Title News - July/August, 2004

July/August 2004 - Volume 83, Number 4

The Promise of eNotes: Fact or Fairy Tale?

by Dan McLaughlin

A new system, operated by MERS, will allow you to sell a legally enforceable eNote to any investor participating in the MERS® eRegistry.

The Promise of eNotes: Fact or Fairy Tale?

The Problem
If you could wave a magic wand and instantly turn paper promissory notes into electronic ones (eNotes), you would transform an industry in a flash. But then, with your next stroke, would you just blindly turn document custodians into a multitude of electronic vaults (eVaults)? Given the opportunity, wouldn't you rather create one giant eVault and forever banish the evil practice of transferring documents from one custodian to another? Then we could electronically transfer ownership rights to mortgages exclusively within this benevolent giant's domain. Peace and prosperity would settle upon our industry like the morning dew, and lenders, warehouse lenders, and investors would trade happily ever after. But, alas, we live in the real world where paper and electronic notes will coexist for ages to come. And, as mere mortals, we are wedded to the illusion that we must "hold" our eNotes in our own proprietary eVaults, lest we lose our perceived perfection. Herein lies the dilemma for those wanting to buy and sell eNotes. An eNote can be duplicated from eVault to eVault without definitive proof of which is the "original." If you can't prove possession, you can't enforce your rights as note holder. Is the promise of eNotes then nothing but a fantasy?

Paper World
Original Signed Note
Possession
Investor
Custodian
Endorsement
Holder in due course status

Electronic World
Authoritative Copy of eNote<
Control
Controller
Location
Transfer of Control
Transfer of Control audit trail

The Solution
The MERS® eRegistry solves the problem of duplicate eNotes by providing a central registry to identify the current controller and location of the Authoritative Copy of the eNote. But what doublespeak is this, you ask? Patience friend, and ponder the table below: In place of the original signed note, the enabling legislation (E-SIGN and UETA) has established the concept that, of the many potential exact copies of the eNote, only one at a time can be the Authoritative Copy.

As the investor, you can't physically possess an eNote in the same way that you can possess a paper note, but you can control it. You control it by establishing yourself as the sole controller on the MERS® eRegistry.

In addition to your status as controller, you identify on the registry the sole location of the Authoritative Copy of the eNote (the sole location is actually the custodian that holds the eNote on your behalf in its eVault). Now you have the electronic equivalent of "possession" in the paper world.

Rather than endorsing the eNote upon sale to an investor, you transfer control on the Registry. This transfer of control on the electronic records of the Registry maintains "holder in due course" status for each investor in turn. The location of the Authoritative Copy need not change. In plain English, the MERS® eRegistry provides liquidity for eNotes on a "best execution" basis. It ensures that an otherwise legally enforceable eNote can be sold to any investor participating in the MERS® eRegistry. Outside the MERS® eRegistry you can only sell your eNote through a proprietary registry operated by your investor.

This is true because the "safe harbor" provision of UETA requires you to use the registry specifically named in the eNotes that your investor is willing to purchase. Without the MERS® eRegistry, each investor would be required to operate its own propriety registry, and the uniform Fannie/Freddie Note would no longer be uniform.

Why, Pray Tell, MERS?
After Fannie Mae and Freddie Mac published their respective preliminary guidelines for purchasing eNotes, MERS began working with MBA's eMortgage workgroups and its Residential Technology Committee to help reconcile differences between the approaches of the GSEs to purchasing eMortgages. Once Fannie and Freddie agreed that a central registry was the answer to the duplicate eNote issue, we used our experience in developing and running the MERS® System to help formulate the MBA's National eNote Registry Requirements Document. Immediately following the publication of the requirements on March 7, 2003, MERS announced its intent to build the National eNote Registry, which we named the MERS® eRegistry.

The MERS® eRegistry is the logical extension of the services that MERS currently provides as the industry's utility for eliminating assignments. That is, MERS was created by the mortgage banking industry to streamline the mortgage process by using electronic commerce to eliminate paper. By leveraging the systems and infrastructure that MERS has already created, we can deliver the registry quickly and cost effectively.

To make it as easy as possible for our existing members to use the MERS® eRegistry, we re-used two industry standards pioneered by MERS:

The Mortgage Identification Number (MIN) is the industry standard life-of-loan identifier. You use the same MIN to register an eNote on the MERS® eRegistry, as you do to register its corresponding security instrument on the MERS® System.

The MERS Organizational ID Number (Org ID) uniquely identifies our members. It is the industry standard alternative to investor seller/servicer numbers. Our members can use the same Org ID for the MERS® System as they do for the MERS® eRegistry. We also built the interfaces to the MERS® eRegistry in compliance with the MBA's MISMO XML industry data standards.

The result of using these non-proprietary standards is that members and vendors can more easily interface their systems with the MERS® eRegistry, while preserving much of the investment they have already made in interfacing with the MERS® System. Our MERS® eRegistry users also benefit from the investment that we have already made in our first-class help desk, data center, and network infrastructure operated on our behalf by EDS.

Standards aside, the principal reason why MERS is the solution is its unique position as the industry's utility. Any organization can build a registry. To be successful, however, that organization must convince the investor community that only its registry should be specifically named in the eNotes that those investors purchase. In the future, major investors have committed that they will purchase eNotes where the MERS® eRegistry is named. Additionally, based on our success with the MERS® System, the MBA has formally endorsed MERS as the preferred solution for their require-ments for a National eNote Registry.

A Happy Ending
We kept the commitment that we made to the mortgage industry last year and delivered the MERS® eRegistry on April 26, 2004. However, we know, based on our experience with eliminating assignments, that it will take many years for most investors in the mortgage industry to take advantage of the promise of eNotes. We also know that we can't sit idly by and wait for the mortgage industry to beat a path to our door.

We will continue to work closely with our partners like ALTA® and the MBA to identify and resolve issues, help educate the rank and file, and create meaningful marketing tools to actively promote the benefits of eNotes.

The moral of this story is that hard work, experience, and determination create the magic behind eNotes, not wishful thinking.

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Dan McLaughlin is executive vice president and product division manager for MERS, the Mortgage Electronic Registrations System, in Vienna, VA. He can be reached at danm@mersinc.org. ALTA® funded the development of MERS to help mortgage lenders eliminate the need for recording mortgage loan assignments when ownership rights change in secondary market transactions.