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Specific rules applicable to Luxembourg
undertakings for collective investment
("UCI") pursuing alternative
investment strategies issued by the Commission
de Surveillance du Secteur Financier (CSSF)
in 2004.
Preamble
The law of 30 March 1988 relating to UCIs
does not comprise any provisions regarding
restrictions applicable to UCIs governed
by Part II of such law. Such restrictions
are fixed in the IML Circular 91/75 of
21 January 1991 applicable to
UCIs. However, the UCIs who adopt alternative
investment strategies are not specifically
covered by the provisions of the above-mentioned
circular. Therefore, in the past, the
investment restrictions applicable to
UCIs pursuing so called "alternative"
investment strategies were dealt with
by the Commission for the Supervision
of the Financial Sector ("CSSF")
on a case by case basis.
Considering the increasing number of applications
for the creation and authorisation of
Luxembourg UCIs which pursue investment
strategies similar to those pursued by
"hedge funds" or "alternative
investment funds", the CSSF would
like to clarify the legal and regulatory
framework applicable to such UCIs.
This circular is issued in the context
of the existing legal framework and its
purpose is to clarify the specific rules
applicable to Luxembourg UCIs which pursue
alternative investment strategies. In
this context and due to the high investment
risks which the investment strategies
pursued by the UCIs concerned by this
circular may entail, the CSSF pays attention
in particular to the reputation, the experience
and the financial standing of the promoters
of such UCIs. Moreover, the CSSF considers
that the professional qualification and
the experience of the directors of the
management bodies, and, if applicable,
of the investment managers and the investment
advisers are particularly important in
relation to such UCIs.
It is to be understood that the rules
laid down in chapter I of IML circular
91/75 of 21 January 1991 applicable to
UCIs other than UCITS and providing for
specific rules for three types of specialised
UCIs remain unchanged. Such rules are
not applicable to UCIs concerned by this
circular. UCIs which pursue alternative
investment strategies are subject to part
II of the law of 30 March 1988 relating
to undertakings for collective investment
as the rules set forth in chapter 5 of
such law are not appropriate for such
UCIs.
Although these UCIs have no obligation
to borrow, their investment policy may
provide for the possibility to borrow
on a permanent basis for investment purposes.
Such UCIs have to comply with the provisions
of this circular. However, the CSSF may
grant derogations to the provisions set
forth hereafter on the basis of an appropriate
justification or impose additional investment
restrictions.
Rules for diversification of risks regarding
short sales.
Short sales may, in principle, not result
in the UCI holding:
a short position on transferable securities
which are not listed on a stock exchange
or dealt on another regulated market,
operating regularly and being recognised
and open to the public. However the
UCI may hold short positions on transferable
securities which are not quoted and
not dealt on a regulated market if
such securities are highly liquid
and do not represent more than 10%
of the assets of the UCI;
a short position on transferable securities
which represent more than 10% of the
securities of the same type issued
by the same issuer;
a short position on transferable securities
of the same issuer, (i) if the sum
of the prices at which the short sales
relating thereto have been effected
represents more than 10% of the assets
of the UCI or (ii) if the short position
entails a commitment exceeding 5%
of the assets.
The commitments arising from short sales
on transferable securities at a given
time correspond to the cumulative non-realised
losses resulting, at that time, from
the short sales made by the UCI. The
non-realised loss resulting from a short
sale is the positive amount equal to
the market price at which the short
position can be covered less the price
at which the relevant transferable security
has been sold short.
The aggregate commitments of the UCI
resulting from short sales may at no
time exceed 50% of the assets of the
UCI. If the UCI enters into short sales,
it must hold sufficient assets enabling
it at any time to close the open positions
resulting from such short sales.
The short sales of transferable securities
for which the UCI holds adequate coverage
are not considered for the purpose of
calculating the total commitments referred
to above. It is to be noted that the
fact for a UCI to grant a security,
of whatever nature, on its assets to
third parties to guarantee its obligations
towards such third parties, is not to
be considered as adequate coverage for
the UCI's commitments.
In connection with short sales on transferable
securities, undertakings are authorised
to enter, as borrower, into securities
lending transactions with first class
professionals specialised in this type
of transactions. The counterparty risk
resulting from the difference between
(i) the value of the assets transferred
by a UCI to a lender as security in
the context of the securities lending
transactions and (ii) the debt of the
UCI owed to such lender may not exceed
20% of the assets of the UCI. It is
to be noted that UCIs may, in addition,
grant guarantees in the context of systems
of guarantees which do not result in
a transfer of ownership or which limit
the counterparty risk by other means.
Borrowings
UCIs referred to in this circular may
borrow permanently and for investment
purposes from first class professionals
specialised in this type of transactions.
Such borrowings are limited to 200%
of the net assets of the UCI. Consequently,
the value of the assets of the UCI may
not exceed 300% of the net assets of
the UCI .
