Related Author: Serena Brent, Trainee Solicitor at Mayer Brown
On 27 July 2023 the Prudential Regulation Authority (the "PRA") published a Consultation Paper1 (the "CP") setting out the PRA's proposed new securitisation rules to replace requirements for PRA-authorised persons that are currently in the UK Securitisation Regulation2 (the "UK SR") and in related technical standards.
The proposed new PRA rules relate to the following provisions of the UK SR:
- Article 5 (Due-diligence requirements for institutional investors);
- Article 6 (Risk retention);
- Article 7 (Transparency requirements for originators, sponsors, and securitisation special purpose entities);
- Article 8 (Ban on resecuritisation); and
- Article 9 (Criteria for credit-granting).
The PRA's proposed new rules mainly restate retained EU legislation but also contain a limited number of 'targeted adjustments' to the current rules.
One of the most significant proposed changes is a move to a more principles-based due diligence regime for UK investors investing in either UK or non-UK securitisations, doing away with the requirement for investors to verify that the transaction has reporting on prescribed templates. The proposed rules would also adopt many of the current draft EU regulatory technical standards on risk retention3.
The proposed changes to the current rules include:
- clarifying that all PRA-authorised manufacturers4 who are established in the UK are subject to the relevant rules, even in the case of one-off securitisations, and setting out supervisory expectations for all such manufacturers;
- adopting a more principles-based approach to due diligence obligations for PRA-authorised institutional investors in relation to disclosures by manufacturers;
- clarifying that in certain circumstances only the managing party and not the delegating party would be subject to due diligence requirements;
- changing risk retention requirements for securitisations of non-performing exposures;
- clarifying the timelines for manufacturers making available certain information;
- indicating that the PRA would usually envisage granting permissions for resecuritisations only in circumstances broadly similar to those in which it could currently grant permissions for resecuritisations under the UK SR; and
- making other smaller changes to risk retention requirements, mainly intended to make these requirements clearer or more proportionate.
The CP does not contain proposals for revising the distinction between private and public securitisations for the purposes of the transparency and disclosure requirements or for revising the disclosure templates. These issues are being considered jointly by the PRA and the Financial Conduct Authority ("FCA") and are addressed in a FCA consultation paper published on 7 August 20235.
The CP follows the publication by HM Treasury ("HMT") on 11 July 2023 of a near-final draft Statutory Instrument6 (the "SI"), which would create a new UK framework for the regulation of securitisation and replace the UK SR and related EU-derived secondary legislation (which are to be repealed by the Financial Services and Markets Act 2023 ("FMSA 2023"), discussed further in our previous article.
The SI enables the FCA and the PRA to make most of the detailed rules currently in retained EU law regulating the UK securitisation market through revisions to their rulebooks. This is intended to bring the regulation of securitisation in line with other UK financial services regulation under the 'FSMA model of regulation'7. The SI will restate some provisions of the UK SR in legislation, while other provisions in the UK SR will be repealed and replaced with PRA or FCA rules (or will fall away).
The CP follows HMT's 2021 Review8 of the UK SR (the "2021 Review"), which identified specific areas where policy changes to the UK SR might be considered.
The FCA published a consultation paper on 7 August 2023 (the "FCA CP") on replacing relevant provisions in the UK SR and related technical standards with FCA rules. Some of these FCA rules relate to securitisations that are simple, transparent, and standardised ("STS") and will also apply to PRA-authorised persons. The FCA is also responsible for supervising securitisation repositories and third-party verifiers of STS securitisations.
Together the CP, the FCA CP, and the SI contain the proposals for replacing the UK SR and its related technical standards. The CP proposals would result in a new Securitisation Part of the PRA Rulebook and a new statement of policy on Permissions for Resecuritisations.
Scope and application
The PRA currently supervises compliance of PRA-authorised persons9 with the requirements in Articles 5-9 of the UK SR in relation to post-2019 securitisations. These requirements include:
- due diligence requirements for institutional investors in securitisations;
- risk retention requirements, transparency requirements, credit granting standards; and
- restrictions on resecuritisations.
