The U.S. Securities and Exchange Commission (“SEC”) adopted Final Rule 192 on November 27, which prohibits certain conflicts of interest in securitization transactions. Rule 192 implements Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”).

Rule 192 prohibits a “securitization participant” from directly or indirectly engaging in a conflicted transaction with respect to an asset-backed security (“ABS”) transaction during a specified prohibition period.  

The Adopting Relase’s definition of a “securitization participant” generally includes any underwriter, placement agent, initial purchaser and sponsor, along with any affiliate or subsidiary, but it does make a few minor changes to slightly narrow who would be considered a sponsor.  For instance, the proposed definition of a “directing sponsor” was modified in the final rule to exclude long-only investors who solely act pursuant to their contractual rights as a holder of the ABS.  Similarly, the final rule narrows the coverage of affiliates or subsidiaries to those that act in coordination with a securitization participant or who receive information about the ABS prior to the date of the first sale closing.  

The definition of a conflicted transaction has two parts: first, either a short sale of the ABS or purchase of a derivative (or any substantially similar instrument) that would receive a payout upon the occurrence of an adverse event for the ABS; and second, there is a substantial likelihood that a reasonable investor would consider the transaction important to the investor’s investment decision, including a decision whether to retain the ABS.  Of note, general interest rate and currency hedges, as well as any other hedge that is unrelated to the credit performance of the relevant ABS, are not considered conflicted transactions.  

The prohibition against conflicted transactions begins with an agreement to become a securitization participant for a specific ABS and will last until one year after the first closing of the sale of that ABS.  However, the final rule provides three prohibition exemptions for risk-mitigating hedging, certain market-making activities and liquidity commitments.   

For hedges that are related to the performance of the ABS, Rule 192 imposes several conditions to qualify for the risk-mitigation hedging exemption.  First, at its inception, the hedge must be designed to mitigate specific, identifiable risks related to the ABS.  Second, the hedging activity must be subject to ongoing recalibration to avoid creating an opportunity to materially benefit from a conflicted transaction, such as a net short position.  The third condition is that securitization participants must establish and maintain an internal compliance program reasonably designed to ensure the securitization participant’s compliance with the conditions for each exemption.  

The liquidity exemption is limited to the fulfillment of commitments made by the securitization participant to provide liquidity for the relevant ABS.  The final rule exempts bona fide market-making activities to permit securitization participants to continue providing intermediation services in illiquid markets.  

The final rule provides a safe harbor for non-U.S. ABS securitization participants in connection with securitizations that occur outside of the United States.  The following conditions must be met to qualify for the exemption: the ABS offering must not be required to be registered under the Securities Act, the issuer must not be a U.S. person, and all offers and sales of the ABS must be made in compliance with Regulation S.  However, this means that securitization participants in a U.S. private placement transaction or a dual 144A/Reg S transaction cannot rely on the safe harbor. 

Unfortunately, the final Rule 192 contains several key flaws.  It fails to provide a clear definition for synthetic ABS, incorporates a vague catchall provision in the definition of a conflicted transaction, creates uncertainty about what affiliates may be excluded from the definition of an ABS sponsor, and excludes private placements from the foreign safe harbor provision.  All of these will pose challenges to establishing effective compliance programs. 

The final rule’s effective date is February 5, 2024, but compliance will only be required with respect to any ABS the first closing of which occurs after June 9, 2025. 

If you would like to read more about the requirements of this final rule, you can access our full summary.

If you have any questions, please contact Joe Engelhard at [email protected] or Nick Pernas at [email protected].

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  Joe Engelhard

  Head of US Private Credit and Asset Management Policy & Regulation

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  Nick Pernas

  US Policy & Regulation Analyst