Developments in the Luxembourg Financial Sector
The Luxembourg government recently launched the “reserved alternative investment fund” – a new form of Luxembourg AIF that does not require prior approval from the Luxembourg supervisory authority, the CSSF. In other developments, the CSSF issued frequently asked questions on UCITS eligible assets and diversification rules, as well as a regulation providing rules for marketing foreign AIFS to retail investors in Luxembourg. These developments are discussed below.
Luxembourg Government Launches Reserved Alternative Investment Funds
By Patrick Goebel and Antonios Nezeritis
The Luxembourg Council of Government approved on 27 November 2015 the bill of law on reserved alternative investment funds (RAIF), a new form of Luxembourg alternative investment fund (AIF) that does not require prior approval from the Luxembourg supervisory authority, the Commission de Surveillance du Secteur Financier (CSSF). The bill of law was deposited with the Luxembourg Parliament on 14 December 2015, published under number 6929 on 15 December 2015, and is expected to be adopted during the second quarter of 2016. This article provides a summary of key features of the RAIF. For more detailed information (including comparative charts), please refer to Dechert OnPoint, Luxembourg Publishes Bill of Law on the Reserved Alternative Investment Funds.
In the post-AIFMD1 environment – where regulation is focused on the alternative investment fund manager (AIFM) of the AIF and only indirectly imposes certain requirements upon the AIF itself – the Luxembourg Government is creating a fund vehicle with the advantages of specialized investment funds (fonds d’investissement spécialisé, or SIF) or investment companies in risk capital (sociétés d’investissement d'investissement en capital à risque, or SICAR) in terms of structuring (e.g., ability to adopt a variable capital structure and to establish sub-funds) without being required to seek prior authorization by the CSSF. The bill of law is largely inspired by the Luxembourg SIF Law2 and the Luxembourg SICAR Law3.
Legal Nature of the RAIF – Management and Administration of the RAIF
The RAIF is an undertaking for collective investment that always qualifies as an AIF4. Unlike the SIF or the SICAR, the RAIF cannot be structured as a non-AIF5. The RAIF must always be managed by an external AIFM that does not seek exemption from the AIFMD under the sub-threshold regime of article 3(2) of the AIFMD6.
Although the RAIF will not be authorized by the CSSF, the AIFM must ensure that the AIF complies with the conditions set under the AIFMD. The RAIF is therefore indirectly regulated, as it is managed by an external AIFM that in turn must be authorized. An AIFM must notify its supervisory authority once it starts to manage a RAIF.
Any authorized AIFM established in Luxembourg or in another EU Member State can manage a RAIF. A non-EU AIFM will be permitted to manage a RAIF when the non-EU AIFM is authorized under the passport regime to manage and/or market an AIF in the EU7.
The RAIF must have a Luxembourg depositary fulfilling the conditions and obligations set under the AIFMD. The administration of the RAIF must be conducted in Luxembourg.
The RAIF must issue an annual report, which is made available to the investors within six months after the closing of the accounting year. The annual report must be reviewed by a Luxembourg statutory auditor (réviseur d'entreprises agréé).
Risk Spreading – Concept of Risk Capital – Tax
The RAIF can invest in any type of assets and follow any type of investment strategy. The portfolio of the RAIF must be managed under the principle of risk spreading, unless the RAIF invests exclusively in risk capital. The concept of risk spreading is taken from the SIF Law, while the concept of risk capital is taken from the SICAR Law.
As with the SIF, the RAIF is subject to an annual subscription tax (taxe d’abonnement) of 0.01% unless it invests exclusively in risk capital. Where the RAIF is a company investing exclusively in risk capital, its income generated from securities or capital gains is exempted. In such a case, the tax regime of the RAIF is thus comparable to that of the SICAR.
Structures Available to the RAIF
The RAIF can be structured: (i) as a common fund (fonds commun de placement, or FCP), which is a contractual co-ownership scheme without legal personality; (ii) as an investment company with variable capital (société d’investissement à capital variable, or SICAV) whose capital is automatically adjusted to its net asset value; or (iii) in a form other than FCP or SICAV, in which case the capital of the RAIF is generally fixed.
