Luxembourg’s alternative investment environment: an attractive option for Japanese fund managers
With its flexible and efficient alternative investment fund options, Luxembourg is increasingly becoming the centre of choice for fund managers in Japan.
Luxembourg is Europe’s largest fund centre, and the second largest in the world, with over €5.16 trillion in assets under management (AUM). While it is gaining popularity as an investment fund jurisdiction for alternative fund managers, Luxembourg is not as well known in the Japanese fund industry as, say, the Cayman Island structures which are more commonly used for private equity and real estate investment.
With ongoing uncertainty around western relations with China, European investors have taken a renewed interest in Japan, and this is where a Luxembourg structure is extremely advantageous.
Here we look at what makes Luxembourg an attractive jurisdiction for Japanese fund managers looking to broaden their investor appeal, both in general, and for alternative investment funds in particular.
To attract large numbers of private equity and real estate investors to Japanese funds, fund structures need to be strong in areas such as compliance, anti-money laundering (AML) and data protection. Perhaps the biggest advantage Luxembourg has as a location for establishing investment funds is its attractive regulatory framework and the various benefits it offers.
Regulatory environment – a well-established, reputable regulatory framework for investment funds offers a flexible and investor-friendly legal and tax environment. Fund managers and investors alike value the stability and transparency this provides.
Access to Europe – Luxembourg funds can provide their services and products across the European Union (EU) and the European Economic Area (EEA) due to passporting arrangements, enabling fund managers to market and distribute their funds throughout Europe under a single regulatory regime: the Undertakings for Collective Investment in Transferable Securities (UCITS) directive, or the Alternative Investment Fund Managers Directive (AIFMD).
Investor protection – high levels of investor protection and market integrity are ensured through rigorous regulatory standards, along with regulatory oversight from Luxembourg’s Commission de Surveillance du Secteur Financier (CSSF).
Diverse investment strategies – fund managers are free to pursue a wide range of investment strategies and vehicles, including equities, fixed income, real estate, private equity, infrastructure and private debt.
Tax efficiency – Luxembourg is an appealing jurisdiction for fund structuring and domicile, thanks to a tax regime that offers benefits such as double tax treaties and tax exemptions on certain types of income.
Global reputation – With its long-standing history as a leading global financial centre, and its reputation for professionalism, expertise and stability, Luxembourg attracts investors and fund managers from around the world.
Luxembourg’s fund structures for private equity and real estate can be tailored to the specific needs of Japanese fund managers. The jurisdiction’s two unsupervised structures – the Reserved Alternative Investment Fund (RAIF) and the Special Limited Partnership (SLP) – are especially appealing to Japanese sponsors looking to expand their asset and limited partner (LP) bases.
As with offshore centres like the Cayman Islands and the British Virgin Islands (BVI), unsupervised structures in Luxembourg do not require intervention from the regulator to be launched. Such unsupervised funds are increasingly popular among more sophisticated investors who do not necessarily need regulatory protection from the CSSF.
Alternative fund managers are typically keen to establish their funds very efficiently, and the SLP caters to this (similar to limited partnership structures in the Cayman Islands and the UK). While the SLP does not have a legal personality, it still owns assets under its own name, and was established as a complement to the Cayman Islands funds or to offer sponsors the option of setting up a single fund only.
Luxembourg offers two other partnership types, both with their own legal personality:
- partnership limited by shares: Société en Commandite par Actions (SCA)
- common limited partnership: Société en Commandite Simple (SCS).
Dubbed a gamechanger when it entered the European funds world in 2016, Luxembourg’s RAIF investment vehicle provides a flexible, efficient investment structure for alternative investment strategies.
Regulatory framework – the RAIF is governed by the Luxembourg Law of 23 July 2016 and supervised by the CSSF.
Flexible alternative investment strategies – RAIFs offer considerable flexibility in terms of investment strategies, investment instruments, and asset classes. They can be used for a wide range of investment vehicles, including private equity, real estate, hedge funds, venture capital (VC), securities, derivatives, real estate, and infrastructure funds.
