The start of 2024 heralds the rollout of a new suite of rules for securitisation in the UK, which once adopted, will replace the existing on-shored UK Securitisation Regulation (the “UKSR”).
A previously unified regulation will be split between three sets of overlapping rules, with some duplication and differing application depending on who is being regulated. Once adopted, the Prudential Regulation Authority’s new rules (the “PRA Rules”) will form part of the PRA Rulebook, and the Financial Conduct Authority’s new rules (the “FCA Rules”) will be added to the FCA Handbook. Both regimes will sit under the Securitisation Regulations 2023, a statutory instrument (the “Securitisation SI”) to be enacted under the Financial Services and Markets Act 2023 as part of the UK’s wider post-Brexit programme to repeal and replace retained EU law.
Preparations for the new regime should begin in earnest, even as the new rules are being finalised. This article sets out what both buy- and sell-side parties should consider when preparing to comply with the new regime as 2024 unfolds.
A reformatting and duplication of rules
The PRA and FCA have differed in their approach to drafting their rules. The PRA Rules largely keep the look and feel of the UKSR and associated regulatory technical standards, while the FCA has undergone a redrafting exercise to reformat the requirements into a style more consistent with other parts of the FCA Handbook. Although this exercise does not involve a substantive rewrite of the requirements of the UKSR, buy- and sell-side parties will need to adapt to the new formats in which each set of rules are enacted.
In practice, buy- and sell-side parties will need to consider the requirements of both the PRA Rules and FCA Rules for most securitisations. While the substance of each set of rules will remain largely the same, they are not identical — firms will need to adopt a “lowest common denominator” approach, contemplating the combined set of rules alongside the Securitisation SI. With the rules scattered in multiple documents and blackline comparisons being difficult to produce, the updating process will require familiarity with the substance of the existing UKSR’s requirements as well as the new rules. In addition, the new rules are silent as to the status of pre-Brexit regulatory guidance provided by the European regulators and post-Brexit advice provided by the PRA and FCA on the UKSR. While previous guidance from the PRA and FCA under the UKSR had assured the continued relevance of pre-existing regulatory guidance following the UK’s departure from the EU, such continuity is conspicuously absent in the new rules.
What transaction parties can do now to prepare
Buy-side and sell-side firms should conduct a thorough review of their internal policies and procedures, reporting systems and processes in light of the new rules. This may involve a mapping exercise to identify where the existing rules have migrated, and how current practices will comply with the new framework. Internal policies and checklists will need to be updated with new legislative references and any relevant changes. In addition, a rollout of training could help personnel familiarise themselves with the changes introduced by the reforms.
Preparations should begin right away. The new regime does not include a comprehensive set of grandfathering or transitional provisions (other than the UKSR’s transitional provisions in respect of pre-2019 securitisations and the grandfathering of requirements relating to simple, transparent and standardised (“STS”) eligibility). The new rules are expected to apply to all securitisations (existing and new) once the rules enter into force (proposed to be as early as Q2 2024). Furthermore, there are no transitional provisions in respect of obligations arising under the EU Securitisation Regulation (the “EUSR”) for transactions entered into before Brexit, or the UKSR for those executed after Brexit.
Increased flexibility for UK institutional investors
Amendments to the investor due diligence provisions will introduce a more principles-based and proportionate approach to verification of documentation and reports provided in connection with securitisations. UK institutional investors exposed to UK and non-UK securitisations will no longer be required to obtain prescribed reporting templates from sell-side parties (as is currently the case under the UKSR), provided that they have at least the information required under the rules sufficient to assess the legal structure and risks involved in holding the securitisation position, along with a commitment to receive ongoing disclosure.
The Securitisation SI will limit the scope of due diligence obligations under the Draft Rules in respect of alternative investment fund managers (“AIFMs”), since the definition of “institutional investor” will specify UK-authorised AIFMs and small, registered UK AIFMs. While helpful, this change could also have practical implications for existing due diligence delegation arrangements in which UK institutional investors delegate investment decisions (and therefore due diligence activities) to a non-UK AIFM, which will no longer be considered an “institutional investor”. While the new rules will clarify that certain types of investment managers appointed to invest on behalf of institutional investors would be solely responsible for complying with due diligence obligations, it is unlikely that UK institutional investors will be able to delegate responsibility for due diligence to another investor that technically falls outside the definition.
Key sell-side considerations
The new rules remove uncertainty regarding the geographic scope of application to sell-side parties — the rules will apply to UK-established originators, sponsors, original lenders and securitisation special purpose entities only.
The PRA and FCA will impose separate (albeit identical) sets of reporting templates, which are consistent with existing UKSR reporting templates. Initially, the PRA and FCA will not make significant changes to the disclosure requirements, procedures and templates. However, sell-side parties will need to identify the correct templates that apply to them and update their systems and procedures accordingly. The new rules also clarify when sell-side parties must provide underlying documentation, offering documentation/transaction summaries and STS notifications — initial drafts must be made available before pricing, with final documents only required to be provided within 15 days after the transaction closes.
Risk retention requirements will be amended to facilitate securitisations of non-performing exposures (“NPEs”). Sell-side parties will be able to take into account the non-refundable purchase price discount when calculating retained interest in NPE securitisations. This change aligns the new framework closer to EUSR risk retention requirements, which were implemented post-Brexit. However, unlike in the EU, the new rules will not allow NPE asset servicers to act as eligible risk retainers. The new rules will allow the transfer of retained risk upon the insolvency of the retainer, or in certain limited cases where risk is retained on a consolidated basis. However, retention on a consolidated basis will be less likely in cross-border transactions, since each of the UK and EU risk retention requirements allow retention within a prudential consolidation group based solely within its own territory. Since none of the U.S., EU or UK regimes currently provide for mutual recognition, transactions may need to comply with multiple risk retention regimes in order to be marketed on a cross-border basis.
In contrast to the EU position, the “sole purpose test” applying to originators for risk retention purposes would not take into account whether income from the securitised exposures represents a retaining entity’s “sole or predominant source of revenue”. Instead, the new rules will focus on the fact that an originator retaining the risk should not rely on income from securitised exposures or retained securities in meeting its payment obligations, and the originator would still need:
- a business strategy and capacity to meet payment obligations consistent with a broader business model;
- substance from assets, capital and income other than the securitised exposures / risk retention interests;
- sufficiently experienced management; and
- appropriate governance.
Helpfully, the above criteria are stated to be “considerations”, implying a principles-based approach to applying the sole purpose test, in contrast to the EU’s imposition of an exhaustive, prescriptive list.
Looking forward into 2024
Neither the FCA nor the PRA have decided to propose major changes to the transparency rules or definitions of private and public securitisations — yet. A second consultation, to be published later in 2024, is expected to reform the substance of the disclosure requirements, reconsider the definitions of public and private securitisations and potentially introduce environmental, social and governance (“ESG”) disclosure obligations.
The FCA in particular has suggested broadening the definition of what constitutes a “public” securitisation, to capture securitisations listed on certain types of UK or non-UK unregulated markets (i.e., “multilateral trading facilities”), or those securitisations for which a public announcement or other general communication is made to a wide audience of potential investors. More substantial changes down the line will undoubtedly require further system and procedural adjustments. However, as a new year resolution, both buy- and sell-side market participants should start preparing for the new rules closer to hand.