The Asset Management Review: Luxembourg
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. The second-largest fund servicing jurisdiction in the world after the United States is a favourite of investment fund managers (IFMs) and investors alike, thanks to its stable political and social environment, versatile fund products, robust investor protection and experienced and responsive regulator and service providers.
The assets under management of Luxembourg-regulated investment funds have consistently remained above €4 trillion since 2017, owing to the growth of undertakings for collective investment in transferable securities (UCITS), but also to the attractiveness and flexibility of alternative investment funds (AIFs), a category that includes hedge funds, private equity, real estate, infrastructure and debt. Concurrently with the growth in the AIF market, Luxembourg has significantly developed its fund finance activity, supported by efficient security packages supporting credit facilities for funds, and has contributed to the emergence of environmental, social and governance (ESG) and impact investing funds.
Recent years have also seen Luxembourg consolidate its position as the leader in cross-border distribution, as Luxembourg investment funds are distributed in more than 70 countries around the globe.
Lately, government efforts have been mainly directed at increasing compliance and transparency, protecting market stability and preventing the build-up of systemic risk in the financial system. These large-scale reforms have been, to a large extent, driven by international and European initiatives.
The lingering uncertainties surrounding Brexit have continued to strengthen Luxembourg as an EU hub for UK banks, brokers, asset managers, and insurers.
More recently, the covid-19 pandemic has deeply affected financial institutions in Luxembourg, prompting a review of continuity plans, working arrangements and office space needs, and accelerating the digital transformation of many firms, and of the financial services regulator.
General introduction to the regulatory framework
Luxembourg's comprehensive legal and regulatory system lies at the core of is its success as an investment fund centre.
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.2 It operates under the authority of the Ministry of Finance.
As regards the fund industry, the CSSF is the prudential regulator of IFMs, and of the regulated investment funds they manage. The main duties of the CSSF in this respect include:
- licensing Luxembourg IFMs and regulated investment funds;
- supervising Luxembourg regulated IFMs and investment funds based on periodic reporting, on-site inspections, and regular or ad hoc requests for information;
- imposing fines and disciplinary sanctions on regulated IFMs and investment funds, and finance professionals; and
- overseeing the marketing of domestic and foreign investment funds in Luxembourg.
In addition to those supervisory duties, the CSSF issues regulations and circulars in accordance with existing laws.
ii Regulations applicable to investment funds
Fund initiators can choose between the following categories of investment funds:
- funds that are subject to a specific regime (product law) or not.
- regulated or unregulated funds;
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) be licensed by 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 (the Pension Law); and
- securitisation undertakings subject to the Law of 22 March 2004 (Securitisation Law) when they offer their securities to the public on a continuous basis.
UCITS are subject to complex asset eligibility, liquidity and diversification rules. They may only invest in transferable securities and other liquid financial instruments authorised under the UCI Law.
Part II UCIs may in principle invest in all types of assets subject to diversification requirements and borrowing restrictions. Those rules depend on the assets in which the UCI invests, and are further detailed below.
SIFs are not restricted as to their eligible assets either but must in principle comply with a risk-spreading requirement of maximum 30 per cent of their assets or commitments in securities of the same type issued by the same issuer.3 This rule is subject to exceptions and, when appropriately justified, to derogations granted by the CSSF.
SICARs may in principle only contribute their assets to 'risk capital', that is, to entities in view of their launch, development or listing on a stock exchange.4 They are not subject to diversification requirements.
Unregulated investment funds
Investment funds that are not subject to CSSF supervision include:
- reserved alternative investment funds (RAIFs) subject to the RAIF Law;
- standard commercial companies subject to the Law of 10 August 1915 on commercial companies (the Companies Law);
- limited partnerships subject to the Companies Law; and
- securitisation undertakings subject to the Law of 22 March 2004 (the Securitisation Law) when they do not offer their securities to the public on a continuous basis.
RAIFs are in principle subject to the same asset eligibility and risk-spreading requirement as SIFs, except for RAIFs investing in risk capital, which are not subject to diversification rules.
