Exciting times await the UK financial sector. Thanks to the rulemaking power of the Financial Conduct Authority ('FCA') and the Prudential Regulation Authority ('PRA'), vested in them by the Designated Activities Regime, UK securitisation can now be tailored to the UK financial markets to promote the appropriate objectives and reflect the latest UK market developments.
The FCA opened their first consultation on their proposed rules in relation to the UK securitisation markets on 7th August 2023. Firms and other entities with direct and indirect involvement in securitisation markets are encouraged to provide feedback on the FCA's proposed new rules. The aim of this consultation is to replace the firm-facing provisions in the Securitisation (Amendment) (EU Exit) Regulations 2019, also known as the UK Securitisation Regulation ('UK SR') with FCA rules.
Following its review of the UK SR in 2021 (the 'Treasury Review'), HM Treasury recognised that the UK SR plays a vital role in the securitisations markets, but also identified specific areas for policy improvement to make the regulations better suited to the UK financial markets.
The UK securitisation markets are at present regulated by the UK SR, which is retained EU law ('REUL'). HM Treasury prioritised the UK SR as one of the first REUL files for the “repeal and replacement” process. As part of the repeal and replacement of REUL the intention is that some provisions of the UK SR will be brought into new UK legislation and most firm-facing provisions of the UK SR will be covered by new FCA rules and PRA rules.
The plan is to lay a statutory instrument published by HM Treasury on 10 July 2023 (the 'Near-final SI') in Parliament to repeal the UK SR (and all related statutory instruments and technical standards), keeping part of it in new legislation. The new UK securitisation regime will consist of the new legislation to be approved by Parliament and the rules set by the FCA and PRA, who have shared supervisory responsibility in this space. The PRA has published its own consultation paper for PRA-authorised investors, i.e. entities not supervised by the FCA.
Areas identified for improvement and proposed changes
The Treasury Review identified three main areas for policy change relevant to FCA rules. These are the disclosure/reporting/transparency regime, due diligence obligations and risk retention requirements. The current FCA consultation seeks views on the due diligence and risk retention issues, as the transparency requirements will be explored at a later date.
The due diligence requirements are a key part of the UK SR. They provide protection to investors and potential investors. The new due diligence proposals are intended to increase protection for institutional investors (as defined in the Near-final SI).
Changes are proposed in relation to the disclosures made by the manufacturers of UK securitisation. The UK SR currently requires UK institutional investors to verify before investing that overseas securitisation manufacturers have made available information which is 'substantially the same' as that which would have been made available by UK manufacturers under Article 7 of the UK SR in accordance with the frequency and modalities provided for in that article. The existing 'substantially the same' information requirement for overseas manufacturers has brought some confusion and the FCA intends to clarify this by implementing a unified approach to both UK and overseas securitisation manufacturers.
The new rules will focus on the quality of information provided by the manufacturers to allow institutional investors to sufficiently assess the risk, as well as ensure a continuous commitment of the manufacturers to make available appropriate information.
The FCA further addresses the issue of delegation of due diligence and offers clarification on the matter.
Non-performing exposure securitisation
Risk retention aligns the interests of the manufacturers of a securitisation with those of the investors and is one of the key principles in the UK SR. The UK SR requires an originator, original lender or sponsor to hold a material net economic interest of at least 5% in each securitisation on an ongoing basis.
The FCA is proposing new rules on risk retention requirements for the securitisations of Non-performing Exposures ('NPEs'). Currently the risk retention for NPE securitisation is calculated as 5% of the face value of the underlying NPE. However, NPEs are typically sold to securitisation special purpose entities at a (potentially deep) discount, reflecting the market's assessment of the likelihood that a renegotiation of the loan repayment terms will generate sufficient recoveries. Using face values for risk retention purposes ignores the price discount at which the underlying assets are transferred, and can make securitisation of NPEs expensive and uneconomical for originators.
The FCA's proposals would implement a non-refundable purchase price discount ('NRPPD'). The proposed risk retention calculation would involve factoring of the NRPPD in the net value of the default portfolio on the date of securitisation, as opposed to the current risk retention calculated as 5% of the face value of the underlying NPE. The aim of the proposed changes is to remove a barrier connected with securitisation of NPE's and make the sale of NPE a more attractive and profitable option for the originator/investor.
The consultation paper offers the following recommendations to improve other aspects of the current UK SR:-
- Removal of the risk retention in the event of insolvency of the retainer;
- Redesignation of the sole purpose test;
- Clarification of rules on securitisation;
- Extension of the rules on cash collateralisation;
- Amendments to the criteria on 'cherry picking' for high risk profile assets; and
- Clearer distinction between private and public securitisation.
The consultation closes on 30 October 2023 and the new rules are planned to be published in a policy statement in Q2 of 2024. The FCA anticipates opening a second consultation in the future which will aim to expand on the issues introduced in the first consultation paper i.e. the reporting regime for private securitisations and changes to disclosure templates.
For further information on Brodies' Securitisation practice please contact Marion MacInnes or another member of Brodies' dedicated Securitisation and Structured Finance Team.