The UK Prudential Regulation Authority’s discussion paper on securitization capital requirements is a landmark moment for the UK’s principles-based approach to regulation.
It shows the UK departing from the EU’s approach as it rewrites securitization rules after Brexit, and proves the PRA has a radical aspiration to craft a more concise rulebook.
Despite its assurance, perhaps the most consequential line of the 30 page discussion paper was buried at the bottom of the sixteenth page, in paragraph 2.46, amid an explanation of the PRA's receptiveness to copying the EU’s solution to the significant risk transfer market’s qualms about the output floor.
The PRA wrote: “concern over the impact of the output floor on firms with certain securitisation exposures may point to issues with the calibration of the Pillar 1 securitisation capital framework”.
In among the jargon is a radical departure from the typical regulatory practice of simply layering rules on top of rules. Too often, regulators' mantra is: if something isn’t working, don't fix it, just write a carve-out for that specific problem.
This approach has left a thicket of regulation so dense it snares even the most experienced lawyers trying to navigate it.
That is what the EU has done, with head-spinning terminology, in the output floor example. Rather than rethink the ruleset, it has temporarily reduced the p-factor in calculations of risk-weighted averages under SEC-SA, solely for the purposes of the output floor.
Back on the chopping block
In contrast, the PRA hints that it is ready to take a scythe to the regulatory overgrowth.
It acknowledged that if a rule has unintended consequences then the rule itself may be flawed. In this instance, at least, its chosen solution is to change the underlying rule rather than grant specific exemptions.
Revisiting previous legislation is not about loosening the rules. It’s about a belief that a good rule should be applicable to multiple situations.
It takes a regulator that is optimistic and believes in its rulemaking abilities to pursue such an approach, but the benefits are great.
Broadly applicable rules are easier to understand, so make the market work better. From the regulators' perspective the biggest upside is an enhanced ability to deal with unforeseen circumstances. This removes the need to continually play catch-up.
Further proving that universal rulemaking can ease the burden on regulators, it seems the PRA approach to the output floor could quieten demands for synthetic securitizations to be eligible for the ‘simple, transparent and standardised’ stamp, which brings better capital treatment.
Such deals are typically “bespoke”, as the PRA says, so are hardly standardised. Unsurprisingly, in the EU such deals can (but don't necessarily) qualify for the STS hallmark, in what can be seen as a workaround to improve their capital treatment.
Compared with what has gone before, the PRA’s approach could even be called radical. However, it is hardly a deregulatory spree.
Holding a bonfire of red tape, even at this time of year, would be irresponsible for an organisation with ‘prudential’ in its name. The danger of isolation if the UK rapidly diverges with from the EU is not desirable.
It is clear that both the UK and the EU want to boost their securitization markets while remaining prudent, despite their differing approaches.
Most sources agree that no tangible progress is likely before the end of 2025. With EU parliamentary elections coming next year, legislators are now refusing to look at level one text.
In that context, the PRA’s hint — that even if the UK is aiming for a similar destination to the EU, it might get there by simpler means — is tantalising.