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IN THE PAST WEEKS, INVESTMENT FUND MANAGERS HAVE BEEN FACED WITH THE ISSUE OF MANAGING RUSSIAN AND BELARUSIAN ASSETS IN THEIR MANAGED FUNDS. THE FINANCIAL SECTOR SUPERVISION COMMISSION (CSSF) HAS NOW PUBLISHED ADVICE ON HOW TO DEAL WITH THIS SITUATION.
On 31 March 2022, the CSSF published a FAQ on the application of liquidity management tools (LMT) by investment funds. With these guidelines, the CSSF answers the questions received from market participants concerning temporary as well as more structural measures to deal with assets made illiquid due to the Ukrainian crisis and the restrictive measures taken by the EU and other countries in this context.
Although the FAQ mainly concerns UCITS, it can also apply to AIFs. Currently, the FAQ contains three questions. The first two questions relate to the LMTs that the CSSF deems suitable for dealing with the issue of illiquid assets, depending on the percentage represented by these assets in the portfolio of the fund concerned. The third question dives specifically into creating side pockets.
The CSSF emphasizes that the approach adopted, including the choice of LMTs and the valuation to be applied to the assets concerned, is the responsibility of the governing body of the investment fund concerned. The CSSF also specifies that it does not create a precedent for the systematic use of side pockets in investment funds, the FAQ only applying to illiquid assets resulting from the Ukrainian crisis.
General CML Clarifications
The CSSF specifies its expectations regarding the use of LMTs to deal with the issue of illiquid assets by funds with different exposures to these assets.
For investment funds whose exposure to illiquid assets is limited, the CSSF expects managers to apply fair valuation adjustments and, where applicable, to close the investment funds concerned to new subscriptions. investors. The CSSF also specifies that side pockets can be considered as a subsequent measure.
For investment funds with a higher exposure to illiquid assets, the CSSF expects managers to immediately suspend the investment funds concerned in order to protect investors’ interests. If necessary, investment funds can then apply structural measures such as side pocketing: for example, trying to reopen the fund with only the remaining liquid assets, or even liquidating the fund. If the governing body decides to suspend new subscriptions, the CSSF must be informed of this suspension via the usual notification process.
Three side pocket options
The CSSF provides for three segregation or “side pocket” options. However, it also clarifies that other options can be considered, leaving it to the fund’s governing bodies to find the most appropriate solution while always keeping the investors’ interests in mind.
- Option 1 | New class of shares: creation of a side pocket by allocating illiquid assets to a new class of shares with the aim of realizing them in the best interests of investors. The CSSF specifies that the ESMA opinion on UCITS share classes does not preclude this possibility.
- Option 2 | Splitting a compartment into two compartments: creation of a side pocket by splitting the compartment into two, the initial compartment retaining the illiquid assets and the cash being transferred to the new compartment. The initial compartment would be closed to subscriptions and redemptions. The CSSF also offers the possibility of creating a compartment in a new umbrella fund.
- Option 3 | Splitting of a compartment into two compartments with immediate liquidation of the illiquid compartment: creation of a side pocket by splitting the compartment into two, the initial compartment retaining the liquid assets and the illiquid assets being transferred to a new compartment which is put into liquidation immediate.
Regulatory process for setting up side pockets
Before determining the most appropriate option, the governing body of the fund must carry out a thorough analysis from a tax, legal and accounting perspective (which also covers other aspects detailed in the FAQ, such as an assessment of the costs for the selected model). The use of a side pocket is also subject to CSSF authorization, the FAQ listing the information that such authorization requests are supposed to contain.
The CSSF requires that the investors affected be informed of the option implemented, in accordance with the provisions of the prospectus on notifications to investors. When the prospectus does not provide for specific provisions relating to a particular assumption, the governance body of the fund must decide on the appropriate means of communication.
Concerning option 2 and option 3, the CSSF does not specify whether the authorization process for the creation of a new compartment will be simplified for the compartments created to set up a side pocket.
With this long-awaited FAQ, the CSSF has addressed the key questions regarding the possibility of using segregation mechanisms. We expect the positions taken by the CSSF in this FAQ to be received positively by the market as a whole, as they leave the door open to side pockets in UCITS with flexible structuring options.
However, the establishment of side pockets can raise complex issues from a legal, accounting, regulatory (such as applicable penalties) and tax point of view that should be assessed before submitting an authorization request.
For more information, please contact your usual contact within the Fund Formation Group.
To access the CSSF FAQ, Click here_
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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