luxembourg legal update march 2013

Luxembourg Legal Update

March 2013

Summary CSSF Regulation No. 12-02 of 14 December 2012 on the fight against money laundering and terrorist financing



Criminal settlement soon in Luxembourg



Groundbreaking reform of rules for electronic archiving



The ESMA Guidelines on sound remuneration policies of AIFMs

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AIFMD Implementing Measures - The Delegated Regulation

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CSSF Regulation No. 12-02 of 14 December 2012 on the fight against money laundering and terrorist financing According to Article 2 (1) of the Regulation, the latter applies to all professionals enumerated under Article 2 of the law of 12 November 2004 on the fight against money laundering and terrorist financing (the “Law”) who are also subject to the supervision of the CSSF (the “Professionals”).

On 16 January 2013, the Commission de Surveillance du Secteur Financier (the “CSSF”) published the circular letter 13/556 (the “Circular Letter”) announcing the entry into force of the CSSF Regulation No. 12-02 of 14 December 2012 on the fight against money laundering and terrorist financing (the “Regulation”). In addition, the Circular Letter repeals and replaces (i) the former circular letter 08/387 on the fight against money laundering and terrorist financing and prevention of the use of the financial sector for the purpose of money laundering and terrorist financing, as amended (the “Circular Letter 08/387”) as well as (ii) the former circular letter 10/476 on the fight against money laundering and terrorist financing, which has abrogated and amended certain provisions of the Circular Letter 08/387.

II.

The Regulation focuses on five main subjects: risk-based approach (approche fondée sur le risque – chapter 3), customer due diligence (chapter 4), adequate internal organisation (chapter 5), cooperation with authorities (chapter 6) and control by the external auditor (chapter 7). While the basic rules and principles of the Circular Letter 08/387 are maintained in the Regulation (in simplified, completed and/or clarified form), certain of its provisions are removed completely. In particular, the Regulation no longer contains any provisions as to money laundering and terrorist financing offences, the rules applying to domiciled companies, money laundering indicators, simplified due diligence measures, the particular role of the CSSF in anti-money laundering and terrorist financing matters or the criminal and administrative sanctions applicable in the event of non-compliance.

The purpose of the present section is to provide a broad overview of the Regulation’s context of adoption as well as of the main changes that it introduces into Luxembourg law in relation to the provisions of the repealed Circular Letter 08/387. In this context, it should be noted that the Regulation considerably enhances the level of detail with which the internal procedures of the concerned professionals are regulated (i. a. in relation to internal reporting requirements, record keeping and the role of the person responsible for the fight against money laundering and terrorist financing), entailing that the internal set-up and organisation of the relevant professionals will have to be adapted accordingly. I.



Risk-based approach (chapter 3)

Articles 4 to 7 of the Regulation set out new provisions as to the Professionals’ risk evaluation and risk management obligations. Professionals are now required to classify their clients according to different risk categories each representing a different level of money laundering and terrorist financing risk. The same provisions also enumerate the risk factors and variables to be applied by the Professionals in order to determine a client’s risk level and thus the category according to which it should be classified.

Objective of the Regulation

According to the Circular Letter, the objective of the Regulation is to clarify, complete and improve the Luxembourg legal provisions on the fight against money laundering and terrorist financing (the “AML/CTF Provisions”), notably in order to address the criticism expressed by the Financial Action Task Force (the “FATF-GAFI”) in its third mutual evaluation report of February 2010, by conferring a legally binding character upon the professional obligations that were previously only set out in CSSF circular letters. The Regulation further takes into account certain of the new recommendations issued by the FATF-GAFI in February 2012.

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Key provisions of the Regulation

 



Customer due (chapter 4)

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Section 1 - Client acceptance: According to Articles 8 to 11 of the Regulation, Professionals shall adopt a client acceptance policy (politique d’acceptation des clients) which will subject each new

diligence

procedures

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beneficial owner: Articles 21, 22 and 23 of the Regulation deal with the due diligence measures regarding the beneficial owner, which have essentially remained the same as under the previous regime.

client to a specific risk assessment containing i.a. the procedures to be followed in the presence of “high risk level clients”, numbered accounts as well as contracts with prospects not resulting in a client relationship (which must be duly documented). Any acceptance of a new client shall further be subject to a written authorisation issued by a person situated at a sufficiently high level of the Professional’s internal hierarchy. -

