Further legal and regulatory developments

On 13 October 2023, the CSSF published a Circular 23/841 to endorse the ESMA guidelines published on 3 April 2023 addressing specific aspects of the MiFID II remuneration requirements (the “Guidelines”) and repealing CSSF Circular 14/585. The Guidelines provide clarifications on MIFID II (i) design of remuneration policies and practices, (ii) governance and (iii) control of the risks related to remuneration policies and practices.

The Guidelines highlight the importance of aligning the interests of financial market participants with those of clients, particularly in variable remuneration structures. Firms are advised to define sufficient and clear criteria for variable components, incorporating quantitative (e.g. value of instruments sold, sales volumes, establishment of targets for sales or new clients, etc.) and qualitative (e.g. return on the client’s investment, very low number of complaints over a large timescale, etc.) factors that encourage actions in the best interests of clients.

The Guidelines also caution against setting short-term-focused performance targets, emphasising the potential conflicts of interest or harm to clients' interests. Firms should moreover consider and mitigate risks arising from cross-selling objectives. In this context, periodic reviews of remuneration policies, especially after significant business changes, are recommended and robust controls throughout the organisation are urged to assess compliance and ensure intended outcomes. It shall be noted that senior management bears responsibility for daily policy implementation and compliance risk monitoring.

On 10 November 2023, following months of negotiations, the EU Council published the final political agreement on the AIFMD (the “AIFMD 2”).

The AIFMD 2 key changes are:

• Delegation regime remains unchallenged: AIFMs delegating portfolio or risk management functions will need to provide more comprehensive information on the delegates, the delegation arrangement as such and AIFM resources monitoring the delegated functions.
• Clear vision of the AIFM’s substance and operations: AIFMs must employ at least two conducting officers, and in consideration of their application should disclose a description of (i) their role, title, and level of seniority, (ii) their reporting lines and responsibilities in and outside the AIFM, (iii) the time each person allocates to each responsibility and (iv) technical and human resources that support their activities.
• Harmonisation of rules for loan originating AIFs: The AIFMD 2 explicitly allows EU AIFMs to engage in loan origination. This clarification ensures that EU AIFs managed by an EU AIFM are authorised to conduct loan origination across all EU Member States, addressing the current inconsistency in some countries. The AIFMD 2 has now implemented a definition of loan-originating AIF, which is an AIF whose investment strategy is mainly to originate loans; or where the notional value of the AIF's originated loans represents at least 50% of its net asset value. Additionally, AIFMD 2 requests the implementation of effective policies, procedures, and processes for the granting of loans (like assessing credit risk, administer and monitor credit portfolios).
• Liquidity Management Tools (LMT): AIFMs overseeing open-ended AIFs must choose at least two LMTs (list set out in Annex V), with an exception for money market funds, and are required to provide detailed policies for the activation/deactivation of LMTs.
• Depositaries in another Member State: At present, the depositary must be established in the same EU country as the AIF. The AIFMD 2 exceptionally permits the appointment of a depositary in another Member State under certain conditions (a depositary designated for an EU AIF in a given Member State must be established in that same Member State).
• Enhancing transparency towards investors: Article 23 on the disclosure to investors must include (i) a description of the possibility and conditions under which the AIFM might use liquidity management tools, (ii) an annual basis a list of fees, charges and expenses borne by the AIFM in connection with the operation of the AIF which will be directly or indirectly allocated to the AIF, and (iii) the composition of the originated loan portfolio, related administration costs and expenses.
• Improvement of reporting data: AIFMD 2 seeks to enhance reliability and utility of data provided by the AIFMs to the regulators by expanding certain economic information.
• Undue costs: AIFs are to be more transparent on costs incurred and charged to any fund vehicle under its management. When launching an AIF, AIFMs must disclose a pricing policy including costs to be considered upfront.

By the end of Q1 2024, it is anticipated the publication and entry into force of AIFMD 2. EU Member States must then implement it within two years meaning that its application should commence from 2026.

On 29 November 2023, the CSSF published an update to the CSSF FAQ (the “FAQ Update”) to the Circular CSSF 22/811 (the “Circular”) on UCI Administrators (“UCIA”).

In question 3.3, the FAQ Update discusses NAV calculation and accounting responsibilities. The FAQ Update emphasises that, in accordance with point 28 of the Circular, merely compiling or inputting accounting information received from delegates, or third parties is not sufficient to fulfil UCIA duties when the UCIA is responsible for the NAV calculation and accounting function. Even if certain tasks relating to NAV calculation are delegated, UCIA must maintain a critical stance, being ready to challenge NAV calculations or accounting information provided by delegates. Additionally, as per point 96 of the Circular, any delegation model that diminishes the UCIA's substance to the extent that it becomes a mere letter-box entity is considered non-compliant. In essence, delegation models where the UCIA's role is limited to compiling accounting information from third parties or delegates do not meet the requirements set forth in the Circular.

