Structured Finance Bulletin - Legal Insights and Trends in the Structured Finance Markets - Mayer Brown
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
Winter 2020 Structured Finance Bulletin Legal Insights and Trends in the Structured Finance Markets
NOTES FROM THE EDITORS James J. Antonopoulos Christopher J. Brady Michael P. Gaffney In this Winter 2020 edition of our Structured Finance Bulletin, we provide updates on recent legal and regulatory developments in the consumer loan space as well as the latest on the transition from LIBOR. We also analyze the Federal Housing Agencies and GSE updates to COVID-19 relief measures for mortgage loan borrowers and US M&A considerations for Fintech Businesses during the COVID-19 pandemic. Finally, we review recent Volcker Rule revisions and developments in the EU Securitisation Regulation and the EU securitization market as a whole and address legal issues in cross-border trade receivable securitizations and the CFPB QM proposal for the GSE Patch. Please visit Mayer Brown’s structured finance blog, Retained Interest, designed to provide clients updates and analysis on legal and regulatory developments impacting the structured finance industry. Our lawyers provide insights related to developments and innovations in the structured finance industry and concise and timely briefings on current issues affecting financial asset transactions. retainedinterest.com The Consumer Financial Services Review blog provides insights from an industry-leading group of lawyers within Mayer Brown’s global Financial Services Regulatory & Enforcement practice. For more than 20 years, the Consumer Financial Services group has been recognized for its thought leadership and for providing high-caliber regulatory counseling, enforcement defense and transactional advice to a broad range of consumer financial services providers, including mortgage and auto lenders, consumer finance companies, payment companies, credit card issuers and investment banks. cfsreview.com Additionally, we recently launched an IBOR transition blog, Eye on IBOR Transition, designed to enable our global, cross-practice IBOR Task Force to keep to keep market participants abreast, in real time, of continuing regulatory and legislative announcements, trade group tools, and the status of market transition. eyeonibor.com
Structured Finance Bulletin TABLE OF CONTENTS What a Biden Presidency Will Mean for Structured Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 SEC Report Underscores the Interconnectedness of the US Residential Mortgage Credit Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Eye on IBOR Transition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Federal Housing Agencies and GSEs Provide Relief Measures for Residential Mortgage Loan Borrowers Negatively Impacted by COVID-19 . . . . . . . . . . . . . . 23 US M&A During the COVID-19 Pandemic — Considerations for Fintech Businesses . . . . . . . . 31 Cross-Border Trade Receivables Securitisation — Opportunity Awaits . . . . . . . . . . . . . . . . . 35 CFPB Hatches QM Proposals for the GSE Patch and a Seasoned QM . . . . . . . . . . . . . . . . . . . 49 Disclosure Technical Standards and Templates Published in Relation to the EU Securitisation Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Recommendations for Developing the EU Securitisation Market — Report by the High Level Forum on Capital Markets Union . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Securitisation after Brexit — Considerations for Securitisations Involving UK Entities . . . . . . 65 US Agencies Finalize Revisions to Volcker Rule Covered Funds Provisions . . . . . . . . . . . . . . . . 69 Volcker Rule Revision Complete — Easing the Compliance Burden for Banks . . . . . . . . . . . . 83
What a Biden Presidency
Will Mean for Structured Finance
ANDREW OLMEM
ARTHUR S. RUBLIN
The authors appreciate the assistance of Jon D. Van Gorp, Carol A. Hitselberger, Paul A. Jorissen,
Julie A. Gillespie, Stuart M. Litwin, Steven M. Kaplan, Laurence E. Platt and Ryan Suda, partners at
Mayer Brown.
The implications of the 2020 election for (or later events occur that shift the Senate
structured finance are coming into focus. majority to the Democrats), then it is very
Informed by our discussions in Washington, we likely that Democrats would aggressively
can anticipate the likely direction of federal use their narrow majorities in Congress,
policy over the next two years that will impact including to pass substantial tax legislation
the structured finance markets. and far-reaching regulatory reforms. The
course of financial policy over the next
Although former Vice President Joe Biden has
two years largely hinges on which party
won the U.S. Presidency, the predicted “Blue
controls the Senate.
Wave” that would have given Democrats control
of both the White House and Congress did not From a macroeconomic perspective, if the
materialize. Republicans will likely retain the Republicans hold the Senate, the U.S. would
Senate and unexpectedly gained seats in the likely continue its current accommodative
House of Representatives, substantially reducing monetary and fiscal policies, since significant
the Democratic House majority. tax increases would be unlikely. The open
question is the degree to which fiscal policy
If Republicans retain their Senate majority
will be accommodative going forward.
following the two runoff elections in Georgia
set for January 5th, the absence of unified With respect to interest rates, a critical factor for
Democratic control will mean that while structured finance, yields on Treasuries fell when
financial policy will shift in a Biden the predicted “Blue Wave” failed to materialize,
Administration, that shift will be muted, though which reduced expectations of the amount of
not insignificant, and will primarily be effected future borrowing by the federal government,
through presidential and regulatory actions including for a new COVID-19-related stimulus
rather than legislation. However, it is package. Indications are that interest rates will
important to note that if Democrats do remain low for the foreseeable future, which is
win both of the runoff elections in Georgia generally positive for the demand for consumer
MAYER BROWN | 1loans and ABS/MBS but potentially decreases the With respect to appointments to the Federal
demand for some consumer receivables such as Reserve Board, President-elect Biden may open up
auto leases. a seat if he nominates Fed Governor Lael Brainard
to be Treasury Secretary. Another seat is expected
A Threshold Matter: to open up in October of next year, when Randy
Quarles’s term as Vice Chair ends. The Senate is
Personnel is Policy currently considering nominees for the two open
The likelihood that the Republicans will retain seats at the Fed. If those nominees are not
their majority in the Senate increases the confirmed before the end of this Congress, the
importance of the Biden Administration’s Biden Administration will immediately be able to
financial regulatory appointments. The Biden nominate two individuals to the Fed Board.
transition team has indicated that President-
Federal Deposit Insurance Corporation (“FDIC”)
elect Biden’s senior economic team will likely be
Chair Jelena McWilliams’s term lasts until 2023,
rolled out in December. We expect to see first
but because the director of the CFPB and the
an announcement of the nominee for Treasury
Comptroller of the Currency are members of the
Secretary, followed by announcements of the
FDIC Board, once President Biden appoints new
nominees for Chair of the Securities and
leadership to those agencies, a majority of the
Exchange Commission, the Commodity
FDIC board will consist of Democratic appointees.
