Luxembourg is considering the innovative use of a particular liquidity management tool known as “side pockets” in order to deal with the suspensions of investment funds with significant exposure to Russia.
If accepted by the Luxembourg financial supervisor CSSF, the use of such side pockets could bring closer the end of suspensions of funds with Russia exposure. Some 850 investment funds, according to Morningstar data, have exposure of more than 5 percent to Russia. More than 100 of these are funds domiciled in Luxembourg.
The CSSF is expected to make an announcement on the use of side pockets and other liquidity management tools in the near future, according to a person familiar with the discussions. A CSSF spokesperson has yet to respond to questions on this topic.
‘Direction of travel is clear’
Opening the second day of the European Asset Management conference in Luxembourg, Camille Thommes, managing director of the Association for the Luxembourg Fund Industry, known as Alfi, said side pockets are considered as a possible next step.
“The direction of travel is clear,” Thommes said, adding that the industry is considering “the widest possible variety” in the use of liquidity management tools.
As industry representative, Alfi plays a key role in discussions between the asset management Luxembourg industry and the national financial supervisor in the Grand Duchy.
Investment firms, including major international asset managers such as BlackRock, JP Morgan Asset Management and Pictet, and specialised emerging market firms such as East Capital and Prosperity, last month announced suspensions of their Russia funds because it was no longer possible to accurately price the funds due to the fallout from Russia’s war against Ukraine.
Hedge fund tool
By using a “side pocket”, the assets at risk are separated from the other assets in the fund and placed into a specific section, or pocket. The remainder of the assets then could still be accurately priced and could be traded again. The side pocket tool is known to have been used in the past by hedge funds that had exposure to particular illiquid assets. Only “current investors” would still face exposure to the the total fund including the side pocket, while new investors would not be exposed to losses or gains stemming from the assets in the side pocket.
It would be a first time that such a side pocket tool would be applied to Ucits funds, said a person with knowledge of the discussions.
Claude Marx, director general of the CSSF, on Tuesday said that a total of 61 Luxembourg-domiciled investment funds had an exposure of 10 percent or more of their assets to Russia. Out of these, two thirds were equity funds, and one third were debt security funds.
National competence
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.
A spokesman for the European Securities and Markets Authority, or Esma, told InvestmentOfficer.lu that “the use of side-pockets and other liquidity management tools, with the exception of fund suspensions, is not yet harmonised in EU legislation and therefore subject to national law.”
ESMA has commented on this topic in the ESMA letter to the European Commission on the AIFMD review, and the Commission recently presented its legislative proposals to harmonise the AIFMD and UCITS rules, the spokesperson said.
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