UK securitisation regulation FCA consultation paper

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UK securitisation regulation FCA consultation paper

UK securitisation regulation FCA consultation paper

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August 16, 2023

Overview

On 7 August 2023, the Financial Conduct Authority published Consultation Paper 23/17 – Rules relating to Securitisation (the FCA CP).¹ The FCA CP sets out the FCA's proposed replacement rules for the UK securitisation markets and contains proposals for FCA-facing requirements of the UK Securitisation Regulation.

Such proposals include the related technical standards for all authorised and unauthorised originators, sponsors, original lenders and SSPEs which are not PRA-authorised firms, in relation to risk retention requirements, transparency obligations, re-securitisation restrictions and credit granting standards.

In addition, the FCA proposes to:

use the rulemaking powers under the DAR given to the FCA under the Financial Services and Markets Act 2023 to make rules relating to STS securitisations for all UK originators and sponsors;
provide that selling a securitisation position to a retail client located in the UK will also be a designated activity under the DAR. For that activity, the FCA proposes to make rules for all UK sellers;
utilise the power granted to it under the Draft UK SR SI to make due diligence rules for small, registered UK AFIMs and make due diligence requirements for all FCA solo-authorised institutional investors under the FCA's FSMA general rulemaking powers; and
utilise the powers given to it under the Draft UK SR SI in relation to securitisation repositories and third party verifiers.

Key Developments

The proposals of the FCA contained in the FCA CP look to largely preserve the provisions of the UK Securitisation Regulation, the Risk Retention Technical Standards and the Disclosure Technical Standards. The FCA has set out in the FCA CP an overview of its proposed rule changes along with its proposed rules contained in a new Securitisation Sourcebook (SECN) to be added to the Specialist Sourcebooks block within the FCA Handbook. The FCA CP covers a number of subject areas which overlap with the PRA CP (albeit with application to different cohorts of persons and which we set out again below for reference) and, to the extent there is an overlap, the provisions proposed by the FCA in substance mirror those proposed by the PRA. However, the FCA has a number of other areas of competence, such as regarding STS securitisations which are not subject to PRA rules.

Such proposed FCA rules include the following more substantive changes:

Due diligence requirements for institutional investors – the FCA notes that the PRA and HM Treasury have sought to align the proposed due diligence requirements for the different types of investors comprised within the definition of "institutional investor" under the UK Securitisation. The FCA CP includes a number of proposals that mirror or largely mirror those made by the PRA in the PRA CP. Specifically, the FCA CP provides that:

Due diligence rules for small Alternative Investment Fund Managers (AIFMs) – while the definition of "institutional investor" already includes small-authorised UK AIFMs, the Draft UK SR SI contemplates that the FCA will be given a specific new power to make due diligence rules for small, registered UK AIFMs when investing in securitisations and the FCA's proposed rules would cover them in the same way as for other investors;
Adjustments to the due diligence requirements in relation to manufacturers' disclosures – the FCA has proposed that Article 5(1)(e) (on verifying disclosure by UK manufacturers) and Article 5(1)(f) (on verifying disclosure by overseas manufacturers) of the UK Securitisation Regulation are replaced with a "more principles-based and proportionate approach". This revised obligation would be a singular approach (as more fully set out in SECN 4) which broadly aligns the information that the institutional investors are expected to receive with the reporting regime on UK manufacturers. UK institutional investors would be required to verify under FCA rules that:

the sufficiency of the information a manufacturer has made available to them, to enable them to independently assess the risk of holding the securitisation position;
they have received at least the information listed in the rules; and
there is a commitment from the manufacturers to make further information continually available, as appropriate.

The FCA has further proposed that:

those items which are currently required under Article 7(1)(b), (c) and (d) of the UK Securitisation Regulation to be made available before pricing should now be provided at least in draft form prior to pricing with final versions made available within 15 days of the closing of the transaction (aligning this requirement with the equivalent STS provision) (as more fully set out in SECN 4.2.1(1)(e)); and
recital 14 of the UK Securitisation Regulation is moved to become an operative provision of the FCA rules, to make clear that credit-granting criteria need not be met with respect to trade receivables not originated in the form of a loan (as more fully set out in SECN 4.2.1).

