ARTICLE
1 November 2024

Luxembourg Regulator Issues Recommendations For Portfolio Management Delegation By Luxembourg Fund Managers

The CSSF has released findings from its 2021-2024 review of portfolio management delegation practices among Luxembourg-based investment fund managers.
Luxembourg Corporate/Commercial Law

The CSSF has released findings from its 2021-2024 review of portfolio management delegation practices among Luxembourg-based investment fund managers. Our specialists discuss the key points in this article.

The CSSF's observations on the IFM's procedures for the selection of PM delegates

The CSSF reminds IFMs that they must establish a procedure for the selection and ongoing monitoring of their delegates. The procedure should factor in the IFM's risk appetite and should secure that the IFM acquires a clear understanding of the delegate's role. The CSSF emphasizes that the procedure must be clear on "who does what, when and how". It should e.g. identify the staff members empowered to validate the selection or change of a delegate.

The CSSF's observations on the selection of a PM delegate

The CSSF reminds IFMs that delegates must be selected with all due care. Prior to signing a delegation contract, the IFM must undertake a due diligence on its delegate. In addition, periodic due diligence must be conducted on the delegate, backed by a risk-based and multi-year plan. This process must amongst others focus on the delegate's headcount, skills, expertise, reputation and organization in general. The CSSF emphasizes that the diligence cannot solely rely on self-assessment questionnaires and onsite visit memos.

The CSSF reminds IFMs that a delegation arrangement must be justified by objective reasons. Examples of objective reasons are leveraging on expertise and achieving cost savings. The objective reasons must be documented and made available to the CSSF upon request. The CSSF clarifies that excessive reliance on delegates from the same group must be avoided.

The CSSF's observations on contracting with a PM delegate

The CSSF reminds IFMs that the delegation arrangement must be laid down in a written contract after the diligence process has been completed. The contract must accommodate the CSSF's supervision over the IFM, the IFM's compliance with the delegation framework and the IFM's diligence and monitoring of the delegate. The contract must therefore accommodate e.g. information, inspection and access rights. To secure that the PM function is conducted in line with the fund's investment policy, the contract must provide detailed information on that policy.

The CSSF's observations on ongoing monitoring of the PM delegate

The CSSF reminds that an IFM must be in a position to effectively monitor the delegate and all aspects of the delegation at all times. The IFM must secure sufficient human and technical resources to monitor the delegated functions. Monitoring must e.g. focus on compliance with the fund's investment policy and general conduct rules (e.g. acting in the best interest of investors). IFMs should monitor the delegate's compliance with the personal transaction rules aimed at preventing insider trading or trading that conflicts with the interest of the IFM or the fund. The result of the monitoring process must be documented and made available to the CSSF upon request. The CSSF recommends covering conduct rule and personal transaction rule monitoring in the IFM's internal audit plan.

The CSSF reminds IFMs that potential conflicts of interest between the delegate and the IFM and investors must be properly identified, managed, monitored and disclosed to the investors of the IFM. The IFM must keep a conflicts of interest register. The CSSF underlines that a conflicted individual must refrain form participating in discussions and decisions relating to the delegates concerned.

The IFM should verify the robustness of the delegate's control functions (compliance, risk management and internal audit) and escalate any concerns to the governing body of the delegate. The CSSF clarifies that control should be reinforced if a delegate is exposed to key person risks, has limited resources or a weak "three lines of defense" system. The three lines of defense are: the risk policy, the risk control functions and the audit function on the first two elements.

The CSSF's observations on ending the contract with the PM delegate and business continuity

The delegation contract must accommodate immediate termination when justified by investor interest. To anticipate cases where an IFM withdraws a delegation mandate, a plan must be put in place aiming to secure a smooth transfer and continuation of the PM function. The IFM and the delegate should both foresee in an adequate business continuity plan. The CSSF expects the IFM to regularly tests and verifies the adequacy of the delegate's business continuity plan. We note that, in case the "host-IFM" invokes the termination clause, the fund sponsor doesn't necessarily lose control over the fund as it usually also controls the Luxembourg general partner entity of the fund.

The CSSF invites IFMs to assess their delegation practices against its findings by the end of Q1 2025. We anticipate that this assessment will result in a certain degree of additional scrutiny on delegates by the CSSF on IFMs, but the Report is by no means a game changer.

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.

Mondaq uses cookies on this website. By using our website you agree to our use of cookies as set out in our Privacy Policy.

Learn More