The Reform of the Luxembourg Securitisation Law

Introduction

After a marked absence of changes in law in the Luxembourg securitisation sector for a number of years, there are now a number of recent developments that merit some attention, key of which the Luxembourg law of 25 February 2022 amending the law 22 March 2004 on securitisation (the “New Securitisation Law”) that entered into effect on 8 March 2022.

The New Securitisation Law has brought about considerable changes to the Luxembourg securitisation regime by rendering it more flexible with respect to the specific requirements and creating new opportunities for securitisation market participants.

Overview of New Securitisation Law

The purpose of the New Securitisation Law has been twofold: 

a.  to explicitly set out and clarify current market practice, such as the criteria to be taken into account when assessing the authorisation requirements for securitisation undertakings which offer securities to the public on a continuous basis while introducing legal definitions in relation to the treatment of different types of securities with respect to their legal subordination; and

b.  to lift particular restrictions securitisation undertakings had to comply with under the previous regime, such as certain constraints regarding borrowing structures and portfolio management.

There are several key changes implemented by the New Securitisation Law which are worth focusing on and which should be of particular interest to market participants.

FUNDING OF THE SECURITISATION UNDERTAKING

Under the old regime, Luxembourg securitisation undertakings had to be financed by the issuance of securities whose value or yield depended on the risks assumed by them.

Funding through the issuance of financial instruments

Given the absence of specific legal definitions of what type of instruments could indeed be defined as “securities”, there was frequently some uncertainty where Luxembourg securitisation undertakings issued instruments subject to a law other than Luxembourg law. In that scenario the governing law of the relevant instrument would have needed to qualify such instrument as “securities” in order for the instrument to be eligible.

The New Securitisation Law now refers to the notion of “financial instruments” and provides a definition by reference to the Luxembourg law of 5 August 2005 on financial collateral arrangements instead of securities¹. This law contains an extremely broad definition of financial instruments, which now, and previous to the old regime, also captures German law governed “Schuldscheine”.

Funding through the taking out of loans

Under the old regime, a securitisation undertaking was foremost an issuance vehicle and therefore the entry into borrowing structures by taking out loans to investors could only be done on an ancillary basis.

In specific instances it was however acceptable that a securitisation undertaking borrowed funds or entered into intra-group financing on a temporary basis in order to pre- finance the acquisition of the risks to be securitised while it proceeded to the issuance of securities to investors at a later stage (so-called warehousing).

Additionally, it was also accepted that borrowing could be done on a lasting but limited basis. However, such borrowing could only be proceeded to on an ancillary basis while the main and determining purpose of the transaction had to be securitisation, i.e. the economic transformation of risks into securities. In other words, borrowing was only considered acceptable if the transaction as a whole also entailed the issuance of securities for a proportionately substantial amount.

Finally, the securitisation undertaking was also required to adequately inform its investors as regards any additional risks they might be facing on account of such additional borrowing by including specific information in the issuance documentation. The same applied with respect to any security interests that had to be created in consideration of such borrowings.

These restrictions were no longer reflective over the wider securitisation market practice. Indeed Regulation (EU) 2017/2402 of 12 December 2017 creating a general framework for securitisation (the “EU Securitisation Regulation”) does not require a securitisation vehicle to issue securities in order to fall under its scope.

The New Securitisation Law has now removed these restrictions and expands the scope of financing arrangements available to a securitisation undertaking by permitting it to enter into loans in addition to or instead of, the issuance of financial instruments for the purpose of, wholly or partially, funding the acquisition of the underlying assets on which the loans depend².

The easing of this restriction should in particular benefit certain investors who might have been subject to specific regulatory constraints with respect to the type of instruments they can invest in.

The yield or principal repayment of such loans will still need to depend on the underlying securitised assets, as is the case for securities issued by a securitisation undertaking which are linked to a specific compartment or pool of underlying.

In this respect, it is however important to note that when establishing the financing structure in a securitisation transaction the set-up of a specific scheme might result in “tranching” as defined under the EU Securitisation Regulation and thus trigger the application of an array of additional obligations for the securitisation undertaking, its sponsors, its originators and/or its investors in terms of due diligence, risk retention as well as transparency and disclosure requirements.

