## cr17257 ## Source details **Canonical URL:** [cr17257](https://www.imf.org/-/media/files/publications/cr/2017/cr17257.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17257.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17257.pdf.json) --- ### EXECUTIVE SUMMARY — overview and context - Luxembourg has an internationally significant fund management sector and applies a strong and comprehensive regulatory framework. - As of November 2016, total investment fund net assets domiciled in Luxembourg stood at approximately €3.35 trillion according to CSSF figures, equivalent to around 62 times Luxembourgish GDP. - Luxembourg’s investment fund sector is the world’s second largest by assets under management (second only to the United States). - Luxembourg-domiciled investment funds and money market funds account for 28 and 24 percent of euro area totals respectively. - The CSSF has reflected EU legislation and IOSCO standards at national level; in some cases Luxembourg has gone further than the relevant rule or principle to achieve a stronger framework. - Following the recommendations of the 2011 FSAP Update, the CSSF has shed its industry promotional role. ### Market structure and legal framework - UCITS represent 84 percent of investment fund assets in Luxembourg. - Distribution of asset classes by volume of AUM, in descending order: bonds, equity, mixed, money market, other funds, real estate, and hedge funds. - Key legislative and regulatory milestones: - UCITS: part I of the Luxembourg law of December 17, 2010 (Law of 2010), as amended; UCITS V transposed into law in Luxembourg in June 2016. - AIFs: law of July 12, 2013 transposing the AIFMD (the AIFM Law) and Luxembourg AIF product laws. - RAIFs: law adopted July 14, 2016; entered into force in August 2016 — reserved to Luxembourg AIFs managed by an authorized external AIFM; RAIFs are not subject to authorization and direct supervision by the CSSF but qualify as AIFs managed by a duly authorized AIFM subject to the full AIFMD requirements. - Circulars give guidance and are considered to have de facto binding force; FAQs have no legal content but steer regulated entities on CSSF expectations. - Part II Funds are AIFs allowed to be marketed to retail investors in Luxembourg, subject to additional investor protection requirements under Luxembourg law. ### Supervisory objectives and cooperation - CSSF’s four key objectives: - promoting a considered and prudent business policy in compliance with the regulatory requirements; - protecting the financial stability of the supervised companies and of the financial sector as a whole; - supervising the quality of the organization and internal control systems of the supervised companies; - strengthening the quality of supervised companies’ risk management. - CSSF cooperates with the Banque Centrale du Luxembourg (BCL), the European Supervisory Authorities (ESAs) and other supervisory authorities at European and international level. - Collaboration with the BCL: (i) data sharing; and (ii) ad hoc discussion within the Comité du risque systémique (CRS). ### Structural features warranting increased supervisory attention - Extensive use of delegation in the typical Luxembourg fund model, often including portfolio and risk management. - Finding: Of the 50 largest funds in Luxembourg, only 5 percent of the assets under management (AuM) are managed by a portfolio manager based in Luxembourg; the top two locations of portfolio managers in terms of AuM are the US (over 40 percent) and the UK (almost 30 percent). - Recommendation: strengthen guidance on substance in the context of delegated activities and engage actively with regulators in the jurisdiction of the delegate. - Concentration of fund directorships: - Finding: CSSF does not systematically record information on directorships held outside Luxembourg. - Recommendation: gather comprehensive data on the number of mandates held by individuals, determine an appropriate threshold (in terms of aggregate time commitment) for directorships and issue guidance. ### Liquidity management, leverage and systemic considerations - Identified regulatory shortfall: - UCITS managers are required to conduct stress tests which enable assessment of UCITS liquidity risk under exceptional circumstances, but are not required to conduct liquidity stress tests under normal liquidity conditions. - Recommendation: require Luxembourg UCITS to carry out liquidity stress testing under normal liquidity conditions (to align with AIFMD). - Liquidity management tools (LMTs): - Findings: broad range of LMTs available (swing pricing, redemption fees, anti-dilution levy, redemption gates, redemptions in kind, side pockets, lock-ups, limits on illiquid assets, concentration limits, limits on leverage/derivative use, maturity restrictions, short term borrowings, valuation at bid price). - Recommendation: CSSF should assess the effectiveness of LMTs for different types of funds for financial stability purposes and consider issuing guidance to fund managers to include those LMTs deemed most effective in their founding documents. - Leverage information and measurement: - AIFMD defines leverage and requires calculation using gross method and commitment method; an AIF is considered to be “substantially leveraged” when exposure calculated according to the commitment method exceeds three times its net asset value. - Recommendation: continue to contribute to discussions at European and international level on the development of a single method of calculating leverage. ### Depositaries, safekeeping and segregation - Appointment and prudential requirements: - UCITS depositaries in Luxembourg: only credit institutions may act as depositary; credit institutions in Luxembourg are required to have capital of at least €8,700,000. - AIF depositaries: can be a credit institution or an investment firm under the Law of 1993. - Seventy-six Luxembourg-based AIFs (52 regulated AIFs and 24 non-regulated AIFs) have a PSF as their depositary. - Depositary independence and governance: - UCITS V strengthened independence rules; where management company and depositary belong to same group, at least one third of supervisory body members (or, if lower, two members) should be independent. - CSSF 2015 assessment: 47 Luxembourg fund managers (44 management companies and three SICAVs) belonged to the same group as their depositary, corresponding to 31 percent of total UCITS assets in Luxembourg; CSSF estimated at least 64 additional directors had to be appointed to ensure compliance. - Recommendation: assess impact of recent changes and identify whether any risks remain with respect to depositary independence; consider additional safeguards or requiring more independent directors. - Safekeeping and segregation: - AIFMD/UCITS V introduced specific asset segregation requirements incorporated into Luxembourg law. - Finding: lack of clarity on interpretation of segregation obligations when safekeeping duties are delegated; CSSF should continue contributing within ESMA to develop a common approach. - Depositary liability: - AIFMD: depositary remains liable for any loss of financial instruments held in custody despite delegation (can discharge liability subject to contract in certain cases). - UCITS V: more stringent — does not allow discharge of liability when safekeeping duties delegated. ### Supervision, inspections and data gaps - Resources and organization: - CSSF has 216 full-time equivalents working on fund issues across relevant departments; total CSSF staff increased from 357 (December 1, 2010) to 651 (June 13, 2016). - On-site inspections department headcount stands at 40 and will be increased by 50 percent till year-end 2016. - Supervisory approach: - CSSF is rolling out a risk-scoring approach initially for UCITS and UCITS management companies (covering 83 percent of assets as of March 2016) and will extend to AIFs and AIFMs. - On-site inspections: - Two departments dedicated to controls: On-site Inspections (“OSI”) and “Contrôles Sur Place” of the Métier OPC (OPC-CSP). - Thematic inspection counts (Total): 2013 — 26; 2014 — 37; 2015 — 35. - Thematic inspection types and counts: - Anti-money laundering/terrorist financing: 2013 — 13; 2014 — 10; 2015 — 14 - Risk Management: 2013 — 3; 2014 — 1; 2015 — 5 - Governance of UCTIS management company and AFIM: 2013 — 3; 2014 — 5; 2015 — 4 - NAV error and breaches of investment restrictions: 2013 — 1; 2014 — 1; 2015 — 1 - Depositary Bank: 2013 — 12; 2014 — 13; 2015 — 10 - Central Administration: 2013 — 4; 2014 — 7; 2015 — 1 - Recommendation: increase the number of thematic on-site inspections further and introduce comprehensive on-site inspections as a further element of the supervisory toolkit. - Data access and gaps: - CSSF has access to a broad range of periodic reports and to reports provided by CIS to the BCL, including the “Reporting SbS” security-by-security portfolio data. - CSSF has not yet been granted full access to all descriptive data in the ECB’s Centralized Securities Database; discussions initiated to obtain such access. - Recommendation: continue efforts to obtain access to the ECB’s Centralized Securities Database; continue engagement with the BCL and ECB to close data gaps such as on individual securities holdings of funds. - Recommendation: raise for discussion within ESMA the issue of data on fund liabilities (i.e., the categorization of underlying investors in the fund). ### Money Market Funds (MMFs) - MMFs represent 22 percent of the EU market. - MMF categories: VNAV, CNAV, LVNAV (compromise introducing Low Volatility Net Asset Value MMFs with specific liquidity requirements). - Finding: Luxembourg (with Ireland) is one of two EU centers for CNAV MMFs. - Recommendation: CSSF should monitor consequential changes to the Luxembourg MMF industry arising from the EU MMF Regulation and assess whether any particular supervisory actions would be warranted once the Regulation starts to apply. ### Valuation, accounting, auditors and pricing errors - Valuation — UCITS: - Valuation must be carried out at least twice a month unless limited redemption arrangements apply; Luxembourg UCITS must publish issue, sale and redemption price each time and at least twice a month. - Currently there is only one UCITS in Luxembourg that permits monthly redemptions; the vast majority of UCITS offer daily redemptions. - OTC derivatives must be subject to reliable and verifiable valuation on a daily basis; independent verification required by third party or independent unit. - Valuation — AIFs: - AIF assets must be valued and NAV per unit calculated at least once a year; for open-ended AIFs frequency must be appropriate to assets held and issuance/redemption frequency. - External valuer must be independent; depositary cannot be external valuer unless functionally/hierarchically separated. - Accounting regimes: - Options: (a) Luxgaap under historical cost conventions; (b) Luxgaap with some fair value options; (c) IFRS as implemented via EU legislation. - Approximate usage: Luxgaap used by approximately 95 percent of Luxembourg CIS; IFRS used by approximately 5 percent of Luxembourg CIS. - Role of auditors: - UCITS and AIFs must have accounting information in their annual report audited by an external auditor authorized by the CSSF and member of the IRE. - Pricing/NAV errors — empirical findings: - Number of NAV calculation errors notified to the CSSF: 2015 — 343; 2014 — 226; 2013 — 215. - Number of pricing errors notified, including valuation differences of derivative instruments: 2015 — 107; 2014 — 71; 2013 — 59. - Proportion (in percent): 2015 — 31; 2014 — 31; 2013 — 27. - Finding: Increase primarily due to CSSF decision to extend to SIFs the regime set out in circular 02/77. ### Reporting framework and risk monitoring tools - Key reporting types and features: - Reporting U1.1: Monthly reporting covering each type of UCI including NAV, subscriptions, redemptions, distributions, share class data, income and expenses. - Reporting O4.1: Annual reporting (each UCI except SICAR) including balance sheet positions split by investment categories. - Reporting K3.1: Semi-annual SICAR reporting including balance sheet positions, income and expenses, principal exposures. - AIFMD Reporting: Frequency quarterly to annually depending on AUM and strategy; Annex IV template includes investment strategy, principal exposures, instruments traded, risk profile, monthly return, NAV changes, subscriptions and redemptions, stress test results, borrowing and exposure, leverage. - UCITS Risk Reporting: Semi-annual reporting for UCITS with leverage exceeding 250 percent (notional amount) and/or net assets above €500 million. - VaR & Leverage Report: Ad-hoc quarterly reporting for UCITS with expected leverage exceeding 600 percent (notional amount). - MMF Regular Reporting: Monthly ad-hoc reporting for largest Luxembourg-based MMFs covering performance, portfolio structure and flows, subscription and redemption activity, portfolio