The Structured Products Law Review: Luxembourg
Luxembourg is an important ecosystem for structured products. Both international and domestic players are active on this market and issue a panoply of structured products through Luxembourg structures for numerous reasons. The robust yet flexible legal framework allows various types of issuers to cater for the needs of investors and makes Luxembourg one of the main jurisdictions of choice for structured products.
With more than 125 banks2 and around 1,370 securitisation vehicles3 located in Luxembourg, it is not surprising that the main issuers of structured products in Luxembourg are Luxembourg securitisation undertakings4 set up under the Act dated 22 March 2004 on securitisation, as amended (the Securitisation Act) and financial institutions issuing products via their on-balance sheet programmes. Banks and securitisation undertakings under the Securitisation Act (SVs)5 also frequently act as issuers of structured products on a fiduciary basis pursuant to the Luxembourg Act dated 27 July 2003 related to trusts and fiduciary contracts, as amended (the Fiduciary Act).
Driven by investor demand and legal and accounting requirements, bulge bracket investment banks and other financial institutions often offer both on- and off-balance sheet solutions for the issuance of structured products. These actors typically act as arrangers for such SPVs, though very often they also fulfil related roles such as that of the issuing and paying agent, disposal agent, calculation agent or hedging counterparty.
In terms of products, the Luxembourg rules do not generally delimit the types of structured products that can be issued to a particular type of issuer. Numerous types of issue structures are seen on the Luxembourg market, ranging from vanilla repackaging transactions to complex payouts involving the use of derivatives typically as a means to hedge a particular exposure offered to the holders of the structured product. The financial instruments to which such structured products are linked are typically equity indices, baskets of shares or units of undertakings for collective investment, as well as debt underlying such as loans and other comparable assets.6
Instruments are often issued in the form of debt securities, in particular bonds or similar instruments governed by foreign laws. Luxembourg structured product issuers7 would traditionally have their issuance programmes governed by English law;8 this clearly represents the vast majority of major platforms, though an increasing number of actors tend towards the use of Luxembourg law for their issuance programmes. There also appears to be a trend for local credit institutions issuing on-balance sheet structured products to move to domestic law.
Legal and regulatory framework
i Prospectus Regulation
Structured products issuers and distributors will inevitably need to have regard to the provisions of the Prospectus Regulation.9 This Regulation embeds the principles laid down by IOSCO and is implemented in Luxembourg by the Prospectus Act.10 A prospectus compliant with the Prospectus Regulation is required when securities are offered to the public or listed on a regulated market within the sense of MiFID II, or both.11 The Luxembourg competent authority to approve such prospectuses is the Commission de Surveillance du Secteur Financier (the CSSF), which is the regulator of the financial sector in Luxembourg. The CSSF accepts prospectuses in four languages, notably English, German, French and Luxembourgish and is perceived to be a sensible regulator with a vast experience in dealing with capital markets matters in Europe.
Luxembourg has taken advantage of the implementation flexibilities of the prospectus exemptions under the Prospectus Regulation. A prospectus does not need to be drawn up for offers to the public below €8 million over a 12-month period. Nonetheless, for public offers above €5 million, an information notice needs to be published. Most recurrent structured products issuers will not remain below the minimum thresholds and will not benefit from this exemption.
Irrespective of the size of the offer, market participants commonly rely on further independent exemptions to publishing a prospectus. In particular, offers of securities only to qualified investors within the meaning of the Prospectus Regulation, to fewer than 150 investors or with a denomination of at least €100,000 (or foreign currency equivalent), are not subject to the obligation to publish a prospectus.
Structured product issuers who need to draw up a prospectus will, in most cases, establish a programme with a base prospectus. A base prospectus containing overarching disclosures and product descriptions is likely to be more cost-efficient for frequent issuers compared to the use of a stand-alone prospectus for each issuance. However, a base prospectus is unlikely to be able to foresee and disclose all contemplated permutations from the outset. Therefore, certain complex structured products such as specific basket credit-linked instruments will require additional disclosures and collateral descriptions to be made in a drawdown prospectus, leveraging on the content of an existing base prospectus.
