Why an UK edition?
After a period of uncertainty over the UK’s direction of travel in its approach to finance (and hence financial regulations), things are starting to move and the intended path of the rails is starting to appear. This movement also encompasses (and as a priority no less) the revision of the rules governing securitisation.
In this piece we will outline the Edinburgh Reforms, the Financial Services and Markets Acts (“FSMA”, since – distinct from price inflation- acronym inflation is untameable) and then the “near-final” securitisation statutory instrument before closing with the bi-cephalous PRA and FCA consultations. We do not cover all these merely to fill out the newsletter. We believe that, in a technically focused industry such as ours, it is often too easy to address regulatory changes as if they were merely mathematically driven calibrations. In reality, notwithstanding what regulators propound, regulations are political acts. To understand what drives them, it is important to understand the context. And by context, we mean the nestled Russian dolls where the tiny securitisation regulatory doll rests within the overall regulatory framework doll within the larger conceptual framework for finance which itself lies in the high political game of post-Brexit choices. It does not mean that the final regulations are indifferent to data and statistical analysis. It does mean that what can be done and when it can be done is driven more by higher level political calculations than be spreadsheets.
In our regular features, we share updated data on the STS securitisation market and, in the people section, we present Daniele Vella, from our analytical team.
And as usual, in “news you may have missed”, short bullet points draw attention to events that may have flown under the radar in the last few months.
As ever, we very much welcome any feedback.
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.
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.
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.
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.
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 market data is now interactive. You can select any of the 8 tabs (STS Type, asset class, .... ) and you can enable or disable any of the time series. Hoover the mouse over any of the number to get more info.
Remember, as always, that PCS’ data is by transaction 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.
Comparing full year data to partial year data is always somewhat misleading. In this case, comparing 2023 to 2022 for STS is more so than usual. On the simple numbers for true sale transactions (term and ABCP) 2023 would, at first glance, look like a continuation of last year. However, this would miss the substantial upswing in the public market. After a slow(ish) first half of the year, the late spring and summer of 2023 saw a real surge of STS transactions getting ready for post-August launch. This resulted in September in the largest monthly volume of issuance (STS and non-STS) since the GFC. And deals continued to come out in October with a pipeline that looks still fairly full till the end of the year.
Also most noteworthy was the investors' absorption capacity. At one point in August, when we saw the number of STS transactions we were verifying in-house, we became quite concerned at the market's capacity to take up this volume. Most of the concern was not about the availability of cash but investors' bandwidth. The regulatory requirements on due diligence make the mandated analysis of a securitisation much more time consuming than for other capital market instruments. With the very limited number of investors still left standing in this market, would they be able to analyse so many deals? Our original scepticism proved unfounded. Wisely, originators and arrangers shifted to longer lead times in bringing deals to market. This repaid handsomely last month and earlier this month. Not only did the market absorb the volume but was able to do so with only moderate spread softening at the senior end and pretty much none lower down the capital structure.
Based on what we have seen and continue to see in our pipeline, 2023 could prove a very good year indeed for STS true sale.
Why? In a rare case of a market prediction being correct, we are seeing the delayed effect of the end of ultra-loose monetary policy from central banks. As the "free money" open bar was closed, banks have returned to traditional funding sources. Even though covered bonds have become (thanks to regulatory asymmetry) banks' favoured funding tool, a securitisation diversification play has always made strategic sense. This growth should have happened last year but war, inflation and rates volatility kept many players out of the capital markets. This phenomenon was particularly visible in the United Kingdom, but we expect it to spread further in the EU.
Another reason is the looming approach of the final implementation of the Basel capital requirements in January 2025. This is focusing banks' attention intensely on capital usage and management. So a number of true sale transaction were also full stack capital trades.
Focus on capital management should also be driving synthetic STS transactions. This is not, however, visible in the numbers so far with 17 STS notifications to ESMA versus 41 for the full year in 2022. Our conversations in the market suggest that not much need be read, at this stage, in this number as the market is reported to be working on quite a few transactions and this may be only a timing issue. We shall see.
In July, the US Fed published a "notice of proposed rulemaking" ("NPR") aimed at completing the capital adequacy regime set out in the final, amended Basel 3 agreement. It is unclear to us what possessed someone in officialdom to name this process the "Basel Endgame". Whether this is because, as US banks are claiming, the Fed is a regulatory Thanos, intent of wiping out half of all banks or, as the Fed possibly imagines, they are the regulatory Avengers come to save the financial world, the jokes write themselves. But this is serious business.
The NPR is over a thousand pages long. But at its core lies the removal of the "internal ratings based approach" ("IRB") and its replacement by an "enhanced standardised approach". In simple terms, US banks will not longer be able to base their risk weighted assets ("RWA") calculations on the output of their own internal credit models. But it gets worse (for the banks). The NPR also adopts what is known as the "dual stack" approach: banks must calculate their RWAs under the new enhanced standardised approach and the old standardised approach and use the higher of the two in setting their capital.
