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.

Our people

PCS is a compact organisation with a total staff of 15.

In each newsletter we will introduce one of them so that people get to know us. This time, meet Daniele Vella.

EU Green Bond Standard Regulation.
Where does it leave green securitisation?

The final agreed text of the proposed EU Green Bond Standard Regulation has been published.  (You may find it here).  What does it hold for securitisation?

The EU GBS

The EU GBS is a proposed green designation for bonds.  It is voluntary.  The regulation contains no prohibition on marketing as “green” or “sustainable” a bond which does not meet the requirements of the EU GBS and so far, no such prohibition is being proposed.  The EU GBS is a designation that can but need not be chosen by an issuer seeking to tap the market for green investments.

Secondly, and differently from the STS standard for example, the use of the EU GBS designation is not limited to EU issuance.  UK, US, Australian, Chinese bonds, etc,,, can be marketed in the EU with a EU GBS label.

Skipping over the details – and, as with all things green in the EU, there are many, many details – the essence of the EU GBS is two-fold: first, use of proceeds and secondly, external independent verification.

To meet the EU GBS standard, the proceeds of the bond must be used for green purposes.  “Green purposes” are basically defined as those complying with the EU Taxonomy.

Also, to meet the EU GBS standard, the terms under which the proceeds will be used for taxonomy compliant purposes must be the subject of a verification by a new type of regulated verification agent.  The EU GBS text contains extensive rules for the regulation of these  agents by the European Securities and Markets Authority (ESMA).

What about securitisation?

First, securitisation is not only mentioned in the final text but has fairly extensive and specific rules attached to it.  This means that there can be no doubt that a securitisation can be awarded EU GBS designation.

Secondly, the big question regarding securitisations under the EU GBS has been answered definitively.  Should an EU green securitisation be a securitisation of green assets or a securitisation whose proceeds go to fund green purposes?  PCS has written about this extensively and, for reasons this is not the place to rehearse, emphatically supported the latter approach. We are therefore happy to report that the EU GBS final text now makes it clear that a securitisation will be eligible for EU GBS status based on the use made by the originator of the proceeds generated by the securitisation irrespective of the "greeness" of the assets.  This aligns the securitisation rules with those for all other bonds thus maintaining a level playing field.

Thirdly, and somewhat unfortunately, the co-legislators have seen fit to add specific and additional burdens on securitisations seeking to be EU GBS compliant.  First, a limited set of financial assets connected to fossil fuels cannot be securitised under the EU GBS banner.  (The list is in article 13(c)).  Secondly, notwithstanding that the “greenness” of a securitisation is based on the use of its proceeds, the co-legislators have mandated additional disclosure as to the sustainability of the securitised assets, to the extent that the originator has this information.

PCS is opposed in principle to such additional rules falling solely on securitisations as, in our opinion, they unfairly tilt the playing field.  In practice though, we suspect that they will not be a material impediment to the growth of an EU GBS securitisation market since (a) there are very few, in any, securitisations of fossil fuel receivables and (b) disclosure is only required in cases where the originator actually has the information.

In a provision that is bound to disappoint some market participants though, synthetic securitisations are explicitly prohibited from achieving the EU GBS designation.

So what next?

Now that the text has been agreed by the Parliament and Council, it will proceed to a vote.  Although nothing is impossible, it is exceedingly unlikely that this will not pass on the text that has been published.  This should occur sometime in the next few weeks.  So, the EU GBS will come into force, in all likelihood, around mid-2023.  But it will not be applicable, and so EU GBS bonds could not be issued, until 12 months later – by mid-2024.

However, we note that EU GBS bonds cannot be issued unless they are verified by an ESMA authorised verification agent.  But the text provides ESMA with 24 months to come up with drafts of key provisions without which it is not possible to authorise green verification agents.  Providing an additional 3 months from ESMA’s presentation of these drafts to the draft becoming a level 2 law, then time for aspiring verification agents to digest the requirements and apply – at the very least, another 3 months – and we could easily not see a fully authorised verification agent for 30 months. The rules do allow aspiring verification agents to operate without ESMA authorisation for 18 months from the EU GBS regulation becoming applicable (ie 12 months after coming into force). But they must do this on a "best efforts" basis of complying with the law. Whether they are volunteers for this somewhat nebulous obligation and liability remains unanswered.

