According to figures released by ALFI at the end of July 2014, there were 3,891 funds with total assets of EUR2.90trn. By comparison, at the end of 2013 the size of Luxembourg’s fund industry was EUR2.61trn with 3,902 funds. During 2013 the number of sub-funds increased by 265 and there were 279 SICARs established. Between end-2012 and end-2013, the number of Specialised Investment Funds (SIFs) – Luxembourg’s most popular regulated fund vehicle – increased from 1,485 to 1,562.
Much emphasis has been placed by the Luxembourg authorities on ensuring that financial market regulation is closely monitored. As the fund numbers listed above show, the Grand Duchy remains Europe’s leading onshore fund domicile. Far from being hesitant over the potential impact of the AIFMD, Luxembourg used its experience of building out a successful UCITS fund market to embrace the Directive to likewise grow its alternative funds market.
“Very early on the Luxembourg authorities were involved in discussions to lobby and influence regulation coming out, and was one of the first EU countries to transpose the AIFMD. Like UCITS, it wanted to have a first mover advantage,” says Jean-Daniel Zandona, Director, Financial Institutions/Asset Managers at Credit Suisse (Luxembourg).
“In addition to the AIFMD, the authorities revamped and strengthened the country’s legal arsenal. The SCSp, Luxembourg’s new LP regime, is a clear move by Luxembourg to introduce more flexibility. Accommodating the new AIFMD regulations is important; bringing a flexible investment manager structure under the SCSp is also important. This was a good move by the authorities and it has translated into inflows into new funds, into new managers coming into Luxembourg and leveraging the cross-border expertise of the domicile as a hub for fund distribution under AIFMD,” he adds.
To be sure, the new SCSp (Special Limited Partnership) introduced last year has the potential to take Luxembourg onto a new level altogether as global private equity and real estate managers begin to sit up and take notice. Even though Luxembourg has close to EUR3trn in regulated AuM alone, it still felt the need to innovate and offer more potential to US, UK and Asia managers. The SCSp is an important step towards achieving this.
“Typically these managers have chosen UK, Delaware or Cayman partnership structures. That’s what Luxembourg wanted to tap into with the introduction of the SCSp.
“I really think that Luxembourg has a complete toolbox for fund structuring. Of course there were already plenty of options in the past – maybe somewhat less familiar to Anglo-Saxon managers – but the SCSp is a very good addition and completes the picture,” says Paul Van den Abeele, Partner at Clifford Chance (Luxembourg).
It certainly strengthens Luxembourg’s position. PERE managers have a lot more choice, depending on the make-up of their investors, as to whether to structure the partnership without legal personality – as is now the case with the SCSp – or with legal personality under the existing Common Limited Partnership (SCS).
“Both can be set up as regulated entities, in this case SIFs, SICAVs or Part II funds. The promoter can also set up the partnership as an unregulated entity. The partnership set up as an unregulated or a regulated product may be an AIF. In such case it may fall under the AIFMD and have to be managed by an AIFM,” explains Christine Casanova, a director in the Alternative Group at PwC (Luxembourg). “If the partnership is unregulated it is only subject to Company Law. It is not subject to the regulations of the CSSF.”
For non-EU managers, Van den Abeele believes the SCSp could potentially become an important part of their global distribution strategy, especially given the preference that continental European institutions have for regulated fund structures.
“The SCSp is a good solution that combines the LP structure that managers are used to with the tax efficiency they require. At the same time, they are able to tap into the EU investor market and benefit fully from the passport,” says Van den Abeele, who notes that currently more managers are choosing to go down the regulated SCSp route and get licensed as an AIFM.
“Nevertheless, some clients are structuring joint ventures which means they can remain out of scope. A lot of insurance companies will have their own funds and look to leverage group exemption. There are different cases; it’s not a one-size-fits-all approach but a typical PERE manager is now seriously considering the benefits of the passport under the AIFMD.”
There is a palpable sense that under the Directive, and with the SCSp now in place, Luxembourg’s PERE funds sector could really start to ramp up. Maitland, a leading legal, fiduciary and funds services group with over USD200bn in AuA, has been active in Luxembourg since 1976. In May 2014 it acquired a Management Company license allowing it to act as a third party AIFM. In addition to the ManCo (MS Management Services S.A.) the firm also established the MS SICAV SIF, a platform allowing managers to set up their own sub-funds to market across Europe.
Kavitha Ramachandran, Director of MS Management Services S.A. says that Maitland is expanding into the real estate funds area to provide AIFM services.
“We are looking to extend our AIFM license to these asset categories. We see the demand. We are currently speaking to the CSSF with a view to expanding our services in the PERE space,” comments Ramachandran.
Every year, PwC (Luxembourg) runs an emerging trends survey. Current market perception is improving for pan-European real estate funds and in the opinion of Alexandre Jaumotte, partner and Real Estate and Infrastructure Tax Leader at PwC, Luxembourg is in a prime position to benefit.
“Since the launch of the SIF, real estate fund numbers have grown steadily. Case in point: there are now around 380 regulated real estate funds in Luxembourg. For unregulated vehicles there are no official statistics. Big institutional investors from Asia, the Middle East and the US who were originally passively investing in commingled pan-European real estate funds are these days more willing to invest into segregated accounts where they can get access to much more information and could take a more active role. They can sit on the investment committee or even the Board of Directors of the fund. This is keeping us busy at the moment,” comments Jaumotte.
Investors are becoming much more selective in the underlying assets they invest in. They want to be much more involved in the management of the structure and have the assets available to insist on doing so.
“Instead of allocating to a large commingled European fund they prefer to have a segregated account with one of the big name managers and of course, these segregated account structures are often unregulated. I cannot say we see more segregated account structures than regulated pan-European funds, per se, but we are certainly seeing more of these unregulated structures than we did in the past,” observes Jaumotte.
Hugh Stevens is head of Private Equity and Real Estate Services at BNP Paribas Securities Services. He notes that a continuing trend among the top 20 real estate managers is that more and more are global alternative managers and mainstream managers. “These are starting to make it on to the top 20 list. Pure play real estate managers are now facing much more competition.”
Zandona says that by adapting Luxembourg’s regulations to bring it more in line with the traditional Anglo-Saxon LP model brings greater comfort not just to managers, but investors as well.
“Typically, the largest investors are sovereign wealth funds, UK and Nordic pension plans, US pension plans and endowments. As such, they need to invest into structures that are well known to them and robust. That’s why the SCSp has been such a good introduction; managers have to spend less time explaining the legal structure and can focus more time on explaining performance objectives.
“Investors are now more aware of the SCSp and this is helping the PERE fund sector,” says Zandona.
One of the biggest adjustments that PERE managers are facing, not just under European but global regulatory regimes, is the need to up the ante when it comes to risk transparency. Typically, people will always refer to Solvency II as if it was the only piece of regulation to impact managers. This is not the case.
Take Australia for example. Under proposed Stronger Super reforms, its much vaunted superannuation system – in particular self-managed superannuation funds – will need to provide much greater disclosure and reporting details on the economic interests within their portfolios. The Australian Securities & Investments Commission (ASIC) will not concern themselves with the fund’s domicile meaning Luxembourg-based funds will fall under its net just as much as Cayman funds.
“For any one of these regulatory regimes, the ability to offer look-through capabilities provides the answer. If the investor or underlying manager is only reporting on the immediate asset(s) in the portfolio then there are maybe 40 or 50 asset lines in the portfolio. If the manager must look through these lines to the 40 or 50 portfolio companies or other investments underneath, that is an exponential growth in the volume of information that you’d need to track and report on,” says Stevens. This appetite for more data will continue to increase, not just to meet regulatory requirements but satiate investors’ thirst.
“The costs for providing that information are starting to decrease on a marginal basis. The big service providers are developing smart tools and for us as a firm that’s been a key development; to be able to respond to the data needs of our clients by collecting, transforming and reporting it for them. We are building more and more sophisticated and industrial tools to manipulate and present data the way managers want. That is very difficult for small boutique players to do.
“This discussion on risk transparency is moving from an intellectual debate into reality. Managers of Luxembourg funds need to be engaging specialists in smart data who are equipped to provide this service on a variable cost basis,” stresses Stevens.
Luxembourg service providers are all too well aware of the pressure that all alternative fund managers are under as they adapt to global regulations. The operational burden it puts on the middle and back office teams is getting heavier each year. Managers don’t want to be consumed by reporting and compliance obligations which is why the third party management company solution is becoming an essential solution.
Take, for example, a US hedge fund manager who wishes to expand his investor base in Europe. Do they go to Luxembourg or Ireland? Regulated or unregulated? Where is the best jurisdiction from a tax perspective? Then the manager has to think about their fund strategy. Where are they looking to attract investors? What is their distribution strategy? It quickly becomes very complicated.
“They realise that if they don’t raise EUR100-200m within six to 12 months, there’s really no point setting up a regulated fund. There aren’t too many banks offering full value chain services ranging from platform and ManCo services down to administration services, financing services, asset management services etc. That for us is a clear advantage. We cover financing, cash management, brokerage services, middle office services. We can cover it all,” explains Credit Suisse’s Zandona.
The point Zandona makes is that asset servicing is a given for financial institutions like Credit Suisse. What is now more important for managers is finding the right solution, the right distribution strategy and how best to cope with regulation for different fund structures. Only after, does the discussion turn to fund services.
“Increasingly, managers are looking for a partner that can support all of their needs and make their lives easier. You don’t make life easier just by settling trades faster than everybody else.
“You need to adapt your business proposition to cope with the challenges managers face today and offer support across the entire value chain,” adds Zandona.
Maitland too offers a ManCo solution as well as a full SIF platform solution – MS SICAV SIF – for managers who want help setting up new funds to distribute in the EU.
“It was key for us to build a position to support alternative regulated alternative funds, making sure our operational procedures and technology capabilities were up to the task. We have had a lot of enquiries with regard to our platform and ManCo solution. We also see an increase in requests for the Special Limited Partnership. We are talking to some US managers whereas before it would have more continental European managers so we are seeing a shift,” confirms Ramachandran.
The great advantage to third party AIFMs and platforms is that it raises the portcullis and stops non-EU managers viewing Europe as a fortress that frankly isn’t worth the hassle, or cost, of trying to penetrate.
“The third party ManCo is already popular in Luxembourg under its UCITS regime. There are a lot of these companies operating in Luxembourg. Applying the same model to AIFs under the AIFMD is a good development and makes complete sense,” says Ramachandran who, when asked about distribution opportunities under this arrangement.
He concludes: “Typically as the AIFM we would delegate the distribution function where the manager is then free to choose their own sub-distributors. What we help with is registering the fund(s) in different countries. For example, we have assisted with fund registrations for clients in the UK, Spain, Italy, France. Eventually, we will look to offer our own distribution network; we see that as a real opportunity.”