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Section 2 - Moment of client identification and identity verification: The former possibility of opening bank accounts prior to the verification of the client’s identity is maintained, but subject to strict conditions (i. a. no disposal of any assets placed into the relevant account prior to the completion of such verification, low risk situation and verification measures to be completed swiftly). The same principles apply to bank and fund transfers. This section also addresses the moment of identification and verification measures for companies in the process of being incorporated and for occasional transactions. Section 3 - Identification and identity verification measures: This section clearly distinguishes between identification procedures on the one hand and the verification of identity procedures on the other hand. As to the former, Article 16 enumerates the precise elements of minimum client information that need to be collected, while Articles 18 and 19 enumerate the documents on the basis of which the latter are to be performed, as well as providing examples of supplementary verification measures for clients (both natural persons and legal persons). A written declaration must be sought from the client on whether or not he acts on his own account. Section 4 - Identification and identity verification of clients’ agents: Article 20 of the Regulation specifies that the definition of clients’ agents is not limited to corporate organs but includes legal representatives of incapable natural persons as well as any person to whom a mandate has been granted. They must be identified and their identity must be verified in the same way as a client’s. Their representative powers must be verified and copies of the relevant documents must be received. Section 5 – Identification and identity verification measures regarding the

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Section 6 - Information as to the purpose and intended nature of the business relationship: Article 24 of the Regulation clarifies that “knowing your customer” also means collecting and recording information as to the origin of funds, types of contemplated transactions and purpose of the client/bank business relationship and that the information gathered must be used for the ongoing monitoring of the business relationship.

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Section 7 - Record keeping: According to Article 25 of the Regulation, the Professionals’ conservation obligation shall apply to any document and information obtained following the application of customer due diligence procedures, including the results of any analysis carried out by the Professional, internal reports and decisions taken. This section also contains requirements regarding record keeping measures (which must allow that documents kept may be used as evidence in court).

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Section 8 - Enhanced customer due diligence obligations: Article 26 of the Regulation enumerates a list of general examples of enhanced customer due diligence measures. Article 28 specifies the particular type of information to be collected as well as the procedures to be applied in the presence of correspondent banks, while Article 29 further provides examples of what is meant by “relationships similar” to those with correspondent banks. The provisions in relation to politically exposed persons (“PEPs”) focus on a description of the procedures to be applied in order to determine whether or not a client, an agent or a beneficial owner qualifies as a PEP. Finally, this section describes which specific measures must be applied regarding business relationships linked to countries which do not apply or insufficiently apply AML/CTF measures.

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Section 9 - Ongoing monitoring of the business relationship: Such obligation requires professionals to detect complex operations and unusual transactions, persons/groups/entities subject to sanctions or restrictive measures as well as activities requiring particular attention, all three types 4

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Compliance Officer and whose identity must be communicated to the CSSF. Said AML/CTF Manager shall also be the main person of contact of the authorities competent for the fight against money laundering and terrorist financing.

of situations being further specified under Articles 32 to 34 of the Regulation. -

Section 10 – Due diligence measures carried out by third parties: This section deals with the conditions Professionals need to comply with when using third party introducers or delegating tasks related to customer due diligence to third parties. Article 36 of the Regulation now requires that, prior to any intervention of a third party introducer, (i) Professionals verify whether such third party introducer belongs to one of the admitted categories of entities/professions enumerated in the AML/CTF Provisions and keep record of the verification documents, and (ii) the relevant third party introducer commits, by way of written confirmation, to comply with its obligations imposed under the AML/CTF Provisions.



Adequate internal requirements (chapter 5)

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Section 1 - Fight against money laundering and terrorist financing (“AML/CTF”) policy: According to Article 38 of the Regulation, Professionals are required to set up a general AML/CTF policy covering all of the elements enumerated under said provision (notably the client acceptance policy), which shall be coordinated with their foreign subsidiaries and branches and be subject to an initial validation and ongoing control of the person responsible for the control of said policy (the “AML/CTF Manager”). These requirements are much more detailed than under previous regulatory guidance.

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Section 4 - Internal Audit: Article 44 of the Regulation specifies that the control of the AML/CTF policy shall be an integral part of the missions of the internal audit function which shall evaluate the management and surveillance of money laundering and terrorist financing risks and report back to the authorised management or the board of directors by means of annual reports.

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Section 5 - Recruiting, training and awareness-raising of employees: Article 45 of the Regulation requires Professionals to set up, for all of their employees, recruiting procedures which ensure that such employees meet certain criteria of adequate professional standing according to the risks of money laundering and terrorist financing involved with their tasks and functions. Article 46 further requires that employee training and awareness-raising programmes shall be documented in writing and enumerates a non-exhaustive list of elements that such programmes shall comprise.



