With over 120 banking institutions and over 14,500 funds and sub-funds, Luxembourg is a major private banking centre in Europe and the second most important investment funds centre in the world after the US. Luxembourg is the first European platform for cross-border fund distribution, with over EUR5.4 billion of net assets under management.

Luxembourg also has highly skilled human resources and has a longstanding reputation for business-supportive and highly responsive regulatory authorities.

Luxembourg offers a highly mature legal and regulatory framework known for its reliability and flexibility.

Luxembourg offers a vast panel of vehicles involving varying levels of regulation to address every type of need in terms of investment and distribution strategies. The alternative investment funds (AIFs) may be supervised by the Luxembourg regulator, the Commission de Surveillance du Secteur Financier (CSSF) or adopt the legal form of partnerships or corporations without opting for a regulatory regime applicable to certain categories of funds.

Both types of setup are commonly used under Luxembourg laws depending on the objectives of the fund’s sponsors and the targeted investors. For a fund aimed at raising capital from a vast number of investors, the flexible structure of a reserved AIF is the most appreciated by both asset managers and investors due to limited regulatory requirements and fast setup. Holding companies (Soparfi) are also a good alternative to realise investments in the alternative assets space when the structure is tailored-made for one or several investors without any marketing activity.

Luxembourg laws are constantly evolving to ensure that the needs of the AIF market are addressed while providing a very flexible legal framework.

AIFs are typically organised in the form of limited partnerships, which allow for a great contractual freedom when it comes to the organisation of the governance, the rights and obligations of the investors, the distribution waterfall rules and the exit.

Depending on the regulatory regime, they can adopt a number of other legal forms such as a public limited liability company (SA), a private limited liability company (SARL), a corporate partnership limited by shares (SCA), a co-operative company in the form of a public limited liability company, a common limited partnership (SCS) or a special limited partnership (SCSP).

Regulated AIFs may also adopt the contractual type of a mutual fund, being the Fonds Commun de Placement – this entity has no legal personality and must be managed by a Luxembourg management company as per its management regulations.

AIFs may be open-ended or closed-ended; ie, with or without the possibility for the investors to request the redemption of their interests in the fund before the end of its lifetime.

While single funds are more common, a number of AIFs are set up as umbrella funds, accommodating a number of different investment strategies in compartments where assets and liabilities are ring-fenced.

Reserved Alternative Investment Funds (RAIF)

This regime is the most recent type of AIFs and is the most chosen regulatory form for AIFs set up in Luxembourg. It was introduced by the law of 23 July 2016 (RAIF Law). The RAIF Law added an important tool to Luxembourg’s investment funds range and is deemed by many industry professionals as crucial in facilitating Luxembourg’s ability to better compete with other major AIF centres. In the wake of the changing regulatory landscape for managers of AIFs, the RAIF represents a move away from “double layer” supervision by allowing the creation of an AIF, having all the features of a regulated investment fund but without requiring any prior authorisation or continued supervision by the CSSF.

The RAIF is indirectly supervised, as it is required under the RAIF Law to be managed by an authorised external alternative investment fund manager (AIFM) subject to the supervision of the CSSF or another EU member state regulator as per the EU Directive 2011/61/EU of 8 June 2011 on alternative investment fund managers (AIFMD).

RAIFs can be marketed on a cross-border basis thanks to a marketing passport available to its AIFM for professional investors residing in the EU. Professional investors (Professional Investors) are defined at the European level in Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments (MIFID II).

It may also be offered to well-informed investors. Well-informed investors are defined as institutional investors, professional investors and investors who have confirmed in writing that they adhere to the “well-informed” investor status, and who either invest a minimum of EUR100,000 in the fund or have been assessed by a credit institution, investment firm or management company, which certifies the investors’ expertise, experience and knowledge in adequately appraising an investment (Well-Informed Investors).

Specialised Investment Fund (SIF)

The SIF regime was created in 2007 by the law of 13 February 2007 (SIF Law) and is reserved for Professional Investors and Well-Informed Investors.

The SIF can be established with the prior authorisation of the CSSF and remain under its supervision until the closing of its liquidation. This vehicle is characterised by its flexibility, allowing all types of strategies in the alternative space with an investment diversification rule being limited to the principle that no asset may represent more than 30% of the portfolio.

SIFs remains an interesting alternative to RAIFs, for instance when the investors have constraints to invest in a regulated vehicle.

Investment Company in Risk Capital (SICAR)

The SICAR regime was created in 2004 to offer a customised framework for venture capital projects. A SICAR can be used for infrastructure, real estate, mezzanine or new technologies funds, if the target assets qualify as risk capital investments. The notion of risk capital comprises a significant level of risk, mostly related to the limited liquidity of the investments, and the active management of the portfolio to create value upon exit.

Similar to the SIFs, the SICARs are supervised by the CSSF and are available only to Professional Investors and Well-Informed Investors.

European Long-Term Investment Funds (ELTIFs)

ELTIFs are governed by Regulation (EU) 2015/760 (ELTIF 1 Regulation), which was amended in February 2023 (ELTIF 2 Regulation). ELTIF 2 Regulation will apply as of 10 January 2024, with a grace period for existing ELTIFs to comply or opt in before the end of the grandfathering period.

ELTIFs are EU-regulated AIFs managed by an authorised EU AIFM in compliance with the AIFMD and the ELTIF Regulation.

To be authorised as an ELTIF, an EU AIF must only invest in eligible investment assets that have been expended with ELTIF 2 Regulation to include, among others, securitised assets, green bonds, UCITS and other AIFs managed by EU AIFMs, which themselves invest in eligible assets on a “look-through basis”. The definition of real asset has also be updated to include immovable property, such as communication, environment, energy or transport infrastructure, social infrastructure (including retirement homes or hospitals, as well as infrastructure for education, health and welfare support) or industrial facilities, installations and other assets, including intellectual property, vessels, equipment, machinery, aircraft or rolling stock.

Access to retail investors will be simplified, with notably the removal of the minimum investment requirement, increased diversification requirements and higher borrowing limits. Retail investors will have protections, including suitability assessments, the ability to cancel subscriptions and early exit options.

Undertaking for Collective Investment (Part II UCI)

Part II UCI is the reference framework for hosting non-UCITS strategies open to retail investors. Part II UCIs are governed by Part II of the Law of 17 December 2010 (“UCI Law”). They are open to all categories of investors, from Professional Investors to retail investors. As a result, the regulatory regime is stricter than the one applicable to the other AIFs mentioned above. Part II UCIs are supervised by the CSSF.

SOPARFI

A Société de Participations Financières (SOPARFI) is a common corporation whose purpose is the acquisition, holding and management of participations. In certain instances, such SOPARFIs may be used for a particular project. They are governed by the law of 10 August 1915 on commercial companies and not subject to any supervision.

Eligible Assets and Risk Diversification

Luxembourg laws governing most of the AIFs set up in Luxembourg do not provide for any restrictions on eligible assets. Accordingly, full flexibility is granted to fund managers to design their product for investments in any kind of assets, from financial instruments to real estate properties, infrastructure assets, debt, new technologies companies or renewable energies facilities to mention a few.

As a matter of principle, AIFs must have a diversified portfolio of assets as referred to above.

The SICAR regime is an exception, as there is no diversification requirement, and this vehicle may invest in one asset only. However, SICARs may only invest in securities representatives of capital risk, which covers private equity and venture capital. The CSSF provided some guidance on the characteristics of risk capital investment.