Clarification around the delegation of due diligence – the FCA highlights the same ambiguity contained in the PRA CP in that, whilst Article 5(5) of the UK Securitisation Regulation currently 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 (for example, a fund (falling within the definition of "institutional investor") delegating to its investment manager (falling within the definition of "institutional investor")), there may be some ambiguity as to whether enforcement action could be taken against both the delegating party and the managing party for failure to fulfil such due diligence obligations of the delegating party. Accordingly, the FCA 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 these circumstances, the delegating party would not be responsible for failure to comply with the relevant obligations, provided that the managing party is an institutional investor other than a pensions investor who accepts authority to make investment decisions on behalf of another institutional investor (as more fully set out in SECN 4.4.1).

Non-performing exposure (NPE) securitisations and risk retention – again, as similarly set out in the PRA CP, the FCA proposes the use of an NRPPD for NPEs in the risk retention requirements for NPE securitisations. The risk retention requirement would be calculated on the basis of the net value of the defaulted portfolio on the date of the securitisation (factoring in the NRPPD), as opposed to the face value of the underlying assets (as more fully set out in SECN 5.2.12(2)).
Risk retention rules – mirroring the PRA CP, the FCA's proposed rules contain more granular risk retention provisions that would replace the currently applicable 2014 regulatory technical standards (which currently apply pursuant to Article 43(7) of the UK Securitisation Regulation). The principal amendments highlighted in the FCA CP are:

Insolvency of the retainer – an additional exception to the requirement that the risk retention piece is retained by the retainer on an ongoing basis is proposed where the insolvency of the retainer has occurred (as more fully set out in SECN 5.5.1(3)). However, again like the Draft PRA Rules, the draft SECN does not contain the additional exemption contained in the Commission Draft RR RTS "where the retainer, for legal reasons beyond its control and beyond the control of its shareholders, is unable to continue acting as a retainer".
Sole purpose test – the FCA proposes the addition of rules creating specificity when considering if an entity is established for the sole purpose of securitising exposures. The factors to be considered under the proposed FCA rules would "include whether" broadly: (a) the entity has a business strategy and payment capacity consistent with a broader business enterprise; and (b) 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 (as more fully set out in SECN 5.2.11). Again, like the Draft PRA Rules, these do not contain the requirement under the Draft EU RTS that "all" such factors must be met.
Re-securitisations – the FCA proposes, again in line with the Draft PRA Rules, clarifications to circumstances in which the FCA, in consultation with the Bank of England, may grant permission to a re-securitisation. The proposals (as more fully set out in SECN 7.2 and SECN 7.3) clarify that: (a) in re-securitisations that may be permitted, a retainer shall retain the material net economic interest in relation to each of the respective transaction levels, which is consistent with the purpose of risk retention restrictions; and (b) fully supported ABCP programmes which are not considered to be re-securitisations for the purposes of Article 8 of the UK Securitisation Regulation would also not be considered as re-securitisations for risk retention purposes. The proposal also clarifies that the re-tranching of an issued tranche into contiguous tranches by the securitisation's originator does not amount to re-securitisation for purposes of the risk retention. In re-securitisations that may be permitted, the risk retention rules must generally be complied with at the levels of both the underlying securitisation and of the re-securitisation (as more fully set out in SECN 5.10).
Cash collateralisation for synthetic/contingent form of retention – the FCA proposes extending the scope of the cash collateralisation exemption from only credit institutions to all CRR and Solvency II firms.
Additional criteria on "cherry picking" – the FCA has made a number of changes to the rules preventing an originator "cherry-picking" assets (as more fully set out in SECN 5.12.1).

