Luxembourg Complex alternative UCITS & Specialised Investment Funds pot

Luxembourg Complex alternative UCITS & Specialised Investment Funds Asset class - Hedge... These assets under management are held in 2,450 undertakings for collective investment, includ

Luxembourg

Complex alternative UCITS &

Specialised Investment Funds

Asset class - Hedge

A founder member of the European Union

benefiting fully from free movement of capital

and freedom of establishment within the EU,

Luxembourg is also one of the largest global

financial centres, benefiting from flexible and

attractive legal, regulatory and tax regimes and a

significant concentration of professional service

providers to the financial services industry

Luxembourg ranks as the largest EU fund

domicile jurisdiction and the second largest fund

domicile jurisdiction globally After more than

30 years of development, total net assets under

management of Luxembourg undertakings for

collective investment and specialised investment

funds stood at €2.157 trillion as at January 2012

These assets under management are held in

2,450 undertakings for collective investment,

including UCITS, introduced in 1988, and

approximately 1,400 specialised investment

funds, introduced in 2007

Approximately 75% of internationally distributed

UCITS are domiciled in Luxembourg

Luxembourg’s solid track record of stability

has enabled it to meet the challenges arising in

global markets since 2008 with a Triple A credit

rating, low levels of sovereign debt and one

of the highest per capita GDP globally This

economic and political stability, allied to the legal,

regulatory and fiscal attributes of its investment

funds industry has resulted in Luxembourg’s

position as a premier-ranking fund domicile

Domicile

diversification

Over the last 5 years, Luxembourg regulated

fund products have been increasingly used

by managers pursuing complex, alternative

strategies in a complementary fashion to

structures in traditional hedge fund domiciles

This has enabled managers to respond to

regulatory change and an increasingly broad

range of investor preferences with diversification

in both product ranges and distribution networks

Complex UCITS in particular have played a key

role in this

Principal Luxembourg hedge fund vehicles

There are two principal, regulated Luxembourg fund vehicles which may be used for complex, alternative strategies, as follows:

1 undertakings for collective investment in transferable securities (UCITS) and

2 specialised investment funds (SIF).

Both UCITS and SIF are regulatory classifications They describe regulated fund products which can be structured in various legal forms, with tax efficient outcomes following from such selection A summary of the vehicles commonly used as complex UCITS and SIF for hedge-type strategies and the corresponding tax treatment is set out below

As regulated products, both UCITS and SIF are subject to the prior authorisation and ongoing supervision of the Commission de Surveillance

du Secteur Financier (CSSF), the Luxembourg

regulatory authority In discharge of its duties, the CSSF is charged with maintaining investor protection and the stability of Luxembourg’s financial services industry

In addition to complex UCITS and SIF, complex alternative funds pursuing an equities-only strategy and with the aim of influencing the management of portfolio companies may be structured as “investment vehicles in risk capital” (SICAR) In relation to SICAR, please refer to

our separate briefing “Luxembourg Alternative Investment Funds”, which may be accessed via the Luxembourg section of www.ogier.com

2

Choice of fund

vehicle

The regulatory frameworks for both UCITS and

SIF result in identical basic fund structures (as

shown below) As tax outcomes are also broadly

similar, selection of regulatory product will be

driven by a balancing of the following factors:

• distribution;

• investment policy & portfolio composition;

• leverage policy;

• risk-spreading and;

• preferred level of regulation

Example structure

Between complex UCITS and SIF (and similarly SICAR), the fundamental balance lies between greater distribution benefits for UCITS but less prescription as to investment policy, portfolio composition, leverage, risk-spreading and operational matters for SIF

A summary of these factors is set out in

“Luxembourg Hedge Funds - Executive Summary” in the Luxembourg section of www.ogier.com A fuller description appears in this briefing below

Notes:

1 Investment advisory role most common in practice but varies with client structuring requirements

2 Luxembourg situate and regulated (or approved for auditors)

3 ManCos are only required for FCP Funds (both UCITS and SIF)

Fund: UCITS / SIF

• Co-owned asset pool (FCP); or

• Open-ended investment company (SICAV)

Investment

Manager/Advisor

Management Company Custodian

Auditor

Fund administrator, transfer and registrar agent

4

2

2 2 2; 3

Holding Companies

UCITS Investments

• Restricted asset classes

• Detailed diversification requirements

• Borrowing prohibition (but leverage effect possible through derivatives).

