USA Law and Practice Contributed by: Bjorn Bjerke, Corey Reis and Joshua Kopel, A&O Shearman
4.3 Credit Risk Retention The Dodd-Frank Act introduced a mandate to the SEC and the bank regulatory agencies to promulgate rules requiring “securitisers” to retain credit risk, which are generally the same but codified in the relevant sections under the Code of Federal Regulations (CFR) for the rel - evant regulator. For the SEC, the risk retention rules are codified as “Regulation RR” in 12 CFR part 373. The Risk Retention Rules require a “sponsor” or one of its “majority-owned affiliates” to retain the required risk exposure in one of the prescribed forms under the rules. For most securitisations, risk retention may take any of three standard forms: • vertical risk retention by holding of at least 5% of each class of “ABS interests” issued; • horizontal risk retention by holding junior most interests in an amount equal to at least 5% of the “fair value” of all ABS interests issued; and • “L-shaped” risk retention, by holding a com - bination vertical and horizontal risk retention that adds up to 5%. The person required to retain the risk is the “sponsor”, defined as a “person who organises and initiates an asset-backed securities trans - action by selling or transferring assets, either directly or indirectly, including through an affili - ate, to the issuer”, a phrase that is substantially identical to the definition of “sponsor” under Regulation AB. Notably, the DC Court of Appeals ruled in 2018 that subjecting managers of open-market CLOs to the Risk Retention Rules exceeded the statu - tory authority under Section 941 of the Dodd– Frank Act and consequently such CLOs are
currently not subject to the risk retention require - ments. The Exchange Act allocates enforcement author - ity for the risk retention rules to the appropri - ate federal banking agency with respect to any securitiser that is an insured depository insti - tution and the SEC with respect to any other securitiser. Penalties for Non-Compliance The Federal Deposit Insurance Act (FDIA) pro - vides the bank regulatory agencies with broad enforcement powers against individuals and entities for violation of the applicable bank - ing laws and regulations, including the Risk Retention Rules. As such, the banking agen - cies may seek cease-and-desist orders requir - ing cessation and potential corrective actions. The agencies may also impose civil monetary penalties that can range between USD5,000 and USD1 million per day, and it may seek to impose removal and prohibition orders against any “institution-affiliated party” (a potentially broad list of persons), which may remove and potentially bar the person from participating in the business of the relevant banking entity or other specified entities. The SEC’s enforcement authority and remedies for violations of the Risk Retention Rules would be the same as its general enforcement authority against those in violation of securities laws and regulations and their “control persons”, includ - ing permanent or temporary cease-and-desist orders, fines, withdrawal of registrations and restrictions on acting as officers or directors of SEC-registered companies, and otherwise may strip a person or entity of privileges afforded to registered persons. Any Exchange Act violation could also result in equitable remedies, including the right of rescission. If the violation of the Risk
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