Futures Trading Commission, and the
Comptroller of the Currency.
Lame Duck Session:
How a Biden Administration will handle the
Consumer Financial Protection Bureau (“CFPB”) Prospects for Stimulus Bill
and the Federal Housing Finance Agency The most immediate impact of the election in
(“FHFA”) is unclear at this time. Those agencies terms of economic policy, with implications for
are led by Trump-appointed directors whose structured finance, will be on the ongoing
terms have not expired, but who, in the case of negotiations for another stimulus bill to address
the CFPB, can be removed at will by the the continuing impact of the COVID-19
President, or, in the case of the FHFA, will be pandemic. During the lame-duck period (the
subject to removal at will by the President if, in a period between the election and the swearing-in
Supreme Court case to be decided early next of the new Congress in January), Congress will
year, the high Court follows its recent precedent likely seek to pass another stimulus bill. Senate
permitting at-will removal of the CFPB director. Majority Leader Mitch McConnell has said that he
Expectations that the Biden Administration would like to pass a bill by the end of the year.
would promptly terminate those directors may Such legislation would still need to secure House
now be tempered by the likely need for the Speaker Nancy Pelosi’s support, and she has so
Biden Administration to work with a Republican- far insisted that the price tag be north of $2
controlled Senate to confirm its nominees. trillion. Senate Republicans voted in favor of a
Nevertheless, expectations are that the Biden package with a $650 billion price tag in
Administration will seek to have a new director September, but a deal would likely be above that
of the CFPB in place as soon as possible. figure, as the White House has voiced support for
2 | Structured Finance Bulletin | Winter 2020a package above $1 trillion. It is possible that Toomey (R-PA) has already publicly stated that
Congress passes another stimulus bill in the the Fed’s emergency lending facilities should
lame-duck, but it is not guaranteed. terminate at the end of the year. If the CARES
Act funding for the emergency lending facilities
Another stimulus bill would likely build on the
is not reauthorized, the Fed would be
programs established by the CARES Act and
prevented from making new loans through its
include:
emergency lending facilities, though it would
• Reauthorization of the Paycheck Protection not have to terminate existing loans. The Term
Program for small businesses (with Asset-Backed Securities Loan Facility (“TALF”)
additional restrictions on eligibility and new that supports structured finance utilizes funds
requirements for participating banks); and appropriated in the CARES Act, and would
• Extension of enhanced unemployment likely be prevented from making new loans if
benefits at a rate below the $600 per the CARES Act funding is not reauthorized.
week provided in the CARES Act. If the CARES Act funding is extended and the
The bill could also include: economy displays weakness next year, the Biden
Administration will likely encourage the Fed to
• A new foreclosure moratorium and payment
modify its underwriting criteria for its Main
forbearance for federally-backed mortgages,
Street Lending Program to increase eligibility
which would impact mortgage servicers, the
and participation.
value of MBS, and the residential mortgage
space more generally;
• A possible eviction moratorium; an GSE Reform
eviction moratorium could adversely affect In the immediate term, the most significant
Single-Family Rental securitizations; reform on the horizon for structured finance is the
• An extension of funding for Federal Reserve Trump Administration’s current effort to end the
emergency lending facilities (see below); decades-old conservatorships of Fannie Mae and
Freddie Mac (the “GSEs”). The Biden team has
• Funding for state and local government,
not indicated its policy views on the future of the
though in a far smaller amount than the
GSEs. However, FHFA Director Mark Calabria has
$1 trillion sought by Speaker Pelosi; and
signaled his intention to finalize a new capital rule
• A liability shield for COVID-19 pandemic-
for the GSEs before the end of the year. Once
related lawsuits.
that rule is finalized, or possibly beforehand, he is
expected to announce how he intends to
The Future of TALF and proceed with terminating the conservatorships.
Other Federal Reserve Director Calabria has indicated that the
conservatorships could be terminated with an
Emergency Credit Facilities interim step being that the GSEs would operate
The funding authorized by the CARES Act for under a consent order while raising capital.
the Federal Reserve’s emergency lending
It is important to note that the Supreme Court is
facilities expires at the end of the year. Likely
hearing a case next month about the validity of
incoming Senate Banking Committee Chair Pat
MAYER BROWN | 3the Third Amendment to the Preferred Stock A Republican-controlled Senate and a closely
Purchase Agreement between Treasury and divided House would very likely prevent the
FHFA, through which Treasury provides fiscal passage of legislation that would:
support for the GSEs. If the Supreme Court signals
• Enact major housing finance reform
at its oral argument next month that it may
impacting the residential mortgage space
invalidate the Third Amendment when it issues its
and related securitization products;
decision, likely in March or April, it may compel the
FHFA and the Treasury Department to proceed • Use the Congressional Review Act to
more quickly with reform. Alternatively, it is invalidate regulations adopted by the
possible that the Biden Treasury Department will Trump Administration since May of 2020
seek to halt the reform efforts upon taking office. (the statutory timeframe in which the CRA
can be used with respect to a regulation);
the regulations exposed to reversal under
Legislative Possibilities the CRA include the recent revisions to the
Limited – IF Republicans Keep Volcker Rule, including changes paving the
way for liberalization of certain investment
the Majority in the Senate restrictions in CLOs that bank investors in
While significant legislation is always a possibility many such vehicles had required in order
if there is a major event that galvanizes public to comply with the previous version of the
support for a legislative response (such as the Volcker Rule;
2001-2002 accounting scandals that prompted
• Impose substantial tax increases;
Congress to pass the Sarbanes-Oxley Act), we
• Establish interest rate caps on
anticipate that the votes will not exist for
non-residential consumer lending; or
dramatic financial regulatory reform if the
Republicans retain the Senate majority. • Enact the “Green New Deal” or other
environmental legislation that greatly
That said, we would still expect Congress to be expands corporate legal liability.
