I OVERVIEW OF RECENT ACTIVITY
The asset management market in Lebanon is in a transitionary and transformative phase, while still being challenged by a dominant traditional banking services and products market which offers high returns on deposits thus hindering the creation of nurturing market conditions.
Further, narrowing profit margins worldwide and stagnant local economic conditions exacerbate the pressure on asset management companies in Lebanon (henceforth Lebanese asset managers). In this challenging environment, front runner firms have been working strategically on key areas such as restructuring their product portfolios to meet higher investor demands, streamlining their operations (importantly including those of their front office) by utilising technologically advanced platforms, and creating unique digital-based customer experiences aligning with the demands as well as opportunities of a digital era.
The Lebanese asset management industry comprises an ecosystem of mainly international participants, mostly of EU domicile, with a number of local asset managers, being foremost investment arms of big local financial players, offering a broad spectrum of investment funds, while certain participants have a niche strategy of specialising in alternative investment funds.
II GENERAL INTRODUCTION TO THE REGULATORY FRAMEWORK
i Asset management supervision
The Capital Markets Authority (CMA) is an independent, administrative body, set up by way of Law No. 161 of 17 August 2011 (the Capital Markets Law), which is entrusted with duties to protect savings invested in financial instruments, organise the availability of information to those distributing financial instruments to the public, and ensure the integrity of the financial markets in Lebanon.
With regard to asset management, the CMA is the primary prudential supervisor of Lebanese asset managers as well as the investment funds they manage. The main duties of the CMA include:
- issuing of regulations and decisions for a licensed institution ('approved institution') (which encompasses asset managers), including in relation to licensing procedures applicable to a collective investment scheme manager (CIS manager) and investment funds, as well as the rules applicable to the activities of collective investment scheme custodians (CIS custodians);
- licensing of Lebanese asset managers and investment funds, including securitisation funds;
- prudential and ongoing supervision of Lebanese asset managers and investment funds offered to retail clients;
- review, inquiry and investigation of the activities of CIS managers and CIS custodians (including inspections on-site);
- imposition of administrative sanctions on CIS managers, investment funds and CIS custodians in the event of breach of applicable laws and regulations; and
- supervision of the marketing of Lebanese and foreign investment funds (with emphasis on Lebanese investment funds marketed to retail clients).
For the purposes of fulfilling its duties the CMA coordinates and cooperates with its counterparts, as well as the Central Bank of Lebanon (Banque Du Liban, BDL) and any other concerned authority or institution in Lebanon or abroad.
With regard to specifically asset securitisation funds (including Islamic asset securitisation funds), which are established pursuant to Law No. 705 of 9 December 2005 (the Asset Securitisation Law), the BDL is the main regulator.
ii Legal framework for asset management activities
The laws applicable with respect to asset management activities consist of the following:
- the Capital Markets Law, which governs, inter alia, the issuance, purchase, sale and marketing of financial instruments for public offer and the financial markets in general;
- the Asset Securitisation Law, which defines the legal framework governing asset securitisation in Lebanon by way of establishing and managing asset securitisation mutual funds;
- Law No. 706 of 9 December 2005 (Law 706), which governs collective investment schemes in securities and other financial instruments;
- Law No. 160 of 17 August 2011 (Law 160), which sets out the prohibition of insider trading made on the basis of material non-public information; and
- Law No. 234 of 10 June 2000 (Law 234), which regulates the financial intermediation profession.
A number of new regulations have been recently enacted by the CMA governing generally the financial markets in Lebanon (including asset management), which have been the result of focusing on the issues of enhanced investor protection and transparency in an effort to align with international standards. In particular, with respect to asset management, the relevant regulations are:
- Collective Investment Schemes Regulation – Series 8000, dated 24 January 2019 (the CIS Regulation), which covers the establishment, approval, offering and management of collective investment schemes (including Islamic schemes) and associated activities in Lebanon (but excludes the use of collective investment schemes for asset securitisation purposes under the Asset Securitisation Law) and establishes requirements governing CIS managers, CIS custodians and approved institutions;
- Regulation on Offers of Securities – Series 6000, dated 7 August 2017 (the Offers of Securities Regulation), which sets out the main rules regarding offering of financial instruments in Lebanon, including all types of investment funds, as well as the requirements for offering such funds to retail clients and professional clients;
- Business Conduct Regulation – Series 3000, dated 10 November 2016 (the Business Conduct Regulation), which establishes the rules of conduct for approved institutions, including asset managers, when carrying out securities business and dealing with clients;
- Market Conduct Regulation – Series 4000, dated 10 November 2016 (the Market Conduct Regulation), which details the prohibitions of insider trading and market manipulation; and
- Licensing and Registration Regulation – Series 2000, dated 19 January 2017 (the Licensing and Registration Regulation), which sets out the licensing and operational requirements for approved institutions, including Lebanese asset managers.
