10 changes transforming Luxembourg's securitisation market

Luxembourg is enhancing its appeal as a destination for securitisation transactions by amending its highly successful 2004 Securitisation Law. Head of Capital Markets - Luxembourg, Sandra Bur summarises 10 of the key changes.

Luxembourg's securitisation market has often been cited for its flexibility and security. These attributes have made it a significant European hub for securitisation transactions, with over 1,300 active securitisation vehicles containing more than 8,000 compartments and controlling roughly EUR400 billion in AUM.

Luxembourg's Securitisation Law (the "Law") of 22 March 2004 provides the framework for the market's success and is now undergoing some long-awaited changes and clarifications. Draft bill number 7825 (the “Draft Bill”) was submitted on 21 May 2021 and further develops the flexibility and relevance of Luxembourg's securitisation vehicles.

Key amendments to the Law as proposed in the Draft Bill and their impact on Luxembourg's securitisation environment are listed below. It should be noted that adjustments to the Draft Bill can be expected before it is voted into law. 

1. Replacement of the notion of “securities” by “financial instruments”

The Draft Bill suggests that the term “securities" (valeur mobilieres), which is currently the only mechanism by which a securitisation vehicle can offer investment to an investor, but which is not defined under the current Law, is replaced with “financial instrument” as defined in the collateral law of 2005. This would broaden the scope of instruments that can be issued by the securitisation vehicle to the investors, affording them greater flexibility.

2. Possibility for a securitisation vehicle to be financed by borrowings

The Draft Bill suggests that a securitisation vehicle could now be financed via loans or through any kind of debt. This would be a landmark for the Law as it would provide legal certainty for the financing of securitisation transactions by the issuing of “hybrid” instruments by the securitisation vehicle. These would have characteristics of both debt and equity and would give more flexibility to investors in jurisdictions where there may be restrictions on the types of financial products in which they can invest.

3. Clarification for CSSF supervised securitisation entities that offer securities on a continuous basis to the public

The Draft Bill asserts that a securitisation vehicle must obtain CSSF approval if it offers securities to the public on a continual basis (more than three issuances per financial year, including all compartments). This provides the clarity the Law was previously lacking concerning which activities securitisation vehicles should obtain approval from the CSSF for. The definition of what constitutes public is as follows:

• the issuance is not meant for professional clients (as defined in the Luxembourg Law of 5 April 1993 on the financial sector, as amended);
• the nominal amount of the financial instruments has denominations less than EUR 100,000; (N.b. this change is to align the securitisation regime with the whole sale exemption of the prospectus regulations); and
• the issuance is not made by way of private placement

4. Additional forms of commercial companies allowed for securitisation

In relation to setting up securitisation companies, the following four company types are currently permitted, with the first two by far the most common:

• a public limited liability company (société anonyme);
• a private limited liability company (société à responsabilité limitée);
• a corporate partnership limited by shares (société en commandite par actions); and
• a cooperative company organised as a public limited liability company (société coopérative organisée comme une société anonyme).

The Draft Bill introduces four additional legal forms that can be used for establishing securitisation companies:

• special limited partnerships (sociétés en commandite spéciale);
• simple limited partnerships (sociétés en commandite simple);
• general corporate partnerships (sociétés en nom collectif); and
• simplified joint stock company (sociétés par actions simplifiée).

This expands Luxembourg's product offering and allows more flexibility and efficiency in the structuring of transactions, in particular through the SNC (general corporate partnership) and the SCSp (special limited partnership) which are transparent for Luxembourg tax purposes.

This would be the first time a securitisation vehicle could be a tax transparent vehicle without needing to be set up as a fund. This will be welcomed given the introduction of the Anti-Tax Avoidance Directive (ATAD) and its impact on Luxembourgish securitisation vehicles. Indeed, it will be a great relief to many to have this option to circumvent the difficulties posed by the ATAD legislation.

These additional vehicles will still be able to create segregated compartments and should make securitisation structures far more desirable for private equity houses or family offices who already extensively use partnership structures in Luxembourg.

5. Indirect acquisition of risks

The Draft Bill clarifies and provides a legal framework permitting a securitisation vehicle to acquire intangible and tangible assets and their associated risks directly (by being a party itself to the acquisition agreement) or indirectly (e.g. through a wholly owned subsidiary which would then acquire ownership of the asset).

N.b. This does not permit the securitisation company to carry on commercial or entrepreneurial activity. It simply clarifies that the securitisation vehicle would be a tool to refinance the acquisition on a tangible asset by a subsidiary where such subsidiary owns and operates the asset.

