On 29 March 2024, the CSSF published Circular CSSF 24/856 (the ‘Circular 24/856’) on the protection of investors in the event of NAV calculation errors, non-compliance with investment rules and other errors at the level of a UCI.
Circular 24/856 replaces the previous CSSF circular 02/77 and will come into force on 1 January 2025.
Circular 24/856 applies to regulated investment funds such as UCITS, Part II UCIs, specialised investment funds and venture capital investment companies (SICARs), but also, in whole or in part, to other types of funds such as ELTIFs, MMFs, EuVECAs and EuSEFs which do not take the form of one of the aforementioned regulated investment funds.
Like the previous circular, the new circular establishes guidelines that investment management professionals must follow in the event of errors in the administration or management of a UCI.
According to the CSSF, Circular 24/856 will help maintain investor confidence in collective portfolio management in general and in the professionals operating in Luxembourg in particular.
Without being exhaustive, we set out below a few points which we consider to be important.
- Reminder of the rules under CSSF circular 02/77
The previous CSSF circular 02/77 (which remains in force until 31 December 2024) already provided for the obligation to compensate for the consequences of NAV calculation errors and non-compliance with investment rules in the following 3 cases:
- Investments that do not comply with the investment policy (obligation to realise these investments)
- Exceeding investment limits other than those for which a legal derogation was provided (by article 46 of the former law of 1988 on UCIs) (also obligation to realise these investments)
- Exceeding the limit on borrowings (obligation to reduce borrowings to the authorised limit).
In the 3 cases mentioned above, CSSF circular 02/77 provided, in addition to the aforementioned obligations, that the UCI had to be compensated “up to the amount of the damage suffered”.
In the first two cases, the loss was to be determined in principle in relation to the loss resulting for the UCI from the realisation of the unauthorised investments.
In the third case, the UCI was in principle to be compensated up to the amount of the debit interest and other charges attributable to the unauthorised part of the loans.
Circular CSSF 02/77 provides that it was possible to apply an alternative calculation method to determine the loss suffered, in particular the method consisting of determining the loss in relation to the performance which would have been achieved if the unauthorised investments had been subject to the same variations as the portfolio invested in accordance with the investment policy and the investment restrictions provided for by law or by the prospectus.
Circular CSSF 02/77 also provides that the damage must be made good by ‘those who caused the damage’, or, if these persons cannot be determined, by the promoter.
- Rules under Circular CSSF 24/856
Circular CSSF 24/856 (article 3) begins by explaining the role of the various stakeholders in dealing with errors and non-compliance. The CSSF also points out that, for investment funds which have adopted a corporate form, the directors are liable, even if an investment fund manager (IFM) has been appointed. In this case, the directors retain an obligation to supervise the IFM and may impose guidelines on the latter (even if the IFM itself delegates certain functions).
CSSF Circular 24/856 also describes the rules to be put in place as a preventive measure to avoid errors, the behaviour to be adopted after the event and the compensation rules in the event of an error in calculating the NAV (article 4), failure to comply with the investment rules of a UCI (article 5) or in the event of ‘other errors at the level of a UCI’ (article 6). Other errors at the level of a UCI’ include incorrect application of swing pricing (article 6.1.), incorrect payment of costs/fees at the level of the UCI (article 6.2.), incorrect application of cut-off rules (article 6.3.) and allocation errors at the level of investments (article 6.4.).
A new feature of this circular is that it takes into account the particularities of financial intermediaries between ‘final’ investors and the fund (e.g. a nominee bank). CSSF Circular 24/856 reminds that in the presence of such a financial intermediary, if compensation is payable to investors, the UCI must ensure that the final beneficiaries, who have subscribed or redeemed via financial intermediaries, receive the compensation due to them as a result of the error or non-compliance. If the UCI is not in a position to provide such compensation, it must provide the financial intermediaries with sufficient information to enable them to assume their responsibility towards the final investors.
CSSF Circular 24/856 provides for a ‘ de minimis ’ rule which allows (but does not oblige) UCIs not to pay compensation to investors if these amounts do not exceed a certain amount which is in principle fixed as a lump sum. The ‘de minimis’ rule must be covered by the internal policy and procedures in place for the UCI.
CSSF Circular 24/856 also provides for an alternative method of compensation, which is the allocation of additional units of the UCI instead of compensation in cash (article 7.2.3).
Like CSSF Circular 02/77, CSSF Circular 24/856 specifies the role of the auditors in the event of errors and non-compliance (article 8).
- Application of these regimes in the event of litigation or delisting?
When a regulated investment fund loses its authorisation due to a breach of one or more of the applicable legal provisions, it will, in principle, sooner or later find itself in judicial liquidation.
If there have been breaches, it is not uncommon for the liquidator to take legal action against those responsible in order to obtain compensation for the loss suffered by the fund.
The question then arises as to whether the provisions of these circulars can be applied to determine the methods for calculating the loss.
To the best of the author’s knowledge, the Luxembourg courts have so far considered the application of CSSF circular 02/77 only once, in a judgment of 13 July 2023 (no. 2023TALCH06/00969).
In this case, the liquidator of a UCITS sued the fund’s management company, seeking to hold it contractually liable for various breaches. In particular, the liquidator invoked Circular 02/77 to claim compensation for all damages and losses incurred by the fund.
In its ruling, the court recalls that CSSF Circular 02/77 is a document for the attention of professionals and is intended to provide them with rules of conduct in the event of non-compliance with the investment rules applicable to undertakings for collective investment. The court also indicated that the circular in question provides recommendations from the CSSF, but that the court is not obliged to follow these recommendations, especially as circular 02/77 provides for alternative methods of redress.
In the case in question, the Court found that the management company was at fault for failing to comply with its duty of diligence and risk control in selecting and monitoring investments, but considered that the damage caused by these faults could not be equivalent to the loss of the portfolio. The Court concluded that the damage consisted of the loss of opportunity for the Fund not to have invested in positions selected with the level of diligence and risk control required by the contractual, legal and regulatory provisions in force.
Disclaimer: The author of this article is acting as liquidator in the case which resulted in the judgment of 13 July 2023. The judgment of 13 July 2023 is not final and is currently under appeal.
