Other Author Serena Brent, Trainee Solicitor
On 7 August 2023 the Financial Conduct Authority (the "FCA") published a consultation paper (the "FCA CP")1 setting out its proposed rules for the UK securitisation markets. The FCA CP contains a proposed legal instrument which includes the proposed rules, together with related technical standards and their annexes.
The FCA CP follows the publication of the near-final draft statutory instrument and an accompanying policy note published by the Treasury on 10 July 20232 (the "SI") and a consultation paper published by the Prudential Regulation Authority (the "PRA") on 27 July 2023 (the "PRA CP").3 For further details on the SI and the PRA CP, please see our briefings on the Reform of the UK Securitisation Regulatory Framework and on the PRA Consultation Paper.
The FCA CP, the PRA CP and the SI collectively contain the proposed replacement rules for the rules currently in the UK Securitisation Regulation4, including all related EU-derived statutory instruments and technical standards (together, the "UK SR"). The SI will repeal the UK SR and restate part of it in new legislation, while other provisions in the UK SR will be replaced with PRA or FCA rules (or will fall away). This "repeal and replace" process is intended to provide a more agile regulatory framework by giving responsibility for most of the rules to the FCA and the PRA.
The FCA's proposals align with the proposals in the PRA CP and cover amendments to or guidance on: due diligence and disclosure templates, risk retention (including the sole purpose test and resecuritisations), the geographical scope of the UK SR and criteria for homogeneity in STS transactions. The proposed replacement rules do not involve any changes to the reporting templates. The FCA intends to consult on changes to the reporting regime in a second consultation to be published at a later stage. The review of the reporting regime will also seek to advance ESG reporting.
The FCA CP does not consider prudential matters, as they are outside the scope of the UK SR.
FCA's objectives and approach
The primary aim of the FCA's proposals is to remove unnecessary barriers to the issuance of – and investment in – securitisations and to reduce ambiguity in the rules, while maintaining appropriate protections in the regulatory framework. Another key aim is to make the UK securitisation market more competitive, by making the rules more proportionate and clearer and so reducing compliance costs.
The FCA and the PRA have coordinated their approach to the replacement of the UK SR provisions and the development of policy proposals, with a view to creating a coherent framework for regulating securitisation in the UK.
As is the case with the PRA CP, the FCA's proposals relating to the replacement of the relevant provisions in the UK SR would largely preserve the current requirements, with some targeted amendments. The FCA CP prioritises some key areas identified for policy change in the review of the UK SR published by HM Treasury in 20215 (the "Treasury Review") and also proposes amendments which are intended to improve unclear drafting and ensure the wording follows FCA Handbook-style drafting.
The proposed rule changes
The FCA CP contains proposed new rules which will:
- clarify what kind of information UK institutional investors require to fulfil their due diligence obligations;
- amend and clarify risk retention provisions, with particular reference to changes to facilitate non-performing exposures ("NPE") securitisation; and
- make a number of clarificatory changes to other areas of the UK SR based on market feedback, such as the geographical scope of the UK SR and the criteria for homogeneity in Simple Transparent and Standardised ("STS") securitisations.
The FCA CP also includes a discussion on the definitions of public and private securitisations.
Application of the FCA CP
The FCA CP sets out proposed rules for all authorised and non-authorised originators, sponsors, original lenders and SSPEs, which are not PRA-authorised firms, in relation to risk retention requirements, transparency obligations, resecuritisation restrictions and credit granting standards. The PRA will make rules for PRA-authorised firms in relation to those obligations.
In addition, the FCA will use its powers6 under the SI to make rules relating to STS securitisations for all UK originators and sponsors. The FCA CP also contains proposed rules relating to securitisation repositories (SR) and third party verifiers (TPV).
The FCA's proposed revisions to the UK SR's due diligence requirements are designed to remove ambiguities for UK institutional investors looking to invest in non-UK securitisations. Currently, the UK SR provides that UK institutional investors must verify, before investing, that third country securitisation manufacturers7 have made available information which is 'substantially the same' as that which would have been made available for UK securitisations.
The FCA proposes replacing Article 5(1)(e) of the UK SR (on verifying disclosure by UK manufacturers) and Article 5(1)(f) of the UK SR (on verifying disclosure by overseas manufacturers) with a single approach which requires UK institutional investors to verify: (i) the sufficiency of the information a manufacturer has made available to institutional investors to enable them to independently assess the risk of holding the securitisation position; (ii) that they have received at least the minimum information listed in the rules in the proposed legal instrument8; and (iii) there is a commitment from the manufacturers to make further information continually available, as appropriate.
