Securitisation 2020

Last Updated January 13, 2020

UK

Law and Practice

Authors



Hogan Lovells has a structured finance and securitisation practice that handles every aspect of structured finance transactions. Its global team has advised on transactions with assets originated in more than 30 countries, including the USA, Latin America, the Caribbean, Europe, South Africa, the former CIS, the Middle East, Japan and Southeast Asia. The team advises on the financing of a wide range of classic and innovative asset types, as public and private standalone issues, master trusts and programmes, and through conduit structures. It also handles matters relating to Dodd-Frank legislation in the USA and the Securitisation Regulation and other relevant EU legislation, including compliance counselling, disclosure and advocacy relating to the legislation. Clients include issuers and originators of securitised assets, underwriters, managers and arrangers, trustees, investors, and collateral and portfolio managers. We would like to thank Nicholas Watmough, senior associate in the debt capital markets practice, Philip Harle, partner in the tax practice, and Adam Parry, counsel in the tax practice.

Structurally Embedded Laws of General Application

At the time of writing, the details of the UK’s planned withdrawal from the EU are unclear. This introduces an element of uncertainty to some areas of the legal and regulatory framework applicable to securitisations in the UK, or with a UK nexus, when the UK leaves the EU (in particular in relation to cross-border transactions). This guide focuses on the regime applicable to securitisations in the UK at the time of writing.

Insolvency Laws

Insolvency law and practice is a key consideration when structuring and documenting securitisations under English law. In securitisations, structural and contractual protections are used to de-link the credit risk of the underlying financial assets (and therefore the credit risk of the notes to be backed by such assets) from the credit risk of the originator. We use "originator" to refer to the seller of financial assets.

In particular, securitisations typically involve a "true sale" of financial assets to the issuer to ensure they would not form part of the insolvency estate of the originator. The two primary risks in relation to a true sale analysis are whether the sale transaction could be re-characterised as a secured loan, and/or subject to claw-back (ie, whether, on an insolvency of the originator, the sale of financial assets to the issuer could be contested successfully, avoided or set aside under the transaction avoidance provisions of the Insolvency Act 1986 ("IA 1986")).

Note that, where the originator is a bank or other regulated credit institution, provisions of the Banking Act 2009 will also need to be considered.

In addition, a securitisation in the UK may be structured as a secured loan – for example, in a whole business securitisation or a commercial real estate securitisation (CMBS). See "Protection for the Transferred Assets – True Sale vs Secured Loan Transactions" below and "Difference Between "True Sale" or a Secured Loan" in 1.3 Transfer of Financial Assets.

True Sale vs a Secured Loan

To determine whether a sale transaction should be re-characterised as a secured loan, the courts would review the sale agreement to determine whether the sale was a sham or did not meet the legal criteria for a sale. The court would look to the substance of the transaction, and beyond any labels given to it by the parties.

The three key differences between a sale and a secured loan are as follows:

  • in a sale transaction the seller is not entitled to have the transferred assets returned to it in exchange for a return of the purchase price to the purchaser;
  • in a sale transaction if the purchaser re-sells the transferred assets, it is not obliged to account to the seller for any profit (under a secured loan the chargee having to account to the chargor for any profits made on disposition of the charged assets is known as the "equity of redemption"); and
  • in a sale transaction if the purchaser re-sells the purchased assets at a loss, there is no right to recover this loss from the seller.

However, there may be a sale even though (i) the purchaser has recourse to the seller for any shortfall if the underlying obligor fails to pay in full or (ii) the purchaser may have to adjust the purchase price after recovery by the seller against the underlying obligor.

In practice, the following are generally considered to be acceptable in the context of a true sale securitisation.

  • The right of an originator (or an option of the issuer to require the originator) to repurchase financial assets in certain limited circumstances, such as:
    1. breach of warranty relating to those assets; and
    2. a "clean-up call" whereby the originator repurchases all of the outstanding financial assets once the principal amount outstanding of the notes reaches a sufficiently low threshold (usually 10% of the initial amount outstanding) to allow the redemption of the notes and the wind-down of the securitisation.
  • A deferral of part of the purchase price payable by the issuer to the originator.
  • A degree of credit risk on the assets being held by the originator as a first loss position in the securitisation (including as fulfilment of risk retention requirements – see 4.3 Credit Risk Retention).
  • The originator receiving certain residual profits as part of the securitisation structure.

Protection for the Transferred Assets – True Sale vs Secured Loan Transactions

A valid true sale is effective to transfer beneficial title (and, following requisite perfection steps, legal title) to the assets from the originator to the issuer. Therefore, the transferred assets would no longer be an asset of the originator and so would not form part of the originator's insolvency estate (subject to the potential claw-back risks mentioned above).

In contrast, under a secured loan the charged assets would remain as an asset of the originator – albeit subject to the security granted to the issuer. Therefore, upon the insolvency of the originator, the issuer would have to rely on its security interest to realise its rights to the charged assets.

Security created by an English company generally has to be registered within 21 days of its creation in order for it to be valid. No registration would be made in relation to a sale of financial assets from an originator to an issuer (as this could impact the true sale analysis). Therefore, if a purported true sale transfer was re-characterised as a secured loan, in an administration or liquidation of the originator the assets would form part of the originator's insolvency estate and the security is likely to be void for lack of registration. This would leave the issuer with an unsecured claim over the assets.

In practice, the precise position of the issuer with respect to the charged assets would depend on the nature of the security granted over them and the ranking of claims of other creditors of the originator. However, even if the issuer benefited from first-ranking security over the charged assets, it would need to rely on the insolvency process to realise its rights to the assets. Therefore, securitisations are generally structured to achieve the protection of a true sale of assets to the issuer. That said, as stated above, certain securitisations are structured using a secured loan, in which case the considerations discussed in this section are particularly relevant.

It may be possible to achieve a more robust secured loan transaction if the issuer holds a qualifying floating charge over the assets of a UK company acting as borrower, and this is security for a capital market arrangement. However, the floating charge would need to be over all or substantially all of the assets of the borrower, which would be difficult if the business had multiple creditors. If this can be achieved, the issuer would be able to appoint an administrative receiver on the insolvency of the borrower to enforce the security, and any administrator appointed by other creditors would need to vacate office. In some instances, where the subject of the securitisation is non-financial assets (such as whole business securitisations), such a secured loan structure may be used.

Furthermore, if a court were to consider whether any security granted constituted fixed or floating security, the description given to it as fixed security would not be determinative. The hallmark of a floating charge, and a characteristic inconsistent with a fixed charge, is that the chargor is left free to use the assets subject to the charge and, by doing so, to withdraw them from the security.

Under a secured loan transaction, if the security was actually held to take effect as a floating charge there would be certain potential disadvantages, including the following.

  • If an administrator, liquidator or floating charge receiver were appointed in England and Wales, or the security trustee entered into possession, the claims of the security trustee for itself, the noteholders and other beneficiaries would be subject to the claims of preferential creditors. The Crown's preferential status in respect of taxes was abolished in 2003. However, draft Finance Bill clauses were published on 11 July 2019 that, if enacted, will have the effect that, from 6 April 2020, for insolvencies commencing after that date, HM Revenue & Customs (HMRC) will obtain preferential status as a secondary preferential creditor in respect of VAT. The draft clauses provide that HMRC will also obtain preferential status in respect of other amounts where (i) the debtor is required by statute to make a deduction from a payment made to another person and to pay an amount to HMRC on account of that deduction and (ii) HMRC credits the payment against any liability of that other person, if the deduction is of a kind specified in secondary legislation. The government has announced that this will apply in respect of Pay As You Earn (PAYE), employee National Insurance Contributions (NICs) and Construction Industry Scheme deductions but no secondary legislation has yet been published. The remaining preferential claims include contributions to occupational pension schemes, any amounts owed in certain circumstances for the remuneration of employees, levies on coal and steel production, debts owed to the Financial Services Compensation Scheme (FSCS), retail banking deposits whose amount is protected under the FSCS, and certain retail banking deposits owed to depositors that are not otherwise protected by the FSCS.
  • The claims of the security trustee for itself and other beneficiaries would be subject to the requirement that a prescribed part of the net floating charge realisations be made available for the satisfaction of unsecured debts, under Section 176A IA 1986 and the Insolvency Act (Prescribed Part) Order 2003. If an administrator, liquidator, provisional liquidator or floating charge receiver were to be appointed in relation to the chargor, a prescribed part (calculated at the rate of 50% of the first GBP10,000 and 20% thereafter, up to a maximum fund of GBP600,000) of the net realisations derived from the floating charge would have to be ring-fenced for the benefit of creditors generally. The UK government had proposed increasing the prescribed part to GBP800,000 to take account of the effect of inflation since its introduction in 2003. However, at the time of writing it is not yet clear whether there will be sufficient parliamentary time to pass this legislation in light of the ongoing Brexit debate. The requirement for the ring-fenced fund may be disapplied in certain cases if the cost of distribution would be disproportionate to the benefit.
  • A floating charge is invalid if it is created within 12 months (or, in some cases, two years) of the onset of the chargor's insolvency, except to the extent of money advanced or goods or services provided to the chargor (or debts of the chargor discharged) at the same time as, or after, the creation of the charge.
  • An administrator would be free to deal with the floating charge assets without reference to the floating charge-holder, and to pay his or her remuneration and expenses out of the sale proceeds of such assets.
  • The expenses of the winding-up of a company commencing on or after 6 April 2008 are payable out of the floating charge assets, in priority to the claims of the floating charge-holder, to the extent that the company's assets available for the payment of general creditors are insufficient to meet them.

Opinion of Counsel

Parties to securitisations generally obtain a transaction opinion from their legal advisers to provide comfort as to the bankruptcy remoteness of the transfer of financial assets to the issuer, among other things.

Legal advisers are asked to opine that the sale agreement is effective to transfer the assets to the issuer, including concluding that the sale should not be re-characterised as a secured loan, and that the transfer would not be subject to claw-back on an insolvency of the originator.

These opinions are subject to factual assumptions, including (i) the originator having good title to the assets prior to transfer and complying with the procedural requirements of the sale agreement and (ii) that the confirmations given by the originator of its good faith entry into the transaction and its solvency are true and accurate.

These opinions are also subject to the detailed application of legal principles relating to re-characterisation risk and claw-back.

Other Material Relevant to Insolvency Law(s)

As mentioned above, a key risk when structuring a bankruptcy remote sale of financial assets to the issuer is that the transfer could be subject to claw-back on an insolvency of the originator.

The primary considerations are whether the sale of financial assets to the issuer could be contested successfully, avoided or set aside on the basis that it constitutes one of the following.

Transaction at an undervalue (Section 238 IA 1986)

A transaction entered into by the originator within the two years prior to the onset of its insolvency could be set aside if it is considered to be a transaction at an undervalue (ie, if the value of the consideration received by the originator is significantly less than the value of the consideration that it provides).

The sale of assets to the issuer would not be set aside if the court is satisfied that:

  • the originator entered into the transaction in good faith and for the purpose of carrying on its business, and there are reasonable grounds for believing that the transaction would benefit the originator; or
  • the originator was not unable at the time of the transaction to pay its debts as they fell due (within the meaning of Section 123 IA 1986) and did not become unable to do so as a consequence of the transaction.

In a securitisation, the originator will be required to give the confirmations set out above in board minutes and to provide a solvency certificate.

The confirmations set out above also provide comfort that a court would not hold the sale transaction to be a transaction defrauding creditors (under Section 423 IA 1986) if it was asserted that the transaction was at an undervalue and had been entered into with an intention to defraud creditors.

The typical obligation on the originator to repurchase at par assets affected by a breach of warranty (which could result in the originator paying a purchase price greater than the amount recoverable under the relevant asset) is generally not considered to be a transaction at an undervalue as the repurchase is a contractual remedy for breach in relation to an asset for which the originator has already received full value. However, in practice, this right to require the originator to repurchase may not be enforceable upon an insolvency of the originator (other than with the leave of the court or administrator).

Preference (Section 239 IA 1986)

A transaction entered into by the originator within the six months prior to the onset of its insolvency (two years if the transaction is with a connected person of the originator) could be set aside if it was considered to be a preference.

