The Bank of England is considering diverging UK capital requirements for securitisations from the path taken by the European Union over the past three years in several ways, according to a discussion paper published on Tuesday.
The Prudential Regulatory Authority, which is the part of the BoE that regulates the financial sector, does not want to replicate the EU's approach to soften the blow of the latest Basel standards nor extend the benefits of the simple, transparent and standardised (STS) label to synthetic transactions as the European authorities have done.
The UK regulator also floated the idea of overhauling the order in which the various approaches to calculating the risk weights of securitisations must be applied, to bring it into closer alignment with the international Basel framework.
“In general, the PRA considers that broad alignment with these Basel standards would advance the PRA’s primary objective of promoting the safety and soundness of PRA-authorised firms,” the regulator said. It has asked market participants to provide their feedback on the discussion paper by January 31 2024. A full consultation on the proposed changes would then follow.
Output flaw
The new rules being formulated by the PRA are designed to replace parts of the UK’s capital requirements regulation that is in the process of being repealed and replaced following the country’s official departure from the EU almost four years ago, in January 2020.
Since that date, the EU has implemented several changes to the capital rules for securitisation in an attempt to make the market work better and to address problems expected to arise as a result of the implementation of the latest Basel standards, including the so-called output floor, which is a measure designed to reduce inconsistencies in the capital treatment of securitisation by banks using the different approaches available to them.
In June, a proposal to soften the impact of the output floor by reducing a parameter called the p-factor was accepted in discussions between the European Parliament, the European Commission and the Council of the EU.
But the PRA on Tuesday signalled that it would take a different tack. “The PRA considers that it would be better to consider whether to address any such issues by means of a targeted adjustment to the [securitisation standardised approach] than to modify the output floor methodology.”
This could still entail a reduction of the p-factor, but it would apply to the whole Pillar 1 framework for calculating capital requirements for securitisation exposures rather than just the calculation of risk weights for the purposes of the output floor.
Synthetic proposition
Another change to the European securitisation framework since 2020 has been the roll-out of the STS label, previously only applicable to true-sale securitisations, to synthetic transactions as well.
Again, the PRA said it did not agree with the EU's move. Among other things, it said extending the UK STS framework to synthetic securitisations would likely place considerable demands on its resources as well as the Financial Conduct Authority’s.
The PRA is also considering a break with the EU approach in the hierarchy, or the order in which the various approaches to calculating risk weights for securitisations can be applied. It said the existing hierarchy diverged from what was proposed under Basel, was much more complex and could even result in incorrect risk-weighting.
In the discussion paper, the UK regulator suggested that the convoluted hierarchy may in part reflect a preference in the EU for not using a calculation method based on external ratings when sovereign ceilings in ratings agency methodologies might increase risk weight outcomes.
“The PRA considers that, in principle, changing the securitisation hierarchy of methods in the UK to better align with Basel standards could result in more risk-sensitive capital requirements for some securitisation exposures,” the regulator said.
Corrected story: Corrects time reference in first paragraph