## 1luxea2024004 ## Source details **Canonical URL:** [1luxea2024004](https://www.imf.org/-/media/files/publications/cr/2024/english/1luxea2024004.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1luxea2024004.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1luxea2024004.pdf.json) --- ### Executive summary — overview and scale - The Assets Under Management (AUM) of the IF industry in Luxembourg is around 80 times its GDP. - By domicile, Luxembourg has the largest fund industry by AUM in Europe, followed by Ireland; Luxembourg is the second largest fund industry in the world, next only to the USA. - The AUM of IFs managed by Luxembourg domiciled fund managers is €6.1 trillion. - AUM comparison within the domestic financial sector: banking is 13 times GDP and insurance is 3 times GDP. - Structural shift since last FSAP (2016): UCITS share fell from 84 percent to 71 percent; AIFs increased from 16 percent to 29 percent. - Within AIFs, unregulated/indirectly regulated AIFs (e.g., RAIFs, SCSp) are the most popular structures for new funds. - MMF industry: total assets increased by 52 percent since 2016 with net inflows of over €200 billion; Luxembourg has a 29 percent share of the entire MMF industry in Europe and is the second largest MMF domicile in Europe (behind Ireland). ### CSSF supervisory framework — strengths and enhancements needed - Strengths and role: - CSSF is the key authority for supervision of the investment funds sector and has strengthened its supervisory framework since the last FSAP. - Regulatory framework for IFs and fund managers in Luxembourg is largely based on EU level requirements; CSSF acts as National Competent Authority (NCA). - CSSF uses a risk-based approach (RBA) across authorization, off-site supervision and on-site inspections and operates a global scoring model “global RBA IFM”. - Key supervisory gaps and recommendations: - Over half of depositaries in Luxembourg have group links with fund managers (55 percent as of Oct. 2023); CSSF should integrate such links as key risks in the risk-based supervision approach for both fund managers and depositaries. - Luxembourg hosts a large third-party fund managers industry (white-label providers) with different business models and conflict-of-interest risks compared with intra-group managers; recommendation to enhance supervisory framework by incorporating differentiated risk sets. - CSSF should obtain clear and granular data on credit lines put in place by IFs, including extent of sharing, commitment, and drawdown to better analyze liquidity risks. ### Delegation, cross-border supervision, and on-site inspections - Delegation patterns: - Delegation of portfolio management to entities outside Luxembourg is the dominant structure for Luxembourg-domiciled fund managers. - Main jurisdictions for delegated portfolio management: United Kingdom (~€1.2 trillion), USA (€0.7 trillion), Switzerland (€0.5 trillion), France (€ 0.38 trillion), Germany (€0.38 trillion). - Delegation to non-EU/EEA entities is subject to cooperation arrangements between CSSF and the delegate’s home supervisor. - On-site inspection framework and recommendation: - CSSF has two key inspection departments: On-site Inspections (OSI) and OPC-CSP (Métier OPC), plus OPC-PRUD for risk-management/NAV issues. - On average over the last five years, CSSF has conducted around 57 on-site inspections every year. - FSAP recommendation: initiate an on-site inspection framework for delegates outside Luxembourg with a risk-based approach; CSSF has initiated talks with foreign supervisors and should continue these to implement joint or consented inspections. ### Enforcement framework — shortcomings and actions - Current issues: - Enforcement and investigation powers under different laws are inconsistent and could be harmonized; CSSF’s power to impose fines under certain laws is very limited or lacks clarity. - Luxembourg lacks a regime for collective action by IF investors. - Recommendations: - Government should review relevant Laws regarding amount of fines, scope, thresholds, clarity, and harmonization, and substantially strengthen the sanctioning regime for administrative fines to have a deterrent effect. - CSSF should integrate accountability of relevant individuals/boards in enforcement approaches and consider enforcement action against such individuals, individually or collectively. - Ongoing legislative efforts to introduce a mechanism for class action suits should be prioritized. ### Regulatory gaps: valuation, winding up, and indirectly regulated AIFs - Valuation and NAV: - IFM (or delegate) is responsible for valuation; IFs may choose Lux GAAP or IFRS—more than 95 percent opt for Lux GAAP. - Product Laws (except SICAR Law) permit derogation from fair valuation “unless otherwise provided in articles of incorporation, management regulations or partnership agreement”; CSSF reviews practices at authorization but legal discretion remains. - Recommendation: CSSF/the government should clarify the specific situations where deviation from fair valuation by AIFs is permitted. - Circular 02/77 on pricing errors (investor compensation) is under review and will be replaced by Circular 2024/856 from January 1, 2025. - Winding up: - Product Laws provide differing winding up provisions by legal form (corporate vs contractual) and type of fund; investor rights and procedures (e.g., appointment of liquidators, CSSF approval requirements) vary. - Gaps: lack of harmonization with many IOSCO Good Practices for Termination of Investment Funds not fully incorporated. - Recommendation: harmonize winding up provisions in Product Laws and consider incorporation of IOSCO’s good practices on termination of funds where not covered. - Indirectly regulated AIFs: - RAIFs and other unregulated AIFs rely on indirect supervision via authorized AIFM; time-to-market is a key incentive for RAIFs. - Risk of regulatory arbitrage if new regulatory requirements apply only to regulated AIFs. - Recommendation: while introducing new regulatory requirements, consider applicability to indirectly regulated AIFs to avoid regulatory arbitrage. ### Depositaries, segregation and conflicts of interest - Regime and functions: - Depositaries perform safekeeping, cashflow monitoring and oversight; a single depositary is required per fund. - UCITS can only appoint credit institutions as depositaries; for certain AIFs (SIFs, SICARs, RAIFs, Part II UCIs to well-informed investors) depositaries may be credit institutions, investment firms or PDAOFIs. - As of Sept. 2023, some 145 regulated AIFs domiciled in Luxembourg have PDAOFIs as their depositaries. - Independence and group links: - IOSCO standards require functional independence of custodians; AIFMD and UCITS V prohibit manager acting as depositary and require separation of depositary tasks. - For UCITS with group links, at least one third of supervisory body members (or two members) must be independent; equivalent detailed safeguards are absent for AIFs. - 55 percent of depositaries have group links to at least one fund manager for whose funds they act as depositary (Oct. 2023). - Recommendation: CSSF should promote EU-level reforms to strengthen depositary independence and harmonize UCITS and AIFM Directive requirements; meanwhile integrate group links as material risk factors into CSSF’s risk-based supervision. ### Liquidity risk management, LMTs, stress testing and leverage - Liquidity Management Tools (LMTs) and usage: - Luxembourg IFs use a wide range of LMTs; swing pricing is widely used and was an active anti-dilution tool during COVID-19. - Categories of LMTs covered include anti-dilution/price-based tools (swing pricing, dual pricing), quantity-based tools (redemption gates, side pockets, redemption in kind), and portfolio composition measures (limits on illiquid assets). - Some LMTs are discretionary and set in funds’ constitutional documents; CSSF reviews LMTs at initial authorization. - Supervision and findings: - CSSF–BIS assessment (2022) findings: (i) most funds have sufficient liquidity buffers to generally cover maximum daily redemptions; (ii) estimates of portfolio liquidity under stress vary considerably; (iii) swing pricing dampens outflows but is not very effective in extreme stress; (iv) suspensions are rare and often precede closures; (v) further guidance needed on use/timing of suspensions and calibration of swing pricing. - ESMA review: every open-ended fund should have at least two LMTs mandatory in its toolkit, except MMFs which may have only one; ESMA to issue guidance on LMTs. - Recommendation: CSSF should continue to actively contribute to ESMA’s guidance on LMTs and to FSB/IOSCO discussions; use Luxembourg empirical evidence in EU-level guidance. - Stress testing and leverage: - ESMA guidelines on liquidity stress testing issued in 2019 and adopted by CSSF via Circular 20/752 in 2020; MMF stress testing guidance requires inclusion of LMTs. - CSSF monitors leverage risks quarterly under Article 25 of the AIFMD and reports annually to ESMA; Article 25 allows NCAs to impose leverage limits but CSSF has not exercised that discretion to date. - AIFs are “substantially leveraged” if exposure (commitment method) exceeds three times NAV and require additional reporting. ### Money Market Funds (MMFs) - Role and scale: - MMFs invest primarily in short-term instruments and aim to maintain stable or near-stable share prices. - Luxembourg is the second largest MMF domicile in Europe, accounting for 29 percent of MMF assets in Europe (Ireland 42 percent). - CNAV and LVNAV dominate in Luxembourg, constituting "around three-fourth" of the industry compared to VNAVs. - Regulatory developments and monitoring: - MMFR (2019) introduced detailed rules on liquidity, diversification and stress testing. - March 2020 turmoil exposed challenges for MMFR; FSB proposals (2021) to enhance MMF resilience were proposed; a 2022 review of MMFR including some FSB proposals was debated and dropped by the European Commission in 2023. - ESMA (June 2023) published stress-test analysis highlighting vulnerabilities of MMF types under different stress scenarios. - Recommendation: CSSF should continue close supervision and monitoring of MMFs and EU-level developments. ### Data reporting, access gaps and recommended enhancements - Reporting framework: - Regular reporting includes annual/semi-annual, quarterly and monthly reporting by UCITS and regulated AIFs; MMFR reporting; AIFMD manager reporting. - Ad-hoc reporting includes VaR and Leverage Report, net redemptions reporting (early warning), large redemptions reporting, crisis reporting thresholds (e.g., daily net redemptions exceeding 5 percent of NAV). - Self-assessment questionnaires (since 2021) replace earlier Long Form reports; auditors perform selected reviews and produce separate reports. - Data gaps and actions: - CSSF receives security-by-security information from BCL and is discussing access to the centralized securities data base (CSDB); full access to descriptive portfolio data (e.g., credit quality, issuer name) is not yet granted. - CSSF entered into agreement to obtain rating data from a credit rating agency to address credit quality gap. - Remaining data gap: granular reporting on credit lines (shared vs committed vs drawn down) used as liquidity tools is insufficient. - Recommendation: enhance reporting framework to include clear and granular details on credit lines put in place by IFs. ### Crisis management, supervisory responses and past episodes - Crisis management procedure: - Includes preliminary risk assessment, formulation of crisis management strategy, ongoing crisis monitoring, activating communication channels and prudential actions. - Used in COVID-19, Russia–Ukraine war, and United Kingdom LDI crisis. - CSSF collaborates with BCL, ESMA, ESRB, and international groups (FSB NMEG). - Supervisory