valuation. - Quarterly prudential reporting for Asset Managers: balance sheet & profit and loss accounts, assets under management, number of employees (Quarterly). - UCITS risk reporting scope: - Reporting required for UCITS with a leverage (in terms of notional amount) exceeding 250 percent and/or net assets above €500 million, with objective to broaden scope to all UCITS. - Note: leverage referred to is calculated as the sum of the notionals of derivatives used; no hedging or other risk offsetting is taken into account. ### Enforcement framework and systemic risk monitoring - Enforcement procedures: - CSSF internal procedure outlines general enforcement principles and involvement of the “Comité Enforcement”. - CIS department has standardized sanction proceedings where Enforcement Committee involvement is not necessary (e.g., fines for late filing; withdrawal of approval). - Administrative fines and withdrawals: - CSSF has withdrawn a total of 28 authorizations over the past three years (including three management companies and the funds they managed). - Sanctions for UCITS and managers derived from UCITS Directive include public statements, orders to cease conduct, suspension/withdrawal of authorization, temporary/permanent bans, and administrative pecuniary sanctions up to €5,000,000 or 10 percent of total annual turnover for legal persons; for natural persons maximum administrative pecuniary sanctions of €5,000,000; alternative sanction of at least twice the amount of benefit derived from the infringement. - Sanctions for AIFs: warning; reprimand; fine between €250 and €250,000; and in certain cases prohibitions or activity restrictions. - Systemic risk monitoring: - Domestic: Comité du risque systémique (CRS) installed as main process to monitor, mitigate and manage systemic risk. - CSSF participates actively in international workgroups (IOSCO, FSB) on liquidity and leverage. - UCITS risk reporting and AIFMD reporting enable monitoring of key metrics such as leverage and SFTs. - Example power: CSSF can impose a limit on leverage employed by an AIFM or group of AIFMs if leverage buildup is considered excessive. ### Main recommendations (selected and categorized by priority) - High priority: - Require Luxembourg UCITS to carry out liquidity stress testing under normal liquidity conditions. - Assess effectiveness of liquidity management tools and consider issuing guidance to industry on the merits of having access to particular tools. - Engage with the Luxembourg industry to assess the impact of the recent changes on depositary independence and identify whether any risks remain; consider whether additional safeguards should be put in place to enshrine the independence of the depositary. - Strengthen guidance on substance in the context of delegated activities and engage actively with regulators in jurisdiction of delegate. - Gather data on the holdings of directorships of funds, their managers, depositaries and administrators; determine an appropriate threshold and issue guidance. - Continue to increase the frequency of on-site inspections (and introduce comprehensive inspections) of regulated entities in the fund sector. - Medium priority: - Continue to contribute to discussions within ESMA on leverage (with a view to developing a single methodology for measurement of leverage across the fund industry) and asset safekeeping. - Continue to engage with the Banque Centrale du Luxembourg (BCL) and ECB to close data gaps such as on individual securities holdings of funds. - Raise for discussion within ESMA the issue of data on fund liabilities (i.e., the categorization of underlying investors in the fund). - Monitor the consequential changes to the Luxembourg MMF industry arising from the EU Regulation currently under negotiation and assess whether any particular supervisory actions would be warranted once the Regulation starts to apply. *Source: IMF staff report (cr17257).* ### EXECUTIVE SUMMARY __________________________________________________________________________________ 4 ### EXECUTIVE SUMMARY ### Overview and context - Luxembourg has an internationally significant fund management sector and applies a strong and comprehensive regulatory framework. - As of November 2016, total investment fund net assets domiciled in Luxembourg stood at approximately €3.35 trillion according to CSSF figures, equivalent to around 62 times Luxembourgish GDP. - Luxembourg’s investment fund sector is the world’s second largest by assets under management (second only to the United States). - Luxembourg-domiciled investment funds and money market funds account for 28 and 24 percent of euro area totals respectively. - The CSSF has reflected EU legislation and IOSCO standards at national level; in some cases Luxembourg has gone further than the relevant rule or principle to achieve a stronger framework. - Following the recommendations of the 2011 FSAP Update, the CSSF has shed its industry promotional role. ### Market structure and legal framework - UCITS represent 84 percent of investment fund assets in Luxembourg. - The distribution of asset classes by volume of assets under management (AUM), in descending order, is: bonds, equity, mixed, money market, other funds, real estate, and hedge funds. - Key legislative and regulatory milestones and instruments: - UCITS: part I of the Luxembourg law of December 17, 2010 (Law of 2010), as amended; UCITS V transposed into law in Luxembourg in June 2016. - AIFs: law of July 12, 2013 transposing the AIFMD (the AIFM Law) and Luxembourg AIF product laws. - RAIFs: law adopted July 14, 2016; entered into force in August 2016 — reserved to Luxembourg AIFs managed by an authorized external AIFM; RAIFs are not subject to authorization and direct supervision by the CSSF but qualify as AIFs managed by a duly authorized AIFM subject to the full AIFMD requirements. - Luxembourg circulars and FAQs: - Circulars give guidance and are considered to have de facto binding force. - FAQs have no legal content but steer regulated entities on CSSF expectations. - Part II Funds are AIFs allowed to be marketed to retail investors in Luxembourg, subject to additional investor protection requirements under Luxembourg law. ### Supervisory objectives and cooperation - The CSSF’s four key objectives (covering micro- and macroprudential responsibilities): - promoting a considered and prudent business policy in compliance with the regulatory requirements; - protecting the financial stability of the supervised companies and of the financial sector as a whole; - supervising the quality of the organization and internal control systems of the supervised companies; - strengthening the quality of supervised companies’ risk management. - The CSSF cooperates with the Banque Centrale du Luxembourg (BCL), the European Supervisory Authorities (ESAs) and other supervisory authorities at European and international level. - Collaboration with the BCL takes two main forms: (i) data sharing; and (ii) ad hoc discussion within the Comité du risque systémique (CRS). ### Structural features warranting increased supervisory attention - Extensive use of delegation in the typical Luxembourg fund model, often including portfolio and risk management. - Although this structure has not given rise to problems in the past, rapid industry growth and the extent of delegated activities warrant additional supervisory scrutiny. - Recommendation: strengthen guidance on substance in the context of delegated activities and engage actively with regulators in the jurisdiction of the delegate. - Concentration of fund directorships: - Directorships of funds, their managers and service providers merit increased CSSF focus. - Recommendation: gather comprehensive data on the number of mandates held by individuals, including at entities outside Luxembourg; determine an appropriate threshold (in terms of aggregate time commitment) for directorships and issue guidance. ### Liquidity management, leverage and systemic considerations - Luxembourg framework for liquidity management tools (LMTs) compares favorably to peers at both EU and international level. - Recommendation: the CSSF should assess the effectiveness of LMTs for different types of funds for financial stability purposes and consider issuing guidance to fund managers to include those LMTs deemed most effective in their founding documents. - Information on leverage of funds is potentially relevant from a systemic risk perspective. - Recommendation: continue to contribute to discussions at European and international level on the development of a single method of calculating leverage. ### Depositary oversight and asset safekeeping - Given the importance of depositaries for oversight and asset safekeeping: - The CSSF should assess the impact of recent changes and identify whether any risks remain with respect to depositary independence. - The CSSF should consider whether additional safeguards should be put in place to enshrine the independence of the depositary. - Recommendation: continue contributions within ESMA on asset safekeeping (aimed at clarifying the rules on asset segregation throughout the custody chain). ### Supervision, inspections and data gaps - Since the 2011 FSAP, the CSSF has significantly increased resources in the fund management area, allowing an increase in thematic on-site inspections. - Recommendation: efforts should be made to increase the number of thematic on-site inspections further and to introduce comprehensive on-site inspections as a further element of the supervisory toolkit. - Data access: - The CSSF has access to a broad range of periodic reports from regulated entities and can use ad hoc requests. - Recommendation: continue efforts to obtain access to the ECB’s Centralized Securities Database to fill possible data gaps; continue engagement with the BCL and ECB to close data gaps such as on individual securities holdings of funds. - Recommendation: raise for discussion within ESMA the issue of data on fund liabilities (i.e. the categorization of underlying investors in the fund). ### Money Market Funds (MMFs) and regulatory change - Luxembourg authorities have been actively monitoring and contributing to discussions on the EU Money Market Funds (MMF) Regulation. - The final outcome of the EU MMF Regulation may result in consequential changes to the MMF industry in Luxembourg. - Recommendation: the CSSF should monitor those changes and, once the Regulation has started to apply, assess whether any particular supervisory actions would be warranted. ### Main recommendations (Table 1) - Require Luxembourg UCITS to carry out liquidity stress testing under normal liquidity conditions (the current rules require only stress testing which enables assessment of liquidity risk under exceptional circumstances). — High - Assess effectiveness of liquidity management tools and consider issuing guidance to industry on the merits of having access to particular tools. — High - Engage with the Luxembourg industry to assess the impact of the recent changes on depositary independence and identify whether any risks remain; consider whether additional safeguards should be put in place to enshrine the independence of the depositary. — High - Strengthen guidance on substance in the context of delegated activities and engage actively with regulators in jurisdiction of delegate. — High - Gather data on the holdings of directorships of funds, their managers, depositaries and administrators; determine an appropriate threshold and issue guidance. — High - Continue to increase the frequency of on-site inspections (and introduce comprehensive inspections) of regulated entities in the fund sector. — High - Continue to contribute to discussions within ESMA on leverage (with a view to developing a single methodology for measurement of leverage across the fund industry) and asset safekeeping (aimed at clarifying the rules on asset segregation throughout the custody chain). — Medium - Continue to engage with the Banque Centrale du Luxembourg (BCL) and ECB to close data gaps such as on individual securities holdings of funds. — Medium - Raise for discussion within ESMA the issue of data on fund liabilities (i.e. the categorization of underlying investors in the fund). — Medium - The CSSF should monitor the consequential changes to the Luxembourg MMF industry arising from the EU Regulation currently under negotiation and assess whether any particular supervisory actions would be warranted once the Regulation starts to apply. — Medium *Source: IMF staff report (Executive Summary).