On 31 March 2022, the CSSF provided guidance with respect to the challenges faced by investment funds holding Russian and Belarussian assets that have become illiquid as a consequence of the Ukraine crisis as well as due to the restrictive measures taken by the EU and other countries in this context, by publishing a FAQ on liquidity management tools (LMTs) that may be applied by investment funds. The FAQ addresses more specifically the segregation of assets or creation of so-called “side-pockets”.
● Which funds are in scope of the FAQ?
The FAQ mainly relates to the application of possible LMTs by UCITS but the CSSF indicates that theses LMTs might also be applied by AIFs. The CSSF further considers that a distinction has to be made to determine the relevant available LMTs between (i) funds having a limited exposure to illiquid assets, which allows the funds to continue their operations and (ii) funds having a higher exposure to such illiquid assets, which may cause problems for a normal functioning of the funds.
● What are the LMTs available for funds with limited exposure to illiquid assets?
According to the CSSF, these funds will have more straightforward and temporary options to deal with the situation, including fair valuation adjustments of the affected assets (taking into consideration the specifics of the concerned assets such as nature, currency and place of listing, and by applying appropriate haircuts that could go up to 100%) and a possible suspension of the subscriptions into the impacted sub-fund. As a next step and depending on the size of the exposure to the illiquid assets, a segregation of these assets could also be considered as further specified below.
● What are the LMTs available for funds with higher exposure to illiquid assets?
The CSSF expects these funds to suspend their subscription and redemption activities as a first immediate measure to protect the interests of the investors, before deciding in a second step to apply one of the segregation options specified below or, as a measure of last resort, to put the fund into liquidation.
● What are the possible segregation options for funds?
According to the CSSF, the following segregation options could be considered, without prejudice of any other options that could be assessed by the CSSF on a case-by-case basis (the references hereafter to “fund/sub-fund” distinguishing the situation between a UCITS without or with multiple compartments):
Option 1 – Accounting segregation of the illiquid assets of the impacted fund/sub-fund by allocating the illiquid assets to a new share class created within the same fund/sub-fund (closed to new subscription and suspended for redemptions) with the aim to realise the illiquid assets in the best interest of the investors.
Option 2 – Split of the impacted fund/sub-fund in two funds/sub-funds with (i) the existing fund/sub-fund retaining the illiquid assets and being closed to subscriptions and redemptions, and (ii) the liquid assets being transferred to a newly created fund/sub-fund. After the split, existing investors would be invested in both funds/sub-funds in a proportionate manner.
Option 3 – Split of the impacted fund/sub-fund with applying in reverse Option 2 above, meaning in this case that (i) the existing fund/sub-fund would retain the liquid assets, and (ii) the illiquid assets would be transferred to a fund/sub-fund newly created and immediately put into liquidation.
The CSSF adds that other options may be assessed on a case by case basis which will need to be discussed with the CSSF. We note in that respect that the CSSF does not specifically mention the option to segregate the illiquid assets by extracting them from the assets of the fund (by means of a distribution in kind, for example) and holding them on a fiduciary basis by a trustee pending their realization on behalf of the investors.
Amongst the three options specifically mentioned by the CSSF, the first one contemplating the allocation of the illiquid assets to a separate share class within the same fund/sub-fund seems to be the most straight forward one on the assumption that, as contemplated by the CSSF in their FAQ, the ESMA opinion on share classes of UCITS (ESMA 34-43-296) does not apply in the circumstances. Option 2 and 3 require the creation of a new fund/sub-fund and Option 3 may, in addition, raise issues as regards the transfer of illiquid assets from a fund/sub-fund to another fund/sub-fund in breach of the applicable sanctions.
● What needs to be done by funds and by when for determining the adequate segregation option?
According to the CSSF, the following actions/steps have to be undertaken:
Thorough prior analysis by the governing body of the relevant funds, which must be able to justify why the selected tool is the only possible/adequate tool to be implemented taking into consideration the best interest of the investors. Such analysis will be made by taking into account legal aspects (e.g. assessment of potential breaches with respect to the UCITS rules) as well as fiscal and accounting aspects of the envisaged option, and by ensuring that such option is compliant with, amongst others, the specific fund documentation and the sanction regime in the context of the Ukraine crisis. It should also be checked to what extent and under what conditions the approval of investors is required (although, in our opinion, questionable if the fund is suspended for redemptions).
Prior notification to the CSSF with a view to authorisation, which requires the submission of an application file to the CSSF via email containing at least the information and supporting documents listed in the FAQ.
Information of investors in accordance with the provisions set forth in the prospectus and by considering in each case if the option selected can be considered as a significant change triggering the application of a one-month period notice before being implemented (although, in our opinion, questionable if the fund is suspended for redemptions).
Ultimate responsibility of the fund’s governing body, in the context of which the CSSF stresses that it remains the responsibility of the governing body of the fund to ascertain, on basis of the constitutional documents of the fund whether the selected option is a tool that could be implemented and under what circumstances and conditions, considering, amongst others, also the provisions of article 1(5) of the UCITS Directive, which prohibits UCITS from transforming themselves into collective investment undertakings which are not covered by the UCITS Directive (we understand that Option 3 above is specifically considered here).
The FAQ comprises a Final Remark where the CSSF expresses that the CSSF reserves the right to alter its approach at any time if developments at European level would so justify or require.
In case of any questions regarding this topic, please do not hesitate to get in touch with your usual contact at Elvinger Hoss Prussen or:
Gast Juncker, Partner | Tel: +352 446644 5233 | E-mail: gastjuncker@elvingerhoss.lu
Olivia Moessner, Partner | Tel: +352 446644 5212 | E-mail: oliviamoessner@elvingerhoss.lu
Yves Elvinger, Partner | Tel: +352 446644 5271 | E-mail: yveselvinger@elvingerhoss.lu
Benjamin Rossignon, Partner | Tel: +352 446644 5234 | E-mail: benjaminrossignon@elvingerhoss.lu