Broadly, a transaction would be a preference if the originator desired to put a creditor, surety or guarantor in a better position than it otherwise would have been in upon an insolvency of the originator.

The sale of financial assets to the issuer would remain valid if the court was satisfied that the originator was not unable at the time of the preference to pay its debts as they fell due (within the meaning of Section 123 IA 1986) and did not become unable to do so as a consequence of the preference.

In a securitisation, the originator will have to give the confirmation set out above in board minutes and a solvency certificate.

Onerous Property (Section 178 IA 1986)

A liquidator may disclaim any onerous property of the originator, which could include the sale agreement (or any other transaction document) entered into by the originator that was held to be an unprofitable contract.

Whether a contract is unprofitable is determined by tests relating to whether it is detrimental to the insolvent company's creditors or impedes the insolvency process.

Practitioners are generally comfortable that a liquidator would not disclaim the sale agreement if the effect of such a disclaimer would be to take away from the issuer its interests in the transferred assets which are the subject of, and have vested in the issuer under, that agreement.

Rescission of Contract by Court (Section 186 IA 1986)

If a company is in liquidation, any person who is entitled to the benefit or is subject to the burden of a contract with that company may apply to the court for an order rescinding that contract.

Practitioners are generally comfortable that a court would not make an order for rescission of the sale agreement transferring the financial assets to the issuer that would render totally ineffective the transactions effected by such an agreement.

The issuer is generally structured as a bankruptcy remote special purpose entity (SPE) in order to de-link further the credit risk of the financial assets from the credit risk of the originator.

The SPE is usually structured as an orphan limited liability company (with its share capital held on charitable trust by a corporate services provider).

The SPE's activities will be restricted by comprehensive negative covenants in the transaction documents. For example, it will agree not to engage in any activities beyond those contemplated by the transaction documents, including not having any employees or subsidiaries, and not incurring any indebtedness or granting any security other than as part of the securitisation.

Ideally, none of the directors of the SPE should be nominated by the originator. This is to mitigate the risk that the SPE could be viewed as being connected or associated with the originator for the purposes of the Pension Act 2004, which could in some cases lead to the SPE being required to provide financial support for any deficit in a defined benefit pension scheme of the originator group. In practice, though, there are a number of factors that could mitigate this risk. If common directors are used, it would still be preferable to include at least one independent director on the board.

The transaction parties (other than the SPE) will also agree:

  • under non-petition provisions, not to commence insolvency proceedings against the SPE; and
  • to limited recourse provisions, whereby each party's recourse against the SPE is limited to (i) the transferred financial assets actually held by the SPE and (ii) enforcement in accordance with the transaction documents (in particular in accordance with agreed priorities of payment).

Risk of Consolidation

There is no concept of substantive consolidation under English insolvency law.

Even if the SPE was an affiliate of the originator rather than an orphan, it is a key principle of English law that a company has a legal personality that is distinct from its shareholder(s). Therefore, there is no presumption that assets and liabilities of the SPE would be amalgamated with those of its affiliates.

However, under English law the assets of an entity may be available to meet the liabilities of another entity over which it acts as a shadow director. To mitigate the risk that the originator could be held to be a shadow director of the SPE, the SPE should be a distinct legal entity from the originator and should clearly hold itself out as doing business separately from the originator, and the separate decision-making process of the directors of the SPE should be properly documented.

There are also certain types of claims that may be payable by connected or grouped companies, such as:

  • pension liabilities (see above); and
  • secondary tax liabilities – if the SPE is within the same group as other companies, a number of secondary tax liabilities may be relevant (in addition to other potential tax liabilities of the SPE itself). Some of these are now disapplied where the SPE is within the securitisation company regime but others may still apply, including the following.
    1. Corporation tax on chargeable gains – unpaid corporation tax on chargeable gains of group companies falls to be paid by the principal company of the chargeable gains group and any other company that was a member of the group in the 12 months preceding the gain accruing and that owned the asset disposed of. There could, therefore, be a risk that a secondary tax liability will accrue to the SPE if it is treated as being in a chargeable gains group with the originator.
    2. VAT – there will be joint and several VAT liability for the SPE if the SPE is in the same VAT group as the originator or other members of the originator's group. VAT grouping might be elected to manage any VAT on servicing of the financial assets, in which case some form of tax covenant would be expected from the operating group companies to mitigate associated risks to the SPE.

Opinion of Counsel

The transaction opinion given by legal advisers should provide comfort as to the corporate capacity of the issuer, and report on the results of insolvency searches carried out against the issuer on closing.

The opinions set out above will be given subject to factual assumptions relating to, for example, the accuracy and authenticity of the issuer's constitutional documents reviewed and the accuracy of the information revealed by insolvency searches.

Legal advisers are also asked to opine that the non-petition and limited recourse provisions are legal, valid, binding and enforceable.

These opinions are subject to general factual assumptions as to the good-faith entry by the parties into, and their due execution of, the documents in which these provisions are included. They are also subject to detailed application of legal principles relating to these provisions. For example, it is generally noted that:

  • a court may not grant an order for injunctive relief (which would be the most effective method for enforcing a non-petition provision) if it viewed the provision as being contrary to public policy as an attempt to oust the jurisdiction of the court or applicable insolvency laws; and
  • a court could consider a petition for winding up even if this petition were presented in breach of a contractual non-petition provision.

Other Material Relevant Law

Tax laws relating to an SPE (for example, withholding tax treatment and the application of the Taxation of Securitisation Company Regulations 2006) are a key consideration for practitioners (see 2 Tax Laws and Issues).

Depending on the nature of the financial assets acquired by the SPE, legal advisers may also need to advise on issues relating to the consumer credit regime (or, if applicable, the residential mortgage regime). The underlying contracts relating to the assets may be subject to legal due diligence – in particular in relation to any consumer credit issues that could lead to a contract being held to be unenforceable. A primary concern is whether the underlying contracts with consumers comply with requirements as to fairness.

Originators will have obligations relating to how they can use and disclose customers' personal data under data protection legislation. If the SPE receives personal data or determines how and why it is used, it will also have certain data protection obligations. Initial data protection notices sent by the seller to customers at the time of origination should be reviewed to determine whether passing the data to the SPE and any changes in the scope of processing are permitted. Consideration should be given to whether further notification to customers is necessary, as well as to the legal basis for the disclosure and any new processing (eg, legitimate interest, contractual necessity or consent).

The originator and the servicer should also hold relevant permissions to carry on regulated activities for the purposes of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. Legal advisers may be asked to advise the parties as to whether the correct permissions are held and, as is typical, whether the issuer is exempt from holding permissions on the basis that it can rely on the fact that the servicer holds appropriate permissions.

The rights under the financial assets are generally transferred from the originator to the issuer by way of assignment: either legal or equitable.

For there to be a legal assignment (transferring both the legal and beneficial title to the financial assets), under Section 136 of the Law of Property Act 1925 (LPA):

  • only the benefits of the underlying agreement relating to the assets may be assigned (unlike novation – as to which see below);
  • the assignment must be absolute;
  • the rights to be assigned must not relate to only part of a debt;
  • the assignment must be in writing and signed by the assignor; and
  • notice of the assignment must be given to the underlying obligor.

Provided there is a clear intention to assign, an assignment not meeting the above criteria would generally constitute an equitable assignment.

Originators generally want to remain the holder of legal title (and therefore the lender of record), in order to preserve their relationships with their customers. Therefore, to avoid providing notice to the underlying obligors, financial assets are usually transferred to the issuer by equitable assignment, under which only the beneficial title to the assets is transferred. If required, equitable assignment also allows financial assets to be partially securitised, as (unlike legal assignment) equitable assignment allows transfer of only part of the rights under a financial asset (although this may introduce additional complexities and prevent the assignment being perfected).

The equitable assignment will usually be subject to rights of the issuer (as directed by noteholders or the security trustee) to perfect its title to the assets by completing the requirements under Section 136 LPA so that the transfer becomes a legal assignment. Upon perfection, the issuer or a nominee will hold legal title to the assets.

The triggers to exercise this perfection right will be set out in the transaction documents and would generally apply on the occurrence of certain specified events. Standard perfection events include it becoming necessary under law to perfect the legal title, termination of the servicer and an event of default under the notes. The originator should also grant a power of attorney to the issuer to allow it to take actions on behalf of the originator to perfect the issuer's title to the assets.

Both legal assignment and equitable assignment should be effective to ensure the transfer of financial assets is valid and enforceable by the issuer against the originator, an insolvency official and the originator's creditors. There are, however, certain risks associated with an equitable assignment as compared to a legal assignment (see "Rights for a Transferee" below).

Note that the transfer could also be effected by novation, which would transfer both the rights and obligations under the financial assets to the issuer. However, novation requires the consent of all parties to the agreement giving rise to the financial assets – including the underlying obligor – and is therefore usually impractical. A transfer of obligations could also be problematic as it could mean that the issuer was, for example, obliged to fund any undrawn commitment. For these reasons, the transfer is usually carried out by way of assignment.

In addition, the underlying contracts with the obligors should be reviewed to establish whether they include any contractual restrictions on transfer or confidentiality obligations that would prohibit the assignment to the issuer or unduly limit dealing with information on the obligors. The general position under English law is that, in the absence of an express restriction, rights under a contract may be assigned.

In September 2017, the UK government put draft regulations before Parliament to tackle contractual terms that prohibit or restrict the assignment of receivables. The primary aim of the legislation was to enable small and medium-sized enterprises in the UK to obtain greater access to finance by removing restrictions preventing those enterprises from using their receivables to obtain finance. However, these regulations were withdrawn from Parliament in late 2017 in response to concerns that they would have caused significant commercial uncertainty for transactions that were not intended to be impacted by the legislation. It is anticipated that these regulations will be redrafted and laid before Parliament again, but the timeframe for this is, at the time of writing, uncertain.

Difference Between "True Sale" or a Secured Loan

As above, for a true sale by equitable assignment, the issuer's legal title to the transferred assets would be perfected by notice to the underlying obligors (in accordance with Section 136 of the LPA).

Security under English law can take a number of forms. It is likely that security over contractual rights (including the financial assets in a securitisation) would be granted through an assignment by way of security, with a condition for re-assignment on discharge of the secured obligations – thereby giving rise to a mortgage over the charged assets. The legal requirements for such security are the same as for an absolute assignment, as noted above in relation to a "true sale". Accordingly, if the parties are seeking the protection of a legal mortgage, among other things, notice would need to be given to the underlying obligors. If such requirements are not fulfilled, the assignment by way of security would give rise to an equitable mortgage until notice is given. Security can also be granted by way of charge, which constitutes an encumbrance over the charged assets (as opposed to a mortgage, which, as above, is a transfer with a condition for re-assignment).

In addition, in relation to a secured loan, subject to limited exceptions, interests under charges or mortgages created by an English company (on or after 6 April 2013) are perfected through registration within 21 days of creation. Registration is made with the registry of companies incorporated in England and Wales (Companies House), and is accessible to the public.

The characterisation of the security as fixed or floating will also be relevant in determining the rights of the lender. See "Protection for the Transferred Assets – True Sale vs Secured Loan Transactions" under 1.1 Insolvency Laws for further information.

Rights for a Transferee

The primary risks of a true sale by equitable assignment (as compared with legal assignment) in the context of a securitisation are as follows.

