The PRA’s consultation paper CP15/23, published yesterday, 27 July 2023, follows the enactment of the Financial Services and Markets Act 2023 and the “near final” draft Securitisation Regulations 2023 (plus a 26-page policy note) published a fortnight ago and, further back, the five reforms heralded by H.M. Treasury’s December 2022 policy note. The consultation closes on 30 October 2023.
Broadly, the PRA proposes to retain the existing onshored laws, other than a few sensible (but not radical) “targeted adjustments”. Most of them, including Articles 5-9, are transferred into a new section of its rule book (as the FCA will for firms regulated by it). The STS provisions are not included and it seems these are going to be included in a new chapter of the revised FCA rulebook. So any radical change will have to wait. For example, the draft PRA rulebook (in appendix 1 of the consultation paper) retains the definitions of “securitisation” and “originator”, and makes no change regarding disclosures for private securitisations, all of which have caused plenty of legal head-scratching and client frustration in the last few years. Regulatory capital, possibly the hottest topic of all, is not covered by this consultation.
Still, it is not just jam tomorrow, there is also some jam today (or at least, by the end of the year). Below, we concentrate on the following areas, where there are some helpful “targeted adjustments” proposed:
- Due diligence
- New rules on risk retention
- Private securitisations, and “before pricing”.
For completeness, there also proposed tweaks relating to restrictions on resecuritisations, the delegation of investment management decisions as regards due diligence, the comparability of assets held on the balance sheet of the originator with assets transferred to the SSPE, and some other minor adjustments to risk retention requirements.
Article 5(1)(e) and (f) of the Securitisation Regulation are to be replaced as part of a “more principles-based and proportionate approach” (with Articles 5(3) and 5(4) being retained). The revised version appears as Article 5(1)(e) of Chapter 2 in the revised PRA rule book. Instead of requiring a potential investor to verify that information will be disclosed in accordance with the detailed requirements of Article 7 – which has been such a problem for UK and EU investors wanting to buy into US and Japanese issues - we now have a requirement that they must verify that the sell-side “has made available sufficient information to enable the institutional investor independently to assess the risks of holding the securitisation position and has committed to make further information available on an ongoing basis, as appropriate”.
It then goes on to specify a minimum level of disclosure, which includes:
- details of the underlying exposures, on at least a quarterly basis;
- investor reports at least quarterly;
- “all information on the legal documentation needed to understand the transaction, including detail of the legal provisions governing the structure of the transaction, any credit enhancement or liquidity support features, the cash flows and loss waterfalls, investors’ voting rights and any triggers or other events that could result in a material impact on the performance of the securitisation position” (and the prospectus, if there is one, and any STS notification) to be provided “in draft or initial form” before pricing, and in final form no later than 15 days after closing (and updated as soon as practicable following any material change);
- information on material changes or events.
So this is significant for UK investors wanting to invest in US securitisations and other non-EU securitisations (EU securitisations will be subject to more than enough disclosure in any event, so they do not present a problem), and in particular investors need “sufficient information” but it does not need to be on prescribed templates, and does not necessarily have to be loan-level.
The existing Article 7 disclosure requirements will be retained for UK sell-side parties. The proposed requirement on the buy side to verify that the sell-side has “committed to make further information available on an ongoing basis, as appropriate” will be a documentary necessity.
So, this should reduce the compliance cost for PRA-authorised institutional investors’ due diligence, will do away with the current legal uncertainty over what due diligence is required under Article 5(1)(f) in relation to overseas securitisations (something that was addressed at Brexit but only in respect of EU issues), which will save some legal fees, and provide a boost for UK investors, and for US sell-side parties.
New rules on risk retention
The new rules on risk retention will at last see the end of the old CRR RTS. However, the PRA proposes largely to retain the old rules, and the main changes are:
- as regards NPEs, an overdue change (in Article 9 of Chapter 3) will calculate the 5% retention based on the value and not the nominal amount. The EUSR has already done this, and has gone further to promote NPE securitisations, for example by permitting the servicer to hold the risk retention. This amendment to Article 6 is obviously sensible and overdue. The PRA says that it “does not at this point propose any other policy change relating to NPE securitisations, but may consider this in the future”, leaving the door open to track the EUSR more closely;
- allowing a change of the risk retainer in the event of the retainer’s insolvency (query why the PRA is not suggesting going as far as the European Commission’s final draft risk retention RTS, which also permit a change “where the retainer, for legal reasons beyond its control and beyond the control of its shareholders, is unable to continue acting as a retainer”). It is worth noting that, on both sides of the Channel, if a risk retainer goes into insolvency, it can only transfer to another willing party which is a sponsor, an originator or the original lender, and so cases could arise where there would be no possible transferee complying with the basic risk retention requirement (Article 6 of the EUSR, or Article 12 of Chapter 3 in the revised PRA rule book);
- criteria to assess the “sole purpose” question (in Article 2(6) of chapter 3 of the new PRA rules). These broadly follow the now-superseded EBA draft risk retention RTS in requiring that it should be “taken into account” whether the entity has a business strategy and payment capacity “consistent with a broader business model” and whether the members of its management body have the necessary experience to enable the entity to pursue the established business strategy and the entity has adequate corporate governance arrangements (the EC-adopted final draft RTS have made this into a safe harbour rather than a ”take into account” requirement). The PRA has thankfully omitted the reference to “or predominant” which had excited some commentators, and adds, interestingly, that it will monitor market practice to see whether a review of the sole purpose test would be appropriate;
- specification of how the risk retention requirements apply in resecuritisations;
- permitting all CRR and Solvency II firms to retain risk in synthetic/contingent form (through a guarantee, LC or similar) without fully collateralising it in cash and holding it on a segregated basis as clients’ money (currently this is required unless the retainer is a credit institution).
Private securitisations, and “before pricing”
The existing disclosure requirements in Article 7 and the existing technical standards (including the templates) are substantially preserved in Article 7 of Chapter 2, but a further consultation about these is hinted at. This is one of the biggest regulatory issues that needs fixing, and what the regulators do here really could and hopefully will make a huge difference, and so this, and the equivalent measures on the European side, cannot come too soon.
The PRA and FCA together are currently reviewing the Article 7 transparency requirements, including whether private securitisations should be subject to a more benign regime, and we are promised an FCA consultation paper about this on 7 August 2023. The European Commission Article 46 report in October 2022 has similarly promised medium-term relief in relation to private securitisations, and in the shorter term the EC has invited ESMA to come up with a much scaled-down template for private securitisations which is tailored to the requirements of regulators, not investors, and which “could replace the existing templates for all private securitisations”.
So, on both sides of the Channel, we can expect some good news in the next few months, and we wait to see just how good it will be. Dare one say it, there is a very sensible school of thought that wonders why private issues are not just exempted altogether, or at least exempted from the due diligence and transparency requirements, but this may be a step too far. Deregulation does not come easily to regulators.
Meanwhile, the PRA proposes to fix the existing Article 7 requirement that certain information is disclosed “before pricing”. This has required the market to take a pragmatic approach so far, given that strictly speaking this can be impossible, because that information includes underlying documentation that is essential for the understanding of the transaction etc. which itself includes information on pricing. Article 22(5) says, in relation to an STS securitisation, that the information required before pricing can be in draft or initial form with final documentation being made available to investors within 15 days after closing, and the PRA rules follow this standard.