Prudential Regulation Authority Rulebook

2.1

The CRR requires any reduction in capital requirements achieved through securitisation to be justified by a commensurate transfer of risk to third parties. Where the PRA determines that the reduction in risk-weighted exposure amounts (RWEA), which would be achieved through a particular securitisation transaction, is not justified by a commensurate transfer of risk then SRT shall not be considered to have been achieved by that transaction.

2.2

SRT is an ongoing requirement. Accordingly, the PRA expects firms to ensure that any reduction in capital requirements achieved through securitisation continues to be matched by a commensurate transfer of risk throughout the life of the transaction. The PRA expects firms to take a substance over form approach to assessing SRT. Firms should be able to demonstrate that the capital relief post-transaction adequately captures the economic substance of the entire transaction, and is commensurate to the retained risks.

2.3

One indication of whether or not risk transfer is commensurate is whether the RWEA post-securitisation is commensurate with the RWEA that would apply if the firm acquired the securitised exposures from a third party. The PRA expects firms purchasing risk transfer products to give adequate consideration to all relevant factors when assessing SRT, including the size of premiums paid and tranche thickness.

2.3a

The PRA expects firms to consider if tranches that are sold, or tranches on which protection is purchased, are sufficiently thick such that the reduction in RWEAs can be justified by a commensurate transfer of risk to third parties. When considering thickness of tranches sold or on which protection is purchased, firms should take into account all relevant factors related to the portfolio of securitised exposures.

2.4

When risk transfer transactions are structured as a group of linked transactions rather than a single transaction, the PRA expects the aggregate effect of linked transactions to comply with the CRR. The PRA expects firms to ensure that analysis of risk transfer incorporates all linked transactions, particularly if certain transactions within a group of linked transactions are undertaken at off-market rates.

2.5

The PRA expects the instruments used to transfer credit risk not to contain provisions which materially limit the amount of risk transferred. For example, should losses or defaults on the securitised exposures occur – ie deterioration in the credit quality of the underlying pool – the PRA expects the originator’s net cost of protection or the yield payable to investors should not increase as a result.

2.6

In order to ensure their continuing appropriateness, the PRA expects firms to update the opinions of qualified legal counsel, required by CRR, as necessary to ensure their continuing validity. For example, an opinion may need to be updated if relevant statutory provisions are amended, or where a new decision or judgment of a court has a bearing on the continuing validity of counsel’s opinion.

2.7

The PRA expects relevant senior management of a firm to be appropriately engaged in the execution of securitisation transactions that lead to a reduction in RWEA.

1. (i) For the purposes of such transactions, ‘relevant senior management’ means any individuals performing Senior Management Functions (SMFs) with oversight of such transactions, and any employees subject to the Certification Regime involved in the transactions (e.g. relevant Material Risk Takers (MRTs) under the Remuneration rules).^[2]
2. (ii) The level of senior management engagement may vary in line with the complexity of the transaction and the amount of reduction in RWEA. For transactions with complex structural features or risk characteristics that could materially affect the assessment of risk transfer or retention, the PRA expects oversight of these transactions to be linked to Prescribed Responsibility (PR) 7.

2.8

The PRA does not operate a pre-approval process for securitisation transactions. The PRA nevertheless expects a firm to discuss with its supervisor at an early stage securitisation transactions that are material or have complex features, including any non-sequential amortisation. Where a firm claims a regulatory capital reduction from securitisation transactions in its disclosures to the market, the PRA expects such disclosures to include caveats making clear the risk of full or partial re-characterisation where this risk is material in the light of the PRA’s stated policy.

2.9

Although this supervisory statement sets out the PRA’s expectations regarding securitisation, these expectations are also relevant for other similar credit protection arrangements.

2.10

The PRA will seek to ensure that the securitisation framework is not used to undermine or arbitrage other parts of the prudential framework. In relation to other similar credit protection arrangements, including those subject to credit risk mitigation or trading book rules, the impact of certain features (eg significant premiums, call options or excess spread) may cast doubt on the extent of risk transferred and the resulting capital assessment.^[3] Features which result in inadequate capital requirements compared to the risks a firm is running may result in the credit protection not being recognised or the firm being subject to extra capital charges in their Total Capital Requirement (TCR) in the form of Pillar 2 add-ons. Credit protection arrangements in general are subject to the same overarching principles as those in the securitisation framework.

2.11

Where a firm achieves SRT for a particular transaction, the PRA expects it to continue to monitor risks related to the transaction to which it may still be exposed. The PRA expects firms to consider the capital planning implications of securitised assets returning onto their balance sheets. The CRR requires firms to conduct regular stress testing of their securitisation activities and off balance sheet exposures. The PRA expects those stress tests to consider the firm-wide impact of stressed market conditions on those activities and exposures and the implications for other sources of risk, for example, credit risk, concentration risk, counterparty risk, market risk, liquidity risk and reputational risk. The PRA expects a firm’s stress testing of securitisation activities to take into account existing securitisations and pipeline transactions. The PRA expects a firm to have in place procedures to assess and respond to the results of that stress testing and would expect them to be taken into account under Pillar 2.

(CRR Articles 243, 244 and 337)