The Edinburgh Reforms to financial services regulation announced by the UK Government on 9 December 2022 include proposals for reform of the UK securitisation framework. These proposals take the form of an illustrative statutory instrument (the “SI”)1 and an associated policy note (the “Policy Note”)2.
The draft SI and the Policy Note are intended to illustrate how the powers in the Financial Services and Markets Bill will be used to implement reform of the UK Securitisation Regulation.
The main effect of the proposals will be to shift most of the substantive rules on UK securitisation regulation from legislation to the Financial Conduct Authority ("FCA") and Prudential Regulation Authority ("PRA") rulebooks.
What is being proposed?
The Financial Services and Markets Bill (the “FSM Bill”), which was introduced into Parliament in July 2022, provides for retained EU financial services law to be revoked and replaced by UK domestic law. The FSM Bill also creates a ‘designated activities regime’ which allows the FCA to make rules that bind anyone engaging in financial markets activity, including those it does not authorise.
Reform of the UK securitisation rules is being prioritised because HM Treasury wishes to ensure the delivery of the reforms to which it committed in its December 2021 review3 of the UK Securitisation Regulation (i.e. the retained version of the EU Securitisation Regulation) (the “UKSR”).
HM Treasury intends to use powers introduced in the FSM Bill to move to a “comprehensive FSMA model for the regulation of securitisation”, by applying the regulatory model principally set out in Financial Services And Markets Act 2000, under which financial regulators make the detailed regulatory requirements within a wider legislative framework.
The FSM Bill will repeal the UKSR. Most of the specific regulatory requirements currently in the UKSR will not be restated in legislation, but will be replaced (with potential changes) by FCA and PRA rules. Technical standards (a type of instrument which is derived from EU law) will also be repealed and their content replaced by FCA and PRA rules.
What will be in the SI?
The draft SI contains provisions which mainly relate to the overall securitisation framework, such as provisions for the authorisation and regulation of securitisation repositories and third party verifiers. The draft SI grants powers to the FCA and the PRA to make most of the substantive rules relating to securitisation activities through their rulebooks, including in relation to key aspects such as due diligence, risk retention and transparency requirements.
The draft SI also restates certain requirements of the UKSR that are regarded as being more appropriate to retain in legislative form, such as a ban on securitisation special purpose entities being established in certain high-risk jurisdictions and other international issues which are within the government’s remit. The draft SI also sets out due diligence requirements for occupational pension schemes (“OPS”) investing in securitisations.
The Policy Note makes clear that important points of details, such as enforcement and transitional provisions, have not been included in the draft SI and that the drafting, design and format of the draft SI will continue to develop before the final legislation is laid before Parliament following Royal assent to the FSM Bill.
What will stay the same?
The proposed approach in the draft SI is intended to maintain the status quo for:
- regulator responsibilities (except for the change from the Pensions Regulator to the FCA for some requirements for OPS);
- the entities subject to securitisation regulatory requirements; and
- the definitions for what constitutes a ‘securitisation’.
Although the regulators’ exact rulemaking approach is still under development, the majority of the rules currently in the UKSR are expected to be maintained in the FCA and PRA rules.
The simple, transparent and standardised ("STS") securitisation regime will remain in place, but the STS criteria will be delegated to the FCA. This opens the door to the possibility of STS synthetic securitisations, if the FCA considers this appropriate.
An equivalence regime for STS is set out in the FSM Bill and HM Treasury is responsible for deciding which jurisdictions qualify. By contrast, an equivalence regime was rejected by the European Commission in its recent report4 on the functioning of the European Securitisation Regulation.
The third-party verification and data repositories regimes will be broadly unchanged.
What will change?
The FCA and PRA are expected to implement the reform areas identified in HM Treasury’s Report of December 2021, namely:
- certain risk retention provisions, for example in relation to (i) transferring the risk retainer where there is a change of CLO manager and (ii) risk retention in securitisation of non-performing exposures ;
- the definitions of public and private securitisation, as well as the disclosure requirements for certain securitisations;
- due diligence requirements for institutional investors when investing in non-UK securitisations, “to provide greater clarity on what is required”; and
- the definition of institutional investor as it relates to certain unauthorised non-UK AIFMs who are currently in scope of due diligence requirements.
The draft SI allows for re-securitisations. However, any re-securitisation transaction will need to be pre-approved by the regulatory authorities on a case-by-case basis.
The draft SI grants powers to the FCA to dispense with its rules in certain circumstances, which may be intended to establish a mechanism equivalent to the Securities and Exchange Commission ‘no action’ letter regime in the US.
Separately, the PRA is also expected to examine the capital and liquidity treatment of securitisations, including as part of the PRA’s implementation of Basel IV and reforms to Solvency II.
What is the timing?
The FCA and the PRA intend to set out the detailed replacement rules “including any appropriate reforms” in consultations beginning early next year. It is expected that the securitisation reforms will come into force in 2023 at the earliest.
The proposed reforms to the UK securitisation rules may introduce welcome additional flexibility into UK securitisation regulation, for example in relation to issues such as the due diligence requirements for investing in non-UK securitisations, the ability to carry out re-securitisations on a case-by-case basis and the potential for a no action letter regime.
However the flip side of this potential increased flexibility is a likely increase in regulatory divergence between the UK securitisation rules and the EU securitisation rules. The extent to which the proposed new UK securitisation rules will diverge from the EU rules will only become clear once the FCA and PRA have published the detail of the replacement rules early next year.