The Luxembourg Commission de Surveillance du Secteur Financier (CSSF) has released an update on the FAQ Virtual Assets – Undertakings for collective investment in relation to the UCIs investing directly or indirectly in virtual assets and has once again demonstrated its commitment to maintain a balanced and progressive regulatory environment. With its latest guidelines, the CSSF has drawn a clear line between the investment capabilities of Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds. According to the CSSF,

UCITS, along with other UCIs (Undertakings for Collective Investment) that are not targeted at well-informed investors, and pension funds, are not permitted to invest directly or indirectly in virtual assets. The CSSF’s aim is clear: protect the retail investor by restricting UCITS from investing into virtual asset investments due to the broader, and potentially less experienced, investor base and the associated risks. On the other hand, it allows AIFs to explore crypto assets, but only under certain rules.

We will now try to understand the possible reasons behind this approach. The first consideration to be made is that, at the present situation, virtual assets carry specific risks (such as volatility, liquidity, and technological risks) not suitable for all investors and investment objectives and these characteristics may not align with the UCITS (Undertakings for Collective Investment in Transferable Securities) strategy.

Essentially, today retail investors are buying and selling cryptocurrencies to make quick profits, rather than holding them as part of a diversified long-investment strategy that is common in a UCITS fund, many investors still see virtual assets primarily as a speculative tool rather than a stable investment for a long-term portfolio. This speculative nature adds an additional layer of risk, reinforcing regulatory bodies’ decisions to limit these assets’ presence in investment vehicles aimed at the retail investor.
Moreover, one of the main aspects of the virtual assets is their price fluctuations, it is crucial the importance of retail investors understanding the risks associated with such volatility, especially for those who perceive UCITS funds as generally safer investments, as they could face substantial financial losses. The underlying complexities and technicalities of these assets and blockchain technology remain a challenge, and might not be well understood by retail investors. The CSSF’s decision aims to ensure that virtual assets are acquired by a better informed and prepared class of investors, reducing risk exposure when investing in virtual assets. A consideration should be made also on the potential market dynamics distortion caused by the entrance of large institutional investors into the virtual assets UCITS fund market and the possible adverse effects of large-scale institutional movements against small retail investors.

In the FAQ – Virtual Assets, the CSSF provides clarification about the prohibition on investing in virtual assets which refers to the definition provided in Article 1 (20b) of the Law of 12 November 2004 concerning the fight against money laundering and terrorist financing (AML Law). The CSSF makes an important distinction regarding digital assets that fulfill the conditions of financial instruments as per the Law of 5 April 1993 on the financial sector. Digital assets that are classified as financial instruments are not considered virtual assets under the AML/CTF Law and therefore are not subject to the restrictions outlined for virtual assets. This means that UCITS may invest in these types of digital assets if they qualify as financial instruments. Examples could include shares of companies that are active within the virtual asset ecosystem, provided they meet the legal definition of financial instrument. The implication is that while direct investment in virtual assets is generally prohibited for UCITS and certain other UCIs, investments in digital assets that are recognized as financial instruments might be permissible. This would allow UCITS to participate indirectly in the virtual asset market by investing in entities involved in the virtual asset sector, assuming these investments comply with the broader regulatory framework governing UCITS.

On the other hand, AIFs may now invest directly (and indirectly) in virtual assets under the condition that their units are only marketed to well-informed investors on the investment in virtual assets by Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs), updated as of 22 February 2024. According to the CSSF, AIFs can invest in virtual assets provided they only market their units to well-informed investors. The well informed investor is defined by the law of 23 July 2016 on reserved alternative investment funds as amended. The classification of well-informed investors is defined to include two main groups: first, institutional and professional investors known for their expertise in investments; second, individual investors who commit at least 100,000 euros to a Reserved Alternative Investment Fund. These individual investors need to be evaluated by a trusted entity like a bank, investment firm, or a fund management company. This process aims to certify that the investor has the requisite expertise, experience, and knowledge necessary for properly evaluating the potential risks of investing in a RAIF.
This allows AIFs more flexibility in including virtual assets in their investment strategies, whether directly or indirectly (e.g., through derivatives or transferable securities with underlying virtual assets).
We also remind that, if such an AIF is managed by a Luxembourg-authorized AIFM (Alternative Investment Fund Manager), the manager must seek an authorization extension from the CSSF for this new investment strategy, ensuring compliance with existing regulatory frameworks and obtain an authorization extension for the strategy “Other-Other Fund-Virtual assets” from the CSSF.
This process requires the IFM to submit detailed documentation, including descriptions of the investment project, risk and valuation policies tailored to virtual assets, the experience of the management team in handling such assets, custody arrangements, investor targeting and distribution channels, as well as a analysis of anti-money laundering and counter-terrorist financing (AML/CTF) aspects related to the investments.

The CSSF highlights the importance of recognizing the specific risks associated with virtual assets, such as volatility, liquidity, and technological risk, and how they could influence the risk profile of the investment vehicle. In the even where an AIF invest in virtual assets, Investment managers are advised to conduct a assessment on a case-by-case basis, ensure transparent and timely communication with investors, and update the relevant fund documentation accordingly.
In summary, while UCITS are restricted from investing in virtual assets due to their broader investor base and the inherent risks of such assets, AIFs can engage in such investments under certain conditions. This reflects the regulatory intent to safeguard retail investors while allowing more informed or professional investors to explore innovative investment opportunities within a controlled and informed framework.

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The views and opinions expressed in this article are my own and do not reflect the official policy, position, or opinions of any financial institution, or other organization.
The content of this article is based on personal research of the author and understanding of AML (Anti-Money Laundering) and compliance topics.