The CSSF has published Regulation 20-09 of December 14, 2020, amending a previous regulation of June 29 on the equivalence of certain third countries regarding supervision and authorisation rules for the provision of investment services or performance of investment activities and ancillary services by third-country firms. The regulation confirms that in the absence of an equivalence decision by the European Commission, from January 1, Luxembourg will include the UK in the list of jurisdictions deemed equivalent for the application of the national third-country regime. The CSSF may withdraw equivalence if changes to the UK regulatory framework mean the conditions underpinning the decision are no longer met.

The CSSF has set out in a press release of December 7 the implications for the fund industry of the end of the UK’s 11-month transition period following its withdrawal from the EU on January 31.

Up to now EU law and regulations have continued to apply in the UK and British-domiciled  entities have been able to provide services in Luxembourg under EU single market passporting rights, but these will expire at the end of the year (December 31, 2020) .

The CSSF notes that this change will affect all UK managers on a cross-border basis of  UCITS and alternative investment funds domiciled in Luxembourg, regarding passporting rights for cross-border marketing of UCITS and AIFs in Luxembourg and throughout the European Economic Area. The loss of passporting rights will also apply to entities established in Gibraltar.

Loss of passporting for cross-border management of Luxembourg funds

All Luxembourg funds currently managed by a UK manager will need to appoint an EU-domiciled manager in order to maintain EU passporting rights. Existing regulatory notifications of cross-border management of EU funds from the UK under the UCITS and AIFMD regimes will expire at midnight on December 31.

Successor notifications must be carried out according to the applicable laws in the home member state of the newly appointed EU manager. The CSSF must be informed of a change by a Luxembourg-domiciled fund to a manager in the grand duchy or in another EU jurisdiction.

Under limited circumstances Luxembourg alternative investment funds (AIFs) under supervision of the CSSF and whose direct or indirect investors are defined as professional investors may continue to be managed by existing UK managers, although they will no longer benefit from the manager’s passporting rights. This must be notified to the CSSF at the latest by December 31; investor approval is required unless the constitutive or information documents already provide for measures to be taken in the event of Brexit.

Luxembourg investment fund managers seeking to continue currently managing UK funds or operating in the UK through a branch must apply for the UK’s Temporary Permissions Regime and inform the CSSF that they have done so. Luxembourg managers of UK UCITS must be authorised by the CSSF to continue to do so after December 31 because the funds will no longer be covered by the UCITS regime and will henceforth be treated as AIFs in Luxembourg and the EU, as long as they meet the AIFMD criteria.

End of passporting for cross-border distribution of funds in Luxembourg

UK fund managers losing passporting rights for cross-border distribution of funds into Luxembourg must issue a notification to withdraw from cross-border distribution under the current regime applicable and submit a new notification or request for authorisation, depending on the new fund management arrangements, such as a cross-border notification for distribution into Luxembourg through the home regulator of an EU manager replacing a UK entity.

Loss of passporting rights also applies to European Venture capital (EuVECA) funds , European social entrepreneurship (EuSEF) funds and European Long-Term Investment Funds (ELTIFs) managed in the UK and marketed in Luxembourg.

In cases of so-called de-notification, the CSSF must be informed whether the fund or any sub-funds will retain Luxembourg investors and whether a new notification for post-transition marketing will be submitted.

Any fund subject to a marketing de-notification that will continue to have Luxembourg investors after the end of the transition period but will not conduct further marketing in the grand duchy must be registered with the CSSF and provide ongoing reporting to the regulator as long as it retains Luxembourg investors. This does not apply to UK AIFs with an EU management company that undertake no further marketing after December 31.

New notifications or requests for authorisation for cross-border marketing into Luxembourg must be made under the 2010 investment fund legislation or the AIFM law, taking into account the required distinction between marketing of AIFs to professional and retail investors. Marketing of UK funds automatically qualifies as marketing of third-country AIFs in Luxembourg, and UK managers are considered third-country managers from January 1.

Marketing in Luxembourg to professional and retail investors

Marketing to professional investors in Luxembourg after December 31 must take place mainly under the provisions of Article 37 of the AIFM law, covering the marketing in Luxembourg of UK AIFs managed by an EU AIFM, or Article 45, covering the marketing of EU or third-country AIFs with a UK manager. Notification to the CSSF under Article 45 must be made before the start of the marketing in Luxembourg, and automatically triggers de-notification under the pre-Brexit regime. Notification under Article 37 is required only when active marketing in Luxembourg will take place or continue after December.

The CSSF also notes that Luxembourg AIFMs currently managing UK AIFs and that have issued notification of marketing to professional investors in other member states will need to review marketing requirements for the funds after January 1, which are subject to the provisions in each country on marketing of third-country AIFs.

