Revising the UK’s legal framework governing securitisations was identified as a priority in the government’s so-called Edinburgh Reforms announced in December last year. The government has published a near final draft statutory instrument (Final Draft SI) setting out the high-level framework and granting the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) rule-making powers to flesh out the detail of the new regime. The PRA and FCA have each recently consulted on the proposed rules they wish to make, and the approaches taken are unsurprisingly broadly consistent. The Final Draft SI, together with the proposed PRA and FCA rules, for ease are referred to below as the Draft Rules. The requirements set out in the Draft Rules do not represent a major departure from the existing regime contained in the UK Securitisation Regulation (the retained law version of the EU Securitisation Regulation). However, there are a number of targeted amendments, many of which are welcome, especially when seen in the context of potentially generating greater deal flow.
Some key changes to the existing regime include a more unified approach to due diligence requirements for UK and non-UK securitisations, improved clarity surrounding the timing of disclosures in the context of the issue of securities, and a more principles-based approach generally (and particularly with respect to risk retention). Potentially less welcome is the proposed extension of the regime to entities that were not previously covered by the rules and proposed changes to the definition of a “public securitisation”, which could result in greater disclosure for certain issuances.
1. What changes have been made to the due diligence requirements for investors in securitisations?
The Draft Rules propose that UK institutional investors in UK and non-UK securitisations will be able to adopt a unified approach in terms of verifying the disclosures made by the sell-side parties on the transaction. The more principles-based and proportionate approach will require UK institutional investors to verify that:
- sell-side parties have provided sufficient information to enable the investors to independently assess the risk of holding the securitisation position;
- they have received at least the information listed in the rules (for example, offering and marketing materials, and information on the transaction documents and legal structure); and
- they have a commitment from sell-side parties to continually provide further information (for example, investor reports and material information or significant change reports).
While UK sell-side parties will still be required to provide reporting information in a prescribed template, this change will mean that UK institutional investors will be able to invest in non-UK securitisations without requiring sellers to provide information in a prescribed template provided that the above requirements are satisfied in substance.
The Draft Rules also clarify that, where investment management has been delegated to another institutional investor, the delegate is responsible for any failure to comply with the due diligence requirements rather than the delegating party. This has removed an area of ambiguity under the current regime.
2. Have any changes been made to the disclosure and reporting requirements?
The Draft Rules provide some helpful clarity regarding disclosure requirements, specifically the time at which disclosure must be provided to potential investors. Underlying documentation that is essential to the understanding of the transaction, as well as a prospectus (or, where no prospectus is required, a transaction summary), must be made available in draft form before pricing, and the final documentation must be made available to investors at the latest 15 days after closing. This is a welcome development and, from a legal, operational and transaction management perspective, provides helpful clarity for those putting together securitisations where timing is often critical, especially around the time of pricing.
As regards reporting requirements, as mentioned above, UK sell-side entities will still be required to report information to investors using prescribed reporting templates. The proposed PRA and FCA templates are identical and do not differ materially from the existing templates under the current regime. As a result, they are unlikely to cause operational difficulties or require substantial system changes when they come into force. After a period where regulatory requirements have in some respects been in a state of flux, the consistency shown here will be welcomed by dealmakers in the market.
There are also hints in the FCA’s consultation paper that it has listened to industry feedback that the existing reporting requirements are too onerous, particularly in the context of private securitisations. We can perhaps look forward to paring back of the requirements in this area in future, which has the potential to incentivise and grow the already booming private securitisation market.
Less welcome is the FCA’s apparent intention to expand the definition of “public securitisation” to cover not only primary listings on UK or “appropriate equivalent non-UK” markets but also “primary admissions to trading on an appropriate UK MTF and similar non-UK venues, where there is at least one UK manufacturer”. If the FCA does go down this path, that would presumably mean full disclosure in prescribed templates for issues listed on those trading venues analogous to the disclosure which is currently required for public securitisations under Article 7 of the UK Securitisation Regulation.
3. Have there been any changes around risk retention?
The risk retention requirements are broadly aligned with the EU’s Risk Retention Regulatory Technical Standards (RTS), which were put in place under the Capital Requirements Regulation regime, but also reflect some of the subsequent changes made by the EU since that time. For instance, they 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. This is a sensible change and a positive development.