Where the relevant structured products qualify as packaged retail and insurance-based investment products (PRIIP) under the PRIIPs Regulation12 and are offered to retail investors, a key information document (KID) needs to be drawn up and published. A KID is a concise document setting out the key risks and features of the product in a language comprehensible for retail investors. The obligation to draw up a KID is incumbent upon the 'manufacturer' (as the term is defined in the PRIIPs Regulation) of structured products. Any person who sells or advises the product must make the KID available to retail investors in good time before such investor is bound. Investment advisers and distributors must pay attention to their obligations in this respect. Structurers and issuers, among others, must make sure their KID is prepared in time in order to avoid delaying the issuance.
iii Securitisation Act
As mentioned above, a plethora of structured products are issued by SVs. These can either take the form of a securitisation company or a securitisation fund without legal personality, represented by a management company.
SVs are generally set up in the form of a securitisation company which can take the form of a public limited liability company, a private limited liability company, a partnership limited by shares or a cooperative company organised as a public limited liability company. Historically, public limited liability companies dominated the SV landscape because certain restrictions applied to private limited liability companies with respect to issuing bonds to the public. Following a reform of the Luxembourg legislation on commercial companies in 2016, there are very few relevant distinctions left between the two forms and the use of private limited liability companies has been on the rise.
SVs can be regulated or unregulated. The Securitisation Act requires an SV to be regulated when it issues securities to the public on a continuous basis. In that case, the SV will need to apply for a licence to have its activities and framework supervised by the CSSF. At the time of writing, there are 31 securitisation undertakings supervised by the CSSF, and the vast majority of SV remains unregulated. It is worth noting in this context that out of these 31 securitisation undertakings, a large number constitute platforms for the issuance of structured products (as against more traditional securitisations).
The concept of 'issuing securities to the public on a continuous basis' under the Securitisation Act is not to be confused with the 'issuance of securities to the public' under the Prospectus Regulation. Under the Securitisation Act the criteria of continuity and offer to the public are cumulative. Guidance of the CSSF has clarified that issuances are deemed to be made 'on a continuous basis' when there are more than three issuances per year.13 Issuances are not deemed to be made to the public when the denomination per unit of the securities is at least €125,000 or if the securities are offered to professional investors only. Therefore, a retail programme involving an SV is likely to trigger the above-mentioned licensing requirement. Some structured product issuance platforms are designed in such a way that the criteria for continuous issuance of securities to the public are not met so as to avoid separate licensing procedures.
SVs subject to the Securitisation Act must limit their activities to conducting securitisation as determined in the Securitisation Act. Securitisation is defined under the Act as a transaction whereby a securitisation undertaking acquires or assumes, directly or through another undertaking, risks relating to claims, other assets or obligations assumed by third parties or inherent in all or part of the activities of third parties, and issues securities whose value or yield depends on those risks.14 The type of instruments that can be issued and the type of underlying assets that can be used are very broad and are deliberately construed as such in order to grant flexibility as to the operations SVs can undertake.
One of the main features of the Securitisation Act is that issuances of instruments by an SV can be segregated into distinct compartments created by its board of directors or managers. Each compartment forms a separate estate of the SV having its own assets and liabilities, segregated from all other compartments of the SV. The Securitisation Act foresees statutory limited recourse with respect to such compartments. Therefore, investors in structured products issued by one compartment will not have any rights with regard to the structured products issued by another compartment of the SV, which is a major driver for opting for an SV under the Securitisation Act as issue vehicle for multi-compartment platforms.
The Securitisation Act further allows for the constitutional document and offering documentation to hardwire non-petition language into the issue documentation pursuant to which all parties contracting with the SV accept not to commence any winding-up, liquidation or bankruptcy proceedings against the SV, in particular when the assets in a compartment are insufficient to satisfy their claims. A creditor initiating proceedings in breach of these provisions will in principle find his or her claim declared inadmissible by a Luxembourg court based on the provisions of the Securitisation Act.
