LEASING LAW By Stephen T. Whelan Regulation RR: On Track O of coal into the stockings of every sponsor of equipment lease and loan securitizations. That is the day when Regulation RR (for Risk Retention) will become effective for all nonmortgage securitizations. The general rule is that the originator or sponsor of the transaction must hold, while the asset-backed securities (ABS) are outstanding, at least 5% of the “credit risk” for the assets that are transferred, sold or conveyed through the issuance of an asset-backed security by the securitizer. interest in the issuer, which can include one or more of the most subordinated ABS classes, or some combination of the two. This is the most common form of risk retention in Equipment ABS. A vertical interest is one in which the sponsor owns at least 5% of every class of ABS interests, including the equity in the issuer. An eligible reserve ac-count also has been a common feature of recent Equipment ABS transactions and consists of an account, owned by the issuer and pledged to the inden-ture trustee for the ABS. The account typically is funded at closing and is re-plenished through the monthly flow of funds from collections on all the equip-ment leases and loans. N CHRISTMAS EVE NE XT YEAR the federal government will drop a lump Background Section 941 of the Dodd-Frank Wall Street Reform and Investor Protection Act of 2010 required federal banking agencies and the Securities and Ex-change Commission to issue regula-tions “to require any securitizer to re-tain 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.” On Dec. 24, 2014, six federal agen-cies published their final rule. SEC Regulation RR will become effective Dec. 24, 2015, for mortgage-backed securities issued on or after that date, and December 2016 for all other cat-egories of asset securitization. They apply to a “sponsor” or “securitizer,” which is a person who organizes and initiates an ABS transaction by selling or transferring assets, either directly or indirectly (including through an affili-ate), to the issuer of the ABS. It Could Have Been Worse The federal agencies issued a “Re-Pro-posal” in September 2013 that would have had several pernicious, albeit un-intended, effects on Equipment ABS. Thanks in large part to ELFA advocacy efforts, Regulation RR did not contain any of these elements. The Re-Proposal solicited com-ment on whether the sponsor (as the holder of the horizontal retained risk) should be prohibited from receiving a cumulative amount that exceeded the sponsor’s proportionate share of pay-ments made to the holders of the ABS; the proportionate share would have been determined in accordance with the closing date fair value calculated for the sold interest and the retained interest. The impact of this concept would have been that (assuming that no event of default was in effect) spon-sors could not receive their share of equipment residual proceeds, even though those proceeds would have been payable to the sponsor as the last The General Rule Under Regulation RR, the sponsor of an ABS deal will have to retain an eli-gible first loss “horizontal” or “verti-cal” interest equal to at least 5% of “the fair value of all ABS interests in the is-suing entity that are issued as part of the securitization transaction.” This risk retention can be satisfied either by a horizontal or vertical retained inter-est or by an eligible reserve account. A horizontal interest is one in which the sponsor (usually the parent of the ABS issuer) puts at risk its equity 50 OCTOBER 2015 EQUIPMENT LEASING & FINANCE MAGAZINE Don’t miss the session “Hot Legal Topics for the Industry Executive” at the 2015 ELFA Annual Convention. Learn more at www.elfaonline.org/AC. SHUTTERSTOCK