Cooperation with authorities (chapter 6)

organisation

Article 48 of the Regulation specifies that any unusual or suspect operation shall be subject to a written report by the relevant client representative (chargé de clientèle) to the AML/CTF Manager who will analyse the report and decide whether to proceed with the declaration of the reported fact or transaction to the Cellule de Renseignement Financier. In the event such declaration occurs, the relevant business relationship shall be subject to enhanced customer due diligence.

Section 2 - Business relationship and transactions monitoring device: Article 39 of the Regulation requires Professionals to develop procedures and mechanisms allowing for the detection of any unsusual or suspect operation or high risk person (non-exhaustively enumerated), which shall cover the entirety of the clients’ accounts and transactions and be validated and regularly controlled by the AML/CTF Manager. Any detected operation or person must be recorded in a written report.

This Article further clarifies that declarations must also be made where no business relationship is entered into. 

Control by the external auditor (chapter 7)

Article 49 of the Regulation specifies that the external auditor’s report shall include the control by such auditor of the Professionals’ compliance with AML/CTF rules (including the Professionals’ risk assessment, its AML/CTF policy, its ongoing monitoring measures and its internal training) and with Resolution (CE) No. 1781/2006 and that the

Section 3 - AML/CTF Manager: Article 40 of the Regulation requires Professionals to appoint at least one AML/CTF Manager at the level of the Professionals’ management or authorised management (direction autorisée), who, for credit institutions and investment firms, must be the Chief

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auditor’s control shall include the Professionals’ foreign subsidiaries and branches. 

Specific rules regarding funds (chapter 2)

investment

Article 3 of the Regulation specifies that, when units or shares of a collective investment undertaking (“UCI”) or a risk capital investment company are subscribed by an intermediary acting for the account of its clients, the UCI, its management company, the risk capital investment company or, as the case may be, the respective agent of such professionals, must implement enhanced customer due diligence measures with respect to said intermediary, in accordance with Article 3-2 §3 of the Law, Article 3 §3 of the Grand Ducal regulation of 1 February 2010 providing details on certain provisions of the Law and Article 28 of the Regulation, in order to ensure that all the obligations imposed under the AML/CTF Provisions and the Regulation or at least equivalent obligations are complied with. The Regulation introduces thus into Luxembourg law a specific provision which aims at covering nominee constellations. We would be pleased to provide additional or more detailed information should further explanations be required on any of the above developed points. The CSSF Regulation No. 12-02 is available in French and in English.

For further information please contact:

Glenn Meyer Banking & Financial Services Partner Tel: +352 40 78 78 352 [email protected]

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Manfred Hoffmann Investment Funds Counsel Tel: +352 40 78 78 516 [email protected]

 

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Criminal settlement soon in Luxembourg initiative to broker a criminal settlement4. This is in contrast to Germany where the courts have the sole prerogative of initiating such a settlement. However, the defendant must always be assisted by legal counsel in order to conclude the settlement5. The Bill of law further states that the victim is not entitled to object to a criminal settlement, even though he or she is closely involved in the procedure6. It should be emphasized that the settlement will not extinguish the victim’s civil claim for compensation. The Bill of law even provides that the plaintiff’s claim for compensation could be integrated into the settlement7.

The bill of law n° 6518 (“the Bill of law”) lodged before the Luxembourg parliament is about to introduce “criminal settlement” into the Luxembourg Code of Criminal Procedure. Although the concept of criminal settlement is unfamiliar in civil law, it is certainly not a revolution. We are rather witnessing an unforeseeable and somewhat unavoidable development. The bill introducing criminal settlement is intended to create a new means to avoid lengthy criminal trials and unclog the courts. Though “criminal settlement” is commonly associated with the US equivalent of “plea bargaining”, it should be stressed that both concepts differ substantially from one another. For example, the US “plea bargaining” plays a significant part in the US criminal justice system whereas the Luxembourg procedure of criminal settlement will only apply in certain limited cases. Furthermore, Luxembourg is not taking a leading role in this area in Europe. In fact, 18 Member States of the Council of Europe (including all of Luxembourg’s neighboring countries) have already introduced criminal settlement procedures into their legal arsenals which are more or less similar to the concept of plea bargaining1.