To enhance the insolvency remoteness, most SVs on the Luxembourg market will be structured as orphan vehicles. That means that the equity of the SV will be held by a trust or charitable foundation (often a Dutch stichting) in order to minimise the risk of adverse shareholder decisions and the insolvency of the holding company or financial group arranging the vehicle (which in various cases will be credit institutions).
In some jurisdictions, there may be uncertainty as to whether structured products issuances and structures fall within the remit of AIFMD.15 The pragmatic position of the Luxembourg financial regulator is very clear in this respect. In addition to the exemptions available under AIFMD, the CSSF has, in its CSSF FAQ Securitisation, determined to what extent securitisation undertakings can qualify as AIFs. Pursuant to this guidance, SVs exclusively issuing debt instruments should not be considered to be AIFs. In the CSSF's view it was not the intent of the European legislator to capture such instruments as they do not represent an ownership interest in the securitisation undertaking.16 Although this view was expressed in respect of SVs, it can be extrapolated to other Luxembourg issuing vehicles as well. Where nonetheless the constitutive elements of an AIF need to be further analysed, the CSSF states that in respect of an investment policy, SV issuing structured products offering a synthetic exposure to assets, such as, for example, shares, indices or commodities, based on a pre-established formula, and that either or both of acquiring underlying assets and entering into swap agreements with the sole purpose of hedging their payment obligations under the issued structured products may be considered as not being managed according to an 'investment policy'. Accordingly, these vehicles would not be considered as being managed according to an 'investment policy' within the meaning of the AIFMD and hence not qualify as an AIF.17
iv BRRD credit institutions
Credit institutions are not only active in the structured products market via their off-balance sheet programmes through their SVs, but do issue a vast number of structured products from their own on-balance sheet. These structured products are typically senior instruments issued by the institution rather than any form of regulatory capital product. Of course, these instruments may, in line with the European bank insolvency legislation adopted in the aftermath of the financial crisis, potentially be subject to bail-in measures and write-down and conversion mechanisms deriving from the Act dated 18 December 2015 on the failure of credit institutions and certain investment firms (the BRR Act 2015), implementing the BRRD.18 In Luxembourg, the CSSF is the supervisory authority for credit institutions and the competent authority under the BRR Act 2015.
v Fiduciary capacity and instruments
Credit institutions and SVs also make wide use of the Fiduciary Act to issue structured products. The Fiduciary Act permits such entities to establish segregated fiduciary estates. Fiduciary estates are booked off balance sheet and represent a separate pool of assets and liabilities from the own assets of the fiduciary and any other fiduciary estates it has created.
Where structured products are issued by a credit institution or SV pursuant to the Fiduciary Act, the entity acts as fiduciary and on a fiduciary basis (the Fiduciary). Each structured product issued under the Fiduciary Act must be governed by Luxembourg law. Pursuant to the Fiduciary Act, a structured note evidences the existence of a Fiduciary contract between the holder of such product and the Fiduciary. The Fiduciary is considered the legal owner of the fiduciary assets but it holds such assets for the sole and exclusive benefit of the structured product holder(s). The fiduciary contract embeds the terms and conditions of the relevant structured product ensuring that the product functions as intended.
The fiduciary construct may have a different tax treatment to where credit institutions or SVs would not act on a fiduciary basis. Structurers do have a keen interest in this legal framework as it allows combining the segregation of assets and liabilities with alternative tax treatments which may be required by investors. Depending on the terms and conditions of the fiduciary contract, assets that are legally owned by the Fiduciary may be allocated to the structure product holders for tax purposes.
vi Benchmark Regulation
The Benchmark Regulation applies to issuers of structured products when using benchmarks and indices for their structured products. Issuers will need to ensure that there are robust fallback methods in place in case the relevant benchmark can no longer be utilised. In light of the ongoing IBOR reforms, the CSSF will take into account the recommendations of the relevant IBOR working groups and regulatory bodies when reviewing prospectuses. The CSSF recommends not to continue using benchmarks that are imminently discontinued during the validity of the prospectus or are no longer recommended to be used in their relevant market.
