Luxembourg has deposited a new Bill of Law with the Luxembourg Parliament called the Reserved Alternative Investment Fund (RAIF) Regime. It is a regime that embraces the concept of AIFMD being manager-focused regulation. The RAIF, unlike the heretonow popular SIF, does not need to be under the direct supervision of Luxembourg's regulator, the CSSF. Instead, the RAIF merely needs to appoint an authorised AIFM, based in Luxembourg or any other EU jurisdiction.
This could be a key stage in the future development of Luxembourg as Europe's leading funds centre – and still the second largest fund centre in the world – as it seeks to embrace alternative investment funds and build on the success it has enjoyed with the UCITS regime over the last 20 years.
"I think going forward, the RAIF will be the norm and the regulated alternative investment fund – the SIF – will probably become more of the exception," comments Claude Niedner, Chairman of the ALFI Alternative Investments Committee and Partner at law firm Arendt & Medernach (Luxembourg).
Jean-Pierre Gomez is Head of Regulatory and Public Affairs for Societe Generale Securities Services in Luxembourg. He fully agrees with Niedner's sentiment, stating that some of the bank's clients are already starting to convert their SIF products into RAIFs.
"We see two types of demand," says Gomez. "Firstly, we have clients who want to set up a fund very quickly and want to benefit from the possibility of having a RAIF. Secondly, we are seeing some clients wishing to convert their existing SIF fund(s) into a RAIF. Why? Because if tomorrow they decide they want to close the fund, it means they won't have to notify the CSSF and wait for their approval."
Before going any further it's necessary to give a brief description of the RAIF.
In terms of the legal entity, a RAIF can be created in the form of a company or a contractual common fund (FCP). If it is established as an investment company with variable capital, it will be called a `SICAV'. There, it can choose to operate as a partnership – Luxembourg offers the société en commandite simple (SCS) and the more recent société en commandite special (SCSp) – a limited liability company, or a limited company form; whatever suits the manager best.
"This latest initiative shows Luxembourg's ability and willingness to adapt to a new framework and anticipate asset managers' needs. Luxembourg is filling the gap between regulated fund products and unregulated fund products with the introduction of the RAIF," remarks Nathalie Dogniez, Partner at PwC (Luxembourg).
Gomez states that in Luxembourg the SICAV is still the preferred legal structure, set up either as a limited company by shares or as a Special Limited Partnership "but we also have the SCS, the Sarl. There are a variety of options. For me I would say that the SICAV is more flexible than the FCP, the common contractual fund."
He adds: "Three or four years ago we created a dedicated desk in Luxembourg for alternative investments. The RAIF is not available in other jurisdictions like France, the UK, Germany or even in Ireland so for us as a group, we definitely see clear advantages with the RAIF. One of the reasons Luxembourg created the RAIF, in fact, was to compete with the Irish ICAV."
Conceptually, one can think of the RAIF as combining the legal and tax features of the SIF and the SICAR fund regimes, but without the regulatory oversight of the CSSF.
Prior to the introduction of the RAIF, private equity and real estate fund managers tended to use the Société d'investissement en capital à risqué (SICAR). However, this has tended to be viewed as too rigid compared to the all-asset class capabilities that the RAIF now offers.
Niedner is quite optimistic on the potential that the RAIF now offers: "Following the success of the SIF and the limited partnership, I think we will likely see the number of RAIFs exceed 1,000 in the next five years."
The RAIF should be viewed as additive to Luxembourg, not a threat to other fund products. It may well overtake the SIF, in terms of new structures, but just to re-emphasise this is an unregulated fund product and as such will only be suitable to specific types of investors. Many in Europe will still prefer the regulated comfort of a SIF.
At the end of the day, managers are driven by their investors.
"I expect we will see demand for both the SIF and the RAIF going forward depending on the type of investors," says Kavitha Ramachandran, Senior Manager, Business Development and Client Management, Maitland Group and Director, MS Management Services S.A. "With the introduction of the Special Limited Partnership (SCSp) three years ago and now the RAIF, the two go hand in hand and we are seeing a number of structures being set up in the private equity & real estate world using this arrangement. They make an ideal marriage in terms of legal structure and fund structure."
"I think fund managers will continue to consider both fund products, in addition to the SICAR," suggests Jean-Florent Richard, Head of Fund Engineering Services at BNP Paribas Securities Services (Luxembourg branch). "The way the legislation has been written for the RAIF, it is practically the same as it is for the SIF, just without any references to the CSSF. In addition, it includes some nice tax alternatives which may allow fund sponsors to choose their tax regime. In short, if your RAIF is mainly invested in risk capital, the RAIF may benefit from the tax features of the SICAR.
"That said, I still think the SIF will be used by our clients. For instance, asset owners such as insurance companies will certainly have a preference for regulated fund structures so for the time being the SIF will likely remain relevant. My expectation is that this might change in the coming years once the AIF brand becomes more established, as we have seen with the UCITS framework."
Timothe Fuchs is the CEO of Fuchs Asset Management, which offers management company services to both UCITS and alternative investment funds. He says that the firm still sees a lot of demand for the SIF for the same investor-based reasons that Richard refers to above.
"If you have pension funds or institutional private banks, they will typically not be authorised to invest in unregulated structures and will prefer the SIF. I would estimate that 90 per cent of the requests we receive are to act as the appointed AIFM to SIFs," confirms Fuchs.
The RAIF was only officially introduced this summer so it is still early days but over at Maitland group, a global administrator with its own authorised AIFM, MS Management Services, there are already signs that interest is strong.
"We have had a number of RAIF enquiries, which have since converted into projects we are working towards launching in the coming weeks. As an authorised AIFM, we have seen quite a bit of interest coming to us from managers looking to establish one of these products. The RAIFs we are working on currently are mainly for private equity and real estate strategies but cover hedge funds as well," says Ramachandran.
Fuchs says that they are currently acting as the AIFM to three RAIFs. One of the RAIFs is a real estate strategy, two are private equity strategies. "One of the clients initially wanted to launch a SIF but the process was taking too long and investors were becoming impatient so it was converted to a RAIF," says Fuchs. "The issue with the SIF is that it can take quite a long time to incorporate. It needs to be authorised by the CSSF and there is a dual layer of regulation at both the manager and fund level."
For investors who express an interest in a manager's strategy, they don't want to wait around six months waiting for the fund to come to market. With the RAIF, within a timeframe of three to five weeks, investment managers can expect it to be up and running.
"Some say it can be done in one week but that is not realistic. You still need to incorporate one or two companies – the fund and the GP – you still need Articles of Incorporation, a fund prospectus, operational, risk and investment procedures, as well as approve the directors, so the workload is really no different to setting up a SIF," clarifies Fuchs.
Whilst the RAIF is an unregulated product, it still offers significant investor protection through the requirement to appoint an authorised AIFM in addition to appointing a depositary bank, which in turn has a duty to independently oversee the operations of the RAIF, cash monitoring, and asset verification (as well as asset safekeeping if the RAIF's assets are tradable securities).
"We support our clients to better understand the RAIF and what it may allow them to do in terms of structuring flexibility, investor protection, structuring flexibilities and so on. We also support them on how best to position the RAIF when it comes to establishing a European marketing," confirms Richard.
Indeed, this requirement to appoint an authorised AIFM and depositary is no different to creating a regulated AIF such as a SIF or an Irish QIAIF. The RAIF should not, in other words, be interpreted as a way to circumvent regulation and go back to pre-AIFMD days.
"The position of SGSS and I think any depositary bank in Luxembourg is that we will not accept any type of client. If the investment manager is not appropriate in terms of expertise, pedigree and resources during the onboarding phase with the AIFM, we will not accept them. This is not a route for managers to avoid regulation. So of course, we have to be careful – perhaps even more careful – given that the RAIF is not CSSF approved.
"We work only with top-rated clients. The RAIF does not change that," stresses Gomez.
Maitland's Ramachandran explains that as the appointed AIFM to a RAIF it will not act as the depositary. She says that Maitland has consciously stayed away from the depositary area, firstly, because as an AIFM they believe it should be an independent function; and secondly, because it has good relationships with existing depositaries in Luxembourg.
"This is a unique point of difference for us when we go to clients; that they will have an independent depositary in place, which is completely separate from our role as the appointed AIFM.
"As the board of the AIFM is completely independent of the board of the fund it means we can give a completely objective view to the RAIF board in terms of what we think as an AIFM. The same unbiased view also applies in terms of how we deal with the depositary. This is an important criteria for us," confirms Ramachandran.
There are now believed to be between 12 and 15 authorised AIFMs in Luxembourg, according to Richard, and one might suspect that this number will increase as the RAIF becomes more popular. The product is certainly good news for AIFMs keen to capitalise on its potential. Conceptually, the idea of appointing a third party management company is still unfamiliar to a lot of non-EU fund managers, especially those in the US, but there are signs that this starting to change.
"I was in the US recently and one of the things I noticed is fund managers are getting more comfortable with the concept of using a third party AIFM. They are more willing to go down this road in Europe. If you are a mid-tier manager and you know you can attract European investors but don't wish to take on the cost burden, then a third party AIFM is a good option to test the water. If you grow to a certain level of AUM then you can become your own AIFM.
"I think this will become a more popular option with the RAIF regime," suggests Ramachandran.
When thinking about launching a RAIF, one of the key considerations for fund sponsors to be aware of is whether such a structure will actually be acceptable to prospects. This should be clarified as early as possible.
Another consideration is deciding on the type of legal form for the RAIF. Depending on the end investor, it could be transparent or opaque and as such one needs to consider the implications.
Once managers are sure that investors are happy with the RAIF, they should check that the legal form they decide on is acceptable.
"The legal set-up will depend on the type of assets the manager wants to invest in," says Gomez. "If managers want the benefit of double taxation treaties, these do not apply to FCP structures, only to SICAVs.
"Also, when doing a new fund set-up, if it uses a GP/LP arrangement it is important to define the responsibilities of each party in the set-up phase. There is no single answer as to which legal structure is the preferred option for a RAIF, suffice to say that there are various options."
Looking ahead for the next couple of years, Richard believes that the introduction of the RAIF will change the way that people look at Luxembourg. In his view, the Grand Duchy has accelerated the process of establishing AIFMD as a recognisable brand, just as it has helped to do with UCITS.
"I do think it is a game changer for Luxembourg's funds universe, and indeed the wider European funds universe because Luxembourg is the leading jurisdiction for UCITS funds and is now in the process of positioning itself as Europe's leading centre for alternative investment funds. Some AIFMs are taking advantage of the RAIF and are considering redomiciling their offshore structures as RAIFs. It is a trend that is fast evolving," says Richard.
"It is definitely a big opportunity for us, as it is for everyone else in Luxembourg," says Fuchs in conclusion. "With the RAIF, fund sponsors can get a European passportable fund to market very quickly with the flexibility of an offshore fund, in terms of what it can invest in. There are no limitations compared to UCITS funds."