* ### Box 1. Investment Fund Types in Luxembourg ### Box 1. Investment Fund Types in Luxembourg ### Fund categorization and legal forms - As an EU member state, Luxembourg must comply with the EU UCITS Directive and Alternative Investment Fund Managers Directive (AIFMD). Most Luxembourg investment funds fall into one of two categories: UCITS or AIFs. - UCITS: the UCITS Directive requires a UCITS fund to be authorized; the AIFMD applies to the manager (rather than the fund). - Further distinctions are made between different types of AIF and specific national laws apply to each type. - Types and legal forms (as presented): - UCITS (Part I UCI) - Legal form: Contractual investment fund or common fund (fonds commun de placement (FCP)) - Investment company with variable capital (SICAV1) or fixed capital (SICAF) - Regulated AIFs - Part II UCI - FCP - SICAV taking one of the following legal forms: - a public limited company (société anonyme (SA)); - a partnership limited by shares (société en commandite par actions (SCA)); - a limited partnership (société en commandite simple (SCS)); - a special limited partnership (société en commandite spéciale (SCSp)); - a limited company (société à responsabilité limitée (SàrL)); or - a cooperative in the form of a public limited company (société cooperative organisée sous forme de société anonyme). - SICAF - Specialized Investment Fund (SIF) - FCP - SICAV taking one of the legal forms listed above (SA, SCA, SCS, SCSp, SàrL, SCoSa) - SICAR - SICAR legal forms mirror those listed above (SA, SCA, SCS, SCSp, SàrL, SCoSa) - Unregulated AIFs / Other - Some fund vehicles fall outside the scope of the specific product laws (e.g. SIF, SICAR etc.) and are therefore unregulated AIFs (e.g. Reserved Alternative Investment Funds (RAIFs)). - Footnote: 1 In the form of a public limited company only. ### Valuation of assets — UCITS - The UCITS Directive: - Leaves determination of valuation requirements for UCITS funds to the member state of the fund. - Requires rules for valuing assets and calculating the price of UCITS units to be laid down in national law, in the fund rules, or in the instruments of incorporation of the investment company. - Responsibilities and procedures: - UCITS fund managers are responsible for calculating the net asset value (NAV) and determining related subscription and redemption prices. - Managers must have accounting policies and procedures in accordance with the accounting rules of the UCITS fund’s home state and procedures to ensure proper and accurate valuation of assets and liabilities in accordance with the fund rules and prospectus. - Frequency and publication: - Valuation must be carried out at least twice a month, unless the fund applies limited redemption arrangements. - Luxembourg UCITS must publish the issue, sale and redemption price of their units each time they issue, sell and redeem, and at least twice a month. - The CSSF may permit reduction to once a month if derogation does not prejudice unitholders; such derogations are exceptional and require detailed reasoned explanations and knowledge of the investor base. - Currently there is only one UCITS in Luxembourg that permits monthly redemptions. The vast majority of UCITS offer daily redemptions. - Valuation principles: - Listed assets: valuation based on the last known stock exchange quotation. - Securities not listed or where the latest quotation is not representative: valuation based on probable realization value estimated with care and in good faith, determined according to fund rules. - OTC derivatives: - Listed derivatives or derivatives on a regulated market valued on latest available market quotation. - OTC derivatives must be subject to reliable and verifiable valuation on a daily basis and capable of being sold, liquidated or closed by offsetting transaction at any time at their fair value at the UCITS initiative. - OTC derivatives to be valued at fair value (i.e. amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction), on basis of either a reliable up-to-date market value or, if not available, a pricing model using an adequate recognized methodology. - The UCITS shall not rely only on market quotations by the counterparty. - For OTC derivatives the rules require independent verification of the valuation by either an appropriate third party or an independent unit within the UCITS. - Securities and money market instruments (MMI): - Securities (including MMI) shall be valued in an accurate, reliable and fair way by referring to market prices or valuation systems/models. - For MMI, amortized cost valuation system is permitted where the UCITS must ensure this will not result in a material discrepancy between the value of the MMI and the value calculated according to the amortization method. - For unlisted/unquoted securities, reliable valuation derived periodically from issuer information or competent investment research. - Cross-reference: Box 4 provides further detail on the latest developments regarding the regulation of money market funds in Luxembourg. ### Valuation of assets — AIFs - AIFMD valuation framework: - Extensive set of valuation requirements covering which entities may carry out valuations, development and periodic review of valuation policies, and use of models. - AIF assets must be valued and NAV per unit calculated at least once a year. - For open-ended AIFs, valuations and calculations must be carried out at a frequency appropriate to the assets held and issuance/redemption frequency. - Financial instruments must be valued every time NAV per unit is calculated; other assets must be valued at least once a year and whenever evidence indicates the last value is no longer fair. - For closed-ended AIFs, valuations and calculations must be carried out in case of an increase or decrease of the AIF’s capital. - Implementing measures include detailed requirements on content, consistency of application and periodic review of valuation policies/procedures, use of models, and review of individual asset values. - Who can conduct valuations: - If the AIFM performs valuation, those responsible must be functionally independent from portfolio management; remuneration policy and other measures must ensure conflicts of interest are mitigated. - Any external valuer must be independent from the AIF, the AIFM and any other person with close links to the AIF or the AIFM. - The AIF’s depositary cannot be appointed as external valuer unless functionally/hierarchically separated and conflicts of interest properly identified, managed, monitored and disclosed. - The external valuer is prohibited from delegating the valuation function. - The AIFM must notify the competent authority of the appointment of the external valuer. - If valuation is not performed by an independent external valuer, the competent authority may require valuation procedures and/or valuations be verified by an external valuer or auditor; the competent authority can require an external valuer to verify the independence of internal valuation. - Specific AIF rules: - Part II AIFs: some rules applicable to UCITS (namely those relating to pricing of units) must be complied with; disclosure requirements regarding determination of sale/issue price and redemption/repurchase price applicable to UCITS must also be applied by Part II funds. - SIFs: general principle that valuation of assets must be based on fair value, determined in accordance with constitutive documents, management regulations, articles of incorporation or partnership agreement. - Real estate AIFs: directors must appoint one or more independent property valuers with specific experience; properties may not be acquired/sold unless valued by property valuer(s) (a new valuation unnecessary if sale occurs within six months after last valuation); acquisition prices may not be noticeably higher nor sales prices noticeably lower than relevant valuation except in exceptional duly justified circumstances, with managers required to justify decision in next financial report. - SICARs: general principle of fair value applies; value determined in accordance with articles of incorporation or partnership agreement. ### Accounting rules - Accounting regimes available for preparing and filing stand-alone and consolidated accounts: - a. Luxgaap under historical cost conventions; - b. Luxgaap with some fair value options; or - c. IFRS as implemented via EU legislation. - For investment companies: - The accounting and CIS laws require valuation to be done on the basis of fair value. - Consequently, CIS prepare and file annual accounts according to regimes b and c above. - By analogy, these two accounting regimes are also applicable, in practice, to common (mutual) funds. - Luxembourg legislation provides that entities may request derogations, exceptionally, for application of another recognised accounting standard (e.g., US GAAP). - Usage statistics and choices: - The accounting standard most commonly used by collective investment schemes (CIS) established in Luxembourg is the Luxembourg Generally Accepted Accounting Principles (Luxgaap). - Footnote: Approximately 95 percent of the Luxembourg CIS. - As an exception, listed (closed-ended) CIS must establish financial statements under International Financial Reporting Standards (IFRS) as implemented via EU legislation. - CIS may voluntarily choose to apply IFRS for financial statements and for NAV calculation. - Footnote: This is the case for approximately 5 percent of the Luxembourg CIS. - CIS opting for IFRS generally do so at request of shareholders/institutional investors, due to consolidation at parent level using IFRS or need for consolidated reporting in the group. - Compliance with IOSCO Principles: - Luxembourg requirements appear to comply with Principles 26 and 27 of the IOSCO Principles requiring CIS accounts preparation and NAV calculation in accordance with high quality, internationally acceptable accounting standards. - Main differences between Luxgaap and IFRS relate to presentation of annual accounts and treatment of formation expenses: - Presentation differences: schedule of investments vs statement of cash flows and volume of information contained in notes (i.e., financial instruments, fair value hierarchy etc.). IFRS requires more extensive disclosures. - Formation expenses: Luxgaap allows capitalization and write-off within a maximum period of five years; under IFRS (IAS 38) formation expenses are expensed as incurred and cannot be capitalised. - These differences do not impact CSSF’s supervision of funds as both standards provide appropriate level of disclosure. ### Role of auditors - External auditors verify accounting information for UCITS and AIFs. - Requirements: - Luxembourg UCITS must have accounting information in their annual report audited by an external auditor (authorized by the CSSF and a member of the IRE (Institut des réviseurs d’entreprises)). - This also applies to Part II funds, SIFs and SICARs. - Whenever valuation is delegated, the UCITS management company or AIFM has to perform a verification of such valuation. - AIF-specific audit rules: - Law provides that accounting information in the annual report of each AIF must be audited by one or more persons empowered by law to audit accounts in accordance with EU accounting legislation. - The auditor's report, including any qualifications, must be reproduced in full in the annual report. - Derogation: for AIFMs marketing non-EU AIFs, annual reports of those AIFs may be subject to an audit meeting international auditing standards in force in the country where the AIF has its registered office. ### Treatment of pricing errors - IOSCO Principles for the Valuation of Collective Investment Schemes: - Require responsible entities to have policies and procedures to detect, prevent and correct pricing errors. - Pricing errors that result in material harm to CIS investors should be addressed promptly, and investors fully compensated. - EU directives: - UCITS Directive and AIFMD include only general references to treatment of pricing errors. - UCITS Directive notes that UCITS home member state rules apply to errors in NAV calculation and related investor compensation. - AIFMD implementing measures require an AIFM to ensure remedial procedures are in place in the event of incorrect calculation of the NAV. - Luxembourg regulatory approach: - CSSF circular lays down regulatory requirements related to treatment of CIS pricing errors; applies to errors in administration or management of UCITS and Part II UCIs qualifying as AIFs. - The circular sets out minimum rules of conduct to be followed by collective investment professionals in Luxembourg in case of errors in administration or management of the UCITS for which they are responsible. - The circular underlines responsibility of UCITS promoters (management company or investment company) to ensure errors are correctly dealt with in strictest compliance with the rules of conduct specified; in case of irregularities the CSSF sets deadlines for rectifying the situation. - The circular clarifies procedures for correction of calculation errors with material impact on the NAV, including information to be provided to management company, depositary of the UCI and to the CSSF, and rules for determining financial impact of significant calculation errors (distinguishing cases where NAV is undervalued vs overvalued). - SIFs may either opt to apply the same circular or set out