active next year, as is the case during the first
Again, it is important to emphasize that
year of any presidency. Legislation could include
if Democrats win both of the Georgia Senate
the following areas affecting structured finance at
seats on January 5th (or other unanticipated
least indirectly:
events flip control to the Democrats), we
• Infrastructure legislation, as the Highway would expect that Democrats would then
Trust Fund expires in September of 2021, aggressively use their legislative majorities
requiring reauthorization and providing a - as narrow as they would be - to potentially
vehicle for a substantial infrastructure bill; pass some of the above items, in particular
• Additional funding for renewable energy substantial tax reform and far-reaching
research and production (including solar, environmental legislation, and a Senate
which could increase the supply of solar- rule change to eliminate the filibuster.
loan-backed ABS); and Again - a lot of financial policy that could
impact structured finance hinges on the
• Additional subsidies for electrical vehicle
narrow margin of control in the Senate.
purchases and charging stations.
4 | Structured Finance Bulletin | Winter 2020Given the substantial federal deficit and soaring regulatory weaknesses in the non-bank sector that
debt-to-GDP ratio, the Biden Administration have surfaced in the wake of the COVID-19
also is likely to examine how to place the economic shock. They have focused on the need
federal government’s finances on a more to re-examine the regulation of securities dealers,
sustainable footing, including by reversing the in particular primary dealers, and non-bank
Trump tax cuts. It will be extremely difficult to mortgage lenders and servicers due to the
adopt substantial budget reforms on both the continued movement of the mortgage credit
revenue and spending sides given the likely market away from banks. This push for reform is
divided control of Congress and sharp divides likely to extend beyond the Trump Administration
in the Democratic caucus in Congress. and set the stage for the Biden Administration to
Nevertheless, we expect that the Biden pursue new regulation that could have a
Administration will seek to include targeted tax substantial impact on structured finance.
increases (including raising the corporate and
One option for reforming non-bank finance
capital gains rates and treating carried interest
would be for the Financial Stability Oversight
as ordinary income) as part of future budget
Council (“FSOC”) to designate large non-bank
deals with Senate Republicans.
companies for enhanced prudential supervision
by the Federal Reserve and/or to determine that
Executive Branch lending or other activities by non-bank
Regulatory Reforms companies should be subject to additional
regulation or a new statutory regime.
An inability to pass significant financial services
legislation if Republicans retain the Senate Biden appointees to financial regulatory agencies
majority will likely force the Biden Administration are likely to consider implementing a wide range
to implement its financial service policy agenda of other rules that would impact structured
through existing presidential and regulatory finance, including:
authorities. President-elect Biden is expected to
• Reforms to the Volcker Rule to limit bank
revoke many of the Trump Administration’s
exposures to structured finance risks, either
executive orders and issue a series of new
through supervision or modifications to the
orders that set policy for his Administration.
recently finalized rules (Fed Governor Brainard
Although the president does not have
voted against the recently finalized Volcker
substantial authority to change financial
changes, signaling that she may want to revisit
regulatory policy through executive orders, the
the rules at a later date);
issuance of executive orders will signal the
• New capital and liquidity requirements for
direction of policy under a Biden Administration.
non-bank mortgage companies;
The groundwork for reform by financial regulators • Reforms of the Treasury market, including
that could impact structured finance has already potentially creating a central clearinghouse
begun. Federal Reserve Vice Chair for Supervision for Treasury securities;
and current Chair of the Financial Stability Board
• Relief with respect to Federal Direct Student
Randy Quarles and SEC Chair Jay Clayton have
Loans and FFELP student loans, including
signaled that reforms are likely needed to address
forbearance and forgiveness with respect
MAYER BROWN | 5to loans owned or guaranteed by the enforcement actions on the following areas of
Department of Education; relevance to structured finance markets:
• Reversal of the True Lender/Valid-When- • Fair lending;
Made regulations issued by the Comptroller
• Student loan and mortgage servicing
of the Currency and the FDIC;
violations;
• Stronger oversight of consumer lending
• Unfair, deceptive, or abusive consumer
(including credit cards);
lending (especially auto loans, non-bank
• Credit score and credit bureau reforms; lending, student loans, and credit cards);
• Environmental, social and governance (“ESG”) • Debt collection practices;
requirements for public companies and
• Consumer and investor protections, with
government contractors; and
larger penalties and less credit for
• Capital charges or other supervisory self-reporting and cooperating with
restrictions on banks financing regulators upon the discovery of a violation;
carbon-energy-intensive businesses or carbon- and
energy-producing businesses.
• Stricter application of antitrust laws, especially
with respect to larger financial institutions.
Enforcement For more information, please do not hesitate to
The Biden Administration will also likely use contact us or any of the other listed Mayer
enforcement to advance its policy agenda due Brown contacts. Mayer Brown continues to
to both the difficulty of passing legislation and monitor developments relevant to structured
the discretion afforded to craft remedies. The finance as the Biden transition team identifies
Department of Justice and financial regulators senior personnel, and as the incoming Biden
(including in coordination with state regulators Administration and Congress signal their policy
and attorneys general) will likely focus priorities for the coming weeks and next year. n
6 | Structured Finance Bulletin | Winter 2020SEC Report Underscores the
Interconnectedness of the US
Residential Mortgage Credit Markets
ANDREW OLMEM ANNA T. PINEDO
LAURENCE E. PLATT JON D. VAN GORP
When John Donne wrote the famous book, No other consumer lending markets and (vi) the
Man is an Island, he most certainly wasn’t commercial mortgage markets. With respect to
thinking about residential mortgage credit. But each of these markets, the report examines
the idea of interconnectedness has universal COVID-19-induced stresses of different types,
applicability and lies at the heart of the SEC’s which fall into three categories.
newly released report titled “U.S. Credit
• Short-term funding stresses: These are stresses
Markets Interconnectedness and the Effects of
caused by a sudden and immediate demand
the Covid-19 Economic Shock.” This report,
for liquidity in the short-term funding markets.