The EU Securitisation Regulation defines “tranching” as

a. a contractually established segment of the credit risk associated with an exposure or a pool of exposures,
b. where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment, and
c.  without taking account of credit protection provided by third parties directly to the holders of positions in the segment or in other segments.

ACTIVE MANAGEMENT OF RISK PORTFOLIO

A key aspect of the Luxembourg securitisation regime has been that the active management by a securitisation undertaking of its securitised portfolio is generally not permitted and that the portfolio management must therefore be restricted to a prudent person’s passive management.

This restriction on active management has historically been a major challenge for the development of the Luxembourg Collateral Loan Obligation (CLO) market. The New Securitisation Law has eased this restriction to a considerable extent and therefore provides now major opportunities for market participants that previously could not offer their products through Luxembourg vehicles.

A look back on the old regime

Under the old regime, the Luxembourg supervisory entity, the Commission de Surveillance du Secteur Financier (the “CSSF”) has taken the view that the management of the underlying securitised portfolio must in all instances be passive in character, irrespective of whether or not the actual management was delegated to a professional acting on behalf of the securitisation undertaking.

However, in particular cases the CSSF accepted structures where the management of the securitised assets included, for instance, the renegotiation of any schedules of repayments of any of the credit terms in a situation in which the relevant debtor was facing financial difficulties. Under no circumstances, however, a securitisation vehicle was permitted to manage its underlying assets in such a way that short-term market fluctuations of market prices could be taken advantage of, such management resulting in ongoing claim acquisitions and assignments³.

The reason for this restriction has been seen in the fact that in securitisation structures the securitised risk of specific underlying assets should predominantly depend on the nature and characteristics embedded in such assets and should not hinge on the competence of a portfolio manager and his/her ability to restructure the underlying portfolio in light of market developments and price fluctuations at a short notice.

Active management of debt portfolios under the New Securitisation Law

The New Securitisation Law now implements an exception to this general requirement of passive management in so far as it allows active management of a portfolio consisting of debt securities, debt financial instruments or receivables on the condition that the securitisation undertaking has not issued financial instruments to the public to finance the acquisition of the underlying assets⁴.

This means that it should now be possible to manage risk portfolios, presumably even in accordance with short-term market fluctuations and price developments. The easing of this restriction will undoubtedly create new extensive opportunities for actively managed CLOs or CDOs to be set up in Luxembourg.

However, it must be emphasized that the passive management restriction must still be complied with whenever the underlying portfolio of assets consists of other types of securities such as equity securities or other physical assets.

GRANTING OF COLLATERAL AND SUBSIDIARIES

Another restriction under the old regime was that the granting of collateral over a securitisation vehicle’s assets was limited to situations in which it was done for (i) the benefit of the vehicle’s investors or (ii) the purpose of assuring the securitisation of the charged assets.

More specifically, the former version of the New Securitisation Law explicitly required that the creation of security interests over the securitisation undertaking’s assets could only be done in order to secure the obligations the securitisation undertaking has assumed for their securitisation or in favour of its investors, their fiduciary- representative or the issuing vehicle participating in the securitisation. Any security interests and guarantees which had been created in breach of this rule were considered void by direct application of the law.

This restriction has now been lifted considerably as securitisation undertakings are now allowed to give security for obligations relating to the securitisation transaction⁵. This change in law now allows for greater flexibility in structuring the collateral package for securitisations transactions by significantly expanding on possibilities.

As such a securitisation undertaking may now grant security for the obligation of third parties or in favour of creditors other than its investors (such as custodians, registrars or other related parties). This means that a securitisation undertaking acquiring a junior loan is now also allowed to provide security over that loan in favour of the senior lenders. Likewise, where the securitisation undertaking holds assets via one or more wholly owned subsidiaries it is now possible for the securitisation vehicle to grant security or give guarantees with respect to the indebtedness of the subsidiaries in question.

