September 2007 The Luxembourg Specialized Investment Fund t 1
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Introduction Luxembourg introduced a new law for investment funds to be distributed to informed investors in February 2007. The law on Specialized Investment Funds (the SIF Law) significantly simplifies the rules for setting up fund structures such as hedge funds, real estate funds and private equity funds, greatly enhancing Luxembourg as a domicile of choice for such products. It replaced the 1991 institutional investor fund law (the 1991 Law). Drivers for the introduction of a new legal regime In recent years, Luxembourg has seen substantial growth both as a domicile and as an administration center for all types of alternative investment fund products. These include hedge funds, private equity funds and real estate funds, and, more recently, multi-asset class alternative funds. The primary driver for the SIF Law was the demand from the buy side (especially from institutional, professional and high net-worth investors) along with their advisors for a lightly regulated on-shore investment fund vehicle for all types of alternative investment fund products. In addition, Luxembourg as the largest investment fund center in the world (excluding the US) wished to leverage its vast experience both as a domicile and administration center in servicing products tailored specifically for a sophisticated investor base. Providing continuity but replacing the 1991 Law The SIF Law of 13 February 2007 replaces the institutional investor fund law (the 1991 Law) with a complete stand-alone text. Funds created under the 1991 Law became subject to the SIF Law on 13 February 2007. The SIF Law provides continuity for such funds by, for example, continuing to implement previously available fund and legal structures and not adding any additional restrictions. 1
Informed investors The SIF Law introduces a qualified/professional investor scheme. A fund created under the SIF Law (a SIF) may be sold to informed investors whereas previously, under the 1991 Law, the fund could only be sold to institutional investors such as banks, insurance companies, pension funds, large companies and other investment funds. Informed investors are: Institutional investors Professional investors Other types of investor who have declared in writing that they are informed investors, and either: -- Invest a minimum of 125,000 or -- Have an appraisal from a bank, an investment firm or a management company (all of these with a European passport) 1 certifying that they have the appropriate expertise, experience and knowledge to adequately understand the investment made in the fund Objective and legal forms The primary objective of a SIF must be the collective investment of the funds raised from its investors while applying the principle of risk diversification. The SIF may be structured as an investment company with variable capital (SICAV) 2, an investment company with fixed capital (SICAF) 2, or a common fund (FCP) 2 which must have a management company. These different entities may create sub-funds each with a different investment policy. The rights of investors and of creditors concerning a sub-fund, or which have arisen in connection with the creation, operation or liquidation of a sub-fund, are limited to the assets of that sub-fund (i.e., protected cell concept), unless a clause included in the constitutional documents provides otherwise. A SICAV can be set up as a public limited company (S.A.), a European company (S.E.), a private limited liability company (S.à r.l.), a partnership limited by shares (S.C.A.), or a cooperative organized as an S.A.. A SICAF is not limited as to the legal form; it may take any of the aforementioned legal forms or, for example, that of a limited partnership (S.C.S.). SIF set-up No prior authorization from the financial sector regulator (CSSF) 3 is required. However, the constitutional documents, choice of custodian and information regarding the directors and officers must be submitted to the CSSF within one month of the formation of the fund. The CSSF subsequently informs the SIF of authorization. 1 A credit institution as defined in Directive 2006/48/EC, an investment firm as defined in Directive 2004/39/EC or a management company as defined in Directive 2001/107/EC 2 SICAV: société d investissement à capital variable; SICAF: société d investissement à capital fixe; FCP: fonds commun de placement 3 Commisssion de Surveillance du Secteur Financier 4 The obligation to publish an issuing document is not applicable to closed-ended investment funds where they are required to publish a prospectus under the Law of 10 July 2005 relating to prospectuses for securities. The SIF (or its management company in the case of an FCP) is required to draw up an issuing document. The issuing document must include the information necessary for investors to be able to make an informed judgment about the investment proposed to them. 4 The issuing document and any modifications thereto must be communicated to the CSSF. 2
Investment restrictions and leverage The SIF Law does not specify any detailed investment restrictions or leverage rules. It simply states that a SIF should apply the principle of risk diversification. CSSF Circular 07/309 on risk spreading in the context of specialized investment funds, of 3 August 2007, complemented the SIF Law and provided clarification on the investment restrictions that must be adhered to in order to ensure adequate risk diversification: 1. A SIF cannot, in principle, invest more than 30% of its assets or its commitments to subscribe to securities of the same nature issued by the same issuer. This restriction is not, however, applicable to investments in securities issued, or guaranteed, by Organisation for Economic Co-operation and Development (OECD) Member States, their local authorities, supranational bodies or organizations; nor is it applicable to target Undertakings for Collective Investment (UCIs) which are subject to risk diversification principles that are at least comparable to those relevant to SIFs. 2. Short selling cannot, in principle, result in the SIF holding uncovered securities of the same nature issued by the same issuer representing more than 30% of its assets. 