In the case of a SICAV, the RAIF can be formed as a public limited liability company (société anonyme, or SA), private limited liability company (société à responsabilité limitée, or Sàrl), corporate partnership limited by shares (société en commandite par actions, or SCA), common limited partnership (société en commandite simple, or SCS), special limited partnership (société en commandite spéciale, or SCSp), or cooperative company formed as a public limited liability company (société cooperative sous forme de société anonyme, or SCoSA).
The RAIF can be structured as an umbrella fund with one or more sub-funds, where the assets and liabilities of each sub-fund are segregated from the assets and liabilities of other sub-funds, unless otherwise stated in the constitutive documents of the RAIF.
Eligible Investors – Marketing of the RAIF
Only “well-informed investors”8 will be admitted to the RAIF.
As a RAIF is required to appoint an authorized AIFM, the RAIF can be marketed to Professional Investors (as defined under Directive 2015/65/EU on markets for financial instruments) in the various EU Member States under the passport regime, in accordance with the notification process established under the AIFMD.
Although marketing under the passport regime of the AIFMD is limited to Professional Investors, well-informed investors who do not qualify as Professional Investors will be permitted to invest in the RAIF.
CSSF Issues FAQ on UCITS Eligible Assets and Diversification Rules
By Patrick Goebel and Antonios Nezeritis
The CSSF recently published its first version of frequently asked questions on the eligible assets of a Luxembourg undertaking for collective investment in transferable securities (UCITS) and diversification rules applicable to UCITS. The following is an overview of key points addressed in the FAQ.
Investments in UCITS and UCIs
As per the Luxembourg law of 17 December 2010 on undertakings for collective investment, as amended (Law of 2010), a UCITS may invest in other UCITS and in other undertakings for collective investment (UCIs) that comply with the requirements of article 2(2)9 and article 41(1)(e)10 of the Law of 2010.
Until recently, the CSSF did not take the view that open-ended SIFs and SICARs qualified as other UCIs within the meaning of Article 41(1)(e). This had been reiterated by the CSSF for SIFs in the CSSF’s 2014 annual report. Pursuant to the FAQ, however, a UCITS may now invest in open-ended SIFs and SICARs, provided that such SIFs and SICARs qualify as AIFs under the AIFMD and comply with the above-mentioned requirements of the Law of 2010. As a consequence, a UCITS may invest up to 30% of its assets in such SIFs and SICARs.
The CSSF also indicates in the FAQ that exchange-traded funds (ETFs) that are not UCITS qualify as other UCIs, and are therefore eligible investments if they comply with the requirements of article 2(2) and article 41(1)(e).
Eligible Assets in the 10% “Trash Ratio”
The CSSF reiterated in the FAQ that only certain transferable securities and money market instruments constitute eligible investments in the so-called 10% “Trash Ratio” – a UCITS may not invest within the 10% “Trash Ratio” in open-ended undertakings for collective investment. This is in line with ESMA’s 20 November 2012 opinion (2012/721), as well as the CSSF’s 23 November 2012 press release (12/46).
Eligibility of Transferable Securities Linked to the Performance of Other Underlying Assets
The FAQ also deals with the analysis to be conducted in considering whether particular transferable securities linked to the performance of other underlying assets (structured financial instruments) may be eligible assets within a UCITS’ investment policy. The determinative factor is whether or not a derivative is embedded in the transferable security – if so, the “look through” approach should be followed to assess the eligibility of the underlying asset; otherwise, a “look through” approach is not required.
Eligibility of OTC Bond Markets in a Non-Member State of the European Union
OTC bond markets are eligible if they are regulated, operate regularly, are recognized and are open to the public within the meaning of the Law of 2010. In the FAQ, the CSSF confirmed the eligibility of the following OTC bond markets: US OTC Fixed Income Bond Market; Hong Kong OTC Corporate Bond Market; China Interbank Bond Market; and the OTC bond market organized by the International Capital Market Association.
