A fork in the road or a dual carriageway? Brexit and Securitisation transactions - some practical perspectives

Summary

• On 31 December 2020 at 11pm ("IP Completion Day") the UK ceased to be part of the European Economic Area.
• Prior to IP Completion Day, the significant majority of securitisation legislation applicable in the UK consisted of EU legislation directly applicable in the UK comprising Regulation EC 2017/2402 and RTSs and ITSs published in the Official Journal (the “EUSR”).
• The EUSR and EU RTSs and ITSs published in the Official Journal have been onshored in the UK through the EU Withdrawal Act (the “EUWA”), effective from IP Completion Day and amended by UK regulations to ensure they work in a UK context (the “UKSR”). The PRA/FCA under their temporary transitional powers ("TTPs") have also temporarily suspended or modified certain provisions of the UK Securitisation Regulation so as to allow participants time to adjust to the new UK regime.
• The result is a new UK securitisation regime (including an STS regime) which largely follows the EU rules but not always so and which exists in parallel to the EU regime.  Although perhaps difficult to qualify, there is also the risk that UKSR and EUSR diverge over time. One or both of these regimes are relevant to securitisations depending upon the place of establishment of the originator and SSPE and the potential investor base. There are also a number of other areas of legislation applicable to securitisation transactions which are impacted by the UK leaving the EEA.
• This article examines some practical issues to consider in documenting securitisation transactions following IP Completion Day noting that in some respects market practice is developing in these areas and that outcomes may also depend on originator and/or investor preferences.

UK Securitisation Regulation and EU Securitisation Regulation

Originators and SSPEs are legally required to comply with the EUSR or UKSR in the jurisdiction of their establishment. If established in the EEA their compliance will be supervised by the relevant competent authority in the EEA in accordance with Article 29 EUSR or if established in the UK by the FCA in accordance with the UKSR.

Points to consider in documentation

Differences between UKSR and EUSR

If the originator and SSPE are located in the UK, then the UKSR will apply. Many of the onshoring amendments are merely designed to ensure the EUSR functions in a UK context once onshored, however care will need to be taken when considering any amendments from the EUSR. We highlight below some key areas of focus.

• Risk Retention: The UK and EU risk retention regimes are currently the same except for the financial holding company definition. The UKSR contains a revised definition of financial holding company (which will only allow UK regulated entities) but the FCA’s use of the TTPs postpones this change until 31 March 2022. Under the EUSR the existing EU Risk Retention RTS¹ pursuant to CRR remains relevant until the revised Risk Retention RTS is adopted and this has been onshored in the UK through the EUWA. The existing and draft Risk Retention RTSs are very similar.
• Reporting: Reporting will be made on the basis of the UKSR and the FCA has published its own form or reporting templates² . In onshoring the EU Disclosure RTS³ and ITS⁴ , the FCA has made a limited number of minor changes to the reporting fields (eg, the EU NUTS geographic designations are replaced with UK terms). Under the TTPs UK reporting entities and UK regulated investors can continue to use the ESMA templates until 31 March 2022.
• Securitisation Repository: Public securitisation transactions will only need to report to one securitisation repository depending upon whether the prospectus is approved in the UK or EEA and the location of the SSPE and originator.   The rules on use of securitisation repositories are not subject to the TTPs. No securitisation repositories have yet been registered with the FCA. Whilst the reporting entity can post data to a website qualifying under Article 7, given the requirement for the repository to be in the UK if the prospectus is approved in the UK it would be beneficial to consider a UK repository if a UK listing is contemplated. Additionally, if the prospectus is approved in the EEA, but the SSPE and originator are both located in the UK (thereby subject to UKSR), then there may not be any obligation to report to a securitisation repository in either the UK or EEA. Whilst the definition of securitisation repository in UKSR is not territorially specific, there would not be a public securitisation transaction for the purposes of the obligation to report to a securitisation repository under UKSR and the EUSR does not directly apply to a UK SSPE and originator. Once UK and EEA securitisation repositories start to become registered, it remains to be seen if originators and SSPEs look to voluntarily comply with the requirements.
• Sponsor: EUSR is unclear as to whether or not an investment firm located in a third country may act as sponsor for the purposes of EUSR and (in its capacity as sponsor) to provide an EU risk retention undertaking. This point has been specifically clarified in the UKSR where it is confirmed that an investment firm can act as sponsor for the purposes of the UKSR whether or not it is located in the UK. However, for a UK STS securitisation the investment firm would nevertheless need to be established in the UK.

EUSR compliance on a UK transaction

If a transaction with a UK originator and UK SSPE is to be marketed to EU investors, then in order to assist the EU regulated investors in conducting their initial and ongoing due diligence under Article 5 EUSR it is likely that the UK originator and UK SSPE would need to contractually elect to comply with all or certain provisions of EUSR. The alternative would be that EU regulated investors would have to form a view that Article 5(1)(e) allows them to satisfy their due diligence requirements by reference to the UK reporting templates as being substantially similar to the ESMA templates.  These arguments have been advanced in the context of US transactions marketed into the EU and they have not been universally accepted and there is not specific EU regulatory guidance on this point.

