By Romin Dabir and Nathan Menon, Partners, Reed Smith
Revising the United Kingdom’s legal framework governing securitisations was identified as a priority in the UK Government’s so-called Edinburgh Reforms, announced last December. One of the key aims of the Edinburgh Reforms was to take advantage of the UK’s exit from the European Union (EU) to create laws and regulations more tailored to the needs of the UK financial-services market and, by doing so, bolster the competitiveness of the City of London, cementing its status as a global financial centre post-Brexit.
The new legal regime governing UK securitisations will comprise three parts: (i) a new statutory instrument, the Securitisation Regulations 2023, that will establish the regulatory perimeter and grant rule-making powers to the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) for the firms that they regulate; (ii) the rules enacted by the PRA that will apply to PRA-authorised firms (broadly, banks, insurers and systemically important investment firms) (PRA Rules); and (iii) the rules enacted by the FCA (FCA Rules). The PRA and the FCA recently consulted on the proposed rules they wish to make (the Draft Rules).
The proposed approach to be taken by the PRA and the FCA is unsurprisingly broadly consistent in the areas at which the Draft Rules overlap, and the requirements imposed do not represent a major departure from the existing regime contained in the UK Securitisation Regulations, the retained legal version of the EU Securitisation Regulation. This will likely come as good news to market participants who may have worried about complying with radically different regimes in the UK and the EU. In a market where dealmakers regularly bemoan the constantly shifting regulatory landscape, the lack of divergence between the respective systems in the UK and the EU certainly has the potential to incentivise participants.
Despite the similarities with the existing regime, the new proposed framework makes several noteworthy, targeted amendments, many of which are welcome, especially when seen in the context of potentially generating greater deal flows.
Changes to due-diligence requirements
The Draft Rules propose that UK institutional investors in UK and non-UK securitisations adopt a unified approach to verifying the disclosures made by sell-side parties on transactions. This more principles-based and proportionate approach will require UK institutional investors to verify that
- sell-side parties have provided sufficient information to enable them to independently assess the risks of holding the securitisation position;
- they have received at least the information listed in the rules (for example, offering and marketing materials, information on the transaction documents and legal structure, etc.); and
- sell-side parties have committed to continually providing 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 can invest in non-UK securitisations without requiring sellers to furnish information in a prescribed format, provided that the above requirements have been satisfied.
The Draft Rules also clarify that when investment management has been delegated to another institutional investor, the delegate is responsible for any failures to comply with the due-diligence requirements, not the delegating party. This has removed an area of ambiguity and confusion under the current regime.
Another area of uncertainty under the current regime is the time at which disclosure must be provided to potential investors. Under the Draft Rules, requirements around the timing of disclosure have happily been clarified: 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 15 days after closing at the latest. This is a welcome development and, from a legal, operational and transaction-management perspective, provides greater clarity for those putting together securitisations—with timing often critical, especially regarding pricing.
Reporting and transparency
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 when regulatory requirements have been in flux in some respects, dealmakers in the market will welcome the consistency shown here.
There are hints in the FCA’s consultation paper that it has listened to industry feedback that existing reporting requirements are too onerous, particularly in the context of private securitisations. We can, therefore, look forward to some paring back of the requirements in this area in the future. This could potentially incentivise and grow the already booming private securitisation market.
By contrast, 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 [multilateral trading facility] and similar non-UK venues, where there is at least one UK manufacturer”. If the FCA goes down this path, that would presumably mean full Article 7 disclosures on prescribed templates for issues listed on those trading venues.
Risk retention
The Draft Rules include risk-retention requirements based on Article 6 of the existing UK Securitisation Regulations. The details of how the risk-retention requirements may be complied with are similar to the EU’s regulatory technical standards (RTS) under the Capital Requirements Regulation regime but also reflect some of the subsequent changes made by the EU since then. For instance, they include amendments to facilitate securitisations of non-performing exposures (NPEs), allowing for the net value of the NPEs to be used (when a non-refundable purchase price discount has been agreed) instead of the nominal value in calculating the 5-percent material net economic interest.
However, the Draft Rules are not fully aligned with the final draft of the EU Risk Retention Regulatory Technical Standards adopted by the European Commission (EC) earlier this year related 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 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 set out regarding the originator should be “taken into account”, the 2023 European Commission Final Draft RTS clarifies that an entity shall not be considered to have been established or have operated for the sole purpose of securitising exposures when all the specified features are present. 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 not rely on income from securitised exposures or retained securities to meet its payment obligations.
Consistent with the EU’s latest revisions, the Draft Rules propose to allow the transfer of the retained risk if the retainer becomes insolvent or when 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 welcome and addresses a lacuna in the current regime.
While it is true that the UK has taken a more principles-based approach to this issue than the EU, we do not believe that the differences should cause issues for transactions going forward. In some respects, the accessible nature of such an approach may be helpful for those structuring these transactions, meaning that the importance of risk retention is made clear at the outset whilst also allowing sufficient flexibility to accommodate nuances that often crop up as part of the structuring process.
Expansion of the regime’s scope
The FCA has confirmed that the UK regime will be expanded to include unauthorised entities acting as an original lender, originator or securitisation special purpose entity (SSPE)—in other words, the special purpose vehicle (SPV) typically set up to purchase the exposures and issue the securities—under the new Designated Activities Regime (DAR) introduced in the Financial Services and Markets Act 2023 (FSMA 2023). Such entities would remain unauthorised, but the FCA would have certain powers of direction over them.