Control/Holding Limits Applicable to UCITS
As per article 48(2) of the Law of 2010, a UCITS may acquire no more than:
- 10% of the non-voting shares of the same issuer;
- 10% of the debt securities of the same issuer; 25% of the units of the same investment fund; and
- 10% of the money market instruments of any single issuer.
The FAQ provides that the above-referenced limitations are applied at the sub-fund level of each UCITS and not at the umbrella fund level.
CSSF Clarifies the Marketing of Foreign AIFs to Retail Investors in Luxembourg
By Patrick Goebel, Antonios Nezeritis and Gwendoline Licata
Article 43 of the AIFMD enables EU Member States to permit the marketing of AIFs to retail investors in their respective jurisdictions. Luxembourg transposed this authority into Luxembourg law in article 46 of the AIFM Law.
Under Article 46, authorized AIFMs established in Luxembourg or in another EU Member State are permitted to market non-Luxembourg AIFs to retail investors in Luxembourg, if the AIF is subject in its home jurisdiction to: (i) a permanent supervisory authority considered by the CSSF to be equivalent to that provided under Luxembourg law; and (ii) regulation providing investors with guarantees of protection at least equivalent to those provided by a Part II UCI.
On 26 November 2015, the CSSF released Regulation CSSF N° 15-03, which provides rules, summarized below, for marketing foreign AIFs to retail investors in Luxembourg.
The AIF Must be Managed by an Authorized AIFM
Only AIFs that are managed by an AIFM authorized in Luxembourg or in another EU Member State may be marketed to retail investors in Luxembourg. However, AIFs managed by an AIFM that is exempted from the AIFMD under the sub-threshold regime of article 3(2) of the AIFMD may not market AIFs to retail investors in Luxembourg. A non-EU AIFM will be permitted to market AIFs to retail investors in Luxembourg when such non-EU AIFM is authorized under the passport regime to manage and/or market AIFs in the EU.
An AIFM that wishes to market an AIF to retail investors in Luxembourg must first notify its home supervisory authority of its intent to market the AIF to Professional Investors in Luxembourg.
The AIF Must be Managed under the Principle of Risk Spreading
The portfolio of the AIF must be managed under the principle of a risk spreading. The AIF must comply with the following investment restrictions, subject to derogation by the CSSF upon adequate justification. The AIF may not:
- invest more than 10% of its assets in non-listed securities;
- acquire more than 10% of the securities of the same nature from the same issuer;
- invest more than 20% of its assets in the securities from the same issuer; or borrow cash in excess of 25% of its net assets.
An exemption from these restrictions is provided for securities issued by: an OECD Member State or any of its local authorities; supranational institutions or bodies with an EU, regional or global scope; and units of undertakings for collective investment subject to similar risk-spreading requirements.
When entering into financial derivative transactions, the underlying assets must be subject to appropriate risk spreading.
Where an AIF invests in real estate: the AIF must limit its exposure to any single property to 20% of the AIF’s assets; and the AIF’s borrowing is limited to 50% of the estimated value of the portfolio.
The AIF Must be Open-Ended
The issue and redemption prices of the units of the AIF must in principle be determined at least once per month, subject to the CSSF’s acceptance of a lengthier frequency of determination upon adequate justification.
A Luxembourg Credit Institution Must be Appointed as the AIF’s Paying Agent
The AIF or its AIFM must appoint a Luxembourg credit institution as the AIF’s paying agent to make payments and handle redemption and subscription requests in Luxembourg.
Prior Approval by the CSSF is Required
An application must be filed with the CSSF to request permission to market the AIF to retail investors in Luxembourg.
The application must include, inter alia, the following information:
- a certificate from the supervisory authority of the AIF’s home jurisdiction, attesting to the AIF’s authorization and supervision;
- the AIF’s prospectus or offering document, including an addendum containing specific information for investors in Luxembourg (e.g., name, address and functions of the Luxembourg paying agent, name of the Luxembourg newspapers in which notices to Luxembourg investors are published);
- the AIF’s constitutive documents;
- the AIF’s most recent financial statements;
- biographies of the AIF’s managers;
- a draft of the agreement between the AIF and its AIFM;
- and the name of the AIF’s Luxembourg paying agent.
