Risk retention rule
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The Law and Lore of Repackaging
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Base risk retention requirement. Except as otherwise provided in this part, the sponsor of a securitization transaction [...] shall retain an economic interest in the credit risk of the securitized assets in accordance with any one of §§ 246.4 through 246.10. Credit risk in securitized assets required to be retained and held by any person for purposes of compliance with this part, whether a sponsor, an originator, an originator-seller, or a third-party purchaser, except as otherwise provided in this part, may be acquired and held by any of such person's majority-owned affiliates (other than an issuing entity).[1]
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“Asset” means a self-liquidating financial asset (including but not limited to a loan, lease, mortgage, or receivable)
The risk retention rule requires that those who sponsor an asset-backed security to “retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party”.
The key question is whether the ABS is collateralised by any type of “self-liquidating financial asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable)” for which payments “depend primarily on cash flow from the asset”.
Self-liquidating financial asset
A “self-liquidating financial asset” is generally viewed as one that is capable, pursuant to its terms, of generating sufficient income by way of distributions and payment at maturity to return its original cost. This would cover things like (non-perpetual) bonds, loans, mortgages and receivables but we think[2] not commodities, emission allowances or equities none of which necessarily generate any intrinsic cashflow of their own (okay, equities might pay dividends, but don’t have to, and certainly don’t pay down their whole capital value.
Transfer
To be in scope for risk-retention, the sponsor needs to be offloading the assets in the first place. If it just originates them in the market (as is the case for certain CLO structures, for example) the requirement for there to be a “transfer” is not met. On February 9, 2018, the Circuit Court, reversing an earlier ruling, ruled[3] that collateral managers in “open-market” CLO transactions are not subject to the risk retention rule or any related regulations.
Loans
If you do your repack in non-securities format — such as a loan — then the risk retention rules don’t seem to apply. Which — if true — is nice. We think it has something to do with the definition of “asset-backed security” which must be — you know — a security. A bilateral, non-negotiable loan isn’t. Now it is not beyond the great wall of credibility that U.S. Attorneys and their regulators might confect a disposition that a loan is in fact a security — many of them seem to think of a swap as a security, so why not — so be extra careful, young fool, when galloping into this terrain, sparsely-troubled with angelic footsteps as it appears to be.