Luxembourg’s essential role in the revitalization of the German securitization market

Europe stands at a critical point, needing to enhance its competitiveness and attractiveness amid global competition for investments. According to the latest EY research¹ Europe’s foreign direct investments declined by 4% in 2023, marking the first annual downturn since 2020. Current projections from the International Monetary Fund² released in October 2024, indicate a stagnation of Germany’s economy for 2024 – Europe’s biggest economy. At the same time, growth is expected in all the other G7 countries.

In addition to the current difficult economic environment resulting from high inflation, volatile energy prices, supply issues, and high interest rates, Europe, and especially Germany, are expected to face a tremendous challenge with the required investment needs for the green and digital transformation of the economy. According to the European Central Bank, these requirements are estimated to cost EUR 620 billion annually within the European Union.³

Securitization Back on the Highest Agenda of Policymakers

There is a consensus among politicians, business organizations, and other stakeholders that transformative changes are necessary to address these challenges. As highlighted by recommendations from thought leaders like former Italian Prime Minister Letta in April this year (report on the future of the Single Market), or former ECB President Draghi in September 2024 on EU competitiveness, these investments can only be financed with the completion of the Capital Market Union and a revival of the securitization market. As Letta stated: “Securitization acts as a unique link between credit and capital markets. In this sense, the securitization market offers significant potential.”

Compared to the US, issuances in the EU securitization market have remained at very low levels since the financial crisis, reflected by USD 2.5 trillion in the US vs. EUR 203 million in the EU.⁴ European securitizations were unjustly discredited, as evidenced by their consistently low default rates before, during, and after the crisis. Nevertheless, securitizations in Europe still appear to be stigmatized.

Given the current economic challenges and the massive investment needs required for the transformation, securitization seems to be back on the highest agenda of policymakers. This was confirmed by the release of the consultation paper of the European Commission for the regulation of the securitization market⁵ which is closing for feedback from market participants in December 2024.

Limitations in the German Securitization Regulatory Environment

As mentioned previously, securitizations have been enjoying a lot of political attention over the past few months. In addition, associations and market participants have issued concrete action calls to unlock the potential of securitization in Germany. Recently, the Association of German Banks, together with True Sale International GmbH, issued a report⁶ summarizing current obstacles in the securitization regulatory environment to strengthen the market.

The most common issues identified at a European level, impacting the Luxembourg securitization market as well, pertain to:

Reducing transaction costs in the market – simplifying the Securitization Regulation (SECR): Concrete measures focus on making the process of issuing securitizations faster and easier to broaden the investor base. The report calls for enhancements and changes in the European Securitization Regulation (SECR), for example, in relation to Due Diligence and Transparency requirements as well as changes to requirements for simple, transparent, and standardized (STS) transactions.

Appropriate adjustments to the framework for securitization for banks and insurance companies: Two major reasons for the non-involvement of small and medium-sized banks are identified: high costs of implementation and disproportionate capital requirements. While in recent years, we have observed an increased use of synthetic risk transfers for larger banks, a boost and revitalization of the securitization market can only be achieved when small lenders from the partially fragmented German banking market, which includes more than 1,200 banks, are substantially involved. However, even for large institutions, substantial improvements to regulations and cost reductions are seen to be required. This report addresses these issues and considers concrete adjustments to the Capital Requirements Regulation (CRR), Liquidity Coverage Ratio (LCR), and other regulatory requirements.

Insurance entities' role: With their funded capital investment, insurance entities could play a key role in fostering the German economy. However, they face similar issues in the revitalization of the European securitization market. To address this, specific adjustments are highlighted, especially in relation to the capital requirements pursuant to Solvency II, as well as the participation of insurers in STS securitizations.

In addition to the obstacles at the European level for revitalizing the securitization market, the report from the Association of German Banks, together with True Sale International GmbH, calls for the creation of a national German securitization framework. While the Luxembourg Law of 22 March 2004 on securitization (the ‘Securitization Law’) has been in force for two decades, Germany still lacks a specific law covering securitization vehicles (SV) and transactions.

Luxembourg’s Proven Securitization Law

Generally, together with Ireland and Italy, Luxembourg remains one of the leading financial centers for securitization. Based on the European Central Bank’s Q3/2024 statistics, which can be seen as a good indication of general market developments during the year, 1,542 Financial Vehicle Corporations (FVC) were registered in Luxembourg (1,512 on 31 December 2023), representing 30% of all FVCs across Europe. A substantial amount of the Luxembourg SVs are securitizing assets originated in Germany, including to a large extent trade receivables and auto loans and lease receivables, which are performed mainly through Asset-Backed Commercial Paper (ABCP) programs or true sale public/non-public ABS transactions.

When comparing key proposals for a German securitization law with the current situation in Luxembourg, the conclusion is clear:

Specific legal form with multi-compartment feature: Currently, there is no special securitization purpose entity foreseen to be introduced to German law, and the general requirements are stipulated in the Act on Limited Liability Companies. This law does not foresee any provisions with regards to the legal segregation of assets in compartments. When comparing to the Luxembourg Securitization Law, it is clear that this has been one of the main contributors to the huge success of Luxembourg SVs over the last decades. With the possibility to create multi-compartment structures, Luxembourg stands out with a cost- and time-efficient legislative framework.

True Sale transactions: Given the absence of a dedicated German securitization framework, this report highlights the need to include regulations for true sale transactions, more specifically for the SV to claim separation of the assets from the originator in case of insolvency. The Securitization Law in Luxembourg already provides such clarification by stipulating that the assignment of receivables by or to an SV includes the transfer of the associated guarantees and security interests. Additionally, it ensures that the SV is entitled to claim any cash collected on its behalf before the commencement of liquidation proceedings.

Responsive to market demands: Not only does Luxembourg have a dedicated securitization law, but the Luxembourg government has also recently responded to market practices and demands by clarifying and modernizing the Luxembourg Securitization Law. These changes pertain to, inter alia, further possibilities to actively manage risk portfolios and to grant security interests, offering new ways of funding and increasing the number of legal forms allowed for the purpose of setting up securitization companies. These measures underline the importance of the securitization market on the agenda of the Luxembourg government and highlight the very favorable and knowledgeable environment that originators, arrangers, and investors find in Luxembourg.

In addition to the various legislative aspects required to build a German securitization framework, which – given the current political situation in Germany – does not appear to be very likely to succeed in the short term, Luxembourg has an advantage of more than 20 years, which has led to a well-developed ecosystem around securitizations, including experienced and well-established service providers, listing facilities, custodians, and other market participants.

Conclusion

From a Luxembourg perspective, the rising spotlight from European policymakers and thought leaders on the European securitization market is very welcome. As highlighted, without a real revitalization of securitization, the essential investments will be difficult to finance. As an example, the first 'solar securitization' was seen in October this year, allowing investment in nearly 8,500 loans to German homeowners for the financing of solar panels. This indicates the key role securitization can and will play in financing the green transition. This transaction is enabled via a Luxembourg securitization vehicle and clearly shows that from an originator or arranger perspective, Luxembourg as a key hub for securitizations cannot be missed out.

Luxembourg’s well-established and flexible securitization framework will play a key role in financing transformation and enabling growth. In comparison to the situation in Germany, the strengths of the Luxembourg Securitization Law are undeniable. However, from a European point of view, the aforementioned report highlights required changes and simplifications to the SECR. Without changes to broaden the investor base, the European securitization market will not move forward substantially. Therefore, the current consultation on the SECR and the expected changes under the new EU Commission should be closely monitored by all market participants.