By Joy Wiltermuth

NEW YORK, June 24 (IFR) - Four top law firms are working on a white paper that some hope would help bring more clarity to risk-retention regulations in the CMBS market which come into effect at the end of the year.

Law firms Cadwalader, Wickersham & Taft, Dechert, Sidley Austin and Orrick, Herrington & Sutcliffe, which are involved with a bulk of transactions in the primary structured finance market, are working on the paper, two attorneys involved in the project told IFR.

The attorneys declined to give details of the paper's content or when it will be finalized, but it is expected to be in a question and answer format.

The hope is that players in the US$600bn commercial mortgage bond industry could use the paper as a discussion point to make regulators address specific points within 166-pages of risk retention rules that the industry is grappling with.

"The sooner we can get clarity around this the better," said Jack Mullen, founder of real estate advisory firm Summer Street Advisors.

"Otherwise, we will be left by the wayside as a US$50bn or US$60bn a year market, and balance sheet lenders and community banks will step in to fill the void."

The final draft of the white paper could, for example, include clarity around what types of leverage - if at all - might be acceptable to use by a party designated as retaining the 5% risk retention stake.

"I've never heard of a regulatory hurdle that has gone this far along without a solution," one lawyer said at a recent industry conference in New York.

"People are exploring different structures (to meet the requirements and gauge) what is the closest we can come without getting ourselves in trouble."

CLOCK TICKING

In the wake of the financial crisis, tougher rules were drafted that require originating banks to hold at least 5% of any new CMBS on their own balance sheets - or find investors who will hold it instead.

They were designed to force banks to keep "skin in the game" when selling new mortgage bonds - and avoid the fast-and-loose attitude that helped spur the crisis.

But finding a way to structure new deals without falling foul of the rules is proving a big challenge - and time is running out as the December 24 deadline creeps closer.

Wells Fargo, Bank of America and Morgan Stanley, for example, are prepping a CMBS that is expected to be roughly US$1bn in size, and is being hailed by some as a litmus test for the market.

The banks plan to keep a "vertical" strip of the deal - that is, a sliver of each class of the bond, from Triple A all the way down to the unrated bottom - according to people with knowledge of the trade.

The banks, they said, plan to argue that the strip is akin to mini slices of loans.

If regulators agree, the capital charge incurred on the banks could be relatively low but no one is absolutely sure the structure will get the regulatory green light.

Among the other unknowns are the penalties that would be incurred if the rules are violated, and how the changes would impact the cost of financing.

Most believe it will be more expensive to lend on malls, hotels, office towers and other properties - regardless of what shape deals take.

Pacific Investment Management Co warned this week that US commercial real estate prices could fall 5% in the next 12 months - and said one of the reasons was tighter regulation.

"In essence, bank originators will have to go from being a 'moving business' model to a costlier 'storage business' model, which in turn means lower volumes and higher rates for CRE borrowers," the investment giant said.

The CRE Finance Council, a real estate trade group, told IFR it is supportive of the working group, but that it will not sanction any of the outcomes.

"Any product will reflect the point of view of working group members," said CREFC spokesperson Cary Brazeman in a statement.

"At the end of the day, participants in the CMBS market will have to determine for themselves reasonable approaches that constitute compliance with the rule." (Reporting by Joy Wiltermuth; Editing by Natalie Harrison and Shankar Ramakrishnan)