Capital requirements become latest focus of UK securitisation framework

The document has been issued to gather feedback on a range of issues ahead of a full consultation on draft PRA rules, which is expected in the second half of 2024. Capital requirements for securitisation transactions is another important topic under the planned new UK Securitisation Regulation and the paper complements previous consultations by the Financial Conduct Authority (FCA) and the PRA relating to securitisation transactions, which have demonstrated the regulators’ new approach to rulemaking post-Brexit.

Katie McCaw of Pinsent Masons, a specialist in the regulatory aspects of securitisation and debt capital markets transactions, said: “It is encouraging that the PRA is seeking early industry input on the planned revisions to the capital requirements for securitisation transactions ahead of its full consultation next year. The global and EU standards have been regarded as overly punitive for securitisation and it is encouraging that the UK may consider taking a more pragmatic approach – at least in some areas – to the post-Brexit rules.”

The PRA discussion paper covers several issues on capital requirements, including the potential impact of the “output floor” introduced by the Basel 3.1 standards on securitisation transactions and, in particular, the impact on a certain type of securitisation known as ‘significant risk transfer’ securitisations.

The output floor essentially ensures that banks’ own internal capital requirements cannot fall below a certain percentage of the same calculation under the basic, standardised (non-model) approaches.  An earlier, wider, PRA consultation on Basel 3.1 implementation confirmed that the PRA would implement this approach, on a phased-in basis over several years. However the rule, said McCaw, potentially has detrimental effects on certain securitisations especially where capital-intensive tranches are retained.

In addition, the role of the so-called ‘p-factor’ in capital requirements for securitisation is under consideration, which refers to a ‘smoothing’ factor used within capital calculations that accounts for the difference between the capital calculation on the underlying assets as compared to the securitisation tranches.

Considering the interaction between effects of the ‘output floor’ and the ‘p-factor’, the PRA puts forward three possible options on which feedback is sought: keep the rules as they are; make targeted adjustments for securitisations; or carve-out securitisation completely from the rules.

The paper also focuses on the “hierarchy” of methods for determining securitisation capital requirements. The range of methods and the order in which they can be used by banks differs between the EU rules under the Capital Requirements Regulation (CRR), which the UK currently implements, and the original Basel standards. The PRA is considering the impact of aligning its rules more closely with the Basel standards’ hierarchy and is seeking feedback on the possible impacts on securitisation structures and capital requirements of doing so.

‘Simple, Transparent and Standardised’ (STS) securitisations, a special category of securitisation which meet strict structuring criteria, benefit from preferential capital requirements under the CRR. The PRA notes that balance sheet ‘synthetic’ STS securitisations cannot benefit from this treatment in the UK. The market has been critical of this stance since the EU allows it following amendments to the EU Securitisation Regulation and EU rules under the CRR in 2021.

The discussion paper suggests that the regulator is reluctant to change its position, as it seeks feedback on its position not to propose extending the STS framework to balance sheet synthetic securitisations under the new capital framework. “Such an extension of the UK STS framework would not advance the PRA’s primary objective to promote the safety and soundness of firms,” it says in the paper.

Another area the PRA is also seeking input on is the use of credit risk mitigation techniques in synthetic securitisation transactions.

Input to the PRA’s discussion paper is requested by 31 January 2024.