Further legal and regulatory developments

On 24 April 2025, ESMA published its annual report on leveraged alternative investment funds (AIFs) in the European Union, based on 2023 data.

The report aims to assess the systemic risks of leveraged AIFs and identifies the different types of funds, their level of leverage and their exposure to risks such as forced sales, contagion or disruption of financing to the real economy.

The report covers 3,144 funds, with €5.4 trillion in assets under management (AuM). Overall leverage is moderate, but the most leveraged funds have seen their leverage increase from 450% to 530% between 2022 and 2023.

For each category of funds, ESMA has assessed their potential systematic relevance in terms of market impact, risk of fire sales, risk of direct spillovers to financial institutions and risk of interruption to direct credit intermediation.

Real Estate Funds:

In 2023, Real Estate Funds were significantly impacted by declining property values, particularly those investing in commercial properties.

RE Funds are concentrated from a geographical perspective, with more than 90% of the assets managed in 5 jurisdictions (Germany, Luxembourg, France, the Netherlands and Italy) and highly exposed to liquidity mismatches. Hence, these funds make increasing use of liquidity management tools such as suspensions, notice periods and redemption gates.

While some RE Funds use substantial leverage, these tend to be smaller funds (2% of the total NAV in the sample) and, overall, most RE Funds in the EU exhibit low leverage.

Finally, ESMA notes that there is a systemic risk in countries where these funds hold a large proportion of the real estate market.

Hedge Funds:

This is the most leveraged category in the sample, with a median leverage of 653%, and leverage of more than 1,800% for some. On aggregate, their AuM is six times higher than their NAV. ESMA notes, however, that 90% of hedge funds have a leverage of less than 150%, but extreme cases require greater macro-prudential attention.

Given their leverage and the size of their positions, combined with their significant exposures to sovereign bonds across various strategies, they may pose a risk of market impact.

Private Equity Funds:

Concerning Private Equity Funds, there is a limited risk of market impact due to low leverage and mostly closed-end structures. ESMA’s report underlines that 99% of PE Funds are not substantially leveraged, and 90% have a leverage ratio below 113%. Although some PE Funds are highly leveraged, these represent only a small portion of the market. However, leverage may be underestimated, as it often sits with portfolio companies or special purpose vehicles. The sector’s rapid growth (that has nearly doubled since 2020) calls for stronger supervision.

Funds of Funds (FoFs):

Although 80% of the FoFs have a leverage ratio below 150%, the median leverage ratio of substantially leveraged FoFs rose from 446% to 842% between 2022 and 2023.

ESMA notes that FoFs are particularly exposed to liquidity mismatches as the liquidity offered to investors is superior to the liquidity of the assets under management, particularly in Germany. These funds remain highly interconnected with other financial institutions which may pose a risk of direct spillovers to financial institutions, but with a diversified investor base limiting the risk of a sectoral shock.

Other AIFs (such as liability-driven investment or bond funds):

This is the broadest and most diverse category that includes fixed income, equity, infrastructure AIFs and other funds. The report focuses in particular on liability-driven investment funds (LDI) that are mostly exposed to GBP-denominated assets. In September 2022, a sharp and sudden rise in UK sovereign yields triggered a liquidity crisis for GBP LDI funds, which highlighted the vulnerability of highly leveraged LDI strategies to interest rate shocks. In response to this crisis, ESMA welcomed the 300bps minimum level buffer of liquid assets required in Ireland and Luxembourg.

On 17 April 2025, the CSSF updated its FAQ on circular 22/811 (“UCIA Circular”), which aims to clarify the notion of “central administration”. By means of this update, the CSSF confirmed that the ”central administration” under the amended Law of 17 December 2010 relating to UCIs, the amended Law of 13 February 2007 relating to SIFs and the amended Law of 15 June 2004 relating to SICARs is broader than the notion of “UCI administration” provided for in the UCIA Circular.

and must be interpreted in light of the amended Law of 10 August 1915 on commercial companies, which includes both decision-making centre and administrative centre. Both of which must be based and remain at all times in Luxembourg.

On 15 April 2025, ESMA published its final report on the guidelines addressing the selection and calibration of LMTs for open-ended AIFs.

The guidelines will apply upon entry into force of the Regulatory Technical Standards (RTS) on LMT characteristics, with a 12-month compliance period for existing funds.

Key takeaways

Following the feedback received to the consultation paper, several amendments have been reflected in the revised text of the guidelines, including:

• Selection and use of LMTs:

ESMA encourages the use of at least one quantitative tool (e.g., redemption gate, notice period) and one Anti-Dilution Tool (ADT). Managers are allowed to use multiple ADTs (e.g., swing pricing + anti-dilution levy) simultaneously, especially under extreme market stress conditions.

• Suspensions and redemption gates:

Suspensions should be temporary and only considered in exceptional circumstances and when justified in the interests of investors.

Redemption gates should be considered for all funds whatever their strategy. No fixed thresholds or maximum durations are provided and activation should be determined on a case-by-case basis.

• Extended Notice Periods:

Extensions of notice periods are supported especially for less liquid assets without providing any minimum duration Their activation should be considered both under normal and stressed market conditions taking into account the best interest of investors.

• Redemptions in Kind:

Managers have discretion over the assets to be delivered and are not required to obtain third-party valuations.