UCIs pursuing a strategy which entails
a high degree of correlation between
long positions and short positions are
authorised to borrow up to 400% of their
net assets. The counterparty risk resulting
from the difference between (i) the
value of the assets transferred by the
UCI to a lender as security in the context
of the borrowing transactions and (ii)
the debt of the UCI owed to such lender
may not exceed 20% of the assets of
the UCI. It is to be noted that UCIs
may, in addition, grant guarantees in
the context of systems of guarantee
which do not result in a transfer of
ownership or which limit the counterparty
risk by other means.
The counterparty risk resulting from
the sum of (i) the difference between
the value of the assets transferred
as security in the context of the borrowing
of securities and the amounts due under
item A.5 above and (ii) the difference
between the assets transferred as security
and the amounts borrowed referred to
above may not exceed, in respect of
a single lender, 20% of the assets of
the UCI.
Restrictions applicable to investments
in undertakings for collective investment
(" target UCIs")
The UCIs referred to in this circular
may, in principle, not invest more than
20% of their net assets in securities
issued by the same target UCI. For the
purpose of this 20% limit, each compartment
of a target UCI with multiple compartments
is to be considered as a distinct target
UCI provided that the principle of segregation
of the commitments of the different
compartments towards third parties is
ensured. The UCI referred to may hold
more than 50% of the units of a target
UCI, provided that, if the target UCI
is an UCI with multiple compartments,
the investment of the UCI concerned
by this circular in the legal entity
constituting the target UCI represents
less than 50% of the net assets of the
UCI concerned by this circular.
These restrictions are not applicable
to the acquisition of units of open-ended
target UCIs if such target UCIs are
subject to risk diversification requirements
comparable to those applicable to UCIs
which are subject to part II of the
law of 30 March 1988 and if such target
UCIs are subject in their home country
to a permanent supervision by a supervisory
authority set up by law in order to
ensure the protection of investors.
This derogation may not result in an
excessive concentration of the investments
of the UCI in one single target UCI
provided that for the purpose of this
limitation, each compartment of a target
UCI with multiple compartments is to
be considered as a distinct target UCI
if the principle of segregation of the
commitments of the different compartments
towards third parties is ensured.
UCIs which principally invest in other
UCIs must make sure that their portfolio
of target UCIs presents appropriate
liquidity features to enable the UCI
to meet its obligation to repurchase
its shares. Their investment policy
must comprise an appropriate description
in that respect.
Additional Investment Restrictions.
UCIs referred to in this circular shall,
in principle, not:
invest more than 10% of their assets
in transferable securities which are
not quoted on a stock exchange or
dealt on another regulated market,
which operates regularly and is recognised
and open to the public,
acquire more than 10 % of the securities
of the same nature issued by the same
issuer,
invest more than 20% of their assets
in securities issued by the same issuer.
The restrictions set forth under a),
b) and c) above are not applicable to
securities issued or guaranteed by a
member state of the OECD or by its local
authority or by supranational institutions
and organisations with European, regional
or worldwide scope.
The restrictions set forth under a),
b) and c) above are not applicable to
units or shares issued by target UCIs.
The restrictions set forth in section
C. above are applicable to investments
in target UCIs.
Use of derivative financial instruments
and other techniques
The UCIs referred to in this circular
are authorised to make use of the derivative
financial instruments and the techniques
referred to hereafter. The derivative
financial instruments may include, amongst
others, options, forward contracts on
financial instruments and options on
such contracts as well as swap contracts
by private agreement on any type of
financial instruments. In addition,
such UCIs may participate in securities
lending transactions as well as sale
with right of repurchase transactions
and repurchase transactions1. UCIs which
make use of such derivative financial
instruments and techniques must indicate
in their prospectus a maximum leverage
which may not be exceeded and include
in their prospectus a description of
the risks arising from the transactions
which they intend to pursue. The derivative
financial instruments must be dealt
on an organised market or contracted
by private agreement with first class
professionals specialised in this type
of transactions.
The aggregate commitments resulting
from short sales of transferable securities
together with the commitments resulting
from financial derivative instruments
entered into by private agreement and,
if applicable, the commitments resulting
from financial derivative instruments
dealt on a regulated market may not
exceed at any time the assets of the
UCI.
Restrictions relating to derivative
financial instruments
1. Margin deposits in relation to derivative
financial instruments dealt on an organised
market as well as the commitments arising
from derivative financial instruments
contracted by private agreement may
not exceed 50% of the assets of the
UCI. The reserve of liquid assets of
such UCIs must represent at least an
amount equal to the margin deposits
made by the UCI. Liquid assets do not
only comprise time deposits and regularly
negotiated money market instruments
the remaining maturity of which is less
than 12 months, but also treasury bills
and bonds issued by OECD member countries
or their local authorities or by supranational
institutions and organisations with
European, regional or worldwide scope
as well as bonds listed on a stock exchange
or dealt on a regulated market, which
operates regularly and is open to the
public, issued by first class issuers
and being highly liquid.
2. The UCI may not borrow to finance
margin deposits.
3. The UCI may not enter into contracts
relating to commodities other than commodity
future contracts. However, the UCI may
acquire, for cash consideration, precious
metals which are negotiable on an organised
market.
4. The premiums paid for the acquisition
of options outstanding are included
in the 50% limit referred to under item
1. above.
5. The UCI must ensure an adequate spread
of investment risks by sufficient diversification.
