Luxembourg is one of the world's leading onshore domiciles where, over the last 30 years, it has become the default option for managers wishing to establish UCITS funds. It is, by size, the world's second largest fund centre after the US, and, from a funds expertise perspective, offers managers everything they need; not just for UCITS funds but also unregulated or regulated alternative fund structures under AIFMD.
Through February 2017, total Assets under Management (AuM) for Luxembourg funds had risen 13.6 per cent year-on-year to EUR3.86 trillion, according to the latest statistics by the Association of the Luxembourg Fund Industry. Back in 1985, when Luxembourg became the first jurisdiction to transpose the UCITS Directive into national law, total AuM stood at 58 billion euros.
"All of the largest service providers operate in Luxembourg. If you draw a circle of 500 kilometres around Luxembourg you can attract more than 40 per cent of the European wealth ," says Mike Delano, partner at PwC Luxembourg. "If you look at the size of Luxembourg's financial services industry, relative to its wider economy, it is very substantial. The government is willing to work with the financial services industry to make sure it remains a viable part of the economy." Luxembourg is famous for its long standing political stability and has one of the lowest debt to GDP ratio in the EU.
Luxembourg's funds do not just have European investor appeal; they are sold in more than 72 countries worldwide. In Europe, a large part of the Grand Duchy's appeal is that it is viewed neutrally by investors.
"There is a lot of flexibility with Luxembourg fund vehicles and in many ways reflects the legal and regulatory environment. It is neutral, it has been geared towards the asset management industry, and the services it offers are able to support the global asset management community. It makes Luxembourg a viable option for a lot of fund managers," explains Begga Sigurdardottir, tax partner at PwC Luxembourg.
Part of that flexibility applies to Luxembourg's tax regime; a key consideration for any fund manager. Luxembourg investment funds are generally tax neutral.
"Whether it's a private equity fund, real estate fund or hedge fund, very often the manager needs holding companies and additional vehicles for legal ring fencing reasons, and in such situations you do not want those vehicles to be tax inefficient. This is where Luxembourg's tax laws have allowed for enormous flexibility to make sure vehicles remain tax neutral and investors are not penalised," states Sigurdardottir.
Before a start-up manager even thinks about setting up an AIF in Europe, there are a couple of key considerations. "Firstly, who will be the target investors and which EU countries will they be located in? Secondly, what is the fund's asset class and where are the assets going to be located? It's important that everything works from a tax perspective because unlike a UCITS fund, an AIF is very different. It may need to use holding vehicles in various jurisdictions, especially if it is a private equity or real estate structure," says Delano.
Also, managers should think about the capability of the jurisdiction they are considering for the fund. Does it offer the service providers and level of expertise needed to fully support the fund? Recently, several large alternative investment managers of Blackstone and Carlyle Group, have announced that they've chosen Luxembourg as their hub for Europe.
"Those are good names for the jurisdiction. It adds real credibility, from an AIF perspective," adds Delano.
These announcements show the impact that Brexit is now having, as large established managers look to set up operations on the mainland – Luxembourg or otherwise – to fully benefit from the passporting rights offered by AIFMD; something that cannot be guaranteed for the UK unless an equivalence agreement is achieved.
In terms of fund structuring, Luxembourg offers a menu of options. These range from regulated AIFs, known as Specialised Investment Funds, which can be established as a Luxembourg Common Fund (FCP) that has no legal personality and managed by a management company, or as an investment company with variable capital (i.e. Luxembourg SICAV); two choices of limited partnerships, called a common limited partnership (i.e. société en commandite simple, or SCS) and a special limited partnership (société en commandite special, or SCSp), which can either be regulated or unregulated; and finally, the most recent product innovation called the Reserved AIF (`RAIF'), which is an unsupervised product.
"Luxembourg offers a wide range of vehicles that fit all investors. You may have investors that prefer a regulated vehicle, in which case you would opt for product regulation (SIF). Or, if the institutional investors being targeted are used to offshore unregulated products, you may want to offer them something similar in Europe. In this case, one could use either a RAIF or an unregulated SCS or SCSp. Unregulated limited partnerships are very popular in private equity, less so in real estate and credit. The difference between the two is that the SCSp has no legal personality," explains Sigurdardottir.
As of now, Delano says that there are more than 110 RAIFs registered. It has proven to be a relatively successful product in a short space of time.
"I think alternative fund managers are excited about the opportunities the RAIF offers. One of the benefits of the RAIF that is worth pointing out is that it can, at a later date, be converted into a SIF if a large institutional wants to invest but only if it is a regulated vehicle.
"It can be launched and marketed as a RAIF in the early stages, and transformed into a SIF at a future point in time, which is advantageous," observes Delano.
The RAIF can also be compartmentalised, meaning that the fund sponsor is able to incorporate different cell companies, which could be used to create a suite of fund strategies. The benefit of it is that it avoids the cost impact of setting up multiple funds. Sigurdardottir confirms that in principle a RAIF needs to adhere to risk diversification limits: this is typically a 30 per cent counterparty exposure limit based on the NAV.
Anyone who opts for Luxembourg knows that they will be getting access to a premier funds centre, which is fast becoming used as the focal point for global distribution among the world's largest fund management groups.
"Many global service providers operate in Luxembourg with multi-national workforces that can interact with different regulators, investors, other service providers, etc in their native language – English, German, Italian, French and so on – and being able to do that is one of the country's strengths. It is a truly international community here," says Delano.
He thinks that over time, AIFs have got the potential to become a brand like UCITS.
"We hope it turns into something that is recognised as a solid regulatory regime and accepted by global institutional investors, not just those based in Europe. In the past, managers might just have used a Cayman Master fund and a Delaware LP. That will still remain popular but I have, for example, a client who has set up a RAIF Master fund with an EU feeder, a Cayman feeder and a Delaware feeder to ensure they can continue to easily raise capital from European investors.
"They are taking one fund and achieving global reach by using Luxembourg as their European hub for distribution," says Delano in conclusion.
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