issued on October 14, 2020, describes in detail
the stresses experienced by the credit markets • Markets structure/liquidity-driven stresses:
immediately following the shutdown of the US These are stresses caused by an elevated
economy in early March 2020 in response to demand for financial intermediation in the
COVID-19. The report is thorough and data context of constrained capital and risk
driven. It identifies a cohort of approximately limits. Liquidity constraints were a limiting
$54 trillion of credit issued and outstanding in factor in the volume of trades that regulated
the US financial system at the end of 2019 and intermediaries (specifically broker-dealers)
traces the flow of that credit through various could undertake when trading volumes
intermediaries during the period of time studied spiked during the initial COVID-19 shutdown
by the report. The data in the report supports a hindering their ability to be a countercyclical
widely-held view that credit markets are force in the market.
interdependent, directly linked through a myriad • Long-term credit stresses: These are longer-
of complex, interconnected transactions. term stresses from COVID-19, which may still
be unfolding. Examples are building stress in
The report studies several different markets to
the commercial real estate and leveraged loan
illustrate their level of interconnectedness,
markets. The health of financial intermediaries,
namely, (i) short-term funding markets, (ii)
which have significant holdings of these
corporate bond markets, (iii) leveraged loans
assets, will be highly correlated to the ultimate
and CLO markets, (iv) municipal securities
performance of these assets.
markets, (v) residential mortgage markets and
MAYER BROWN | 7For this alert, we have chosen to focus on the changes in the value of highly leveraged credit-
aspects of the report that discuss the residential linked securities, or “CRT,” which are owned by
mortgage credit markets. many mortgage REITs, were directly correlated
to the negative performance of the mortgage
A. Changes in the credit markets, potentially increasing the
severity of the stress experienced by the
Mortgage Credit Markets mortgage credit markets in March 2020.
As many of us who observe the residential
mortgage credit markets know, the early days B. COVID-19 as a
of the March 2020 COVID-19 lockdown
produced tremendous challenges for non-bank Triggering Event
entities that owned residential mortgage credit In the early days of the COVID-19 crisis, the lack
in the form of securities and loans and that of certainty about future economic conditions
depended on short-term funding to finance and the scattered consumer payment relief policy
their assets. Mortgage REITs were impacted initiatives among federal, state and local
heavily by these market conditions, but so were regulators that were often in conflict with one
non-bank mortgage originators and private another drove severe and sharp declines in the
credit funds, which originate and invest in value of mortgage credit assets. In an effort to
residential mortgage credit. deliver assistance to US consumers who were
increasingly losing their jobs and being
The SEC report highlights the evolution of the
furloughed as employers scaled back or shut
non-bank mortgage intermediaries as a key
down operations, the federal government and
reason for the COVID-19-related stress in the
state governments announced legally mandated
mortgage credit markets. Currently, 70% of
forbearance periods for the enforcement of
mortgage loans are originated by non-bank
residential mortgage loans. These legislative
mortgage originators. While banks have access
initiatives and executive orders were intended to
to liquidity from deposits to fund their mortgage
bring quick and immediate relief to affected
origination activities, non-bank mortgage
borrowers, providing very few hurdles for
originators do not have that source of liquidity
borrowers seeking relief to qualify for the various
and, therefore, must depend on the short-term
forbearance programs. As a result, anticipated
repo markets for funding. Similarly, mortgage
and actual mortgage delinquencies increased
credit assets are increasingly held by mortgage
quickly, causing the mark-down of mortgage
REITs, which grew significantly after the 2008
credit assets. At about the same time, the Federal
subprime credit crisis from $168 billion in assets
Reserve restarted a quantitative easing program
in 2009 to almost $700 billion in assets in 2019.
to deliver stimulus to the economy and increase
The concentration of mortgage credit assets in
liquidity to the credit markets during a time of
the hands of mortgage REITs and other entities
sudden need. Many of the bond purchasing
that depend on short-term repo funding to fund
programs created in the 2008 subprime credit
long-term assets exacerbated the impact of the
crisis were reactivated, increasing demand for
COVID-19 shocks in the mortgage credit
credit securities and, therefore, rapidly raising
markets. The SEC report also points out that
prices for those securities, including
8 | Structured Finance Bulletin | Winter 2020mortgage-backed securities issued or guaranteed of the COVID-19-related forbearance initiatives.
by the Government Sponsored Enterprises For margin calls made and enforced, the credit
(“GSEs”) Fannie Mae and Freddie Mac, as well impact of the write-downs created a negative
as by Ginnie Mae (collectively, “Agency MBS”). feedback loop; as holders of mortgage credit
sold securities and loans into an illiquid market
Along with mortgage REITs, the non-bank
to meet margin calls, they drove prices lower,
residential mortgage loan originators immediately
increasing the margin calls. The SEC report
felt the impact of these two events. Mortgage
acknowledges this phenomenon and attributes
loans made and held in inventory by non-bank
additional stress to the lack of buyers in the
mortgage originators pending securitization or
Agency MBS market. Agency MBS buyers and
delivery to GSEs were marked down by the
market-makers are predominantly broker-
lenders that financed those loans on short-term
dealers. However, the SEC report suggests that
repo facilities, triggering margin calls. When the
liquidity requirements, among other
Federal Reserve bond buying programs were
constraints, limited their trading capacity and
resurrected causing prices of Agency MBS to rise
their capacity to build inventories, which
rapidly, hedging arrangements used by these
significantly undermined their ability to serve as
non-bank mortgage originators to hedge their
market-makers at a time when large quantities
pipeline of mortgage loans immediately dropped
of mortgage credit assets were being sold into
in value. This produced a separate set of margin
the market. This is why the Federal Reserve’s
calls that, when combined with the margin calls on
bond buying program was so important, even
the short-term warehouse facilities for mortgage
though it caused short-term stress on the
loans, produced a sudden liquidity crisis for the
non-bank mortgage originators that hedged
non-bank mortgage originators.
their pipelines of mortgage loans.
