On 9 February 2022, the Luxembourg parliament amended the law of 22 March 2004 on securitization in order to further clarify the existing legal framework and to introduce new changes which were long expected by market participants. While the securitization law has proven over the past 20 years to be an effective framework to structure a wide range of securitization, financing and repackaging transactions, the new changes introduced are welcome. This law, which is to come into force shortly, offers, in particular, greater opportunities to investors by adding new tools to structure securitization transactions.
The innovations brought by the law will undoubtedly further strengthen the position of Luxembourg as a leading hub for securitizations in Europe.
This news flash outlines the main new features introduced by this law and briefly explains some of the practical implications for the Luxembourg securitization market.
New financing methods
One of the main changes brought by the law is to clarify and broaden the existing funding methods available for securitization vehicles. The means by which a securitization vehicle can now finance itself is extended to any form of financial instruments and loans. Previously, the core of financing had to be provided by the issuance of “securities”. However, the term was not clearly defined by the Luxembourg law and arrangers were facing legal uncertainty, especially where the law applicable to such instruments was a foreign law. Going forward, the securitization vehicles will be able to issue any form of financial instruments, in the broadest sense, as opposed to the narrower concept of securities. This change is welcome to the extent that it adds certainty and will allow the issuance of more complex or novel forms of financial instruments.
Allowing securitization vehicles to finance their acquisition of risks by way of any form of loan also constitutes a major innovation. Previously, the use of loan funding was only allowed if the loan was granted on an ancillary basis, or for specific purposes such as leverage and liquidity management or during any warehousing phase. This change will surely add to the attractiveness of the Luxembourg securitization regime by enticing investors which were not allowed, until now, to invest in certain type of securities. By way of example, it will now be possible for banks to participate in securitizations by making direct loans. This means that they will be in a position to intervene as investors in a transaction as well as lenders.
Active management of assets
One of the major innovations of the new law is the possibility granted to a securitization vehicle to actively manage a portfolio of debts if the financial instruments issued for the purpose of the securitization are not offered to the public. The securitization can now actively manage those assets or outsource their management to an asset manager acting on its behalf.
Previously, the securitization law was silent as to whether a securitization vehicle could actively manage its investments. However, the position of the CSSF was that only passive investment was permitted.
This new change is welcome and will undoubtedly have a significant impact on the market, as this will improve the attractiveness of Luxembourg for CLO managers who historically implemented their structures in other jurisdictions, such as Ireland, for example.
Securitization of tangible assets made easier
Under the Luxembourg securitization framework, both intangible and tangible assets can be securitized. The new law improves legal certainty by confirming that tangible assets (such as commodities, aircrafts or vessels) can be securitized directly or indirectly. In that respect, the new law clarifies that a securitization vehicle may acquire the risks to be securitized indirectly through a wholly or partially owned subsidiary which would acquire ownership of the securitized asset. However, such direct or indirect acquisition of the tangible assets must be clearly understood; the Luxembourg legal framework does not allow the securitization vehicle to carry out a commercial or an entrepreneurial activity. Hence, any operational risks attached to tangible assets must be assumed solely by the users of the assets.
In practical terms, this means that the transfer or the acquisition of the tangible assets by the securitization vehicle must only be used to for the purpose of refinancing of the tangible assets.
More flexibility in granting security interests
Prior to the amendments of the law of 22 March 2004 on securitization, a securitization vehicle could only grant security interests or guarantees to cover its obligations incurred in connection with the securitization or for the benefit of its investors, the trustee, or the issuing vehicle in a two-tier securitization. Security interests and guarantees granted to persons other than those mentioned before were ipso jure void. This restrictive rule is now a thing of the past. The new law now allows a securitization vehicle to grant security interests or guarantees in favor of any party that is involved in the securitization transaction, including persons that are not direct creditors/investors of the securitization vehicle.
This new change will remove obstacles for certain types of financing arrangements. For instance, where a securitization vehicle indirectly holds assets via one or more wholly subsidiaries, the securitization vehicle will be in a position to grant security interests, or give guarantees to secure the indebtedness of its subsidiaries. Likewise, where the parent company of the securitization vehicle receives a loan from a third-party lender, which is on-lend to the securitization vehicle, the latter can grant a security interest or a guarantee to the lender to secure the indebtedness of its parent company.