So, unless ESMA accelerates their drafting, we could possibly wait until early-to-mid 2026 for the first EU GBS.

Finally, some question marks hang over the whole endeavour: meeting the EU GBS standard is onerous.  It requires amongst other things, wading through the complexities of the taxonomy, getting a verification, reporting via mandatory templates and becoming liable to sanctions.  But it is currently a voluntary standard.  Will issuers seek it or will they market green bonds on other standards already accepted by investors?  Will investors insist on this standard and the EU taxonomy, or elect to craft their own? Will there be volunteers to become verification agents?

This, in turn, leads one to ask how long the EU institutions will leave the EU GBS as a truly voluntary standard?

Conclusion

For securitisation (excepting synthetics), although the EU GBS final text is not perfect, it is as good as could be hoped for.  It provides a broadly level playing field that should allow securitisations to find their place in the ecology of EU GBS issuance and fully play their role in financing the transition of the European economy to a sustainable structure.

For green issuance though, there is very little visibility both as to timing and the shape of the EU GBS path forward.

Our people

PCS is a compact organisation with a total staff of 15.

In each newsletter we will introduce one of them so that people get to know us. This time, meet Lauren Shirley, Events Manager and newest member of the Outreach Team.

Welcome !

Welcome to the end-of-year edition of the STS Newsletter by PCS, keeping stakeholders up to date about market and regulatory developments in the world of STS.

As ever, we very much welcome any feedback on this Newsletter.

Market data – Looking back at 2022 – What the numbers tell us about STS

In this section, we will focus on specific numbers in 2022 before going, in section 3., to a broader analysis of what transpired in 2022 in the STS securitisation markets.

Please note that, differently from most year-end commentaries, we have focused on number of deals rather than volume of issuance. The reason for this is not that numbers have a greater explanatory power than volume but rather that they have a different and complementary explanatory power.

Many research firms and other commentators provide the volume numbers and it seemed of limited value to just do the same. By focusing on numbers, PCS hopes to shed not a better light but a different light on the year.

(All numbers are as of 12th December 2022 and so comparisons with 2021 are not exactly on the same basis. PCS only expects very few additional STS deals by year end though..)

The big picture

(Hover over the sections for legends)

Commentary

Europe-wide STS transactions went from 206 to 177 and term true sale transactions went from 125 to 99.

Last year’s comparison showed a misleading steep decline in EU true sale STS deals. This, as we explained at the time, was the result of legacy ABCP transactions achieving STS in 2020 and therefore falling out of the figures in 2021. This year’s decline has however nothing misleading about it. Publicly placed STS true sale transactions decreased (from 79 to 75) in 2022, for reasons we explain below.

Looking at the UK alone adds little to change to this downbeat analysis. UK STS transactions were at 18 for both years.

Asset classes

Public Transactions	2021	2022	YoY
RMBS	23	27	+17%
Auto	37	32	-14%
Consumer	12	13	stable

Commentary

As RMBS shows a slight increase and consumer loan numbers remain almost identical, the victim of the lower number of public European STS transactions is the auto sector. Last year’s asset class story had been the emergence of autos as the dominant product in number, overtaking RMBS, the previous holder of the title. This year saw its percentage of deals drop back, almost back to sharing the top spot with mortgages.

This is consistent with other market data showing that auto issuance (STS and non-STS) in 2022 was €12.5 bn. This is not only a meaningful climb down from 2021’s €16.7 bn issuance but is also the lowest auto public issuance since the GFC¹PCS is grateful to BAML for its non-STS numbers.

As for last year, non-bank/non-captives grew as a percentage of issuance at the expense of captives. The best guess though is that this is not so much a reflection of long-term trends as much as the subdued market for new cars due to supply issues. When (if?) Europe’s industrial supply chain problems are solved, it is reasonable to expect a rebalancing of the auto securitisation mix.

To be clear though, this is a relative decline for autos. RMBS issuance in the EU (STS and non-STS) is also down 21 % in volume. Even CLOs (not an STS product) went from €39 bn in 2021 to €25 bn in 2022. Placed securitisations Europe wide fell from €125 bn to €88 bn.

Jurisdictions

Commentary

Not a lot of evolution in the jurisdictional distribution except for the decrease of Germany relative to the other countries. This though seems to be primarily the jurisdictional mirror image of the decline in auto issuance, long associated with that country.

