Vassiliyan Zanev examines the success of Luxembourg as an Islamic finance hub, with its flexible, tax efficient regime and significant number of Shari’a vehicles incorporated in the jurisdiction.
Several Shari’a compliant securitisation and structured finance transactions have been implemented in Luxembourg, which has gained international recognition as a structured finance hub for Islamic investors.
Luxembourg Shari’a special purpose vehicles may be established as securitisation vehicles (SVs), governed by the law of March 22, 2004 on securitisation (the Securitisation Law) or as non-regulated ordinary commercial companies (ie, what are often referred to as sociétés de participations financières or Soparfi). Both regimes have offered various solutions suitable for Islamic investors.
The Securitisation Law defines “securitisation” as the transaction by which an SV acquires or assumes, directly or indirectly through another undertaking, risks relating to claims, other assets, or obligations assumed by third parties or inherent to all or part of the activities of third parties, and issues securities (valeurs mobilières), the value or yield of which depends on such risks.
A Soparfi and an SV can be formed as a corporate entity having a legal personality, whereas an SV may in addition be organised as a co-ownership of assets (without legal personality) - a so-called securitisation fund (fonds de titrisation). The Soparfi and SV acronyms do not refer to specific legal forms, but merely to a specific set of legal, regulatory and tax provisions with the actual securitisation entity being formed either as: (i) a public limited liability company (société anonyme) (SA), (ii) a corporate partnership limited by shares (société en commandite par actions), (iii) a private limited liability company (société à responsabilité limitée) (SARL), (iv) a co-operative company organised as a public limited liability company (société coopérative organisée comme une société anonyme) and (v) solely in respect of an SV, a securitisation fund (fonds de titrisation).
The securitisation fund does not have legal personality and has to be managed by a Luxembourg-based management company (société de gestion). Given that a securitisation fund constitutes co-ownership(s) of assets, it provides a higher connection to the underlying assets and easily ensures compliance with Shari’a principles.
An SV formed as a corporate body or a securitisation fund may be compartmentalised, meaning that each compartment represents a distinct part of the assets and liabilities of the SV. The compartmentalisation allows for the segregation of the assets and liabilities between various compartments, whereby assets are ring-fenced on a compartment by compartment basis in the case of insolvency of the SV. Where the rights of investors and creditors relate to a specific compartment or have arisen in connection with the creation, the operation or the liquidation of a specific compartment, the recourse is limited to the assets of the relevant compartment. Between investors, each compartment is treated as a separate entity, unless otherwise provided for in the constitutional documents of the SV.
An SV company is subject to Luxembourg corporate income tax and municipal business tax. An SV company benefits from a special tax deduction right which aims to achieve corporate income tax neutrality. Under such right, commitments vis-à-vis investors and other creditors are tax-deductible. The SV is exempt from the annual net wealth tax. Payments of dividends or interest are not subject to withholding tax (except payments falling within the scope of the EC Savings Directive).
A fund type SV is transparent for Luxembourg tax purposes, hence it will not be subject to corporate income tax or net wealth tax.
The acquisition of the securitised risks by an SV has to be financed through the issuance of securities (valeurs mobilières), the value or yield of which is linked to such risks. There is no definition of securities (valeurs mobilières) in the Securitisation Law. The Luxembourg Supervisory Commission for the Financial Sector (CSSF) considers in its Frequently Asked Questions guidance issued in 2013 (the 2013 FAQ) that (i) instruments, which are considered as securities under their governing law (lex contractus), and (ii) instruments, which constitute securities within the meaning of the Directive 2004/39/EC of April 21, 2004 on markets in financial instruments (the MiFid Directive), will be recognised as securities for the purpose of the Securitisation Law.
An SV or a Soparfi may issue sukuk. There is a high degree of contractual flexibility and, accordingly, an SV may issue securities the value or yield of which is linked to specific compartments, assets or risks, or the repayment of which is subject to the repayment of other instruments, certain claims or certain categories of shares. Insolvency remoteness can be achieved through the use of limited recourse, non-petition and subordination provisions in the issuance or constitution documentation of the SV.
The Luxembourg Stock Exchange (LuxSE) is one of the key European stock exchanges for sukuk listings. The LuxSE has two markets: (i) the EU regulated market (which is compliant with the Prospectus Directive) and (ii) the multilateral trading facility designated as Euro MTF. Sukuk have been listed both on the EU regulated market and the Euro MTF.
One of the major factors of the popularity of the Luxembourg special purpose vehicles is the large range of eligible assets (other than interest-bearing assets) which can be securitised through such vehicles. According to the Securitisation Law, risks relating to the holding of assets, whether movable or immovable, tangible or intangible, as well as risks resulting from the obligations assumed by third parties or relating to all or part of the activities of third parties may be securitised.
During the last years, the securitisation transactions in Luxembourg included diverse Shari’a compliant asset classes, such as ijara and murabaha contracts, intellectual property rights, real estate, whole businesses etc.
In 2012, the German based FWU Group issued US$55 million in Islamic trust certificates (Sukuk Al-Ijarah) (the Sukuk), through a Luxembourg special purpose vehicle, established as a Soparfi (the SPV), with intellectual property rights (a software program) as the underlying asset. FWU Group, which primarily offers global Takaful (Islamic insurance) solutions through strategic cooperation and distribution arrangements in Europe, the Middle East and Malaysia, entered into the transaction through the Dubai branch of its subsidiary FWU Dubai Services GmbH (the Seller) in order to refinance its Shari’a compliant global factoring business. The SPV purchased from the Seller, a computer software program developed and designed for the distribution of Shari’a-compliant Takaful products (the Software). The SPV then leased the Software to the Seller and for this purpose, a leaseback (Ijarah) agreement was entered into between the SPV as lessor and the Seller as lessee.
The SPV issued Islamic trust certificates (Sukuk Al-Ijarah) with an aggregate face value of US$55 million and the proceeds from the issue were used to pay the Seller for the purchase of the Software. This is the first ever Sukuk issuance by a German corporate and the largest ever Sukuk from a European corporate. It is also the first Sukuk issue anywhere to use intellectual property rights (in this case a software program) as the underlying asset of this Sukuk, making this transaction ground-breaking in a number of ways.
The deal also had a significant impact on the financial services industry by enlarging the possibilities for Shari’a compliant structured finance transactions and adding new asset classes (such as intellectual property rights), which may back the Sukuk issuances. The scale, success and innovative aspects of this transaction have been instrumental in the development of Shari’a compliant structured finance, and have taken Luxembourg to another level as a hub for similar issuances and for Islamic investors in general.
Luxembourg SVs are in principle unregulated entities and are not subject to any authorisation or prudential supervision, unless the SV issues securities to the public on a continuous basis. In the latter case, the SV must be approved by the CSSF. An SV issues securities on a continuous basis, if it makes more than three issues to the public per year (2013 FAQ).
The issue of securities to professional clients as defined in Annex II of the MiFid Directive is not considered by the CSSF as an issue to the public for the purpose of the Securitisation Law. Securities issued with a nominal value of at least EUR 125,000 each are presumed as not being issued to the public. Private placements of securities do not constitute an issuance to the public. However, the characterisation of private placement is assessed on a case-by-case basis by the CSSF and, for instance, the subscription of securities by an institutional investor or financial intermediary with a view to a subsequent placement of such securities with the public does constitute a placement with the public for the purpose of the Securitisation Law.
The Directive 2011/61/EU of the European Parliament and of the European Council of June 8, 2011 on the Alternative Investment Fund Managers Directive (AIFMD) and the Luxembourg law of July 12, 2013 on alternative investment fund managers (the AIFM Law) do not apply to securitisation special purpose entities (SSPE). SSPEs are defined in the AIFMD as entities whose sole purpose is to carry on a securitisation or securitisations within the meaning of the Regulation ECB/2008/30 of the European Central Bank of December 19, 2008 concerning statistics on the assets and liabilities of financial vehicle corporations engaged in securitisation transactions and other activities which are appropriate to accomplish that purpose.
The Luxembourg legislation, with its flexible, lightly regulated and tax efficient regime, provides a wide range of Shari’a compliant vehicles for securitisation and structured finance transactions. The success of Luxembourg as an Islamic finance hub is confirmed by the significant number of Shari’a vehicles incorporated in Luxembourg and their sukuk issuances, as well as the diversity in terms of structures and underlying assets.
Vassiliyan Zanev, Partner, Loyens & Loeff, Luxembourg