responses to major events: - COVID-19: material liquidity stress, valuation effects and outflows (notably March 2020); LMT deployment (swing pricing, gates, suspensions); special crisis reporting covering ~90 percent of total net assets; daily/weekly monitoring for MMFs. - Russia–Ukraine war: direct exposure of ~€18 bn to Russian assets; around 61 funds had >10 percent exposure to RU securities at Dec. 2021; reporting requirements expanded to ~130 IFMs from Feb. 2022. - UK LDI crisis: Luxembourg hosted 104 LDI funds with total NAV of €30.8bn (£26.6bn) at end-August 2022; CSSF and Central Bank of Ireland issued supervisory expectations on an average “yield buffer” of 300–400 bps and consulted on potential macroprudential measures (consultation published Nov. 23, 2023). - 2023 banking crisis: exposures of Luxembourg domiciled funds to stressed banks were negligible; LVNAV MMFs saw moderate net outflows (~4 percent NAV). - Policy signals: - CSSF uses crisis reporting and enhanced data collection as central tools; issues FAQs and regulatory expectations in crisis contexts (e.g., swing pricing, side-pockets). - International coordination (ESMA, BoE, FCA, Central Bank of Ireland, etc.) was central during large episodes. ### Main recommendations on oversight of investment funds (selected from Table 1) - 1. While introducing new regulatory requirements, consider applicability to indirectly regulated AIFs to avoid regulatory arbitrage. Addressee: CSSF; Ministry of Finance. Timing*: ST. Priority**: H. - 2. Promote depositary independence reforms at the EU level; meanwhile, CSSF should strengthen supervision of depositary-fund manager group links through integration as risk factors into the risk-based approach. Addressee: CSSF; Ministry of Finance. Timing*: Reforms-LT; Supervision-ST. Priority**: M. - 3. Clarify the specific situations where deviation from fair valuation by AIFs is permitted. Addressee: CSSF/Ministry of Finance. Timing*: MT. Priority**: M. - 4. Continue to actively contribute to EU regulatory initiatives relating to Liquidity Management Tools Guidance and revisions to Eligible Assets Directive. Addressee: CSSF. Timing*: MT. Priority**: H. - 5. Harmonize winding up provisions in Product Laws and consider incorporation of IOSCO’s good practices. Addressee: CSSF; Ministry of Finance. Timing*: MT. Priority**: M. - 6. Enhance supervisory approach to incorporate differentiated risks of third party and intra-group fund managers. Addressee: CSSF. Timing*: MT. Priority**: M. - 7. Continue efforts to initiate an on-site inspection framework of delegates outside Luxembourg with a risk-based approach. Addressee: CSSF. Timing*: ST. Priority**: H. - 8. Enhance reporting framework to include clear and granular details on credit lines put in place by IFs. Addressee: CSSF. Timing*: MT. Priority**: M. - 9. Strengthen enforcement framework: harmonize powers, increase administrative fines, and ensure accountability of individuals. Addressee: CSSF; Ministry of Finance. Timing*: MT. Priority**: H. - 10. Prioritize legislative efforts to introduce a class action suits mechanism. Addressee: Ministry of Finance. Timing*: MT. Priority**: H. * ST = Short Term; MT = Medium Term; LT: Long Term ** H = High; M = Medium; L = Low.* *Source: EXECUTIVE SUMMARY; INTRODUCTION; Part II of the same law deals with UCI Part II Funds which are set up as AIFs; Box 1; Box 2; and staff report excerpts from 1luxea2024004.* ### EXECUTIVE SUMMARY __________________________________________________________________________ 4 ### EXECUTIVE SUMMARY ### Overview and scale - The Assets Under Management (AUM) of the IF industry in Luxembourg is around 80 times its GDP. - By domicile, Luxembourg has the largest fund industry by AUM in Europe, followed by Ireland. - Luxembourg is the second largest fund industry in the world, next only to the USA. - AUM comparison within the domestic financial sector: banking is 13 times GDP and insurance is 3 times GDP. - Luxembourg has made good progress in implementing IF related recommendations from the previous FSAP. - The regulatory framework for IFs and fund managers in Luxembourg is largely based on EU level requirements, with substantial improvements since the last FSAP and many more underway. ### CSSF supervisory framework — strengths and enhancements needed - CSSF has strengthened its supervisory framework since the last FSAP and is the key authority for supervision of the investment funds sector. - Considering more than half of the depositaries in Luxembourg have group links with fund managers, CSSF should consider integration of such links as key risks in the risk-based supervision approach for both fund managers and depositaries. - Luxembourg has a large third-party fund managers industry (white-label service providers) with a business model very different from traditional intra-group fund managers, each posing a different set of risks, especially on conflicts of interest. - Recommendation: enhance the supervisory framework by suitably incorporating the differentiated sets of risks between the two different types of fund managers. - To enhance capabilities on analyzing liquidity risks, CSSF should obtain clear and granular data on credit lines put in place by IFs, including on the extent of sharing, commitment, and drawdown. ### Delegation, cross-border supervision, and inspections - Delegation of portfolio management to entities outside Luxembourg is the dominant structure used by fund managers domiciled in Luxembourg. - Given the structural importance of delegation for Luxembourg domiciled funds, initiating an on-site inspection framework for delegates outside Luxembourg assumes importance. - CSSF has initiated talks with foreign supervisors on this subject; CSSF should continue these discussions with a view to initiating an onsite inspection framework, with a risk-based approach, of the delegates outside Luxembourg, whether jointly with the relevant supervisor or by CSSF itself (with the supervisor’s consent). ### Enforcement framework — key shortcomings and actions - The enforcement and investigation powers under different laws are currently inconsistent and could be harmonized to ensure CSSF has a comprehensive set of powers to investigate and take enforcement actions against the wide set of entities in the IF sector. - CSSF’s power to impose fines under certain laws is very limited, lacks clarity in certain others, and needs overall harmonization. - Recommendation: the government should review the relevant Laws with respect to the amount of fines, scope, thresholds, clarity, and harmonization, and substantially strengthen the overall sanctioning regime for administrative fines to have a deterrent effect. - CSSF should integrate, in the enforcement approach against entities, the accountability of relevant individuals/boards and consider taking enforcement action against such individuals, whether individually or collectively, as appropriate. - Luxembourg lacks a regime for collective action by IF investors; ongoing legislative efforts to introduce a mechanism for class action suits should be prioritized. ### Regulatory gaps: valuation, winding up, and indirectly regulated AIFs - Luxembourg has increasingly become a popular domicile for Alternative Investment Funds (AIFs); unregulated/indirectly regulated AIFs are the most popular structures for new funds. - Certain new proposals are proposed to be applicable only to regulated AIFs, which may create regulatory arbitrage. - Recommendation: while introducing new regulatory requirements, consider applicability to indirectly regulated AIFs to avoid regulatory arbitrage. - IF Product Laws generally permit significant deviation from fair valuation if provided for in certain fund constitution documents; although practically this is usually not the case and subject to CSSF’s review during authorization, the specific situations where deviation from fair valuation by AIFs is permitted should be clarified to avoid potential misuse. - As part of ongoing efforts to strengthen the winding up framework, CSSF should harmonize various winding up provisions in the Product Laws, especially those involving rights of the investors/shareholders, and consider incorporation of IOSCO’s good practices on termination of funds to the extent not covered in the current framework. ### EU-level engagement - Given Luxembourg’s position as the domicile of EU’s largest IF sector, CSSF should actively continue to promote and contribute to EU level reforms on various topics. - CSSF should take an active role in promoting reforms to strengthen depositary independence at the EU level, including harmonization between requirements under UCITS and AIFM Directives, given the significant depositary-fund manager linkages. - With respect to liquidity risks, CSSF should continue to actively contribute to ESMA’s guidance on the use of Liquidity Management Tools (LMTs) and to engage closely with ESMA and the EU Commission on the proposed revision of the Eligible Assets Directive. ### Main recommendations on the oversight of investment funds (Table 1) - 1. While introducing new regulatory requirements, consider applicability to indirectly regulated AIFs to avoid regulatory arbitrage. Addressee: CSSF; Ministry of Finance. Timing*: ST. Priority**: H. - 2. Promote depositary independence reforms at the EU level; meanwhile, CSSF should strengthen supervision of depositary-fund manager group links through integration as risk factors into the risk-based approach. Addressee: CSSF; Ministry of Finance. Timing*: Reforms-LT; Supervision-ST. Priority**: M. - 3. Clarify the specific situations where deviation from fair valuation by AIFs is permitted. Addressee: CSSF/Ministry of Finance. Timing*: MT. Priority**: M. - 4. Given Luxembourg’s position as the leading fund domicile in Europe, and based on its significant experience, continue to actively contribute to EU regulatory initiatives relating to Liquidity Management Tools Guidance and revisions to Eligible Assets Directive. Addressee: CSSF. Timing*: MT. Priority**: H. - 5. As a part of its ongoing efforts on revision of winding up provisions, harmonize provisions in Product Laws and consider incorporation of IOSCO’s good practices, as appropriate. Addressee: CSSF; Ministry of Finance. Timing*: MT. Priority**: M. - 6. Enhance the overall supervisory approach incorporating the differentiated nature of risks of third party and intra-group fund managers, as appropriate. Addressee: CSSF. Timing*: MT. Priority**: M. - 7. Continue efforts to initiate an on-site inspection framework of delegates outside Luxembourg, with a risk-based approach. Addressee: CSSF. Timing*: ST. Priority**: H. - 8. Enhance the reporting framework to include clear and granular details on credit lines put in place by IFs. Addressee: CSSF. Timing*: MT. Priority**: M. - 9. Strengthen the enforcement framework in terms of harmonization of powers, increasing administrative fines, and accountability of individuals. Addressee: CSSF; Ministry of Finance. Timing*: MT. Priority**: H. - 10. Prioritize the ongoing legislative efforts to introduce a class action suits mechanism. Addressee: Ministry of Finance. Timing*: MT. Priority**: H. * ST = Short Term; MT = Medium Term; LT: Long Term ** H = High; M = Medium; L = Low. *Source: EXECUTIVE SUMMARY.