Issuers using proprietary indices outside the scope of the Benchmark Regulation for their structured products are subject to particular disclosure requirements as and when they seek approval of their prospectuses.
vii Court decisions
Luxembourg courts have rendered decisions with regard to structured products legislation and product governance rules. However, there is no recent major publicly available case law issued by the Luxembourg courts in this respect.
Offering process and post-sale requirements
i Product governance rules
The issuance and distribution of structured products is principally governed by MiFID II as implemented by the Luxembourg Act dated 30 May 2018 on markets in financial instruments, the MiFID Grand Ducal Regulation19 and MiFIR.20 The MiFID II rules contain various information, disclosure and product testing requirements applicable to manufacturers and distributors of structured products. The CSSF is the competent authority in respect of the application of the product governance rules to securities offered in Luxembourg and manufacturers and distributors established in Luxembourg. It may in case of non-compliance with the applicable rules restrict or prohibit the further offering and sale of the relevant structured products.
The intention of MiFID is primarily to protect investors from acquiring products which are not suitable for their needs. Structured products are often complex in terms of payout and their underlying. Certain structured products may thus not be appropriate for retail investors. Therefore, manufacturers and distributors of structured products are obliged to determine the target market of their products and to test the knowledge and experience of the relevant end-investors. MiFID II requires a categorisation of clients as professional clients, eligible counterparties or retail investors based on their characteristics and level of protection required. In certain cases, investors showing requisite experience can opt-in to be treated as professional clients upon request.
Manufacturers and distributors should have particular regard to the ESMA Guidelines on MiFID II product governance requirements (the ESMA Product Governance Guidelines) and the ESMA Guidelines on complex debt instruments and structured deposits (the ESMA Complex Product Guidelines), which determine which products are generally perceived as complex structured products.21 Both manufacturers and distributors have their own particular target market obligations and where a manufacturer is also a distributor, the obligations need to be met for both roles.
Where a firm is solely acting as manufacturer it is less likely to have the direct relationship with the end-client to which the product is distributed. As such, the ESMA Complex Product Guidelines provide that the manufacturer takes into account five categories to determine the potential target market of the structured products based on theoretical knowledge. In particular, the manufacturer should specify to which clients the product is targeted, the requisite knowledge they need to have, the ambit of losses the investor should be willing to take, their risk attitude and the needs the structured product is designed to meet. The assessment should be made both on the basis of quantitative and qualitative data, rather than quantitative data alone.22 For complex products the target market should be more granular than for vanilla products.
Distributors should, in accordance with their internal business models, determine to which clients the products can actually be distributed by considering to the intended target market of the manufacturer and the five categories mentioned above. Distributors should scrutinise the target market and determine which of their clients in fact meet the target market and are suitable to acquire the structured products.
The obligations of manufacturers and distributors are essential to the functioning of the offering and sale process, and the fulfilment of their roles is contingent upon receiving reciprocal information. Therefore, distribution agreements will generally be entered into between manufacturers and distributors in order to determine their responsibilities and liabilities. Term sheets and applicable offering documentation will contain information about the target markets for the specific structured products issued as well as the persons responsible.
Where the offering of the structured products requires a prospectus to be prepared in accordance with the Prospectus Regulation or the applicable product is a PRIIP and offered to retail clients, the structured products should not be distributed without a prospectus or KID (as applicable). Infringement of the rules under the Prospectus Law or the PRIIPs Law may lead to substantive administrative and criminal sanctions.23 Fines for natural persons and legal persons breaching the Prospectus Law may be up to €700,000 or €5 million, respectively. Failure to draw up and provide a KID may be subject to fines of up to €700,000 or €5 million depending on whether the person is a natural or legal person or alternatively 3 per cent of the annual turnover of the legal entity. Fines for natural or legal persons may also be up to twice the amount of the losses avoided or benefits gained from the infringement of the PRIIPs Law.
