Trends and Developments

Current Perspective

While certain cross-border transactions were adversely affected by the pandemic (notably due to the disruption caused to industries such as aviation, hospitality, healthcare and retail) last year, 2021 has, to date, proven to be a very active year for the banking and finance practice.

The cross-border real estate finance market has been particularly dynamic, with many new transactions and old deals that had been put on hold picking up to completion. While the market has not fully recovered to the level preceding the crisis yet, new properties are emerging on the market, which suggests a new dynamism.

Fund finance

Fund finance has shown unprecedented levels of activity. 2020 had already been exceptional, but there has been a further 25% increase in deal volume. This includes technical amendments to existing facilities (upsizes, accessions of addi­tional borrowers or guarantors, higher advance rates, extension of terms and adjustments to LIBOR related provisions), sponsors launching new funds to seize the opportunities arising from the unprecedented circumstances and putting in place bridge facility arrangements. The UK and North American institutional lenders remain keen to respond to funds' demand for tradi­tional bridge financing arrangements. More and more net asset value (NAV) or hybrid financing arrangements are being seen, an option where higher advance rates may not be borne or as means to provide long term financing facilities that shall remain available throughout the entire life cycle of the funds, regardless of whether there remain unfunded capital commitments to be drawn down.

Alternative lenders have continued to step in to largely negate the prospect of higher pricing and fund sourcing issues (due to regulatory thresh­olds). Already, 2021 has seen a surge of ESG-linked subscription credit facilities governed by New York or English law.

The remainder of 2021

The outlook for the remaining months of 2021 and the year to come is very positive and Lux­embourg lawmakers have been proactive in drafting new laws and regulations (a number of which will be addressed later on in this article) to prepare and adapt the financial centre and to seize new opportunities.

Inspiring Perspectives for the Securitisation Practice

In the securitisation market, 2021 has likewise, proved to be very dynamic, a continuation of the impressive volumes seen during Q3 and Q4 of 2020.

Implementation of regulations

On the regulatory front, further progress was made to clarify the implementation of Regula­tion (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific structure for simple, transpar­ent and standardised Securitisation (the EU Reg­ulation on Securitisation). Firstly, on 25 March 2021 the EBA, ESMA and the EIOPA (European Insurance and Occupational Pensions Authority) jointly published an opinion to the Commission on the jurisdictional scope of application of the STSR.

This opinion is particularly interesting in post-Brexit Europe, as it clarifies the position of regulators with respect to the risk-retention, due diligence and transparency obligations of non-EU parties, which participate in a securitisa­tion transaction subject to the STSR. While this instrument is not binding, it provides valuable insight on how the relevant regulators approach the questions treated therein.

A day later, on 26 March 2021, the same authori­ties published a Q&A which, amongst other top­ics addressed therein, confirms that underlying exposure-level documents (such as term sheets, final terms, prospectuses, facility agreements, intercreditor agreements, mezzanine documents and hedging documents) must be made availa­ble pursuant to Article 7 of the EU Regulation on Securitisation only to the extent it is "essential for the understanding of the transaction". The Q&A provides helpful insight by stating that in most securitisation transactions, it is not essen­tial to make the underlying documentation avail­able in order to understand the transaction, but that there would likely be a need to make docu­mentation available in the context of commer­cial mortgage-backed securities with only a few underlying exposures. On 28 May 2021, ESMA published a further update to its Q&A clarifying technical and practical issues.

Securitisation transactions

A trend which initiated in late 2020 and has continued into 2021 is the strong flow of secu­ritisation transactions originating out of the US, Asian, Middle East and/or Latin American markets. These transactions which were, in the past structured through foreign jurisdictions are now being implemented through Luxembourg because of new constraints (such as diversified payment rights securitisations or REPO transac­tions) in originators' or lenders' jurisdictions.

These deals, where the parties are seeking to replicate, to the widest extent possible, the agreements, arrangements and structures that were previously used in (foreign) jurisdictions, may sometimes be challenging to implement in Luxembourg, and therefore require careful con­sideration regarding restrictions and limitations that are specific to the securitisation regime under the Luxembourg law of 22 March 2004 on securitisation, as amended (the "Securitisa­tion Law"). These restrictions and limitations constitute a significant proportion of the subject matter of a draft law that aims at increasing the attractiveness of the Luxembourg securitisation regime.

Amendments to the Securitisation Law

On 21 May 2021, the long-awaited draft law 7825 amending the Securitisation Law (the "Draft Law on Securitisation") was lodged at the Luxembourg Parliament. The amendments con­tained in the draft, whether aimed at enhancing legal certainty or strengthening the flexibility of the Luxembourg securitisation regime are very ambitious and address a number of issues that have been generating legal discussions over the last 15 years. The legislative process is still in its early stages and many changes may be made before the amendments are adopted. However, a number of the contemplated amendments are expected to increase tremendously the attrac­tiveness of the financial centre as a European hub for securitisations.

One of the main changes alleviates the condi­tions pertaining to the means of funding and financing for Luxembourg Securitisation Vehi­cles (SVs). As a matter of principle, SVs estab­lished under the Securitisation Law must finance their operations primarily through the issuance of securities (in practice, through the issuance of notes, preferential shares or units, but also derivative instruments). Additionally, they may also seek leverage by way of loans that do not qualify as securities:

  • on a transitional basis (for warehousing and bridging purposes between the acquisition of the assets and the issuance of securi­ties - prudent market practice suggests that a securitisation transaction may be entirely loan-financed at the beginning of the trans­action for a period of time not exceeding 18 months); and/or
  • on the basis that any lasting loan financing would not account for more than one third of the total financing.

