Guaranteed Funds In Luxembourg - The Prudential Regime In A Nutshell

Authors: Michel Mengal and Jérôme Wigny1

INTRODUCTION - BASIC CONCEPTS, A FEW FIGURES & A BIT OF HISTORY

1. Generalities - As from the early 1990s, the CSSF2 has approved the establishment of Guaranteed Funds3 in Luxembourg and developed a body of mainly unpublished prudential rules which any fund should comply with in order to name or claim itself as "guaranteed" or to suggest in any way that it is offering or securing some kind of Guarantee4 to investors. The purpose of this paper is to summarise and provide a few insights into this prudential regime, as well as to comment on it where appropriate. This paper expresses the views and is mainly based on the past daily practice of our firm, but does not purport to expose exhaustively the different types of Guarantees or Guaranteed Funds in existence nor how the latter may be operated.

2. Evolving regime - It should be noted from the outset that the praetorian regime applicable to Guaranteed Funds is evolving and that what may have been approved in the past may no longer be possible or will be subject to additional conditions. This paper is qualified entirely by the foregoing sentence. To illustrate, this means that when we refer to certain arrangements or clauses which have been approved by the CSSF, no assurance may be given that the same or similar arrangements or clauses will be approved in the future.

3. Basic concepts and features - A "Guaranteed Fund" may be defined as a fund which is marketing itself and selling its units or shares with the "Guarantee" given or suggested to each of its potential investors that, at one or several predetermined dates or periods, same investors will recover all or part of their invested capital and possibly (as is the case for most structured products) will in addition obtain any form of financial result or performance determinable on the basis of external objective criteria. 5 6 7

4. Formal agreement and third party guarantor - In anticipation of the developments below, we must point out immediately that in order to be allowed to market and sell a fund under the "guaranteed" label, it is essential for the Guarantee to be formalised by an agreement (the "Guarantee Agreement") between the Guaranteed Fund and an eligible third party guarantor (the "Guarantor"). In the absence of any such Guarantee Agreement and eligible Guarantor, the fund will merely and at most be allowed to advertise and offer its units or shares under the "protected" label.

5. A few figures and a bit of history - The first Guaranteed Fund was established in Luxembourg in 1990. By the end of 2011, 190 Guaranteed Funds were registered, with approximately EUR 40 billion assets under management.8 These funds may be set up using virtually any of the legal forms or financial label available under Luxembourg law (e.g. UCITS, Part II UCIs, SIFs, SICAVs/FCPs, etc.) and be targeting any type of investors. The prudential regime applicable to Guaranteed Funds applies equally irrespective of the form or label of the funds or of the type of investors. Although UCITS IV legislation has indirectly addressed this topic9, no specific body of legislation has been enacted for the purpose of regulating Guaranteed Funds per se, leaving it to national supervisory authorities to deal with this matter on a case-by-case basis.

   ELIGIBILITY OF THE GUARANTOR

6. Generalities - The CSSF requires that the Guarantor which will issue the Guarantee to the benefit of the Guaranteed Fund or its investors be a third party fulfilling certain eligibility conditions and criteria. These conditions and criteria are listed in the following paragraphs. The CSSF considers these to be sufficient to approve the Guarantor, but reserves the possibility to request additional conditions to be fulfilled depending on the particularities of the proposed project and intervening parties. Moreover, the CSSF will re-examine the eligibility of each Guarantor each time a new project involving a Guarantor already approved for another Guaranteed Fund is presented. As a result, the fact that a Guarantor has been approved for a previous project does not mean that it will be automatically approved for a new one.

7. Regulated entity and place of incorporation - As a matter of principle, the CSSF requires (i) that the Guarantor be a first class financial institution (e.g. a credit institution, an investment firm, a...