Following the law of 26 March 2012 amending the law of 13 February 2007 on specialized investment funds (the Law of 2007) in Luxembourg, specialized investment funds (SIFs) are now required in accordance with Article 42a of the Law of 2007:
- to implement risk management systems to identify, measure, manage and monitor appropriately the risks associated with their investment positions and the contribution of those positions to overall portfolio risk; and
- to be structured and organised in such a way as to mitigate the risk of any potential conflicts of interest.
On 13 August 2012, the CSSF issued CSSF Regulation 12-01, which adopted the implementing measures relating to these requirements (Regulation 12-01).
SIFs that existed at the time of the entry into force of Regulation 12-01 will have until 31 December 2012 to comply with its provisions.
Risk Management Function and Policy
Risk Management Function
Regulation 12-01 requires that SIFs implement and maintain a permanent risk management function that is hierarchically and functionally independent from operating units, unless a derogation has been granted by the CSSF (which can be done on a case-by-case basis). This is a concept similar to that proposed under the Alternative Investment Fund Managers Directive (the AIFM Directive).
Risk Management Policy
A SIF’s risk management policy must allow the SIF to detect, measure, manage and monitor the exposure to market, liquidity and counterparty risks, and exposure to all other risks, including operational risk, which may be material to the SIF’s activities.
Delegation of Risk Management Function
SIFs may delegate all or part of their risk management function to a third party, provided that the third party has the necessary competence and capacity to perform the activities of the risk management function reliably, professionally and efficiently in accordance with applicable legal and regulatory requirements. The delegation of the risk management function does not relieve the board of directors of the SIF (or the board of directors of the management company of a SIF in the form of an FCP) from their responsibility in terms of the implementation of the risk management, as indicated above.
The risk management policy (and any subsequent change thereto) must be communicated to the CSSF and approved by the SIF’s board of directors (or the board of directors of the management company of a SIF in the form of an FCP). It must be subject to regular and documented review.
Conflicts of Interest
Identification of Conflicts of Interest
Regulation 12-01 identifies several types of conflicts of interest that may arise in the course of providing services and activities. The conflicts of interest rules aim to determine if a “relevant person”, as defined below (whether as a result of providing collective portfolio management activities or otherwise):
- is likely to make a financial gain, or avoid a financial loss, at the expense of the SIF;
- has an interest in the outcome of a service or an activity provided to the SIF or another client or of a transaction carried out on behalf of the SIF or another client, and which is distinct from the SIF’s interest in that outcome;
- has a financial or other incentive to favour the interests of another client or group of clients over the interests of the SIF;
- carries on the same activities for the SIF and for another client or clients that are not also SIFs; and/or
- receives or will receive, from a person other than the SIF, an inducement in relation to collective portfolio management activities provided to the SIF, in the form of monies, goods or services, other than the standard commission or fee for that service.
Regulation 12-01 defines a “relevant person” as any person contributing towards the business activities of the SIF or any person directly or indirectly linked to the SIF.
Conflicts of Interest Policy
SIFs will need to implement and maintain an effective conflicts of interest policy that must be set out in writing and, more specifically, must be appropriate to the size and organisation of the SIF as well as the nature, scale and complexity of the business of the SIF in question.
The policy must identify the circumstances that constitute, or may give rise to, a conflict of interest entailing a material risk of damage to the interests of the SIF, and the procedures to be followed and measures to be adopted in order to manage each such conflict. The policy must also cover personal transactions by a relevant person and the exercise of voting rights attached to instruments held by the SIF that may give rise to a conflict of interest. If the SIF is a member of a group, the policy shall also take into account any circumstances that may give rise to a conflict of interest resulting from the structure and business activities of other members of the group.
Management of Conflicts of Interest
The conflicts of interest policy should provide measures and procedures to manage any conflicts of interest or potential conflicts of interest. More specifically, the SIF must ensure that these measures and procedures take account of the following to ensure a requisite degree of independence:
- effective procedures to prevent or control the exchange of information between relevant persons if the exchange of such information would harm the interests of the SIF;
- the separate supervision of relevant persons
- involved in carrying out collective portfolio management activities on behalf of, or providing services to, clients or investors whose interests may conflict with the interests of the SIF;
- the removal of any direct link between the remuneration of relevant persons principally engaged in a given activity and the remuneration of, or revenues generated by, other relevant persons principally engaged in another activity, where a conflict of interest may arise in relation to those activities;
- measures to prevent or limit any person from exercising inappropriate influence over the way in which a relevant person carries out collective portfolio management activities; and
- measures to prevent or control the simultaneous or sequential involvement of a relevant person in separate collective portfolio management activities where such involvement may impair the proper management of conflicts of interest.
Regulation 12-01 specifies that SIFs may adopt alternative or additional measures and procedures if the adoption or the practice of one or more of the above measures and procedures does not provide the requisite degree of independence.
In the event that organisational or administrative arrangements do not prevent a risk of damage to the interests of the SIF or its unitholders/shareholders from arising, the board of directors of the SIF (or the board of directors of the management company of a SIF in the form of an FCP) must be promptly informed and may take any necessary decision to suggest solutions to such a situation. This action must be reported to investors along with the reasons for the decision taken by the board of directors.
The SIF must confirm to the CSSF that a conflicts of interest policy has been implemented, in order to be approved by the CSSF.
The aforementioned law of 26 March 2012 was the first step in the implementation of the AIFM Directive in Luxembourg. Regulation 12-01 is the logical followup, especially in view of the draft bill implementing the AIFM Directive, which is further described later in this article.