With respect to the latter scenario it is worth noting that the New Securitisation Law now explicitly provides that a securitisation vehicle is allowed to acquire directly or indirectly the assets which it securitises⁶. The new provision now confirms the approach that a securitisation undertaking can acquire the assets or risks to be securitised indirectly, either through a fully-owned subsidiary or via the acquisition of an already existing entity which holds these assets or risks to be securitised by the securitisation vehicle.

AUTHORISATION REQUIREMENTS

Another important change in the New Securitisation Law is that it now contains an explicit definition as to when a securitisation undertaking is to be considered to be “issuing securities to the public on a continuous basis” triggering the requirement to be authorised by the CSSF⁷.

The answer had previously only been based on the CSSF FAQs on Securitisation which provided that issuances were made to the public on a continuous basis if more than three issuances were made to the public per calendar year on an all-compartment basis⁸.

The New Securitisation Law now provides a statutory definition of “issuance to the public on a continuous basis” which has the benefit of a higher degree of legal certainty with respect to this pivotal question and clarifies that an issuance is not to be viewed as being made to the public if it falls within any of the following categories:

a. the issuance is solely made to professional clients as defined in MiFID II as implemented in the Luxembourg law of 5 April 1993 on the financial sector (the “Luxembourg Financial Sector Law”);

b. the denomination of the financial instruments offered is equal or exceeds EUR 100,000; and

c. the financial instruments are distributed by way of a private placement.

Article 19 (2) of the New Securitisation Law codifies the position provided under the CSSF FAQs on Securitisation by providing that securitisation undertakings which issue on a continuous basis as those that carry out more than three issuances of financial instruments offered to the public during one financial year. In this respect, the number of issuances corresponds to the total number of issuances carried out by all compartments of the securitisation undertaking during that period.

In contrast, item (b) above means that more certainty has been obtained in relation to the required per unit minimum denomination securities in order for them not to be deemed to be issued to the public as the CSSF FAQs on Securitisation seemed to suggest should at least be EUR 125,000. This threshold of EUR 125,000, however, was not entirely in line with the legal situation under Regulation (EU) 2017/1129 of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market (the “Prospectus Regulation”) given that article 1 (4) (c) of the Prospectus Regulation sets out that an offer of securities to the public, the per unit denomination of which is at least EUR 100,000, does not require the prior publication of a prospectus.

This divergence previously led to uncertainty in cases where the per unit minimum denomination of securities offered by a securitisation undertaking only amounted to EUR 100,000 and not to EUR 125,000. The legal consequence was clear under the Prospectus Regulation as no prospectus needed to be approved for such offers under prospectus rules. However, under the previous securitisation regime this did not automatically make the offer a private placement under Luxembourg securitisation rules on account of the CSSF’s explicit reference to a per unit minimum denomination of Euro 125,000.

In fact, in this respect the CSSF FAQs on Securitisation were to some extent ambiguous given that on the one hand they clearly stated that an offer of securities, where the per unit denomination was at least EUR 125,000, needed not be taken into account in the context of the assessment when a securitisation undertaking was offering securities to the public on a continuous basis. On the other hand, the CSSF FAQs on Securitisation also noted that issues distributed as private placements irrespective of their denomination were not considered issues to the public.

This change in law is therefore clearly welcomed as the New Securitisation Law now offers more coherence with the Prospectus Regulation.

Criminal sanctions and fines have also been introduced in a situation in which financial instruments are publicly issued without the prior authorisation by the CSSF. Persons infringing on the authorisation requirement can be punished by an imprisonment from three months to two years and/or a monetary fine ranging from EUR 500 to EUR 125,000.

TRANCHING IN THE CONTEXT OF THE CLARIFICATION OF SUBORDINATION RULES

The New Securitisation Law also clarifies certain aspects regarding the issuance of tranched securities. In this respect it is worth remembering that, as discussed under section Funding through the taking out of loans, only structures in which a securitisation undertaking engages in tranching fall within the scope of the EU Securitisation Regulation.