* ### INTRODUCTION ### INTRODUCTION ### A. Background - Luxembourg has the largest IF industry (in terms of AUM) in Europe and second largest in the world, behind the US, by fund domicile. - The AUM of IFs managed by Luxembourg domiciled fund managers is €6.1 trillion. - The AUM of Luxembourg-domiciled IFs amount to roughly 80 times Luxembourg’s GDP in 2023, up from 62 times GDP during the last FSAP in 2016. - Other financial sectors in Luxembourg (by size relative to GDP): banking at 13 times GDP and insurance at 3 times GDP. - A significant portion of banking business includes depositary, administration, and other services to investment funds; the insurance industry is closely linked to the IF industry through unit-linked products. - Luxembourg is the favored domicile for cross-border funds distributed across the world, particularly across Europe, enabled by EU Directives for UCITS and AIFM and a passporting regime. - Ireland is the next leading domicile for cross-border funds in Europe. - Structural shift in product mix since the last FSAP: UCITS share fell from 84 percent to 71 percent; AIFs increased from 16 percent to 29 percent, i.e., the share of AIFs has almost doubled. - Within AIFs, unregulated/indirectly regulated funds have become a popular choice of structure especially for new AIFs. - The MMF industry saw total assets increase by 52 percent since the last FSAP in 2016, with net inflows of over €200 billion, particularly since 2019; Luxembourg has a 29 percent share of the entire MMF industry in Europe and is the second largest MMF domicile in Europe (behind Ireland). - Fund strategy composition (2023): bond and equity funds together comprise almost 60 percent of AUM; the share for bond funds decreased by almost 10 percentage points since 2016, with valuation effects (due to rise in interest rates) potentially important. - Real estate and “Other” fund types have increased significantly, together accounting for nearly 10 percent of total assets in 2023. - Close to 85 percent of Luxembourg-domiciled IFs are managed by Luxembourg-based Investment Fund Managers (IFMs). - Luxembourg is a key domicile for third-party fund managers (white-label service providers) and has a robust ecosystem of depositaries, administrators, and auditors. - Luxembourg’s highly skilled and multilingual workforce contributes to its attractiveness as a fund management center, though increasing labor costs are a concern. - The Technical Note author is Nila Khanolkar; this Technical Note should be read in conjunction with the Technical Note on Risk Analysis of the Luxembourg IF sector. ### B. Institutional Structure for Regulation and Supervision - The Commission de Surveillance du Secteur Financier (CSSF) has the responsibility for regulation and supervision of the investment fund industry in Luxembourg. - Under the Law of 23 December 1998 (“Law of 1998”) establishing CSSF, supervisory powers are granted to CSSF with respect to IFs, fund managers, depositaries, and central administration/transfer agents. - CSSF is the competent authority in Luxembourg under various EU Level Directives/Regulations relating to IFs; domestic Product Laws relating to IFs also provide specific powers to CSSF. - CSSF’s roles under the Law of 1998 include investor protection, financial stability, and fair markets; CSSF is required to cooperate with the Luxembourgish government, the BCL and other national, community and international supervisory authorities to contribute to ensuring financial stability. - CSSF must consider the potential impact of its own decisions on stability of the financial system at national, community and international level. - The regulatory and supervisory framework in Luxembourg must be understood against the background of the EU framework; regulation of investment funds/fund managers in Luxembourg is primarily based on the European framework, a unified set of capital market rules. - CSSF’s regulatory role as a National Competent Authority (NCA) is relatively restricted to areas where discretion is granted to member states in EU-level requirements and to areas not covered by EU requirements; market oversight, supervision and enforcement are primarily tasks of NCAs. - ESMA is playing an increasingly important role with respect to supervision of investment funds/fund managers through efforts towards supervisory convergence, especially through Common Supervisory Actions (CSAs); enforcement continues to be primarily the role of NCAs. ### C. Legal and Market Structure - All Luxembourg domiciled funds fall into one of two categories: UCITS or AIFs, reflecting UCITS and AIFM Directives. - UCITS are fund-based, can invest only in transferable securities or other liquid financial assets as detailed in the Eligible Assets Directive, are open-ended, primarily retail vehicles, and are subject to significant restrictions on type of investments, leverage, and diversification. - AIFMD is manager-based; obligations apply to the fund manager. Under AIFMD, AIFs do not have EU-wide restrictions on liquidity, leverage, or diversification and may invest in assets not eligible for UCITS (e.g., private equity, venture capital, real estate, physical commodities). - AIFMD leaves broad discretion to EU member states to apply rules to AIFs; Luxembourg has Product Laws imposing some restrictions on specific types of AIFs. - Classification of AIFs in Luxembourg: - Regulated AIFs: UCIs, SIFs, and SICARs are directly regulated, authorized, and supervised by CSSF through Product Laws. - Unregulated/indirectly regulated AIFs: RAIFs and other AIFs set up under commercial law are not directly authorized or supervised by CSSF; they are indirectly supervised through the authorized AIFM managing them. - For RAIFs, it is mandatory to have an authorized AIFM; for other unregulated AIFs, the AIFM may be registered or authorized depending on AUM and applicable thresholds. - Table 2: Key requirements by fund type (high-level summary of Product Laws): - UCITS (Part I UCI): marketable to retail investors; open-ended with UCITS redemption rights; stringent portfolio composition, diversification, and leverage restrictions; must be managed by UCITS-compliant Management Companies (Mancos) authorized by CSSF/another EU supervisor; must appoint a credit institution as depositary. - Regulated AIF (Part II UCI): marketable to retail investors; open/closed-ended; no restriction on type of assets but subject to strict diversification obligations comparable to ELTIFs and leverage restrictions (e.g., up to 300 percent NAV); same depositary regime as UCITS if marketed to retail investors, otherwise same as other regulated AIFs. - Specialized Investment Fund (SIF): marketable only to well-informed investors; open/closed-ended; no restriction on type of assets or leverage but general diversification obligation (generally 30 percent); must appoint a depositary (credit institution, investment firm or PDAOFI). - SICAR: marketable only to well-informed investors; open/closed-ended; can only invest in securities representing risk capital; no diversification obligations or restrictions on leverage; must appoint a depositary (credit institution, investment firm or PDAOFI). - Reserved AIFs (RAIFs): marketable only to well-informed investors; must appoint an authorized AIFM; not directly authorized or supervised by CSSF; no restriction on type of assets or leverage but general risk-diversification obligation (except if investing in risk capital); must appoint a depositary (credit institution, investment firm or PDAOFI). - Other unregulated AIFs: meet the AIF definition in article 1(39) of the AIFM Law; no authorization or supervision by CSSF; can only be marketed to professional investors; no restrictions on type of assets, leverage, diversification; subject to AIFMD requirements depending on whether managed by an authorized or registered AIFM and indirectly supervised through the AIFM. - EU-level product classifications within UCITS and AIFs with dedicated regulatory requirements include MMFs, ELTIFs, EuVECA, and EuSEF; MMFs can be set up as UCITS or AIFs. - Luxembourg is home to more than half of the ELTIFs domiciled in Europe; with ELTIF Regulation revisions (ELTIF 2.0) and the trend toward “retailization”/“democratization” of AIFs, the number of ELTIFs is expected to rise significantly in the future. - The trend of “retailization”/“democratization” of private assets is increasing interest in products that provide retail investors access to private markets; most ELTIFs are structured as Part II UCIs as it offers flexibility to offer AIFs to retail investors. - Practical note: most MMFs are set up as UCITS; EuVECAs and EuSEFs are small by size. *Source: 1luxea2024004 - INTRODUCTION* ### 2023. ESMA has also recently finalized the technical standards for ELTIFs 2.0, including granular requirements, in ### 1luxea2024004 - 2023. ESMA has also recently finalized the technical standards for ELTIFs 2.0, including granular requirements, in ### ELTIFs and liquidity / investor protection - ESMA has recently finalized the technical standards for ELTIFs 2.0, including granular requirements, in particular, around liquidity risks. - CSSF should closely supervise new trends related to ELTIFs, especially for potential liquidity risks and investor protection concerns. ### Recent trends in AIF structures and market activity - The structure adopted for setting up an AIF depends on strategy and choice of investors, among others. - Regulated AIFs include Part II UCIs, SIFs and SICARs. - Unregulated / indirectly regulated AIFs include RAIFs and other legal structures. - Part II UCIs are typically the structures adopted for retail vehicles that do not qualify to be a UCITS. - There was little interest for Part II UCIs over the past few years; interest has picked up recently, especially with the trend of “retailization”/“democratization” of AIFs and increasing popularity of ELTIFs. - SIFs remain the traditional vehicle for structuring AIFs for sophisticated investors and continue to be an important option for investors seeking a regulated product. - SICARs are AIFs structured mainly to invest in risk capital (e.g., private equity/venture capital funds); the structure has not been very popular to date. - Since the introduction of Special Limited Partnership (SCSp; a new type of company) in 2013 and RAIFs (a new investment vehicle) in 2016, unregulated/indirectly regulated funds have become preferred vehicles for new AIF launches. - SCSp became popular because it provided a vehicle similar to the Anglo-Saxon limited partnerships (LPs), offering a familiar structure to investors used to investing in the LP structure. - RAIFs became popular due to efficiency in time-to-market (no authorization from CSSF) and an umbrella structure enabling quicker sub-fund launches. ### Legal forms and product-specific restrictions - Regulated Funds and RAIFs can be launched under the contractual form or the corporate form. - Contractual form: Fonds commun de placement (“FCP”) — an undivided collection of assets managed according to the principle of risk spreading on behalf of joint owners (the investors); investors are liable only up to the amount contributed and their rights are represented by units in the FCP. Funds set up as FCPs are necessarily managed by a management company in accordance with the management regulations set up by the latter. - Corporate form: investment companies have their own legal personality and can be set up with a variable capital (“SICAV”) or a fixed capital (“SICAF”); such funds are managed in accordance with their articles of incorporation. Unlike FCPs, investment companies can be self-managed and investors have the right to vote at shareholder meetings as shareholders. - Product-specific restrictions: - If UCITS choose a corporate form, they must be set up as a public limited company (société anonyme). - SICARs can only be launched in the corporate form. - Unregulated/indirectly regulated AIFs (other than RAIFs) cannot be organized as FCPs or investment companies, but they can choose any other legal form under the Company Law. - Usual legal forms for non-FCP / non-investment company structures include partnerships limited by shares (sociétés en commandite par actions), limited partnerships (sociétés en commandite simple) or special limited partnerships (sociétés en commandite spéciale). ### Oversight framework for investment funds - The Luxembourgish regulatory framework for the investment fund (IF) industry is primarily based on EU requirements. - Key EU requirements underpinning the legislative and regulatory framework for IFs in Luxembourg are the UCITS Directive and the AIFMD. - The UCITS and AIFM Directives have been transposed in Luxembourg in the Law of 2010 and Law of 2013 respectively. - The Law of 2010, under Part I, lays down rules on the authorization and supervision of UCITS funds and the companies that manage them, as well as UCITS depositaries. - The Law of 2013 on AIFMs (manager-based) lays down requirements for managers’ compliance and operational frameworks, regulatory and investor reporting obligations. - The legislative framework also includes Product Laws for specific AIFs (UCI Part II, SIF, SICAR and among indirectly regulated AIFs, RAIFs). - Funds covered by specific/dedicated Regulations such as MMFs, ELTIFs, EuVECAs or EuSEFs have to additionally comply with the regulatory requirements under the respective European Regulations. ### Relevant directives and dates quoted in the source - Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). - Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010. *Source: IMF — Luxembourg (excerpt).