The Limited Qualified Investor Fund (L-QIF): first overview of the draft implementing provisions

Background

On December 2021, the Swiss parliament adopted the revision of the Swiss Collective Investment Schemes Act (CISA) to introduce the Limited Qualified Investor Fund (L-QIF).

On 23 September 2022, the Swiss Federal Council has released its proposal of the revised Collective Investment Schemes Ordinance (CISO or Draft Ordinance), which contains the details of the implementing provisions. The L-QIF should be available during the second quarter 2023. Consultations with the industry on the Draft Ordinance will last until the 23 December 2022.

The L-QIF is devised as a new fund vehicle under Swiss fund regulations. No approval or authorisation by the Swiss Financial Market Supervisory Authority (FINMA) will be required to launch the product.

L-QIFs can be structured as (i) Swiss contractual funds, (ii) Swiss investment companies with variable capital (SICAVs), or Swiss limited partnerships for collective investment (Swiss LPs). L-QIFs, therefore, do not constitute a new legal form, but must be structured according to pre-existing legal forms already set out under Swiss fund regulations.

Since the product will not need FINMA approval, an L-QIF must be managed by a supervised entity, which will be ultimately responsible for ensuring proper management and compliance with all applicable regulations, including all specific limits or restrictions that will be set forth in the fund documentation.

Improved time-to-market does not mean no regulation

L-QIFs are regulated by the CISA (unless otherwise specified in the L-QIF specific provisions), the CISO, the FINMA-CISO as well as by analogy (and not directly) in the guidelines issued by the Asset management Association Switzerland (AMAS), which have been set as a FINMA-recognised minimum standard for the industry.

Recognition of the AMAS-issued guidelines implies that the following rules are applicable to L-QIFs: (i) the Rules of Conduct, (i) Guidelines for real estate funds, (ii) Guidelines for money market funds, (iii) Guidelines for the valuation of assets of collective investment schemes and for the treatment of valuation errors for open-ended vehicles, (iv) Guidelines for the calculation and publication of the performance of collective investment schemes and (iv) Guideline for the calculation and publication of the Total Expense Ratio of collective investment schemes.

Finally, if an L-QIF invests in real estate, it will be subject to the Federal Act Governing the Acquisition of Real Estate by Persons Abroad (also known as "lex Koller") just as any other investment vehicle that is regulated or not.

Conversions

Conversion from a FINMA-regulated vehicle to an L-QIF is governed by a detailed set of rules. The Draft Ordinance specifies that a change of status of a regulated vehicle in an L-QIF requires the approval of FINMA. To avoid any loophole, the Draft Ordinance does not permit the restructure of an L-QIF by combining it with a regulated vehicle or by transforming it into such a vehicle.

The last sentence is ambiguous since it could be interpreted as a general prohibition of converting an L-QIF into a regulated vehicle. Such a prohibition is pointless if the L-QIF decides to comply with the rules applicable to regulated structures, including seeking full approval by FINMA. As a matter of principles, L-QIFs should in principle also be convertible into FINMA-regulated vehicles. The transition from a regulated to a non-regulated structure and vice versa would not be a problem in itself, if the legal provisions are complied with.

Minimum fortune for open-ended vehicles

One year after its launch at the latest, an L-QIF structured as a contractual fund or a SICAV (open-ended vehicles) must have a minimum net fortune of CHF 5 million. If the fund documentation so provides, the fund management company may extend this period once by six months. If the fund management company makes use of the right to extend the deadline, it must inform the audit firm immediately as well as the investors (by publication or in writing).

Reporting

L-QIFs are required to report a certain number of data to the Swiss Federal Department of Finance (SFDF). The list of data is rather comprehensive. There is in total for all data to be reported 17 fields (without counting sub-fields), which can be pided in three categories:

First batch of data – early stage

Under the current Draft Ordinance, within 14 days of the contractual formation of an L-QIF, the institution in charge of the L-QIF administration must notify SFDF with a certain number of data, including for instance: (i) its legal form, whether it is open or closed-end, (ii) the expected launch date, (iii) the names and contact details of the audit firm, the institution in charge for investment decisions and the custodian bank (where relevant), and (iv) its investment policy.

