Investment Funds 2024

Last Updated February 08, 2024

Luxembourg

Law and Practice

Authors



BSP is an independent full-service law firm based in Luxembourg, and is committed to providing the best possible legal services to its domestic and international clients in all aspects of Luxembourg business law. The firm’s lawyers have developed particular expertise in banking and finance, capital markets, corporate law, dispute resolution, employment law, investment funds, intellectual property, private wealth, real estate and tax. In these practice areas, as in others, the firm’s know-how and its ability to work in cross-practice teams and to swiftly adapt to new laws and regulations allow it to provide clients with timely and integrated legal assistance vital to the success of their business. Building on the synergy of its different professional experiences and the richness of its diverse cultural background, BSP stands ready to meet its clients’ legal needs, no matter how challenging they are.

As the second largest fund market in the world after the US, Luxembourg has earned itself a reputation for stability, a business-friendly environment and excellence in the provision of services to the investment management industry. The world’s leading asset managers have chosen Luxembourg as a centre for their international fund ranges, and Luxembourg regulated funds are now distributed in more than 80 countries throughout the world. As of October 2023, Luxembourg had approximately EUR5.07 trillion in assets under management in regulated funds.

Since the first UCITS Directive in 1985, Luxembourg has been at the forefront of the implementation of European financial legislation, showing an ability to evolve and adapt quickly to changing requirements. A wide choice of vehicles now exists, allowing managers to structure a fund – both alternative investment funds (AIFs) and retail funds – in Luxembourg that best suits their own needs as well as the needs of their investors.

The success of Luxembourg as a financial centre is testament to the strong regulatory and operational environment that Luxembourg has created. Its willingness to adapt to change will ensure that the industry will continue to thrive over the coming years.

The principal legal vehicles used to set up alternative funds in Luxembourg are as follows.

  • Undertakings for collective investment (Part II UCI) governed by Part II of the Law of 17 December 2010 (the “UCI Law”), which may be constituted in the form of a common fund (fonds commun de placement – FCP), an investment company with variable capital (société d’investissement à capital variable – SICAV) or an investment company with fixed capital (société d’investissement à capital fixe – SICAF). A 2023 amendment to the UCI Law broadened the range of corporate forms available for a Part II UCI. They may now be established as SICAVs in the form of an SCA, SCS, SCSp, société coopérative organised as an SA and Sàrl, as opposed to just SAs. Part II UCIs are supervised by the Commission de Surveillance du Secteur Financier (CSSF), which is the supervisory authority in Luxembourg. The main advantage of these funds is that they are open to all types of investors, including retail.
  • Specialised investment funds (fonds d’investissement spécialisé – SIF) governed by the Law of 13 February 2007 (the “SIF Law”), which may be constituted as an FCP, SICAV or SICAF. While SIFs have the advantage of having almost no restrictions in terms of what they can invest in, they are only open to well-informed investors. Like the Part II UCI, they are supervised by the CSSF.
  • The investment company in risk capital (société d’investissement en capital à risque – SICAR) governed by the Law of 15 June 2004 (the “SICAR Law”), which may only be constituted as a corporate or partnership entity (ie, it cannot be an FCP). It has the advantage of having no investment diversification rules, but it must invest in risk capital. As such, it is generally used for investments in venture capital and private equity. The SICAR is supervised by the CSSF and is only open to well-informed investors.
  • Reserved alternative investment funds (fonds d’investissement alternatif réservé – RAIF) governed by the Luxembourg Law of 23 July 2016 (the “RAIF Law”), which may be constituted as an FCP, SICAV or SICAF (in the case of a SICAV or SICAF it can choose any of the available corporate or partnership forms). The RAIF can choose to follow the SIF or SICAR regime in terms of the type of assets it invests in. Its particular advantage is that it is not subject to the supervision of the CSSF and, as such, a RAIF can potentially be brought to the market more quickly than the supervised entities. Unlike the Part II UCI, SIF and SICAR, the RAIF is always obliged to appoint an authorised external alternative investment fund manager (AIFM).
  • The Luxembourg special limited partnership (société en commandite spéciale – SLP), which is an unregulated and unsupervised entity. It is characterised by its contractual freedom and is not subject to any investment or diversification constraints.

RAIFs, Part II UCIs, SIFs, SICARs and SLPs that have designated an AIFM established in the European Economic Area (EEA) can market their shares, units or limited partnership interests to professional investors throughout the EEA, pursuant to the specific notification procedure provided for by the Alternative Investment Fund Managers Directive (AIFMD).

Each Part II UCI, SIF, SICAR and RAIF may be established as an umbrella fund, allowing the creation of multiple compartments. This option is not available to the unregulated SLP.

Any of these vehicles which are set up in the form of an FCP issues units. Those in corporate form issue shares, and those in the form of partnerships issue limited partnership interests.

The Part II UCI, the SIF and the SICAR are subject to authorisation by the CSSF prior to establishment. An application file must be submitted to the CSSF consisting of at least the following documents (there are certain ancillary documents and the CSSF may always request further information):

  • an offering document;
  • a constitutive document;
  • agreements with key service providers, including the depositary, the AIFM, any delegated portfolio manager and the central administration agent;
  • information on the directors or managers, who must be of sufficiently good repute and be sufficiently experienced;
  • a PRIIPs key information document (KID) if retail investors are targeted; and
  • application forms.

The RAIF is not subject to approval by the CSSF, but the following documents will still be required:

  • an offering document;
  • a constitutive document; and
  • agreements with key service providers, including the depositary, the AIFM, any delegated portfolio manager and the central administration agent.

The SLP is frequently structured as an unregulated AIF, which is not authorised and not regulated by the CSSF. There is no requirement to have an offering document, although one is frequently prepared for marketing reasons. The limited partnership agreement is the key document for an SLP. As there is no approval process at the CSSF, the set-up time is shorter for the RAIF and the SLP.

However, for all vehicles, the establishment process needs to factor in time for due diligence to be performed by the service providers as well as time to complete bank account opening processes.

The largest set-up costs are generally legal costs, although service providers also sometimes charge a set-up or on-boarding fee. In addition, there are fees payable to the CSSF for regulated funds. For a Part II UCI, SIF and SICAR, the CSSF charges an examination fee and an annual fee for its supervisory activity. The fee amount differs depending on whether the fund is a standalone or an umbrella fund, and on whether or not it is self-managed. For example, the examination fee for a standalone Part II UCI, SIF or SICAR is EUR4,650, whereas for an umbrella fund it is EUR9,250.

The liability of an investor is generally limited to its commitment or subscription to the fund. In the case of an AIF in the form of an SCA, SCSp or SCS, there will always be an unlimited partner, which is generally an entity controlled by the fund initiators and usually referred to as the general partner. The general partner has unlimited and joint and several liability for all the obligations of the fund.

For a Part II UCI, SIF, RAIF and SICAR, a prospectus or offering document and an audited annual report must be made available to investors. A PRIIPs KID must also be made available if the fund is to be marketed to retail investors.

The Part II UCI must also prepare a semi-annual report.

There are no specific disclosure requirements for an SLP, unless it has appointed a fully authorised AIFM, in which case it is obliged to also prepare audited annual accounts.

Pursuant to the AIFMD, certain disclosures must be made to investors in the offering documents of those funds managed by an AIFM.

In addition, regulated vehicles (SIF, SICAR and Part II UCI) are subject to periodic reporting to the CSSF for statistical and oversight purposes.

Finally, any fund vehicles that are managed by a fully authorised AIFM will be indirectly subject to the Annex IV reporting required to be submitted to the CSSF, pursuant to the AIFMD.

There has been increased demand for access to AIFs in recent years, as investors seek more diversification than is offered by retail funds. Well-informed and institutional investors represent the majority of investors in AIFs in Luxembourg, although there has been a trend towards the retailisation of AIFs.

The legal structure used will depend on the type and location of the investors, as well as the nature of the investment. SIFs, SICARs and RAIFs are intended for well-informed investors, and Part II UCIs are often used if there is an intention to target retail investors.