other internal rules that must remain within reasonable limits with respect to the SIF’s investment policy. - CSSF considers that SIFs that have not set out specific internal rules must apply the aforementioned circular. - Any NAV calculation error by a SIF must be notified to the CSSF, as well as information on whether the SIF chose to apply the relevant circular or to rely on internal rules. *Source: cr17257 - Box 1. Investment Fund Types in Luxembourg* ### 34. The following table shows the number of NAV calculation errors notified during the ### cr17257 - 34. The following table shows the number of NAV calculation errors notified during the ### NAV calculation errors: empirical findings - Table 2. Luxembourg: NAV Calculation Errors (2015, 2014, 2013) - Number of NAV calculation errors notified to the CSSF: 343, 226, 215 - Number of pricing errors notified, including valuation differences of derivative instruments: 107, 71, 59 - Proportion (in percent): 31, 31, 27 - The increase in the number of NAV calculation and pricing errors notified is primarily due to the decision of the CSSF to extend to SIFs the regime set out in circular 02/77. - CSSF 02/77: on the Protection of investors in case of NAV calculation error and correction of the consequences resulting from non-compliance with the investment rules applicable to undertakings for collective investment. *Risk and Liquidity Management* ### Regulatory requirements and gaps - UCITS requirements - UCITS funds are subject to investment limits and the fund manager is required to manage and measure the funds’ risk on a continuous basis. - The UCITS Directive requires a risk management process enabling monitoring and measurement at any time of the risk of positions and their contribution to the overall risk profile. - UCITS Implementing Directive includes additional due diligence, risk management and measurement requirements. - Risk management policy must enable assessment of exposure to market, liquidity and counterparty risk, and other relevant risks. - Competent authority must review the risk management policy when authorizing the manager and on an ongoing basis; material changes must be notified to the competent authority. - Liquidity-specific expectations for managers - Management companies must adopt effective arrangements, processes and techniques to establish, implement and maintain a documented system of internal risk limits, including for liquidity risk, where relevant. - Managers must employ an appropriate liquidity risk management process to ensure each UCITS complies with its redemption obligation and, where appropriate, conduct stress tests which enable assessment of UCITS liquidity risk under exceptional circumstances. - Liquidity profile of the UCITS must be appropriate to the disclosed redemption policy. - Identified regulatory shortfall - The robustness of the regulatory framework would be enhanced by requiring UCITS fund managers to conduct liquidity stress tests also under normal liquidity conditions (aligning with AIFMD). - Recommendation: CSSF is encouraged to seek enhancements to the liquidity risk management requirements for UCITS fund managers, either through changes to the UCITS Directive or through its own measures. ### AIFMD liquidity obligations - AIFMD requires: - Consistency between the investment strategy, liquidity profile and redemption policy of each AIF. - Employment of an appropriate liquidity management system and procedures to monitor AIF liquidity risk. - Regular stress tests under normal and exceptional liquidity conditions to assess and monitor liquidity risk. - Disclosure to investors of the AIF’s liquidity risk management, including redemption rights in normal and exceptional circumstances, and existing redemption arrangements with investors. - Identification, management and monitoring of conflicts of interest between redeeming and remaining investors and between the AIFM’s incentive to invest in illiquid assets and its redemption policy. ### Policy recommendation (liquidity stress testing) - Recommendation: It would be beneficial to require Luxembourg UCITS to carry out liquidity stress testing also under normal liquidity conditions to align approaches between funds covered by the AIFMD and those covered by the UCITS Directive, given the predominance of UCITS in the Luxembourg fund industry. ### Liquidity management tools: role and rationale - Suspensions or deferrals of redemptions are ex post liquidity management tools, typically used once liquidity risk has crystallized; suspensions are a blunt tool. - Frequent trading imposes costs that dilute value of existing shareholders’ interests (first-mover advantage), potentially exacerbating runs. - A broader range of pricing tools can protect existing investors and reduce first-mover advantage. - The Financial Stability Board (FSB) consultation recommends authorities make a broad range of liquidity management tools—including swing pricing—available to CIS. - Swing pricing and charging redemption fees are highlighted as mechanisms to price-in cost of liquidity and deter destabilizing redemptions. ### Liquidity management and pricing tools available in Luxembourg (Box 2) - Swing pricing: ensures an investor with a large redemption pays for market impact of the redemption so remaining investors are not diluted. - Redemption fees: imposition of an exit fee or redemption fee to deter redemptions in particular (stress) scenarios. - Anti-dilution levy: fee to ensure an investor with a large redemption pays for market impact so remaining investors are not diluted. - Redemption gates: limit on redemptions (for example, 10 percent of net assets) to limit substantial redemptions in a short period; orders exceeding the limit are partially executed and the rest postponed. - Redemptions in kind: fund may redeem by payment in underlying investments of equivalent value rather than selling assets and paying cash; requires valuation by external auditor (réviseur d’entreprises agréé). - Side pockets: sub-account to separate illiquid assets from more liquid investments; only present participants share side-pocketed assets. - Timing restrictions between subscription and redemption: lock-up period prevents redemption or sale for a window of time while capital is put to work. - Limits on illiquid asset investment: may require maintaining a certain percentage of highly liquid assets (for example, 20 percent) of net assets. - Limits on asset concentration: limits on holdings by issuer, issuer type, credit rating, maturity, value, counterparty or industry classifications; diversification ranges for assets and country exposures. - Limits on leverage or derivative use: limits may derive from regulatory obligations (e.g., global exposure limitation under UCITS) or be fund specific; borrowing limits (for example 20 percent) may apply. - In synthetic leverage, limits placed on leverage derived from derivatives. - Maturity restriction: limits on amount of assets of a given maturity so fund can meet short term obligations. - Short term borrowings: temporary borrowing or entering repos to meet redemptions (e.g., line of credit or bank overdraft). - Valuation at bid price: valuing fixed income securities at bid price effectively makes redeeming investor pay part of transaction costs. ### Assessment and recommendation on tool availability and usage - Findings: - There is a broad range of liquidity management tools available to CIS domiciled in Luxembourg. - The availability of tools means Luxembourg compares favorably to other important fund centers, as set out in IOSCO’s Liquidity Management Tools in Collective Investment Schemes: Results from an IOSCO Committee 5 survey published in December 2015. - CSSF powers: CSSF only has the power to require that redemptions be suspended; all other tools are at the discretion of the CIS or its manager. - Recommendation: - The CSSF should carry out a study to assess which tools have been most efficient from a financial stability perspective at addressing possible issues of illiquidity and/or investor runs. - In light of the study outcome, CSSF should consider issuing guidance—in line with recommendations of the FSB consultation—encouraging CIS managers to incorporate the most effective liquidity management tools in their founding documents. - Such guidance should leave some discretion to CIS and managers but provide a firm basis for the CSSF to challenge a decision by a CIS manager not to incorporate a particular tool (e.g., at the authorization stage). ### Suspension and deferral of redemptions: rules and statistics - Legal and procedural points: - IOSCO Principles recommend inclusion in constitutional documents of ability to use specific tools or exceptional measures affecting redemption rights where permissible and appropriate. - The only tool with express requirements in UCITS Directive or AIFMD is suspension of redemptions. - Article 84 of the Directive: a UCITS may temporarily suspend redemption of its units only in exceptional cases where suspension is in the interest of unitholders; competent authority and investors must be informed about any suspension. - CSSF has power to order management company to suspend redemption of fund units if necessary in the interests of investors or the public. - Suspensions and deferrals of valuation and redemptions are generally decided by the CIS or its fund manager; management company must immediately communicate suspension decision to the CSSF and, if marketed in other member states, to competent authorities of those member states. - For UCITS, suspension of NAV calculation is only permitted for reasons clearly beyond the control of the fund (e.g., market closure or implausible prices). Deferrals/gates are permitted as set out in the fund rules (e.g., where more than 10 percent of the NAV of a sub-fund is impacted by redemption orders). - Suspensions and deferrals are exceptional measures expected not to exceed a reasonable number of days; CSSF monitors to ensure NAV calculation is resumed within a reasonable time and carries out ongoing monitoring where redemptions are not resumed within a short period. - Empirical statistics: - The CSSF has been notified of 511 suspensions of redemptions since 2007. - One third of these were due to redemption pressure and/or illiquidity of assets. - A further quarter were technical suspensions caused by e.g., the temporary closure of the referenced market. - Other important drivers included market events, such as the sub-prime crisis, or difficulties in the valuation of the assets. - Around two-fifths of suspensions lasted less than seven days. - Almost two-thirds were resolved within 90 days. *International Monetary Fund — Luxembourg chapter (extracted content unit).* ### 50. It is important to distinguish the possibility for the CIS or fund manager to suspend or ### 50. It is important to distinguish the possibility for the CIS or fund manager to suspend or ### Suspension and notification rules - UCITS: the fund rules must specify the circumstances in which a temporary suspension of redemptions is permitted. - AIFs: - The AIFMD obliges AIFMs to notify investors immediately where they activate gates, side pockets or similar special arrangements or where they decide to suspend redemptions. - In accordance with Annex IV of the AIFM Delegated Regulation, information on what percentage of the AIF’s NAV is subject to suspension of dealing as of the relevant reporting date has to be reported to authorities as specified in the reporting template related to AIF-specific information (Articles 3(3)(d) and 24(1) of the AIFMD). - Luxembourg-specific rules: circumstances in which suspensions or deferrals can be introduced by the CIS or its manager must be disclosed in the fund’s rules, instruments of incorporation or equivalent. ### Use of Leverage — regulatory differences and definitions - UCITS: - UCITS Directive limits a UCITS fund’s global exposure from derivative instruments to 100 percent of the total net value of the UCITS portfolio. - Global exposure must be calculated using either the commitment approach or the Value-at-Risk (VaR) method. - Borrowing is not taken into account when determining the global exposure of a UCITS fund, but UCITS funds are permitted to borrow, on a temporary basis, only up to 10 percent of their NAV. - AIFs: - AIFMD defines leverage as “any method by which the AIFM increases the exposure of an AIF whether through borrowing of cash or securities, or leverage embedded in derivative positions or by any other means.” - The Directive requires AIFMs to set leverage limits in respect of each AIF they manage, but does not set maximum limits on leverage. - Leverage must be calculated using two methods: the gross method and the commitment method. - The overall leverage of an AIF is expressed as a ratio between the exposure of the AIF and its NAV. - Key numeric threshold: - An AIF is considered to be “substantially leveraged” when the exposure of the AIF calculated according to the