Luxembourg has transposed MiFID II into its national law, albeit five months after the deadline for doing so. In other matters, the Luxembourg supervisory authority, the Commission de Surveillance du Secteur Financier (CSSF) issued two circulars in August: one reshaping the organisational rules for Luxembourg UCITS management companies, self-managed UCITS, authorised AIFMs and internally managed AIFs; the second, providing guidance as to the requirements for Luxembourg depositaries servicing Luxembourg AIFs (other than Part II UCIs marketed to retail investors), as well as SIFs and SICARs that do not qualify as AIFs. These developments are discussed below.

MiFID II Transposed into Luxembourg National Law

With a delay of five months, Luxembourg has transposed and implemented the main parts of the markets on financial instruments (MiFID) framework into national law, by the act of 30 May 2018 on markets in financial instruments (MiFID II Act) and the Grand-Ducal Regulation on markets in financial instruments of the same date (GDR). For further information on the transposition and implementation of MiFID II in Luxembourg, please refer to Luxembourg Developments: Luxembourg Publishes Bill to Implement MiFID.

The MiFID II Act: (i) transposes the MiFID II Directive1 (Directive) into Luxembourg Law; (ii) implements certain provisions of MiFIR2; and (iii) transposes into Luxembourg law certain provisions of the European Commission directive pertaining to the safeguarding of client funds3. The MiFID II Act also amends parts of the act of 5 April 1993 on the financial sector, as amended (Financial Sector Act)4.

The MiFID II Act came into effect on 4 June 20185, although the deadline to transpose the Directive was 3 January 20186.

The MiFID II Act does not gold plate7 rules on UCITS management companies and alternative investment fund managers (AIFMs). Luxembourg UCITS, alternative investment funds (AIFs)8 and other undertakings for collective investment, and their respective management companies and AIFMs, continue to be outside the scope of the Financial Sector Act, unless the relevant management company or AIFM is also authorised to provide discretionary portfolio management and non-core services. However, in practice, certain obligations under MiFID II will have an indirect effect on UCITS management companies and AIFMs when they enter into contractual relationships with entities that are subject to the MiFID framework (for instance, where adequate product governance arrangements need to be put in place by distributors, or where portfolio managers and brokers need to ensure compliance with inducement rules).

Third-country firms are required to establish a branch in Luxembourg to provide investment services to retail clients and “opt-up” professional clients9 in Luxembourg. The branches will be subject to the same rules as those applicable to Luxembourg investment firms.

Reshaping of Organisational Rules for Luxembourg UCITS Management Companies and AIFMs and Enforcement of Local Substance Requirements, by CSSF Circular 18/698

The CSSF issued a circular on 23 August 2018 (Manager Circular)10, which consolidates into one document the requirements for Luxembourg UCITS management companies, self-managed UCITS, authorised AIFMs, and authorised internally managed AIFs (collectively, Managers). The Manager Circular does not apply to AIFMs (and internally managed AIFs) that are registered only.

For further information regarding the Manager Circular (including with respect to the governing body and management of a manager, requirements as to delegation of key functions, investment and valuation committees, appointment of investment advisers, limitations on number of mandates of Managers’ directors and conducting persons, and local substance requirements of Luxembourg-based Managers), please refer to Dechert OnPoint, Luxembourg CSSF reshapes organisational rules for UCITS management companies and AIFMs, enforces local substance requirements.

The Manager Circular applies with immediate effect from its issuance on 23 August 2018. Unfortunately, as it contains a number of new provisions, Managers, directors and conducting persons have not been given a reasonable period of time to adapt to the Manager Circular. It is therefore important that priority be given to ensuring immediate compliance.