The Luxembourg legislator intends to limit the risk of possible abuses and aims to prevent this procedure from being used as a sort of “private deal” between the Public Prosecutor and the defendant. Criminal settlements will therefore be subject to the approval of the criminal district court which will review the lawfulness of the transaction and will enter a reasoned judgment endorsing or dismissing the settlement8. As a result, the Luxembourg procedure departs from the Belgian out-of-court settlement on this issue9. Indeed Belgian law does not provide a “court control”; the settlement is valid once it is signed both by the Public Prosecutor and the defendant.

The explanatory statement to the Bill of law points out that the procedure will only apply to cases which need not be investigated given the statements and confessions made by the accused, and which may allow him to obtain a lighter sentence2.

The legislator’s intent to curb possible abuses does not stop there. The Bill of law provides that a criminal settlement will only be possible where a judgment has not yet been awarded. In other words, it will not be possible for a defendant to appeal a severe sentence and in the meantime request a settlement hoping to be better off.

The scope of the procedure covers mass litigation and complex cases such as trade and business disputes. In concrete terms, criminal settlement will be admitted for any offence (délit) or crime which is punishable with a five year maximum term of imprisonment or with a fine3. On the other hand, the settlement will not be allowed for crimes (crimes) punishable with an imprisonment which exceeds five years, and minor offences (contraventions).

In addition, a settlement will not put an end to public prosecution against others defendants who may be involved in the same case. The same is

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Article 564 of the Bill of law. “Eléments de la cohérence de la procédure pénale allemande” by Jocelyne Leblois-Happé in “La procédure pénale en quête de cohérence”, Dalloz, 2007, page 241. 6 Article 574 of the Bill of law. 7 See paragraph 2 article 574 of the Bill of law. 8 Article 575 of the Bill of law 9 “La transaction pénale de droit commun. La justice garde-t’elle son âme” by Adrien Masset and Marie Forthomme in Justine N°33-mai 2012, page 9 and seq. 5

The Bill of law also provides that the settlement should be concluded between the Public Prosecution and the defendant, both taking the 1

“La justice pénale en Europe dans le rapport 2010 de la CEPEJ" by Jean-Paul Jean; AJ Pénal, December 2010. Page 542 and seq. 2 See page 6 of the Bill of law. 3 Article 563 of the Bill of law. Copyright © 2013 Arendt & Medernach  

 

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true for civil claims which the victims may pursue against them10. Finally, the investigating magistrate will have the power to object to the transaction by issuing a reasoned order refusing to terminate the investigation against the suspect who is about to reach an agreement with the prosecutor11. Both the order handed by the investigating magistrate and the judgment entered by the Court opposing the settlement may be appealed. The Bill of law tries to strike a balance between common law pragmatism and the procedural requirements under civil law. The drafters of the Bill of law hope that criminal settlement will remove a significant amount of cases from the courts12. The bill of law is available at the Luxembourg Parliament’s website.

For further information please contact:

Christian Barandao-Bakele Dispute Resolution Associate Tel: +352 40 78 78 9452 [email protected]

François Kremer Dispute Resolution Partner Tel: +352 40 78 78 276 [email protected]

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Article 566 of the Bill of law.

Article 569 of the Bill of law. 12 See explanatory statements, page 7 last paragraph. Copyright © 2013 Arendt & Medernach  

 

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Groundbreaking reform of rules for electronic archiving status. In addition, the PSDC will be subject to professional secrecy rules.

A draft bill aimed at introducing new rules for electronic archiving was filed with the Luxembourg Parliament on 13 February 2013.

The activities carried out by the PSDC will need to comply with a specific set of rules laid down in the draft bill in order to guarantee that digitisation and archiving procedures are secure and reliable.

The purpose of the proposed new law is to better address the needs of businesses with regard to the organisational and technological realities of document archiving.

Financial sector professionals will have to outsource the digitisation and archiving of their documents to PSDCs that have been duly authorised by the financial service regulator, the CSSF. To this end, the draft bill introduces two new categories of support professionals of the financial sector (“support PSF”): the digitisation support PFS and the archiving support PFS. Entities wishing to acquire the status of digitisation support PFS and the archiving support PFS will have to demonstrate that they possess a capital share value of at least 50.000 euro for digitisation activities, and 100.000 euro for archiving activities.