In light of these differences a Luxembourg securitisation transaction can primarily be structured in two possible ways:

a. Securitisation which is only subject to the New Securitisation Law: It is possible to structure a Luxembourg securitisation transaction so that it is only required to be compliant with the New Securitisation Law and does not fall under the scope of the EU Securitisation Regulation. This can generally be achieved by either (a) securitising a risk other than a credit risk (the EU Securitisation Regulation only focuses on the securitisation of credit risk) or (b) by not tranching the securities to be issued.

b. Securitisation under the EU Securitisation Regulation:Securitisation transactions which securitise credit risks and issue tranched securities or loans, i.e. debt obligations which contain different segments, e.g. senior and subordinated segments, will usually be subject to both the New Securitisation Law and the EU Securitisation Regulation as mentioned above.

The second type of transactions implies that the requirements with respect to risk retention, transparency and due diligence as required by the EU Securitisation Regulation need to be complied with by the securitisation undertaking, in addition to the application of the general framework of the New Securitisation Law. Consequently, the provisions set out in both the New Securitisation Law and the EU Securitisation Regulation have to be respected by a Luxembourg incorporated securitisation vehicle in such a case.

While the tranching for the purpose of the EU Securitisation Regulation should be based on contractual subordination, the New Securitisation Law now includes explicit rules regarding the legal subordination between different types of securities, unless contractually agreed otherwise⁹.

This means that the following ranking of instruments issued by a securitisation vehicle is now legally established:

• the units, shares or interests issued by a securitisation undertaking are subordinated to the other financial instruments issued and loans entered into by the securitisation vehicle;
• the shares or interests in a securitisation undertaking are subordinated to any beneficiary shares issued by the securitisation vehicle;
• the beneficiary shares issued by the securitisation undertaking are subordinated to the debt financial instruments issued and the loans entered into by the securitisation vehicle; and
• the debt financial instruments with non-fixed yield

In a nutshell this means that any form of debt ranks senior to shares, units and beneficiary units and fixed income debt ranks senior to profit participating debt.

There is however the general possibility for the securitisation undertaking to derogate from these subordination rules in its articles of association, its management regulations or any other agreement entered into by the securitisation undertaking by explicitly establishing different subordination rules with respect to particular issuances¹⁰.

ACCOUNTING AND DISTRIBUTION RULES TO BE ESTABLISHED ON A PER-COMPARTMENT BASIS

The New Securitisation Law now also provides for the possibility for equity-financed compartments to make certain decisions at the compartment level in order to obtain increased investor protection.

Concretely, this means that only the shareholders or members who hold shares or units issued by the relevant compartment can approve the balance sheet or profit and loss accounts provided such right is set out in the securitisation undertaking’s constitutive documents¹¹. In the same manner, the profit and the distributable reserves can now also be determined on a compartment basis, without taking into account the situation of the securitisation undertaking as a whole.

In other words this means that equity-financed multiple compartment securitisation undertakings can now approve the balance sheet and the profit and loss statement of each compartment concerned by virtue of the votes of the shareholders of such compartment only.

Furthermore, the New Securitisation Law requires that securitisation vehicles which have chosen to be set up under the corporate form of a partnership (either general, limited or special limited) draw up and publish annual accounts in accordance with the provisions of the Luxembourg law of 19 December 2002 on the register of commerce and companies and the accounting and annual accounts of companies. The purpose of this approach is to ensure a degree of transparency and protection for investors who thus benefit from increased disclosure of the financial information as regards the securitisation undertaking in which they invest.

ADDITIONAL LEGAL FORMS AND RCS REGISTRATION REQUIREMENT FOR SECURITISATION FUNDS

Another area of increased flexibility under the New Securitisation Law is that it opens the door to new legal forms for securitisation undertakings.

Indeed it is now possible to set up securitisation undertakings as unlimited companies (sociétés en nom collectif) (SENC), common limited partnerships (sociétés en commandite simple) (SCS), special limited partnerships (sociétés en commandite spéciale)(SCSp) and simplified public limited liability companies (sociétés par actions simplifiées) (SAS) in addition to the previously allowed legal forms (being, private limited liability companies (société à responsabilité limitée), public limited liability companies (société anonyme) and partnership limited by shares (société en commandite par actions))¹².

