The AIFMD2 gives the option3 to Member States to allow the depositary of certain AIFs4 to be a professional entity which does not necessarily qualify as a bank5 or an investment firm6. According to a recently published Bill7, Luxembourg intends to exercise this option by introducing in the Financial Sector Act8 a new category of specialised PSF named "professional depositary of assets other than financial instruments". This memorandum purports to describe the main features of this new depositary.

1. Introduction – As far back as one may go, any piece of Luxembourg legislation dealing with investment schemes9 has always reserved the function of depositary to banks (section 2). In the advent of the AIFMD's transposition, it is likely that Luxembourg will extend the list of authorised depositaries to certain investment firms and to a new category of specialised PFS (section 3). This latter extension results from an option granted by the AIFMD to Member States (section 4) which is exercised in the Bill via the introduction of a new Article 26-1 in the Financial Sector Act (section 5). This new specialised PSF may only act as depositary for limited types of investment schemes (section 6). It will be subject to restrictions whilst also benefiting from certain flexibilities (sections 7, 8 and 9) and will require prior authorisation before commencing its activities (section 10). This new status should create additional opportunities and hence be of interest to the industry (section 11).

2. Currently eligible depositaries – Pursuant to current Luxembourg laws and as illustrated in Table I below, any Luxembourg investment scheme qualifying under the UCI Act10, the SIF Act11 or the SICAR Act12 must appoint a depositary which must be a bank established in Luxembourg. In relation to SIFs13 the depositary must have its registered office in the EU, whereas in relation to UCI IIs14 or SICARs15 the depositary may have its registered office in a non-EU Member State.

3. Eligible depositaries post-AIFMD transposition – Table II below illustrates the new eligibility regime resulting from the Bill and which should apply to non-UCITS16 investment schemes. The Bill should convey two main changes to the regime described in the foregoing section.

On one hand, the list of entities which may be appointed as depositary will, in addition to banks17, include (i) investment firms complying with the conditions set forth in Article 19 (3)i) of the AIFM Act18 and (ii) under certain conditions the new specialised PSF, which is more fully described in the following sections.

On the other hand, any non-UCITS Luxembourg investment scheme which is not a Full Scope AIF19 may appoint as depositary the Luxembourg branch of a non-EU Member State bank20.

4. Option offered by AIFMD – According to the last paragraph of Article 21.3 of the AIFMD, for AIFs which fulfil the following conditions (the "Eligibility Conditions") :

  • they have no redemption rights exercisable during the period of 5 years from the date of the initial investments21; and
  • in accordance with their core investment policy, they generally:
    • do not invest in assets that must be held in custody in accordance with Article 21.8(a) of the AIFMD; or
    • invest in issuers or non-listed companies in order to potentially acquire control over such companies in accordance with Article 26 of the AIFMD;
    • Member States may allow the depositary to be an entity (a "Qualified Entity"):
    • which carries out depositary functions as part of its professional or business activities in respect of which such an entity is subject to:
    • mandatory professional registration recognised by law; or
    • to legal or regulatory provisions or rules of professional conduct; and
  • which can provide sufficient financial and professional guarantees to enable it to perform effectively the relevant depositary functions and meet the commitments inherent in those functions.

A key component of the Eligibility Conditions which requires further precision is the term "generally". Recital (34) of the AIFMD simply lists private equity funds, venture capital funds and real estate funds among the investment schemes potentially fulfilling the Eligibility Conditions. In the absence of further explanations in the EU texts, the determination of whether the "generally" criteria is met or not should rest with the Member States and their regulators' administrative practice. See below, in section 6, for a first hint in this regard.

5. Article 26-1 – According to the Bill, Luxembourg should count among the Member States who have elected to exercise the option described in the foregoing section. Luxembourg should not, however, go as far as allowing notaries, lawyers and registrars (which are all suggested in Recital (34) of the AIFMD as Qualified Entities) to be depositaries. For the purpose of better meeting the Qualified Entity's conditions, the Bill has chosen to introduce in the Financial Sector Act a new Article 26-1 creating a new specialised PSF named "professional depositary of assets other than financial instruments" and which, for ease of language, will be hereafter simply referred to as the "Special Depositary". An unofficial English translation of this Article 26-1 is reproduced at the end of this memorandum.

