LEXIS-NEXIS® Congressional Universe-Document
LEXIS-NEXIS® Congressional
Copyright 1999
Federal News Service, Inc.
Federal News Service
MARCH 18, 1999, THURSDAY
SECTION: IN THE NEWS
LENGTH: 5586 words
HEADLINE: PREPARED STATEMENT OF
SETH GROSSHANDLER, ESQ.
PARTNER
CLEARY, GOTTLIEB, STEEN
& HAMILTON
BEFORE THE
HOUSE JUDICIARY COMMITTEE
SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW
SUBJECT - THE
BANKRUPTCY REFORM ACT OF 1999 (H.R. 833)
BODY:
I. Introduction
Certain types of financial transactions involve ongoing economic relationships
or commitments to be fulfilled in the future. For example, risk management
tools such as forward contracts and swaps are based on contractual agreements
between parties to transfer assets or payments at some future time. Repurchase
agreements, which are important sources of liquidity in the debt markets and,
to an increasing degree, in the equity markets, involve financial commitments
that must be fulfilled at a later date. In these important market activities
which can involve huge sums and concentrated exposures, the inability of one
party to exercise its contractual
"self-help" rights in the event of the insolvency of the other party could cause ripple
effects by undermining the financial condition of the non-bankrupt party (and
its counterparties) and the markets more generally.
Recognizing the important role of these transactions in capital formation and
market liquidity and the potential for a chain reaction of insolvencies should
non-bankrupt parties' contractual self-help rights be impaired, Congress has
included provisions in the
Bankruptcy Code, the Federal Deposit Insurance Act and the Federal Deposit Insurance
Corporation Improvement Act of 1991 (applicable in proceedings under the
Bankruptcy Code and the Federal Deposit Insurance Act) that expressly protect the
exercise of such rights in the event of
bankruptcy or insolvency. In 1982 and 1984, the
"securities,"
"forward" and
"commodity" contracts and
"repurchase agreement" provisions were added to the
Bankruptcy Code. In 1989, the Federal Deposit Insurance Act was amended to enhance the
FDIC's powers, and to provide
"market safe harbors" from those powers for parties to
"qualified financial contracts" ("securities,"
"forward" and
"commodity" contracts and
"repurchase" and
"swap" agreements). In 1990, the
"swap agreement" provisions were added to the
Bankruptcy Code, and in 1991 the
"Payment System Risk Reduction" provisions of the Federal Deposit Insurance Corporation Improvement Act
(applicable to the treatment of
"netting contracts" in proceedings under the
Bankruptcy Code and the Federal Deposit Insurance Act) were enacted.
It is almost ten years since the last of the
Bankruptcy Code and Federal Deposit Insurance Act
"market safe harbors" was enacted, and almost twenty years since the first of the
Bankruptcy Code's
"market safe harbors" was enacted. Unfortunately, the
Bankruptcy Code and the Federal Deposit Insurance Act have not kept pace with the
development of sophisticated financial markets transactions. The risks to the
markets that Congress has previously addressed remain the same -- the
insolvency of a party to a financial markets transaction could cause a chain
reaction of insolvencies -- but the
Bankruptcy Code and the Federal Deposit Insurance
Act need important technical corrections to minimize these risks in light of
market developments. The
Bankruptcy Code, especially, needs corrections that were made in the analogous provisions
of the Federal Deposit Insurance Act in 1989. In the last two decades, the
financial markets have evolved and matured in ways that leave various
transactions and parties subject to legal uncertainty. As more types of market
participants have engaged in a broader range of transactions, statutory
inconsistencies have surfaced that make it difficult to conclude that
Congress's goal of minimizing systemic risk has been fully achieved through the
existing market safe harbors.
