Legislative and regulatory framework
In Luxembourg, there are no laws dedicated specifically to Islamic financial products or services. The existing legal framework has proved both flexible and innovative enough to accommodate the demands of Islamic financial practitioners, implementing various shariah-compliant structures through the use of Luxembourg vehicles and legislation. It is also relatively common and straightforward to combine, in a single transaction, elements of Luxembourg law with foreign law-governed agreements and structuring tools, such as, for instance, a trust governed by English law. Although it currently has no equivalent under Luxembourg law, an English law trust will generally be recognised, subject to certain conditions, by Luxembourg courts on the basis of the Convention on the law applicable to trusts and on their recognition concluded at The Hague on 1 July 1985. An English law trust declared in favour of sukuk holders over the underlying assets held by the issuer of sukuk will allow sukuk holders to retain a form of ownership over those underlying assets as prescribed by shariah law.i Legislative and regulatory regimeBanking
The regulatory regime applicable to credit institutions in Luxembourg is mainly shaped by the European directives and regulations dealing with the banking and the investment sectors, as further completed by national law. All the provisions and requirements in force in Luxembourg relevant for credit institutions would apply to Islamic banks as no specific regime is provided, or indeed required, for this type of institution. This was confirmed by the findings of a cross-sector task force set up by the Luxembourg government in 2008. The relevant provisions of European law are implemented in large part in the Luxembourg act of 5 April 1993 on the financial sector, as amended (the Banking Act), and in the Luxembourg act of 18 December 2015 on the failure of credit institutions and certain investment firms, as amended.
According to the Banking Act, no person established under Luxembourg law may carry on the business of a credit institution without holding a written authorisation from the Minister responsible for the Commission de Surveillance du Secteur Financier (CSSF), which is the Luxembourg banking and financial supervisory authority. This licensing requirement to carry out banking and financial activities also applies to Islamic banks. Since 2014, Luxembourg has been a participating member of the Single Supervision Mechanism (SSM), which means, among other things, that entities willing to carry out banking activities in and from Luxembourg must obtain their licence from the European Central Bank (ECB), through the services of the CSSF (which remains the point of entry for licence applications).
Except for covered bond banks (the exclusive activity of which is to issue covered bonds), Luxembourg banks (including Islamic banks) qualify as 'universal' banks (which means that Luxembourg credit institutions are authorised to carry out any activity of the financial sector). According to the principle of the European passport, a Luxembourg bank may provide services, either through a branch or on a cross-border basis, in any other country of the European Economic Area (EEA) without any further licensing requirement in a host country. A Luxembourg branch of a third-country institution (from outside the EEA) would, however, require a specific type of licence in Luxembourg, which would not allow it to benefit from the European passport.
Luxembourg banks are subject to two main sets of requirements:
- those relating to prudential supervision aimed at preventing systemic risks; and
- those relating to investors' and clients' protections that mainly stem from Directive 2014/65/EU and the EU consumer protection rules.
The prudential regulation imposes a number of requirements and ratios in terms of internal governance, own funds, liquidity and risk management, whereas the client and investor protection corpus requires certain conduct of business rules to be implemented and a high level of contractual formalism when dealing with clients.
As mentioned above, the CSSF is Luxembourg's national competent authority for banks with respect to both the prudential aspects and the client protection aspects. However, in the context of the SSM, the competence of the CSSF in relation to prudential matters is delegated to it by the ECB, which is now, as a matter of principle, the competent supervisory authority in the eurozone. Any credit institution that will qualify as a significant institution would be under the direct supervision of the ECB for those aspects. The CSSF remains the competent authority for less significant institutions.Investment funds
Shariah investment funds may be set up under the general legal framework applicable to investment funds in Luxembourg as there is no specific legal requirement concerning these products. Therefore, these funds fall, depending on their structure, within the scope of the Companies Act, the Alternative Investment Fund Managers Act (AIFM Act) or one of the Product Acts, or a combination of these. The Association of the Luxembourg Fund Industry (ALFI) has also published a set of best practice guidelines for setting up and servicing Islamic investment funds, which have become an international standard in the financial sector. Thus, from a supervisory and regulatory perspective, there is no particular distinction between a shariah investment fund and any other type of fund.