With ELTIF 2 Regulation, concentration limits and diversification rules will be removed for ELTIFs marketed solely to Professional Investors. The limit on cash borrowing for ELTIFs reserved to Professional Investors will be increased to 100% of the ELTIF’s net asset value.

Authorisation Process

A SIF, SICAR, UCI and ELTIF can be established after obtaining the CSSF’s authorisation based on the constitutional documents of the vehicle, its issuing documents and various confirmation in respect of the managers of the vehicles. The approval process takes between two to six months depending on the complexity of the project.

Offering Documentation

Regulated funds are subject to CSSF’s prior authorisation and ongoing supervision. It reviews in particular all the pre-contractual information that has to be made available to potential investors under the applicable regulation in respect of the regime of the AIF. The most important documents are the constitutional document of the AIF and the issuing document, which should provide all the information needed for the investor to be able to make its investment decision.

The Luxembourg law that implemented the AIFMD on 12 July 2013 (AIFM Law) provides, in particular, in its Article 21 the list of the minimum information with an indication as to where it can be found in the AIF’s documents.

Any material changes to the documentation or to the management of a regulated fund must be approved by the CSSF in advance and accompanied by the amended supporting documents for consideration and approval by the CSSF, in addition to eventual approval of the investors in the AIF.

Annual Reports

Depending on the regulatory regime of the AIFs, annual audited accounts and management reports must be made available to the investors, filed with the CSSF and eventually published on the register of commerce and companies of Luxembourg.

In practice, the reporting to AIFs’ investors is frequently on a quarterly or even on a monthly basis depending on the class of assets and types of strategies. The AIFM has to ensure that these reports are made available to investors in due time.

Sustainability

European Union Regulation 2019/2088 of the European Parliament and the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (SFDR) imposes mandatory disclosure requirements regarding environmental, social and governance (ESG) considerations. SFDR is applicable since 10 March 2021 to financial market participants and financial advisers and aims to harmonise and increase the transparency requirements applicable in relation to the AIFs they manage or advise. It covers both pre-contractual disclosure requirements and non-financial periodic reporting, which has to be prepared at least annually.

SFDR was supplemented by a number of subsequent delegated acts notably Commission Delegated Regulation (EU) 2022/1288 of 6 April 2022 with regard to regulatory technical standards specifying the details of the content and presentation of the information in relation to the principle of “do no significant harm”, specifying the content, methodologies and presentation of information in relation to sustainability indicators and adverse sustainability impacts, and the content and presentation of the information in relation to the promotion of environmental or social characteristics and sustainable investment objectives in pre-contractual documents, on websites and in periodic reports, as amended and corrected (RTS).

AIFMs are obligated to disclose information about how they integrate sustainability risks within the management of AIFs and how they address adverse sustainability-related details. AIFMs may elect to adopt an investment strategy promoting investments that integrate environmental and/social criteria while ensuring proper governance. A further step commitment is to adopt an investment policy focusing on sustainable assets, which are further defined in the taxonomy regulation, being notably EU Regulation 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment (Taxonomy Regulation) as supplemented from time to time.

SFDR provides various means for conveying this information. Pre-contractual disclosures should be made available to investors through channels similar to those allowed under Article 23 of AIFMD, such as dedicated disclosure statements, annual reports and websites. Additional obligations may necessitate disclosure in the AIF’s annual report or on the AIFM’s website.

The RTS provide for specific templates for pre-contractual disclosures and periodic disclosures applicable to AIFs, notably those that have elected to promote environmental or social criteria when making their investments and those that have as an investment policy to invest in sustainable investments.

Luxembourg funds constituted under the 2010 UCI Law as amended, the 2007 SIF Law as amended or the 2016 RAIF Law (SIF-like only) as amended are tax-exempt in Luxembourg with the exception of the registration duty and annual subscription tax.

A UCI in a corporate form with a registered office or central administration in Luxembourg is subject to a registration duty of EUR75 upon incorporation or modification of the articles of incorporation. It also applies on the transfer to Luxembourg of the registered office or central administration.

This registration duty is fixed.

UCIs constituted as common funds are not subject to this registration duty.

Luxembourg retail funds are generally subject to an annual subscription tax of 0.05% on their net assets, whereas certain types of funds reserved for Well-Informed Investors, such as SIFs and RAIFs, benefit from a reduced rate of 0.01% without conditions. Since 1 January 2021, UCITS and Part II UCIs or their individual compartments investing in sustainable assets are also eligible for the super reduced rate of 0.01%.

On 24 July 2023, the chamber of deputies adopted a law on the modernisation of Luxembourg’s investment toolbox to increase the attractiveness and competitiveness of the country as a financial centre. From a tax perspective, the law provides clarifications on existing provisions related to the subscription tax exemption (eg, SICAR) and extends this exemption to new types of funds. SIFs, Part II UCIs and RAIFs will benefit from the subscription tax exemption when they separately indicate the value of assets represented by units held in other collective investment undertakings already subject to the subscription tax in the periodic declarations filed to the indirect tax authorities (Administration de l’enregistrement, des domaines et de la TVA). Additionally, the law provides an exemption from the subscription tax for ELTIFs irrespective of their regulatory regime. Under a transitional regime, existing exemptions from subscription tax for SIF remain applicable.

There is no stamp duty in Luxembourg on share issues or transfers.

Most UCIs have to register for Luxembourg VAT purposes to self-assess the VAT due in Luxembourg on services received from foreign suppliers, unless an exemption applies.

RAIF

Corporate tax

There is no corporate tax for an SIF-like regime. However, for a SICAR-like regime, the fund is fully taxable and subject to corporate income tax (CIT) and municipal business tax (MBT) at an aggregate rate of 24.94% for Luxembourg City.

For a RAIF structured under the form of a SICAR, there is an exemption on income and gains derived from risk capital investments.

Withholding tax

There is no withholding tax on dividends, interests or redemptions of shares/units.

Net wealth tax

There is no net wealth tax (NWT) for an SIF-like regime. A SICAR-like regime is subject to the minimum net wealth tax (MNWT).

Subscription tax

In principle, the subscription tax is 0.01% of the net asset value for an SIF-like regime and there is no subscription tax for a SICAR-like regime. However, in some cases, subscription tax may be reduced to 0% (eg, for the value of the assets represented by units held in other UCIs and SIFs, if such units have already been subject to the subscription tax, and some RAIFs under certain conditions).

VAT

Management fees are not subject to Luxembourg VAT.

SIF

Corporate tax

This is not applicable.

Withholding tax

There is no withholding tax on dividends, interests or redemptions of shares/units.

Net wealth tax

This is not applicable.

Subscription tax

In principle, the subscription tax is 0.01% of the net asset value. However, in some cases, subscription tax may be reduced to 0% (eg, for the value of the assets represented by units held in other undertakings for collective investment, if such units have already been subject to the subscription tax).

VAT

Management fees are not subject to Luxembourg VAT.

SICAR

Corporate tax

For a SICAR established as a corporation, it is fully taxable and subject to CIT and MBT at an aggregate rate of 24.94% for Luxembourg City. However, an exemption is available on income and gains derived from transferable securities (eg, shares, bonds, etc), as well as on income from funds awaiting (maximum 12 months) to be invested in risk capital securities.

SICARs established as partnership are not taxable.

Withholding tax

There is no withholding tax on dividends, interests or redemptions of shares/units.

Net wealth tax

There is no NWT; however, the SICAR is subject to the MNWT if set up as a corporation (ranging from EUR535 to EUR32,100).

Subscription tax

This is not applicable.

VAT

Management fees are not subject to Luxembourg VAT.