3. When using financial derivative instruments, the SIF must ensure comparable risk diversification through appropriate diversification of the underlying assets. Counterparty risk of over-the-counter (OTC) operations must be limited according to the quality and qualification of the counterparty. The CSSF may provide exemptions from these restrictions on a case-by-case basis. However, the CSSF may also request that additional restrictions are adhered to, in cases of funds with specific investment policies. Promoter, manager and directors Under the SIF Law, the CSSF does not require a promoter, nor will it perform checks on the status or financial position of the portfolio manager, this being left to the due diligence of the investors. Thus, SIFs may be created both by and for institutional and non-institutional investors (e.g., family offices or high net-worth individuals). An FCP must be managed by a management company established under Luxembourg law and which complies with the provisions for management companies of funds under the 2002 Law 5 (i.e., it must be a management company of Undertakings for Collective Investment in Transferable Securities (UCITS) or of other Luxembourg funds). If the management company is replaced, this must be communicated to the CSSF. Directors of the SIF must be of good repute and have sufficient experience in relation to the type of SIF being created. To this end, the names of the directors, and of every person succeeding them in office, must be communicated to the CSSF. 5 The Luxembourg general law on investment funds 3
Custodian and prime broker A SIF must appoint a Luxembourg custodian (i.e., it must have its registered office in Luxembourg or be the Luxembourg branch of a bank with its registered office in another Member State in the EU). The role of SIF Law fund custodian may be regarded as supervisory in general, this means knowing where the funds assets are located, how they are invested and ensuring that the correspondent banks entrusted with the safe-keeping of the funds assets are of adequate reputation and experience. The custodian is not required to control the regularity of operations (such as ensuring that the sale, issue, redemption and cancellation of units or shares are carried out in accordance with the law and the management regulations or the articles of incorporation and ensuring that the income of the SIF is applied in accordance with the management regulations or the articles). If the custodian is replaced, this must be communicated to the CSSF. The SIF Law does not impose any restrictions on the appointment of a prime broker. In the specific case of SIFs with alternative investment strategies (i.e., hedge funds) appointing a prime broker, CSSF Circular 08/372 of 5 September 2008 clarifies the rules applicable to the SIF s custodians. The custodian s responsibility would include accepting the prime broker chosen by the SIF, which means ensuring that the prime broker meets the following criteria: It is subject to a supervisory regime recognized as equivalent to EU legislation It is a recognized financial institution specialized in such operations The custodian is also responsible for organizing its relationship with the prime broker to enable it to monitor at any time the composition, and value, of the assets of the SIF. The custodian must also have the right of intervention on the assets of the SIF where it decides that it is no longer able to execute its supervisory responsibilities. The custodian is not required to know at which correspondent banks the assets of the SIF are held. While the SIF Law states that the custodian will be responsible for all daily administration of the assets of a common fund, where a prime broker is appointed, this responsibility can be contractually delegated to the prime broker. Sales documents of a SIF using the services of a prime broker must contain an adequate description of the involvement of the prime broker and associated risks, including counterparty risk. 4
Central administration The central administration (primarily fund accounting and transfer agency functions) of a SIF must be situated in Luxembourg. It should be noted that the CSSF may permit, on a case-by-case basis, the performance of certain preparatory tasks outside Luxembourg subject to the overall responsibility of the appointed Luxembourg central administrator. Auditor The SIF must appoint a Luxembourg-based independent auditor. Reporting Reporting is limited to an annual report (no requirement for a semi-annual report), which must be made available to investors within six months of the end of the financial year. It must also be communicated to the CSSF. It is not necessary to disclose details of the portfolio, though enough quantitative and/or qualitative information for investors to make an informed judgment about the evolution of the activity and results of the fund should be provided. No long-form report is required. There is no requirement to publish the net asset value (NAV) per share or unit. In a similar manner to funds under the 2002 Law, SIFs are required to submit, electronically via CCLux, monthly and annual financial information to the CSSF, for statistical and supervisory purposes. The contents of the monthly and annual financial information are set out in CSSF Circular 07/310. The information is to be submitted within 20 days and 6 months of the reference date, respectively. Issues and redemptions There is significant flexibility regarding issue and redemption of units or shares. The issue and redemption of units or shares must be carried out in accordance with the rules laid down in the management regulations (FCP) or articles of incorporation (SICAV). These rules could provide, for example, for units or shares to be transferred at a price other than the NAV per share or unit. Valuation of the assets Unless otherwise provided for in the issuing document, the valuation of the assets must be based on fair value, determined in accordance with the procedures laid down in the management regulations (FCP) or articles of incorporation (SICAV). These procedures could, for example, provide for valuation principles established by professional associations of a specific industry. 6 6 e.g., the International Private Equity and Venture Capital Valuation Guidelines for private equity/venture capital funds and the Royal Institution of Chartered Surveyors (RICS) Valuation Standards for real estate funds 5
