Guide about Luxembourg securitization vehicles
Securitization vehicles (SVs) are becoming increasingly popular, tangible assets in the market. It is a legally owned vehicle by a company and its subsidiaries by using the company capital, sales, and other liquid assets. These vehicles are a source of third-party purchase that provides immunity to the company in terms of credit risk.
In other words, it refers to two different things: a) a wholly-owned bankruptcy-remote subsidiary formed solely for the purpose of effecting one or more securitizations to which the company or its subsidiaries transfer Securitization Assets and issue Third Party Interests; and b) a subsidiary formed solely for the purpose of buying Securitization Assets from the company and other subsidiaries.
Over years, the companies in Luxembourg have realized the importance of these SVs as well which is evident from the increasing popularity of these in the region. Overall, the securitization and financial transactions in Luxembourg are considered as one the stronger pointers in finance industry. Lately, around 1000 SVs have been reportedly registered which is expected to get on even faster in the future.
The Luxembourg Securitization Law was passed on 22 March 2004 and has been subjected to several amendments and scrutiny. To facilitate the securitization of a nearly endless spectrum of risks, Luxembourg provides a pragmatic and safe legal and tax system that allows for the securitization of many types of Securitization vehicles (SVs), with decreased complexity and almost total tax neutrality.
However, the most recent change was made at the beginning of this year (on 9 February 2022). With this latest amendment, a variety of new practices have emerged. The nascent practices include new market practices as well as regulations to allow more freedom to the interested parties.
Legal factors around securitizations in Luxembourg:
There are two basic aspects that come to securitization. These include the liabilities and assets of a third party along with the classic market capital structures. The claims and assets include financial assets that are undertaken by third parties or are inherent by the company directly. It guarantees the value of money as well as the return of financial instruments on the claims made as well.
Secondly, the classic market capital structures including commercial assets are secured by SVs from bankruptcy. They are mostly based on real sale ventures or maybe a part of a portfolio made artificially in a secure manner. Either way, the arrangement is secured for the investor.
However, despite all the security, single-asset portfolios are considered safer as compared to those that involve any third-party liabilities. The liquidity and volatility of the assets further bring about risks and conceivable loopholes within the securitization.
The transactions are confirmed after the structural possibilities are carefully analyzed. During the process of transaction, the new amendment provides freedom to the SV to buy an asset directly or indirectly at the cost of a considerable leeway.
Source of Securitization vehicles (SVs) funding
Legally, there is no perfect definition of such assets that come under the SVs. They can include a variety of financial assets that may include market shares and equity bonds. These assets are intangible and are securitized against the risks when it comes to returns.
Most of the financial instruments in Luxembourg by SVs are debt securities. It implies that there is minimal risk for bankruptcy which provides assurance to the SVs from going into debt to maintain their business activities. This subjects them to foreign legislation as well which establishes how secure or insecure an investment is. The value and the dividend along with the ring-fence around them reflect the performance and future value of a Securitization vehicle (SV).
The Euro MTF, a multilateral trading facility, and the Luxembourg Stock Exchange, a European regulated market, are both part of the Luxembourg Stock Exchange. In Luxembourg or abroad, the financial instruments may be traded.
The modernised Securitization Law stipulates that SVs may get financing via borrowing or intra-group financing The laws has significantly increased the funding options available to them. SVs now have a far broader range of funding sources accessible to them (previously, the financing by way of loans was possible under limited circumstances only). The Securitization vehicle (SV) is now compelled to repay any kind of loan that places them in a position of obligation.
Investing in Luxembourg does not have any restrictions. Nevertheless, investors from other countries should be aware of the legislation on financial instruments that may apply to them. Eligible investors in Luxembourg are not subject to any limitations under the law.
Setting up a securitization vehicle (SV) in Luxembourg:
A Luxembourg Securitization vehicle (SV) may be founded in a number of different ways. A securitization vehicle in Luxembourg can be set up as:
- a limited liability company (Sàrl)
- a public limited company (SA)
- a co-operative company (SCOA)
- a co-ownership of assets
- a general partnership (SNC)
- a simplified limited or special partnership (SCS or SCSp)
- an incorporated partnership issuing shares (SCA)
In most cases, the Securitization Law’s necessary amendments apply to SVs organised as companies. However, in a few rare cases, the SVs are controlled by the Luxembourg corporate law.
Even though corporations represent the bulk of Luxembourg special purpose vehicles (SVs), certain investors may prefer the more flexible structure provided by SVs organised as partnerships.
