Luxembourg Governance Rules – Are You on Board?

Luxembourg recently released a set of rules concerning governance arrangements of management companies. This has been an evident regulatory trend as Ireland and the UK previously made similar announcements. Here’s what UCITS and AIFMD management companies need to know.

As Brexit negotiations continue to play out, Luxembourg and Ireland are experiencing a steady influx of fund industry professionals as UK-based asset managers continue to expand their presence to increase their substance and preserve access to their EU clients. Recently, Luxembourg revamped its fund governance rules to more closely align with similar guidelines from the European Securities and Markets Authority (ESMA) and the Central Bank of Ireland (CBI).

The CSSF, Luxembourg’s regulator, released the Circular 18/698 in August, summarizing its expectations in relation to the establishment, approval, and running of Luxembourg management companies. While at first, it may seem like a significant imposition of additional requirements, upon further review, it’s clear the circular consolidated and formalized corporate governance requirements for UCITS and AIFMs that have been in practice for years now into a single binding document. The circular also addresses provisions on anti-money laundering, however for now we will primarily focus on the corporate governance elements. Industry players welcomed the circular as it gives a clearer picture and greater level of transparency to rules and expectations.

Setting up Shop

The definition of “substance” and permissible delegation have also been two hotly debated concepts within the Brexit-related asset management debate. The circular addresses these issues. As firms look to set up shop in new domiciles, such as Luxembourg, Dublin, and Frankfurt, the question arises – what does a shop really need to comply with local regulation?   The circular requires all managers have a minimum of three locally-based full time equivalent (FTE) staff, who collectively must devote a minimum of 120 hours per week to key functions. Basically, an individual must maintain a daily presence in Luxembourg to be considered “local.”

In addition, at least 2 FTEs in Luxembourg must qualify as conducting persons, collectively devoting at least 80 hours per week to key functions. However, the CSSF may grant an exemption if the assets under management (AuM) are less than €1.5 billion. The CSSF defines key functions to include: portfolio management, risk management, administration, marketing, compliance, internal audit, complaints handling, valuation, IT, and accounting. Additionally, managers cannot delegate responsibility for the oversight of outsourced tasks to a third party. The circular took effect on the date of release; however, ‎it will take management companies some time to make the required changes, especially where required to appointment new non-executive directors and conducting officers. The industry widely believes the CSSF will show a degree of leniency if management companies can at least show progress towards compliance.

What is most interesting about the requirements is the level of prescription contained in the Luxembourg rules. These numbers were also a debate in the CBI’s CP86, however the final rules take a more fluid approach. The Irish regulator argued the number of engagements directors are capable of performing can vary depending on the scale and complexity ‎of mandates. The CSSF has imposed very specific objective figures on non-executive directors and competent persons.

Two questions remain under scrutiny:

  1. Will ‎Luxembourg be required to add to its available pool of directors and conducting persons to adhere to the requirements?
  2. Will the CBI feel compelled to add a similar layer of prescription to their current guidelines to ensure consistency between the rules of EU’s two largest fund domiciles?

Across the EU, as Brexit triggers firms to relocate, and especially in Luxembourg and Dublin, regulators want to ensure that adequate resources in terms of capacity and capability are retained within the domicile of management companies in terms of fitness, probity, and decision making. Regulators are looking at firms based on AuM, number of funds, complexity of structure, breadth, and distribution models, number and geographic proximity of management company delegates, and diversity of asset classes.

Over the last ten years, across the industry, there has been greater focus on governance, substance, oversight, and reliance on technology to satisfy regulatory requirements. Financial technology products are catching up with monitoring and oversight requirements so that all is “on board” safely and efficiently. More governance and oversight would require increased usage of technology and transparent reporting.

What’s Next

In the light of the circular’s formalization of local regulatory practices, asset management service providers and custodian banks may receive more questions from asset management firms. Firms may need to further formalize the delegation of tasks and partition of responsibilities and review their set up and governance in terms of capital, people, systems, and processes.

Going forward, asset managers will increasingly require daily oversight as they face the challenge of managing complex data sets amid more stringent regulations, without additional overhead requirements and in an efficient manner. Applying expertise and continued focus and investment in machine learning, artificial intelligence, and other emerging financial technologies, custodians and administrators plan to introduce additional tools to further facilitate asset manager control and transparency, including those designed to detect anomalies, status updates, and breaks or exceptions.

This article was contributed by BBH Luxembourg’s Chief Risk Officer Mehtap Numanoglu Tasiopoulos.