RAIFs must be managed by an external authorised AIFM and comply with the requirements of the Law of 12 July 2013 on alternative investment fund managers (the AIFM Law).
They benefit from the AIFM Directive passport in order to be marketed to professional investors (and to other investors where permitted) in the EEA.
Standard commercial companies (SOPARFIs)
SOPARFIs are ordinary commercial companies whose purpose is to hold participations in other companies. While they may take any corporate form available under the Companies Law, in practice they are incorporated as companies with share capital.
SOPARFIs are not subject to any risk-spreading requirements, and may invest in any asset class. They 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.
Limited partnerships (LPs)
Luxembourg LPs typically take the form of common or special limited partnerships. They are not subject to any risk-spreading requirements or restricted as to the assets in which they may invest.
iii Regulations applicable to IFMs
Regulated IFMs include:
- UCITS management companies subject to Chapter 15 of the UCI Law; and
- authorised AIFMs subject to the AIFM Law.
Commencing business as a regulated IFM in Luxembourg is subject to prior approval by the CSSF. IFMs may apply for authorisation under the UCI Law or the AIFM Law, or both.
In accordance with CSSF Circular 18/698, the application for authorisation must detail, in relation to the IFM:
- its organisation (shareholding structure, own funds, team and substance); and
- its operations (internal policies and processes, external control and reporting).
The CSSF reviews in particular the portfolio management and risk management duties, the anti-money laundering procedures, and any delegation arrangements. Once granted, the authorisation as a regulated IFM covers all EEA countries.
Some IFMs established in Luxembourg do not need to seek CSSF authorisation prior to carrying out the management of a Luxembourg investment fund,5 when they manage either directly or indirectly:
- AIFs that are not leveraged and have no redemption rights for a period of five years, and whose aggregate assets under management do not exceed €500 million; or
- AIFs whose assets under management, including any assets acquired through leverage, do not exceed €100 million.
Those AIFMs must however register with the CSSF, disclose to the CSSF the AIFs they manage and their investment strategies, and report regularly on the investments they hold and their related exposure.
Registered AIFMs do not benefit from the AIFM Directive passport. They may, however, opt to use the European marketing passport regime offered by the EuVECA Regulation and the EuSEF Regulation. The passport under those two regulations only applies if the AIF uses the denomination EuVECA or EuSEF, registers with the competent authority and complies with the applicable regulation.
iv Regulations applicable to depositaries
Under the AIFM Directive and the UCITS Directive, the duties of Luxembourg depositaries in relation to investment funds include:
- safeguarding the assets they have been entrusted with;
- monitoring 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.
Directive 2014/91/EU broadly aligned the role and responsibilities of UCITS depositaries with the regime applicable under the AIFM Directive. Those two regimes, however, differ in that the AIFM Directive 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.
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 retail Part II UCIs are subject to the UCITS V Directive depositary regime.6 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.
Non-retail Part II UCIs are covered by the AIFM Directive depositary regime.7 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 AIFM Directive 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.
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 of foreign UCITS in Luxembourg
EEA-based UCITS may be freely marketed in Luxembourg, on the condition that:
- they (or their IFM on their behalf) have been approved by their national regulator; and
- their national regulator has notified the CSSF of their intention to market the securities of those UCITS in Luxembourg.
Where a foreign UCITS is marketed to retail investors in Luxembourg, it must appoint a Luxembourg credit institution as paying agent, and one or more correspondents in Luxembourg to make payments to investors and redeem their securities.
Marketing of foreign AIFs in Luxembourg
Any marketing at the initiative or on behalf of an EAA AIFM of an EAA AIF it manages in Luxembourg requires prior notification to the CSSF.
A notification to the CSSF is also required before any marketing of a foreign or Luxembourg alternative investment fund by a non-EU IFM to Luxembourg investors.8
Foreign AIFs may only be marketed to retail investors in Luxembourg if they comply with the rules laid down in CSSF Regulation 15-03.
