Luxembourg is on track to give its collateralised loan obligation (CLO) market a major boost by permitting the active management of securitisation vehicles. Head of Capital Markets - Luxembourg, Sandra Bur analyses just what kind of impact it could have.
Since 2019, when the Netherlands effectively closed the door, Ireland has become the de facto home for the European CLO market. As we have witnessed many times across multiple asset classes and structures, the Luxembourg finance industry is focused on providing an attractive and tangible option to CLO managers for their European transactions.
It was unsurprising then that in May 2021 the Luxembourg government submitted Draft bill number 7825 (the "Draft Bill"), which will further develop the flexibility and relevance of its securitisation vehicles under its Securitisation Law (the "Law") of 22 March 2004.
The Draft Bill proposes adding a new article in the Law that specifically permits active management of securitisation vehicles for risks linked to bonds, loans or other debt instruments (but not for equity type assets) so long as these are issued under private placement. This would enable Luxembourg to attract more CDO/CLO structures which have historically been set up in other jurisdictions.
Permitting the active management of securitisation vehicles in Luxembourg would significantly strengthen the country's securitisation proposition and likely attract CDO/CLOs back to the jurisdiction.
CLOs can be broken down into two types:
- Actively managed: this type of CLO aims to achieve a rate of return on the SPV's assets (the CLO portfolio) which is higher than the cost of servicing the debt on its liabilities (the CLO securities).
- Not actively managed: The underlying portfolio remains broadly the same for CLOs that are not actively managed. The purpose of securitising these CLOs is mainly to remove assets from an originator's balance sheet to achieve regulatory capital relief against its loan book.
Given the Law does not currently permit active management, the vast majority of CLO securitisation transactions in Luxembourg are not actively managed e.g. "balance sheet" CLOs.
Active management will be allowed for all debt portfolios providing that the financial instruments being issued by the securitisation vehicle are not offered to the public in line with the definition given in point three. This means that securitisation vehicles will no longer be bound to the buy and hold CLO strategy; they will be able to make active investing decisions on the assets within the CLO, enabling the portfolio to adapt to market developments. This will be performed by the securitisation vehicle itself or by an appointed a portfolio manager.
Furthermore, this new provision in the Draft Bill will put an end to the "2/3 structure" commonly seen in Luxembourg, whereby a Luxembourg securitisation vehicle is used for the financing but the active management is done in an unregulated vehicle. Having the possibility to have it all within the securitisation will also decrease the cost of such structures whilst increasing investor protection due to being audited.
The Draft Bill's proposal significantly increases Luxembourg's chances of becoming a jurisdiction of choice for CLO securitisation transactions. In addition to its favourable legislation, a vehicle's financial statements can be prepared in Lux GAAP which reduces costs in comparison to the more cumbersome IFRS statements.
A bright horizon for Luxembourg's CLO landscape
The financing and refinancing markets continue to drive investor appetite for actively managed CLOs, a global market that is approaching one trillion USD. Ireland is currently the location of choice for CLO transactions in Europe, with assets in Irish-domiciled CLOs rising to ?170 billion by April 2021. However, the Draft Bill is expected to turn heads once it enters force and put Luxembourg in a great position to host such structures and capitalise on market growth.
It is now up to the key players of Luxembourg's securitisation market to advertise these new opportunities to investors and demonstrate its competitive offering.
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Ocorian is a market leading independent provider of administration services to the CLO market. With a sizeable presence and demonstrable expertise in the main CLO hubs of Cayman, Ireland and Luxembourg, we are exceptionally well placed to assist clients with their CLO transactions.
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