Consolidation of Organisational Rules for Luxembourg Depositaries of AIFs as well as for SIFs and SICARs that do not Qualify as AIFs, by CSSF Circular 18/697

The CSSF issued a circular on 23 August 201811 (Depositary Circular), which consolidates into one document the requirements for Luxembourg depositaries servicing Luxembourg AIFs (other than Part II UCIs12 marketed to retail investors), as well as SIFs13 and SICARs14 that do not qualify as AIFs (collectively, Funds). To a large extent, the content of the Depositary Circular replicates the administrative practice of the CSSF15. The Depositary Circular will become effective on 1 January 2019, providing time for depositaries, Funds and their AIFMs to comply with its terms.

For AIFs managed by an authorised AIFM (as well as authorised internally managed AIFs), the Depositary Circular provides certain clarifications and practical guidance with respect to article 19 of the AIFM Act16 and chapter IV of Commission Delegated Regulation 231/201217 (both of which set rules for depositaries of AIFs). In this regard, the Depositary Circular describes a depositary’s obligations when safekeeping real estate, private equity, other collective undertakings for investment, financial derivative instruments, non-tangible rights and tangible assets. Where intermediary vehicles are used for investing in underlying assets, a look-through approach is required to properly carry out the safekeeping obligations.

For Part II UCIs not marketed to retail investors, as well as SIFs and SICARs that are managed by an AIFM exempted from the scope of the AIFM Act (e.g., by being registered as a sub-threshold AIFM) and SIFs and SICARs that do not qualify as AIFs18, the Depositary Circular clarifies that a depositary: (i) has a general mission to supervise the Fund’s assets, and must know at all times how the assets are invested and where and how these assets are available; and (ii) must ensure that general administrative tasks pertaining to the assets (e.g., collection of dividends and interest, exercise of option rights) are appropriately carried out. The Depositary Circular indicates that the depositary is responsible to investors for any damage caused by its failure to appropriately supervise the assets.

The Depositary Circular applies to all types of depositaries: (i) Luxembourg banks and Luxembourg branches of banks established in the EEA; (ii) Luxembourg investment firms authorised to provide safekeeping and administration functions with respect to financial instruments, and Luxembourg branches of such investment firms established in the EEA; and (iii) depositaries for assets other than financial instruments19.

The Depositary Circular describes the process to become authorised by the CSSF to provide depositary services to Funds. The Depositary Circular also formalises the requirements applicable to persons responsible for the depositary business within a bank, investment firm or Luxembourg branches of an EEA bank or investment firm, as well as staffing and the technical infrastructure and on delegation.

The Depositary Circular also sets forth rules on conflicts of interest, and lists functions a depositary may assume alongside its function as depositary – these include (among others): reception and transmission of orders; brokerage; fund administration; maintaining the registry of investors; transfer agency services; currency hedging; collateral management; and valuation. Although a depositary may directly or indirectly be a shareholder of an AIFM, none of the depositary’s employees can assume the function of a conducting person of the AIFM. However, where a depositary’s direct or indirect participation exceeds 10% of an AIFM’s capital, the AIFM must have a procedure in place to avoid the conflicts.

Written procedures must be in place between the depositary and external parties (e.g., fund administrator) when servicing a Fund. These procedures may either take the form of an operating memorandum or a service-level agreement. Where the AIFM of a Luxembourg Fund is not located in Luxembourg, a written agreement covering the information flow between the non-Luxembourg AIFM and the Luxembourg depositary must be put in place, to enable the latter to assume its safekeeping obligations.

The depositary must have the right at all times to access the information necessary to enable it to carry out its legal obligations. This right is important as the depositary is required to inform the Fund and the AIFM of any fact potentially affecting the Fund’s assets. The right can be granted, for instance, by online access to the systems of the delegates, prime brokers, clearing brokers, registrars, transfer agents or other counterparties and brokers.

Where a Fund is in liquidation or the depositary has resigned, the continued safekeeping of the Fund’s assets must be ensured. In such an instance, the latest depositary that had been appointed for the Fund is required to keep the Fund’s accounts open until the liquidation is completed or another depositary is appointed.