By Olivier Sciales, Chevalier & Sciales – As, after more than four years of preparation, the European Union’s Alternative Investment Fund Managers Directive takes full effect for existing managers, Luxembourg finds itself in the position it wanted to be in – ideally placed to become a domicile and servicing platform for alternative funds distributed across borders in the same way that it has become for traditional retail funds under the UCITS regime.
Luxembourg has long been an established jurisdiction for alternative investments, starting with funds governed by Part II (dealing with non-UCITS vehicles) of the country’s fund legislation. Already a location favoured by the private equity industry for transaction and intermediary structures, usually in the form of financial participation companies (Soparfis), it created a dedicated vehicle aimed at private equity, venture capital and real estate investment in 2004 with the launch of the risk capital investment company (SICAR).
The alternative fund sector gained significant traction in February 2007 with the launch of the Specialised Investment Fund (SIF), a light-touch regulated regime aimed at hedge funds, private equity, real estate and other types of non-traditional investments. Since then the number of SIFs authorised by the Financial Sector Supervisory Authority has grown to 1,558, with aggregate assets of EUR331.5bn (out of a total of EUR2.71trn for all Luxembourg funds).
According to the Association of the Luxembourg Fund Industry (ALFI), hedge fund assets administered in the grand duchy, including both local funds and those domiciled elsewhere, totalled EUR128.8bn at the end of 2012, including 347 Luxembourg hedge funds or sub-funds and 649 fund of hedge fund portfolios.
Alternative UCITS hub
Also at the end of 2012, Luxembourg was home to 273 SICARs with assets of EUR25.5bn (as well as to more than 25,000 Soparfis). In September 2013, there were 244 real estate funds and sub-funds with assets of EUR30.1bn, an increase of 26 funds and EUR4.2bn (16%) from the end of the previous year. These statistics cover only vehicles regulated by the CSSF; including unregulated real estate vehicles would increase the numbers substantially.
In addition, the grand duchy has emerged as the leading centre for the domicile, servicing and marketing of so-called alternative UCITS that typically follow hedge fund strategies while remaining within the constraints of the EU retail fund regime. As of mid-2013, around 60% of all alternative UCITS funds were established in Luxembourg, almost double the level in the next largest domicile, Ireland, according to Preqin.
This means that at the dawn of the AIFMD era, Luxembourg is already a jurisdiction with substantial alternative fund business. However, all the indications suggest that its role in the sector is poised to expand significantly in the coming months and years, in part because of the expertise on hand in deal with regulated alternative vehicles, and the fact that many of the fund houses entering the AIFMD space already have UCITS operations in the grand duchy.
An additional boost is likely to come from the initiatives taken by the authorities to enhance the jurisdiction’s attractiveness to alternative fund managers and promoters, This includes notably an enhanced and expanded limited partnership regime introduced as part of the country’s AIFMD implementation law, offering structures with the same characteristics and benefits as those found in Anglo-Saxon common law jurisdictions such as England, Scotland and the Channel Islands, the Cayman Islands or 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. The SCSp offers complete tax transparency and neutrality, contractual freedom in areas such as the allocation of voting rights and economic benefits, and flexibility regarding regulation, structuring and provision of information. Limited partners no longer have to be identified publicly, and they may become involved in internal management 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. Already Luxembourg limited partnerships are being used by early adopters for SICARs, and considered for complex structures such as carried interest or management investment vehicles.
The grand duchy’s advantageous position is reflected in the level of demand for authorisation as an alternative investment fund manager in Luxembourg, which has surpassed the expectations of both the regulator and industry members. Even though some managers of alternative Luxembourg funds may have sought AIFMD authorisation in their home countries, such as the UK and France, the CSSF nevertheless reports having received no fewer than 203 applications as of the beginning of June, at least 50 more than were forecast just a couple of months earlier.
Of the applications received, 76 had been approved, although some of these are not yet on the official list of authorised AIFMs. This comprised 47 fully authorised managers as of June 6, plus a further five licensed to provide ancillary services. The approvals include at least 35 so-called Super ManCos that are authorised to manage both UCITS and AIFMD funds.
The progress being made by the regulator in dealing with this exceptional number of applications has eased the fears of industry members that bottlenecks might arise; the CSSF has taken on more employees and called on staff to work longer hours to deal with the workload. Media comment earlier this year about the relative lack of Luxembourg-authorised AIFMs has now been demonstrated to be unfounded.
The regulator has been providing guidance to the industry in Luxembourg on various aspects of AIFMD implementation through a Frequently Asked Questions document, now in its sixth updated edition since June last year, on the grand duchy’s law of July 12, 2013 implementing the directive as well as the European Commission’s Level 2 regulation on implementation of the AIFMD.
The FAQ document highlights key aspects of the AIFMD rules from a Luxembourg perspective and for the purposes of alternative funds and managers established in the grand duchy. They cover the scope of the law, the authorisation and registration (for managers below the assets under management thresholds) regimes, delegation requirements, entry into force of the law and transitional provisions, the scope of authorised managers’ activities, depositary rules, the application of the AIFMD passport to Luxembourg managers and funds and to foreign managers marketing in Luxembourg, reporting, valuation, transaction costs, and co-operation agreements signed by the CSSF with non-EU regulators.
