• The CSSF has issued a new circular (Circular 24/856) aiming to protect investors in the event of certain errors and breaches.
• Circular 24/856 will enter into force on 1 January 2025 and will repeal circular 02/77.
• Compared to circular 02/77, Circular 24/856 widens (i) the type of entities subject to the requirements and (ii) the type of breaches covered by the rectification rules and notification processes.
• Circular 24/856 will require in scope entities to review, amend and adapt their policies and processes in order to ensure they comply with the new requirements.

The Commission de Surveillance du Secteur Financier (“CSSF”) released circular 24/856 on the protection of investors in the event of a net asset value (“NAV”) error, a breach of investment rules and other breaches at the level of the fund (the “Circular”). The Circular¹ will enter into force on 1^st January 2025, giving management companies and alternative investment fund managers (together the “Investment Fund Managers”), management boards, administrators, depositaries, and auditors time to adapt their policies and processes to comply with the requirements of Circular. Amendments will need to be made a range of documents including to the policies of funds and Investment Fund Managers, contractual arrangements, and operational memoranda. The Circular will repeal circular 02/77 which has set out the rules to correct NAV errors and investment breaches mainly for UCITS² and Part II UCIs³ since 2002.

Compared to circular 02/77, the scope of the Circular is widened, both in terms of (i) the type of entities which will be subject to the requirements of the Circular and (ii) the type of breaches covered by the rectification rules and notification processes. The Circular also takes into consideration the latest regulatory changes and the evolution of market practices since 2002, amongst others, by clarifying the rules applicable for open-ended or semi-open-ended Luxembourg ELTIFs⁴ in case of the occurrence of a NAV calculation error.

Entities falling within the scope of the Circular

A range of entities are in scope either of all the Circular or certain parts of it. We have set out the applicable parts for the relevant “UCI”⁵ below.

Authorised Investment Fund Managers (including non-Luxembourg Investment Fund Managers managing Luxembourg UCIs/AIFs on a cross-border basis) will need to comply with the Circular if the UCIs they manage fall in one of the above categories.

Guidelines in case of an NAV calculation error

The Circular requires open-ended and closed-ended UCIs to have appropriate policies and procedures in place to (i) ensure reliable valuation of their assets and liabilities, (ii) determine the NAV in accordance with statutory and contractual requirements and (iii) minimize the risk of NAV calculation errors.

NAV calculation errors are of a lower importance for closed-ended funds than for open-ended fund because investors cannot subscribe or redeem units based on the NAV. Accordingly, the Circular requires only open-ended UCIs and their Investment Fund Managers to take all required actions to (i) correct significant NAV calculation errors, (ii) remedy any prejudice for the UCI and its investors resulting from a significant NAV calculation error and (iii) indemnify the UCI and its investors, as applicable, for losses or damages incurred as a result of a significant NAV calculation error.

As with circular 02/77, the Circular considers a NAV calculation error as ‘significant’ if the error exceeds certain materiality thresholds set out in the Circular or determined by the UCI (the “Materiality Thresholds”). The Materiality Thresholds take into consideration the type of asset class and permit adjusting the Materiality Threshold in light of the type of investors admitted to the UCI. For UCITS, Part II UCIs and AIFs that qualify as ELTIFs that are held by retail investors (i.e., who do not qualify as well-informed investors¹¹ under the applicable Product Law¹²), the following Materiality Thresholds apply:

For Part II UCIs and AIFs regulated as ELTIFs solely marketed to professional investors¹⁴ and well-informed investors, as defined in the applicable Product Law, higher materiality thresholds may be applied, provided they do not exceed 5% of the NAV and further to a detailed analysis that takes into account the characteristics of the UCI, its subscription and redemption frequencies, its investment policy, the nature of its investments, the risk profile including toward liquidity risks and valuation policy.

For AIFs that are not in the scope of the Circular, the materiality threshold can be freely determined by the management board and the Investment Fund Manager of the AIF. The threshold still should be disclosed to investors.

The Circular also outlines the procedure for correcting and remedying any significant NAV calculation errors (i.e., errors which exceed the applicable Materiality Threshold). The management board of the UCI must establish a remedial plan that details the process for (i) identifying and correcting the relevant NAV calculation error, (ii) determining the corrected NAV for the relevant calculation period, (iii) applying the corrected NAV to any subscriptions and redemptions during the relevant period, (iv) adapting the accounts and records of the fund accordingly (including any redress payment obligations arising from the erroneous NAV calculation), (v) notifying the error and the remedial plan to the investors, (vi) proceeding to indemnify the fund and its investors for losses or damages, where applicable, and (vii) implementing a remedial action plan to avoid similar errors occurring in the future.

