The Edinburgh reforms and securitisation: The road ahead

Introduction

On 9 December 2022, the Chancellor of the Exchequer announced a set of reforms (the “Edinburgh Reforms”) that aim to drive growth and competitiveness in the financial services sector[1]. As part of the Edinburgh Reforms, the UK Government published both an illustrative Statutory Instrument on the Securitisation Regulation (the “Illustrative Securitisation SI”) and a related policy note (the “Securitisation Policy Note”)[2]. Both the Securitisation Policy Note and Illustrative Securitisation SI provide further explanation about how HM Treasury (“HMT”) may use its future powers to move to a comprehensive regulator-led model for the regulation on securitisation following the repeal of retained EU law in this area.

This client briefing provides further background on (a) the future UK regulatory landscape for securitisation, (b) the Edinburgh Reforms and the December 2021 HMT Report on the Review of the UK Securitisation Regulation[3] (the “Securitisation Regulation Review Report”) and (c) some further points to note from the Securitisation Policy Note and the Illustrative Securitisation SI.

The future UK regulatory landscape for securitisation

On 20 July 2022, the Financial Services and Markets Bill (“FSMB”) was introduced to Parliament. The FSMB will repeal retained EU law on financial services (including the UK Securitisation Regulation[4]) so that it can be replaced with a UK specific regulatory regime. This regime will broadly adopt the existing UK regulatory model whereby the framework for the creation of detailed regulatory rules is set out in primary legislation (particularly the Financial Services and Markets Act 2000 (“FSMA”)). The detailed rules are then made by regulators operating under the broad authority conferred by FSMA.

The Designated Activities Regime for sell-side

The FSMB introduces a ‘designated activities regime’ (“DAR”) which allows HMT and the Financial Conduct Authority (the “FCA”) to regulate certain financial markets activities even when carrying out such activities does not require the person doing so to be authorised by a financial regulator. In other words, any person, whether required to have an authorisation or not, must comply with the specific rules set down by HMT and the FCA when undertaking any designated activity (unless an exemption is available).

Because the rules applicable to securitisations should apply to both authorised and unauthorised entities, HMT considers the DAR to be an appropriate framework to regulate the provision of securitisation. Under the Illustrative Securitisation SI, the following activities will be considered ‘designated activities’ for the purposes of the DAR (the “Securitisation Designated Activities”): (a) acting as an originator, sponsor, original lender or securitisation special purpose entity in a securitisation or (b) selling a securitisation position to a retail client located in the United Kingdom. Any investment activity (see below) would not be considered a Securitisation Designated Activity.

The Illustrative Securitisation SI clarifies that the FCA will be the regulator responsible for making rules relating to the Securitisation Designated Activities save for certain rules that apply to authorised persons by the Prudential Regulation Authority (the “PRA”). The latter carve-out has been included to maintain the current split of regulatory responsibilities between the FCA and the PRA when it comes to the securitisation requirements for PRA-authorised persons, with the FCA currently responsible for a number of securitisation requirements (selling securitisations to retail clients and the designation of securitisation as Simple, Transparent, and Standardised (“STS”)) and the PRA for the other securitisation requirements (including risk retention, disclosures, re-securitisation and credit granting). With regards to occupational pension schemes (“OPSs”), the Illustrative Securitisation SI also means that, when an OPS undertakes a Securitisation Designated Activity, it will need to comply with the future FCA rules and be subject to supervision of the FCA in this respect. Regulatory responsibility for supervising compliance of OPSs undertaking any Securitisation Designated Activities will therefore move from the Pensions Regulator to the FCA.

Institutional Investor Regime for buy-side

As mentioned above, investing in a securitisation will not be considered a Securitisation Designated Activity and therefore not fall within the DAR. However, investing in a securitisation will remain subject to regulation. The Illustrative Securitisation SI clarifies that the appropriate regulators must make rules requiring an institutional investor to carry out due diligence before and while holding a securitisation position. Even though this is still being considered, it is currently envisaged that the PRA (for PRA-authorised persons) and the FCA (for any other institutional investor, including small registered UK AIFMs, other than OPSs) will need to make the rules relating to such due diligence requirements. For OPSs, the due diligence requirements, which will continue to be monitored by the Pensions Regulator and mirror those set out in the UK Securitisation Regulation, are set out in the Illustrative Securitisation SI as the Pensions Regulator does not have the appropriate rulemaking powers (it not being an FSMA regulator).

Securitisation Repositories and Third-Party verifiers

The regulatory perimeter will be maintained in relation to securitisation repositories and third party verifiers. These firms are and will remain registered or authorised with the FCA and therefore will not be subject to the DAR or the institutional investor regime set out above. The requirements for those entities, along with the FCA’s powers, are set out in the Illustrative Securitisation SI and mirror those in the UK Securitisation Regulation.