Synthetics/on-balance-sheet transactions

The number of synthetic/OBS transactions notified to ESMA as STS went from 15 in 2021 to 32 in 2022. The comparison is misleading to some extent since synthetic/OBS securitisations could only be STS as of April of last year. The comparison is therefore of part of a year vs a full year.

However, the incorporation of synthetic/OBS transactions within STS has clearly been a success and PCS anticipates that it will continue to grow as an STS asset class in 2023 and beyond.

Asked what he had found the most challenging part of being a prime minister, Harold Macmillan is reported to have answered: “Events, dear boy, events…” And how 2022 has proved him right.

When PCS looks back at its prediction section in last year’s End of Year Newsletter , there is a certain sense of pride that we had been so extraordinarily prescient. Our predictions were spot on .… or rather would have been if the year had ended on June 1st. Thereafter, not so much.

Any attempt by the writer to escape footballing metaphors in this season is as lost a cause as that of an astronaut escaping the gravitational pull of a black hole beyond its event horizon. So .…

2022 – a game of two halves

The first part of the year, until June, looked good for European securitisation as a whole and especially STS. The withdrawal of central bank liquidity was bringing traditional originators back to the market after long absences, especially in RMBS, including in the UK. The approaching January 2025 deadline for the final implementation of Basel III was also leading originators to eye “full-capital-stack” securitisations to achieve capital relief.

The previous year had been very positive for securitisation as a whole (with issuance of € 125 bn) but not so good for STS in relative terms. This year looked like the year STS would play some catch-up on CLOs and non-STS RMBS (such as BTL and NC loans).

Synthetics were going strong to add to the upbeat outlook.

Then Ukraine was invaded, followed by a panic over energy supplies, followed by an acceleration of inflationary pressures, followed by increasingly dire predictions of central bank rate hikes; the whole wrapped in a deep fog of uncertainty.

As a result, the second half of the year saw something of a collapse in public issuance. It must be noted that this was not a panic, nor was it a dead stop. Deals did get done, albeit with reduced demand, albeit often on a pre-placed basis with a small investor group.

This second half can itself be divided in two. From June to October, the driver of reduced issuance was entirely price volatility. An originator was reluctant to go to market with initial price talk at 60 bp to find that it was having to pay 90 bp on the day of pricing. On the other side of the equation, an investor was reluctant to buy at 60 bp to find that the same paper would be trading at 90 bp at the end of the year, forcing a mark-to-market loss. So both stayed away.

By October, the macro-economic outlook for Europe dimmed and credit concerns began to creep in – especially for less “top end” issuers. These credit concerns fed into investor expectations on price and resulted in deals being postponed or pulled by originators not willing to pay the new spreads.

Miscellaneous observations on 2022

Securitisation is part of fixed income…

Although, in itself, a fairly trivial observation, it is important to see what happened to STS securitisation as part of what happened to securitisation; and what happened to the latter as part of what happened to fixed income generally. The increase in spreads seen in STS securitisations broadly reflect increases seen in the whole fixed income market in 2022 (with somewhat of a timing lag for securitisation both on the increase and the decrease).

…but that is not the whole story

As securitisation volumes dropped in 2022, covered bond issuance hit an all-time high at €210 bn for benchmark issuance and probably about three times that for overall issuance.

For years now, the regulatory community has deflected responsibility for the weakness of the European securitisation market away from an inappropriate regulatory framework to the monetary policy of the central banks. This led them to predict (or strongly imply) that tighter monetary policy would lead to a growth in issuance. This year has proved them partly right. There was growth in issuance. It is just that all of it was in covered bonds. PCS invites regulators and policy makers to draw the correct conclusions from the data and focus on fixing the regulatory framework.

Privatisation: no need to panic

Policy makers have been concerned by the number of deals going to the private STS market as against the public market. First, the numbers for this year indicate that this is not a trend. Last year saw 79 public transactions against 127 private ones. In 2022 so far, 75 public deals compete with only 102 private ones.

But also, PCS has seen a number of deals scheduled for public distribution that were “privatised”. This includes technically public securitisations that were, however, pre-placed with a very small group of investors as well as private transactions with banks. In all cases PCS has dealt with, these “privatisations” reflected concerns of price volatility (see above) and never over the regulatory burden of private versus public disclosure.