Asset securitizations, which provide a secondary market for consumer,
commercial and industrial loans and other debt obligations, are multi- stage
transactions where the integrity of securities payment commitments rests on the
finality of earlier transfers of underlying assets. The
key to these transactions is that the underlying assets be separated from the
creditworthiness of the seller through a
"true sale" of the assets. The FDIC has published for comment a Policy Statement designed
to give comfort to the markets that these transactions will not be impaired if
a bank seller becomes the subject of insolvency proceedings. Similar comfort is
important in the case of sellers that are potentially subject to proceedings
under the
Bankruptcy Code; investors counting on the predictability of certain cash flows rely on
the finality of the earlier sale of underlying assets. Amendments to provide
such comfort will not only enhance the development of future asset-backed
securitizations, they will provide a safeguard against market turmoil should a
seller become the subject of proceedings under the
Bankruptcy Code and attempt to disrupt the cash flow on assets it has securitized.
The
Bankruptcy Reform Act of 1999 (H.R.
833) would bring the treatment of financial transactions under the
Bankruptcy Code and the Federal Deposit Insurance Act up to date through a number of
important amendments. This statement does not focus on all of the technical
corrections that would be made by the bill. Instead if focuses on three sets of
provisions in particular. The first set of provisions would modernize outdated
definitions and classifications that can cause different types of parties in
similar economic circumstances to receive dramatically different treatment
under the law and that seem inconsistent with the goal of minimizing systemic
risk. The second set of provisions would address situations where parties have
multiple outstanding obligations to one another involving different types of
products (so-called
"cross-product netting"). Although the Federal Deposit Insurance Act does not make arbitrary
distinctions between netting among different products, the
Bankruptcy
Code does; these distinctions do not seem consistent with the goal of reducing
the risk of a chain reaction of insolvencies. A third set of provisions is
specifically designed to protect the integrity of certain asset securitizations
from the
bankruptcy of a seller of assets.
These proposed changes should not raise sweeping new policy issues-- they are
entirely consistent with many statutory provisions that have already been
enacted, and are in the nature of technical corrections.
II. The Current Market Safe Harbors Need to be Updated
A. Swap Agreements
Swap agreements are privately negotiated contracts between parties to exchange
payments under specified conditions. The parties' obligations are linked to
some index, commodity price, interest rate, currency or other indication of
economic value. In an interest rate swap, for example, two parties agree to
exchange payments based on some agreed upon notional
principal amount. However, principal does not typically change hands in a swap
contract. It merely serves as the reference for the calculation of the payments
to be made.
The primary purpose of swaps is risk management. The universe of parties
actively engaged in swaps is expansive and growing: banks, securities firms,
mutual funds, pension funds both public and private, manufacturing firms, state
and local governments, just to name a few. Virtually all significant commercial
enterprises face certain risks that can be managed through the use of a swap.
In the example that follows, Party B attempts to manage its exposure to changes
in interest rates through the use of an interest rate swap:
Example 1. Two parties to an interest rate swap agree to exchange payments
based on a $1 million notional
amount.
Party A agrees to pay a fixed rate of seven percent, and Party B agrees to
make floating payments based on some market index. Assuming payments are
exchanged once per year, Party A would pay Party B $70,000 (seven percent of $1
million) and Party B would pay Party A $40,000 in the first year (four percent
of $1 million), assuming that the floating rate index were four percent at the
time of calculation. In practice, the payments are netted so that Party A
simply pays Party B $30,000, or $70,000 - $40,000. (In this example, Party B
may have floating rate assets and fixed rate liabilities, and it desires to
hedge that mismatch. In this example, the payment that Party B receives makes
up for the reduced return Party
B receives on its floating rate assets, allowing it to satisfy its fixed rate
liabilities. Party A may be a dealer, who hedges its position by taking an
offsetting position, either in the swaps market or in another fixed income
market.)
The fundamental contractual terms in a swap for the exercise of remedies in the
event of
bankruptcy or insolvency provide for
"close- out,"
"netting" and foreclosure. Close-out involves the termination of future obligations
between the parties and the calculation of gain or loss. Netting involves
offsetting the parties' gains and losses to arrive at a net outstanding amount
payable by one party to the other. Foreclosure involves the use of pledged
assets to satisfy the net payment obligation. The ability to execute this
process swiftly is key to the financial markets and the solvency of its
participants due to the
potential exposure a counterparty in such transactions has to market risks and
the possibility of changes in the values of financial contracts and collateral
due to market movements. The inability of a financial market participant to
exercise these remedies promptly could impair its liquidity and solvency.
