On 9 February 2022, the Luxembourg Parliament (Chambre des Députés) adopted the draft law 7825 (the "New Law"), which amends the law of 22 March 2004 on securitisation (the “Securitisation Law”, and as restated pursuant to the New Law, the "Amended Securitisation Law"). The New Law was published in the Luxembourg official gazette (Mémorial A) on 4 March 2022 and entered into force on 8 March 2022.
Below, you will find the key changes to the Securitisation Law.
1. Issuance of “financial instruments”
In order to clarify by what means a securitisation undertaking ("SV", which in this briefing includes both securitisation companies and securitisation funds, unless otherwise indicated) can raise finance, the reference to "securities" (valeurs mobilières) issued by SVs is now replaced by the term "financial instruments" (instruments financiers), the definition of which cross-refers to the law of 5 August 2005 on financial collateral arrangements, as amended.
Under the Amended Securitisation Law, financial instruments (what follows in italics is a free translation of the French legal text) has the broadest possible meaning, including:
a) all securities and other instruments, including, but not limited to shares in companies and other securities equivalent to shares in companies, participations in companies and units in collective investment undertakings, bonds and other forms of debt instruments, certificates of deposit, loan notes and payment instruments;
b) securities which give the right to acquire shares, bonds or other securities by subscription, purchase or exchange;
c) term financial instruments and instruments giving rise to a cash settlement (excluding instruments of payment), including money market instruments;
d) all other instruments evidencing ownership rights, claim rights or securities; and
e) all other instruments related to financial underlyings, indices, commodities, precious metals, produce, metals or merchandise, other goods or risks;
whether these financial instruments are in physical form, dematerialised, transferable by book entry or delivery.
By substituting “financial instruments” to “securities”, the Luxembourg legislator sought to remove what it perceived to be a source of legal uncertainty caused by the absence of a precise definition of “securities” under Luxembourg law and potentially diverging interpretations of the term under Luxembourg law and the governing law of the securities, which can be, and in practice often is, a foreign law (e.g., English law). Whether the meaning of “financial instruments” under the above open-ended definition, which includes “securities”, is clearer than that of “securities” is debatable, but it appears to be boarder, thus further increasing structuring options.
2. Loan financing
The Securitisation Law was silent on the possibility for SVs to be financed by loans, in addition to “securities”. The position of the CSSF, the Luxembourg financial regulator, was that for SVs (at least those that come under its prudential supervision because they are issuing securities on a continuous basis to the public), loan financing is only acceptable if the financing of the securitisation transaction also includes the issuance of securities for a proportionally substantial amount. This has been construed by the market as requiring that at least 50% of the total financing of a securitisation transaction is provided by the issuance of securities.
In a welcome development, the Amended Securitisation Law now explicitly allows for taking out any form of loans (toute forme d’emprunts), in whole or in part. As is the case for financial instruments issued by SVs, the value or return of such loans must be linked to the underlying risks.
The commentary on draft law 7825 (the "Commentary") states that “loan” should be interpreted broadly and should not be limited to transactions where the repayable amount is the amount borrowed, plus accrued interest, if any. Regardless of their accounting treatment, loans within the meaning of the Amended Securitisation Law include any form of indebtedness that gives rise to a repayment obligation by SVs, including indebtedness where the amount repayable depends on the performance of the underlying assets.
The larger choice of financing options at the disposal of SVs - financial instruments, loans or a mix of both - will ensure that all forms of securitisations governed by the European Regulation (EU) 2017/2402 of the European Parliament and of the Council laying down a general framework of securitisation and creating a specific framework of simple, transparent and standardised securitisation can be carried out by SVs under the Amended Securitisation Law.
It will also allow investors who by law or by their internal policies are prohibited from acquiring certain financial instruments, to generate and hold securitisation positions by means of loan financings.
3. Regulated Securitisation Undertakings
SVs that issue financial instruments on a continuous basis and offer them to the public must apply for a license and are subject to ongoing prudential supervision by the CSSF. Prior to the New Law, the terms "continuous" and "offered to the public" (then applied to “securities”) were only defined in a FAQ published by the CSSF. The gist of the regulatory guidance is now incorporated in the Amended Securitisation Law, with the slight difference that the denomination criterion has been dropped from EUR 125,000 to EUR 100,000.
As a result, SVs will henceforth be considered to offer financial instruments to the public if the issuance meets the following three cumulative conditions:
- it is not meant for professional clients (within the meaning of article 1(5) of the law of 5 April 1993 relating to the financial sector)
- the financial instruments have a denomination of less than EUR 100,000; and
- the issuance is not made by way of private placement.
If SVs carry out more than three such issuances to the public in aggregate (i.e. taking into account all the compartments of the SVs) per financial year, they will be deemed to issue on a continuous basis to the public and will be pulled into the regulatory perimeter of the Amended Securitisation Law.
4. Additional legal forms of Securitisation Companies
Previously, securitisation companies could only take the following legal forms:
- a public limited liability company (société anonyme);
- a private limited liability company (société à responsabilité limitée);
- a corporate partnership limited by shares (société en commandite par actions); and
- a cooperative company organised as a public limited liability company (société coopérative organisée comme une société anonyme).