The FCA currently supervises UK firms other than PRA-authorised persons and occupational pension schemes in relation to Articles 5-9 of the UK SR and has sole supervisory responsibility for other 'firm-facing' provisions of the UK SR.
The CP proposals will apply to all PRA-authorised manufacturers and institutional investors that are UK undertakings, and so does not apply to UK branches of overseas PRA-authorised firms.
The CP sets out the PRA's proposed rules to replace retained EU law requirements for PRA-authorised persons in relation to those provisions of the UK SR for which the PRA has supervisory responsibility and the related risk retention technical standards10 (the "Risk Retention Standards") and disclosure technical standards11 (the "Disclosure Technical Standards").
The CP also explains the circumstances in which the PRA envisages using a new power12 to disapply or modify proposed rules on the use of resecuritisations and sets out the PRA's proposed new rules to replace the current transitional provisions for pre-2019 securitisations.13
General approach of the PRA
The PRA's proposed approach to the replacement of relevant provisions in the UK SR with PRA rules would largely preserve current requirements, with a limited number of policy adjustments, the most important of which are discussed below.
Due Diligence obligations of institutional investors
Article 5(1)(f) of the UK SR requires UK institutional investors to verify that overseas securitisation manufacturers have made available information which is "substantially the same" as that which they would have made available in accordance with the disclosure requirements of Article 7 of the UK SR if they were UK securitisation manufacturers, including substantially the same frequency and modalities.
As HMT acknowledged in its 2021 Review, the meaning of the words "substantially the same" is unclear, with the result that investors are not sure whether they are complying with their due diligence requirements in respect of overseas securitisations.
In the CP, the PRA proposes to resolve this issue by adopting a more principles-based and proportionate approach when replacing both Article 5(1)(e) on verifying disclosure by UK manufacturers and Article 5(1)(f) on verifying disclosure by non-UK manufacturers with PRA rules.
The PRA's proposed rules would require UK institutional investors to verify that a manufacturer of securitisation (whether a UK securitisation or a non-UK securitisation) has made available sufficient information to enable them to assess the risks of holding the securitisation position. The proposed rules would require the relevant information to include certain minimum information, including in relation to the underlying exposures and the structure of the securitisation, at specified times or frequencies, but without requiring verification of all the details (including the availability of reporting on prescribed templates) currently in Article 7 of the UK SR and the Disclosure Standards. The proposed list of minimum information is set out in the Appendix to this note.
The proposed rules would also expressly require UK institutional investors to verify that a manufacturer committed to make further available on an ongoing basis, as appropriate.
If implemented, the PRA rules on investor due diligence would result in an approach which is very different from the EU due diligence requirements in relation to third country securitisations, which the European Commission has interpreted14 as requiring EU institutional investors to verify that all information required by Article 7 of the EU Securitisation Regulation15 has been disclosed to EU institutional investors, regardless of whether the manufacturer is established in the EU or a third country.
The proposed PRA rules would make it significantly easier for UK investors to invest in US, Australian or other third country securitisations, which currently do not typically make available full Article 7 reporting.
Clarification of the scope of requirements for 'manufacturers'
The PRA proposes to clarify the scope of the rules which would replace Articles 6-9 of the UK SR so that it is clear that they capture one-off securitisations for PRA-authorised non-CRR firms and non-Solvency II firms. In addition, the PRA proposes to extend its supervisory expectations in relation to arrangements, processes, and mechanisms for compliance with the SR16 to PRA-authorised non-CRR firms and non-Solvency II firms.
Clarification of provisions on delegation of due diligence to a managing party
Article 5(5) of the UK SR provides that where an institutional investor (the delegating party) has given another institutional investor (the managing party) authority to make investment management decisions that might expose it to a securitisation, the delegating party may instruct that managing party to fulfil its due diligence obligations in respect of any exposure to a securitisation arising from those decisions. The PRA proposes to clarify in its proposed rules that if a delegating party instructs a managing party to fulfil any of its due diligence obligations in those circumstances, the delegating party would not be responsible for failure to comply with the relevant obligations. This is subject to the proviso that the managing party is subject to the equivalent due diligence obligations under the proposed PRA rules or FCA rules.