Increasingly, unregulated RAIFs or SLPs (managed by an authorised AIFM) are used as they offer more certainty in terms of time to market.

SIFs, SICARs and RAIFs are restricted to investment by well-informed investors. The Part II UCI can be marketed to both professional and retail investors in Luxembourg. There are no restrictions under Luxembourg law on who the limited partnership interests of an SLP can be sold to. However, for marketing in other jurisdictions, the AIFMD marketing passport will only allow the marketing of the interests in an SLP to professional investors.

Pursuant to the Law of 12 July 2013 on alternative investment fund managers (the “AIFM Law”), authorised AIFMs established in Luxembourg, in another EEA member state or in a third country are authorised to market AIFs they manage to retail investors in Luxembourg, provided the following conditions are met:

  • the AIFs must be subject to permanent supervision in their home state, in order to ensure the protection of investors; and
  • the AIFs must be subject to regulation in their home state, providing investors with guarantees of protection at least equivalent to those provided by Luxembourg laws governing AIFs authorised to be marketed to retail investors in Luxembourg. The home state supervision must also be equivalent to that provided in Luxembourg.

The regulatory regime applicable to an AIF differs depending on the type of fund. All AIFs are indirectly subject to the provisions of the AIFM Law. The extent to which the AIFM Law is applicable depends on whether a fund is managed by a fully authorised AIFM or a registered AIFM.

The Part II UCI is subject to investment restrictions and risk diversification rules arising from the “UCI Law” and various implementing CSSF circulars. For example, a Part II UCI cannot generally:

  • invest more than 10% of its assets in securities that are not listed on a stock exchange and are not traded on another regulated market that operates regularly and is recognised and open to the public;
  • acquire more than 10% of the same type of securities issued by the same issuing body; and
  • invest more than 20% of its net assets in securities issued by the same issuing body.

These general investment restrictions do not apply to Part II UCIs that adopt a fund of fund structure if the investment funds in which the Part II UCI shall invest are open-ended and are themselves subject to similar general investment restrictions. In addition, these general investment restrictions do not apply to Part II UCIs that are mainly investing in venture capital or real estate, or pursuing alternative investment strategies.

Part II UCIs may, in principle, borrow the equivalent of up to 25% of their net assets without restriction as to the intended use thereof.

Part II UCIs that are mainly investing in real estate may borrow the equivalent of up to an average of 50% of the valuation of all their properties.

Part II UCIs that are mainly pursuing alternative investment strategies (hedge funds) may borrow up to 400%.

There are no asset restrictions for SIFs, but they may not invest more than 30% of their assets or commitments in securities of the same type issued by the same issuer.

A RAIF that has chosen the SIF regime is subject to similar rules.

The SICAR is obliged to invest its funds in assets representing risk capital but is not subject to any diversification rules. A RAIF that has chosen the SICAR regime is subject to the same rules.

In general, the SLP is not subject to any investment restrictions or risk diversification rules.

AIFs may choose one of the EU labels, such as European Venture Capital Fund (EuVECA), European Social Entrepreneurship Fund (EUSEF) or European Long Term Investment Fund (ELTIF), in which case they will also be governed by the rules applicable to those regimes.

Luxembourg AIFs may be managed by an AIFM based in a member state of the EEA. If an AIFM established in another member state intends to market units or shares of an EEA AIF that it manages to professional investors in Luxembourg, the competent authorities of the home member state of the AIFM must transmit the notification file to the CSSF.

For RAIFs, SIFs, SICARs and Part II UCIs, the respective depositary must either have its registered office in Luxembourg or have a branch there if its registered office is in another EU member state. The central administration of these entities must be located in the Grand Duchy of Luxembourg.

CSSF Circular 22/811 clarified that foreign investment fund managers with the appropriate licence may act as administrator for non-regulated funds in Luxembourg (eg, SLPs).

Part II UCIs, SIFs or RAIFs established in the form of an FCP must appoint a Luxembourg AIFM. AIFs in corporate or partnership form can appoint an AIFM established anywhere in the EEA. In order to manage a Luxembourg fund, such AIFMs must provide a notification to their home supervisory authority, which will transmit it to the CSSF.

The portfolio management of Luxembourg AIFs can be delegated to managers situated in third countries, provided that, in the case of regulated funds, prior approval is obtained from the CSSF.

AIFMs that intend to delegate the task of carrying out functions on their behalf to third parties must notify the supervisory authorities of their home member state before the delegation arrangements become effective.

The approval process usually takes between three and six months and is dependent on several factors, including:

  • the completeness of the initial application;
  • the speed with which the CSSF’s queries are answered;
  • whether it is a first-time fund; and
  • the nature of the investment policy.

Pursuant to the AIFM Law, an AIFM that is established in another member state and is pre-marketing or intending to pre-market an AIF to professional investors in Luxembourg must notify the supervisory authority of its home country (the CSSF in the case of Luxembourg AIFMs), including:

  • specifying in which countries and during which periods the pre-marketing is taking or has taken place; and
  • providing a brief description of the pre-marketing, including information on the investment strategies presented and, where relevant, a list of the AIF(s) and compartments of AIF(s) that are or were subject to pre-marketing.

Information presented to potential professional investors in the context of pre-marketing cannot:

  • be sufficient to allow investors to commit to acquiring units or shares of a particular AIF;
  • amount to subscription forms or similar documents, whether in draft or final form; nor
  • amount to constitutional documents, a prospectus or offering documents of a not-yet-established AIF in final form.

The AIFM must ensure that professional investors do not acquire units or shares in an AIF through pre-marketing, and that investors contacted as part of pre-marketing may only acquire units or shares in that AIF after the formal marketing notification.

Any subscription by professional investors, within 18 months of the AIFM having begun pre-marketing, to units or shares of an AIF referred to in the information provided in the context of pre-marketing, or of an AIF established as a result of the pre-marketing, shall be considered to be the result of marketing and shall be subject to the applicable notification procedures (see 2.3.8 Marketing Authorisation/Notification Process).

AIFMs marketing AIFs in Luxembourg must comply with the provisions of the AIFMD. Where another firm is marketing in Luxembourg, it could be considered to be carrying out an activity of the financial sector and should thus be licensed or otherwise authorised to do so, pursuant to the Law of 5 April 1993 on the financial sector. Firms from other EU member states with the appropriate licence pursuant to the Markets in Financial Instruments Directive (MiFID) would be authorised to carry out distribution activities in Luxembourg.

All marketing communications will need to comply with the requirements of Article 4 of Regulation 2019/1156 on facilitating cross-border distribution of collective investment undertakings. CSSF Circular 22/795 stipulates that Luxembourg AIFMs must provide the CSSF with information regarding marketing communications, and the CSSF will conduct testing to verify their compliance with the applicable requirements under Article 4.

SIFs, SICARs and RAIFs are reserved for and can only be marketed to well-informed investors in Luxembourg – ie, institutional investors, professional investors or any other investors who meet the following conditions:

  • they have confirmed in writing that they adhere to the status of well-informed investor; and
  • they invest a minimum of EUR100,000, or have been the subject of an assessment made by an entity such as a bank, management company or AIFM certifying their expertise, experience and knowledge in adequately apprising an investment in a fund.

Part II UCIs can be marketed to any type of investors (both retail and well-informed investors).

In addition to the above restrictions, EEA AIFs managed by an authorised AIFM can be marketed to professional investors in Luxembourg, pursuant to Article 32 of the AIFMD.

As previously discussed, in certain circumstances authorised AIFMs may market non-Luxembourg AIFs to retail investors in Luxembourg.

EuVECAs and EUSEFs governed by Regulation (EU) No 345/2013 and Regulation (EU) No 346/2013, respectively, can be marketed to professional investors and other investors, provided that each investor (noting that such funds could take one of the available forms of fund in Luxembourg like SICAR or SIF):

  • commits to investing a minimum of EUR100,000; and
  • states in writing that they are aware of the risks associated with the envisaged investment.

ELTIFs, which are AIFs that could take the form of one of the available funds in Luxembourg, are potentially available to be marketed to both retail and professional investors upon notification in accordance with Article 32 of the AIFMD, depending on the rules with which they comply.