The Draft Law on Securitisation removes these restrictions and authorises SVs to be entirely financed through borrowings.

Another existing limitation under the Securiti­sation Law is that, irrespective of whether the management has been delegated by the SV, the management must at all times be limited to a passive, prudent man management of the secu­ritised risks and the administration of financial flows linked to the securitisation operation itself. Under no circumstance may the activity of an SV amount to an economic activity that would re-qualify the SV as an entrepreneur. The Draft Law on Securitisation authorises the active manage­ment of securitised debt portfolio to the extent that it is not offered to the public. The elimina­tion of this limitation means that Luxembourg will now offer an efficient legal framework for actively managed collateralised loan obligations (CLOs) and collateralised debt obligations.

Collateralised obligations

CLOs have been in existence since the late 1980s and constitute a form of securitisation of debt obligations (senior loans or bonds, unse­cured senior or mezzanine obligations, etc). The vast majority (approximately 85%) of CLOs are issued in the USA. Despite the negative effects of the pandemic in 2020, the new issuance level for CLOs in Europe was EUR22.11 billion from 43 deals and 2021 has, so far seen strong volumes of new European issuances of CLOs continue in addition to the resets and refinancings. Addi­tionally a recent trend, the introduction of loan tranches has been adopted from the US market and continues to gain ground. Since the post financial crisis resurgence of European CLOs in 2013, Ireland has become issuers' jurisdiction of choice. Since 2020, all European CLOs are established in Ireland following the migration of nearly all existing Dutch CLO transactions (over 70) in Q4 2020.

The changes contemplated by the Draft Law on Securitisation may be reasonably expected to attract some of the transactions that were previ­ously structured either through other European jurisdictions or issued in the US but structured through offshore jurisdictions, making Luxem­bourg one of the preferred jurisdictions for Euro­pean CLOs.

When putting in place Luxembourg securitisa­tion deals that used to be structured through foreign jurisdictions, another limitation that at times leads to some controversy is the limita­tion relating to the granting of security interests and guarantees.

According to Article 61(3) of the Securitisation Law, SVs are not allowed to grant security over their assets to third parties to the securitisation transaction, unless such security is granted to the SV's investors or for the purpose of secur­ing the obligations subscribed in connection with the securitisation of those same assets. This sometimes goes against the expectations of third-party creditors extending loans to the SV and expecting to take security over the SV's assets. The Draft Law on Securitisation grants some flexibility in this respect by expressly authorising the SV to grant security interests to a wider scope of beneficiaries, ie, any creditor, be it direct or indirect, to the securitisation transac­tion, and any reference to the current sanctions applicable in case of the granting of a security interest in breach of the rules currently set forth in the Securitisation Law will be removed.

Future amendments

A few other amendments and changes are contemplated, such as enlarging the panel of options for legal forms available to SVs, and in particular the inclusion of partnerships (gen­eral corporate partnerships (sociétés en nom collectif), simple limited partnerships (sociétés en commandite simple), simplified joint stock companies (sociétés par actions simplifiées) and special limited partnerships (sociétés en com­mandite spécial)), clarifications on the legal sub­ordination by including express rules in the law, refining the definition of issuance of securities to the public as per the Luxembourg Supervisory Authority, the Commission de Surveillance du Secteur Financier (CSSF) recommendations or clarifying the treatment and distribution of profits and losses of equity-financed compartments or reducing ambiguity of omissions regarding the registration of securitisation funds.

As anticipated last year, heightened interest was shown in securitisation funds, as tax-transparent structures are exempt from the interest limitation rules under ATAD, which confirmed the actual trend in favour of securitisation funds in the form of fiduciary estates. The law of 27 July 2003 on trust and fiduciary contracts (Fiduciary Law) allows the issuance of notes on a fiduciary basis in the name of the securitisation vehicle but for the benefit of the noteholders. It is believed that this trend will continue until hearing back from the European Commission following Luxem­bourg's response to their letter of formal notice issued on 14 March 2020, whereby the Commis­sion requested Luxembourg to amend its ATAD I law so as to exclude SSPEs, ie, securitisation vehicles that are subject to the EU Regulation on Securitisation, from the list of interest limitation rule exempted entities.

Financial Assistance

The latest and major Luxembourg legal updates while preparing this overview are the new law adopted on 16 August 2021 amending the law of 10 August 1915 on commercial companies (the "Law on Commercial Companies") and the pro­vision of long-awaited clarification on the scope of the prohibition of financial assistance.

The Law on Commercial Companies

According to Article 430-19 of the Law on Com­mercial Companies, "a company may not direct­ly or indirectly, advance funds or make loans or provide security with a view to the acquisition of its shares by a third party" except under strin­gent conditions expressly set out in the Law on Commercial Companies. From a practical per­spective, the issue is encountered from time to time in the context of acquisition finance trans­actions as this would prevent a target subsidiary whose shares have been acquired to guarantee or grant a security interest to secure the obliga­tions subscribed by the acquiring parent or its affiliates to fund the purchase price.

The obligations pertaining to the amounts cor­responding to the purchase price of the shares in the target entity need to be carved out of the scope of the repayment obligations guaranteed by such target entity in any guarantee or secu­rity interest granted by it. Criminal penalties are provided for in the Law on Commercial Compa­nies at Article 1500-7 2° and apply to any person acting in the capacity of director or manager of a company who knowingly granted advances, loans or sureties in violation of the financial assistance rules.

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Previously published in Chambers Global Practice Guide

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