New Finalised Rules on Luxembourg Specialised Investment Funds

On 6 March 2012 the Luxembourg Parliament passed important amendments to the Luxembourg law of 13 February 2007 on specialised investment funds (“SIFs”). We discussed these proposals in our August 2011 newsletter and the details remain largely unchanged.

SIFs have become popular due to the flexibility they offer in terms of investment policies and the fast set-up and authorisation processes. Luxembourg aims to build on this popularity through enhancing its SIF legislation in line with the Alternative Investment Fund Managers Directive (“AIFMD”).

Now that the law has been passed by the Luxembourgish Parliament, the legislative process will be completed shortly.

The law’s most significant effects concern restrictions on the delegation of investment management responsibilities to third parties, which must now be only made to entities authorised or registered for the purpose of asset management. Delegation of investment management can be done to portfolio managers established outside the EU provided there is cooperation between the CSSF and the regulatory authority of the non-EU country.

This requirement is somewhat mitigated since a person or an entity not authorised or registered for the purpose of asset management can still perform this function for SIFs, if approved by the CSSF, based on criteria of repute and experience.
The delegation can therefore only become effective if approved by the CSSF.

SIFs will further be required to perform due diligence on third parties performing outsourced activities by assessing whether these entities can be considered as qualified and capable of undertaking the functions in question. This is likely to require new internal policies and checks by senior management which the board of SIFs should consider carefully.

SIFs will not be allowed to delegate any core investment management functions to the depositary and this therefore reinforces the liability of senior management. SIFs will also need to be in a position to, at all times, effectively monitor the delegated activities with the ability to withdraw the mandate with immediate effect in order to protect the interests of investors.

Existing SIFs have until 30 June 2013 to comply with the restrictions on delegation to third parties.

The law will also require new SIFs to be approved by the CSSF before they can start trading and the directors will have to be approved before any commercial activities take place. The law includes a requirement for CSSF approval for the appointment and replacement of directors of the SIF. Approval will further be required for the appointment and replacement of investment managers. This is not such a new requirement but may cause the CSSF to further scrutinise such applications. Therefore precautions should be taken to avoid delays which may be caused especially if filings to the CSSF are prepared without enough care and caution.

The business impact of these changes is expected to be limited, as it is envisaged they will not cause any significant delay in obtaining authorisations. The CSSF is committing to provide feedback within 10 working days of the filing of a new application.

In line with UCITS requirements, SIFs will be required to have risk management systems allowing for the appropriate identification, measurement and management of the risks associated with the investment positions and their contribution to the overall risk profile of the portfolio. Each SIF will also have to measure the risks associated with each of its strategies and must implement a strong liquidity and leverage risk management process. This obligation is expected to be further detailed by the CSSF. Existing SIFs will have until 30 June 2012 to design and implement a risk management process. This is pushy and deserves more attention as the process can be onerous considering what happened with UCITS IV, where many funds were too late in starting the process.

SIFs will be required to be structured and organised in such a way as to mitigate the risk of any conflict of interest between the SIF and, where applicable, any person involved in the activities of the SIF adversely affecting the interests of the investors. The CSSF is expected to specify this regulation further but this could lead to a new degree of scrutiny by the CSSF over the functions of the principals in all SIFs. Existing SIFs will have until 30 June 2012 to implement and maintain procedures relating to conflicts of interests.

On a more positive note the new law confirms that there will also be increased scrutiny from the CSSF to ensure that investors are eligible and SIFs must have procedures to ensure that only well-informed investors subscribe to them.

Approval from the CSSF will further be required for any material amendments to the issuing document of a SIF, it is also notable that articles of incorporation drawn up in English no longer need to be translated into French or German.

Umbrella SIFs will be allowed to have compartments investing in other compartments of the same SIF, provided that these compartments do not invest in the investing compartments.

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