An AIFM wishing to market to professional investors in Luxembourg must submit a notification to the competent authorities of its home member state (the CSSF for Luxembourg AIFMs) in respect of each EEA AIF that it intends to market. This does not apply to Luxembourg AIFMs marketing Luxembourg regulated funds. The notification must contain certain information, including:

  • a notification letter, with a programme of operations identifying the AIFs 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;
  • the indication of the member state in which it intends to market the units or shares of the AIF to professional investors; and
  • information about arrangements made for the marketing of AIFs and, where relevant, information on the arrangements established to prevent units or shares of the AIF from being marketed to retail investors, including in the case where the AIFM relies on activities of independent entities to provide investment services in respect of the AIF.

The competent authorities of the home member state of the AIFM should transmit the complete notification file to the CSSF, no later than 20 working days after the date of receipt. From the date of notification of such transmission, marketing can begin.

Those AIFMs wishing to market non-Luxembourg AIFs to retail investors must follow the detailed rules laid down in CSSF Regulation 15-03 on the marketing of foreign alternative investment funds to retail investors in Luxembourg. Prior to marketing its units or shares to retail investors in Luxembourg, any foreign AIF must have obtained authorisation from the CSSF for such marketing.

Material Changes

In the event of a material change in the information contained in its original marketing notification file, an AIFM must provide written notice of this change to its home state competent authority (the CSSF in the case of Luxembourg AIFMs), by resubmitting a marked-up version of the original notification file, indicating the proposed changes.

All material changes planned by the AIFM must be notified to the CSSF at least one month before implementing the change, or immediately after an unplanned change has occurred.

De-notification

An AIFM may de-notify arrangements made for marketing as regards units of shares of some or all of its AIFs in Luxembourg, if the following conditions are met:

  • other than in respect of closed-ended funds and ELTIFs, a blanket offer is made to repurchase or redeem all such units or shares held by Luxembourg investors, free of any charges or deductions;
  • the intention to terminate arrangements made for marketing such units or shares is made public by means of a publicly available medium; and
  • any contractual arrangements with financial intermediaries or delegates are modified or terminated with effect from the date of de-notification in order to prevent any new or further, direct or indirect, offering or placement of such units or shares.

The de-notification procedure is carried out through the home supervisory authority of the AIFM, which then informs the CSSF.

However, if an AIFM intends to cease the marketing of its non-Luxembourg AIF to retail investors in Luxembourg, it must inform the CSSF about whether Luxembourg investors are still invested in the AIF.

SIFs, SICARs and RAIFs are intended for well-informed investors that are able to adequately assess the risks associated with an investment in such vehicles.

Part II UCIs can be marketed to retail investors, but the applicable investment restrictions add to investor protection, in addition to the fact that they are supervised by the CSSF. The fact that all AIFs bar the unregulated SLP must appoint a depositary and an auditor provides additional protection for investors.

Any AIF managed by an authorised AIFM needs to provide audited annual accounts which, in the case of regulated AIFs, need to be provided to the CSSF. The CSSF is also made aware of the content of the management letters.

In addition, such funds are required to disclose certain information to investors, pursuant to the rules of the AIFMD, and to inform investors of any changes thereto. The AIFMD imposes rules on the preferential treatment of investors and disclosure to them, and the valuation of an AIF’s assets must be carried out in accordance with such rules.

AIFMs are also required to have risk management, liquidity management and conflict of interest policies in place, all of which serve to add to the protection of investors. Part II UCIs must, in addition, produce a half-yearly report for submission to the CSSF.

All of the regulated funds are subject to regular reporting to the CSSF, to enable it to carry out its supervisory function.

In the case of a dispute with a Part II UCI, a retail investor can request the CSSF to impartially intervene for an out-of-court resolution, although the CSSF's out-of-court decision is not binding on the parties.

In the case of regulated funds, CSSF Circular 02/77, relating to the protection of investors in the case of net asset value (NAV) calculation errors and correction of the consequences resulting from non-compliance with the investment rules, sets out specific rules for dealing with such circumstances in a way that does not harm investors.

The CSSF takes a practical approach. It can be approached for face-to-face meetings, particularly in relation to a new entry to the market or in relation to new projects. As regards ongoing matters, it can be reached by phone or email. The CSSF has also set up an electronic platform to facilitate the exchange of documents and information.

See 2.3 Regulatory Environment for further discussion on investment restrictions, borrowing restrictions and risk diversification rules applicable to Luxembourg AIFs.

AIFs managed by a fully authorised AIFM and SIFs, SICARs and Part II UCIs that do not have an AIFM must appoint a depositary acting in the interests of investors and providing services as required by the respective product laws as well as the AIFM Law (ie, safekeeping of assets, cash monitoring and monitoring of compliance with the legal and regulatory framework). Depositaries must be credit institutions established in Luxembourg and must have a specific licence granted by the CSSF in order to carry out such business or be so-called depositary-lites, which may be appointed for certain types of AIFs that do not hold financial instruments and that must be held in custody.

AIFs must have an AML policy and comply with the AML Law for their business relationships (including for their investors).

The asset valuation of AIFs must be done in accordance with the laws applicable to them, and in accordance with the AIFM Law where the AIFs are managed by a fully authorised AIFM.

Luxembourg AIFs frequently borrow for bridging finance, for working capital purposes or, in the case of some funds, for leverage.

While there are lenders on the Luxembourg market, lenders are often from outside Luxembourg.

There are no borrowing restrictions applicable to SIFs, SICARs, RAIFs or SLPs, although pursuant to the AIFMD there are rules around disclosing the maximum amount of leverage. Part II UCIs are subject to borrowing restrictions (generally 25% of the NAV, although this can be increased in the case of hedge funds).

The lender will generally always take security, the type of which will depend on the type of borrowing and the types of assets involved. Security over undrawn commitments and pledges over Luxembourg bank accounts are often seen.

Part II UCIs, SIFs and RAIF-SIFs

Part II UCIs, SIFs and RAIF-SIFs are exempt from net wealth tax, municipal business tax and corporate income tax. Luxembourg withholding tax does not apply to distributions made by the SIF to investors. These entities also benefit from a value-added tax (VAT) exemption on management services.

SIFs and RAIF-SIFs are subject to subscription tax at an annual rate of 0.01% based on their NAV. There are, however, several categories of exemptions. Part II UCIs are subject to a subscription tax at an annual rate of 0.05% of the NAV, reduced to 0.01% or exempted in certain conditions.

In addition, the SIF, RAIF-SIF and Part II UCI in the form of a SICAV or SICAF may benefit from double tax treaties that have been concluded by Luxembourg. The SIF, RAIF-SIF or Part II UCI in the form of an FCP do not, in principle, have access to double tax treaties.

To encourage investment into ELTIFs, the Law of 21 July 2023 modernising the Luxembourg fund toolbox provides that RAIFs, Part II UCIs and SIFs (or sub-funds thereof) authorised as ELTIFs are exempt from subscription tax.

SICARs and RAIF-SICARs

The tax regime applicable to SICARs and RAIF-SICARs will depend on the legal form adopted. Those taking a corporate form are fully taxable entities (corporate income tax and municipal business tax) but benefit from an exemption for income derived from transferable securities and income from cash held for a maximum period of one year prior to its investment in risk capital. Those taking the form of a common limited partnership (SCS) or SLP are tax-transparent under Luxembourg law.

Luxembourg withholding tax does not apply to distributions made by these entities to investors. These entities also benefit from a VAT exemption on management services.

SICARs and RAIF-SICARs are not subject to an annual subscription tax, but they are subject to a minimum amount of annual net wealth tax.

SICARs and RAIF-SICARs in corporate form have full access to double tax treaties from a Luxembourg perspective; those in the form of SLPs do not, and nor do SCSs and RAIFs in the form of an FCP.

SLP

An SLP is tax-transparent and is not subject to subscription tax, net wealth tax or withholding tax. Corporate income tax is not applicable. Municipal business tax of 6.75% (for an SLP registered in Luxembourg City) may be applicable if the SLP carries out a commercial activity or is deemed to carry out a commercial activity.