UCI Part II

Corporate tax

This is not applicable.

Withholding tax

There is no withholding tax on dividends, interests or redemptions of shares/units.

Net wealth tax

This is not applicable.

Subscription tax

In principle, the subscription tax is 0.05% of the net asset value. However, in some cases, subscription tax may be reduced to 0.01% of the net asset value (ie, money market, cash and institutional funds) or to 0% (eg, for the value of the assets represented by units held in other UCIs, SIFs and RAIFs, if such units have already been subject to the subscription tax).

VAT

Management fees are not subject to Luxembourg VAT.

SOPARFI

Corporate tax

For SOPARFIs incorporated as corporations, the fund is fully taxable and subject to CIT and MBT at an aggregate rate of 24.94% for Luxembourg City. Regarding SOPARFIs incorporated as partnerships, they are not subject to CIT but are subject to MBT in limited cases (ie, if the SCS/SCSP (i) carries out a commercial activity or (ii) is deemed to carry out a commercial activity; the latter occurs when the general partner is a joint-stock company holding at least 5% of the partnership’s interests).

Dividends and liquidation proceeds may benefit from participation exemption under certain conditions (ie, a qualifying company is holding 10% or with an acquisition price of at least EUR1.2 million in a qualifying subsidiary for a minimum holding period of 12 months). Capital gains may benefit from the participation exemption under certain conditions (ie, a qualifying company is holding 10% or with an acquisition price of at least EUR6 million in a qualifying subsidiary for a minimum holding period of 12 months).

Withholding tax

For SOPARFIs incorporated as corporations, there is a 15% withholding tax on dividends paid by a Luxembourg company. However, the withholding tax is reduced or is zero under double tax treaties or is exempt under the participation exemption regime under certain conditions (ie, a qualifying company is holding 10% or with an acquisition price of at least EUR1.2 million in a qualifying subsidiary for an uninterrupted period of 12 months).

For those incorporated as partnerships, no withholding tax on dividend applies.

Net wealth tax

For SOPARFIs incorporated as corporations, the NWT is 0.5% of the unitary value of the SOPARFI less than or equal to EUR500 million and 0.05% above EUR500 million, as per 1 January of each year. However, a shareholding of at least 10% or with an acquisition price of at least EUR1.2 million in qualifying subsidiaries is exempt from NWT.

For those incorporated as partnerships, there is no NWT.

Subscription tax

This is not applicable.

VAT

The VAT status of a SOPARFI is to be analysed on a case-by-case basis.

As Luxembourg AIFs are authorised to invest in any kind of assets, they are generally able to invest in debt and also to originate loans. However, this general authorisation is limited to funds that are under the supervision of the CSSF. Other entities that originate debt on a professional basis and for multiple loans are otherwise under the authorisation process provided in the law on the financial sector.

Among authorised AIFs, a SICAR can only invest in securities, which means that it cannot originate loans but can subscribe to bond issuances.

In March 2023, the CSSF adopted the guidelines of the European Banking Authority, whose aim is to ensure that in-scope entities have prudent loan origination and monitoring standards in place to prevent newly originated performing loans from becoming non-performing in the future and specify the internal governance arrangements for granting and monitoring of credit facilities throughout their life cycle. The guidelines also aim to ensure that the institutions’ practices are aligned with consumer protection rules and anti-money laundering (AML)/counter-terrorist financing (CFT) requirements.

The revised AIFMD, which is being adopted at the EU level, is expected to add new requirements for loan-origination funds, such as the need to be a closed-ended fund to avoid long-term illiquid loans and maturity mismatches. An exception will be available when the loan-originating AIF’s liquidity risk-management system is compatible with its investment strategy and redemption policy so that the fair treatment of investors is ensured. The current proposal contains a few indications, such as the nature of the loan origination (shareholder loan versus third-party loans); selection and use of the liquidity management tool (LMT); appropriate redemption policy given the liquidity profile of the AIF; availability of liquid assets and stress testing. AIFMs managing such loan-origination AIFs will have to implement detailed policies and procedures for the activation and deactivation of the chosen LMTs and to notify the regulator of the home member state of the AIF accordingly.

AIFMs will be prohibited from managing “originate-to-distribute” AIFs with the sole purpose of transferring those loans to third parties.

In principle, nothing prevents funds from investing in virtual assets qualifying as financial instruments or electronic money.

Based on the FAQ released by the CSSF, AIFs may invest directly and indirectly in virtual assets that are not financial instruments under MiFID or electronic money under the Electronic Money Directive, if the following conditions are met.

• The AIF markets its units only to Professional Investors.
• The investment by the AIF in virtual assets does not prevent the application of and compliance with existing regulatory requirements.
• If the AIF is managed by an authorised AIFM, the AIFM should have obtained from the CSSF the extended authorisation for this new investment strategy.

In response to the specificities of the virtual assets and associated risks (ie, volatility, liquidity and technological risk) that may affect the risk profile of the AIF, the CSSF expects that a proper assessment be made during the integration of the virtual assets in the investment policy, it should be ensured that adequate internal control functions are implemented and investors are properly informed in a transparent and timely manner.

The AIFs may further invest in crypto-assets, defined as “a digital representation of a value or of a right which may be transferred and stored electronically, using distributed ledger technology or similar technology,” which are not regulated by existing EU financial services legislation.

Investments in these crypto-assets falling outside existing EU financial services legislation are subject to Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets (MiCA Regulation), which establishes a specific regulatory regime for the following stablecoins, e-money tokens and asset-referenced tokens.

In particular, the MiCA Regulation imposes investor disclosure requirements, with the notification and publication of an information document (a crypto-asset white paper similar in nature to a securities prospectus) (White Paper). The MiCA Regulation sets out mandatory requirements for the content and form of the White Paper, which include the following.

• Provisions requiring detailed descriptions of the project.
• The rights and obligations attached to the crypto-asset.
• Information on the underlying technology.
• A description of the risks involved.
• Information on the principal adverse environmental and climate-related impact of the consensus mechanism used to issue the crypto-asset.

The White Paper and, where applicable, the marketing communication must be notified to the CSSF and published on the issuer’s website. An ex ante approval of the White Paper or of any marketing communication relating to it before its publication is not required.

It is common to set up subsidiaries for investment purposes or to implement certain strategies.

Aside from the benefit of certain structuring for tax and liability reasons, it is often beneficial from a commercial perspective to anticipate the sale of an asset from the AIF. The use of intermediate companies permits the choice of an asset deal or a share deal, which is difficult to anticipate at the time of the investment when the exit strategies and potential buyers are unknown.

Generally, there is no requirement for a Luxembourg fund to appoint a local investment manager established in Luxembourg.

AIFs set up with a view to raise capital from investors are typically managed by supervised AIFMs. They are granted a licence to manage and market AIFs set up in Luxembourg or in other EU member states, and they benefit from an EU passport for such activities allowing them to manage the AIFs established in another EU member state or market the fund’s units, shares or partnership interests to any Professional Investors within the EU. AIFMs may delegate portfolio management subject to compliance with the following delegation rules set forth under the AIFM Law:

• The AIFM must be able to justify its entire delegation structure on objective reasons.
• The AIFM must be able to demonstrate that:
1. the delegate is:
1. qualified and capable to undertake the delegated functions; and
2. selected with due care; and
2. it is in a position to:
1. monitor effectively the delegated activity;
2. give further instructions to the delegate; and
3. withdraw the delegation with immediate effect.
• The delegate must dispose of sufficient resources to perform the respective tasks.
• The persons who effectively conduct the business of the delegate are of sufficiently good repute and experienced.
• The delegation will not prevent the effectiveness of supervision of the AIFM (ie, to act and manage the AIF in the best interests of its investors).

