The Edinburgh Reforms
Following a fairly long period of what friends of the British government would call “reflection” and its foes “drift”, His Majesty’s Treasury (HMT) finally came out with an overarching policy approach to post-Brexit financial regulations. This was announced in December 2022 in Edinburgh, hence the package being named the “Edinburgh Reforms”.
The result is not especially surprising. Between the poles of maximum equivalence with EU rules and a radical and complete re-invention of the UK regulatory framework, the Edinburgh Reforms appear to lie on a mid-point. They seek to keep most of the existing framework but with departures whenever those are perceived in the national interest.
The reforms also seek clearly to re-define this national interest by explicitly setting as the goal of regulatory rules not only the prudential safety of the overall system but also the international competitiveness of the UK (together with supporting the “real” economy’s access to finance). Clearly, HMT is inviting rule makers to create an environment where the UK (and particularly the City of London) is a major global hub for international finance, servicing the global capital markets and not only the needs of UK borrowers. The obvious target of these efforts will be European market participants who will be, if the government gets its way, invited to use London for their transactions. How the European Union will react to these efforts will bear some attention. How the UK regulators balance prudential considerations with competitiveness will also likely prove interesting.
Beyond this, though, the Edinburgh Reforms are aspirational, setting out the broad direction of travel rather than a series of specific changes.
For our market though, it is notable that the government does set out in the reforms an order of priority for rule changes. And, securitisation is named as a tranche 1 priority. So far, so good.
Financial Services and Market Act
The tool the government gave itself to implement the Edinburgh Reforms is the Financial Services and Market Act (FSMA) of June 2023.
We will not go into technical details and invite you to read the many good technical pieces on the FSMA published by law firms. These are the four points someone with an interest in securitisation needs to know.
First, as a matter of general constitutional legal order, regulators and central banks are only allowed to do what is set out in their democratically determined mandates. So, to enact the ambitions of the Edinburgh Reform, the UK government has widened the mandates of the PRA and FCA to include, as a secondary objective and after prudential safety, growth and competitiveness. This can be important since, when discussing possible reforms of the securitisation regulations, neither the PRA nor the FCA can claim that they are prohibited by the exiguity of their mandates from caring about such things.
Secondly, the FSMA basically devolves pretty much the entirety of what was the EU’s Securitisation Regulation to the FCA and PRA. This is, technically, why although the FSMA explicitly repeals many existing EU laws, it does not repeal the Securitisation Regulation. There is no need since the FCA and PRA can now change pretty much any aspect of the old EU Sec Reg without any resort to HMT or the UK Parliament. As an example, the entirety of the STS criteria have been removed from primary legislation to rest in the FCA Handbook where the FCA can change them at any time.
Thirdly, and more of interest to amateurs of the minutiae of regulatory law, the FSMA introduces an interesting way to get round a common regulatory conundrum. Usually, regulatory oversight is applied to types of entities. In other words, the FCA supervises funds, the PRA supervises banks, etc… So, when an entity that is of a different type than those supervised performs an activity, it can fall between the cracks. Those cracks then need to be laboriously filled by legal provisions. The FSMA creates a new category of “designated activities”. These DAs are chosen by HMT and allocated to a regulator so that no entity performing such a DA goes unregulated. Securitisation was named a “designated activity” so that even an industrial corporation, if it engages in a securitisation, will be regulated by the FCA.
Fourthly, the FSMA invents a new expression: “manufacturer” of securitisation. This is self-explanatory covering originators, CLO managers, ABCP sponsors, etc… Not very exciting but we mention it to forestall some head scratching by our readers when they stumble for the first time on yet another technical term.
Near-Final Statutory Instrument
In July, HMT published what it described as the “near-final statutory instrument” (NFSI) amending the EU Securitisation Regulation. PCS gave a brief analysis at the time that you can find here.
Because, as we mentioned in the FSMA section, so much of the rules have now been moved to the PRA and FCA, the NFSI is not long or involved. You can read our original publication for a slightly more detailed analysis but there are two key general takeaways.