6. Eligible investment schemes – According to Article 26-1, the Special Depositary may be appointed as depositary by any investment scheme qualifying under the SIF Act or the SICAR Act, as well as by any AIF22, provided this investment scheme complies with the Eligibility Conditions set forth in section 4 above. Interestingly, the commentaries of the Bill list funds investing in physical non-financial assets (such as wine or art) as well as the EuVCAs23 among the investment schemes authorised to appoint a Special Depositary as depositary. We may infer from the confirmed eligibility of EuVCAs24 that the "generally" criteria of the Eligibility Conditions should at least be met when an investment scheme invests 70% of its assets in assets other than financial instruments that can be held in custody. In our opinion, an umbrella investment scheme should only be able to appoint (or to maintain) a Special Depositary if all of its compartments meet the Eligibility Conditions individually.

7. Delegation – The following lines contain a few developments regarding the possible delegation of certain functions to or by a Special Depositary.

Delegation to a Special Depositary. According to the last paragraph of Article 26-1 (1) referred to in section 5 above, Special Depositaries are expressly authorised to safe-keep "assets other than cash or financial instruments that can be held in custody25 when this mission is delegated to them by the sole depositary of an AIF" (whether based in Luxembourg or not). In view of this last stipulation, the type of safekeeping of assets which may be delegated to the Special Depositary by the sole depositary of an AIF appears to be limited to that described in Article 21.8(b) of the AIFMD, i.e. in substance to record keeping and ownership verification.

Delegation by a Special Depositary. In certain circumstances, a Special Depositary may be willing (and as a matter of fact will sometimes be compelled) to delegate certain of its functions to third parties. Interestingly, the commentaries of the Bill confirms that the Special Depositary may delegate the safekeeping of financial instruments that can be held in custody, but adds that in such a case the delegation rules provided for in Article 19 of the AIFM Act26 should apply. In our opinion, this is only correct when the Special Depositary is acting as (or under delegation of) a depositary of a Full Scope AIF.

8. Safekeeping of financial instruments – This is somewhat a paradox of the AIFM Act. In spite of its official and legal denomination (i.e., emphasis added, "professional depositary of assets other than financial instruments"), a Special Depositary is nevertheless authorised to safe-keep any financial instruments (that can be held in custody or not). This authorisation is indirectly confirmed by the commentaries of the Bill which, as indicated in the foregoing section, expressly envisages the delegation of the safekeeping of financial instruments that can be held in custody. As a matter of fact, when acting as depositary of a Full Scope AIF, a Special Depositary is not only authorised, but is compelled pursuant to Article 21 of the AIFMD to safe-keep financial instruments that can be held in custody and belonging to this Full Scope AIF. Let us finally recall here that a Special Depositary should, on the contrary and in view of the last paragraph of Article 26-1 (1), be prohibited from safe-keeping financial instruments that can be held in custody when acting under delegation of the sole depositary of a Full Scope AIF.

9. Other activities – The commentaries of the Bill confirm that – although incompatible with an activity of collective management for investment schemes – the new licence of Special Depositary created by Article 26-1 may be combined with other PSF licences including that of administrative agent27, registrar agent28, client communication agent29 or corporate domiciliation agents30. The commentaries, however, specify that if a Special Depositary combines the role of depositary and administrative agent for the same investment scheme, it might be appropriate to implement a hierarchical and functional separation to properly supervise the identification and management of potential conflicts of interests between the depositary and the AIF, the investors of the latter and the AIF's AIFM, it being understood that provisions of the AIFM Act relevant to depositaries will apply.

10. Authorisation – As imposed by Article 15 of the Financial Sector Act on any PSF, a Special Depositary will not be authorised to start conducting its activities without holding a written authorisation from the Minister responsible for the CSSF, which is granted pursuant to the procedure set forth in Article 15 of the Financial Sector Act. In addition to the general applicable conditions set forth in Section 1 of Chapter 2 of Part I of the Financial Sector Act, the upcoming Article 26-1 (2) will require that (i) the authorisation to act as Special Depositary shall only be granted to legal persons and that (ii) it is conditional on the production of evidence of capital amounting to not less than 500,000 Euros31.

