CSSF issues new guidance on virtual assets (AML/Funds)

The Luxembourg Supervision Commission of the Financial Sector (CSSF) has published new guidance and frequently asked questions (FAQ) regarding virtual assets, both dated November 29, 2021. The guidance is in response to increased interest in virtual assets from professionals under the supervision of the CSSF, and professional associations and investors. The market has also requested clarification in this respect, particularly when considering investments made by investment funds, direct investments or depository duties linked to virtual assets.

Communication

The CSSF pointed out that many professionals consider the potential benefits of virtual assets when looking to diversify their portfolios with a variety of additional types of assets. The CSSF has advised investors to weigh up the risks and benefits associated with the proposed virtual assets activities, considering current regulations, in particular taking into account the upcoming European Markets in Cryptoasset Regulation (MICA) that will regulate certain virtual assets that until now have fallen outside of the scope of existing legislation.

The CSSF expects professionals to proactively engage with the CSSF where they plan any activity involving virtual assets and draw up a business and risk strategy concerning virtual assets for the purposes of internal governance arrangements. Moreover, the CSSF expects supervised entities to ensure sound and prudent management of all such activities and implement a clear risk-taking process. This process should include a formally and precisely defined risk appetite in all of the business areas and a rigorous decision-making process.

The CSSF further stressed that tokens may bear more complex representations of rights that are difficult to assess and that those intrinsic characteristics and functions of tokens determine their risks and possibilities for a professional of the financial sector to get involved in them.

FAQ

The FAQ address four questions linked to one of the most important items to consider when considering virtual assets – the provisions of the law of November 12, 2004, on the fight against money laundering and terrorist financing, as amended (AML Law). The answers concern investments in virtual assets by undertakings for collective investment in transferable securities (UCITS), alternative investment funds (AIF) and Luxembourg investment fund managers (IFM) as well as any mitigation of money laundering and terrorist financing (ML/TF) and proliferation financing.

Investing as UCITS

The CSSF confirmed that it is important to understand that virtual assets as defined in article 1 (20b) of the AML Law exclude digital assets that fulfill the conditions of financial instruments within the meaning of the law of April 5, 1993, on the financial sector, as amended.

While assets qualifying as financial instruments (eg shares of companies active in virtual asset ecosystems) could fall within the scope of eligible investments for UCITS, the CSSF makes clear that investments in virtual assets as defined within the AML Law are not suitable for every kind of investor or within every investment objective. UCITS, pension funds and undertakings for collective investments addressing non-professional customers are not allowed to invest in such virtual assets, be it directly or indirectly.

Investing as AIF

The CSSF stated that AIF with an authorized AIFM can invest in virtual assets within the meaning of the AML Law, directly or indirectly, if:

• the authorized AIFM obtains an extension of authorization from the CSSF for the new investment strategy; and
• the AIF markets the units only to professional investors.

The AIF’s investment must not prevent the compliance and application of any existing regulatory requirements and sufficient and adequate internal control functions must play a key role in the approval of the new investment strategies and products.

The CSSF further clarifies that IFM must assess the impact of investments on the risk profile of the AIF on a case-by-case basis, inform the investors in a transparent and timely manner and keep the respective fund documentation updated.

Prior authorization requirement for Luxembourg IFM

The CSSF stressed that a prior CSSF authorization must be obtained by each authorized Luxembourg IFM contemplating managing a regulated or unregulated AIF wishing to invest in virtual assets. In this respect, the CSSF requires a set of information and documentation containing the description of the services and project, targeted investors and distribution channels, and the updated risk management policy.

Furthermore, the CSSF expects any AIF initiator to present its project to the CSSF before investing in the virtual assets and that the IFM preform an analysis on the services under consideration of article 1(20) of the AML Law and submit a complete application file for registration as a virtual asset service provider with the CSSF before starting such activity.

Mitigation of ML/TF risks

The CSSF stressed that the responsible du respect and the responsible du contrôle of the supervised entities intending to invest in virtual assets have to be able to demonstrate an adequate understanding of the risks linked to ML/TF and proliferation financing risks of virtual assets and of the relevant measures to mitigate such risks.