The NPR also revises the capital requirements for securitisations by doubling the infamous p factor. It also lowers the floor on senior AAAs but raises it for lower tranches. And, of course, the general dual stack rules and disappearance of the IRB approach is likely to impact capital requirements for banks' holding of securitisations.
For those concerned about the political impact this may have in Europe (UK included), two points should be borne in mind.
First, as PCS has set out in its response to the FSB and in other publications, the key issue with European regulations is follow through: the first wave of regulations dealt with all securitisations as an undifferentiated whole and calibrated its treatment on the worst as revealed by the GFC; the second wave defined in great detail a high quality securitisation type (STS) similar to those securitisations that survived the GFC with ease. We have argued that Europe needs to finalise the reforms by completing a third wave that takes into account the creation of STS and recalibrates the securitisation rules to the actual risks (very low) associated with this new category. Now, the United States never introduced a high quality category (such as the Basel "simple, transparent and comparable (STC)" model). Therefore, there is some kind of logic to the Fed approaching securitisations as still riddled with potential agency risk. This is not an endorsement of the precise proposals included in the NPR, but it does underline the inapplicability of the Fed's reasoning to the European context.
Secondly, the impact of the securitisation part of the NPR is likely to be much less impactful in the US than a similar approach in Europe. The US has the deep capital market to which Europe aspires. It also has sensible capital rules for insurance companies (in contradistinction with Solvency II). Therefore, the bank bid is much less crucial to the securitisation market than it is in Europe, where - in the absence of a revision to Solvency II - bank purchases are a necessary starting point (but not end point) to the revitalisation of the market. Also, the NPR only applies to banks with over US$ 100 billion in assets - whereas the European regime applies to all banks.
The NPR is still, at this stage, a proposal. Should it proceed, it will come into force in 2025 with a three year phase in.
To say that US banks reacted negatively would be more than an understatement. They have predicted Armageddon should these rules be introduced. (PCS was told that, so horrified were the banks that they have taken out ads on Washington DC bus stops opposing the proposals. We must wonder how bemused commuters were to see their traditional add for cut-price fried chicken buckets replaced by a poster addressing Basel III capital requirements).
Well, maybe not a thousand, but we have seen two interesting reports published on the securitisation market. The first by ESMA, the other by the ESRB on the SRT market. Full of interesting facts, they repay reading. You can also find them on the PCS website in our Great Library section.
Although not technically securitisation news, PCS is convinced that, in order to thrive, the European securitisation market will need to carve out a niche in the green finance ecology. Therefore, it behoves us to pay attention to existing and future green rules. In June, the European Commission published a new EU Sustainable Finance Package.
Broadly, the package adds to the existing Taxonomy, deals with the proposed regulation of ESG ratings firms and adds some flesh around the Commission's approach to "transition finance".
A year after the EBA published its proposals on retention, the European Commission finally issued its final draft retention regulatory technical standard. Basically unchanged from the original EBA proposal, bar exceptional circumstances, this draft will become law sometime late in Q3 2023 or in Q1 2024.
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.
I graduated in Rome on law and economics, with a short parenthesis in Strasbourg, where I studied European law. Then I started working as a lawyer in 1996, initially accruing experiences on various sectors of law, working in Rome and in Paris. Work ranged from real estate contracts and financing to corporate reorganisations, intellectual property, criminal law and regulatory compliance.
In spring 1999, a securitisation law was enacted in Italy and it was a very hot sunny summer day in Rome when I entered in a book shop, probably just to have the relief of air conditioning, and found a book on securitisation, then another and another again. I found this so enlightening and this was the sign I was waiting for. My focus on securitisation started from that moment. So, following an LLM on banking and finance law at the University of London, my career focused exclusively on securitisation and banking transactions, working initially for Clifford Chance and then Allen & Overy and Hogan Lovells. Clients have been investments banks acting as arrangers or managers, rating agencies, originators or service providers in the securitisation sector.
Then, it was again on a beautiful hot sunny summer day in 2018 when PCS announced the opening of its new office in Paris and, here I am.
On a personal level, I love country life and mountain trekking. And sometimes it’s only thanks to noise reduction software clinking cow-bells are not in the background when I’m on a call. Actually, especially in the summer, I often work from a cosy nest in the Alps, where everything can be seen from high level and with larger horizons.
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 | Member of the Outreach Team | [email protected] |
| Harry Noutsos | Member of the Outreach Team | [email protected] |
| Ashley Hofmann | Member of the Outreach Team | [email protected] |
| Lauren Shirley | Events Manager | [email protected] |
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