The following is a basic example of the close-out, netting and foreclosure
process:
Example 2. Party A and Party B enter into two interest rate swaps at different
times (Swap X and Swap Y). Both contracts contain provisions that allow for
close-out, netting and foreclosure and are in effect when Party A becomes
insolvent. At the time of Party A's insolvency, Party A's mark-to-market loss
under the terms of Swap X is $30 million and its mark-to-market gain under the
terms of Swap Y is $20 million. Through the process of close-out and netting, the swaps are terminated and Party A owes Party B $10 million.
If Party A had pledged $15 million of collateral to Party B, Party B would
foreclose on the collateral, use $10 million to satisfy Party A's obligation,
and return $5 million to Party A.
If Party A became subject to a proceeding under the
Bankruptcy Code, Party B would be entitled under current law (Sections 362(b)(17) and 560
of the
Bankruptcy Code) to exercise its self-help close-out, netting and foreclosure remedies as
described above. If Party A were an FDIC-insured bank that became subject to a
receivership (and Swaps X and Y were not transferred to a successor entity),
Party B would be entitled under the Federal Deposit Insurance Act to exercise
its self- help close-out, netting and
foreclosure remedies as described above. Party B's inability to exercise such
remedies could impair its liquidity and solvency, creating gridlock and posing
the risk of systemic problems.
The swaps market has evolved since the protections for interest rate and other
swaps were first put in place. Parties have learned to apply the principles of
risk management in many different ways that are not expressly covered under the
applicable definitions in the
Bankruptcy Code and the Federal Deposit Insurance Act. As a result, the markets in some
cases proceed under some degree of legal uncertainty regarding the
enforceability of certain contracts, even though they are economically
equivalent to other contracts that are expressly protected and pose the same
risks that Congress has sought in the past to avoid.
For example, if in the above hypothetical the two swaps were equity swaps in
which the payments were calculated on the
basis of an equity securities index, it is not entirely clear that the
transactions would fall within the market safe harbor in the
Bankruptcy Code or the Federal Deposit Insurance Act for
"swap agreements." If both of the parties were
"financial institutions" under the Federal Deposit Insurance Corporation Improvement Act or the Federal
Reserve Board's Regulation EE and the swap agreement were a
"netting contract," then Party B might (although it is not entirely clear) be able to exercise
close-out, netting and foreclosure rights in respect of the equity swap
transactions. If one of the parties were not a
"financial institution" or the contract did not constitute a
"netting contract" (for example, because it was governed by the laws of the United Kingdom), then
Party B could be subject, among other things, to the risk of
"cherry-picking" -- the risk that Party A's trustee or receiver would
assume Swap Y and reject Swap X, leaving Party B with a $30 million claim
(which would be undersecured because of the impairment of netting) and to the
risk that its foreclosure on the collateral would be stayed indefinitely. This
could impair Party B's creditworthiness, which in turn could lead to its
default to its counterparties. The
Bankruptcy Reform Act of 1999 would minimize these risks by making clear that an equity swap is
a
"swap agreement," entitled to the same market safe harbors as interest swap agreements.
B. Repurchase Agreements
Repurchase agreements, also known as
"repos," are contracts involving the sale and repurchase of securities or other
financial assets at predetermined prices and times. Although structured and
treated for legal purposes as purchases and sales, economically repos resemble
secured lending transactions. In economic terms, one participant in the repo
transaction (the
"seller") is borrowing cash at the same
time that the other participant (the
"buyer") is receiving securities. The recipient of cash agrees to pay the cash--to
repurchase the securities--at a predetermined time and price, including a price
differential (the economic equivalent of interest). The buyer agrees to
purchase and later resell the securities.