* ### Part II of the same law deals with UCI Part II Funds which are set up as AIFs. ### 1luxea2024004 - Part II of the same law deals with UCI Part II Funds which are set up as AIFs. ### Regulatory framework and CSSF initiatives - Part II of the law deals with UCI Part II Funds which are set up as AIFs. - The legislation is complemented by an extensive set of CSSF Regulations, circulars and FAQs issued by CSSF; these clarify aspects of the relevant Laws and CSSF enforces circulars and FAQs in conjunction with the relevant provisions of the Laws. - CSSF has key regulatory initiatives in its pipeline, including at a fund level where applicability to unregulated/indirectly regulated funds needs consideration. - CSSF is proposing to strengthen protection of investors in case of NAV calculation errors and correction of the consequences resulting from non-compliance with the investment rules through a review of its Circular 02/77. - Two key circulars are being updated: one on risk management and Circular 18/698, the primary circular applicable to fund managers. - The current incentive to opt for unregulated/indirectly regulated AIFs is the time-to-market. - If new initiatives are applied only to regulated AIFs, the gap between the regulated and indirectly regulated AIFs will widen, resulting in a potential regulatory arbitrage. - Recommendation: While introducing new regulatory requirements, CSSF should consider whether such requirements should be applicable to indirectly regulated AIFs, in order to avoid regulatory arbitrage. - CSSF adopts a consultative approach: several standing Consultative Committees include industry representation and are regularly consulted before major proposals. - Suggestion: CSSF may consider adopting wide public consultation of key long-term proposals to improve transparency and allow a variety of stakeholders to respond and contribute. ### Segregation and custody of assets (Depositaries) - The UCITS and AIFM Directives require appointment of a “depositary” for safekeeping and segregation of fund assets; depositaries have three key functions: safekeeping, cashflow monitoring and oversight. - The Directives require the appointment of a single depositary for each UCITS and AIF. - As a general rule, a depositary is required to have its registered office or a branch in the same country where the fund is domiciled. - The competent authority of the UCITS’ home state must approve the choice of the depositary for a fund domiciled in that state; AIFMD has no such requirement but in Luxembourg CSSF approval is required for any entity seeking to act as depositary for a regulated AIF. - Under both UCITS Directive and AIFMD, the fund manager and the depositary must enter into a detailed written agreement regulating the flow of information. - In Luxembourg: - UCITS can only appoint credit institutions as depositaries. - For Part II UCI marketed to retail investors, only credit institutions may act as depositary. - For other AIFs (SIFs, SICARs, RAIFs and Part II UCIs offered to well-informed investors), the depositary can be a credit institution, an investment firm or a Professional Depositary of Assets Other than Financial Instruments (PDAOFI). - Some 145 regulated AIFs domiciled in Luxembourg have PDAOFIs as their depositaries (Sept. 2023). - IOSCO Standards require IF assets be entrusted to a third-party custodian that is functionally independent. - Under AIFMD and UCITS V, AIFMs and UCITS management companies are prohibited from acting as a depositary and must functionally and hierarchically separate depositary tasks from other potentially conflicting tasks; conflicts of interest must be identified, managed, monitored and disclosed to investors. - For UCITS with group links between manager and depositary, additional safeguards exist: - Where management company and depositary belong to the same group, at least one third of members (or, if lower, two members) of the body in charge of supervisory functions in both manager and depositary are required to be independent. - For AIFs, these detailed safeguards (e.g., requirement of independent directors) are absent; CSSF recommends AIFMs to apply such requirements but it is not binding. - As of October 2023, 55 percent of the depositaries have group links to at least one fund manager for whose funds they act as depositary. - Related-party revenues to depositaries from related fund managers may be significant and, if conflicts are not adequately managed, may adversely impact depositary functions including custody and oversight; such risks could rise to systemic proportions if they translate into actual failures. - CSSF engaged with industry on depositary independence and noted that enhancements at Luxembourg level may not be appropriate for a level playing field with other EU jurisdictions and are better addressed at the European Level. - At supervisory level, group links are considered during on-site inspections; however, risk of conflicts arising from group links should be integrated better into the overall risk-based supervision approach for both fund managers and depositaries. - Recommendation: Given Luxembourg’s role as a key depositary domicile and the significant extent of group links, the government/authorities should consider actively promoting EU-level reforms to strengthen depositary independence and harmonize UCITS and AIFM Directive requirements; meanwhile CSSF should integrate such group links as important risk factors into its risk-based supervision approach for both fund managers and depositaries. ### Valuation and accounting (NAV, valuation policies, pricing errors) - The Investment Fund Manager (IFM) is responsible for valuation of the IF, even if delegated. - The IFM / the delegate must justify necessary resources, infrastructure, experience and expertise to perform valuation, and have written valuation policies (including risk management) and procedures. - Valuation procedures and requirements (including independence, delegation, and sub-delegation) applicable to IFMs under AIFMD are more detailed than for UCITS; CSSF in Circular 18/698 recommends UCITS Management Companies also apply requirements currently applicable to AIFMs. - In case of a self-managed IF, the valuation responsibility falls on the IF itself. - Investment Funds can choose between Lux GAAP and IFRS, and more than 95 percent opt for Lux GAAP. - Lux-GAAP and the Product Laws predominately require valuation of assets with the last known stock exchange quotation, the probable realization value (for UCITS and Part II Funds) or the fair value. For UCITS, additional detailed valuation requirements are specified for OTC derivatives. - IFs are expected to calculate their NAV at least as frequently as they allow subscriptions and redemptions; derived mainly from EU level requirements. - For UCITS and open-ended AIFs, clear requirements exist to calculate NAV every time they sell, issue, repurchase or redeem units/shares; for UCITS there is also a requirement to make prices public. - There is a requirement to calculate NAV at least twice a month (and make the price public) for UCITS and at least once a year for open-ended AIFs. - Most UCITS offer daily dealing; AIFs less so, by the nature of their strategy. - Some 35 percent of AIFs domiciled in Luxembourg are open-ended, of which 31 percent offer daily, 33 percent weekly to monthly and 24 percent quarterly redemptions. - The legal framework for valuation of IFs could be strengthened: different Product Laws provide significant discretion for funds to deviate from fair valuation via provisions that allow derogation from fair valuation “unless otherwise provided in articles of incorporation, management regulations or partnership agreement”; such provisions are present in all Product Laws except the SICAR Law. - Based on industry discussions, practical deviations may be limited due to investor pressures; CSSF reviews valuation policies/procedures of regulated funds as part of authorization and supervision, but Product Laws continue to permit deviation from fair valuation (except SICAR), keeping scope for potential misuse. - Recommendation: CSSF/the government should clarify the specific situations where deviation from fair valuation by AIFs is permitted. - CSSF has had a regulatory framework on pricing errors (including investor compensation) since 2002, currently under review for further strengthening. - Detailed requirements apply for NAV calculation errors and non-compliance with investment rules, including on investor compensation and intimation to CSSF; materiality thresholds trigger investor compensation and intimation to CSSF for NAV calculation errors, while these thresholds do not apply for non-compliance with investment rules. - The review proposes expanding the scope of Circular 02/77 to include regulated AIFs (other than UCI Part II which was already covered), and also includes ELTIF, EuVECA, EuSEF and MMFs; proposed expansions include roles of stakeholders, scope to other errors (e.g., swing pricing errors), and review of the role of auditor. - Circular 02/77 will be replaced by Circular 2024/856 from January 1, 2025. ### Delegation and substance (delegation practices, risks, and CSSF requirements) - Delegation structures, particularly relating to portfolio management, are extensively adopted by IFs in Luxembourg; delegation of portfolio management is a critical element contributing to Luxembourg’s popularity as a fund domicile. - Under EU requirements, if a manager delegates a function, it remains fully responsible; in practice, a manager’s role is to oversee delegate activities. - The UK is the main country to which portfolio management is delegated, with fund managers delegating AUM of close to € 1.2 trillion to portfolio managers located in UK. This is followed by USA (€0.7 trillion), Switzerland (€0.5 trillion), France (€ 0.38 trillion), Germany (€0.38 trillion). - In some cases, delegation is to more than one entity and in more than one jurisdiction; delegation of risk management is permitted but rare. - Delegation is permitted under UCITS and AIFM Directives, subject to conditions: arrangements must be disclosed to CSSF and must not prevent effectiveness of CSSF’s supervision; the fund manager must be able to monitor delegate activities on an ongoing basis. - Where delegation involves portfolio/investment management, the mandate can only be given to entities authorized or registered for asset management and subject to prudential supervision by their home authorities. - Delegation to non-EU/EEA entities is subject to cooperation arrangements between CSSF and