The package of over 30 regulatory reforms to drive growth and competitiveness in the UK financial services sector post-Brexit (known as the Edinburgh Reforms) includes UK Government proposals to reform the UK Securitisation Regulation, which is part of retained EU law on financial services. These proposals are set out in an illustrative securitisation statutory instrument proposals and accompanying policy note.

What is securitisation?

On a simple level, securitisation involves the process of packaging together income generating assets to produce new financial instruments that can be sold to investors.

This process allows lenders (such as banks) to, amongst other things, transfer the risk of financial assets to other banks or investors (such as insurance companies or asset managers).

The financial instruments are "tranched" which means that they have different levels of risk and return to suit the appetite of different investors.

The aim of securitisation is to help free up lenders’ balance sheets to allow for further lending to the real economy.

What is the framework for the repeal of the UK's securitisation regulation?

Securitisation in the UK is primarily regulated by the UK Securitisation Regulation (the "UKSR"). The UKSR was implemented in the UK post-Brexit to on-shore the EU Securitisation Regulation. While the UK regime closely resembles the EU regime, they are not mirror images and further divergence is expected with the introduction of the Edinburgh Reforms.

As part of the Edinburgh Reforms, the government introduced the Financial Services and Markets Bill (the "FSMB") which will amend the Financial Services and Markets Act 2000 ("FSMA"). The FSMB will repeal retained EU law on financial services (including the UKSR) and replace it with a new framework tailored to the UK post-Brexit. The stated aim of the Edinburgh Reforms is to establish a smarter regulatory framework for the UK, one that will boost its competitiveness.

Existing EU-derived securitisation rules, will effectively be repealed once the draft statutory instrument for securitisation ("Draft SI") is brought into force, commencing the repeal. The Draft SI is also intended to be paired with the introduction of new rulebooks for the Financial Conduct Authority (the "FCA") and Prudential Regulation Authority (the "PRA") (the "Rulebooks").

What will the regulatory perimeter look like?

While the Draft SI is illustrative only and subject to change it indicates that the regulatory perimeter (i.e. which entities are regulated) will remain largely the same as under the UK Securitisation Regulation post reforms.

How will regulatory responsibility change?

Overall, the proposed approach in the Draft SI is to maintain the status quo for the split of regulatory responsibilities between the FCA and the PRA. Currently the FCA supervises all entities (including PRA-authorised persons) on certain requirements for providing securitisations (for example, designation of securitisation as STS). For certain other requirements for providing securitisations (such as risk retention and disclosures) the PRA is responsible for the supervision of PRA-authorised entities and the FCA generally is responsible for other entities.

Sell-side

The intention is for the PRA to write the replacement securitisation rules for all PRA-authorised sell-side firms.

Any non-PRA authorised sell-side firm will be caught by the new designated activities regime ("DAR"), introduced by the FSMB. For the purposes of DAR, the following activities will be considered "designated activities": (a) acting as an originator, sponsor, original lender or securitisation special purpose entity in a securitisation or (b) selling a securitisation position to a retail client located in the United Kingdom.

The DAR is designed to enable the FCA to make rules relating to activities, products or conduct which may not be regulated by FSMA and which apply to FCA-authorised and non-FCA authorised entities. The DAR gives HM Treasury ("HMT") and the FCA the authority to write the replacement securitisation rules in relation to these entities. These new rules will be contained in the Rulebooks.

Buy-side

The Draft SI clarifies that the appropriate regulators must make rules requiring an institutional investor to carry out due diligence before and while holding a securitisation position. Therefore, it is envisaged that the PRA (for PRA-authorised firms such as credit institutions and large investment firms) and FCA (for all other entities) will make the rules relating to such due diligence requirements.

While the PRA and FCA will make the due diligence rules for most institutional investors, the due diligence rules applicable to occupational pension schemes will continue to be overseen by the Pensions Regulator and will mirror those set out in the UK Securitisation Regulation.

What are the proposed reforms?

The Rulebooks rules have not yet been drafted by the regulators. However, the accompanying policy note to the Draft SI states that the regulators should implement the securitisation policy changes HMT identified in its December 2021 review (the "Review"). These include:

  • revising the disclosure requirements and, in particular, the public (securitisations requiring a prospectus) /private (securitisations not requiring a prospectus) distinction in order to provide more flexibility for private deals;
  • reviewing risk retention arrangements to provide more flexibility, especially for collateralised loan obligation and non-performing loan deals; and
  • reviewing the due diligence rules, especially as concerns what information UK investors need in order to invest in non-UK deals.

While not all of these reforms identified in the Review made it into the Draft SI, the UK Government did address a couple of them by:

  • updating the definition of institutional investor to exclude certain non-UK Alternative Investment Fund Managers who are currently in scope of due diligence rules, so that these rules, do not, amongst other things, disincentivise these firms from seeking investors in the UK; and
  • noting that HMT intends to “maintain the exemption for certain private securitisations not to be required to report to securitisation repositories”.

It is likely that the rest of the areas of reform identified in the Review will make it into the detailed replacement rules which the FCA and PRA intend to set out "including any appropriate reforms” in consultations beginning early this year.

Comment

The Draft SI (along with its accompanying policy note) gives us an indication of how the UK's securitisation framework will be reshaped.

However, in the absence of any draft rules by the FCA and the PRA and while we await the finalised Draft SI, we can only anticipate what substantive changes will be introduced once the EU-derived securitisation rules are repealed. The draft Rulebooks rules, on which we can expect consultations with stakeholders to start soon, will give a clearer picture of the shape of the new securitisation framework.

With that said, the intention behind the reforms is clear and it will be the regulators who will steer the direction of the UK's securitisation regulation towards a framework that is “agile, less costly and more responsive to emerging trends”.

This article forms part of a series on the Edinburgh Reforms. You can read about the Edinburgh Reform proposals to repeal retained EU law in financial services here, modernise the ring-fencing regime here and level the playing field for building societies here.

Contributors

Alexandra Munro

Solicitor

Bruce Stephen

Head of Banking and Financial Services & Partner