Published on 28 March 2024 this circular enters into effect on 1 January 2025 and replaces CSSF Circular 02/77.
CSSF Circular 24/856 aims at extending and codifying the rules applicable to Luxembourg investment funds in the event of a NAV calculation error, an investment breach or other errors that can arise in the management of such funds. It imposes obligations in terms of the procedures that have to be in place and certain disclosures that need to be made in the prospectus.
All regulated fund structures are in scope i.e. UCITS, Part II Funds, SIFs or SICARs as well as MMFs, EuVECAs, EuSEFs and ELTIFs regardless of form.
It sets out clearly the rules applicable to each entity concerned by such errors/breaches including the fund’s governing body, the AIFM or management company, the administrator, and the depositary.
The circular makes it clear that the governing body of the fund (or the managers of the portfolio manager under the supervision of the governing body of the fund) must ensure that there are proper procedures in place to avoid errors and, if they do happen, to ensure that the provisions of this circular are applied.
The CSSF is clear however that the general principle is that if an error /non-compliance causes harm, those that caused it due to non-compliance with the obligations which are applicable to them, are liable to ensure it is repaired.
NAV Calculation Errors
Each in scope fund or, if applicable, its manager, must have policies and procedures in place to ensure a proper valuation of the assets and liabilities of the fund, in accordance with all applicable rules. Such policies and procedures should limit as much as possible the risk of errors and should allow for detection of errors as soon as they happen.
While closed ended funds fall outside the scope of the rules of the conduct set out in section 4 of the circular, they are still obliged to have policies and procedures in place and to correct errors in NAV calculations.
The circular defines what a NAV calculation error is and it sets out the circumstances where it could occur.
Only NAV calculation errors that exceed certain thresholds must be notified to the CSSF and corrected in accordance with the rules set out in the circular. The circular sets out different tolerance levels (calculated as a percentage of the NAV) for different types of funds and different investment strategies including MMF, UCITS, and ELTIFs and Part II Funds available to retail investors. In certain circumstances Part II Funds and ELTIFs may apply higher thresholds than those set out in the circular.
For SIFS, SICARs, EUVECAs and EUSEFs as well as Part II Funds and ELTIFs that are only available to well informed investors or professional investors, the governing body of the fund together with the Manager can determine the tolerance thresholds considering the criteria outlined in the circular. In no event can a tolerance level be higher than 5%.
As soon as a NAV calculation error is discovered, the circular sets out detailed rules to be followed by the various parties involved to correct and remediate such error. The circular provides for two different methods of calculating the financial impact of any error - the compound method and the non-compound method. Whatever method is used should be decided by the internal policies applicable to the fund.
Breaches of Investment Rules
Once a breach of an investment rule by a fund is discovered, steps need to be taken to correct the error and indemnify the fund in case of loss. It first needs to be determined whether the breach is an active or a passive breach.
Passive breaches which result from events outside the control of the fund need to be corrected as soon as possible but are not subject to the extensive rules set out in the circular for correction and regularisation and do not need to be notified to the CSSF.
Active breaches, which are breaches resulting from intentional acts (most notably investment or disinvestment decisions), or the absence of any act or decision when a breach was foreseeable, must be dealt with in accordance with the provisions of the circular.
The CSSF points out that both pre and post trade controls need to be in place to avoid breaches in the first place and to catch them as soon as possible if they do occur. Post trade controls must be done at the latest by the date of the next following NAV calculation. In between NAV calculation dates, the CSSF expects controls to be carried out on whether assets are eligible for the fund and on the level of holdings in one issuer. Any thresholds calculated based on NAV, such as risk diversification thresholds, can be controlled on each NAV calculation date.
Once a breach is discovered, the steps necessary to regularise the fund and the calculations to determine whether the fund has suffered because of such breach, need to be done as soon as possible. Where the fund has suffered, it needs to be compensated. There are no tolerance thresholds.
Every fund must have a policy in place governing how investment breaches are dealt with. Such policy must set out the methods for determining the impact. The circular foresees two methods for determining the financial impact – the accounting method and the economic method.
Other Errors
In addition, the circular also sets out rules for dealing with the following:
- incorrect application of swing pricing rules,
- payment of costs/expenses not in conformity with the fund rules,
- misapplication of the cut-off rules, and
- allocation errors.
Miscellaneous
The circular also sets out rules regarding paying indemnity amounts to investors and/or to intermediaries on behalf of the end investors.
The policy put in place by the fund can allow for de minimis rules. The fund always must be compensated for the damage that it suffers but de minimis rules can be applied to amounts that should be paid to investors. Any de minimis rules should be to avoid the investor losing money, for example if bank charges exceed the amount to be paid to the investor.
Costs involved to correct a NAV calculation error, or an investment breach should not be borne by the fund.
The circular has an entire section on when the auditor becomes involved. The auditor may carry out controls that the circular has been complied with in the context of the distinct report it has to do pursuant to CSSF circular 21/790. In certain distinct cases a special auditors report will be required; namely with the error or investment breach relating to a UCITS or a Part II Fund and the total amount of indemnification being greater than EUR 50,000 or if an amount to be paid to one investor exceeds EUR 5,000.
The CSSF are to be notified via a special form of breaches or NAV calculation errors and in general, they should be informed within 4 to 8 weeks after the date that the error or breach was first detected.
The CSSF will make an amended form available for notifying errors/investment breaches prior to the entry into force of the circular on 1 January 2025.
UCITS, Part II Funds, MMFs and ELTIFs should update their prospectuses at the next update in order to inform investors that the rights of final beneficiaries may be affected when paying compensation in the event of errors/non-compliance when they have subscribed through a financial intermediary.
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