Second batch of data – launch phase

Within 14 days, the institution in charge of an L-QIF administration must notify the SFDR with (i) the date of the launch, (ii) any changes in the facts that were announced previously, and (iii) the discontinuation of the administration of the L-QIF (where relevant).

The SFDF may make the first and second batch data publicly accessible in a directory.

Third batch of data – statistical purposes

The institution in charge of the L-QIF administration must periodically provide the SFDF or a third party commissioned by the SFDF data on the relevant L-QIF for statistical purposes, such as (i) assets and change in assets, (ii) a breakdown of the assets in several defined categories, (iii) the income statement and balance sheet, and (iv) certain risk data.

Sanctions

Any intentional breach of this reporting requirement will be subject to a sanction of up to CHF 500,000. In addition to this sanction, responsible institutions may also be subject to FINMA enforcement proceedings in case of a breach.

Liquidity management for open-ended vehicles

The fund management company or the SICAV must ensure that the liquidity of each fund is properly managed. FINMA may specify the modalities. Provisions on liquidity management are intended to be in line with international standards.

The Draft Ordinance contains several requirements aimed at ensuring that the liquidity management process is efficient, duly monitored and tested under normal and extraordinary market conditions including by relying on historical data and assumptions. The stress tests are, however, optional if the net assets of the relevant fund do not exceed CHF 25 million.

As part of the process, the fund management company or the SICAV must draw up a crisis plan in which it must define the measures for the use of the instruments provided for liquidity management, the internal procedures and the allocated resources. The fund management company or the SICAV must regularly review this crisis plan.

The provisions on liquidity management are primarily intended to regulated vehicles. However, they are not included in the list of provisions that do not apply to L-QIFs according to the Draft Ordinance. These provisions should also apply to the L-QIF.

Risk disclosure

If an L-QIF invests in alternative investments, the particular risks associated with these investments must be mentioned in its name, and disclosed in the fund documents and in any advertising material. The risk disclosure must take the form of a warning that appears on the first page of the fund documentation and on advertising material. This disclosure corresponds to the current practice of FINMA for regulated funds investing in alternative investments. Furthermore, the Draft Ordinance specifies that the fund documentation must also contain a glossary of the most important technical terms and a commentary on the particular risks or increased volatility of the L-QIF. Such glossary and specific risk disclosure are relatively standard in practice.

Limitation of redemption rights for open-ended vehicles

General restrictions

In the case of an L-QIF structured as a contractual fund or a SICAV investing in assets that are considered as non-liquid, the fund documentation may limit the investors' right to redeem their units or shares to a maximum of every two years and, in addition, prohibit them from redeeming their units for a period of five years after the fund has been set up (i.e. initial lock-up).

As a general rule and by reference to existing provisions for regulated vehicles, non-liquid investments include investments that are not listed on a stock exchange or traded on any other regulated market open to the public, as well as mortgage or private equity investments. The consultation report also makes a reference to other real estate, private debt investments and infrastructure investments, which could be admissible to a certain extent in this category.

Gating

The fund documentation may include a gating mechanism, provided that this mechanism is justified by extraordinary circumstances and is in the interest of the remaining investors. The remaining portion of the redemption requests must then be deemed received on the next valuation day. The details must be set out in the fund documentation.

The gating mechanism is the same as the one available to a regulated vehicle, except that FINMA approval is not required to include this mechanism in the fund documentation. However, if the fund management company implements a gating, it must immediately inform the audit firm and investors (by publication or in writing).