The CIS Regulation requires collective investment schemes offered to the public to be subject to enhanced investor protection rules that align with international standards. On the other hand, 'exempt offer schemes', which allow for greater risks to be taken in both investments and leverage, are only permitted to be offered to professional clients, whom by definition have a sufficient level of expertise to understand the risks involved and sustain them. This distinction among the varying levels of investor protection applies regardless of whether the public offer is made in connection with Lebanese collective investment schemes or foreign ones. In addition, the international standards with which the CIS Regulation aligns are primarily those of the International Organization of Securities Commissions (IOSCO) and the European Union's Undertakings for Collective Investments in Transferable Securities Directive (the UCITS Directive) governing publicly offered open-ended collective investment schemes, and secondarily, the regional standards of Saudi Arabia (qualified usage applying due to the regulatory framework being under revision there) and Dubai.
iii Regulation of asset managers
CIS managers are entities that establish, offer and manage one or several collective investment schemes in Lebanon (Lebanese or foreign), including any alternative investment funds (AIFs), such as real estate and private equity funds subject to the CIS Regulation.
Accordingly, in order for a company to offer and manage any type of Lebanese collective investment scheme, it must first be licensed by the CMA as a CIS manager.
The licensing provided by the CMA to the CIS manager is distinct from the licensing provided in connection with managing a portfolio of assets on a discretionary basis, as well as with distributing foreign investment funds.
The CIS manager may routinely be authorised to perform certain other investment services (such as investment advisory and execution dealing that is provided, for example, to other CIS managers licensed to manage niche AIFs).
The licensing procedure consists of submitting an application file to the CMA, where the CMA may conduct a review or inquiry as it deems appropriate prior to granting a licence. There is no time limit for the CMA to provide its licence.
Before licensing a company as a CIS manager, the CMA must be satisfied that the following requirements have been met with respect to the company:
- it is established in Lebanon as (1) a bank, financial institution or financial intermediation company registered with the BDL or CMA respectively; or (2) a branch of a foreign financial entity whose parent company is engaged in securities business and is licensed by a competent authority in a recognised jurisdiction;
- it is engaged solely in securities business, or in the case of a company licensed by BDL, solely in business covered by that licence;
- its head office is in Lebanon;
- it has sufficient initial capital (the minimum share capital for managing collective investment schemes is 3 billion Lebanese pounds (US$2 million) but higher limits may apply if the licence includes other securities business activities);
- its management, personnel and agents possess the necessary integrity, skills, qualifications and experience to carry out the related activities;
- it has obtained the prior authorisation of the CMA in the event its equity holdings are acquired by (1) any person by more than 10 per cent or (2) a board member regardless of size;
- if it is an associate of another person, that such person has the necessary integrity, regulatory status, business record and financial soundness; and
- it contributes to the financial institution professional indemnity (FIPI) that includes insurance coverage for risks associated with incomplete transactions and criminal and tort liabilities.
Importantly, the CIS manager must satisfy the 'fit and proper' test, which in turn focuses on the sound management of its business and must also employ such systems, policies and procedures that are sufficient to cover the particular obligations of corporate governance, risk management, compliance, and operations and controls associated with such asset management business. It must also employ skilled and experienced people and sufficient financial and technological resources to serve such purposes.