Separated compartments principle:
The Securitization Law allows for the creation of ring-fenced compartments within the SV, which allows for the unambiguous separation of the assets and responsibilities linked with each compartment. The rights and claims of investors and creditors linked with a certain compartment will be confined to the assets of that compartment, which will only be accessible in order to fulfil those rights and claims. It is not stated in the Securitization vehicle (SV) ‘s constitution, but investors must treat each compartment as though it were an own business while interacting with each other.
Compartments may be created by the SV’s management body with a simple vote, which must be ratified in the organization’s constitutional documents. A company may choose to liquidate a single compartment of an SV instead of liquidating the whole SV.
Consequently, now the financial statements and profit distributions of an equity-financed compartment can be authorized solely by the shareholder of the compartment. Compared to the prior system, this amendment can be considered a big advance.
Legal remedy is limited. There is no capacity to protest, and subordination is endemic. Therefore, the financial instruments issued by Luxembourg SVs are subject to contractual restrictions on recourse, non-petition, and subordination including tranching. These restrictions are in place to secure investments and prevent bankruptcy.
The available options for liquidating and dispersing the assets are a mere suggestion and no one is legally bound to do so. They are free to exercise their freedom will when it comes to the dispersion of their funds in multiple phases.
Rating financial instruments:
In addition to the revision of the Securitization Law, the legal framework now permits a comprehensive set of criteria to be applied to the rating of financial instruments that the Securitization vehicle (SV) issues, the issued instrument under an SV includes units, shares as well as debt instruments.
Regulation of the SVs in Luxembourg:
In Luxembourg, the great majority of SVs are unregulated. Luxembourg law does not need the regulation of an SV if it does not supply financial instruments to the general public and does not do so on a continuing basis. A company that provides financial services on a regular basis and does so to the public must be subject to regulation by the Luxembourg Financial Sector Supervisory Authority (CSSF).
Sale of the securities of securitization vehicles (SVs):
The mere fact that a company has been listed on a stock exchange does not imply that it is ready to sell to the general public. In order to determine whether or not an issue contains an offer to the general public, a look-through basis will be used in relation to any intermediary providing distribution or mechanism.
It is not regarded as a public offering in the context of a Luxembourg SV when financial instruments are solely offered to professional customers, as specified by the Banking Law of Luxembourg of 1993, or when they are offered only via private placements in Luxembourg. For an issue to be excluded from the public offering requirement, each of these requirements must be satisfied. Financial instruments having a nominal value of 100,000 EUR or more are typically not regarded to be issued to the general public in the same way.
The Securitization Law now makes it explicit that an offer is deemed to be made on a “continuous” basis if financial instruments are issued more than three times per year on a regular basis (taking into account the total number of issues of all compartments).
In the case of uncontrolled SVs, there is no need to apply to the CSSF. Selecting a regulated administrator, manager, or custodian is not required by regulation. Furthermore, neither the SV’s documents nor its board members are subject to regulatory scrutiny or approval.
If the issuance of financial instruments falls within one of the exemptions under the Luxembourg Prospectus Law that implements the EU Prospectus Directive, then an unregulated Luxembourg SV does not need to issue any form of private placement memorandum, prospectus, or offer document.
Disposal of assets of securitization vehicles (SVs):
Securitizing risk portfolios that are actively managed by the SV or a third party, such as collateralized loan and debt obligations, is now possible if the financial instruments of the Securitization vehicle (SV) are issued via a private placement. A major shift from the passive management strategy that had been utilised in the past has opened the way for more collateralized loan obligations (CLOs) and collateralized debt obligations (CDO) to be formed in Luxembourg.
Handling SVs in Luxembourg:
There are no banking licencing requirements for an SV in Luxembourg, which allows it to handle its own funds, hire third-party service providers (including the assignor or originator of the funds), and/or designate third-party service providers. When it comes to asset management, an SV may either handle it in-house or hire outside help.
Before, a security interest could only be granted for one of two reasons. It is to ensure the SV’s obligations in connection with the securitization of such assets or in favor of its investors. Anyone violating this regulation would have their security interest declared null and invalid.
Allowing an SV to provide security for securitization-related obligations has been made possible by the Securitisation Law. As a result, parties other than the SV and/or its subsidiaries’ direct debtors may be able to obtain security interests in the securitized portfolio. Securitization Law, on the other hand, now permits an SV to provide security for obligations related to the securitization operation.
Many times, it is the securitization vehicle may choose the Luxembourg Domiciliation Agent, who in addition shall offer a registered office. He may also assist with financial reporting and tax preparation. Independent auditors must be hired by all SVs, including those that have not been regulated by the CSSF, in order to audit their annual financial accounts.
