The FCA recently published its Consultation Paper on Rules relating to Securitisation. This follows the publication by HM Treasury of the near-final draft of the Securitisation Regulations 2023 and the publication by the PRA of a consultation paper setting out its proposed rules for PRA-authorised entities in relation to securitisations. Once in final form, these rules and regulations will replace the UK Securitisation Regulation and related regulations.

BACKGROUND

Pursuant to the announcement of the Edinburgh Reforms in December 2022, various changes to the financial services regime are under way in the United Kingdom, with the intention of driving growth and competitiveness in the sector. Certain “retained EU law” relating to financial services will be repealed under the Financial Services and Markets Act 2023 (FSMA 2023), enacted in June 2023, and the government intends instead to introduce a “Smarter Regulatory Framework” consisting of a mixture of new legislation to be approved by the UK Parliament and rules to be established by the UK regulators.

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, following its call for evidence from market participants, HM Treasury (the Treasury) published a report on the UK Securitisation Regulation (the Treasury Report) and suggested various reforms. This was followed by the publication of an illustrative draft statutory instrument (SI) entitled “The Securitisation Regulations 2023” in December 2022. For further details of the report and the illustrative draft SI, please see our LawFlash: UK Treasury Proposes Changes to UK Securitisation Framework as part of Financial Services Reforms.

The Treasury refined the illustrative draft SI and on 11 July 2023 published a near-final version of the draft Securitisation Regulations 2023 (the Draft SI), together with a Policy Note.

The Draft SI contains a number of provisions that are similar to those in the UK Securitisation Regulation but does not include a number of provisions which are in the UK Securitisation Regulation, including those relating to due diligence (except with respect to occupational pension schemes (OPS)), risk retention, disclosure, credit-granting, and STS (simple, transparent and standardised) securitisations. Those provisions are intended to be dealt with in the rulebooks of the Financial Conduct Authority (the FCA) and the Prudential Regulation Authority (the PRA).

On 27 July 2023, the PRA published a consultation paper (the PRA Consultation Paper) setting out its proposals for its rules that will apply to PRA-authorised entities (the Draft PRA Rules). For more information on both the Draft SI and the PRA Consultation Paper, please see our LawFlash: HM Treasury Publishes Near-Final Draft of UK Securitisation Regulations 2023.

On 7 August 2023, the FCA published its Consultation Paper on Rules relating to Securitisation (the FCA Consultation Paper) in relation to its proposed rules, as contemplated by the Draft SI and FSMA 2023.

THE FCA CONSULTATION PAPER

The FCA Consultation Paper contains a discussion of the proposals together with the draft Handbook text (the Draft FCA Rules) in an appendix.

The Draft FCA Rules contain the following provisions:

Due Diligence Requirements

The Draft FCA Rules include due diligence requirements for institutional investors (as defined in the Draft SI) that are authorised by the FCA, and that are not authorised by the PRA and are not an OPS. These are expected to be aligned with the corresponding requirements for PRA-authorised entities in the final PRA rules and for OPS in the final Securitisation Regulations 2023.

As with the due diligence requirements for OPS in the Draft SI and the due diligence requirements in the Draft PRA Rules, the Draft FCA Rules that relate to investor due diligence are based on the requirements currently set out in Article 5 of the UK Securitisation Regulation, but with some amendments.

Under Article 5, institutional investors are required (among other things), before holding a securitisation position, to verify compliance with credit-granting requirements and risk retention requirements and to verify that certain information has been provided.

There is an explicit statement in the Draft FCA Rules that the institutional investor’s obligation to verify compliance with the credit-granting requirements does not apply with respect to trade receivables (provided they are not in the form of a loan). This is not a new change but is currently only in a recital to the UK Securitisation Regulation.

As regards disclosure by originators, sponsors, and special purpose vehicles (SPVs) (together, Manufacturers), institutional investors are required, before holding a securitisation position, to verify: (a) in the case of securitisations where the Manufacturer is established in the United Kingdom, that it has made available the information required under Article 7 of the UK Securitisation Regulation, which sets out transparency requirements (Article 5(1)(e)), and (b) in the case of securitisations where the Manufacturer is not established in the United Kingdom, that it has provided “substantially the same” information as if it had been so established (Article 5(1)(f)).

The Draft FCA Rules provide instead that investors must verify that the Manufacturer has “made available sufficient information to enable the institutional investor independently to assess the risks of holding the securitisation position.” That disclosure will need to include certain specified information, including details of the underlying exposures, periodic investor reports, transaction documents, details of material changes or events, any prospectus or other offering document, and any STS notification. In addition, the investor needs to verify that the Manufacturer has “committed to make further information continually available, as appropriate.”

