Luxembourg: A Hub for European Securitisation

Since the introduction of its securitisation law in 2004, Luxembourg's structured finance framework has attracted originators, sponsors and investors from all over the continent and is considered the benchmark for European mainland issuers accessing international capital. 

The combination of Luxembourg's strong reputation as an international financial centre, stable legal system and a pro-business regulatory framework has ensured the continued expansion of market share since inception, with some 2,300 vehicles created under the law, around 1,300 of which are still active¹.  Certain transactions, which issue securities to the public on a continuous basis fall under the direct supervision of Luxembourg's financial sector regulator, the Commission de Surveillance du Secteur Financier ("CSSF"), and currently there are 33 such vehicles.

European issuers have confidence in the stability of Luxembourg's long-standing securitisation law and with a competitive tax environment and flexibility in being able to adapt well and promptly to changes in European Union ("EU") regulations, it has become a natural fit for continental borrowers.  Notably, Germany with its vast manufacturing and industrial sectors, almost exclusively uses Luxembourg vehicles for securitisation transactions.

Leveraging on its reputation as a key hub for investment funds and holding companies in Europe, efficiencies are hard wired into securitisation structures: from the close cooperation between the various parties involved such as the stock exchange, the CSSF, tax and legal advisors and corporate service providers.

Nuances of the legal and regulatory framework make securitised debt issuance out of Luxembourg attractive to investors, notably pension funds.  In addition, there are no restrictions on the type of investor²  as well as enhanced investor protections.  Among other factors that enhance the regime are the ability to utilise subordination provisions for investors and creditors, as well as non-recourse provisions whereby investors and creditors can waive their rights to request enforcement and non-petition provisions where investors and creditors can relinquish rights to initiate bankruptcy proceedings against the securitisation vehicle.

Further, the law allows for easy to implement segregation of separate transactions (by means of compartmentalisation) which prevents the contamination of other compartments in the event of insolvency.  Being able to create several compartments within one legal entity or fund means that the rights of investors and creditors are ring fenced and limited to the risk of the relevant compartment's assets.  The vehicle, or its compartments, can also issue several tranches of securities corresponding to different collateral arrangements and risks.  

Additional safeguards are achieved from the requirement for all securitisation companies to be audited by an independent auditor that is approved by the CSSF.  In addition to other global exchanges, Luxembourg vehicles have access to the Luxembourg Stock Exchange which is the world's leading exchange for the listing of international securities, with over 36,000 listed securities. 

In essence, with the definition of the Luxembourg securitisation law being wider than that of the EU Securitisation Regulation, issuers in Luxembourg can take advantage of the jurisdiction's broad and flexible approach in a stable economic, political and fiscal environment.  The Luxembourg securitisation law allows a wide range of assets or rights to be securitised.  The majority of securitisation vehicles are tax neutral, with minimum taxes imposed and no withholding tax, along with access to Luxembourg's expansive global network of double tax treaties.  Investors also welcome structured issuance from Luxembourg, which has proven over the years to have an inherently low default rate in comparison to the US.  With the legislator and the CSSF continuing to promote Luxembourg's securitisation market, its attraction, appeal and reputation looks set to grow further. 

Strength through Regulation

The establishment of the Luxembourg Capital Markets Association in 2019 has provided a focal point for the key participants in the securitisation market, including corporate service providers, lawyers, auditors and representatives of the Stock Exchange.  With so many regulatory initiatives taking place, both globally and within the EU, it has been useful for participants to share information and best practice with peers, exchange views about legal and regulatory developments, while providing input into future policy making.

Even compared to the past decade and the stream of new regulations that followed the global financial crisis, the pace of regulatory change has increased, with a new EU Securitisation Regulation, which outlines a general framework for regulated securitisation activity, coming into force from January 2019.  Requirements related to investor transparency and risk retention were established, while the practice of re-securitisation, prevalent in the run up to the financial crisis where securitisations included other securitised assets within the pool, have been outlawed.  Essentially aimed at raising standards in the market, the regulation maintains the requirement for originators and sponsors to retain a 5% stake throughout the transaction's life. 

With enhanced due diligence requirements, alongside rules relating to disclosure and transparency, the regulation introduced the concept of simple, transparent and standardised ("STS") securitisations, which is effectively a seal of approval that a transaction meets the relevant standards.  Compliance with this regime encompasses certain complex and onerous data certification and reporting requirements in return for more beneficial capital treatment.  After a tentative start in 2019, with some delay in the finalisation of ESMA's technical standards, European issuers have embraced the new standard.  To date, 330 transactions³ in Europe have achieved STS status, with over 180 added to the register from January to mid-August 2020, through the height of the coronavirus pandemic.  

Domestically, in December 2018 the Luxembourg Parliament approved a draft law to implement the EU's Anti-Tax Avoidance Directive ("ATAD"), which included an interest limitation rule, creating some uncertainty over the viability of securitisation structures where the primary income stream arises from capital gains or non-performing loans.  The latest iteration, ATAD 2, much of which came into place from January 2020, broadens the scope to address so called 'hybrid mismatches' involving non-EU countries, where payments are made in one country and not included in another.

A further European directive, DAC6, introduces new mandatory reporting of cross border transactions as part of its tax disclosure rules.  In line with the OECD's efforts to counter tax avoidance, DAC6 requires information to be disclosed about actual transactions undertaken.  While the agenda is aimed at tax motivated transactions, ordinary transactions such as securitisations that may have a potential tax impact, albeit not primarily motivated by tax, may be captured.  Luxembourg's draft law, which is very much in line with the European directive, provides for penalties up to €250,000, depending upon the severity of the infraction, for failure to comply. 

Proven Performance

Luxembourg's heavyweight presence in the European securitisation market is evident from European Central Bank statistics, which shows the jurisdiction accounted for around 30% of the total European securitisation transactions completed in 2019, second only to Ireland.  Active sectors include lease deals and asset-backed commercial paper transactions, while it is the clear jurisdiction of choice for German automobile manufacturers.  While Luxembourg securitised asset volume had reached almost €300 billion by the end of 2019⁴, effectively doubling in size over the past five years, the inevitable COVID-19 influence on international structured finance markets has impacted deal flow in 2020 and it is likely that asset values will deteriorate as well.  Luxembourg's traditional strengths, however, which have made it into a highly regarded centre for securitisation activity, will be equally supportive throughout the recovery.  Pre-COVID-19 deal activity saw a proliferation of repackaging programmes to lock in better funding rates, which is a trend likely to continue, once confidence in securitisation markets returns.  Other asset classes include performing and non-performing loans related to commercial and residential real estate in addition to fintech and supply chain loan origination.  Another recent trend that is expected to continue is the heightened interest in securitisation funds, notably in the form of a fiduciary estate.  These are expected to be used considerably more in the future as the securitsation fund structure is exempt from ATAD.

Going forward, the EU Securitisation Regulation and the associated Capital Requirements Regulation will likely lead to a growing number of deals issued to be STS compliant, or existing structures restructured to meet that standard.  Alongside more scrutiny from regulators and auditors, STS will also improve the quality of reporting, with greater transparency.  This means the industry will be able to reinforce the message that a European securitisation product provides investors with stability and assurance that they fully understand the risks associated with the investment, while re-energising this key source of funding for banks and insurance companies by virtue of the better capital treatment received under the STS framework.

For service providers in the market it has been a case of continuing to adapt to the sweeping regulatory changes that have been implemented through the past decade and the recent collection of directives to ensure clients are in compliance with the rapidly changing landscape and best positioned to launch transactions at the right moment.  The Maples Group's fiduciary team in Luxembourg has long-standing experience in the local market and a specialised team focused exclusively on securitisation transactions.  The Group provides a broad range of related services, including listing services, either in Luxembourg or in Ireland, as well as process agent services, security trustee services and the formation of Netherlands Stichtings.  The Group also offers a comprehensive range of legal, fund, regulatory and compliance, and entity formation and management services, and is highly regarded for its strong visibility both in the Luxembourg market and in Germany, as well as across key global financial centres.

 

¹PwC – Securitisation in Luxembourg – June 2020

²It being noted that, for structures falling within the scope of the EU Securitisation Regulation, restrictions as to the sale of securitisation positions to retail investors apply.

³List of Securitisations notified to ESMA as meeting the requirements of Articles 19 to 22 or Articles 23 to 26 of Regulation (EU) 2017/2402

⁴PwC – Securitisation in Luxembourg – June 2020