Risk of divergence between rules issued by different regulators

In the future UK securitisation regulatory landscape, securitisation related rules and requirements will therefore be set out by the FCA and the PRA whilst for OPSs the buy-side rules will be set out by way of statutory instrument (given that the Pensions Regulator is not an FSMA regulator). This risks fracturing the regime that currently exists. This in turn may make the placing of securitisations more complex for originators, issuers and their advisers if due diligence rules differ as between different types of investors. Given the importance of the regulatory regime being clear and coherent, HMT intends to require the FCA and the PRA to have regard to the coherence of the overall framework for the regulation of securitisation when making relevant rules. This requirement is expected to apply on an ongoing basis. It is however unclear how coherence will be achieved when it comes to buy-side OPSs relative to other types of investors. The dialogue between the FCA and the PRA will not involve the Pensions Regulator and any changes to the due diligence requirements that may be agreed between the PRA and the FCA will need to be put into a statutory instrument (which will need to be tabled in Parliament to be effective) in order to apply to buy-side OPSs.

The Edinburgh Reforms and the Securitisation Regulation Review

HMT conducted a review of the UK Securitisation Regulation in 2021. This review presented an opportunity to consider ways in which the UK Securitisation Regulation could be improved to ensure the regime is as effective as it can be. The review’s overarching aims were (a) to bolster securitisation standards in the UK in order to enhance investor protection and promote market transparency; and (b) to support and develop securitisation markets in the UK, including through the increased issuance of STS securitisations, in order to ultimately increase their contribution to the real economy.

As outlined in the Securitisation Regulation Review Report, HMT is committed to working with the FCA and the PRA to bring forward, where appropriate, reforms in the following areas:

certain risk retention provisions, for example in relation to (i) transferring the risk retention manager (which appears to relate to the CLO market and the potential for changing CLO managers in particular) and (ii) the calculation of the risk retention amount in securitisations of non-performing exposures;
the definitions of public and private securitisation, as well as the disclosure requirements for certain securitisations, to ensure they are appropriate;
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 Alternative Investment Fund Managers (“AIFMs”) who are currently in scope of due diligence requirements, so that these requirements do not disincentivise these firms from seeking investors in the UK, and to address extraterritorial supervision and enforcement problems.

Given the future UK regulatory landscape for securitisation (see above), not all the reforms identified in the Securitisation Regulation Review Report have made their way into the Illustrative Securitisation SI. A number of the above proposals may instead be set out in the rules to be made by the FCA and the PRA, drafts of which are not yet available. However, HMT has indicated in the Securitisation Policy Note that it remains committed to the reforms identified in the Securitisation Regulation Review Report and that it is considering the best way of engaging with the regulators in relation to the timely delivery of appropriate reforms in these areas.

Some of the reforms have however made it into the Illustrative Securitisation SI (even if only by way of note), with detailed drafting to follow:

the definition of institutional investor in the Illustrative Securitisation SI has been updated to exclude certain non-UK AIFMs;
it is noted in the Illustrative Securitisation SI that HMT intends to “maintain the exemption for certain [private] securitisations not to be required to report to securitisation repositories”.

The Securitisation Regulation Review Report also noted HMT would introduce a regime to recognise equivalent STS securitisations issued by entities established outside the UK. This has been included in the FSMB and the Illustrative Securitisation SI. HMT also confirmed that the EU STS securitisations will be continue to be considered STS in the UK until 31 December 2024. This approach contrasts with the European Commission’s recent view that it is “premature to introduce an STS equivalence regime at this time” [5].

Further points to note from the Securitisation Policy Note and Illustrative Securitisation SI

The Securitisation Policy and Illustrative Securitisation SI do not provide the full picture for UK securitisation regulation in the future. The exact drafting, design and format of the Illustrative Securitisation SI is not final and will continue to develop before the final legislation is laid before Parliament following Royal Assent of FSMB. In addition, a large number of rules (including, amongst others, risk retention requirements, credit-granting requirements, due diligence requirements and STS criteria) will no longer be set out in primary and secondary legislation but rather in rules made by the FCA and, where applicable, the PRA. It is therefore unclear whether any further significant changes to the current securitisation regime set out in the UK Securitisation Regulation will be introduced.

