Author: Manfred Dietrich, Partner Norton Rose Fulbright Luxembourg
Luxembourg – a growing Top financial centre for asset management – CSSF issues its annual report 2017
As mentioned in our last update, Luxembourg once again ranked as one of the top 3 financial centres in the EU, is the largest investment fund domicile in Europe (second to the United States globally) and hosts more than 139 banks from over 28 countries. The financial centre is committed to leading the drive towards digital financial services and is playing a pioneering role in sustainable finance.
On August 29, 2018, the Luxembourg regulator (CSSF) issued its annual report for the year 2017 containing additional market analytics, statistics and details as well as certain positions of the regulator and may be downloaded from the CSSF here.
Market trends in Luxembourg
The recent growth in establishing alternative investment funds (AIFs), which are not subject to specific regulatory approval, includes increasing interest for the “reserved alternative investment fund” (RAIF). On the other hand, the interest for the “specialised investment fund” (SIF) persists, in particular in cases where the success of (previous) funds has relied on this structure or for entities which are not AIFs, such as fund vehicles reserved for a pre-existing group of investors, i.e. a family (please refer to the definition provided by ESMA). The main asset classes in these fund structures are typically private equity, venture capital, infrastructure, clean technology (and similar), real estate and debt. In addition, demand for UCITS funds is holding up well, in particular those having alternative strategies or investing in more “exotic” markets.
The other big theme in Luxembourg at present is the increasing intensity of the discussion around the relocation of additional asset managers, financial institutions and insurance companies regarding relocation or re-domiciliation of all or parts of their business (e.g. their foreign investment funds or management companies/AIFM) to Luxembourg, in particular as Brexit” nears. Preparations for Brexit remain challenging in an environment where the outcome of the political negotiation as well as the content of the future legal relationship between the UK and the EU is uncertain and many market participants are considering a range of different scenarios in their planning in order to be well prepared, based on the best knowledge currently available. In this context, the CSSF has helpfully clarified certain matters in both its new Circular 18/698, regarding its regulatory approval process as well as organisational and substance requirements for fund management companies, and its new Circular 18/697, regarding organisational requirements for non-UCITS fund depositaries, both issued on August 23, 2018. Further details regarding these two CSSF Circulars are set out below.
Relocation or re-domiciliation of all or parts of the business – Brexit
Investor demand, coupled with uncertainties as to the implementation of a third-country AIFM-passport, and limitations of reverse solicitation for attracting investors, has resulted in us seeing clients planning and executing numerous re-domiciliation or next product domiciliation projects in Luxembourg involving both regulated and non-regulated funds.
On the one hand, the ability to transfer a foreign investment fund’s registered office to Luxembourg with the continuation of its legal personality is very attractive for asset managers wishing to raise assets in the European Union. This process allows the foreign fund to preserve its full corporate history, including track record, and to resomicle in a manner which is generally completely tax neutral. On the other hand, Luxembourg offers a broad range of legal structures (for example, the special limited partnership = SCSp or SLP) allowing product manufacturers to design appropriate solutions for the next generation of investment funds. We are also seeing increasing interest in using Luxembourg for parallel funds structures. Both of these trends are proving attractive to UK asset managers looking to keep the benefits of EEA passporting for their fund ranges following Brexit; an increasing number of asset managers are announcing the launch or expansion of their Luxembourg operations in order to manage their business following Brexit. In addition, a steadily increasing number of UK asset managers establishing and licensing management companies as UCITS management companies and regulated AIFMs (so-called Super ManCo’s) in Luxembourg.
A number of financial institutions and insurance companies have also expressed their intention to either increase their existing operations in Luxembourg or to establish newly formed entities to relocate business as a result of Brexit. The CSSF has alerted market participants of the need to take action as fast as possible in order to ensure a proper set-up and receiving a license in time.
*New CSSF Circular 18/698 on approval process and organization of fund management companies in Luxembourg and strengthening of substance requirements
On August 23, 2018, the CSSF issued its Circular 18/698 (the Circular) relating to the approval process for, and organisation of, UCITS management companies, alternative investment fund managers (together, the Investment Fund Managers), self-managed UCITS and self-managed AIFs (repealing circular 12/546, which was only applicable to UCITS management companies). The content of the Circular closely follows ESMA’s opinion of July 13, 2017 on the relocation of UK entities to the EU member States as a result of Brexit.
The Circular sets out detailed rules and requirements regarding
- Shareholders of fund management companies
- Own funds.
- Corporate bodies of such entities.
- Central administration and internal governance.
- Internal controls.
- Fight against money laundering and terrorist financing.
- Delegation of key functions, including portfolio management, the administration and valuation functions.
- Management companies providing discretionary portfolio management services on an individual basis.
- Management companies providing services on a cross border basis or wishing to prevail of the European passport for the establishment of branches within the European Union.
Among the provisions that are of particular interest, it is worth noting the following substance requirements which the CSSF states must be retained
Board of Directors
- Requirement for a majority of board members of the fund management company not to be executive members (managers) of the fund management company at the same time.
