At this is stage, it is unquestionable that the Luxembourg law of 10 July 2020 on professional payment guarantees (the “PPG Law”) is one of the main ground-breaking innovations in Luxembourg financial law over the last decade. In our last newsletter edition , published on 1 July 2020, we introduced our readers to the core characteristics of the professional payment guarantee (the “PPG”). Today, we intend to illustrate how and why the PPG legal certainty and contractual liberty can benefit financial players, in particular in the context of portfolio guarantees and in risk transfer financial transactions.
The PPG: A Quick Recap.
The PPG is defined as “an undertaking by which a person, the guarantor, undertakes towards a beneficiary to pay, at the request of the beneficiary or an agreed third party, a sum determined in accordance with the agreed terms, in relation to a claim or claims or the risks associated with them”.
Any claim or risk may be guaranteed by a PPG. In fact, the enforcement of a PPG relies only on the terms contractually agreed between the financial parties, even in the absence of default in connection with the guaranteed claims.
As opposed to the autonomous or first demand guarantee (garantie autonome), a PPG can expressly refer to the guaranteed claims, including their amount and duration, without incurring any risk of requalification. Furthermore, unless agreed otherwise, the guarantor cannot raise any defences relating to the guaranteed claims or risks.
The PPG overcomes the duality between the suretyship (cautionnement) (which has an accessory nature) and the autonomous guarantee (garantie autonome), whose main downside is the intrinsic risk of requalification into suretyship (cautionnement).
Briefly, the PPG regime offers legal certainty and contractual liberty to financial players, but also adaptability to transactions, where their purposes cannot be easily accommodated under a suretyship (cautionnement) or autonomous guarantee (garantie autonome).
PPG and Portfolio Guarantees
Under the PPG law, the financial parties are free to determine the relevant secured obligations, which may consist in present, future, eventual or even hypothetical claims, as well as the risks associated therewith. This large spectrum allows a PPG to cover risks based on a portfolio where the claims are either undetermined or yet to be determined, thus making the PPG the perfect instrument to be used in the context of portfolio guarantees.
The PPG as a Mechanism of Risk Transfer.
The use of guarantees as a risk transfer mechanism has significantly increased, especially under the influence of the common law systems on international transactions. This is particularly true in operations such as the synthetic securitizations, whereby e.g. credit institutions, instead of transferring the securitized exposures (such as in a true sale securitization), transfer only the credit risk associated to the relevant exposures.
The synthetic securitizations being used as a financial protection which is triggered by a credit event can be perfectly accommodated by a PPG.
Much like as in an English law financial guarantee, under the PPG Law, the financial parties are free to stipulate the credit events (which do not necessarily need to include a payment default) as well as the amount due by the guarantor. Such an arrangement is not possible under a suretyship (cautionnement), where the secured obligations must be due and payable in order to be triggered. As a result, under an ordinary suretyship (cautionnement), it seems unworkable to foresee a credit event disconnected to the payment default.
The PPG opens the possibility for the parties to agree on a tailor-made guarantee, combining elements of both the suretyship (cautionnement) and the autonomous guarantee (garantie autonome). In this regard, a PPG pursuant to which; (i) the credit events may be uncorrelated to a potential payment default, (ii) the amounts should be paid at the first request of the beneficiary (garantie à première demande) and (iii) a direct reference is made to the secured claim would be perfectly valid and enforceable under the PPG law.
Although it might seem too early to predict the exact impact of the PPG regime, it is fair to anticipate a promising future, as market participants have already started considering the numerous possibilities offered by the Luxembourg law of 10 July 2020. Moreover, it is important to remind that, under Regulation (EC) n. 593/2008 (Rome I) the parties can freely choose the law to govern a transaction. In other words, the PPG regime has potential to transcend the Luxembourg borders and become a widely used instrument in international financial transactions.