The CSSF clarifies the relationship between MiFID II & Fund Managers

On the 10th of June 2021, the Commission de Surveillance du Secteur Financier (“CSSF”) updated its FAQs on the Law of 12 July 2013 on Alternative Investment Fund Managers, as amended (the “AIFM Law”) and the Law of 17 December 2010 relating to undertakings for collective investment, as amended (the “UCI Law”). In these FAQs, the CSSF clarified the application of Directive 2014/65/EU, as amended (“MiFID II”) to Luxembourg alternative investment managers and UCITS management companies (together “IFMs”). This contribution analyzes the impact of the new CSSF clarification on the application of MiFID II on IFMs.

1.????Background

On the 10th of June 2021, the CSSF updated its UCI Law and AIFM Law FAQs. The FAQs clarify a number of inconsistencies for Luxembourg IFMs that derive from various EU regulatory regimes that involve MiFID II, at the one, and Directive 2011/61/EU, as amended (the “AIFMD”) and Directive 2009/65/EC, as amended (the “UCITSD”), at the other hand. In particular, the updates deal with the application of MiFID II to Luxembourg IFMs.

The updates can be seen in a broader European context. The European Securities Markets Authority (“ESMA”) in its priority issues letter sent to the European Commission in August 2020 already highlighted questions with respect to a regulatory level playing field and possible circumvention of AIFMD/UCITSD regulatory standards concerning IFM delegates established in other Member States or outside the EU. With respect to EU delegates, the letter highlighted that there is not always regulatory consistency between the various EU regulatory regimes, such as, for example, between the AIFMD and UCITSD, at the one, and MiFID II, at the other hand. In the same letter, ESMA noted that, in case of delegation to non-EU delegates, the regulatory arbitrage and investor protection concerns may be further increased since the non-EU delegate is not directly subject to the AIFMD or UCITSD frameworks. Consequently, AIFs and UCITS can be largely managed on a day-to-day basis by third parties (within or outside of the EU) that are not directly subject to the AIFMD or UCITSD. To avoid regulatory arbitrage and protect EU investors, ESMA considered that legislative amendments should ensure that the management of alternative investment funds (“AIFs”) and undertakings for collective investment in transferable securities (“UCITS”) is subject to appropriate regulatory standards, irrespective of the regulatory license or location of the delegate.

In the light thereof, the CSSF clarifies in the FAQs the MiFID II status of third parties and authorized IFMs providing (i) “portfolio management services”, (ii) investment advice and (iii) marketing to or on behalf of other IFMs. The CSSF, furthermore, also clarifies relevant MiFID II exemptions that might be applicable.

This contribution continues to clarify the impact of the application of MiFID II to IFMs in the context of the above-mentioned MiFID II investment services, as addressed by the CSSF FAQ updates.

2.????“Collective Portfolio Management” versus “Individual Portfolio Management”

In the priority issues letter published by ESMA in August 2020, ESMA highlighted that Member States apply different approaches as to which rules apply in cases where investment management functions for an AIF/UCITS are performed on a delegation basis. While some national competent authorities (“NCAs”) considered these cases as discretionary portfolio management and, therefore, took the view that MiFID II rules would need to be applied, other NCAs argued that the management of AIFs/UCITS on a delegation basis would not be discretionary portfolio management and the relevant IFM performing functions on a delegation basis would only be subject to the AIFMD/UCITSD delegation rules.

The CSSF with its updated AIFM Law and UCI Law FAQs has chosen for the first approach. The management of undertakings for collective investment (“UCIs”) by IFMs is not a service under MiFID II. IFMs and their UCIs are, therefore, exempted from the scope of MiFID II under Article 1-1(2)(i) Law of 5 April 1993 on the financial sector, as amended (“LFS”) when performing the functions included in the collective portfolio management themselves. However, the exemption does not cover the functions of collective portfolio management undertaken by:

·??????????????an authorized IFM under a delegation arrangement (the “Delegate IFM”) from another authorized IFM; or

·??????????????delegated by an authorized IFM to a third party (the “Third-Party Delegate”).

a)???Third-Party Delegates

In its updated AIFM Law and UCI Law FAQs, the CSSF has opted for the approach that Third-Party Delegates that perform one or more functions of the “collective portfolio management function” do not fall under the “collective portfolio management exemption” foreseen under Article 1-1(2)(i) LFS. In such a circumstance, the IFM gives a mandate to a Third-Party Delegate to execute on its behalf the relevant activity. Furthermore, the CSSF clarifies that IFMs and UCIs qualify as “clients” under Article 1(3) LFS. Thus, the IFM becomes a client of this Third-Party Delegate and the Third-Party Delegate may be subject to the MiFID II rules if:

·??????the service rendered qualifies as an investment service or an activity under Annex II LFS;

·??????the service relates to transactions on financial instruments as defined under section B of Annex II LFS; and

·??????the service is rendered by a third party established in the EU or is considered to be rendered in Luxembourg by a third party established outside of the EU (i.e. in a third-country), as further clarified by the CSSF in Part III of CSSF Circular 19/716, as amended.

In short, Third-Party Delegates are, thus, required (i) to have a license as a “portfolio manager” under MiFID II or, if located outside the EU, (ii) have a “MiFID II third-country registration” in accordance with Part II of CSSF Circular 19/716, as amended.

b)???Delegate IFM

Where an IFM delegates the performance of one or several functions included in the collective portfolio management to another IFM, the exemption foreseen under Article 1-1(2)(i) LFS does not apply to the Delegate IFM.

