Friday, October 29, 2010
Chairman Volcker's Concerns on Banks Gaming Regulations Applies to Structured Finance Disclosure
Chairman Volcker's concerns about the implementation of the "Volcker Rule" banning proprietary trading in today's Wall Street Journal article, Volcker on his 'Rule' - Keep It Broad, are also relevant for the regulatory efforts to revise disclosure requirements for structured finance securities.
His concern is that narrow or prescriptive rules, like setting the specific data fields that must appear in a structured finance reporting template, invite gamesmanship by the banks that ultimately could allow them to avoid the intent of the rules.
Examples of gamesmanship cited in the article are the efforts of banks and their lobbyists to sway the regulators to write rules in a certain way. This is an excellent description of the activities of the Association of Financial Markets For Europe (AFME) and the American Securitization Forum (ASF) with regards to structured finance security disclosure.
Particularly susceptible to this form of gamesmanship are Article 122a of the Capital Requirements Directive and SEC Regulation AB. Article 122a requires European credit institutions that invest in structured finance securities to know what they own and issuers to provide the loan-level performance data so that these investors can do their homework. Regulation AB establishes disclosure requirements for structured finance securities in the US.
Article 122a and Regulation AB need regulators to define disclosure: either broadly or with narrow, prescriptive rules. To be effective for investors, 'what' is disclosed has to be done 'when' it is most relevant. For example, tender offers for common stock have to be announced when the tender offer is made and not at the end of the month or quarter.
The gamesmanship surrounding Article 122a and Regulation AB has been to focus on 'what' and keep repeating that the current frequency of reporting must be the appropriate 'when' for disclosure since it is the current frequency of reporting.
As readers of this blog who have taken the Brown Paper Bag Challenge know, investors need current information, what is in the bag right now, if they are going to know what they own and not be blindly betting on the value of the contents of the bag. Current information, which is only achievable through observable event based reporting, is not the same as existing structured finance reporting practices of once-per-month or less frequently.
For structured finance, the way to keep the structured finance disclosure rules from being gamed is to require issuers to disclose on a borrower privacy protected basis all the loan-level data fields that they track on an observable event basis. Where observable events include activities like payments, delinquencies, defaults, insolvency and identification, acceptance or denial of representation and warranty claims