SLPs do not benefit from the EU Parent-Subsidiary Directive and have no access to double tax treaties signed by Luxembourg.

Undertakings for collective investment in transferable securities (UCITS) and undertakings for collective investment subject to Part II of the UCI Law (Part II UCIs – together with UCITS, the “retail funds”) are the two main investment funds for retail investors.

Retail funds are subject to direct supervision by the CSSF and require prior CSSF approval before they can be set up. A retail fund may be set up as a standalone fund or as an umbrella fund. However, the umbrella fund structure is used most often as it is cost-effective if several sub-funds are launched.

Each retail fund may issue classes and sub-classes of shares (or units depending on the legal form chosen – see 3.2.2 Legal Structures Used by Fund Managers), enabling the retail fund’s shares to be adapted to the needs of its investors and its sponsor.

UCITS

UCITS are highly regulated investment vehicles that can be easily marketed to retail investors in the EEA thanks to the EU passport, but also to professional and institutional investors.

Stringent diversification rules are laid down by the UCI Law. In particular, a UCITS may invest no more than 10% of its assets in transferable securities (which must be listed on a regulated market) or money market instruments issued by the same body, and specific restrictions apply to index funds, holdings of other funds, use of financial derivative instruments and deposits. Leverage is restricted, and a UCITS must be an open-ended fund – ie, investors must be able to redeem.

Part II UCIs

Although Part II UCIs always qualify as AIFs, they are open to retail investors. Part II UCIs are subject to a less stringent diversification policy than UCITS:

  • they may borrow money or securities (up to 400% of the NAV for Part II UCIs following alternative investment strategies);
  • they can be closed or open-ended funds; and
  • they can be used to invest beyond transferable securities (private equity, real estate, etc).

However, Part II UCIs remain subject to the supervision of the CSSF. They are not entitled to the European UCITS passport for distribution to retail investors in the EEA, but they can rely on the AIFMD marketing passport if they fall within the scope of the full AIFMD regime.

Retail funds must be authorised and supervised during their lifetime by the CSSF. A retail fund set up in contractual form as an FCP shall only be authorised if the CSSF has approved its management company, which must be based in Luxembourg.

A retail fund set up in corporate form and appointing a management company or AIFM shall only be authorised if the CSSF has approved the management company or AIFM (if a Luxembourg entity), or if the relevant management company or AIFM has notified pursuant to the management passport. Where the management company or AIFM delegates portfolio management, the entity to which they have delegated is subject to the approval of the CSSF.

Directors (who must be of sufficiently good repute and sufficiently experienced) and other service providers of retail funds are subject to the approval of the CSSF.

The application is carried out online on a CSSF portal and requires the provision of, inter alia, the following documents:

  • application questionnaire;
  • draft instruments of incorporation;
  • draft prospectus;
  • draft PRIIPs KID or, in the case of UCITS exclusively distributed to professional investors, a UCITS key investor information document (KIID);
  • key policies (generally already in place within the investment fund manager);
  • various AML documents;
  • confirmation letters regarding main service provider agreements;
  • information on the directors of the fund in question; and
  • a business plan.

Once the application is complete, the authorisation process for a retail fund will range between three and six months. The actual length and cost depend mainly on the complexity of the investment strategy, the completeness of the application file and whether or not it is a first-time fund.

The largest set-up costs are generally legal fees, although service providers also sometimes charge a set-up or on-boarding fee. In addition, there are fees payable to the CSSF for regulated funds. The CSSF charges an examination fee and an annual fee for its supervisory activity of retail funds. The fee amount differs depending on whether the retail fund is a standalone or an umbrella fund and on whether or not it is self-managed. For example, the examination fee for a standalone retail fund is EUR4,650, whereas for an umbrella fund it is EUR9,250.

Regardless of the legal form or structure, investors in retail funds are only liable up to the amount of their contributions.

UCITS

UCITS must publish a prospectus that includes the information necessary for investors to be able to make an informed investment decision and containing at least the information listed in Schedule A of Annex I of the UCI Law, as well as information about the remuneration policy. The prospectus must be kept up to date. In addition, a three-page PRIIPs KID (or a two-page KIID for UCITS exclusively distributed to professional investors) summarising the key elements of the prospectus must be issued and kept up to date.

The following reports must be produced:

  • an annual report;
  • a semi-annual report covering the first six months of the financial year;
  • a semi-annual risk report (only intended for the CSSF);
  • a monthly financial report (only intended for the CSSF); and
  • an annual long form report (only intended for the CSSF).

Part II UCIs

As with UCITS, Part II UCIs must also publish a prospectus that includes the information necessary for investors to be able to make an informed investment decision and containing at least the information listed in Schedule A of Annex I of the UCI Law. The prospectus must be kept up to date. In addition, a three-page PRIIPs KID summarising the key elements of the prospectus must be issued if the Part II UCI is marketed to retail investors.

The following reports must be produced:

  • an annual report;
  • a semi-annual report covering the first six months of the financial year;
  • a semi-annual risk report (only intended for the CSSF);
  • a monthly financial report (only intended for the CSSF); and
  • an annual long form report (only intended for the CSSF).

The majority of retail fund investors are located outside Luxembourg. All types of investors invest in retail funds (retail, professional and institutional investors).

Usually, a retail fund is set up in the contractual form of an FCP or a SICAV (ie, a corporate entity with variable capital taking the form of a public limited liability company (société anonyme)). The Law of 21 July 2023 modernising the Luxembourg fund toolbox (the “Modernising Law”) extends the choice of legal forms for Part II UCIs to the form of an SCA, SCS, SCSp, société coopérative organised as an SA and Sàrl. However, in the case of a Part II UCI, it is possible to opt for a SICAF in a different corporate legal form or in the form of a partnership.

There are no restrictions – all investors (ie, retail, professional and institutional investors investing for their own account and/or on behalf of retail investors) can invest in retail funds.

Non-Luxembourg investment funds that do not qualify as UCITS can be marketed to retail investors in Luxembourg if the provisions of CSSF Regulation 15-03 are complied with and the CSSF has authorised them; if such funds qualify as ELTIFs, CSSF Regulation 15-03 does not apply but rather the rules applicable under the ELTIF regulation.

UCITS

Eligible assets are restricted to transferable securities admitted on a regulated market, investment funds, financial derivative instruments, cash and money market instruments.

Risk diversification requirements for UCITS include the following:

  • they cannot invest more than 10% of assets in transferable securities or money market instruments issued by the same issuer, and those holdings that exceed 5% cannot in aggregate exceed 40% of their assets;
  • they cannot invest more than 20% of assets in deposits made with the same body; and
  • global exposure relating to financial derivative instruments cannot exceed the total value of the portfolio.

A UCITS cannot borrow more than 10% of its assets on a temporary basis. Uncovered short positions are not allowed, but a UCITS can pursue a long-short investment strategy and achieve short exposure synthetically through the use of financial derivative instruments. Various liquidity monitoring requirements are provided for.

Part II UCIs

Part II UCIs are subject to investment restrictions and risk diversification rules arising from the UCI Law and various implementing CSSF circulars. For example, generally a Part II UCI cannot:

  • invest more than 10% of its assets in securities that are not listed on a stock exchange and are not traded on another regulated market that operates regularly and is recognised and open to the public;
  • acquire more than 10% of the same type of securities issued by the same issuing body; and
  • invest more than 20% of its net assets in securities issued by the same issuing body.

These general investment restrictions do not apply to Part II UCIs that adopt a fund of fund structure if the investment funds in which the Part II UCI shall invest are open-ended and are themselves subject to similar general investment restrictions. In addition, these general investment restrictions do not apply to Part II UCIs that are mainly investing in venture capital or real estate, or pursuing alternative investment strategies.

Part II UCIs may, in principle, borrow the equivalent of up to 25% of their net assets without restriction as to the intended use thereof.

Part II UCIs that are mainly investing in real estate may borrow the equivalent of up to an average of 50% of the valuation of all their properties.

Part II UCIs that are mainly pursuing alternative investment strategies (hedge funds) may borrow up to 400%.