The custody of the liquid assets and securities of regulated SVs must be entrusted to a credit institution domiciled in Luxembourg or incorporated there. Shareholders of the SV must approve and then publish these accounts at least once a year.
Luxembourg securitization vehicles are required to report certain information to the European Central Bank (the ECB) under Regulation ECB/2013/40 and Circular 2014/236, respectively, of the Luxembourg Central Bank on statistical data collection for securitization vehicles. These rules were established by the European Central Bank and the Luxembourg Central Bank, respectively.
When entering into derivatives transactions, SVs may also be subject to specific reporting and other requirements set by the European Market Infrastructure Regulation (EMIR) (EMIR).
In certain cases, they will also be obliged to produce information in line with EMIR (EU Regulation No. 648/2012), in addition to meeting other obligations such as entering into derivative contracts.
There is a new requirement that securitization funds, both new and existing, must now register with the Luxembourg Trade and Companies Register. According to the amendment made on 8 June 2011, AIFMD Entities whose only purpose is to carry out one or more securitization operations within the meaning of Article 1(2) of the ECB/2013/40 Regulation (the Securitisation Special Purpose Entities) fall as a general rule outside of the scope of the Directive 2011/61/EU of the European Union issued in 2011.
Exemption from the AIFM laws:
The AIFM (Alternative Investment Fund Management) Law does not apply to the following cases:
- primary lenders including those entities whose primary business is to originate new loans are involved
- SVs issue structured products that primarily offer synthetic exposure to assets other than loans
- in conditions where the credit risk transfer is only ancillary.
Alternative Investment Funds (AIFs)
However, even though SVs fulfill the AIFM Law’s requirements to be classified as Securitization Special Purpose Entities, they do not meet the criteria to be classified as Alternative Investment Funds (AIFs). This is true if they only issue debt-based financial products or are not managed according to “defined investment plan” standards.
Regulation of the European Union on Asset Securitization
Luxembourg SVs will be exempt from the regulation due to the Securitization Law’s definition of securitization being more expansive than the Regulation’s definition.
After the European Union Regulation (EU) No. 2017/2402 came into effect on January 17, 2018, transactions containing securitization have been subject to it. This means that the Regulation’s definition of “securitization” will need to be scrutinized on an individual basis, despite the fact that, in practice, many securitization transactions have been carried out so far without particular regulations.
Tax regime of the Securitization vehicles (SV)
There are no exemptions from Luxembourg’s corporate income tax for an SV that is set up as a company. As a reminder, an SV may be set up either as a corporate entity or as a third-party-owned asset when it’s established.
Net Wealth Tax:
There’s the possibility that an SV will have to pay an annual minimum net wealth tax (NWT). The annual minimum NWT charge for SVs is 4,815 euros if their balance sheet comprises at least 90% of eligible financial assets and bank cash. The SV must be subject to the SV tax system for this to apply. For SVs that do not meet the above criteria, the annual price for the NWT might vary from 535 to 32,100 euros, depending on the total amount of the company’s gross assets.
Corporate Income Tax (CIT)
Corporate Income Tax (CIT) on global income for the fiscal year 2022 would be 18.19 percent, including the 7 percent solidarity surcharge for the employment fund. Accordingly, this would provide an overall total tax rate of 24.94%.
This may be avoided if the tax structure of SV can be effectively implemented. A company may deduct any interest, dividends, or other payments made to holders or creditors of its issued securities even if the SV is subject to the Aggregate Rate since such payments are deductible in determining the corporation’s total taxable income.
Luxembourg’s extensive network of double tax treaties provides the SV with access to EU Directives (such as the Parent-Subsidiary Directive) and EU regulations.
Tax transparent vehicles:
A tax-transparent vehicle is a securitization fund-based special purpose vehicle. It is the investors in SV who are ultimately liable for paying taxes on the generated income, not the securitization vehicle itself.
Luxembourg’s income tax legislation (LITL):
The Luxembourg tax authorities released Circular L.I.R. No. 168bis/1 on January 8, 2021. Using the Circular, taxpayers may better understand how the new interest deduction restriction regulation implemented by the Anti-Tax Avoidance Directive (EU) 2016/1164 of July 12, 2016, would be applied. (ATAD).
