The concept of substance
Luxembourg’s position as a leading European fund domicile is underpinned by a robust regulatory framework to ensure that investment fund managers (IFMs) not only have their address in Luxembourg but are actually operating from Luxembourg, with qualified staff, robust infrastructure and real decision-making happening locally and independently, i.e. that they have sufficient “substance” in Luxembourg.
The concept of substance is central to this framework, finding its source in the Alternative Investment Fund Managers Directive (AIFMD) and the UCITS Directive, and reinforced by the supervisory expectations of both the European Securities and Markets Authority and the Commission de Surveillance du Secteur Financier (CSSF). In particular, the CSSF has provided detailed guidance on how an IFM should be set-up and run in Luxembourg. This is in CSSF Circular 18/698, aka CSSF Circular on substance.
This concept of substance is particularly important to the CSSF in the context of cross-border delegation arrangements, which are quite common in Luxembourg-based set-ups and especially since Brexit with numerous UK-based firms seeking to establish a presence in Luxembourg to retain passporting rights under the AIFMD and UCITS Directive whilst delegating certain functions back to their UK-based teams.
This concept is still very much at the centre of discussions today with the rules around the reinforcement of the delegation model under the AIFMD and UCITS Directive being amended and currently being implemented into local laws of EU Member States.
What does it mean to have sufficient substance in Luxembourg?
IFMs based in Luxembourg must demonstrate that they retain real and effective control over all critical functions of their operations, including portfolio and risk management, regardless of any delegation arrangements. And while delegation is permitted, it must be justified, carefully structured, documented, and continuously monitored to ensure that the IFM retains substantive decision-making authority, risk oversight, and accountability. These principles are considered central to safeguarding investor protection and ensuring robust governance across the related fund structures.
The CSSF has translated these principles into concrete expectations through Circular 18/698, which outlines minimum standards for governance, staffing, infrastructure, and internal controls.
Under Circular 18/698, IFMs must demonstrate a real presence in Luxembourg. This includes maintaining physical office space, employing qualified staff locally, and ensuring that key decision-making functions are carried out within the jurisdiction. The CSSF expects the board of directors to meet regularly in Luxembourg, that the senior management be physically present in Luxembourg and that the IFM has robust internal governance, including compliance, risk management, and internal audit functions proportionate to the size and complexity of the business.
Circular 18/698 also sets out detailed requirements for the oversight of delegated functions, including marketing and distribution. IFMs must implement a risk-based approach to monitor their delegates, supported by a multi-year due diligence plan and clear internal procedures. Delegated activities must be continuously supervised by staff based in Luxembourg, and the IFM must retain access to all documentation related to initial and ongoing due diligence. Importantly, the monitoring of delegated functions cannot itself be delegated.
Focus on the delegation of portfolio management
These expectations were further reinforced in the CSSF’s 2024 thematic review on the delegation of portfolio management. Conducted over several years, the review assessed how IFMs in Luxembourg comply with delegation and substance requirements under the UCITS and AIFMD frameworks. While overall compliance was found to be satisfactory, the CSSF issued targeted recommendations to strengthen delegation oversight and avoid the emergence of letter-box structures. Key takeaways included the need for formalised procedures for initial and ongoing due diligence on delegates, clear conflict of interest management, contingency plans for the withdrawal of delegation mandates and allocation of sufficient human resources in Luxembourg to supervise delegated activities.
The CSSF also required all IFMs to conduct a comprehensive self-assessment of their delegation monitoring frameworks by Q1 2025, with corrective measures expected where gaps were identified.
In its 2024 annual report, the CSSF noted that 58% of administrative sanctions issued between 2020 and 2024 related to shortcomings in the supervision of delegated activities, reinforcing the need for strong oversight frameworks.
Bottom line
Substance is not just a checkbox, but it is a tangible demonstration of an IFM’s capacity to manage risk, safeguard investor interests, and its willingness to contribute meaningfully to the Luxembourg financial ecosystem. As regulatory scrutiny continues to evolve, IFMs need to stay sharp, stay local, and stay in control. And why not try to unplug potential and leverage opportunities out of these substance requirements?