Where the delegation concerns portfolio/risk management and is conferred to the following.

• EU delegate – only undertakings authorised or registered for asset management and subject to supervision or, if not, only subject to prior approval by the national competent authority (NCA) of the home member state of the AIFM.
• Third-country delegate – same requirements apply as for EU delegates, in addition, co-operation between the NCA of the AIFM’s home member state and the supervisory authority of the undertaking must be ensured.

Depending on the investment strategy, it is very common to see the Luxembourg AIFM appointing an investment adviser from the sponsor located in another jurisdiction in the EU or in a third-party country.

The central administration of the AIF has to be performed in Luxembourg. It is then required to ensure that all AIF decisions are adopted in Luxembourg by the governing body of the AIF. As a result, the board of managers is composed mainly of Luxembourg resident managers.

There is a general requirement to demonstrate that such central administration is in Luxembourg through the rent of premises or the engagement of personnel; however, the setup is generally adapted to the recourse of external service providers, as the case may be.

AIFs typically rely on the administrative services provided by a number of professionals, notably in respect of accounting, maintenance of the registrar of investors, corporate services, etc.

Luxembourg as a financial centre comprises numerous companies that can deliver these services to AIFs.

From a regulatory perspective, it is compulsory for a number of AIFs to appoint a depositary that must be either of the following.

• Regulated banks for financial instruments.
• Professional depositaries for assets other than financial instruments.

The current AIFMD requirement is that a depositary should be located in the same member state as the appointing EU AIF.

All AIFs are subject to AML/CFT regulations, which derive from EU legislation. Compliance with the AML/CFT regulations is performed either internally or outsourced to other professionals with the necessary competencies and expertise. The appointment of service providers depends on the legal form and regulatory regime of the fund. Directors, conducting officers, AML officers (responsable du respect des obligations en matière de lutte contre le blanchiment et le financement du terrorisme (RR)) and compliance officers (responsable du contrôle du respect des obligations en matière de lutte contre le blanchiment et le financement du terrorisme (RC)) are required to have sufficient knowledge and experience of the legal and regulatory framework applicable to the fund they serve and have sufficient time to dedicate to the function.

The RR can be the board of directors of the AIF acting as a collegial body. Alternatively, the board may appoint one of its members as the RR. The RR must be reachable for any contact by the Luxembourg AML/CFT competent authorities.

The RC should be mandated intuitu personae by the board of directors (or other governing body) of the AIF. The AIF may appoint a third-party RC. The RC may also be chosen among the staff of the AIFM. As a principle, the RC must be available in Luxembourg for the accomplishment of their tasks. However, on an exceptional basis, and under certain conditions, it is acceptable that the RC is located outside of Luxembourg, if the AIFM and its relevant staff member acting as the RC are not domiciled in Luxembourg.

Their appointment/replacement may be subject to the CSSF’s prior approval.

Ancillary services may be outsourced to non-Luxembourg entities, for instance IT services, if the outsourcing of these services is in line with Luxembourg regulatory safeguards.

In November 2023, the final text of the political agreement on the proposal of a new directive, called “AIFMD II”, that will amend the existing AIFM and UCITS directives was published. A formal vote at the European Parliament and the Council on AIFMD II is expected during Q1 2024, and EU member states will have two years to transpose it within their national law.

Based on the final text, the changes expected are as follows:

Loan-Originating Funds

AIFMD II defines a loan-originating AIF as an AIF: (i) whose investment strategy is mainly to originate loans; or (ii) where the notional value of the AIF’s originated loans represents at least 50% of its net asset value.

Under AIFMD II, the loan originating funds will be governed by the following rules.

• Loan-originating AIFs are generally required to be closed-ended, unless the AIFM demonstrates compatibility with the investment strategy and redemption policy, with the European Securities and Markets Authority (ESMA) developing draft RTS for open-ended AIFs’ compliance requirements.
• Leverage limits for loan-originating AIFs are set at 300% for closed-ended and 175% for open-ended, calculated as the ratio between exposure and net asset value.
• A 20% concentration limit on loans to a single borrower applies if the borrower is a financial undertaking, AIF or UCITS.
• AIFMs must retain 5% of originated loans transferred to third parties until maturity (up to eight years for consumer loans) or at least eight years for other loans.
• AIFMD II prohibits AIFMs from managing AIFs with an “originate-to-distribute-strategy”, with the sole purpose of transferring those loans to third parties.
• Transitional rules distinguish between existing AIFs’ originating loans (with a five-year opt-in period for AIFMs) and existing loans (benefiting from rules’ implementation exemption).

Liquidity Risk Management

The AIFMD II will require EU and non-EU AIFMs to disclose to investors the AIF’s liquidity risk management system before they enter into a subscription agreement.

An AIFM overseeing an open-ended AIF will be required to choose a minimum of two liquidity management tools, such as redemption gates, notice periods, liquidity fees, swing/dual pricing, anti-dilution levy or redemptions in kind. Money market funds are, as an exception, allowed to use only one tool.

The AIFM must establish and follow detailed procedures for activating and deactivating selected tools. Any unusual use of these tools, including suspension of redemptions, side pockets or others, must be promptly reported to the NCA of the home member state. The NCA then informs the host member state’s NCA and the ESMA, with potential risks to financial stability reported to the ESRB. The ESMA is tasked with creating regulatory standards for loan-originating AIFs’ open-ended structure and guidelines on selecting and calibrating liquidity tools for AIFM risk management and financial stability mitigation.

Delegation

EU AIFMs will be required to report to the NCA the delegation arrangements they may have, including disclosure of the total delegated asset under management, the percentage of the portfolio, and details about the persons involved.

AIFMD II grants the NCA of the AIF’s home member state the authority, following a case-by-case evaluation of the absence of relevant depositary services, to permit institutions from another member state to serve as depositaries. This is contingent upon the AIFM submitting a justified request, demonstrating the lack of suitable depositary services in the home member state and proving that appointment of a depositary from another member state aligns with the AIF’s investment strategy. Additionally, this is subject to the aggregate amount of assets in the national depositary market of the AIF’s home member state not exceeding EUR50 billion or its equivalent. When such an appointment is approved, the relevant NCA must inform the ESMA. AIFMD II also specifies conditions for appointing a depositary from a third country, including the country not being high-risk, having a signed agreement with the home member state and not being listed in the EU’s non-co-operative jurisdictions for tax purposes. If these conditions change post-appointment, a new depositary must be appointed within a reasonable period, not exceeding two years, considering investors’ interests.

Independent Directors

Under AIFMD II, AIFMs managing AIFs marketed to retail investors are encouraged to appoint at least one non-executive or independent director to the board of the AIFM. In making that appointment, the AIFM has to ensure that the director is independent in character and in judgment and has sufficient expertise and experience to be able to assess whether the AIFM is managing the AIF or UCITS in the best interest of investors.

Cost and Charges

AIFMD II will also require the AIFM to report each year all the direct and indirect fees and charges incurred by the AIF. In addition, the AIFM will have to disclose annually the charges and expenses incurred by investors, whether directly or indirectly.

In Luxembourg, promoters/sponsors come mainly from the US, the UK, Germany, Switzerland, France, Italy, Belgium, Luxembourg, Denmark, the Netherlands and Asia.

See 3.3 Regulatory Regime for Managers.