If the intention is to comply with EUSR as well then the following points will need to be considered.

• Sound credit granting: If the originator is established in the UK (ie, a third country for EUSR purposes) it would need to agree to give the sound credit granting confirmation or the EU investor would need to get comfortable based on its own diligence (Article 5(1)(b)).
• Risk Retention: UK originators would need to contractually agree to comply with EU risk retention requirements to assist EU investors in satisfying their Article 5(1)(d) requirements.
• Reporting: In Article 5(1)(e) of the EUSR the due diligence requirements with respect to Article 7 reporting are phrased as “where applicable” which suggests some scope for allowing substantial but not exact compliance with the EU reporting templates although, as noted above, the arguments around "substantial" compliance have not been tested with ESMA which may leave some EU investors uncomfortable without ESMA template reporting. In addition, in that case EU investors would need to be comfortable with any regulatory divergence risk. As a result an originator and SSPE established in the UK would need to adopt one of the following approaches:
  • UK only reporting: UK reporting templates only, especially if they do not have a presence in the EU and are only targeting UK investors;
  • ESMA reporting plus UK when required: ESMA reporting templates only until the expiry of the UK standstill period and thereafter produce both sets of templates in the event of regulatory divergence; or
  • UK reporting with EU assistance provision: UK reporting templates only but agree to assist EU investors in complying with their regulatory obligations.

The position would need to be agreed by the arrangers/JLMs on each transaction bearing in mind the potential impact on liquidity in the secondary market.

UKSR compliance on an EU transaction

A similar analysis would need to be undertaken with respect to UKSR compliance on an EU securitisation if UK institutional investors are involved (whether the transaction was public or private) in relation to sound credit granting, risk retention and reporting.

As noted above, until March 2022 if the reporting entity completes the ESMA reporting templates then the UK institutional investor could rely on these for the purposes of complying with its due diligence obligations under Article 5 of UKSR.  In addition, Article 5 of UKSR specifically permits the due diligence requirements of a UK investor to be satisfied by reference to information which is "substantially the same" as it would have been had UK reporting been required.  UK institutional investors should, nonetheless, consider the risk of regulatory divergence in the future.

UK based parties involved in EU transactions (for example, as an arranger) will also need to consider whether they are undertaking any regulated activity in the EU for which they need to hold permissions in the EU.

STS Securitisations

UK STS

New UK STS for UK investors - The UKSR establishes a new UK STS regime which provides, for qualifying transactions, preferential regulatory capital treatment for investors subject to UK CRR. A transaction can be eligible for UK STS with an originator/sponsor established in the UK but an SSPE incorporated in another country. If a third party verifier it used to verify compliance with the UK STS criteria it needs to be on the list of entities approved by the FCA, currently PCS is registered with the FCA.

Notification of new UK STS transactions - A new UK STS transaction needs to be notified to the FCA using the UK STS notification forms which closely follow the ESMA Article 27 STS notification forms with a number of minor changes.

If a UK originator/Issuer lists its securities outside of the UK, the FCA's private securitisation template will need to be completed even where the prospectus has been approved by a competent authority in the EU and is publicly available.

Notification of STS transactions closed prior to the Brexit - An existing UK transaction issued prior to IP Completion Day needed to have been notified to the FCA prior to IP Completion Day to be included on the UK STS register from IP Completion Day.

EU STS no longer available for UK

If an existing STS securitisation previously notified to ESMA under Article 27 involved either solely UK originators/sponsors or UK SSPE it ceased to be eligible for EU STS purposes from 31 December 2020 with no grandfathering. New transactions with a non-EU originator/sponsor or SSPE will not be eligible. 

Suggestions have been made that an EU sponsor or originator may be available within a group to act as originator for the purposes of EU STS treatment on a UK securitisation.  We are not aware of this approach being adopted and it is not without potentially significant challenges. 

Investor perspectives

From the perspective of UK investors invested in EU STS transactions, under the TTPs, UK investors investing in EU STS transactions which closed in the period prior to and up to 31 December 2022 for the life of those transactions can apply regulatory capital treatment to these transactions as if they were UK STS transactions. 

EU investors invested in UK STS transactions do not have the benefit of equivalent grandfathering treatment. STS equivalence could potentially be a topic reviewed at ESA level as part of the wider review of EUSR ahead of 1 January 2022.

Prospectus Regulation and Transparency Directive

The Prospectus Regulation (EU) 2017/1129 has been incorporated into UK domestic law through the EUWA and amended to ensure it operates in the UK. Whilst passporting will no longer apply between the UK and the EU, if issuers rely on the public offer exemption for wholesale denomination debt (which will almost always be the case on securitisations), then a separate prospectus would not need to be prepared for EU or UK investors targeted as part of the offering.

