Luxembourg’s financial regulator CSSF has delivered a sharp warning to the country’s Investment Fund Managers (IFMs) regarding weaknesses in oversight practices when delegating portfolio management. The CSSF’s latest review highlights specific shortcomings, particularly in conflict of interest management and contingency planning, that could expose IFMs to regulatory risk and potential operational failures.
Delegation is integral to Luxembourg’s status as a global fund hub, but the CSSF’s thematic review -a feedback report- identifies three main areas of concern: due diligence, conflict of interest management, and contingency planning. These findings are significant, given the extensive presence of over 330 management companies, 260 authorised AIFMs, and 600 registered AIFMs in Luxembourg, collectively managing 5.582 trillion euros in assets as of 30 June 2024.
Enhanced scrutiny
According to industry experts, third-party managers with numerous delegated functions are particularly impacted by the CSSF’s directive. “Third-party managers with a large number of delegates are naturally most impacted by the need to review arrangements by end of Q1 next year,” Jens Schmidt and Norman Finster of EY told Investment Officer via email.
EY emphasised the urgency for IFMs to revamp their conflict of interest management frameworks. “In particular in relation to conflicts of interest management, the CSSF thematic review already addresses requirements of the AIFMD II package that were only expected to become applicable a full year later in April 2026. Hence, impacted IFMs must accelerate their implementation efforts and plan accordingly.”
Intra-group conflicts of interest
CSSF’s review found that 55 percent of surveyed IFMs reported conflict disclosures from delegates within the last two years, often linked to intra-group delegations. The CSSF mandates that IFMs must establish detailed conflict registers and implement protocols to prevent individuals with conflicts from influencing decisions.
“Managers must ensure that potential and effective conflicts of interest arising from delegation are identified,” CSSF stated. This task is particularly complex in international and multi-entity structures, where transparency can be difficult to maintain. A comprehensive conflict register that covers both the IFM and its delegates is deemed crucial for reducing regulatory risks, especially when delegations span borders or involve closely linked entities.
Fund initiators
Waystone, a major management company in Luxembourg, said the CSSF review reflects that fund managers now are specifically expected to monitor conflicts of interests involving fund initiators, who may act or not as delegated portfolio managers or investment advisors. “To meet this expectation, fund managers will need to revisit and, if necessary, update their policies and procedures to ensure clarity on this front,” Waystone told Investment Officer.
EY pointed out that this area is the most operationally challenging for IFMs. “Of all areas highlighted by the CSSF, this proves to be the operationally most impactful and complex requirement,” said Schmidt and Finster.
Reinforcing business continuity planning
The CSSF report also shines a spotlight on inadequate business continuity and contingency planning among IFMs. The regulator noted that many firms lack predefined exit strategies and identified alternative delegates, which are essential for swiftly reassigning portfolio management responsibilities if a delegation arrangement ends abruptly. CSSF’s recommendations include conducting thorough assessments of resources, costs, and logistics involved in implementing exit plans and regularly updating these strategies to ensure they remain viable.
EY highlighted the importance of market readiness and rapid response capabilities. “Effective contingency planning starts with a market sounding to get a clear view on possible alternatives in relation to the various investment strategies managed by the IFM,” said Schmidt and Finster. “In case a transition is required, speed will be of the essence. Hence, IFM will likely need to create and subsequently maintain a short list of suitable alternative delegates to demonstrate robust exit strategies.”
Tighter due diligence
The CSSF’s review criticises IFMs for inadequate due diligence in selecting and overseeing delegates, a gap that could compromise investor protection. While CSSF rules, as per Circular CSSF 18/698, lay out stringent due diligence requirements, the regulator found that many IFMs rely heavily on self-assessment questionnaires and infrequent site visits instead of comprehensive, documented reviews.
CSSF said many firms struggle to integrate their legal responsibilities into ongoing monitoring. The report advised each IFM to adopt its own key performance indicators (KPIs) to provide clear insights into delegate performance and to establish well-defined organisational structures that clarify responsibilities and streamline oversight.
Waystone emphasised that despite the delegation of portfolio management functions, the ultimate responsibility remains with the IFM. In this setup, it said, effective communication with all stakeholders is vital to ensure a successful transition.
“However, positive engagement from all parties cannot be guaranteed in every context,” Waystone said. “Hence the IFM plays a central role and must ensure that such projects are led by experienced professionals with a broad enough background. This approach is essential to preserve investors’ interests and minimize the risk of regulatory breaches.”
(This article has been updated to add comments from Waystone in the 6th, 13th and 14th paragraphs.)