Once licensed, CIS managers are subject to prudential supervision by the CMA throughout their managing of investment funds. They are also subject to the rules of the Business Conduct Regulation, as well as the specific conduct rules included in the CIS Regulation and Market Conduct Regulation on an ongoing basis. In particular, the rules require CIS managers to comply with:
- client classification;
- best-execution policy;
- prevention of conflicts of interest;
- organisational and operational requirements (bookkeeping, registration records of unitholders, audited reports and accounts, delegation of activities, remuneration policy and compliance);
- valuation of assets;
- liquidity management;
- insider dealing and market manipulation prohibitions; and
- fighting money laundering and terrorist financing (pursuant to Law No. 44 of 24 November 2015).
Importantly, following an initial offer period, CIS managers are obliged to make investment decisions that provide a prudent spread of risk in addition to aligning with the investment objectives and policies of the funds they manage.
In addition, any payment of fees, charges or any other payment in cash or in kind may be made to the CIS manager on the condition that the nature, amount and method of applying such fee, charge or payment as well as the description of how these are levied are disclosed in a clear manner in the offering document of the investment fund and are within the limits stated therein.
Powers of the CMA
In the event of breach of applicable laws and regulations by the CIS manager, the CMA has the power to, in addition to imposing a number of administrative sanctions that apply to all approved institutions, remove the CIS manager and appoint a replacement CIS manager in respect of managing a particular fund as well as taking any other steps as necessary.
The CMA can also revoke the licence of a CIS manager for persistent failure of one or more schemes under its management to comply with the CIS Regulation. The licensing procedure and requirements applying to CIS managers apply mutatis mutandis to the approved distribution agents.
Approved distribution agents
For a company to market the giving or offer of advice with regard to investing in a collective investment scheme in Lebanon (whether Lebanese or foreign) or deal in subscriptions and redemptions of such scheme, it must be licensed as an approved distribution agent for such scheme in accordance with the Licensing and Registration Regulation.
The licensing procedure and requirements applying to CIS managers apply mutatis mutandis to the approved distribution agents.
Regulation of investment funds
Lebanese investment funds
Lebanese investment funds comprise of:
- regulated funds, which are: (1) collective investment schemes, including certain types of AIFs such as real estate collective investment schemes; (2) Lebanese private equity investment vehicles, both of which (1) and (2) are supervised by the CMA; and (3) asset securitisation funds, which are supervised by the BDL; and
- non-regulated funds, which are not supervised.
Funds for public offer
With respect to regulated funds to be offered to the public, the CMA generally grants its approval to the investment fund within four weeks of the submission of the application, which must include all the required information and documents. The CMA has wide discretionary powers in respect of the approval application and can carry out any investigation, inquiry or on-site inspection to the CIS manager as appropriate, whereby the period for approval extends accordingly.
Licensing of additional sub-funds to an umbrella investment fund can generally be granted if the CMA raises no objection within 30 days following notice of such addition by the CIS manager.
In order to safeguard fair treatment among investors, the statute and offering documents of approved investment funds for public offer that are open-ended or interval must apply enhanced disclosure requirements, such as the following:
- specifying if different classes of units are issued, whereby the principle is that it is not permissible to include a unit class that results in disadvantaging the investors in other unit classes of the same sub-fund or scheme, or when the unit class has a structure risk that cannot be clearly explained to the public, or when it contravenes the purpose of the CIS Regulation (such as, for example, when a unit class is intended to be offered by misleading the public as to the risks they would be exposed to);
- specifying if different subscription charges, annual management charges or redemption charges apply as well as accounting in detail for such differences; and
- specifying if different currency classes apply.
In addition, there are strict borrowing limits and leverage limits applicable to investment funds for public offer.
With regard to an open-ended scheme, interval scheme or sub-fund, the CIS manager can only borrow up to a maximum of 10 per cent of the fund's total asset value for a maximum of 80 days by way of overdraft. Moreover, such borrowing is not permitted to be either rolled over, or used to meet redemptions, or for investment, or financing payment of investment returns to the investors.
With regard to a closed-ended scheme or sub-fund of a scheme, the CIS manager can borrow up to 20 per cent of the fund's total asset value, whereby the nature and duration of such borrowing must be clearly disclosed in the CIS prospectus of the scheme or sub-fund.