Marketing to retail investors in Luxembourg will require authorisation under the 2010 legislation for UK or non-UK funds other than closed-ended vehicles managed by a UK manager or for UK funds managed by a EU manager; only regulated funds can be marketed under these provisions. The procedural details regarding requests for authorisation for marketing in Luxembourg under the 2010 law will be published by the CSSF later.

Delegation of portfolio or risk management to UK entities

The CSSF notes that Luxembourg’s fund legislation permits delegation of investment fund manager functions including investment or portfolio management and risk management to entities outside the EU as long as the delegate entities are authorised or registered for asset management and are subject to prudential supervision, that supervisory co-operation is in place between the CSSF and the entity’s home regulator – in this case UK’s Financial Conduct Authority (FCA).

On February 1, 2019 ESMA, EU national securities regulators and the FCA signed a multilateral memorandum of understanding covering supervisory cooperation, enforcement and information exchange between EU national regulators and the FCA, allowing them to share information in areas including market surveillance, investment services and asset management. The agreement, confirmed on July 17, 2020, allows activities such as the delegation of fund management functions to continue to be carried out by UK entities on behalf of investment fund managers in the EEA.

Compliance with investment policy and eligibility issues

After the transition period, any non-compliance with investment rules or policies triggered by the withdrawal of the UK from the EU will be considered active breaches. The CSSF highlights provisions related to structures such as a UCITS feeder fund in Luxembourg investing in a UCITS master fund in the UK, given that UK UCITS will henceforth be considered ‘other UCIs’ under the 2010 law, and investments in them may not in aggregate exceed 30% of the assets of the Luxembourg UCITS.

In addition, the EU’s 2017 Money Market Funds Regulation states that deposits with a credit institution with a registered office in a third country is an eligible investment by a money market fund only if the institution is subject to prudential rules considered equivalent to those in the EU. Currently this will not be the case from January 1, 2021 for banks whose registered office is in the UK.

Secondment of staff

Under UCITS and AIFMD subsidiary legislation, investment fund managers in Luxembourg may use seconded staff in the provision of portfolio management services, and the CSSF says this remains acceptable, as long as the secondees comply with applicable requirements and the fund manager ensures they are appropriately supervised. The requirements include secondees’ physical presence in the premises of the Luxembourg manager, although travel for professional purposes is admissible. The CSSF must be notified in advance of any use of secondments.

The regulator also underlines the need for market participants to reorganise certain functions and specifically the marketing function, if it is staffed with secondees from the UK that are not always physically present in Luxembourg because of business travel. Reorganisation of affected functions should in principle take place before December 13, with regard to the  Covid-19 pandemic.

The CSSF’s full press release 20/26 on the changes to the rules governing funds, managers, delegation and investment policy can be viewed here.

On 19 November 2020, the Luxembourg regulator (“CSSF“) issued press release 20/23, on behalf of the UK Financial Conduct Authority (“FCA”) wishing to address Luxembourg-based entities regarding the UK Temporary Permissions Regime (“TPR”) following the Brexit.

As such, it is reminded that the TPR will enable Luxembourg based firms and funds operating in the UK through the passport regime to continue their activities in the UK from the end of the transitional period. In order to benefit from the TPR, the FCA will have to be notified so as to start authorization and recognition proceedings. The press release 20/23 addresses three (3) key points:

• For firms and funds passporting into the UK, the notification window for the TPR has reopened on 30 September 2020, allowing to submit or update previously notifications, as the case may be;
• If firms hold a passport and have already notified the FCA but that do not require a UK authorization (i.e. because they do not wish to pursue business in the UK), they should withdraw their TPR notification and cancel their passport; and
• For firms or funds with a passport to the UK that do not enter the TPR but wish to perform an existing contract, the Financial Services Contracts Regime (“FSCR”) will automatically apply in order to wind down their UK business. As a consequence of the aforementioned, firms in the FSCR will not be able to perform new business in the UK.

On 23 September 2020, the FCA issued the consultation paper 20/20 for firms or funds that wish to undertake regulated activities in the UK on an on-going basis and how the FCA will assess these international firms against minimum standards. Substantially the content of the consultation paper is the following:

Scope of application

The consultation paper applies (i) to European Economic Area (“EEA”) firms that have applied for authorization in the UK or intend to do so (including the TPR) and (ii) international firms from non-EEA countries that are authorized in the UK, or that have applied or intend to do so.

This consultation paper does not apply to (i) depositaries, trustees and managers of UK authorized funds (including UK undertakings for collective investment (“UCITs”)), as such entities are supposed to be incorporated and administered in the UK; (ii) international alternative investment firms (“AIFs”) managers, after the transition period as only firms with their registered office in the UK can obtain permission to manage an AIF.