ii AML, KYC and suitability
Anti-money laundering (AML) rules are principally governed by the Act dated 12 November 2004 on the fight against money laundering and terrorist financing, implementing the relevant EU Directives on AML (the AML Act). AML has taken a prominent place in the day-to-day tasks of the CSSF and the CSSF has published various Regulations and Circulars to guide financial professionals in determining beneficial owners and AML-related requirements. Beneficial owners are considered to be those persons who ultimately control or direct a relevant entity by direct or indirect ownership. A holding of 25 per cent or more is considered by the AML Act to be an indication of direct ownership.24
Where the structured products are issued through a fiduciary structure under the Fiduciary Act, fiduciaries must, in accordance with the Act dated 10 July 2020 creating a register of fiduciaries and trusts, file certain information including details of the beneficial owners with the Registration Duties, Estates and VAT Authority in Luxembourg.
At MiFID II level, know your client and know your product requirements also apply, requiring manufacturers and distributors to have procedures in place to understand the characteristics of their clients. In most cases, information will be sought from clients through questionnaires to determine their investment profile and if a given structured product is suitable for them.
For illustration, the CSSF fined a large professional of the financial sector in 2020 and a handful of financial institutions with six- and seven-figure fines for shortcomings in their AML processes, and continuous scrutiny of the CSSF in this field can be expected.
Exchange listing and trading
i Main markets
Structured products can be listed and traded on two different markets of the Luxembourg Stock Exchange (LuxSE). The MiFID II regulated market eligible for Prospectus Regulation passporting requirements is the Bourse de Luxembourg (BDL). A separate market exists that is an MTF for MiFID II purposes and named the Euro MTF. It does not qualify as a regulated market allowing for passporting under the Prospectus Regulation.
Both the BDL and Euro MTF feature professional segments which are only accessible to professional investors. When applying for listing and admission to trading on the BDL and Euro MTF, it is essential to indicate which segments the structured products are intended to be traded on. The professional segments do remediate certain issues arising when trading structured products in the secondary markets. In particular, where the structured product in question qualifies as a PRIIP it should not be sold to retail investors unless a KID has been prepared.
This obligation does not apply where the product is sold only to professional investors. Fencing off market access for retail investor by listing securities on the professional segment will reduce the risk of the structured product being sold to retail investors and triggering the requirement to draw up a KID.
Furthermore, issuances of wholesale structured products are subject to alleviated requirements under the Prospectus Regulation. The determination that the structured products are only accessible to professional investors can easily be done by opting for the professional segments.
The consideration for a professional segment will also simplify compliance with the product governance rules set out above, in particular the target market requirements.
There is also a possibility to have securities admitted for listing only on a dedicated section of the official list of the LuxSE called the LuxSE Securities Official List (the LuxSE SOL). On the LuxSE SOL securities cannot be traded and will only be listed. The LuxSE SOL allows issuers who do not need their securities admitted to trading or solely require listing, whether for regulatory purposes or visibility, to have their securities and indicative prices displayed on the LuxSE.
With the increasing importance of sustainable finance the LuxSE launched the Luxembourg Green Exchange (LGX) in 2016. The LGX is dedicated to sustainable securities and has the largest market share in green, social and sustainability bonds listed worldwide.25 Industry best practices for sustainable financial instrument are hardwired in the mandatory ruleset applicable to those who seek access to the LGX.26 Structured products intended to be listed thereon need to comply with certain eligibility criteria and reporting obligations with regard to their sustainability.
ii Listing procedures and admission to trading
The listing rules for the BDL and Euro MTF are very similar. Their requirements are set out in the Grand-ducal Regulation dated 13 July 2007, relating to the holding of an official list for financial instruments, as amended (the Listing Regulations).
The Listing Regulations require that the issuer is compliant with the laws in its local jurisdiction as well as its constitutional documents. The same goes for the structured products issued, irrespective of the law applicable thereto. Where structured products are issued in physical form it is sufficient that the laws of the local jurisdiction governing their physical form are complied with.
In principle, the minimum number of securities issued should amount to €200,000 or its foreign currency equivalent. The LuxSE may exercise discretion provided that there is a sufficient market for the securities concerned. Tap issuances are not subject to the above-mentioned minimum amount.