Finally, the CSSF has issued guidance on reverse solicitation and marketing in respect of AIFs in Luxembourg.9
Marketing of other funds
Where the securities of a closed-end foreign investment fund which does not qualify as an AIF are offered to the public in Luxembourg, a prospectus must be published in compliance with Regulation 2017/1129/EU on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market (the Prospectus Regulation) and the Law of 16 July 2019 on prospectuses for securities (the Prospectus Law).
Common asset management structures
Investment funds can generally opt for the mutual funds (FCP) or the investment company form. The choice of legal form depends on the applicable product law, corporate governance or tax requirements among other considerations.
An FCP is similar to a unit trust in the UK or a mutual fund in the US. It is organised as an incorporated co-proprietorship whose joint owners are only liable up to the amount they have committed or contributed to the FCP. Because it has no legal personality, an FCP must be managed by a Luxembourg management company.
UCITS, Part II UCIs, SIFs and RAIFs may be formed as FCPs.
ii Investment companies
All investment funds subject to a product law structured in corporate or partnership form may be established as:
- investment companies with variable capital (SICAVs); or
- investment companies with fixed capital (SICAFs).
In a SICAV, the share capital increases and decreases automatically as a result of the subscriptions and redemptions of the investors. Increase and decrease of share capital in a SICAF, on the other hand, requires a formal decision and, where applicable, a notarial deed, which makes SICAFs less attractive, and less common.
The legal forms typically used by investment companies subject to a product law are:
- the public limited company (SA);
- the private limited company (Sàrl);
- the simplified limited company (SAS);
- the partnership limited by shares (SCA);
- the co-operative company in the form of a public limited company (Coop-SA);
- the common limited partnership (SCS); and
- the special limited partnership (SCSp).
While SIFs, SICARs and RAIFs may opt for all these legal forms, UCITS and Part II UCIs may only be set up as SAs. Part II UCIs set up as SICAFs may also be incorporated as SCAs.
A SOPARFI is usually organised in one of the forms under (a) to (e) above, and may only operate with fixed or authorised capital features.
Limited partnerships, such as the SCS and the SCSp, allow more flexibility in relation to capital variations. 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. The SCSp – unlike the SCS – does not have separate legal personality. However, all contributions, acquisitions and dispositions of assets can made in the name of the SCSp rather than in a general partner's or the limited partners' name.
iii Umbrella form
Another feature frequently considered in practice in the choice of the applicable regime is the umbrella form.
All funds subject to a product law may be formed as standalone structures, or as umbrella structures composed of one or more sub-funds. Each sub-fund comprises a specific portion of assets and liabilities of the investment fund segregated from the assets of the other sub-funds. The assets of a sub-fund may in principle not be used to satisfy the debts and obligations of other sub-funds.
The sub-funds may have different investment strategies, or be closed-ended or open ended within the same umbrella fund. Under certain conditions, cross-investments between sub-funds are allowed.
Investment funds not subject to a product law, on the other hand, may not be formed as umbrella funds.
Main sources of investment
Assets under management in Luxembourg funds amounted to €4.585 trillion at the end of June 2020.10 UCITS provide the majority of assets under management in Luxembourg, contributing to more than 82 per cent of total funds in 2020. In recent years, alternative investment funds (AIFs) – a category that includes private equity, real estate, infrastructure, debt and hedge funds – have grown significantly.
In parallel, the total number of investment fund entities has continued to consolidate, due to a preference to create umbrella structures. There were 3,669 regulated entities at the end of June 2020, representing a decrease of 186 entities over 12 months.11
Luxembourg's fund centre has a strong international orientation: over 97 per cent of funds under management in Luxembourg (around €4.461 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.12 17 out of the 50 largest IFMs in Europe are established in Luxembourg and manage 39 per cent of the largest 50 investment funds.13
Luxembourg funds are distributed to investors in more than 70 countries, making the cross-border dimension of Luxembourg's fund centre unequalled.14 Nearly 60 per cent of the funds authorised for cross-border distribution are domiciled in Luxembourg.15
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.16
Luxembourg continues to strengthen its ranking as the world's second-largest fund domicile after the United States. Interest in regulated funds remains strong, in particular those that pursue alternative strategies. In addition, since the implementation of the AIFM Directive, non regulated AIFs – typically private equity, real estate, private debt and, more recently ESG funds – have been the leading force for growth across Luxembourg IFMs with dedicated products such as RAIFs and ScSPs.
