By Simon Gray – The vote in Brussels by the European Parliament on November 11 to approve the EU’s Directive on Alternative Investment Fund Managers, sealing the passage of the much-debated legislation into law, appears set to boost the position of Luxembourg as a domicile and servicing centre for hedge funds, according to members of the alternative fund industry in the grand duchy.
While Luxembourg remains better known as a centre for cross-border retail funds, the introduction nearly four years ago of the Specialised Investment Fund regime has highlighted its fast-growing vocation as a centre for alternative vehicles. Since the SIF legislation came into force in February 2007, more than 900 new funds have been established, for an overall total (including existing institutional funds that were brought under the new regime) of 1,144 SIFs with EUR195bn in net assets at the end of September.
These figures include private equity, property and other alternative investment vehicles as well as hedge funds – a sector in which Luxembourg has long been overshadowed by Ireland, thanks to the latter’s dominant position in the administration and listing of funds established in offshore jurisdictions, especially the Cayman Islands. But in the past few years the grand duchy has attracted more administration and listing work from promoters of offshore funds, and the SIF has firmly put it on the map as a hedge fund domicile.
“Luxembourg as a whole has made a great deal of progress in advertising its capabilities to service alternative investments,” says José-Benjamin Longrée, former managing director of fund services provider Caceis Bank Luxembourg and until recently deputy chief executive of Caceis Group. “Probably 10 years ago, when alternative investments were less mainstream, a lot more hedge fund activity was going on in Dublin than in Luxembourg. There was no big difference in terms of the investment restrictions and the ability to structure portfolios, but it was as if Dublin had a sign out saying ‘We do hedge funds’, like a notice reading ‘Hier man spricht Deutsch’ outside a restaurant.”
But a decade on, much has changed, Longrée says. “Now we have evolved a lot, and today many alternative funds domiciled in Cayman or the BVI are administered in Luxembourg. At the same time, the number of Luxembourg-based alternative funds has grown immensely, and we are now known for servicing a large number of single-manager hedge funds as well as funds of hedge funds.”
Like all hedge fund centres Luxembourg experienced a decline in the number of funds and volume of assets it services during the industry downturn over the past couple of years, but the figures have bounced back over the past 18 months. Meanwhile there is a widespread belief within the industry that although the AIFM Directive will not bar access to European investors for non-EU funds, as seemed possible at one stage, it will reinforce a broader shift toward regulated onshore hedge fund structures.
The revised directive will institute a ‘passport’ allowing EU-based alternative managers to market EU funds freely to professional investors throughout the union from 2013, in a similar way to the single authorisation procedure that for two decades has allowed traditional managers to market Ucits funds to retail investors across the EU.
From 2015, EU managers of funds domiciled elsewhere and non-EU managers will also be able to obtain passports, subject to regulation of non-EU managers in a designated ‘member state of reference’ and the compliance of non-EU fund domiciles with various requirements in areas such as regulatory co-operation, measures to combat money laundering and terrorist financing, and exchange of tax information with EU member states.
Olivier Sciales, a partner with Luxembourg law firm Chevalier & Sciales, believes that managers outside the EU may find it easier to establish onshore funds than face the complications of determining whether an offshore jurisdiction meets the EU’s conditions. “To offer a Cayman fund would not only require the non-EU manager to comply with the directive and subject itself to the oversight of a member state of reference, but would necessitate agreements between Cayman and every EU market into which the manager wanted to market the fund,” he says.
“If, however, the manager marketed a Luxembourg-domiciled SIF to EU investors and took Luxembourg as its member state of reference, these additional conditions regarding the fund domicile would not be necessary. To access investors in multiple EU markets, the manager would simply have to submit a notification file to the Luxembourg regulator, the CSSF, and if it was adjudged to be in compliance with the terms of the directive, it could begin marketing the fund within a maximum of 20 working days.”
Nina Kleinbongartz, product manager for alternative investments in Europe with Citi Global Transaction Services, argues that Luxembourg can offer political stability and a well-developed service infrastructure as well as experience in handling regulated hedge fund structures.
“The big advantage will be when the passport allows distribution to sophisticated investors throughout Europe,” she says. “Ucits is a showcase – Luxembourg has more than 76 per cent of worldwide distribution of Ucits funds, and we are very strong in Asia and South America. Luxembourg already has the network and the ability quickly to repeat the Ucits experience with the AIFMD passport.”
Mariusz Baranowski, until recently managing director of Custom House Fund Services (Luxembourg), adds: “When there is demand from investors for products that are more transparent and domiciled in regulated jurisdictions, Luxembourg will be the first choice. The country has long been home to retail funds for which transparency and liquidity have always been central. Under Luxembourg standards liquidity and transparency are in place at the moment of formation, whereas in traditional offshore centres such as Cayman that would not be central to the set-up.”
Further benefits could well accrue to the country’s service providers. According to Benoît Sauvage, a financial markets and securities adviser at the Luxembourg Bankers’ Association, as the largest centre for fund administration in the EU and with its pivotal role in cross-border fund management, the grand duchy is highly likely to enjoy a positive impact from the directive on its custody and administration sector.
“Even prior to the AIFM, there has been a tendency of some large alternative asset managers either to convert their funds to Ucits-like vehicles or to use the Sicar [risk capital investment company], which is one of the most active segments in the registration of new funds,” he says. While noting Ireland’s strength in the alternatives sector, particularly in the English-speaking world, he believes any increase in business flowing to EU jurisdictions is likely to be shared around.
“The pie is likely to grow since many funds will have to acquire an EU status, and the winners will probably be both Ireland and Luxembourg,” Sauvage argues. “While it is already a dominant player in fund administration, it is to be hoped that with a EU harmonisation regime, Luxembourg will be better positioned to develop and promote its strengths and expertise, most notably in facilitating the sale of alternative investment funds across EU member states.”
The trend is also being noted by suppliers of software systems to the service provider industry. Keith Hale, global head of transfer agency at Multifonds (formerly Igefi), says: “Over the past 20 years Luxembourg has developed a very strong centre of excellence around fund administration. Luxembourg is well established as the centre of the Ucits fund world and Dublin is more the European hedge fund administration centre, but those lines are becoming more and more blurred. As the alternative and long-only spaces blend into each other, it is a good opportunity for Luxembourgto strengthen its position in hedge fund administration.”
Bradford Rowley, a senior business analyst at Pacific Fund Systems, says established administration clients are setting up shop in Luxembourg – as well as in Malta – in addition to their existing operations in fund centres such as the Channel Islands or Ireland. “Regulatory concerns are prompting manager demand, which in turn is driving these firms to establish a presence in Europe,” he says. “Meanwhile, other prospective clients are looking to establish representative offices in Luxembourg. They are trying to mitigate their business risks and look for new opportunities.”
Johnny Yip, an audit partner with Deloitte & Touche in Luxembourg, believes the directive will enable Luxembourg to attract business that currently would probably go to Caribbean jurisdictions such as the Cayman Islands and British Virgin Islands. “Luxembourg is well placed to renew its Ucits success with the AIFMD,” he says. “Our national regulatory environment is already geared up for the implementation of the directive.”
Since mid-2009 the outlook has been positive for funds of all types, according to Justin Egan, managing director of the Luxembourg business of Carne Global Financial Services, an advisor to the hedge fund and asset management industries. “This is a very robust fund market, and there has been a fairly consistent month-on-month increase in assets under management both for hedge funds and across the board,” he says. “Luxembourg has weathered the storm quite well. A number of service providers and banks cut their cloth somewhat in 2008 and early 2009, but now firms have bounced back, and there seems to be a decent pipeline of new fund launches.”
Egan argues that Luxembourg is better placed than ever as an onshore regulated jurisdiction, for a number of reasons. “Being within the EU is now a very important selling point because of the regulation and control that entails,” he says. “In addition, as a major centre for retail funds Luxembourg is also benefiting from the increasing use of Ucits structures for alternative strategies. The launch of Ucits vehicles by hedge fund managers is a huge trend at the moment, and Luxembourg is picking up a considerable amount of that business.”
Another potential source of new business for the grand duchy is the redomiciliation of hedge funds from traditional offshore centres to EU jurisdictions. Despite a great deal of media attention, much of it fanned by Ireland’s (highly effective) promotion of its recent legislation facilitating redomiciliation of different types of fund structure, industry members in Luxembourg – where redomiciliation procedures that do not crystallise tax charges are well established – are cautious about predicting a surge of such business. “We are not seeing a mass exodus [from the Caribbean] but mainly tactical moves,” says Yip.
Egan agrees, saying: “There is definitely a trend. There is a fair bit of redomiciliation happening, but it’s more a slow burn than a waterfall at this stage. Some hedge fund players have already redomiciled their funds, but I think it will take more time to gain momentum. Most hedge fund managers probably are still launching funds in Cayman and the BVI, although more are starting to look at Luxembourg and Ireland.”
According to Sciales, a fund can be relocated to Luxembourg using one of three methods. He says: “There can be a contribution in kind of all the assets and, as the case may be, the liabilities to a Luxembourg fund under the Ucits, UCI Part II fund or SIF regime, and with the legal structure of a Sicav, Sicaf or FCP,” respectively an open-ended or closed-ended investment company or contractual fund.
“An offshore fund can also be redomiciled to Luxembourg under the Ucits, UCI Part II fund or SIF regime as a Sicav or Sicaf, or merged into a Luxembourg fund established under one of these regimes and legal forms. The choice of the method of relocation will depend mainly on the preferred legal structure of the fund and not on the specific nature of the investments contemplated.”
Perhaps more frequent at this stage is the launch of an onshore regulated fund within the European Union that offers the same strategy as an existing offshore vehicle. In recent months the focus has largely been on alternative Ucits products, but Egan says established managers are also opting for sophisticated fund structures such as SIFs.
“An existing player with Cayman hedge funds might consider launching a SIF,” he says. “They might want to dip their toe in the water in a regulated jurisdiction to see how they get on before they take any big decisions like moving everything across from Cayman. There are a lot of good reasons why people might want to redomicile their funds, but it’s a big project to take on with a lot of different angles to look at, not least tax.”
Kleinbongartz argues that increased demand for regulated products by high net worth clients and institutional investors returning to the market following the crisis is prompting a few managers to move established fund structures. “We are seeing onshoring of existing structures to Luxembourg, for example from Cayman, to provide a more regulated environment,” she says.
“There is a natural trend in any case, whether or not it is being boosted by the AIFM Directive, where institutions such as big insurance companies and pension funds need to invest in onshore structures for internal compliance reasons. The response of managers is either to move the structure or replicate it in an onshore jurisdiction. You also see master-feeder structures with the master fund in Cayman and a regulated Sicav-SIF feeder in Luxembourg, although this kind of arrangement will be subject to tighter regulation under the AIFMD third-country rules.”
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