The depositary, administrative agent, registrar, transfer agent and approved statutory auditor of a retail fund must be established in Luxembourg and are all subject to regulation in Luxembourg.

The management company of a UCITS can be established in the EEA, unless the UCITS is an FCP, in which case the management company must be established in Luxembourg. The AIFM of a Part II UCI can be established in the EEA unless the Part II UCI is an FCP, in which case the AIFM must be established in Luxembourg.

Portfolio managers and investment advisers located in third countries can provide advisory or portfolio management services, but this is subject to the CSSF’s authorisation of any delegated portfolio management function.

UCITS and Part II UCIs in the form of an FCP must have their management company established in Luxembourg. UCITS that are SICAVs and are not self-managed may have their management company established elsewhere in the EEA.

An AIFM from any jurisdiction in the EEA can be appointed to manage a Part II UCI unless the Part II UCI is an FCP. Those AIFMs established elsewhere than in Luxembourg need to notify their home supervisory authorities of their intention to manage a Luxembourg fund. Those authorities will in turn notify the CSSF.

The portfolio management of Luxembourg retail funds can be delegated to managers situated in third countries, provided that prior approval is obtained from the CSSF.

For retail funds, the process for obtaining regulatory approval depends on the complexity of the investment policy, the completeness of the file that has been submitted and whether or not it is a first-time fund. Generally, the time ranges from three to six months.

Pre-marketing to Luxembourg retail investors is not allowed for UCITS and AIFs.

No notification or authorisation is required for the marketing of Luxembourg UCITS or Part II UCIs in Luxembourg.

A UCITS located in another EEA country may be marketed in Luxembourg as soon as the home supervisory authority has duly notified the CSSF of the intended marketing. Such EEA UCITS must provide facilities in Luxembourg to facilitate the processing of subscription and redemption orders, and the provision of information. They need not appoint a third party nor have a physical presence in Luxembourg (ie, facilities can be provided via the internet).

An AIF located in a country other than Luxembourg may be marketed to Luxembourg retail investors, in accordance with the provisions of CSSF Regulation 15-03, provided that, inter alia:

  • it is subject to ongoing supervision by its home supervisory authority;
  • it has obtained the authorisation of the CSSF for such marketing;
  • its NAV is calculated at least once a month; and
  • it follows certain risk diversification principles.

Retail funds and AIFs marketed in Luxembourg to retail investors must provide these investors with a PRIIPs KID.

All marketing communications will need to comply with the requirements of Article 4 of Regulation 2019/1156 on facilitating cross-border distribution of collective investment undertakings. CSSF Circular 22/795 provides that the CSSF requires investment fund managers to provide the CSSF with information regarding marketing communications, and will conduct testing to verify their compliance with the applicable requirements under Article 4.

Closed-ended funds marketed to Luxembourg retail investors must generally issue a prospectus in accordance with EU Regulation 2017/1129 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market.

Retail funds can be marketed to all investors located in Luxembourg, whether retail, professional or institutional.

However, a number of rules stemming from the MiFID may restrict the marketing of retail funds through MiFID-regulated firms, as the investor profile of a retail investor must be in line with the type of retail fund being marketed (eg, it is not appropriate to advise a retail investor with a conservative risk profile to invest in a fund presenting higher risk).

Notification or authorisation is required by the CSSF prior to the marketing of non-Luxembourg retail funds taking place.

In the case of cross-border marketing of a UCITS, the notification process described above must be complied with; in the case of marketing a foreign investment fund that is not a UCITS, there is an authorisation process to be complied with in accordance with CSSF Regulation 15-03.

Change in the Content of the UCITS Marketing Notification Letter

Where an amendment has an impact on the notification letter sent to the CSSF via the UCITS home supervisory authority at the time when the UCITS intended to market its units in Luxembourg or regarding a change of the share classes to be marketed in Luxembourg, the UCITS must directly inform the CSSF before implementing this amendment.

De-notification

Investment fund managers may de-notify arrangements made for marketing as regards units or shares of some or all of their UCITS and/or AIFs marketed in Luxembourg, provided that:

  • a blanket offer is made to repurchase or redeem all such units or shares held by Luxembourg investors, free of any charges or deductions;
  • the intention to terminate arrangements made for marketing such units or shares is made public, by means of a publicly available medium; and
  • any contractual arrangements with financial intermediaries or delegates are modified or terminated with effect from the date of de-notification, in order to prevent any new or further, direct or indirect, offering or placement of such units or shares.

The de-notification procedure is carried out through the home supervisory authority, which then informs the CSSF. However, if an AIFM intends to cease the marketing of its non-Luxembourg AIF to retail investors in Luxembourg, it must inform the CSSF whether Luxembourg investors are still invested in this AIF.

Other Ongoing Requirements

Please refer to 3.3.10 Investor Protection Rules regarding reporting and other requirements.

To ensure compliance with the regulatory framework and to detect any potential non-compliance, retail funds must produce the following reports:

  • an audited annual report;
  • an unaudited semi-annual report covering the first six months of the financial year;
  • a report in the case of NAV calculation error or non-compliance with applicable investment rules (only intended for the CSSF);
  • a monthly financial report (only intended for the CSSF); and
  • an annual long form report (only intended for the CSSF).

In addition, UCITS must provide the CSSF with a semi-annual risk report, and their management companies must have a remuneration policy and procedures designed to prevent conflicts of interest and discourage risk-taking that is inconsistent with the risk profile of the managed UCITS.

Furthermore, retail funds must appoint a custodian bank acting in the interests of investors and providing services as required by the UCI Law – ie, safekeeping of assets, cash monitoring and monitoring of retail funds’ compliance with the legal and regulatory framework. The appointment of a custodian bank is ultimately intended to ensure the protection of the fund’s assets.

In the case of a dispute with a retail fund, a retail investor can contact the CSSF in order for the CSSF to impartially intervene for an out-of-court resolution, but the CSSF's out-of-court decision is not binding on the parties.

Finally, NAV calculation errors are highly monitored by auditors and the CSSF, and incoming and redeeming investors are compensated in the case of NAV calculation errors.

The CSSF takes a practical approach. New Luxembourg market participants can have a face-to-face meeting with CSSF officials to present their projects, better understand the CSSF’s expectations and ask questions.

Formalities and filings with the CSSF are mainly done through an online platform, although the CSSF can be contacted via telephone and email during an authorisation process.

Retail Funds

Please refer to 3.1.4 Disclosure Requirements and 3.3.1 Regulatory Regime regarding investment restrictions for retail funds.

Retail funds must appoint a custodian bank acting in the interests of investors and providing services as required by the UCI Law – ie, safekeeping of assets, cash monitoring and monitoring of retail funds’ compliance with the legal and regulatory framework. Custodian banks must be credit institutions established in Luxembourg and have a specific licence granted by the CSSF in order to carry out this business.

Retail funds admitted to trading on the Luxembourg Stock Exchange are subject to the Luxembourg Law of 11 January 2008 on transparency requirements (implementing Directive 2004/109/EC of 15 December 2004 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market and amending Directive 2001/34/EC), and to the Luxembourg Law of 23 December 2016 on market abuse (stemming from Regulation (EU) No 596/2014 of 16 April 2014 on market abuse).

Retail funds must have an AML policy and comply with the AML Law for their business relationships (including for their investors).

UCITS

The asset valuation of UCITS must be done in accordance with the UCI Law, which provides that listed securities should be valued at the last known stock exchange quotation, unless this is not representative. Non-listed securities or listed securities for which the market price is not representative should be valued on the basis of the probable realisation value.

Management companies must have policies in place to prevent insider dealing and the misuse of confidential information by one of their employees or service providers.

Uncovered short positions are not allowed, but a UCITS can pursue a long-short investment strategy and achieve short exposure synthetically through the use of financial derivative instruments.

Part II UCIs

The asset valuation of Part II UCIs must be done in accordance with the UCI Law, which provides that the valuation must be based on fair value, unless the constitutional documents provide otherwise. Part II UCIs also need to value assets in compliance with the AIFM Law if they are managed by an authorised AIFM.