The liquidity story

When limiting the types of securitisations eligible for inclusion in regulatory liquidity coverage ratio pools under the CRR and confining them to the lowest category (2b), banking regulators have cited the alleged illiquidity of this product. Similar considerations are adduced under Solvency II to punish STS securitisations held by insurance companies.

However, one key feature of 2022 has been to demonstrate these concerns are misplaced. Secondary trading in 2022 was the highest since the GFC at €60 bn. More anecdotally but powerfully indicative, in the dark week of the UK’s mini-budget meltdown, when the bid for the 30-year gilt vanished, £4 bn of asset-backed paper traded in the secondary market without a hitch.

The myth of the illiquidity of the asset-backed market was further debunked in a paper by Risk Control that PCS urges regulators and policy makers to read, and which may be found here.

With regards to Solvency II, PCS continues to be puzzled by the assertion that the Solvency II calibrations are fit for purpose when the capital requirements for having an illiquid pool of whole mortgages on the balance sheet remains lower than the capital required to purchase a highly liquid AAA rated senior tranche of a securitisation benefiting from substantive credit enhancement of the same pool of mortgages.

Predicting the future has always been somewhat of a quixotic endeavour but today we suspect it is positively delusional.

In this section, we try to identify the events and phenomena that are likely to be important in determining the course of the STS market. But if it is prediction you seek, honesty forces us to advise that a quick trip to the local supermarket to purchase a chicken followed by some judicious toying with the bird’s entrails is as likely to yield an accurate result. This is the world we live in. “Events, dear boy, events…”

The fundamentals are still favourable to STS

Central bank policy is likely to continue to reverse the quantitative easing of the last few years. This leaves banks with substantial amounts of TLTRO, TFS and TFSME cash to repay and replace by other types of funding. As we saw above, much of that funding is going to be through covered bonds. But strategically minded banks will be inclined to avoid putting all their funding eggs in the same basket and should seek to issue some securitisations.

The role of non-bank lenders is likely to continue to grow. These players cannot access covered bonds and have credit ratings too low to access non-equity financing at a commercially viable rate.

The final implementation of Basel III deadline of January 2025 will be one year closer in 2023. This will require banks, if they wish to preserve their lending envelopes, to raise meaningful new capital or reduce risk-weighted assets (RWAs). The latter, short of portfolio sales, can only be achieved by securitisations – whether in traditional or synthetic format.

Finally, the price volatility of 2022 has left a decent size overhang of transactions which were originally scheduled for this year. Should volatility abate and spreads land in an acceptable place, those postponed securitisations could result in a strong recovery in early 2023.

But the headwinds are rising

Fears of recession are growing.  A meaningful economic slowdown in Europe could negatively impact securitisation in two ways. 

First, credit concerns could push up spreads to levels that make it impossible or deeply unattractive for issuers to come to market.  In particular, there is the impact of high spreads on the securitisability of pools generated in lower interest rate environments – “underwater pools”.  These can be securitised, of course, but only if the originator takes a “loss on sale” impact to its P&L.

From January to October 2022, spreads rose inexorably for all asset classes in all jurisdictions.  Senior auto paper trading at 4 bp in January was trading at 50 bp in October.  Dutch RMBS that could be purchased at 11 bp in late January would cost you 65 bp by late October. Since then, spreads in the secondary have pulled back a little.  A key question of 2023 will be whether spreads continue to retrace their steps and how far down they will go before stabilising, or indeed if their rising resumes.

Secondly, a recession may slow the generation of new loans.  This will reduce the volume of primary assets capable of being securitised, as well as the need for financing.

Conclusions?

If the lights do not go out over winter in the largest economy in Europe, and Russia does not resort to a nuclear attack, and China does not invade Taiwan to distract from a botched COVID policy and slowing economy, and central banks do not dreadfully overshoot on rate rises tipping the economy into deep recession, and central banks do not fail to tame inflation leading to major industrial unrest and no foolish archaeologists decide to open that tomb covered in mysterious undecipherable markings despite the terrified warnings of the local autochthonous population then ….

We think that we will see a fairly decent first half of 2023 in STS with a quieter second half.  We think overall issuance will be better than 2022 but not dramatically so. We also see synthetic STS issuance continuing at roughly the same pace.

