be issued and possibly the issuance of ABS interests in
violation of the sponsor's risk retention requirements.
    Under the final rule, to the extent a sponsor uses a valuation
methodology that calculates fair value based on the pool of securitized
assets as of a certain date, a sponsor would be permitted to use a cut-
off date for establishing the composition and characteristics of the
pool of securitized assets collateralizing the asset-backed securities
(or similar date) that is not more than 60 days prior to the date of
first use of the fair value calculation with investors, except in the
case of a securitization transaction that makes distributions to
investors on a quarterly or less frequent basis, in which case the
sponsor may use a cut-off date or similar date not more than 135 days
prior to the date of first use of the fair value calculation with
investors.\60\ The final rule requires that disclosures to investors be
based on information about the asset pool (such as the characteristics
of and assumptions regarding the pool that will be used to determine
fair value) as of the cut-off date or similar date specified by the
sponsor. The actual balance of the securitized assets (and the
calculation of fair value) may include anticipated additions to and
removals of assets that the sponsor will make between the cut-off date
or similar date and the closing date. For purposes of the fair value
calculation, the ABS interests must include all ABS interests issued
prior to, and expected to be issued in, the pending offering of ABS
interests.\61\ The agencies believe this will accommodate the reporting
described by commenters and the evaluation of pool assets suggested by
commenters with respect to fair value calculations. The agencies
recognize that not all securitization transactions update information
about securitized assets on a monthly basis. The final rule permits
sponsors to rely on information about the securitized assets based on a
date not more than 135 days prior to the date of first use with
investors for subsequent issuances of ABS interests by the same issuing