Market participants are likely to view this principles-based approach to obtaining information from Manufacturers as a helpful revision that will facilitate investment by UK investors in overseas transactions, while still requiring them to consider the information they receive from Manufacturers and assess the risk of their investment.

The Draft FCA Rules also clarify that where an institutional investor delegates the compliance with the due diligence requirements to another institutional investor (other than an OPS) (the Managing Party), the Managing Party is liable for any failure to comply.

The Draft SI anticipates that the FCA will be given a new power to make rules in relation to the due diligence requirements for small registered UK alternative investment fund managers (AIFMs).

Risk Retention

The Draft FCA Rules include risk retention requirements for originators, sponsors, and original lenders that are not PRA-authorised entities, based on Article 6 of the UK Securitisation Regulation.

The Draft FCA Rules also include further details of how to comply with the risk retention requirements. These provisions are similar to the regulatory technical standards put in place under the previous Capital Requirements Regulation regime (as it now applies in the United Kingdom, the CRR RTS) and which currently apply. The Draft FCA Rules also reflect a number of the changes that are included in the final draft of the EU regulatory technical standards relating to risk retention adopted by the European Commission (the Commission) on 7 July 2023 (the 2023 Final Draft EU Risk Retention RTS) (for more details, please refer to our LawFlash: European Commission Adopts Final Draft Regulatory Technical Standards on EU Risk Retention). However, the relevant provisions of the Draft FCA Rules and the 2023 Final Draft EU Risk Retention RTS are not identical.

The risk retention provisions of the Draft FCA Rules include the following new provisions, compared with the CRR RTS, in a similar way to the Draft PRA Rules:

• Amendments to Facilitate Securitisations of Non-Performing Exposures (NPEs): The Draft FCA Rules allow for the net value of the NPEs to be used instead of nominal value in calculating the 5% material net economic interest. However, contrary to the 2023 Final Draft EU Risk Retention RTS, there are no provisions allowing the servicer in an NPE securitisation to act as a risk retainer.
• Insolvency of the Risk Retainer: The Draft FCA Rules allow for the risk retainer to transfer the retained interest in the event of its insolvency. However, they do not include the additional wording that is included in the 2023 Final Draft EU Risk Retention RTS, which allows for a transfer of the retained interest where the retainer, for legal reasons beyond its control and beyond the control of its shareholders, is unable to continue acting as a retainer.
• Sole Purpose Test: As in the UK Securitisation Regulation, an originator may not act as a risk retainer unless it has not been established and does not operate for the sole purpose of securitising exposures. The Draft FCA Rules elaborate on the features of the “sole purpose test.” The wording is similar to that in the 2023 Final Draft EU Risk Retention RTS but is not identical. The Draft FCA Rules indicate that, for the purpose of assessing whether the sole purpose test is met, “the relevant considerations include” the specified features, rather than stating that all of them must apply, as in the 2023 Final Draft EU Risk Retention RTS. The wording in the Draft PRA Rules is slightly different again, stating “the following shall be taken into account.” The 2023 Final Draft EU Risk Retention RTS also include a requirement that the entity does not rely on the securitised exposures, the retained interest, or any income therefrom “as its sole or predominant source of revenue,” whereas this wording is not included in the Draft FCA Rules or the Draft PRA Rules.
• Resecuritisations: While resecuritisations generally remain prohibited, they may be permitted in limited circumstances. The Draft FCA Rules include a general requirement for retention at each level of the transaction, but usefully clarify that this does not apply to fully supported asset-backed commercial paper programmes that meet certain requirements set out in the rules, as they are not considered to be resecuritisations.
• Cash Collateralisation Exemption for Synthetic/Contingent Forms of Retention: Generally, if risk retention is fulfilled through a synthetic or contingent form of retention, it needs to be fully cash collateralised. Under the CRR RTS, there is an exception to this requirement for cash collateralisation where a credit institution is acting as the risk retainer. As in the 2023 Final Draft EU Risk Retention RTS, it is proposed to extend this exception to investment firms and insurance firms.
• Prohibition on “Cherry Picking”: As in the UK Securitisation Regulation, the Draft FCA Rules provide that originators must not select assets to transfer to the SPV in order to render the losses on those assets (measured over the life of the transaction or over four years if the transaction is longer than four years) higher than the losses over the same period on comparable assets held on the balance sheet of the originator. This is carried forward into the Draft FCA Rules. An exception is included (based on wording in a previous recital in the UK Securitisation Regulation) allowing originators to select assets with a higher risk profile for the securitisation as long as that is clearly communicated to investors or potential investors. Guidance is also included on how to assess whether retained assets and securitised assets are comparable and deeming the requirements to be complied with where no comparable assets are left on the originator’s balance sheet (similar to the 2023 Final Draft EU Risk Retention RTS).