The FCA has sought to align its proposed due diligence requirements for FCA-authorised firms with the corresponding due diligence requirements made by the Treasury in the SI in relation to occupational pension schemes and by the PRA for its authorised firms9.
The FCA's due diligence requirements mean that UK institutional investors would not be required to verify that overseas securitisation manufacturers will provide asset-level reporting in the form of the prescribed reporting templates. The FCA notes that its proposals place more reliance on the substance of the information, rather than prescribing the format in which it will be provided, which it considers to be a more proportionate, better targeted approach. This approach will be welcomed by UK investors, especially those seeking to invest in US or other overseas securitisations, which typically do not provide reporting on the prescribed templates.
Separately, the FCA proposals specify that the information described in points (b), (c) and (d) of Article 7(1) of the UK SR which is required to be made available before pricing may be in draft form, with final versions made available within 15 days of closing of the transaction. This would align the general reporting regime with the STS pre-pricing information provisions and with market practice.
In addition, the FCA's proposed due diligence rules preserve the exemption (previously only in recital 14 of the UK SR) under which credit-granting criteria need not be met with respect to trade receivables not originated in the form of a loan.
The FCA also proposes to exercise its power under the SI to make due diligence rules for small, registered UK alternative investment fund managers (AIFMs).
The FCA intends to keep the due diligence requirements under review and may consider further changes in a second consultation to make the due diligence requirements more proportionate.
Non-performing exposure (NPE) securitisations and risk retention
The FCA's draft rules provide that the risk retention requirements for NPE securitisations will be calculated on the market value of a non-performing asset (i.e., the price at which the asset is sold to the securitisation vehicle), rather than its face value. This proposal would reduce absolute risk retention requirements in relation to NPE securitisations and is consistent with changes made to the EU Securitisation Regulation10 in 2021. The FCA's proposed rules do not propose allowing eligible servicers to fulfil the risk retention requirements, as is permitted under the EU's final draft regulatory technical standards on risk retention (the "EU Final Draft RTS").
Other changes to risk retention rules - General
The FCA's proposed rules also contain new risk retention provisions which replace or elaborate on the currently applicable rules in the UK SR and the 2014 regulatory technical standards.11 These include provisions relating to:
- insolvency of the retainer;
- sole purpose test;
- cash collateralisation for a synthetic/contingent form of retention;
- additional criteria on 'cherry picking'; and
- various minor provisions as described below.
Insolvency of the retainer
The FCA CP proposes that the risk retention may be transferred to another entity upon the insolvency of the risk retainer, which would reduce / avoid potential forced sales of securitisation positions due to non-compliance with the risk retention requirement. The proposed rules do not include the provision from the EU Final Draft RTS12 which allows 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 the retainer". Accordingly, the proposed FCA rules appear to be more restrictive than the EU rules in relation to transfers of the retained interest, despite the Treasury Review's conclusion that there was merit in allowing a transfers by CLO managers retaining risk where investors in a CLO choose to replace the manager.13
Sole Purpose Test
The UK SR provides that the risk retention holder must not be established, or operate, for the "sole purpose" of securitising exposures. The FCA provides further guidance on the "sole purpose" test providing that when considering whether an entity has been established for the sole purpose of securitising exposures, the following must be considered: (i) the entity has a business strategy and payment capacity consistent with a broader business enterprise; and (ii) the members of the management body have the necessary experience to enable the entity to pursue the established business strategy, as well as adequate corporate governance arrangements.
This wording substantially adopts the wording in the 2018 draft EU risk retention regulatory technical standards.14 The FCA does not propose to adopt the provision in the EU Final Draft RTS which sets out a 'safe harbour', under which an entity shall not be considered to have been established or to operate for the sole purpose of securitising exposures if it meets specified criteria, including that its 'sole or predominant' source of revenue does not rely on the securitised exposures. The FCA's proposed version of the 'sole purpose' test, with its requirement to 'take into account' the specified criteria, would avoid uncertainty regarding the scope and effect of the 'sole or predominant' wording in the EU version of the rule.
The FCA CP confirms that resecuritisations are prohibited under the UK SR except in narrowly specified circumstances. The FCA's proposals clarify that retention of a material net economic interest is required in relation to each of the transaction levels and that ABCP programmes which are not considered to be resecuritisations for the purposes of Article 8 of the UK SR are not considered resecuritisations for risk retention purposes.
Cash collateralisation for a synthetic/contingent form of retention
Under current rules, if risk retention is held through a synthetic or contingent form of retention, it needs to be fully cash collateralised unless a credit institution is the risk retention holder. The FCA CP proposes that the exemption is extended from only credit institutions to all CRR and Solvency II firms.