In the Amended Securitisation Law, the following additional legal forms are now available to securitisation companies:
- an unlimited company (société en nom collectif - SNC),
- a common limited partnership (société en commandite simple - SCS),
- a special limited partnership (société en commandite spéciale - SCSp); and
- a simplified limited company (société par actions simplifiée - SAS).
The new forms of companies also call for closer inspection of the tax considerations that go into the setting up securitisation companies. The possibility of using a SNC or SCSp now allows to give them tax transparency. This result could previously only be achieved by setting up an SV as a securitisation fund. Furthermore, depending on the legal form chosen, this may alleviate some difficulties posed by the ATAD legislation (on which we shall not expound in this briefing).
5. Indirect acquisition of risks
Favouring an economic approach to securitisation, the Amended Securitisation Law specifies that SVs can acquire assets directly – that much was clear before -, but also indirectly, e.g. through a company wholly or partly- owned by SVs, thereby opening up new structuring possibilities.
6. Granting of security
SVs used to be prohibited from granting any form of security over their assets, except to secure obligations assumed by them in connection with their securitisation or in favour of their investors. This limitation was intended to protect the interests of creditors and investors (whose claims are backed by the SVs’ assets), but proved at times too restrictive, such as for example for SVs that provided junior financing to a borrower and securitised it, but could not grant a security over their junior tranche to the senior lenders.
The Amended Securitisation Law now allows SVs to secure any obligation related to securitisation transactions. SVs will enjoy more flexibility to use their assets as collateral without sacrificing the protection of their investors and creditors, since the granting of a security will in any event only be possible in the context of a securitisation transaction.
7. Equity-financed compartments
The Amended Securitisation Law increases the legal and financial autonomy of equity-financed compartments. More specifically, provided it is set out in the constitutional documents of the SVs, the approval of the annual accounts drawn up with respect to compartments can be given by shareholders of the such compartments (as opposed to the SV). It is a logical consequence of the existence of compartments and the segregation of assets within each compartment, but until now there was no legal basis for it in the Securitisation Law or under Luxembourg company law. In addition, certain decisions, such as the distribution of profits, can also be taken at the level of the compartments rather than the SV.
8. Clarification of the legal subordination rules
To avoid uncertainties that could arise regarding the subordination of multiple financial instruments issued by SVs, the Amended Securitisation Law implements a new set of rules on legal subordination applicable to the financial instruments issued by SVs. The order is as follows:
- Units of a securitisation fund are subordinated to other financial instruments issued by the securitisation fund and to loans.
- Shares (actions), corporate units (parts sociales) or partnership interests (parts d’intérêts) in a securitisation company are subordinated to other financial instruments issued by such securitisation company and to loans.
- Shares (actions), corporate units (parts sociales) or partnership interests (parts d’intérêts) in a securitisation company are subordinated to beneficiary shares (parts bénéficiaires) issued by the securitisation company.
- Beneficiary shares (parts bénéficiaires) issued by a securitisation company are subordinated to debt instruments issued by the securitisation company and to loans.
- Non-fixed income debt instruments issued by a SV are subordinated to its fixed income debt instruments.
Importantly, parties to a securitisation transaction can contractually organise subordination rules distinct from those provided for in the Amended Securitisation Law. These rules can also be derogated from under the constitutional documents of SVs.
9. Active management
The Securitisation Law was silent on active management by SVs of their portfolio of securitised assets. For a number of reasons which we cannot detail here, both the regulatory guidance and market practice supported restricting the management activity of SVs to the administration of cash flows generated by the securitisation transaction and the prudent management of the securitised assets, so that the management itself would not create additional risks compared to those embedded in the securitised assets.
However, acknowledging that active portfolio management is not viewed at EU level as incompatible with securitisation and that there is indeed a market for managed CDOs, the Amended Securitisation Law now expressly authorises SVs to actively manage certain securitised assets as long as it concerns a basket of risks made up of debt securities (titres de créance), financial debt instruments or receivables, and it is reserved for SVs that do not finance themselves by issuing to the public. For the remainder, SVs are still restricted to passive management.
10. Fiduciary Representative
It was already possible for investors and creditors of SVs to be represented by, and to entrust their interests to, a fiduciary representative (the Luxembourg version of an English law trustee), as long as the latter was authorised in accordance with the Securitisation Law. However, the Securitisation Law prohibited fiduciary representatives from engaging in activities other than those pertaining to the function of fiduciary representative, which barred Luxembourg banks and other local regulated financial services providers (Professionals of the Financial Sector or PFS) from offering fiduciary representative services. This appears to have been unduly restrictive as no fiduciary representative licence has been issued (and apparently sought) since the entry into force of the Securitisation Law in 2004.
In the Amended Securitisation Law, the function of fiduciary representative is no longer incompatible with other regulated financial activities. In addition, the minimum share capital threshold for fiduciary representatives has been brought down from EUR 400,000 to EUR 125,000, thus easing the access to the function.