Luxembourg strengthens its regulatory regime as it prepares for Brexit
Luxembourg is well established as the second largest funds domicile globally, after the US, with a record number of assets under management (AUM) of over EUR 4 trillion. As we edge closer to the Brexit deadline of 30 March 2019 with still a lot of uncertainty for the funds market, Luxembourg’s regulatory body Commission de Surveillance du Secteur Financier (CSSF) has been ahead of the curve in demonstrating that the country is open for business and bolstering its regulatory regime to further enhance its position on the global stage.
The funds industry in Luxembourg has already witnessed significant growth in recent years, with the increase in AUM taking a giant leap from EUR 3 to 4 trillion in just three years. According to the latest available data, Luxembourg funds are distributed in more than 70 countries and there were 4,110 funds domiciled in Luxembourg. Luxembourg continues to perform strongly with growth of both traditional UCITS funds and alternative investment funds in areas including private equity and real estate.
As the protracted Brexit negotiations continue, with the UK set to become a third country vis-à-vis the EU and the possibility of a ‘hard Brexit’ still on the table, the CSSF sent a clear signal to the market on 25 July 2018. They called upon fund managers who may wish to service the European market via a Luxembourg relocation to anticipate and submit their applications to become a fully authorized alternative investment fund manager (AIFM) as soon as possible to avoid any risk of disruption in business and in the industry globally, in view of the substantial time required to analyze authorisation requests.
So what are Luxembourg’s latest efforts to boost the regulatory regime at a time of rising demand as the clock keeps ticking on Brexit? CSSF has come forward with two new circulars, 18/697 and 18/698, on the governance and organization of alternative investment fund (non-UCITS) depositaries and on the authorization and organization of Luxembourg investment management companies respectively.
The first, Circular 18/697, seeks to provide clarification on Luxembourg depositary regimes, and recommends that depositaries covered by the Luxembourg regime should comply with the Alternative Investment Fund Managers Directive (AIFMD) depositary regime, which offers a higher level of investor protection. Governance will be boosted by new provisions on eligibility criteria to become an AIF depositary, ensuring that management is fit and proper. It shall be mandatory to have conflict of interest procedures and policies, as well as escalation procedures in place.
The circular lists a series of specific measures in terms of ownership verification and reconciliation to be complied with by depositaries when they safekeep AIF assets. The circular classifies such measures per type of assets in which the AIF invests: real estate, fund of funds, non-listed issuers, intangible assets, movable assets and financial derivative instruments. The new rules shall also require that the depositary shall be informed of all derivative transactions in order to monitor on a daily basis the exposures related to initial margin and track variations.
Looking ahead, Circular 18/697 takes into account some of the amendments to be introduced to the AIFM Regulations in the light of recent changes set out in an EU Commission Regulation of July 2018. These amendments will introduce changes that affect the safe-keeping duties of depositaries, obligations on asset segregation, information and access, and delegation of contractual information. The new circular will enter into force on 1 January 2019, while the EU Commission Regulation will not come into force until 2020, meaning Luxembourg will be blazing the trail in ensuring industry best practice.
The second circular, Circular 18/698, focuses on ensuring governance and substance, and applies across UCITS management companies and AIFMs, as well as to management companies subject to the rules on undertakings for collective investment. It establishes the necessary governance and organizational structures as well as some new requirements regarding central administration and internal controls, the fight against money laundering and terrorist financing, and also key functions including delegated activities, internal administration, marketing and valuation, among others. Some of the key changes include that directors are in principle limited to 20 mandates and 1,920 professional hours, while some flexibility is permitted for mandates on SPVs that are held by the funds and for mandates within the same family of funds. When it comes to staffing, the circular recommends a minimum staffing of three full-time equivalents (FTE) who should be employed and located in Luxembourg. This circular is effective immediately so fund managers are recommended to take all necessary steps without further delay.
The role of investor services firms such as SGG Luxembourg is to work hand-in-hand with our clients to ensure compliance with the changes being introduced by the two circulars. We constantly adapt our service offering to meet the new regulatory and compliance reality. We are confident that Luxembourg will continue to lead the field as the example of a robust, well-regulated and globally competitive funds domicile, and attract business from Europe and beyond for the years to come.
First published in realdeals.
By Christian Heinen,
Managing Director, SGG Luxembourg.