11. Conclusion: New opportunities for the industry – The new regime is, without any doubt, eagerly awaited by private equity and real estate fund managers and promoters (who have long been questioning the requirement to appoint a bank as depositary), but also by entities servicing these promoters and managers, including administrative agents. As a matter of fact, in very practical terms and at the risk of repeating certain of the above developments, it can be expected that the activities which will actually be performed by a Special Depositary in Luxembourg (i.e. activities performed without delegation to a third party) will mainly consist of oversight and monitoring duties (as per Articles 21.7 and 21.9 of the AIFMD) as well as of record keeping and ownership verification (safekeeping of assets within the meaning of Article 21.8(b) of the AIFMD). In other words, the activities actually performed by a Special Depositary will mainly consist of duties which are not custodianship of assets in the "civil" sense of the term. Luxembourg service providers (which for that matter includes both depositaries and administrative agents) have long been developing human knowledge and expertise as well as adequate systems and processes in this field, particularly (over the past 10 years at least) in relation to schemes investing in private equity, real estate and more generally in non-financial instruments which precisely form the clientele targeted by Special Depositaries. Luxembourg administrators which do not currently qualify as banks are now offered the possibility to extend their licence to become Special Deposi tary and, without further extension to a full banking licence, be able to capitalise on and further develop these capacities, know-how and experience by offering a one-stop shop (depositary and administration) to Luxembourg AIFs and non-EU AIFs, as well as – under delegation – to other depositaries of AIFs, whether based in Luxembourg or not. Further, it cannot be excluded that – for joint venturing, more neutral labelling or other streamlining purposes – certain banks will regroup and lodge these activities and associated resources in a dedicated Special Depositary. In the medium to long term, it can finally be expected that the new competition faced by well-established banks will spur cost reduction and/or increase innovation, productivity and quality, which will together ultimately contribute to the enhancement of the attractiveness of Luxembourg as a top international financial centre.

Art. 26-1. Professional depositary of assets other than financial instruments.32

(1) Professional depositaries of assets other than financial instruments are professionals who engage in the activity of depositary for:

  • specialised investment funds within the meaning of the SIF Act,
  • investment companies in risk capital within the meaning of the SICAR Act,
  • AIFs,

for which no redemption right may be exercised during a period of five years from the date of the initial investments and which, in accordance with their core investment policy, generally do not invest in assets that must be held in custody in accordance with Article 19, paragraph 8, point (a) of the AIFM Act or generally invest in issuers or non-listed companies in order to potentially acquire control over such companies in accordance with Article 24 of the AIFM Act.

Professional depositaries of assets other than financial instruments may also engage by delegation in the safekeeping of assets other than cash or financial instruments that can be held in custody when this mission is delegated to them by the sole depositary of an AIF.

(2) Authorisation to act as professional depositaries of assets other than financial instruments shall only be granted to legal persons. It is conditional on the production of evidence of capital amounting to not less than 500,000 Euros.

Footnotes

1 The preparatory work, analysis and drafting of a memorandum rarely result from the sole efforts of the person signing it. However basic, this memorandum makes no exception to that. In this case, the efforts have been shared by several Elvinger, Hoss & Prussen colleagues, in particular by Jacques Elvinger, Xavier Le Sourne, Virginie Lebbe and La Vigar. Thank you to all of them.

2 "AIFMD" refers to the Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers.

3 Article 21.3, last paragraph of the AIFMD.

4 "AIF" refers to an Alternative Investment Fund within the meaning of the AIFMD.

5 "bank" refers to a credit institution within the meaning of the Financial Sector Act (as defined in footnote 8).

6 In addition to banks and investment firms, Article 21.3, 1st paragraph of the AIFMD also considers, in its item (c), as eligible "another category of institution that is subject to prudential regulation and ongoing supervision and which, on 21 July 2011, falls within the categories of institution determined by Member States to be eligible to be a depositary under Article 23(3) of Directive 2009/65/EC". The category of depositaries described in this item (c) is, however, irrelevant for Luxembourg.

7 "Bill" refers to the Luxembourg Bill of Law Nr 6471 deposited with the Luxembourg Parliament on 24 August 2012 and relating to the Alternative Investment Fund Managers Act (the "AIFM Act"). The Bill is currently only available in French (click here to consult the Bill). An English translation will be available on www.ehp.lu shortly.

8 "Financial Sector Act" refers to the Luxembourg Act of 5 April 1993 on the financial sector, as amended.

9 In the context of this memorandum, investment schemes include SICARs (as defined in footnote 15).

10 "UCI Act" refers to the Luxembourg Act of 17 December 2010 concerning undertakings for collective investment, as amended.

11 "SIF Act" refers to the Luxembourg Act of 13 February 2007 relating to specialised investment funds, as amended.

12 "SICAR Act" refers to the Luxemburg Act of 15 June 2004 relating to the investment company in risk capital (or société d'investissement en capital à risque).

