Non-Performing Loans: a Luxembourg Framework has emerged

The past few years, the European Union has put tremendous efforts in creating a true single and strong capital markets union (“CMU”). To achieve this purpose, it is essential to monitor and ensure the proper balance of banking activity.

One of the main activities of credit institutions is to grant credits for which they receive remuneration in the form of interest. As long as the borrower remains financially sound and pays the instalments and interests due on time, the credit agreement is said to be “performing”. However, when the borrower fails to repay his credit agreement, said credit agreement is classified as “non-performing”, in other words it is a non-performing loan (“NPL”).

NPLs are an inherent part of these banking activities and are de facto, under the radar of the European legislator. To achieve this ultimate harmonization purpose of the CMU, it is essential to ensure a reduction of the number of NPLs, particularly due to the interconnection of banking and financial systems within the European Union (“EU”) as credit institutions are required to carry out their activities in several jurisdictions and EU member states. To avoid such contagion to all EU member states that may severely compromise growth and the financial stability of the EU, it is essential to promote a cross-border risk sharing approach while keeping in mind that NPLs reflect debtors’ financial distress. 

The purpose of the NPLs Law is to control the level of NPLs and introduce clear rules to reduce their number as well as to avoid any excessive accumulation in the future by enabling credit institutions to effectively manage NPLs and ensure an efficient secondary market and recovery while maintaining strong protection for borrowers. This new regime will have significant impacts on the trading and management of NPLs and related securitisation transactions.

1. Scope and purpose

NPLs initially concluded by EU credit institutions fall within the scope of the NPLs Law pursuant to its article 2.

Specifically, the NPLs Law applies to:

1. credit servicers (gestionnaires de crédit)^[1] acting on behalf of a credit purchaser in respect of a creditor’s rights under an NPL agreement, or the NPL agreement itself, issued by a credit institution established in the EU;
2. credit purchasers (acheteurs de crédits) of a creditor’s rights under an NPL agreement, or the NPL agreement itself, issued by a credit institution established in the EU;
3.  credit service providers (prestataires de services de gestion de crédits) when credit servicing activities are outsourced and carried out by a credit service provider;
4. the transfer of creditor’s rights under an NPL agreement, or the transfer of the NPL agreement itself, issued by a credit institution established in the EU, from a creditor to a credit purchaser.  

The NPLs Law shall not apply to the servicing of creditors’ rights under a credit agreement or the credit agreement itself carried out by (i) an EU credit institution, (ii) an alternative investment fund managers^[2] or an authorised investment company^[3] (provided that no management company has been appointed) and (iii) any lenders within the scope of the Consumer Code as set out under article 2 (a) c) of the NPLs Law.  

The servicing of creditor’s rights under a credit agreement, or of the credit agreement itself, carried out by public notaries, bailiffs or lawyers is also excluded. 

Notes:

^{[1] Pursuant to the law of 5 April 1993 on the financial sector (“LSF”) as amended, the credit services (gestionnaires de crédit) shall be introduced as a new category of professional of the financial sector (“PSF”) and be subject to approval procedure and be supervised by the Commission de Surveillance du Secteur Financier (the “CSSF”). 
[2] In accordance with the law of 12 July 2013 on alternative investment fund managers, as amended.
[3] In accordance with the law of 17 December 2010 relating to undertakings for collective investment, as amended.} 

2. Information obligations

1. Pre-contractual information of credit purchasers

Pursuant to article 3 of the NPLs Law, credit institutions selling NPLs to credit purchasers are required to disclose to the prospective purchaser all necessary information regarding the creditor’s rights and any relevant collateral. This pre-contractual information right enables credit purchasers to conduct their own assessment (i) of the creditor’s rights under the NPL before entering into the transfer agreement and (ii) the likelihood of the NPLs’ recovery. The protection and the confidentiality of the information must be maintained at all times during this stream of information.

2. Post-trade information

Under articles 10 and 11 of the NPLs Law, it is required for credit institutions and for Luxembourg established credit purchaser transferring certain creditors’ rights under an NPL agreement or transferring the NPL agreement itself to report details of their sales to the CSSF.

The minimum reportable details will need to include: (i) the identity and the address of the credit purchaser or where applicable, its representative, (ii) the aggregate outstanding balance of the creditors’ rights, (iii) the number and size of the creditors’ rights sold to the purchaser and (iv) whether the transfer includes NPLs with consumers and the type of collateral, if applicable.

3. General information obligation

In their relationship with the borrowers, the credit purchaser and the credit servicer must particularly ensure to (i) act fairly, professionally and in good faith and (ii) provide information to the borrowers that is not misleading unclear or false. This communication obligation remains even after the transfer of creditors’ rights[1].

The disclosure of information required by the NPLs Law is made without prejudice to any other additional communication requirements provided by Luxembourg laws.

Note:

^{[1] Article 9 of the NPLs Law.}

3. Credit purchasers’ obligations

1. Credit agreement with consumers

Credit purchasers will need to appoint either (i) an authorised credit servicer, (ii) an EU credit institution or (iii) an EU supervised consumer credit or mortgage creditor to service the NPLs (unless the credit purchaser is authorised to service the NPLs by itself)[1]. This obligation only applies to EU credit purchasers in relation to NPLs to consumers and to non-EU credit purchasers in relation to any natural person or micro, small or medium-size enterprises.

2. Third-country credit purchasers

Pursuant to article 4 of the NPLs Law^[2], third-country credit purchasers must appoint a representative established in the EU for the performance of all of the credit purchaser’s obligations as set out in the NPLs Law. This written appointment is essential since otherwise no creditor’s rights can be transferred. 

3. Reporting obligation to the CSSF

A Luxembourg credit purchaser or a Luxembourg representative appointing an UE credit institution or UE supervised consumer credit or mortgage creditor or credit servicer to operate credit servicing activities related to the creditor’s rights transferred under the NPL agreement or the non-performing credit agreement itself, must notify the CSSF of the identity and address of the credit servicer, no later than the date on which the credit management activities has taken effect[3].

4. Continuing applicability of relevant Luxembourg laws

The relevant Luxembourg provisions, particularly those related to (i) the execution of contracts, (ii) consumer protection, (iii) borrower rights, (iv) credit applications, (v) banking secrecy, and (vi) criminal law continue to apply to the credit purchaser following the transfer of the creditor’s rights under the credit contract or the assignment of credit contract itself[4].

Notes:

^{[1] Article 4 of the NPLs Law.
[2] Article 19 of the NPLs Directive.
[3] Article 6 of the NPLs Law.
[4] Article 4 (3) of the NPLs Law.} 

4. Credit servicers’ obligations

1. Prior authorisation

As requested under the NPLs Directive[1], all credit servicers must obtain an authorisation by the CSSF before exercising their activities.

The requirements and the process to obtain the CSSF’s prior authorisation are now defined in the LSF. Authorised credit servicer will benefit from the European “passport” enabling them to provide services across the EU without the need to obtain additional authorisations in other Member States.

2. Contractual relationship between a credit servicer and a credit purchaser

Credit servicers are authorised to use credit service providers to perform any of the credit servicing activities. The credit servicing agreement between the credit purchaser and the credit servicer needs to comply with the information requirements set out under article 7 of the NPLs Law^[2] (e.g., detailed description of services, level of remuneration of the credit services provider to be calculated, the extent to which the credit servicer can represent the credit purchaser,…).

The credit servicer must notify the credit purchaser prior to outsourcing any of its credit servicing activities.

3. Outsourcing by a credit servicer

A credit servicer may use a credit service provider to perform any of the credit servicing activities. Notwithstanding the outsourcing, the credit servicer remains fully responsible for complying with all obligations under the NPLs Law^[3]. It is prohibited for any written outsourcing agreement to externalise all the credit servicing activities at the same time^[4].

The outsourcing agreement with the credit service provider does not alter the contractual relationship between the credit servicer and the credit purchaser, nor does it change the obligations of the credit servicer towards the credit purchaser or borrowers.

Outsourcing credit servicing activities must be conducted in a manner that does not compromise the quality of the credit servicer’s internal controls or the soundness and continuity of its credit servicing operations[5].

The CSSF must be informed in advance about any outsourced credit servicing activities and all information regarding the related outsourcing agreement must be available for the CSSF^[6].

Notes:

^{[1] NPLs Directive, chapter I: Authorisation of credit services.
[2] Article 11 of the NPLs Directive.
[3] Article 8 of the NPLs Law.
[4] Article 8 of the NPLs Law and article 12 of the NPLs Directive.
[5] Ibidem
[6] Article 8 of the NPLs Law and article 21 of the NPLs Directive.}

5. Impact on existing legislations

New dispositions for lenders have been added in the Consumer Code regarding, among others, (i) communication information relating to any amendments to the provisions and the terms and conditions of a credit agreement with a consumer, (ii) late payment and execution, (iii) the consumer’s right of defence and (iv) the transfer of any creditors’ rights or of the credit agreement itself^[1].

Moreover, the LSF has been amended in order to establish a new category of PSF namely, the credit servicer (gestionnaire de crédit). These amendments frame, amongst others, the requirements applicable to credit servicers, the procedure to obtain the CSSF’s prior authorisation, the credit servicing activities scope, the CSSF’s supervisory and authority and any others specific provisions regarding credit servicer. 

Pursuant to the NPLs Law and the amended law of 23 December 1998 establishing a financial sector supervisory commission, the CSSF is the competent supervisory authority to sanction and supervise any violation of the LSF’s provisions regarding credit servicer and of the NPLs Law.

The CSSF has the power to take:

• appropriate administrative penalties such as administrative fines up to 5,000,000 or 10% of the annual turnover for legal persons and 5,000,000 euros maximum for natural person; and
• appropriate remedial measures such as the withdrawal of an automatization for credit servicers, an injunction to remedy the violation or a temporary ban on practicing.

Please contact the members of our Banking & Capital Markets team should you need any assistance.