According to published reports, on an average day last year, nearly $1.7
trillion in repos were outstanding between dealers of U.S. government and
federal agency securities, up from a daily average of $567 billion in 1987.
Parties also routinely engage in repo transactions involving non-agency
mortgage-backed securities, whole loans and other financial instruments. As a
result of recent legislative changes enacted as part of the National Securities
Markets Improvement Act and recent changes to federal margin regulations, repos
may now involve equity
securities. Participants in the repo market are diverse, including commercial
banks, securities firms, thrifts, finance companies, non-financial
corporations, state and local governments, mutual and money-market funds and
the Federal Reserve Banks, among others.
In 1984, Congress acted to protect certain types of repos from the insolvency
of market participants after the 1982 Lombard-Wall
bankruptcy court decision cast uncertainty on the ability of market participants to close
out their positions. According to the Senate Judiciary Committee report on the
1984 legislation, that decision had a distinct adverse effect on the financial
markets. At that time, Congress granted protection only to repos involving
certificates of deposit, eligible bankers' acceptances, and securities that are
direct obligations of, or that are fully guaranteed as to principal and
interest by, the federal government. In doing so, Congress expressly
stated that repos serve a vital role in reducing borrowing costs in the markets
for these securities and sought to encourage market participants to use repos
with confidence.
Unfortunately, the list of instruments protected by those 1984 amendments to
the
Bankruptcy Code has grown outdated as market participants have entered into repos
involving a wide range of financial assets. Besides repurchase agreements on
government and federal agency securities, which are covered under the
Bankruptcy Code and Federal Deposit Insurance Act definitions of
"repurchase agreement," firms now actively engage in repurchase agreements on the foreign sovereign
debt of OECD countries, whole mortgage loans, and mortgage-backed securities of
many types. Under H.R. 833, each of these types of repurchase agreements would
be covered by the market safe harbors provided in the
Bankruptcy Code (they are already covered
by the Federal Deposit Insurance Act and regulations thereunder). Market
participants could then enter into such transactions with greater confidence
that they will be easily enforceable, improving the liquidity and cost of
financing in the markets for the underlying instruments, and minimizing
systemic risk.
C. Securities Contracts, Forward Contracts and Commodity Contracts
Market participants enter into contractual arrangements for the sale of
securities and commodities where payment and delivery obligations are fulfilled
at some future date. Securities contracts, forward contracts, and commodity
contracts all can take many forms, but they can also be similar from an
economic perspective.
"Securities contracts" include forward purchases of securities, pursuant to which the parties agree
to exchange payments and securities at a fixed date in the future.
"Forward contracts" include privately negotiated arrangements where one party agrees to sell a
commodity to another
party at a fixed price for delivery at a future date. The terms of forward
contracts can closely resemble those of futures contracts (which are
"commodity contracts"). However, forward contracts are not traded on commodity exchanges under
standardized terms and the parties envision actual delivery of the underlying
commodity.
Despite the economic similarities of securities contracts, forward contracts
and commodity contracts, the
Bankruptcy Code and the Federal Deposit Insurance Act are inconsistent in their treatment
of these transactions. Under the Federal Deposit Insurance Act, any
counterparty can close out and net obligations under all securities contracts,
forward contracts or commodity contracts it may have outstanding with the
FDIC-insured bank in a liquidating receivership. However, if the failing
counterparty is a debtor subject to the
Bankruptcy Code, the enforceability of close-out provisions depends on a
number of factors, including the type of counterparty, and the type of contract
involved. In order to close out and net
"securities contracts," the non-bankrupt counterparty must be a
"stockbroker,"
"financial institution" or
"securities clearing agency." In order to close out and net
"forward contracts," the non-defaulting party must qualify as a
"forward contract merchant." A few examples illustrate these differences:
Example 3. Party A, a mutual fund, and Party B, a securities dealer, have two
outstanding contracts for the purchase of securities, one that is in-the-money
to Party A, one that is out-of-the-money to Party A. If Party B becomes the
subject of proceedings under the
Bankruptcy Code, Party A would not be able to close out the contracts and net its
obligations to Party B under the out-of-the-money contract against Party
B's obligations under the in-the-money contract (unless it had acted through a
bank agent). However, if it is Party A that becomes the subject of proceedings
under the
Bankruptcy Code, Party B would be able to close out the transactions and net its
obligations. This is because Section 555 of the
Bankruptcy Code allows liquidation of securities contracts only by stockbrokers,
financial institutions and securities clearing agencies, none of which includes
the mutual fund (unless it had acted through a bank agent).
