Insurance regulator's White Paper sets global standard for disclosure of structured finance securities

A recently released White Paper by the US National Association of Insurance Commissioners (NAIC), set the global standard for disclosure for structured finance securities ranging from covered bonds to securitizations.

The NAIC is a regulator for the buy-side with a mandate to protect the insurance companies and specifically their policyholders.  As a result, it has set a standard for the insurance community and the buy-side in general.

This standard applies whether or not the SEC revises Reg AB, the disclosure regulation for structured finance securities, to meet the NAIC standard.

This standard applies whether or not the Bank of England and the ECB use it as the standard for determining the eligibility of covered bonds and structured finance securities as acceptable collateral to be pledged to the central banks.

The insurance companies are both direct and indirect buyers of covered bonds and structured finance securities.  The standard for their own portfolio will also apply to the portfolios they run for third parties.

Why does this disclosure standard apply globally?

Structured finance securities are designed to appeal to a global investor base.  Without the insurance companies, the market for these securities is drastically reduced and the economics of these securities becomes very unattractive.

In its concluding remarks the NAIC observed:

There are two ways to implement change in the way the RMBS [or any other covered bond or securitization] market performs. 

Government can enact laws and regulations requiring the reporting of certain data and insist on a level of transparency that sellers of RMBS must meet, or the private sector can recognize the market is not working well and an alliance of buyers, regulators and the public can insist on greater transparency and effective disclosure of sufficient information to allow RMBS investors and regulators to have greater confidence in the market. 

If a private sector solution is developed, insurance regulators could influence its success by providing greater credence to assets ... [that] provide collateral performance disclosure on a more frequent basis. 

Regulators might want to give greater credence, perhaps in the way of reduced capital requirements, to insurers who invest in assets with greater transparency both through more frequent disclosure ....  Improving transparency would be a good thing for insurers, regulators and the capital markets.... 

From an insurance regulatory perspective, the goal is to improve the knowledge insurers have regarding their RMBS holdings. The true value of RMBS holdings should be readily available to insurance regulators charged with monitoring solvency.

The goal to improve the knowledge insurers have regarding their RMBS [covered bonds or securitization] holdings is simply a restatement of the European Capital Requirement Directive Article 122a's 'know what you own' requirement for commercial and investment banks.

From the White Paper, disclosure which allows the insurers to know what they own has two elements.

• First, a covered bond/structured finance security would report on an observable event basis any activity like a payment or delinquency that occurs with the underlying collateral before the beginning of the next business day.  This is a change from the current once-per-month or less frequent reporting. 

• Second, the disclosure would include all data fields tracked by the originators and servicers while protecting borrower privacy consistent with HIPAA patient privacy standards.  This is a change from the current focus on data templates that don't include all non-borrower privacy protected data fields.  After all, why exclude any non-borrower privacy protected data field that the experts, the originators and servicers, confirm is useful and relevant by spending money to track? 

There are two reasons that the NAIC white paper has effectively set the global disclosure standard for structured finance.

• First, the market depends on the capacity of insurance companies as buyers either for their balance sheet or for the third party portfolios they manage.  Deals that don't provide sufficient disclosure will not be economically attractive for insurance companies to buy due to the amount of capital they need to hold against the security.

• Second, setting capital standards for insurance companies based on disclosure effects the entire buy-side.  Non-insurance company portfolio managers and fiduciaries have an incentive to adopt these standards as it reduces their risk of an adverse finding should litigation occur related to losses on these securities.