the supervisory authorities in the domicile of the delegate. - IOSCO Principles require that use of delegates should not diminish effectiveness of primary regulation and supervision and the CIS operator should not be allowed to delegate to the extent it becomes a letter-box. - AIFMD and its implementing rules set a detailed framework to assess letter-box risk, including circumstances such as loss of necessary expertise/resources to supervise delegated tasks or delegating investment management functions to an extent that substantially exceeds the functions performed by the AIFM itself. - Since the last FSAP, CSSF issued Circular 18/698 (2018) with granular requirements on delegation and substance: limits to scope of delegation; delegation framework (reporting to CSSF, contracts, initial due diligence, ongoing monitoring); specific conditions for delegating portfolio management, administration, marketing, risk management and depositary function. - Circular 18/698 clarifies substantial presence threshold: CSSF expectations are at least three full-time equivalent (FTE) at the head office in Luxembourg who perform key functions. - Detailed substance requirements for conducting officers: minimum number of such officers should be two; in principle, they need to be permanently located in Luxembourg; their maximum number of mandates as conducting officers should be two. - The EU regulatory requirements on delegation were recently reviewed with renewed focus post Brexit; delegation has come under increased scrutiny because a significant amount of delegation by fund managers domiciled in Europe now sits outside the EU. - As part of the AIFMD/UCITS review, requirements with respect to delegation were reviewed and strengthened for transparency, substance, and alignment of UCITS delegation requirements with AIFMD requirements. - Post adoption of Circular 18/698 in 2018, especially on substance requirements, it is understood that the impact of the proposed review on the Luxembourgish fund industry will not be significant. *Source: IMF — Part II of the same law deals with UCI Part II Funds which are set up as AIFs.* ### 39. UCITS are open-ended funds (most offering daily redemptions) while AIFs may be ### 39. UCITS are open-ended funds (most offering daily redemptions) while AIFs may be ### Redemption frequency and liquidity profile - UCITS: open-ended funds with stringent requirements to invest in certain assets, predominantly considered to be liquid, permitting widespread use of daily dealing structures. - AIFs domiciled in Luxembourg: - 35 percent of the AIFs (by Total Net Assets) domiciled in Luxembourg are open-ended. - Of those open-ended AIFs: 31 percent offer daily redemptions, 33 percent weekly to monthly redemptions, and 24 percent quarterly redemptions. - Under EU requirements, the investment strategy, liquidity profile and redemption policy of each AIF are required to be aligned. ### Liquidity risk management (LRM) framework and tools - CSSF circular 2019 implemented IOSCO’s recommendations for liquidity risk management (LRM) in collective investment schemes (2018), covering: - LRM design process, - day-to-day liquidity management of UCIs, - contingency planning. - IOSCO’s 2022 review considered Luxembourg as fully compliant with all of its recommendations. - Luxembourg IFs have a wide range of liquidity management tools (LMTs); active deployment notably of swing pricing: - Swing pricing used as anti-dilution tool in normal times and widely used during the COVID crisis. - Choice of LMTs: - Largely at the discretion of the fund manager rather than a strict regulatory requirement. - Regulatory framework does not generally prescribe concrete approaches to LMTs, though some tools are mentioned in Product Laws/circulars. - Vast majority of LMTs are set up in funds’ constitutional documents; CSSF reviews these at initial IF authorization. - CSSF–BIS assessment (published 2022) on LMTs, focusing on swing pricing and temporary suspensions by UCITS, key findings: - (i) Most funds have sufficient liquidity buffers to generally cover the maximum daily redemptions. - (ii) Estimates of how portfolio liquidity would be affected under stress vary considerably; some may underestimate the impact of sales. - (iii) Funds frequently use swing pricing; while swing pricing dampens outflows during elevated market volatility, it is not very effective during stress episodes such as the March 2020 turmoil. - (iv) Funds rarely suspend redemptions; suspensions usually precede permanent closures and liquidations. - (v) Further guidance would be beneficial on the use and timing of suspensions as well as the calibration of swing pricing. - CSSF issued proactive guidance on swing pricing and side pockets during March 2020 turmoil and early stages of the Ukraine-Russia war (2022); side-pockets are not commonly permitted for UCITS but CSSF permitted use through FAQs during the Russia-Ukraine crisis. - Recent AIFMD/UCITS review at EU level: every open-ended fund should have at least two LMTs mandatory in its toolkit, except for MMFs which may have only one. - ESMA mandated to issue guidance at European level on LMTs; CSSF is engaging with ESMA and contributing experience. ### Recommendations on LMTs and international standards - Recommendation: CSSF should continue to actively contribute to ESMA’s guidance on LMTs at the European level, using its growing body of analytical work based on empirical evidence on the deployment of those tools in Luxembourg. - FSB and IOSCO recommendations (2023) on LMTs and product design: - If implemented, these will have a large impact on the nature of the fund industry worldwide, including Luxembourg. - CSSF has been contributing actively to FSB and IOSCO discussions and should continue to review and consider the impact on the Luxembourgish IF industry if adopted. ### Stress testing and ESMA guidance - ESMA issued guidelines for liquidity stress testing in UCITS, AIFs and MMFs developed in 2019 and adopted by CSSF via Circular 20/752 in 2020. - ESMA developed stress testing guidelines for MMFs that require inclusion of LMTs in stress tests. - January 2023: ESMA started a consultation on the review of the methodology in the guidelines on stress test scenarios for MMFs under the MMFR, to be finalized by end 2023. ### Leverage: rules, monitoring and reporting - UCITS leverage constraints: - 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 calculated using either the commitment approach or the Value-at-Risk (VaR) method. - Borrowing is not considered when determining global exposure, but UCITS may borrow, on a temporary basis, up to 10 percent of their NAV. - Note: UCITS using a VaR method may have leverage in excess of the 100 percent limit. - AIF leverage framework under AIFMD: - AIFMD requires AIFMs to set leverage limits for each AIF they manage but does not set maximum limits. - Leverage must be calculated using two methods: the gross method and the commitment method. - The overall leverage of an AIF is expressed as the ratio between the AIF’s exposure and its NAV. - AIFs beyond a threshold (if the exposure of the AIF calculated according to the commitment method exceeds three times its NAV) are considered to be ‘substantially leveraged’ and additional reporting for such funds is required. - Reporting includes the overall level of leverage employed by each AIF and the extent to which the AIF’s assets have been reused under leveraging arrangements. - CSSF practice: - December 2020: ESMA published guidance on application of Article 25 of the AIFMD; CSSF has complied. - CSSF actively monitors leverage risks under Article 25 on a quarterly basis and sends a report to ESMA every year, with close interaction and follow-up with managers. - Article 25 permits NCAs to impose leverage limits after notifying ESMA, ESRB and relevant competent authorities; CSSF has not deemed it necessary so far and has not exercised this discretion to impose regulatory limits under this section. - Regulatory requirements on leverage risk management apply to both UCITS Management Companies and AIFMs; risk-management processes must enable monitoring and measurement of positions and their contribution to overall portfolio risk at any time. ### Operational and conduct of business requirements - Extensive rules apply to IFs and their managers, primarily stemming from the UCITS Directive and AIFMD. - Managers authorized both as an AIFM and a UCITS management company (“Super ManCo”) must comply with operational and conduct of business requirements of both regimes; most managers in Luxembourg are “Super ManCos” and thus both regimes apply. ### Composition of IF portfolios and Eligible Assets review - UCITS: detailed eligibility requirements via EU Eligible Assets Directive and ESMA guidelines; permitted assets include transferable securities, UCITS and other investment funds under conditions, financial derivative instruments, deposits with credit institutions, and specific money market instruments. Diversification and leverage restrictions also apply. - AIFs: extensive discretion on portfolio composition; AIFMD does not impose restrictions on portfolio composition, leverage, or diversification though member states may impose more stringent rules; CSSF Product Laws provide certain product-specific restrictions. - Current revision: Eligible Assets Directive for UCITS under review at European level; European Commission has requested ESMA to provide technical advice; Luxembourg, as leading domicile for UCITS, would be significantly affected by any revision. - Recommendation: CSSF should continue to engage closely with ESMA and the EU Commission on the revision of the Eligible Assets Directive. - Luxembourg AIFs can invest in all types of assets, subject to some diversification requirements depending on AIF type: - SICARs: permitted to invest only in risk capital. - Part II UCIs, SIFs and RAIFs: subject to diversification requirements (examples: Part II UCIs comparable to ELTIFs 10 percent/20 percent limits; SIFs generally 30percent per issuer as per Circular CSSF 07/309; RAIFs follow risk-diversification principle similar to SIFs). - No specific liquidity buffers imposed on Luxembourg IFs by AIFMD or Luxembourg law generally; certain EU Product Regulations (MMFs, ELTIFs, EuSEF, EuVECA) have specific portfolio composition requirements. ### Crypto-assets exposure and supervisory treatment - CSSF FAQs: UCITS, UCIs addressing non-professional investors and pension funds cannot directly or indirectly invest in crypto assets (unless investments are in financial instruments); AIFs marketed to well informed investors can invest directly or indirectly in crypto assets. - Data: crypto exposure of Luxembourg domiciled IFs is limited at present (less than €1 bn). - CSSF covers crypto asset risks in supervisory framework under topics such as disclosure and valuation. ### Winding up and liquidation framework - Product Laws provide winding up provisions depending on legal form (corporate vs contractual) and type (voluntary, operation of law, judicial decision). Company Law general rules apply unless derogated by Product Laws. - Differences in process and investor rights: - Voluntary winding up for corporate-type IF: pursuant to an extraordinary meeting of shareholders in presence of a notary public. - Voluntary winding up for contractual-type IF: decision of the management company; investors may not have power to decide unless management regulations provide accordingly. - Investor rights to disclosures, appointment of liquidators, etc., differ depending on contractual vs corporate form. - Prior approval of CSSF required for appointment of liquidator in case of UCITS and regulated AIFs, but not for unregulated AIFs. - Gaps and lack of harmonization identified in winding up framework; many IOSCO Good Practices for Termination of Investment Funds (2017) not fully incorporated, especially granular requirements. - CSSF actions: - Some liquidation provisions amended as part of 2023 legislative changes. - CSSF is in the process of amending other aspects of winding up framework through further Product Laws amendments. - Recommendation: As part of ongoing efforts, the government/CSSF should harmonize various winding up provisions in the Product Laws, especially those involving rights of the investors, and consider incorporation of IOSCO’s good practices on termination of funds to the extent not covered in the current framework. *Source: IMF staff report on Luxembourg investment funds (extract).