The most recent update, posted on March 17, includes details of reporting requirements for Luxembourg managers. The frequency and nature of the reporting requirements depend on managers’ levels of assets under management, investment strategies and use (if any) of leverage, as set out in the directive and in the corresponding sections of the Luxembourg legislation.
AIFMs authorised after the entry into force of the directive last July 22, but before June 30 this year, must submit their first reporting statement, for the period starting July 1, by the end of October for those subject to quarterly reporting, or by the end of January 2015 for those reporting half-yearly and annually. AIFMs authorised between July 1 and 22 must submit their first reporting, for the period from October 1 to December 31, by January 31, 2015. The deadlines for funds of funds are 15 days later, to allow the gathering of data reported by underlying funds.
Managers of funds with assets below the authorisation threshold that received confirmation of registration in 2013 must report for 2014 by January 31, 2015, or February 15 for funds of funds. Those registered in 2014 must begin reporting as of the quarter following registration for a period up to the end of the calendar year (2015 for managers registered in the fourth quarter), and file their report by the end of the following January, or February 15 for funds of funds.
The latest FAQ guidance also covers the sole language for all AIFMD reporting (English) and authorised reporting channels (e-file and SOFIE). The regulator says an annual report in conformity with article 20(2) of the 2013 law must be made available for all funds whose managers were authorised before the end of the fund’s financial year, including managers authorised during 2013 for the 2013 financial year.
Requirements for non-EU managers
Annual reports must include a balance sheet or a statement of assets and liabilities, and an income and expenditure account for the financial year. Managers must comply with the requirements under scheme B of Luxembourg’s 2010 funds law for part II funds, in the appendix to the 2007 SIF law where applicable, and article 104 of the AIFMD Level II regulation.
The reporting requirements also apply to non-EU managers managing Luxembourg-domiciled alternative funds (irrespective of where the funds are marketed, even if exclusively outside the EU) or marketing either EU or non-EU funds in Luxembourg, during the transitional period before the marketing passport is made available to non-EU managers and funds, which will become possible (but is not guaranteed) from July 2015.
The CSSF says non-EU managers should in principle take the date of CSSF approval for marketing in Luxembourg as the start date for AIFMD reporting requirements, with the same reporting frequency and reporting periods as those applicable to Luxembourg managers, with the exception of non-Luxembourg funds that were marketed in the grand duchy by non-EU managers under Luxembourg’s private placement rules before July 22 last year.
Previous editions of the FAQs have covered issues including the definition of an alternative investment fund under the directive, which brings with it the requirement to appoint an AIFM, noting that the manager of any collective investment vehicle must make an assessment of whether the vehicles falls within scope, and the fact that the definition covers both regulated and unregulated entities. For Luxembourg purposes, they include all Part II funds, SIFs, SICARs and any other relevant vehicle not regulated under the UCITS rules.
Feedback on AIFMD functioning
The CSSF has clarified that credit institutions, financial sector professional entities established under Luxembourg’s 1993 financial sector legislation and investment firms cannot obtain authorisation as an AIFM, although banks and investment firms can manage alternative fund assets under a delegation arrangement with an authorised AIFM. The regulator also says its circular 12/546, which sets out the delegation rules for UCITS management companies, should be used by Luxembourg AIFMs in determining that they are not considered a letterbox company under the AIFMD implementation law.
One the July 22 deadline is past, the CSSF is expected to have more time to devote to aspects such as providing assurances on whether certain types of vehicle or structure are within AIFMD scope. However, the regulator will also have to start providing feedback fairly rapidly to the European Securities and Markets Authority on the functioning of the AIFMD, including both passporting arrangements and the continuing use of private placement distribution by non-EU managers and funds.
The information to be provided to ESMA, on four more or less quarterly occasions up to the end of January 2015, will cover use of the passport, any misconduct issues, co-operation with other regulators and systemic risk. On the responses will hang ESMA’s advice to the European Commission on the planned extension of full AIFMD authorisation and passporting privileges for managers and funds outside the EU, which would eventually be followed by the complete abolition of private placement arrangements for alternative funds.
For the moment, non-EU managers may consider establishing an AIFMD management company in Luxembourg in order to target the EU market, especially given the greater restrictions placed on national private placement regimes in many countries over the past two years. The number of applications for AIFMD authorisation suggests some of them may already be doing so. But extension of the passport to non-EU managers could equally boost the role of Luxembourg as a fund servicing centre, given the growing share of business coming from outside funds and managers.
Up-to-date information about the implementation of the AIFM Directive in Luxembourg as well as related regulatory measures, guidance and consultations issued by ESMA and the European Commission is published regularly in the AIFMD blog on the firm’s web site at www.cs-avocats.lu/aifm-directive/