The UK's currently applicable Risk Retention Standards17 date back to 2014 and do not include a number of significant changes which have been included in successive drafts of the equivalent EU risk retention standards, for example provisions such as the definition of a 'sole purpose' originator, 'adverse selection of assets' requirements, amendments to the risk retention provisions for securitisations of non-performing exposures ("NPEs")18 and provisions relating to the impact of any fees that may be used to reduce the effective material net economic interest.
It has been a long-standing matter of uncertainty whether, and to what extent, the UK would adopt the text of the EU risk retention standards (the "EU Final Draft RTS"), a final draft of which was adopted by the European Commission on 7 July 2023, discussed in our previous legal update.
The PRA has proposed the following changes to current UK requirements:
- allowing a change of the risk retainer in the event of the retainer's insolvency;
- adjusting the existing risk retention methods to take into account the net value of NPEs for NPE securitisations, where appropriate;
- introducing criteria to assess whether an entity retaining the risk in a securitisation has not been established and is not operating for the 'sole purpose' of securitising exposures;
- specifying how the risk retention requirements apply in resecuritisations;
- permitting all CRR and Solvency II firms to retain risk in synthetic/contingent form without fully collateralising it in cash and holding it on a segregated basis as clients' money; and
- specifying how the comparability between the securitised assets remaining on an originator's balance sheet and the ones transferred to a securitisation special purpose entity (SSPE) should be assessed.
The PRA proposes to make some other minor changes to the relevant provisions in the Risk Retention Standards. For example, while the current risk retention requirements require disclosure of certain information about the risk retention, the PRA proposes to specify that this information has to be included in the final offering document or transaction summary.
Notable differences between the PRA's proposed rules on risk retention and the EU Final Draft RTS include the following:
Transfer of retainer
The proposed PRA rules allow for the transfer of risk retainer in the event of the retainers insolvency. However the proposed rules do not include the provision in the EU Final Draft RTS 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 PRA rules appear to be more restrictive than the EU rules in relation to transfers of the retained interest, despite HMT's conclusion in its 2021 Review that there was merit in allowing a transfers by CLO managers retaining risk where investors in a CLO choose to replace the manager.19
The risk retention requirements in Article 6 of the UK SR currently refer to the nominal value of the securitised exposures. NPEs are usually securitised at a substantial discount to their nominal value. The PRA proposes implementing one of the changes introduced into the EU Securitisation Regulation in 2021 to allow this reduction in value (the 'non-refundable purchase price discount' or 'NRPPD') to be reflected, where appropriate, in the risk retention requirements for NPE securitisations'.
The PRA rules do not propose allowing eligible servicers to fulfil the risk retention requirements, as is permitted under the EU Final Draft RTS. The CP states that the PRA does not at this point propose any other policy change relating to NPE securitisations, but may consider this in the future.
The 'sole purpose' test
Article 6(1) of the UK SR sets out the 'sole purpose' test, which states that the entity retaining the risk must not be established for the sole purpose of securitising exposures. The PRA proposes that, when considering if an entity is established for the sole purpose of securitising exposures, the following should be taken into account:
- whether the entity has a business strategy and the capacity to meet payment obligations consistent with a broader business model and involving material support from capital, assets, fees or other income available to the entity, relying neither on the exposures being securitised, nor on any interests retained or proposed to be retained, as well as any corresponding income from such interests and exposures; and
- 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.20 The PRA 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 UK 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 PRA states that is expects its proposed test to be broadly in line with current market expectations, but that it will continue monitoring market practice to see whether reviewing the proposed specification of the sole purpose test would be appropriate.
L-shaped risk retention
The PRA does not propose to allow for L-shaped risk retention (i.e. for a portion of risk retention to be first loss and a portion to be vertical). In its 2021 Review, HMT noted21 that it could see potential benefits to L-shaped risk retention, but that further work with the regulators is required to ensure that these changes, if implemented, would not negatively impact the alignment of sell side parties' incentives.