Minimum fund size and capital paid up The SIF must reach a minimum size of 1.25 million within 12 months of its date of authorization. While issued shares of a SICAV must be fully subscribed, only 5% of the amount of the subscription per share or unit must be paid up in cash or by means of a contribution other than cash. This will facilitate structures such as private equity funds to make capital calls over a period of time. Dividends There are no restrictions on the payment of dividends. However, such payments may not result in the size of the SIF falling below the minimum level of 1.25 million. Taxation and expenses SIFs are not subject to any Luxembourg taxes on capital gains or income. Such funds are, however, subject to registration duties (droit d enregistrement) and a subscription tax (taxe d abonnement). SIFs incorporated as SICAVs or SICAFs are subject to a registration duty of 75 at incorporation and in case of: Modification of the articles of incorporation Transfer of the effective place of management or registered office to Luxembourg SIFs constituted as FCPs are not subject to this registration duty. SIFs may also be subject to a fixed or proportional registration duty related to some specific investments (e.g., real estate located in Luxembourg). SIFs are no longer subject to capital duty (droit d apport); the 75 registration duty became applicable on 1 January 2009. The annual subscription tax of 0.01% is levied based on the quarterly net asset value of the SIF. The following are exempt from the subscription tax: 1. Assets of investment funds which have already been subject to the subscription tax 2. Investment funds and sub-funds of umbrella funds whose exclusive object is the collective investment in money market instruments and the placing of deposits with credit institutions, and whose weighted residual portfolio maturity does not exceed 90 days, and that have obtained the highest possible rating from a recognized rating agency 3. Investment funds whose securities are reserved for (i) institutions for occupational retirement provision, or similar investment vehicles, created on the initiative of a same group for the benefit of its employees and (ii) undertakings of this same group investing funds they hold to provide retirement benefits to their employees Luxembourg has concluded over 50 double taxation treaties. It should be possible to structure SIFs and their related investments to benefit from the majority of these treaties. 6
The application of the EU Savings Directive (EUSD) depends on the legal structure of the SIF and on the type of investments made by the SIF. Distributions made by a SICAV falling under the SIF Law or capital gains realized from the sale, refund or repurchase of the shares in a SICAV should be out of the scope of the EUSD. Luxembourg law states that, for the purposes of the application of the EUSD, all FCPs established in Luxembourg must be considered as having opted to be treated as a UCITS. Therefore, Luxembourg FCPs are always potentially in scope for the EUSD. For such FCPs, a distinction has to be made according to the nature of the income realized by the beneficial owner the following rules apply: Distributions from an FCP are in the scope of the EUSD if the FCP invests directly or indirectly (via other UCITS) more than 15% of its assets in debt claims (including cash). Capital gains from the sale, refund or repurchase of the shares or units in an FCP fall within the scope of the EUSD if the FCP invests more than 40% (25% as of 1 January 2011) of its assets in debt claims. If the FCP is in scope, a withholding tax (15% until 30 June 2008, 20% as from 1 July 2008, 35% as from 1 July 2011) may apply unless adequate exchange of information takes place. The CSSF filing duty is fixed at 1,500 for a single compartment SIF and 2,650 for a multiple compartment SIF. The CSSF annual fee is fixed at 1,500 for a single compartment SIF and 2,650 for a multiple compartment SIF. 7
Summary The key principles of the SIF Law may be summarized as follows: A lightly regulated on-shore structure Emphasis being placed on self-regulation as regards promoter and manager A structure that is designed to be suitable for all investment styles including both traditional and alternative investment products No detailed investment restrictions or leverage rules No restrictions on use of prime brokers in the case of hedge funds No distribution restrictions (apart from investor qualification as informed investor) No limitations on promoter or manager Limited local custodian responsibilities Issuing document and annual report only reporting required No taxes on capital gains, profits or income Access to Luxembourg double taxation treaties Continuity with the 1991 Law Conclusion The SIF offers institutional, professional and other informed investors and their advisors a lightly-regulated on-shore Luxembourg branded investment fund. It has therefore generated much interest and a substantial number of new funds have already been launched primarily alternative structures. It is expected that this trend will continue. 8
Contacts Hedge Funds Michael Ferguson Asset Management Leader +352 42 124 8714 michael.ferguson@lu.ey.com Private Equity Alain Kinsch Private Equity Leader +352 42 124 8355 alain.kinsch@lu.ey.com Real Estate Michael Hornsby Real Estate Leader +352 42 124 8310 michael.hornsby@lu.ey.com Tax André Pesch Financial Services Tax Leader +352 42 124 7335 andre.pesch@lu.ey.com
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