Luxembourg is one of the largest global investment fund domiciles, benefiting from the following factors:
- Flexible and attractive legal, regulatory and tax regimes
- Significant concentration of professional service providers
- Financial and political stability - AAA credit rating and stable institutional framework
- Extensive track record in fund establishment and cross-border distribution.
In April 2016 the assets under management for Luxembourg-domiciled investment funds (including both alternative investment funds (AIF) and UCITS) exceeded €3.4 billion. The domiciling of funds of such value in Luxembourg has also enabled the development of mature cross-border distribution channels.
As an EU founder member, with stable institutional membership, Luxembourg's fund services industry benefits from all EU passporting rights, including under AIFMD.
Accessing EU professional investors – AIFMD passporting
Since the complete entering into force of the EU alternative investment fund managers directive (AIFMD) in the national laws of EU member states in July 2014, initial concerns relating to its potential impact on the industry have been increasingly mitigated and supplanted by the distribution benefits of the AIFMD cross-border EU passport.
Use of the EU passport as a distribution mechanism is simple in relation to Luxembourg AIFs having appointed an authorised Alternative Investment Fund Manager (AIFM) whether situate in Luxembourg or another EU member state. The AIFM simply:
- notifies its home state regulator of its appointment as AIFM to the relevant fund, and
- notifies its intention to passport identifying the target investor jurisdictions.
In each case notification is made through the filing of a prescribed form with the AIFM's home-state regulator with some standard attachments / disclosures. In the case of Luxembourg AIFM, the regulator is the Commission de Surveillance du Secteur financier (CSSF). CSSF (or other home-state regulator) then transmits the notice of intention to passport to its equivalent regulator(s) in the target investor jurisdiction(s) within 20 working days of receipt by CSSF of the notification file, provided CSSF does not conclude that there is any breach of AIFMD by the AIFM.
On transmission by CSSF to regulators in the target investor jurisdictions, CSSF informs the AIFM and this constitutes authorisation to commence passported marketing under AIFMD, to the identified target jurisdictions.
Although some investor jurisdictions purport to levy national fees to passport, this is not envisaged by AIFMD.
Passporting distribution obviates certain drawbacks associated with other forms of access permitted under AIFMD such as (i) reverse solicitation or (ii) reliance on national private placement regimes.
Whilst reverse solicitation, which occurs at the instigation of the investor, and not at the instigation of the manager, is not affected by AIFMD, its availability is fact sensitive to each case. There is no EU-level definition of, or guidance on, reverse solicitation. However, in general terms, it must be demonstrated that the investor actively approached the manager to seek information on investment opportunities in the specific AIF in question (and not in response to any action by or on behalf of the manager). It will also be subject to any individual positions on reverse solicitation in each relevant national jurisdiction where target investors are situated. Wherever relied on, it will be prudent to clearly document when and how both the relevant investor relationship and the specific contact in relation to the proposed investment in the relevant AIF commenced.
The other principal route to market involves use of a non-EU AIFM and reliance on individual, national private placement regimes, subject to an AIFMD overlay of universal application.
The AIFMD overlay that a non-EU AIFM must meet in order to use national private placement regimes (where available) requires as follows:
- European Securities and Markets Authority (ESMA) approved, inter-regulator co-operation agreement(s) between (1) the relevant EU, target-investor, member state(s) and (2) the domicile(s) of the non-EU AIFM and (if different) of the non-EU AIF
- The non-EU domicile(s) of the AIFM and the AIF being on the OECD "white list" relating to non-co-operative territories and jurisdictions
- Tax information exchange agreements between (1) the relevant EU target-investor member state(s) and (2) the non-EU domicile(s) of the AIFM and AIF
- The AIFM does not constitute a "letter-box entity" (an implicit requirement)
- Compliance with AIFMD-required investor disclosures and regulator reporting
The first criterion, the existence of inter-regulator co-operation agreements, is considered to also imply a requirement that the non-EU AIFM is subject to regulatory authorisation and oversight in its jurisdiction of establishment.
The regulator reporting obligations require the non-EU AIFM to use an ESMA pro-forma reporting template to report both annually and either quarterly or semi-annually (depending upon assets under management) to the national regulator in each target-investor EU member state where marketing occurs. The annual reporting includes: financial and activities reporting for each AIF marketed in that member state together with any material changes to the AIF's offering document disclosures; a summary of the total remuneration paid by the AIFM, the number of recipients of that aggregate remuneration and the fixed and variable allocations within it. The quarterly or semi-annual reporting includes a summary of the AIF's principal assets or trading, any change to liquidity arrangements, stress testing results, and a summary of the risk and leverage profiles.
Whilst many of these general, overlay requirements are met (or are easy to satisfy) in relation to structures established in the principal non-EU international fund domiciles, accessing investors through this route also requires the availability of, and then compliance with, individual, national securities laws in each target investor jurisdiction.
