Along with its stability, reputation, and wide range of investment vehicles, Luxembourg’s strong regulatory framework is a central reason why it has become Europe’s largest investment fund centre. As the number of regulations – and upgrades to these regulations – grows, the quality of investor protections also increases. Under these circumstances, staying compliant is a challenge for any entity, but it can be particularly burdensome for smaller companies and funds.
As the number of regulations – and upgrades to these regulations – grows, the quality of investor protections also increases.
The question then is how to best tackle these challenges. Some companies opt for IT solutions, which are useful up to a point, but they can be quite costly, and you need trained people who are experienced using software – and are aware of its limitations. We can look to KYC and AML as an example. Obviously, no one wants to onboard a client who has been blacklisted, and with the ongoing war in Ukraine, the list is updated with new names on a daily basis. Imagine, then, that your company purchases software to help you avoid onboarding such clients, and now a client gets flagged. Is this due to truly being blacklisted, or just having been the target of negative press coverage? Only someone trained in AML and KYC is able to discern the difference. To meet this need, a fund might either try to train an existing staff member, or it could opt to recruit new talent.
We can look to the CSSF, the supervisory agency of the Luxembourg finance sector, for another example of why having the right people is vital. Fifteen years ago, much of the reporting submitted to the CSSF was done by email. Now, all this information must be transferred via specific platforms and in certain formats. For instance, you must possess a degree of know-now to convert an Excel sheet into XML, which is what the agency requires. Complying with this and many other rules requires specific tools and relevant experience.
The two solutions mentioned above – invest in IT, or invest in people – represent significant challenges and costs, and yet the penalty of failing to be compliant leads to much greater costs, both to an entity’s reputation and financially in the form of fines, not to mention the negative impact that such failure will have on investors. For example, U.S. tax authorities impose FATCA on both US persons and non-US financial institutions that do business with them. If you are a Luxembourg fund that decides to distribute cash to U.S. investors, and you neglect to follow the rules and declare the distribution to the IRS, you face the risk of serious financial penalties and damage to your reputation.
At the end of the day, companies and funds want to focus on their core activity. Diverting time, resources, and money to keeping up with the latest changes to the regulatory framework can be a real drain of attention and capital. For many, the solution is to work with a service provider who will take on the burden. The services these entities provide range from regulatory and KYC to tax and VAT, although some have a focus on just one area or even a specific type of reporting.
At the end of the day, companies and funds want to focus on their core activity.
Due to the many negative repercussions of missing deadlines, neglecting to correctly follow procedures, or submitting documentation to the CSSF in the wrong format, a fund manager should feel impetus to choose an experienced, reliable service provider. Yet, in a busy market like Luxembourg, this can prove to be a rather daunting task, especially for entities that have limited experience here. Some providers, especially those specialising in niche services, seem to pop up overnight. Some of these may seem to be an attractive option, but it is vital to look at their track record in Luxembourg as well as their ability to see the larger picture or provide other key services that will be needed down the road.
While it is imperative to fully comply with the regulatory framework, it is worthwhile to point out that sometimes it is neither suitable nor pragmatic to follow the rules more than spelled out in the law. While some service providers are only concerned with the bare minimum in terms of compliance, others are overly focused on risk-avoidance, which create additional burdens and obstacles and might not be ideal for small funds or companies that need to remain agile and keep costs under control.
At the end of the day, finding the right path to compliance is a question of balance. For a small fund, you have to think about which is the best way to continue to follow the rules. Investing in IT, training, and recruitment might be the right choice for some, but for others, it could make sense to outsource certain tasks to local service providers. If so, make sure that you choose one with a proven track record, experienced staff, and, ideally, the ability to provide you with other ancillary services when you need them later on.