Example 4. Now assume that in the above example Party B is an FDIC- insured
depository institution. If Party B becomes the subject of receivership
proceedings and the securities contracts with Party A are not transferred to a
successor institution, Party A will be able to close out the transactions and
net the obligations thereunder. This is because the Federal Deposit Insurance
Act,
since 1989, contains no counterparty restrictions.
Example 5. Party A, the mutual fund, and Party B, an affiliate of a securities
dealer, have two outstanding forward foreign exchange contracts. If Party B
becomes the subject of proceedings under the
Bankruptcy Code, Party A would be able to close out and net the foreign exchange
transactions. This is because Section 556 of the
Bankruptcy Code allows liquidation of
"forward contracts" (the foreign exchange transactions) by forward contract merchants, a
classification that includes the mutual fund. (Note that the forward foreign
exchange contracts would also be
"swap agreements," and the mutual fund, as a
"swap participant," could exercise its rights on that basis as well. Other
"forward contracts" would not qualify as
"swap agreements.")
Thus, parties of similar size who enter the markets with equal frequency and in
the er enjoy different degrees of protection
under the
Bankruptcy Code and the Federal Deposit Insurance Act. This makes no sense from the point
of view of the reduction of systemic risk -- the failure of these market
players could trigger the same kind of chain reaction that a bank,
broker-dealer or clearing agency failure could trigger. H.R. 833 would improve
the current situation by making certain technical definitional changes under
the
Bankruptcy Code (to bring it closer to the Federal Deposit Insurance Act). The amendments
would expand the universe of counterparties whose contractual rights would be
enforceable. In addition to stockbrokers, financial institutions, registered
investment companies and securities clearing agencies, large and sophisticated
market participants would be able to close out their securities contracts,
forward contracts and commodity contracts against
Bankruptcy Code debtors. Such counterparties would be defined as
"financial participants" under the
Bankruptcy Code through certain quantitative tests modeled on the
Federal Reserve Board's Regulation EE. Once amended, the counterparty
limitations under the
Bankruptcy Code would have a more rational scope than they do under current law.
D. Cross-Product Netting
Financial market participants often have a wide range of transactions
outstanding with one another at any given time. Thus, a given party's exposure
to the risk of default by another party may be understood only by considering
the total value of the payments that party expects to receive and pay under all
of the various contracts. The Federal Deposit Insurance Act reflects an
understanding of this and permits the netting of obligations stemming from one
type of
"qualified financial contract" against obligations stemming from another type of
"qualified financial contract." This practice, known as
"cross- product" netting, permits more rational risk management practices and allows market
participants to resolve whatever problems arise from the insolvency of one of
their counterparties in a more orderly fashion. Cross-product netting also
reduces the likelihood of systemic risk, as it allows the non-bankrupt
counterparty to crystallize its exposure and not be treated as a secured
creditor with an interest in cash collateral subject to the automatic stay.
Cross-product netting is also permitted under the
Bankruptcy Code, but to a lesser degree. Parties can net their obligations under
securities contracts, forward contracts and commodity contracts against one
another. It is unclear whether cross-product netting is permitted, however,
when the contracts involved are swaps and repurchase agreements.
Example 6. Party A, a securities dealer, and Party B, a large corporation, have
an outstanding securities contract that upon close- out is profitable for Party
A. The parties also have
an outstanding forward contract that upon close-out is profitable for Party B.