  • Cash-flow interruption – prior to notice being given to the underlying obligor, the obligor is entitled to continue to pay amounts due under the relevant financial asset to the originator, and this constitutes good discharge of the obligor's obligations. Securitisations usually include some or all of the following features to minimise this risk: (i) the originator directs the obligor to pay directly to the issuer; (ii) the originator transfers any payments received in respect of assigned assets to the issuer's account on a regular basis (known as "sweeping"); (iii) prior to sweeping any payments into the issuer's account, the originator holds such payments on trust for the issuer (this is usually under the terms of a specific collection account trust); and (iv) the originator may agree to collateralise a proportion of expected collections. Certain of these features may be drafted to commence or step up following a ratings trigger in relation to the originator.
  • Subject to equities – the originator's rights under the transferred assets will be subject to any prior equities that have arisen in favour of the obligors before the assignment, and to any equities that may arise in the obligors' favour after the assignment but prior to notice of the assignment being given. The effect of giving notice of assignment to the obligor is that the interest of the issuer in the transferred asset will remain subject to equities that were in existence before notice is given. However, in general, equities arising as against the originator after the giving of notice will not affect the issuer. If, however, the equitable right were to arise out of the same contract or if it were to flow out of and be inseparably connected with the dealings and transactions that gave rise to the subject matter of the assignment, the obligor could rely on it as against the issuer, even though that right arose after notice was given. In particular, equitable rights of set-off may accrue in favour of an obligor, enabling the obligor to set off payments due from it to the originator against any amounts due from the originator to it. Examples of such payments include wages (if the obligor is an employee of the originator) or claims for breach of contract against the originator. Securitisations usually include some or all of the following features to minimise such risk:
    1. providing in the underlying contract that obligors cannot exercise any rights of set-off (though subject to consumer protection laws and insolvency laws);
    2. the originator warrants that rights of set-off have not arisen and will not be exercised; if that warranty is breached the originator will be required to repurchase the affected asset(s); and
    3. excluding or limiting assets under which set-off is more likely to arise (eg, loans to employees).
  • Join originator to sue obligors – the lack of notice to an obligor of the assignment means that the issuer will have to join the originator as a party to any legal action that the issuer may want to take against such obligor. This risk is usually minimised by requiring the originator to grant a security power of attorney in favour of the issuer (and the security trustee), allowing the issuer to bring proceedings in the originator's name or to give notice of the assignment to the obligor.
  • Modification of contracts – prior to notice to an obligor of the assignment, the originator could modify the assigned contract without the involvement of the issuer. This risk is usually minimised by the originator undertaking in the sale agreement not to modify the contracts (except in accordance with its procedures for servicing the contracts).
  • Good-faith assignee – a later encumbrancer or assignee of the originator's rights for valuable consideration acting in good faith, and who has no notice of the assignment to the issuer, that gives notice of its interest to the obligors first would take priority over the interest of the issuer. Contractual protections will be included to prevent the originator making such an assignment.
  • Prior trust – beneficiaries under a prior trust have priority over a subsequent assignee even if no notice of the trust is given to the assignee. This risk is usually mitigated by requiring the originator to assign the contracts with full title guarantee, which includes an implied covenant that the originator has the right to dispose of the contracts.

As set out above, securitisations are generally structured using a “true sale” of financial assets. However, as an alternative, the originator could declare a trust over the rights under financial assets as this is also generally an effective method of transferring beneficial title to achieve bankruptcy remoteness. For example, in securitisations, in addition to a sale of financial assets, originators will generally also agree to hold amounts received in respect of the financial assets on trust for the issuer.

However, while a trust is effective to transfer beneficial title, this cannot be perfected to legal title in a straightforward manner. If financial assets were transferred from an originator to an issuer by way of declaration of trust only, this lack of ability to perfect means that legal title would remain with the originator. Therefore, the issuer's title would remain subject to some of the limitations set out in 1.3 Transfer of Financial Assets. This could, among other things, affect the issuer's ability to recover amounts in respect of the financial assets on insolvency of the originator.

Therefore, securitisations are not generally structured to rely solely on a transfer of assets by declaration of trust. If there are restrictions on assignment or assignment of proceeds in the underlying contracts that could affect the validity of a transfer by assignment, then, when assessing the credit risk of the transaction, investors may place a greater reliance on the effect of the trust provisions – however, this will depend on the drafting of such underlying restrictions. Nonetheless, the transfer of financial assets would generally still be primarily effected through a prospective equitable assignment (with rights to perfect). In practice, restrictions on assignment and assignment of proceeds are also quite likely – in effect, to restrict the creation of a trust.

In transaction opinions, legal advisers are typically asked to opine that the trust declared by the originator over amounts received in respect of the transferred assets is validly constituted. This opinion will be given subject to, in particular, qualifications relating to uncertainties over whether the subject matter of the trust will be clearly identifiable (particular issues may arise if there is commingling of amounts received by the originator in respect of the financial assets and other amounts belonging to the originator).

As above, there may be increased focus on such opinions and issues if there are doubts over whether the transfer by assignment will be effective (due to restrictions on assignment in the underlying contracts relating to the assets).

Stamp duty or Stamp Duty Reserve Tax (SDRT) can apply on the transfer of financial assets. Stamp duty can apply to instruments transferring stock and marketable securities at a rate of 0.5% of the consideration for the transfer (or, if the transfer is to a connected company and is of listed securities, 0.5% of the value of the securities if higher). Other securities that can be transferred without a written instrument may be subject to SDRT at the same rate. In most cases, the financial assets will not be stock or marketable securities. If they are, stamp duty can be dealt with by making sure the transferred securities fall within the loan capital exemption provided for in Section 79(4) Finance Act 1986. This will mean that neither stamp duty nor SDRT will apply to the transfer. Practitioners need to be careful where the transferred securities have certain equity-like features – for example, where they include a right to participate in the profits of an entity – as this exemption may not apply.

VAT should not apply to the transfer of financial assets. HMRC has agreed to follow the decision in MBNA Europe Bank Ltd v HMRC [2006] EWHC 2326 (Ch), which found that a transfer of financial assets as part of a securitisation was not a supply for VAT purposes. Even if HMRC decided to change its policy in this respect, the transfer of financial assets should generally be an exempt supply under item 1 of Group 5 of Schedule 9 to VATA 1994 where the supply is made to a UK SPE.

The transfer could be subject to corporation tax for the originator. The accounting treatment is key, and securitisations will regularly have an "on balance sheet" accounting presentation so that no income is recorded in respect of the sold financial assets. The tax rules here are notoriously complex, but practitioners are generally able to find a structure whereby the tax analysis follows the accounting treatment.

If the SPE meets the conditions under the Taxation of Securitisation Company Regulations 2006, it will only be subject to tax on its retained profit. There is no particular minimum amount that the retained profit must equal; however, HMRC has previously accepted GBP1,000 as sufficient.

If the SPE does not meet the above conditions, it would be subject to normal UK corporation tax rules, which is likely to be problematic. Even though the SPE typically pays out almost everything it receives, under normal UK corporation tax rules there could still be a taxable profit for the SPE, unless all payments were to qualify for tax deductions. A particular concern is that "limited recourse" debt is typically characterised as a distribution (or dividend) for UK tax purposes and, as such, is not tax-deductible. A catastrophic position for the SPE to find itself in would be if all its income under the financial assets were to be taxable but none of the interest on the capital market debt was deductible, which is a possible outcome in the absence of the securitisation company treatment referred to above. Another issue is derivatives that are taxed in accordance with their accounting treatment, which could give rise to profit in years where swaps are "in the money" and accounted for on a fair-value basis. This could give rise to tax on profit that is never economically realised by the SPE, as invariably the SPE will hold its swaps to maturity. Securitisation company treatment solves this problem, as payments and receipts under swaps are treated on a cash basis with only the issuer's retained profit (after all payments and receipts have been made) being subject to tax.

Withholding tax should not apply on the transfer of the financial assets itself, although practitioners do need to consider whether withholding tax applies to payments made on the financial assets where the assets have been transferred overseas. For example, in the classic case of residential mortgages, interest on the securitised mortgages would be subject to withholding if the SPE was not tax-resident in the UK. Double tax treaty clearances are available if the SPE is in a jurisdiction with which the UK has a treaty with an appropriate interest article (eg, Luxembourg, the Netherlands, Ireland).

In addition to ensuring the SPE qualifies as a securitisation company, the application of withholding tax to payments made under the notes is a key tax consideration. There are multiple exemptions that can apply. One of the most common is the "quoted Eurobond" exemption, which applies when the notes are listed on a recognised stock exchange. Where this does not apply, practitioners will need to consider to whom the notes are being issued and whether specific exemptions can apply in all circumstances.

Withholding tax on annual payments may need to be considered in the context of payments under any residual certificates. This will not apply where the SPE is a securitisation company. Where the residual certificate-holder is subject to UK corporation tax, there will also be no withholding. In other cases, HMRC would typically be expected to give clearance that payments are not "annual payments" so that no withholding is required.

Practitioners will also need to consider the application of secondary tax liabilities, to ensure that other parties in the transaction do not become liable for tax that is the primary liability of another party. This is dealt with by making sure other parties in the transaction do not have control of – or are not under common control with – the party that could become primarily liable for the tax. Certain secondary tax liabilities do not apply to securitisation companies.

From a tax perspective, legal opinions in relation to securitisations usually cover:

  • the tax treatment of the SPE;
  • potential stamp taxes and VAT on the transfer of the financial assets;
  • stamp taxes on issue of the notes;
  • VAT on the services provided to the SPE;
  • withholding tax on payments under the notes; and
  • secondary tax liabilities.

The qualifications include that the opinion only relates to UK tax, that the parties will remain tax-resident in their respective jurisdictions, and limits on the activities that are assumed to be carried out by the SPE. The opinions may also be subject to assumptions about the identity of the noteholders, the group structure, and the purposes for which the parties have entered into the arrangement.

Balance sheet treatment, and the related question of whether the SPE is consolidated for accounting purposes into the originator's group, will be addressed by accountants separately from the legal analysis, according to applicable accounting principles.

Whether a transaction is a true sale and whether it should be treated as on or off balance sheet are separate questions. It is possible to have a true sale for legal purposes but to be on balance sheet for accounting purposes.

As above, accounting analysis in relation to a securitisation is generally undertaken separately from the legal analysis.

The Securitisation Regulation ((EU) 2017/2402) has applied in the EU since 1 January 2019. It forms part of the European Commission's Action Plan on Building a Capital Markets Union, and is intended to harmonise rules on risk retention, due diligence and disclosure across the different categories of European regulated investors. The Securitisation Regulation applies to all securitisations (subject to grandfathering provisions – see below) and, in addition to the rules applicable to all securitisations, introduced a framework for simple, transparent and standardised (STS) securitisations.

The Securitisation Regulation repealed the disclosure, due diligence and risk retention provisions that previously applied to different categories of regulated investors under, as applicable, the Capital Requirements Regulation (CRR), the Alternative Investment Fund Managers Directive (AIFMD) (and the related delegated regulation – AIFMR) and the Solvency II Directive and related Solvency II Delegated Act (“Solvency II”). These requirements have been replaced with one set of harmonised rules applying to securitisations across all financial sectors (to banks, investment firms, insurers and other entities).

For these purposes, it is important to note that "securitisation" has the same wide meaning as under CRR. A "securitisation" is defined to be any transaction under which the credit risk associated with an exposure or pool of exposures is tranched and (i) payments in the transaction are dependent upon the performance of the exposure or pool of exposures and (ii) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction. Accordingly, the Securitisation Regulation is relevant to any securitisation in the EU, regardless of whether or not there is an issue of securities and whether or not those securities are marketed or acquired bilaterally. This can be contrasted with, for example, the US risk retention rules that apply on the issue of asset-backed securities.

Securitisations that closed prior to 1 January 2019 are subject to grandfathering, so the previous regime continues to apply to such transactions. However, grandfathering is lost if there is a new issue of securities under such transactions on or after 1 January 2019 (or new securitisation positions are created under transactions that do not involve an issuance of securities – eg, where the issuer’s liabilities are documented under loan facilities). Parties should consider the rules relating to grandfathering when pre-2019 transactions are subject to amendment – particularly if the amendments relate to further issuances of notes, extensions to maturity and/or changes to investor commitment – as this could lead to grandfathering being lost. Drawings under committed variable funding notes (VFNs) or revolving credit facilities (RCFs) should not be considered a new issue of securities for these purposes, although there is no specific guidance on the point.

It is possible to designate pre-2019 transactions as STS-compliant, providing the applicable criteria are satisfied.

The general provisions under the Securitisation Regulation apply to all securitisations. These include the requirements in respect of risk retention, due diligence requirements for investors, transparency requirements (for originators, sponsors and issuers), criteria for credit granting and a ban on re-securitisation (see under "Specific Disclosure Laws or Regulations" below, and 4.3 Credit Risk Retention).