Certain EU member states have tightened or stated an intention to tighten, under national law, their existing private placement regimes. For example, Germany now requires a new form of notification to, and approval from, the German regulator and the appointment of a depositary under national law. The Netherlands has indicated a very similar proposal to change its registration requirements under its securities laws. It is also the case that some jurisdictions' existing national private placement regimes are considered less feasible to use in practice or uncertain as to their scope or existence.
Market trends in certain jurisdictions also appear to indicate a growing internal asset allocation preference by certain EU institutional investors for AIFMD compliance.
Use of the AIFMD marketing passport avoids the uncertainties, complexities and multiple requirements of navigating several, national distribution routes by providing.
- Easier access to professional investors in jurisdictions which are restricting their national private placement regimes or where such regimes are uncertain
- Access to institutional investors whose internal asset allocation requirements prefer such a platform
- Cross-border ease of distribution to all EU-domiciled, institutional investors, following a single notification to the AIFM's home regulator.
To utilise the AIFMD marketing passport available to authorised AIFM, two options exist:
- Set up an in-house AIFM in an appropriate EU member state; or
- Appoint an independent AIFM as a service provider to the relevant fund(s).
In each case, this will also require full compliance with AIFMD and any applicable, additional national financial services regulation (in Luxembourg exemptions apply from any additional, national requirements). Full AIFMD compliance is a detailed area. The following is a headline summary only of the most relevant points:
- Regulator approval of AIFMD directors and ownership
- Physical office and staff (a Luxembourg requirement in practice)
- Full AIFMD-compliant remuneration policy and delegation arrangements
- Leverage and risk management-policies
- Functional and hierarchical separation of risk management from portfolio management
- Regulatory capital requirements
- No undisclosed differential treatment between investors
- Conflicts of interest management policy
- Leverage and liquidity management policy and stress testing
- Data control rules
- Regulation of employees' personal transactions
- Independent portfolio valuation requirements
- Delegation criteria
- Regulated depository, administrator and approved auditor to the AIF(s)
- Required investor disclosures
- Private equity specific requirements & regulatory notifications
- Notification of ownership-threshold changes in portfolio companies
- Notification to portfolio companies of annual business review, future development & conflicts management policies
- No capital returns or distributions from portfolio greater than available profits for two years post-acquisition.
Arm's length regulatory oversight of AIF
Whilst the regulatory process for authorisation as an AIFM is lengthy and detailed, there are two positive factors. First, it is a single process which relates exclusively to the AIFM. Secondly, no regulation of the AIF itself is required under AIFMD.
Extrapolating this, CSSF policy allows authorised AIFM to act in relation to Luxembourg AIF without requiring the AIF also to be separately regulated, although the AIF could elect to do so if it wished. Therefore, no additional regulatory approval is required in relation to AIF within an AIFM's authorised asset class. Notification only of appointment to the non-regulated AIF is required, although authorised AIFM are themselves subject to ongoing regulatory oversight monitoring, as are all regulated businesses.
This CSSF policy position has enabled the development of substantial market usage of recently modernised Luxembourg limited partnerships as non-regulated AIF appointing established AIFM, with the flexibility and speed to market that this entails but with the benefit of the EU AIFMD marketing passport.
These limited partnerships, the Special Limited Partnership (SCSp) and Common Limited Partnership (SCS) are specifically modelled on international, Anglo-American investment fund norms and provide:
- Tax transparent, fully flexible limited partnership fund & carried interest vehicles
- EU professional investor AIFMD marketing passport
- Maximum structuring flexibility and speed-to-market.
Tax opaque, but substantively neutral, regulated AIFs in corporate form are also available and widely used for investors requiring such characteristics.
SCSp / SCS - key characteristics
The SCSp and SCS are substantively identical in all respects except one. This is that the SCSp is an unincorporated association of persons without separate corporate legal personality (similar to many standard common law limited partnerships). In contrast the SCS has separate legal personality (similar to the Jersey Separate Limited Partnership, the Guernsey Limited Partnership Inc and the Scottish Limited Partnership model).
In accordance with international norms, both of these Luxembourg limited partnerships require one or more general partners and one or more limited partners. General partners have joint, unlimited liability for partnership obligations. Limited partners' liability for partnership obligations is limited to the amount of their agreed partnership contribution, provided they do not act, in their capacity as limited partners, in the management of the partnership towards third parties or hold themselves out as being general partners. There are extensive non-management safe harbours.
In practice, the general partner's liability risk in this area is neutralised by use of a limited liability vehicle to act as general partner.
In a departure from civil law norms, no notarial involvement (or consequent fee) is required to constitute or amend the constitutional documents of SCSp or SCS. These documents can also be exclusively in the language most appropriate to the funds' investors, without requiring a parallel version in French, German or Luxembourgish.
Limited liability for limited partners exists immediately from signature and exchange of the limited partnership agreement, notwithstanding the fact that the limited partnership will then need to be registered with the Luxembourg Trade and Companies Register.
