By Olivier Sciales – Luxembourg’s Parliament has adopted on 6 March legislation amending the February 2007 law on Specialised Investment Funds, adapting the highly successful SIF regime to European and international developments regarding regulation and transparency of alternative investments.
The revised legislation reflects in particular the requirements of the European Union’s Directive on Alternative Investment Fund Managers, which will take effect on July 22, 2013. It also follows some aspects of Luxembourg’s funds legislation of December 17, 2010, which transposed into national law the Ucits IV Directive governing cross-border distribution of retail funds within the EU and introduced other changes affecting non-Ucits funds.
In addition, the revisions to the SIF regime reflect the experience of Luxembourg’s regulator, the Financial Sector Supervisory Authority (CSSF), over the more than five years since it was established by legislation of February 13, 2007. Over that period the number of SIFs has grown from around 220 (vehicles recategorised from Luxembourg’s previous regime from institutional funds) to 1,387 at the end of January 2012, and they account for more than one-third of all investment funds domiciled in the grand duchy.
The revised legislation was submitted to the Chamber of Deputies on August 12 last year. Although it was originally hoped that the law could be adopted by the end of the year, it was not until January that Parliament’s Finance and Budget Committee approved an amended version of the draft bill. The committee finalised its report on the legislation to the full Chamber on February 28, and it received almost unanimous approval from deputies a week later. The law will come into force on the day following its publication in the Mémorial, Luxembourg’s official journal.
The revisions to the legislation include measures to bring the SIF law into line with AIFM Directive rules covering areas including delegation, risk management and the handling of actual or potential conflicts of interest. Following the December 2010 legislation, it will allow sub-funds of a SIF umbrella structure to invest in other compartments of the same structure in the same way that Ucits funds can do.
The most notable change abolishes an eye-catching, but not heavily used, provision of the 2007 SIF that allowed fund promoters to wait until up to a month after the launch of a fund to submit it to the CSSF for approval. Henceforth funds must be authorised by the regulator before they can be launched.
In its advice to Parliament, Luxembourg’s Chamber of Commerce noted that “one might regret the disappearance of certain advantages relating to the approval and information procedures that up to now have made SIFs particularly flexible investment vehicles”.
However, the Council of State, which is responsible for scrutinising legislation, said in its report that this change was “more a measure of legal security and a codification of existing practice than a restriction, since almost all promoters applied for approval before launching their funds in order to avoid the risks and costs entailed by any changes to the documentation, operating model or investment policy that the CSSF might have required in the case of approval sought following the launch of the fund”.
The legislation is relatively short, consisting of just 18 articles covering five A4 pages. The first article states that the activity of management of a SIF must comprise at a minimum management of the investment portfolio. This explicitly excludes from the SIF regime passive funds that seek to create value solely by the long-term holding of assets and creates a distinction between SIFs and private wealth management companies created under Luxembourg’s law of May 11, 2007, but it does not exclude private equity or real estate funds.
Article 2 requires SIFs to have in place procedures to verify that its investors qualify as sophisticated rather than retail clients. The Council of State argued that this measure was superfluous, but the Finance and Budget Committee decided to retain it as a means of reminding SIFs and their promoters of their obligations.
Article 3 allows SIFs created as open-ended investment companies (Sicavs) to benefit from measures in the 2010 law under which fund articles of association drawn up in English no longer need to be translated into French or German. In addition, such funds no longer need to send shareholders physical (as opposed to electronic) copies of their annual reports unless this is specifically requested, Finally, given potential for high turnover of shareholdings in a SIF, they may establish a registration date five days preceding an annual general meeting of shareholders for the purposes of determining voting rights and what constitute a quorum.
Article 5 of the draft law amends Article 42 of the 2007 SIF legislation, which allowed promoters of a fund to apply for approval of their articles of association, choice of custodian and their executives and portfolio managers after the fund’s launch rather than before. This change brings SIFs into line with funds created under the 2010 legislation.
A new requirement makes authorisation subject to notification of the persons responsible for management of the SIF’s investment portfolio to the CSSF, which must certify that they are of good reputation and have the experience necessary to manage the type of alternative investment fund in question. Any changes in the identity of the fund’s portfolio managers must also be notified to the regulator.
Article 6 creates a new Article 42bis of the legislation requiring SIFs to implement systems to detect, measure, manage and monitor the investment risk of its individual positions and their contribution to the portfolio’s overall risk profile. They must also be structured and organised to minimise the risk of conflicts of interest, and draw up rules to manage such conflicts that do arise to prevent any harm to investors. The CSSF is mandated to draw up regulations setting out detailed requirements in these areas.
Reflecting the CSSF’s experience in supervising SIFs since 2007, Article 7 defines the conditions under which SIFs may delegate various tasks and functions to third-party providers. The CSSF must be informed in advance and delegation should not affect oversight of the fund; individuals or legal entities to which portfolio management is delegated must be authorised or licensed for that function and subject to prudential regulation, unless the CSSF grants permission for delegation to individuals or entities that do not meet this requirement.
A fund’s managers must be able to determine that the delegated provider is qualified and capable, and they must retain ultimate control over the fund’s activities and the ability to revoke the delegation. Delegation should not create conflicts of interest – so, for instance, investment management may not be delegated to the fund’s custodian – and the delegation of functions must be revealed in the fund’s offering documents.
The CSSF’s powers of supervision and enquiry over SIFs are set out in Article 8, which brings the legislation into line with the requirements of the Ucits IV Directive, while Article 9 set out circumstances in which the CSSF or the Luxembourg prosecutors may apply to the courts for the dissolution and liquidation of one or more fund compartments.
Article 10 deals with administrative fines, which the CSSF may publish unless this would seriously affect financial markets, damage the interests of investors or cause disproportionate prejudice to the parties affected. On the insistence of the Council of State, a clause has been inserted into the text confirming that firms may appeal against such penalties.
Under Article 12, the CSSF’s approval is now required for any substantial change made to the SIF’s offering documents, such as the name of the fund or of sub-funds, the replacement of the custodian, administrator, auditor or manager, the creation of new sub-funds or a significant change in investment policy.
Article 13 states that funds are not prohibited from deviating from their investment policy for the purposes of liquidity management, hedging or efficient portfolio management, while Article 14 bars SIFs in the form of companies that are in the course of being liquidated from issuing new shares, except where this is beneficial to the outcome of the liquidation itself. Article 15 allows the CSSF to withdraw authorisation for one or more sub-funds of a SIF while maintaining the authorisation for other sub-funds of the same structure.
Article 16 of the new law follows the 2010 legislation in allowing one sub-fund of a SIF to invest in another. This article clarifies that the rules regarding a company’s investment in its own shares set out in Luxembourg’s 1915 company law do not apply to SIFs. Sub-funds of the same SIF may not cross-invest in each other, and voting rights of shares held by one sub-fund in another are suspended.
Finally, Article 17 stipulates that SIFs established before the date of entry into force of the revision law will have a transitional period up to June 30, 2012 before they are obliged to comply with its requirements on ascertaining that their investors are sophisticated (Article 2, paragraph 3) and risk management and conflicts of interest (Article 42bis), and up to June 30, 2013 to comply with the new rules on the delegation of functions (Article 42ter).
Olivier Sciales is a partner at Chevalier & Sciales. More information can be found on the AIFM Directive blog at www.cs-avocats.lu/aifm-directive .