Given that Luxembourg’s Generally Accepted Accounting Principles (GAAP) already allow for substance over form rules to be applied to the accounting of any assets, the above change should have no impact on the account treatment of the assets (if Lux GAAP is being used). Regardless of whether the asset is held directly or indirectly, it can still be recognisable on the balance sheet of the securitisation vehicle. The Draft Bill just provides certainty that this is permissible under the scope of the law.

6. Expansion of the scope of security interests granted by a securitisation vehicle

The existing Law does not permit a securitisation vehicle to grant security or guarantees over a securitisation vehicle’s assets for the benefit of third parties, it is only investors (or a security agent or trustee acting on behalf of the investors) of the transaction that can benefit. Therefore, the assets of the securitisation vehicle or compartment are exclusively available to satisfy the obligations to the investors.

The Draft Bill does not seek to change this approach but broadens the scope of creditors that are granted partial benefit of the securitised asset, proposing that both direct and indirect creditors of the securitisation vehicle should be granted benefit.

7. Rules governing the operation of equity financed compartments

The Law does not currently stipulate any rules or guidance regarding equity financed compartments. This has proved challenging for service providers and auditors alike who have not had clarity over requirements around items such as distributions.

The Draft Bill clearly defines the treatment and distribution of profits and losses of equity financed compartments, stating that this has to be done on a compartmental basis. This means the shareholders of the compartment will determine and approve the compartments’ distributions. This further protects investors in each compartment and solidifies the idea of ringfencing each compartment.

Furthermore, the Draft Bill states that for equity financed compartments, their individual balance sheets and statements of profit and loss should only be approved by the compartments’ shareholders and be included in the financial statements of the securitisation vehicle.

It is worth mentioning that although rare in Luxembourg, equity financed compartments are non-existent in locations such as Ireland. This is an attractive alternative that Luxembourg can offer to its investors.

8. New requirements for securitisation funds

Securitisation funds do not currently have to register with the Luxembourg Trade and Companies Register (RCS), which has led to some lost opportunities for securitisation funds. For example, a securitisation fund without an RCS number would be unable to issue its securities on a stock exchange.

The Draft Bill changes this. It states securitisation funds (and their liquidation) have to be registered with the RCS, with existing securitisation funds having to register within six months after the Draft Bill has entered into force. This does come with increased reporting obligations for securitisation funds whereby they will need to draw up and publish annual accounts in accordance with the law of 19 December 2002 on the RCS.

9. Legal subordination rules establishing a default waterfall of payment

The Draft Bill provides a default waterfall / priority of payments order that is applicable to all securitisation vehicles regardless of if they are a fund or a company. This can be used in the absence of a stipulated waterfall / priority of payments order in the contractual documents.

The order rules defined in the Draft Bill are as follows:

• Units of a securitisation fund are subordinated to other financial instruments issued by the securitisation fund and borrowings contracted by the fund.
• Shares (actions), corporate units (parts sociales) or partnership interests (parts d’intérêt) in a securitisation company are subordinated to other financial instruments issued by such securitisation company and borrowings contracted by the securitisation company.
• Shares (actions), corporate units (parts sociales) or partnership interests (parts d’intérêt) in a securitisation company are subordinated to beneficiary shares (parts bénéficiaires) issued by the securitisation company.
• Beneficiary shares (parts bénéficiaires) issued by a securitisation company are subordinated to debt instruments issued and borrowings contracted by the securitisation company.
• Non-fixed income debt instruments issued by a securitisation undertaking are subordinated to fixed income debt instruments issued by the securitisation undertaking.

The Draft Bill's clarification will be beneficial for funds where the subordination between units issued by a securitisation fund and the debt instruments issued by a securitisation fund is unclear.

10. Active management of securitisation vehicles now permitted

The Draft Bill proposes adding a new article in the Law that specifically permits active management of securitisation vehicles for risks linked to bonds, loans or other debt instruments (but not for equity type assets) so long as these are issued under private placement. This would enable Luxembourg to attract more CDO/CLO structures which have historically been set up in other jurisdictions. For more information about how the Draft Bill could strengthen Luxembourg’s CLO proposition, read our article Luxembourg - a new home for CLOs?.

A bright horizon for Luxembourg's CLO landscape

The financing and refinancing markets continue to drive investor appetite for actively managed CLOs, a global market that is approaching one trillion USD. Ireland is currently the location of choice for CLO transactions in the Eurozone, with assets in Irish-domiciled CLOs rising to €170 billion by April 2021. However, the Draft Bill is expected to turn heads once it enters force and put Luxembourg in a great position to host such structures and capitalise on market growth.

It is now up to the key players of Luxembourg's securitisation market to advertise these new opportunities to investors and demonstrate its competitive offering.

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