As is the case currently under circular 02/77, investors who suffered damages as a result of the NAV calculation error exceeding the applicable Materiality Threshold (i.e., subscribed for units in the fund at an NAV that was incorrectly calculated as too high or redeemed the units at an NAV that was calculated as too low) must be indemnified for losses incurred. The indemnification can take the form of cash payment or the issuance of additional units. If a retail investor benefits from an error in the NAV calculation, the UCI cannot require the investor to make a reimbursement. If a professional investor or a well-informed investor benefit from an error in the NAV calculation, the UCI can require reimbursement.

Any significant NAV calculation error must be notified to the CSSF without delay – the Circular stipulates a notification within four to eight weeks of the discovery of such NAV calculation error as an acceptable timeframe. The CSSF has a form of notification that can be downloaded from the website. The CSSF will not acknowledge notifications but may ask for additional information on the NAV calculation error or may request changes to the proposed remedial plan.

Guidelines in the event of an Investment Breach

An investment breach occurs if a non-eligible asset is acquired for the UCI or if the acquisition, sale, or conversion of an asset actively breaches an investment limit (each an “Investment Breach”). Passive breaches caused by the changes in the value of the assets are not considered as an Investment Breach under the Circular. Equally other “involuntary” breaches are not considered as “Investment Breaches”, however, a breach that is the result of a foreseeable or avoidable action may be considered an Investment Breach.

Investment eligibility and investment limits must be monitored both on a pre-trade basis - which is particularly important for illiquid assets - and on a post-trade basis. Post-trade monitoring must be made at the latest when the next NAV is determined unless the UCI is subject to risks between two calculation dates in which case the risks should be monitored before.

If there is an Investment Breach, the Investment Fund Manager, the members of the UCI’s management board and the depositary must be informed without delay. For UCITS and AIFs investing in liquid assets, the Investment Breach must be rectified promptly. For AIFs investing in less liquid assets, the process of rectifying the Investment Breach must start without delay, even though the CSSF acknowledges that rectification process may take more time.

If the Investment Breach results in the UCI suffering losses, the party or the parties who caused or contributed to the Investment Breach must indemnify the UCI. As with circular 02/77, the Materiality Thresholds do not apply under the Circular if a NAV needs to be recalculated following the occurrence of an Investment Breach.

Guidelines in case of the occurrence of other errors

The Circular expands the type of errors that are currently covered by circular 02/77. The types of errors now includes: (i) incorrect application of swing pricing or of other anti-dilution measures; (ii) incorrect payment of fees and expenses for the UCI; (iii) incorrect application of cut-off rules; (iv) errors regarding investment allocations; and (v) any other errors that may occur, where the relevant UCI must assess whether these errors require correction and indemnification for the losses suffered by the UCI or its investors.

• For errors in the swing pricing and other anti-dilution measures, the UCI must be indemnified for the losses that the error causes. It is only required to indemnify the investors for losses incurred when subscribing or redeeming units if the applicable Materiality Threshold was exceeded.
• For excessive fees or expenses paid by the UCI, the UCI must be reimbursed. If the overpayment of fees or expenses also causes a significant NAV calculation error, investors must be indemnified if the applicable Materiality Threshold was exceeded. If the UCI has paid less fees or expenses than it should have paid, the Circular aims to protect the investors from the late payment of these fees or expenses by either requiring that the losses of the UCI are borne by the party that has caused the error or, if the amount is charged to the UCI, by recalculating the NAVs affected by the error and without applying the Materiality Thresholds.
• If the NAV must be recalculated because of the non-compliance with cut-off times¹⁵, the UCI and the investors must be indemnified for the damage caused by this error. The Materiality Thresholds cannot be applied in this case.
• In case an investment has been allocated incorrectly to a UCI, a compartment, or a class, the erroneous investment must be investigated to determine if the error negatively impacted the portfolio, by either exposing it to risks of an asset which should not have been included in the portfolio or by not benefiting from the performance of this asset. The UCI, the relevant compartment, or class must be indemnified for the damage caused by the wrong allocation. The UCI, the relevant compartment, or class can retain any gains resulting from the wrong allocation. If the wrong allocation causes a significant NAV calculation error, the guidelines applicable to a NAV calculation error, as summarized above, apply.

General guidelines on remediation of errors

Prompt indemnification

The errors should be corrected, and any indemnifications paid, as soon as possible. It is not acceptable to pay any amounts in installments. If prompt payment is not possible, the CSSF must be informed of the reasons for the delay in payment through the notification process.