This increased flexibility in set-up and structuring of securitisation undertakings means that the incorporation in front of a notary is now no longer needed in case of the incorporation of an SV, as this is not required for partnerships.

In this respect, it is worth taking into account that all securitisation undertakings (including those set up under the form of a partnership) now have to prepare and publish annual accounts, in each case to be audited by one or more approved Luxembourg independent auditors (réviseurs d’entreprises agrees).

Furthermore, the New Securitisation Law clarifies that securitisation funds have to be registered with the Luxembourg Trade and Companies Register (RCS). Existing securitisation funds have a six months transitional period to register with the RCS following the entry into force of the law¹³.

The New Securitisation Law is however not the only change in law having an impact on the Luxembourg securitisation regime and other recent developments are worth examining.

Virtual assets and tokenisation

The use of virtual assets in the financial sector is one of the most talked about developments in recent years and its potential impact on the securitisation sector may be significant.

Virtual assets are very diverse and usually range from digital representations of traditional assets to more complex representations of rights. Their development as an asset class has been significant over the past few years and aroused interest from investors while posing challenges and legal uncertainties for investment professionals at the same time.

The Luxembourg legal framework is particularly well-prepared for investments in virtual assets. This is also the case when the set-up of securitisation transactions is concerned in the context of virtual asset investments. As both regimes are highly flexible they provide an ideal system for investors.

The reasons for such conclusion are mainly the following ones:

Since April 2013 Luxembourg benefits from a legal framework applicable to dematerialised securities keeping pace with market developments. This dematerialised securities framework is similar to the French, Swiss and Belgian regimes but exists in addition to the more traditional bearer and registered forms of securities. Dematerialised securities thus constitute a third type of securities and issuers, including securitisation undertakings, can freely choose from the three types available. Generally speaking, dematerialisation is achieved by the registration of the securities in an account held by a single body such as settlement organisation or a central account keeper.

On 26 January 2021 the Luxembourg dematerialisation framework was amended by the entry into force of the so-called Blockchain Bill (Bill 7637) (the “Luxembourg Blockchain Law”). The Luxembourg Blockchain Law explicitly allows for the issuance of dematerialised securities using distributed ledger technology such as Blockchain (the “DLT”).

Previously, the Luxembourg dematerialised securities framework had already been modified by the law of 1 March 2019 with a view towards establishing a legal framework for DLT allowing accounts to be held and securities to be registered on such accounts pursuant to technologies such as DLT. However, securities in such accounts continued to need to exist independently in the form of a global certificate, registered or bearer securities. The Luxembourg Blockchain Law extended this legal framework by two major aspects.

ISSUER ACCOUNT

The Luxembourg Blockchain Law introduced a new type of issuer account corresponding to an account held with a settlement organisation or a central account keeper (as referred-to below) for the purpose of registering securities issued using DLT. This means that no other record of the existence of such securities is required allowing them to only be settled within a DLT environment. The main advantage of using DLT rather than traditional methods for issuing securities is that the DLT creates a network of data which is shared among peers participating in the DLT without requiring recourse to a number of usual intermediaries.

CENTRAL ACCOUNT KEEPERS

Another innovation introduced by the Luxembourg Blockchain Law is the amendment to the definition of the notion of “central account keepers” under the dematerialised securities framework.

Prior to the Luxembourg Blockchain Law only entities having received a dedicated authorisation from the CSSF as a financial services provider under article 28-11 of the Luxembourg Financial Sector Law or settlement organisations were entitled to hold securities accounts for the issuers in Luxembourg. The Luxembourg Blockchain Law now however also allows credit institutions and investment firms to operate as central account keepers for the purpose of the above referred-to issuer accounts using DLT without being required to obtain any additional authorisation from the CSSF.

However, these entities have to be in a position to demonstrate that they:

• dispose of appropriate security controls and IT systems for the purpose of their role as central account keepers which allow for the registration of the entirety of securities in every issuance they handle in an account;
•  are in a position to secure book entry transfers of securities;
• are capable of ascertaining that the total amount of any issuance having been registered in an issuer account corresponds to the aggregate sum of all securities registered in the securities accounts of their respective account holders; and
• allow for the exercise of rights attached to such securities.

