Cssf Guidance And Faq Virtual Assets - Luxembourg

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CCSF Guidance And FAQ On Virtual Assets - Luxembourg:
CRYPTO FUNDS: CAN A LUXEMBOURG FUND INVEST IN CRYPTO AND OTHER VIRTUAL ASSETS?
Over the last few years, virtual assets have taken numerous forms, have experienced exponential growth, and have generated a lot of interest from both professionals and investors.

What is a virtual asset fund?
Virtual asset funds are funds that are investing into digital representations of value which may be in the form of digital tokens (such as security tokens or asset-backed tokens), virtual commodities, crypto assets, or other similar assets. Crypto funds give investors the ability to invest more flexibly in various cryptocurrencies, such as Bitcoin, Ethereum, and Ripple.

Why set up a virtual asset fund in Luxembourg?
Investment funds are collective investment vehicles, which invest in assets and may operate according to the principle of risk-spreading. Capital can then be raised from a group of investors that go beyond the small circle of persons or may raise capital in a private placement from a selected group of investors. Setting up a fund investing ...
... into virtual assets may allow investors to spread their investment risks between a selection of virtual assets, such as cryptocurrencies.

Why establish a Blockchain or Crypto fund in Luxembourg?
Luxembourg is the globally leading fund center in the world for cross-border funds, Luxembourg is the second largest investment fund center in the world after the United States and the largest fund domicile in Europe with currently more than EUR 4,7 trillion of assets under management. The country is a politically and financially stable EU country with an AAA rating. As an EU domicile, investment funds established in Luxembourg can be more easily distributed within the EU and have gained furthermore global recognition for the ease of cross-border distribution.

What is the position of the CSSF on virtual asset funds?
Virtual assets in their broadest sense are a rapidly evolving sector that constantly raises questions from professionals under the supervision of the Luxembourg Financial Supervisory Authority (Commission de Surveillance du Secteur Financier or CSSF). Many of these questions notably concern investments in virtual assets by investment funds and direct investments in virtual assets. The CSSF has recently published a statement with frequently asked questions (FAQ) on virtual assets.

The CSSF underlines that its mission is to promote an open, technology-neutral, and prudent risk-based regulatory approach. It concurs that virtual assets may present potential benefits for professionals as they may constitute an alternative to diversify their portfolios with a variety of additional types of assets. There is however a very wide variety of virtual assets, ranging from digital representations of traditional assets with a simple return/risk rationale to more complex representations of rights that are more difficult to assess.

The Luxembourg financial regulator, therefore, stresses that entities regulated by the CSSF that are contemplating engaging in an activity involving virtual assets must conduct a thorough due diligence review, considering the relevant professional’s business model and risk appetite, and weighing risks and benefits for its investors.
BELOW ARE THE MAIN ELEMENTS OF THIS STATEMENT AND THE FAQ ADDRESSED BY THE CSSF:
1. May an alternative investment fund (AIF) invest in virtual assets?
An alternative investment fund (AIF) is typically a fund investing in an alternative asset class in the broadest sense, covering private equity funds, real estate funds, hedge funds, art funds, or venture capital funds. There are different alternative investment fund types in Luxembourg, ranging from the SIF (Specialised Investment Fund), the RAIF (Reserved Alternative Investment Fund), the SICAR (Investment Company in Risk Capital), the Special Limited Partnership (SCSp or SLP), the Common Limited Partnership (SCS or CLP) to the SOPARFI (financial holding company).

The CSSF clarifies, that investing in virtual assets as defined by the AML/CTF Law may be compatible with funds that target professionals, such as AIFs. This is subject to the condition that the fund does not prevent the application of and compliance with existing regulatory requirements.
Therefore, an AIF with an authorized alternative investment fund manager (AIFM) may invest directly (and indirectly) in virtual assets under the condition that:
(i.)the AIF markets its units exclusively to professional investors and
(ii.)the authorized AIFM receives an extension of its authorization from the AIF.

In consequence, an AIF may invest in virtual assets, but those AIF with an authorized AIFM (not a registered AIFM or falling under an applicable exemption), will need to fulfill the above-mentioned conditions. A registered AIFM is not required to receive such an extension, as it is not subject to prudential supervision by the CSSF.

In addition to their volatility, liquidity, and technological risk, virtual assets have specific characteristics which affect the risk profile of the investment vehicle. In its statement, the CSSF, therefore, points out the importance of the integration phase for virtual assets in the investment policy and points out the critical role internal controls play in the approval of new products and investment strategies.
Fund managers are expected to ensure that investors are properly informed in a timely and transparent manner and that fund documentation is updated accordingly.

2. May a UCITS invest in virtual assets?
The CSSF reminded entities that are subject to its prudential supervision that investments in virtual assets (as defined in Article 1 (20b) of the Law of 12 November 2004 on the fight against money laundering and terrorist financing, as amended, “the AML/CTF Law”) are not suitable for all investors and all investment objectives.
UCITS are collective investment schemes based on a consolidated EU directive intended for the European retail market, that allow funds to operate freely throughout the EU based on a single authorization from a member state.

UCITS and other undertakings in collective investments (UCIs) that address retail investors and pension funds are accordingly not allowed to invest directly or indirectly in virtual assets.

The definition of virtual assets in the context of the above article excludes, among other things, digital assets that fulfill the conditions of financial instruments within the meaning of the Law of 5 April 1993 on the Financial Sector.

The CSSF, therefore, clarifies that any assets that qualify as financial instruments, such as shares of companies active in the virtual asset ecosystem, are not subject to this restriction and could potentially fall within the scope of eligible investments for UCITS.

3. Do Luxembourg Investment Fund Managers need any authorization for the management of virtual assets?
Each Investment Fund Manager (“IFM”) under the prudential supervision of the CSSF, which intends to manage an AIF (whether regulated or not), investing in virtual assets, needs to obtain prior authorization from the CSSF for the strategy “Other-Other-Fund-Virtual assets”.

In this context, the CSSF expects to receive, among others, the following information:
a. Description of the project and the different services providers involved;
b. Information on whether or not the investments in virtual assets will be made directly or indirectly;
c. An updated risk management policy on the management of the virtual assets;
d. An updated valuation policy including the rules as to how the value of the virtual assets will be determined;
e. Description regarding the experience of the portfolio manager (and other involved entities in the investment management process) in virtual assets;
f. Description of how the custody of the assets will be organized by the depositary;
g. Information regarding the targeted investors, as well as any information on the distribution channels of the AIF;
h. The IFM’s AML/CTF analysis on the assets side.

It is also stressed that entities should closely monitor and adjust their activities to any regulatory developments on virtual assets, as well as the imminent European Regulation on Markets in Crypto Assets (MICA), that could affect their investments and their investors.
Lastly, professionals should interact with the CSSF when planning activities involving virtual assets and, where appropriate, submit an application for registration as a virtual asset service provider before initiating the activity.
The full text of the CSSF guidance can be found here: https://www.cssf.lu/en/2021/11/cssf-guidance-on-virtual-assets/
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