On 23 August 2018, the CSSF published a new Circular, CSSF Circular 18/697, which (i) specifies organisational requirements for depositaries of funds that are not subject to the PART I of the Law of 17 December 2010; (ii) modifies CSSF Circular 16/644 [see our article here] applicable to depositaries of Luxembourg UCITS subject to the Part I of the UCI Law of 17 December 2010 insofar as Annex 1 of the Circular 16/644 is replaced by Annex 1 of the new Circular 18/697 and (iii) repeals Chapter E of IML Circular 91/75, as amended by CSSF Circular 05/177.
Moreover, the Circular clarifies and brings additional information on certain aspects of the AIFM Law of 12 July 2013 (AIFM Law), of the EU delegated regulation 231/2013 (so-called "Level II"), and also to some aspects of the Luxembourg SIF and/or SICAR laws, in laying down the expected governance principles and detailing the organisational requirements and the best practices applicable to depositaries of non-UCITS Funds.
The present article aims at highlighting the main contributions of the new text.
Scope of Circular 18/697
The Circular is addressed to all non-UCITS depositaries:
- Luxembourg credit institutions in the meaning of the PSF Law of 1993;
- Luxembourg investment firms which fulfil all the conditions of Art. 19(3) i) of the AIFM Law;
- Professional depositaries of assets that are not financial instruments, so-called "other assets", which fulfil all the conditions of Art. 19(3) i) 4th sub-paragraph of the AIFM Law; and
- EU credit institutions and investment firms or their branches which are acting or intend to apply for an authorisation to provide depositary services in Luxembourg.
When these provide depositary services to:
- AIFs managed by an Investment Fund Manager (IFM);
- The Luxembourg "Part II" funds managed by a fully authorised AIFM and having expressly specified in their constitutive documents that they are not distributed to retail investors established in Luxembourg;
- The Luxembourg "Part II" funds managed by a registered AIFM and having expressly specified in their constitutive documents that they are not distributed to retail investors established in Luxembourg; and
- SIFs and SICARs that do not qualify as AIFs or that qualify as AIFs but are managed by a registered AIFM.
Main features of the generally applicable rules
- The approval process
The Circular revisits the documents necessary for the approval process. Depositaries who have received their approval before the entry into force of the Circular, or after the entry into force of the Circular based on Circular 16/644 for UCITS depositaries, will not have to file for a new approval. However, they will have to make sure that they will become compliant with the new rules by the date of the entry into force, on 1 January 2019.
Within a month after the entry into force of the Circular, the depositaries in scope will have to notify their activity as depositary for AIFs by communicating to the CSSF certain information that has not already been communicated in the context of Circular 16/644 – such as the name of the managers of the depositary, the name of the person responsible of the depositary business line (see hereafter), their CVs, the organisation chart, the number of employees, the list of delegates, a written confirmation of the person responsible of the depositary business line that the contracts appointing the depositary contain all the elements requested by the applicable laws.
The Circular introduces the requirement to appoint a person responsible for the depositary business line who shall either have himself adequate professional experience (i.e. relevant expertise in relation to the investment strategies of the funds it provides services to and experience in similar activities with depositaries of UCITS or alternative funds) or collectively with the persons that support him in his function. This approach differs from the one adopted in Circular 16/644 which requires that the person responsible for the depositary business line possesses himself the adequate professional experience.
- Delegation and outsourcing contract
The contract by which the depositary delegates its functions or outsources material activities shall grant the depositary the right to access all data in relation to the AIFs. However, the Circular specifies that where the depositary's request in relation to the AIFs may lead the delegate or the service provider to be in breach of any applicable law, he is entitled to refuse to provide the information.
Moreover the contract by which the depositary delegates its functions or outsources material activities shall grant the right to the CSSF to have direct access to the third party's office.
- Permitted additional activities
In addition to the activities allowed for UCITS depositaries under Circular 16/644, credit institutions acting as depositaries for AIFs – excluding non-bank depositaries – can act as:
- Credit and/or financing granter
- Prime broker
- Currency hedging agent
- External valuer
- Asset segregation
Unsurprisingly, the Circular refers to the AIFM Law and to its recently amended Level 2 [see our article here] for the rules organising the segregation of the assets. However, the CSSF specifies that the depositary may at any time require his delegates to open new accounts in addition to those required by the AIFMD Level 2, where it considers that it is necessary to reduce the risk of losses or decrease of value of the financial instruments of its clients. It is noteworthy that this possibility is not provided for in CSSF Circular 16/644.
- Specific responsibilities of the depositary in relation to
- As regards the depositary's obligation of ownership verification, registration and record-keeping for the "other assets" of the AIFs, the Circular clarifies the Level 2 requirements by requiring that the depositary should always know which assets belong to the fund and where they are kept.
- As a significant element of the text, the CSSF inserts detailed guidance to depositaries on how they should perform their obligation to verify the ownership on non-financial instruments depending on the type of asset classes they are facing (real estate, other funds, private equity, intangible rights, derivatives and movable property). This way, the CSSF enhances the provisions contained in the AIFMD Level 2.
- The Circular also requires the depositary and the fund – or the investment fund manager (IFM) acting on its behalf – to agree on a written procedure detailing the types of transactions and the cash flows that should be anticipated.
- The depositary should after each transaction and at least once per year verify that the assets remain in the ownership of the fund. For this purpose, the depositary must ensure that the IFM implements and applies adequate procedures to verify that assets acquired by the fund are registered in its name.
- The depositary's right of pledge
The depositary's right of pledge on the assets of the AIF is confirmed by the Circular. Therefore, the depositary may, subject to the inclusion of specific contractual provisions in the depositary contract, benefit from a general or specific pledge on the assets of the fund.
- The depositary's internal procedures
The Circular provides additional guidance on internal procedures and written procedures or contracts to be established with third parties. Depositaries should also ensure to have in place an escalation procedure to follow in case of detection of a breach or irregularity to inform the fund or its manager. The fund or its manager should have a similar escalation procedure in place.
- The depositary's right to access information from third parties
The Circular confirms that the depositary should be granted the right to access any relevant information from a delegate or a clearing broker in order to be able to perform its duties.
Rules for specific categories of depositaries
Part I of the Circular addresses how the provisions apply to specific types of depositaries covering notably:
- The non-bank depositaries, i.e. the Luxembourg investment firms which fulfil all the conditions of Art. 19(3) i) of the AIFM Law and the professional depositaries of assets that are not financial instruments, so-called "other assets", as introduced by Art. 19(3) i) 4th sub-paragraph of the AIFM Law. These are treated in their dedicated sections, respectively Chapter 2 and Chapter 3 of the Part I of the Circular.
- The depositaries acting for SIFs and SICARs which do not qualify as AIFs, depositaries acting for SIFs and SICARs which qualify as AIF but are managed by a registered AIFM and depositaries acting for "Part II" UCIs managed by a registered AIFM and who have explicitly excluded in their distribution documents to be distributed to Luxembourg retail investors. It must be emphasised that their dedicated regime is largely inspired by the now abrogated Chapter E of IML Circular 91/75. However they are subject to the general approval procedure for depositaries as outlined above.
The new Circular will enter into force on 1 January 2019.
The text of the CSSF Circular 18/697 is accessible via the following web link.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.