UK's "new" securitisation regime offers some benefits, but it is spreading.
In the Edinburgh Reforms, announced by the UK Government last December, changing the laws that rule securitisation was named a top priority. One of the main goals of the Edinburgh Reforms was to use the UK's decision to leave the European Union (EU) to make laws and rules that better fit the needs of the UK's financial services market; this would make the City of London more competitive and solidify its position as a global financial centre after Brexit.
The new rules for securitisations in the UK will be made up of three parts:
The Securitisation Regulations 2023 will set the regulatory perimeter and give the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) the power to make rules for the firms they regulate.
The rules made by the PRA will apply to PRA-authorised firms (generally banks, insurers, and systemically important investment firms).
The PRA and the FCA recently held a meeting to discuss the Draft Rules they want to make.
The proposed approach to be taken by the PRA and the FCA is similar in the areas where the Draft Rules overlap. The requirements do not make a significant change from the current rules in the UK Securitisation Regulations, which is the version of the EU Securitisation Regulation that is still in force in the UK; this is likely good news for people in the market who were worried about having to follow rules that were very different in the UK and the EU. In a market where dealmakers often complain about how regulations are constantly changing, the fact that the UK and EU processes are similar could incentivise people to take part.
Even though the new suggested framework is similar to the current system, it makes a number of significant, targeted changes, many of which are good, especially when you consider that they could lead to more deals.
Changes to the standards for due diligence
The Draft Rules suggest that UK institutional investors in both UK and non-UK securitisations use the same method to check the information that sell-side parties give about deals. With this more principle-based and fair strategy, institutional investors in the UK must ensure that.
The sell-side parties have given them enough information to independently evaluate the risks of holding the securitisation position. They have received at least the information required by the rules, such as offering and marketing materials, information on the transaction documents and legal structure, etc., and the sell-side parties have agreed to keep giving them more information, such as investor reports and material information or significant information.
Even though UK sell-side parties will still have to report information in a prescribed format, this change will allow UK institutional investors to invest in non-UK securitisations without requiring sellers to convey information in a prescribed form, as long as the above conditions are met.
The Draft Rules also make it clear that if investment management has been given to another institutional investor, the delegate is responsible for failing to meet the due diligence standards, not the investor who gave the job to the representative; this has taken away a point of uncertainty and doubt in the way things are done now.
Under the present system, there is also a lot of uncertainty about when potential investors must be told what they need to know. Under the Draft Rules, the rules about when disclosures must be made have been clarified. Documentation essential to understanding the transaction and a prospectus (or, if no prospectus is needed, a transaction summary) must be made available in draft form before pricing, and the final documentation must be made available to investors by 15 days after closing; this is a good thing, and from a legal, operational, and transaction-management point of view, it gives people who put together securitisations more clarity. Timing is often essential, especially when it comes to price.
Reporting and being honest
As was said above, sell-side entities in the UK will still have to give investors information using reporting templates. The proposed templates for the PRA and FCA are the same and do not vary much from the templates already in place under the current system. So, when they go into effect, they will likely avoid problems with operations or require significant changes to how systems work. After a time when regulatory standards changed in some ways, dealmakers on the market will be glad to see that this is consistent.
There are hints in the FCA's consultation paper that it has heard complaints from the industry that the current standards for reporting are too hard, especially regarding private securitisation. Some of the criteria in this area will be cut back; this could give more people a reason to invest in the already growing private securitisation market and help it grow.
Less welcome is the FCA's apparent plan to expand the definition of "public securitisation" to include not only primary listings on UK or "appropriate equivalent non-UK" markets but also "primary admissions to trading on an appropriate UK MTF [multilateral trading facility] and similar non-UK venues, where there is at least one UK manufacturer." If the FCA goes this route, full Article 7 disclosures would likely have to be made on pre-made templates for issues traded on these trading sites.
Keeping the risk
The risk-retention rules in the Draft Rules are based on Article 6 of the UK Securitisation Regulations that are already in place. The details of how the risk-retention requirements can be met are similar to the EU's regulatory technical standards (RTS) under the Capital Requirements Regulation regime. Still, they also represent some changes the EU has made since then. For example, they include changes to make securitise non-performing exposures (NPEs) easier. For example, when a non-refundable purchase price discount has been agreed upon, the net value of the NPEs can be used instead of the nominal value to figure out the 5 per cent material net economic interest.
However, the Draft Rules are only partially in line with the final draft of the EU Risk Retention Regulatory Technical Standards, approved by the European Commission (EC) earlier this year, because the final draft only covers part of the purpose test. The sole purpose test lists the things that need to be considered when deciding whether or not a company was set up and is running for the sole purpose of securitising exposures so that it can hold the risk retention as an originator.
Earlier versions of the draft Risk Retention RTS said that the different features set out about the originator should be "taken into account." However, the 2023 European Commission Final Draft RTS clarifies that an entity shall not be considered set up or operated for securitising exposures when all the specified features are present. The "taken into account" language is still in the Draft Rules, again suggesting a more principle-based approach. In another way that the UK differs from the EU, its "sole purpose test" for originators would not look at whether the income from securitised exposures is the originator's "sole or predominant source of income." Instead, the UK test would say that the originator could not count on income from securitised exposures or retained securities to meet its payment obligations.
In line with the latest changes made by the EU, the Draft Rules propose to allow the transfer of the retained risk if the retainer goes bankrupt or if the parent entity in a consolidation group includes risk on a consolidated basis. Still, the risk retainer falls outside the scope of close supervision. This extra flexibility is a good thing, filling a hole in the present system.
Even though the UK has taken a more principle-based approach to this problem than the EU, the differences should prevent transactions from happening in the future. In some ways, the fact that such an approach is easy to understand may help those structuring these transactions because the importance of risk retention is made clear from the start. There is enough room for nuances that often arise during the structuring process.
Widening the reach of the regime
Under the new Designated Activities Regime (DAR) in the Financial Services and Markets Act 2023 (FSMA 2023), the FCA has confirmed that the UK regime will be expanded to include unlicensed entities acting as an original lender, originator, or securitisation particular purpose entity (SSPE). This special purpose vehicle (SPV) is usually set up to buy the exposures and issue the securities. Such organisations would not be licensed, but the FCA would have some control over them.