We think the UK will play a bigger role in overall issuance than it has over the last few years.

But then again, you might want to double check against that chicken liver.

The new dispensation

On December 9^th, the Chancellor of the Exchequer unveiled the roadmap to the post-Brexit reform of the regulatory framework for British finance.

Although overshadowed by more headline grabbing subjects such as the future of ring-fencing and bankers’ bonuses, proposals around securitisation were part of the package.

To summarise, since Brexit and during the post-Brexit negotiations, the Treasury kept its powder dry.  Other than promising to devolve large sections of financial regulation from legislative acts, where the European Union had placed them, to regulatory handbooks drafted by the FCA and the PRA, little indication was given about the overall direction of travel.  In particular, it was not clear whether UK rules would stay almost identical to those in the EU in the hope of access to the European market or whether the UK would go it alone.

Maybe it is the result of the new-new-new UK government being run by free-trade, deregulating, “Singapore-on-the-Thames” Brexiteers.  Maybe it is the recognition that, having left the club slamming the door, the club trustees were not going to allow you to still use the clubhouse for free. Either way, the British government has now openly opted for the go-it-alone and make your own rules approach.

However, because the government has also – as promised – devolved most of the technical rulemaking to the FCA and the PRA, it is not clear how deeply the new securitisation rules will differ from the current rules inherited from the EU.  But that will depend primarily on the views of the regulators rather than those of the politicians.

Securitisation proposal

The current proposals for the UK regime unveiled by the Treasury were published in a draft statutory instrument (an application decree/level 2 instrument for our continental readers).

The draft can be found here.

There are quite a few highly technical drafting changes the implications of which are still somewhat unclear.  But here are the highlights.

The definition of “securitisation” remains unchanged.

The STS regime remains in place.   However, the criteria of what makes a securitisation STS have disappeared from the legislative text altogether and are now entirely delegated to the FCA to draft.  Presumably, the FCA will have a consultation to determine what criteria need be met for a securitisation to achieve the STS standard.

Intriguingly enough, with the criteria for STS having disappeared from the draft legislation and, in the absence of a definition of “non-ABCP securitisation” the proposed text appears to leave open the possibility of synthetic securitisations being STS.  This seems now to be in the gift of the FCA although it should be noted that so far the PRA has shown a marked reluctance to assist synthetic securitisations.

The third-party verification and data repositories regimes are kept broadly unchanged.

In line with the free-trade approach of the Treasury, an equivalence regime for STS is set out, with the Treasury deciding which jurisdictions may benefit. 

In a similar vein, the exemption for the special purpose vehicle having to be in the UK is maintained.  The originator and sponsor though need to be UK located.  (However, the concession that allows EU STS to be treated as STS in the UK until December 2024 remains in place.)

Oddly, in our view, the text allows for re-securitisations – which are banned in the EU.  However, any re-securitisation transaction will need to be pre-approved on a deal-by-deal basis.

Retention and disclosure requirements are still in place but the text seems to allow non-UK issuers to sell to UK investors provided they comply with substantially the same standards.  So the total identity of standards required by the EU has been abandoned.

Bear in mind that this is merely a summary of the high points and the document is still a draft.  It could change quite a lot before becoming law.

• Hot off the press, the Joint Committee’s response to the European Commission’s call for advice came out on December 12th. As Christmas presents go, the regulatory Santa must have thought the securitisation community had been very bad in 2022 and only deserved a long, wordy lump of coal this year. For a first blush reaction, you can read our News Item.
• The definition and rules around future green securitisation are still part of active discussions between the European Parliament and the European Council which, together with the European Commission, are currently negotiating the final text of the forthcoming EU Green Bond Standard Regulation.  It is expected that something will be emerging within the next few weeks.
• In 2022, PCS has brought out its European Symposia Series. These one day complimentary events are devoted to the securitisation market in each specific country as well as across Europe, including a look at current trends and possible future developments. The events offer a chance to meet securitisation experts, regulators, originators, arrangers, investors and servicers, discuss market trends and build relationships. In 2022 we have held Symposia in Warsaw, Lisbon, Athens, Helsinki, Brussels and Milan. For our 2023 calendar see Stakeholders Calendar.
• Two studies were published recently by Risk Control.  The first is an analysis of the relative liquidity of Corporate Bonds, Covered Bonds (CB) and Asset Backed Securities (ABS). The main finding is that the relative liquidity of ABS shifted significantly after 2016, becoming superior to that of CB. The paper may be found here.  The second is a detailed study of how the new output floors regime within Basel III will affect bank incentives to securitise loans. The main finding is that securitisation of some asset classes, most notably corporate loans, will be greatly discouraged whereas that of residential mortgages will actually be boosted. This paper may be found here.
• In the Netherlands, DNB came with news about the way they are going to fill in their role as STS supervisor going forward. From November 1^st, 2022, DNB will no longer send an assessment of each deal to the institution that had notified the transaction. Instead, they will start conducting investigations at institutions in order to review the arrangements, processes and mechanisms that have been implemented to comply with the Securitisation Regulation. This resembles the approach of the French AFM (as described in our previous Newsletter).

