Another step in the right direction
The PRA consultation came out on Tuesday, and is another step along the way to some overdue reforms about non-neutrality that will give securitisation a deserved boost after years of being unfairly penalised.
What to do with the output floor?
Readers will be familiar with Basel 3.1 and the output floor (if not, then see for example our commentary on “Securitisation capital requirements under Basel and the CRR”).
The PRA offers three options, but its preference seems clearly to be “a targeted and data-based adjustment to the Pillar 1 framework for determining capital requirements for securitisation exposures”: the other two are either to implement Basel 3.1 as is (!), or to adopt a variety of ad hoc carve-outs – the sort of thing that the EU has agreed to do, but only as a temporary measure, pending completion of its comprehensive review of the EU CRR securitisation capital requirements (see “Prospects for reform” in our commentary).
Industry has been vocal on the output floor’s consequences, and the PRA has evidently got the message. As it says in paragraph 2.10:
“… to the extent that a firm is bound by the output floor at an aggregate level, the difference between RWAs for particular exposures under the internal model approaches and the SA will drive up overall post-output floor RWAs. The PRA is also aware from its engagement with industry in the wake of CP16/22 that in relation to securitisation exposures, there is particular concern about the implications for retained senior tranches of synthetic SRT securitisations.”
Support for a wider review by Basel
Over and above these specifics regarding the output floor, the PRA supports the idea that the BCBS should conduct a wider review of the Basel capital requirements for securitisation, and “particularly its level of ‘non-neutrality”: meaning the size of the “p” factor. As it notes, these “have not been implemented uniformly across jurisdictions” (for example, as readers know, in the USA the “p” factor is less aggressive than in the EU and the UK).
The PRA also asks about synthetic STS. This exists in the EU, but not the UK, because the BOE has never favoured it. The PRA still thinks there is no need for it (and it would deviate from the Basel STC standards – the EU synthetic STS regime is a world first). As it says, synthetic securitisations are private, negotiated structures involving sophisticated investors, and so it is unclear how standardisable they are, and doubtful whether the investors would place any value on the “STS” badge. Some firms in the marketplace have been and doubtless will continue to be vocal advocates for synthetic STS, but the main attraction is the reduced capital charge under the current regime, and if the non-neutrality problem is addressed satisfactorily, query whether we would see so much demand for synthetic STS? Still, the PRA invites feedback.
It also raises the prospect of changing the hierarchy of methods for determining securitisation capital requirements. At the time of the Securitisation Regulation, the CRR amendment inverted SEC-IRBA and SEC-SA so that SEC-SA ranked ahead. This was the outcome of an EU political compromise over a debate about the effect of sovereign rating caps between the north and south of Europe, and the result - a victory for banks in the south – led to a public statement in 2017 by the UK and Germany expressing concerns about the consequences for financial stability and the wider economy. Post-Brexit, the PRA is free to posit a reversion to the Basel hierarchy.
Responses are due by the end of January 2024. This is all good news for the securitisation industry, and securitisation lawyers.