Brexit and beyond
On 1st January 2021, the UK became a "third country" as regards the EU (and indeed vice versa). The UK adopted the EU Securitisation Regulation as it then existed, with only some minor but benign tweaks, and the first major divergence was when the EUSR was amended by the "quick fix" (Regulation (EU) 2021/557 of the European Parliament and of the Council of 31st March 2021). We have since had the parallel Article 46 reports from H.M. Treasury and the European Commission and await their implementation, which promises some degree of further divergence between the UK and EU positions, although some of the envisaged developments appear to be going in the same direction (for example, as regards private issues and NPL securitisations), and there is little to suggest that any major schisms are imminent.
UK tweaks at Brexit
UK investors' ability to invest in non-UK issues
A major uncertainty about the EUSR since its inception has been about what transparency it (indirectly) requires non-EU issuers to provide to potential EU investors so that they can do their due diligence under Article 5(1)(e). For EU investors, that uncertainty was largely resolved - but in an unhelpful way - by the European Commission's Article 46 review issued on 11th October 2022. We comment further on this in "Do EU investors need loan level data to invest in non-EU issues?" but, in short, as of December 2022, most EU investors are probably unwilling to invest in non-EU issues unless those issues comply with the EUSR Article 7 disclosure standards, including loan-level data; but most non-EU issuers are probably unwilling or unable to do so. In the medium term, we should see an end to this stand-off as regards private issues because the EC has asked ESMA to work on revised disclosure ITS (with a substantially simplified disclosure template for private securitisations) which, once in force, should significantly reduce the disclosure requirements for private issues; and even before that there is the prospect of what we might loosely call a no-action letter from ESMA to permit at least some EU investors to carry on investing in such issues in the interim.
For UK investors, as from 1st January 2021 the problem diminished so far as EU issues were concerned, because the Securitisation (Amendment) (EU Exit) Regulations 2019 created a new Article 5(1)(f) which applies in relation to originators, sponsors and SPPEs established outside the UK, and which requires only "substantially" the same information as Article 7 requires. We have no guidance on what "substantially" means, and it is unlikely to help UK investors other than with EU issues; US issues wanting to attract UK investors would still have "substantially" to meet relevant UK standards. Then, in December 2022 the H.M. Treasury policy note heralded various reforms to the UK regime, including, as regards due diligence requirements for UK institutional investors when investing in non-UK securitisations (a) “to provide greater clarity on what is required” - a potential advance on the EU position; and (b) to introduce a new disclosure regime for private issues - which would probably result in broadly parallel alleviations by both the UK and the EU.
Foreign "investment firms" holding the risk retention as "sponsors"
A non-EU investment firm which wants to hold the risk retention as a "sponsor" in a securitisation to which the EUSR applies is currently on thin ice. It is clear that an “originator” or “original lender” can be established in the EU or outside it, and it is equally clear that any credit institution, whether located in the EU or not, is within the definition of “sponsor”. However, what about non-EU investment firms? The phrase “whether located in the Union or not” appears after "credit institution" but before "investment firm". This (further considered in "Brexit - impacts and changes for securitisations in the UK and Europe") remains ambiguous in the EU. The corresponding definition in the UKSR has no ambiguity because the UKSR was amended upon Brexit to clarify that non-UK investment firms which qualify as a "sponsor" may hold the risk retention in that capacity (and so need not try to fit themselves into the "originator" definition).
The EUSR quick fix amendments
The first major divergence between the UK and EU positions came about when the EU introduced its "quick fix" post-pandemic amendments to the EUSR by enacting Regulation (EU) 2021/557 on 31st March 2021. This, in particular:
- corrected some flaws as regards the securitisation of non-performing exposures - such as in relation to risk retention - which had made the original EUSR regime unworkable for NPL securitisations (and this remains the case in the UK, although the December 2022 H.M. Treasury policy note has indicated a reform to the UK regime which will presumably bring it back closer to the EUSR);
- introduced an STS regime for synthetic securitisations. This is a world first, and there is no suggestion in the H.M. Treasury policy note of any equivalent future change in the UK;
- took tentative steps to increase the required environmental disclosures via a tweak to Article 22(4) and the inclusion of a new Article 46(f), which required the EC to consider, in its Article 46 report, whether to go further "with a view to mainstreaming environmental, social and governance disclosure". We examine this further in our commentary about environmental disclosures. Again, there is no mention in the H.M. Treasury policy note of any equivalent future change in the UK regime, so this has potential for divergence.