We would like to take this opportunity to celebrate the ten years of the PCS initiative and thank our readers and other stakeholders for their support through a decade of seeking, with their help, to support the European securitisation market as well as to convey our season's greetings and best wishes for the new year.

So, from London, Paris, Milan, Munich, Poznan, Amsterdam and Banholt, the Outreach Team and the Analytical Team from PCS send you Season’s greetings and wish you a happy, prosperous and, above all, healthy 2023.

Regulatory state of play

Between consultations on regulatory technical standards which are key to the functioning of the market (SES, homogeneity, SRT) and more in-depth reviews of entire segments of the regulatory architecture (Securitisation Regulation review, Call for Advice on the CRR and Solvency II) it seems that there is great potential for progress for the EU stalled market. Yet, is this more light than heat?

In this edition we look in more detail at the European Commission’s report on the Securitisation Regulation and what lessons it may hold.

EC report on the functioning of the Securitisation Regulation

On October 10^th the European Commission released its report on the functioning of the Securitisation Regulation. The Commission was obligated by the regulation itself to produce such a report. (The obligation was in article 46 of the regulation which is why you will see it mentioned by some commentators as the “Article 46 Report”).

Some General Points

First, we were heartened to read the full support for the revitalisation of the European securitisation market displayed in the report’s introduction and the reiteration by the Commission of the benefits such revitalisation would bring to the real economy. PCS hopes this vocal support will be met by equally strong practical legislative and regulatory steps but some recent public pronouncements and proposals from supervisory authorities make us wary that each oratorical step forward could well be met by a practical step backwards.

Secondly, reading between the lines, it seems that a driving force behind the report was the avoidance of any recommendation requiring an amendment to the regulation itself rather than to delegated acts: in the lingo of Brussels, any changes to the level 1 text. PCS is not unaware of the political calculations that may lie behind this position. But it is an unfortunate self-limitation particularly when looking at disclosure for private transaction – as to which more below.

Finally, for those who pay attention to these things, the report does not deal with the burning topics of the CRR capital requirements for banks investing in securitisations, the liquidity coverage ratio (LCR) eligibility criteria or the Solvency II capital requirements for insurance investors. As these key rules appear in other regulations than the Securitisation Regulation, the Commission not unreasonably deemed them “out of scope” of this report. These issues, of course, are the subject of a Call for Advice issued by the Commission to the Joint-Committee of the ESA’s which was supposed to be produced by September 1st and should emerge any day.

What the report does deal with are the following topic:

• Risk retention
• Investor due diligence
• Private vs public transactions and disclosure
• STS equivalence regimes for non-EU transactions
• Green securitisations and the EU “Green Bond Standard”
• Third party verification agents in STS
• Using limited licensed banks instead of SPVs
• Non-EU issuer obligations for sales to EU investors (the “jurisdiction issues”)

Risk retention

Here the Commission decided all was working as it should and no changes need be made to the rules. This seems sensible.

Investor due diligence

The Commission acknowledged the view of many, both on the sell and buy sides, that the mandated disclosures in the ESMA templates were disproportionate. It also noted what we have repeated many times: even if the disclosure requirements for securitisation can be defended on their own merits, there are no equivalent or even remotely as onerous requirements on similar instruments. This uneven playing field encourages regulatory arbitrage and is a major headwind to any revitalisation of the market.