Requests for relief, although reasonable, were
Interestingly, the SEC report only gives passing
difficult for repo lenders and hedge
mention to non-bank residential mortgage
counterparties to grant, because they, too,
servicers, which have a unique role in the
were experiencing similar margin calls or
mortgage markets. Not only are they tasked
write-downs of mortgage credit positions on
with the responsibility of processing mortgage
their books, illustrating the interconnectedness
payments and working out COVID-19-related
of the mortgage credit markets. Although
forbearance plans with borrowers, they are also
broker-dealers, for example, were sympathetic
mortgage credit holders to the extent that they
to non-bank mortgage originators’ requests for
own mortgage servicing rights and fund
more time to meet margin calls on hedging
mortgage servicing advances. This is an
arrangements, they were unable to grant the
interesting dynamic not replicated in other
requested extensions because of
service industries. Mortgage servicers must not
corresponding and interconnected transactions
only be excellent operators, but they must also
they had entered into. Similarly, mortgage
be astute financial managers. Mortgage
REITs, facing margin calls, tried to convince
servicing rights represent the right to a fixed
their repo lenders to forego or reduce margin
payment on each mortgage loan in a pool of
calls until the mortgage credit markets were
serviced mortgage loans. This right to payment
able to reach more certainty on the true impact
MAYER BROWN | 9is in excess of the cost of servicing and, financial markets and, as a result, the
therefore, has value and trades in the market. exponential impact that a shock like COVID-19
Because mortgage servicers don’t receive can have throughout the system. The credit
payment of this amount on delinquent loans but markets are analogous to a collection of
are still required to service them, the value of interconnected circuits that may individually
mortgage servicing rights can drop severely in function but can produce an overall system
anticipation of a long period of elevated failure if one or more of the circuits in the system
mortgage delinquency. An expectation of malfunction. This result is magnified from the
elevated delinquencies that reduces the value of 2008 subprime credit crisis because of changes
mortgage servicing rights can produce liquidity in the size, structure and function of the US
strains for servicers, many of which depend on credit markets, which now depend more heavily
short-term funding arrangements to finance on non-bank owners of credit and financial
their ownership of mortgage servicing rights. intermediaries. This is particularly true for the
mortgage credit markets. The SEC report notes
Similarly, mortgage servicers are responsible
that, as of August 20, 2020, 7.4% of residential
for making advances of principal, interest,
mortgage loans were in forbearance (although
taxes, insurance and other payments on
this percentage has been dropping recently) and
delinquent mortgage loans in order to keep
concludes that, if mortgage delinquencies
MBS payments current and to protect the
increase from that level going forward (which
related mortgaged properties from losses and
could happen as government support programs
claims. These advancing obligations generally
for small business, in particular, expire), it would
are first supported by prepayments on other
escalate the financial stress for non-bank
mortgage loans in the pool of serviced
mortgage originators, owners of mortgage
mortgage loans for principal and interest
credit assets and non-bank mortgage servicers,
advances, but, to the extent that prepayments
and that stress would flow through the financial
are insufficient to fund the monthly payments
system given its interconnectivity.
on delinquent mortgage loans, the mortgage
servicer must come out-of-pocket or turn to The SEC report is rightly complementary of the
third-party financing sources to fund advances. bond buying programs restarted by the Federal
Funding advances on Agency MBS with third- Reserve to mute the impact of the stress in the
party lenders is especially complicated, credit markets, particularly the short-term
requiring the cooperation of the GSEs. funding markets. The report identifies
securitization as a strength of the mortgage
C. Conclusions of the credit markets because it eliminates the
mark-to-market and extension risk of short-term
SEC Report and Possible repo funding. This is an accurate observation,
Solutions but it only holds true to the extent that those
mortgage-backed securities (“MBS”) are not
The SEC report does not propose solutions to
themselves funded with short-term repo
these past, present and emerging problems. It
financing, which is how most non-bank holders
was not written to do so. It was intended to
of MBS, such as mortgage REITs and credit
demonstrate the interconnectivity of the
funds, finance their holdings of MBS.
10 | Structured Finance Bulletin | Winter 2020Bond buying programs and other similar financial obligations that go along with mortgage
measures that add liquidity to the servicing, namely, owning mortgage servicing
interconnected credit markets when it is most rights and making advances for delinquent loans.
needed are an effective way to address Creating and developing coordinated
temporary market dislocations of the type government crisis support programs to help
experienced shortly after the COVID-19 non-bank mortgage servicers fund mortgage
shutdown. Situational problems require servicing rights and advances is necessary for the
situational solutions, such as the bond buying stable and proper functioning of the residential
programs, that can be easily calibrated to the mortgage credit markets going forward,
duration and severity of the problem. particularly following an economic shock similar
Unimaginative and inflexible solutions, like to COVID-19. Expecting the banks to jump back
imposing leverage limits on mortgage REITs, for in to pick up the slack, absent significant
example, are attractive in theory but not ideal. regulatory reforms, doesn’t account for their
They are blunt tools that may prevent future regulatory capital impediments to holding
liquidity challenges, but, at the same time, they mortgage servicing rights and their general
may unintentionally stunt the growth of the hesitation to own them again as a result of the
mortgage credit markets at a time when banks losses and reputation or harm they suffered from
have exited the markets and non-bank capacity the asset during the 2008 subprime credit crisis.
is needed to support consumer demand.
We applaud the SEC’s effort to put the data out
We think, however, the role the non-bank in a comprehensive report and expect that this
mortgage servicers play in the mortgage credit first step will lead to further action toward
market was underplayed by this report. These are mitigating the effects of a future economic
the entities tasked with the frontline work of shock similar to COVID-19. The report
collecting payments and working out forbearance intentionally leaves its readers with the open
plans with affected consumers, but, at the same question of how contingency plans should be
time, they do not get paid for this work, because made for future events given the changing
servicing fees are not paid on delinquent, nature of the credit markets and the increasing
non-remitting mortgage loans. Non-bank participation by non-bank intermediaries. Over
mortgage servicers now make up more than half the coming weeks and months, we expect that
of the mortgage servicing market, which is a market observers, regulators, including the
significant change from the 2008 subprime Financial Stability Oversight Council, and
mortgage crisis. Non-bank mortgage servicers participants will attempt to answer these and
use the mortgage credit markets to fund the other questions posed by the report. n
MAYER BROWN | 1112 | Structured Finance Bulletin | Winter 2020
Eye On IBOR Transition
J. PAUL FORRESTER
MARY JO N. MILLER
With December 31, 2021, in plain sight, preparation Authority (“FCA”) that a particular LIBOR no
for the transition from the London Interbank longer is representative of its underlying market.