Transparency

The FCA Rules include disclosure requirements based on those in Article 7 of the UK Securitisation Regulation. Similar to the Draft PRA Rules, it has been clarified that certain information that is required to be provided before pricing should be in draft or initial form (for practical reasons since the final version of some of that information will include pricing information), and that a final version of such information should be provided by 15 days after closing.

In a similar way to the UK Securitisation Regulation, under the Draft FCA Rules the Manufacturer disclosing the relevant information must comply with confidentiality and personal data laws and confidentiality obligations in relation to customer, original lender or debtor information, and confidential information may be anonymised or aggregated. However, we note these provisions are not included in the Draft PRA Rules.

The disclosure templates are also included. The FCA does not expect any changes to the way firms complete those templates.

Resecuritisations

As mentioned, these will generally continue to be banned, but the FCA may grant permission in certain limited circumstances.

Credit-Granting Criteria

Credit-granting criteria are included based on those in the UK Securitisation Regulation. As with the relevant section of the investor due diligence requirements, the Draft FCA Rules clarify that the credit-granting requirements do not apply with respect to trade receivables (which are not in the form of a loan).

STS

The Draft FCA Rules include the criteria for a securitisation to be considered STS, based on the requirements in the UK Securitisation Regulation, with some amendments. One notable change is that it is no longer necessary for there to be a transfer to an SPV. The Draft FCA Rules also clarify that a securitisation that meets the STS criteria needs to be notified to the FCA only if the originator or sponsor actually wants it to be designated as STS.

In addition, the Draft FCA Rules include requirements for determining whether the underlying exposures in the pool are homogeneous, including some amendments to the existing requirements that are similar to those proposed by the European Banking Authority in its draft regulatory technical standards published in February 2023.

Templates for STS notification are included.

Unlike in the European Union, it is not possible for a synthetic securitisation to be STS.

Other Clarifications and Adjustments

There are a number of other clarifications and adjustments, including the following:

• Geographical Scope: The Draft FCA Rules clarify that the rules apply only to entities established in the United Kingdom (except for the definition of institutional investors).
• Meaning of “established in the UK”: The UK Securitisation Regulation includes a number of references to entities which are “established in the UK.” The Draft FCA Rules clarify that, for their purposes, this wording refers to an entity that is constituted under UK law with a head office, or if it has a registered office, that office is in the United Kingdom, similar to the wording in the Draft SI.
• Currency Adjustments: References to Euros will be amended to refer to Sterling.

Overall Coherence of the Framework

In general, the FCA and the PRA are required to have regard to the coherence of the overall framework for the regulation of securitisation. However, it is worth noting that the wording of the Draft FCA Rules and the Draft PRA Rules is not identical.

SECOND CONSULTATION

One key topic that was discussed in the context of market participants’ feedback to both the consultation on the EU Securitisation Regulation and the UK call for evidence in relation to the UK Securitisation Regulation has been the question of whether the distinction between public securitisations and private securitisations could be reevaluated, and as a result whether the disclosure requirements for private securitisations could be made more proportionate. For UK purposes, a public securitisation is one with a prospectus under section 85 of FSMA 2000 and that is traded on a UK regulated market. The Treasury indicated that it was open to considering this issue in the Treasury Report. This is in contrast to the conclusion of the Commission in its report on the functioning of the EU Securitisation Regulation, published in October 2022, where it rejected the idea of amending the equivalent definition of private securitisation under the EU Securitisation Regulation (please refer to our LawFlash: European Commission Publishes Report on the Functioning of the EU Securitisation Regulation for more information).

The FCA Consultation Paper contains an initial discussion of this issue and takes note of industry feedback that the required reporting is disproportionate and not always useful in the case of many private transactions. The FCA has identified and considered different approaches as to how public and private securitisations could be distinguished and intends to have a separate consultation on this at a later date (the Second Consultation).

In addition, the FCA and the PRA are considering whether the disclosure templates for private securitisations could be made more proportionate. Limited adjustments to the public templates may also be considered, in particular with respect to whether the amount of information for granular and short-term assets is appropriate.

Due diligence requirements may also be reviewed further in the Second Consultation.

NEXT STEPS

As with the PRA Consultation Paper, responses on the Draft FCA Rules may be provided by 30 October 2023.

Technical comments on the Draft SI may be provided by 21 August 2023.

The Treasury hopes to lay the SI before Parliament before the end of 2023. Provisions relating to certain powers of the regulators would be expected to come into force as soon as the SI is made. 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.

CONCLUSION

Together with the Draft SI and the PRA Consultation Paper, the FCA Consultation Paper represents an important step towards the establishment of the new UK securitisation regime. We expect that market participants will want to review the proposals carefully and monitor further developments, including the anticipated Second Consultation.

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