Consistent with the 2023 Commission Final Draft RTS adopted by the European Commission in July of this year, the Draft Rules propose to allow for a transfer of the retained risk if the retainer becomes insolvent, or where risk is retained on a consolidated basis by the parent entity within a consolidation group and the risk retainer falls outside the scope of consolidated supervision. This additional flexibility is to be welcomed and addresses a lacuna in the current regime.
However, the Draft Rules are not fully aligned with the 2023 Commission Final Draft RTS when it comes to the “sole purpose” test. The sole purpose test sets out certain features that need to be considered when determining that an entity has not been established and does not operate for the sole purpose of securitising exposures, in order for that entity to hold the risk retention as an originator.
While previous versions of the draft Risk Retention RTS stated that the various features which were set out with respect to the originator should be “taken into account”, the 2023 Commission Final Draft RTS clarifies that an entity shall not be considered to have been established or operate for the sole purpose of securitising exposures where all of the specified features are present. By contrast, the Draft Rules retain the “taken into account” formulation, again suggesting a more principles-based approach.
In another departure from the EU position, the UK’s sole purpose test for originators would not take into account whether income from the securitised exposures amounts to the originator’s “sole or predominant source of revenue”. Instead, the UK test would require that the originator should not rely on income from securitised exposures or retained securities to meet its payment obligations.
While it is true to say that the UK has taken a more principles-based approach to risk retention requirements than the EU, we do not believe that the differences should cause issues for transactions going forward. In some respects, the more accessible nature of the UK’s approach may be helpful for those structuring these transactions, meaning that the importance of risk retention is made clear at the outset, while also allowing sufficient flexibility to accommodate nuances which often crop up as part of the structuring process.
4. How has the scope of the regime changed?
The FCA has confirmed that the UK regime will be expanded to include unauthorised entities acting as original lender, originator or securitisation special purpose entity (i.e., the Special Purpose Vehicle typically set up to purchase the exposures and issue the securities) and to cover the sale of securitisation positions to retail investors under the new Designated Activities Regime introduced in the Financial Services and Markets Act 2023. Such entities would remain unauthorised, but the FCA would have certain powers of direction over them in specific circumstances.
Helpfully, the Draft Rules make clear that only UK established sell-side parties will have to comply with the UK regime. This is an area of ambiguity under the existing regime and so this clarification brings greater certainty.
On the buy side, the Draft Rules propose to limit the scope of due diligence requirements so that they apply only to UK-authorised alternative investment fund managers (AIFMs) and small registered AIFMs. Under the existing regime, it is not clear to what types of AIFM the obligations apply.
5. Are there any changes to the capital treatment of securitisation positions?
The regulatory capital treatment that applies to holders of securitisation positions will be key to the growth of the sector, and market participants will be keen to learn about the intended approach in this area. Unfortunately, the Draft Rules do not yet contain any proposals around capital treatment. This will be the subject of a future consultation.
6. What are the key implications of the new approach for deal structuring?
The lack of significant divergence from the EU regime will no doubt come as good news to market participants who might have been worried about having to comply with radically different regimes in the UK and the EU. In a market where dealmakers regularly bemoan a constantly shifting regulatory landscape, the lack of divergence between the respective systems in the UK and EU certainly has the potential to incentivise the markets. Similarly, regulatory consistency and clarity, which have been lacking over recent years, will be welcomed by those structuring the transactions as a vote of ongoing confidence in the wider regime, with the potential to generate more market activity.
A central aim of the Edinburgh Reforms was to take advantage of the UK’s exit from the European Union to create laws and regulations that are more tailored to the needs of the UK financial services market. Implementing these targeted amendments to the UK securitisation regime is intended to contribute to this aim, and to the wider objective of bolstering the competitiveness of the City of London with a view to cementing its status as a global financial centre post-Brexit. While the proposed changes so far are relatively modest, they do bring clarity in a number of areas that have caused difficulty in the past and signify a more principles-based approach going forward. As long as this approach is maintained, market participants involved in transactions with both a UK and EU dimension should not have significant difficulties in complying with the requirements of the different regimes.