The Luxembourg law on securitizations dated 22 March 2004 (the “Securitization Law”) has been providing a sound, flexible and very efficient legal, regulatory and tax framework for securitization transactions for the past two decades. In a highly attractive but also fast-moving Luxembourg securitization landscape, the requirements of the market have evolved. A modernized Luxembourg Securitization Law has therefore been voted for by the parliament, with the purpose to further clarify the existing framework and to adapt it, while maintaining high protection for investors. Papa Saliou Diop, Associate Partner, Securitization Leader and Oliver Cloess, Associate Partner at EY Luxembourg, analyze the six key changes brought by this update, which has been transposed into the Securitization Law on 25 February 2022 and will be effective as from 8 March 2022.
According to the European Central Bank1, Luxembourg is one of the most favorable countries for domiciliation of securitization vehicles within the Euro Area, behind Ireland, its main competitor. A dedicated Securitization Law, the compartment feature, a wide range of assets allowed to be securitized, the VAT exemption on the management of these vehicles and the ease of communication with the regulator were until now among the biggest competitive advantages of our country.
To close the gap with Ireland, applying “active management” principles for a few years now and gaining more and more market shares, it was time for Luxembourg to align with the Risk Management needs arrangers are facing when dealing with certain asset classes such as Collateralized Loan Obligations (CLOs) or Collateralized Debt Obligations (CDOs). Another necessity was to enlarge the means of financing which the Securitization Vehicles (SVs) could benefit from – allowing a wider connectivity with the financial ecosystem when raising funds.
The definition in the Securitization Law is not solely limited to the transfer of credit risks while issuing multi-tranche securities. Amongst the well-known features of the Securitization Law, there are investor protection rules provided by subordination, non-recourse, and non-petition clauses as well as the full ring-fencing of assets and liabilities within separate compartments. The purpose of the modernized Securitization Law is therefore to adapt to changing requirements, and to further clarify the existing legal framework. EY Luxembourg’s Securitization specialists identified six key changes brought by this modernization:
Loan financing
The long-standing restriction for securitization vehicles to only issue securities for their own financing is lifted. Henceforth, any financial instruments can be used, including loans. The involvement or extent of other means of financing was often discussed in practice. This change will increase the use of certain structures, e.g. a securitization vehicle being financed via the use of bank loans.
Active management
The activities of securitization vehicles were traditionally limited to the passive management of their assets while active management, e.g. trading or active replacement of assets in the collateral pool, was not easy to achieve. This also often raised questions in practice for securitization structures which require active management of the collateral pool such as CLOs or the granting of loans. The modernization of Luxembourg’s Securitization Law now makes it possible for a Luxembourg securitization vehicle to actively manage a debt portfolio as long as no issuance of financial instruments is made to the public with the aim to achieve easier the administration of actively managed CLO’s and to revive this market for Luxembourg.
Regulation
The vast majority of Luxembourg securitization vehicles are currently unregulated. However, a few securitization vehicles are regulated by the Commission de Surveillance du Secteur Financier (CSSF) under certain circumstances. The modernized Law defines the authorization requirement criteria which is mainly aligned with the existing CSSF guidance referring to the continuous issuance to the public. The definition of “continuous” has still the meaning of more than three issuances per calendar year. In addition, the concept of “public” refers to three cumulative criteria being that (i) the issuance of financial instruments is aimed at non-professional clients, (ii) the issuance of financial instruments do not exceed EUR 100k and (iii) the financial instruments are not distributed as private placement.
Available legal forms
The available legal forms for securitization companies were limited to public limited liability company (S.A.), a private limited liability company (S.à r.l.), a partnership limited by shares (S.C.A), or a co-operative company organized as a public limited liability company (S.C.O.S.A). The modernized Securitization Law introduces additional legal forms to setup securitization companies, i.e. general partnerships ((sociétés en nom collectif), common limited partnerships (S.C.S.), special limited partnerships (SCSp) and simplified public limited liability companies (sociétés par actions simplifiées). This is adding additional flexibility as it is the first time that a fully unregulated Luxembourg partnership can use compartments.
Guarantees
Before the modernized Securitization Law, a securitization vehicle could provide securities/guarantees over its securitized asset(s) solely to its investors. Therefore, banks and other involved parties could not benefit from such guarantees making the structuring of the transaction unnecessarily complex or impossible. The modernized Securitization Law allows to provide securities/guarantees to third-party creditors whilst maintaining high protection for the investors adding further flexibility in structured financing.
Compartment rules
Securitization vehicles may either issue debt or equity securities (now extended to financial instruments). In case of equity financed securitization vehicles, the Securitization Law was silent about the governance rules applicable to structures with compartments. The modernized Law now clarifies that financial statements of such equity financed compartments shall only be approved by the respective compartment shareholders and that the decision to allocate legal reserve shall also be taken at the compartment level. This removes the uncertainty surrounding equity financed multi-compartment securitization vehicles.
Overall, the very successful and flexible Securitization Law was modernized in some areas that are considered to be important and relevant to Arrangers. Hence, this modernization provides for more structuring flexibility than ever while keeping high the reliability and investor protection rules that made this Securitization Law so successful in the past.