The common regulatory principles applicable to managers of a regulated investment fund or its regulated external manager set up under Luxembourg law must also be fulfilled. For these investment funds and asset managers, shariah board members must therefore be of sufficiently good repute and be sufficiently experienced in relation to the investment policy of the concerned investment fund. The administrative practice is constantly changing. For instance, for certain regulated funds the CSSF may require that a board member be specifically designated as being in charge of anti-money laundering and counter terrorist financing (AML/CFT) matters, even where this function is delegated, and this therefore would require specific AML/CFT knowledge. Equally, the CSSF may also stipulate that the board members dedicate sufficient time to the regulated fund, and it may control the number of directorship mandates and time allocated per mandate by the board members. This rule has already been set in a circular for certain internally managed funds and asset managers, and limits managing members to a maximum of 20 mandates and 1,920 hours per year.Capital markets
Traditional shariah-compliant structures can be replicated using Luxembourg vehicles, with the full benefits of the applicable Luxembourg tax and legal regime. A Luxembourg securitisation undertaking subject to the Securitisation Act (discussed in more detail below) is frequently the vehicle of choice for clients who seek to raise finance in compliance with shariah principles, in particular using murabahah and ijarah structures.
As regards the offering of securities in Luxembourg – whether by way of private placement, an offer to the public or admission to trading on the regulated market or the Euro MTF market of the Luxembourg Stock Exchange, the same rules apply to sukuk as to conventional bonds. While private placements are not subject to any regulation and can be carried out without any form of offering document, an offer of securities to the public will (unless an exemption is available) have to be conducted in accordance with the Prospectus Regulation, which requires the publication of a prospectus drafted in accordance with the Prospectus Delegated Regulations. The Prospectus Regulation also requires a prospectus to be published in connection with the admission of securities to trading on the regulated market of the Luxembourg Stock Exchange. Once approved in Luxembourg by the CSSF (in circumstances where Luxembourg is the issuer's home Member State within the meaning of the Prospectus Regulation), a prospectus prepared in compliance with the Prospectus Regulation and the applicable annexes of the Prospectus Delegated Regulations can be used for public offers or admission to trading on regulated markets in other countries of the EEA without the need for a separate approval from the local competent authorities (subject to the CSSF notifying the competent authorities of its approval). Issuers of securities traded on the regulated market of the Luxembourg Stock Exchange will have to comply with the highly harmonised ongoing obligations relating to transparency and prohibition of market abuse. Alternatively, securities may be admitted to trading on the Euro MTF market of the Luxembourg Stock Exchange, which is not included in the list of regulated markets published by the European Commission, but which has built up a strong international reputation among issuers and investors. An offering circular to be prepared in connection with trading on the Euro MTF market will be approved by the Luxembourg Stock Exchange and it must comply with the disclosure requirements set out in the Rules and Regulations of the Luxembourg Stock Exchange – these requirements are lighter than those under the Prospectus Regulation, but they do not offer the possibility of 'passporting' the offering circular to other jurisdictions. The Rules and Regulations of the Luxembourg Stock Exchange also prescribe most of the ongoing disclosure requirements applicable to issuers of securities admitted to trading on the Euro MTF market.
Those interested in issuing or investing in sukuk should note that the Luxembourg Stock Exchange is a prime listing location for sukuk in Europe. At the end of 2016, the aggregate amount of sukuk traded on the markets of the Luxembourg Stock Exchange reached US$95 billion. Issuers of sukuk who have chosen the Luxembourg Stock Exchange come from Muslim countries as well as Europe, Hong Kong, South Africa and the United States.ii Regulatory and supervisory authorities
In Luxembourg, there is no office or authority charged with the supervision and monitoring of Islamic financial transactions or market participants using shariah-compliant structures. The CSSF is a secular institution, which will treat Islamic financial transactions in the same way as any other financial activity subject to its supervision. The extent of the CSSF's supervisory role is very broad and covers a wide range of actors in the financial sector, including regulated investment funds (also those that are shariah-compliant), regulated securitisation vehicles and credit institutions, to name just a few (but excluding insurance undertakings, which are supervised by the Insurance Commission). If a particular project falls within the scope of the CSSF's competence, the regulator will aim to ensure compliance with all relevant Luxembourg laws and regulations. Whether the project also meets the conditions set under shariah law would, from a Luxembourg law perspective, be a matter of contractual arrangements between the parties.