When Party B becomes the subject of a proceeding under the
Bankruptcy Code, Party A would be able to close out each of the contracts and offset its
obligation to pay Party B under the forward against Party B's obligation to
Party A under the securities contract.
Example 7. Party A and Party B have an outstanding swap that upon close-out is
profitable for Party A. The parties also have an outstanding repurchase
agreement under which Party A holds securities purchased from Party B that upon
close-out is profitable to Party B (i.e., the value of the securities exceeds
the repurchase price). If Party B becomes the subject of proceedings under the
Bankruptcy Code, Party A would not clearly be able to offset the excess repo proceeds
against Party B's outstanding obligation under the swap. At worst, Party A
would be treated as a secured creditor with a security interest in the repo
proceeds. Its rights could, however, be subject to the automatic stay, thereby
impairing its liquidity and creating the potential for systemic risk.
There is no plausible rationale for treating cross-product netting between
securities, forward and commodity contracts differently from cross-product
netting between those contracts, swap agreements and repurchase agreements.
These anomalies emerged over time, as various protective provisions were added
to the
Bankruptcy Code to protect various types of markets. (Because the
"qualified financial contract" provisions of the Federal Deposit Insurance Act were enacted at the same time,
no such anomalies exist in those provisions.) However, the capital markets have
grown and matured to such an extent that various types of market participants
now engage in many
types of transactions, and it is time for the market safe harbors to be
rationalized and made consistent in their application to all financial products
for all participants.
Wider and more certain cross-product netting in cases of
bankruptcy should allow parties to enter into additional types of transactions with the
same counterparty without necessarily increasing, on a net basis, their overall
credit exposure or risk to the markets as a whole. Indeed, some cross-product
transactions will serve to reduce a counterparty's overall risk, facilitating
better risk management and reducing overall risk in the financial markets.
III. Mortgage- and Asset-backed Securities
The process of assembling pools of financial assets and selling securities with
payments derived from the assets' cash flows is known as
"securitization." Almost any financial asset can be securitized. The earliest examples were home
mortgage loans, but today financial services firms securitize car loans and
leases, credit card receivables, business loans and many other assets
generating current or future cash flows.
The proceeds from sales of securities supported by those assets make their way
back into the capital markets and become available for new lending to
homeowners, car owners, consumers, businesses and myriad other borrowers. A
larger supply of lendable capital means that home buyers, car buyers, consumers
and companies can all borrow at lower interest costs.
A simple example demonstrates the process of financial asset securitization:
Example 7. Party O originates mortgage loans with a total principal amount of
$100 million and sells the whole loans to a special-purpose vehicle (an
"SPV"). The SPV issues mortgage-backed securities ("MBS"), the payments on which are supported by cash flows from the mortgage loans.
As borrowers make principal and interest payments on their mortgage loans,
these payments pass through a servicer and eventually are distributed to the
MBS investors. The proceeds of the sale of the loans by Party O to the SPV are
available for new loans to home buyers.