* ### Box 1. Use of Artificial Intelligence/ Machine Learning by Asset Managers ### Box 1. Use of Artificial Intelligence/ Machine Learning by Asset Managers ### Use and supervision of AI/ML by supervised institutions - CSSF undertook a survey regarding the use of artificial intelligence (AI) by its supervised institutions between Oct 2021-Jan 2022. - Purpose of the survey: - Analyze use of AI by supervised institutions. - Identify AI use cases. - Assess application of certain ethical principles outlined in CSSF’s 2018 white paper on the subject. - Survey findings: - The level of adoption of AI and other innovative technologies by the supervised institutions was fairly limited and still at early stage. - The survey found a general increase of investments in the technology. - The survey found a lack of specific AI related governance mechanisms. - International guidance and CSSF response: - IOSCO issued guidance on the use of artificial intelligence and machine learning by asset managers in 2021. - IOSCO’s guidance lays down six guidance areas that may be incorporated by regulators to address conduct risks associated with development, testing and deployment of AI/ML by asset managers. These include governance framework, testing, resources, third-party providers disclosures and controls. - Currently, IOSCO’s guidance has not been incorporated in CSSF’s regulatory framework. - CSSF proposes to incorporate IOSCO’s guidance in its ongoing revisions to the regulatory framework for fund managers, while awaiting clarity on EU level developments. - After discussions during the FSAP mission, CSSF indicated that IOSCO’s guidance is being incorporated in the proposed update of the CSSF circular 18/698 regarding the authorization and organization of investment fund managers incorporated under Luxembourg law. - Considering the increase in the use of AI in general since 2022, incorporation of IOSCO’s guidance in CSSF’s regulatory framework would help strengthen the resilience of the IF industry to AI/ML risks. - CSSF is following the evolution of the EU AI Act (to be finalized by end 2023) and AI in general by participating actively in different working groups at the EU level. ### Authorization: scope and requirements - CSSF grants authorization to funds, fund managers and other key service providers domiciled in Luxembourg including depositaries, administrators, and auditors. - Passporting regimes: - The passporting regimes for UCITS and AIFMs permit entities authorized in another EU State to operate in Luxembourg without obtaining a separate authorization from CSSF. - A UCITS or an AIF domiciled in Luxembourg can have a manager authorized in another EU Member State. - A manager authorized by CSSF can manage UCITS/ AIFs domiciled in another EU Member State. - Authorization specifics: - All UCITS Management Companies (ManCos) domiciled in Luxembourg need to be authorized by the CSSF; an AIFM domiciled in Luxembourg may be authorized or registered by the CSSF depending on the AUM. - A UCITS authorization is approved only if the ManCo is authorized. - An AIFM with AUM less than €100m including leveraged assets or €500m unleveraged with no redemption rights for 5 years does not need to be authorized; in such cases the AIFM is registered with the CSSF with some basic reporting requirements. - If the thresholds are exceeded more than temporarily, the registered AIFM must seek authorization as an authorized AIFM. - Key authorization requirements for managers are covered under CSSF’s Circular 18/698; criteria include shareholding, fitness and probity, financial capacity, internal controls, delegation and substance, valuation, etc. - CSSF’s authorization approach for UCITS ManCos and AIFMs is largely the same, with differences due to detailed requirements for AIFMs at the EU level. - Fund authorization: - All UCITS and regulated AIFs need to be authorized by the CSSF. - For regulated AIFs (Part II UCIs, SIFs, and SICARs), there is dual authorization: both the fund and the manager are authorized by the CSSF. - For unregulated/indirectly regulated AIFs (RAIFs and other AIFs not covered under Product Laws), the fund is not authorized and reliance is on indirect supervision through the manager. - RAIF is required to be managed by an authorized AIFM—i.e., the full set of AIFMD requirements apply. - At the authorization stage, key checks by CSSF for funds include review of the prospectus, initiator, manager, key service providers, fitness and probity, sub-fund and share class information, delegation arrangements, among others. - The authorization process does not distinguish in terms of the depth of scrutiny depending on the nature of investors; UCITS and AIFs have the same level of scrutiny. - For retail funds (UCITS and Part II UCIs), if strategies are seen to be very risky (e.g., high leverage), at the authorization stage CSSF may advise the fund to restrict the nature of investors permitted to invest in the fund. - Digitalization of authorization: - Funds are currently authorized through an electronic portal called eDesk which has improved efficiency in the authorization process and risk monitoring during authorization. - CSSF is examining extension of eDesk authorization process to other entities to bring similar efficiencies. - Recommendation: CSSF should consider continuing improvements in the authorization process through extension of eDesk to authorization applications beyond funds to managers as well as other key service providers, as appropriate. - Other authorizations: - CSSF also grants authorization to depositaries, administrators, and auditors of investment funds. - EU level requirements require the depositary of a Luxembourg domiciled fund to be based in Luxembourg. - CSSF revamped and updated its authorization procedure for administrators domiciled in Luxembourg. - CSSF authorizes auditors, a key gatekeeper in the IF industry. ### Supervision: risk-based approach and off-site supervision - Risk-Based Supervision (RBA) framework: - CSSF uses a risk-based approach for compliance checks and monitoring of risks based on information from regulatory reporting (regular and ad hoc), other authorities, legal advisors, auditors, whistleblowers, investor complaints and media. - The RBA is adopted at three levels (three pillars of the supervisory framework): authorization, off-site supervision, and on-site inspections. - Criteria considered include complexity, risk profile, type of investors, level of net assets, quality of internal control, quality of information and the source of information. - Global scoring model: - CSSF has a scoring model referred to as “global RBA IFM,” based on indicators at the fund manager, sub-fund and fund level. - Factors considered for determining this score include net assets, frequency of NAV calculation errors and investment breaches, issues highlighted in management letter issued by the independent auditor, stability of the shareholders of the IF manager, activities performed by the IF manager, AML/KYC risks, etc. - This enables CSSF to concentrate supervision efforts on the riskiest entities. - Thematic RBAs and extensions: - CSSF relies on dedicated thematic RBAs including RBA on funds’ and fund managers’ closing documents and RBA for critical files. - Extension of global scoring at IFM and Fund level is under development; proposals include integrating individual supervisory actions/measures and results of existing thematic RBA tools, extending indicators covering AIFs, expanding existing indicators on UCITS (e.g., liquidity risk), integrating scoring of on-site inspections, among others. - Some improvements have been recently implemented; pending ongoing improvements should be implemented on a priority basis. - Differentiated risk considerations: - Luxembourg has a significant proportion of third-party fund managers (white-label service providers) whose business models result in a different nature of risks vis-à-vis other fund managers where the delegate is usually part of the same group. - Risks, particularly conflicts of interest, differ for such providers due to revenue dependencies and the influence of partners. - CSSF already considers differences during on-site inspections when a targeted review is conducted. - Recommendation: CSSF should enhance its overall supervisory approach incorporating the differentiated nature of risks of third party and intra-group fund managers, as appropriate. - Off-site supervision components: - Performed through review of quarterly and annual financial reporting and annual closing documents filed with CSSF. - Manager’s annual closing documents include audited annual report, management letter (by independent auditor), report of the compliance function, internal audit report, and report of the permanent risk management function assessing adequacy and effectiveness of risk management. - Fund prudential supervision is based on the fund’s annual closing documents and findings raised by the independent auditor of each fund; fund’s annual closing documents include audited annual report of each fund, management letter, fund’s self-assessment questionnaire and fund’s auditor separate report. - Since 2019, an annual review of the risk management process pertaining to a representative sample of IFMs is performed. - Off-site supervision also includes ad-hoc supervision, outlier analysis based on reporting and micro-prudential analysis for certain funds. - CSSF receives notifications on NAV calculation errors and investment breaches which are reviewed and analyzed according to the RBA. - CSSF has defined thresholds for certain reporting to identify statistical outliers; based on these CSSF engages with relevant managers, requests additional information, requires remedial actions where necessary and follows up. - Micro-prudential analysis is carried out for certain UCITS and regulated AIFs depending on particular risks or following specific events. - Problems communicated to CSSF in relation to a current UCITS or regulated AIF are analyzed by dedicated teams, often after cooperation requests by foreign national competent authorities, complaints or whistleblowing. - Supervision of depositaries: - The approach to off-site supervision of depositaries is similar to that applied for IF and their managers. - Periodic reporting by depositaries is analyzed and follow-up supervisory action is implemented as appropriate. - The approach is based on assessment of risks associated with the depositary function including operational risks of processing transactions and risk of non-compliance with fund regulations. - Thematic reviews and ESMA CSAs: - Thematic reviews have been carried out; in the last five years twelve thematic off-site reviews have been done on various topics, many initiated during and post crises (COVID and Russia-Ukraine crisis). - Since the last FSAP, ESMA has stepped up its involvement on supervisory convergence through Common Supervisory Actions (CSAs), directing significant supervisory efforts of CSSF. - Three CSAs have been done so far on liquidity risk management, valuation, and cost and fees of UCITS and a CSA on ESG is currently ongoing. - During thematic reviews, CSSF closely interacts with funds and