The proposed PRA rules do not include certain other provisions in the EU Final Draft RTS including: (i) provisions relating to the use of synthetic excess spread for certain synthetic securitisations; and (ii) provisions requiring certain guaranteed or upfront fees payable to the retainer on a priority basis and which relate to post-closing services to be deducted from the recognised retention amount.
Distinction between private and public securitisations
The UK SR distinguished between 'public' securitisations (for which an approved prospectus is required under UK law) and 'private' securitisations (for which an approved prospectus is not required). The disclosure requirements are more extensive for public securitisations, for example requiring information to be made available via a securitisation repository and additional disclosure templates to be completed. The distinction means that there is a different treatment for a securitisation which is admitted to a UK regulated market from a securitisation which is admitted to trading or traded on a UK venue that is not a UK regulated market or a non-UK trading venue.
Together with the FCA, the PRA is considering how this distinction might be redrawn to support the development of more risk-sensitive disclosure requirements. The FCA proposes outlining possible approaches for revising the distinction in the FCA CP.
The Disclosure Technical Standards provide details of the content and format of information that manufacturers have to provide in order to comply with the transparency requirements of Article 7 of the UK SR, including detailed disclosure templates. The PRA's proposed rules preserve the substance of the existing rules, except that they make no explicit provision requiring manufacturers to comply with laws governing the protection of confidentiality of information and the processing of personal data.
The PRA, together with the FCA, is considering whether the disclosure templates for private securitisations could be made more proportionate while still supporting the provision of sufficient information by manufacturers to investors, and also whether more limited adjustments to disclosure requirements for public securitisations might be appropriate. The FCA will outline possible approaches for revising the disclosure templates in the FCA CP.
Permissions for resecuritisations
The CP contains a draft statement of policy which sets out the PRA's approach to considering applications from, and granting permissions to, PRA-authorised persons to include securitisation positions as underlying exposures in a securitisation using its powers under section 138BA of FSMA. The CP indicates that if the PRA were to grant such a permission, it would exercise its powers to disapply or modify the prohibition on securitisation in largely the same circumstances as under the current rules.
Other proposed changes
The PRA proposes transferring some of the wording currently contained in certain recitals of the UK SR into rules. For example, a new rule would replicate recital (14) of the UK SR which states that 'to the extent that trade receivables are not originated in the form of a loan, credit-granting criteria need not be met with respect to trade receivables.'
Timetable for responses to the CP
The PRA has requested responses to the CP by Monday 30 October 2023.
List of Minimum Information to be verified by UK Institutional Investors
The PCA's proposed list of minimum information that must be verified by UK institutional investors before investing in a UK or a non-UK securitisation is as follows:
1 CP15/23 – Securitisation – General Requirements: CP15/23 – Securitisation: General requirements | Bank of England.
2 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.
3 Draft Commission Delegated Regulation, adopted by the European Commission on 7 July 2023, but not yet in force: csrd-delegated-act-2023-5303-annex-1_en.pdf (europa.eu).
7 I.e. the current model of UK financial services regulation introduced by the Financial Services and Markets Act 2000 ("FSMA") whereby independent regulators, in particular the PRA and the FCA, set the direct regulatory requirements which apply to firms, within a framework set by Parliament and government.
8 HM Treasury, Review of the Securitisation Regulation: Report and call for evidence response (December 2021): Securitisation_Regulation_Review.pdf (publishing.service.gov.uk).
10 Currently 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,
11 Technical Standards (Specifying the Information and Details of a Securitisation to be Made Available by the Originator, Sponsor and SSPE) (EU Exit) Instrument 2020 (FCA 2020/80), available at https://www.handbook.fca.org.uk/instrument/2020/FCA_2020_80.pdf.
14 In the European Commission's Report from the Commission to the European Parliament and the Council on the functioning of the Securitisation Regulation (10 October 2022): eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52022DC0517.
16 See PRA supervisory statement (SS) 10/18: SS10/18 - Securitisation: General requirements and capital framework | Bank of England.