With little more than five months to go before alternative managers active in Europe must be fully compliant with the European Union’s Alternative Investment Fund Managers Directive, Luxembourg is perfectly positioned to accommodate fund firms, from global investment houses to specialist boutiques, eager to exploit the potential of a passport to an EU-wide market.
Luxembourg’s law of July 12, 2013 may have been approved by parliament just a matter of days before the deadline for EU member states to adopt the directive into their national legislation, but the country’s fund practitioners regard it as more important that the statute incorporated the creation of a new legal partnership form designed to boost the grand duchy’s appeal to the global private equity industry.
Similarly, French industry members have boasted about the number of local managers that have already received authorisation from the country’s Financial Markets Authority. But 16 firms, including some big global asset management groups, had already been approved by the Financial Sector Supervisory Authority (CSSF) as of February 7, and as many as 90 more applications are in the pipeline, in good time to receive regulatory endorsement by the time of the full implementation of the directive on July 22 this year.
Media debate about which jurisdictions are ‘winning the race’ to sign up managers under the directive is something of a red herring since there is no evidence that fund firms are opting for authorisation by whichever jurisdiction is first in a position to do so. What matters more is that many potential applicants already have the comfort of an existing relationship with the CSSF.
A favoured domicile
Luxembourg already enjoys a significant advantage when asset managers are deciding the most favourable domicile for their AIFMD management company because of its longstanding role as a home for conventional funds that benefit from the UCITS fund passport for retail cross-border investment vehicles.
Many groups that already have a business infrastructure and service provider relationships (especially with a depositary) in the grand duchy have the opportunity to develop further economies of scale if they establish a Luxembourg ‘super-ManCo’ authorised to manage and distribute both types of fund through their respective passporting regimes.
The synergies offered by Luxembourg are particularly attractive because it has already emerged as Europe’s largest domicile and servicing centre for so-called alternative UCITS funds that offer hedge fund strategies using the freedom to invest in derivatives offered by the most recent iterations of the UCITS directive.
Many alternative UCITS providers are likely to offer AIFMD-authorised funds in order to benefit from their more flexible investment rules while still enjoying the ability to market and distribute them throughout the European Economic Area with relatively few additional approval formalities.
Preparing for the compliance deadline
The CSSF has told Luxembourg-based firms that they should submit AIFMD authorisation applications as soon as possible, and by April 1 at the latest. After this date, the regulator has indicated, it cannot guarantee that the turnaround time for authorisation will be in time for the July 22 deadline.
The CSSF is also requesting by April 1 information for all existing funds set up under Part II (non-UCITS) of Luxembourg’s investment funds legislation, risk capital investment companies (SICARs) and specialised investment funds (SIFs) benefitting from the transitional arrangements on how they plan to comply with the directive’s product rules covering the annual report, valuation, investor reporting and appointment of a depositary.
In the meantime the CSSF is regularly keeping industry members informed about the evolution of its rules and guidance for alternative investment fund managers through a Frequently Asked Questions document on its website. The latest version, published in January, contains new guidance on marketing and reporting.
The FAQs detail the provisions applicable to managers established in Luxembourg marketing EU-domiciled funds using the AIFMD passport, as well as rules for the marketing in Luxembourg of EU-based alternative funds by managers based elsewhere in the union. Under the grand duchy’s transitional arrangements, Luxembourg’s private placement regime remains open for the distribution of EU-based funds run by EU managers until July 22.
The document also provides detailed explanation of AIFMD regulatory reporting obligations, referring to the guidelines issued by the European Securities and Markets Authority. These set out reporting start dates and transmission deadlines that depend on how often managers are required to provide information and whether or not the funds in question are funds of funds (their transition deadlines are 15 days later than single-manager funds).
Enhanced product choices
Luxembourg’s fund industry, law firms, regulator and legislators have prepared for the arrival of the AIFMD regime by upgrading the country’s limited partnership rules. Private equity houses and other alternative fund providers now can use a structure offering the same characteristics as common law partnerships in the UK, the Channel Islands, Caribbean fund domiciles such as the Cayman Islands and the US state of Delaware.
