The SEC staff concurred that data center securitization falls outside the risk retention requirements of Dodd-Frank.

      Last week, Nvidia announced a $500 billion financing initiative for AI infrastructure, in collaboration with Apollo, BlackRock, Blackstone, Brookfield, Goldman Sachs, and KKR.

      Two weeks prior, the staff of the Securities and Exchange Commission (SEC) addressed a query regarding the regulation of such transactions. The response took six days to arrive.

      The inquiry and its outcome

      On July 23, Latham & Watkins sent a letter to the SEC, posing a specific question: do data center securitizations fall outside the definition of an asset-backed security under the Exchange Act? This definition is significant as it includes the risk retention rules established by Dodd-Frank following the 2008 financial crisis. These rules mandate that a deal sponsor retains some risk on its balance sheet.

      Kayla Roberts, chair of the SEC’s Office of Structured Finance, provided a reply on July 29, agreeing with Latham's interpretation.

      Latham's argument

      The discussion hinges on a particular term—an asset-backed security is based on a self-liquidating financial asset. Since 1992, the SEC has interpreted this to mean it must convert into cash within a defined timeframe.

      A typical mortgage qualifies because repayment extinguishes the obligation.

      Latham contended that a data center does not fit this definition. The facilities are physical, lasting beyond the lifespan of the securities, and may even appreciate. Once the notes are repaid, the issuer still retains ownership of the building.

      In contrast, a single-asset commercial mortgage deal results in the issuer holding only the loan and becoming left with nothing after repayment. This comparison was coherent enough for the staff to accept it.

      Latham has been involved in data center securitization since its inception in 2018, informing the SEC that the market has exceeded $50 billion in cumulative debt issuance. Additionally, the letter outlined that participants have adhered to the asset-backed rules "out of an abundance of caution" rather than due to the necessity of the definition.

      Content of the letter

      The letter details the securitized assets, including buildings, data halls, electrical and backup power systems, cooling, and network connectivity, along with physical security, land, and necessary contracts for facility operations. Notably, it does not mention chips or graphics processors.

      It also outlines the structure of these deals, wherein loan-to-value can reach up to 70% of appraised value, with anticipated repayment dates around five years and final maturities spanning 25 to 30 years. The letter states that nearly all transactions utilize a master trust, allowing sponsors to issue additional securities later, add data centers, and, in some cases, dispose of or replace assets.

      Generally, investors have no recourse to the sponsor or operator, with common exceptions being fraud, willful misconduct, and gross negligence in site management.

      Self-referential aspects of the letter

      The SEC's response delineates its own limitations. It represents the views of the Division of Corporation Finance staff and is not an official position of the Commission, which has “neither approved nor disapproved its content.” The response lacks legal force or effect.

      The staff further clarifies that their opinions are based on the details in Latham’s letter and that "any different facts or circumstances might require the Division to arrive at a different conclusion."

      Reactions from legal professionals

      Orion Mountainspring, a securitization attorney at Orrick, stated to CNBC that the SEC’s response offers sponsors the opportunity to reduce the equity requirement in deals over time, which he views as beneficial news.

      B.K. Lee from Alston & Bird anticipates more flexible and capital-efficient structures, along with an increase in deals now that the guidance is documented.

      Seth Messner of Katten Muchin Rosenman mentioned that Latham was essentially requesting the SEC to exempt these transactions from risk retention rules, to which the SEC largely acquiesced.

      Messner expressed caution regarding Nvidia, noting uncertainty about whether its agreements are structured for securitization, though the guidance seems relevant if they are.

      Katten’s data center experts contextualized the rules as stemming from the aftermath of the 2008 crisis, which itself was initiated by securitizations of poorly underwritten residential mortgages.

      The SEC and several rating agencies declined to comment to CNBC.

      Nvidia’s strategy and release cycle

      Nvidia has not confirmed whether any assets will be securitized through the partnerships with the six financial firms, which were established through memoranda of understanding. The stated goal of these partnerships is to pool capital so that AI labs, companies, and cloud service providers can access computing hardware without affecting their own balance sheets.

      Nvidia has characterized its equipment as a revenue-generating asset, describing it as productive, long-lasting, fungible, and flexible, a phrasing noted by Quartz.

      Nvidia’s release timeline is already a matter of public record; the company has historically shifted significant customers to its latest hardware on an almost annual basis. At Computex in