An AIF is required to appoint an AIFM. AIFMs are generally obligated to adhere to the regulations outlined in the AIFM Law and must obtain a licence while being subject to regulatory supervision. It’s noteworthy that an AIFM can be appointed for an AIF situated in another EU member state, thanks to the passport regime introduced by the AIFMD.

Nevertheless, the AIFM Law does provide an exemption for AIFMs with smaller assets under management. Such entities only need to undergo a simple registration with the CSSF and are obligated to report the size of their assets under management. This exemption is applicable if the AIFs they manage have less than EUR100 million (when leverage is used) or less than EUR500 million (for AIFs that are closed-ended for at least five years and do not use leverage). It’s important to note that this exemption does not extend to RAIFs, which must always be managed by a fully licensed AIFM.

Entities offering investment advice exclusively to a Luxembourg AIF (without making investment decisions) and located in Luxembourg are subject to the Luxembourg law dated 5 April 1993 on the financial sector, as amended (1993 Law). Generally, they are required to obtain a licence for providing such services and are supervised by the CSSF. However, exemptions exist for entities serving a limited number of AIFs. Advisers situated outside Luxembourg and not offering services within the country are not bound by these requirements, and none of the specific investment fund laws mandate regulatory supervision for such entities.

Authorised AIFMs must notably comply with the following requirements.

Shareholding

Authorisation is subject to communication to the CSSF of the identity of the shareholders whether direct or indirect, natural or legal persons who have qualifying holdings in the AIFM as well as the amount of the holdings. Shareholders must possess the requisite qualities to ensure sound and prudent management of the AIFM.

Initial Capital and Own Funds

Full authorisation of an AIFM is subject to the fund having an initial capital of at least EUR125,000.

The AIFM must hold sufficient own funds, which is determine with regard to the volume of assets under management.

Professional Liability Risk

To cover professional liability risks resulting from its activities, an AIFM must either have additional own funds to cover potential liability risks arising from professional negligence or hold a professional indemnity insurance against liability for such risks.

Members of the Governing Body and Conducting Officers

The members of the governing body of the AIFM and the persons in charge of the day-to-day management must be of adequate repute and sufficiently experienced with regard to the investment strategies pursued by the AIF managed by the AIFM.

They must pass a fit and proper test by the CSSF and the number of their mandates must be limited.

Infrastructure and Organisation

The head office and registered office of an AIFM established in Luxembourg must be located in Luxembourg. AIFMs must, at all times, employ adequate and appropriate human and technical resources necessary for their proper management. The AIFM must have in place sound administrative and accounting procedures, reliable control and safeguard arrangements for electronic data processing and adequate internal control mechanisms.

Risk, Compliance, and Internal Audit

Every AIFM must establish and maintain operational permanent risk management, compliance and internal audit functions. Each of these functions must be independent and separate from the services and activities they monitor. Permanent compliance and internal audit functions must be established by the AIFM. Under certain conditions, outsourcing or delegation will be possible.

Remuneration Policies

AIFMs are required to establish remuneration policies that align with sound and effective risk management and do not encourage excessive risk-taking.

Luxembourg management companies are commercial companies subject to standard corporate taxes in Luxembourg.

Luxembourg companies are subject to a registration duty of EUR75 upon incorporation and if the articles of incorporation are modified. The registration duty also applies when the effective place of management or registered office is transferred to Luxembourg.

Luxembourg resident management companies are fully taxable entities. Their worldwide taxable income is subject to CIT plus an employment fund surcharge and MBT at an aggregated rate of 24.94%.

Companies are subject to the annual Luxembourg NWT at a rate of 0.5% on the adjusted net asset value up to and including EUR500 million and 0.05% on the part of the adjusted net asset value exceeding EUR500 million at the beginning of the year.

Luxembourg resident companies subject to Luxembourg CIT are subject to a minimum NWT equal to EUR4,815 if the sum of financial fixed assets, amounts owed by affiliated undertakings and by undertakings with which the company is linked by virtue of participating interests, transferable securities, cash in banks, cash in postal check accounts, checks and cash in hand, exceeds 90% of the company’s balance sheet total and EUR350,000.

Luxembourg resident companies subject to Luxembourg CIT are subject to whichever is higher between the minimum NWT and the NWT determined based on their unitary value. The unitary value is calculated, in principle, as the difference between: (i) assets estimated at their fair market value; and (ii) liabilities toward third parties.

Management companies are considered as taxable persons for Luxembourg VAT purposes but may be relieved from the obligation to register for Luxembourg VAT subject to certain conditions. Management services provided to UCIs, including AIFs and other investment vehicles, are VAT-exempt.

Article 214 of the AIFM Law provides that AIFs established outside of Luxembourg territory are exempt from CIT, business tax and wealth tax where their effective management centre or head office is on Luxembourg territory.

In accordance with the AIFM Law, “carried interest” is defined as a share in the profits of the AIF accrued to the AIFM as compensation for the management of the AIF and excluding any share in the profits of the AIF accrued to the AIFM as a return on any investment by the AIFM into the AIF.

There is no predefined form set under the AIFM Law.

The carried interest is taxable at standard tax rates in the hands of the recipient and the tax consequences depend on the structure of the carried interest (eg, dividend, capital gain, employment income, and service fee).

The favourable tax regime set under the AIFM Law, and according to which individuals having established their tax domicile in Luxembourg in the period from 1 January 2013 to 31 December 2018 could benefit from a beneficial tax rate, is no longer available (ie, no longer applicable to individuals establishing their residence in Luxembourg after 31 December 2018). A new regime is currently under discussion. However, it is not yet known when new measures will be enforced.

If the carried interest is considered as compensation for the management of the AIF, the remuneration falls within the scope of VAT but should benefit from the VAT exemption scheduled for the management of UCIs.

Managers may delegate and outsource some of their investment functions or business operations to third parties subject to certain regulatory requirements as set forth in the AIFM Law, the CSSF circulars and regulations. The delegation or outsourcing may be subject to prior approval of the CSSF and should not, in any case, result in a situation where all functions are outsourced and delegated, with the AIFM being a letter-box entity.

The requirements in relation to delegation and outsourcing relate notably to the effective management of functions, due diligence and supervision of appointed delegates or outsourced companies, and reporting requirements as further detailed in the legal and regulatory sources.

The Luxembourg regulator issued a number of circulars and communications describing in more detail the conditions applicable to outsourcing, notably for IT and other services, which are key for the business continuity of the AIFMs.

For AIFMs established in Luxembourg, the CSSF requires the following conditions to be fulfilled.

• The AIFM has enough initial capital and own funds as provided by the law.
• The persons conducting the AIFM must have a good reputation and sufficient experience (their identity, along with their successors, must be disclosed to the CSSF).
• The AIFM’s shareholders or partners must be suited to the position.
• Both the head office and registered office must be located in Luxembourg.

According to CSSF Circular 18/698, the substance requirements for a AIFM are the following:

Management Body Requirements

• At board level:
1. There must be at least three members of the management body/governing body. However, in case of a two-tier system in which the supervisory and management functions are separated, the supervisory board must be composed of at least three members and the management board must be composed of at least two members.
2. There are requirements regarding the skills, experience and good repute and the composition of the management body/governing body.
3. Fund managers may not hold more than 20 mandates and their total contractual hours may not exceed 1,920 per annum (according to the circular, the CSSF may grant derogations to the mandate cap).
4. Obligations regarding meetings and deliberations – board meeting should be held at least once every quarter and the minutes should be easily available to the CSSF.
• Senior management:
1. Required number, presence in Luxembourg and contractual relationship with the AIFM – a fund must have at least two full-time executive directors. For the accomplishment of their tasks, the conducting officers must, in principle, be permanently located in Luxembourg. However, this does not prevent the conducting officers from having their domicile in a place allowing them, in principle, to come to Luxembourg every day.
2. There are requirements regarding the skills, experience and the good repute of the senior management.

