HM Treasury recently published a near-final draft of a statutory instrument that, together with rules to be made by the UK regulators, will replace the UK Securitisation Regulation. This will result in some noteworthy changes to the UK securitisation regime.
The UK financial services regime is undergoing a transformation. Announced in December 2022, the Edinburgh Reforms seek to drive growth and competitiveness in the UK financial services sector. The government intends to deliver a "Smarter Regulatory Framework" tailored to the United Kingdom. Under the Financial Services and Markets Act 2023 (FSMA 2023), which was passed in late June 2023, certain "retained EU law” relating to financial services will be repealed.
Following the end of the Brexit transition period on 31 December 2020, the EU Securitisation Regulation, in its then existing form (the EU Securitisation Regulation), was adopted into UK law and was amended by way of the Securitisation (Amendment) (EU Exit) Regulations 2019 (the 2019 Regulations) to ensure that it would operate effectively in the United Kingdom. The EU Securitisation Regulation, as incorporated into UK law and as amended, including by the 2019 Regulations, is often referred to as the UK Securitisation Regulation.
The onshoring and amendment of the EU Securitisation Regulation was intended as a temporary measure only and under FSMA 2023, both the onshored EU Securitisation Regulation and the 2019 Regulations will be revoked and replaced by a combination of new regulations and rules.
In December 2021, HM Treasury (the Treasury) published a report on the UK Securitisation Regulation (the Treasury Report), which, following responses from market participants to a call for evidence, suggested various reforms. In December 2022, the Treasury published an illustrative draft statutory instrument (SI) entitled "The Securitisation Regulations 2023." For information on both the report and the illustrative draft SI, please refer to our LawFlash: UK Treasury Proposes Changes to UK Securitisation Framework as part of Financial Services Reforms.
The Treasury has now further refined the illustrative draft SI and published a near-final version of the draft Securitisation Regulations 2023 (Draft SI) together with a Policy Note (the Policy Note) on 11 July 2023.
The Draft SI omits a number of key provisions in the UK Securitisation Regulation relating to due diligence (except with respect to occupational pension schemes (OPS)), risk retention, disclosure, credit-granting and STS (simple, transparent and standardised) securitisations. These areas will be dealt with via separate rules to be made by the Financial Conduct Authority (the FCA) and the Prudential Regulation Authority (the PRA). The latter published a consultation on 27 July 2023, setting out initial proposals in this regard (see below), and the FCA consultation is expected on 7 August 2023.
The Draft SI includes the following changes from the initial illustrative draft:
Amendment to the ‘Institutional Investor’ Definition with respect to Alternative Investment Fund Managers (AIFMS)
The Draft SI amends the paragraph in the definition of "institutional investor" that refers to AIFMs so that, with respect to the due diligence requirements for securitisations as they apply to AIFMs, only AIFMs which are authorised in the United Kingdom will be subject to those due diligence requirements.
FCA Powers in relation to Designated Activities Regime (DAR) Activities
The Draft SI gives the FCA rulemaking powers in relation to certain designated activities carried out by both authorised and unauthorised persons, including acting as an originator, a sponsor, an original lender or a special purpose vehicle (SPV) in a securitisation.
In addition, the Draft SI introduces a new power of direction which may be used by the FCA in relation to firms subject to the DAR regime in the event of actual or potential breaches of the relevant rules.
Restrictions on the Jurisdiction of SPVs
The UK Securitisation Regulation provides that SPVs cannot be established in certain overseas jurisdictions which are considered to be high risk or non-cooperative by the Financial Action Task Force or which have not agreed to comply with certain OECD standards with respect to exchange of information on tax matters. However, it has been unclear to which entities the ban applies.
The Draft SI provides that the ban will apply to originators and sponsors of a securitisation and that institutional investors will be prohibited from investing in securitisations with SPVs in such jurisdictions.
Framework for Recognising STS-Equivalent Non-UK Securitisations
The Treasury Report envisaged that an STS equivalence regime could be introduced in order to allow securitisations that meet equivalent requirements in another jurisdiction to be treated in a similar way to securitisations that meet the UK STS requirements. FSMA 2023 granted the Treasury the power to designate other jurisdictions as having law and practice equivalent to the UK STS requirements.