commitment method exceeds three times its net asset value. - AIFMs that manage AIFs employing leverage on a substantial basis must make available additional information to their competent authorities, including the overall level of leverage employed by each AIF and the extent to which the AIF’s assets have been reused under leveraging arrangements. ### Recommendation on leverage - Recommendation: To allow authorities to have a clearer overview of the use of leverage by CIS, work towards a common method for the calculation of leverage in the investment funds area is useful. - Action: Luxembourg authorities should continue to contribute to regional and international initiatives aimed at developing a common global approach to measuring CIS leverage, such as the work already performed by FSB and IOSCO. ### Leverage calculation methods (Box 3) - UCITS — commitment approach (standard methodology): - The global exposure under the UCITS Directive only takes into account financial derivatives and securities financing transactions (SFTs) that generate leverage. - UCITS can apply netting and hedging arrangements to reduce their global exposure. - Calculation summary: - Derivatives: sum of the equivalent positions in the underlying assets after netting and hedging arrangements - + SFT: market value of the collateral received (including cash) when reinvested with a return in excess of the risk-free rate of return - VaR method triggers: - Use VaR (relative or absolute) when (i) complex investment strategies represent more than a negligible part of the UCITS’ investment policy; (ii) more than a negligible exposure to exotic derivatives; or (iii) the commitment approach does not adequately capture the market risk of the portfolio. - VaR key elements: - Relative VaR: VaR of the UCITS’ current portfolio compared to the VaR of a reference portfolio (unleveraged). The portfolio VaR limit is twice the VaR of the unleveraged reference portfolio. - Absolute VaR: - Risk limited to maximum of 20 percent of NAV - Specific requirements on confidence interval, holding period and effective observation period of risk factors - AIFMD — two methods: - Commitment method (similar to UCITS commitment approach but includes all positions): - Direct positions: Accounting value - + Derivatives: Sum of the market value of the equivalent position in the underlying asset (after netting and hedging) - + SFT: market value of the collateral received (including cash) when reinvested - + Reuse of cash borrowing: the higher of the market value of the investment realized or the total amount of the cash borrowed - Gross method: - Direct positions: accounting value - - Cash equivalents - + Derivatives: Sum of the absolute values of derivative positions converted into equivalent positions in the underlying assets - + SFT: market value of the collateral received (including cash) when reinvested in assets. - + Reuse of cash borrowings: the higher of the market value of the investment realized or the total amount of the cash borrowed ### Depositaries — standards and appointment - IOSCO Standards for the Custody of Collective Investment Schemes’ Assets provide that the regulatory regime should make appropriate provision for custodial arrangements of the CIS and may include requiring the appointment of a single custodian for each CIS. - UCITS Directive and AIFMD require the appointment of a single depositary for each UCITS fund and AIF. - General rule: a depositary must have its registered office or a branch in the same country where the fund is domiciled. - Exception: a non-EEA AIF’s depositary may be established in the AIFM home state. - Luxembourg specifics: - No general AIFMD requirement for approval analogous to UCITS home-state approval, but Luxembourg requires specific approval by the CSSF for any entity seeking to act as depositary for an AIF. - Under the UCITS Directive and AIFMD the fund manager and the depositary must enter into a detailed written agreement regulating the flow of information necessary for performance of their roles. ### Prudential requirements for depositaries in Luxembourg - UCITS depositaries in Luxembourg: - Only credit institutions may act as the depositary of a UCITS. - The credit institution must have its registered office in Luxembourg or have a branch in Luxembourg if its registered office is in another member state. - Credit institutions in Luxembourg are required to have capital of at least €8,700,000. - AIF depositaries in Luxembourg: - A depositary for a Luxembourg AIF can be either a credit institution or an investment firm within the meaning of the Law of 1993 on the financial sector. - The depositary of a Luxembourg AIF must either have its registered office in Luxembourg or have a branch there if its registered office is in another Member State. - Establishment requirements for EU and non-EU AIFs: - For EU AIFs the depositary must be established in the home Member State of the AIF. - For non-EU AIFs, it must be established in the third country where the AIF is established or in the home Member State of the AIFM managing the AIF or—once the passporting regime for non-EU managers is in place—in the Member State of reference of the AIFM managing the AIF. - Specialized professional of the financial sector (PSF) as depositary: - Under article 26 of the Law of 1993 a ‘professional depositary of assets other than financial instruments’ may act as depositary if both conditions are met: a. it must have no redemption rights exercisable during the period of five years from the date of the initial investments; and b. it does not generally invest in assets to be held in custody or generally invests in issuers or non-listed companies in order to potentially acquire control over such companies. - Seventy-six Luxembourg-based AIFs (52 regulated AIFs and 24 non-regulated AIFs) have a PSF as their depositary. ### Depositary independence and governance - AIFMD and UCITS Directive require functional and hierarchical separation of depositary tasks from other potentially conflicting tasks, with proper identification, management, monitoring and disclosure of conflicts of interest. - AIFMD specifically prohibits an AIF’s prime broker from acting as the AIF’s depositary, unless prime brokerage and depositary functions are separated and conflicts of interest are properly identified, managed, monitored, and disclosed. - UCITS V Directive strengthened rules on depositary independence; allows depositary belonging to same group as management company subject to principles and safeguards, including acting solely in the interest of unitholders and rules on identification and management of conflicts of interest. - CSSF circulars and requirements: - Circular clarifies relationship between conducting officers and employees of a UCITS depositary; a conducting officer may not be employed by the depositary of a UCITS which the management company manages. - Circular CSFF 14/587 replaced by Circular CSSF 16/644 as of October 13, 2016; specifies organizational requirements for credit institutions acting as depositary for UCITS established in Luxembourg. - UCITS V board independence requirement: - Where the management company and depositary belong to the same group, at least one third of the members (or, if lower, two members) of the body in charge of supervisory functions should be independent. - CSSF 2015 assessment: - CSSF found 47 Luxembourg fund managers (44 management companies and three SICAVs) belonged to the same group as their depositary. - This corresponds to 31 percent of total UCITS assets in Luxembourg. - CSSF estimated that at least 64 additional directors had to be appointed to ensure compliance with independence requirements depending on board sizes. ### Recommendation on depositary independence - Recommendation: Given links between depositaries and management companies in a significant number of fund structures in Luxembourg, the CSSF should assess whether depositary independence is achieved to a sufficient degree in practice following UCITS V introduction. - Potential actions: Depending on assessment results, CSSF should consider further strengthening depositary independence requirements, e.g., requiring more independent directors, or prohibiting intra-group links in instances of non-compliance with existing safeguards. ### Safekeeping and segregation of fund assets - IOSCO Principles require adequate segregation of investment funds’ assets from the assets of the fund manager, custodian and other custody clients; safekeeping should be entrusted to independent depositaries or protected by special legal/regulatory safeguards if independent depositary use is not possible. - Segregation expectations: - Client assets should be identified to the depositary and any sub-custodian. - Investment fund assets should be segregated from: (i) the assets of the fund manager and its related entities; (ii) the assets of the custodian/sub-custodian throughout the custody chain; and (iii) the assets of other investment funds and other clients of the custodian throughout the custody chain (unless held in a permissible omnibus account). - Delegation of safekeeping to third parties: - For financial instruments that can be held in custody, the depositary ensures instruments are registered in the books of the depositary on separate accounts opened in the name of the UCITS/AIF or its management company, to enable clear identification at all times. - For other assets the depositary verifies ownership title and keeps records of those assets. - Assets which cannot be held in custody must be monitored by the depositary on an ongoing basis; the depositary agreement must require prompt and comprehensive information from the management company about each transaction and a maintained list of assets which cannot be held in custody. - Sub-custodian requirements: - Sub-custodian must separate assets of the depositary’s clients from its own assets and from the depositary’s assets so they can be clearly and at all times identified as belonging to clients of a particular depositary. - Level 2 Regulations require the depositary to ensure the sub-custodian keeps records and accounts necessary to distinguish assets of the depositary’s UCITS or AIF clients from its own assets and assets of other clients without delay. - The sub-custodian cannot make use of the assets unless it has received prior consent from the AIF or the AIFM and notified the depositary. - Delegation to third parties outside the EU: - If third-country law requires certain financial instruments be held in custody by a local entity and no local entities satisfy delegation requirements, the depositary may delegate only to the extent required by third-country law and only until local entities satisfying delegation requirements are available. - Investors must be informed that such delegation is required due to legal constraints in the law of the third country and of the circumstances justifying the delegation, prior to their investment. - The UCITS or AIF must instruct the depositary to delegate the custody of such financial instruments to such local entity. *Source: cr17257 - 50. It is important to distinguish the possibility for the CIS or fund manager to suspend or* ### 70. Recommendation: The AIFMD and UCITS V Directives introduced specific requirements on ### Recommendation: The AIFMD and UCITS V Directives introduced specific requirements on asset segregation and these have been incorporated into Luxembourg law ### Depositary liability and asset segregation - The AIFMD and UCITS V Directives introduced specific requirements on asset segregation that have been incorporated into Luxembourg law. - There is a lack of clarity on the proper interpretation of the segregation obligations in the AIFMD and UCITS Directive when safekeeping duties are delegated; the CSSF should continue to contribute actively to discussions within ESMA to develop a common approach to increase investor protection and reduce regulatory arbitrage. - AIFMD depositary liability: - Depositary remains liable for any loss of financial instruments held in custody despite delegation. - If loss occurs, the depositary must return to the AIF or the AIFM a financial instrument identical to the type lost or the corresponding amount. - The depositary will not be liable if it proves the loss arose from an external event beyond its reasonable control, unavoidable despite all reasonable efforts (force majeure). - Subject to the AIF’s agreement, the depositary can discharge liability if a written contract between the depositary and the delegate expressly transfers liability to the delegate and makes it possible to make a claim against the delegate. - UCITS V depositary liability: - Largely aligned with AIFMD but more stringent: UCITS V does not allow any discharge of liability (including for loss of assets) when safekeeping duties have been delegated to a third party. - UCITS V requires member states to ensure that, in the event of insolvency of the depositary or a