For a long time, the boundary between crypto-assets and investment funds aimed at the general public was clearly defined. On the one hand, there was a digital market known for its volatility, accessible mainly through specialised platforms or certain listed products. On the other, Ucits funds, which have become one of the main European standards for collective investment, are subject to high standards of diversification, liquidity and investor protection. This distinction is now beginning to blur.
In an updated version of its FAQs on crypto-assets, the Financial Sector Supervisory Commission (CSSF) has authorised Ucits funds to invest indirectly in this asset class up to 10% of their net asset value. Alternative investment funds open to retail investors, excluding sophisticated investors, are subject to the same limit. The CSSF also specifies that an extension of authorisation is required for AIF managers where exposure exceeds 10%.
This development is far from trivial for Luxembourg. It enables the local industry to begin integrating crypto-assets into a framework with which it is already familiar: that of regulated funds, distributed across several jurisdictions and supported by a comprehensive network of service providers.
From a ban to supervised integration
This is not an unrestricted opening up of the market. Ucits funds will not be able to freely and directly hold just any digital asset. Exposure must remain indirect, limited and compatible with the product’s standard rules: liquidity, valuation, diversification, risk control and investor protection. But the shift in principle is significant. The question is no longer simply whether crypto-assets can be admitted into the Ucits framework. It has now become a question of how they will be implemented.
“Just a few years ago, the answer was simply ‘no’. Today, limited exposure is possible, provided you have the controls, expertise and internal procedures in place,” explains Quentin Werlé, head of portfolio management at 6 Monks, a Luxembourg-based asset management firm specialising in digital assets.
According to him, the requirements relate in particular to adapting AML controls specific to these assets, training staff, adapting risk management, valuing instruments, identifying technological and liquidity risks, and using service providers with the necessary authorisations. For the Luxembourg industry, this accumulation of constraints may appear to be a hindrance. It also presents an opportunity to capitalise on its expertise. The more complex the integration of this asset class becomes, the greater the need for specialist players capable of structuring, administering, holding and monitoring the products.
A new market for Mancos and AIFMs
The first potential beneficiaries of this development are asset management firms. Until now, a Ucits manager wishing to meet the growing demand for digital assets had limited options. They could either allow their clients to purchase a crypto product or an ETP directly, or choose not to include this exposure in their own asset allocation. The new approach allows them to consider a third option: incorporating a crypto component into an existing fund or a new product, whilst maintaining a regulated structure and comprehensive portfolio management.
This could create a new market for Mancos and Luxembourg-based asset management firms, particularly those wishing to develop multi-asset, thematic or diversification strategies. Indirect exposure is likely to remain focused on the largest and most liquid assets, such as Bitcoin or Ether, as well as on listed instruments that meet the eligibility criteria for a Ucits.
For an active fund manager, the challenge lies precisely in not simply offering passive exposure.
For fund managers, the appeal lies not only in gaining access to a new asset class. It also lies in regaining control of the investment relationship. Rather than letting a client combine a traditional fund with a separately purchased crypto product themselves, the manager can integrate this allocation into an overall strategy, adjust it in line with market conditions and manage it in accordance with their own risk rules.
“For an active manager, the challenge lies precisely in not simply offering passive exposure. They can adjust the asset allocation, minimise losses during certain market phases and use volatility as a potential source of returns,” says Quentin Werlé.
This argument is, of course, that of an industry player. It will need to be tested against the reality of the performance, costs and behaviour of crypto-assets in various market conditions. But it already illustrates how the debate is evolving: asset management firms no longer view crypto-assets solely as competing products. They are beginning to view them as a potential component of their own portfolios. Below is an example of Bitcoin’s (BTC) negative performance last year, alongside that of one of the funds managed by 6 Monks, which significantly outperformed Bitcoin.
Bitcoin prices compared with those of an investment fund. (Source: 6 Monks)
Custodians at the heart of the system
Regulatory liberalisation is also expected to strengthen the role of custodians and asset servicing providers. In a traditional fund, the custodian plays a central role in holding assets, monitoring cash flows and overseeing certain transactions. The integration of crypto-assets held in direct custody adds a layer of complexity. Ownership certificates can be recorded on a blockchain, transactions are carried out on specific platforms, and custody relies on technological mechanisms that differ from those used for traditional securities.
This does not mean that the role of the custodian will disappear. On the contrary, it must adapt and coordinate with service providers specialising in the safekeeping of digital assets.
The EU’s Mica Regulation now provides part of this framework. It imposes requirements on crypto-asset service providers in relation to authorisation, governance, client protection, asset segregation, the management of conflicts of interest and operational continuity. It also requires providers to hold their clients’ assets separately and to clearly warn them of the risks associated with crypto-assets.
In practice, a fund may need to work with several parties: a management company, a traditional custodian, an authorised trading platform, a specialist custodian, a fund administrator and legal advisers. This structure creates a potential market for the major asset servicing players already established in Luxembourg. Their ability to bridge the gap between traditional finance and crypto infrastructure could become a new point of differentiation.
6 Monks has therefore developed its platform in partnership with Société Générale Securities Services and Arendt. The bank provides its custody and asset servicing infrastructure, whilst the law firm handles the legal and regulatory structuring. The aim is to ensure that interested fund managers do not have to build the entire operational chain themselves.
