Developments in the Luxembourg Financial Sector

Luxembourg has transposed MiFID II into its national law, albeit five months after the deadline for doing so. In other matters, the Luxembourg supervisory authority, the Commission de Surveillance du Secteur Financier (CSSF) issued two circulars in August: one reshaping the organisational rules for Luxembourg UCITS management companies, self-managed UCITS, authorised AIFMs and internally managed AIFs; the second, providing guidance as to the requirements for Luxembourg depositaries servicing Luxembourg AIFs (other than Part II UCIs marketed to retail investors), as well as SIFs and SICARs that do not qualify as AIFs. These developments are discussed below. 

MiFID II Transposed into Luxembourg National Law 

With a delay of five months, Luxembourg has transposed and implemented the main parts of the markets on financial instruments (MiFID) framework into national law, by the act of 30 May 2018 on markets in financial instruments (MiFID II Act) and the Grand-Ducal Regulation on markets in financial instruments of the same date (GDR). For further information on the transposition and implementation of MiFID II in Luxembourg, please refer to Luxembourg Developments: Luxembourg Publishes Bill to Implement MiFID. 

The MiFID II Act: (i) transposes the MiFID II Directive¹ (Directive) into Luxembourg Law; (ii) implements certain provisions of MiFIR²; and (iii) transposes into Luxembourg law certain provisions of the European Commission directive pertaining to the safeguarding of client funds³. The MiFID II Act also amends parts of the act of 5 April 1993 on the financial sector, as amended (Financial Sector Act)⁴. 

The MiFID II Act came into effect on 4 June 2018⁵, although the deadline to transpose the Directive was 3 January 2018⁶. 

The MiFID II Act does not gold plate⁷ rules on UCITS management  companies and alternative investment fund managers (AIFMs). Luxembourg UCITS, alternative investment funds (AIFs)⁸ and other undertakings for collective investment, and their respective management companies and AIFMs, continue to be outside the scope of the Financial Sector Act, unless the relevant management company or AIFM is also authorised to provide discretionary portfolio management and non-core services. However, in practice, certain obligations under MiFID II will have an indirect effect on UCITS management companies and AIFMs when they enter into contractual relationships with entities that are subject to the MiFID framework (for instance, where adequate product governance arrangements need to be put in place by distributors, or where portfolio managers and brokers need to ensure compliance with inducement rules). 

Third-country firms are required to establish a branch in Luxembourg to provide investment services to retail clients and “opt-up” professional clients⁹ in Luxembourg. The branches will be subject to the same rules as those applicable to Luxembourg investment firms. 

Reshaping of Organisational Rules for Luxembourg UCITS Management Companies and AIFMs and Enforcement of Local Substance Requirements, by CSSF Circular 18/698 

The CSSF issued a circular on 23 August 2018 (Manager Circular)¹⁰, which consolidates into one document the requirements for Luxembourg UCITS management companies, self-managed UCITS, authorised AIFMs, and authorised internally managed AIFs (collectively, Managers). The Manager Circular does not apply to AIFMs (and internally managed AIFs) that are registered only. 

For further information regarding the Manager Circular (including with respect to the governing body and management of a manager, requirements as to delegation of key functions, investment and valuation committees, appointment of investment advisers, limitations on number of mandates of Managers’ directors and conducting persons, and local substance requirements of Luxembourg-based Managers), please refer to Dechert OnPoint, Luxembourg CSSF reshapes organisational rules for UCITS management companies and AIFMs, enforces local substance requirements. 

The Manager Circular applies with immediate effect from its issuance on 23 August 2018. Unfortunately, as it contains a number of new provisions, Managers, directors and conducting persons have not been given a reasonable period of time to adapt to the Manager Circular. It is therefore important that priority be given to ensuring immediate compliance. 