Once admitted to marketing to retail investors in Luxembourg, the AIF will be registered by the CSSF on the list of foreign AIFs admitted to marketing to retail investors in Luxembourg, which can be consulted online.
1) Directive 2001/61/EU on Alternative Investment Fund Managers.
2) Law of 13 February 2007 on SIFs, as amended.
3) Law of 15 June 2004 on SICARs, as amended.
4) Under Luxembourg law, AIFs are collective investment undertakings, including any sub-funds thereof, that: (a) raise capital from a number of investors, with a view to investment in accordance with a defined investment policy for the benefit of those investors; and (b) do not require authorization pursuant to article 5 of Directive 2009/65/EC on undertakings for collective investment funds in transferable securities (UCITS Directive).
5) SIFs or SICARs that do not raise any capital from investors do not fall within the scope of the definition of an AIF under article 1(39) of the law of 12 July 2013 on alternative investment fund managers (AIFM Law). Examples of such SIFs or SICARs are entities whose access is limited to a predefined group of investors or which have only one investor within the meaning of ESMA/2013/600, Final report: Guidelines on key concepts of the AIFMD.
6) The sub-threshold exemption applies to AIFMs managing assets below EUR 100 million; or below EUR 500 million, provided no redemption rights are granted to investors during a minimum period of five years after the first investment was made and no leverage is undertaken. AIFMs qualifying for this exemption must only register with their home supervisory authority for the purpose of reporting.
7) Article 66(3) of the AIFMD.
8) The definition of well-informed investor is taken from the SIF Law and the SICAR Law, which distinguish among three types of investors: (i) institutional investors (as defined by the administrative practice of the CSSF); (ii) Professional Investors; and (iii) well-informed investors – this category refers to any investor who is neither an institutional investor nor a Professional Investor, and who invests or commits to invest at least EUR 125,000 in the RAIF and confirms in writing to maintain the status of a well-informed investor. In instances where an investor who is neither an institutional investor nor a Professional Investor wishes to invest less than EUR 125,000 in the RAIF, such investor’s experience and knowledge to adequately appraise the investment in the RAIF must be certified pursuant to an assessment by: a credit institution (within the meaning of Directive 2006/48/EC); an investment firm (within the meaning of Directive 2004/39/EC); or a management company (within the meaning of the UCITS Directive).
9) For the purposes of the Law of 2010, and subject to Article 3, UCITS means an undertaking: whose sole object is the collective investment in transferable securities and/or in other liquid financial assets (as referred to in Article 41(1) of the Law of 2010) of capital raised from the public, and which operates on the principle of risk-spreading, and whose units are, at the request of holders, repurchased (directly or indirectly) out of the undertaking's assets. Action taken by a UCITS to ensure that the stock exchange value of its units does not significantly vary from their net asset value is regarded as equivalent to any such repurchase.
10) A UCITS may invest in units of UCITS authorized according to the UCITS Directive and/or other UCIs within the meaning of Article 1(2)(a) and (b) of the UCITS Directive, whether or not established in a Member State, provided that: such other UCIs are authorized under laws which provide that they are subject to supervision considered by the CSSF to be equivalent to that laid down in “EU law”, and that cooperation between authorities is sufficiently ensured; the level of protection for unitholders in the other UCIs is equivalent to that provided for unitholders in a UCITS and, in particular, that the rules on asset segregation, borrowing, lending, and uncovered sales of transferable securities and money market instruments are equivalent to the requirements of the UCITS Directive; the business of the other UCIs is reported in half-yearly and annual reports to enable an assessment of the assets and liabilities, income and operations over the reporting period; and no more than 10% of the assets of the UCITS or of the other UCIs whose acquisition is contemplated, can, according to their management regulations or instruments of incorporation, be invested in the aggregate in units of other UCITS or other UCIs.