A call for new skills
The regulatory changes will also have an impact on employment and the skills sought after by financial institutions. Incorporating exposure to crypto-assets is not simply a matter of selecting an additional product for a portfolio. It requires an understanding of how platforms operate, custody mechanisms, the risks associated with private keys, the quality of market data, valuation methods and the differences between the many digital assets available.
The risk management, compliance, portfolio management and internal control functions will therefore need to broaden their remit. In particular, management companies will need to be able to demonstrate that they understand the risks specific to the instruments used and that they can monitor them over the long term. Valuation policies must also specify the price sources used, how price discrepancies between platforms are handled, and the procedures applied in the event of market disruption. For the main crypto-assets, transaction data is available in real time and volumes can be monitored across different platforms. However, the smaller or less liquid an asset is, the more difficult it becomes to value it.
“For the most significant crypto-assets, there is a market that operates 24 hours a day and numerous price sources. However, when moving on to less liquid projects, other methodologies must be used, sometimes similar to those employed in private equity,” explains Quentin Werlé. He also believes that the first Ucits funds should remain focused on the most liquid assets in order to remain true to the product’s philosophy and meet its daily liquidity requirements.
A knock-on effect on the Mica ecosystem
The opening up of Ucits could also accelerate the development of the Mica ecosystem in Luxembourg. The European regulation allows service providers authorised in one member state to provide their services throughout the EU, subject to certain conditions. Authorisation obtained in Luxembourg can therefore serve as a gateway to a wider market.
If asset management firms begin to incorporate digital assets into their products, they will need trading platforms, custodians and technology providers capable of operating within a regulated environment. This demand could attract new service providers to the Grand Duchy or strengthen those already established there. Luxembourg has a historical advantage in this regard, as its fund industry has developed on the strength of its ability to bring together, within a single jurisdiction, all the players necessary for the creation and distribution of cross-border products.
“Today, a fund manager visiting Luxembourg can meet, in the course of a single day, with a management company, a custodian, a custody specialist, a law firm and the other key players essential to the development of the product,” emphasises Quentin Werlé. This concentration of service providers could reduce the cost and time required to bring new products to market. It could also strengthen the country’s position as a European centre for product structuring, even though the technological infrastructure and platforms used are themselves international.
The return of a competition between local teams
This development reinforces Luxembourg’s appeal as one of Europe’s leading fund centres. Luxembourg remains Europe’s leading centre for cross-border investment funds, although Ireland also has a strong Ucits industry, a management ecosystem and close ties with Anglo-Saxon players. France and Germany, for their part, are developing their own regulatory frameworks relating to digital assets and tokenisation. Authorising exposure to cryptocurrencies will therefore not, on its own, be sufficient to guarantee a lasting advantage for Luxembourg.
The difference will lie in the speed of execution, the clarity of the regulator’s expectations, the availability of service providers and the ability to launch products without adding excessive complexity or costs. The CSSF’s change in approach can, however, be interpreted as a signal that Luxembourg intends to play a part in the emergence of a significant asset class. This stance forms part of a series of broader developments.
The country has already adopted several pieces of legislation relating to the use of distributed ledger technology in the issuance, holding or trading of securities. The opening up of Ucits to crypto-assets marks a new stage in this strategy of gradual adaptation.
The more funds, capital and market participants there are using this infrastructure, the easier it will be to generate liquidity.
From cryptocurrency to tokenisation
The impact could ultimately extend beyond the cryptocurrency market alone. Crypto-assets, stablecoins and tokenised assets serve different purposes, but they rely on infrastructure that is partly shared. The platforms, custody mechanisms, settlement systems and expertise developed for one asset class can then be applied to another.
For Quentin Werlé, this development should be seen as the gradual assembly of several building blocks. Bitcoin has helped to popularise the use of blockchain. Stablecoins enable fast digital payments. Tokenisation then offers the possibility of representing traditional financial assets, such as fund units or monetary instruments, on a distributed ledger.
“All these building blocks are interconnected. The more funds, capital and market participants there are using this infrastructure, the easier it will be to create liquidity and a secondary market for tokenised assets,” he believes. This convergence could be particularly significant for Luxembourg. The financial centre is positioning itself not only as a hub for crypto-asset management, but also as a potential testing ground for the evolution of fund infrastructure.
The market has yet to respond
Despite this potential, the move is, for the time being, more regulatory than commercial. The platform presented by 6 Monks is up and running, but no initial Ucits fund using the solution has yet been announced. The company is now seeking fund managers wishing to incorporate this exposure into their products. This is where the true significance of the change will be seen.
Regulatory authorisation does not automatically create a market. Management companies will need to be convinced of investor demand, the financial merits of such exposure and their ability to bear the additional costs associated with structuring and monitoring.
The 10% cap therefore appears to be a compromise. It allows fund managers to experiment without fundamentally altering the risk profile of their funds. It also gives the regulator the opportunity to observe how market participants are implementing this new flexibility. For Luxembourg, the challenge is now clear: to convert this regulatory leeway into products, expertise and economic activity. The country already has the key building blocks in place. It now needs to demonstrate that its ecosystem can bring them together more quickly and more effectively than its European competitors.
