Flexible private/intermediate portfolio holding or investment vehicles
With over 1,000 securitisation vehicles (SVs) and thousands of related compartments, the Luxembourg securitisation market enjoys a continuous and steady growth, and it is forecast that this well-established trend will continue and gain further strength in the coming years. As a leading hub in Europe for securitisation and structured finance transactions, Luxembourg indeed offers a pragmatic and secure legal and tax regime which allows the securitisation of virtually an unlimited range of risks, through different forms of SVs with reduced complexities and almost full tax neutrality.
The regime that has developed in practice arising from the statutory framework created by the Luxembourg Securitisation Law of 22 March 2004, as amended from time to time (the Securitisation Law) and the regulatory guidance issued by the Luxembourg Financial Sector Supervisory Authority (the CSSF) in the form of published Q&As has therefore led to a widespread market usage of SVs to cover a range of activities from (i) regulated, continuously offered securities to the public, through (ii) institutional capital raising and (iii) private, unregulated securities-issuing investment vehicles.
The Luxembourg SV is indeed used for a diverse range of economic purposes, including:
- structures that would be recognised as classic capital markets structures set up with a view to being bankruptcy remote, taking on either a true sale assignment or a synthetic exposure to a portfolio of numerous assets which are secured to a fiduciary for the benefit of the securities' holders whose proceeds of issue financed the original portfolio acquisition;
- private vehicles that are simply issuing securities whose value or yield is dependent on the performance of one or a number of portfolio assets; or
- intermediate portfolio holding vehicles for non-EU funds holding debt or other receivables.
What is securitisation under Luxembourg law?
Securitisation under the Securitisation Law means the transaction by which a SV (cumulatively):
- acquires (true sale securitisation) or assumes (synthetic securitisation), directly or through another undertaking, risks relating to claims, other assets, or obligations assumed by third parties or which are inherent to all or part of the activities of third parties; and
- issues securities, whose value or yield depends on such risks.
Risks relating to all types of assets, whether movable or immovable, tangible or intangible, as well as those relating to obligations assumed by third parties or inherent in all or part of third-party activities, may be securitised. There are no portfolio diversification requirements, so that SVs are able to hold single asset portfolios where appropriate.
Securitisation may occur either through a true sale under which assets are assigned to or acquired by the SV or through a "synthetic" securitisation, where only the risk linked to the portfolio assets is transferred.
Financing of the SV
Aside from the fact that a SV as a company will have a share capital and corresponding issued equity, it shall finance its securitisation operations through the issue of securities. There is neither a legal definition nor any prescription as to the characteristics of such securities, simply that their yield or value accretion must derive from the securitised risks. On this basis the following is to be noted:
- securities subject to foreign law which are recognised as "securities" under applicable law or which constitute securities within the meaning of the Markets in Financial Instruments Directive (MiFID) are deemed to be securities under the Securitisation Law;
- in general, securities issued by Luxembourg SVs are debt securities (but shares are authorised too) and are often subject to foreign law;
- the securities issued may be secured or unsecured, provided their value or yield is effectively ring-fenced to the performance of the underlying portfolio;
- a SV may also issue securities whose value or yield is linked to specific compartments, assets or risks; and
- the securities may be listed in Luxembourg (the Luxembourg Stock Exchange operates two markets, (a) the Luxembourg Stock Exchange, a European regulated market offering European passport and (b) the Euro MTF, a Multilateral Trading Facility) or abroad.
In addition, SVs may receive financing through borrowing or intra-group financing, provided this lending is granted on a transitional or ancillary basis and subject to the investors in the SV being sufficiently informed of the additional risks they may incur and other factors relevant to them in light of such alternative financing.
There are no restrictions on eligible investors under Luxembourg law; however, the laws on securities applicable to investors in their own jurisdictions will need to be taken into account.
A Luxembourg SV can be constituted as (a) a private limited liability company (SARL), a public limited company (SA), an incorporated limited partnership issuing shares (SCA), a co-operative company organised as a public limited company (société cooperative organisée comme une société anonyme), or (b) alternatively as a co-ownership of assets (i.e. a securitisation fund without legal personality) managed by an independent management company or under a fiduciary arrangement. The vast majority of Luxembourg SVs are structured as companies.
The Luxembourg companies law applies to SVs set up as companies, except in relation to a few limited instances where changes required by the Securitisation Law will apply.
The Securitisation Law offers the possibility to have ring-fenced compartments within the SV, allowing a clear segregation of assets and liabilities between them. The rights/claims of investors/creditors relating to a specific compartment will be limited to the assets of that compartment, which will be exclusively available to satisfy such rights/claims. As between investors, each compartment shall be treated as a separate entity, except if otherwise provided for in the SV's constitutional documents. Compartments must be authorised in the SV's constitutional documents and are created by a simple decision of the management body of the SV.