In addition, the Securitisation Regulation sets out criteria with which a securitisation must comply if it is to be designated as “STS” and therefore provide favourable prudential treatment for certain regulated investors. Specific STS criteria are included for simplicity, enhanced transparency and standardisation (see also "Specific Disclosure Laws or Regulations" below). STS designation is only available for traditional "true sale" securitisations (although there are ongoing discussions on the possibility of extending classification to synthetic securitisations) and where the originator and issuer are established in the EU.

Detailed requirements in relation to provisions of the Securitisation Regulation are included in regulatory technical standards (RTS). These cover, for example, disclosure rules for securitisations, risk retention requirements, STS homogeneity, STS notifications and rules for securitisation repositories. Certain of the RTS have been published in the Official Journal of the European Union (the "Official Journal") and apply,  although at the time of writing not all RTS have been finalised.

The CRR Amending Regulation (Regulation (EU) 2017/2401) has also applied since 1 January 2019. The CRR Amending Regulation implemented the revised Basel framework for securitisation in the EU and provides for a more risk-sensitive prudential treatment for STS securitisations. The prudential treatment for securitisations has also been amended in relation to the Liquidity Coverage Ratio and Solvency II to take account of the introduction of STS designation for securitisations. See 4.6 Treatment of Securitisation in Financial Entities for further details.

As EU regulations, the Securitisation Regulation and CRR Amending Regulation are, at the time of writing, directly applicable in the UK (and other EU member states). The precise position when the UK leaves the EU is, at the time of writing, uncertain. Current expectations are that, upon the UK leaving the EU, UK securitisations would not qualify for STS treatment because the originator and issuer must be established in the EU (third country recognition arrangements are not included in the Securitisation Regulation). The Securitisation Regulation should be “mirrored” into UK law as “retained EU law” as contemplated by the European Union (Withdrawal) Act 2018 and the Securitisation (Amendment) (EU Exit) Regulations 2019. If these exit regulations are implemented, there would be a parallel UK STS regime that would be recognised in the UK but not (absent another step by the EU) in the EU. As drafted at the time of writing, under the exit regulations, EU STS transactions notified to the European Securities and Markets Authority (ESMA) within two years of the UK's exit from the EU would be treated as eligible for UK STS status. This guide focuses on the regulatory regime applicable at the time of writing to securitisations in the UK, which includes applicable EU law such as the Securitisation Regulation and CRR Amending Regulation.

In addition to the rules applicable to investors under the Securitisation Regulation discussed in this section (4 Laws and Regulations Specifically Relating to Securitisation), note that specific rules in relation to securitisation also apply to money market funds under the Money Market Funds Regulation (MMFR). The aim of the MMFR is to ensure that money market funds are able to withstand future market turmoil by introducing requirements on portfolio structure, establishing a capital buffer, improving transparency, risk management and reporting, and reducing over-reliance on rating agencies. Among other matters, MMFR imposes requirements on the investment policies of money market funds as regards investments in securitisations.

The MMFR was negotiated separately from the Securitisation Regulation. However, the investment criteria under MMFR have been amended, where applicable, to include reference to STS criteria under the Securitisation Regulation.

4.1 Specific Disclosure Laws or Regulations

There is no separate disclosure regime relating to securitisations in England and Wales. However, as above, securitisation-specific disclosure obligations are placed on transaction parties under the Securitisation Regulation (see below). In addition, to the extent relevant, general rules relating to disclosure in respect of issuances of debt securities apply to certain securitisations (see 4.2 General Disclosure Laws or Regulations).

The transparency and disclosure requirements under the Securitisation Regulation replace, and closely follow, the securitisation-specific disclosure requirements that previously applied under Article 8b of Regulation 462/2013 (“CRA 3”), which were never fully implemented. The RTS relating to disclosure under the Securitisation Regulation has been adopted by the European Commission but, at the time of writing, has not yet been published in the Official Journal (although changes to the form adopted by the Commission are not expected). Once the RTS relating to disclosure under the Securitisation Regulation applies, transaction parties must report under the specific disclosure templates provided by ESMA. Until the RTS relating to disclosure under the Securitisation Regulation applies, transaction parties are technically required to look to the reporting templates settled under Article 8b of CRA 3 (but read in conjunction with a statement published by the Joint Committee of the European Supervisory Authorities on 30 November 2018).

The Securitisation Regulation places disclosure requirements on the originator, sponsor and issuer. These entities must designate one entity (the “Reporting Entity”) among themselves to fulfil these requirements.

The requisite information must be made available to investors, competent authorities and (upon request) potential investors. For public transactions, the Reporting Entity must fulfil this requirement by making the requisite information available:

  • through filings with a securitisation repository (a specific role introduced by the Securitisation Regulation as an entity that collects and maintains details of the securitisation to enable regulated entities and investors to fulfil their obligations); or
  • pending registration of an entity to act as a securitisation repository in the market, on a website (satisfying safety and operational requirements as provided for by the Securitisation Regulation).

On private transactions, this information will be provided directly to investors, the competent authority and (on request) potential investors. The PRA and the FCA (as the applicable competent authorities) have developed forms of notification to be used in the UK in relation to the obligation to provide information to the competent authority. Provided such a notification is delivered, further information is not required to be provided to the PRA or FCA (as applicable) as competent authority in the UK (unless requested).   

Prior to the pricing of a securitisation, the Reporting Entity must make the following available:

  • the documentation that is essential for the understanding of the transaction (ie, the transaction documents);
  • for an STS securitisation, the STS notification (which confirms and explains the manner in which each STS criterion is satisfied);
  • for a securitisation where a prospectus has not been prepared (see 4.2 General Disclosure Laws or Regulations), a transaction summary of the main features of the securitisation, including:
    1. diagrams containing an overview of the transaction;
    2. the ownership structure;
    3. the cash flows;
    4. details regarding the exposure characteristics;
    5. the priority of payments; and
    6. details of the voting rights of noteholders and their relationship with other secured creditors.

There are also certain periodic reporting requirements that apply for the life of the transaction (see 4.4 Periodic Reporting).

Prior to investing in a securitisation, regulated investors must verify that the originator, sponsor and issuer have made available (through the Reporting Entity) all information that is required to be disclosed under the Securitisation Regulation.

Separately, certain specific disclosure requirements will also apply if the notes are intended to be admitted as eligible collateral for liquidity schemes provided by the European Central Bank and/or the Bank of England under the rules of those schemes.

Unlike the securitisation-specific disclosure rules mentioned under 4.1 Specific Disclosure Laws or Regulations, in order for general disclosure rules relating to the issue of securities to be relevant to securitisations there will actually need to have been an issue of securities (ie, bonds or notes). If there has been, the level of disclosure required will turn on (i) whether there is an offer to the "public" and (ii) whether, even though there might be an exempt offer, the notes are expected to be admitted to trading on a trading venue that constitutes a "regulated market" for the purposes of MiFID II (a "MiFID-regulated market") or an exchange-regulated market.

Where an offering document for securities is subject to Regulation (EU) 2017/1129 (the "Prospectus Regulation"), it is referred to as a "prospectus", while an offering document falling outside the scope of the Prospectus Regulation can have a variety of names, such as offering circular, listing particulars or offering memorandum - depending on the jurisdiction and context. We use the term "prospectus" solely for offering documents subject to the Prospectus Regulation and "offering document" for other cases.

Under the Financial Services and Markets Act 2000 (FSMA), offers of transferable securities in the UK cannot be made without the publication of an approved prospectus, unless the notes offered or the person to whom the offer is made satisfies an exemption. Such exemptions include offers to professional investors, or notes that are issued in denominations of at least EUR100,000 (or the equivalent). For securitisations, it is therefore very unlikely that there will be an offer to the "public" under FSMA because the target investors will usually be professional investors (for example, financial institutions and pension funds).

Nonetheless, a prospectus or offering document may still be required for securitisations where the notes are expected to be admitted to trading on a MiFID-regulated market or an exchange-regulated market. Admission to trading, and in some cases, admission to the related official list (or "listing", as more commonly known) may be sought for a variety of reasons, including liquidity, market visibility and to fall within the "quoted Eurobond" withholding tax exemption.

The Prospectus Regulation entered into force on 20 July 2017. As a regulation, the Prospectus Regulation is (unlike a directive) directly applicable in each member state of the EU without further implementation measures. The Prospectus Regulation (together with related legislation) provides for a single regime in the EU governing the content, format, approval and publication of prospectuses. With effect from 21 July 2019, the Prospectus Regulation repealed and replaced the provisions of the Prospectus Directive (which, together with related legislation, provided the EU regime applicable to prospectuses prior to such date). The Prospectus Regulation was introduced with the aim of (among other things) increasing comprehensibility for investors, and it therefore made certain changes to the detailed requirements in respect of the contents and format of prospectuses that applied under the Prospectus Directive regime – in particular, in relation to prospectus summaries and risk factors. See "Material Forms of Disclosure" below for further details of the requirements in relation to prospectuses.

The principal places for debt securities to be admitted to trading are London, Dublin and Luxembourg.

Admission to trading is subject to approval by the relevant stock exchange where admission is sought – ie, the London Stock Exchange (LSE), Euronext Dublin and the Luxembourg Stock Exchange, respectively. If there is an exempt offer under the Prospectus Regulation and admission is not being sought on a MiFID-regulated market, then any offering document (if required) would be approved solely by the relevant stock exchange.

However, where a prospectus is required (either because the securities are subject to a non-exempt offer or because admission to trading is sought on a MiFID-regulated market), approval of the prospectus would be determined by the relevant local competent authority under the Prospectus Regulation, which in the case of London, Dublin and Luxembourg are:

  • for London, the UK Listing Authority (UKLA);
  • for Dublin, the Central Bank of Ireland; and
  • for Luxembourg, the Commission de Surveillance du Secteur Financier (CSSF).

Material Forms of Disclosure

Applicable disclosure requirements are fulfilled through publication of an offering document or prospectus. As described above, a prospectus is required for public offers in the UK (unless an exemption applies) or if the securities will be admitted to trading on a MiFID-regulated market (which includes the LSE's Main Market).

A prospectus (or offering document) is a listing, marketing and disclosure document that describes the issuer, the terms of the notes, the originator, the financial assets, the transaction and the risks (so-called risk factors) of investing in the notes. The content of prospectuses is primarily governed by the Prospectus Regulation, while the content of offering documents (and also, to a lesser degree, prospectuses) is governed by local legislation, rules of the listing authority or stock exchange and market custom.

As noted above, with effect from 21 July 2019, the Prospectus Regulation repealed and replaced the provisions of the Prospectus Directive. However, grandfathering applies, such that a prospectus approved in accordance with the Prospectus Directive regime prior to 21 July 2019 continues to be governed by that regime until the end of the prospectus's validity or 21 July 2020 - whichever is earlier.

In the case of debt securities to be admitted to trading on a MiFID-regulated market of the LSE, the prospectus must satisfy the following.

  • Specific content requirements that are to be found in (i) the applicable Annexes to the Commission Delegated Regulation (EU) 2019/980 supplementing Regulation (EU) 2017/1129 and (ii) in the UKLA's rules.
  • The general content requirements of Section 87A of FSMA, which provides that the prospectus:
    1. "… must contain the information necessary to enable investors to make an informed assessment of: the assets and liabilities, financial position, profits and losses, and prospects of the issuer of the securities; and
    2. the rights attaching to the securities".
  • The requirement under FSMA that the prospectus should be comprehensible and easy to analyse, and reflect the particular nature of the securities and the issuer.

In addition:

  • under Article 29(2) of the EU Benchmark Regulation (Regulation (EU) 2016/1011) (BMR), where a prospectus published under the Prospectus Regulation relates to an offer of transferable securities that reference a benchmark, the issuer, offeror or person asking for admission to trading on a MiFID-regulated market needs to ensure that the prospectus includes clear and prominent information stating whether the benchmark is provided by an administrator included in the register provided for by the BMR; and
  • under Regulation (EU) No 1286/2014 (as amended, the "PRIIPs Regulation"), a key information document must be prepared if the notes issued under a securitisation are to be made available to retail investors in the EEA. Where notes issued under a securitisation are not intended to be made available to retail investors in the EEA, the prospectus must include disclosure about the PRIIPs Regulation clearly stating this.

