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Legislator adds to flexibility in hedge fund structuring, by Rémi Chevalier and Olivier Sciales, partners with the law firm of Chevalier & Sciales

Solidly established as a global leader in the investment funds world, the Grand Duchy of Luxembourg has recently been seeing an increasing number of hedge funds, and especially funds of real estate funds. Luxembourg hedge funds are subject to the same legal and regulatory requirements applicable to other funds and thereby benefit both from the high degree of flexibility available in the setting-up period as well as in day-to-day management, and from the strong level of investor protection. Luxembourg hedge funds may be constituted as a Ucits, as a fund subject to CSSF Circular 02/80, or as a Specialised Investment Fund.

In its law of December 2002 Luxembourg updated its regulatory framework to reshape the whole concept of Ucits funds in line with the new EU directive as well as commercial realities. A fund set up under Part I of the legislation is aimed at retail investors, and a European passport enables it to be freely marketable throughout the EU with a minimum of formalities.

Under certain conditions, a Ucits fund can be established that uses hedge fund techniques. The main condition is to calculate the global exposure linked to the fund's value at risk, limiting the use of derivatives for sophisticated Ucits.

In early 2008, Luxembourg broadened the scope of financial instruments a Ucits may invest in through CSSF Circular 08/339, which incorporates the guidelines of the Committee of European Securities Regulators on eligible assets. The range of eligible instruments now consists of transferable securities and money market instruments, bank deposits, funds of funds, financial derivatives and, finally, index tracking funds.

Hedge funds may also be set up under Circular 02/80, issued in 2002, setting out specific rules for Luxembourg funds pursuing alternative investment strategies. The main difference with the previous option is that the fund must be set up under Part II of the 2002 law and hence does not benefit from a European passport.

However, it is not restricted to investment in transferable securities but may also invest in assets such as venture capital or real estate. This circular also sets out different investment restrictions for hedge funds and funds of hedge funds. Recently Luxembourg has experienced a boom in funds of real estate funds, prompted by their lower overall level of risk and greater diversification.

An additional option is offered by the law of February 13, 2007, allowing the establishment of Specialised Investment Funds that combine an innovative framework with unprecedented flexibility. Its innovations include the fact that a promoter is no longer required for the approval of the SIF by the Financial Sector Supervisory Authority (CSSF), and that investors may participate in a SIF by means of equity or debt without the need to respect any debt-equity ratio, thereby allowing effective tax optimisation. Crucially a SIF, in contrast to a fund set up under the 2002 law, can be offered to wide range of investors, including not only institutions but professional and sophisticated individual investors.

The SIF legislation has rapidly become a motor for the development of alternative funds in general, not only hedge funds but also real estate funds, whose numbers have increased by around 50 per cent since 2006 and which constitute the largest share of newly-launched SIFs.

Rémi Chevalier and Olivier Sciales are partners with the law firm of Chevalier & Sciales in Luxembourg

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