Consolidation of Organisational Rules for Luxembourg Depositaries of AIFs as well as for SIFs and SICARs that do not Qualify as AIFs, by CSSF Circular 18/697

The CSSF issued a circular on 23 August 2018¹¹ (Depositary Circular), which consolidates into one document the requirements for Luxembourg depositaries servicing Luxembourg AIFs (other than Part II UCIs¹² marketed to retail investors), as well as SIFs¹³ and SICARs¹⁴ that do not qualify as AIFs (collectively, Funds). To a large extent, the content of the Depositary Circular replicates the administrative practice of the CSSF¹⁵. The Depositary Circular will become effective on 1 January 2019, providing time for depositaries, Funds and their AIFMs to comply with its terms. 

For AIFs managed by an authorised AIFM (as well as authorised internally managed AIFs), the Depositary Circular provides certain clarifications and practical guidance with respect to article 19 of the AIFM Act¹⁶ and chapter IV of Commission Delegated Regulation 231/2012¹⁷ (both of which set rules for depositaries of AIFs). In this regard, the Depositary Circular describes a depositary’s obligations when safekeeping real estate, private equity, other collective undertakings for investment, financial derivative instruments, non-tangible rights and tangible assets. Where intermediary vehicles are used for investing in underlying assets, a look-through approach is required to properly carry out the safekeeping obligations. 

For Part II UCIs not marketed to retail investors, as well as SIFs and SICARs that are managed by an AIFM exempted from the scope of the AIFM Act (e.g., by being registered as a sub-threshold AIFM) and SIFs and SICARs that do not qualify as AIFs¹⁸, the Depositary Circular clarifies that a depositary: (i) has a general mission to supervise the Fund’s assets, and must know at all times how the assets are invested and where and how these assets are available; and (ii) must ensure that general administrative tasks pertaining to the assets (e.g., collection of dividends and interest, exercise of option rights) are appropriately carried out. The Depositary Circular indicates that the depositary is responsible to investors for any damage caused by its failure to appropriately supervise the assets. 

The Depositary Circular applies to all types of depositaries: (i) Luxembourg banks and Luxembourg branches of banks established in the EEA; (ii) Luxembourg investment firms authorised to provide safekeeping and administration functions with respect to financial instruments, and Luxembourg branches of such investment firms established in the EEA; and (iii) depositaries for assets other than financial instruments¹⁹. 

The Depositary Circular describes the process to become authorised by the CSSF to provide depositary services to Funds. The Depositary Circular also formalises the requirements applicable to persons responsible for the depositary business within a bank, investment firm or Luxembourg branches of an EEA bank or investment firm, as well as staffing and the technical infrastructure and on delegation. 

The Depositary Circular also sets forth rules on conflicts of interest, and lists functions a depositary may assume alongside its function as depositary – these include (among others): reception and transmission of orders; brokerage; fund administration; maintaining the registry of investors; transfer agency services; currency hedging; collateral management; and valuation. Although a depositary may directly or indirectly be a shareholder of an AIFM, none of the depositary’s employees can assume the function of a conducting person of the AIFM. However, where a depositary’s direct or indirect participation exceeds 10% of an AIFM’s capital, the AIFM must have a procedure in place to avoid the conflicts. 

Written procedures must be in place between the depositary and external parties (e.g., fund administrator) when servicing a Fund. These procedures may either take the form of an operating memorandum or a service-level agreement. Where the AIFM of a Luxembourg Fund is not located in Luxembourg, a written agreement covering the information flow between the non-Luxembourg AIFM and the Luxembourg depositary must be put in place, to enable the latter to assume its safekeeping obligations. 

The depositary must have the right at all times to access the information necessary to enable it to carry out its legal obligations. This right is important as the depositary is required to inform the Fund and the AIFM of any fact potentially affecting the Fund’s assets. The right can be granted, for instance, by online access to the systems of the delegates, prime brokers, clearing brokers, registrars, transfer agents or other counterparties and brokers. 

