The funds, or SIFs, are part of a wider portfolio of instruments approved by the Luxembourg parliament over the last few years. Bounded by Belgium, France and Germany, the world’s only remaining Grand Duchy is developing a niche within the EU as a modern investment capital with highly sophisticated financial services. The sector, whose contribution to the economy is growing as a percentage of GDP, is a key factor in the Luxembourg having the highest GDP per capita in the world.
Specialised investment funds, or SIFs, have proved extremely popular with investors since they were authorised in February last year. In the end of 2007, 581 files had been authorised by the Commission for the Surveillance of the Financial Sector, Luxembourg’s regulatory authority. According to Luxembourg-based corporate and tax law firm Loyens & Loeff, the take-off in these specialised investment funds is unprecedented. As such, they have added another string to the financial sector’s bow. The wave of interest in SIFs has also thrown a broader spotlight on the Grand Duchy’s long-held but still-developing appeal as a stable, on-shore location for the increasingly sophisticated needs of international investment capital. The relatively small size of the country encourages a close dialogue between the financial sector community and the law-makers – a partnership that helps Luxembourg adjust rapidly to international investment trends. Considered a safe haven for such capital, Luxembourg has for instance proved largely immune so far to the turmoil of the international credit crisis.
An instrument for a fast-changing investment environment
SIFs are the result of a new law that creates an umbrella structure that in some ways reflects long-standing Anglo-Saxon structures in collective investment. The purpose of the legislation, which required a rewrite of legal, regulatory and fiscal provisions, was to deliver a multi-purpose product that dove-tails with the contemporary investment environment. Lightly regulated, flexible and fiscally efficient, SIFs have demonstrated over the last year they have more than met their designed purpose.
A key element of SIFs is that they are highly inclusive rather than rigidly prescriptive. The law allows any institutional, professional or “well-informed” investor, according to the definition, to access an SIF. Also, the entry threshold is relatively low.
Designed for accessibility
Based on Luxembourg’s previous experience with instruments such as the SICAV regime (an investment company with variable capital), the new definition of a well-informed investor has considerably broadened the attraction of SIFs by admitting non-institutional capital. A well-informed investor is classified as one with a minimum of 125,000 euros [£95,000] to invest, and lesser sums may qualify in certain circumstances. In this way the SIF law admits investors other than those able to prove the existence of “deep pockets”. So far, the level set for minimum capitalisation rules have proved to be about right. Under the law, at least 1.25m euros must be invested within a year of the fund being approved.
Investors also cite the relative simplicity of establishing an SIF, particularly the absence of excessive red tape, as an important factor in their appeal. For instance, an SIF does not require the prior approval of the regulatory authority before it becomes operational. Indeed many of the SIFs awaiting official registration are already in business and investing. The CSSF only requires that all the essential complying documentation be delivered to the regulatory authority within one month of the fund becoming operational. Once the authority confirms the SIF fully satisfies the law, it is admitted to the official list as a bona fide, approved investment instrument.
An additional attraction to investors has been the flexibility of SIFs. For instance, it does not prescribe rules that might inhibit investment strategy, whether in quantitative or qualitative terms. The only specific instruction is that the fund observes certain parameters in the spreading of risk. Thus the law has created a versatile fund regime that gives the initiators of SIFs the freedom to determine investment policy according to the prevailing environment and their own requirements. Thus they are able to diversify the fund according to need in terms of geography, sector and product.
Importance of high-quality management
However in a lightly-regulated environment, the regulatory authority sets considerable store on the quality of the fund’s management. The supervisory regime requires directors to establish their suitability and qualifications to guide the fund and, although the law encourages flexibility, it also requires transparency in the form of correct documentation. For instance, directors are now preparing the first generation of annual reports for the first generation of SIFs. These documents require directors to follow established templates. They must be delivered to investors and the authority within six months of the specific period.