Offered Rate (“LIBOR”) and similar interbank ISDA reports that during the two-week period
offered rates (“IBORs”) to replacement benchmark prior to official launch of the Protocol, 257
interest rates is accelerating rapidly. In this article, market participants elected to adhere to it.
we explore a number of recent core developments
Supplement No. 70 to the 2006 ISDA
affecting structured finance products.
Definitions,3 which also takes effect on January
25, 2021, amends ISDA’s standard definitions to
ISDA IBOR Fallbacks Protocol incorporate appropriate fallbacks for GBP (United
and Supplement Kingdom), CHF (Switzerland), USD (United
States), EUR (Europe) and JPY (Japan) LIBOR, as
The International Swaps and Derivatives
well as EURIBOR (Europe), TIBOR (Japan), BBSW
Association (“ISDA”) launched the long-awaited
(Australia), CDOR (Canada), HIBOR (Hong Kong),
IBOR Fallbacks Protocol and related IBOR
SOR (Singapore) and THBFIX (Thailand). These
Fallbacks Supplement on October 23, 2020.1
fallback rates are deemed robust and follow the
The IBOR Fallbacks Protocol2 allows market recommendations of applicable governmental
participants that choose to adhere to it to working groups. They will apply to new cleared
incorporate fallback language into existing and non-cleared interest rate derivatives that
non-cleared derivatives with no further action. reference the 2006 Definitions from the effective
Derivatives contracts involving a counterparty date. The Supplement also addresses the
that has not adhered to the Protocol will require treatment of discontinued rate maturities.
a bilateral amendment to address IBOR
cessation. The fallbacks in the Protocol apply ARRC Recommendations
upon a permanent cessation of an applicable
IBOR. In addition, for LIBOR only, the fallback and Resources
will become operative upon the occurrence of a The US Alternative Reference Rates Committee
pre-cessation trigger; that is, upon a (the “ARRC”), convened by the Federal Reserve
determination by the UK Financial Conduct Board and New York Federal Reserve Bank, has
MAYER BROWN | 13been very active in producing tools, across prudential banking regulators reiterated that
numerous product categories, to ease the banks should choose a robust replacement rate
transition from LIBOR to its recommended that is appropriate for their needs and include
replacement: the Secured Overnight Financing fallback language in their loan agreements
Rate (“SOFR”). providing for the use of such chosen rate if
LIBOR were to be discontinued.
FALLBACK LANGUAGE AND SPREAD
ADJUSTMENT BEST PRACTICES
After conducting product-specific consultations, To assist market participants in preparing for
and refreshing its loan recommendations based LIBOR cessation, the ARRC released a set of
on market evolution, the ARRC has produced recommended best practices in May 2020,
final recommendations for key product which it updated in September.6 Included in
categories that incorporate a “hardwired” these best practices are timelines and
approach to LIBOR fallback rate language. While intermediate steps that market participants
the rate waterfall within the hardwired approach should consider to accelerate their transition to
varies somewhat by product,4 the essence of a replacement benchmark interest rate. Key
falling back to Term SOFR is constant. recommendations include:
Separately, the ARRC published its • New USD LIBOR cash products should include
recommendation for a spread adjustment to ARRC-recommended (or substantially similar)
recognize the difference between LIBOR and fallback language as soon as possible;
SOFR resulting from the fact that SOFR is a • Institutions should implement clear and
secured rate while LIBOR is not. In response to rigorous internal programs to assess and
global market preference to align product address their LIBOR exposure across all
fallbacks with potentially linked derivative relevant activities;
product fallbacks, the ARRC’s recommendation
• Third-party technology and operations
mirrors that of ISDA: a spread adjustment
vendors relevant to the transition should
methodology based on a historical median over
complete all necessary enhancements to
a five-year lookback period calculating the
support SOFR by the end of 2020;
difference between USD LIBOR and SOFR.
• For contracts specifying that a party will select
It should be noted that many financial a replacement rate at their discretion following
institutions still are considering whether SOFR is a LIBOR transition event, the determining party
the appropriate fallback rate for them based on should disclose their planned selection to
their funding models and loan activity relevant parties at least six months prior to the
structures, and specifically whether a more date that a replacement rate would become
credit-sensitive rate might be more suitable. For effective; and
the structured finance market, there would be
• New use of USD LIBOR should stop, with
obvious implications for securitization and
timing depending on specific circumstances
hedged transactions that are SOFR-based. In a
in each cash product market.
statement5 released on November 6, 2020, US
14 | Structured Finance Bulletin | Winter 2020The following table shows the ARRC’s recommended target end dates by product:
Hardwired Tech / Ops Target For
Anticipated Fallback
Product Fallbacks Vendor Cessation Of New
Rates Chosen By
Incorporated By Readiness By Use Of Usd Libor
6 months prior to
Floating
6/30/2020 6/30/2020 12/31/2020 reset after LIBOR’s
Rate Notes
end
Syndicated:
9/30/2020 6 months prior to
Business Loans 9/30/2020 6/30/2021 reset after LIBOR’s
Bilateral: end
10/31/2020
Mortgages:
6/30/2020 In accordance with
Consumer Mortgages: Mortgages:
relevant consumer
Loans Student Loans: 9/30/2020 9/30/2020*
regulations
9/30/2020
6 months prior to
CLOs: 9/30/2021
Securitizations 6/30/2020 12/31/2020 reset after LIBOR’s
Other: 6/30/2021
end
Dealers to
Not later than
take steps
3-4 months after
to provide
the Amendments
Derivatives liquid SOFR 6/30/2021
to ISDA 2006
derivatives
Definitions are
markets to
published
clients
* The September 30, 2020, date for consumer loans refers to new applications for closed–end residential mortgages using USD
LIBOR and maturing after 2021.