Where a Fund is in liquidation or the depositary has resigned, the continued safekeeping of the Fund’s assets must be ensured. In such an instance, the latest depositary that had been appointed for the Fund is required to keep the Fund’s accounts open until the liquidation is completed or another depositary is appointed. 

Footnotes 

_{1) Directive 2014/65/EU on markets in financial instruments, as amended.
2) Regulation (EU) 600/2014 of 15 May 2014 on markets in financial instruments, as amended (a set of rules created alongside MiFID II, mainly pertaining to transparency and reporting of trades and transactions, which are directly applicable in the Member States).
3) Article 6 of Commission Delegated Directive (EU) 2017/593 with regard to safeguarding of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or any monetary or non-monetary benefits (CDD 2017/593). The GDR transposes the remaining parts of CDD 2017/593.
4) Further, the MiFID II Act amends: the act of 23 December 1998 establishing a financial sector supervisory commission, as amended; the act of 5 August 2005 on financial collateral arrangements, as amended; the act of 7 December 2015 on the insurance sector, as amended; and the act of 15 March 2016 on OTC derivatives, central counterparties and trade repositories and amending different laws relating to financial services. The MiFID II Act repeals the act of 13 July 2007 on markets in financial instruments, as amended, with the exception of its article 37.
5) In a 29 December 2017 press release, the CSSF reiterated these deadlines with respect to transposition and implementation, and indicated that rights under MiFID II which are more favorable than the applicable national rules (in particular, rules which aim to strengthen investor protection (e.g., regarding inducement and research)) would be considered as applicable in the interim.
6) This was also the date on which MiFIR became effective.
7) In the context of the transposition of European directives into national law, goldplating means an excess of norms, guidelines and procedures that may interfere with the intended policy of the directive. 8) An AIF is defined in article 1(39) of the AIFM Act (i.e., a collective investment undertaking, including sub-funds, that raises capital from a number of investors with a defined investment policy for the benefit of those investors, and which does not require authorisation as a UCITS).
9) Professional clients under MiFID are distinguished between “per se” professional clients and those who can elect to be treated as professional clients.
10) Circular 18/698 on the authorisation and organisation of fund managers, et al.
11) Circular 18/697 on organisational provisions applicable to depositaries of funds which do not fall under part I of Luxembourg act of 17 December 2010 on undertakings for collective investment, as amended (UCI Act) and, where applicable, to their branches.
12) Part II UCIs are undertakings for collective investments under part II of the UCI Act. Unlike SIFs and SICARs, Part II UCIs may be invested in by any type of investor (including retail investors, in which case the UCITS depositary regime is applicable). The Depositary Circular only applies for Part II UCIs whose constitutive documents prohibit the marketing to retail investors in Luxembourg.
13) A SIF is a specialised investment fund under the Luxembourg law of 13 February 2007 on specialised investment funds, as amended, and which may only be invested in by well-informed investors.
14) A SICAR is an investment company in risk capital under the Luxembourg law of 15 June 2004 on investment companies in risk capital, as amended, and which may only be invested in by well-informed investors.
15) The Depositary Circular implicitly confirms that there are three depositary regimes in Luxembourg: (i) the UCITS regime that also applies to Part II UCIs marketed to retail investors; (ii) the AIFMD regime; and (iii) the regime for AIFs (including Part II UCIs restricted to professional investors) managed by an AIFM exempted from the scope of the AIFM Act, and for SIFs and SICARs that do not qualify as AIFs (where the obligations of the depositary are determined in part I, chapter 5 of the Depositary Circular).
16) The Luxembourg act of 12 July 2013 on alternative investment fund managers, which transposed the AIFMD into Luxembourg law.
17) Commission Delegated Regulations 231/2012 of 19 December 2012, supplementing the AIFMD with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision.
18) Part II UCIs are by law always AIFs. SIFs and SICARs can be structured as non-AIFs.
19) These are depositaries authorised under article 26-1 of the Financial Sector Act.}