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An update on the regulatory requirements for originating debt from Luxembourg

The global private debt market has been rising consistently to reach $1.3tn in 2020, compared to $0.4tn in 20121. In Luxembourg, the private debt held by the Luxembourg Funds is estimated to amount to EUR 158bn in 20202
Private debt usually encompasses different strategies like Direct Lending, Mezzanine, Venture Debt, Distressed Debt and Special Situations. In this regard, we see more and more asset managers originating debt themselves. In Luxembourg, it is estimated that 45% of the private debt under management corresponds to originated debt, while secondary debt would represent 55%3.
Originating debt is subject to multiple regulatory requirements either in Luxembourg or in the jurisdictions of the borrowers.

State of play in Luxembourg 

In Luxembourg, the CSSF considers that AIFs in the meaning of the AIFMD can originate loans4. However, the AIFM (or the AIF when self-managed), should ensure it addresses all aspects and risks of such activity and shall have proper organisational and governance structures, the necessary expertise and experience in origination activity combined with an appropriate technical and human resources focusing on credit and liquidity risk management, concentration and risk limitation as well as clear policies regarding assets and investors. 

The CSSF has also confirmed that regulated securitisation undertakings in accordance with article 19 of the law of 22 March 2004 on securitisation can originate loans5 under certain conditions. It is the market practice to consider that such guidelines are also applicable to unregulated securitisation undertakings not supervised by the CSSF. In this regard, the CSSF considers that, in specific circumstances, a securitisation vehicle undertaking can itself grant loans instead of acquiring them on the secondary market provided that the securitisation undertaking does not allocate the funds raised from the public to a credit activity on its own account. Moreover,  the CSSF requires that the documentation relating to the issue, either clearly defines the assets on which the service and the repayment of the loans granted by the securitisation undertaking will depend, or clearly describes (ii) the borrower(s) and/or (ii) the criteria according to which the borrowers will be selected. The purpose of all these requirements is to ensure that the investors are adequately informed of the risks, including the credit risks and the profitability of their investment at the time securities are issued by the securitisation undertaking.

Moreover, on 15 June 2021, the CSSF updated its Q&A on the statutes of Professionals of the Financial Sector to clarify the cases where lending operations would require a licence as a professional performing lending operations. In principle, granting loans to the public requires a banking license or a licence to act as a professional performing lending operations according to the law of 5 April 1993 on the financial sector. However such law provides that no license is needed when the loan origination activity is performed notably by UCIs (UCITS6 or Part II Funds), SIFs, and SICAR directly or through Luxembourg SPVs they hold at 100% or they directly or indirectly control. As to what is the definition of granting loans to the public, the CSSF considers that the concept of the public generally refers to a multitude of non-identifiable persons so that where the loans are granted to a limited circle of previously determined persons, the CSSF is of the view that such loans are not granted to the public so that no license is needed. This is also true where the loans are granted through a Luxembourg SPV and granted to a limited circle of previously determined persons by the entity that holds the SPV at 100% or directly or indirectly controls it. Therefore a RAIF or an unregulated Luxembourg fund can originate loan either directly or through a Luxembourg SPV. By the same token, a foreign fund such as  a Cayman Fund, can originate loans through a Luxembourg SPV. 

In addition, the CSSF considers that a lending activity is not aimed at the public within the meaning of the law on the financial sector where (i) the nominal value of the loan amounts to EUR 3m at least and (ii) the loans are granted exclusively to professionals such as defined in the consumer code.

Despite the fact that a loan origination activity can be conducted from Luxembourg under certain conditions mentioned above, it remains that regulatory requirements of the country where the borrower is located need to be respected. In the absence of harmonisation across Europe, there is currently a patchwork of domestic rules to comply with when an asset manager wants to originate loans across Europe from Luxembourg. In this regard, France, Italy, Germany and Belgium have very different regulations for loan origination. 

Mitigating the regulatory burden in the jurisdictions of the borrowers

To mitigate such regulatory burden in the various European jurisdictions of the borrowers, asset managers could consider originating loans from a Luxembourg ELTIF subject to the Regulation (EU) 2015/760. Indeed an ELTIF can grant loans across the EU to borrower(s) qualifying as qualifying portfolio undertaking in the meaning of the regulation. This advantage will however go with some constraints, for example having the obligation to have an authorised AIFM, being subject to the approval of the CSSF when the ELTIF is established in Luxembourg and being subject to strict diversification rules.

However, further harmonisation for loan origination may come soon as the European Commission released a proposal to amend the AIFMD on 29 November 2021. In this regard, the European Commission proposes the establishment of common rules for loan-originating AIF to ensure that the European Union has a uniform level of investor protection. Particularly, any AIFMs engaged in lending activities will need to implement effective policies, procedures and processes for granting loans, assessing credit risk and administering and monitoring their credit portfolios that resonate with the CSSF requirements mentioned above. Moreover, only close-ended AIFs would be allowed to originate loans when such loans represent more than 60% of the capital of that AIF. If adopted, the amended AIFMD will allow AIFs to conduct a loan origination activity across the European Union with the objective to facilitate access to finance by EU businesses. 

Conclusion 

As a takeaway, Luxembourg offers a flexible framework for asset managers who want to conduct a lending activity from Luxembourg. However,  such asset managers shall keep in mind that regulatory requirements may also need to be satisfied in the jurisdictions of the borrowers depending on the type of vehicle used. 

Notes:

1. Source : PwC Global AWM Research Center
2. Source : PwC Global AWM Research Center
3. 2021 ALFI Private Debt Fund Survey
4. CSSF section 22 of Luxembourg Law of 12 July 2013 on Alternative investment fund managers - FAQ
5. CSSF Section 7 of FAQ on securitisation
6. For a UCITS, the originated debts cannot be loans but debt securities

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Luc Petit

Alternatives Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 3148

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