In such a case, the Delegate IFM, must, depending on the tasks performed, be authorized for a “MiFID II top-up license”, i.e. to provide MiFID II discretionary portfolio management and non-core services foreseen under Article 101(3) UCI law or under Article 5(4) AIFM Law.?The mentioned non-core services include the performance of investment advice, the administration of units of UCIs and, additionally, for authorized AIFMs, the reception and transmission of orders (“RTO”).

Delegate IFMs are not subject to the full scope of MiFID II rules. Only Articles 1-1, 37-1 and 37-3 of LFS apply. Furthermore, Delegate IFMs are not authorized to provide other MiFID II services or activities than those covered under Article 101(3) UCI Law or under Article 5 (4) AIFM Law.

3.????“Investment Advice”

The CSSF in its AIFM Law and UCI Law FAQs have confirmed that “investment advice” is not listed in the functions included in the activity of collective portfolio management under Annex II UCI Law or Annex I AIFM Law.

In addition, the CSSF clarifies that, in principle, MiFID II rules apply to third parties (i.e. investment advisors) when they provide investment advice to an IFM, provided that the advice relates to financial instruments, as defined under Section B of Annex II LFS. As per Article 9 Commission Delegated Regulation (EU) 2017/565, as amended, investment advice given to an IFM that enable to take an investment decision, qualify as personal recommendations issued to a client under MiFID II as the recommendations are not issued exclusively to the public.

Furthermore, the CSSF highlights that IFMs are only authorized to provide investment advice to another IFM if the IFM is also authorized under Article 101(3)(b) UCI Law or under Article 5(4)(b)(i) AIFM Law to provide investment advice.

4.????“Marketing”

The CSSF’s AIFM Law and UCI Law FAQs confirm that the “marketing of funds” is part of the functions included in the “collective portfolio management”. Consequently, if the authorization of an IFM includes the marketing function, the IFM can perform the marketing for the funds under its management (“direct marketing”).

If the IFM does not perform the marketing function itself (i.e. “indirect marketing”), the exemption foreseen under Article 1-1(2)(i) LFS does not apply and MiFID II rules may apply to the entity undertaking the marketing function, depending on where and to whom the funds are distributed.

a)???Third Parties

The marketing of funds is not an investment service “per se” under MiFID II, as it is not part of the list of services and activities included in sections A and C Annex II LFS. However, the following MiFID II services may be used for the distribution of funds:?

·??????reception and transmission of orders relating to UCIs;

·??????execution of orders on behalf of clients;

·??????dealing on own account;

·??????portfolio management;

·??????investment advice;

·??????underwriting and/or placing of UCIs on a firm commitment basis; and

·??????placing of UCIs without a firm commitment basis.

In this respect, it should be noted that units in UCIs always qualify as “financial instruments” under section B Annex II LFS.

b)???Authorized IFMs

As explained above, if an IFM does not operate the activity of marketing by itself, the exemption foreseen under Article 1-1(2)(i) LFS does not apply.

Any Luxembourg IFM that (indirectly) markets funds that it does not directly manage on behalf of another IFM, acts as an intermediary as any investment firm covered by MiFID II and must, therefore, be authorized for a “MiFID II top-up license” under Article 101(3) UCI Law or under Article 5(4) AIFM Law, depending on the type of fund and services offered, namely:

·??????discretionary portfolio management; and

·??????investment advice relating to UCIs; or/and,

·??????safekeeping and administration of UCIs; or

·??????for authorized AIFMs, RTO relating to UCIs.

In such case, Articles 1-1, 37-1 and 37-3 LFS will be applicable to the Luxembourg IFM.

EU IFMs marketing on behalf of another IFM, in Luxembourg, funds that they do not manage directly, must be authorized for a “MiFID II top-up license” ?under Article 6(3) UCITSD or under Article 6(4) AIFMD.

5.????Relevant MiFID II Exemptions

The third parties providing investment services to IFMs may, depending upon their status as IFM or not benefit (partially) from exemptions from the MiFID II rules.?

a)???Third Parties

Third parties providing “investment services” to IFMs may benefit from the following LFS/MiFID II exemptions:

·??????intragroup service exemption under Article 1-1(2)(b) and (c) LFS;

·??????service complementary to their professional activities as foreseen under Article 1-1(2)(d) LFS;

·??????investment advice not specifically remunerated rendered in the course of providing another professional activity not covered by MiFID II under Article 1-1(2)(l) LFS.

In any case, third parties must be able to demonstrate that they fall within the scope of an exemption, should they provide services without an authorization under the MiFID II applicable framework.

b)???Authorized IFMs?

IFMs providing “investment services” (i.e. MiFID II top-up services) to other IFMs are partially exempted from the MiFID II rules.

Authorized EU IFM rendering “MiFID II top-up” services to other IFMs are partially exempted from the MiFID II rules. When providing discretionary portfolio management and non-core services under Article 101(3) UCI Law / Article 5(4) AIFM Law, they are subject to Articles 1-1, 37-1 and 37-3 LFS.

6.????Conclusion

With its AIFM Law and UCI Law FAQ updates, the CSSF has clarified that IFMs and UCIs to whom third parties/authorized IFMs provide (i) portfolio management, (ii) investment advice and (iii) marketing qualify as “clients” under MiFID II. Authorized EU IFMs and third parties (located in or outside of the EU) that provide such investment services involving financial instruments that are not exempted, thus, have to ensure that they obtain relevant (third-country) MiFID II permissions when providing such services to IFMs.

In a broader context, the CSSF interpretations could be a source of inspiration for future changes on the EU level as to the relationship between MiFID II, at the one, and the AIFMD/UCITSD, at the other hand.