By James Williams – “What the Special Limited Partnership (SCSp) does is provide a legal vehicle that specifically and systematically addresses every area of concern for private equity managers when they look at what are the available options to them across different jurisdictions,” comments Daniel Richards, partner at Ogier (Luxembourg).
This summer, the Grand Duchy made the strategic decision to revamp its limited partnership regime (the societe en commandite simple or SCS) at the same time as transposing the AIFM Directive into national law. By doing so the message it intended to relay was clear: Luxembourg is ready to support global private equity managers and intends to become the leading onshore private equity hub.
“The SCSp is a huge opportunity for Luxembourg, which has always been quick to grasp opportunities and proactively adapted its regulation. For alternative investment funds (AIF) under the AIFMD, this update to the limited partnership regime is important and Luxembourg’s regulators want to make sure they have a leading edge in the AIF space,” says Yves Courtois, Corporate Finance Partner at KPMG (Luxembourg), who continues: “Luxembourg has long been a perceived safe haven for institutional investors. It transposed the Directive quickly and decided upon a couple of modernisation measures to its laws which govern investment vehicles. As part of this, they brought in a new limited partnership – the SCSp, which was inspired by the Anglo-Saxon limited partnership model. Part of the reason Luxembourg has adopted that regime is because from a GP’s fund raising standpoint LPs are more familiar with that regime.
“It was the missing piece of the jigsaw. The existing fund regimes have experienced some level of success in the past but not to the expected level to attract fund raising vehicles in private equity. Introducing the SCSp clearly gives a boost for the fund raising activities of private equity managers.”
In essence, what Luxembourg’s lawmakers have done is modernise what was quite an antiquated limited partnership regime in the SCS based on the 1915 company law. By introducing the SCSp alongside the enhanced SCS – they are both peas in the same pod – what Luxembourg has done is present managers with two choices: they can either use the updated SCS regime, which is invested with legal personality, or use the SCSp which is invested with no legal personality. Both limited partnership regimes are likely to better appeal to LPs, particularly the SCSp as it is based on such a well-recognised Anglo-Saxon model.
“The SCSp was something that was missing from the panel of products available to private equity players in Luxembourg,” says Olivier Coekelbergs, Private Equity Leader at EY (Luxembourg). “Luxembourg has strong experience in traditional asset management (UCITS) and is considered a stable country. It has a AAA credit rating and a proactive, knowledgeable regulator. We are in the centre of Europe with a strong international reputation. But until now we didn’t have a vehicle that was favoured by private equity firms.”
With the SCS/SCSp limited partnership regime, managers now have complete flexibility when choosing to establish either regulated (under SIF and SICAR law) or unregulated (governed by the Company Act) investment vehicles.
Given the relative success of the Specialized Investment Fund (SIF), it is possible that over the coming years global private equity firms who will be required to comply with the Directive will use this fund vehicle to passport to European investors.
“There have been a couple of key steps to attract private equity funds. The first was the creation of the SICAR in 2004. Then in 2007, the SIF was introduced. Although both vehicles were key steps in enlarging the type of domestic products we could propose to private equity managers, we did not have the typical limited partnership they were used to. Now, this is something that we have with the SCSp.
“When we look at the picture today Luxembourg can offer acquisition structures, fund structures and also management structures under the Directive. Consequently, I think we could be well positioned moving forward to see the private equity funds space grow. However, we need to demonstrate that this new limited partnership works, and works properly,” stresses Coekelbergs.
Under the old SCS, one of the main drawbacks was that the GP was required to fully disclose the identity of every LP in the partnership. Under the enhanced SCS regime, this is no longer necessary. Also, in terms of voting rights historically one share equated to one vote.
Now, there is complete flexibility within the Limited Partnership Agreement with respect to voting rights and distribution of the economic benefits of the partnership. In addition, there is no longer any risk to an LP which wishes to engage in the management activities of the company losing its limited liability status.
Ogier’s Richards provides further clarity on the improvements of the SCS/SCSp regime by adding: “You have a large degree of flexibility in drafting the LPA. You have partnership rights in terms of economic interests, non-management safe harbours for LPs who become more closely involved in the internal management of the LP without any risk of loss of limited liability. You have modernised confidentiality agreements to provide the appropriate level of confidentiality to LPs. You have freedom of contract in relation to provision of information and in relation to assets of the partnership register.
“What Luxembourg’s lawmakers have done is take the best-in-class solution on various points used in comparative jurisdictions (Jersey, UK etc) and adopt it into the SCSp. The result is a limited partnership regime that meets all of the needs of private equity managers in terms of the vehicle itself, and which gives them the freedom to structure the fund as they and their investors need without reference to any artificial restrictions from legislation.”
Given the clear improvements made with this new SCS/SCSp regime it begs the question: why has it taken so long? Why now?
“Corporate structures like the SCS shared many of the same characteristics of the common limited partnership but sometimes when a solution has been tried and tested for a long period of time it’s difficult to convince LPs to switch from one vehicle that they are familiar with to another.
“This is why the SCSp was introduced: to fill this gap. The Luxembourg authorities basically decided this year that they should take one step further to attract LPs by introducing this new Special Limited Partnership,” explains Courtois.
By introducing this new limited partnership regime in conjunction with the AIFM Directive, Luxembourg has singularly addressed two key issues: structuring the legal entity, and manager regulation. The third strand is, of course, domestic fund regulation.
As mentioned, the beauty of the SCS/SCSp regime is that GPs now have complete flexibility over whether to have a regulated or unregulated fund. Assuming that a manager is looking to tap in to a wider source of European institutional assets, they would need to consider that the most commonly used form of regulated fund product among professional investors in Luxembourg is the SIF.
“That again is a vehicle characterised by a high degree of flexibility,” Richards states. “The SIF is a tax neutral vehicle and takes either a corporate form or a limited partnership form. It can be self-managed or can appoint an external manager. Managers who choose the SIF need to be aware that there is a regulatory approval process (with the CSSF) that will include a detailed track record of the manager, information on the board of directors, and on the regulated service providers such as the central administrator, custodial bank, and auditor.
“Regulation will only apply to the SIF – and not to the manager as an AIFM – if a manager falls below the AuM threshold of EUR100million. So when considering the SIF, managers should ask themselves a series of questions such as: does the Directive apply? If yes, shall I apply now or make use of the grandfathering period until next July?”
Tax considerations under the new SCS/SCSp regime
The SCS/SCSp regime provides the opportunity for full tax transparency and tax neutrality on the basis that certain conditions are met:
As the Luxembourg Private Equity & Venture Capital Association pointed out in a July newsletter, it will therefore be possible under the new tax framework to structure a private equity fund in total tax neutrality.
Amendments have also been made to Luxembourg’s tax regime with respect to carried interest.
“A temporary carried interest regime has been introduced and it is designed to provide what I would call ‘the red carpet treatment’ for employees of alternative investment fund managers moving to Luxembourg for the first time,” explains Nina Kleinbongartz, Director at Sanne Group (Luxembourg), a fund administration group with in excess of EUR40billion assets under administration.
This is effectively a tax benefit for which employees, under certain conditions and for a limited period of time, will be able to avail themselves of, marking yet a further development in the attractiveness of the Grand Duchy to AIFMs.
“This is a temporary provision for the employees of AIF Managers whereby the income of carried interest will be taxed at a maximum progressive rate of 10 per cent. Employees will be able to get this preferential tax rate if they become tax resident over the next five years. Whilst a temporary regime, it nevertheless shows that Luxembourg regulators are focused on Luxembourg becoming a location of choice for alternative fund managers,” adds Kleinbongartz.
Ogier has already structured an SCSp for one of its clients this July. The client, based in Germany, wanted to move their assets into a Luxembourg regulated vehicle i.e. a SIF, where the SIF would act as a feeder fund into the Jersey-based master fund, which itself invests in Asia-Pacific real estate assets. This original plan then had to be revised when changes to German tax law meant that insurance companies could only invest assets in a Luxembourg vehicle under the following conditions:
Ulrike Jacquin-Becker, who worked on the restructuring, explains: “The SIF we wanted to incorporate did not meet these criteria required to meet the German investors’ needs so we had to work out a new structure. At the same time a new Luxembourg limited partnership regime was being introduced. The SCSp was the easiest solution to respond to the investors’ needs because it is tax transparent, it has no legal personality, it offers confidentiality of the identity of the LPs, and it offers the possibility to be an unregulated entity.
“Following various discussions it was decided in July that the SCSp would be the best vehicle to incorporate to respond to the needs of the client’s investors. We established the special limited partnership agreement very quickly as a private deed in collaboration with our Ogier team in Jersey. There was no need for a notary.
“The management of the SCSp has been entrusted to a general partner, a corporate entity incorporated in the form of a Luxembourg limited liability company has been incorporated in the form of a private limited liability company (société à responsabilité limitée) whereby the liability of the partner is limited to the amount of its contributions.”
The opportunity for Lux under AIFMD
Whilst updating its limited partnership regime is undoubtedly a positive move, some believe the domicile’s ability to leverage on the AIFM Directive could potentially act as an even greater catalyst for private equity funds growth.
Mario Mantrisi is chief strategy and research officer at KNEIP, a legal and regulatory service provider to the asset management industry. In Mantrisi’s view, the AIFMD is a huge opportunity for Luxembourg: “We are a strong UCITS market and very well known for cross-border distribution of these funds. By replicating the same scheme under AIFMD, Luxembourg could well become the preferred onshore domicile for a lot of alternative fund managers and become the central hub of cross-border distribution of AIFs.
“I think the Irish have already done a good job and both markets will be well positioned to grow their alternative fund markets over the coming years.”
One of the challenges that Luxembourg faces is how it will effectively monitor private equity funds, should their numbers grow under the Directive. In Mantrisi’s opinion, it needs to ensure that it establishes robust risk management expertise. “If I had one concern, it is the overall understanding in Luxembourg of the private equity business; what are the related risks, and how do you effectively monitor those risks? If Luxembourg gets that expertise in risk management it will put it in a powerful position but it still has to strengthen that area in my opinion.”
This is not to suggest that Luxembourg will overnight become a major private equity hub, with managers turning their backs on offshore jurisdictions. What is more likely to happen is a dual domiciliation trend, where global private equity houses maintain their Cayman master/feeder structures, and choose a European hub like Luxembourg from which to passport regulated funds.
In Kleinbongartz’s view it will ultimately be driven by the LPs: “The fund initiator would probably prefer to stay offshore given the choice, because with additional regulation comes additional costs but without their investors they are nothing. I spoke to one of our clients recently who is turning their existing offshore fund into a regulated Luxembourg fund structure as a result of investor demand. So it ultimately depends on the investors.”
Richards believes that Luxembourg will be well placed to capitalise on the growth of onshore regulated funds as GPs look to distribute to European institutional investors who prefer onshore regulated products. “What the new SCSp limited partnership does is, because of its flexibility, allow managers to create a multi-jurisdictional master/feeder structure in a way that uses substantially the same documents.”
This suggests that Luxembourg could become an attractive option for managers looking to consolidate their fund structures. And whilst the message is clear that Luxembourg is keen to grow its private equity market, Mantrisi says it will not do so by inviting all and sundry. After all, it has a reputation to uphold:
“It isn’t Luxembourg’s intention to get each and every private equity manager. It’s a serious market for serious players.”
Going forward, Kleinbongartz says that GPs who choose Luxembourg can expect to receive the red carpet treatment:
“I think it will take time for momentum to build but based on the enquiries that we’ve been receiving recently the signs are positive that Luxembourg will achieve more substance as a centre of excellence for private equity funds. I expect to see a higher volume of private equity funds coming here over time.”