Importantly, responsibility for monitoring compliance of an investment fund for public offer with the investment, borrowing and leverage limits lies with the CIS custodian in accordance with Law 706 and the CIS Regulation.
Funds for exempt offer
Regulated funds to be offered by way of an exempt offer must be offered exclusively to professional clients and have a minimum subscription amount of US$50,000 per investor or their equivalent in another currency.
The CIS managers of such investment funds are only required to notify the CMA of their intention to create such funds and offer them to institutional investors. If the CMA does not object within 15 days of receipt of such notice, the CIS manager may proceed to create the scheme. Further, the CMA may, at the request of the CIS manager, issue a certificate of registration and enter the name of the scheme on its official register of schemes.
Following approval, the CMA notably does not supervise such institutionally offered investment funds; however, it can cancel its approval in the event of breach of the regulations by the CIS manager or breach of the exempt offer requirements.
Critically, there are significant disclosure requirements that apply even to the institutionally offered investment funds, and while the ability of an exempt offer scheme to borrow or apply leverage is unlimited, important details such as maximum amount, duration and type of borrowing, means of achieving leverage as well as implications analysis are required to be stated in the scheme's constituting and offering documents.
Funds for public offer
Public offer of foreign funds in Lebanon is permitted only with respect to collective investment schemes that have been approved in their home jurisdiction for public offer and are further approved by the CMA as offering equivalent investor protection to Lebanon. Notification to the CMA of the public offer of the foreign fund is made by an approved institution and the CMA generally grants its approval within 30 days from the submission of the application.
Funds for exempt offer
The requirements for offering foreign funds by way of an exempt offer are similar as with regard to the Lebanese exempt offered funds.
Regulation of CIS custodians
In accordance with the CIS Regulation, the assets of investment funds (including those of AIFs that fall within the scope of the CIS Regulation) must be held by independent custodians, appointed by the CIS manager, which must be either an approved institution that the CMA has licensed to provide custody services in Lebanon or Midclear (being the national custodian and settlement agent of Lebanon). The duties of the CIS custodians are critically twofold – safekeeping as well as supervisory – with regard to the investment fund and mainly consist of the following:
- exercising custody over the assets of the investment fund; in particular in respect of securities and real estate titles this must be done by holding these beneficially on behalf of the investors and in respect of cash and deposits, by either holding these beneficially on behalf of the investors or by exercising control over them. Importantly, the CIS Custodian has to keep the assets of the investment fund segregated from those of the CIS manager, the CIS custodian and the CIS custodian's other clients;
- monitoring compliance with the investment fund's investments, borrowing and leverage requirements in accordance with Law 706 and the CIS Regulation;
- monitoring compliance of the cash flows of the investment fund; in particular this would involve receiving full payment of subscription cash or any income due to the investment fund, making full payment of redemption cash, as well as holding all cash received in accounts in the name of the investment fund;
- monitoring compliance of the instructions of the CIS manager with the applicable laws and regulations and constituting documents of the fund, with the obligation to immediately notify the CMA in the event of non-compliance of the CIS manager concerning the property of the fund; and
- keeping updated records of the transactions of the fund and reconciling those with the records of the CIS manager at least once a month.
The CIS custodian may delegate the holding of the fund's assets, in whole or in part, to any sub-custodian outside of Lebanon, provided the latter is licensed to exercise custody in their home jurisdiction by a regulator considered as having equivalent standards by the CMA. In delegating, the CIS custodian must ensure that the beneficial ownership of the assets of the fund by the investors is clearly established and the assets are not therefore commingled with those of the foreign sub-custodian, CIS custodian or CIS manager.
Notwithstanding any delegation, the CIS custodian remains liable in relation to the investors for any losses that may be sustained by the fund through error or omission, and as this is a liability imposed by regulation, the parties cannot limit it by contract.
Regulation of marketing of investment funds
There is an elaborate and strict set of rules regulating the marketing of investments funds in Lebanon, by way of both the generic securities advertisements requirements under the Licensing and Registration Regulation as well as the specific securities advertisement requirements under the CIS Regulation.
Accordingly, any form of verbal, electronic, broadcast or written communication made for the purpose of inviting or inducing potential unitholders in Lebanon into investing in an approved fund would qualify as a securities advertisement and would have to be clearly identified as such and made by the CIS manager or approved distribution agent for the relevant fund.