The CSSF is the competent authority to approve a Prospectus Regulation-compliant prospectus (in view of carrying out a public offering or admitting securities on a regulated market such as the BDL, or both) where it is determined to be the competent authority in accordance therewith. A Prospectus Regulation compliant prospectus benefits from the European passport. Admission to trading of the relevant securities is sought by completing the application forms of the LuxSE for the relevant type of securities.
Part III Chapter 2 of the Prospectus Act foresees an alleviated prospectus regime for securities which are not covered by the Prospectus Regulation. The LuxSE is the competent authority to approve alleviated prospectuses.
The LuxSE is also the competent authority to approve prospectuses (not relating to any public offering) covering the admission to trading on the Euro MTF, in accordance with Part IV of the Prospectus Act.
As mentioned above, it is possible to be admitted to the LuxSE SOL without admission to trading of the relevant securities for which the Listing Regulations apply as well. The LuxSE is the competent authority for admission of securities to the LuxSE SOL. The listing requirements for the LuxSE SOL are set out in the LuxSE's Rulebook – Securities Official List (the LuxSE SOL Rulebook) and revolve around low barriers to entry for issuers. No prospectus or offering document is required. An information notice containing an outline of the securities and the issuer structure are sufficient. Further, notes listed on this segment do not need to be cleared (as opposed to notes listed on the regulated market or the Euro MTF market).
iii Secondary market trading
Secondary market trading of structured products in Luxembourg mainly happens through the applicable LuxSE markets or over-the counter. Where instruments are issued and settled via (international) central securities depositaries (CSDs), market participants need to have regard to the procedures of such entities in order to issue and settle their trades successfully. This may require, among other things, the holding of certain accounts directly or via intermediaries. The Luxembourg CSDs are Clearstream Banking SA and LuxCSD SA.
Whereas SVs set up in the form of securitisation funds are generally considered as tax transparent, SVs set up as securitisation companies are considered as tax opaque from a Luxembourg tax perspective and are subject to the tax regime set out below.
i Corporation taxes
Luxembourg incorporated and tax-resident SVs are subject to corporation taxes in Luxembourg. SVs are, therefore, entitled to request Luxembourg tax residency certificates (including for the purposes of double tax treaties entered into by Luxembourg). Whether SVs ultimately benefit from reduced withholding tax rates or other advantages under a given double tax treaty requires a case-by-case analysis.
An SV set up with multiple compartments is generally considered as a single taxpayer in Luxembourg.
The aggregate applicable rate (including CIT,27 MBT28 and the solidarity surcharge) in the municipality of Luxembourg for the financial year 2021 is 24.94 per cent. SVs are assessed on the basis of their worldwide profits, after deduction of allowable expenses and charges, subject to the provisions of applicable tax treaties. Expenses relating to an item of income that is not taxable in Luxembourg are not deductible for tax purposes.
The Securitisation Act provides for special rules for SVs in relation to the deductibility of expenses. Under the Securitisation Act, payments made or accrued by SVs to investors and commitments by SVs to distribute net profits to investors are deemed tax deductible expenses in relation to the year in which they are incurred, regardless of whether investors hold equity or debt securities of the SV. SVs should, therefore, be able to deduct any payments due or made to investors from their taxable profits, it being noted that such deductions may be restricted by rules such as the recently introduced ATAD1 interest limitation rule and the ATAD II hybrid mismatch rules. Depending on an SV's activities, the SV's corporation taxes base may be limited.
ii Net wealth tax
SVs are subject to a minimum net wealth tax (NWT) of €4,815 if its financial assets, intra-group receivables, bank deposits and cash at bank exceed: (1) 90 per cent of its total balance sheet; and (2) €350,000. In all other circumstances, SVs are subject to a minimum NWT ranging between €535 and €32,100 depending on the total balance sheet.
iii Withholding tax
Any interest payable under or in respect of debt instruments issued by SVs and dividend payments may generally be made free and clear of withholding or deduction for or on account of withholding tax in Luxembourg.