Organisational Requirements

• There are arrangements regarding the central administration of the AIFM. Every AIFM must employ at least three full-time people at the head office in Luxembourg who perform key functions. Depending on the nature and complexity of its activity, the AIFM must adapt the size of the teams performing key functions and employ more people with the necessary skills, knowledge and expertise in order to perform key functions.
• Backup and replacements of key persons have to be well managed. Long-term absences or departures of staff members (for example, resignations or dismissals) cannot impair the proper functioning of the AIFM in the long run. In the absence of a staff member in charge of key functions, it is necessary to arrange that a staff member with appropriate experience and necessary independence replaces them if needed.
• Every AIFM must have a central administration in Luxembourg, consisting of a “decision-making center” and an “administrative center”. This requirement implies that the AIFM cannot just have a corporate or registered office in Luxembourg. The AIFM must have own secured office space.
• There are requirement for technical infrastructure, IT and business continuity.

General Internal Governance Arrangements and Internal Control Functions

• Permanent risk management function.
• Permanent compliance function.
• Permanent internal audit function.

AML/KYC Requirements

• Obligation to designate an AML/CFT compliance officer at senior management level and drawing up of a summary report on AML/CFT.
• RR/RC appointment.

Information Flows to the CSSF

• Annual reports are to be sent within five months of the relevant year-end.
• Annual reports have to include sections on mandates for each board member and senior manager, risk management process, the derivatives used, compliance function, internal audit function, AML/KYC obligations, direct distributors, complaints handling, the list of third-parties authorised to receive complaints and all delegates of collective management tasks.

Requirements With Respect to Organisation and Procedures

• Management information and internal reporting system.
• Business continuity.
• Manual of procedures.
• Management of conflicts of interest.
• Rules of conduct.
• Remuneration policy.

Management of Delegation

• Mandatory notifications to CSSF and yearly reporting.
• Details of the due diligence process in terms of content, criteria to be used for the selection, risk-based approach, permanent monitoring, periodicity and follow-up.
• Delegation framework to avoid letter-box entity concept.

In addition, an external auditor should be appointed.

Reorganisation, structuring and change of control of Luxembourg AIFMs or management companies such as mergers, liquidations, spin-offs, etc, are subject to the CSSF’s prior approval (with provision of supporting documents), as well as the approval of the shareholders/partners of the AIFMs or management companies under the rules set forth in their articles of association.

See 2.12 Anticipated Changes.

Following the US, Luxembourg is the second most important investment funds centre in the world and the most important in Europe. The combination of Luxembourg’s political stability with the lowest debt-to-GDP ratio in the world, its highly skilled human resources, longstanding reputation for business-supportive and reactive regulatory authorities, as well as a highly mature legal and regulatory framework makes it a very attractive market for investors.

The most common investors are Professional Investors, who are the investors investing in SIFs, RAIFs and SICARs, for example.

More challenging investors for funds in Luxembourg are retail investors, ie, investors that are not Professional Investors. These investors benefit from greater protection from the law. In Luxembourg, retail investors can only invest in UCITS or UCI Part II funds, as such funds provide for a more protective legal framework for non-Professional Investors.

Side letters are very common and are generally requested by Professional Investors to ensure that they can meet their own regulatory regime or conform with the internal organisation requirements. The side letter will then typically provide either confirmation on the interpretation of the AIF’s documentation or additional information, documents or reports that should be provided to the investor from time to time.

The side letters cannot cover items that would impact on the other investors in the AIFs. Accordingly, the provisions of the side letters can not alter the investment policy, the distribution rules or the governance of the AIFs. This principle does not prevent an investor from obtaining a seat at an advisory committee composed of representatives of the investors, which has only a consultative role.

It has become common practice to have a most favoured nation clause in these side letters, which results in other investors being offered the opportunity to elect the benefit of the clauses contained in side letters entered into by other investors in the same AIF.

In Luxembourg, AIFs can be marketed to the following investors depending on their regulatory regime (see 3.3 Regulatory Regime for Managers):

• professional investors:
• well-informed investors; and
• retail investors.

In general, marketing Luxembourg AIFs in Luxembourg does not require any other authorisation than the one needed at the time of the creation of the AIF, be it regulated or not.

However, if there is an offer to the public, the provisions of Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market will apply.

Premarketing

The law of 21 July 2021 implementing Directive (EU) 2019/1160 with regard to the cross-border distribution of collective investment undertakings and amending the AIFM Law, introduced a premarketing regime pursuant to which the pre-distribution of AIF units is subject to a notification to the CSSF to be made within two weeks of the beginning of the activities.

EU AIFMs will be allowed to engage in premarketing activities to test an investment idea or an investment strategy with potential Professional Investors domiciled or with a registered office in the EU, to test their interest in an AIF or a compartment, not yet established and benefiting from the AIFMD passport regime.

However, premarketing in the EU is not permitted where the information presented to potential Professional Investors meets any of the following conditions:

• Is sufficient to allow investors to commit to acquiring units or shares of a particular AIF.
• Amounts to subscription forms or similar documents whether in a draft or final form.
• Amounts to constitutional documents, a prospectus or offering documents of a not yet established AIF in final form.

The normal process to benefit from the marketing passport should be complied with within the 18 months of the beginning of the premarketing activities, if the idea of a fund so tested be successful. The premarketing notification does not grant any derogation right to the marketing regime under the AIFMD.

Marketing

Managers authorised under the AIFM Law may perform marketing activities without requiring an additional authorisation from the CSSF.

A Luxembourg AIFM that intends to market to Professional Investors in Luxembourg the units or shares of an AIF, which is managed by that AIFM and is established in another member state, must submit a notification file to the CSSF. The notification file should include the following information:

• A notification letter, including a programme of operations identifying the AIFs that the AIFM intends to market and information on where the AIFs are established.
• The AIF rules or instruments of incorporation.
• Identification of the depositary of the AIF.
• Description of, or any information on, the AIF available to investors.
• Information on where the master AIF is established if the AIF is a feeder AIF.
• Any additional information referred to in Article 21(1) of the AIFM Law for each AIF the AIFM intends to market.
• Where relevant, information on the arrangements established to prevent units or shares of the AIF from being marketed to retail investors, including where the AIFM relies on activities of independent entities to provide investment services in respect of the AIF.

Within 20 working days following receipt of a complete notification file, the CSSF must inform the AIFM whether it may start marketing the AIF identified in the notification file. The CSSF will prevent the marketing of the AIF only if the AIFM’s management of the AIF does not or will not comply with the AIFM Law or the AIFM otherwise does not or will not comply with the AIFM Law. For a positive decision, the AIFM may start marketing the AIF in Luxembourg from the date of the CSSF’s notification to that effect.

The CSSF will also inform the competent authorities of the AIF that the AIFM may start marketing units or shares of the AIF in Luxembourg.

Passporting

Where the EU AIFM wishes to market in other member states, the home regulator must transmit the notification documentation to the regulator of the relevant member state within 20 working days. Upon transmission, the home regulator must notify the EU AIFM “without delay” of such transmission and the EU AIFM may market to Professional Investors in the relevant member state from the date of such notification.