The Article 46 reports
H.M. Treasury's Article 46 report and December 2022 policy note
In December 2021 we had the H.M. Treasury Article 46 report, which rather pulled its punches, but the follow-up publication in December 2022 of the H.M. Treasury policy note announced that it was “committed” to bring forward, “where appropriate”, reforms in the following areas:
- risk retention, e.g. in relation to (i) transferring the retention (of interest to CLO managers) and (ii) NPLs (as the EUSR had done in 2020);
- definitions of public and private securitisation (see further above);
- disclosure requirements for private securitisations (more detail in this commentary);
- due diligence requirements for UK institutional investors when investing in non-UK securitisations (such as US CLOs), “to provide greater clarity on what is required” – see further above; and
- the definition of “institutional investor”, so as to take unauthorised non-UK AIFMs which manage or merely market AIFs in the UK out of scope of the UKSR Article 5 due diligence requirements. The EC had no doubt in its Article 46 review that non-EU AIFMs marketing or managing funds in the EU were “institutional investors”, and that they should be, because Article 5 is there to protect EU investors, so no EU movement seems likely here.
At the same time, the draft UK Securitisation Regulations 2023 were published, setting out an equivalence regime that would specify the due diligence that a UK investor would be required to carry out regard to an STS equivalent non-UK securitisation. There is of course no EUSR equivalent, and any such regime would require level 1 changes to the EUSR, which do not seem to be a priority for the EC.
The draft UK Securitisation Regulations 2023 also indicate a change to the future structure of UK regulation (with much being subsumed into the PRA/FCA rulebooks). This permits future changes to be made more quickly, without UK parliamentary involvement, and also gives us the first inklings of a potentially more independent, and less dirigiste, UK approach compared to that of the EU. How this potential develops remains to be seen.
The European Commission's Article 46 report
Reading between the lines, the EC may have concluded that seeking to amend the level 1 text of the EUSR is unrealistic at present, and so it is limited to doing what can be done by way of level 2 revisions - such as the revised disclosure ITS which ESMA has been asked to bring forward, further level 3 Q&A, and possibly a no-action letter (see below) to bridge the period between now and the revised ITS coming into force and so permit (in a not particularly satisfactory sense) EU investors to invest in non-EU issues which do not provide the level of detail which Article 7 currently requires.
The main change heralded by the EC is as regards the disclosure templates. ESMA had originally concluded that its mandate did not permit it to produce a different and simpler template for private securitisations, but the EC has in effect overruled ESMA, concluding that having different templates for private and public securitisations is legally possible, on the basis that Article 7(3) of the EUSR allows for the development of templates “taking into account the usefulness of the information for the holder of the securitisation position”.
The UK regime is envisaged to undergo reform during 2023, with the UKSR being repealed, and to some extent replaced by the Securitisation Regulations 2023, with much of the regime being subsumed into the PRA and FCA rulebooks; although the timescale for some of the more ambitious reforms envisaged by H.M. Treasury's Article 46 could be longer, as it requires new rules to be written - we wait to see.
The main EU regime change is the revision of the disclosure ITS templates, which ESMA began working on in October 2022. On the basis of usual timescales, we should not expect these until some time in 2024. Pending them, the best we can hope for is what can loosley be called a no-action letter (strictly speaking of course, it is not this, because there is no EU legal basis for no-action letters, and it will be the usual letter suggesting that NCAs do not prioritise the enforcement of the rule in question) from the ESAs, perhaps in early 2023.
Mutually-equivalent UK and EU STS regimes seem as far away as ever. The UK's approach is open, whereas the EU's remains closed.
At the time of Brexit, ESMA wasted no time in amending its list of STS deals to exclude 81 UK-related issues, whereas the UK FCA grandfathered all EU-STS securitisations which had been notified to ESMA, and announced it would accept any more that were notified to ESMA in the first two years after Brexit; which the December 2022 draft UK Securitisation Regulations has now envisaged would now be further extended to 31st December 2024.
Back in 2016, the European Parliament had proposed, in response to the Brexit referendum result, an equivalence regime for STS, but this was dropped as it was regarded by some EU countries (reports at the time suggested France and Germany) as being too political for resolution except as part of a future UK-EU agreement, and it seems that nothing much has changed on the EU side since then, and the European Commission Article 46 report dismissed the idea of any equivalence regime. The accompanying 60-page summary of responses report notes that most respondents had been impacted by the lack of recognition of non-EU STS securitisation (typically, being prevented from purchasing some UK- or US-originated securitisations because they would face higher capital charges) but their call for an equivalence regime for UK STS was seemingly outweighed by the views of the EU public authorities, two of which cautioned that this “could encourage investment in third country securitisation instead of enhancing the EU securitisation market”.
Meanwhile, the December 2022 draft UK Securitisation Regulations contain a definition of “STS equivalent non-UK securitisation”, and specifically contemplate (in regulation 6) that if and when H.M. Treasury specifies the EU STS regime as being equivalent, it may specify rules as regards the due diligence assessment that a UK investor must perform before investing in an EU-STS securitisation (the wording substantially tracks the wording that we saw in the draft Financial Services and Markets Bill 2022, which contemplates adding a new Chapter 4A to the UKSR covering equivalence).
The two markets seem destined to remain separate for years to come, not to the benefit of investors or issuers.