The RAIF in particular continues to attract investors (especially professional investors) who perhaps see it as a viable alternative to the SIF (and to a lesser extent to the SICAR) in terms of structure and flexibility but without an add-on regulation of the product itself. Since July 2016, 1,151 RAIF vehicles have been registered in Luxembourg with a variety of different investment policies,17 and 64 per cent of Luxembourg IFMs now manage at least one RAIF.18
There also has been robust demand for unregulated AIFs structured as partnerships (SCS or SCSp), in particular for illiquid asset classes, mostly private equity, private debt and, to a lesser extent, real estate.
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.
Heightened awareness of climate change and the European Commission's Sustainable Finance initiative are important drivers of ESG and impact investing in Luxembourg, which are expected to increase in importance compared other world regions.
In addition to circular letters issued by the CAA, insurance companies in Luxembourg are governed by:
- the amended Law of 7 December 2015 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 provisions detail 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 products19 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 risk profile of the 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.
Pension funds regulated by the CAA
Pension funds supervised by the CAA are subject to the Grand Ducal Regulation of 31 August 2000. CAA pension funds offer flexibility in the form of the vehicle and can finance either defined benefits or defined contributions schemes, and can offer additional benefits on the death or disability of their members.
Four legal forms can be chosen, but in practice the not-for-profit association form is the most commonly used vehicle.
iii Real estate
Real estate funds are typically formed as Part II UCIs, SIFs, SICARs, RAIFs, SOPARFIs or limited partnerships.
Part II UCIs must comply with CSSF Circular 91/75, which requires that the fund invests 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, 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 the four-year ramp-up period. Although borrowing restrictions are more flexible than for Part II UCIs, the AIFM Law requires that their 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.
Depending on their strategy, real estate RAIFs follow the same rules as those detailed for SIFs and SICARs above.
Finally, SOPARFIs and limited partnerships can also be used to set up unregulated real estate funds and are not subject to investment restrictions.
v Hedge funds
Although a limited number of UCITS employ hedge fund strategies, hedge funds are usually set up as Part II UCIs, SIFs or RAIFs.
CSSF Circular 02/80 details specific investment rules applicable to regulated investment funds pursuing hedge fund strategies.
SIFs and RAIFs are not in principle subject to any asset restrictions, and are, therefore, best suited to accommodate all sorts of hedge fund strategies. They are both, however, required to diversify their investments to 30 per cent of their assets (subject to exceptions) as further detailed 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 may be established as Part II UCIs, SICARs, SIFs, RAIFs, and other types of unregulated companies or partnerships. In practice, the SCSp, the SCS or the SOPARFI are typically used.
In addition, 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 AIFM Directive 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 AIFM Directive 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 also provides an appropriate legal, regulatory and tax environment for microfinance, ESG and other sustainable funds. It is also home to a number of investment funds compliant with shariah principles.
The tax regime applicable to Luxembourg investment funds depends on the legal form of the fund and whether it is subject to a specific product law or not.
i Corporate income tax (CIT), municipal business tax (MBT) and net wealth tax (NWT)
Investment funds subject to a product law
UCITS, Part II UCIs and SIFs are exempt from corporate income tax (CIT), municipal business tax (MBT) and net wealth tax (NWT), but are subject to subscription tax on their net asset value. The annual subscription tax rate is 0.05 per cent for a UCITS and Part II UCIs, and 0.01 per cent for a SIF. The tax is computed and payable quarterly, and there are certain reductions and exemptions. Those funds do not usually qualify for the benefit of EU Directives or double tax treaties.