Context

The FCA states that firms having notified their intention to enter the TPR will be allowed to continue their UK business within the scope of their current permissions for a limited period after the end of the transition period, while they wait to be called by the FCA to submit their applications for full UK authorization. If an EEA firm or fund do not obtain a permanent authorization, the FSCR will apply until its contracts in the UK expire.

Firms and funds seeking an authorization will rely on Part 4A of the Financial Services and Markets Act 2000 (“FSMA”), setting out the threshold conditions in its schedule 6 (as well as the Cond part of the FCA’s handbook). Other legislations may set threshold conditions, similar to those of the FSMA.

With the FSMA, the FCA seeks to (i) secure an appropriate degree of protection for consumers; (ii) protect and enhance the integrity of the UK financial system and (iii) promote an effective competition in the interests of consumers. The consultation does not seek to challenge or amend the threshold conditions of the FSMA.

Minimum standards

• Branch or subsidiary: the FCA will consider as to whether there is a heightened potential to cause harm from the activities being undertaken from a branch and whether the risks can be adequately mitigated. The FCA will also consider the nature and scale of the activities the international firm intends to conduct from outside the UK. Therefore, the FCA recommends to rather operate through an UK-incorporated subsidiary;
• Risk of harm: the FCA will consider the following;
  • Protection for the UK office’s retail customers, through redress and supervisory oversight for example, could be less effective, especially if the international firm becomes insolvent or exits the UK (‘retail harm’);
  • The UK rules that protect client money or custody assets safeguarded through the UK office and the home state insolvency regime which become applicable if the international firm fails may not be aligned (‘client assets harm’); and
  • Shocks or risks that originate from the international firm’s overseas offices could, in some circumstances, be more difficult to detect or prevent and could be passed easily to its UK office, affecting the stability and integrity of the UK markets in which it operates or to which it is connected (‘wholesale harm’).

Mitigation of those above-mentioned risks will be considered on a case-by-case basis.

Following an assessment, the FCA may impose (i) limitation to the activities performed by the firms or funds and (ii) requirements to refrain from taking certain actions, in order to comply with the minimum standards on an ongoing basis. In case of noncompliance the FCA may refuse the firms or funds to perform the requested regulated activities.

To sum up the above, an international firm or fund that performs or plans to perform any activity requiring an authorization needs to demonstrate that it (i) is ready, willing and organized and (ii) meets the relevant minimum standards.

The FCA will then consider, (a) the nature of the operations; (b) the personnel and decision making process; (c) the systems and controls in place; (d) the factors related to the home state and lastly (e) adequate mitigation process against the retail, client assets and wholesale harm.

The consultation closes on 27 November 2020.

The consultation paper can be accessed here and the CSSF press release 20/23 here.

The Bill of law 7401 regarding the measures to be taken in relation to the Luxembourg financial sector in case of an hard Brexit was deposited on 31 January to the Luxembourg Parliament.

The departure of the United Kingdom from the European Union will have consequences for the British companies that are currently active in Luxembourg in the financial sectors using the European passport. In case of a messy withdrawal, these British companies may not be able to benefit from the system of the European passport and risk losing access to the Luxembourg market from one day to the other. Such a situation will make especially uncertain the fate of a number of contractual relationships that exist at the time of the withdrawal of the United Kingdom from the EU on basis of the European passport between companies of the British financial sector and Luxembourg counterparties and which produce effects far beyond this date. In order to avoid the risks which may arise from such a situation for financial stability, good functioning of financial markets, the Luxembourg financial sector actors as well as their customers, depositors, investors, policyholders and holders, it is important that the Luxembourg competent authorities have the necessary powers to ensure, as appropriate, the continuity of the above contracts after the withdrawal of the UK from the European Union for a specific period.

The Bill 7401 aims to confer to the Luxembourg competent supervisors (i.e. the CSSF and the CAA), the power to take temporary measures to remove the aforementioned risks and to ensure an orderly transition. The Bill 7401 modifies the text of the main legislation on the financial services in order to register for provisions transitional specific to Brexit.

The transitional period (21 Months from Brexit date) foreseen by the Bill 7401 shall be applicable, inter alia, (if adopted as deposited) to UK companies performing the following services:

• Management of AIFs (Luxembourg law of 12 July 2013 on alternative investment fund managers, as amended from time time);
• Management of UCITS (Luxembourg law of 17 December 2010 on undertakings of collective investment, as amended from time time);
• Financial and banking services (Luxembourg law of 5 April 1993 on the financial sector, as amended from time time).

The marketing passport for AIFs and UCITS is not covered by the Bill 7401.