The level of disclosure required in a prospectus is significantly less if the offering is governed by the wholesale regime rather than the retail regime (this requires the securities to have a minimum denomination equal to or greater than EUR100,000).

The requirements of a prospectus are set out in the Prospectus Regulation itself and the Commission delegated regulations enacted thereunder, and are incorporated into UK regulations by the Prospectus Regulation Rules published by the UKLA. The Prospectus Regulation Rules (together with the Listing Rules and the Disclosure and Transparency Rules) form part of the FCA Handbook and are available on the FCA website.

In relation to securitisations, there are certain building blocks setting out minimum disclosure requirements for offerings of "asset-backed securities". These are set out in annexes to the Prospectus Regulation Rules (see, in particular, annexes 9 and 18).

Principal Regulators

The principal regulator of disclosure requirements for offerings of securities is the relevant competent authority under the Prospectus Regulation (as above, in relation to securities subject to a non-exempt offer in the UK or to admission to trading on a MiFID-regulated market of the LSE, this would be the UKLA, which is part of the FCA).

Principal Laws and Regulations on Violations of Required Disclosure

The inaccuracy of information in, or omission of information from, the prospectus or offering document may give rise to criminal and civil liability for the issuer (or other parties who accept responsibility for certain sections of the prospectus or offering document but, generally, not for the directors of the issuer of debt securities admitted to trading where the UKLA is the competent authority).

Civil sanctions could include fines, compensation payments to investors who suffer a loss and/or suspension of securities from trading.

Criminal sanctions, which would generally only apply if there is dishonesty involved, could include fines or imprisonment.

See 5 Documentation on transaction provisions relating to risk allocation in respect of such potential liability.

The Public Market vs the Private Market

Investors in public and private offerings will be similar (or the same) entities.

However, generally speaking, a public offering allows access to an additional funding source and a wider investor base and may allow the issuer (and therefore the originator) to achieve tighter financing terms (subject to market conditions).

The notes issued under a public offering may be viewed by investors as having greater liquidity, and certain investors require any securities that they invest in to be listed as part of their internal investment guidelines.

Public offerings will also generally attract more publicity and promote market awareness of the originator.

However, a public offering generally entails greater upfront costs (relating to the drafting of the prospectus or offering document and related due diligence) and ongoing disclosure obligations. Therefore, a private securitisation (or a variant, such as a portfolio sale or forward flow with senior financing) is sometimes viewed as a preferable route by market participants (and certain aspects of the disclosure and transparency requirements of the Securitisation Regulation will not apply to private securitisations). An originator will have to hold a sufficiently large pool of eligible financial assets to justify the greater upfront costs of a public securitisation and to allow an issue of notes that will be sufficiently liquid in the market, pending which an originator may use a private "warehouse" securitisation to fund origination of financial assets until it has a sufficiently large pool.

Legal Opinions

There will generally be legal opinion coverage that the issuer does not require any consents or approvals for the purposes of the transaction. This would address whether or not a prospectus needed to be filed and approved with the relevant competent authority. The legal opinion will not cover whether the prospectus content is itself sufficient for these purposes.

Retention Requirements

The Securitisation Regulation provides that the originator, sponsor or original lender in respect of a securitisation must retain on an ongoing basis a material net economic interest in the securitisation of not less than 5% (in one of the five specified methods for retention).

In addition, there is an “indirect” due diligence obligation on institutional investors to verify that the above retention obligation is being fulfilled. This indirect obligation closely follows the requirements in respect of risk retention that applied to regulated investors prior to 1 January 2019 (under, as applicable, CRR, AIFMD/AIFMR and Solvency II). However, the “direct” obligation placed on the originator, sponsor or original lender noted above was introduced by the Securitisation Regulation.

An institutional investor that invests in a securitisation must also verify that relevant information in relation to the retention is disclosed to it (see "Disclosure Obligations" below, and 4.4 Periodic Reporting).

An originator for these purposes must either (i) itself or through related entities, be directly or indirectly involved in the original agreement which created the obligations being securitised or (ii) purchase a third party's exposures on its own account and then securitise them. The originator must also be an “entity of real substance”, as opposed to an entity established or operating solely for the purpose of securitising exposures.

A sponsor for these purposes includes either a credit institution or an investment firm (other than the originator) that (i) establishes and manages a securitisation that purchases exposures from third parties or (ii) establishes a securitisation that purchases exposures from third parties and delegates day-to-day portfolio management to an entity authorised under the UCITS Directive (Directive 2009/65/EC), AIFMD or MiFID (Directive 2014/65/EU).

An original lender is an entity that, itself or through related entities, directly or indirectly, concluded the original agreement that created the obligations being securitised.

The retained exposure must be held for the life of the transaction and must not be hedged or transferred.

Methods of Retention

There are five different methods of retention:

  • vertical slice;
  • originator’s pari passu share;
  • randomly selected exposures kept on balance sheet;
  • first loss tranche (similar to the US horizontal slice option); and
  • first loss exposure to every securitised exposure in the securitisation.

Disclosure Obligations

As discussed in 4.1 Specific Disclosure Laws or Regulations and 4.4 Periodic Reporting, details of the risk retention must be provided by the Reporting Entity, through quarterly investor reports, to investors, competent authorities and (on request) potential investors.

The information to be provided includes details of the risk retention method and the risk retention holder.

Provision of Disclosure

As noted in 4.1 Specific Disclosure Laws or Regulations, for public transactions the Reporting Entity must fulfil its disclosure requirements, including providing investor reports containing details of the risk retention, through filings with a securitisation repository (or, pending registration of an entity to act in this role in the market, on a specified website). On private transactions, this information will be provided directly to investors, the competent authority (to the extent requested by the competent authority in addition to the required notification in the UK) and (on request) potential investors.

In addition, on a public transaction, details of the retention are typically included in the "Summary" and "Risk Factors" sections of the prospectus, as well as in a dedicated risk retention section. On both public and private transactions, the retention requirements are also generally covered by representations and covenants in the transaction documents.

Penalties for Non-Compliance

Penalties would be determined by the relevant competent authority as regulator.

EU member states are required to adopt rules that provide for administrative sanctions for cases of negligent or intentional violation of obligations under the Securitisation Regulation, which would include such violations of the risk retention requirements. Sanctions can include:

  • public censure concerning the identity of the person who committed the violation and the type of violation committed;
  • a temporary ban of the members of the administrative bodies of the originator, sponsor or issuer (as the case may be) from the exercise of the management of such companies; and/or
  • fines of up to EUR5 million or up to 10% of annual net sales.

In addition, EU member states may, at their option, also provide for criminal sanctions for the most serious violations.

"Substitutive Compliance" by Foreign Issuers

European risk retention rules do not include a concept of "substitutive compliance" in relation to securitisations that have not been structured to comply with European risk retention rules. Where relevant, parties would need to take advice on what changes would need to be made to a securitisation in order to allow it to comply with European risk retention rules in each particular instance.

Legal Opinions

Legal advisers generally provide advice in relation to structuring a transaction in light of risk retention requirements.

It is not general practice for legal advisers to provide a formal legal opinion on risk retention compliance. However, specific advice is sometimes sought by arrangers and/or originators on whether the identity of the retainer and the method of retention are within the scope of the risk retention rules. This would often take the form of a memorandum and would be subject to, in particular, a qualification noting the absence of clear regulatory or judicial guidance on the application of the rules in more complex or unusual retention scenarios.

As noted above, the Securitisation Regulation places periodic reporting obligations on the originator, sponsor and issuer (who must designate a Reporting Entity among themselves to fulfil these requirements).

During the lifetime of a securitisation, the Reporting Entity must make the following available at least on a quarterly basis.

  • Information on securitisation positions (ie, loan level reporting).
  • An investor report including information on:
    1. performance of the underlying exposures;
    2. trigger events entailing any changes in the priority of payments or substitution of any party to the transaction;
    3. the cash flows generated by the underlying exposures and by the liabilities of the securitisation; and
    4. the risk retention (eg, which retention modality has been applied).

As noted under 4.1 Specific Disclosure Laws or Regulations, ESMA has developed forms of the loan level and investor reporting templates that will need to be used on all securitisations – both public and private transactions – once the RTS relating to disclosure under the Securitisation Regulation applies. Until the RTS relating to disclosure under the Securitisation Regulation applies, transaction parties are technically required to comply with the existing requirements in this regard as set out in the regulatory technical standards relating to Article 8b of CRA 3 (but, in the case of reporting obligations, read in conjunction with a statement published by the Joint Committee of the European Supervisory Authorities on 30 November 2018), which has led to a variety of approaches to reporting being adopted.

As noted in 4.1 Specific Disclosure Laws or Regulations, for public transactions, these reporting requirements must be fulfilled through filings with a securitisation repository (or, pending registration of an entity to act in this role in the market, on a specified website). On private transactions, this information will be provided directly to investors, the competent authority and (on request) potential investors. The PRA and the FCA (as the applicable competent authorities) have developed forms of notification to be used in the UK in relation to the obligation to provide information to the competent authority. Provided such a notification is delivered, further information is not required to be provided to the PRA or FCA (as applicable) as competent authority in the UK (unless requested).   

There is also a requirement to promptly make any inside information (for the purposes of the Market Abuse Regulation ((EU) No 596/2014) (MAR)) relating to the securitisation available to investors, the competent authority and, if requested, potential investors. This is in addition to the requirement to make such information available to the public under MAR. Even if MAR is not applicable to the notes, the following information must nonetheless be provided promptly:

  • any material breach of the obligations under the transaction documents;
  • any structural change that could materially impact the performance of the securitisation;
  • any change in the risk characteristics of the securitisation or of the underlying exposures that could materially impact the performance of the securitisation;
  • any material amendment to the transaction documents; and
  • in the case of STS securitisations, any loss of STS eligibility.

The CRA Regulation (Regulation 1060/2009) established a compulsory registration process for credit rating agencies (RAs) operating in the EU. The CRA Regulation also aimed to:

  • ensure that RAs avoid and manage appropriately any conflict of interest;
  • ensure the quality of rating methodology and ratings;
  • increase the transparency of RAs; and
  • provide a mechanism by which EU-registered RAs can endorse ratings issued by non-EU RAs.

The CRA Regulation was amended by CRA 2 (Regulation 513/2011), which transferred responsibility for the registration and ongoing supervision of credit rating agencies to ESMA.

Certain securitisation-specific amendments applying to RAs and other market participants were made to the CRA Regulation under CRA 3. Particular requirements in relation to securitisations are set out below.

Disclosure Requirements

As noted in 4.1 Specific Disclosure Laws or Regulations, the Securitisation Regulation repealed and replaced the disclosure obligations relating to structured finance instruments set out in Article 8b of CRA 3. However, until the RTS relating to disclosure under the Securitisation Regulation applies, transaction parties are technically required to comply with the requirements under Article 8b of CRA 3 (but, in the case of reporting obligations, read in conjunction with a statement published by the Joint Committee of the European Supervisory Authorities on 30 November 2018), which has led to a variety of approaches to reporting being adopted.

Used on Structured Finance Transactions

CRA 3 also:

  • introduced a two ratings requirement for securitisations requiring issuers, originators, arrangers or sponsors (or related third parties) of structured finance instruments to obtain ratings from two credit-rating agencies where any such party obtains the ratings; and
  • requires that when any of those parties intend to mandate at least two credit rating agencies it must consider mandating an agency with 10% or less of total market share.

CRA Regulators

The securitisation-specific requirements above are primarily placed on issuers and originators rather than on rating agencies themselves. As such, violations of those rules would be a matter for the relevant competent authority. Penalties could include financial, regulatory or other sanctions.

In calculating their regulatory capital requirements, banks and investment firms are required to allocate risk weights to any securitisation exposures they hold as investors. They are also prohibited from investing in a securitisation unless the originator of the securitisation retains at least 5% of the risk arising from the underlying assets. Insurance companies are subject to similar requirements.