fund managers including follow-ups; most reviews resulted in recommendations and advice to the industry, reminding the industry of relevant regulatory provisions and advising strict compliance. *Source: 1luxea2024004 - Box 1. Use of Artificial Intelligence/ Machine Learning by Asset Managers* ### 75. CSSF has two key departments primarily charged with on-site inspection ### 75. CSSF has two key departments primarily charged with on-site inspection ### Departments and responsibilities - Two key departments: (i) On-site Inspections (OSI), and (ii) “Contrôles Sur Place” of the Métier OPC (“OPC-CSP”). - OSI: - In charge of coordinating all on-site inspections conducted by the CSSF. - Has dedicated teams to cover topics such as AML/CFT (on transfer agent) and Central Administration/Depositary Bank. - OPC-CSP: - Put in place during the year 2015 to specifically focus on IF related requirements deriving from substance requirements applicable to Luxembourg managers or IF, and provisions of the AIFM Directive or the UCITS Directive. - Charged specifically with the preparation, execution, and follow-up of on-site inspections of management companies, AIFMs and investment vehicles. - OPC-PRUD: - Conducts on-site inspections in relation to IFMs involving the risk management system and NAV errors and breaches of investment restrictions. - Coverage examples: - UCITS/ regulated AIFs considered by CSSF’s management "to be closely monitored," after authorization or after a particular event requiring periodic screening. - UCITS/ regulated AIFs identified as critical or exposed to higher risk according to a risk-based approach. - UCITS/ regulated AIFs exposed during their lifetime to a failure or risk of failure to comply with legal and regulatory provisions. ### Planning and inspection types - OSI undertakes planning and coordination of all CSSF inspections for the forthcoming year using a standard planning tool. - For UCI Department responsibilities, OPC-CSP undertakes planning and coordination of all on-site inspections. - Frequency determined by off-site supervision department’s RBA; scope determined by issues arising from supervision activities, including IF closing documents. - OSI and OPC-CSP aggregate and analyze inputs and plan each inspection; planning is presented to senior management of CSSF for review and approval. - Four types of on-site inspections: - Thematic: cut across the industry, focus on specific topics, objective to establish a benchmark and identify outliers. - Full scope / partial scope: comprehensive inspections initiated since the last FSAP; subjects usually include AML/CFT, Risk Management, Corporate Governance, NAV Errors and Breaches of Investment Restrictions, Money Market Funds, UCI Administration and Depositary function. - Ad hoc: intended to identify a very specific situation/problem, usually identified through off-site prudential supervision (e.g., problems noted by the external auditor, delay in reporting, suspicion of fraud, whistleblowing, etc.). - Activity level: - On average over the last five years, CSSF has conducted around 57 on-site inspections every year. - Areas of focus included governance of managers (covering a variety of conduct obligations), risk management, AML/CFT, depositary and administrative functions. ### Scope of on-site inspections and delegation issues - On-site inspections are carried out at the level of the fund manager, depositaries, and administrators. - If located in Luxembourg, inspections are also carried out at the investment manager and distributor level. - FSAP recommendation: initiate on-site inspections of delegates, especially portfolio managers, where they are located outside Luxembourg. - CSSF has initiated discussions with foreign regulatory authorities on delegate inspections; discussions are currently in progress and were delayed by the Covid crisis. - Given extensive use of delegation (especially portfolio management) by fund managers in Luxembourg, priority initiation of such on-site inspections is important. - Suggested approach: extend the current risk-based approach to inspections of delegates outside Luxembourg. ### Recommendation on delegate inspections - CSSF should continue its discussions with relevant supervisors so as to initiate an on-site inspection framework with a risk-based approach, of the delegates outside Luxembourg, whether jointly with such supervisors or by CSSF itself (with that supervisor’s consent). ### Investigation procedures and outcomes - Potential breaches of legal and regulatory requirements undergo detailed investigation. - Main information sources: various reports submitted by entities. - Case prioritization applied (e.g., retail funds are prioritized). - Investigation process: - Compilation of relevant information from supervisory teams and external public sources. - Sending formal notice to the entity. - CSSF powers in investigations include: - Right to access any document in any form and to receive a copy. - Right to require information from any person (including through summons and questioning). - Instruct an auditor or expert to carry out verification or investigations. - Carry out on-site inspections (including surprise inspections). - Possible investigation conclusions: - Recommendations to close the investigation. - Send an observation letter. - Engage formal enforcement/sanction proceedings. - Other investigations: - Relating to investor complaints, properness assessment, service providers and whistle-blower reports. - Major sources among these: properness assessments and service providers. - Negative information from press, other supervisory authorities, self-denunciation can trigger investigations in properness assessments. - Investigations relating to service providers may relate to provider decisions to terminate relationships with regulated funds. ### Data reporting enhancements and gaps - Data reporting enhanced since last FSAP to support CSSF’s data-driven supervision approach. - Reporting sources: IFs, fund managers and other service providers. - Reporting forms: regular and ad hoc. - Regular reports include: - Annual/ semi-annual, quarterly, and monthly reporting by UCITS and all regulated AIFs. - Semi-annual UCITS Risk Reporting. - MMFR Reporting. - Extensive data reporting by managers under the AIFMD. - Ad-hoc reporting includes: - VaR and Leverage Report, net redemptions reporting (early warning), large redemptions reporting, etc. - Both regular and ad hoc reporting have been stepped up since the last FSAP; ad hoc reporting especially during crises. - Reporting is also required from depositaries, both banks and PDAOFIs. - Crisis monitoring example: - During COVID19 and Ukraine/Russia crises, CSSF implemented specific crisis monitoring of the largest fund managers, requiring notification of significant developments and issues as well as related decisions and measures taken by fund managers—e.g., daily net redemptions exceeding 5 percent of the NAV, net redemptions over a calendar week exceeding 15 percent of the NAV and/or application of gates/deferred redemptions. This reporting is still in place. - Data sharing and access: - CSSF receives security-by-security information from BCL, enhancing supervision capability. - CSSF discussions with BCL and ECB ongoing on access to the centralized securities data base (CSDB); securities-by-securities data exchange between BCL and CSSF is working smoothly. - For licensing reasons, CSSF has not yet been granted full access to all descriptive data of portfolio holdings (e.g., credit quality of the security, name of issuer); discussions are ongoing to obtain such access. - CSSF has entered into an agreement to obtain rating data from one of the credit rating agencies to address credit quality data gap. - Proposed revisions to the UCITS Reporting framework under ongoing reforms to the UCITS Directive expected to enhance data availability for CSSF. - While continuing discussions on access to CDSB, CSSF should maintain efforts to plug data gaps. - Self-assessment reporting (since 2021): - CSSF requires funds and fund managers to submit a self-assessment questionnaire, subjected to a selected review by the auditor. - These questionnaires replaced earlier Long Form reports required for UCITS and Part II funds (now extended to managers, other regulated funds). - Topics include asset valuation, compliance of investments, costs/expenses and take into account characteristics and risks of IF managers and IF types. - Purpose: require a self-assessment by fund managers and IFs of their legal and regulatory compliance. - Auditor role: perform certain checks and procedures on the responses and additional specific checks on legal and regulatory compliance. - Scope and results of these reviews are included in auditor separate reports at fund manager and IF level. - Documents collectively referred to by CSSF as “closing documents”: - Annual report (including audit opinion), Management Letter (by auditor), Self-Assessment Questionnaire, and Separate report (by auditor). - Remaining data gaps: - Credit lines with credit institutions are often an important liquidity management tool for funds but lack clear and granular reporting. - UCITS report some information on credit lines in the “other tools” section of UCITS Risk Reporting on LMTs, but a lack of clear and granular reporting remains. - AIFM reporting under the AIFMD includes some data on credit lines (under Item 210), but lacks detailed breakdown and granularity to ascertain the extent credit lines can act as liquidity management tools. - Detailed and granular information needed: whether credit lines are shared with other funds/within the group, whether they are committed, and to what extent they are drawn down. - Such information provides clearer picture of how IFs would cope with unusually high redemptions and/or unexpected illiquidity in portfolio assets. ### Recommendation on reporting - CSSF should enhance its reporting framework to include clear and granular details on credit lines put in place by IFs, including the extent of sharing, commitment, and drawdown. *Source: 1luxea2024004 - 75. CSSF has two key departments primarily charged with on-site inspection* ### Box 2. Money Market Funds ### Box 2. Money Market Funds ### Role and types of MMFs - Money Market Funds (MMFs) invest primarily in short term instruments and aim to maintain stable, or near stable, share prices. - MMFs are a key source of short-term funding for a variety of issuers and are used as cash management vehicles by investors. - Under the EU MMF Regulation (MMFR) there are three types of MMFs: Variable NAV (VNAV), Public Debt Constant NAV (CNAV) and Low Volatility NAV (LVNAV) MMFs—each differing by the nature of price offered to investors. - Key distinction preserved from the source: - VNAV offers a variable price derived from the underlying market value of the assets. - CNAV offers a constant price, irrespective of the underlying market value of the assets. - LVNAV offers a constant price till a certain threshold, beyond which it turns into VNAV. - IOSCO has specific recommendations on MMFs that carry a stable NAV (CNAV and LVNAVs) due to unique features that make them prone to potential systemic risks. ### Luxembourg MMF market: scale and composition - Luxembourg is home to the second largest MMF industry in Europe, after Ireland. - Luxembourg accounts for 29 percent of MMF assets in Europe, behind Ireland at 42 percent. - Luxembourg MMF assets are spread out across types and currencies, especially in comparison to Ireland and France. - CNAV and LVNAV are dominant in Luxembourg, constituting "around three-fourth" of the industry compared to VNAVs. - Luxembourg MMFs have seen significant inflows, particularly from 2019 onwards. ### Regulatory developments, stress episodes, and evaluations - The implementation of the EU MMF Regulation (MMFR) in 2019 introduced detailed rules on liquidity, diversification, and stress testing. - March 2020 turmoil highlighted concerns about MMFR’s ability to tackle systemic risks: non-public debt MMFs experienced significant outflows resulting from liquidity needs, flight-to-safety and other factors. - The Financial Stability Board (FSB) published policy proposals to enhance MMF resilience in 2021 reflecting lessons learned from the COVID crisis. - A review of the MMFR was proposed in 2022 (including proposed incorporation of some FSB proposals—e.g., removal of amortized cost for LVNAVs, decoupling activation of LMTs from regulatory thresholds), but it was debated and dropped by the European Commission in 2023. - ESMA in June 2023 published its analysis from stress tests of MMFs across the EU and highlighted potential vulnerabilities of different types of MMFs in different stress scenarios. ### Supervision, monitoring, and policy recommendations for Luxembourg - Continued close supervision of the MMF industry remains key. - CSSF requires detailed reporting from MMFs and integrates MMF risks into its supervision framework. - With the proposed revisions to the MMFR dropped, CSSF should: - continue its supervision efforts and closely monitor the MMF industry for any financial stability concerns that may arise, especially in light of the stress testing results; - continue to monitor regulatory developments at the EU level on this aspect. - ESMA stress-testing results underscore the need for ongoing vigilance across MMF types and scenarios. *Source: Box 2. Money Market Funds.