Further, depending on whether the fund that is being marketed is an approved fund for public offer or exempt offer, different requirements will apply as to the content of promotional materials.
Funds for public offer
In particular, with respect to a publicly offered Lebanese fund, any security advertisement must be consistent with the CIS prospectus of the fund and include information on how to obtain a copy of the fund's CIS prospectus and key information document if available, as well as a copy of the most recent annual report and accounts of the fund, and a statement that the value of units and the income derived from them can fall as well as rise and that investors may not get back the money they invested.
Importantly, it is prohibited for the CIS manager to include in the security advertisement any projection or prediction of future total return or performance of a fund, or any endorsement or testimonial whatsoever.
The CIS manager is also required to maintain records of all the marketing it performs via any media and provide a copy of any particular record of such marketing upon request by the CMA.
Critically, any reference in the media to total return for the fund should be stated net of subscription charges, redemption charges and annual expenses paid out of the fund, while there is an obligation to state prominently these charges and operational expense ratio as a percentage of the net asset value of the fund unit.
Similarly, total return must be presented compared with the relevant benchmark or index that the fund utilises and must state whether costs are included in such benchmark or index. If the index or benchmark does not include all elements of total return, the advertisement must disclose what elements of return are not included and how that omission affects the comparison of the scheme's total return with the benchmark or index.
Funds for exempt offer
With regard to Lebanese exempt offer funds any advertisement or use of promotional materials must: (1) be directed only to professional clients; (2) comply with the Licensing and Registration Regulation provisions, mainly in that they have to be fair, accurate and not misleading; and (3) be distributed only following the expiry of a period of 14 days starting from notification to the CMA, where the CMA did not object to the offer.
Foreign exempt funds
Any advertisement or use of promotional materials in Lebanon with regard to exempt foreign funds requires the appointment of a local distribution agent that must be an approved institution. Further such advertisement or promotional material is subject to the same requirements as applicable for Lebanese exempt funds but for the notification period (without objection) to the CMA, which is 15 days.
Provision of investment services
Any dealing in, advising and managing of assets (including discretionary mandates and managing of collective investment schemes) qualifies as a regulated securities business activity and is therefore permitted to be provided only by investment services providers in Lebanon duly licensed for such activities. In respect of collective investment schemes, such entities will be licensed as a CIS manager or in the case of distributing foreign collective investment schemes, an approved distribution agent.
An exemption to these licensing requirements arises in the event of occurrence of reverse solicitation, pursuant to the Licensing and Registration Regulation.
However, since reverse solicitation is an exemption from the licensing requirements, the scope of what is allowed to be provided in this way will be limited. With regard to investment funds, the potential investor approaching any locally non-licensed asset manager will have to be very specific in their request for information in respect of the particular type of fund they wish to enquire about (and will have to identify this by certain investment features of the fund and not by seeking more generic information about what types of funds are available out there for their investment needs), as otherwise it would effectively lead the asset manager into marketing, which is prohibited.
In addition, the activity of an asset manager organising local training seminars and other training events in Lebanon, which cover general topics related to asset management, is also permitted under the laws and regulations of Lebanon, provided there is no marketing of any specific product or sale and purchase of any fund units whatsoever.
III COMMON ASSET MANAGEMENT STRUCTURES
The main structures currently used for collective investment schemes in Lebanon are:
- mutual funds that are (1) open-ended schemes, (2) closed-ended schemes, (3) interval funds, which are a hybrid form of the former two introduced by the CIS Regulation, or (4) Islamic schemes; and
- companies, the use of which is obligatory under the CIS Regulation with regard to real estate funds.
Publicly offered open ended funds are not permitted to invest in alternative investments (in line with the requirement under the UCITS Directive, which represents the international standard for such funds) but closed ended funds can invest in real estate. Foreign funds offered in Lebanon may be subject to different structures such as investment companies or trusts.
IV KEY TRENDS
There are a number of challenges currently faced by Lebanese asset managers and the changes that such challenges mandate into their business models tend to shape the new trends in the market.
Main trends include primarily solutions-driven approaches based on current EU-tightening regulatory framework challenges and digital transformation challenges.
In particular, there is a distinct indirect impact from MIFID II's heightened investor protection requirements on Lebanese asset managers with regard to the product governance rules, which affect how the Lebanese asset managers offer their products or services to EU-based clients via EU placement agents. Lebanese asset managers are now required to provide specific information on the proposed target market for a product or fund, as well as on the distribution strategy, in order for the EU placement agents to establish both the appropriateness for such a target market and ensure that marketing is directed to the relevant investor group. It has been established that the 'target market analysis' requires consideration of the client's objectives and experience as well as the identification of a negative target market, which makes the use of a blanket 'not for retail' legend redundant.
Consequently, the additional costs of enhanced technology and operational infrastructure that Lebanese asset managers may have to bring into their business models in order to meet the MIFID II heightened investor protection obligations (such as those of best execution reporting, monitoring and controlling, or thorough investor intentions analysis and recording) may adversely affect business flow and product pricing and thus inevitably restrict the investor base to which they may be able to make an offering.
As a result, Lebanese asset managers with an EU nexus are currently seeking to integrate as competitive technologically advanced platforms as possible, while at the same time adjusting their business models to enhance the targeting of investors with optimal business returns.
Another key trend deriving from the EU-tightening regulatory framework are re-evaluations and adjustments in the corporate strategy of Lebanese asset managers due to restrictions imposed on them by way of the Alternative Investment Fund Managers Directive, 2011/61/EU (AIFMD) impact. Being non-EU based asset managers that manage non-EU AIFs, Lebanese asset managers are deprived from benefiting from passporting when targeting institutional clients within the EU. This means they have to obtain authorisation from each EU Member State in accordance with the latter's individual private placement regime. In addition, should passporting be extended to non-EU AIFMs in the future, satisfaction of the AIFMD requirements when marketing non-EU AIFs is likely to prove problematic.
As a result, Lebanese asset managers are considering changes to their corporate strategy, whether be it by establishing branches within the EU or entering into strategic alliances by way of mergers and acquisitions with EU-AIFMs and realigning part of their funds offering to be EU based in order to retain a competitive foothold within the EU client based market.
A further trend stems from the recent notable announcement of the CMA for the creation of an electronic trading platform (ETP), to be supervised by the CMA and operated by the private consortium of one of the largest Lebanese banks (Audi Bank) in collaboration with the Athens Stock Exchange (ATHEX), which aims to list a variety of investment products among which, importantly, shares of Lebanese SMEs and start-ups, with the aim of energising the economy. It is expected that within the ecosystem that will necessarily have to evolve out of the functionality of the platform, Lebanese asset managers will play a constructive role by investing in such shares (or generally in the ETP's products) or by straightforward assisting the SMEs and start-ups by way of private equity funds' investments or by establishing relationships of consultancy and advice and sharing of know-how with them. In addition, given the increasing importance within the global asset management community of the environmental, social and governance (ESG) considerations when weighing up investment options, Lebanese asset managers who integrate the ESG factor in their investment strategies related to the platform and beyond are expected to be rewarded accordingly.
A final trend stems from the global challenge of digital transformation as this is combined with the behavioural change that a new costs disclosure regulatory environment is driving, both of which lower execution and research costs and incentivise the asset managers to focus more strongly, as a matter of competition, on the client's portfolio maximum returns. As a result of this global trend, a number of Lebanese asset managers are currently restructuring their portfolios with a macroeconomic strategic view.
To the extent that there may be a concerted effort by the Lebanese public authorities and the principal market players to implement effective strategies and deliver changes to the financing of the economy as a whole, the Lebanese asset management industry will enjoy new opportunities for growth for itself and the Lebanese investment funds, thus contributing to the energising of the economy. It remains to be seen whether such concerted effort will materailise.
Alternatively, increasing business pressures arising from within the local market as well as from the EU and international regulatory restrictive environment and the constantly evolving digitalised and competitive global environment may lead to consolidations and downsising of the Lebanese asset managers in critical aspects.
1 Rita Papadopoulou is a partner at Abou Jaoude & Associates Law Firm.