The CSSF updates the rules for SIFs, Part II Funds and SICARs

Restrictions applying to specific fund-categories

1. SIFs and Part II Funds

1. The fund may invest up to 25% of its assets or commitments to subscribe in:

• one and the same entity/person, except for securities issued or guaranteed by an OECD Member State (or its local/regional authorities) or by EU/regional/global supranational institutions and bodies.

• one and the same undertaking for collective investment or other investment vehicle, unless comparable or stricter risk-spreading is ensured at the target level (as described in the target’s sales document or applicable rules), and subject, where applicable, to article 15 AIFMD requirements.

• one and the same other asset. Economically closely linked assets count as a single  asset.

2.  Short sales may not result in the SIF or Part II Fund holding a short position in securities issued by the same entity representing more than the applicable concentration limit above.

3. Where derivatives are used, the SIF or Part II Fund must ensure comparable risk-spreading through diversification of the underlying assets, and must limit unmitigated counterparty risk (not cleared by a clearing institution or not collateralised by pledge or transfer of ownership) taking into account the quality and qualification of the counterparty. 

4. The SIF or Part II Fund may invest up to 50% of its assets in one and the same infrastructure investment. 

It is important to note that the Circular allows for an increase of aforesaid maximum limits in case of a SIF or Part II Fund whose securities are reserved for well-informed investors or professional investors. In such case, the 25% limits described above are raised to 50%, whereas the 50% infrastructure limit mentioned above is raised to 70%.

Where intermediary vehicles are used, investment limits apply to the investments made through the vehicles, not to the vehicles themselves.

The CSSF may grant derogations based on a duly motivated justification, however, the regulator may also impose additional restrictions in case of a specific investment policy.

ii) Timing-based application of investment limits

The Circular sets out rules for ramp-up and wind-down periods.

1. Ramp-up period

There are different timelines depending on whether the fund mainly invests in UCITS-eligible assets or in private assets.

Where the SIF or Part II Fund invests mainly in UCITS-eligible assets, the sales document may allow a derogation from investment limits for up to 12 months following launch of the SIF or Part II Fund (typically starting with the first subscription).

Where the SIF or Part II Fund aims to make private investments, the ramp-up period may be longer but in principle may not exceed four years from launch of the fund, with an exceptional extension of up to one year subject to CSSF acceptance. 

2. Wind-down period

Where the objective of the SIF or Part II Fund is to make private investments, the sales document may provide that investment limits cease to apply during the wind-down period.

The Circular highlights that, during periods where investment limits do not apply, the SIF or Part II Fund must not be exposed to excessive risks or conflicts of interest that had not been previously identified, and available cash may be temporarily invested as provided in the sales document.

iii) Borrowing

The Circular confirms that a SIF or Part II Fund may borrow cash, in particular to make investments, cover costs and expenses, or meet redemption requests, and may encumber assets when borrowing.

According to the Circular, borrowing for investment purposes is, where the fund is marketed to unsophisticated retail investors (thus only of relevance for Part II Funds), in principle limited up to 70% of assets or commitments of such fund.

Where securities are reserved for well-informed or professional investors, such 70% limit does not apply, and those SIF or Part II Funds may set their own maximum borrowing limit.

These requirements are without prejudice to leverage requirements under AIFMD (where applicable).

The Circular clarifies that temporary borrowing arrangements fully covered by investor capital commitments are generally not regarded as borrowings, and the same applies in principle to debt securities issued by a SIF or Part II Fund whose income is linked to the performance of the assets in the portfolio of the SIF or Part II Fund.

iv) Efficient Portfolio Management Techniques

SIFs and Part II Funds may use efficient portfolio management techniques (including repo/reverse repo, securities lending/borrowing, and similar arrangements).

The Circular confirms that such techniques must be used in the interest of investors, must not change investment objectives or create higher risks than disclosed, must be economically appropriate, meaning they should reduce risk or cost, or generate additional capital or income for the SIF or Part II Fund. 

The SIF or Part II Fund must ensure risk-spreading comparable to the risk limits set out in section 1) i) above through diversification of collateral received, and must limit unmitigated counterparty risk not cleared by a clearing institution or not mitigated by collateral.

i) Risk capital requirements

The Circular clarifies that the law of 15 June 2004 relating to the investment company in risk capital, as amended, covers private equity strategies, but may also include debt financing strategies for non-listed companies.

It also highlights that various forms of capital contribution are possible and explicitly mentions loan origination, bond subscriptions, bridge or mezzanine financing as well as the acquisition of securities on the secondary market.

In order to assess compliance with the risk capital requirement, the CSSF refers to the following criteria:

1. Concept of development

The Circular highlights that it is expected that steps are taken to increase the value at the level of the target, so a purely passive (holding) approach is not sufficient.

The SICAR is expected to have a certain degree of control or supervision to ensure invested amounts are used to develop the target entity (especially for indirect investments), often through active involvement (though active intervention is not necessarily required where other factors support risk capital qualification).

2. Specific risk

The specific risk associated with the investment must go beyond market risk. A case-by-case analysis is necessary, covering aspects such as the number and type of target entities, their activities and markets, their degree of maturity and development as well as the holding period.

3. Exit strategy

According to the Circular a key indicator is the SICAR’s exit strategy. The objective of a SICAR is, in principle, the acquisition of financial assets in view of their sale at a profit after a holding period once the investment has matured or upon development by the SICAR, so investments should be time-limited with an intention to sell.

ii) Specific restrictions

As a result of such concept of risk capital, the Circular gives further details as regards the following specific restrictions:

1. Securities can be an eligible investment, even when listed on a regulated market (e.g., in case the issuer qualifies as risk capital, in case associated with development projects or a delisting). Similarly, the listing of an investment does not necessarily result in an obligation of the SICAR to disinvest. However, the Circular clarifies that ABS, CDOs and similar securities do not qualify as an eligible investment for SICARs.

2. A SICAR may hold cash to be able to meet its liabilities. The investment policy may also provide for the temporary investment of cash in liquid listed securities with low market risk and deposits pending its investment in risk capital.

3. Mezzanine financing is eligible provided the financed target entity meets risk capital eligibility criteria (for example, non-listed companies). Mezzanine financing of listed companies is only eligible where part of a specific development project, such as a delisting. Existing mezzanine and distressed debt investments may be eligible where the objective is to increase value through restructuring of the undertakings concerned.

4. Derivatives may only be used for hedging or where necessary to realise the investment policy.

5. Real estate or infrastructure assets may be invested in only through intermediary vehicles or real estate funds. However, the Circular highlights that the underlying assets must satisfy the risk capital criteria.

6. Whereas direct investments in commodities are prohibited, an indirect investment in commodities may be possible (e.g., through investments in companies that exploit commodities).

7. Target funds and other investment vehicles are permitted only where the target vehicle’s objective is aligned with the SICAR’s investment policy; private equity/venture capital target funds as well as real estate funds are acceptable insofar as their policy restricts them to assets eligible as risk capital, whereas hedge funds are generally not eligible.

8. Intermediary vehicles are acceptable where their objective restricts them to invest in risk capital. The SICAR must implement adequate measures enabling it to ensure that incoming cash is actually used for risk capital investments.

9. The Circular highlights that the SICAR-specific principles limit the use of borrowing as well as of efficient portfolio management techniques in light of the risk capital objective of the SICAR.