Certain types of mortgage-backed and asset-backed transactions raise issues
under the
Bankruptcy Code that make them more costly or difficult to complete. The central issue in
such situations is the risk that securitized assets transferred to a
special-purpose vehicle, which then issues securities backed by such assets,
will be considered part of the
bankruptcy estate of the party selling them into the pool if that seller becomes
insolvent. Such treatment could subject the cash flows from the securitized
assets to the automatic stay and inhibit the timely distribution of principal
and interest payments to
investors in the subsequently issued asset-backed securities. It could also
subject the pool of transferred assets to attack by a
bankruptcy trustee who might seek to reclaim them for the bankrupt's estate for the
benefit of general creditors, denying beneficial holders of asset- backed
securities the primary source of repayment that was intended to be provided by
these securitized assets. Consider the following transaction:
Example 8. Party A originates mortgage loans with a total principal amount of
$100 million and sells the loans to Party B. Party B sells two classes of
asset-backed securities based on the pool. The Class A securities, totaling $90
million, have a senior claim on the cash flows generated by the mortgage loans
and receive an investment-grade credit rating. The Class B securities, totaling
$10
million, are subordinated to the Class A securities and not rated
investment-grade. Assume Party B obtained the mortgage loans from Party A in
exchange for (i) the $90 million raised through the sale of the Class A
securities and (ii) the Class B certificates. If Party A becomes insolvent,
Party A (as debtor-in-possession) or its trustee could attempt to
recharacterize the sale of the mortgage loans as a pledge to secure a
financing, based on Party A's retention of the Class B securities. If it were
successful, notwithstanding that it had received fair value at the outset of
the transaction and the reasonable expectations of the investors in the Class A
securities, distribution of the principal and interest payments on the loans to
the investors would be subject to the automatic stay, jeopardizing timely
payment to the Class A investors. Such a result would not only harm the
particular
investors in question, it could have a material, negative effect on the
mortgage-backed and asset-backed securities markets more generally.
In order to obtain sales treatment under the relevant accounting standards,
participants in mortgage-backed and asset-backed securitization transactions
must obtain assurances from counsel that the sale of assets will be final under
applicable
bankruptcy law. Such legal advice is referred to as a
"true sale opinion." Unfortunately, there is a lack of guiding judicial precedent regarding what
constitutes such a true sale of assets. The considerations in the analysis are
highly subjective and depend on a qualitative assessment of a wide variety of
facts and circumstances. For these and other reasons, any true sale opinion
will generally be a reasoned one, with various assumptions as to factual
matters and conclusions that introduce an unnecessary
degree of legal uncertainty in the asset- backed market. As a result, for some
types of transactions, true sale opinions can be extremely difficult, costly,
and in a few cases, impossible to render.
The FDIC recently released for comment a proposed Policy Statement that would
clarify that, with respect to certain securitizations by FDIC-insured
institutions, the FDIC would not seek to reclaim the assets the subject of the
securitization. In particular, the Policy Statement
"provides that subject to certain conditions, the FDIC will not attempt to
reclaim, recover, or recharacterize as property of the institution or the
receivership estate . . . the financial assets transferred . . . in connection
with the securitization." 63 Fed. Reg. 71926 (December 30, 1998). Similar action is needed to cover
transfers by market participants who later become debtors under the
Bankruptcy Code. In an effort to
clarify the rights of investors in asset-backed securities and bring the
benefits of securitization to a broader spectrum of market activity, H.R. 833
includes a series of amendments to the
Bankruptcy Code that would specifically exempt certain transferred assets from a debtor's
bankruptcy estate and clarify whatever
"true sale" confusion may exist. The amendments would be narrowly tailored to apply only
to eligible assets transferred as part of a bona fide securitization involving
the issuance of securities rated investment grade by at least one nationally
recognized rating organization. Through a series of definitions, the proposed
amendments would exclude from a debtor's estate any asset
"to the extent that such eligible asset was transferred by the debtor, before
the date of commencement of the case, to an eligible entity in connection with
an asset-backed securitization."
These changes would not only
reduce transaction costs for future mortgage- and asset-backed securitizations,
they would minimize the likelihood that an insolvent debtor could attempt to
reclaim already- securitized assets in a proceeding under the
Bankruptcy Code, notwithstanding the structural safeguards designed to avoid such a
result. Even if such a debtor were not successful, the possibility of
recharacterization could have a significant adverse impact on the markets in
mortgage- and asset-backed securities.
IV. Conclusion
The above examples illustrate the need for Congress to enact the
Bankruptcy Reform Act of 1999 which would make important, but highly technical, changes to the
Bankruptcy Code and the Federal Deposit Insurance Act. These changes are consistent with
the existing market safe harbors in the
Bankruptcy Code and the Federal Deposit Insurance Act, will encourage broader use of
sound risk management techniques and help to minimize overall systemic
risk.
END
LOAD-DATE: March 23, 1999