Luxembourg a competitive hedge fund jurisdiction
One of the misconceptions about Luxembourg is that it is a newcomer to the hedge fund industry with the launch of the Specialised Investment Fund vehicle earlier this year. In fact the country already has a flourishing presence in the sector, with 38 administrators of hedge funds and funds of hedge funds, according to the fund industry association Alfi.
Luxembourg had total hedge fund assets of EUR160bn under administration at the end of last year, of which EUR104bn is domiciled and administered in Luxembourg, and the rest consisting mainly of Cayman, BVI and Bermuda funds serviced by Luxembourg administrators. Overall, the volume of assets serviced by the industry here grew by 57 per cent during 2006.
However, until the establishment of the SIF structure the growth of the industry was constrained by the requirements of the existing fund legislation. Traditionally Luxembourg hedge funds were established as Part II funds under the fund legislation, subject to guidance from the regulator, the Financial Sector Supervision Commission (CSSF), on the interpretation of investment restrictions, along with the requirement that that the promoter needed to be highly reputable and have an extensive track record. This was a problem for small boutique managers setting up hedge funds for the first time.
A new avenue for the provision of alternative funds was opened up by the adoption in 2002 of the Ucits III directive, which made it possible to offer certain hedge fund strategies, such as convertible arbitrage and long/short equity, through funds established under Part I of the new legislation. This has helped to expand the range of Luxembourg-based products and made it possible to distribute these funds under a European passport, although the requirement for promoter approval by the regulator still exists.
The passage of the SIF legislation has brought considerably greater flexibility. Notably the new vehicle offers a wider definition of sophisticated investors entitled to invest in hedge funds, subject to a minimum investment limit of EUR125,000. The legislation offers various advantages to promoters, including the ability to launch a fund without prior approval from the CSSF, which offers considerable benefits where speed to market is essential.
These changes have closed the competitiveness gap between Luxembourg and other centres for the domicile and servicing of alternative funds. The country has already demonstrated its expertise in hedge fund servicing, while many of the funds currently administered in the country but domiciled elsewhere could now be set up under the new legislation.
The opportunity exists to build upon this base of expertise. For example, there is less reason now for a promoter to set up a fund in Cayman when by doing so in Luxembourg they can offer a product more attractive to European institutional investors. One indication of the success of the SIF is that more than 140 new funds had already been approved or were in the process of being approved within the first six months of the new regime.
Nor has this been achieved by abandoning the principle of effective regulation, although the level of supervision has been adjusted to take into account the greater expertise of institutional investors. In its recent risk diversification circular, the CSSF insists on adequate disclosure in a fund's offering memorandum to ensure that shareholders and potential investors are fully aware of what they are investing in. Finally, SIFs must be submitted to the CSSF for approval within a month of launch, and funds also need a Luxembourg administrator and custodian, which are themselves regulated.
Victor Chan Yin is a director with KPMG Luxembourg
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