At the end of May 2021, the Luxembourg government submitted a bill of law1 (the Bill of Law) to the Parliament amending the Luxembourg law dated 22 March 2004 on securitization (the 2004 Law).
This long-awaited update of the Luxembourg securitization regime aims to clarify certain aspects of the 2004 Law, as well as to adapt it to the requirements of the current securitization market. The proposed changes should further increase the appeal of Luxembourg securitization vehicles and bring new opportunities to the Luxembourg financial services industry.
This OnPoint discusses the main proposed changes to the 2004 Law.
Additional financing options
Under the current regime, the acquisition of the risks that a Luxembourg securitization vehicle (SV) intends to securitize must be financed by the issue of securities (valeurs mobilières) and in principle2 the SV cannot make use of other financing means, such as entering into a traditional loan agreement which is not structured as a debt security.
Under the Bill of Law, it is proposed that SVs will also be permitted to finance their activities by entering into contractual types of borrowing, partially or totally.
It is also proposed that the reference to ‘securities’ is replaced by ‘financial instruments’ (instruments financiers), as ‘securities’ (valeurs mobilières) is a term which is not clearly defined under Luxembourg law and can lead to interpretation issues especially when the issued securities are not governed by Luxembourg law. ‘Financial instruments’ are however clearly defined in the Luxembourg law dated 5 August 2005 on financial collateral arrangements3.
These proposed changes clarify and extend the means through which SVs can finance their securitization activities. They also align the Luxembourg securitization regime with the European securitization regime by ensuring that any securitization subject to the Securitization Regulation4 can be performed by Luxembourg SVs (including securitization resulting from entering into loan agreements).
Active management of debt portfolios: opening the door to CLOs?
While the 2004 Law is silent on this subject, the current regulatory practice is very restrictive on the management by an SV of its securitized assets. The CSSF5 considers that the SV’s “action must be limited to a “prudent man” passive management”6 and that such management “can under no circumstances consist of either active management of the portfolio aiming to take advantage of short-term fluctuations of market prices and resulting in an ongoing activity of claim acquisition and assignment or (…) a professional credit activity performed by the securitization undertaking on own account”7.
Given current debt market practices and the opportunities that a more permissive approach would offer to the Luxembourg financial service specially for CLOs managers. s industry, the Bill of Law proposes allowing SVs to actively manage a portfolio of assets consisting of debt financial instruments or claims, provided that their acquisition is not financed by the issuance of financial instruments to the public8.
Such a development should further increase the appeal of using Luxembourg SVs as both standalone investment vehicles as well as core parts of wider investment structures managing debt portfolios, especially for CLOs managers.
Clarification of the criteria for SVs to be approved by the CSSF
SVs issuing securities to the public on a continuous basis must be authorised by the CSSF.
The concept of the “issue of securities to the public on a continuous basis” is not defined in the 2004 Law. It is therefore proposed under the Bill of Law to clarify the conditions under which SVs must be authorized by the CSSF, by adding the following definitions, in line with current regulatory practice:
- An SV issues financial instruments on a continuous basis when it performs more than three issues of financial instruments offered to the public during one financial year, taking into consideration the total number of issues by all compartments of the SV;
- An issue of financial instruments is offered to the public when:
- It is not reserved to professional clients9; and
- The nominal value of the financial instruments is lower than €100,000; and
- It is not distributed by means of a private placement.
Granting of security interests
Under the 2004 Law, SVs can grant security interests over their assets or transfer their assets for guarantee purposes, but only in order “to secure the obligations it has assumed for their securitization or in favour of its investors, their fiduciary-representative or the issuing vehicle participating in the securitization”10.
The Bill of Law proposes to allow the SV to grant security interests over its assets in order to cover obligations relating to the securitization transaction, broadening the circumstances under which security interests can be granted while maintaining investors’ protection.
Subordination
It is proposed to introduce a set of rules to clarify the ranking between the claims that holders of instruments issued by an SV may have against the SV. These rules would apply by default and may be overruled by specific contractual arrangements between the parties.
More flexibility as to the legal form of the SV
The 2004 Law11 limits the legal form that can be used to set up a Luxembourg securitization company and in practice most of the securitization companies take the form of a public company limited by shares (société anonyme or SA) or a private limited liability company (société à responsabilité limitée or Sàrl).
The Bill of Law proposes to offer more flexibility and allow securitization companies to also be set up as a common limited partnership (société en commandite simple or SCS), special limited partnership (société en commandite spéciale or SCSp), simplified limited liability company (société par actions simplifiée or SAS) or general partnership (société en nom collectif or SNC). The addition of the SCS and the SCSp will in particular be welcomed by investors and managers which are familiar with such tax transparent partnerships.
Accounting requirements
In order to ensure the same level of accounting transparency to investors no matter the legal form of the SV, the Bill of Law provides that an SV which is set up as an SCS, SCSp or SNC (which legal forms are in principle subject to less strict accounting requirements) shall have the same obligations in terms of accounting preparation and publication as an SV which is set up as an SA or a Sàrl.
Furthermore, to reinforce the effectiveness of the legal segregation between compartments of an SV, under the changes proposed when a compartment is financed by the issue of shares, it will be possible to have the accounts prepared at the level of the compartment approved only by the shareholders of that compartment.
Conclusion
The changes proposed to Luxembourg’s securitization regime by the Bill of Law have been welcomed by the Luxembourg financial services industry, with the additional opportunities and flexibility for Luxembourg SVs that they would bring. Although the timing of approval of the Bill of Law is currently unclear, we will provide further updates as the legislation progresses.
Footnotes
1) Projet de loi portant : 1° modification de la loi modifiée du 22 mars 2004 relative à la titrisation ; 2° modification de la loi modifiée du 23 décembre 1998 portant création d'une commission de surveillance du secteur financier ; 3° modification de la loi modifiée du 19 décembre 2002 concernant le registre de commerce et des sociétés ainsi que la comptabilité et les comptes annuels des entreprises ; 4° modification de la loi du 16 juillet 2019 portant mise en œuvre des règlements EuVECA, EuSEF, MMF, ELTIF et Titrisation STS ; et 5° mise en œuvre du règlement (UE) 2020/1503 du Parlement européen et du Conseil du 7 octobre 2020 relatif aux prestataires européens de services de financement participatif pour les entrepreneurs, et modifiant le règlement (UE) 2017/1129 et la directive (UE) 2019/1973.
2) Except on an ancillary and/or limited basis.
3) Article 1, point 8 of the Luxembourg law dated 5 August 2005 on financial collateral arrangements, with the exception of claims and rights under Article 1, point 8, f.
4) Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitization and creating a specific framework for simple, transparent and standardised securitization.
5) The Commission de Surveillance du Secteur Financier, i.e. the Luxembourg financial supervisory authority.
6) Frequently Asked Questions, Securitisation from the CSSF dated 23 October 2013.
7) Frequently Asked Questions, Securitisation from the CSSF dated 23 October 2013.
8) See below on the concept of “issue of securities to the public”.
9) Under the meaning of article 1 of the Luxembourg law dated 5 April 1993 on the financial sector.
10) Article 61(3) of the 2004 Law.
11) Article 4 of the 2004 Law: “Securitization companies must be set up as a public limited company (société anonyme), a corporate partnership limited by shares (société en commandite par actions), a private limited liability company (société à responsabilité limitée) or a co-operative company organised as a public limited company (société cooperative organisée comme une société anonyme).”