If there is any material change to any of the information provided by the EU AIFM, the EU AIFM must give prior written notice of such change to its home regulator.

Marketing Communications

Luxembourg AIFMs must ensure that all marketing communications addressed to investors are identifiable as such and describe the risks and rewards of purchasing units of an AIF in an equally prominent manner, and that all information included in marketing communications is fair, clear and not misleading. Luxembourg AIFMs must comply with the requirements under Article 4 of the EU Regulation 2019/1156 on Cross Border Distribution of Funds (CBDF Regulation), as well as with the ESMA Guidelines on Marketing Communications (ESMA34-45-1272) under the CBDF Regulation and CSSF Circular 22/795.

There is no regulatory requirement in Luxembourg to appoint a placement agent for the distribution of AIFs.

Distribution of AIF’s units is typically governed by MIFID rules, which provide for a comprehensive set of obligations in respect of sharing of information and co-operation with the distributor and inducement rules.

Rules regarding the remuneration of managers of AIFs are governed by the AIFMD. Managers are required to adhere to the ESMA Guidelines governing sound remuneration policies under the AIFMD. Additionally, each manager must comply with CSSF Circular 10/437, applicable to all entities under CSSF prudential supervision. The fundamental principles entail ensuring that the remuneration policy fosters sound risk management, avoids encouraging excessive risk-taking, strikes a suitable balance between fixed and variable components, and when the variable component represents a significant part of the remuneration, the payment of a considerable portion of this variable component must be deferred for a minimum period (over three to five years as appropriate).

These rules extend to staff whose professional activities have a material impact on the AIFM’s risk profile or an AIF it manages.

The tax treatment applicable to investors depends on whether they are individuals or corporations and whether they are residents in Luxembourg.

Non-resident fund investors (individuals and corporations) are exempt from taxation in Luxembourg on capital gains realised upon the sale of their shares in a Luxembourg corporate fund even if they held a substantial shareholding of more than 10%.

Upon distribution of dividends by the fund or redemption of the shares or units of the fund, the Luxembourg resident individual or corporate investor has to declare its income from the fund in its annual tax return.

Capital gains arising from the sale of shares or units other than speculative gains (ie, sale of the shares or units within six months after acquisition) are exempt from taxation in the hands of Luxembourg-residing individual investors. If the individual investor holds more than 10% of the capital of a fund in corporate form, any gain realised on the sale of the shares is subject to individual taxation in Luxembourg. The level of taxes varies based on whether the capital gain qualifies as long-term or short-term capital gain.

Dividends and capital gains realised upon redemption of shares or units in a Luxembourg fund are generally subject to corporate taxation at the level of a Luxembourg corporate investor regardless of the holding period and the percentage held.

Luxembourg funds may be subject to withholding taxes on dividends and interest and to tax on capital gains in the source country of their investments. Only certain double tax treaties (DTTs) signed by Luxembourg are applicable to Luxembourg funds. Based on Circular LG – A No 61 of 8 December 2017 released by the Luxembourg tax authorities, DTTs signed with 56 countries should be applicable to investment companies.

For investment companies set up under the SIF Law, DTTs with these countries should, in principle, also apply except for the DTT with Spain.

DTTs should also apply to investment companies set up under the RAIF Law.

Common funds, however, will not benefit from the DTT provisions unless the unitholders themselves are able to claim the reduced rate under the DTT.

Investment companies may also rely on the provisions of the DTTs signed with Bulgaria, Greece and Italy even if the applicability is not expressly mentioned.

Under the FATCA legislation published in the official gazette on 29 July 2015, Luxembourg entities should assess whether they qualify as reporting financial institutions (RFIs).

The definition of a financial institution is very broad and includes investment vehicles.

If these investment vehicles are RFIs, they should identify all US clients and investors to the US tax authorities (IRS).

If they do not maintain US reportable accounts, the RFIs are required to file “nil returns” with the Luxembourg tax administration.

Failure to comply with FATCA provisions will result in a 30% withholding tax applied by US withholding agents and by other FFIs on “withholdable payments” to “non-participating foreign financial institutions,” including, for example, dividends and interest paid by US issuers.

The Law of 24 December 2015 introduced the Common Reporting Standard (CRS). According to the CRS, each Luxembourg RFI will have to file a report to the Luxembourg tax authorities prior to 30 June of each year. The report has to include each reportable account and has to fulfil certain criteria.

The RFIs are required to identify the residents of CRS partner jurisdictions, via the collection and reporting of certain information pertaining to the tax resident status of any account holder or beneficial owner of certain entities. They are required to report this information to the Luxembourg tax authority (Administration des Contributions Directes), which will in turn transfer the information to the relevant competent foreign tax authorities.

The law of 18 June 2020 amended the CRS law and introduced a new obligation for Luxembourg RFIs according to which a nil report should be filed to the Luxembourg tax authorities in the absence of CRS reportable accounts. As mentioned above, such a nil report was already required under FATCA law but was only recommended for CRS purposes. Only the non-reporting financing institutions such as exempt collective investment vehicles for CRS were exempt from this nil reporting obligation. The Luxembourg tax authorities clarified that “Luxembourg Investment Advisers and Investment Managers”, which benefit from a non-reporting status under FATCA but not under CRS, are now required to file a nil report for CRS purposes, whereas they were exempt from such an obligation under FATCA.

Both the FATCA law and the CRS law provide for penalties to be charged by the Luxembourg tax authorities, up to EUR250,000 if a Luxembourg financial institutions fails to comply with the required due diligence procedures or fails to implement reporting mechanisms, and 0.5% of amounts due to be reported by the FI (and a minimum of EUR1,500) for failure to report or incomplete or incorrect reporting.

As of 1 January 2021, a further fine of EUR10,000 may apply if a Luxembourg reporting FI fails to submit an annual FATCA or CRS report on time (including, for failure to submit a nil report).

Finally, in fulfilling its obligations under the FATCA law and the CRS law, a Luxembourg fund is acting as a data controller as defined by the EU GDPR and, therefore, has related obligations.

Pursuant to international rules and Luxembourg laws and regulations (comprising but not limited to the 1993 Law, the Luxembourg law of 12 November 2004 on the fight against money laundering and terrorist financing transposing Directive 2001/97/EC of the European Parliament and of the Council of 4 December 2001 on prevention of the use of the financial system for the purpose of money laundering, as may be amended (AML/CFT Law), as well as regulations and circulars of the CSSF (including notably CSSF Regulation No 12-02, and CSSF Circular 18/698, as amended), obligations have been imposed on all financial sector professionals, including AIFMs and self-managed AIFs, to prevent the use of AIFs for money laundering purposes.

In the context of Luxembourg AIFs, the AML and KYC regime typically includes the following key aspects.

Customer Due Diligence (CDD)

AIFs are required to conduct thorough due diligence on their investors and counterparties.

The board of managers of the management company holds the ultimate responsibility for ensuring at all times that all obligations imposed by applicable laws, rules and regulations with respect to AML/CFT are complied with, notably in its capacity as responsable du respect des obligations or RR.

It is required to conduct thorough due diligence on its investors, counterparties and investment opportunities in compliance with the provisions of the aforementioned AML/CFT Law and CSSF Regulation No 12-02. This involves collecting and verifying information about the identity, source of funds and business activities of the investors.

Should the AIFM act as RR, it will be ultimately responsible for the implementation of the AML/CFT policy at the level of the AIF, including in the case of delegation of some tasks in respect of AML/CFT to the central administration agent, to the registrar and transfer agent, the depositary and to the RC as the case may be.

