Ethics and governance in the European Financial centers

Almost 5 years ago the European Commission issued the following content in a Press Release (IP/04/430, dated 31/03/2004 ).

The Internet consultation flagged up significant gaps on, for example, minimum capital requirements, legal duties or the scope of liability for depositaries. A true Internal Market for depositary services will require convergence of these rules. In order to appoint depositaries based in other Member States, domestic fund managers and supervisors will want clarity on the resources of depositaries and on their obligations, whilst investors will need improved standards of information.

The Commission is therefore proposing close cooperation with EU regulators, covering four fields over the next two years.

1. Better prevention of conflicts of interests

Conflicts of interest arise when investors' interests are not at the heart of the depositary's or the fund manager's behaviour. The Commission survey revealed evidence of diverging approaches and it has therefore suggested action to boost convergence of national rules in this field. This includes the list of the functions that fund managers can outsource to depositaries and, conversely, the list of depositary activities which may be outsourced.

2. Clarifying the extent of the depositary's liability

Discrepancies in the level and scope of depositaries' liability constitute huge obstacles to ensuring a high level of investor protection throughout the EU and developing cross-border opportunities for depositaries. The Commission has identified as a key objective ensuring a common interpretation of the principal duty of depositaries which is to keep assets safe - and of the specific control duties assigned to them.

3. Convergence of prudential requirements

The prudential rules which must be applied to set up and operate a depositary differ considerably between Member States, since there are no common EU definitions of eligible institutions. The Commission proposes to foster convergence of these rules, and in particular of capital requirements, by identifying a specific group of relevant supervised institutions.

4. Enhancing transparency and investor information

In order to help create pressure to remove discrepancies in regulations, the Commission has identified the following areas for enhanced public information standards: the organisation of depositaries' tasks; measures taken against conflicts of interest; depositaries' liability; and the costs of their services.


The Madoff affair demonstrates that Luxembourg did not care of these Recs.
The Luxembourg financial center does not comply at all.

The Madoff affair demonstrates that the European Commission did not do its job.

I have quoted circular IML 91/75 (as amended by Circular CSSF 05/177) to demonstrate that the depositary's liability is not as clear as what Luxembourg authorities are saying to reassure the investors.

This circular was modified by a recent circular that is definitely worrying for the investors.

CSSF circular 05/177 dated 6 April 2005 is relating to the abolition of any prior control by the CSSF of advertising material used by persons and companies supervised by the CSSF. (See original text in French)

It is a very short circular the wording of which is worth commenting.


Use of the verb Refrain

“the persons and companies subject to the supervision of the CSSF must continue to comply with the rules of conduct of the financial sector both in Luxembourg and abroad, in refraining from issuing misleading advertising material with regard to the services offered”

This means that It is up to the professional to decide not to circulate misleading Ads. The wording is not direct like “Misleading Ads are prohibited”. It is pragmatic.

Investor's liability

“by mentioning, where necessary, the particular risks inherent to these services and in bringing to the client's attention his own responsibility”

Furthermore a liability may be put on the investor as the professional is invited to mention the particular risks inherent to the services if necessary and bring to the client's attention his/her own responsibility.
When reading Luxalpha documentation it is written is the subscription form a clause, to be signed by investors or their agents, that states that assets would be “safekept” by a US broker – although it did not name Mr Madoff, and investors would bear most of the risk of that broker’s default. A suscription form is not an advertising material but why Luxalpha subscription form was circulated with such clause?


No sanction

“The control of the compliance with the rules of conduct of the financial sector regarding advertisement remains within the competence of the CSSF, which has the authority to require the withdrawal of any misleading advertisement with regard to the services offered as well as of any inappropriate communications of information on the Luxembourg legal framework”

The circular does not state a sanction, but only the withdrawal, which is not a sanction.





Above all, the circular states at the beginning that “advertising material used by persons in charge of the distribution of units of undertakings for collective investment and their representatives no longer needs to be submitted to the CSSF for their control, even if this material is not subject to control by the competent authorities in countries where it is used."

The European passport from Luxembourg is a threat as no control is done at all on the communication from Luxembourg investment funds.