Regulated Alternative Investment Fund Manager (AIFM) – an authorised AIFM must be appointed for RAIFs, to oversee operations and ensure regulatory compliance. The AIFM may be based in Luxembourg or another EU member state, and may delegate either portfolio management or risk management to a third party in accordance with the AIFMD.
No direct supervision – the AIFM is responsible for compliance of the RAIF, unlike other regulated Luxembourg investment vehicles, such as SIFs (Specialised Investment Funds) or SICARs (Investment Company in Risk Capital), which are directly supervised by the CSSF.
Fast launch – The streamlined and efficient setup process allows for RAIFs to be established in a matter of weeks without any approval from the CSSF.
Investor eligibility – RAIFs are available only to well-informed investors, ie institutional investors, professional investors working on behalf of high-net-worth individuals, sophisticated investors and any other investor who can be deemed to be well-informed and meets specific legal conditions.
Taxation – RAIFs are exempt from corporate income, municipal business tax and net wealth tax, but are subject to an annual subscription tax (taxe d'abonnement) charged at an annual rate of 0.01% based on the total net assets of the RAIF, valued at the end of each calendar quarter.
In fact, RAIFs investing in risk capital are entitled to opt for a special tax regime which foresees that the vehicle is not subject to subscription tax mentioned above. These types of vehicles, despite being treated as fully taxable entities subject to the filing obligation of an annual CIT return, may exempt, from their tax base, all income and capital gains derived from securities (valeurs mobilières). RAIFs opting for the special tax regime are further exempt from net wealth tax, except for a minimum net wealth tax (in general, the amount of the minimum net wealth tax would be €4,815 per annum for RAIFs holding mostly fixed financial assets, securities and cash).
Variety of legal forms – RAIFs can take a variety of legal forms. For example, a RAIF set up as an investment company with variable capital (ie in the form of a public or private limited company, a partnership limited by shares, a limited partnership, or a special limited partnership) or a common fund.
Distribution – the authorised AIFM can distribute shares, units or partnership interests to professional investors (defined by the AIFMD) across the EU. Distribution to well-informed investors who do not qualify as professional investors requires compliance with local rules. Fund marketing materials, such as the prospectus or private placement memorandum (PPM) must meet AIFMD disclosure requirements.
Investor reporting – RAIF annual accounts and investor disclosures must meet AIFMD disclosure requirements, be audited by an approved statutory auditor, and meet Luxembourg GAAP or International Financial Reporting Standards (IFRS).
Statutory reporting and filing – the RAIF’s AIFM must comply with AIFMD reporting obligations, which include providing regular reports to the CSSF detailing the fund’s AUM, risk exposures, leverage, and other relevant data. Notifications of material changes, including changes to key personnel or service providers, need to be filed with the CSSF.
AML reporting – RAIFs and their AIFMs must establish and maintain robust AML procedures, including conducting customer due diligence, monitoring for suspicious activity, and reporting any suspicious transactions to the relevant authorities.
It is worth noting that the specific reporting requirements are subject to change, and can vary according to the RAIF’s legal form, its investment strategy, and the relevant regulatory regime.
Establishing parallel funds in the Cayman Islands and Luxembourg is a solution for local investors where certain statutory jurisdictional requirements must be met.
It is very important in these scenarios to be able to service the different funds and the investors behind them in their own time zones. It is also advantageous to appoint a single administrator – such as TMF Group – that can service all the funds in that parallel structure across all jurisdictions, for economies of scale.
When structuring investments, it is important to find a service provider that can perform all the essential functions of the AIFM, depositary and central administrator – from accounting and reporting to depositary, corporate secretarial, transfer agency and domiciliation.
The service provider should have a global footprint to cater to – and service – all entities, including the fund and all related companies in Luxembourg (MasterCos, HoldCos, Carry Vehicles, etc) as well as all entities in all other jurisdictions involved.
TMF Group has offices in 86 jurisdictions, with local teams handling local structures and a network of professionals (including in Luxembourg and Japan) to oversee the entire structure.