As a result of such provisions, the Registrar and Transfer Agent of the AIF must ascertain the identity of the AIF’s investors. Accordingly, the Registrar and Transfer Agent may require, pursuant to its risk-based approach, investors to provide proof of identity. In addition, the Registrar and Transfer Agent may require, at any time, additional documentation to comply with applicable legal and regulatory requirements.

Where scenarios present a higher risk in relation to money laundering and terrorist financing, the AIF will undertake (and ensure that its Registrar and Transfer Agent will act as such) additional customer due diligence measures. Such measures include:

• obtaining additional information on the prospective investor and updating the identification data of the prospective investor and its beneficial owner more frequently;
• obtaining additional information on the intended nature of the business relationship, source of wealth and source of funds that are involved in the business relationship or transaction;
• obtaining information on the reasons for intended or performed transactions;
• obtaining the approval of the RR to commence or continue the business relationship;
• requiring the first payment to be carried out through an account in the prospective investor’s name with a professional subject to similar customer due diligence standards;
• verifying the additional information obtained with independent and reliable sources;
• receiving a visit from the prospective investor or contacting the prospective investor via registered letter with acknowledgment of receipt;
• conducting enhanced monitoring of the business relationship, by increasing the number and timing of controls applied; and
• selecting patterns of transactions that need further examination.

Where the units of the AIF are subscribed through an intermediary/nominee acting on behalf of its customers, enhanced customer due diligence measures will be applied on the relationship of this intermediary/nominee with its customers in accordance with the AML/CFT Law and CSSF Regulation No 12-02.

Risk assessment

A risk-based approach is often employed, meaning that the level of due diligence and monitoring is proportionate to the perceived risk of money laundering or terrorist financing associated with a particular investor or transaction.

The AIF will notably assess the following variables in determining the degree of risk:

• Customer risk factors:
1. The business relationship is conducted in unusual circumstances.
2. Customers resident in geographical areas of higher risk as set out under the section “geographical risk factors” below.
3. Legal persons or arrangements that are personal asset-holding vehicles.
4. Companies that have nominee shareholders or shares in bearer form.
5. Businesses that are cash-intensive.
6. The ownership structure of the customer appears unusual or excessively complex given the nature of the customer’s business.
7. The customer is a third-country national who applies for residence rights or citizenship in exchange for capital transfers, purchase of property or government bonds, or investment in corporate entities.
• Product, service, transaction or delivery channel risk factors:
1. Private banking.
2. Products or transactions that might favour anonymity.
3. Non-face-to-face business relationships or transactions, without certain safeguards, such as electronic signatures.
4. Payment received from unknown or not associated third parties.
5. New products and new business practices, including new delivery mechanism, and the use of new or developing technologies for both new and pre-existing products.
6. Transactions related to oil, arms, precious metals, tobacco products, cultural artefacts and other items of archaeological, historical, cultural and religious importance, or of rare scientific value, as well as ivory and protected species.
• Geographical risk factors:
1. Countries identified by credible sources, such as mutual evaluations, detailed assessment reports or published follow-up reports, as not having effective AML/CFT systems.
2. Countries identified by credible sources as having significant levels of corruption or other criminal activity.
3. Countries subject to sanctions, embargos or other similar measures issued by, for instance, the EU or the UN.
4. Countries providing funding or support for terrorist activities, or that have designated terrorist organisations operating within their country.

The AIF (or the Registrar and Transfer Agent, as the case may be) will examine, as far as reasonably possible, the background and purpose of all complex and unusually large transactions including all unusual patterns of transactions that have no apparent economic or lawful purpose. In particular, the degree and nature of monitoring of the business relationship will be enhanced to determine whether such transactions or activities appear suspicious.

As per CSSF Regulation No 12-02 as amended, when performing an investment, the AIF must compute an AML/CFT risk scoring of the asset and perform an AML/CFT due diligence in line with the computed risk scoring. In the framework of investment business, it will analyse the AML/CFT risk posed by the investment and take due diligence measures adapted to the risk assessed and documented. Such analyses will be formalised. The risk analysis on investments will be reviewed annually and when particular events require it.

Record-keeping

AIFs are required to maintain comprehensive records of customer identification and due diligence measures. These records should be accessible for regulatory inspection.

Reporting obligations

AIFs may have reporting obligations to relevant authorities regarding suspicious transactions, and they are expected to co-operate with law enforcement agencies in the event of an investigation.

Internal organisation and appointment of a compliance officer

Entities are required to establish effective policies and procedures covering various aspects such as CDD, reporting, record keeping, internal control, risk assessment, risk management, compliance management and communication to fulfil their legal obligations related to AML/CFT.

AIFs may need to appoint an RC responsible for ensuring adherence to the AML and KYC regulations and for overseeing the implementation of internal policies related to customer acceptance, identification, monitoring and risk management.

The RC is mandated to produce an annual summary report on compliance with AML/CFT professional obligations. According to CSSF Circular 18/698, this report should include key elements such as the outcomes of the identification and assessment of money laundering/terrorist financing risks along with the measures taken to mitigate them, the results of due diligence and enhanced due diligence on politically exposed persons (PEPs), the count of identified breaches of AML/CFT professional obligations, the monitoring of positions blocked due to AML/CFT concerns, the periodic review of all business relationships based on their risk levels and the number of AML/CFT actions implemented, accompanied by explanations and deadlines for their implementation.

The RC is required to possess adequate experience and knowledge of Luxembourg’s legal and regulatory AML/CFT framework, dedicate sufficient time to their role, maintain a permanent presence in Luxembourg (or have a domicile enabling daily access to Luxembourg), and be an employee of the AIFM. Any changes in these personnel details must be communicated in advance to the CSSF.

The RC is granted access to all internal documents and systems necessary for executing their duties, ensuring compliance with the skills and responsibilities outlined in CSSF Regulation No 12-02.

Sanctions

Money laundering and terrorist financing offences are outlined in Articles 506-1 to 506-7 of the Luxembourg Criminal Code. Broadly speaking, these offences encompass actions such as:

• Assisting in justifying the false origin of the subject or the proceeds from certain criminal activities.
• Assisting in the placement, conversion or concealment of the subject or proceeds of such activities.
• Acquiring, holding or using the proceeds of such activities.

These offences are associated with a range of criminal activities, including but not limited to drug trafficking, tax offences, organised crime, kidnapping of minors, sexual offences against minors and prostitution. It is important to note that the definition of money laundering offences encompasses any crime punishable by a prison sentence exceeding six months.

Laundering money from, or linked to, any of the underlying criminal activities is punishable by one to five years of imprisonment and/or a fine of up to EUR1.25 million.

The Luxembourg legal and regulatory regime applicable in relation to data security and privacy is inspired by EU legislation, namely GDPR with certain adjustments adopted in the Luxembourg law. The aim of the regulation is to protect the personal data of investors (as data subjects), their treatment and communication by a data processor and data controller (especially in the context of outsourcing of activities by service providers to third-country service providers) and their rights of access and amendment as data subjects.

Refer to the developments in 2.12 Anticipated Changes with respect to AIFMD II.

On 20 July 2021, the European Commission presented its proposal for a sixth Directive on money laundering and terrorist financing (AMLD 6), which will replace existing Directive 2015/849. AMLD 6 focuses on harmonising the definition of money laundering offences. This harmonisation addresses the disparities in interpretation across member states’ domestic legislation, creating a more consistent and unified approach in combating illicit activities throughout the EU. Notably, AMLD 6 introduces 22 predicate offences, including cybercrime and environmental crimes.