SVs are generally considered as carrying out an economic activity within the meaning of Luxembourg VAT legislation and should, therefore, qualify as VAT-taxable persons from a Luxembourg VAT perspective.
Under certain circumstances, SVs may benefit from an input VAT deduction right. VAT exemptions may apply to services provided to SVs under certain conditions.
Notwithstanding the volatility in the virtual asset space, the Luxembourg structured product market tends to show a keen interest in tokenisation of securities and underlying portfolios consisting of virtual assets. Although there is a positive attitude of various stakeholder bodies and the CSSF towards financial innovation, the CSSF has issued several warnings with regard to investments in virtual assets and entities offering them.
In the absence of existing harmonised European rules on virtual asset classifications, market participants should be wary that the classifications of virtual assets may not correspond across jurisdictions. Classification of virtual assets may also change over time due to the nature of the virtual assets which adds complexity to the compliance with securities rules, including the Prospectus Regulation. The MICA Proposal aims to create a taxonomy for various virtual assets and a framework related to the provision of services for virtual assets to mitigate this concern.29
As the importance of AML increases and application of AML rules in the virtual asset sphere may prove challenging, market participants should be careful that their products comply with the AML rules.
To foster the digital financial revolution, the European Commission has launched a pilot regime for market infrastructures (the Pilot Regime), which embraces distributed ledger technology as a tool to improve the efficiency of financial markets. Since existing rules may not in all cases be adapted to the use of distributed ledger technology, the Pilot Regime aims at granting exemptions to the application of certain provisions under MiFID II and CSDR.30
Notwithstanding the initiatives of the European legislator, Luxembourg has already taken various steps to digitalise its capital markets infrastructure in the past. In particular, in 2019 the Act dated 1 August 2001 on the circulation of securities has been amended to cater for the holding of securities through distributed ledger technology. In January 2021, the Luxembourg legislator also modernised the rules for dematerialised securities by amending the Act dated 6 April 2013 on dematerialised securities (the Dematerialised Securities Act), to recognise the issuance and recording of dematerialised securities through secured electronic methods such as distributed ledger technology. In respect of unlisted debt securities in dematerialised form, it also expanded the institutions that can act as central account keeper – as required under the Dematerialised Securities Act – from locally licensed entities to EU credit institutions and investment firms.
Outlook and conclusions
i Amendment to Securitisation Act
The Securitisation Act has been a pillar of the Luxembourg structured product market for nearly two decades. To date, it has attracted arrangers and issuers with the balance between product flexibility and legal robustness. Statutory segregation of assets and liabilities through compartments and legal recognition of limited recourse and non-petition provisions have convinced many structurers to make Luxembourg their jurisdiction of choice.
In order to further enhance flexibility, a Draft Bill No. 7,825 amending the Securitisation Act was submitted to Parliament on 21 May 2021 (the Draft Bill). The most important changes of which are summarised below.
Under the Draft Bill, securitisation undertakings are no longer limited to ad hoc securitisation funds and private and public limited liability companies but will also allow for Luxembourg partnership type forms to conduct securitisation under the Securitisation Act. Where previously fiduciary structures and ad hoc securitisation funds were necessary to achieve tax transparent structures, this will also become available through the use of Luxembourg partnership forms.
In Section II, we elaborate on the criteria established by the CSSF for issuances not to be considered continuous issuances to the public under the Securitisation Act. The Draft Bill intends to encode these into the Act and align the minimum denomination of securities with the denomination of €100,000 under the Prospectus Regulation, instead of €125,000 as previously stated.
At present, the Securitisation Act requires securitisation undertakings to issue 'securities', a concept that is not defined thereunder. In certain cases, it is unclear whether the instruments intended to be issued under foreign governing laws qualify as securities. The Draft Bill replaces this concept with the concept of 'financial instruments'. The term 'financial instruments' has a much wider meaning and should remedy the concern as to whether certain instruments qualify as securities.