Clarification as to authorization requirements for securitization vehicles
Any securitization vehicle issuing securities on a continuous basis is required to be licensed and supervised by the CSSF. However, the law of 22 march 2004, in its former version, did not define the concept of “public offer on continuous basis to the public”. Against this backdrop, the CSSF had to set out some criteria for guidance. The new law introduces a definition of this concept broadly based on the guidance previously issued be the CSSF.
The main rule remains the same; financial instruments are deemed to be issued on a continuous basis if there are more than three issuances of financial instruments offered to the public during a financial year (on the basis of the securitization vehicle as a whole, and not on a compartment-by-compartment basis).
In addition, the new law clarifies that the issuance will not be deemed to be offered to the public if any of the following criteria are met:
- the issuance is only intended for professional clients within the meaning of the law of 5 April 1993 on the financial sector; or
- the denomination of the financial instruments is more than EUR 100,000; or
- the financial instruments are distributed in the form of a private placement.
Accounting and distribution rules set up for equity financed compartments
One of the main advantages of the Luxembourg securitization framework is the possibility to create segregated compartments within a securitization vehicle, each representing a distinct part of the assets and liabilities of the securitization vehicle. However, the former legal securitization framework was failing to provide rules or guidance regarding equity financed compartments. This has proven challenging for service providers and auditors alike who have not had clarity over requirements around items such as distributions.
With the adoption of the new law, where a compartment is financed by way of equity, the financial accounts relating to such compartment can be approved by the shareholders of that compartment only, provided that such option is included in the articles of association of the securitization vehicle. Similarly, in such a case, the determination and the distribution of the revenues and reserves can be made at compartment level, without reference to the financial situation of a securitization vehicle as a whole.
Legal subordination rules introduced in the law
The new law introduces a set of rules on legal subordination applicable to the financial instruments issued by securitization vehicles. Those new subordination rules are aligned with rules applicable to commercial companies and mutual funds and are in line with market practice. According to those rules:
- Units of a securitization fund are subordinated to other financial instruments issued by the securitization fund and to the loans granted to the same.
- Shares (actions), corporate units (parts sociales) or partnership interests (parts intérêts) are subordinated to other financial instruments issued by a securitization company and to loans granted to the same.
- Beneficiary shares (parts bénéficiaires) issued by a securitization company are subordinated to other financial instruments issued by this vehicle and to loans granted to the same.
- Floating rate debt instruments issued by a securitization vehicle are subordinated to fixed-income debt instruments issued by it.
However, parties may deviate from these principles as the articles of incorporation, management regulations, or the relevant issue documents of securitization vehicles contain provisions providing for a different ranking of claims.
Registration securitization funds with the RCSL required
The new legislation introduces a statutory obligation for securitization funds to register with the RCSL (i.e., the Luxembourg trade and companies register) and, accordingly, to obtain a registration number. Until now, this requirement was only applicable to the management companies of securitization funds. This change is welcome to the extent that it will help advance the admission of trading on certain stock exchanges. Existing securitization funds will have to comply with this requirement within 6 months of the entry into force of this new law.
New corporate forms available
Prior to the enaction of the new law, securitization companies could only be set up as a public limited company (société anonyme), a corporate partnership limited by shares (société en commandite par actions), a private limited liability company (société à responsabilité limitée), or a co-operative company organized as a public limited company (société cooperative organisée comme une société anonyme).
The new law now expands the types of corporate forms that can be used. In addition to using a simplified joint stock company (société par actions simplifiée), it will now also be possible to use tax transparent partnerships such as a common limited partnership (société en commandite simple), or a special limited partnership (société en commandite spéciale).
Securitization vehicles having opted for the partnership form (either general, limited or special limited) are required to prepare and publish annual accounts in accordance with the provisions of the law of 19 December 2002 on the register of commerce and companies and the accounting and annual accounts of companies. The rationale behind this approach is to ensure a degree of transparency and protection for investors, who will, therefore, benefit from financial information about the securitization partnership in which they invest.