As this article is published, on November 30, ICE these was published in 2019 and related to
Benchmark Administration (“IBA”) has announced floating rate notes (“FRNs”),7 which present a
that it will consult in early December on its particularly thorny transition issue because,
intention to cease the publication of the one- with their widely held market (and like many
week and two-month USD LIBOR settings after structured finance products), they are so
December 31, 2021, and to cease publishing the difficult to amend. These were followed by
remaining USD LIBOR settings after June 30, recommended cross-currency swaps
2023. The effect of this announcement (which has conventions in January 2020,8 syndicated loan
been well received by global regulators), if any, “in arrears” conventions in July 2020,9 and
on the ARRC’s Best Practices timeline bilateral loan “in arrears” conventions in
summarized above has not been determined. November 2020.10
The FRN conventions identify considerations for
CONVENTIONS
market participants interested in using SOFR in
Among the tools published by the ARRC are new issuances, including explanations of
various recommended conventions for different SOFR variants, the possible use of a
implementing LIBOR transition. The first of SOFR Index,11 and the distinction among
MAYER BROWN | 15lockout, lookback and payment delay interest
Sterling Working Group
payment conventions. The November 2019
appendix supplemented the conventions with Recommendations and
sample key provision term sheets by interest Resources
payment convention, and recommended FRN
Another active working group on the global stage
fallback language.
is the UK Working Group on Sterling Risk-Free
The swaps conventions analyze potential Reference Rates (“Sterling Working Group”), which
technical specifications for interdealer trading of recently finalized its spread adjustment
cross-currency basis swaps based on IBORs and recommendations and has produced a wealth of
replacement risk-free rates (“RFRs”), including transition tools for market participants.
IBOR-IBOR, RFR-RFR and RFR-IBOR swaps. The
ARRC notes that these conventions may not be SPREAD ADJUSTMENT
suitable for dealer-to-customer or customer-to- RECOMMENDATION
customer transactions. Consistent with its global counterparts, in
The most recent ARRC conventions support September the Sterling Working Group
bilateral loans, are substantially similar to the recommended12 the use of the historical five-year
syndicated loan conventions, and focus on the median spread adjustment methodology when
ARRC’s recommended “in arrears” structures: calculating the credit adjustment spread that
daily simple SOFR and daily compounded SOFR. should be applied to any relevant Sterling
The conventions address both new and legacy Overnight Index Average (“SONIA”) rate chosen
loans, and analyze structural issues, including or recommended to replace GBP LIBOR pursuant
simple versus compounded SOFR, interest to contractual fallback and replacement of screen
payment conventions, day counts, rounding, rate provisions following a permanent cessation
interest rate floors, break funding and use of the or pre-cessation trigger in relation to GBP LIBOR.
SOFR Index. The bilateral loan conventions also
note that market participants choosing to adopt CONVENTIONS AND OTHER GUIDANCE
the Hedged Loan Approach to the ARRC’s During September and October 2020 alone, the
recommended bilateral loan fallback language Sterling Working Group has produced over a
(which falls back to ISDA’s successor rate and half-dozen resources, including an updated list of
spread adjustment) should follow ISDA’s related “top level priorities,” a paper describing how
conventions. Both the bilateral loan conventions issuers might transition difficult-to-amend
and the syndicated loan conventions rely on the contracts, such as bonds and securitizations, from
ARRC’s August 2020 technical reference LIBOR to risk-free rates, and several resources
appendix, which provides additional detailed relating to loan market conventions and transition.
discussion and spreadsheet calculations of the
In updating its top level priorities,13 the Sterling
different lookback methodologies, calculations
Working Group emphasized the need to cease
for daily simple SOFR and daily compounded
issuing LIBOR-referencing products not later than
SOFR for loans and the implementation of daily
the end of the first calendar quarter of 2021, and
interest rate floors.
to accelerate efforts to transition derivative
16 | Structured Finance Bulletin | Winter 2020volumes from LIBOR to SONIA. Also updated were independent RFR calculators (particularly
the roadmaps included in the priorities, as well as addressing compounded rates) in the market.20
the product-specific target milestones, with active The aim of these tools is to inform market
portfolio conversion still targeted to complete by participants about, and support, the use of
the end of the third calendar quarter of 2021. SONIA variants, and to allow market participants
to consider whether any amendments might be
The guidance on transitioning difficult-to-amend
required to their operating systems or product
bond and securitization transaction documents
offerings ahead of transition to such rates.
includes a discussion of the consent solicitation
process, which already has been used successfully The UK Prudential Regulation Authority and FCA
to transition these tough legacy contracts.14 stated earlier this year21 that firms should expect
stepped up regulatory engagement with respect
Half of the recent resources relate to the loan
to LIBOR transition, which will be a “key input to
market and the instruments that underlie many
[the Financial Policy Committee’s] consideration
structured finance products. In publishing these
… whether sufficient progress is being made to
resources, the Sterling Working Group has stated
avoid seeking recourse to supervisory tools.”
that it hoped to facilitate “the maximum possible
degree of consistency across currencies, products
and market,”15 and that although some interim Progress in Europe
transition targets were adjusted to address the The transition to a new risk-free rate—the Euro
COVID-19 pandemic, the importance of Short-Term Rate, or €STR—has been slower in
transitioning product portfolios before the end of Europe than in the United States and United
2021 is unchanged.16 The suite of resources includes Kingdom. This may be because its interbank
detailed loans conventions17 (intended to support offered rate—EURIBOR—was reformed in 2019
the use of SONIA in loan markets for sterling to employ a “hybrid methodology” of rate
bilateral and syndicated facilities, including quotation that relies on a three-level waterfall
multicurrency syndicated facilities where there is a that prioritizes the use of real transaction data
sterling currency option) and a paper outlining whenever available from a group of quoting
practical steps that market participants can take to banks that is larger than the LIBOR panel. The
amend GBP LIBOR-referencing loans to SONIA.18 robustness of EURIBOR is reassessed annually,
The latter resource in particular emphasizes (i) the and currently is deemed to comply with the EU
need to ensure that operating systems are updated Benchmark Regulation (“BMR”). As a result of the
to accommodate alternative reference rates, (ii) the 2019 reformation, the quotation and use of
importance of treating customers fairly and EURIBOR is not expected to cease as of January
mitigating any transfer of value between the parties 1, 2022 (subject, of course, to ongoing robustness
and (iii) the substantial time that will be required to and BMR compliance).
amend all existing LIBOR-referencing loans.