SICARs organised as a corporate entity are formally fully subject to CIT and MBT, but benefit from specific exemptions on income and gains from risk capital securities. In addition, SICARs are exempt from NWT, except for the minimum NWT. SICARs are deemed to qualify for the benefit of EU Directives and double tax treaties. Foreign tax authorities may, however, take a different stance. SICARs transparent for tax purposes are subject to the partnership provisions detailed under Section VII.ii.
RAIFs follow the tax regime of the SIF by default, but can opt for the tax regime applicable to the SICAR if they invest in risk capital.
Investment funds not subject to product laws
As transparent entities for Luxembourg tax purposes, the SCS and the SCSp are not subject to CIT or NWT. An SCS or SCSp may, however, be subject to MBT at a rate of 6.75 per cent (in Luxembourg City in 2020) on its profits if it carries out a business or is deemed to carry out a business. An SCS or SCSp that is an AIF in the meaning of the AIFM Law is deemed not to conduct a business, unless its general partner qualifies as a Luxembourg capital company holding at least 5 per cent of interests in the partnership or a foreign capital company with a permanent establishment in Luxembourg through which it holds at least 5 per cent of interests in the partnership.
SOPARFIs are companies subject to CIT and MBT on their income at an aggregate rate of 24.94 per cent (in Luxembourg City in 2020), and NWT on the fair market value of its worldwide net assets (again, subject to certain exemptions) at a rate of 0.5 per cent for the first €500 million of net assets and 0.05 per cent for the tranche of net assets exceeding €500million. 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.
SOPARFIs benefit from the double taxation treaties concluded by Luxembourg, as well as from the EU Directives.
ii Withholding tax
In relation to WHT on distributions to investors, the following rules apply:
- there is no withholding tax on distributions made by funds that are tax transparent for Luxembourg tax purposes;
- distributions made by funds subject to a product law are not subject to withholding tax; and
- distributions by a corporate fund not subject to a product law are in principle subject to a 15 per cent withholding tax, subject to reductions or exemptions for qualifying investors.
iii Taxation of IFMs
Luxembourg IFMs are generally subject to CIT, MBT and NWT under the same conditions as those applicable to SOPARFIs.
Managing funds subject to a product law is exempt from VAT in Luxembourg. The exemption covers investment management (portfolio and risk management), administration (e.g., investment advice, fund accounting, registrar and transfer agent), and marketing and distribution. Essential management services outsourced to third parties also benefit from the exemption under conditions.
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.
Other services, such as legal and audit services, are not exempt from VAT and are subject to the standard rate of 17 per cent.
The agenda will remain challenging for Luxembourg's asset management industry in the years to come, but will also offer many opportunities for development. In addition to regulatory challenges, the fund industry will continue to face the effects of covid-19, and will need to progress in its digital and environmental transitions.
As a result of the covid-19 crisis, the CSSF is expected to continue to take action to relieve the finance industry from operational pressures in order for firms to keep their workforces safe and continue to deliver services in the best possible circumstances. The regulator has recently insisted on the importance of maintaining quality, and the relief measures it took to help deliver critical services and protect consumers and market integrity.
Compliance and transparency will continue to dominate the outlook of the Luxembourg fund industry in the years to come. The CSSF has recently reminded investment funds and IFMs that they must register as a reporting entity on goAML, an electronic platform used for the reporting of suspicious transactions to the Luxembourg Financial Intelligence Unit (FIU), and appoint at least one compliance officer responsible for reporting suspicious transactions to the FIU.
Following the entry into force of the Law of 13 January 2019 introducing a register of ultimate beneficial owners (RBE), Luxembourg entities must collect information about their ultimate beneficial owners (UBOs), file it with the RBE, keep it up to date and give it to national authorities upon request. The Law of 10 July 2020 introducing a register of fiducies and trusts imposes similar obligations in connection with these arrangements.
The implementation of the 5th AML Directive will also impose additional obligations on investment funds and their IFMs, with extended and enhanced due diligence measures in relation to certain high-risk clients and countries, additional provisions on internal management requirements and group-wide policies and procedures and enhanced cooperation between competent authorities and self-regulated bodies.
