What does CSSF Circular 18/698 mean for PE fund managers in Luxembourg?

On 23 August 2018, the CSSF issued a new circular, Circular 18/698, which outlines (i) the authorisation and organisation of investment fund managers (IFMs) incorporated under Luxembourg Law, and (ii) specific provisions on the fight against money laundering and terrorist financing applicable to IFMs and entities carrying out the activity of a registrar agent.


This Circular is particularly important to AIFMs, as it replaces CSSF Circular 12/546, which did not include any provisions for AIFM licensing requirements. The CSSF’s 2013 Annual Report highlighted that the regulator expected AIFMs to comply with the internal corporate governance requirements defined in Circular 12/546. Before the Circular was issued, many aspects of the licence application for AIFMs were seen as 'market practice' rather than coming from strict written rules laid down by the regulator. The Circular puts in writing for the first time dispositions, which were already, during the last years, the applied administrative practice by CSSF. As such, the Circular has broughtmuch-needed clarity when it comes to internal corporate governance requirements at management-company level, especially in the context of the political uncertainty brought about by Brexit.

When it comes to governance, the Circular restates many of the previous requirements regarding having procedures in place to manage conflicts of interest, valuation, own-funds requirements, IT risks, complaints handling, voting rights, personal transactions, the exchange of information between IFM and depositary, etc. Over the last couple of years, CSSF stepped up their on-site visits on several authorised AIFMs in Luxembourg. For the AIFMs who have been subject to such reviews and received feedback from the regulator, the requirements stated in the Circular should not come as a surprise.  However, below is a summary of the new requirements that the circular imposes on AIFMs:

  1. The AIFM's supervisory board must be independent from the management of the fund;
  2. Capital letters are only required when referring to a specific body/function, not a hypothetical one or a group of them in general. This comment applies to all the capitalisation changes made in the list below.The management of the fund must be conducted by authorised conducting officers or senior managers, who are responsible for day-to-day operations and report to the supervisory board;
  3. The maximum number of mandates for the board has been set at 20; however, mandates in special-purpose vehicles belonging to the same fund and mandates across different funds with the same strategy may be grouped or counted as a single mandate if properly justified to the CSSF;
  4. The maximum amount of time that board members may dedicate to professional commitments has been set at 1,920 hours or 48 working weeks per year;
  5. Staff requirements: there must be at least 3 full-time equivalents on the ground in Luxembourg, including senior management (conducting officers) and other staff members;
  6. There is a concept of two-tier management, with a 3-member supervisory board and at least a 2-member management committee (conducting officers), notwithstanding the application of the proportionality criteria and total assets under management (€1.5 bn threshold);
  7. Valuation function shall be independent for risk management function at the AIFM, although the CSSF may apply the principle of proportionality in its assessment of the organization of the valuation function;
  8. Risk Management Process shall be communicated to the CSSF as per the template provided in the Annex 1 to the Circular;
  9. Delegation rules have become strict with respect to the need for justification and ongoing due diligence of delegates (including investment advisors and intra-group delegates).

The immediate impact on PE fund managers can be broadly divided into two categories: (i) PE fund managers in the process of setting up their operations in Luxembourg or who have been operational for less than a year; and (ii) relatively mature PE fund managers who have had a presence in Luxembourg for at least 3 years.

Fund managers in the first category who are in the process of a licence application or upgrade will need to revisit their application pack to ensure that they have considered all the points that the CSSF has outlined in the Circular. This is particularly important for players wishing to operate with a lean presence in terms of the number of FTEs in Luxembourg, with a major reliance on delegation. It should be noted that any delegation that ultimately results in the fund manager not being ultimately responsible for the delegated function may be viewed as a letter-box entity and will not be permitted under the regulations. Needless to say, this presents a challenge to fund managers who are transferring their operations to Luxembourg, as they need to find the right resources in Luxembourg. The second challenge is the new internal operating model. In order to build sustainable and value-added presence in Luxembourg, fund managers’ internal operating models need to change. This means involving the Luxembourg office in the different stages of the fund’s life cycle (from fundraising, through the investment life cycle to the ultimate liquidation of the fund). For many fund managers, this may not be as easy to design, especially if engaging a third-party AIFM to manage the funds.

One of the main concerns for the second category of fund managers - who have been operating for a few years, are familiar with the CSSF requirements and have a fairly advanced operating model - is expected to be delegation oversight. One of the key findings in the CSSF's 2017 Annual Report concerned the inconsistencies in the level of initial and ongoing due diligence performed by IFMs on their delegates, to allow the risks related to the use of delegation to be appropriately identified and assessed. One of the key challenges for PE AIFMs will be the obligation to perform such due diligence on their investment advisors. The Circular clearly identifies the rules and requirements regarding the use of investment advisors by IFMs. This is understandably tricky for PE fund managers, who are working with intra-group investment advisors typically located in major cities around the world, advising AIFMs on many transactions related to the funds that they manage. While it may seem logical to deem working with intra-group investment advisors low-risk when compared to working with third-party ones, AIFMs cannot preclude them from their oversight and monitoring requirements. For example, while IFMs previously simply checked whether a proposed transaction complied with the investment restriction, this is now deemed insufficient. The IFM must define and implement a procedure describing the independence and critical analysis process of the transactions proposed by the investment advisors. This process cannot be done properly without the initial due diligence and sharing of information between the two parties. It is important that fund managers take stock of all the delegation arrangements and ensure that all controls are in place.

In summary, PE fund managers who are relatively new to Luxembourg will face challenges when it comes to finding the right resources on the ground, while more mature players will need to revisit their existing operating models to comply with the Circular. However, it is also good news for fund managers in Luxembourg, as they can seize this opportunity, using it more than a pure compliance exercise, to build their fund operations in a manner that is scalable and robust to meet any regulatory requirements. Starting with a pure gap analysis of the requirements, clearly identifying the key risks and defining a clear action plan are essential.

Contact us

Benjamin Gauthier

Partner, PwC Luxembourg

Tel: +352 49 48 48 4137

Max Von Frantzius

Director, PwC Luxembourg

Tel: +352 49 48 48 4478

Prasanta Mandal

Manager, PwC Luxembourg

Tel: +352 49 48 48 5928

Follow us