The dematerialised securities framework in Luxembourg is not limited to certain types of issuers or entities. Furthermore, there are no specific restrictions in the New Securitisation Law in the context of securitisation transactions. Consequently, the advantages and flexibility with respect to DLT issuances of dematerialised securities can also be used by Luxembourg securitisation undertakings which are subject to the New Securitisation Law. In this respect, there is also no distinction between unauthorised and authorised securitisation undertakings so that entities which offer securities to the public on a continuous basis, provided that all relevant requirement under EEA prospectus rules are met, can resort to the issuance of dematerialised securities using DLT.

Consequently, the flexible framework with respect to the issuance of dematerialised securities in general and dematerialised securities using DLT in particular is compatible with Luxembourg securitisation rules in most instances and should therefore enable the vast majority of market participants to set up tailor-made transactions providing for a maximum of advantages for all parties involved.

Impact of ATAD III on securitisation undertakings

The Luxembourg securitisation sector also risks being impacted by another recent legal development, the proposal published by the Council of the European Union on 22 December 2021 for a Council Directive laying down rules to prevent the misuse of so-called shell entities for tax purposes and amending Directive 2011/16/EU (the “Shell Directive Proposal”)¹⁴.

Under the Shell Directive Proposal certain reporting obligations would be imposed on entities resident in a Member State for tax purposes that cross certain substance thresholds. Indeed it includes in its article 6(1) three specific assessment items, also referred to as “gateways” that undertakings would be required to apply.

Undertakings meeting all three of these gateways would be considered high-risk entities and, if not benefiting from a carve-out, would be required to report on their substance through their annual tax return. Entities that subsequently fail to meet specific substance indicators, would be presumed to be “shell entities” or “shell companies” and, should they not be able to rebut this presumption or obtain a general exemption from their obligations under the Shell Directive Proposal, certain tax benefits otherwise available based on double tax treaties and EU directives could be denied to them.

In order for shell companies to be identified, the Shell Directive Proposal contains a multiple-step process which any entity engaging in an economic activity, regardless of its legal form, being a tax resident in a Member State, must apply (if it is not carved-out or exempted).

Should the Shell Directive Proposal therefore be implemented in Luxembourg in its current form, a considerable number of Luxembourg market participants would be directly affected by the new rules. In particular it might have a considerable impact on Luxembourg incorporated securitisation undertakings, which usually rely quite heavily on the use of Luxembourg based corporate services companies providing their own staff for the management purposes and needs of their clients.

In such cases an entity relying exclusively on the use of third entity staff which is not part of any group it belongs to might be deemed to be a high-risk entity and thus be required to do the substance indicator reporting to the Luxembourg tax authority as further set out below (should the other two gateways also be met).

It is therefore, important that Luxembourg securitisation undertakings and their investors monitor closely any further developments with respect to the Shell Directive Proposal and understand its key aspects.

APPLICATION OF SPECIFIC “GATEWAYS”

According to the proposal all entities irrespective of their legal form or size engaging in economic activities would be required to self-assess whether or not they would qualify as high-risk entities. This would be the case if their profile matches three so-called “gateways” which are set out in article 6(1) of the Shell Directive Proposal. Consequently, all such entities must start a self-assessment by way of which they are to analyse whether they meet all three gateways in a cumulative manner.

a. Relevant revenues

The first gateway is met if (i) more than 75 percent of the overall revenue – for the previous two years, is not generated from the entity’s business activity, or (ii) 75 percent of the assets consist of real estate or other valuable private property.

b. Cross-border activities

The second gateway is met if a majority of the entity’s revenue is generated from cross-border transactions, or the income is passed on to foreign entities.

c. Management and administration

The third and last gateway relates to the question whether the undertaking is managed by in-house personnel or whether such management functions are provided by third entities such a corporate service providers. An entity that meets all three gateways is deemed to be a high-risk entity. Consequently, entities which have only met one or two criteria are considered low-risk entities.