Banks often act as originators of securitisations in order to reduce the capital requirements that arise from portfolios of their assets, subject to satisfying applicable regulatory conditions. Such securitisations may take effect either as a "true sale" or as a synthetic securitisation of the relevant assets to achieve regulatory capital relief for the bank.

Banks may also act as investors in securitisations, and the position of banks as investors is focused on below.

The Basel Committee on Banking Supervision (the "Basel Committee") published a regulatory capital framework in 2006 (the "Basel II framework"), and subsequently approved significant changes and extensions to the Basel II framework (such changes and extensions being commonly referred to as "Basel III"), including new capital and liquidity requirements intended to reinforce capital standards and establish minimum liquidity standards for credit institutions. In particular, the changes refer to, amongst other things, new requirements for the capital base (including an increase in the minimum Tier 1 capital requirement), measures to strengthen the capital requirements for counterparty credit exposures arising from certain transactions and the introduction of a leverage ratio as well as short-term and longer-term standards for funding liquidity (the latter being referred to as the "Liquidity Coverage Ratio" and the "Net Stable Funding Ratio", respectively).

The European Union authorities incorporated the Basel III framework into EU law, primarily through Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (Capital Requirements Directive, or CRD) and the CRR, together known as the "CRD IV-Package", which generally entered into application in the EU on 1 January 2014. It should be noted that, whilst the provisions of the CRD were required to be incorporated into the domestic law of each EU member state, the CRR has direct effect, and does not need to be implemented into the relevant national law.

Additionally, in accordance with Article 460 of the CRR, on 17 January 2015, the Commission Delegated Regulation (EU) 2015/61 of 10 October 2014 to supplement Regulation (EU) No 575/2013 of the European Parliament and the Council with regard to liquidity coverage requirement for Credit Institutions (the "LCR Regulation") was published in the Official Journal of the European Union; this subsequently entered into application on 1 October 2015. The LCR Regulation sets out assumed asset inflow and outflow rates, the better to reflect actual experience in times of stress. Further, it sets out the EU application of the Liquidity Coverage Ratio, and defines specific criteria for assets to qualify as "high-quality liquid assets", the market value of which shall be used by credit institutions for the purposes of calculating its relevant Liquidity Coverage Ratio. Subject to the satisfaction of certain criteria, notes issued in a securitisation may qualify as high-quality liquid assets. Due to amendments to the LCR Regulation under Delegated Regulation (EU) 2018/1620 (“LCR Delegated Regulation”), which entered into force on 19 November 2018 and applies from 30 April 2020, only STS-compliant securitisations will be able to qualify as high-quality liquid assets. Grandfathering of legacy non-STS transactions is not expected be included for these purposes.

The calibrations for securitisation investments by insurance and reinsurance undertakings under Solvency II have also been revised to take account of the introduction of STS designation for securitisations.

In November 2016, the European Commission published details of its proposals for an amended version of the CRR and CRD IV, namely (i) CRR II (COM(2016)850) for implementation no earlier than January 2019, and (ii) CRD V (COM(2016)854), to be transposed into national law within one year of the date of its entry into force. CRD V and CRR II were considered by the European Parliament and the Council, and the CRD V Directive (EU) 2019/878 and CRR II Regulation (EU 2019/876) were subsequently published in June 2019.  As at the time of writing, the majority of the amendments to the CRD IV-Package under the CRR II Regulation and CRD V Directive do not yet apply. The majority of the amendments under the CRR II Regulation will apply from 28 June 2021. Member states are expected to adopt measures to comply with the CRD V Directive by 28 December 2020 and to apply such measures by 29 December 2020. Binding regulatory technical standards and implementing technical standards are to be developed by the European Banking Authority. A proposal included in COM(2016)(850), which has been separately implemented, is the phasing-in of the new incremental provisioning requirements for credit risk under IFRS (see Regulation (EU) 2017/2395, which entered into application on 28 December 2017).

The CRR Amending Regulation (as mentioned in 4.1 Specific Disclosure Laws or Regulations) amends the capital requirements in the CRR for credit institutions and investment firms originating, sponsoring or investing in STS transactions, and addresses the shortcomings of the previous regime, in particular reducing reliance on credit rating agencies by implementing a new hierarchy of the three approaches for calculation of capital requirements (broadly following the recommendations set out in the revised Basel framework for securitisations, which was originally published by the Basel Committee in December 2014 and updated in July 2016 to include regulatory capital treatment for simple, transparent and comparable securitisations) and adopting a more risk-sensitive prudential treatment for STS securitisations by providing for the three approaches to be recalibrated in order to generate lower capital charges for positions in transactions qualifying as STS securitisations.

Senior positions in STS securitisations have the advantage of being subject to a lower floor of 10%, provided they meet additional requirements set out in the CRR Amending Regulation, which are designed to minimise risk further. A floor of 15% continues to apply to non-senior positions in STS securitisations and to non-STS securitisations, and a floor of 100% applies to re-securitisation positions.

Enforcement

These requirements are enforced by the Prudential Regulatory Authority (PRA) in relation to UK-regulated banks.

Material Terms of Regulations

The main European regulation that applies to the use of derivatives in securitisations is the Regulation on over-the-counter (OTC) derivatives, central counterparties (CCPs) and trade repositories (also known as the European Market Infrastructure Regulation), which entered into force on 16 August 2012 and was amended by a regulation that broadly came into force on 17 June 2019 (as amended, EMIR). EMIR introduced new requirements including trade reporting, certain risk-mitigation techniques such as the requirement to post margin in respect of OTC derivative transactions, and the requirement to clear certain derivative transactions through a CCP. For the purpose of this section, the term "OTC derivative transaction" will be used to refer to non-cleared derivative transactions.

Under EMIR, parties to an OTC derivative transaction are classified as financial counterparties (FCs) or non-financial counterparties (NFCs). FCs are entities such as credit institutions, investment firms, insurers and pension schemes, while NFCs are all entities other than FCs or CCPs. FCs and NFCs are further divided into those whose consolidated group aggregate positions in derivatives are above certain thresholds (FC+s and NFC+s) set out in EMIR and delegated legislation enacted thereunder, and those whose aggregate positions are below these thresholds (FC-s and NFC-s). FC+s will need to clear all their OTC derivatives transactions that are within classes of derivatives that ESMA has declared to be subject to mandatory clearing, while NFC+s will only need to clear their OTC derivatives transactions within such classes where they have exceeded the relevant EMIR threshold for such classes. To date, certain interest rate swaps and credit derivatives have been declared to be subject to the clearing obligation. Derivatives transactions entered into by NFCs for the purposes of commercial hedging or treasury activities that are objectively measurable as reducing risks directly in relation to the commercial activity of the group or treasury financing activity of the NFC or that group will not count towards the determination of the EMIR thresholds. There is also an intragroup exemption, subject to certain conditions being met, and an initial exemption for certain pension schemes.

Under EMIR, all derivatives contracts within the scope of EMIR must be reported to a registered trade repository by the working day following their trade date.  Prior to 18 June 2020, in the case of an OTC derivative transaction both parties to the transaction are responsible for ensuring that the details of the transaction (including modifications and amendments) are reported, without duplication, to the trade repository, although the reporting obligation can be delegated by prior agreement to one counterparty or to a third party. From 18 June 2020, the above remains the same, except, in the case of an OTC derivative transaction between an FC and an NFC-, where the FC is responsible for ensuring details of both sides of the transaction are reported to a trade repository.

Under EMIR, parties to OTC derivatives transactions need to have appropriate procedures in place to monitor and mitigate operational and counterparty credit risk, including timely confirmation of the terms of their OTC derivatives transactions, portfolio reconciliation, portfolio compression and dispute resolution. FCs and NFC+s must also engage in the timely, accurate and appropriately segregated exchange of collateral (initial and variation margin), and conduct a mark-to-market valuation of their transactions on a daily basis, reporting this to a trade repository. The obligation to exchange initial margin is being phased in, based on the size of the parties to the transactions, and will ultimately apply (once the phased implementation is complete) to all new OTC derivative transactions where both parties have or belong to groups with an aggregate average notional amount of OTC derivative transactions of more than EUR8 billion. Neither FCs nor NFC+s need to exchange initial margin or variation margin where their counterparty is an NFC- (or would be an NFC- if it was incorporated in the EU). In many cases, an SPE is likely to be an NFC- and therefore the margin requirements should not apply.

Enforcement

Under EMIR, enforcement is dealt with at a national level. Penalties must be effective, proportionate and dissuasive, and must include administrative fines. The FCA can impose penalties for contravening a requirement under EMIR or for knowingly or recklessly giving the FCA materially false or misleading information. The FCA has been granted additional powers under statutory instruments to investigate counterparties that fall within EMIR, to gather information on FCs and NFCs, and to release public statements to censure counterparties if they have failed to comply with their obligations under EMIR.

No information has been provided in this jurisdiction.

The regulatory framework applicable to securitisations, and to issuances of debt securities more broadly, has investor protection as a primary aim. In particular:

  • the disclosure requirements under the Securitisation Regulation are intended to protect investors by allowing them to undertake due diligence of and monitor securitisations properly (see 4.1 Specific Disclosure Laws or Regulations, 4.3 Credit Risk Retention and 4.4 Periodic Reporting);
  • similarly, the disclosure requirements under the Prospectus Regulation are intended, among other things, to allow investors to make an informed assessment of the securities they are acquiring (see 4.2 General Disclosure Laws or Regulations);
  • the Market Abuse Regulation is also intended to protect investors by preventing insider dealing and market manipulation; and
  • the Markets in Financial Instruments Directive II framework (known as "MiFID II", and consisting of an EU regulation and an EU directive) contains certain requirements that are intended to protect investors, such as the product governance rules, and rules around conflicts of interest and allocations, record keeping and inducements.

Regulators and Penalties

For details of the applicable regulators and any penalties for non-compliance, please see the relevant sections noted above.

In addition, under MAR, civil sanctions powers (including unlimited fines, information gathering powers and the ability to make referrals to criminal investigators) are granted to the relevant competent authority, which is the FCA in the UK. In addition, in the UK, criminal sanctions for insider-dealing and market manipulation can incur custodial sentences of up to seven years.

No information has been provided in this jurisdiction.

Other than certain tax laws relating to SPEs that are "securitisation companies" (see below), there is no specific regime that applies to securitisation SPEs in England and Wales.

It should be noted, however, that if the SPE is incorporated in England and Wales and offers the notes on a marketed basis (or, potentially, to a wide number of funders on a bilateral basis), it may need to be incorporated or re-registered as a public limited company to comply with requirements under the UK Companies Act 2006 (this is a different test from a public offer under the Prospectus Regulation). The main difference is that, as a private limited company, its minimum paid-up share capital is GBP1, whereas for a public limited company it is GBP50,000 paid up as to one quarter.

Under the Taxation of Securitisation Company Regulations 2006, the SPE will be subject only to tax on its retained profit if it qualifies as a "securitisation company", satisfies the "payments condition" and does not have an "unallowable purpose".

To be a "securitisation company", generally the SPE must:

  • issue notes with an aggregate value of at least GBP10 million;
  • have limited activities of (i) acquiring, holding and managing financial assets as security for some or all of the notes; (ii) acting as guarantor of liabilities of other companies where the note-issuing company's rights under the guarantee form security for some or all of the notes; or (iii) being party to a creditor relationship with an insurance SPV;
  • issue notes as part of a capital market arrangement (this is usually satisfied where notes are issued that are rated, traded or listed);
  • issue notes wholly or mainly to independent persons; and
  • have a retained profit.

There are other ways to be a "securitisation company". However, a company meeting the above criteria, or holding financial assets and having a retained profit whilst intending to meet the other criteria in the future, will be a securitisation company.

The SPE will satisfy the payment condition if it pays out all of its income within the 18 months following the end of the accounting period in which it is received, other than:

  • its retained profit;
  • amounts reasonably required to provide for losses or expenses arising from its business; and
  • amounts reasonably required to maintain or enhance its creditworthiness.

The SPE will not have an "unallowable purpose" if it only has business or commercial purposes for entering into the transaction.