Under the current regime, securitisation undertakings under the Securitisation Act can only finance themselves via loans under limited circumstances. This has led to mismatches with the possibilities offered under the EU securitisation rules. The revised framework will allow for securitisation undertakings to finance themselves exclusively by loans at any stage of the securitisation process.
Under the current rules, security interests granted by a Luxembourg securitisation undertaking can only be in favour of its direct creditors and investors, but not to parties involved in the securitisation transaction generally. This is intended to be remedied by the Draft Bill so that all parties involved in the securitisation transaction can benefit from security interests and guarantees granted by the securitisation undertaking.
The Securitisation Act is currently not adapted for structured products with actively managed portfolios. This has proven to be a disadvantage to international institutions looking to use off-balance sheet structures under the Securitisation Act. To overcome this, the Draft Bill foresees that baskets of debt portfolio subject to securitisation may be actively managed provided that they are not offered to the public within the meaning of the Securitisation Act.
The implementation of the Draft Bill has been long awaited by the Luxembourg structured products market. The above-mentioned revisited features are likely to boost the already thriving Luxembourg structured product markets further in the years to come.
ii General and green outlook
The Luxembourg structured product ecosystem is dynamic and has shown resilience to economic changes. A timeless legal design has permitted the market to flourish since inception and it is expected to moderately follow this tendency. Promising growth can also be observed in the sustainable finance sector, confirming Luxembourg's importance in a sector essential for Europe's financial future.
1 Frank Mausen, Paul Péporté and Jean Schaffner are partners, David Van Gaever and Franz Kerger are counsel and Kristina Vojtko is a senior associate at Allen & Overy.
2 List of banks obtained from the website of the Commission de Surveillance du Secteur Financier (CSSF) in August 2021, available at https://searchentities.apps.cssf.lu/search-entities/search.
3 According to data published by PWC in PWC, Securitisation in Luxembourg – A comprehensive guide, June 2021, 10th Edition, p.10.
4 While most issue vehicles used for structured products are SVs, some issue platforms are making use of an ordinary Luxembourg holding company as issuing vehicle.
5 A reference to SV is used as an exclusice reference to a securitisation undertaking set up under the Securitisation Act and does not include commercial companies conducting securitisation but which are not set up under the Securitisation Act.
6 CSSF, Annual Report 2019, p. 71.
7 In particular the SPVs.
8 The parties are in principle free to choose the governing law of the relevant instruments, except for instruments issued on a fiduciary basis in accordance with the Fiduciary Act, which are mandatorily governed by Luxembourg law.
9 Regulation (EU) 2017/1129 of the European Parliament and of the Council 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, and repealing Directive 2003/71/EC.
10 Luxembourg Act dated 16 July 2019 on prospectuses for securities and implementing the Prospectus Regulation.
11 Article 56 of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments (MiFID II).
12 Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retail and insurance-based investment products, implemented in Luxembourg pursuant to the Law of 17 December 2018 (the PRIIPs Law).
13 CSSF Frequently Asked Questions Securitisation, p. 4 (CSSF FAQ Securitisation).
14 Article 1 of the Securitisation Act.
15 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers.
16 CSSF FAQ Secutisation, p.15.
18 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms.
19 Grand-ducal Regulation of 30 May 2018 on the protection of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or any monetary or non-monetary benefits.
20 Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments.
21 ESMA Guidelines on MiFID II product governance requirements, ESMA35-43-620 and https://www.cssf.lu/en/Document/esma-guidelines-on-complex-debt-instruments-and-structured-deposits/ ESMA Guidelines on complex debt instruments and structured deposits, ESMA/2015/1787.
22 ESMA Product Governance Guidelines, pp.5–6.
23 Luxembourg Act dated 17 April 2018 implementing the PRIIPs Regulation.
24 Article 1(7) of the AML Act.
25 Luxembourg Green Exchange, 'The world's leading platform for sustainable securities', p.3
27 Corporate income tax.
28 Municipal business tax.
29 Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937 (MICA Proposal).
30 Regulation (EU) No 909/2014 on improving securities settlement in the European Union and on central securities depositories.