To the extent that a taxpayer incurs “exceeding borrowing expenses” during a given tax period, only the greater of 30 percent of the taxpayer’s EBITDA or EUR 3 million is deductible under Luxembourg Income Tax Law (LITL) Article 168bis. Article 168bis of the LITL was amended to include the requirements of the Law. This provision’s intention is to discourage enterprises from reducing their total tax burden by making excessive interest payments, which is in keeping with the ATAD’s stated goal and the comments expressed on the preliminary language of the Law.
ATAD I and II:
As a result of recent advancements in BEPS, such as the Anti-Tax Avoidance Directive (ATAD), which was implemented into Luxembourg’s income tax legislation (LITL) on January 1, 2020 (ATAD I), then on January 1, 2022 (“ATAD II”). ATAD I, focuses on establishing laws for controlled foreign companies, new interest limitation rules, anti-hybrid rules, and exit taxes as well as general anti-avoidance rules.
Hybrid mismatch criteria in ATAD I are now more broadly applicable thanks to ATAD II, which includes new restrictions for the reverse hybridization process. When it comes to international securitizations, one of Luxembourg’s legislative problems and ambitions is to keep SVs and/or their particularities out of ATAD scope as much flexible and adaptive as possible in order to keep Luxembourg’s attractiveness for securitization transaction completion intact.
When it comes to anti-treaty clauses, BEPS efforts and the execution of those measures by adopting the Multilateral Instrument (MLI) are both relevant here. In order to comply with the latest anti-BEPS regulations, the MLI provides participating states like Luxembourg with an easy-to-use tool.
Limitation of benefits (LOB):
Limitation of benefits (LOB) measures, or at the least, the main purpose test, should be established to discourage governments from “treaty shopping”. Due to the LOB requirement, SVs, like collective investment vehicles, must not be denied the benefits of tax treaties. In light of the fact that the LOB rule will very certainly be unable to be met by a Luxembourg SV (investors mostly do not reside in Luxembourg).
For this reason, SVs should be treated as residents of contracting states who are tax-responsible) in that state and who are the beneficial owners of their earned income and earnings. Ownership and control of income and profits made by SVs should likewise be required. To be eligible for the benefits of treaties, an SV must meet certain criteria.
Principal Purpose Test (PPT):
The bulk of Luxembourg’s tax treaties will now incorporate a Principal Purpose Test (PPT) from here on out. The most current OECD guideline outlines a number of requirements that Luxembourg SVs must meet. An SV is also used as an example in the guide.
There are multiple ways by which PPT can be implemented. It can be used as a common currency of the regional grouping. It must be implemented along with a high reputation among the investors by ensuring the availability of a qualified workforce that is multilingual and located in a member jurisdiction of that particular regional grouping.
Along with the credibility and mutual trust among the investors and the workforce, political stability plays a vital role in this case as well. In case a government is not stable, different amendments and policies can affect the SVs.
Furthermore, strict guidelines on asset securitization and an extensive worldwide network of double tax treaties can also be crucial point when it comes to the implementation of PPT.
Transfer pricing laws:
The Luxembourgish government levies withholding taxes and capital charges except a fixed EUR 75 fee on incorporation and any amendments to articles for SVs set up as companies.
A SV’s management services may be subject to VAT which is subjected to variations case by case. However, the unregulated SVs are exempted from regulatory fees.
Articles 56 and 56 bis LIR of the LITL broaden and clarify the transfer pricing law that applies to Luxembourg SVs in addition to the general transfer pricing requirements. Despite the fact that this should only have a limited impact in practice, it must be taken into consideration when it comes to treaty matters.
Due to Luxembourg’s evolving transfer pricing legislation, including the Group Financing Circular (which clarifies the rules for intra-group financing transactions), and in particular the new circular letters nr LIR 56/1 and LIR 56Bis/1, the Luxembourg tax authorities have increased their focus on related-party transactions. This is the result of changes in Luxembourg’s transfer pricing regulations. The Group Financing Circular does not apply to an SV’s operations since there is no active management of assets in the transactions normally carried out by an SV.
Due to a lack of defined thin or minimum capitalization standards under Luxembourg’s tax legislation, firms domiciled in Luxembourg, such as SVs, are exempt from debt-to-equity ratios. Even if thin capitalization is allowed, this is the case.
When it comes to regular SOPARFIs, the Luxembourg tax authorities have created administrative practices that view an 85/15 debt to equity ratio as a safe harbor for investment holding operations done by SOPARFIs whose only collateral is their own assets.
Luxembourg investment holding corporations that use their own assets as security for their investments are subject to this practice. One percent stock and 14 percent shareholder loans with no interest make up the remaining 15 percent. Due to this difference between Luxembourg SVs and SOPARFIs, they may be able to attain better efficiency.
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