The EU and the UK endeavoured to conclude an equivalence assessment aimed at maintaining a close partnership between the EU and the UK afterr the end of the 11-month transition period. Parties committed to preserve financial stability, market integrity, investor protection and fair competition but keep their ability to take equivalence decisions in their own interests.
From a Luxembourg perspective, the areas expected to be affected are the eligibility of deposits with UK credit institutions for UCITS and money market funds, the eligibility of UK-domiciled UCI shares for UCITS and the possibility of entering OTC derivatives, securities lending and REPO transactions with UK counterparties. Eligibility of guarantees provided by UK entities to Luxembourg IFMs as a partial substitute for their own funds requirements will be also conditional to equivalence of UK prudential rules for credit institutions and insurers. AML/CFT rules are also in scope of the mutual assessment with potential consequences on reliance on due diligence performed by distributors, intermediaries and delegates. UK-based AIFMs will have to rely on the EU assessment of the UK prudential/supervisory framework in order to continue to manage EAA AIFs as non-EAA AIFMs or market non-EAA AIFs in the EAA.
Following the publication of a report on the application and scope of the AIFM Directive,20 the European Commission is expected to make proposals to amend the AIFM Directive in September 2020 in relation to review of marketing of AIFs, loan origination, leverage and liquidity risk management, remuneration, reporting, and depositary and transparency rules. On the other hand, there is no definite timeline for the review of the UCITS Directive at this stage.
ESMA has provided guidance on performance fees for UCITS and retail AIFs, and a briefing on the supervision of costs in UCITS and AIFs. It is also conducting a common supervisory action throughout 2020 to assess adherence of IFMs to liquidity management rules, and is consulting on standardised information to facilitate cross-border funds distribution.
The European Commission has also recently proposed new delegated legislation which will require IFMs to consider the social and environmental factors, risks in their governance, organisation, conflicts of interest policies, investment due diligence and their risk policies and procedures.
Luxembourg introduced interest deduction limitation and controlled foreign companies rules, and made changes to its exit tax, anti-hybrid and general anti-abuse rules in order to comply with the Anti-Tax Avoidance Directive (ATAD). Most of these rules (except the exit tax) entered into force for tax years starting on or after 1 January 2019. The expected impact of these ATAD rules on investment funds themselves is fairly limited; however, they may have a significant impact on underlying special purpose vehicles.
The expanded anti-hybrid rules of ATAD II are expected to affect AIFs significantly and will require more attention and planning, both in terms of investment structure and additional disclosures in the legal documents of funds in scope.
Another relevant development is the mandatory disclosure rules introduced by Luxembourg as part of the implementation of Directive 2018/822/EU (DAC6), which requires intermediaries and, on a subsidiary basis, taxpayers and entities established in Luxembourg to report certain schemes that meet hallmarks deemed indicative of tax avoidance. Luxembourg has adopted the implementation bill and amended its FATCA and CRS laws, but deferred reporting due to covid-19. Investment funds, IFMs and investors will need to adapt their documentation as necessary, assess their compliance and review their operations, failing which they may face additional reporting obligations.
1 Pierre de Backer is a principal and Emmanuelle Bauer is a partner at Deynecourt.
2 Law of 23 December 1998 establishing a financial sector supervisory commission.
3 CSSF Circular 309/07.
4 SICAR Law, Article 1(2).
5 AIFM Law, Article 3(3).
6 UCI Law, Articles 17 to 22 and 33 to 37.
7 AIFM Law, Article 19.
8 AIFM Law, Article 45.
9 FAQ Alternative Investment Fund Managers.
11 CSSF Newsletter June 2020.
12 CSSF annual report 2018.
13 PwC Asset Management Barometer 2020.
14 PwC Global Fund Distribution 2020.
16 CSSF annual report 2018.
17 RCS, Registre de Commerce et des Sociétés, 3 August 2020.
18 PwC Asset Management Barometer 2020.
19 CAA Circular 08/1.