Investment Funds - UCITS risk management process - clarification on the information to be provided to the CSSF

Two particularly relevant pieces of legislation in the context of eligible assets for investments by UCITS have recently been implemented in Luxembourg. The first one is the Grand-Ducal Regulation dated 8 February 2008, which amends certain definitions specified in the 2002 Law, and which replicates closely the EC Directive 2007/16/EC.
The other piece of legislation is the groundbreaking CSSF Circular 08/339 (released on 19 February 2008) which points out, inter alia, that the provisions of the above Grand-Ducal Regulation must be read in conjunction with the CESR guidelines.
Investors should first note that UCITS already set up at the time of the implementation of the guidelines will benefit from an extension until 23 July 2008 at the latest to comply with the guidelines.
However, more fundamentally, what should be raised is the somewhat more flexible attitude adopted by the CSSF, particularly in circumstances where there is further need of interpretation of the provisions of the Grand-Ducal Regulation and the CESR guidelines. The impact of this Circular should however not be overestimated since the CSSF already fully applied the provisions of the Directive and the related CESR advices, and hence no significant changes are to be expected in practice. However, this evolution of the CSSF’s practice is especially remarkable throughout the appreciation of the circumstances in which a security embeds a derivative or permitted investment within the 10% trash ratio (e.g possibility to include regulated open-ended hedge funds, funds of hedge funds, real estate funds and commodity funds). This more flexible attitude of the CSSF is also to be noted in its administrative practice.

by leohil

Investment Funds - Update on the eligible assets for investments for UCITS

Two particularly relevant pieces of legislation in the context of eligible assets for investments by UCITS have recently been implemented in Luxembourg. The first one is the Grand-Ducal Regulation dated 8 February 2008, which amends certain definitions specified in the 2002 Law, and which replicates closely the EC Directive 2007/16/EC.
The other piece of legislation is the groundbreaking CSSF Circular 08/339 (released on 19 February 2008) which points out, inter alia, that the provisions of the above Grand-Ducal Regulation must be read in conjunction with the CESR guidelines.
Investors should first note that UCITS already set up at the time of the implementation of the guidelines will benefit from an extension until 23 July 2008 at the latest to comply with the guidelines.
However, more fundamentally, what should be raised is the somewhat more flexible attitude adopted by the CSSF, particularly in circumstances where there is further need of interpretation of the provisions of the Grand-Ducal Regulation and the CESR guidelines. The impact of this Circular should however not be overestimated since the CSSF already fully applied the provisions of the Directive and the related CESR advices, and hence no significant changes are to be expected in practice. However, this evolution of the CSSF’s practice is especially remarkable throughout the appreciation of the circumstances in which a security embeds a derivative or permitted investment within the 10% trash ratio (e.g possibility to include regulated open-ended hedge funds, funds of hedge funds, real estate funds and commodity funds). This more flexible attitude of the CSSF is also to be noted in its administrative practice.

by leohil

Investment Funds - securities lending in relation to UCITS

A new regime applicable to securities lending operations performed by UCITS – and, in principle, by other UCIs subject to the 2002 Law – was introduced by CSSF Circular 08/356 released on 4 June 2008. The main point of this new regime is, by reforming the previous one (referred to in the Commission Directive 2007/16/EC, and the corresponding CESR guidelines) set out in 1991 (by CSSF Circular 91/75) to take into account the fast growing number of securities lending transactions Luxembourg UCITS and UCIs have recently been engaged in.
This Circular lays down the techniques and instruments which may be used by UCITS, comprising in particular securities lending transactions. The criteria to be fulfilled by the techniques and instruments subject to the Circular are threefold, namely that:

  • They are economically appropriate (= realised in a cost-effective way);
  • They are entered into for one or more of the following specific aims
    • reduction of risk
    • reduction of cost
    • generation of additional capital or income for the UCITS with a level of risk which is consistent with its risk profile and the risk diversification rules applicable to it; and
  • The risks they entail are adequately captured by the risk management process of the UCITS.

