Luxembourg Securitisation Law

On 21 May 2021 a new bill of law (N° 7825) was submitted to the Luxembourg Chamber of Deputies (Chambre des Députés) with the purpose of amending the Luxembourg law of 22 March 2004 on securitisation (the "Bill of Law" and "Luxembourg Securitisation Law", respectively).

The Bill of Law, once fully approved by the Luxembourg Parliament, will bring about considerable changes to the Luxembourg Securitisation Law rendering the securitisation regime more flexible with respect to different types of securitisation structures and the specific requirements securitisation market participants might have in particular cases.

In this respect, the Bill of Law’s main purpose is twofold: (a) to explicitly set out and clarify current market practices in the law such as the criteria to be taken into account when assessing the authorisation requirement with respect to 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) the lifting/easing of particular restrictions securitisation undertakings have to comply with under the current regime such as the constraints regarding borrowing structures and portfolio management, etc.

There are five main aspects in the Bill of Law worth focusing upon of particular interest to market participants.

1) Issuance of loans in addition to the usual issuance of securities (valeurs mobilières)

Under the current Luxembourg securitisation regime a securitisation undertaking is foremost an issuance vehicle and therefore the entry into borrowing structures by taking out loans to investors should only be done on an ancillary basis.

In other words the securitisation undertaking is usually financed by the issuance of securities whose value or yield depends on the risks assumed by the securitisation undertaking pursuant to article 1 (1) of the Luxembourg Securitisation Law. In specific instances it is however acceptable that a securitisation undertaking may use borrowing or intra-group financing on a temporary basis in order to pre-finance the acquisition of the risks to be securitised while it proceeds to the issuance of securities to investors at a later stage (warehousing).

However, it is also acceptable that borrowing can be done on a lasting but limited basis. In this respect, it is important to note that such borrowing can only be done on an ancillary basis while the main and determining purpose of the transaction must always be securitisation, i.e. the economic transformation of risks into securities. In other words, borrowing is considered acceptable if the transaction as a whole also entails the issuance of securities for a proportionately substantial amount. This current practice is reflected in question 9 of the CSSF Frequently Asked Questions on Securitisation, October 2013 (the “CSSF FAQs on Securitisation”).

This restriction is now intended to be lifted given that the Bill of Law foresees changes which would allow a securitisation undertaking to enter into all types of borrowing structures providing a much more flexible framework as well as allowing certain investors, whose investments might be restricted for internal reasons to specific loan products, to also participate in Luxembourg securitisation structures.

The yield or principal repayment of such loans would also depend on the underlying securitised assets, as is the case with usual debt securities issued by a securitisation undertaking which are linked to a specific compartment or pool of underlying. This approach would also be in line with (EU) Regulation 2017/ 2402 of 12 December 2017 creating a general framework for securitisation (the “EU Securitisation Regulation”) given that the EU Securitisation Regulation does not require a securitisation vehicle to issue securities in order to fall under its scope.

2) Active management of risk portfolio

Furthermore, the limitation that active management is generally not permitted, and portfolio management restricted to a prudent person’s passive management, is expected to be eased as well.

In this respect it is worth recalling that the CSSF is of the opinion that the management of the underlying securitised portfolio must first of all be passive in character, irrespective of whether or not the actual management is delegated to a professional acting on behalf of the securitisation undertaking.

However, in particular cases the CSSF accepts structures where the management of the securitised assets includes for instance the renegotiation of any schedules of repayments or any of the credit terms in a situation in which the relevant debtor is facing financial difficulties. Under no circumstances however is it permitted for a securitisation vehicle to manage its underlying assets in such a way that short-term market fluctuations of market prices are taken advantage of, such management resulting in ongoing claim acquisitions and assignments. ¹

The reason for this restriction has always been seen in the fact that in traditional 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.

Once the Bill of Law has been passed in this respect it should be possible to manage risk portfolios even in accordance with short-term market fluctuations and price developments. However, in order for such active management to be permitted it is important to note that the risk portfolio to be actively managed would need to be composed of debt securities, financial debt instruments or receivables as per the current structure of the Bill of Law. Furthermore, active management would only be allowed in structures in which the securitisation undertaking did not offer securities to the public (ie restriction to private placement structures). ²

3) Granting of collateral by a Luxembourg securitisation undertaking

The granting of collateral by a Luxembourg securitisation vehicle over its assets is currently limited to situations in which it is done for the benefit of the vehicle’s investors (i.e. the subscribers of the securities issued) or if the granting of collateral is carried out with a purpose of assuring the securitisation of the underlying in question (i.e. whenever the granting of collateral is necessary in order for the vehicle to be able to acquire and securitise the assets).

In this respect, the relevant article 61 (3) of the Luxembourg Securitisation Law explicitly stipulates that the creation of security interests over the securitisation undertaking’s assets can 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 have been created in breach of this rule are considered void by direct application of the Luxembourg Securitisation Law. ³

However, the Bill of Law now foresees the introduction of a much wider scope which would already allow a Luxembourg securitisation undertaking to provide collateral to any third party provided the granting of collateral were linked to the securitisation structure as a whole (relatifs à l’opération de titrisation). ⁴

4) Authorisation requirement for a Luxembourg securitisation undertaking

Furthermore, the Bill of Law contains an explicit definition regarding the question of when a securitisation undertaking is to be considered to be issuing securities to the public on a continuous basis requiring it to be authorised by the CSSF. The answer to this question is currently still based on the CSSF FAQs on Securitisation which provide that issuances are made to the public on a continuous basis if more than three issuances are made to the public per calendar year and on an all compartment basis.

