The Luxembourg securitization market has been showing a growing trend over the years thanks to its resilience and its trusted legal framework. 2021 showed a net growth of 4.7% in the number of securitization vehicles (SVs), exceeding 1,4001. The modernization of the Luxembourg securitization law will be an accelerator and reinforce the country’s positioning on the EU market. The amendment of the EU Securitization Law will also enlarge the type of assets to be securitized in Luxembourg.
To sustain the current level of growth and to better position the Luxembourg securitization market in the future, the following actions might be considered: continue to be resilient, anticipate impacts on the rapid evolving regulatory environment (e.g., EU Securitization, ESG, Tax) and build a stronger governance framework that will guarantee a more transparent reporting for investors around valuation of assets and Anti-money laundering compliance.
Capacity to show resilience in the rapid evolving regulatory environment
The EU regulation 2021/557 amending the EU Regulation 2017/2402 (the EU Securitization Law), in force since April 2021 includes two additional types of assets: on-Performing Exposures (NPEs) and on balance synthetic securitizations. For NPEs, considerations are given to the possibility to perform adequate due diligence on the pricing of assets to provide more transparency to investors. In addition, the calculation of the risk retention criteria has been revisited to better calibrate capital requirements when investing on NPEs. With regards to onbalance sheet synthetic securitizations, they are now eligible to the Simple, Transparent and Standardized (STS) regime as long as they comply with STS criteria. Several restrictions have been included in the credit protections agreement terms and conditions to reinforce a better monitoring of the credit risk transfer. A third-party verification agent of the accuracy of certain aspects of the credit protection agreements when a credit event occurs has been put in place to increase both investors and originators protection.
The Anti-money Laundering (AML) and the Tax avoidance aspects have also been addressed by this amendment, requiring investors to notify tax authorities when investing in SVs located in a jurisdiction with a harmful tax regime. SVs under this EU framework should not be in a country considered as an EU non-cooperative jurisdiction regime or as a high-risk country which have strategic deficiencies in its regime on AML.
This new developments in the EU Securitization framework should provide additional room of growth for the Luxembourg market considering these new classes of assets and the increasing level of NPEs coming from the Covid 19 crisis in addition to the modernization of the Luxembourg securitization law which introduce this active management possibility on CLOs/CDOs structures.
The main challenges are the set-up of comprehensive valuation models that would be able to capture complexities of ATAD 1 rules for NPEs securitized assets, and to develop efficient operational processes to face the high volumes of CDOs and CLOs that will be onboarding in the coming weeks and months. But also, key differentiators would be the demonstration of our capacity to comply with AML rules as it is often a blocker for the set-up of new structures and a must have to ensure the transparency of Luxembourg SVs.
Environmental, Social and Governance (ESG) Factors
The ESG topic is on the nerves of the market currently. The emphasis is on funding the sustainable products and all aspects related to transparency requirements towards the investors.
The transparency on ESG reporting has been strengthened by the new amended Securitization framework which aims to implement a comprehensive framework around the transparency of reporting on sustainability risk policies, on adverse sustainability impacts at the entity level and at financial product level, on the remuneration policies in relation to the integration of sustainability risks and on the promotion of ESG characteristics in the pre-contractual disclosures.
The majority of Investors in securitization entities also have expressed an interest in sustainable investment and consider the ESG risks. With this swift shift in the investment strategies and new sustainable financial products under development, there are a couple of challenges to be considered, such as the impact of these investments on the business model and on overall risk management framework including the global policies of the investors. There is also an evolving process to expend this awareness and how to collect the required data to be used for decision making and reporting purposes.
Current and upcoming ESG regulations trigger strategy and operational questions for Wealth and Asset Managers (WAM), which are addressed with different levels of maturity and speed. The fact is, it’s only the beginning of the ESG agenda, and WAM entities and their products must operate a shift towards a more sustainable growth.
Non-Financial Reporting timetable
Securitization entities’ Directors will need to have a good understanding of ESG factors impacting asset backed securities and assess from a broader standpoint the scope of the non-financial reporting directives for each entity based on the legal form and listing status. As this reporting aspect is still developing and will require some additional internal processes, the Directors have to get this on their agenda and up their game.
Main changes for securitization vehicles are coming from the Corporate Sustainability Reporting Directive (CSRD)and the EU Taxonomy. CSRD will be applicable from 1 Jan 2023 and introduce the obligation of a limited audit.
Companies’ managers/Directors have to understand and adapt to the regulation and assess the criteria for reporting requirement. If the SVs fall in the scope, it is important to initiate the journey to screen the organization’s level of readiness to produce the relevant and required information and put in place the right milestones to get ready for 2023 and the related audit.
Valuation of Assets
In performing valuation of different asset classes, the availability of all the relevant data points is quite challenging. This was the case in particular at the start of the Covid-19 pandemic. Today, sufficient data points for most sectors in assessing covid-19 impact are available, and significant investments have also been made in technological tools to make the interactions with our clients more efficient. With regards to ESG, a lot has been achieved over the past years (e.g. reporting) but there’s more yet to come to enable quantification of the valuation impact of ESG on certain asset classes. Even today, a couple of market segments are more difficult than others to value. Adequate management of data and an independent review of the models developed inhouse should be a top priority to be included in Board members’ agendas to capture the new complexity of the new types of assets that we will see on the market.
Anti-Tax Avoidance Directive 3 (ATAD 3)
The forthcoming hot topics for securitization vehicles will be the fate of the exemption of companies covered by the Securitization Regulation from the interest limitation rules and the new draft ATAD 3 Directive that seeks to deny treaty and tax directive access for “shell” companies. Due to the nature of their income, securitization companies covered by the Regulation would not generally be expected to be adversely affected by the exemption going away, but a case-by-case analysis is highly recommended. ATAD 3 will be applicable as of 2024 at the earliest but securitization companies would be well advised to analyze whether they are affected by the draft ATAD 3 Directive and monitor developments.
The above topics will need to be anticipated by Securitization leaders and stakeholders through an adequate analysis of the impact of these hot topics on their entities. This analysis at an early stage will bring the growth perspectives to their portfolios and will help them to comply with the upcoming reporting and taxation requirements.
[1] Banque Centrale du Luxembourg, Q4 2021
