Luxembourg’s financial supervisor, releasing its eagerly anticipated guidance for investment funds exposed to Russia, has outlined a range of segregation options to handle stranded assets in Russia. Funds also were reminded to assess if they are potentially in breach of sanctions against Russia and Belarus.
In a first under fund legislation in the European Union, the CSSF guidance endorsed the use of “side-pockets” which would group the stranded assets into a new sub share class, a feature from the hedge fund industry that is not envisaged in the EU Ucits directive. Luxembourg’s national supervisor however believes EU authorities will not block this option because of “exceptional circumstances”.
Nevertheless, for emerging market funds with a relatively high exposure to Russia, the supervisor also suggests a clear split into two new sub-funds, one with the liquid assets and one with the illiquid, stranded holdings which would remain closed to subscriptions and redemptions. Each of these sub-funds would be subject to the EU rules for Ucits funds.
‘Immediate liquidation’
“CSSF deems this solution to be in line with… the Ucits Directive as the new sub-fund would be another Ucits,” said Luxembourg’s national financial supervisor in its eight-page guidance document, which outlines that under some conditions, “the new sub-fund with the illiquid assets shall be put into immediate liquidation.”
Once split, the managers of the fund are required to assess whether such re-attribution into two sub-funds would “potentially be in breach of any of the applicable sanctions in the context of the Ukraine crisis”.
Some 145 Luxembourg Ucits funds collectively held more than 9 billion euro in Russian assets at the beginning of this year, an analysis by Investment Officer of Morningstar fund data has shown. Worldwide, some 850 funds held 5 percent or more of their assets in Russia at the beginning of the year.
Haircuts
Fund managers have significantly divested Russian assets before the war started on 24 February. For funds with significant exposures, trade has been suspended since the war started, while those with a limited exposure to Russia and Belarus in many cases have taken haircuts, an approach which CSSF endorsed in its guidance.
“A limited exposure to illiquid assets might leave the governing body of the fund with more straightforward and temporary options to deal with the situation, including fair valuation adjustments,” CSSF said.
The list of firms managing the Luxembourg funds with the highest exposure in terms of asset values includes Pictet, Schroders, BlackRock, JP Morgan, Fidelity, East Capital, BNP Paribas, Robeco, Vontobel, Abrdn, Franklin Templeton and Amundi.
Safeguarding investors
With its guidance towards a clear split into two new sub-funds, the supervisor wants funds to safeguard “the interests of all investors, existing and future”.
The Association for the Luxembourg Fund Industry, or Alfi, in recent weeks has been in close contact with CSSF to discuss next steps. Alfi’s Managing Director Camille Thommes said at a recent conference that the industry was considering “the widest possible variety” in terms of tools to manage liquidity in these funds.
Under European financial regulation, the use of liquidity management tools is for decision by national competent authorities such as the CSSF in Luxembourg, although a proposal is under discussion to harmonise the use of such tools at EU level.
The ultimate responsibility for deciding how to resolve illiquid assets rests with the “governing body” of each individual fund, CSSF repeated several times in its guidance document. It said that it is willing to discuss specific options on a case-by-case basis.
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