The Circular provides broad guidelines on, inter alia, how the fund may lend its securities, which assets are eligible as collateral, and on the content of the prospectus of the fund addressed to investors, which overall reveals a more flexible administrative attitude adopted by the CSSF.
Crucial points to be noted may be summarized as follows:

  • A Fund may lend its securities
    • Directly;
    • Via a standardized lending system organized by a recognized securities lending institution; or
    • Via a lending system organized by a financial institution subject to prudential supervision rules considered by the CSSF as equivalent to those laid down by Community law and specialized in that type of transactions.
  • The assets eligible as collateral include:
    • Liquid assets (cash and short-term banking deposits, money market instruments, and letters of credit or guarantees on first demand issued by a first class credit institution non affiliated to the counterparty);
    • Bonds issued or guaranteed by an OECD Member State or a first class issuer offering adequate liquidity; and
    • Shares or units issued by daily valued money market UCIs (assigned a rating of
      AAA or its equivalent) or a UCITS investing in bond / shares referred to in the Circular.
  • The prospectus of the fund must indicate:
    • That the Fund intends to enter in securities lending operations;
    • The purpose of such securities lending transactions;
    • The conditions and limits of such securities lending transactions;
    • The conditions and limits of collateral cash re-investment if the Fund intends to do so; and
    • As the case may be, a description of the risks inherent to such securities lending operations.

by leohil

Amendment to the SICAR regime – possibility to have multiple compartments

On 21 February 2008, the Luxembourg government has introduced a draft law aimed to make more attractive the SICAR vehicle to private equity and venture capital investors.
Brief overview of the main changes proposed in the draft law:

  • introduction of possibility to create multiple compartments (as is already the case for the Luxembourg specialized investment fund (SIF) vehicle;
  • share premiums will be taken into account for the computation of the minimum capital (share capital + share premium must be at least 1,000,000 Euro)
  • no requirement to publish NAV of its assets;
  • obligation to publish annual report within 6 months following the end of the accounting year;
  • lighter requirements imposed upon custodian (the SICAR regime will be aligned on the SIF regime as to that). Consequently, the annual running costs of the SICAR will be reduced;
  • the assets of the SICAR will have to be valued at fair market value;

Please contact Olivier Sciales or Rémi Chevalier should you have any further questions.

by leohil

130/30 funds in Luxembourg

Alfi (Luxembourg Association of Investment Funds) has announced that the fund industry has been facing a strong demand for so called 130/30 funds which allocate 100% of their NAV to long positions and short sell securities to the value of 30% of their NAV. The proceeds from the short sale are usually used to acquire additional long positions. Alfi’s Legal and Regulatory Committee is currently analyzing the opportunity for the development of such products in Luxembourg. The results of the analysis will be discussed with the CSSF at a second stage.
We will keep you updated on the forthcoming changes.

by leohil

CSSF circular - financial information to be provided by specialized investment funds

The CSSF has issued circular 07/310 of 3 August 2007 which specifies the drawing-up and communication of financial information that specialized investment funds are requested to submit to the CSSF. This information which be drawn up on a monthly and yearly basis respectively, will be used by the CSSF for statistical purposes and for the purposes of supervising the specialized investment funds concerned. The financial information required under circular CSSF 07/310 concerns the same data as that required from undertakings for collective investment under circular IML 97/136.

by leohil

CSSF Risk spreading guidelines for SIFs

On 3 August 2007, the CSSF (Luxembourg regulator) issued a circular letter 07/309 (the “Circular”) containing guidelines on the principle of risk spreading as laid out in article 1 of the Law of 13th February 2007 on specialized investment funds (the “SIF Law”).
Article 1 of the SIF law provides that:
“For the purpose of this Law, specialized investment funds shall be any undertakings for collective investment situated in Luxembourg: – the exclusive object of which is the collective investment of their funds in assets in order to spread the investment  and to ensure for the investors the benefit of the results of the management of their assets….”.
In general the CSSF has upheld a flexible interpretation to the principle of risk spreading with some minor restrictions. The CSSF leaves it up to the investors of the fund to evaluate the principle of risk spreading by gathering themselves all the information they deem necessary. As a general matter, the CSSF considers that the principle of risk spreading is fulfilled if the investment policy of the fund is in accordance with the following guidelines:

  • An SIF can in principle not invest more than 30% of its assets in securities of the same type issued by the same issuer. These restrictions are not applicable for:
    • Investments in securities issued or guaranteed by a member state of the OECD or by its public collectivities or by a supranational organization with a global or regional character;
    • Investments in target UCIs whose risk spreading criteria are at least equivalent with those required for the SIF.
  • Uncovered sales can in principle not have as consequence that the SIF holds a covered position on securities of the same type issued by the same issuer which represents more than 30% of its assets;
  • When derivative instruments are used, the SIF has to ensure an equivalent risk spreading policy by an appropriate diversification policy of its underlying assets. In over the counter operations, the risk of consideration has to be limited in function of the quality and qualification of the consideration.

These guidelines apply in principle to each SIF. However, the CSSF can provide for derogations based on an appropriate justification.

by leohil

Luxembourg parliament adopted a law replacing the 1991 law on UCIs

On 13th February 2007, the Luxembourg parliament adopted a law replacing the 1991 law on UCIs (undertakings of collective investment) dedicated to institutional investors.
The law provides a more flexible framework for specialized investment funds. We set out hereunder the most important changes:

  • no need to be set up by an institutional promoter;
  • the minimum share capital of 1,25 million Euro must only be reached within a period of 12 months following the approval by the CSSF (and not 6 months as prior to the law);
  • enlargement of the scope of investors: not only institutional investors but all sophisticated investors may invest in SIFs. A sophisticated investor includes institutional investor, professional investor and also any private individual who(a) confirms formally that he adheres to the status of sophisticated investor; AND
    (b) (i) invests a minimum of 125,000 Euro or (ii) has obtained a certificate of a credit institution or another professional of the financial sector certifying his experience and his knowledge in appraising the contemplated investments;
  • SIFs can start their activity before the CSSF has granted approval, provided the request for authorization is filed with the CSSF within one month after the SIFs creation;
  • Assets should be valued at fair value but it can be determined in the management regulations or the by-laws of the SIF;
  • No detailed investment restrictions (risk spreading rules);
  • No need to issue a prospectus;
  • No requirement to publish a semi-annual report.

The new law provides a more flexible framework for the establishment of Luxembourg funds and more in particular allows private individuals to invest in funds.

by leohil

CSSF – guidelines on the concept of risk capital for SICARs

On 5 April 2006, the CSSF issued a circular letter (06/41) (the “Circular”) containing guidelines and clarifications on the criteria applied by the CSSF when assessing whether a project is eligible under the SICAR law or not.
We refer to the section client memorandums on our website for an outline of the SICAR law, which you can receive upon request.

Concept of risk capital

The purpose of the SICAR law is to favour the collection, in a vehicle specialized in risk capital, of funds contributed by well-informed investors accepting with full awareness and in expectation of a better return the increased risks most often associated with risk capital, i.e. lower liquidity, higher price volatility and lower credit quality.
Risk capital is defined in the SICAR law in a broad manner as to include any direct or indirect contribution of assets to entities in view of their launch, their development or their listing on a stock exchange. The Circular reminds that SICAR application files submitted for CSSF approval require the simultaneous combination of two elements i.e. (i) a high risk associated with the investment in the target company and (ii) the intention to develop the target company, which is broadly construed as the “creation of value” at the level of the target companies.