The main feature of the bill is to acknowledge the legal value of electronic copies and to put in place a new legal presumption according to which the evidential value of electronic copies of certain types of documents may not be legally challenged if they have been created in accordance with applicable legal conditions. The crucial point of the new rules is that the existence of the original copies no longer poses a threat to the value as evidence of the electronic copies, as is currently implied under article 1333 of the Civil Code. The new rules apply to two types of documents: binding contracts under article 1334 of the Civil Code and the documents referred to under article 16 of the Commercial Code such as accounts, charts of accounts, letters received and sent, and supporting documents.

On the other hand, a digitised copy that has not been made by a PSDC will not benefit from the legal presumption. In such case, it will need to be proven that the electronic copy has been created in accordance with the legal requirements.

A digitised copy shall be presumed to be in conformity with and equivalent to the original document when such copy is made by a certified service provider known as a Digitisation and Archiving Service Provider (“PSDC”). A company may also choose to acquire PSDC status for its own requirements.

The provisions of the draft bill do not apply to archiving activities which do not require a guarantee of the electronic copies’ integrity. The rules laid down in the bill not only update the existing legal framework which has become obsolete, but are also a resolute step towards the future. The new legal framework presents the advantage that Luxembourg businesses may increase the efficiency and cost-effectiveness of their archiving process by resorting to electronic archiving. The Luxembourg government also believes that the new legislation will make Luxembourg more attractive for companies that wish to centralise their document digitisation and archiving activities in Luxembourg in order to benefit from the services offered by the duly certified PSDC datacenters.

PSDC status may be acquired by legal persons which are certified by the Luxembourg Office of Accreditation and Surveillance (“OLAS”) to comply with the technical regulation requirements and measures. The technical regulation is based on international standards published by the International Organisation for Standardisation (“ISO”). In order to obtain PSDC status, notification will have to be made to the Luxembourg Institute for Standardisation (“ILNAS”, Institut Luxembourgeois de la Normalisation, de l’Accréditation, de la Sécurité et qualité des produits et services). If the legal person is compliant with the requirements of the law relating to electronic archiving and the ad hoc quality system of ILNAS, it will be registered in the PSDC list by ILNAS and then acquire PSDC

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The bill of law is available at the Luxembourg Parliament’s website.

 

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For further information please contact:

Héloïse Bock IP, Commercial, Communication & Technology Partner Tel: +352 40 78 78 321 [email protected]

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The ESMA Guidelines on sound remuneration policies of AIFMs With regard to the recent developments in the context of the AIFMD, on 11 February 2013 the European Securities and Markets Authority (ESMA) published its final Guidelines on sound remuneration policies under the Alternative Investment Fund Managers Directive (AIFMD; the Directive).

bracket as the aforementioned categories of staff. For the purposes of the guidelines, remuneration comprises all forms of payments or benefits paid by the AIFM, any amount paid by the AIF itself, including carried interest (as such term is defined in the Directive), and any transfer of units or shares of the AIF, in exchange for professional services rendered by the AIFM’s identified staff. However, any payment made directly by the AIF to the identified staff which consists of a pro-rata return on any investment made by such staff members is not covered by these guidelines.

Pursuant to Article 13 (2) of the AIFMD, ESMA was entrusted with the task of adopting guidelines on sound remuneration policies which comply with the remuneration policy principles laid down in Annex II of the Directive. The underlying aims of these guidelines are to curb excessive risk taking by alternative fund managers and to help to align the interests of both fund managers and investors.

In light of the guidelines, each AIFM is required to put in place sound and prudent remuneration policies and organisational structures which avoid conflicts of interest that may lead to excessive risk taking.

This information focuses on key principles of the final guidelines, which are similar to the remuneration policy rules applicable to banks and investment firms (see our Newsflash of December 2010 regarding CEBS Guidelines on remuneration policy). I.

Scope of application of the new rules under the AIFMD

Key principles of the guidelines



Remuneration policy principles

The guidelines also confirm and develop certain principles, laid down in Annex II of the AIFM Directive, most of them stemming from the CRD III as amended in 2010.