Forms of Entities

The main form of issuer is a company (either a private limited company or a public limited company). In certain securitisations, SPE entities may also act as a trustee – for example, on credit card securitisations and some RMBS transactions, where the SPE holds the financial assets under the terms of a "master" trust for the benefit of multiple issuer SPEs and the originator. These transactions allow for frequent "top-ups" and/or make regular issuances more cost-effective, although in recent years such structures have been less favoured, given the push for relative simplicity and transparency. Other structures and legal entities may be used, but less frequently. The SPE may also be established in other jurisdictions, subject to appropriate tax analysis.

See also 1.2 Special Purpose Entities.

There is no regime under English law comparable to the US Investment Company Act of 1940. However, the possibility that the issuer could be held to be a covered fund for the purposes of the Volcker Rule can be a concern in UK securitisations – particularly if one or more of the investors in the transaction is a US banking entity (or an affiliate).

Typically, the issuer will represent for the benefit of the noteholders that it is not a covered fund.

Often, US legal advisers on a transaction will also be asked to provide comfort to noteholders in the form of a memorandum concluding that the issuer should not be considered a covered fund (and/or that the financing provided by the noteholders should not be considered a covered transaction). This comfort will generally be subject to, in particular, qualifications as to the uncertainty of the application of US securities law.

There is also a range of regulated activities under FSMA that the SPE will not be authorised to undertake. In the context of a standard securitisation these are not usually relevant (or exemptions are available). If the transaction involves a master trust structure or other instruments that are not notes or bonds, then one area for review will be whether the SPE is operating a Collective Investment Scheme. Among other matters, this is a regulated activity under FSMA.

Securitisations are structured using various forms of credit enhancement, to give some protection to repayments under the senior notes from losses arising under the portfolio of financial assets.

Securitisations involve a subordination of junior notes (and/or a subordinated loan). This tranching of credit risk means that the junior noteholder will suffer the first losses on the portfolio. The junior noteholder will generally be the originator (or an affiliate) in order to fulfil risk retention requirements (see 4.3 Credit Risk Retention) and because investors typically expect the originator to have some "skin in the game".

Issues can arise in relation to such subordination. For example, the parties may need to consider intercreditor arrangements (either within the note trust deed itself or, if there are other types of debt, in a separate inter-creditor agreement) – particularly where there is more than one class of subordinated noteholder.

In addition, over-collateralisation (where financial assets are transferred to the SPE with an aggregate value greater than the consideration paid by the SPE) and various cash reserves are often utilised to provide further credit enhancement. One method of funding a cash reserve is through excess spread (which is the remaining net interest payments from the underlying assets after all expenses are covered).

Where cash reserves are used, parties need to agree where such deposits are held and whether they are invested prior to being utilised by the SPE. Typically, unused reserves may be invested for a period in certain specified types of liquid, low-risk investments.

Unlike in the USA, there are no particular government-sponsored entities that are active in the UK securitisation market.

However, the UK government has disposed of the credit risk of certain assets through securitisations (including Income Contingent Repayment student loans originated by the government and mortgage loans acquired by the government during the financial crisis). The British Business Bank is also involved in facilitating certain securitisation transactions undertaken by SMEs.

The Bank of England also allows certain notes in securitisations to be eligible for its bank liquidity schemes.

Investors in securitisations include banks and other credit institutions, various investment funds (including hedge funds, money market funds and funds associated with asset managers and pension providers), and insurance and reinsurance undertakings.

In true sale securitisations, the bankruptcy remote transfer will generally be effected through a sale agreement (usually referred to as the "receivables sale agreement” or "mortgage sale agreement") between the originator and the issuer (and often the security trustee).

The receivables sale agreement includes provisions under which:

  • the assets are transferred by the originator to the issuer;
  • the issuer agrees to pay consideration for the assets to the originator (this may consist of initial consideration and deferred consideration);
  • conditions precedent to the transfer of assets are set out;
  • the originator declares a trust in favour of the issuer over the proceeds arising under the assets (as discussed above);
  • circumstances in which the issuer can perfect its title to the assets are set out (see 5.3 Principal Perfection Provisions);
  • if applicable, the originator agrees to repurchase non-compliant receivables in certain circumstances; and
  • the originator provides undertakings in respect of matters that are relevant to its role as originator of the assets and representations and warranties relating to both its corporate status and the assets being transferred (see 5.2 Principal Warranties).

The originator typically provides comprehensive warranties relating to both its corporate status (for example, its capacity, power and authority to enter into the transaction documents, its solvency, and that it holds relevant permissions and/or licences to carry out its obligations under the transaction documents) and the assets being transferred (generally referred to as "receivables warranties" or "asset warranties"). Asset warranties generally include confirmations as to, among other things, the originator's good title to the assets, that the assets comply with the agreed eligibility criteria and that the assets have been originated on the basis of agreed standard forms and in compliance with applicable laws.

Breach of the corporate warranties would generally lead to a breach for misrepresentation under the transaction documents, which, if not remedied, could lead to an event of default and/or early amortisation in respect of the notes and a claim in damages or under any indemnity provided.

If there is a breach of asset warranty, the originator is generally obliged to repurchase the affected assets from the issuer.

The issuer will also provide comprehensive corporate warranties under the terms of the notes. Again, breach of these warranties can lead to a misrepresentation constituting an event of default under the notes.

Other parties to the securitisation, such as the servicer, will also provide corporate warranties to provide comfort in relation to their ability to fulfil their role (see 5.5 Principal Servicing Provisions).

Additional warranties may be required on transactions to show full compliance with STS requirements where STS treatment is sought.

Under the receivables sale agreement, the parties generally agree that the issuer's title to the assets may only be perfected on the occurrence of certain agreed "perfection events" (see 1.3 Transfer of Financial Assets).

Once a perfection event has occurred, the issuer (or the servicer or security trustee) can take the following steps:

  • give notice in its own name to the underlying obligors of the transfer of the assets;
  • direct the underlying obligors to pay amounts outstanding in respect of the assets directly to the issuer; and
  • take such other action as it reasonably considers necessary to recover any amount outstanding in respect of the assets, or to protect or enforce its rights against the underlying obligors in respect of the assets.

As noted above, the originator should also grant a power of attorney to the issuer in order to allow it to carry out the above actions in the originator's name.

The key covenants in securitisation documents are primarily provided by the issuer and the originator. As discussed in 1.2 Special Purpose Entities, the issuer's activities will be limited by comprehensive negative covenants. The issuer will also provide positive covenants – for example: (i) that it will comply with all of its obligations under the transactions documents and use reasonable endeavours to procure that the other parties to the transaction documents comply with theirs; and (ii) if applicable, that it will maintain hedging in accordance with the transaction documents.

In addition to the warranties mentioned above, the originator will provide covenants relating to its corporate status, the transferred assets and its ability to fulfil its role under the transaction documents. These should include maintenance of required authorisations and licences, compliance with the terms of the underlying contracts relating to the assets, and agreeing not to create any additional interests in the assets.

Subject to grace periods and/or materiality qualifiers, failure of the issuer or originator to comply with an undertaking would generally lead to early amortisation or an event of default under the notes.

The servicer, which is often the originator, is appointed under a servicing agreement entered into with the issuer (and the security trustee).

The servicer will agree to service the transferred assets, including:

  • collecting payments from underlying obligors and transferring those payments to the issuer's account(s);
  • enforcing the obligations of obligors under the underlying contracts;
  • maintaining necessary permissions;
  • maintaining records in respect of the assets; and
  • generally administering the assets in accordance with the originator's credit and collection policies, and in accordance with applicable laws.

The servicer typically receives a fee for these services from the issuer (which would be paid in accordance with the agreed priorities of payment).

Failure of the servicer to comply with its obligations under the servicing agreement may lead to its replacement by another servicer and/or early amortisation or an event of default under the notes.

Typical events of default under the notes include:

  • non-payment by the issuer of (i) interest on the most senior notes on any payment date and (ii) principal on any notes on the final legal maturity date;
  • breach by the issuer of its other obligations under the transaction documents;
  • misrepresentation by the issuer under the transaction documents;
  • an insolvency event in respect of the issuer; and
  • illegality for the issuer and repudiation or termination of transaction documents.

Private securitisations and warehouse financings usually also include additional events of default.

Subject to any agreed grace periods and/or materiality qualifiers, a default under the notes would generally lead to the most senior class of noteholders having the ability to instruct the note trustee to declare all outstanding amounts under the notes due and payable, and to enforcement of the transaction security.

The precise indemnities included in each transaction vary and will depend on the outcome of negotiations between the parties.

The issuer (and the security trustee) may receive indemnities from (i) the originator under the receivables sale agreement for certain losses arising in connection with the sale of assets and (ii) the servicer under the servicing agreement for losses arising from, for example, the servicer's negligence in respect of the performance of the services.

Depending on the outcome of negotiations, on private transactions the noteholders may also benefit directly from indemnities from the issuer and/or originator in relation to breaches of warranties or covenants given by those parties.

In the context of public securitisations, the issuer and originator would typically also agree in the subscription agreement to indemnify the arranger and managers for losses arising due to misrepresentations; in particular, the issuer will represent that there are no inaccuracies in the prospectus or other marketing materials.

No information has been provided in this jurisdiction.

No information has been provided in this jurisdiction.

No information has been provided in this jurisdiction.

The issuer is generally a bankruptcy remote special purpose vehicle. See 1.2 Special Purpose Entities for details.

The term sponsor can be used to refer to the originator (or an affiliate of that entity). The sponsor generally initiates the securitisation process, devises the appropriate structure for the securitisation (in conjunction with other advisers) and establishes the initial lending relationship with the underlying obligors (potentially through an affiliate), or may have been responsible for the acquisition of the portfolio of financial assets to be securitised. Sponsors tend to be financial institutions, large corporates or funds.

Underwriting entities are usually referred to as managers, and are generally investment banks. The managers help to build a book of investors and agree in the subscription agreement to underwrite the issuance of notes.

One or more of these entities may act in a lead role as arranger(s) and fulfil some of the roles mentioned above in relation to sponsors – for example, devising the appropriate structure for the securitisation together with the originator. Such entities are generally investment banks, although originators themselves sometimes also act as arrangers.

As noted above, the servicer will typically be the originator (or an affiliate); however, the role is sometimes fulfilled by a specialist financial asset servicing company. See 5.5 Principal Servicing Provisions for details of the servicer's role.

Investors subscribe for the notes issued by the issuer. See 4.15 Entities Investing in Securitisation for further details.

There are two distinct trustee roles:

  • the note trustee, who holds the benefits of the covenants and rights in the secured assets on behalf of the noteholders pursuant to a deed of trust; and
  • the security trustee, who holds the security created over the issuer's assets and rights in favour of the noteholders (as well as the issuer's other secured creditors) under a deed of security.

The same entity will typically carry out both functions. Trustees are usually professional trust corporations, often affiliated to large banks.

Synthetic securitisations are permitted within England and Wales. For the purpose of this discussion, it is assumed that a "synthetic securitisation" is as defined in the Glossary of the FCA Handbook, published by the FCA. This is based on the definition of "securitisation" in the FCA Handbook, which includes both (i) a "traditional" securitisation, where the assets are sold to an SPE funded through the issuance of debt securities to investors, and (ii) the wider set of transactions that satisfy the requirements that the credit risk associated with a pool of exposures is tranched, payments are dependent upon the performance of the pool of exposures, and the subordination of the tranches determines the distribution of losses during the transaction. This latter type of structure may involve, but does not require, the issuance of securities, and would be viewed as a synthetic securitisation.

As discussed in 4 Laws and Regulations Specifically Relating to Securitisation, in relation to regular securitisations, at a European level, the regulation of securitisations applies to the broader type of securitisation transactions – see (ii) above. From 1 January 2019, the Securitisation Regulation also applies to synthetic securitisation and governs matters such as risk retention, disclosure and due diligence. Synthetic securitisation will not, at least in the beginning, be eligible for the new framework for simple, transparent and standardised securitisations (STS). There had been some consideration around proposals to expand the STS framework to apply to synthetic securitisations, but the proposals to extend the STS framework to synthetic structures did not ultimately make it into the final text of the regulation. However, pursuant to the Council's compromise text, the European Banking Authority (EBA) was required to prepare a report on the extension of the STS framework to synthetic securitisations by mid-2019. The EBA accordingly published a discussion paper on 24 September 2019 and launched a two-month consultation period on 26 September 2019 for stakeholders to provide comment on the discussion paper. The EBA also held a public hearing on the paper on 9 October 2019. The consultation period ended on 25 November 2019, but at the time of writing the EBA has not yet published the results of the consultation.