delegated third party, the assets of the UCITS held in custody are unavailable for distribution among creditors of the depositary or of the third party delegate. - Luxembourg law reflects the requirements of the AIFMD and UCITS Directive on these aspects. ### Authorization responsibilities and criteria - CSSF responsibilities: - Authorizing UCITS funds, entities that wish to act as a management company of a UCITS or market a a UCITS, third parties that wish to manage the assets of a UCITS and entities seeking to act as a depositary of a UCITS, to the extent those entities are established in Luxembourg. - Authorizing regulated AIFs (Part II UCIs, SIFs and SICARs), entities that wish to manage regulated AIFs and entities seeking to act as a depositary of a regulated AIF. - Fund authorization: - Prior authorization by the CSSF of UCITS and regulated AIFs (Part II UCIs, SIFs and SICARs) is required before any activities can be undertaken. - Authorization depends on CSSF approval of the fund rules, the choice of depositary, approval of the designated manager, and assessment that the directors of the CIS are of sufficiently good repute and sufficiently experienced in relation to the type of CIS concerned. - For both UCITS and AIFs, listing on the official list may not be presented as a positive assessment by the CSSF of the quality of the securities offered for sale. - CSSF engagement with applicants: - CSSF typically meets with key individuals from a management company as part of the fund authorization process and often meets during the year following granting of authorization. ### Eligibility criteria for managers, depositaries, and service providers - Criteria for prospective UCITS management companies and AIFMs (as considered by the CSSF): - (i) honesty and integrity of the management bodies; - (ii) appropriate and sufficient human and technical resources to perform necessary functions; - (iii) financial capacity of the management company/AIFM and their shareholder(s); - (iv) appropriate identification, monitoring and management of risks, based on size, complexity and risk profile of the CIS; - (v) internal controls and compliance arrangements sufficient to ensure diligent, effective, honest and fair conduct. - Third party asset managers: - Specific criteria apply to entities wishing to manage assets of a CIS on the basis of delegation (described in paragraphs 86 and 87 of the source). - Depositaries: - Only credit institutions with registered office in Luxembourg or branches of credit institutions with registered office in another EU member state are eligible to act as depositary of a CIS in Luxembourg (exception for depositaries for AIFs which are not Part II funds—see source). - Entities must receive specific authorization from the CSSF to act as depositary of a CIS; authorization is granted based on criteria set out in a dedicated CSSF circular. - Criteria include that person(s) responsible for depositary activity be of good repute and have requisite experience; CSSF requires a precise and detailed description of human and technical resources to perform depositary tasks, taking into account the type of CIS. - Other service providers: - Specific rules apply to delegation of the central administration function (fund accounting and NAV calculation and/or transfer agency and registrar). - When delegated by a Luxembourg-based management company or AIFM, only Luxembourg-based entities regulated under the Law of 1993 and supervised by the CSSF (credit institutions, professionals of the financial sector) can be designated. - For AIFs established in Luxembourg but not regulated under a specific Luxembourg product law, central administration need not be located in Luxembourg. - When granting authorization, CSSF checks appropriate and sufficient human and technical resources for the entity. ### Delegated management: risks, supervision, and recommendations - Regulatory principles: - Delegation must not undermine effectiveness of supervision of the management company/AIFM or permit entity to become a letter-box. - Common principles for UCITS and AIFs: delegation must not undermine supervision, delegate must be qualified and capable, and management company/AIFM retains liability for delegated functions. - AIFMD contains a more detailed set of criteria to assess whether an AIFM has delegated to such an extent that it has become a letter-box entity. - CSSF processes for delegation: - Emphasis at notification stage on written due diligence on each external service provider, extensive requirements on information provided to the CSSF about scope of delegation, and procedures to monitor delegated activities. - For mandates to undertakings outside the EU, CSSF checks that cooperation between the CSSF and the supervisory authority of the other country is ensured. - Ongoing supervision performed via assessment of periodic reports and on- and off-site supervision; CSSF has less power to intervene with non-Luxembourg delegates and relies on supervision in the delegate’s home country and information exchange with that authority. - Industry model and supervisory challenge: - CIS industry in Luxembourg typically involves extensive delegation of portfolio and risk management activities to entities based outside Luxembourg. - Of the 50 largest funds in Luxembourg: - only 5 percent of the assets under management (AuM) are managed by a portfolio manager based in Luxembourg; - the top two locations of portfolio managers in terms of AuM are the US (over 40 percent) and the UK (almost 30 percent). - Clear and comprehensive regulatory cooperation arrangements between the CSSF and other authorities are an important safeguard. - Recommendation on delegation (paragraph 86): - Strengthen requirements regarding delegation by UCITS, for example by applying the same criteria to UCITS as are set out in the AIFMD. - CSSF should engage actively with regulators in the jurisdiction where delegated activities are carried out; this could include on-site inspections of the delegate (jointly with the foreign supervisor or, with that supervisor’s consent, by the CSSF itself) and making more ad hoc requests for information. - CSSF could consider adding a delegation-related factor to its risk scoring methodology (see paragraphs 95 to 97). ### Governance of CIS, their operators, and related service providers - Regulatory basis: - IOSCO Principles require clear criteria and standards on governance of CIS. - CSSF circular 12/546 provides guidance on regulator expectations with respect to fund governance. - ALFI issued a non-binding code of conduct in 2013 which exerts peer pressure. - Approval and assessment: - CSSF approves all individuals applying to hold directorships of CIS and their Luxembourg-based operators and assesses ability to fulfil responsibilities. - Governance challenges and recommendation: - Large number of actors in Luxembourg relative to population and reliance on experts from other jurisdictions can make it difficult to find individuals with relevant expertise and sufficient time commitment. - CSSF does not systematically record information on directorships held outside Luxembourg, nor has it issued guidance on appropriate time commitment. - Recommendation (paragraph 89): - CSSF is encouraged to take a broader and more systematic approach to gather detailed information across the CIS sector—covering funds, their managers and related service providers such as depositaries and administrators, whether based in Luxembourg or elsewhere—on the number of directorships held by each director. - If individuals hold an excessive number of directorships, CSSF should consider appropriate follow-up action as part of ongoing supervision. - CSSF should determine an appropriate threshold in terms of time commitment (also taking into account positions the individual may hold outside the fund sector) for a given individual and issue guidance to the industry. - CSSF’s work could draw on similar initiatives recently undertaken by supervisory authorities in other jurisdictions in relation to their fund sectors. ### Supervision: organization, resources, and risk-based approach - Organization and resources: - A specific directorate within the CSSF is charged with authorization and supervision of CIS and their managers; departments draw on expertise from other departments. - CSSF has determined there are 216 full-time equivalents working on fund issues across the relevant departments. - This compares to approximately 110 employees in the equivalent departments at the end of 2011. - Supervisory approach: - CSSF uses a risk-based approach to supervision to verify compliance with legal requirements for investor protection and transparency and to identify risks, contributing to overall financial sector stability. - Criteria considered include complexity, type of investors, level of net assets, quality of internal control, quality of information, and source of information. - The CSSF is rolling out a more formalized risk-based approach to determine a risk score for each fund, sub-fund and management company, combining quantitative and qualitative elements (e.g., net assets, frequency of NAV calculation errors and investment breaches, issues highlighted in the management letter, stability of shareholders of the management company, etc.). - Expected benefits: better assessment of overall risk profile, detection of entities requiring more intensive supervision, enhanced efficiency in allocation of internal resources, and thematic assessment of risk themes (e.g., market risk, legal/compliance). - Implementation plans: - First step: implement risk-scoring approach for UCITS and UCITS management companies, which covered 83 percent of the assets of the Luxembourg CIS industry as of March 2016. - Second step: extend the approach to AIFs and AIFMs. - The risk-based supervision framework is designed to evolve over time to integrate new regulatory developments, additional information sources (such as new UCITS risk reporting) or new risk indicators. - Off-site and on-site supervision and reporting: - Off-site inspection generally assesses periodic and ad hoc reports submitted to the CSSF by CIS managers and CIS. - Common sources of information include documents submitted at authorization and any notified changes; periodic information depends on entity type. - Periodic off-site supervision of CIS managers includes review of quarterly and annual financial reporting and annual closing documents: audited annual report, management letter by the independent auditor, report of the compliance function, internal audit report, and report of the permanent risk management function. - CSSF reviews financial situation including capital adequacy and reports of control functions to assess financial solidity and appropriateness of structure, organization and effectiveness of processes and procedures; checks are synthesized in a prudential supervision fact sheet. *Source: IMF staff report text in content unit cr17257.* ### 98. Periodic off-site supervision of CIS is performed through the general reporting regime ### 98. Periodic off-site supervision of CIS is performed through the general reporting regime ### Off-site supervision: scope and inputs - Periodic off-site supervision of CIS is performed through the general reporting regime applicable in the CIS domain and analysis of a broad range of documentation. - Report types used: - periodic and ad-hoc financial reports to be drawn up by the CIS; - periodic reporting to be drawn up by the external auditor of each CIS in the form of management letters or reports on the activity of the CIS in accordance with Circular CSSF 02/81. - Screening and risk categorization: - Once received, the reports are screened on a preliminary basis to detect those that present irregularities/suspected breaches and categorized into low/medium/high risk. - Ad hoc information sources: - notifications of investment breaches and NAV calculation errors; - exchange of information and general cooperation with other supervisory authorities. - Additional contributor sources: - investor complaints; - whistleblowing mechanisms (UCITS V Directive obligation; CSSF website contains a specific section for whistleblower reports). ### Depositaries and Administrators - Supervisory approach: - Similar to CIS and their managers; periodic analysis of reports and follow-up supervisory action may be carried out. - Responsibility and focus: - Off-site supervision of depositary banks is the responsibility of a separate team within the Banking Supervision department of the CSSF. - Approach based on assessment of risks such as operational risks of processing transactions and risk of non-compliance with fund regulations. - Supervisory tools for depositaries: - analysis of the Long Form Reports (containing a specific section covering the fund business); - receipt of ad-hoc reports prepared by auditors on depositary bank activities; - on-site inspections; - future annual self-assessment questionnaire for