The guidelines will apply in relation to the remuneration policies and practices for managers of alternative investment funds (AIFMs)13 including hedge funds, private equity funds and real estate funds. Apart from general requirements (such as rules on governance and on disclosure) which apply to AIFMs as a whole, they focus in particular on remuneration of identified staff of AIFMs which comprises various categories of staff whose professional activities might have a material impact on the AIF’s or the AIFM’s risk profile. The following individuals are considered to be identified staff:    

II.

senior management; risk takers; control functions; any employee whose remuneration results in his inclusion in the same remuneration

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the remuneration policy should be in line with the business strategy, objectives, values and interests of the AIFM;

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fixed and variable components of remuneration must be appropriately balanced (fixed component to be sufficiently high so as to allow for a fully flexible variable policy, including no variable remuneration);

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excessive risk taking must be limited, while variable remuneration should be performance-based and risk adjusted;

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the pay-out of part of the variable remuneration is to be deferred (40 to 60 % depending on the impact of the staff member on the AIF’s risk profile, with, as a general rule, a minimum deferral period of three to five years);

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at least 50% of the variable remuneration is to be paid in instruments with an

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Except for non-EU AIFMs which market to professional investors shares of AIFs in Member States without a passport until the end of application of the national regimes. Until then, they are only subject to the disclosure rules of the Guidelines. Copyright © 2013 Arendt & Medernach  

 

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appropriate retention policy (the 50% minimum threshold for instruments shall be applied equally to the non-deferred and the deferred part); any variable remuneration paid in instruments, either upfront or deferred, is subject to a retention period;

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early termination payment cannot reward failure;

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deferred variable remuneration is subject to an ex-post risk adjustment (malus, clawback, etc.),

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no personal hedging may undermine risk adjustment.



Delegation of activities

An AIFM which is significant should establish a remuneration committee. The guidelines provide for specific elements which shall be taken into account when determining whether or not to establish a remuneration committee, such as the AIFM’s assets under management, the legal structure of the AIFM, the number of employees of the AIFM, whether the AIFM is listed or not. 

The disclosure of the remuneration policies and practices may be made on a proportionate basis. III.

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delegates are subject to regulatory requirements on remuneration that are equally as effective as those under the guidelines; or appropriate contractual arrangements are put in place with the delegates to ensure that there is no circumvention of the remuneration rules. Application of proportionality

the

principle

Next steps

of Within two months of the publication of the translations of the guidelines into the official languages of the EU on ESMA’s website, competent authorities should confirm to ESMA whether they comply or intend to comply with the guidelines by incorporating them into their supervisory practices.

The different risk profiles and characteristics among AIFMs and within a given AIFM justify a proportionate implementation of the remuneration principles. In taking measures to comply with the remuneration principles, AIFMs should comply in a way that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities, and those of the category of staff concerned.

In case of non-response by this deadline, the competent authorities will be deemed noncompliant.

In addition, the application of the principle of proportionality may, exceptionally, lead to “the complete disapplication” of the following requirements imposed by the guidelines: the payout process (for example, the requirements relating to variable remuneration in instruments, retention, deferral and ex-post incorporation of risk for variable remuneration) and the remuneration committee (see below). However, where specific numerical requirements are set out (for example the minimum deferral period of three to five years), such criteria, if disapplied, may only be disapplied in their entirety. In other words, these numerical thresholds cannot be lowered by an AIFM based on proportionality.

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Entry into force

The new rules will apply from 22 July 2013, subject to the transitional provisions of the AIFMD. In this respect, as pointed out above, non-EU AIFMs which market funds (using passport agreements) to EU investors will also be subject in full to the guidelines after a transitional period. IV.



Disclosure

The guidelines provide for a certain flexibility with regard to the disclosure of the information which may be made through an independent remuneration policy statement, a periodic disclosure in the annual report or any other form.

When delegating portfolio management or risk management activities, AIFMs should ensure that: -

Remuneration committee

The ESMA Guidelines on sound remuneration policies under the AIFMD are available here.

 

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For further information please contact:

Camille Bourke PE/RE Investments Partner Tel: +44 207 456 9803 [email protected]

Philippe-Emmanuel Partsch EU & Competition Law Partner Tel: +352 40 78 78 350 [email protected]

Agata Kostrzewa Investment Funds Junior Associate Tel: +352 40 78 78 802 [email protected]

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AIFMD Implementing Measures - The Delegated Regulation On 19 December 2012, the European Commission released the delegated regulation supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (the “Delegated Regulation”). Such Delegated Regulation marks the “Level II” of the legislative measures expanding on the framework Directive 2011/61/EU (the “AIFMD”). The Delegated Regulation will be directly applicable in all Member States subject to a threemonth scrutiny period by the European Parliament and the Council, after which the Delegated Regulation will enter into force on the twentieth day following its publication in the Official Journal of the European Union, if no objections were raised. The Delegated Regulation shall apply from 22 July 2013. Topics covered by the Delegated Regulation include, inter alia, the calculation of assets under management and leverage, additional own funds requirements and professional indemnity insurance, operating conditions (including risk and liquidity management), delegation of AIFM functions, depositaries’ duties and liabilities, valuation, transparency and third-country rules. Due to the plethora of issues addressed by the Delegated Regulation, we will focus on those we consider of particular interest to stakeholders from a Luxembourg perspective. I.