* ### 108. CSSF has a robust and clearly laid down crisis management procedure. The procedure ### CSSF has a robust and clearly laid down crisis management procedure. The procedure ### Crisis management framework and institutional cooperation - Crisis management procedure includes: - preliminary risk assessment - formulation of a crisis management strategy - ongoing crisis monitoring - activating appropriate communication channels - based on analyses, prudential actions, as appropriate - Procedure has been used recently in three cases—COVID-19, Ukraine War and United Kingdom LDI crisis. - CSSF and BCL contribute to systemic risks analysis and monitoring at the EU and international level: - European cooperation primarily with ESMA and the ESRB. - International participation in expert/working groups related to nonbanks (for instance, the FSB Non-Bank Monitoring Experts Group (NMEG)) and in the FSB data collection exercise. - Engagement in various IOSCO and FSB workstreams on financial stability topics. - Bilateral cooperation with other countries’ authorities given the cross-border nature of Luxembourg’s IF industry. ### Supervisory responses to major global events (findings and actions) - General: - CSSF has taken strong supervisory actions during and after each event, including stepping up reporting obligations, enhanced interactions with the industry and other authorities (domestic and globally), close monitoring of developments and in some cases, issuance of FAQs and regulatory expectations. - Brexit: - CSSF received 40 Brexit application files. - More than half of these were linked to managers already present in Luxembourg expanding activities via a MiFID top-up license or Super Manco license. - CSSF asserts it did not treat Brexit files differently from non-Brexit files in reporting and supervision. - ESMA organized a Supervisory Coordination Network (SCN) from 2017–2020 to avoid regulatory arbitrage; CSSF presented fund manager files linked to Brexit monthly in that forum. - COVID-19 (Feb–Mar 2020): - Material liquidity stress and significantly higher transaction costs and bid/ask spreads in segments such as corporate bonds, high-yield bonds, emerging market bonds and money market instruments. - Significant negative valuation effects and significant outflows, particularly in March 2020. - Money Market Funds (US$ LVNAV MMFs) saw net outflows; net inflows resumed after large-scale public sector support. - MMFs benefited indirectly from the United States Federal Reserve’s Money Market Mutual Fund Liquidity Facility (MMLF). - Luxembourg domiciled funds deployed LMTs, mainly swing pricing and to some extent, gates, and suspensions. - Supervisory actions by BCL and CSSF included increased data reporting and sharing, engagement with industry and authorities, daily data exchange under CdRS to monitor MMF redemptions, and special crisis reporting covering around 90 percent of total net assets of the industry. - Specific daily and weekly monitoring for MMFs introduced; real estate investment fund survey conducted in June/July 2020; FAQs on swing pricing and clarifications on VaR breaches issued. - Russia–Ukraine war (exposures and actions): - Luxembourg IFs had a direct exposure of ~€18 bn to Russian assets. - In December 2021, 61 investment funds held more than 10 percent of their assets in RU securities, primarily equity (64 percent) in oil and gas corporates and a large Russian bank subject to sanctions; bond exposures were mainly to Russian sovereign bonds. - Impact mainly through liquidity and valuation effects for affected funds; some funds suspended redemptions, others switched to fair valuations without suspending redemptions. - Some suspensions lasted beyond 2022; others were liquidated in 2022. - A limited number of IFs created side-pockets to segregate the assets concerned. - From February 2022, CSSF required around 130 IFMs to report significant events/issues, including significant valuation challenges and large redemptions; a dedicated valuation questionnaire with instrument-specific price data collection started and is in final stages of analysis. - CSSF issued FAQs on side pockets (since UCITS typically are not permitted to use side pockets as an LMT). - United Kingdom LDI crisis: - Luxembourg hosted 104 LDI funds with a total NAV of €30.8bn (£26.6bn) at the end of August 2022. - Of these, 3 IFMs with a total of 86 LDI sub-funds represented a total NAV of approximately €20bn and were exposed to the UK gilt market. - Before the turmoil, Luxembourg hosted a significant population of LDI funds (second largest in the EU behind Ireland). - Leveraged LDI funds faced significant margin/collateral calls as gilt yields rose suddenly; liquidity buffers could not withstand the shock and recapitalization processes were too slow. - One fund manager temporarily suspended some LDI funds; borrowing was used in some instances. - CSSF actions included increased reporting, issuance of regulatory expectations of yield buffers, interaction with ESMA, United Kingdom and Irish authorities, and with affected managers. - On November 30, 2022, CSSF issued a public letter to LDI fund managers indicating that, going forward, CSSF (and the Central Bank of Ireland) expected GBP LDI funds to maintain an average “yield buffer” of 300–400 bps. - CSSF and the Central Bank of Ireland published on November 23, 2023, a consultation on GBP LDI funds regarding introducing macroprudential measures by imposing a minimum yield buffer. - Regular coordination meetings between EU authorities and United Kingdom authorities (BoE, FCA, United Kingdom Pensions Regulator (TPR)) took place; a decision was made to set up a common reporting for LDI funds applicable in principle as from end of June 2023 (covering at least the five largest actors) with a relatively high reporting frequency (probably monthly). - 2023 banking crisis: - CSSF monitored and collected data on funds affected by/exposed to stressed banks. - Exposures of Luxembourg domiciled funds to such banks were negligible and redemption pressures were minimal. - Moderate net outflows from Luxembourg domiciled LVNAV MMFs (around 4 percent NAV). - Broadly similar (in nominal value) cumulated inflows were seen on public debt CNAV (U.S. dollar). - CSSF held discussions with ESMA and other European securities regulators during the stress period. ### Key supervisory tools, requirements and regulations (findings) - Depositary and custody regime (Appendix I): - Depositary must hold in custody all financial instruments that may be registered in a financial instruments account opened in the depositary’s books and all financial instruments that can be physically delivered to the depositary. - Depositary must ensure financial instruments are registered in segregated accounts per Article 16 of Directive 2006/73/EC so they can be clearly identified as belonging to the relevant UCITS/AIF at all times. - For other assets, depositary must verify ownership of the UCITS/AIF and ensure updated records. - Assets held in custody by the depositary are not permitted to be reused by the depositary, or by the delegate, for their own account except in certain limited situations. - Segregation rules are broadly similar for UCITS and AIFs; aim to protect fund assets throughout the custody chain and in case of depositary insolvency. - Delegation of custody is permitted under the UCITS Directive and AIFMD subject to conditions: depositary must exercise due skill, care and diligence in selection and appointment of third parties and carry out periodic reviews and ongoing monitoring; delegate must segregate depositary clients’ assets and be subject to prudential regulation including minimum capital requirements, supervision and external periodic audit; sub-delegation permitted subject to same requirements. - Liability: UCITS and AIFMD provide depositary is liable to UCITS/AIF and unitholders for any loss suffered as a result of “the depositary's negligent or intentional failure to properly fulfil its obligations,” which is not affected by delegation. AIFMD allows transfer of liability to a third party via a written contract establishing objective reason for transfer (unlike UCITS Directive). - Liquidity Management Tools (Appendix II) — categories and examples: - Anti-Dilution/Price-Based Tools: Swing pricing; Redemption fees; Anti-dilution levy; Valuation at bid or ask price; Dual pricing. - Quantity Based Tools: Redemption gates; Redemption in kind; Side pockets (for AIFs); Leverage limits; Maturity restrictions; Short term borrowing; Timing restrictions between subscription and redemption; Liquidity buffers. - Other Tools (Including Relating to Portfolio Composition): Limits on illiquid asset investment; Limits on asset concentration. - Notes: - Some of these tools may arise from regulatory restrictions (e.g., restrictions on investment in certain assets considered illiquid for UCITS funds); most listed are discretionary for fund managers. - Dual pricing and bid/ask valuations are theoretically possible but not commonly used in Luxembourg; swing pricing is more prevalent. - CSSF FAQ on illiquid assets resulting from the Russia-Ukraine crisis issued in March 2022 allows exceptional use of side-pockets by UCITS with higher exposure to such illiquid assets. ### Policy signals and supervisory expectations - Crisis reporting and enhanced data collection have been central to CSSF’s approach: e.g., special crisis reporting covering around 90 percent of total net assets during COVID; reporting requirement for around 130 IFMs from February 2022 for Russia-related valuation and redemption issues. - Regulatory guidance and FAQs used to clarify permissible LMTs in crisis contexts (example: swing pricing, side-pockets for exceptional cases). - Coordinated international and EU engagement stressed as important given cross-border industry; CSSF engaged with ESMA, ESRB, BoE, FCA, Central Bank of Ireland, and other peers during various crises. - For GBP LDI funds, supervisory expectation for an average “yield buffer” of 300–400 bps and consideration of macroprudential measures (consultation published on November 23, 2023). *Source: IMF staff report section and Appendices (excerpts).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1luxea2024004.pdf_