As well as upgrading and modernising the existing common limited partnership (société en commandite simple), the July 12, 2013 law established the special limited partnership (société en commandite special, or SCSp), a structure without legal personality with features familiar to Anglo-Saxon private equity, venture capital and real estate fund houses and their limited partners.
The SCSp improves on the previous legal framework by ensuring complete tax transparency and neutrality, as well as contractual freedom in areas such as the allocation of voting rights and economic benefits, and flexibility regarding regulation, structuring and provision of information. The identity of limited partners no longer has to be published in the Mémorial, the country’s official gazette, and they may become involved in the internal management of the partnership, such as taking on advisory board roles, without risking loss of limited liability.
The SCSp can be either a regulated fund structure, usually a SICAR or SIF, or an unregulated vehicle such as an SPV that may lie outside the direct scope of the AIFMD, depending on the requirements of the limited partners, the fund’s investment policy and considerations relating to the jurisdictions in which investments are made. While it’s still early days, anecdotal evidence suggests that the new limited partnership regime is already enjoying healthy take-up from private equity firms and other types of investor.
Luxembourg has already gained significant traction for alternative investment providers since its launch of the SIF in February 2007. Seven years on, the number of SIFs has grown to 1,562 at the end of last year, with assets of €306bn. In addition to private equity and real estate funds, the regime is used for debt funds, hedge funds and funds of funds, and exotic assets such as wine, forestry and collectibles.
Carried interest incentive
To reinforce its appeal to the alternative sector, the grand duchy has adopted a carried interest regime offering tax benefits – a maximum effective income tax rate of 10.9 per cent - for general partner employees that become tax resident over the next five years, subject to certain conditions. In addition, management services provided to alternative funds are exempt from value-added tax.
The grand duchy is particularly well positioned to benefit if institutions such as pension funds and insurance companies come under greater pressure to invest in alternatives through onshore structures. In addition to its longstanding distribution ties the country has a well-developed service infrastructure including fund administrators and custodians; and the requirement for SIFs to appoint a depositary means that the experience and expertise required to meet the AIFMD requirements is already in place.
In addition, in recent years the range of administration providers has been swelled by firms, many of them originating in the Channel Islands, that specialise in handling the requirements of private equity and real estate vehicles. And since the AIFMD adoption deadline last July, various firms have started offering management company services in Luxembourg to fund promoters with limited resources; others are offering risk management and reporting solutions.
Ultimately Luxembourg offers a compelling combination of advantages to alternative fund managers: a careful thought-out legal framework and a regulator that communicates closely with the industry; a service infrastructure with critical mass whose economies of scale can ease the compliance cost burden for managers; and a level of experience in handling regulated alternative funds unmatched in the EU. As the July compliance target gets nearer, those benefits will seem ever more compelling.
Olivier Sciales is a founding partner of Chevalier & Sciales, Olivier Sciales specialises in investment management and focuses principally on the structuring and implementation of UCITS and SIF funds. His clients include firms managing mutual funds, hedge funds, and private equity and real estate investment structures. He obtained a law degree with distinction from the University of Antwerp and an LLM from Cornell University in New York. Olivier Sciales has been recommended by various specialist publications including the Legal 500 and Euromoney’s Guide to the World’s Leading Investment Funds Lawyers, and speaks regularly at seminars and conferences on topics including UCITS, the AIFM Directive and Luxembourg holding and financing companies. He speaks French, English and Dutch.
Chevalier & Sciales is a Luxembourg niche law firm established in 2005 and dedicated to the investment management, banking and financial industry. Our services cover the formation of funds / investment vehicles or corporations and ongoing advice for financial professionals and promoters. The firm’s practice, though exclusively focused on Luxembourg law, is global and multidisciplinary. Indeed, Chevalier & Sciales offers a comprehensive and specialized legal service covering all the key legal and tax aspects relating to an investment process from structuring and devising creative and tax efficient investment structures up to their complete implementation. Our team composed of high-skilled lawyers, with interdisciplinary expertise and in-depth understanding of financial markets, is responsive and renders high-quality and competitive advice. Chevalier & Sciales has continuously grown and expanded over the past few years and is now recognized as having a strong expertise in the set-up of sophisticated investment funds and the implementation of complex financial transactions. For more information, please visit www.cs-avocats.lu