Unfortunately, the Commission did not address the issue of the uneven playing field. It did provide a small silver lining by requesting ESMA to revisit the templates with a view to slimming them down. This is certainly better than nothing but, we feel, side-steps the crucial problem of the discriminatory treatment of securitisation compared to other instruments.

Private vs public transactions

The Commission addressed the fear that a rise in private securitisation transactions was occurring as a result of issuers trying to avoid the disclosure requirements of public deals. Based on our own experience, we are fairly certain this is not the case. The report wisely concluded that there was not enough evidence to decide either way.

On the use of the same templates for private and public transactions, the Commission is asking ESMA to devise a dedicated private transaction template. The twist though is that the Commission seems to accept that such template is not required by or for investors. It wants one for supervisory authorities.

Our own view, communicated to policy makers, is that the dilemma of not allowing, on the one hand, capital market deals to “hide in the private shadows”, to use a somewhat overdramatic expression, but without, on the other hand, burdening bank lenders with unnecessary data requirements is to redraw the public/private line away from where it is now (on the use of a prospectus). It seems more prudentially logical to distinguish between (a) capital market instruments and (b) traditional relationship banking facilities.

The advantage of this approach is that traditional banking facilities (including ABCP and warehouse facilities), together with the banks’ due diligence processes, are already regulated by banking supervisors. Such deals should not require any obligatory disclosure since banks’ existing due diligence should be sufficient. Public deals defined as capital market instruments with non-bank investors (or bank treasury investors) would require the extensive disclosure templates produced by ESMA. Sadly, this would require an amendment to the level 1 text which the Commission does not appear willing to contemplate.

If ESMA is going to draw up new templates based on the needs of supervisors, we urge the supervisors to provide ESMA with a realistic list of the data they will genuinely use in their supervision rather than a laundry list of all the data they may wish to use in an ideal world.

STS equivalence

A number of market participants wished the Commission to grant an equivalence regime so that issuance from non-EU originators meeting local requirements could be treated as STS when held by EU investors. The Commission pointed out, rightly in our view, that outside the UK no jurisdiction had anything close to the EU STS regime and so equivalence was not relevant.

As for the UK, the Commission skirts the question which, let us be honest, is one of high politics rather than technical standards.

Green securitisation

The Commission endorsed the position of both the EBA and the ECB (as well as that of PCS and the majority of market participants) that there should be no special regime for green securitisations and that these should be governed by the general principles laid out in the European Green Bond Standard – namely that an instrument is green if the money raised is used for green purposes.

Third party verification agents

The Commission decided all was working well and no changes were required. We agree.

Limited licensed banks

Someone suggested that the Commission look into the idea of using limited licensed banks instead of SPV’s to issue all securitisations. The Commission concluded – as did pretty much everyone else – that this was a terrible idea.

The jurisdictional scope

This is likely to be the most controversial part of the report.

From the moment it passed, the regulation has contained an ambiguity as to whether non-EU securitisations were required to conform to the mandatory provisions imposed on EU securitisations – specifically the retention requirements, the disclosure requirements and the obligation not to cherry pick assets. In other words, was the Securitisation Regulation extra-territorial or did it only apply to EU deals.

This ambiguity was made worse when the Joint-Committee of the ESAs took a hard line on interpretation arguing not only for extra-territoriality but for imposing on non-EU deals not only EU obligations but the requirement of EU located liable party e.g. EU based retention holders.

The report pulls back from the Joint-Committee’s more extreme view that the law requires EU based entities to be involved in all non-EU securitisations sold to EU investors. However, it does endorse a wide extra-territorial approach. For the Commission, any non-EU securitisation sold to EU investors does need fully to comply with all the Securitisation Regulation requirements.

Since EU supervisors cannot control non-EU parties, the Commission also throws the obligations to ensure that non-EU transactions meet the EU standards on EU investors. EU investors, of course, are subject to sanctions by EU supervisors.

In theory, a non-EU issuer who wants to sell to the EU could choose to meet all the retention, disclosure and no-cherry picking requirements of the Securitisation Regulation. This is not therefore a legal prohibition on EU investors buying non-EU deals.

In practice, unless the European bid is a large part of the investor bid for any deal, it is hard to see why an issuer would meet all of its national rules (e.g. Reg A B in the US) and all the European rules. This interpretation may well be the death-knell of European investors capacity to purchase non-European securitisations, at least directly.