Nonetheless, the European Central Bank (“ECB”)
The two most recent Sterling Working Group is moving forward to establish €STR as a robust
tools, released on October 16, 2020, are an and appropriate replacement rate and in October
overview of the key features of SONIA term 2020 released a summary of the responses22 to its
rates19 and a summary of the freely available July 2020 consultation on compounded €STR term
MAYER BROWN | 17rates.23 The respondents supported the proposed SOR-linked products (following an approach
calculation methodologies for compounded rates consistent with the United States, United
and index values, as well as proposed day-count Kingdom and Europe, but not beginning until
conventions, selection of maturities and rate late in the first quarter of 2021); a report on
precision of four decimal places. customer segments and preferences,29 which
was compiled based on surveys of a range of
Most recently, on November 23, 2020, the ECB
market participants and provides guidance on
released two new consultations: one on EURIBOR
adopting SORA for various types of loan
Fallback Trigger Events24 and one on €STR-based
products; a SORA market compendium30
EURIBOR Fallback Rates.25 The consultations seek
(intended to serve as a companion to the
market feedback with respect to a proposed set
customer segments report, and which analyzes
of potential permanent EURIBOR fallback trigger
key issues by product type and provides fallback
events, and to the most appropriate EURIBOR
language and conventions); and an end-user
fallback provisions for cash products, including
checklist31 providing practical steps that should
rate structure, spread adjustment, and market
be taken to effectively transition away from SOR.
calculation conventions. Comments are due by
January 15, 2021. These resources follow the publication by the
Monetary Authority of Singapore, the
The National Working Group on Swiss Franc
administrator of SORA, of a SORA methodology
Reference Rates (the “Swiss Working Group”)
document32 and related User Guide33 in
also has been making steady progress,26
September. SC-STS has stated that it will be
emphasizing that conventions for its
publishing additional resources to assist
replacement rate, the Swiss Average Rate
corporate users and retail customers.
Overnight, or SARON, be consistent with the
international market. The Swiss Working Group
has published recommended fallback language Legislative Solutions for
that tracks ISDA’s implementation.
Legacy Contracts
Perhaps the thorniest issue delaying transition
Singapore Working Group from IBORs to applicable replacement
Recommendations and benchmark rates is how to address so-called
legacy contracts; that is, active contracts due to
Resources mature after 2021, that were entered into before
The most ample set of transition guidance in fallback rates for a permanent discontinuance of
Asia has been published in Singapore. On LIBOR were contemplated, that are widely held
October 27, 2020, the Steering Committee for by holders that are difficult or impossible to
SOR Transition to SORA (“SC-STS”) published27 identify, and that require unanimous holder
a suite of IBOR transition guidance documents consent to amend essential provisions, such as
to lay the foundation for “a coordinated shift” the interest rate. The nature of these contracts
from SOR to SORA. has thwarted efforts to effectively transition
them to a new benchmark interest rate. In
Included in these resources were: recommended
response, governmental authorities in the
timelines28 for discontinuing the issuance of
18 | Structured Finance Bulletin | Winter 2020United States, UK, and Europe have introduced encouraging firms to continue to prioritize active
legislative solutions to effect a mandatory and transition away from LIBOR to alternative
automatic transition, under specified benchmarks, and providing further detail on the
circumstances, for these contracts. framework for the FCA’s enhanced powers.
Additional momentum was gained on November
UNITED STATES
18, 2020, when IBA announced its intention to
New York Senate Bill S9070,34 introduced October cease the publication after December 31, 2021,
28, 2020, proposes to add a new Article 12 to New of all tenors of GBP, EUR, CHF, and JPY LIBOR
York’s Uniform Commercial Code that substantially settings,38 and again on November 30, when IBA
adopts the language from the proposed legislative announced its intention to continue to publish
solution35 produced by the ARRC in March 2020. the most frequently used tenors of USD LIBOR
The ARRC’s proposal establishes both mandatory through June 30, 2023.39 Each of these
(for contracts that either are silent as to LIBOR proposals is subject to IBA consultations
cessation or that default to the last quoted LIBOR expected in December 2020. In connection with
in such event) and permissive (for contracts IBA’s November 18 announcement, FCA stated40
granting the parties discretion to choose a fallback that it will consult on policies for implementing
rate) applications of the statutory language, sets its proposed new powers under the Financial
forth an “opt-out” provision, applies to all product Services Bill and released two new consultations:
types and provides a safe harbor for “conforming one with respect to the designation of
changes” consisting of operational or benchmarks41 and one with respect to the
administrative adjustments to implement the exercise of its proposed new powers.42 43
transition. We understand that a similar bill,
applicable to all states, including New York, is EUROPE
under consideration at the federal level.
Earlier this summer, in July, the European
Commission proposed an amendment to the EU
UNITED KINGDOM
Benchmark Regulation44 to enable the
On October 21, 2020, the UK government amendment of specified financial instruments or
released its promised draft legislation36 to contracts by way of a directly applicable
assist the “tough legacy” issue for certain regulation, to avoid a significant disruption in
LIBOR-referencing contracts by providing the the functioning of the EU financial markets. A
FCA with new and enhanced powers to oversee new Article 23(a) would empower the European
the orderly wind-down of critical benchmarks, Commission to designate a mandatory
such as LIBOR. The legislation includes the replacement benchmark and, by operation of
authority, subject to specified requirements, for law, replace all references to a benchmark that
the FCA to direct a change in the methodology has ceased to be published with the
of a critical benchmark and extend its replacement benchmark. This legislative solution
publication for a limited time period. would apply to financial instruments, financial
Contemporaneously, HM Treasury issued a contracts and measurements of the performance
policy statement37 supporting the proposed of an investment fund that are within the scope of
amendments to the UK Benchmark Regulation, the BMR; that is, in EU contracts involving EU
MAYER BROWN | 19You can also read
