The View From Across the Pond — UK/EU Updates
The “The View From Across the Pond — UK/EU Updates” panel featured Financial Markets and Funds partner Neil Robson and Transactional Tax Planning partner Charlotte Sallabank and was moderated by Private Credit partner Peter Englund. The panel included discussion of rules and regulations put into place to help businesses address economic uncertainty caused by COVID-19, challenges facing the Coronavirus Business Interruption Loan Scheme (CBILS) and bounce-back loan programs that were developed to help businesses struggling with COVID-19, updates to the EU Securitization Regulation, the effects of the UK tax regime on securitization and the effects of Brexit on the securitization market. Here are the top five takeaways from the panel.
Legislative and Regulatory Uncertainty in Response to COVID-19
Certain rules and regulations put in place to help businesses cope with the economic impacts caused by COVID-19 are approaching their expiration dates, and it’s unclear whether they will be extended. For example, a moratorium to prevent companies from being pushed into an insolvency process unless its creditors had reasonable grounds to believe that COVID-19 had no financial impact of that company, i.e., such company’s debt would have existed even without COVID-19, is set to expire on December 31. Other protections limiting a director’s liability have already expired. Even though vaccines are being administered, COVID-19 is likely to continue to have an effect on the broader economy for several more months, and it is unclear how businesses will cope if or when such protections expire.
Loan Programs Intended to Assist Businesses Uncertain as Asset Classes
Two schemes providing loans to businesses struggling with COVID-19 have faced some challenges. In the CBILS scheme, the British Business Bank (BBB) agreed to guarantee up to 80 percent of loans issued to businesses. Many origination platforms were quick to get the necessary accreditation from the BBB, but we saw that sourcing funding for such loans was made difficult due to the restrictions from the BBB in assigning the government guarantee and an insistence that funding sources were robust and of a high standard, i.e., big name banks or well-established funds. The other scheme, bounce-back loans, have mainly been provided by traditional banks issuing small/micro business loans between £2,000 to £50,000 that are 100 percent guaranteed by the British government. According to a study, up to 40–60 percent of those bounce-back loans are likely to suffer defaults, which could present a long-term issue for the government as guarantor of those loans and of such loans remaining a viable asset class during their six-year term.
Updates to EU Securitization Regulations
In 2020, the European Union largely completed the implementation of its new Securitization Regulation, which establishes the first true pan-EU framework regulating issuers of, and investors in, securitizations. The new rulescover more than traditional risk retention: potential investors in securitizations must conduct an initial diligence assessment of the securitization to evaluate all risk characteristics of the deal, including reviewing underlying exposures and structural features, e.g., the priority of payments, and ensuring that certain ongoing disclosure obligations are met. The application of this regime to EU investors in non-EU issuances remains unclear and generally depends on the risk appetite of the specific EU investors. Finally, the Securitization Regulation will be reviewed by 2022, which provides an opportunity for investors, issuers/originators and European policymakers to address certain shortcomings in the regime that have acted as a drag on the relaunch of the EU securitization market. Following Brexit, the United Kingdom will onshore the Securitization Regulation and implementing secondary legislation into domestic law, meaning that the two frameworks will be nearly identical in the immediate near term, however the United Kingdom may ultimately determine to diverge from the EU framework where it is justified based on the specificities of the UK market.
UK Tax Regime and Its Effects on Securitization
A UK tax regime was introduced in 2005 to address the adverse effect that the introduction of International Accounting Standards had on the taxation of UK securitization vehicles. The introduction of IAS 32 and IAS 39 resulted in potentially large annual fluctuations in securitization companies’ accounting profits, which in turn led to fluctuations in tax liabilities year on year, as accounting profits are the basis for the computation of taxable profits. This variation in annual tax charge created unique problems for securitizations.
The large fluctuations were hard for rating agencies to rate and, in the event the profits unexpectedly increased, the securitization SPV issuer may not have enough cash on hand to pay the necessary taxes. Consequently, the 2005 tax regime for securitization vehicles was introduced in the United Kingdom to flatten out the fluctuations. However, these regulations only apply to securitization vehicles that are part of a capital markets arrangement, which essentially requires there to be a fund raising through an issue of securities to third parties which are rated by internationally recognized rating agencies and are traded on a recognised exchange. These regulations were a step in the right direction, but many securitizations do not fall within the definition of capital markets arrangement and so the regulations cannot apply to them, or originators do not want to have to comply with the stringent requirements of the regulations, and so many UK-sourced securitizations have non-UK issuers in jurisdictions where the securitization regime is easier to comply with, such as Ireland and Luxemburg. Effects of Brexit on the Securitization Market Under the EU Withdrawal Act, all EU rules and regulations as of December 31, the end of the transition period, shall become UK law for purposes of financial market regulation. Thus, the rules will be identical between the United Kingdom and the European Union on January 1, 2021.
As time passes, though, we expect the rules to deviate as the United Kingdom and European Union have no obligations to follow changes in each other’s laws and regulations and are free to, and have already expressed interest in, diverging from one another. This will inevitably lead to new structuring and tax issues for future securitizations. However, there is also an opportunity for either the United Kingdom or European Union to implement a regulatory scheme that attracts increased securitization activity.