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Adapting the SIF law for the AIFM Directive era

September 2011 - Finance. Legal Developments by Chevalier & Sciales .

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Four and a half years after Luxembourg introduced the law creating the Specialist Investment Fund regime for alternative vehicles, the grand duchy’s government has drafted legislation amending the SIF rules. The new legislation, which was placed before the Chamber of Deputies (Parliament) on August 12 and which is expected to become law before the end of this year, aims principally to adapt the SIF law to the requirements of the European Union’s Directive on Alternative Investment Fund Managers, which will take effect in July 2013, including rules on delegation, risk management and the handling of actual or potential conflicts of interest.

In addition, in some instances the proposed changes will bring the SIF regime into line with Luxembourg’s funds legislation of December 17, 2010, which transposed into national law the Ucits IV Directive governing cross-border distribution of retail funds within the EU as well as introducing other changes affecting non-Ucits funds. For example, the law will enable sub-funds of a SIF umbrella structure to invest in other compartments of the same structure, as is already now the case for Ucits funds.

Moving early to adopt requirements to be introduced by the AIFM Directive is in keeping with Luxembourg’s tradition, maintained over more than two decades, of putting EU legislation in place ahead of many competing European jurisdictions, enabling promoters to plan future fund launches with confidence about the stability of the country’s regulatory regime.

The first of 18 articles of the draft  legislation states that the activity of management of a SIF must comprise at a minimum management of the investment portfolio. This stipulation aims explicitly to exclude from the SIF regime passive funds that seek to create value solely by the long-term holding of assets and to create a distinction between SIFs and private wealth management companies governed by Luxembourg’s law of May 11, 2007. However, it does not exclude private equity or real estate funds from the SIF regime. Article 2 requires SIFs to have in place procedures to determine that its investors qualify as sophisticated rather than retail.

Article 3 aligns the SIF rules with various features of the 2010 law. Where the fund’s articles of association are drawn up in English, the legislation no longer insists that these be translated into French or German. Funds no longer need to send shareholders physical copies of their annual reports unless this is specifically requested, and in addition, SIFs may establish a registration date five days preceding an annual general meeting of shareholders for the purposes of determining voting rights and what constitute a quorum.

Article 5 of the draft law amends Article 42 of the 2007 SIF legislation, which allowed promoters of a fund to apply for authorisation by Luxembourg’s regulator, the Financial Sector Supervisory Authority (CSSF) up to one month following their launch. This provision, which in any case was not widely used by the promoters, is now abolished; once the law comes into force funds must have received approval from the CSSF before they can be launched, as is the case for funds created under the 2010 legislation.

A new requirement makes authorisation subject to notification of the persons responsible for management of the SIF’s investment portfolio to the CSSF, which must henceforth ascertain that they are of good reputation and have the experience necessary to manage the type of alternative investment fund in question. Any changes in the identity of the fund’s portfolio managers must also be notified to the regulator.

Under Article 6, SIFs must implement systems to monitor, measure and manage the investment risk of its individual positions and their contribution to the portfolio’s overall risk profile. They must also be structured and organised to minimise the risk of conflicts of interest, and draw up rules to manage such conflicts that do arise. The CSSF may draw up further regulations setting out detailed requirements on risk management and conflicts of interest.

Article 7 defines the conditions under which SIFs may delegate various tasks and functions to third-party providers. Such delegation should not affect regulation of the fund; entities to which portfolio management is delegated must be approved for that function and subject to prudential regulation, unless the CSSF grant permission for delegation to individuals or entities to which this condition does not apply.

A fund’s directors must be able to determine that the delegated provider is qualified and capable, and they must retain ultimate control over the fund’s activities. Delegation should not create conflicts of interest – so, for instance, investment management may not be delegated to the fund’s custodian – and the delegation of functions must be revealed in the fund’s offering documents.

The CSSF’s powers of supervision and enquiry over funds set out in Article 8 aligns the provisions of the SIF legislation with those laid down by the Ucits IV directive, while Article 9 set out circumstances in which the CSSF or the Luxembourg prosecutors may apply to the courts for the dissolution and liquidation of one or more fund compartments. Article 10 deals with administrative fines, which the CSSF may publish unless this would seriously affect financial markets, damage the interests of investors or cause disproportionate prejudice to the parties affected.

Under Article 12, the CSSF’s approval is now required for any substantial change made to the SIF’s offering documents, such as the name of the fund or of sub-funds, the replacement of the custodian, administrator, auditor or manager, the creation or new sub-funds or a significant change in investment policy.

Article 13 authorises funds to deviate from their exclusive investment policy for the purposes of liquidity management, hedging or efficient portfolio management, while Article 14 bars SIFs in the form of companies that are in the course of being liquidated from issuing new shares, except where this is beneficial to the outcome of the liquidation itself. Article 15 allows the CSSF to withdraw authorisation for one or more sub-funds of a SIF while maintaining the authorisation for other sub-funds of the same structure.

The draft law follows the 2010 legislation in allowing one sub-fund of a SIF to invest in another, although not all provisions are identical. This clarifies that the rules set out in Luxembourg’s 1915 company law regarding a company’s investment in its own shares do not apply to SIFs. Sub-funds of the same SIF may not cross-invest in each other, and voting rights of shares held by one sub-fund in another are suspended.

Finally, Article 17 stipulates that SIFs established before the date of entry into force of the revision law will have a transitional period up to June 30, 2012 before they are obliged to comply with its requirements on ascertaining that their investors are sophisticated (Article 2, paragraph 3) and risk management and conflicts of interest (Article 42bis) and up to June 30, 2013 to comply with the new rules on the delegation of functions (Article 42ter).

You may find more information on our AIFM blog at www.cs-avocats.lu/aifm-directive

For any query, please contact:

Olivier Sciales
Partner
Tel: + 352 26 25 90 30
Fax: +352 26 25 83 88
Email: oliviersciales@cs-avocats.lu