The Draft SI includes an amended version of this power. This framework could allow securitisations which meet the EU STS requirements or the Basel STC (simple, transparent and comparable) requirements as adopted by a particular jurisdiction to be treated as equivalent to UK STS securitisations.
The Draft SI also preserves the grandfathering provided under the 2019 Regulations (as amended) for securitisations which were designated as EU STS between the end of the Brexit transition period on 31 December 2020 and the end of 2024. Unlike the 2019 Regulations, it does not mention securitisations which were designated as EU STS before the end of the Brexit transition period.
Due Diligence Requirements for OPS
The Draft SI includes due diligence requirements for OPS (as the Pensions Regulator does not have separate rule-making powers). While this provision is based on the wording in the UK Securitisation Regulation, certain amendments and clarifications were made. The following points are particularly noteworthy.
First, the requirement to verify compliance with certain credit-granting requirements is explicitly amended to exclude trade receivables (provided that they are not in the form of a loan). This exception already exists in a recital to the UK Securitisation Regulation but will now be included in the text of the due diligence requirements itself.
Second, the due diligence requirements are amended to reflect a more principles-based approach. Under the UK Securitisation Regulation, investors must verify, before holding a securitisation position (a) in the case of securitisations where the originator, sponsor or SPV is established in the United Kingdom, that the relevant entity has made available the information required under Article 7, which sets out transparency requirements (Article 5(1)(e)), and (b) in the case of securitisations where such entity is not established in the United Kingdom, that such entity has provided "substantially the same" information as if it had been so established (Article 5(1)(f)). The Draft SI provides instead that investors must verify that the relevant entity has "made available sufficient information to enable the trustees or managers of the occupational pension scheme to assess the risks involved in holding the securitisation position" and has "agreed to continue to provide such information on a regular basis." Certain minimum information requirements will be set out and aligned with the FCA and PRA rules.
This development is likely to be welcomed by market participants, as it will make it easier for UK investors to invest in securitisations where sell-side parties are outside the United Kingdom, while still allowing investors to perform a risk assessment based on the information they receive.
This change contrasts with the conclusions of the European Commission in its October 2022 report, which indicated that EU investors would need to obtain the relevant Article 7 information, including the relevant reporting templates, in securitisations with non-EU parties (for more information on this point please refer to our LawFlash: European Commission Publishes Report on the Functioning of the EU Securitisation Regulation).
As mentioned above, several key aspects of the UK Securitisation Regulation were omitted from the Draft SI and are expected to be dealt with in rules to be made by the FCA and the PRA. Under the Draft SI, the FCA and the PRA must have regard to the coherence of the overall framework for the regulation of securitisation when making these rules.
On 27 July 2023, the PRA published a consultation paper setting out its proposals for the rules which will replace certain requirements in the UK Securitisation Regulation as these apply to PRA-authorised persons (the PRA Consultation Paper). A draft Securitisation Rules instrument (the Draft PRA Rules) is appended to the PRA Consultation Paper.
The Draft PRA Rules include the following:
Due Diligence Requirements
The PRA Rules include due diligence requirements based on the due diligence requirements for institutional investors in Article 5 of the UK Securitisation Regulation. However, as with the due diligence requirements for OPS under the Draft SI, they allow for a more principles-based approach to due diligence obligations with respect to disclosures by originators, original lenders, sponsors and SPVs (together, Manufacturers).
The PRA considers that this approach might reduce the cost of compliance and address the legal uncertainty over the meaning of the words "substantially the same" in Article 5(1)(f) of the UK Securitisation Regulation with respect to the information to be obtained from a non-UK Manufacturer. By making these requirements more proportionate, the PRA also hopes this will allow UK investors to be more competitive internationally.
The Draft PRA Rules clarify that where compliance with the due diligence requirements is delegated to another institutional investor, that entity is responsible for any failure to comply (where it is subject to equivalent due diligence obligations).
Risk Retention Requirements
The Draft PRA Rules include risk retention requirements based on Article 6 of the UK Securitisation Regulation.