The FCA has moved the exception which was included in recital 11 of the EU Securitisation Regulation to the operative provisions of the SECN, such that the rules should not restrict the ability of originators or sponsors to select assets which as a whole have a higher risk profile compared to other asset classes on the originator's balance sheet, as long as that higher risk profile is clearly communicated to the investors or potential investors (as more fully set out in SECN 5.12.1(2)).
The FCA has clarified the meaning of "comparable assets" for the purposes of considering securitised and non-securitised assets for the non-cherry-picking rule (as more fully set out in SECN 5.12.2). For the purposes of the proposed FCA rules to qualify as comparable assets, comparability is assessed based on the use of similar factors to determine the expected performance of both asset "buckets" (equality of checks) and that the forecast performance of the assets on the balance sheet should not be significantly better than the performance of the assets transferred in the relevant timeframe (forward looking comparability). In addition, the proposed FCA rules provide that the FCA shall deem such non-cherry-picking requirements to have been complied with when no "comparable assets" are left on the originator's balance sheet, which position has been clearly communicated to investors.

Other amendments regarding risk retention – the FCA proposes to make some more minor adjustments to the UK SR risk retention provisions when replacing them with rules. For example, the FCA proposes that it is specified that disclosure of risk retention information needs to be included in the final offering document, prospectus, transaction summary or overview of the main features of the securitisation. The FCA will continue to consider, including for the second consultation, how the risk retention provisions could be improved.

Geographical scope – the FCA proposes to expressly limit the application of its rules with respect to the UK Securitisation Regulation to entities (including manufacturers) established in the UK (apart from the definition of "institutional investor" as its scope will be set out in the SR SI). This is to clarify the existing provisions of the UK Securitisation Regulation, particularly in the case of scenarios where some, but not all, of the manufacturers of a securitisation are established in the UK, whilst broadly reflecting what the FCA understands to be the market position as to this issue. The FCA notes that rules in this regard will be subject to ongoing review.
Currency adjustments – to amend the slightly odd situation resulting from no amendments to reference currencies being made when the EU Securitisation Regulation was onshored into UK law, the FCA is proposing replacing references to Euros with references to Sterling, except in reporting templates which would be amended as part of the larger template amendment process. The FCA proposes to change the currency but keep the notional amounts unchanged.
Established in the UK – for similar reasons with respect to changes from Euro to Sterling, the FCA proposes references to "established in the United Kingdom" in the onshored EU securitisation regime will be clarified to mean an entity which is constituted under UK law with a head office or, if it has a registered office, such office is in the UK.
STS notification – the FCA proposes to clarify that a securitisation which meets all STS criteria need only be notified if the originator/sponsor wishes to obtain the STS label.
Homogeneity – the FCA proposes to make changes to the homogeneity requirements of STS-labelled securitisations with the aim of reducing the potential for mixed pools of exposures which would be inconsistent with the STS designation itself:

The FCA is proposing certain amendments (similar to those proposed by the EBA²) with the effect that loans to certain corporates will be treated as homogeneous with loans to individuals if the relevant underwriting approaches and servicing procedures to both those corporate and individual loans are the same or similar.
To clarify one of the conditions for homogeneity under the UK Securitisation Regulation (i.e. the loans are serviced in accordance with similar procedures for monitoring, collecting and administering cash receivables by the SSPE) which could be taken to imply that the loans must be transferred to an SSPE which is servicing the loans, which may not be the case where the loans are kept on the balance sheet of the originators but put in trust for the investors or a similar arrangement to achieve true sale, the FCA proposes to make a policy change that the loans must be serviced in accordance with similar procedures for monitoring, collecting and administering cash receivables "by the originator or the SSPE".
The FCA also proposes to clarify that, where no homogeneity criteria are relevant for a particular securitisation, no homogeneity conditions should apply.
The draft FCA rules also clarify that underlying exposures may include corporate bonds for homogeneity purposes, provided that they are not listed on a trading venue (again a further move of a recital (number 27) from the UK Securitisation Regulation into an operative provision).
The draft FCA rules will also include guidance specifying that the FCA's expectation is that, in most cases, mixed pools of buy-to-let and owner-occupied mortgages will not be deemed homogeneous.