Investment restrictions and investment techniques for open-ended L-QIF

General restriction/investment techniques

An open-ended L-QIF may (i) use loans up to 50% of the fund's net assets, (ii) pledge or guarantee up to 100% of the fund's net assets, and (iii) enter into commitments amounting in total to a maximum of 600% of the fund's net assets. These restrictions correspond to those applicable to regulated funds investing in alternative investments. Stricter restrictions apply to L-QIFs that invest in pledged real estate.

In addition, the CISO-FINMA requirements applicable to securities lending, repo transactions, derivatives and security management will apply by analogy, except that the model-based approach set out in CISO-FINMA will not be available to L-QIFs.

Investments in other collective investments (target funds)

Fund documentation must specify the extent to which the fund is entitled to invest in other collective investments (target funds). If this represents a significant portion of the fund's assets, the fund documentation must state (i) the maximum amount of the management fee to be paid by the L-QIF itself and the target funds, and (ii) the annual report must state the maximum amount of the management fee to be paid by the L-QIF and target funds.

Disclosure in the fund documentation

The fund documentation must (i) expressly state investment restrictions, and (ii) describe the permitted investment techniques, such as securities lending, repo, use of derivatives, borrowing, assignment by way of security, short selling (including the authorised amount), and the granting of loans. If securities lending or repo is permitted, the fund documentation and the annual report must contain the details of these transactions.

Compliance with restrictions

According to the Draft Ordinance, the general restriction/investment techniques limits apply to the fund's assets valued at market value and must be complied with at all time. In case an L-QIF has sub-funds, the restrictions and investment techniques apply to each sub-fund on an inpidual basis.

The L-QIF must comply with the limits no later than two years after its launch. If this deadline cannot be met, the fund management company may extend the deadline once by six months, provided that this extension is specified in the fund documentation. If the fund management company makes use of this right, it must immediately inform the custodian bank, the audit firm and the investors (by publication or in writing).

The Draft Ordinance also contains provisions in case of breach of limits (including remediation processes general principles). It makes a distinction between a passive breach caused by market fluctuation and an active breach caused by investment management decisions. It also contains the specific information duties that must be performed in the case of an active breach (e.g. mention in the annual report, immediate notification to audit firm and investors in case of a detrimental impact). These provisions are in line with market practices and the regulator's general expectations.

Specific provisions applicable to L-QIFs structured as Swiss LPs

In the same way as a regulated Swiss LP, L-QIFs structured as Swiss LPs will in principle not be subject to any restrictions or legal investment techniques. The LQIF will be free in this respect, but any restrictions and investment techniques adopted must be described in detail in the partnership agreement.

A Swiss LP must be set up for five years at least. According to the consultation report, this duration is justified insofar as the right of investors to redeem their interest at any time in the case of an L-QIF structured as a contractual fund. A SICAV may, under certain circumstances, be restricted for a period of five years. The possibility of launching an L-QIF structured as a Swiss LP for a period of less than five years would thus remove the demarcation between open and closed-end funds.

Specific provisions applicable to L-QIF investing in real estate opportunities

The Draft Ordinance also contains a number of specific provisions, restrictions and limitations applicable to open-ended L-QIFs investing in real estate opportunities, such as rules on co-ownership, risk allocations, transactions with related parties and requirements for experts in charge of valuation. Specific rules also apply to closed-end L-QIFs in terms of transactions with related parties. Requirements for valuation experts will apply by analogy.

Outlook

Based on a first assessment of the Draft Ordinance, there is room for improvement, such as the restrictions and investment techniques for open-ended vehicles, and where it might be appropriate not to replicate the existing rules for regulated vehicles. Side pocketing rules (under the responsibility of the fund management company) might also be contemplated. Based on the current Draft Ordinance, this option only seems available to regulated vehicles (with the approval of the FINMA). The general framework proposed by the Draft Ordinance and its consequences should be carefully reviewed and commented on during the consultation period in order to ensure that L-QIFs will remain as attractive as initially expected for all market participants.

For more information on L-QIFs and fund regulations in Switzerland, contact your CMS client partner or local CMS expert: