What Do the New Risk Retention Requirements of the Dodd-Frank Act Mean for Securitization? <br>

Wed Dec 01 15:24:38 EST 2010
By Dr. Faten Sabry

Third in a NERA series examining the impact of the new financial regulations

The Dodd-Frank Wall Street Reform and Consumer Protection Act ("the Act"), which was enacted into law on 21 July 2010, is the most significant piece of financial legislation since the 1930s and is expected to affect every aspect of the US financial services industry. Regulators now face the daunting task of writing rules for securitizers to comply with the Act's requirements, and the new risk retention rules require securitizers to retain not less than 5% of the credit risk for most asset-backed securities without hedging or transferring the credit risk.

In this paper, the third in a NERA series examining the impact of the new financial regulations, Senior Vice President Dr. Faten Sabry examines economic evidence indicating that the contraction in the credit markets observed since 2007 may be exacerbated by strict adherence to a "one size fits all" risk requirement. Dr. Sabry discusses the recent academic literature on the optimal design and types of risk retention rules, and notes that recent studies show that different retention mechanisms can have different effects on the incentives of the securitizers and there is no economic basis for a "one size fits all" rule. Finally, she argues that economic modeling can be used effectively to design the appropriate risk retention rules to take into account the significant heterogeneity across different asset classes and deal structures, which would help the alignment of incentives.

Other papers in the series:
Economic Analysis in the Federal Rule-Making Process to Implement the Dodd-Frank Wall Street Reform and Consumer Protection Act
By Dr. James Overdahl

Summary of Dodd-Frank Rulemakings and Studies