Luxembourg Financial Services Regulator CSSF Issues FAQ on Investments in Virtual Assets by Undertakings in Collective Investments and Credit Institutions
Like other financial centers, Luxembourg has recently seen a strongly growing interest in investments in new technologies, including virtual assets such as digital tokens. Complementary to that interest is a growing strong demand for guidance regarding the regulatory treatment of virtual assets.
Luxembourg law defines a “virtual asset” (VA) as a digital representation of value, including a virtual currency, that can be digitally traded, or transferred, and can be used for payment or investment purposes, except for digital (i) financial instruments and (ii) electronic money.1
On 4 January 2022, the Luxembourg financial sector supervisory authority, Commission de surveillance du secteur financier (CSSF), updated and complemented its frequently asked questions (FAQ) on investments in VA by (i) undertakings for collective investments and (ii) credit institutions (CI). The FAQ, which were first published at the end of 2021, are in furtherance of the CSSF’s guidance published on 29 November 2021 and its previous communications on virtual asset service providers (VASP).2 They will be updated from time to time going forward. On the European level, the forthcoming European Regulation on Markets in Crypto Assets3 is expected to influence the regulatory framework in the foreseeable future.
1. Key Takeaways of the CSSF’s November 2021 Guidance
The CSSF embraces the challenges raised by financial innovation such as VA. As part of its mission, the CSSF is committed to promote an open, technology neutral and prudent risk-based regulatory approach. Any entity under the prudential supervision of the CSSF intending to pursue an activity involving VA is required to carry out a thorough due diligence, weigh the risks and benefits of such activity and proactively engage with the CSSF when planning such activity.
2. Undertakings for Collective Investments
2.1 Investment in VA Reserved to Professional Investors
Only regulated or unregulated alternative investment funds that are marketed to professional investors (AIFs), may invest in VA. In contrast, undertakings for collective investments that are marketed to non-professional investors and pension funds generally may not invest in VA.
An AIF may invest in VA directly or indirectly (such as through using derivative instruments), provided that such investment does not compromise the existing regulatory requirements applicable to that AIF. AIFs interested in the investment in VA must bear in mind that VA are specific in terms of volatility, liquidity, and technological risk, all of which may affect the AIF’s risk profile. Furthermore, it is important for the AIF to keep investors informed in a timely and transparent manner and to update the fund documentation.
2.2 Requirements for Luxembourg Investment Managers
Specific requirements apply to Luxembourg authorized investment managers (IFMs) managing an AIF investing in VA.
An IFM managing an AIF that invests or intends to invest in VA must obtain prior authorization by requesting an extension of its license for the strategy referred to as “Other-Other Fund-Virtual Assets”. In the context of the license extension, particular emphasis is put on the risk management, the valuation determination, the Anti-Money-Laundering/Counter-Terrorism Financing analysis and mitigation, and the control of the VA (that is, access to, and control over, the cryptographic keys).
Depending on the activities performed by the IFM (or another participant in the management of the AIF), it may be necessary to apply to the CSSF for registration as a VASP.
2.3 Requirements for Luxembourg Fund Depositaries
A Luxembourg authorized fund depositary must notify the CSSF before acting as depositary for an AIF investing directly in VA, and it must implement both organizational arrangements and an operating model that appropriately reflect the specific risks related to the safekeeping of VA.
In respect of VA that are ineligible to be held in custody as financial instruments under article 19(8)(a) of the Luxembourg law of 12 July 2013 on alternative investment fund managers, as amended, the depositary’s role is limited to ownership verification and record keeping (as opposed to the safekeeping of financial instruments).
A Luxembourg fund depositary that provides services related to the safekeeping or the administration of VA (including the custodian wallet service) must file an application with the CSSF for registration as a VASP. In addition, a depositary envisaging to directly safeguard VA has to inform the CSSF of that intention.
3. Credit Institutions
Banking regulation does not prevent a CI from investing in VA directly (subject to certain accounting and capital-related requirements),4 or from opening accounts that permit its customers to deposit their VA. However, CI cannot take deposits, or execute payments, in virtual currencies.
The CSSF requires that a CI intending to offer VA-related services or to directly safeguard VA consult with the CSSF before starting that activity (with a particular focus on the governance and risk management frameworks, the effective handling of counterparty and concentration risks and the implementation of investor protection rules).
Where a CI is acting as a fund depositary, the rules outlined under point 2.3 above apply.
Depending on the circumstances, it may be necessary for a CI to file an application with the CSSF for registration as a VASP before it can offer VA-related services.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of the law firm's clients.