Calculation of assets management (Art. 2-5)

under

The Delegated Regulation sets out the procedure for the calculation and monitoring of the assets under management (“AuM”) to be performed by managers of alternative investment funds (the “AIFMs”). It is notably clarified that investments in derivative instruments will require the conversion into their equivalent position in the underlying assets. Investments in another alternative investment fund (an “AIF”) managed by the same AIFM or cross-investments between compartments of one and the same AIF are disregarded for calculation purposes. The value of the AuM must be calculated at least on an annual basis, but monitored on an ongoing basis.

II.

Leverage (Art. 6-11)

The Delegated Regulation further contains provisions on the calculation of leverage, which the AIFMD defines as any method by which the AIFM increases the exposure of an AIF it manages whether through borrowing of cash, securities, or leverage embedded in derivative positions or by any other means. The exact procedure for the assessment of leverage will depend on the AIF’s investment policy. Private equity funds may for example benefit from an exclusion of the debt at target level for the purposes of determining the level of leverage incurred. The Delegated Regulation generally foresees two calculation methods to be applied conjunctively: the “gross method” and the “commitment method”. The Delegated Regulation clarifies that temporary borrowing arrangements will not need to be taken into account for the purposes of calculating the leverage, if fully covered by corresponding capital commitments. It should be noted that revolving credit facilities, often used in the context of private equity bridge financing, should not be regarded as temporary in this respect, as expressly stated in the recitals to the Delegated Regulation. The calculation of leverage, together with the assets under management of an AIF, make it possible to determine whether an AIFM will fall within the full scope of the AIMD subject to all its provisions or will merely require registration with the CSSF (Commission de Surveillance du Secteur Financier). III.

Additional own funds and professional indemnity insurance (Art. 12-15)

Covering the risks arising from professional negligence is a further concern addressed by the Delegated Regulation. It consequently provides additional guidance on the appropriate level of additional own funds to be held by the AIFM on top of its capitalization requirements under article 9 of the AIFMD or professional indemnity insurance (“PPI”) coverage to be contracted by the AIFM. Generally, an AIFM’s additional own funds representing 0.01% of the value of the portfolios of AIFs managed by the AIFM and PPI covering 0.7% of the value of the portfolios of 14

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Luxembourg Legal Update AIFs managed by the AIFM per individual claim and 0.9% of the value of the portfolios of AIFs managed by the AIFM or aggregate claims, are considered appropriate. IV.

Operating conditions and organisational requirements (Art. 16-66)

The provisions pertaining to the operating conditions cover several distinct subject matters, such as conflicts of interest, risk management, liquidity management, securitization, establishment of general administrative procedures and resource allocation. As a general rule, the Delegated Regulation stipulates that the AIFM must apply a high standard of diligence in the deal selection and investment monitoring process, to be evidenced by appropriate written procedures and policies to be adopted. The Delegated Regulation foresees the establishment of a permanent risk management function, which must be functionally and hierarchically separated from the portfolio management function. In order to avoid conflicts of interest, the risk manager will be excluded from receiving remuneration based on portfolio performance, such as carried interest. Further monetary aspects governed by the Delegated Regulation are linked to inducementrelated issues, such as “kick-backs”, which must be fully disclosed, if not paid by the AIF (or its investors), and must enhance the quality of the relevant service and must not contravene the AIFM acting in the best interests of the AIF. Unless it is managing an unleveraged closedended AIF, the AIFM must put in place an appropriate liquidity management system. Such system should enable the adequate handling of redemption requests taking into consideration the illiquid nature of portfolio investments and may require the establishment of illiquidity limits and the setting-up of special arrangements, e.g. side pockets. Moreover, stress tests should occur on an annual basis. It must be noted that certain operating conditions, e.g. in relation to the compliance function, are subject to (partial) disapplication, if the AIFM can demonstrate that certain measures are disproportionate in view of the specificities of the AIFM. V.