A compartment may be liquidated separately to the other compartments of the SV.
Limited recourse, non-petition and subordination
There is statutory recognition of contractual limited recourse, non-petition and subordination (i.e. tranching) of the securities issued by Luxembourg SVs, which offers a great means to achieve insolvency remoteness. It is not compulsory to issue different tranches of securities, it is merely enabled for those SVs whose business model is to do so.
Nearly all Luxembourg SVs are unregulated. Indeed, provided a SV does not (a) offer its securities to the public and, cumulatively, (b) does not do so on a continuous basis, it does not need to be regulated under Luxembourg law. Conversely, if it were to both (a) offer securities to the public and (b) to do so on a continuous basis, it would need to be regulated by the CSSF.
Offer to the public
In relation to Luxembourg SVs, securities issues are not considered to be offered to the public if they are issued either (a) only to professional clients (as defined in Annex II of the MiFID) or (b) on a private placement basis only. Similarly, securities' issues whose denominations equal or exceed EUR 125,000 are assumed not to be issues to the public.
Stock exchange listing does not in itself constitute an offer to the public. In determining whether an issuance constitutes an offer to the public, a look through basis will be applied in relation to any intermediate offering distribution/mechanism.
Issue on a continuous basis
Under current practice, an offer will be deemed to be made on a "continuous" basis if more than 3 issues of securities are made per year (taking into account the total number of issues of all compartments).
For unregulated SVs, no application to the CSSF is required. Furthermore, there is no regulatory requirement to appoint a regulated administrator, manager or custodian, nor is there any regulatory oversight of the SV's documents or approval of the SV’s board members.
It is not necessary for an unregulated Luxembourg SV to issue any form of private placement memorandum/prospectus/offer document, provided the issue of securities falls within one of the exemptions under the Luxembourg Prospectus Law implementing the EU Prospectus Directive (which for an unregulated SV, would often overlap closely with the Securitisation Law's approach to offers to the public in any event).
Asset management and disposal
The SV management role should limit itself to the passive monitoring and administration of portfolio performance and securities (re)payment.
A SV may manage its assets itself or entrust such management to third parties (including the assignor/originator of the assets) and/or appoint a third party servicer, without the need for such parties to apply for a license under the Luxembourg law of 5 April 1993 on the financial sector.
The SV is prohibited from (i) assigning its (portfolio) assets other than in accordance with its constitutional documents and/or (ii) granting any security interests over or issuing guarantees in relation them, other than for the purpose of securing the obligations it has assumed for the securitisation of those assets or in favour of its investors, their representative or the issuing vehicle participating in the securitisation.
Main service providers
A Luxembourg domiciliation agent (providing a registered office and other services such as accounting, tax compliance etc.) will generally be appointed by a SV. All SVs (including unregulated ones) must also appoint a CSSF-approved independent auditor, who will audit the annual accounts of the SV. Once a year, such accounts must be approved by the SV shareholder(s) and published.
Regulated SVs must entrust the custody of their liquid assets and securities to a credit institution that is established in or has its registered office in Luxembourg.
Certain reporting and other obligations
Luxembourg SVs are subject to certain reporting obligations set out in (i) Regulation ECB/2013/40 of the European Central Bank (the ECB) of 18 October 2013 concerning statistics on the assets and liabilities of financial vehicle corporations engaged in securitisation transactions (the ECB/2013/40 Regulation) and (ii) circular 2014/236 of the Luxembourg Central Bank dated 25 April 2014 on statistical data collection for securitisation vehicles. In addition, they will be subject to the EMIR (EU Regulation No 648/2012) reporting and other obligations under certain circumstances (i.e. the entering into derivative contracts).
Entities whose sole purpose is to carry out one or more securitisation operations within the meaning of article 1(2) of the ECB/2013/40 Regulation (the Securitisation Special Purpose Entities) fall as a principle outside of the scope of the Directive 2011/61/EU of 8 June 2011 on Alternative Investment Fund Managers (the AIFMD) and the implementing Luxembourg law of 12 July 2013 (the AIFM Law).
However, (i) primary lenders (i.e. entities whose main business is to originate new loans) and (ii) SVs issuing structured products that primarily offer a synthetic exposure to assets other than loans (non-credit-related assets) and where the credit risk transfer is only ancillary are not considered as Securitisation Special Purpose Entities and are therefore not exempt from the scope of the AIFM Law.
Nevertheless, irrespective of the fact of whether SVs qualify as Securitisation Special Purpose Entities under the AIFM Law, they do not qualify as Alternative Investment Funds (AIFs) if:
- they issue only debt instruments; or
- they are not managed in accordance within a “defined investment policy” (within the meaning of the AIFM Law).