Re-securitisation – the FCA can only permit re-securitisations using existing (for example, section 138A of the FSMA) and/or future powers and, as part of the FCA CP, the FCA notes that its intention is that it would usually envisage using its powers to allow a re-securitisation in circumstances broadly similar to those in which the FCA could currently grant permission for a re-securitisation under Article 8(2) of the UK Securitisation Regulation (see above with respect to the changes the FCA proposes to make regarding re-securitisations).
Credit-granting – the FCA has added recital 14 of the UK Securitisation Regulation to its own rules governing credit-granting requirements, providing that credit-granting criteria need not be met with respect to trade receivables not originated in the form of a loan, as again it considers this to be an operative provision.
Enforcement – the FCA notes that consequential amendments will also be made to the Enforcement Guide and the Decision Procedure and Penalties Manual.

The FCA CP also notes:

Public securitisations v. private securitisations – Article 7 of the UK SR introduced a distinction between "private securitisations" and "public securitisations" (being securitisations where a section 85 prospectus under the FSMA has been produced – broadly securitisations traded on a UK regulated market). However, information and disclosure templates required to be produced by manufacturers are broadly similar. The FCA notes that it, together with the PRA, is currently reviewing these requirements and plans to consult on proposals in this area in a second Consultation Paper. The FCA CP notes that 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. Ahead of the second Consultation Paper regarding the information requirements and the reporting templates applicable to private and public securitisations is to consider the distinction between "private securitisations" and "public securitisations" themselves. In doing so, the FCA notes that it has considered three separate means of defining a "public securitisation":

to define a "public securitisation" but update to expand on the link to a UK prospectus to describe all securitisations which are in substance publicly distributed to investors;
to define a "truly private securitisation" and treat every other securitisation as public (for example, a private securitisation could be a securitisation where investors/potential investors have direct and exclusive access to information from the manufacturers); or
to define "public securitisations", "truly private securitisations" and others (probably similar to the current private securitisation category) with disclosure/reporting requirements becoming better calibrated to the characteristics of the individual transactions.

The FCA is proposing following the first approach and redefining "public securitisation", and has considered a number of options (as described in more detail in the FCA CP). The FCA is mindful of maintaining the current description of "public securitisations", but expanding it to cover securitisations that are public in substance (i.e. what the market would recognise as a publicly distributed and traded transaction). The FCA's current thinking is that a "public securitisation" would cover:

securitisations that are subject to listings a manufacturer has requested on UK regulated markets or appropriate equivalent non-UK venues. This would only apply to UK securitisations (i.e. where the originator, sponsor or SSPE is located in the UK), to avoid including overseas securitisations;
primary admissions to trading on an appropriate UK MTF and similar non-UK venues, where there is at least one UK manufacturer; and
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 the primary marketing of the securitisation.

However, the FCA intends that a more precise description of appropriate trading venues for an expanded description of public securitisation would be developed following the culmination of the discussion facilitated by the FCA CP and included in a second Consultation Paper.

Disclosure templates – the FCA is considering the disclosure templates to be provided by manufacturers and, in particular, together with the PRA, it is considering whether the disclosure templates for "private" securitisations could be made more proportionate or principles-based, whilst still supporting the provision of sufficient information by manufacturers of securitisations to investors. The FCA proposes to consult on proposals to the disclosure templates, including ESG reporting, in a later consultation.

Next Steps

The FCA CP consultation closes on 30 October 2023. The implementation date for the changes resulting from the FCA CP is 2024 Q4, subject to progress of the draft Securitisation Regulation 2023.

Additionally, the FCA plans to consult on further changes in a second consultation to be published at a later stage. In the second consultation, the FCA plans to consult on the definitions of "public securitisations" and "private securitisations", the reporting regime (particularly for private securitisations) and changes to the disclosure templates.