13 "SIF" refers to a Luxembourg investment scheme qualifying under the SIF Act.

14 "UCI II" refers to a Luxembourg investment scheme qualifying under Part II of the UCI Act.

15 "SICAR" refers to a Luxembourg investment scheme qualifying under the SICAR Act.

16 "UCITS" refers to a Luxembourg investment scheme qualifying under the EU Directive 2009/65/CE of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (the "UCITS Directive"). Although this is not the subject matter of this memorandum, it is interesting to note that the UCITS Directive gives the option to Member States to authorise UCITS to appoint an investment firm as depositary. Luxembourg has not, however, exercised this option in the past and does not intend to exercise it on the occasion of the Bill. It should also be noted that the regime currently applicable to depositaries of UCITS will be profoundly revamped following transposition in Luxembourg of the so-called UCITS V Directive (currently in draft form).

17 Article 21.3, 1st paragraph, item (a) of the AIFMD.

18 Article 19 (3)i) of the AIFM Act reflects the provisions of Article 21.3, 1st paragraph, item (b) of the AIFMD which reads as follows:"The depositary shall be [...] an investment firm having its registered office in the Union, subject to capital adequacy requirements in accordance with Article 20(1) of Directive 2006/49/EC including capital requirements for operational risks and authorised in accordance with Directive 2004/39/EC and which also provides the ancillary service of safe-keeping and administration of financial instruments for the account of clients in accordance with point (1) of Section B of Annex I to Directive 2004/39/EC; such investment firms shall in any case have own funds not less than the amount of initial capital referred to in Article 9 of Directive 2006/49/EC". In addition to specifying the requirement for a minimum subscribed and paid-in capital of 730,000 Euros, Article 19 (3)i) of the AIFM Act insists on the requirement for (i) the investment firm concerned to have internal governance mechanisms which are appropriate for the conduct of the activity of depositary and (ii) prior notice being given to, and nihil obstat being obtained from, the Luxembourg Commission de Surveillance du Secteur Financier ("CSSF").

19 "Full Scope AIF" refers to an AIF which is (i) an AIF whose AIFM does not benefit from the derogation provided for by Article 3.2 of the AIFMD, or (ii) an AIF whose AIFM benefits from, but has not made use of, the derogation provided for by Article 3.2 of the AIFMD; whereas "AIFM" refers to an Alternative Investment Fund Manager within the meaning of the AIFMD. Article 19 (3) of the AIFM Act.

20 Although this is not the subject matter of this memorandum, it is interesting to note that, according to the Bill, depositaries of non-UCITS Luxembourg investment schemes which are not Full Scope AIFs will not be subject to the depositary regime set forth in Article 21 of the AIFMD or Article 19 of the AIFM Act (among other things regarding delegation and liability) and will hence remain subject to the current regime.

21 Which, by analogy with Article 3.2(b) of the AIFMD (and although the latter is more explicit in this regard), we understand to mean "initial investments in" and not "initial investments by" the investment scheme under consideration.

22 In this context and for the avoidance of doubt, AIF includes any investment scheme qualifying under Part II of the UCI Act as well as an AIF established in an EU Member State other than Luxembourg or an AIF established in a non-EU Member State and which has Luxembourg as its Member State of reference.

23 "EuVCAs" refers to the European Venture Capital Funds within the meaning of the amended proposal for a Regulation on European Venture Capital Funds published by the EU Council on 26 March 2012 the "EuVCAs Regulation". For more information on this topic, see www.ehp.lu/uploads/media/LFR_22_EuVECA_Label.pdf.

24 Which, according to Recital (8) of the EuVCAs Regulation, "are those funds that invest at least 70 percent of their aggregate capital contributions and uncalled committed capital to investments in such undertakings" and which "can never invest more than 30 percent of [their] aggregate capital contributions and uncalled committed capital in assets other than qualifying investments".

25 "financial instruments that can be held in custody" refer to the financial instruments defined in Article 21.8 (a) of the AIFMD.

26 Article 19 of the AIFM Act transposes Article 21 of the AIFMD.

27 Article 29-2 of the Financial Sector Act.

28 Article 25 of the Financial Sector Act.

29 Article 29-1 of the Financial Sector Act.

30 Article 28-9 of the Financial Sector Act.

31 Article 26 of the Financial Sector Act provides that the authorisation to act as professional custodian of financial instruments is conditional on the production of evidence of capital amounting to not less than 730,000 Euros.

32 Where applicable, this translation uses the foregoing defined terms.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.