If properly structured, a SV is tax neutral. The current, maximum flat corporate tax charge applicable to SVs is set at EUR 4,815 per annum provided that the SV's balance sheet is made up of at least 90% of eligible financial assets and cash-at-bank. The SV is also subject to a mandatory minimum net wealth tax charge (which applies in brackets).
This substantial tax neutrality arises because, although a SV is subject to the generally applicable corporate income tax rate of 27.08% (in 2017) on its taxable base, all interest, dividends and other distributions (including commitments) made to the holders of the SV's issued securities constitute deductible items for corporate income tax purposes.
Importantly, SV's can benefit from the relevant EU Directives (such as the Parent-Subsidiary Directive, the Merger Directive and the Interest-Royalty Directive) and generally have access to the Luxembourg double tax treaty network.
Attention should however be paid to the significant recent developments in the field of Base Erosion Profit Shifting (BEPS) and in particular the Anti-Tax Avoidance Directive (ATAD) that must be transposed in Luxembourg within the imposed deadlines (varying, depending on the subject, from 1 January 2020 to 1 January 2022). The ATAD aims to tackle hybrid mismatches and introduces, amongst other things, interest limitation as well as CFC rules. Cross-border securitisations being an important part of the financial system, one of the challenges and objectives of the Luxembourg legislator is to carve out to a maximum extent the SV's and/or their specificities from the scope of the ATAD in order to preserve Luxembourg's attractiveness for securitisations.
The same applies to the BEPS initiatives relating to anti-treaty abuse and their implementation through the adoption of the Multilateral Instrument (MLI). The MLI offers participating states, such as Luxembourg, an easy tool to bring their entire tax treaty network in line with the latest anti-BEPS standards. To avoid treaty shopping, states should introduce limitation of benefits (LOB) provisions or at least a principal purpose test (PPT). It is critical that SV's, like collective investment vehicles, are not prevented from accessing the benefits of tax treaties by reason of an LOB provision which a Luxembourg SV will most likely not be able to comply with (investors mostly do not reside in Luxembourg). SV's should instead be subject to the general requirements of being a resident of a contracting state, being liable (or subject) to tax in that contracting state, and of being the beneficial owner of the income and gains earned. If a SV satisfies these requirements, then it should generally be entitled to treaty benefits.
Most Luxembourg tax treaties will, going forward, contain a PPT. Recent guidance issued by the OECD (which contains an example with an SV), lists various factors which Luxembourg SV's should comply with. The existence of a skilled, multi-lingual work force, located in a member jurisdiction of a regional grouping, the use of the regional grouping's common currency, good reputation/known by investors, a good legal system and a sophisticated regulatory environment, political stability, a robust securitisation legislation and an extensive double tax treaty network are strong indicators of compliance with the PPT.
Luxembourg SVs are also subject to the general transfer pricing legislation which has recently been extended and clarified through the new articles 56 and 56 Bis of the Income Tax Code. Even though this should have limited impact in practice, it should be monitored in treaty situations.
Moreover, as a result of the evolution of the Luxembourg transfer pricing legislation, and in particular in view of the new circular letter nr. LIR 56/1 and LIR 56Bis/1 on intra-group financing transactions (the Group Financing Circular), the Luxembourg tax authorities have increased their scrutiny of entities engaged in related-party transactions. Given the nature of transactions typically performed by a SV (no active management of the assets), its activities should not fall within the scope of the Group Financing Circular.
In addition, as Luxembourg tax law does not contain specific thin or minimum capitalisation rules, Luxembourg companies, including SVs, are not formally subject to debt-to-equity ratios. However, the Luxembourg direct tax authorities have developed an administrative practice whereby a debt-to-equity ratio of 85/15 is considered as a safe harbour for investment holding activities performed by ordinary Luxembourg investment holding companies (SOPARFIs) having as sole collateral the assets of the company. In practice the 15% may be constituted as 1% equity and 14% interest-free shareholder loan. This debt-to-equity ratio however does not apply to Luxembourg SVs, which can result in greater efficiencies for SVs over SOPARFIs.
Finally, none of the following applies to Luxembourg SVs: Luxembourg withholding tax; capital duties (except a fixed EUR 75 fee on incorporation and any amendments to articles for SVs set up as companies); VAT on management services to a SV (the exact services should be carefully reviewed in each case, as should any VAT registration requirements arising from the reverse charge mechanism); net wealth tax (except for the minimum net wealth tax); (annual) subscription tax; and, for unregulated SVs, there are no annual regulatory charges.
To conclude, an unregulated SV is a well-tested and very efficient investment vehicle and provides a solid platform for passive investments financed by profit participating, secured or unsecured securities.