depositaries. ### On-site inspections: organization, scope, and output - Regulatory expectation: - IOSCO Principles require regulators to include on-site inspections and proactive investigative activities in ongoing monitoring (Principle 24, Key Issue 4 and Key Questions 8 and 9). - CSSF inspection structure: - Two departments dedicated to controls related to supervised entities: On-site Inspections (“OSI”) and “Contrôles Sur Place” of the Métier OPC (OPC-CSP). - OSI functions: planning, coordinating and following up on all on-site inspections carried out by various supervision departments; inspections may be carried out by OSI, individual departments, or jointly. - OSI dedicated teams cover: Anti-Money Laundering/Combating Terrorist Financing (AML/CFT); Markets in Financial Instruments Directive (MiFID); Corporate Governance; Central Administration/Depositary Bank; Banking risks and Ad hoc. - OPC-CSP: - Put in place in 2015 to focus on CIS-related requirements, particularly governance of Luxembourg managers or CIS. - Charged with preparation, execution and follow-up of on-site inspections of management companies, AIFMs and self-managed investment vehicles. - External auditors: - External auditors of CIS carry out yearly on-site supervision assessing main activities and risks of CIS and service providers; produce detailed “Long Form Report” and management letter sent to CSSF for off-site analysis. - Inspection planning and escalation: - OSI undertakes planning and coordination for the following calendar year using a standard planning template. - OPC-CSP and other off-site departments send proposed inspections to OSI; frequency determined by off-site departments’ risk-based approach; scope set in light of issues from supervision activities, Long Form Reports, and management letters. - OSI aggregates input, determines dates and leads, and presents plan to CSSF hierarchy for review and approval. Changes to the approved annual plan must be authorized by the hierarchy and communicated to OSI. - Urgent on-site inspections can be undertaken with approval of the relevant CSSF director if a material issue arises. - Types of inspections: - The CSSF broadly distinguishes between thematic inspections and ad hoc inspections; both types are carried out across CIS sector entities including service providers and, when located in Luxembourg, delegated investment managers and distributors. - Thematic reviews: triggered by internal decisions or external initiatives (including ESMA involvement); no systematic program but carried out regularly. - Ad hoc inspections: initiated by CSSF hierarchy or supervision departments to address specific problems identified through off-site supervision (e.g., issues raised by external auditors, reporting delays, suspicion of fraud, whistleblowing); may be planned or short notice; figures for ad hoc inspections are included in thematic visit counts. - Thematic inspection counts (Table 3: Luxembourg: Thematic Inspections): - Anti-money laundering/terrorist financing: 2013 — 13; 2014 — 10; 2015 — 14 - Risk Management: 2013 — 3; 2014 — 1; 2015 — 5 - Governance of UCTIS management company and AFIM: 2013 — 3; 2014 — 5; 2015 — 4 - NAV error and breaches of investment restrictions: 2013 — 1; 2014 — 1; 2015 — 1 - Depositary Bank: 2013 — 12; 2014 — 13; 2015 — 10 - Central Administration: 2013 — 4; 2014 — 7; 2015 — 1 - Total: 2013 — 26; 2014 — 37; 2015 — 35 - Recommendation (onsite): The CSSF should make efforts to strengthen further its regime of on-site inspections, and introduce comprehensive on-site inspections as a further element of the supervisory toolkit. The detailed scope and content of such a program should take into account results of the risk scoring of CIS and their managers to make best use of resources—which are due to increase significantly over the next three years. ### Reporting: types, uses, and data access - Reporting categories received by the CSSF: - (i) regular reporting on financial data (e.g., AIFMD reporting, CIS reporting, UCITS risk reporting, reporting under the European Market Infrastructure Regulation (EMIR)); - (ii) other regular and/or ad hoc reports (e.g., risk management procedures, audited annual reports, management letter, long form report, ad-hoc information requests etc.). - Uses of periodic financial reports: - support the micro- and macroprudential supervisory processes/approach of the CSSF, including assessment of the risk profile of regulated entities and related activities; - support assessment of compliance of regulated entities with legal and regulatory requirements (depending on information received); - produce CSSF’s monthly, quarterly and annual statistics for internal and external purposes and relevant studies. - Portfolio composition and data access: - CSSF has access to reports provided by CIS to the BCL, including the “Reporting SbS” encompassing portfolio data on a security-by-security basis. - The CSSF has not yet been granted full access to all descriptive data of the portfolio holdings (e.g., credit quality of the security, name of issuer etc.) held in the ECB’s Centralized Securities Database, to which the BCL has access, but discussions have been initiated to get such access. - In the meantime, the CSSF focuses on aggregate balance sheet data provided in the BCL reporting (including portfolio composition broken down by factors such as geographical origin of issuers and sector) and uses security-by-security data mainly for specific ad-hoc analysis. - Risk-identifying data gathered: - Data on leverage and securities financing transactions covered by AIFMD reporting and the UCITS risk reporting recently set up by the CSSF; - Information on liquidity, counterparty and credit risk; - Highly-leveraged UCITS subject to the ad-hoc VaR & Leverage Report; - Specific reporting requirements for a selection of money market funds. - Analysis cadence and examples: - VaR and Leverage Reports analyzed on a quarterly basis at sub-fund level to check compliance of highly-leveraged UCITS with relevant requirements (e.g., use of financial derivative instruments, check whether realized leverage is in line with expected leverage disclosed in the sales prospectus). - Regular sectoral analyses based partly on monthly reporting U1.1 to assess investor flows in different fund categories. - Ad-hoc reporting: - CSSF may request additional ad-hoc reporting, used in periods of heightened uncertainty (e.g., the UK referendum on membership of the EU, stock suspensions in China, EU sovereign debt crisis). - Data processing and electronic formatting: - CSSF has taken steps to facilitate electronic processing for statistical or data analysis of documents such as sales prospectuses and application files (e.g., identity of the custodian or fund administrator; identity of members of Board of Directors of a fund/management company, share classes of a fund, type of investment policy, type of MMF (constant or floating NAV), etc.). - This applies to information gathered during approval processes and changes during entity lifetime, and to NAV calculation errors and breaches of investment rules. - Liquidity information expectations: - IOSCO Principles underline importance of reliable information on liquidity of funds on asset and liability sides. - CIS managers should consider how planned marketing and distribution are likely to affect liquidity. - Global distribution channels and use of nominee accounts make it more difficult for fund managers to be fully aware of underlying investor base; managers should take reasonable steps to obtain investor concentration information from nominees (e.g., via contractual arrangements). - The CSSF expects fund managers to understand profile of their underlying investors, while recognizing challenges. - Recommendation (data access and gaps): The CSSF should continue discussions with the BCL and ECB to obtain full access to the Centralized Securities Database to enhance monitoring of trends across the fund sector and identify risks within particular funds or groups. For data gaps on the liability side of CIS, the CSSF should raise the issue within ESMA to identify possible means of improving availability of data. ### Enforcement: powers, process, and sanctions - IOSCO expectations: - Regulators should have comprehensive inspection, investigation and surveillance powers and comprehensive enforcement powers; regulatory system should ensure effective and credible use of these powers and implementation of an effective compliance program. - Enforcement objectives: - CSSF enforcement approach aims to ensure regulated entities in the fund sector comply with relevant requirements, contributing to investor protection and general risk monitoring. - Investigation triggers: - periodic reports (annual report, long-form report, management letter); - investor complaints; - whistleblowing; - cooperation requests or information exchange from other supervisory authorities. - Preliminary assessment criteria for investigations: - urgency, severity and complexity; - type of CIS and type of investors; - level of net assets; - quality of information and source of information; - priority given to UCITS and other funds distributed to retail investors; - significant weight attached to breaches affecting organization of the investment fund (e.g., default on legal requirements regarding service providers). - Supervisory powers during investigations (CSSF rights): - have access to any document in any form and receive a copy of it; - require information from any person and, if necessary, summon and question a person to obtain information; - carry out on-site inspections with or without prior notice of entities subject to prudential supervision. - Post-investigation outcomes: - final memorandum will suggest either closing the investigation based on absence of findings or engaging enforcement/sanction proceedings. - Enforcement powers and criminal referral: - CSSF may revoke a management company license for ongoing infringements. - CSSF has the power (but not the duty) to transmit information to the public prosecutor for initiating criminal proceedings. - Sanctions for UCITS and their managers (derived from UCITS Directive): - (a) a public statement which identifies the person responsible and the nature of the infringement; - (b) an order requiring the person responsible to cease the conduct and to desist from a repetition of that conduct; - (c) a suspension or withdrawal of the authorization of the UCITS or the management company; - (d) a temporary or, for repeated serious infringements, a permanent ban against a member of the management body of the management company or investment company or against any other natural person who is held responsible, from exercising management functions in those or in other such companies; - (e) in the case of a legal person, maximum administrative pecuniary sanctions of €5,000,000 or 10 percent of the total annual turnover of the legal person according to the last available accounts approved by the management body; - (f) in the case of a natural person, maximum administrative pecuniary sanctions of €5,000,000; - (g) as an alternative to points (e) and (f), maximum administrative pecuniary sanctions of at least twice the amount of the benefit derived from the infringement where that benefit can be determined, even if it exceeds the maximum amounts in points (e) and (f). - Sanctions for AIFs (ascending order of severity): - a warning; - a reprimand; - a fine of between €250 and €250,000; - in case of certain types of breach, one or several of the following measures: - a temporary or definitive prohibition on carrying out operations or activities, as well as any other restrictions on the activity of the person or entity; - a temporary or definitive prohibition on acting as directors, managers or conducting persons, whether de jure or de facto, of persons or entities subject to the supervision of the CSSF. - The CSSF may disclose to the public the penalties imposed, unless such disclosure would seriously jeopardize the financial markets or cause disproportionate damage to the parties involved. - Criteria for determining sanctions: - vary between UCITS and AIFs but include common elements such as gravity and duration of the infringement, past infringements by the person(s) involved, and extent of adverse impact on third parties. - Note on severe breach triggers (footnote): Certain breaches that trigger the most severe measures include when: - the entity prevents the CSSF from exercising its powers of supervision, inspection and investigation; - the entity fails to act in response to orders of the CSSF; - the behavior of the entity risks jeopardizing the sound and prudent management of the institution concerned. *International Monetary Fund — Luxembourg financial sector assessment (selected sections).