In question 4.1, the FAQ Update focuses on delegation models, which must not result in fragmentation that makes coordination and supervision difficult or increases costs without justified reasons, as set out in point 83 of the Circular. Delegation of UCIA tasks is permissible (Chapter 3.5 of the Circular), but the UCIA must ensure the entire delegation model, including sub-delegations, is based on objective reasons and does not introduce additional risks. Sub-delegation to an entity within the UCIA's group or the UCI's and/or investment fund managers group is allowed, provided all delegation requirements in point 99 of the Circular are met. For sub-delegations outside these groups, an ad hoc derogation may be granted by the CSSF if the UCIA can demonstrate objective reasons and effective risk management of such sub-delegation.

Question 5.1 of the FAQ Update gives clarification on the required annual reporting under point 7 of the Circular. The first reporting deadline is specified as no later than five months after the UCIA’s financial year-end, starting from 30 June 2023. The reporting must include information regarding the UCIA’s business activities and resources, following the details outlined in Annex B of the Circular.

On 30 November 2023, the CSSF published an update to the CSSF FAQ on the submission of closing documents and financial information by managers (the “FAQ”). This FAQ relates to Circular CSSF 19/708 (as amended by Circular 21/790) outlining the necessary steps for electronically submission of specific documents to the CSSF, specifying the documents that require exclusive electronic transmission, along with the corresponding document types and required nomenclature.

One will recall that Circular 19/708 applies to:

• authorised AIFMs and internally managed AIFs;
• chapter 15 management companies (“Mancos”);
• chapter 16 (article 125-1) Mancos; and
• chapter 16 (article 125-2) Mancos.

Further to the scope of the manager’s authorisation, the latter must submit the following documents:

• the risk management procedure
• a complaint handling report
• the annual list of delegates
• the group organisation chart
• the self-assessment questionnaire and the separate report (both introduced by Circular 21/789)

The FAQ reminded and clarified that despite not being included in Circular 18/698, the AIFMs must submit to the CSSF, the minutes of the meetings of governing bodies, the minutes of the meetings of conducting officers during the year and during which AML/CFT topics have been discussed and proof that all conducting officers and board members followed AML/CFT training.

It is reminded that the closing documents must be submitted annually, within 5 months of the AIFM's financial year-end, except for the audited annual report and the management letter/no comment management letter that must be submitted within one (1) month after the ordinary shareholders’ general meeting approving annual accounts, and no later than seven (7) months from the date of the AIFM's financial year-end.

Finally, the FAQ pointed out that certain documents are to be submitted on a quarterly basis (calculation of capital ratio) or on an ad hoc basis in the event of changes during the year (summary table of mandates for management and senior positions, and updates to the risk management procedure), it being noted that an ad hoc submission of documents does not exempt the managers from submitting the documents on an annual basis.

On 20 December 2023, the Financial Stability Board (FSB) published revised policy recommendations to address structural vulnerabilities from liquidity mismatch in open-ended funds (OEFs) (the “Revised FSB Recommendations”) and the International Organisation of Securities Commissions (IOSCO) issued final guidance on anti-dilution liquidity management tools (“LMT Guidance”) for the effective implementation of the recommendations for liquidity risk management for collective investment schemes.

The Revised FSB Recommendations specifically focus on enhancing clarity regarding redemption terms offered by OEFs to investors and potential structural liquidity mismatch in OEFs, based on the liquidity of the OEF asset holdings. This involves a categorisation framework wherein OEFs are grouped based on the liquidity of their assets, such as liquid, less liquid, or illiquid. Regulatory authorities are encouraged to establish expectations for OEF managers, emphasising the use of both quantitative and qualitative factors to assess asset liquidity under normal and stressed market conditions.

In pursuit of improved liquidity risk management practices and to support these objectives, IOSCO's LMT Guidance provides comprehensive direction on the design and utilisation of anti-dilution LMTs by OEF managers. The LMT Guidance outlines essential operational, design, oversight, disclosure, and other factors that responsible entities should consider when employing anti-dilution LMTs. This encompasses the explicit and implicit transaction costs of subscriptions or redemptions.

Both the FSB and IOSCO will conduct reviews to evaluate the progress made by member jurisdictions in implementing the respective Revised FSB Recommendations and LMT Guidance. The assessment will commence with a stocktake, scheduled for completion by the end of 2026.