In the context of the Madoff case, this means that the investor cannot trust anymore the communication from Luxembourg investment funds.

QED.

There is a motto in Luxembourg, Mir wellen bleiwen wat mir sin, which means "We want to remain what we are"

Yesterday the CSSF, Minister Luc Frieden, the Director of LuxembourgForFinance, and the chairman of the ALFI communicated on the Madoff case in Luxembourg. What they say, which wants analysing between lines, confirms that there is no evolution. And that there will not be any.


The CSSF limits the assessment to a list where it seems that there may be missing funds (for instance what about the possible Luxembourg side of Thema?). It specifies that the amount of EUR 1.7 billion, which is even lower than the amount of EUR 1.9 billion that was stated in December, is given according to the information at its disposal. This means that it may ignore other funds. The CSSF does not contradict the figure of EUR 5-7 that was circulated.

In the first interview Luc Frieden confirms the amount of EUR 1.9 billion, which is a discrepancy with what the CSSF stated the same day, what sounds strange. He denies that Madoff case is a Luxembourg issue, as in his opinion it is an American issue. He denies that Luxembourg is a tax haven saying that France and other jurisdiction are jealous of Luxembourg success. The regulatory framework in Luxembourg is said to be "open and clear". The word "pragmatic" is no longer quoted but the word clear has a similar meaning. The order of words is switched as if Minister Frieden wanted to insist that there is no flexibility in the enforcement.

In the second interview, Luc Frieden explains that Luxembourg adopts an attitude which he describes as favourable to economic development, with decisions fast and close the needs of the economic actors but to in no case contrary with the European rules. It is true that every rule in favour of the business is transposed without delay, which is not the case for rules of regulation (see for instance debates on the directives relating to AML). He admits that decisions are close to the needs of the economic actors: but are the “needs of the economic actors” the needs of the stakeholders: investors, international community (OECD, GRECO)…

In an interview, Fernand Grulms, who is director of LuxembourgForFinance, explains that they must be better known and recognized like a credible and reliable partner.

In an interview, Claude Kremer, who is Managing Director of the ALFI, raises the question of conflicts of interest. He explains that he works in no case connected to Madoff and that "technically" their is no conflict of interest. One of his fellow colleagues in the Law Firm is the Lawyer of UBS and HSBC. Claude Kremer underlines that within his company, he informed the associates that he wishes to remain out of any case having a relationship with Madoff. But there is a huge problem in the small jurisdiction where “everybody knows everyone and where there is a kind of self regulation” as the same Law Firm as legal person is the cornerstone of the regulation.
1. The Law firm provides advises and opinions on law and regulation and has probably a responsibility in the pragmatic wording that harms today the Luxembourg funds by placing the investor in the doubt. As I explained, the famous circular relating to UCITS does not comply with the Luxembourg authorities’ statements. When Luc Frieden said that the professional in Luxembourg had an obligation of conservation, monitoring, control and restitution of the assets of the funds, I am afraid this clear obligation is not what the pragmatic circular says.
2. The Law firm is member of CSSF Committees.
3. The Law firm provides the Chairperson of the ALFI.
4. The Law firm provides representatives at the ABBL
5. The Law firm was chosen by UBS
6. The Law firm was chosen by HSBC
Etc.




All the above leaders never wonder why regularly there are issues and scandals involving Luxembourg, which is definitely the relevant question.
Not a word about the absence of penal liability of legal persons
Not a word about the "fiduciaires" that are neither members of the IRE nor the OEC, which organise scams with exotic jurisdictions
Not a word about statutory auditors from exotic jurisdictions.
Not a word about the absence of balance sheets database
Not a word about bankruptcies with the same individuals that can create companies
Not a word about the wording of the circular relating to UCITS
Not a word about the limited conception of CSR in Luxembourg, which excludes business ethics
Not a word about the persistence of professionals with red flags of bad management and bad governance in the business.
Etc.

It is so easier always to take refuge behind the jealousy undoubtedly probable of the other countries, to start with France which is anyway far from being a model.

Because of all that, there is definitely a country risk for any investor in Luxembourg or any supplier of a Luxembourg client.