Luxembourg’s financial regulator, the Financial Sector Supervisory Authority (CSSF) has published on August 13 a regulation setting out the provisions implementing Article 42b of the revised Specialised Investment Fund legislation regarding risk management and conflict of interest requirements.
CSSF Regulation N° 12-01 specifically concerns paragraph 1 of the article, regarding the criteria for assessing the suitability of risk management systems used by SIFs, and paragraph 2, regarding structures and organisational requirements designed to minimise the risk of conflicts of interest arising.
SIFs are required by the law to establish and keep operational a risk management function that is hierarchically and functionally independent of their operational units, although the CSSF may permit an exemption from the independence obligation where appropriate and proportionate to the fund’s structure and to the nature, scale and complexity of its activities.
The risk management function must exercise a suitable and documented risk management policy allowing the detection, measurement, management and monitoring of market, liquidity and counterparty risks, as well as any other types of risk, including operational, that may have a significant impact on the SIF’s activities.
A SIF must demonstrate that appropriate measures have been put in place to protect against conflicts of interest, in order to ensure the independence of risk management activities, and the risk management function must enjoy the authority and access to all the information necessary to fulfil its role.
All or part of the risk management function may be outsourced to a third party as long as the latter has the necessary expertise and capacity to carry it out reliably, professionally and effectively in line with the legal and regulatory requirements. Outsourcing never relieves the managers of the SIF of responsibility for ensuring the suitability and effectiveness of the risk management system.
Once adopted, the risk management system must be subject to regular, documented review. Within their authorisation file, SIFs must provide the CSSF with a description of the risk management system, and inform the regulator subsequently of any significant changes.
In order to detect any conflicts of interest that may arise in the course of the fund’s activities that could damage its interest, a SIF must at a minimum consider the possibility of various situations arising as a result of its portfolio management or other activities.
These comprise the position of an individual in a position to make a financial gain or avoid a loss at the fund’s expense; having an interest in the provision of a service or activity provided to a fund or another client, or a transaction on behalf of the fund or a client, that does not coincide with the fund’s interest; having an incentive, financial or otherwise, to favour one or more clients at the fund’s expense; carrying out the same activities for both a SIF and other non-fund clients; or receiving a benefit other than from the SIF relating to portfolio management activities on the SIF’s behalf, whether in the form of money, goods or services, other than normal commission or expenses.
Where SIFs detect such conflicts of interest, they must consider the fund’s own interests, including those derived from being part of a group, the provision of services or the carrying out of its activities; the interest of clients; and the fund’s obligations toward its shareholders.
SIFs must implement and maintain an effective policy regarding conflicts of interest, set out in written form and appropriate to the fund’s size and organisation as well as the nature, scale and complexity of its activities. They must also put in place a policy preventing any affected person from carrying out personal transactions that may give rise to a conflict of interest, and a policy to prevent or manage conflicts arising from voting rights attached to the fund’s financial assets. If the SIF is part of a group, the policy should consider any potential conflicts arising from the structure and activities of other group members.
The policy must in particular identify any situations giving rise to actual or potential conflicts relating to portfolio management activities that carry a significant risk of damaging the fund’s activities, and set out procedures and measures to manage any such conflicts. Funds must confirm the implementation of a conflict of interest policy to the CSSF as part of the authorisation process.
These procedures and measures should ensure that individuals involved in activities that may involve conflicts of interest possess a degree of independence appropriate to the size and activities of the SIF and any group to which it belongs, and to the size of the risk of damage to the fund’s interests.
They should include:
• Procedures to prevent or monitor exchanges of information between individuals involved in portfolio management where a conflict could arise that damages the fund’s interest.
• Separate oversight of individuals involved in portfolio management or provision of other services for clients or investors where the interests of the clients or investors may conflict with each other or with those of the fund.
• Prohibition of any link between the remuneration of individuals carrying out different activities, or with revenues arising from different activities, where a conflict may arise between them.
• Measures to prevent or limit any inappropriate influence on the way individuals carry out portfolio management.
• Measures to prevent or monitor the simultaneous or subsequent involvement of an individual involved in various activities outside portfolio management, where this may impair management of conflicts.
If the implementation of these measures and procedures does not result in the degree of independence required, SIFs should take additional or different steps to achieve their aim.
SIFS should compile and keen updated a register of the types of portfolio management activity carried out by the fund or on its behalf where an actual or potential conflict of interest is particularly likely to damage the fund’s interests.
Where the SIF’s organisational and administrative measures do not provide sufficient guarantee of avoiding conflicts to the detriment of the fund or its shareholders, the managers should be aware of this in order to take any measures necessary to ensure that the fund acts in all circumstances in its own and the shareholders’ best interests. SIFs should inform their investors of any cases of this kind that arise and the reasons for the measures they have taken.
The regulation comes into force on the first day of the month following its publication in the Mémorial, Luxembourg’s official journal. Existing SIFs have until December 31, 2012 to comply with its provisions.
Investment Management
10 September 2012