Additionally, the amendments to the capital requirements in the CRR for securitised positions, as implemented through the CRR Amending Regulation, include a provision in Article 270 for preferential risk-weighting of retained senior tranches of a limited subset of synthetic securitisations that satisfy specified requirements.

Synthetic securitisations are generally classified into two categories, balance-sheet and arbitrage, and the reasons why originators engage in each category differ.

Balance-sheet synthetic securitisations involve the transfer of credit risk of assets originated by the originator or another entity within its group (ie, they are risks that are already present on the originator's balance sheet). The primary benefit to an originator of a balance-sheet synthetic securitisation is improved credit risk management (for example, with large exposures where there may be concentration risk) and related regulatory capital treatment, generally in relation to those portions of the securitised assets for which the risk is effectively transferred to another entity.

Arbitrage synthetic securitisations are used to take advantage of the difference (arbitrage) between (i) the higher spread to be received on the (usually low-quality) assets to be securitised and (ii) the lower spread that would be payable to investors under the transaction, once the tranching and other credit enhancement are incorporated. Unlike balance-sheet synthetic securitisations, originators in arbitrage structures do not necessarily have any credit exposure to the assets being securitised, and originators can therefore use arbitrage structures purely for investment purposes. Since the onset of the financial crisis in 2008, the use of arbitrage synthetic securitisations has greatly diminished, not least due to the application of risk retention requirements on the part of the originator.

More generally, originators also engage in synthetic securitisations as they can be easier to structure and establish as compared to traditional securitisations given that the operational issues associated with the transfer of underlying exposures is avoided and, depending on the structure, it may not be necessary to establish an SPE. Synthetic securitisations are also helpful in the context of assets that cannot be transferred to an SPE, for example, loans to SMEs are typically highly negotiated and contain restrictions on transfer, which can make these difficult to securitise using regular securitisation structures.

Notwithstanding the advantages of synthetic securitisations that are outlined above, these structures have disadvantages when compared to a traditional securitisation. As there is no transfer of assets in a synthetic securitisation, there is therefore no funding benefit driving these types of securitisation – as discussed above, capital relief and credit risk management are key reasons for balance-sheet structures, and an expected investment upside for arbitrage structures.

In addition, in a synthetic securitisation (particularly in the context of an unfunded securitisation), the originator takes full credit risk on its counterparty, as it relies on the payment of amounts under the credit default swap or guarantee to offset its losses on the defaulting assets and so this increases the risk in the transaction. This exposure to the counterparty ultimately affects the degree of capital relief that would be obtained from using unfunded structures.

Synthetic securitisations are regulated in the same manner as regular securitisations. At a national level, the primary regulator in England and Wales for banks and credit institutions is the Prudential Regulatory Authority (PRA), which is responsible for regulating the required capital allocated for investments in securitised positions (whether regular or synthetic). As discussed in 4 Laws and Regulations Specifically Relating to Securitisation, the FCA will also have regulatory oversight of a number of aspects of a synthetic securitisation transaction, although this will depend on the structure used. For example, where listed securities are issued to the public or where a prospectus is required for admission to trading on a MiFID-regulated market, the FCA will be involved as the regulator for Prospectus Regulation purposes.

As outlined above, the primary difference between a synthetic securitisation and a traditional securitisation is that there is no transfer of assets from the originator to an SPE or investors. For balance sheet structures, the securitisation is achieved by transfer of credit risk from the originator to an SPE or investors, while retaining the assets on its balance sheet. For arbitrage structures, notional credit risk is transferred but, as discussed above, the originator may have no exposure to the assets being securitised.

As a general matter, and particularly at a regulatory level, the same principal laws and regulations that apply to regular securitisation will also apply to synthetic securitisations, and these are discussed in 4 Laws and Regulations Specifically Relating to Securitisation. This will involve oversight by regulators at a European level as well as a national level.

In addition, the following are areas that need particular focus in the context of a synthetic securitisation.

EMIR needs to be considered in detail where a credit derivative is used to transfer the credit risk and so may subject the parties to margin and other risk mitigation requirements that can impact the structuring of a transaction. If another instrument is used that is akin to a derivative (such as a financial guarantee), then EMIR will also need to be considered on a case-by-case basis to see whether it is applicable.

With a synthetic securitisation there is also a different set of considerations with regard to insolvency laws and issues and the ownership of the financial assets. First, it is not necessary to conduct a true sale analysis in relation to the financial assets as there is no transfer and so the impact of an insolvency and the relevant claw-back rules will be of less relevance, unless credit-risk transfer is in respect of the originator's own obligations. At the same time, there is counterparty risk (particularly in the case of unfunded structures) for the party to whom the credit risk is being transferred, so counterparty credit risk on an insolvency will need to factored in during the structuring phase. Similarly, a number of the issues identified in 1 Structurally Embedded Laws of General Application and that arise as a result of the ownership of the financial assets by the SPE do not arise. For example, considerations around holding personal data, consumer-credit regulation and assignability are normally not a concern on a synthetic securitisation as the SPE or direct investor in the credit risk will not necessarily have access to the specific data regarding the underlying risk due to issues around confidentiality. This, in turn, makes these structures easier to put together and there tend to be fewer operational issues given that there is no transfer of the relevant underlying exposures.

The nature of synthetic securitisations, however, leads to other legal issues that need to be considered. First, due to the bankers' duty of confidentiality to its clients and other confidentiality laws, it may only be possible for the originator to provide the credit-protection seller with limited information around the underlying credit exposures. This leads to concerns around verification, both in terms of the occurrence of a trigger event leading to a payment under the credit-risk transfer instrument and determining the quantum of any such payment that then becomes due. This is normally dealt with through the use of a verification agent, such as an audit firm, which is permitted to have sight of the relevant details and can then provide independent verification without breaching the relevant confidentiality requirements.

Finally, credit risk transfer agreements have many similarities with contracts of insurance. Under English law, it is important to consider whether the instrument transferring the credit risk could be construed as a contract of insurance. The sale of insurance (or arranging the relevant insurance arrangement) is a regulated activity in the UK so, if the instrument was considered to be a contract of insurance, the party providing or arranging the insurance would require authorisation that they may not have. The carrying out of a regulated activity in the UK without authorisation is a criminal offence, and the obligations of the party buying the insurance may be unenforceable. Care therefore needs to be taken to ensure that the relevant instrument is distinguishable from a contract of insurance, that it is being sold by a suitably authorised entity or an entity that is not subject to the relevant requirement to be authorised, or that the relevant activity takes place outside the UK. This would also need to be considered in the jurisdiction in which the relevant activity is taking place.

The two principal structures used for synthetic securitisations are (i) a structure involving securities issued by an SPE, or (ii) a direct transfer of credit risk from the originator to the investor(s).

In structure (i), the originator will transfer the credit risk of the securitised assets to an SPE through a credit default swap (CDS) or guarantee, and the SPE will issue securities, usually described as credit-linked notes, to the investors. Under the CDS or guarantee, the originator will pay a periodic fee to the SPE, and if there is a default on any of the securitised assets, the SPE makes a payment to the originator. These payments are funded from the purchase proceeds of the securities (usually held in a low-risk account for the term of the transaction). During the term of the transaction, the investors would usually be paid a coupon on their securities, funded from the interest on the invested purchase proceeds and the payments from the originator under the CDS/guarantee. At the maturity date, the investors are repaid their principal on the securities, minus any amounts paid to the originator for defaulted assets. In this manner, the investors are effectively providing credit protection on the default of the securitised assets.

In structure (ii), there is no SPE or issuance of securities, and the originator instead enters into a bilateral arrangement, usually in the form of a CDS or guarantee, directly with the investor(s). If there is a default on any securitised asset, the investor(s) would make payment to the originator under the CDS/guarantee.

Additionally, synthetic securitisations can be funded or unfunded. Funded structures involve the upfront payment from the investor to the originator of the amount of credit protection, so that the originator does not have credit risk on the investor. Structure (i), where securities are issued, is an example of a funded structure. Even though the upfront payment goes to the SPE rather than to the originator itself, given the bankruptcy remoteness of the SPE and the security arrangements over its assets in favour of its creditors (including the originator), the originator is effectively insured against non-payment by the investors. Structure (ii) would be a funded structure if the investor is required to collateralise its exposure to the originator under the agreement, possibly with a third-party custodian. It would be unfunded if collateral is not required.

In unfunded structures, there is no upfront payment from the investor, so the originator is exposed to the credit risk of the investor, and relies on the investors' ability to pay the default amounts under the CDS/guarantee if there is a default on the securitised assets.

Please see 4.6 Treatment of Securitisation in Financial Entities for a discussion on the regulatory capital treatment of securitisation transactions. In addition, there are specific requirements under the CRR that a synthetic securitisation will need to satisfy to demonstrate that there has been a significant risk transfer in order to obtain the desired regulatory capital treatment. For instance, the terms of the structure will need to satisfy the eligibility requirements that the CRR applies to funded or unfunded credit risk mitigation arrangements, as applicable. These terms include ensuring that there are no circumstances that are not under the direct control of the originator in which the protection can be cancelled or as a result of which the investor could avoid the obligation to make payment. In addition, the originator will be required to obtain legal opinions confirming that the protection provided by the synthetic securitisation is legally effective and enforceable in all relevant jurisdictions.

As noted above, under the Securitisation Regulation it is not currently possible for synthetic securitisations to take advantage of the STS framework, so they do not currently benefit from the changes to the capital requirements in the CRR that were introduced under the CRR Amending Regulation in relation to STS securitisations.

Public and private securitisations are carried out in the UK in relation to a wide range of asset classes. Public issuances most commonly relate to securitisations of residential mortgage loans (RMBS) and asset-backed securitisations (ABS). The most common ABS securitisations tend to relate to credit cards and auto loans. That said, transactions in relation to other asset classes, including personal loans (including marketplace lending), SME loans, commercial real estate (CMBS) and trade receivables are not uncommon. Collateralised loan obligations (CLO) transactions and whole business securitisation transactions are also common in the UK. Note that student finance in the UK operates on a different model from the US and therefore securitisations of private student loans are not a primary feature of the market, although the UK government has sold portfolios of student loans into securitisations.

Save as set out below, the basic structure of a securitisation does not generally change based solely on the type of underlying asset. However, specific commercial and legal factors in the context of each specific transaction will result in significant structural differences at a detailed level.

Master trust structures are a variation on the general securitisation structure discussed above. Under a master trust structure, a revolving portfolio of assets is held on trust and multiple series of notes are backed by undivided interests under the trust. Due to their flexibility and fluidity, master trusts are particularly suited for short-term revolving receivables, such as credit cards, but are also used in the context of RMBS securitisations (among others).

The basic features, such as a true sale of financial assets and the regulatory regime set out above, do not differ particularly for master trust structures. However, issues relating to the specific application of such aspects to each securitisation transaction differ.

Hogan Lovells

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Law and Practice

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Hogan Lovells has a structured finance and securitisation practice that handles every aspect of structured finance transactions. Its global team has advised on transactions with assets originated in more than 30 countries, including the USA, Latin America, the Caribbean, Europe, South Africa, the former CIS, the Middle East, Japan and Southeast Asia. The team advises on the financing of a wide range of classic and innovative asset types, as public and private standalone issues, master trusts and programmes, and through conduit structures. It also handles matters relating to Dodd-Frank legislation in the USA and the Securitisation Regulation and other relevant EU legislation, including compliance counselling, disclosure and advocacy relating to the legislation. Clients include issuers and originators of securitised assets, underwriters, managers and arrangers, trustees, investors, and collateral and portfolio managers. We would like to thank Nicholas Watmough, senior associate in the debt capital markets practice, Philip Harle, partner in the tax practice, and Adam Parry, counsel in the tax practice.

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