Valuation (Art. 67-74)

Another focus of the Delegated Regulation is the proper and independent valuation of the assets

March 2013 held by the AIF. The stipulated independence of the valuation does not necessarily mean that such valuation must be entrusted to an external valuer, but rather that the AIFM must put certain safeguards in place ensuring the functionally independent performance of the valuation task. To this end, the AIFM must implement consistent valuation policies and procedures in writing. Further provisions cover valuation models, the calculation of the net asset value per unit or share, the frequency of valuations, professional guarantees (for external valuers) and review processes for individual values of assets. VI.

Delegation (Art. 75-82)

The Delegated Regulation also sets out how the delegation of certain functions foreseen under the AIFMD must be performed. Generally, delegations must be documented by a written agreement. As a rule of thumb, the AIFM must retain the decision-making functions in relation to the risk or portfolio management and must be involved in the decision making of the delegates, as this would otherwise result in the AIFM becoming a “letterbox entity”. The existence of the latter would be assumed under the Delegated Regulation, in case the AIFM (i) is no longer in a position to adequately supervise the delegated tasks and delegates, (ii) no longer has the power to perform senior management functions or (iii) delegates investment management functions (which includes both portfolio and risk management) to a degree which substantially exceeds those performed by the AIFM. In practice, not only the latter quantitative criterion but also the appropriate delegation model per structure will need to be assessed on a case-by-case basis. It is also worth noting that any delegation must be supported and evidenced by objective reasons, such as (i) optimizing business functions and processes, (ii) cost saving, (iii) expertise of the delegate and (iv) access of the delegate to global trading capabilities. VII.

Depositary (Art. 83 -102)

Moreover, the Delegated Regulation establishes certain requirements to be fulfilled by the depositaries in relation to cash flow monitoring, financial instruments to be held in custody, general oversight duties, delegation of custody functions, segregation obligations and, last but not least, liability. The depositary and the AIFM must draw up a detailed agreement addressing all items listed in the Delegated Regulation. Certain provisions may prove quite cumbersome in practice, such as the monitoring of cash flows (for certain transactions on a daily basis) and the look15

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Luxembourg Legal Update through approach to be applied to underlying assets held by entities controlled by the AIF, although the latter will not apply to funds of funds and master-feeder structures provided that the underlying funds have a depositary performing ownership verification and record-keeping functions. VIII.

Transparency (Art. 103-112)

The transparency-related provisions focus on financial reporting and accounting standards. This includes disclosing remuneration paid to the AIFM’s staff. The financial reporting obligations pertain to both reporting to investors and competent authorities. In this context, it should be noted that certain reporting obligations, notably in relation to controlling interests, will apply as of the entry into force of the AIFMD and should thus be managed proactively by players anticipating that they will fall within the scope of the AIFMD. IX.

ESMA Guidelines on sound remuneration policies of AIFMs. The Delegated Regulation is available here. The consultation paper on guidelines on key concepts of the AIFMD is available here. The consultation paper on draft regulatory technical standards on types of AIFMs is available here.

For further information please contact:

Third-country provisions (Art. 113 - 115)

The provisions supplementing the “third country”rules contain clarifications as to the co-operation agreements that will need to be concluded between the competent authorities of the Member States (for Luxembourg this would be the CSSF), and the authorities of the third country where the AIFM or AIF, as the case may be, are based. Such clarifications target scope, content and data protection mechanisms. Currently, the European Securities and Markets Authority (“ESMA”) has approved co-operation agreements with their Brazilian and Swiss counterparts, with several other agreements set to be finalized soon. X.

March 2013

Camille Bourke PE/RE Investments Partner Tel: +44 207 456 9803 [email protected]

Myriam Moulla Investment Funds Senior Associate Tel: +352 40 78 78 561 [email protected]

Additional ESMA guidance

In addition to the Delegated Regulation, ESMA also published two consultation papers on 19 December 2012 in relation to (i) guidelines on key concepts of the AIFMD and (ii) the draft regulatory technical standards on types of AIFMs, respectively. Whilst the former relates to the definition of AIF, the latter mainly aims at clarifying the notion of open-ended vs. closed-ended funds.

Adrian Aldinger PE/RE Investments Associate Tel: +352 40 78 78 947 [email protected]

Furthermore, ESMA released its final guidelines on sound remuneration policies under the AIFMD on 11 February 2013, further details of which are set out in the article entitled the

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Luxembourg Legal Update

March 2013

This Luxembourg Legal Update of Arendt & Medernach is designed to provide our clients with information on recent developments of important legal areas. Published comments are not intended to constitute legal advice and do not substitute for the consultation with legal counsel required before any actual undertakings.

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