Authorised AIFMs of Part II UCIs must have policies in place to prevent insider dealing and the misuse of confidential information by one of their employees or service providers.

Part II UCIs may have uncovered short positions.

UCITS

A UCITS may borrow in the following circumstances:

  • on a temporary basis, provided that such borrowing represents no more than 10% of its assets; or
  • to enable the acquisition of immovable property essential for the direct pursuit of its business and representing no more than 10% of its assets.

Such borrowing shall not exceed 15% of its assets in total. Generally, borrowing is used to finance redemption requests, not to invest.

UCITS may invest in derivative financial instruments that can provide leverage, and can enter into back-to-back loans to acquire foreign currencies.

For the above transactions, a UCITS may provide security such as a pledge on securities it owns as collateral.

Securities lending transactions, as well as repurchase agreement transactions and reverse repurchase agreement transactions, can only be used by UCITS for the purpose of efficient portfolio management.

Part II UCIs

A Part II UCI may borrow money or securities up to 25% of its NAV on a permanent basis. However, this cap may increase depending on the investment strategy:

  • 200% of its NAV for alternative investment strategies; and
  • 400% of its NAV for alternative investment strategies with a high level of correlation between long positions and short positions.

A Part II UCI may invest in derivative financial instruments that can provide leverage, but it cannot borrow to finance margin deposits.

A Part II UCI is authorised to enter into securities lending transactions, as borrower, with first-class professionals specialised in this type of transaction.

For the above transactions, a Part II UCI may pledge its own securities as collateral.

Equity bridge financing can be used if the Part II UCI in question operates on a commitment basis.

UCITS and Part II UCIs are exempt from net wealth tax, corporate income tax and municipal business tax. UCITS and Part II UCIs are subject to an annual subscription tax of 0.05% of the NAV (paid quarterly), reduced to 0.01% in certain specific cases.

The Modernising Law amended the UCI Law by regulating a full exemption for the subscription tax stated in the new Article 175 for the following.

  • Those UCITS dedicated to Pan-European Personal Pension Product (PEPP), which is a long-term, individual, non-occupational personal pension product (third pillar pension), subscribed to on a voluntary basis by so-called “PEPP savers” to provide supplementary income on retirement and created per Regulation (EU) 2019/1238 on a pan-European Personal Pension Product (“PEPP Regulation”), which entered into application on 22 March 2022, and by which the Luxembourg congress on 4 March 2022 enacted the law of 25 February 2022, which lays down certain rules on, among others, the PEPP Regulation.
  • Those UCITS as well as individual compartments of UCITS with multiple compartments:
    1. whose securities are reserved for institutional investors;
    2. that are authorised as short-term money market funds in accordance with Regulation (EU) 2017/1131; and
    3. that have obtained the highest possible rating from a recognised rating agency. Where several classes of securities exist within the UCITS or the compartment, the exemption only applies to classes whose securities are reserved for institutional investors.
  • Those UCITS that are authorised as ELTIFs in accordance with Regulation (EU) 2015/760.

In addition, retail funds may benefit from reduced subscription tax rates on the portion of their net assets or compartment thereof invested in economic activities that qualify as being environmentally sustainable within the meaning of the Taxonomy Regulation (“Qualifying Activities”) (Regulation (EU) 2020/852 of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088). For instance, the tax rate is reduced to 0.04% if the retail fund invests at least 5% of its net assets in Qualifying Activities.

Furthermore, the annual subscription tax will be reduced to zero in the case of institutional money market cash funds, special pension funds, exchange-traded funds and microfinance funds, and for retail funds investing in other Luxembourg funds that are already subject to a subscription tax. These exemptions apply to the whole retail fund, the sub-fund or the class of shares qualifying for the exemption.

Investors located outside Luxembourg are not subject to Luxembourg capital gains tax.

Luxembourg withholding tax does not apply to distributions made by these entities to investors. These entities also benefit from a VAT exemption on management services.

These entities may not benefit from the EU Parent-Subsidiary Directive, but if in corporate form may benefit from double tax treaties that have been concluded by Luxembourg.

On 24 July 2023, the Modernising Law was published in the Luxembourg Official Gazette (Mémorial), bringing substantial improvements to the Luxembourg toolbox for investment funds and their managers, as well as greater consistency between the product laws, with a view to further increasing the competitiveness of the Luxembourg fund centre, including in the context of the democratisation of alternative investment funds, as evidenced by the increased interest for Part II UCIs and ELTIFs under Regulation (EU) 2023/606 amending Regulation (EU) 2015/760 as regards the requirements pertaining to the investment policies and operating conditions of European long-term investment funds and the scope of eligible investment assets, the portfolio composition and diversification requirements and the borrowing of cash and other fund rules (ELTIF 2.0).

Approximately one third of the assets managed by sustainable funds in Europe are domiciled in Luxembourg. This trend towards more sustainable investing is expected to continue.

At the European level, the ELTIF 2.0 regime and the AIFMD II framework as reflected in the final political agreement published by the European Council on 6 November 2023, especially in the context of debt funds, will have an impact on the fund regulatory environment in Luxembourg.

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Trends and Developments


Authors



Norton Rose Fulbright is a global law firm that provides a full business law service and has more than 3,500 lawyers and other legal staff based in Europe, the United States, Canada, Latin America, Asia, Australia, the Middle East and Africa. The firm’s Luxembourg investment funds practice is well regarded in the market, and provides high-quality and tailored legal advice on the full spectrum of investment funds law, including the latest regulations, innovations, market practices and trends. It has deep experience in alternative investment funds, mutual funds, ETFs, hedge funds and related fund and asset management matters. The firm is a trusted counsel to international and national clients, including asset managers, institutional and professional clients, banks, non-profit organisations, venture capital firms, family offices/high net worth individuals and pension funds. Its investment funds team works closely with its global tax team, advising on the tax aspects of the structuring of funds, investment into funds and related international tax implications.

Investment Funds in Luxembourg: Trends and Developments

Introduction

Following the turmoil of the past few years, 2023 saw increased activity pushing forward new regulatory measures in the funds industry and preparing for the future of several key regulations. Those regulations in the pipeline seek the right balance between encouraging investments in Europe on the one hand and protecting investors on the other hand.

2024 promises to be as busy as 2023 on the regulatory front, bringing the EU fund industry to a new level of sophistication.

One step closer to AIFMD 2

Following the end of their trilogue, an agreement was reached in October 2023 between the European Parliament (the Parliament), the European Commission (the Commission) and the Council of Europe (the Council) in relation to the proposed revision of two EU directives:

  • Directive 2011/61/EU of 8 June 2011 on Alternative Investment Fund Managers (AIFMs) (AIFMD) and its associated annexes (the revised AIFMD, AIFMD 2); and
  • Directive 2009/65/EC of 13 July 2009 on Undertakings for Collective Investment in Transferable Securities (UCITS) (UCITS Directive).

The adoption of the final text is still pending, and the Parliament has set an initial date for a plenary sitting on 5 February 2024. Accordingly, the final text could be published in the Official Journal in February or March 2024 and the new rules should come into effect around Q1 2026 (ie, two years after adoption).

The key changes will be on the following topics.