Issuers with the UK as a home member state which have securities listed in the EU need to elect an EU Member State as their home member state.

Points to consider in documentation

Prospectus approval language should refer to the law and competent authority in the jurisdiction where approval is sought.

Issuers relying on the wholesale denomination regime (ie debt securities that have a denomination of at least EUR 100,000 or equivalent in another currency) should check when issuing that the denomination of their securities is equivalent to EUR 100,000 where they are issuing in GBP and wish to access the EU markets after the end of the transition period.

CRA Regulation

Regulation (EC) No 1060/2009 on credit rating agencies (as amended) (the “EU CRA Regulation”) has been incorporated into UK domestic law through the EUWA and amended to operate in the UK context (the “UK CRA Regulation”).  If transactions are to be marketed in both the UK and EU then parties will need to ensure that credit ratings can be used in both the UK and EU. 

In respect of transactions listed on a regulated market in the UK or for transactions listed in the EU where UK credit institutions (and certain other firms) are targeted as investors the issuer should include a UK CRA statement in its prospectus and the CRA must be registered with or certified by the FCA or the rating should be endorsed by a UK CRA. There is a standstill regime applicable under the TTP but care will need to be taken to ensure this is applicable particularly for smaller EU CRAs that do not intend to register as a UK CRA or do not have a UK company within their group.

In respect of transactions listed on a regulated market in the EU or if EU credit institutions (and certain other firms) are targeted as investors ratings from UK CRAs will need to be endorsed by an EU CRA.

GDPR

The UK has recognised the EU as having an equivalent data protection regime to the UK so transfers of personal data from the UK to the EU can be made without additional contractual restrictions. The EU has not yet recognised the UK as having an equivalent regime to the EU, but the EU-UK Trade Agreement provides for a 6 month transitional period whilst the EU conducts an equivalence assessment during which the UK will be treated as equivalent to an EU Member State. If the UK is not deemed equivalent then parties will be required to include standard contractual clauses to the extent any processing takes place outside of the EU and may need to conduct a governance assessment.

Points to consider in documentation

In respect of data processing in the UK only, or in respect of data transfers from the UK to the EU where processing will take place in the EU, no changes should be needed to documentation other than to refer to the correct data protection regulation.

For transfers of data from the EU to the UK with processing in the UK documentation should include a requirement to include standard contractual clauses if required.

Choice of Law and Jurisdiction

The UK has implemented Rome I & II into UK law and the courts of EU Member States will continue to give effect to a choice of English law in accordance with Rome I and II.  Where documents specify English law as the governing law, they will continue to do so.  

From the IP Completion Day, the Recast Brussels I Regulation and the Lugano Convention will no longer apply in the UK. The UK has unilaterally acceded to the Hague Convention with effect from IP Completion Day. The UK has also applied to accede to the Lugano Convention, but this is subject to approval by the other signatories. If successful this would mirror the Brussels I Regulation.

Points to consider in documentation

Following its accession to the Hague Convention:

• two-way jurisdiction clauses (clauses conferring exclusive jurisdiction to the courts of one country regardless of the party bringing the claim) in agreements entered into after IP Completion Day (or, in the UK Government’s view after 2015) will be recognised by other Hague Convention signatories; and
• "asymmetric jurisdiction clauses (clauses restricting one party to bringing claims only in the courts of one country whilst permitting another party to bring claims in the courts of more than one country) would not be recognised and should ideally be updated.

COMI Representations and Undertakings

COMI representations are commonly included in documentation. COMI representations remain relevant for EU incorporated companies as they provide comfort as to the location of main proceedings and comfort that secondary or territorial proceedings would not be opened in another Member State. They also remain relevant for UK incorporated companies as they provide comfort that insolvency proceedings would not be opened other than in the UK although local analysis will now need to be obtained.

References to other legislation in documentation

There are a number of other general legislative changes to consider when documenting securitisation transactions following IP Completion Day, including PRIIPs/Product Governance, BRRD, MAR and the Benchmarks Regulation and the changes to be made will depend upon the establishment of the Issuer, the jurisdiction in which the prospectus is approved an the location of investors and transaction parties.

Conclusion

The list of changes required to securitisation documentation as a result of Brexit is relatively significant.  As noted above, in many cases these will be technical changes which have very limited impact on the transactions themselves. However, in some cases the changes required may be more far-reaching for market participants, such as in the context of STS treatment and reporting. It is to be hoped that policy-makers and regulators consider adopting an approach which minimises the additional burden on market participants as a result of dual EUSR and UKSR rules.  Until then it remains to be seen how the market responds to these changes in the coming months. 

Authored by Julian Craughan and David Palmer