SUBSTANCE INDICATOR REPORTING

As referred-to above high-risk entities are required to include specific information on so-called “substance indicators” in their annual tax return. Here again the Shell Directive Proposal has chosen to apply three specific criteria which a high-risk entity will need to meet. This means that should a high-risk entity provide satisfactory supporting documentary evidence to the tax authorities it will be presumed to have minimum substance for the relevant tax year and thus not be considered to be a shell company.

The three substance indicator criteria are the following ones:

a. the undertaking must have its own premises in the relevant Member State or at least premises for its exclusive use;

b. it must have at least one active bank account in the European Union of its own;

c. it must meet at least one out of two staff related indicators, meaning that the undertaking would either need to have:

i.  one or more directors fulfilling the following requirements (A) be resident for tax purposes in the Member State of the entity or at a distance from that Member State that is compatible with the proper performance of their duties; (B) be qualified and authorized to take decisions in relation to the activities that generate relevant income for the entity or in relation to the entity’s assets; (C) actively and independently use that authorization on a regular basis; and (D) not be an employee or perform the function of director or equivalent of non-associated entities; or

ii. have a staff structure in which the majority of the full-time equivalent employees of the undertaking are resident for tax purposes in the Member State of the undertaking or residing close to it, such employees being qualified to carry out the activities that generate the relevant income for the undertaking.

With respect to Luxembourg securitisation undertakings relying on the services of a separate entity corporate services provider in particular item (i)(D) would be problematic as in the vast majority of cases the directors of a Luxembourg securitisation undertaking provided by a corporate services provider are the employees of a non-associated entity (i.e. the corporate service provider in question).

Furthermore, such directors typically perform the same director functions and duties in usually a high number of other entities.

TAX CONSEQUENCES

The Shell Directive Proposal contains a number of tax consequences for a shell company which has failed to rebut its presumption or which has not been exempted. In this respect the Member State of residence of the shell company is primarily required to either deny the granting of a tax residency certificate to the shell company or only provide a tax residency certificate with a warning statement.

Furthermore, the proposal includes rules on how the tax advantages available to the shell company can be disallowed. This also encompasses scenarios which involve payments to a shell company made by a payor or to the shell entity’s shareholder while the payor and/or the shell company’s shareholder reside in another Member State or a third country.

In such a case the Member State of the shareholder would be required to tax the payments received by the “shell entity” as if they had been directly received by the shareholder, and allow deductions for the taxes paid in the Member State where the “shell entity” is located.

In scenarios in which the payer of income to the shell company is resident in a third country, the Member State of the shareholder of the shell company shall apply the above-mentioned rule without prejudice to any treaty it has concluded with the third country.

In cases where the “shell entity” shareholder is tax resident in a third country, the Member State of the payer of the income (to the shell) is obliged to charge withholding tax as per the domestic legislation / double tax treaty concluded with the country of residence of the shareholder.

The above rules are not intended to affect any taxes which might be applicable with respect to the shell company itself. In other words, generally speaking the Member State of the shell company is intended to remain free to continue to regard the shell company as being resident for tax purposes in that Member State’s territory and apply tax on the relevant income flows and / or assets according to domestic law. Furthermore, particular rules are proposed to be applicable to situations where a shell company primarily holds immovable property or other property of high value for private purposes alone or for the purposes of pure equity holdings.

CARVE-OUTS UNDER THE SHELL DIRECTIVE PROPOSAL

The Shell Directive Proposal also contains a list of entities that are carved-out from the substance indicator reporting as set out below (article 6(2) of the proposal).

Entities falling under a carve-out are not required to continue the process. In other words, despite qualifying as high-risk entities, such undertakings, if carved-out, will not need to do the substance indicator reporting.

Such carved-out undertakings are, for instances, companies the securities of which have been listed on a regulated market or a multilateral trading facility, holding companies that do not engage in cross-border activities provided their beneficial owners are tax resident in the same jurisdiction, or where their shareholder or ultimate parent entity is resident in the same state and entities which have at least five full- time employees exclusively carrying out activities generating the relevant income.

