The Securities and Exchange Commission is showing no signs of letting up on its flurry of rule-making in the waning weeks of 2023, and the potential costs for big banks and other financial firms impacted by them is starting to add up.
The latest salvo came Monday, when the SEC finalized a rule meant to prevent conflicts of interest in the asset-backed securitization market. The provision is supposed to put a stop to firms shorting or otherwise betting against asset-backed securities that they had a hand in creating.
In authorizing the regulation, Congress aimed to prevent conflicts like that posed by the financial crisis-era “Abacus” deal. In that case,
Goldman Sachs
allowed a hedge fund to help select assets for a collateralized debt obligation that the fund intended to bet against. Goldman didn’t disclose the fund’s participation to investors who bought the CDO, and the bank in 2010 agreed to pay $550 million to settle SEC charges that its marketing materials for the security were incomplete. The bank didn’t admit or deny the SEC allegations, but Goldman acknowledged at the time that its marketing materials were incomplete.
When the SEC released draft versions of the conflicts-of-interest rule, some financial firms and trade groups were worried that the rule as-written would prevent them from engaging in hedging activities that are part of their day-to-day business.
For example, home lenders sometimes short mortgage-backed securities to hedge against interest rates rising in the period between when a home borrower locks his rate and when he actually closes on the home sale. Not being able to do that sort of hedging could cause some big asset-backed security issuers to partially retreat from the business, said Structured Finance Association CEO Michael Bright, whose trade group represents companies in the securitization industry including JP Morgan Chase and GM Financial.
In the final rule issued Monday, the SEC removed the most onerous provisions, Bright said, but some firms could still end up spending millions or even tens of millions of dollars to build compliance programs that make certain they don’t run afoul of it.
“Everybody is going to have to build controls that ensure there is no one in the firm that can take a short position on any of the ABS that they’re involved in. That’s not free,” Bright said.
In addition to changing the rule to make it clear that it doesn’t capture interest-rate hedging, the SEC made it so that the provisions won’t apply to affiliates or subsidiaries of securitizers that don’t have access to information on the security. That was important to big banks with sprawling investment businesses that might make bets against some securities.
The rule “fulfills Congress’s mandate to address conflicts of interests in the securitization market, a market which was at the center of the 2008 financial crisis,” said SEC Chair Gary Gensler in a statement.
The conflicts-of-interest rule wasn’t as harsh as much of the industry feared, but financial firms and some lawmakers still believe the SEC’s rule-making push–when taken together–is imposing unreasonable costs that will clamp down on firms’ profits and increase fees for consumers.
In testimony to lawmakers, Gensler has argued that the agency’s rule-making agenda would lower costs and bolster financial stability.
In the past year, the SEC has proposed, taken comments on, or finalized disclosure rules related to companies’ climate risks, hedge funds’ stock bets, and private-equity firms’ fees, among dozens of other rules, at a pace that the Securities Industry and Financial Markets Association calls “unprecedented.”
“Even if these proposals are ultimately watered down or even reversed, they are causing a considerable amount of heartburn for covered industries as well as many more billable hours for lawyers and compliance consultants,” said BTIG director of policy research Isaac Boltansky.
Write to Joe Light at [email protected]
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