Fiscal efficiency
The tax regime applying to SIFs builds on Luxembourg’s more than a quarter of a century’s experience with broadly similar investment funds. It provides for a fixed one-off duty of 1,250 euros [£950] on capital contributions and, with certain exceptions, an annual subscription tax rated at 0.01 per cent on value of total net assets.
Financial sector continues to develop
Luxembourg’s financial sector is in a constant state of evolution. For instance, modifications are about to be introduced to the highly successful, four year-old SICAR regime relating to investment companies in risk capital. Reacting to feedback from investors and the financial sector, the regulations will be fine-tuned to make these funds even more flexible than at present. Under the changes, investors will be able to create compartments within existing structures — extra portfolios of investment that allow the development of a wider range of investments under the same umbrella.
Private equity short-circuits traditional banks
Similarly, Luxembourg has moved to meet the global requirement to establish holding companies in secure, on-shore locations. The grand duchy recently replaced the Netherlands as the prime location for the registration of these entities. The rapid growth of Luxembourg-based holding companies is in part a result of the development of private equity in the country, which has helped boost the entire financial sector in the last five years. Official records show that private equity companies is increasingly attracted to Luxembourg as a suitable location for a long-term base, with its fully EU-compliant tax and fiscal regime. The short lines of communication between the financial community and the government are considered to be a particular advantage, particularly compared with much larger legislatures. “Authorities here understand the real world,” as one source put it. A result is that laws and regulations can be quickly streamlined to meet prevailing conditions.
The pace of development in private equity is so marked that many practitioners in Luxembourg believe that it may threaten the long-term future of established banking channels. Investors are increasingly by-passing the major banks, traditionally the first port of call for investment-hungry funds, and placing them with private equity. In this way they are able to access new ventures more directly, eliminating one stage in the investment process.
Luxembourg has not however proved to be entirely immune from the credit crunch. As elsewhere, there has been a slowing of activity in the more highly-leveraged M&A transactions but little change in the appetite for deals at more normal ratios of debt to equity.
A good citizen of the EU
Article 41 of the Luxembourg law on the financial sector – the law that preserves Luxembourg’s bank secrecy laws – has given the state an historic reputation for confidentiality in banking arrangements. That is unlikely to change, given that Luxembourg, a founding member of the EU, fully complies with its financial regime and is in constant dialogue over savings directives and other developments in investment law. The purpose is to widen its appeal as a reputable home for a wide range of investment purposes. For instance, the nation has become a fully compliant channel for investment in the wider EU real estate market. Investors typically use Luxembourg-based funds and financing vehicles, in particular special-purpose vehicles such as tax-efficient real estate investment funds known as REIFs, to purchase properties in one or more jurisdictions. Others may prefer to set up their own portfolio.
In tandem with its widening portfolio of instruments, over the last few years Luxembourg has moved decisively to develop its reputation as a location of integrity for long-term investment funds. In the process it has deliberately distanced itself from regimes that are chosen primarily for their confidentiality. As one practitioner put it, “people don’t come to Luxembourg to hide.” One result is that Luxembourg has become the preferred on-shore location for the registration of investment funds. More than 10 percent of UCITS in the world are located in Luxembourg, which makes of it the second haven for investment funds after the USA.
The strategy of full compliance has proved highly effective, helping the financial sector grow rapidly as it develops a broader array of investment instruments and opportunities. Established practitioners such as Loyens & Loeff report that clients increasingly demand matched solutions that employ a full package of fiscal and legal services that meet best practice in every area.
A result of the demand for the financial sector’s service is the rapid recruitment of highly qualified staff. Indeed the sector’s biggest current problem is attracting professionals of a suitable calibre in law, tax and other areas of expertise. However, compared with other financial-sector hubs around the world that are shedding staff in the wake of the credit turmoil, that can safely be regarded as a desirable state of affairs.
For further information:
Tel: +352 466 230 222 or +352 466 230 233
Email: dirk.leermakers@loyensloeff.com or Thibaut.partsch@loyensloeff.com
Website: www.loyensloeff.lu