Securitisation companies covered by and compliant with article 2, point 2 of the EU Securitisation Regulation are also foreseen to be excluded from the scope of the current version of the Shell Directive Proposal pursuant to its article 6 (2), b), n).

However, given that the Shell Directive Proposal is still subject to negotiations this exemption can still change and therefore any new developments in this respect must be monitored closely.

Securitisation undertakings that have been set up and which operate exclusively under the New Securitisation Law, are for the time being, not expected to be excluded from complying with the obligations set out in the Shell Directive Proposal.

Outlook and perspectives of the securitisation market in Luxembourg

The recent reform of the Luxembourg securitisation regime and Luxembourg’s flexible framework with respect to the issuance of dematerialised securities using DLT creates a highly attractive jurisdiction for a wide array of market participants.

In this respect, it should be worthwhile summarising the key advantages that Luxembourg legislation has to offer and which in our view are already having a significant impact on future securitisation structures in Luxembourg:

•  Luxembourg securitisation undertakings, in addition to the issuance of securities, can also enter into loan agreements and thus do not have to be set up as mere issuance vehicles vis-à-vis their investors.
•  Active management of the underlying compartment assets is permitted with respect to portfolios consisting of debt securities, debt financial instruments and receivables provided that the proceeds for the acquisition of such portfolio is obtained by way of private placements. This creates new opportunities for Collateral Loan Obligation structures.
•  Luxembourg securitisation undertakings are allowed to provide security for obligations relating to the securitisation transaction. This means that for instance security can be provided in the context of the acquisition of a junior loan to senior lenders.
• The acquisition of the underlying assets to be securities can be made by a subsidiary of the securitisation undertaking.
• All Prospectus Regulation exemptions can be used in order for an issuance not to qualify as a public offer and thus reduce the risk of having to be authorised by the CSSF. Therefore, in terms of private placements there is no specific maximum number of issuances which would trigger the application of any particular supervision restrictions or authorisation requirements.
• Luxembourg securitisation undertakings can be set up under a wide array of different legal forms, including various types of limited partnerships.
• Luxembourg securitisation undertakings can issue dematerialised securities using distributed ledger technology such as Blockchain. The Luxembourg Blockchain Law is not restricted to specific types of issuers and therefore provides an attractive framework for securitisation entities. Central account keepers setting up DLT issuer accounts do not require a specific authorisation from the CSSF if they comply with a restricted number of requirements in terms of their corporate and operational structure.
• Any further developments in the sphere of ATAD III need to be further monitored as the common use of directors and managers provided by Luxembourg corporate service providers might mean that such entities could be viewed as shell companies to some extent. However, it is currently foreseen that securitisations operating under the EU Securitisation Regulation or which have issued securities which have been admitted to trading on regulated market or an MTF (such as the Luxembourg Euro MTF market) are carved-out from ATAD III rules.

In light of the above, apart from the considerations to be taken into account in the context of ATAD III, which however are not Luxembourg specific in terms of the proposed legislation but will apply all across the European Union, Luxembourg has been able to establish itself as a major centre for securitisation transactions and given the wide array of flexible and investment-friendly provisions is highly likely to continue to be successful in this respect in the future.

 

_{1 Article 1 (4) of the New Securitisation Law;
2 Article (1) and (3) of the New Securitisation Law;
3 Question 7 of the CSSF FAQs on Securitisation, last paragraph;
4 Article 61-1 of the New Securitisation Law;
5 Article 61 (3) of the New Securitisation Law;
6 Article 53 (2) of the New Securitisation Law;
7 Article 19 (2), (3) of the New Securitisation Law;
8 Question 4 of the CSSF FAQs on Securitisation;
9 Article 64 (1) and (2) of the New Securitisation Law;
10 Article 64 (2) of the New Securitisation Law;
11 Article 47 (2) of the New Securitisation Law;
12 Article 4 81) of the New Securitisation Law;
13 This means until 8 September 2022 (including);
14 (COM (2021) 565 final);}