6. The UCI may not hold an open position
in anyone single contract relating to
a derivative financial instrument dealt
on an organised market or a single contract
relating to a derivative financial instrument
entered into by private agreement for
which the margin required or the commitment
taken, respectively, represents 5% or
more of its assets.
7. Premiums paid to acquire options
outstanding having identical characteristics
may not exceed 5% of the assets.
8. The UCI may not hold an open position
in derivative financial instruments
relating to a single commodity or a
single category of forward contracts
on financial instruments for which the
margin required (in relation to derivative
financial instruments negotiated on
an organised market) together with the
commitment (in relation to derivative
financial instruments entered into by
private agreement) represent 20% or
more of the assets.
9. The commitment in relation to a transaction
on a derivative financial instrument
entered into by private agreement by
the UCI corresponds to the non-realised
loss resulting, at that time, from the
relevant transaction.
Securities lending transactions.
The UCI may enter into securities lending
transactions in accordance with the
provisions set forth in IML Circular
91/75. However, the limitation that
securities lending transactions may
not extend beyond a period of 30 days
is not applicable if the UCI is allowed
to terminate at any time the lending
transaction and obtain the restitution
of the securities lent.
Sale with right of repurchase transactions
("opérations à réméré")
and repurchase transactions ("opérations
de mise en pension").
The UCI may enter into sale with right
of repurchase transactions which consist
in the purchase and sale of securities
where the terms reserve the right to
the seller to repurchase the securities
from the purchaser at a price and at
a time agreed between the two parties
at the time when the contract is entered
into. The UCI can also enter into repurchase
transactions which consist in transactions
where, at maturity, the seller has the
obligation to take back the asset sold
("mis en pension") whereas
the original buyer either has a right
or an obligation to return the asset
sold ("mis en pension").
The UCI can either act as buyer or as
seller in the context of the aforementioned
transactions. Its participation in the
relevant transactions is however subject
to the following rules:
Rules to bring the transactions to
a successful conclusion
The UCI may participate in sale with
right of repurchase transactions or
repurchase transactions only if the
counterparties in such transactions
are first class professionals specialised
in this type of transactions.
Conditions and limits of the transactions
During the lifetime of a sale with
right of repurchase agreement where
the UCI acts as purchaser, it may
not sell the securities which are
the subject of the contract before
the counterparty has exercised its
right to repurchase the securities
or until the deadline for the repurchase
has expired, unless the UCI has other
means of coverage. If the UCI is open
for repurchases, it must make sure
to keep the importance of such transactions
at a level such that it is at all
time able to meet its repurchase obligation.
The same conditions are applicable
in the case of a repurchase transaction
on the basis of a purchase and firm
sale where the UCI acts as purchaser
(transferee). In case where the UCI
acts as seller (transferor) in a repurchase
transaction, the UCI may not, during
the whole lifetime of the contract,
sell the ownership or pledge to a
third party, or realise a second time,
in any other form, the securities
sold. The UCI must hold at the maturity
of the repurchase transactions sufficient
assets to pay, if appropriate, the
agreed upon repurchase price payable
to the transferee.
Periodical
information of the public
In its financial reports, the UCI
must indicate separately for the sale
with right of repurchase transactions
and for the repurchase transactions,
the total amount of the open transactions
at the dates as of which the relevant
reports are issued.
Exceeding investment limits otherwise
than by investment decisions
If the percentage limits referred to
above are exceeded for reasons other
than investment decisions (market fluctuations,
repurchases), the priority objective
of the UCI must be to remedy the situation,
taking due account of the interests
of the investors.
Management and supervisory bodies
Concerning their professional qualification,
the directors of the management bodies
and, if applicable, the investment managers
and investment advisers, must have a
confirmed experience in the area of
the proposed investment policy.
Particular rules
The prospectus must contain a description
of the investment strategy of the UCI
concerned as well as a description of
the specific risks inherent to its investment
policy. The prospectus must, if applicable,
provide that:
the potential losses resulting from
short sales on transferable securities
differ from the possible losses resulting
from the investment of liquid assets
in such transferable securities. In
the first case, the loss may be unlimited
whereas, in the second case, the loss
is limited to the amount of liquid
assets invested in the transferable
securities concerned.
leverage generates an opportunity
for higher return and therefore more
important income, but, at the same
time, increases the volatility of
the value of the assets of the UCI
and, hence, the risk to lose capital.
Borrowings generate interest costs
which may be higher than the income
and capital gains produced by the
assets of the UCI.
due to the limited liquidity of the
assets of the UCI, it may not be in
a position to meet the redemption
requests of its units which may be
presented to it by its investors.
In addition, the prospectus must state
that the investment in the UCI entails
an above-average risk and is only appropriate
for persons who can take the risk to lose
their entire investment. If appropriate,
the offering prospectus must contain a
description of the investment strategy
in forward contracts and options pursued
by the UCI as well as the risks resulting
from such investment policy. It must for
example be mentioned that the forward
contract and option markets are extremely
volatile and that the risk to incur a
loss in relation to such markets and/or
in relation to short sales is very high.
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