First, the NFSI confirms the approach that non-UK based special purpose vehicles can be used in UK STS transactions, but the originators and sponsors must still be on-shore.
Secondly, the draft gives HMT the power to designate other jurisdictions as "equivalent" to the UK for the purposes of the regulation of securitisations e.g. on disclosure requirements. In the specific context of STS, this would mean that a securitisations meeting the STS rules from those jurisdictions will be able to be treated as STS by UK investors. The text deliberately uses the expression "simple, transparent and comparable" derived from the Basel rules so one assumes that equivalence may be available to those countries that have adopted STC. How this will work in practice is still unclear.
By way of contrast, the European Union has firmly set its face against any equivalence regime for securitisation.
The NFSI is expected to come into force before the end of 2023.
The PRA and FCA Consultations
Published a little over a week from each other in July/August, we will treat these two consultations as one. The proximity of their publication dates, the similarity of the approaches and the questions as well as telling facts such as both announcing that there will be a review of the distinction between private and public transactions at a later date, clearly indicate that the PRA and FCA are working closely together on this file. This is most commendable. This is also why PCS is less concerned than some law firms by the fear that different rules for banks (PRA) and everyone else (FCA) will create uncertainty and an uneven playing field.
As a general overview, the word “clarification” appears an awful lot. The consultations do not anticipate any root and branch changes to the rules inherited from the EU. The basic architecture of the Securitisation Regulation will remain, for the time being, unchanged. The key elements of retention, mandatory disclosure, mandated due diligence, STS, third party verification agents, data repositories all stay in place.
What do the consultations portend?
First, a welcome statement that the interpretation of the rules will be principles based rather than focused narrowly on the words of the text. This, of course, is made possible by the fact that the rules are not in a level 1 legislative text, as in the EU, but in the PRA’s or FCA’s own handbooks. This gives the regulators flexibility that is not available to their counterparts across the Channel.
Secondly, some catch up with beneficial changes that have already occurred in the European Union such as changes to the calculation of the retention requirements for non-performing loan transactions.
Thirdly, clarifications of some timelines and nature of disclosures.
Fourthly, the possibility of expanding somewhat the scope of allowable re-securitisations. But for anyone fearing the return of the dreaded CDO cubes, this looks – thankfully – extremely limited.
Fifthly, lots and lots of highly technical changes with minimal impact (if any) on the market but which have become necessary due to the new legal framework under which the regulators now operate. Who is empowered to do what to whom under what legal authority.
In addition to the changes foreshadowed by the consultations and set out above, both the PRA and the FCA as alluded above have indicated their intention to re-examine the definitions of public and private securitisations with the possible intention to amend their respective disclosure requirement.
A technically important note is that both consultations explicitly state that there is no change to the current approach to interpretations and guidelines issued by ESMA or the EBA prior to the coming into force of Brexit (1st January 2021). These still apply unless specifically changed by UK regulators.
There are two items that are not to be found though in the consultations. One logical and understandable, the other a major disappointment.
The first is that there are no questions of possible changes to the capital requirements for holding securitisations inherited from the EU CRR and Solvency II for banks and insurance undertakings respectively. This does not mean these are off the table, but reflects the technical reality that HMT made securitisation a tranche 1 priority and not CRR or Solvency II. Therefore, such questions are simply not on today’s agenda.
Secondly, and disappointingly, there are no suggestions that STS may be extended to synthetic securitisations as it was in the European Union. If competitiveness of UK banks is a concern for the PRA, this could be a major missed opportunity.
Conclusion
In conclusion, although these are only consultations, they announce a very conservative approach, preserving most of the European architecture. This, in PCS’ opinion, is not to be frowned upon. Broadly, the framework inherited from the EU works in balancing safety and market efficiency. It can certainly be improved in places which seems to be the UK regulators intent. This gradualist approach also reflects the call of many market participants who have argued that, after more than a decade of continual changes, stability is what the sector needs more than anything.