The EU continues to press ahead with its Capital Markets Union ('CMU'). The High Level Forum ('HLF') recently published its final report containing 17 sets of recommendations intended to move the CMU towards completion. For each of the sets of recommendations, the HLF sets out detailed proposals for the European Commission, including amendments to specific legislation and the proposed timetable for delivering on each recommendation.
The EU first launched the CMU in 2014, with the aim of broadening the sources of financing in the EU towards non-bank financing, deepening the EU single market in financial services, giving greater capital-raising choices to borrowers and investment opportunities to lenders irrespective of their location within the EU and breaking down regulatory barriers between different EU Member States.
An effective CMU is seen by EU policy makers as critical: not only to rebuild an EU economy that has been damaged by COVID-19, but also to counter the consequence of the UK (and with it Europe's most significant financial centre) leaving the EU's single market and beginning the process of regulatory and supervisory divergence in financial services. Brexit raises some difficult policy choices for the EU with regards to the CMU. To what extent does it make sense to break down regulatory barriers among EU Member States without also trying to break down regulatory barriers with third countries? How integrated should EU capital markets be with wider, global capital markets?
The EU Securitisation Regulation that took effect from 1 January 2019 exemplifies this debate. By imposing uniform due diligence obligations on all EU-established institutional investors and transparency requirements on all EU-established originators, sponsors and SSPEs, the EU may have succeeded in breaking down barriers between EU Member States. But absent jurisdiction-specific or equivalence provisions, these obligations effectively imposed a new regulatory barrier between EU institutional investors and third country originators and sponsors. Under the Securitisation Regulation (at least on a cautious reading) an EU institutional investor may not invest in a third country securitisation if the third country originator, sponsor or SSPE does not comply with the precise letter of the EU transparency requirements (including completing EU templates for loan level data and investor reports, even where they may already have to comply with similar local law requirements).
It is therefore very welcome that the HLF final report recognises this problem and proposes a solution. Among a set of other sensible reforms, the HLF invites the European Commission to: "allow an EU-regulated investor in third-country securitisations to determine whether it has received sufficient information... [and clarify] that Article 5.1 (e) does not apply to third country originator/ sponsor or SSPE. Rather such third country originator, sponsor and SSPE must ensure that the EU-regulated investor has received sufficient information to meet the requirements for due diligence proportionate to the risk profile of the securitisation exposure." Market participants will of course want to look closely at the precise text of these amendments as they make their way through the EU legislative process. It is also likely that these reforms won't be effective for at least another year. But on their face these reforms are sensible and pragmatic and will make it significantly easier for EU-established institutional investors to invest in US-originated (and indeed, post IP Completion Day, UK-originated) securitisations.
The EU's CMU reforms also raise some interesting questions for the UK and its own regulatory framework after the end of the Brexit Implementation Period. To what extent might it make sense for the UK to mirror reforms that the EU is making? Certain CMU reforms that aim at harmonising regulations among different Member States will not necessarily be appropriate for the UK. But other reforms that address specific regulatory problems or seek to integrate the EU's capital markets into global capital markets are surely just as relevant for the UK as they are for the EU.
The EU Securitisation Regulation is due to be on-shored onto the UK statute book via the EU Withdrawal Act 2018 and the Securitisation (Amendment) (EU Exit) Regulations 2019 at the end of the Brexit Implementation Period, currently scheduled for 31 December 2020. This will create parallel and distinct EU and UK Securitisation Regulations, likely well before the EU CMU reforms take effect. The on-shored UK Securitisation Regulation does attempt to fix some of the jurisdictional limitations contained within the EU Securitisation Regulation, but does not, as it stands, go quite far enough. For example, post IP Completion Day, UK-established institutional investors will be required, prior to holding a securitisation position, to verify that an overseas-established originator, sponsor or SSPE has: "made available information which is substantially the same as that which it would have made available... if it had been established in the United Kingdom; and has done so with such frequency and modalities as are substantially the same as those with which it would have made information available... if it had been so established”. The "substantially the same" wording might be sufficient to capture disclosure made by an EU-established entity meeting EU requirements, but is likely not broad enough to capture disclosure made by a US-established entity meeting US requirements, which is regrettable. Further, although UK-established institutional investors may draw some comfort from the PRA's securitisation supervisory statement that "the level and nature of investor due diligence prior to holding a securitisation position may be proportionate to the risks of the securitisation position", this statement is still subject to the text of the Securitisation Regulation which does not on its face contain any proportionality standard. There remains, therefore, at least the question of a regulatory barrier.
Brexit has turned out to be a catalyst for the EU to reform its Capital Markets Union and to consider how to remove regulatory barriers to the cross-border flow of capital markets products even with third countries. There is no reason why Brexit shouldn't also be an opportunity for the UK to make reforms to the UK's regulatory framework that are at least as liberalising as those suggested in the HLF report. In particular it would make sense for the UK to ensure that the UK Securitisation Regulation does not impose unecessary barriers on UK-established entities from participating in securitisations on a global basis.
"Europe has for decades struggled to make its capital markets work as one, and to a large degree still has 27 capital markets, some fairly large, and quite a number rather small. The largest market, the UK, has left the EU, making the financing of the EU economy dependent on a jurisdiction where rules may well start diverging in the medium term. With the UK having left a question for politicians is how much of this market one wants onshore, and how much offshore."