Intermediaries

If the UCIs are distributed through intermediaries, the UCI must ensure that final beneficiaries (i.e. investors and not intermediaries) will be indemnified. If this is not possible, then the UCI must provide all the information and indemnification amounts to the intermediaries to proceed with such indemnifications. In the latter case, the investors must be clearly informed (in the prospectus, if one is issued, or through other means) that if they invest through the intermediaries, their rights to receive indemnification in case of an NAV error may be affected.

De minimis

The UCIs are allowed to not pay out indemnification amounts to the investors if they are under a certain pre-determined threshold (de minimis) which may be determined for each fund or compartment. The de minimis rule cannot be used in case the investors are being indemnified through issuance of new shares/units or fractions thereof. The de minimis rule cannot be applied to any indemnification amounts to be paid to the UCI.

Costs and expenses

The costs and expenses (direct or indirect) relating to the remediation of the errors shall not be paid out of the assets of the UCI, directly or indirectly, and cannot have as consequence future increase in the costs and expenses charged to the UCI.

The Circular also details the role of the auditor of the UCI, covering the types of controls they must carry out (specific and additional controls), what reports they must establish, what verifications and sampling they must carry out per type of fund and type of error and in which situations they need to notify the CSSF.

Conclusion

The overhaul of circular 02/77 became necessary given the increased number of different type of funds and their regulatory regimes and consequently the Circular provides clarity to the market. We expect further clarification with the notification forms and the FAQ which the CSSF is expected to release.

1. The Circular (only in French) is available here.
2. Undertakings for collective investment in transferable securities under part I of the act of 17 December 2010 on undertakings for collective investment, as amended (the “UCI Act”).
3. Undertakings for collective investment under part II of the UCI Act.
4. European Long Term Investment Fund under Regulation (EU) 2023/606 amending Regulation 2015/760. For a summary of ELTIF, please refer to our [OnPoint “ELTIF 2.0: retailization of private funds – the gateway to heaven or a storm in a teacup?” available here and of the recent evolution of the regulatory technical standards, please refer to our OnPoints “ELTIF 2.0 RTS: European Commission recalibrated the draft RTS proposed by ESMA”- available here and “European Commission Requests Changes to ELTIF 2.0 Draft Regulatory Technical Standards” – available here.
5. Undertakings for collective investment, going forward “UCI” shall mean those entities designated as falling within the scope of the Circular and set out in the table.
6. Money market funds subject to Regulation (EU) 2017/1131 of the European Parliament and of the Council of 14 June 2017 on money market funds, as amended.
7. Specialised investment funds under the act of 13 February 2007 on specialised investment funds, as amended (the “SIF Act”).
8. Risk capital investment companies under the act of 15 June 2005 on risk capital investment companies (the “SICAR Act”).
9. European venture capital funds subject to Regulation (EU) No 345/2013 of the European Parliament and of the Council of 17 April 2013 on European venture capital funds, as amended (“EuVECA-R”).
10. European social entrepreneurship fund subject to Regulation (EU) No 346/2013 of the European Parliament and of the Council of 17 April 2013 on European social entrepreneurship funds, as amended (“EuSEF-R”).
11. Investors who do not qualify as institutional or professional investors are falling within the scope of the definition of ‘well-informed investor’ under the relevant Product Law if (i) they confirm in writing that they adhere to the status of well-informed investor, and (ii) either invest a minimum of €125,000 or have been assessed by a credit institution within the meaning of Directive 2006/48/EC, an investment firm within the meaning of MiFID, a UCITS management company within the meaning of Directive 2009/65/EC or an EEA alternative investment fund manager authorised within the meaning Directive 2009/65/EU as having the expertise, experience, and knowledge to adequately appraise its investment.
12. Product Laws regroups for this purpose the SIF Act, the SICAR Act or the act of 23 July 2016 on reserved investment funds, as amended.
13. Money market UCIs are those falling within the scope of Regulation (EU) 2017/1131 on money market funds.
14. Professional investors, also known as professional clients, are outlined in Directive 2014/65/EU on markets for financial instruments, as amended (MiFID) and include entities that are required to be authorized or regulated to operate in the financial markets such as banks and insurance companies, certain large undertakings, national and regional governments, public bodies that manage public debt, central banks, international and supranational institutions, other institutional investors whose main activity is to invest in financial instruments, including entities dedicated to the securitization of assets or other financing transactions and individuals requested to be considered professional investors, provided they meet certain criteria, such as sufficient trading activity, portfolio size, and professional experience.
15. In this case, it must also be verified whether the non-respect of the cut-off time has not caused late trading or market timing under Circular CSSF 04/146 which could cause to additionally apply the procedures under Circular CSSF 04/146.