The ABC of Luxembourg’s main alternative investment fund regimes
As premier international hub for funds, Luxembourg has a comprehensive offering of solutions for fund vehicles and regimes in the field of alternative investment strategies. What are the basics that you need to know as a manager when looking to set up a fund in Luxembourg and what are the most sought after fund structures?
A number of legal vehicles are at your disposal. The most popular vehicle is the Luxembourg limited partnership. The law regarding limited partnerships was modernised and tailored to the needs of international fund managers and investors in 2013. The Luxembourg limited partnership comes in two main categories: one with legal personality (société en commandite simple; SCS) and one without legal personality (société en commandite spéciale; SCSp). Today, the SCSp is the most used legal form in Luxembourg as it resembles the typical anglo-saxon limited partnership that is the international market standard for private equity funds. Other vehicles include the Luxembourg Fonds commun de placement (FCP), the SICAV and the SCA. Below we will focus on the limited partnership, being ‘the market leader’.
Key characteristics of the Luxembourg limited partnership:
- The governance of a Luxembourg limited partnership is extremely flexible. Managers of an SCS may be appointed and removed under the rules established by the limited partnership agreement. The management of an SCS may be entrusted to one or more General Partners, or to persons who are not partners. General Partners and other managers may be either natural persons or any Luxembourg legal entity.
- There are clear rules as to the limited liability of limited partners and the scope of activities that they are allowed to conduct without running into the prohibition for limited partners to participate in the management of the partnership.
- Distributions may be freely arranged in the limited partnership agreement, provided that no limited partner is entirely excluded from participation in the profits. Claw back of distributed capital is only allowed if so provided in the partnership agreement.
- Transfer of partnership interests is also a matter that can be arranged in the partnership agreement.
- The limited partnership enjoys full tax transparency in Luxembourg, assuming it is not conducting a (Luxembourg) business. Please note that Luxembourg tax policy deems that limited partnerships being ‘alternative investment funds’ (AIFs) are not conducting a business. Fund management services rendered to a limited partnership that qualifies as an AIF are exempt from VAT.
Efficient legal vehicles for alternative investment funds
The modernised Luxembourg limited partnership, being fully tax transparent and benefitting from the VAT exemption for fund management services, is seen by the industry as a very efficient legal vehicle for alternative investment funds. Very often such alternative investment funds already have their main investment holding company in Luxembourg, and thus benefit from Luxembourg’s efficient holding company regime and gain access to its extensive tax treaty network and EU Directives. Combining the two in Luxembourg, i.e. in a single jurisdiction, allows for increased efficiency and sustainability in setting up and operating an investment fund.
In the EU you must appoint an AIF manager (AIFM) that is subject to authorisation under the European AIFM Directive, if your fund is an ‘alternative investment fund’ (AIF). Certain exceptions may apply to this compulsory regulatory authorisation. For Luxembourg funds you can appoint an AIFM located in Luxembourg, or in any other member state of the European Union (the latter on the basis of the so-called 'AIFMD Management passport').
With the help of the Luxembourg AIFM you are in a position to gain market access in all EU countries.
Many fund managers that do not have their own AIFM in the EU, are engaging a third party professional AIFM in Luxembourg to act as the authorised manager of their Luxembourg fund vehicles. This allows for the additional advantage of access to the 'AIFMD marketing passport': with the help of the Luxembourg AIFM you can gain market access in all EU countries and market your fund to professional investors throughout the EU. However, certain restrictions may apply, in terms of how you conduct your marketing and limitations imposed by certain EU countries.
In addition to the authorisation of the manager under the AIFMD, the Luxembourg system traditionally provides for certain regulatory authorisation regimes where the fund itself is regulated. The most well-known and tested regime is the SIF regime. Consequently, many Luxembourg funds are subject to a double regulation: they are AIFs with a regulated AIFM, while the AIF itself is also regulated, in most cases as a SIF. This double regulation is still used frequently when foreign investors need regulation at fund level (e.g., certain institutional investors where their own regulator requires that the funds in which they invest are directly subject to regulation).
Reserved alternative investment fund (RAIF)
In 2016, Luxembourg introduced a new flagship institutional fund regime: the 'reserved alternative investment fund’ (RAIF) responding to the demand by fund managers and investors alike for an unregulated fund concept. Initiators are now able to set up a RAIF without approval from the Luxembourg regulator (CSSF), provided the RAIF appoints an authorised AIFM as its manager. A RAIF can benefit from a number of attractive structuring features that before were only available to regulated AIFs, like a SIF (umbrella structure, variable capital, specific tax regime). The RAIF is expressly exempt from tax (except for the annual 0.01% subscription tax for institutional funds).
As a RAIF is mandatorily managed by an AIFM, there will be access to the much sought-after AIFMD marketing passport and investors’ protection will be ensured by the full application of the AIFMD regime at manager level. By simplifying the regulatory burden to set up AIFs, the use of the new RAIF regime significantly reduced 'time to market' as compared to the setup of a SIF. It is an example of how Luxembourg continues to tailor its fund regimes to the wishes of the international investment management industry.