In addition, the Draft PRA Rules include further details of how the risk retention requirements may be complied with. These provisions are similar to the regulatory technical standards which were put in place under the previous Capital Requirements Regulation regime and which currently apply. They also reflect a number of the changes that are expected to be made in the new EU regulatory technical standards relating to risk retention (the EU Risk Retention RTS). Such changes include amendments to facilitate securitisations of non-performing exposures (NPEs), allowing for the net value of the NPEs to be used (where a non-refundable purchase price discount has been agreed) instead of nominal value in calculating the 5% material net economic interest.
However, the Draft PRA Rules are not fully aligned with the final draft of the EU Risk Retention RTS adopted by the European Commission (for more information on this final draft of the EU Risk Retention RTS, please refer to our LawFlash: European Commission Adopts Final Draft EU Risk Retention Regulatory Technical Standards on EU Risk Retention).
In particular, there are differences in the wording of the "sole purpose" test, which sets out certain features which need to be considered in determining that an entity has not been established and does not operate for the sole purpose of securitising exposures, in order for an entity to hold the risk retention as an originator.
Disclosure Requirements
The Draft PRA Rules include requirements for disclosure of certain information based on Article 7 of the UK Securitisation Regulation, and clarify the timelines for the provision of information by Manufacturers.
Additional provisions relating to the information to be disclosed by the originator, sponsor or SPV, and the related templates, are also included, based on the current technical standards.
The PRA Consultation Paper notes that the FCA and the PRA are currently reviewing the disclosure requirements.
In the Treasury Report, the Treasury agreed with many market participants that the distinction between "public" and "private" securitisations should be reevaluated. Disclosure requirements for private securitisations could then be made more risk sensitive. The PRA Consultation Paper notes that the distinction between public and private securitisations will be discussed further in the forthcoming FCA consultation paper.
The FCA and the PRA are considering whether the disclosure templates for private securitisations could be made more proportionate and also whether more limited adjustments should be made to the disclosure requirements for public securitisations.
Ban on Resecuritisations
As in Article 8 of the UK Securitisation Regulation, resecuritisations are generally prohibited. Under the UK Securitisation Regulation the PRA has the power to grant permission for resecuritisations for certain "legitimate purposes." This power has been omitted from the Draft PRA Rules, but a new power is expected to be granted and the Draft PRA Rules include a draft statement of policy in relation to the procedure for considering whether a resecuritisation might be permitted.
Credit-Granting Criteria
The Draft PRA Rules include credit-granting criteria based on Article 9 of the UK Securitisation Regulation.
The Policy Note states that the government welcomes any technical comments on the Draft SI by 21 August 2023.
The PRA Consultation Paper requests responses by 30 October 2023.
The FCA website states that it will publish a consultation paper on its proposed rules on 7 August 2023.
The Treasury hopes to lay the SI before Parliament before the end of 2023. Provisions relating to the regulators’ powers are expected to come into force as soon as the SI is enacted. Other provisions will come into force contemporaneously with the FCA and the PRA rules, and the current EU retained law relating to securitisation will be repealed at the same time.
The PRA is also expected to consider the capital and liquidity treatment of securitisations.
In practice, it is likely that many of the provisions in the new UK securitisation regime will be similar to those in the existing UK Securitisation Regulation regime and in the EU securitisation regime. However, the new UK regime is likely to include some helpful clarifications and improvements and the new regulatory framework is expected to allow regulators to operate in a more agile and responsive manner, all of which is likely to be welcomed by market participants.
Some transactions will need to comply with both the UK and EU securitisation regimes and so differences between the two regimes may require careful consideration.
The Draft SI and the PRA and FCA consultations are significant developments for UK securitisation, with the United Kingdom increasingly setting its own course and introducing a more supportive environment for the UK securitisation market.
Given the ongoing consultations and expected implementation timeline for the new UK securitisation regime, market participants may wish to consider the proposals carefully, participate in the consultations, and look out for further developments.
Morgan Lewis is following this topic closely and we would be happy to assist with any questions.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following: