I OVERVIEW OF RECENT ACTIVITY
Luxembourg combines a diverse fund offering with a depth of expertise developed over many years as Europe's leading investment fund centre. As the second-largest fund servicing jurisdiction in the world after the United States, Luxembourg is a favoured destination for investment fund managers (IFMs) and investors alike, thanks to its stable political and social environment, versatile fund products, leadership in investor protection, and experienced and responsive regulator and service providers.
Assets under management in Luxembourg-regulated collective investment undertakings reached €4.3 trillion at the end of May 2019.2
The steady growth of assets under management in Luxembourg funds has been mostly driven by the country's success in positioning itself as the leading centre for undertakings for collective investment in transferable securities (UCITS). In recent years, a second fund label has remarkedly developed: alternative investment funds (AIFs), which include private equity, real estate, infrastructure, debt and hedge funds, all dedicated to an institutional, professional or sophisticated investor base.
While assets under management have risen steadily over recent years, Luxembourg has seen a consolidation in the total number of entities, driven by a preference to create umbrella structures.3 There are 3,871 entities that are subject to regulatory supervision, of which 2,513 are umbrella funds consisting of 13,553 sub-funds. In addition, 1,358 entities have adopted a standalone structure, bringing the total number of active fund units to 14,911 as at April 2019.4
In addition to 14 internally authorised managers, 207 UCITS management companies, 263 authorised alternative investment fund managers (AIFMs) and 165 other IFMs are authorised as at July 2019.5 There are 570 other IFMs that are registered as below threshold AIFMs.
Over the past few years, government efforts have been mainly directed at increasing transparency, protecting market stability and preventing the build-up of systemic risk in the financial system. Those large-scale reforms have been, to a large extent, driven by European initiatives.
More recently, the uncertainties surrounding Brexit caused a number of British and international operators with a significant presence in the United Kingdom to relocate all or part of their operations to Luxembourg or to establish Luxembourg investment funds. Of those firms that have publicly communicated their plans, more than 60 firms – half of which are in the asset management industry – have chosen to relocate to Luxembourg.
II GENERAL INTRODUCTION TO THE REGULATORY FRAMEWORK
A cornerstone of Luxembourg's success as an investment fund centre is its comprehensive legal and regulatory system, which benefits managers and investors alike.
The Commission de Surveillance du Secteur Financier (CSSF), a public institution with legal personality and financial autonomy, is entrusted with the supervision of the financial sector in Luxembourg.6 It operates under the authority of the Ministry of Finance.
As regards the funds industry, the CSSF is the prudential regulator of IFMs, and of the regulated investment funds that they manage. Its mission is to ensure that they comply with all legal, regulatory and contractual provisions relating to their organisation and operation. The main duties of the CSSF in this respect include:
- the licensing of Luxembourg IFMs and regulated investment funds;
- the prudential and ongoing supervision of licensed IFMs and regulated investment funds based on periodic reporting and regular or ad hoc requests for information, and on-site inspections;
- the imposition of disciplinary sanctions on IFMs, regulated investment funds and depositaries; and
- the oversight of the marketing conditions of Luxembourg and foreign investment funds (in particular, those marketed to non-professional investors).
In addition to those supervisory duties, the CSSF issues regulations and circulars in accordance with existing laws.
ii Regulations applicable to investment funds
Luxembourg collective investment undertakings fall under two broad categories: regulated and unregulated vehicles. Another distinction is made as to whether these collective investment undertakings are subject to a specific law (product law) or not.
The main product laws are:
- the law of 17 December 2010 on undertakings for collective investments (the UCI Law), which implemented EU Directive 2009/65/EC, further amended by EU Directive 2014/91/EU) (the UCITS Directive);
- the law of 13 February 2007 on specialised investment funds (the SIF Law);
- the law of 15 June 2004 on investment companies in risk capital (the SICAR Law); and
- the law of 23 July 2016 on reserved alternative investment funds (the RAIF Law).
Regulated investment funds
Regulated funds are subject to CSSF supervision and must (or their IFM must on their behalf) apply for and receive an authorisation from the CSSF before they start operating.
The CSSF supervises:
- UCITS subject to Part I of the UCI Law;
- other undertakings for collective investment (UCIs) subject to Part II of the UCI Law;
- specialised investment funds (SIFs) subject to the SIF Law;
- investment companies in risk capital (SICARs) subject to the SICAR Law;
- European venture capital funds (EuVECA) subject to Regulation 345/2013 (EU);
- European long-term investment funds (ELTIF) subject to Regulation (EU) 2015/760;
- European social entrepreneurship funds (EuSIF) subject to Regulation (EU) No. 346/2013;
- pension savings companies with variable capital (SEPCAVs) and pension savings associations (ASSEPs) subject to the law of 13 July 2005 (Pension Law); and
- certain securitisation undertakings subject to the law of 22 March 2004 (Securitisation Law) when they offer their securities to the public on a continuous basis.
All these vehicles, once approved, are registered on official lists maintained by the CSSF and accessible on its website.
As regards investment funds subject to its supervision, the CSSF typically reviews and approves:
- the constitutional and offering documents and contractual arrangements;
- the persons to be appointed to the management body of the vehicle or its management company;
- the central administration;
- the depositary;
- the auditor; and
- where appropriate, the IFM and other operators of these vehicles.
The regulator may request additional information as part of the approval process. The operators of the funds or their management company as well as their service providers must demonstrate that they are of good repute and sufficiently experienced.
Any replacement of an operator or a service provider, and any change to the constitutional or offering documents or to the contractual arrangements, are subject to the prior approval of the CSSF. The appointment of a liquidator also requires prior approval, and the CSSF remains competent for the supervision of the vehicle until the close of the liquidation.
UCITS are subject to strict, EU-driven organisation and management requirements, and rules on diversification, liquidity and use of leverage. UCITS benefit from a European distribution passport, and as such are eligible for sale to retail investors in the European Economic Area (EEA) and various non-EEA countries.
Because of their more flexible rules, investment funds subject to Part II of the UCI Law do not qualify as UCITS. They are less constrained as to the type of assets they can invest in, the investment strategy they use, the diversification rules they are subject to and the liquidity they offer to investors.
Introduced in 2007, the SIF is a lightly regulated, operationally flexible and fiscally efficient investment vehicle. Dedicated to institutional, professional and other qualified investors, a SIF may invest in any type of assets and pursue any investment strategy without any quantitative, qualitative, geographical or other restrictions. However, as with any other UCI, a SIF should in principle not invest more than 30 per cent of its assets or commitments in securities of the same kind issued by the same issuer.7
The SICAR is an investment vehicle designed specifically for investment in risk capital, as detailed in CSSF Circular 06/241. SICARs allow direct or indirect contributions of assets to be made to entities in view of their launch, development or listing on a stock exchange. Unlike other investment funds, the SICAR is not subject to investment diversification rules, or lending or leverage restrictions.
Unregulated investment funds
Investment funds that are not directly subject to CSSF supervision include RAIFs, certain securitisation vehicles and standard commercial companies.
The RAIF, a new type of AIF that must be managed by an authorised external AIFM, offers to a large extent similar structuring and investment flexibility as the SIF. However, in opposition to the SIF, the RAIF is not subject to the supervision of the CSSF. RAIFs are required to comply with the specific AIFM Law requirements such as:
- the appointment of a depositary;
- the appointment of an approved statutory auditor;
- minimum content requirements for their annual reports;
- the valuation of their assets; and
- investment and leverage rules regarding certain types of assets.
However, in exchange for complying with the AIFM Law requirements, RAIFs benefit from the AIFMD passport in order to be marketed to professional investors (and retail investors if permitted) in the EEA.
Under certain conditions, securitisation vehicles (whether regulated or not) can be used as an alternative to the more traditional forms of investment vehicles.
SOPARFIs are ordinary commercial companies whose corporate object is limited to the holding of participations in other companies. While they may in principle take any corporate form available under the law of 10 August 1915 on commercial companies (the Companies Law), in practice they will take the form of share capital companies. As an unregulated company, the SOPARFI is not subject to any risk-spreading requirements, and may in principle invest in any asset class. SOPARFIs may also manage their financial participations and conduct commercial activities that are directly or indirectly connected to the management of their holdings, including the debt servicing of their acquisitions.
iii Regulations applicable to investment fund management
Commencing business as an authorised IFM in Luxembourg is subject to prior approval by the CSSF. Authorised IFMs are UCITS management companies subject to Chapter 15 of the UCI Law; and authorised AIFMs subject to the law of 12 July 2013 on alternative investment fund managers (AIFM Law).
Management companies authorised under Chapter 15 of the UCI Law may also apply for authorisation under the AIFM Law (and vice versa) to manage both UCITS and AIFs.
Both the UCI Law and the AIFM Law allow authorised IFMs to benefit from an extended scope of activity, in particular for the provision of discretionary management services. As non-core services, those IFMs can offer investment advice on financial instruments and the administration of UCIs under certain conditions.
The application for authorisation must be accompanied by a programme of activity setting out the capital, human and technical resources, corporate governance and organisational structures of the IFM.
A new CSSF Circular 18/698 details the fundamental substance requirements that are expected from IFMs. The circular consolidates the existing practices that were applied by the CSSF and adds specific new requirements in relation to the IFMs' corporate governance, central administration and internal controls, fight against money laundering and terrorist financing, key functions such as delegated activities, marketing and internal administration, procedures, and valuation. CSSF Circular 18/698 applies to UCITS management companies and AIFMs, as well as management companies subject to Chapters 16 and 17 of the UCI Law.
An authorisation granted to an IFM under the UCITS Directive or the AIFMD is valid for all EEA countries.
UCITS management companies
A UCITS management company is authorised to manage UCITS, as defined by Directives 2009/65/EC (as amended by Directive 2014/91/EU) and 2010/43/EU. The management of UCITS includes:
- investment management;
- marketing shares or units of the investment fund; and
- administrative functions such as:
- legal services;
- fund accounting;
- portfolio valuation and the calculation of net asset value per share (including tax aspects);
- the sale and redemption of shares or units;
- client administration;
- compliance; and
- client servicing.
The business of an AIFM covers the portfolio management and risk management of one or more AIFs. AIFM authorisation is required when the AIF assets the AIFM manages are above the thresholds set out in the AIFM Law. The AIFM may be an external entity, or the AIF itself in the case of an internally managed AIF.8 Only corporate AIFs such as investment companies can be internally managed. Internally managed AIFs are subject to almost all of the same requirements as AIFMs.
Under the AIFMD, IFMs that manage small AIFs (i.e., AIFs whose assets are below (1) €100 million, including assets acquired through leverage, or (2) €500 million, when the AIFs are not leveraged and have no redemption rights exercisable during a five-year period following the date of the initial closing) are subject to a lighter regulatory regime.9
Registered AIFMs do not benefit from the AIFMD passport, and may not freely market the AIFs that they manage on a cross-border basis. For the time being, they may continue to market the AIFs they manage within the EEA under the national private placement regimes on a country-by-country basis.
When the AIF assets under management of a management company are below the AIFM Law thresholds, an IFM subject to Chapter 16 of the UCI Law can manage that AIF without being authorised as AIFM. Otherwise, it must either seek authorisation as an AIFM or designate another entity as AIFM. Chapter 16 management companies may also manage investment vehicles other than AIFs.
iv Regulations applicable to depositaries
Over the past few years, the regulatory regime applicable to depositaries in Luxembourg has been subject to significant changes brought about by the AIFM and the UCITS Directives. Directive 2014/91/EU broadly aligned the role and responsibilities of UCITS depositaries with the AIFMD regime. Those two depositary regimes, however, differ in that the AIFMD allows the contractual transfer of liability from a depositary to a sub-depositary (including a broker acting as sub-depositary) and extended possibilities for rehypothecation of assets.
Under the AIFM and the UCITS Directives, the duties of Luxembourg depositaries include:
- acting as custodian of the fund's assets they have been entrusted with;
- monitoring the fund's cash flows, in particular ensuring that all payments made by or on behalf of investors upon the subscription of securities of a fund have been received, and that all cash of the fund has been booked in cash accounts opened in the name of the fund; and
- overseeing the fund's operations to ensure that they comply with Luxembourg laws and the constitutional documents of the fund.
Investment funds subject to a product law and AIFs managed by an authorised AIFM must appoint a single depositary to supervise and monitor their assets. The appointment and replacement of the depositary of a regulated investment vehicle must be approved by the CSSF.
UCITS and Part II UCIs that may be marketed to retail investors in Luxembourg are subject to the UCITS V Directive depositary regime.10 Their depositary must be a credit institution with its registered office in Luxembourg or a Luxembourg branch of a credit institution with its registered office in another EEA country.
Part II UCIs whose offering documents prohibit marketing to retail investors in Luxembourg are subject to the AIFMD depositary regime.11 SIFs, SICARs, RAIFs and other AIFs managed by authorised AIFMs, and internally managed AIFs that are subject to the AIFM Law, are also subject to the AIFMD regime. They must appoint a Luxembourg credit institution or Luxembourg branch of an EEA credit institution, a Luxembourg investment firm, a Luxembourg branch of an EEA investment firm, or – under certain conditions detailed below – a Luxembourg professional depositary of assets other than financial instruments.
Introduced by the AIFM Law, professional depositaries of assets other than financial instruments may only be used by AIFs that have no redemption rights for a period of five years from the date of the initial investments and either do not invest in financial instruments that must be held in custody in accordance with the AIFM Law (typically real estate funds), or invest in issuers or non-listed companies in order to potentially acquire control over such companies under the AIFM Law (typically private equity and venture capital funds).
Marketing in Luxembourg of foreign UCITS
Foreign UCITS must be notified to the CSSF by the competent authority of the fund's home state before they can market their securities in Luxembourg. They must also appoint a Luxembourg paying agent and one or more financial correspondents whose duties are, among others, dealing with subscriptions and redemptions, informing investors, and paying the CSSF fees.
Marketing in Luxembourg of foreign AIFs
AIFMs authorised in another EEA country may market securities of EEA AIFs to professional investors in Luxembourg12 and, subject to certain conditions, to retail investors. Marketing to retail investors in Luxembourg requires that an EEA AIF established in a country other than Luxembourg is subject in its home country to a level of investor protection and prudential supervision considered by the CSSF as equivalent to that provided for in Luxembourg.
Regardless of whether an existing passport to do management business under another directive (such as UCITS) is held, EEA AIFMs are required to make a separate notification to their home state competent authority if they intend to manage or market an EEA AIF on the basis of the AIFMD passport.
The home state competent authority will send the management passport notification to the CSSF along with a certificate (as mentioned in Article 33(4) of the AIFMD) on behalf of the EEA AIFM if the EEA AIFM intends to distribute to investors, Luxembourg AIFs, or EEA AIFs within Luxembourg. The EEA AIFM can commence its management activities in Luxembourg from the date of notification by the home state competent authority to the CSSF.
Each foreign AIF intending to market in Luxembourg to retail investors must have an authorisation granted by the CSSF before engaging in marketing. Furthermore, those AIFs must have completed the notification procedure required for marketing to professional investors. However, if an AIF is an unregulated AIF, it may only promote such activities to professional investors in accordance with the AIFM Law.13
Currently, non-EEA AIFMs intending to market AIFs in Luxembourg are required to conduct distribution on a private placement basis and to observe the financial promotion rules.
The CSSF proceeds on a case-by-case analysis for non-EEA AIFMs (as there is no official list of equivalent countries). A list of the cooperation agreements signed by the CSSF and other EAA regulators with non-EEA authorities has, however, been published.14
Finally, the CSSF has issued guidance on reverse solicitation and marketing in respect of AIFs in Luxembourg.15
III COMMON ASSET MANAGEMENT STRUCTURES
UCITS, Part II UCIs, SIFs and RAIFs can generally be formed as contractual vehicles (FCPs) or as corporate vehicles (investment companies) depending on, among other considerations, corporate governance or tax requirements. By contrast, SICARs can only be set up as investment companies.
Similar to a unit trust in the UK or a mutual fund in the US, an FCP is organised as a co-proprietorship whose joint owners are only liable up to the amount they have committed or contributed to the fund. An FCP has no legal personality, and must be managed by a Luxembourg management company regardless of whether it is created under the UCI Law, the SIF Law or the RAIF Law. The management company acts on behalf of the FCP, which includes the appointment and oversight of its service providers.
ii Investment companies
Corporate vehicles may be set up either as investment companies with variable share capital (SICAV) or as investment companies with fixed share capital (SICAF). In a SICAV, the capital increases or decreases in proportion to inflows or outflows of funds, or changes in the net asset value of the fund, whereas a SICAF requires a decision (usually formalised in a notarial deed) to vary the capital in accordance with company law requirements.
The legal forms typically used by investment companies are the public limited company, the private limited company, the partnership limited by shares, the common limited partnership or the special limited partnership. While SIFs and SICARs can select all these legal forms, SICAVs subject to Part I or Part II of the UCI Law must be set up as public limited companies. UCIs organised as SICAFs may also be incorporated as partnerships limited by shares.
The common limited partnership and the special limited partnership deserve special attention. Both partnerships must be formed between one or more general partners who are liable for all the debts and obligations of the partnership, and one or more limited partners whose liability is limited to the amount of capital that they contribute or commit to the partnership.
Introduced in 2013 along with the implementation of the AIFM Directive, the special limited partnership – unlike the common limited partnership – does not have separate legal personality. However, all contributions, acquisitions and dispositions of assets can made in the name of the special limited partnership rather than in a general partner's or limited partners' name. The common limited partnership and the special limited partnership benefit from generally being transparent for tax purposes (see Section VII).
A SOPARFI is usually organised in the form of a public or private limited company, or a partnership limited by shares, and will operate with fixed or authorised capital features. The latest company law reform of August 2016 introduced, among other noteworthy changes, the simplified limited company.
iii Sub-funds and classes
All funds subject to a product law may be formed as umbrella structures composed of one or more sub-funds. Each sub-fund comprises a specific portfolio of assets and liabilities separate from the portfolio of assets of the other sub-funds, except if otherwise provided for in the constitutional documents of the fund. The assets of a specific sub-fund may only be used to satisfy its own debts and obligations.
Furthermore, various classes of shares, units or partnership interest may be created within regulated or unregulated investment vehicles alike (or within their compartments). The typical features of these classes include different liquidity and distribution entitlements, minimum subscription or holding requirements, fee structures, reference currencies and target investors. All classes tap into the same pool of assets within the vehicle or the specific sub-fund, but the net asset value per share, unit or interest of each class may vary as a result of the specific features of that class. Unlike for sub-funds, there is no ring-fencing of assets and liabilities among classes of the same compartment.
IV MAIN SOURCES OF INVESTMENT
Luxembourg's fund centre has a strong international orientation: over 97 per cent of funds under management in Luxembourg (around €4.2 trillion) are from overseas. In addition, more than 90 per cent of the large and medium-sized asset management firms in Luxembourg are owned by overseas investors.16
Luxembourg funds are distributed to investors in more than 70 countries, making the cross-border dimension of Luxembourg's fund centre unequalled.17 Nearly two-thirds of the funds authorised for cross-border distribution are domiciled in Luxembourg.18
UCITS provide the majority of funds under management in Luxembourg, contributing to more than 82 per cent of total funds in 2018. The share of assets under management of regulated AIFs managed by authorised IFMs is more modest in terms of managed assets (€704.1 billion). IFMs established in other EEA countries and managing Luxembourg UCITS or AIFs under UCI Law or AIFM Law hold €591.1 billion of assets combined.19
V KEY TRENDS
Luxembourg continues to strengthen its ranking as the world's second-largest fund domicile after the United States: an estimated €4.3 trillion of funds was placed in Luxembourg regulated collective investment undertakings at the end of May 2019, an increase of 1.1 per cent on the previous year and the 11th successive year of growth.20 This increase is not only owed to the growth of traditional retail UCITS (for which Luxembourg contributes to more than 36 per cent of Europe's market share) but also due to the continued increase in the number and assets of AIFs.
i RAIFs and other non-regulated AIFs
Over the past few months, Luxembourg has seen strong interest in AIFs that are not subject to a product law and in RAIFs. The main asset classes in these vehicles are typically private equity, venture capital, infrastructure, clean technology, real estate and debt. Interest in SIFs and UCITS remains continuous, in particular those that have particular strategies or are investing in more 'exotic' markets.
After three years of existence, the RAIF is increasingly attracting investors (especially European institutional investors) who perhaps see it as an alternative to the SIF (and to a lesser extent to the SICAR), and as an investment fund meeting the highest standards of structural quality and flexibility that they were used to in a SIF or SICAR but without an add-on regulation of the product itself. Since July 2016, 655 RAIF vehicles have been registered in Luxembourg with a variety of different investment policies.21
There also has been strong demand for unregulated AIFs structured as partnerships (special limited partnerships or common limited partnerships), in particular for illiquid asset classes.
ii Private equity
Building on the infrastructure, expertise and knowledge that the country has developed in the retail fund industry over the past 30 years, combined with a favourable environment for private equity, Luxembourg has been used for the structuring of international acquisitions via unregulated and regulated vehicles. Today Luxembourg is home to over 25,000 SOPARFIs, mainly used to structure private equity acquisitions. Assets held through Luxembourg private equity vehicles exceed €99 billion in 647 vehicles.22
iii Real estate
Over the past decade, Luxembourg has positioned itself as a hub for real estate investment funds (REIFs). Real estate assets held through Luxembourg REIFs reached an all-time high of over €78 billion in 323 vehicles (outside of fund of fund vehicles or debt fund vehicles related to property).23
iv Debt funds
Debt and credit funds are increasingly present in Luxembourg thanks to the flexible legal and regulatory environment that allows them to implement all types of debt and credit strategies, such as mezzanine, distressed and origination strategies. Luxembourg has also seen a significant development in fund finance activity, supported by efficient security packages, positive growth, strong credit performance and absence of credit defaults.
VI SECTORAL REGULATION
In addition to circular letters issued by the CAA, insurance companies in Luxembourg are governed by:
- the amended law of 6 December 1991 on the insurance sector;
- the amended Grand Ducal Regulation of 14 December 1994 specifying the conditions for the approval and practices of insurance companies; and
- the Grand Ducal Regulation of 5 December 2007 establishing the terms and conditions of the supplementary supervision of insurance and reinsurance undertakings that are part of an insurance or reinsurance group.
These legal provisions determine the authorisation procedure and business conduct of insurance and reinsurance companies, the mission and procedural methods of the CAA, and the free provision of services by Luxembourg insurance companies in other EEA countries.
Insurance contracts are governed by the amended law of 27 July 1997 on insurance contracts.
Traditionally, life insurance companies offer guaranteed return products where premiums are managed in the insurer's general fund (or in that of its parent company). In addition, Luxembourg insurance companies propose a wide range of unit-linked products24 established as external investment funds managed by third-party asset managers; internal collective funds that operate like UCITS and that allow discretionary management tailored to the various risk profiles of investors; or internal dedicated funds that allow discretionary management that takes the subscriber's personal objectives into account.
Several dedicated funds can be grouped within the same life assurance contract.
Pension funds regulated by the CSSF
Pension savings companies with variable capital (SEPCAVs) and pension savings associations (ASSEPs) are two legal entities created by the law of 8 June 1999. They are governed by the law of 13 July 2005 on institutions for occupational retirement provision, which implements Directive 2003/41/EC on the activities and supervision of the institutions for occupational retirement provision.
SEPCAVs have a corporate structure similar to that of SICAVs, in which the members and beneficiaries are shareholders who will receive a share of a fund's profits when retiring. SEPCAVs can only be used for defined contribution schemes.
ASSEPs, on the other hand, work like associations that can be used for both defined contribution and defined benefit schemes. In an ASSEP, the rights of the members and beneficiaries are debt claims that, when the members and beneficiaries retire, will be paid out either as a lump sum or as an annuity. ASSEPs may also cover additional benefits on the death or disability of their members.
SEPCAVs and ASSEPs must be authorised by the CSSF to conduct their business.
iii Pension funds regulated by the CAA
Pension funds supervised by the CAA are subject to the CAA Regulation of 31 August 2000. CAA pension funds offer flexibility in the form of the vehicle for defined contributions, defined benefits or additional benefits on the death or disability of members.
Four legal forms can be chosen, but in practice the not-for-profit association form is the most commonly used vehicle. CAA pension funds can either finance defined benefits or defined contributions schemes.
iv Real property
Real estate funds can be set up as unregulated or regulated vehicles. When they are subject to CSSF supervision, they fall under the Part II of the UCI Law and CSSF Circular 91/75, unless they have been established under the SIF Law or, where their assets represent risk capital investments, under the SICAR Law.
CSSF Circular 91/75 requires that real estate Part II UCIs invest no more than 20 per cent of their net assets in a single property, subject to a ramp-up period of up to four years. In principle, real estate Part II UCIs may not borrow more than 50 per cent of the value of all the properties. Their net asset value must be calculated at least once a year, and an independent valuer must be appointed to assess the value of the properties.
Real estate SIFs are subject to CSSF Circular 07/309, which restricts investment in a single property to 30 per cent of their assets, but they may in practice take advantage of a similar start-up period as real estate UCIs. Although borrowing restrictions are more flexible for this vehicle, the AIFM Law requires that an AIFM determines the maximum leverage levels for the fund.
SICARs may also invest in real estate to the extent that they:
- demonstrate an element of risk capital, such as the objective of developing the target asset, or specific risks associated with the property that are beyond the common level of real estate risk; or
- are acquiring the property to sell at a capital gain in a relatively short time frame.
Real estate funds can also be formed under the RAIF Law under the same conditions as those detailed for SIFs and SICARs above.
Finally, SOPARFIs can also be used to set up unregulated real estate funds.
v Hedge funds
Although a limited number of UCITS employing hedge fund strategies may be marketed to retail investors on the same basis as other UCITS funds, hedge fund strategies are usually pursued under Part II of the UCI Law, the SIF Law or the RAIF Law.
CSSF Circular 02/80 sets forth specific rules applicable to Luxembourg UCIs pursuing alternative investment strategies. The Circular determines the investment restrictions generally applicable to these types of Luxembourg UCIs.
SIFs and RAIFs are not subject to any investment eligibility requirements, and are therefore best suited to accommodate all sorts of alternative strategies. They are both, however, required to diversify their investments to 30 per cent of their assets (except for certain fund of funds or feeder funds) as further set out in CSSF Circular 07/309.
CSSF Circular 08/372 specifies the rules on the appointment of prime brokers, the relationship between the depositary and the appointed prime brokers, and the liability of the depositary in that respect.
vi Private equity
Private equity funds in Luxembourg take advantage of a large choice of structuring options, such as Part II UCIs, SICARs, SIFs, RAIFs, and other types of unregulated companies or partnerships. In practice, the special limited partnership, the common limited partnership or the SOPARFI are typically used. Amid an international regulatory environment seeking to increase transparency and oversight, the SICAR and the SIF are tried-and-tested regulated private equity and venture capital structures. They combine a flexible and accessible regulatory infrastructure with strong investor protection features. The RAIF should follow the same pattern.
In addition, Luxembourg regulated and unregulated vehicles can be set up as EuVECA funds. These are restricted to equity instruments issued by or loans granted to qualifying portfolio undertakings, meaning undertakings that are at the time of the first investment by the fund in that undertaking not admitted to trading on a regulated market or multilateral trading facility, and that employ up to 499 persons. Small and medium-sized enterprises (SMEs) that are listed on SME growth markets will also be allowed under the revised EuVECA Regulation.
EuVECA funds are also subject to specific rules in respect of fund portfolio composition, investment techniques and own funds. In particular, these funds must intend to invest at least 70 per cent of their aggregate capital contributions and uncalled committed capital in assets that are qualifying investments and, as a consequence, not use more than 30 per cent for the acquisition of assets other than qualifying investments. One of the defining features of the EuVECA regime is that it does not require the appointment of a depositary.
The EuVECA Regulation applies to EEA managers that are subject to registration with the competent authorities of their home country in accordance with the AIFMD and manage qualifying venture capital funds with total assets under management of less than €500 million.
The use of the revised EuVECA label is now also open to above-threshold AIFMs that continue to be subject to the requirements of the AIFMD while complying with certain provisions of the EuVECA Regulation (those on eligible investments, targeted investors and information requirements).
EuVECA managers can also manage and market AIFs that are not EuVECA funds. However, the EuVECA passport does not apply to these funds.
vii Other sections
Luxembourg has a long history of commitment to the microfinance sector as part of the country's overseas development aid and training assistance. Promoters can choose from a range of regulated and unregulated structures, such as Part II UCIs, SICARs and SIFs. Other usual structures are the securitisation vehicle and structured products. A Grand Ducal Regulation of 14 July 2010 provides that UCIs and SIFs invested in microfinance and that meet certain conditions are exempt from the annual subscription fee.25
Luxembourg is also home to a number of investment funds that are compliant with shariah principles, and of cleantech and other new technologies funds.
VII TAX LAW
i Investment funds subject to product laws
Regulated investment funds other than SICARs
UCITS, Part II UCIs and SIFs, whether they are established in a contractual form (FCP) or a corporate form (SICAV or SICAF), are exempt from all taxes apart from a fixed registration duty levied on the contribution of capital and a subscription tax.
The subscription tax is calculated in proportion to the net assets of funds at the end of each quarter. The standard annual rate for UCITS and Part II UCIs is 0.05 per cent. Funds investing in money market instruments and bank deposits, SIFs, and sub-funds and classes of UCIs that are reserved to institutional investors, are subject to a reduced rate of 0.01 per cent. In addition, a subscription tax exemption is available for funds investing in other Luxembourg UCIs that are subject to subscription tax, institutional money market UCIs, exchange traded funds, pension pooling funds and microfinance funds.
UCITS, Part II UCIs and SIFs are not subject to withholding tax on distributions.
As tax-exempt entities, Luxembourg funds are not entitled to local or foreign tax refunds (unless a tax treaty applies) or credits. SICAVs and SICAFs may benefit from a limited number of double taxation treaties, reducing withholding tax rates in the countries in which they invest. By contrast, FCPs cannot in principle avail themselves of double taxation treaties: however, their unitholders could claim the reduced rate under a double taxation treaty between the country of source of the income or gain and the country of residence of that investor.
The tax treatment of SICARs will depend on whether they are formed as tax-transparent vehicles or as a non-tax transparent vehicles.
SICARs incorporated as non-transparent vehicles are fully taxable companies and, as such, are subject to corporate income tax (CIT) and municipal business tax (MBT). However, income and capital gains from transferable securities are exempt from income taxes, and distributions of dividends are also exempt from withholding taxes, irrespective of the residence and tax status of their shareholders. Income on cash held by SICARs for future investment is also tax-exempt for a period of 12 months. Other income is subject to CIT and MBT at an aggregate rate of 24.94 per cent (for Luxembourg City in 2019).
SICARs are also subject to an annual net wealth tax (NWT) of €4,815 if their financial assets, transferable securities, bank deposits and receivables against related parties exceed 90 per cent of the total of their balance sheet and €350,000. If any one or more of these requirements are not met, the NWT ranges from €535 to €32,100, depending on a SICAR's balance sheet total.
SICARs can take advantage of most double taxation treaties concluded by Luxembourg, as well as the EU Directives.
SICARs formed as a tax-transparent vehicle for Luxembourg tax purposes are subject to the provisions detailed under subsection ii.
RAIFs can generally elect to be treated as SICARs or SIFs for Luxembourg tax purposes. If their exclusive purpose is to invest in risk capital, RAIFs are subject to the same tax regime as SICARs. If they pursue another strategy, they are subject to the same provisions as SIFs.
ii Investment funds not subject to product laws
Funds that are not subject to a product law are usually set up in the form of partnerships (common or specialised limited partnerships). As transparent entities for Luxembourg tax purposes, partnerships are not subject to CIT or NWT. Further, a partnership that is an AIF is not subject to MBT, provided that (as is usually the case) its general partner holds less than 5 per cent of the interests in the partnership.
Partnerships are not eligible for the benefits of double taxation treaties. However, an investor in a Luxembourg partnership should in theory be able to claim the reduced rate under a double taxation treaty between the country of the source of the income or gain and the country of residence of the investor: this would typically be possible if the partnership is recognised as tax-transparent by both the investee's and the investor's countries.
SOPARFIs are companies subject to CIT and MBT on their income at an aggregate rate of 24.94 per cent (in Luxembourg City in 2019). However, income received by a SOPARFI from its shareholdings (dividends, liquidation proceeds) and capital gains realised upon the sale of these shareholdings are exempt to the extent that the conditions of the Luxembourg participation exemption regime are met. Further, dividend distributions to corporate shareholders are exempt from withholding tax under certain conditions. The distribution of liquidation proceeds is also exempt from withholding tax without any condition.
SOPARFIs benefit from the double taxation treaties concluded by Luxembourg, as well as from the EU Directives.
SOPARFIs are also subject to NWT in Luxembourg: a rate of 0.5 per cent applies on the portion of net wealth that is lower than or equal to €500 million, while the exceeding portion is subject to a reduced rate of 0.05 per cent. However, subject to the application of the participation exemption regime, qualifying shareholdings are exempt from NWT.
A SOPARFI is subject to an annual minimum amount of NWT of €4,815 if the financial assets, transferable securities, bank deposits and receivables against related parties of the SOPARFI represent more than 90 per cent of its balance sheet and exceed €350,000. If the SOPARFI does not meet these requirements, the minimum NWT varies between €535 and €32,100, depending on the level of its total balance sheet.
Taxation of managers
Luxembourg IFMs generally take the form of companies with share capital, which are fully subject to CIT, MBT and NWT under the same conditions as those applicable to SOPARFIs.
The management of funds that are structured under a product law is exempt from VAT in Luxembourg.
The VAT exemption applies to, among other services, investment management (including risk management) and administration (e.g., investment advice, transfer agent and registrar functions).
Management services outsourced to third-party managers also benefit from the VAT exemption under certain conditions (they should notably be specific to, and essential for the management of, the fund). In addition to management services, services related to the distribution of investment funds are also exempt from VAT.
Other services rendered to investment funds, such as legal and audit services, cannot benefit from a VAT exemption and are subject to the standard VAT rate of 17 per cent.
Depositary services are partly exempt from VAT; services related to the control and supervision functions of the depositary are subject to a reduced VAT rate of 14 per cent.
Funds with corporate form are VAT persons, and may be subject to Luxembourg VAT registration if they receive goods or services from abroad for which they must account for Luxembourg VAT on a reverse-charge basis. FCPs must account for Luxembourg VAT on a reverse-charge basis through the VAT number of their management company.
The agenda will remain challenging for the asset management industry in the years to come, but will also offer many opportunities for development. New EU regulatory developments will continue to dominate the outlook of the Luxembourg fund industry. Luxembourg's asset management industry will continue to face regulatory challenges, and will need to undertake digital and environmental transitions.
Assuming that the UK will become a third country after its withdrawal from the EU, the Luxembourg Parliament has passed on 8 April 2019 two laws that aim to mitigate disruptions caused by Brexit.
The first Brexit law would only apply if the UK leaves the EU without an agreement. It introduces a form of EU passport for UK financial service providers currently operating in Luxembourg during a transitional period of 21 months in line with EU contingency plans. In addition, the law gives the CSSF and the CAA powers to take temporary emergency measures in their area of their supervisory activities. In order to ensure the proper functioning of the financial markets, these regulatory bodies would therefore have the possibility to decide, on a case-by-case basis, to allow UK service providers to benefit from an EU passport regime.
The second Brexit law applies whether the UK leaves the EU with or without an agreement with the EU. The law sets out a 12-month grace period for IFMs of Luxembourg UCITS, Part II UCIs and SIFs to address breaches of investment rules resulting from the UK's withdrawal, such as divesting from positions in UK UCITS which could no longer be deemed compliant due to Brexit. It also authorises UK UCITS to continue to be marketed to retail investors in Luxembourg during the grace period. Where the UK UCITS is managed from outside the UK by an EEA IFM also authorised as an AIFM, then the UK UCITS will be considered an AIF for these purposes and permitted to be marketed to retail investors in Luxembourg under local AIF rules after the grace period.
ii Defining and redefining marketing
On 16 April 2019, the European Parliament adopted a package of measures aimed to eliminate current regulatory barriers to the cross-border distribution of investment funds in order to enable a better functioning Single Market and economies of scale. The proposal is designed to improve transparency, remove overly complex and burdensome requirements and harmonise diverging national rules. This marked the end of a review process of cross-border distribution of collective investment undertakings started in 2016 in connection with the Capital Markets Union.
The proposed Regulation will align national marketing requirements and regulatory fees, and will harmonise the process and requirements for the verification of marketing material by national competent authorities. It will further enable the European Securities and Markets Authority (ESMA) to better monitor investment funds.
The proposed Directive will harmonise the conditions under which investment funds may exit a national market and will allow European asset managers to test the appetite of potential professional investors for new investment strategies through pre-marketing activities.
The Directive and Regulation are to be published during the third quarter of 2019 and become effective by the end of 2021.
Luxembourg has recently adopted Organisation for Economic Co-operation and Development proposals as part of the base erosion and profit shifting initiative. On 18 December 2018, the Luxembourg Parliament passed the law implementing the EU Anti-Tax Avoidance Directive (ATAD I). The law covers:
- controlled foreign company rules;
- interest limitation rules;
- exit taxation;
- hybrid mismatches; and
- general anti-abuse rules.
It also contains two additional provisions that are unrelated to ATAD I. The first provision repeals the provision that allows (among others) a debtholder to convert a loan into shares in a tax-neutral manner, while the second amends the permanent establishment provisions under Luxembourg law.
By the end of 2019, Luxembourg will have to implement more extensive anti-hybrid rules when the Anti-Tax Avoidance Directive II (ATAD II) is transposed into domestic law. This will expand the territorial scope of the hybrid mismatch measures under ATAD I to third countries as well as the type of hybrid mismatches covered, which will include hybrid PE mismatches, hybrid transfers, imported mismatches, reverse hybrid mismatches and dual residence mismatches.
The provisions of ATAD II are expected to have a significant impact on fund structures that historically have been financed with shareholder debt throughout with the aim of facilitating funding as well as repatriation of investment proceeds to investors.
iv Retail investors
The flexibility enjoyed by SIFs, SICARs and other UCIs may be reduced in the future. In January 2016, bill of law 6936 was deposited with the Luxembourg Parliament, amending a number of product laws and the AIFM Law. Under the bill, UCI investors that are not professional investors under MiFID II will only be able to invest in certain types of assets (as determined by the CSSF). It is expected that the CSSF will restrict investment in certain tangible assets or investments related to individuals (or their rights). In addition, closed-ended UCIs will no longer be required to issue shares based on their total net asset value. Instead, this will be based on a price fixed in accordance with their constitutional documents.
v Pan-European personal pension product
Luxembourg welcomes the European Commission's plan to create a standardised pan-European personal pension product (PEPP). The PEPP aims to link investment products to individuals rather than to an employment relationship, and provides opportunities not only for workers and job seekers, but also for the Luxembourg asset management industry.
Fintech, and technology in general, will remain an important area of focus for Luxembourg. Various associations aim to raise awareness, identify the challenges and develop opportunities inherent in new digital technologies for the fund industry, such as regtech and blockchain tools, which are expected to reduce costs and increase efficiency in the industry over time.
1 Pierre De Backer is a principal and Emmanuelle Bauer is a partner at Deynecourt.
2 ALFI Global overview, July 2019.
3 CSSF Newsletter May 2019.
4 ALFI Global overview, July 2019.
5 ALFI Global Review June 2019.
6 Law of 23 December 1998 establishing a financial sector supervisory commission.
7 CSSF Circular 07/309.
8 A RAIF cannot be internally managed and must be managed by an authorised AIFM.
9 AIFM Law.
10 UCI Law, Article 17 et seq.
11 AIFM Law, Article 19.
12 AIFM Law, Articles 31 and 33.
13 CSSF Regulation 15/03.
15 FAQ Alternative Investment Fund Managers.
16 CSSF annual report 2018.
17 PwC Global Fund Distribution 2018.
19 CSSF annual report 2018.
20 CSSF Press release 19/30.
21 ALFI Global overview, July 2019.
22 ALFI Global overview, July 2019.
24 CAA Circular 08/1.
25 Grand Ducal Regulation of 14 July 2010.