Innovation in securitisation: a marathon not a sprint
07 March 2023
The Global Financial Crisis of 2008 materially impacted the global securitisation market. Governments across the world stepped in to limit the fallout of a crisis that undoubtedly stemmed from a misuse of securitisation vehicles. Over time firms began to assess and incorporate the risks of securitisation and the market has bounced back by more than 300% since the crisis in the US. Conversely, Europe has seen securitisations shrink to less than a third of what they were pre-crisis.
The most important changes have been the introduction of the possibility to use partnerships and the clarification regarding multi-compartment securitisation structures, as well as the use of active management.
Securitisation can act as a powerful tool to support the growth of capital markets within the EU, help free up bank balance sheets thereby assisting in the redeployment of capital to support small to mid-sized companies, provide new investment opportunities, increase risk sharing across the EU by facilitating cross-border investments, and spur the transition towards a more sustainable European economy. The benefits are clear, however refining policy and legal frameworks will be necessary to boost the market. This refinement usually consists of finetuning certain aspects, at both a country and European level, rather than a tidal wave of change.
“You can’t always create a new product, but more often than not, there is room for some form of innovation,” emphasises Patrick Mischo, Office Senior Partner of Allen & Overy Luxembourg. Even though there have been a few revolutions in recent years relating to securitisation and investment structuring in Luxembourg, be it the introduction of the RAIF or the Limited Partnerships, this area of finance is characterised far more by evolution.
The update of Luxembourg’s Securitisation Law in 2022 is a prime example. Being a robust legal and tax framework, and providing solid investor protection, Luxembourg’s securitisation regime has been popular since its first Securitisation Law in 2004. The update to the Law brought a number of new developments to provide more flexible tools relating to the financing of securitisation vehicles. “The most important changes have been the introduction of the possibility to use partnerships and the clarification regarding multi-compartment securitisation structures, as well as the use of active management,” explains Vassiliyan Zanev, partner and co-chair of the Investment Management Practice Group at Loyens & Loeff Luxembourg.
The EU Securitisation Regulation of 2019 has also played a significant role in taking Luxembourg’s securitisation regime to the next level. Harmonisation at an EU level has been very useful according to Zanev; “there are an array of obligations for securitisation special purpose entities, as well as for originators, sponsors, and institutional investors. Requirements have also been put in place relating to risk retention, due diligence, transparency, disclosure, and other restrictions on the sale to retail investors.” Helping to remove the stigma of securitisation stemming from the subprime crisis, the number of securitisations, including private ones, have grown significantly.
Reducing establishment time and costs by not needing to create new companies is a boon to investors.
A cross-border financial services hub, Luxembourg’s securitisation vehicles are purchasing loans and receivables with debtors and borrowers located across Europe; from commercial and mortgage loans to leases, trade receivables and, increasingly, distressed debt. Notably, an increasing number of US investors are gaining exposure to European debt investments via Luxembourg securitisation vehicles. This is largely due to the structural solutions and flexibility that these vehicles offer particularly related to the multi-compartmentalisation possibility. “One of the key benefits is the economies of scale that stem from Luxembourg’s securitisation regime: reducing establishment time and costs by not needing to create new companies is a boon to investors,” highlights Mischo. “The clarifications provided in the latest update regarding the legal and accounting treatment of the compartments have significantly reduced the number of questions relating to this area. Additionally, the inclusion of active management in relation to debt assets, has been incredibly valuable given the historical obligation for a securitisation vehicle to buy and hold the underlying debt assets,” expands Zanev.
Several other factors contribute to the attractiveness of Luxembourg’s securitisation regime to investors. The ability to use new financing tools such as loans, rather than issuances of securities has been well perceived by market players. However, the most important change stemming from the update to the law has been the introduction of the possibility to structure a securitisation vehicle as a common limited partnership (SCS) or a special limited partnership (SCSp). While not many of these partnerships are in place yet given the historical precedent of using companies with limited liability, when looking at structuring solutions these partnerships can be very useful. Securitisation partnerships provide a much higher degree of contractual freedom compared to a traditional company with limited liability. Furthermore, the securitisation partnerships can offer fiscal neutrality. “One needs to consider that they are more easily tax neutral when compared to the more traditional securitisation vehicles which are sometimes impacted by some of the recently introduced EU inspired tax measures. There is growing need to educate the market that a tax neutral result can also be achieved with a securitisation partnership” highlights Zanev.
Despite the advancements stemming from both the EU Securitisation Regulation and the Securitisation Law of 2022, growth in the future will largely depend on external factors such as the progress of the Capital Markets Union, as well as the monetary and fiscal policy at an EU level.
Several challenges lie ahead for the securitisation market, both in Luxembourg and further afield in Europe. Mischo highlights that while the Securitisation Regulation has increased harmonisation and been largely successful, it has not notably increased access to credit for the real economy. Additionally, “it has added significant reporting and compliance burdens for financial institutions.” While not questioning the necessity of the regulation, Zanev notes that the regime under the Securitisation Regulation should not become too onerous for market players. “Complying with the transparency requirements is the biggest cost associated with the Securitisation Regulation.”
Going forward it will be critical to achieve the right balance between increasing cost and compliance burdens while at the same time ensuring both a benefit for investors and the right level of protection; lest securitisation in Europe becomes too onerous.