  • AIFM and management company (ManCo) governance: AIFMs and ManCos will require at least two full-time employees/executive members domiciled in the European Union (the EU) and will be encouraged to appoint one independent director when managing investment funds open to retail investors. Furthermore, ESG parameters will be integrated into the governance and risk management rules supporting investment decisions (especially when managing alternative investment funds (AIFs) or UCITS with sustainable strategies).
  • Depositary: if opened at the discretion of the EU member states when transposing AIFMD 2, it will be possible to have a depositary in a different country than that of the relevant investment fund under certain conditions, notably:
    1. if there is a lack of relevant depositary services in the country of the investment fund;
    2. if the depositary assets in the country of the investment fund are under EUR50 billion; and
    3. on a case-by-case basis.
  • Leveraged AIFs: a common definition of a leveraged AIF will be introduced – ie, “an AIF whose exposures are increased by the AIFM that manages it, whether through borrowing of cash or securities, or leverage embedded in derivative positions or by any other means”.
  • Loan originating funds: loan originating AIFs are defined in AIFMD 2, together with accompanying rules, with flexibility for nations to enforce stricter rules. In particular, AIFMD 2 contains a prohibition of loans to certain entities (the AIFM, its delegates, depositaries, custodians, etc) and demands full disclosure as to the value of the loan. If the borrower is itself an AIF/UCITS, an investment limit of 20% will be set and a leverage cap for open/closed ended funds will be introduced (175% or 300%, respectively). All of the changes introduced by AIFMD 2 on this topic will benefit from a grandfathering clause.
  • Delegation: AIFMD 2 introduces a stronger supervision of delegated functions, with requirements for the entire delegation structure to be objectively justified, and for the delegation requirement to be automatically applied mutatis mutandis to the entire chain of delegation. However, these requirements are not applicable to distributors marketing the investment funds under their own MIFID licence or through insurance-based products.
  • Reporting and disclosure requirements: the new reporting and disclosure requirements will be applicable to all markets, all exposures, all instruments and all assets, risk profiles and liquidity arrangements, where marketed. For delegates, disclosures will consist in particular of identity, links to the AIFM/ManCo, authorisation (or lack thereof) and applicable supervisory authority. For AIFM/ManCo, the disclosures will consist in particular of employees, qualification, how the percentage delegation of portfolio management is made, resources, due diligence performed, and the same information outlined above on delegates.
  • New requirements on costs borne by investors: there will be new requirements with regard to what is charged by the AIFM/ManCo directly/indirectly to the investment fund/investors. This will need to be provided with a report explaining the reasons of the level of costs and the differences between them. Further reporting to the national authority and the European Securities and Markets Authority (ESMA) will be due, to develop a common understanding of the costs.

EU member states will have to transpose AIFMD 2 and changes to the UCITS Directive into their national legislation, raising interest as to how they will implement it domestically (for example, with or without gold-plating) and how they will make the most of it for the fund industry.

The new EU AML Package

On 20 July 2021, the European Commission presented an ambitious package of legislation to strengthen the EU AML and CFT rules (the AML Package). The aim and content of this AML Package is to remedy the gaps of the 5th AML Directive of 2018, which was not implemented equally or in full by all member states, as well as the lack of serious consequences in the event of non-compliance. This AML Package is based on four pillars that aim to correct existing deficiencies and raise the level of global response with respect to the fight against AML/CFT; they consist of the following.

  • The EU “Single Rulebook” Regulation: an EU-wide mandatory instrument applying within the scope of AML obligations, which contains provisions on conducting due diligence on customers, the transparency of beneficial owners and the use of anonymous instruments such as crypto-assets, and new entities such as crowdfunding platforms. The regulation also includes provisions on so-called “golden” passports and visas.
  • The 6th AML Directive contains national provisions on supervision and Financial Intelligence Units (FIUs), as well as access for competent authorities to necessary and reliable information – eg, beneficial ownership registers and assets stored in free zones.
  • The regulation establishing the European Anti-Money Laundering Authority, which will operate with an independent executive board and will have direct supervisory powers over some financial entities, including both financial and non-financial entities within the scope of AML obligations. It will also have regulatory powers to issue guidelines, technical standards and opinions, and will furthermore support the already existing national FIUs. Following the 2022 invasion of Ukraine, it has been suggested that the role of the European Anti-Money Laundering Authority should be expanded to playing a part in the enforcement of financial sanctions adopted by the EU.
  • The amendment of the EU Transfer of Funds Regulation will update the existing regulation to bring crypto-assets service providers (CASPs) within the scope of the AML/CFT framework. It is the only element of the AML Package that was adopted earlier in 2023 together with the Market in Crypto Asset Regulation (MiCA). As a result, newly obliged CASPs should urgently update their AML/CFT processes to bring them in line with the regulation and the overall AML/CFT framework. However, CASPs that are already subject to AML/CFT rules should implement adjustments, if necessary.

On 28 March 2023, the Parliament adopted its position on the AML Package and on 17 April 2023 initiated a trilogue, which concluded on 17 January 2024. The final vote on the AML Package is expected to occur during the first half of 2024.

Towards ESG compliant fund names

In November 2022, ESMA published a consultation paper about its draft guidelines on the use of ESG or sustainability-related terms in fund names. The consultation closed on 20 February 2023, after an open hearing consultation held on 23 January 2023.

The consultation seems to have been far-reaching among participants, and ESMA received (and published) a wide range of responses. Whereas consensus emerged on the overarching objective of the consultation, which sought to limit greenwashing risks, increase legal certainty and avoid misleading information for investors, many questioned the ESMA approach, both in terms of the suitability of associating specific thresholds with name-associated sustainability claims and also in consideration of this issue on a standalone basis.

This consultation preceded the publication on 2 October 2023 of an ESMA Trends, Risks and Vulnerabilities Risk Analysis on ESG names and claims in the EU funds industry, with findings relevant for its context. The ESMA announced on 14 December 2023 that it was delaying the adoption of its guidelines to fully consider the outcomes of the current review of AIFMD 2, while also taking the opportunity to fine-tune them.

Taxonomy and new technical screening criteria

Commission Delegated Regulation (EU) 2023/2485 (CDR 1) and Commission Delegated Regulation (EU) 2023/2486 (CDR 2) were published on 21 November 2023 in the Official Journal. CRD 1 amends the “Climate Delegated Regulation” (ie, Commission Delegated Regulation (EU) 2021/213 of 4 June 2021 establishing technical screening criteria in relation to the contribution to climate change mitigation or climate change adaptation). These regulations add technical screening criteria with respect to economic activities not previously included under Regulation (EU) 2020/852 of 18 June 2020 on the establishment of a framework to facilitate sustainable investment (Taxonomy) (notably manufacturing activities in relation to key components for low carbon transport and electrical equipment). In addition, CDR 2 establishes technical screening criteria for economic activities making a substantial contribution to non-climate environmental objectives of Taxonomy, namely:

  • the transition to a circular economy;
  • control, or protection and restoration of biodiversity;
  • pollution prevention; and
  • the use and protection of water and marine resources.

The measures under CRD 1 and CRD 2 apply as of 1 January 2024.

Fine-tuning the Sustainable Finance Disclosure Regulation (SFDR) regulatory technical standards (RTS)

Following a mandate received by the Commission on 11 April 2022 to review and revise the SFDR RTS, the European Supervisory Authorities (the European Insurance and Occupational Pensions Authority, the European Banking Authority and ESMA – together, the ESAs) jointly published a consultation paper on 12 April 2023, titled “Review of SFDR Delegated Regulation regarding PAI and financial product disclosures” (the Consultation Paper). The SFDR Delegated Regulation under review was Commission Delegated Regulation (EU) 2022/1288 of 6 April 2022 (the so-called SFDR RTS, which provides technical regulatory standards for the application of the SFDR). A consultation period, which opened with the expectation of a final report being submitted to the Commission by October 2023, together with draft amendments to the SFDR RTS, closed on 4 July 2023.

The ESAs took the opportunity, beyond their initial mandate, to:

  • open a discussion on the “Do No Significant Harm” principle (DNSH) and extensively revisit the templates provided by the SFDR Delegated Regulation;
  • propose an extension of, and enhancements to, the list of indicators for principal adverse impacts (commonly referred to as PAIs);
  • introduce new mandatory decarbonisation disclosures; and
  • propose adjustments to all existing disclosure templates under the SFDR Delegated Regulation.

The future of the SFDR regime

On 14 September 2023, the Commission launched a consultation on the functioning of SFDR, aimed at gathering feedback on its implementation and objectives, and questioning how it should evolve, particularly by opening the door to what is perceived as an alignment with the Sustainability Disclosure Requirements developed in the United Kingdom (the SDR), through the use of a labelling regime overlapping with the SDR regime.

This consultation was open until 15 December 2023 and involved two publications:

  • one focused on how the SFDR is working in practice and the issues of its implementation; and
  • one focusing on identifying the shortcomings of the SFDR and exploring options to improve the regime.