The Securitisation Policy Note and the Illustrative Securitisation SI in its current form do contain a few noteworthy points:

Distinction between traditional securitisation and synthetic securitisation: The definitions currently included in the UK Securitisation Regulation have not been included in the Illustrative Securitisation SI and may well be included in the rules to be made by the FCA. This would leave it for the FCA to decide whether to open up the possibility of synthetic securitisations being STS.
Location of securitisation special purpose vehicle: For the purposes of the UK securitisation regime, the Illustrative Securitisation SI retains the requirement that the securitisation special purpose vehicle does not need to be located in the UK as long as the country in which it is located is not listed as a high-risk and non-cooperative jurisdiction by the Financial Action Task Force or has signed up to an effective exchange of information on tax matters with the UK. Originators and sponsors involved in a UK STS securitisation must be established in the UK (save that originators and sponsors for the purposes of UK STS can still be established in the EU until 31 December 2024 – see above).
Due diligence requirements in relation to non-UK securitisations: Whilst the due diligence requirements will be largely set out in the rules to be made by the PRA and the FCA, the due diligence requirements for OPSs set out in the Illustrative Securitisation SI have maintained the requirement to obtain “substantially the same information” from the originator, sponsor or original lender as if it was a UK securitisation. This therefore allows UK investors to more easily invest in non-UK securitisations. No such ‘substantially the same’ standard applies under the EU securitisation regime, which was confirmed by the European Commission’s recent report on the functioning of the EU Securitisation Regulation[6]. In this report, the European Commission confirmed that EU institutional investors are required to verify that sell-side parties will make available the same disclosure and template reporting for non-EU securitisations as is required for EU securitisations and that “materially comparable information” is not sufficient in this respect.
Ban on re-securitisations: the Illustrative Securitisation SI does not include an outright ban on re-securitisations (as is the case in the UK Securitisation Regulation). Rather investment firms and credit institutions are subject to an obligation to consult the Bank of England before the FCA and PRA (as applicable) grant permission to carry out a re-securitisation. There appear to be no limitations in the Illustrative Securitisation SI on non-banks and non-investment firms carrying out re-securitisations (although such limitations could be included in the FCA and PRA rules as part of the DAR). Under the UK Securitisation Regulation, re-securitisations can only take place for a limited amount of legitimate purposes but the requirement for legitimate purposes is no longer included in the Illustrative Securitisation SI. More worryingly for some banks, the following wording of the UK Securitisation Regulation is no longer included in the Illustrative Securitisation SI: “A fully supported ABCP programme shall not be considered to be a resecuritisation for the purposes of this Article, provided that none of the ABCP transactions within that programme is a resecuritisation and that the credit enhancement does not establish a second layer of tranching at the programme level.[7]” On the basis of the description of a re-securitisation in the Illustrative Securitisation SI (being the situation where a securitisation position is included as an underlying exposure in a securitisation), it may mean additional permission and consultation requirements for banks or institutions with an asset-backed commercial paper programme. However, as mentioned above, the Illustrative Securitisation SI is not final and the re-securitisation clarification for asset-backed commercial paper programmes may still be included in the rules to be made by the FCA and PRA.
Relevant sanctions: In relation to STS securitisations, the definition of ‘relevant sanction’ in comparison to the UK Securitisation Regulation appears to be broader as it no longer refers to the sanction being “by reason of an act or failure, whether intentional or through negligence”. So any failure to meet the STS securitisation requirements would need to be notified and/or included on the list of notified securitisations and no longer when it is intentional or through negligence. Also, even though it is noted that cross-references to the relevant requirements still need to be included in the Illustrative Securitisation SI, the relevant sanctions definition only refers to a failure to meet the requirements and no longer to an STS notification being misleading. This omission may be covered through the new FCA rules, but this is not clear at the moment.

Conclusion

The Edinburgh Reforms build on the Securitisation Regulation Review Report and will give regulators the powers to steer the direction of the UK securitisation regime. The hope is that the Edinburgh Reforms will therefore establish a smarter securitisation regulatory framework for the UK that is “agile, less costly and more responsive to emerging trends” compared to the current EU retained law. Whilst the Edinburgh Reforms are more focussed on detailing the new FSMA model for regulation of securitisation at this time, existing divergences between the UK and EU securitisation regime appear to have been maintained and further divergences may follow under the new powers granted to the UK financial regulators. Unfortunately, in the absence of any draft rules by the FCA and the PRA and the final Illustrative Securitisation SI, it is unclear what substantive changes (if any) will be introduced to the current UK securitisation regime once EU retained law has been repealed.

[1] The Edinburgh Reforms can be found via: https://www.gov.uk/government/collections/financial-services-the-edinburgh-reforms

[2] The HM Treasury’s policy paper on building a smarter financial services framework for the UK together with the Illustrative Securitisation SI and the Securitisation Policy Note can be found via: https://www.gov.uk/government/publications/building-a-smarter-financial-services-framework-for-the-uk

[3] HM Treasury, Review of the Securitisation Regulation: Report and call for evidence response, December 2021, available through: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1040038/Securitisation_Regulation_Review.pdf

[4] The UK version of Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012.

[5] European Commission, Report from the Commission to the European Parliament and the Council on the functioning of the Securitisation Regulation, October 2022, available through: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52022DC0517&from=EN

[6] European Commission, Report from the Commission to the European Parliament and the Council on the functioning of the Securitisation Regulation, October 2022, available through: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52022DC0517&from=EN

[7] Article 8(4) of the UK Securitisation Regulation

United Kingdom (and EU regulation)