- Requirement that boards of funds in company/partnership form managed by a fund management company are not composed in majority of persons being board members of the fund management company at the same time.
- Maximum number of working hours for a Board member set to 1920 hours per annum.
- Maximum number of mandates for a Board member set at 20 (mandates in SPVs belonging to the same fund and mandates across different funds belonging to the same fund promoter can however be counted as a single mandate, subject to certain conditions).
- Thresholds subject to proportionality principle depending on the size and complexity of each fund.
Notwithstanding the application of the proportionality criteria, three full-time equivalents (FTEs) are required on the ground in Luxembourg, including senior management (conducting officers) and other staff members.
Senior managers (dirigeants)
- At least two senior managers (dirigeants) permanently resident in Luxembourg or in a location that allows them to travel to Luxembourg every day.
- A threshold of 1.5 billion of AuM has been set, above which substance and delegation requirements are increased.
- Below the threshold: (i) senior managers may only have up to two roles with investment management firms; and (ii) one of the senior maangers may, subject to a derogation from the CSSF, not be permanently in Luxembourg if he is able to come regularly in Luxembourg and there are sufficient additional staff in Luxembourg to support the activities of the manager in question.
- Above the threshold: (i) senior managers may have only a single role with an investment management firm; (ii) at least two of the senior managers must be permanently resident in Luxembourg; and (iii) if there are more than two senior managers, the additional manager(s) do not need to reside permanently in Luxembourg (subject to CSSF derogation) if they are able to come into Luxembourg regularly and there are sufficient additional staff in Luxembourg to support their activities.
Detailed delegation requirements are described in the Circular with a particular emphasis on initial and ongoing due diligence requirements of delegates.
Among the general conditions for delegations are
- No letter box entity: delegation must not be so substantial that it would result in the Investment Fund Manager becoming a letter box entity within the meaning of the AIFM delegated regulation (subject to the proportionality principle).
- Prior notification to the CSSF, amongst other things, of an updated business plan detailing the delegated functions, identity of delegates and their supervisory authorities and the procedures being put in place to monitor the activities of the delegates.
- Written delegation agreement including among other things: (i) the ability for the Investment Fund Manager to give further instructions to the delegate at any time and to withdraw the delegation with immediate effect when this is in the interest of investors;(ii) a right of access of the Investment Fund Manager on demand to the transactions carried out by the delegate and data relating to the UCIs; (iii) a right of the Investment Fund Manager to conduct on-site visits to perform due diligence in particular in relation to registration agent and AML functions; (iv) a contingency plan; and (v) provisions governing compliance with conduct of business rules.
- Initial and ongoing due diligence policies and procedures relating to the selection and monitoring of the delegate must be documented, which documentation must be made available to the CSSF on demand.
Among the additional conditions for portfolio management delegation are
- Delegates must be authorised or supervised for asset management activities and subject to regulatory supervision.
- Cooperation arrangements must be in place between supervisory authorities for "third country" delegates.
- No conflict of interests: no delegation of portfolio management to the depositary or any undertaking which might give rise to a conflict of interest with the AIFM/ManCo or investors.
- Delegation agreement must incorporate the investment policy/restrictions to be complied with by the delegate.
The Circular enters into force with immediate effect and repeals the CSSF Circular 12/546. Existing fund management companies may need to make appropriate changes to their current set-up and procedures. Companies applying for a fund management company license must also now take into account the requirements of the Circular in their applications with immediate effect.
As for all items but here in particular:
Please do not hesitate to contact Manfred Dietrich, Partner Regulatory/Funds, Norton Rose Fulbright Luxembourg, should you have any query in relation to any potential need for adjustment of your current or future set-up or in case of any query relating to the understanding, practical application and background of a requirement.
*New CSSF Circular 18/697 on Organisational arrangements applicable to fund depositaries, which are not subject to Part I of the Law of December 17, 2010 relating to undertakings for collective investment, and, where appropriate, to their branches;1
On August 23, 2018, the CSSF also issued its Circular 18/697 (Circular (2)) on the governance and organisation of AIF (non-UCITS) depositaries. Circular (2) completes the existing legal framework for depositaries, supplementing the AIFM Law and the Commission delegated regulation (EU) 231/2013, following from the UCITS V directive and the CSSF Circular dedicated to its implementation.
Circular (2) sets out, amongst other things, rules relating to
- The eligibility criteria to be an AIF depositary, the authorisation procedure and specific requirements relating to outsourcing and delegation.
- Governance and organization, including conflict of interest procedures required where the depositary has a relationship with relevant third parties.
- Segregation of assets.
- The responsibilities of the depositary along the chain/over the network of (sub)-custody or delegation.
- The obligations of the depositary in relation to different types of assets (real estate, target fund-of-funds, non-listed companies, intangible assets such as patents or trademarks, tangible assets, financial derivatives) in terms of the verification of ownership and reconciliation.
- Assets offered as collateral to a third party or by a third party to the benefit of the fund from a depositary standpoint.
The rules set out in this new circular will enter into force on January 1, 2019 (and from such date Chapter E. of the IML Circular 91/75, as modified by CSSF Circular 05/177, is repealed).