No related amendments to the SFDR or the SFDR RTS have been proposed by the Commission, the focus of which, for now, is to find solutions to perfect the SFDR regime.

ESG ratings providers

In response to the recent (over) development of ESG rating providers, and noting that “the ESG ratings market currently suffers from a lack of transparency”, the Commission published a set of rules on 13 June 2023, aimed at regulating their activities by:

  • improving the reliability and transparency of ESG ratings activities;
  • setting out organisational principles and clear rules on the prevention of conflicts of interest; and
  • enabling investors to make better informed decisions regarding sustainable investments, which the Commission will now discuss with the Parliament.

European Sustainability Reporting Standards

In November 2022, the European Financial Reporting Advisory Group (EFRAG) submitted the first set of drafts of mandatory European Sustainability Reporting Standards (ESRS), which are the rules and requirements for companies to report on sustainability-related impacts, opportunities and risks under the Directive amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU as regards corporate sustainability reporting (CSRD). These drafts are in the form of technical standards, based on the initial draft standards used in the public consultation run earlier in the year.

In June 2023, the Commission released a proposed version of the final ESRS, with a number of its own changes. The most notable proposed change was that all disclosure requirements, with the exception of a set of general disclosures, will be subject to materiality assessments. This allows companies to focus reporting on sustainability factors that they consider material to their businesses. In addition, the Commission further converted several mandatory datapoints proposed by EFRAG into voluntary datapoints. The datapoints concerned are those considered most challenging or costly for companies, such as reporting a biodiversity transition plan and certain indicators about self-employed people and agency workers in the undertaking's own workforce.

In relation to the above, on 31 July 2023 the Commission adopted a draft delegated regulation (not yet published in the Official Journal), which supplements the CSRD (the ESRS Delegated Regulation). The ESRS that are to be used by entities in scope of the CSRD for their sustainability reporting are set out in Annex I and Annex II.

Annex I contains two sets of standards:

  • ESRS 1 (“General Requirements”), which set out general principles to be applied when reporting according to ESRS; and
  • ESRS 2 (“General Disclosures”), which specify essential information to be disclosed irrespective of the sustainability matter under consideration, and which are mandatory for all companies within scope of the CSRD.

In addition, Annex I contains a set of specific standards on:

  • environmental disclosures covering climate change, pollution, water and marine resources, biodiversity and ecosystems, and resources and the circular economy;
  • social disclosures, covering an organisation's own workforce, workers in the value chain, affected communities and customers and end-users; and
  • governance, covering business conduct.

These specific standards and the individual disclosure requirements and related data are subject to a materiality assessment. However, disclosure requirements subject to a materiality assessment are not optional, but subject to a disclose or explain mechanism.

The ESRS Delegated Regulation was passed along to the Parliament and the Council for a two-month scrutiny period, which ended in October 2023.

EU Retail Investment Strategy (RIS)

In continuation of the 2020 Capital Markets Union action plan (aimed at improving access for retail investors to financial markets and ensuring investor protection), the Commission published the final version of the RIS on 24 May 2023. The Commission’s proposal of the RIS package includes a proposal for an Omnibus Directive amending the UCITS Directive and the AIFMD (among others), therefore requiring that it be considered and voted on by the Parliament and Council before becoming applicable.

This package sets out new requirements and enhancements to the investor protection framework in a wide range of areas, such as:

  • a ban on inducements paid by manufacturers to distributors for execution-only sales, and rules to “further substantiate” the need for firms to act in their clients' best interests, while introducing new tests for advisers to consider when recommending products;
  • stricter rules on marketing communications, with new obligations such as the requirement for management bodies to define, approve and oversee a policy on marketing communications and enhanced record keeping requirements;
  • changes to Directive 2014/65/EU on Markets In Financial Instruments, for clients requesting to be treated as “professional”, including reducing the minimum wealth criterion from EUR500,000 to EUR250,000 and adding a new criterion around professional experience or education; and
  • in furtherance of ESMA's recent opinion on considering “undue” costs in UCITS and AIFs, giving a mandate to ESMA (notably) to regularly update cost and performance benchmarks against which manufacturers would need to compare their products before offering them to the market.

The Commission's RIS package is currently being discussed between the Parliament and the Council and should not enter into force before 2025.

Modernisation of the Luxembourg toolbox

On 11 July 2023 (ie, at the same time as the adoption of the revised – and more accessible – regime on the European Long Term Investment Fund label, available as of 10 January 2024), the Luxembourg legislature adopted the bill of Law No 8183 introduced by the Ministry of Finance on 27 March 2023 (the Law) and amended the following laws:

  • the Law of 15 June 2004 relating to the investment company in risk capital (SICAR), as amended;
  • the Law of 13 February 2007 relating to specialised investment funds (SIFs);
  • the Law of 17 December 2010 on undertakings for collective investment (UCIs);
  • the Law of 23 July 2016 on reserved alternative investment funds (RAIFs), as amended; and
  • the AIFM Law.

The Law was published in the Official Journal on 24 July 2023 and entered into force on 28 July 2023, modernising the Luxembourg investment funds toolbox by introducing the following adjustments to the above-mentioned laws:

  • the threshold to qualify as a well-informed investor has been lowered from EUR125,000 to EUR100,000;
  • SICARs, SIFs and RAIFs now have 24 months to reach their applicable minimum capital, and UCIs subject to Part II of the UCI Law (the UCI Part II) now have 12 months;
  • European long-term investment funds qualifying as SICARs, SIFs, RAIFs or UCIs Part II are exempt from the subscription tax;
  • AIFMs now have the possibility to appoint tied agents (alignment on UCITS);
  • SICARs and SIFs can be marketed in Luxembourg to retail investors that are “well-informed investors”, and also to RAIFs; and
  • the second notarial deed for the incorporation of RAIFs (ie, the constat de constitution) has been removed when the relevant RAIF has been incorporated by way of a notarial deed.

The Law irons out several inconsistencies in and between the above-mentioned laws and is a welcomed improvement for the Luxembourg investment funds industry.

Conclusion

Luxembourg is in the middle of a regulatory wave, caused partly by the current economic, political and financial environment and partly by the need to fill certain gaps and establish a complete and strong harmonised framework in this maturing industry (in particular on the alternative investment side), not to mention the overarching necessity to do business in a more sustainable and responsible manner. One of the biggest challenges for market players will be to find opportunities and gains within this framework for change.

Norton Rose Fulbright

16 Boulevard Royal
L-2449
Luxembourg

+352 285 7391

+352 28 57 39 201

Alfia.Sadykova@nortonrosefulbright.com www.nortonrosefulbright.com
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Law and Practice

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BSP is an independent full-service law firm based in Luxembourg, and is committed to providing the best possible legal services to its domestic and international clients in all aspects of Luxembourg business law. The firm’s lawyers have developed particular expertise in banking and finance, capital markets, corporate law, dispute resolution, employment law, investment funds, intellectual property, private wealth, real estate and tax. In these practice areas, as in others, the firm’s know-how and its ability to work in cross-practice teams and to swiftly adapt to new laws and regulations allow it to provide clients with timely and integrated legal assistance vital to the success of their business. Building on the synergy of its different professional experiences and the richness of its diverse cultural background, BSP stands ready to meet its clients’ legal needs, no matter how challenging they are.

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Norton Rose Fulbright is a global law firm that provides a full business law service and has more than 3,500 lawyers and other legal staff based in Europe, the United States, Canada, Latin America, Asia, Australia, the Middle East and Africa. The firm’s Luxembourg investment funds practice is well regarded in the market, and provides high-quality and tailored legal advice on the full spectrum of investment funds law, including the latest regulations, innovations, market practices and trends. It has deep experience in alternative investment funds, mutual funds, ETFs, hedge funds and related fund and asset management matters. The firm is a trusted counsel to international and national clients, including asset managers, institutional and professional clients, banks, non-profit organisations, venture capital firms, family offices/high net worth individuals and pension funds. Its investment funds team works closely with its global tax team, advising on the tax aspects of the structuring of funds, investment into funds and related international tax implications.

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