* ### 130. The CSSF’s general approach to the use of enforcement powers is governed by an ### cr17257 - 130. The CSSF’s general approach to the use of enforcement powers is governed by an ### Enforcement framework and procedures - The CSSF’s general approach to the use of enforcement powers is governed by an internal procedure that: - Sets out general principles in relation to enforcement aspects for all departments of the CSSF. - Outlines the procedure to be followed for the application of enforcement powers with regards to supervised entities. - Specifies involvement of the “Comité Enforcement” (Enforcement Committee), which selects the cases where the CSSF intends to use its powers. - For each department of the CSSF, a specific Enforcement correspondent per department is appointed to act as the contact point for any enforcement proceedings and is consulted to decide whether the Enforcement Committee should be involved. ### CIS department: standardized sanction proceedings and delegated processes - The CSSF’s CIS department has implemented standardized sanction proceedings for which Enforcement Committee involvement is not necessary: - Specific administrative fine procedure for late filing of reporting documentation (annual report, management letter, long-form report). - Specific “withdrawal of approval” procedure for investment funds/management companies breaching material aspects of applicable law. - For other issues requiring sanction or supervisory powers, the Enforcement department of the CIS department must assess the need to involve the Enforcement Committee. ### Administrative fines and withdrawal of authorization - Administrative fines: - Typically imposed on the directors or members of the management of the CIS rather than directly on the CIS. - Common breaches leading to fines: non- or late submission of financial reports and breaches of transparency rules by directors or conducting officers. - Withdrawal of authorization: - Described as the sanction with the most significant consequences for the entity concerned. - The CSSF has withdrawn a total of 28 authorizations over the past three years 36 (this figure includes three management companies and the funds that they were managing). - Main reasons for withdrawal of authorization of management companies: financial difficulties (suspension of payments or failure to provide for a registered office in Luxembourg in accordance with Luxembourg law). - Withdrawals for funds (consisting entirely of SIFs and SICARs) were generally due to breaches of legal requirements in relation to preparation of the financial reports, minimum capital requirements and/or a failure to appoint fully approved service providers. - Footnote: The data include decisions taken by the CSSF that are currently being challenged in informal procedures (“recours gracieux”), as well as those decisions that are being challenged at the administrative court. ### Other supervisory powers and supervisory tools - Use of supervisory powers has included issuing formal injunctions: - To one management company to improve the risk management process. - To one specialized investment fund to update relevant information in the investment memorandum. - To one UCITS regarding measures to be applied in respect of NAV calculation issues. - Moral suasion: - Used to achieve objectives without formal enforcement action. - Recent examples: asking initiators of four specialized investment funds to withdraw requests for approval for new funds or sub-funds due to current breaches by funds linked to such initiators and/or ongoing investigations. ### Systemic risk monitoring: institutional arrangements and cooperation - Processes to monitor, mitigate, and manage potential systemic risk from fund management activities combine: - Individual processes performed by the CSSF. - Collective processes in cooperation with other authorities at local (e.g., with the BCL), regional (e.g., with ESMA, ESRB), and international level (e.g., FSB). - Domestic: installation of the Comité du risque systémique (CRS) as the main process to monitor, mitigate and manage systemic risk in Luxembourg. - Regional and international cooperation: - European System of Financial Supervision mechanisms with ESMA and the ESRB. - CSSF formally obliged by Luxembourg law to consider EU and international dimensions of its supervisory work. - Active CSSF participation in international workgroups on liquidity (mismatch) and leverage at IOSCO and FSB. ### Legal basis and powers for systemic risk identification - The law establishing the CSSF defines its mission in relation to contributing to financial stability and cooperation with other authorities (Art. 3-2): - Art. 3-2 states the CSSF “in exercising its tasks,...shall duly consider the potential impact of its decisions on the stability of the financial system at national, Community and international level and, in particular, in emergency situations, based on the information available at the relevant time. In the light of its supervisory mission and in compliance with the legal competences of the parties, the CSSF shall cooperate with the government, the Luxembourg Central Bank and with the other national, Community and international supervisory authorities in order to contribute to ensuring the financial stability, notably within the authorities established for that purpose at these different levels.” - Product laws under CSSF supervision grant supervisory and investigative powers necessary for exercising functions; on this basis the CSSF can request data (ad hoc or periodic) to detect developments potentially contributing to systemic risk. - AIFMD: - Establishes a regional framework for coordination of action with respect to AIFMs and grants national supervisory authorities and ESMA specific powers related to systemic risk from AIFM activities (e.g., risks from leverage). - Related reporting obligations enable the CSSF to monitor key metrics that could indicate buildup of systemic risks across the AIF sector in Luxembourg. - Example regulatory measure: power to impose a limit on leverage employed by an AIFM or group of AIFMs if the CSSF considers leverage buildup excessive. ### Data collection, analysis, and monitoring tools - Authorization process: - Used to assess innovative and complex character of applications and identify potential to contribute to systemic risk. - Ongoing supervisory monitoring: - Appraisal of regular or ad hoc reporting submitted by regulated entities (e.g., flow-data on fund assets (overall and sector-specific), leverage). - Data are collected and analyzed according to a risk-based approach to detect atypical/emerging developments and take appropriate measures. - Risk Management division of the CIS department: - Performs cross-sectoral risk supervision, including monitoring of MMFs with reporting on performance, portfolio indicators (WAM/WAL), risk and valuation. - Monitors use of leverage and risk/performance analysis of investment funds. - UCITS risk reporting: - New reporting introduced to collect data on market, credit, liquidity risk, use of EPM, leverage on a cross-sectoral basis. - Reporting required for UCITS with a leverage (in terms of notional amount) exceeding 250 percent and/or net assets above €500 million, with the objective to gradually broaden the scope to all UCITS. - The CSSF has raised the issue of potential harmonization of data collection for UCITS in the EU at the level of ESMA. - Ad-hoc data collection: - Implemented in response to market events (examples: stress in the Chinese market in the second half of 2015/beginning of 2016; the “Brexit” referendum). - Planned early-warning system: a new report to be submitted to the CSSF upon occurrence of significant net redemptions affecting a predefined selection of large UCITS sub-funds (bond funds, mixed funds, and money market funds). - The systemic risk monitoring framework is evolving due to changes in data collected and EU/Luxembourg coordination among authorities and ongoing work programs at European and international level (e.g., FSB, IOSCO, ESRB). ### Box: Money Market Funds (MMFs) in Luxembourg — key points - MMFs in Luxembourg represent 22 percent of the EU market. - MMF categories: - VNAV (variable NAV) MMFs: NAV fluctuates in line with underlying assets on a marked-to-market basis. - CNAV (constant NAV) MMFs: seek to sell or redeem shares at a stable NAV; allowed to value holdings using amortized cost method or share price rounding method. - Luxembourg (with Ireland) is one of two EU centers for CNAV MMFs. - IOSCO 2015 peer review finding: for largest jurisdictions permitting stable NAV MMFs (U.S., Ireland, Luxembourg and China), further implementation measures are needed either to convert from a stable NAV to a VNAV system or to reinforce stable NAV MMF resilience and ability to face significant redemptions. - European Commission 2013 proposal for a Regulation on MMFs (as presented) would have required a capital cushion (a 3 percent buffer) for CNAV funds to support stable redemptions; negotiation difficulties persisted, and a compromise introducing Low Volatility Net Asset Value (LVNAV) MMFs was retained in the final text. - LVNAV MMFs would be allowed a constant NAV but be subject to specific liquidity requirements. - Luxembourg authorities are actively monitoring and contributing to MMF regulatory discussions; CSSF monitoring of consequential changes to the MMF industry in Luxembourg is emphasized. ### Reporting framework: periodic reports received by the CSSF (high-level) - Reporting U1.1: - Monthly reporting covering each type of UCI (SICAR from June 2016 onwards) including NAV, subscriptions, redemptions, distributions, share class data, income and expenses. - Reporting O4.1: - Annual reporting (each UCI except SICAR) including balance sheet positions split by investment categories, income and expenses by categories, changes in net assets and portfolio. - Reporting K3.1: - Semi-annual SICAR reporting including balance sheet positions, income and expenses, principal exposures. - AIFMD Reporting: - Frequency: Quarterly to Annually depending on assets under management, investment strategies, and use of leverage. - Template Annex IV includes: investment strategy; principal exposures and concentration; instruments traded; risk profile; monthly return, NAV changes, subscriptions and redemptions; stress test results; borrowing and exposure; leverage. - UCITS Risk Reporting: - Semi-annual reporting for UCITS with leverage exceeding 250 percent (notional amount) and/or net assets above €500 million; reporting items include global exposure and leverage, stress testing, EPM techniques, counterparty risk, liquidity risk, credit risk. - Note: leverage referred to is calculated as the sum of the notionals of derivatives used; no hedging or other risk offsetting is taken into account. - VaR & Leverage Report: - Ad-hoc quarterly reporting for UCITS with expected leverage exceeding 600 percent (notional amount) including performance indicators, leverage and value-at-risk, stress tests. - Money Market Funds (MMF) Regular Reporting: - Monthly adhoc reporting set up to monitor the largest Luxembourg-based MMFs covering performance, portfolio structure and flows, subscription and redemption activity, portfolio valuation. - Quarterly prudential reporting for Asset Managers (UCITS ManCo and AIFMs): - Includes balance sheet & profit and loss accounts, assets under management, number of employees (Quarterly). - Reporting on capital guarantee UCIs: - Monthly reporting for UCIs with formal guarantee mechanisms tracking monthly NAV evolution vs guaranteed NAV and capital endowment of external guarantor. - EMIR reporting: - Daily reporting on derivatives to trade repositories in accordance with EMIR regulation No 648/2012. - Note: The requirement to provide monthly financial information pursuant to LMI Circular 97/136 and CSSF Circular 07/310 (monthly table "O1.1."), as amended by CSSF Circular 08/348, is repealed as from the U 1.1 reporting due for the reference month of June 2016. ### FSAP follow-up: resources and depositary regime enhancements - Resources and skills: - CSSF staff increased from 357 (December 1, 2010) to 651 (June 13, 2016). - Headcount of the on-site inspections department stands at 40 and will further be increased by 50 percent till year-end 2016. - Enhancement of duties of investment fund depositaries: - Progressively enhanced since 2011: first for alternative investment funds (AIFMD depositary regime), more recently for UCITS (CSSF Circular 14/587 in 2014; law of 10 May 2016 transposing UCITS V Directive; completed by Circular 16/644). - Taken together, AIFMD and UCITS V changes are fully reflected in Luxembourg law and represent a significant enhancement of depositary duties. - Clarification of investment fund shareholder/ownership rights: - CSSF measures implemented to increase investor understanding of rights and obligations where intermediaries in a holding chain are registered in the fund’s shareholder register. *Source: IMF Financial Sector Assessment Program content provided in the supplied text.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17257.pdf_