Additional criteria on 'cherry picking'
The FCA CP proposes to retain, with an exception, the UK SR requirement that originators cannot select assets to transfer to the SPV in order to render the losses on those assets to the SPV (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. The exception is based on wording in a previous recital in the EU Securitisation Regulation) and permits originators or sponsors to select assets with a higher risk profile for the securitisation provided that this is clearly communicated to investors or potential investors. Further information is also included on how to assess whether the assets are "comparable".
Other minor changes
The FCA is also proposing a number of other minor changes to the risk retention rules, including a new requirement that information about risk retention has to be included in 'the final offering document, prospectus, transaction summary or overview of the main features of the securitisation'.
The FCA proposes to limit the application of its rules to entities, including manufacturers, established in the UK (apart from the definition of "institutional investors" because its scope is set out in the SI). As the FCA notes, this is broadly in line with how the market has interpreted the existing rules.
The proposed rules also clarify that references in the rules to an entity which is "established in the UK" means an entity that is constituted under UK law with a head office or, if it has a registered office, that office is in the UK.
The FCA, together with the PRA, is considering whether the disclosure templates for private securitisations could be made more proportionate or principles-based, and whether more limited adjustments to disclosure templates for public securitisations might be appropriate. The FCA intends to consult on proposals to the disclosure templates, including ESG reporting, in a second consultation to be published at a later date.
The FCA's approach in the current consultation is to keep the templates unchanged, except for limited drafting changes (which are not expected to change the way firms populate or submit the templates).
Defining public and private securitisations
Article 7 of the UK SR distinguishes between private and public securitisations. Public securitisations are described as having a section 85 prospectus under the Financial Services and Markets Act 2000. Broadly speaking, this means that public securitisations are those traded on a UK regulated market.
The information and disclosure templates required to be produced by manufacturers are similar for public and private securitisations, but there are extra requirements for public securitisations. Information on public securitisations needs to be made available via an SR and there are also additional disclosure templates to be completed for public securitisations.
The FCA is considering whether the UK prospectus definition of a public securitisation is achieving the right outcome and whether the disclosure requirements in relation to private securitisations could be made more proportionate. A number of UK securitisations do not fall within the definition of a public securitisation, either because they have sought admission to regulated markets in the EU or elsewhere, or because they are listed on non-regulated markets, such as Euronext's Global Exchange Market (GEM).
In the FCA CP, the FCA states that its preference is to maintain the current description of public securitisations, but to expand it to cover securitisations that are "public in substance", i.e. what the market would recognise as a publicly distributed and traded transaction.
This FCA's proposed definition would cover UK securitisations that are subject to primary admission to trading on an appropriate UK MTF or a similar non-UK venue and where there is at least one UK manufacturer. The definition would also include securitisations where there is at least one UK manufacturer and where a public announcement or other general communication is made to a wide audience of potential investors, intended to solicit orders or expressions of interest as part of primary marketing. The FCA's expectation is that a more precise definition would be developed following this consultation.
STS securitisations – Homogeneity
The FCA's proposals for rules governing homogeneity of underlying exposures in STS securitisations retain the technical standards that were in force at the end of the Brexit implementation period but with the addition of proposed further measures similar to those the EBA drafted in 202315, which equate exposures with similar underwriting and servicing standards for homogeneity purposes.
The FCA will be consulting for 12 weeks on its policy proposals, with a closing date for comments of 30 October 2023. The FCA does not see the need for a long implementation period for changes resulting from the FCA CP and expects that the final rules will be implemented in Q2 2024, subject to the progress of the SI and feedback from the consultation.
1 Consultation Paper CP23/17, Rules relating to Securitisation: CP23/17: Rules relating to Securitisation (fca.org.uk).
3 CP15/23 – Securitisation – General Requirements: CP15/23 – Securitisation: General requirements | Bank of England. .
4 Regulation (EU) 2017/2402 as it forms part of UK domestic law as “retained EU law” by operation of the European Union (Withdrawal) Act 2018, as amended, and as amended by the Securitisation (Amendment) (EU Exit) Regulations 2019.
5 HM Treasury, Review of the Securitisation Regulation: Report and call for evidence response (December 2021): Securitisation_Regulation_Review.pdf (publishing.service.gov.uk).
8 For the list of specified information set the Appendix to our briefing on the PRA Consultation Paper.
11 In Chapters I, II and III and Article 22 of the risk retention technical standards set out in Commission Delegated Regulation (EU) 625/2014, as they form part of domestic law by virtue of the European Union (Withdrawal) Act 2018, as amended.