Back from vacation … The sheer joy of re-engagement cannot be captured in words.  But, can there be a better way of restarting than perusing FinReg?  Being the parochial structured finance lawyer that I am, I start with Subtitle D with the Potemkin village-like name of  "Improvements to the Asset Backed Securitization Process" and Section 13, which is the Proprietary Trading or so-called Volcker Rule provisions.  I’ve got some thoughts.

Let’s start with the improvements to the securitization process.  The good news, as I’m sure everyone knows by now, is that some sensible asset class-specific provisions for commercial mortgages were included in the risk retention language.  More flexibility in sorting out what alignment of interests ought to look like.  Included was the notion that a B piece buyer could meet the retention requirement as could really good reps or underwriting.

The bad news is, just as in almost every other corner of this massive regulatory exercise in political self-indulgence, all the tough and important issues have been kicked down the road to the “Regulators”.  The scope of that delegation is breathtaking.  The regulators have been invited to sort out what is and what is not risk retention (vertical strip, horizontal strip, L strip), what is the “credit risk” for which 5% must be retained, what are good hedges and bad, what is the minimum hold period for risk, what is high quality underwriting, and what appropriate risk management practices of securitizers ought to be.  Wow!  They can do all that?  We won’t have to think at all.

And that’s just for commercial real estate.  Our duly elected representatives have tied themselves into knots trying to square an ideological commitment to risk retention with the dawning realization that a private residential securitization market may be critically needed and is on life support and may not tolerate any risk retention.  This broad rush to regulate will almost inevitably result in an overly intrusive and complex set of rules, burdening an already weakened capital formation process far in excess of the benefits conferred.

The second bit of good news may be that the effective dates of these rules have been pushed out into the dim recesses of the middling long term.  Courtesy of Senator Crapo and others, the Fed, FDIC, SEC, and Office of Thrift Supervision (why in the world is the Office of Thrift Supervision still involved? It’s done, isn’t it?) have been, first, directed to study all of this, particularly its impact in light of FAS 166 and 167, before beginning to develop regulations.  So, if my math is right, the study is going to take at least 90 days (with luck a little longer) to complete, then Congress is supposed to react and presumably give further direction to the Regulators.  That’s got to take some real time, right?  Then the rules have to be crafted, which almost certainly will take a very substantial amount of time.  Finally, the effective date for CMBS is 2 years after that.  In a world where we see more game changing news in a week than we used to see in a year, three plus years to implementation sounds a lot like forever.  A lot can happen before forever.  A lot can change.

More on this later, but let me spend a moment on the proprietary trading ban.  A couple of weeks ago, I got myself into a lather worrying that the prohibition on proprietary trading, as written in the framework Senate bill, banned securitization.  The bill said that a depository institution (and affiliates) could not buy or acquire a financial asset with the intention of selling it.  Okay, I’m paraphrasing a bit there, but that’s the gist.  Lo and behold, the final bill contains a specific carveout for securitization.  It’s buried in 13(g) Rules of Construction and it’s worth quoting in its entirety: 

"Nothing in this Section shall be construed to limit or restrict the ability of a banking entity or non-bank financial company supervised by the Board to sell or securitize loans in a manner otherwise permitted by law."  

A nugget of good news, indeed.  I almost cried.

So, what’s it all mean?  Just that the regulations contemplated by these four Sections of the Bill may give us a tome to rival the Internal Revenue Code.  But that won’t happen for a couple of years, and, as I said, a lot can happen in that time.  Does this stop the SEC or the FDIC from pushing forward with their own skin in the game rules?  One might think that the provisions requiring a study to be completed by the applicable regulatory agencies before rule-making commences, a directive to all applicable agencies to coordinate rule-making and a two year effective date might strongly argue for a deferral of the current rule-making process (and note the current comment period for the FDIC version expired July 1, and for the SEC, it expires in early August).  Such a deferral would be consistent with the spirit of the Act.  We should strongly argue that current rule-making efforts be suspended.

It’s important for the industry to remain engaged on this and on all the major regulatory initiatives that will flow from FinReg.  We need to continue a robust educational effort with the regulatory constituencies about how our business can be improved in an efficient manner that doesn’t impair capital formation.  Get ready for a long slog.  We need to get this right.  Otherwise, we’re looking at a choking fog of incredibly complex regulations that will make only the lawyers happy.  Hey, what am I saying?  Is that so bad?