One of the most important characteristics of both the SCSp and the SCS is a very high degree of flexibility, disapplying civil law requirements, in the following ways:
- No minimum capital requirement
- Limited partners may also be general partners (provided there are at least two different partners overall)
- Partnership interests may be unitised (ie represented by shares) if appropriate
- Partner contributions in services are now accepted, in addition to contribution in cash or in tangible assets. Thus contribution of management, advisory or general partner services are specifically recognised with the valuation of such contributions being entirely a matter of private contract
- Freedom of contract prevails to create different classes of partnership interests with different rights
- Conditions of issuance of partnership interests are a matter of freedom of contract
- Debt securities may be issued
- Internal authorisation requirements, required voting thresholds and procedural requirements are (in the vast majority) private, contractual matters for the partnership agreement.
- Voting rights and profit sharing are private, partnership agreement matters, weighted voting rights or non-voting interests, complete contractual determination of profit sharing without statutory constraint are available and there is no partnership law requirement for a general partner profit share (although such a share may be appropriate for other reasons)
- No requirement to allocate profits to a legal reserve
- For non-regulated AIFs, no investment, diversification or leverage rules or constraints apply outside of the fund documents
- Admission and exclusion of partners are entirely determined by the partnership agreement.
Management and governance
One or more managers may be appointed separately from the general partner (although, if appropriate, the same person or vehicle may undertake both roles).
The manager may also delegate its management powers to another party acting as the manager's delegate or agent (subject to AIFMD) and is authorised to act in the name of the SCSp / SCS and to carry out any act necessary or useful pursuant to its objects.
Managers who are not also general partners will not be liable to third parties for obligations of the SCSp / SCS. Managers owe duties only to the partnership itself which are similar to directors' duties in relation to a company.
Limited partners may also either be appointed as a manager or as the delegate or agent of a manager to carry out some of the manager's powers. Such delegation or agency may also be granted by a manager who is also a general partner, to a limited partner. In both of these cases, the limited partner acting as manager (or as a manager's delegate or agent) does not forfeit its limited liability (as limited partner) to third party creditors of the partnership, provided that the representative capacity in which it is acting is clearly stated in all circumstances.
To provide assurance to limited partners undertaking activities in relation to the SCSp / SCS, safe harbours of specifically non-management activities have been created to protect such limited partners. Non-exhaustive examples of such safe harbours include as follows:
- The provision of advice, including investment advice, to the limited partnership, its affiliates or its managers
- The oversight, monitoring and supervision of acts of the limited partnership
- The granting of loans, guarantees and security interests to the limited partnership (or its affiliates) and
- The authorising of the managers' actions outside the specific authority granted by the partnership agreement.
There is no requirement to publically file and publish the partnership agreement or limited partners' names, contributions or interests. Filing is limited to an extract of the following matters:
- The general partner(s') name(s
- The name, corporate objects and registered office of the limited partnership
- The manager(s) name(s) and signatory powers and
- The formation date and duration of the limited partnership.
SCS are required to prepare annual accounts. For non-regulated SCSp, whether formal annual accounts are required is a private matter for the partnership agreement.
As between partners, for SCS, annual accounts, the management and auditor's report (if required) are to be made available to partners at the registered office at least 15 days prior to the annual partners' meeting. In contrast, for SCSp, freedom of contract prevails and the information to be made available to partners is limited to what is provided for in the limited partnership agreement.
Annual accounts for an SCS will be filed and available at the Luxembourg public registry. In contrast, annual accounts for a non-regulated SCSp (if required) will not be.
Both SCS and SCSp will maintain a partnership register. A partner may access this register, subject to any limiting provisions of the limited partnership agreement.
Allocation of profits/losses between partners, any required conditions for distributions, payments in respect of loan contributions or the return of partnership capital are private matters regulated solely by the limited partnership agreement. There is no insolvency clawback risk in respect of such payments (absent fraud).
Both SCS and SCSp can be funded either purely by way of equity commitments or by a mixture of equity and partner loan contributions, as appropriate.
Any conditions for authorisation of a reduction or buy-back of partnership interests must be set out in the limited partnership agreement, they are not prescribed by statute.
The same applies for the admission of new limited partners on an issue, transfer or sub-division of limited partner interests.
This significant contractual freedom to regulate internal partnership matters enables these Luxembourg limited partnerships to adopt international norms relating to AIF with absolutely minimal localisation requirements.
In relation to such AIFs, there is full tax transparency and neutrality in respect of Luxembourg direct tax, ie income tax, net wealth tax and municipal business tax, provided that the partnership interest of any corporate general partner stands at less than 5% of aggregate partnership interests. As will be apparent, this can be achieved in full compliance with commonly encountered structuring norms.
This briefing provides a general summary only of this area based on current law and practice in Luxembourg at July 2016 and is subject to changes therein. It does not purport to be comprehensive and is intended for information only. It does not constitute specific advice issued on a reliance basis. Such specific legal advice should be sought on each occasion.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.