In this respect, the current rule that private placements are not considered offers to the public will still be applicable.

However, certainty will in particular be obtained in relation to the required per unit minimum denomination securities need to have in order for them not to be deemed to be issued to the public, which the CSSF FAQs on Securitisation currently seem to suggest should at least be EUR 125,000.

The threshold of EUR 125,000, however, is 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 has led to uncertainty in cases where the per unit minimum denomination of securities offered by a securitisation undertaking only amounts to EUR 100,000 and not to EUR 125,000. The legal consequence is clear under the Prospectus Regulation as no prospectus needs to be approved for such offers under prospectus rules. However, under the current structure this does not automatically make the offer a private placement under the Luxembourg Securitisation Law.

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

The Bill of Law in this respect intends to clarify that an offer of securities could only be deemed to be made to the public if the securities in question had a per unit denomination of less than EUR 100,000. In addition to this in order for a public offer scenario to arise the securities would also not need to be addressed to professional investors as defined in the Luxembourg law of 5 April 1993 on the banking sector and not be made under the form of a private placement. All three criteria are cumulative.

5) Issuance of tranched securities

Finally, the Bill of Law also intends to clarify certain aspects regarding the issuance of tranched securities. In this respect it is worth remembering that only structures in which a securitisation undertaking engages in tranching fall under the scope of the EU Securitisation Regulation.

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

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

• Securitisation under the EU Securitisation Regulation
  Securitisation transactions which securitise credit risk and issue tranched securities, i.e. securities which contain different segments, e.g. senior and subordinated segments, will usually be subject to both the Luxembourg Securitisation Law and the EU Securitisation Regulation as mentioned above.

In other words, this usually means 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 Luxembourg Securitisation Law. Consequently, the provisions set out in both the Luxembourg Securitisation Law and the EU Securitisation Regulation will have to be respected by a Luxembourg incorporated securitisation vehicle in such a case.

The Bill of Law foresees the introduction of explicit rules regarding the legal subordination between different types of securities, unless contractually agreed otherwise.

For instance units/shares issued by a securitisation undertaking relating to the same underlying assets other debt instruments or loans are also linked to will have to be considered to be tranched by way of law, such equity instruments being legally subordinated to debt instruments issued or loans taken out by the securitisation undertaking. Furthermore, debt instruments having a variable yield will also per se be deemed to be subordinated to debt instruments which contain a fixed-yield rate.

However, the Bill of Law contains the 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 issuances.

Summary

The new Luxembourg Securitisation Law, should the Bill of Law be approved in substantially the present format, will entail, as described above, a series of rather considerable amendments to the current market practice.

The three main modifications which are likely to have the biggest impact on Luxembourg law governed securitisation structures are the following ones (all provided the Bill of Law is indeed adopted on the basis of document N° 7825 dated 20 May 2021):

• Securitisation vehicles will be allowed to engage in all types of borrowing in addition to issuing financial instruments.

• Active management of the underlying securitised assets will be possible for risk portfolios consisting of debt securities, financial debt instruments and receivables. However, such active management will be restricted to situations in which the relevant financial instruments which were issued to finance the acquisition of the assets are not offered to the public.

• Securitisation vehicles will furthermore be allowed to grant collateral over their assets, even to third parties or other group companies, provided a link to the securitisation has been established. This means that the provision of collateral will also be possible whenever such collateral is not being granted with the aim to secure the obligations the securitisation undertaking has assumed in view of their securitisation. This will allow the granting of collateral in scenarios in which the focus and benefit of such collateral provision is predominately linked to the third party’s interests as beneficiary of the collateral rather than on the perspective of the securitisation undertaking securing its own obligations arisen in the context of the acquisition of the underlying assets.

The legislative process has not yet officially been concluded and the Bill of Law is still being discussed in the Commission des Finances et du Budget which was provided with it for further discussions and possible amendment suggestions on 3 June 2021.

However, on 20 September 2021 the official feedback on the Bill of Law provided by the Luxembourg Chamber of Commerce was published. The Luxembourg Chamber of Commerce is in favour of the proposed amendments and in particular of the proposed lifting of the above described restrictions in order to render the securitisation regime more flexible. It however states that it would have preferred to see the obligation that authorised securitisation undertakings must entrust their liquid assets and securities with a credit institution established or having its registered office in Luxembourg as set out in article 22 of the Luxembourg Securitisation Law amended as well.

In this respect, the Chamber of Commerce is of the opinion that in order to obtain more flexibility for the market the use of credit institutions which are registered in another EEA Member State or, of a credit institution which is registered in another European country but the use of which has been specifically authorised by the CSSF, should be allowed as well. Furthermore, the Luxembourg Chamber of Commerce regrets that the Bill of Law does not contain any clarifications with respect the requirements established by the CSSF as regards loan origination done directly by the securitisation vehicle (direct lending).

It can therefore not be excluded that further amendments, and in particular modification suggestions with respect to the points discussed above, will be made.

Furthermore, it is difficult to predict when the legislative procedure will conclude and the new Luxembourg Securitisation Law will enter into force.

However, as depicted it is likely that the changes proposed will have a significant impact on current and future securitisation structures in Luxembourg.

Authors: Isabelle Lentz (Partner) and Markus Waitschies (Senior Associate)

Footnotes:

1. Question 7 of the CSSF FAQs on Securitisation, last paragraph

2. Article 14 of the Bill of Law

3. Article 61 (3), last sentence of the Luxembourg Securitisation Law

4. Article 13 (2) of the Bill of Law