• Redemption Fees:

Managers retain discretion to calibrate the predetermined range of redemption fees with a methodology allowing for review and adjustments.

• Side Pockets:

Activation of side pockets is permitted under exceptional circumstances and where justified having regard to the best interest of investors.

• Transparency:

Managers must ensure that investors and the competent authorities are informed when LMTs are activated, including the reasons for the activations and expected durations.

• Recordkeeping:

Managers are obliged to keep records of the selection, calibration, activation, and outcomes of LMT use, and make these available to competent authorities upon request.

On 22 April 2025, the Association of the Luxembourg Fund Industry (ALFI) published its annual report on the cross-border distribution of investment funds. It provides for the current global trends concerning the expansion of Luxembourg-domiciled investment funds within the international scene and markets. As provided therein, Luxembourg remains a global hub for cross-border fund distribution, with nearly half of global assets domiciled in the country. In fact, these funds are marketed in over 80 countries and as of early 2025, Luxembourg-domiciled cross-border funds (UCITS and AIFs) have an estimated EUR 7 trillion in assets under management, and notably, 48% of all cross-border assets under management are domiciled in Luxembourg.

This report also numerates a number of trends that are impacting the distribution market of these funds, such as:

• Fund managers have optimised operational efficiency in response to market consolidation and cost pressures
• Digitalisation, regulatory alignment, and sustainability integration are regarded as indispensable elements in preserving competitiveness
• ESG considerations continue to greatly influence the development of funds and investor preferences, with ESG-related strategies growing in global markets
• The industry is becoming more concentrated with 49% of assets being managed by the top-10 groups (vs 42% in 2018) and passive strategies like ETFs are inherently reshaping the market

Even though ESG and thematic funds continue to face scrutiny, Luxembourg’s legal framework, infrastructure and international place continue to make it the preferred ‘platform’ for managers seeking cross-border distribution.

In May 2025, the International Organization of Securities Commissions (IOSCO) released its updated recommendations on liquidity risk management for collective investment schemes (CIS), replacing the 2018 version. A new set of seventeen recommendations along with implementation guidance, concerning open-ended funds (OEFs), are included in the final report. The updated framework aims to strengthen CIS structures, particularly under stress, and to promote consistency in regulatory expectations across jurisdictions. The recommendations are grouped into six areas: CIS design, liquidity management tools, daily liquidity management practices, stress testing, governance, and disclosures to investors. IOSCO has implemented multiple significant improvements, such as broader use of LMTs).

The guidance supports the incorporation of a greater number of LMTs, including anti-dilution levies, swing pricing, redemption gates, and notice periods. Fund documentation should incorporate these instruments (e.g. in the prospectus), which should be supported by information concerning the basis on which those apply, their objectives and overall implications. IOSCO emphasises the significance of transparency with investors and regulators, as well as strict governance processes and communication plans. It is expected that fund managers will maintain audit reports and disclose the use of LMTs when applicable.

The revised framework creates stricter standards for liquidity stress testing. OEFs should conduct appropriate stress testing through stressed scenarios that include backward-looking historical scenarios and forward-looking hypotheticals which may depict events such as redemptions associated with margin calls or collateral calls. The recommendations are intended to be established on a principle-based framework, which allow for flexibility in the implementation of the recommendations across jurisdictions. It is expected that national competent authorities will either implement or align their supervisory practices with the new framework in the years ahead. A global stocktake of implementation progress is expected to be finalised by the end of 2026.

On 21 May 2025, ESMA launched a Call for Evidence on the retail investor experience in EU capital markets. In light of digitalisation and changing investor behaviour, the initiative seeks to assess the extent that the current MiFID II requirements help or possibly hinder retail investor participation, which might be used for future amendments to MiFID II. The intent of the consultation is to collect input from interested parties regarding the suitability and proportionality of investor protection laws in the digital age.

ESMA identifies behavioural and structural barriers such as limited financial literacy, perceived complexity of financial products, low trust, and a preference among retail investors for savings products over capital market instruments. The consultation specifically questions whether current disclosure obligations, suitability and appropriateness assessments, and the investor categorisation framework are too complex or not aligned with investor expectations.

ESMA is also asking for feedback on the influence of digital tools, including mobile apps, social media and “gamified” investment platforms, on investor decision-making. The attractiveness of speculative assets, such as crypto-assets and other volatile instruments, especially to younger investors, is a particular area of interest.

Investment firms, consumer protection groups, financial educators, and investor representatives are all qualified to take part in it. Responses may be provided by 21 July 2025.

On 10 April 2025, in the draft RTS, ESMA specified the rules intended to enhance investment firms’ order execution and foster investor protection.

The RTS includes requirements on:

• the establishment of an investment firm’s order execution policy;
• the investment firm’s procedures and criteria to monitor and regularly assess the effectiveness of its order execution arrangements and order execution policy;
• the investment firm’s execution of client orders through own account dealing; and
• how an investment firm should deal with specific client instructions.

On 29 April 2025, based on the ESMA's experience under market abuse regulation (‘MAR’), ESMA issued supervisory guidelines - intended for NCAs - that include general principles for effective supervision and specific practices for detecting and preventing market abuse in crypto assets.

The guidelines set out general principles requiring supervisory activity to be risk-based and proportionate, and set the objective for competent authorities such as the CSSF to build a common supervisory culture specific for crypto-assets through an open dialogue with the industry and interactions with other authorities.