PCS’ own mandate is to focus on European securitisations, so we do not have an official position on this subject. We do have much sympathy for the Commission’s position. Yet, we do wonder if there would not be a less extreme approach that would allow EU investors to purchase non-European deals that substantially meet all the Securitisation Regulation’s requirements.

Other stuff

The report was also bad news for non-EU Alternative Investment Fund Managers (AIFM) who had hoped not to have to comply across the board with EU rules if they were small or if they only marketed a few funds in the EU. The answer, as far as the Commission is concerned, is if you are an AIFM marketing a single fund in the EU, whatever your size, you will have to comply with all the Securitisation Regulation obligations on institutional investors.

Also, the report looked at the supervisory framework – grounded primarily in the national competent authorities – and found no cause to change the current system. Considering the Commission’s reluctance to amend the level 1 text, this is unsurprising.

The report does note the risk of divergence in a system based on national authorities. This echoes concerns voiced by the ESAs and may well be the harbinger of greater attention and cooperation across European national regulators.

Conclusions

On the whole, this is not a bad report although it does miss opportunities for change – especially around private transaction disclosure.

It also clearly lobs the ball into ESMA’s court on some key issues around disclosure. We hope that ESMA will be bold when dealing with these matters and take the opportunity substantially to improve the situation in line with the Commission’s strong support for measures that support the market.

Also, as we have said in our news item when this report came out, much of the key battles still need to be fought around the CRR, LCR and Solvency II amendments.

In this respect, we would like to quote the last paragraph of the report in full:
“The Commission remains fully committed to the aim of creating the framework for a thriving and stable EU securitisation market. Such a market is an indispensable building block of a genuine Capital Markets Union and might become even more important for tackling the challenges of financing economic activity in the significantly more difficult market environment that seems to be evolving at the moment. The Commission will therefore continue to closely monitor the securitisation market and intervene, if and when deemed appropriate, to fully reap the benefits of a thriving securitisation market for the EU.”

We could not have put it better ourselves.

Remember, as always, that PCS’ data is by deal rather than, as many research houses do, by volume.  This is not that this is a better way of presenting the data but it is a different way of presenting the data which, hopefully, reveals additional information.

In the ten years since our founding, PCS has continually strived to improve the ways in which it helps the market. As part of that mission, PCS started a series of symposia across Europe aimed at investors, issuers, regulators and other market participants.  In each symposium we combine a Europe wide view with a local focus

Each complementary event covers fundamental principles as well as the most recent market and regulatory developments. It explores the benefits of securitisation as a crucial mechanism for financial institutions in obtaining funding but also in achieving capital relief. We have been honoured by the participation of experienced voices from the buy side, sell side, legal but also supervisory authorities.

PCS has already held symposia in Warsaw, Lisbon, Athens, Helsinki and Milan which attracted over 350 attendees.

For the upcoming symposia in Brussels, Dublin, Amsterdam, Madrid, London, Paris and Frankfurt see Stakeholders Calendar.

PCS has a new website.  In addition to the traditional sections on verified transactions, the new site has added troves of new resources for anyone looking for information on securitisations.  From the curious novice to the hard core practitioner looking for some highly technical information, the PCS website should be your first stop.  Up-to-date market information, regulatory texts, webinars and presentations on key topics, all and more is there.

PCS is a compact organisation with a total staff of 15.

In each newsletter we will introduce one of them so that people get to know us. This time, Max Bronzwaer, Member of the Board of PCS UK and PCS EU and member of the Outreach Team.

For any questions or comments on this STS Newsletter you can contact the PCS staff.

Ian Bell	CEO	[email protected]
Mark Lewis	Head of the Analytical Team	[email protected]
Martina Spaeth	Member of the Analytical Team	[email protected]
Rob Leach	Member of the Analytical Team	[email protected]
Fazel Ahmed	Member of the Analytical Team	[email protected]
Daniele Vella	Member of the Analytical Team	[email protected]
Rob Koning	Issuer Liaison	[email protected]
Harry Noutsos	Issuer Liaison	[email protected]
Ashley Hofmann	Director Market Outreach	[email protected]
Max Bronzwaer	Member of the Board of PCS UK and PCS EU and member of the Outreach Team	[email protected]