Also as at such date the scope of application of CSSF Circular 16/644 is extended to undertakings for collective investment subject to part II of the Luxembourg law of December 20, 2010 on undertakings for collective investment, as amended (the 2010 Law) which are allowed to market to retail investors in Luxembourg. This applies also to Annex I of CSSF Circular 16/644 being replaced by Annex I of Circular (2).
UCITS: ESMA FAQ updates
Even though not particular to Luxembourg (as opposed to the EU as a whole), please note that ESMA and the European Commission have issued updated versions of their FAQ applicable to UCITS, available here.
New questions and answers have been included in July 2018 concerning Section I – General Question 5: Issuer concentration, Question 6: UCITS investing in other UCITS with different investment policiesand Question 7: Supervision of branches and in Section X – Depositary Question 1: Depositaries as counterparties in a transaction of assets that they hold in custody. Already in May 2018 (after our last update) Section IX – Remuneration Question 1: Application of disclosure requirements on remuneration to delegates has been updated
ESMA has issued an updated version of its FAQ, Questions and Answers on the implementation of the Regulation (EU) No 648/2012 of the European Parliament and of the Council of July 4, 2012 on OTC derivatives, central counterparties and trade repositories (EMIR)- ESMA70-1861941480-52 - July 12, 2018
Some minor adjustments have been made in General Question 1: Funds, counterparties as well as some adjustments and the adding of three sub-questions and answers under TR Question 40 LEI changes due to mergers and acquisitions. Update of identification code to LEI changes have been made.
A draft bill of law has been introduced in Luxembourg on December 6, 2017 to implement the fourth Anti-Money Laundering Directive dated May 20, 2015 (the AML Directive) into Luxembourg Law. This legislation will establish a register of beneficial owners (registre de bénéficiaires effectifs = REBECO) . However, the parliamentary procedure is still ongoing so the bill has not yet been adopted although, as a general rule, it should enter into force the first day of the month following its being voted into law.
In summary, the new legislation stipulates that, for every ultimate beneficial owner (UBO) holding directly or indirectly more than 25 per cent in an entity (the so called Registered Entity), the following information will need to be provided to the REBECO
- Date and place of birth.
- Private or professional address of residence.
- UBO’s nature and extent of beneficial interests held in the relevant entity.
- National identification number (Luxembourg or foreign).
Access to the information stored in the register is, in principle, restricted to self-regulatory bodies (such as the Luxembourg Bar, the Notary Chamber or the Order of Accountants) and specified entities set out in the AML Law (obliged entities, for example credit institutions, insurance undertakings, UCITS management companies and AIFMs). Such access is limited to partial information only and not to the supporting documents that have been filed. The electronic access of these self-regulatory bodies may only be used within the strict context of their supervisory functions, whereas the electronic access of “obliged entities” may be used only where such entities are required to carry out “know your customer” due diligence.
Only national competent public authorities, including but not limited to the Prosecutor, the CSSF, the Commissariat aux Assurances (CAA) and the tax administration will have unfettered access to the REBECO, which will be made available to them electronically.
Finally, limited access to the REBECO will be granted to any person or organisation that: (i) can demonstrate a legitimate interest; (ii) is resident in Luxembourg; and (iii) has made an official written and reasoned request in this respect. Any such access will be subject to the prior approval of a Commission to be created by the Minister of Justice. At this stage it remains to be seen what the authorities might consider a “legitimate interest” for these purposes but, in any event, such access will not include personal information such as an individual’s date and place of birth or their address.
For further information, please refer to the previous edition of Asset Management Quarterly (May 2018).
Update CSSF FAQ concerning the Luxembourg Law of July 12, 2013 on alternative investment fund managers as well as the Commission Delegated Regulation (EU) No 231/2013 of December 19, 2012
On August 14, 2018, the CSSF issued an update of its Frequently Asked Questions (FAQ) in connection with the AIFM Law. A new FAQ aims to clarify the situation for AIFs, which have issued a UCITS KIID, with respect to the PRIIPs Regulation requirements. For ease of convenience please see below the extract taken from the relevant updated CSSF FAQ
23.b) Can Luxembourg AIFs the units of which are being advised on, offered or sold to retail investors benefit from the exemption provided under article 32(2) of the PRIIPs Regulation if they have issued a UCITS KIID? (August 14, 2018)
Yes. Such AIFs may issue a UCITS KIID in order to be exempted from the obligations of the PRIIPs Regulation until December 31, 2019, provided that the following conditions are complied with
- The UCITS KIID to be issued under the Law of 2010 should comply with articles 159 to 162 of the Law of 2010, as well as with the provisions of Commission Regulation (EU) n° 583/2010;.
- The UCITS KIID should be issued for each retail share class of the sub-funds of the relevant Luxembourg AIF.
- The offering document of the Luxembourg AIF in question should be amended in order to reflect the distribution of a UCITS KIID to all retail investors contemplating an investment in the AIF. The offering document should also mention that the UCITS KIID shall be published on the website of the Registered or Authorised AIFM of the Luxembourg AIF and that it shall be available, upon request, in paper form.