In general

The creation of value may take different forms:

  • The type of financingFinancing may be through bond issuance, bridge financing, share capital, mezzanine loans, convertible loans, etc.
  • Different investment typesIt may take the form of buy-offs, LBO’s, MBO’s, and management buy-ins, etc.
  • No restrictions as to the exit of investorsThe exit of the investors in the target company can be structured in the most efficient way from a legal and tax perspective (i.e. via a trade sale of assets or via an initial public offering).
  • Risk repartitionThe SICAR law does not impose any risk repartition with respect to the selected investments and it is thus possible that certain SICARs limit their investments to one or several companies active for example in a niche market or in extremely specialized sectors.
  • Holding periodThe CSSF stressed that the contemplated holding period of an investment is an important criterion in determining whether it is eligible to be considered risk capital. Therefore, the declared intention of the SICAR must be in general to acquire financial assets with a view of a resale at a profit.

<!–
–          the type of financing
Financing may be through bond issuance, bridge financing, share capital, mezzanine loans, convertible loans, etc…
–          different investment types
It may take the form of buy-offs, LBO’s, MBO’s, and management buy-ins, etc.
–          No restrictions as to the exit of investors
The exit of the investors in the target company can be structured in the most efficient way from a legal and tax perspective (i.e. via a trade sale of assets or via an initial public offering)
–          Risk repartition
The SICAR law does not impose any risk repartition with respect to the selected investments and it is thus possible that certain SICARs limit their investments to one or several companies active for example in a niche market or in extremely specialized sectors.
–          Holding period
The CSSF stressed that the contemplated holding period of an investment is an important criterion in determining whether it is eligible to be considered risk capital. Therefore, the declared intention of the SICAR must be in general to acquire financial assets with a view of a resale at a profit.

Special case for real estate investments

Whereas the SICAR law does not allow SICARs to directly hold real estate properties, the indirect investments via entities which hold real estate properties is permitted. The Circular gives criteria of eligibility of investments in private equity real estate under the SICAR law.
The CSSF has confirmed that private equity real estate investments must be made for the purpose of creating value, which can be understood as a change to the existing conditions such as the enhancing of the valuation of the real estate by renegotiation of contracts, renewal of tenants and refurbishment of the properties. Furthermore it is necessary to demonstrate that the relevant real estate represents a specific risk, beyond the normal real estate risk attached to such real estate in a given market.  Such specific risk can lay for example in the fact that it is difficult to find tenants or that the real estate is located in an unfavourable zone.
The CSSF has set out a series of criteria which will be taken into account when assessing whether a private equity real estate investment is eligible to fall within the scope of the SICAR law.

  • The potential for significant profit due to the specific risks attached to the property;
  • High risk/ expected return ratio;
  • Identity of the management, the nature of their remuneration and procedure for selecting real estate property;
  • Financial participation of the managers;
  • Active development of property, limited holding period ;
  • Nature of financing: significant leverage, mezzanine type of financing.

Indirect investments

The Circular clarifies the types of companies that can be used in a structure of indirect investment in risk capital. The indirect investment via an UCI (undertaking for collective investment) or another private equity vehicle is acceptable provided the investments policy of the UCI restricts them to investing in assets that are eligible under the SICAR law. However, the investments into hedge funds are not eligible as hedge funds do not pursue the creation of value for its own investments.

Political risk

The geographical localization of investments in countries where there is a political risk can be taken into account when assessing whether a given investment constitutes a given risk. However, it is possible that it may be necessary to demonstrate the existence of additional risk factors so that creation value at the level of the target company can be proven.

Mezzanine loan

Mezzanine financing is an eligible form of financing insofar as the financing is made to a non-listed company or to a listed company if the financing is given in view of a specific development project.

Investment in listed securities

A SICAR may invest in listed securities when associated to a specific development project or if aimed at a delisting.

Conclusion

The CSSF has provided some guidelines on the concept of risk capital without setting hard rules on what does or does not qualify as a SICAR. At the end, each investment will be reviewed on a case-by-case basis.

by leohil