SIF:

• Eligible investors only:

Institutional, professional, sophisticated

• Private placement currently (unless listed)

• EU AIFMD passport anticipated

UCITS:

• No investor eligibility restrictions

• EU passport distribution

• International recognition

SIF Investments

• All asset classes

• Broad diversification requirements

• No borrowing / leverage restrictions

4

Distribution

Originally set up to implement EU single market

principles in financial services, UCITS may be

distributed to all categories of investors within

the EU, without regulatory restriction as to

investor eligibility

With the introduction of UCITS IV in Luxembourg

in 2011, the process in practice of such

distribution to EU investors has been significantly

stream-lined with the effective time-to-market

from the decision to distribution reduced from 2

months to 10 working days

The process commences with submission of a

notification pack to CSSF including the following:

• key investor information document (KIID) (in

the language of the investors’ jurisdiction);

• prospectus, constitutional documents,

financial reports and original CSSF UCITS

regulatory authorisation; and

• information on target jurisdictions’

applicable marketing rules

All documents other than the KIID may be in

English

CSSF verifies that the notification pack is

complete, transmits details to its equivalent

regulators in the recipient investors’ jurisdictions

within 10 working days and informs the

manager On receipt of that notification, the

manager may start distribution to potential

investors in those jurisdictions Regulators in

the host jurisdictions will then review within 5

working days The manager is responsible for

identifying and complying with any applicable

local requirements In practice this is addressed

through use of established distributors, although

legal responsibility for compliance remains with

the manager

Although UCITS may lawfully be offered to all

categories of EU investors, managers may apply

fund-specific eligibility criteria in the prospectus

if appropriate For example, funds may be

offered only to institutional investors and / or an

appropriate minimum investment threshold may

be set, for example $50,000 / 100,000/ 1 million,

provided such criteria are objective

In addition to geographic distribution advantages

within the EU, UCITS also benefit from advantageous treatment in institutional investors’ asset allocation rules UCITS are also extensively used for distribution to investors in many non-EU markets due to the perceived advantage of their bench-marked brand recognition

UCITS fall outside the scope of AIFMD and the balance of factors which makes them attractive

to managers of complex alternative funds is therefore unaffected by it

In contrast, SIF are available only to eligible investors comprising: institutional; professional; self-certifying sophisticated private investors with

a minimum investment of €125,000; investors certified as sophisticated by a regulated intermediary (no minimum investment required); and carried interest investors acting in the management of the SIF

Distribution of unlisted SIF outside of Luxembourg is currently determined by national private placement regimes SIF will become subject to an AIFMD overlay as AIFMD is implemented, and are anticipated to be an early beneficiary of EU AIFMD passporting, following the UCITS model

Bench-marked brand recognition for Luxembourg SIF in non-EU markets is developing but is at an earlier stage of development than for UCITS

Neither UCITS nor SIF carry any minimum or maximum requirements as to investor numbers, and may be constituted as single-investor or dedicated funds

Investment policy & portfolio composition

SIF have greater flexibility in regulatory

requirements as to investment policy and portfolio composition On condition of adequate disclosure in offer documents, there are no restrictions on asset class, investment policy

or permitted investment-holding instruments applicable to SIF

In contrast, UCITS portfolio composition is

more restricted in scope, being limited to:

transferable securities; derivatives based on

eligible underlying assets (including currencies,

commodities and interest rates); bonds and

money market instruments; cash at bank; certain

eligible structured finance products; and other

collective investment undertakings

Transferable securities are (broadly) negotiable

securities listed on a regulated, liquid market

with regular, accurate price information which are

compatible with the UCITS’ investment policy

and risk management framework

Derivatives (referencing eligible underlying

investments) must be either listed on a regulated

market or be over-the-counter products issued

by eligible counterparties with reliable fair-value

valuation Please note, this is a summary only of

a technical area

Leverage policy

SIF are not subject to regulatory limitations on

leverage policy

In contrast, UCITS are substantially prohibited

from entering into borrowing However, UCITS

may enter into securities lending, sale and

repurchase transactions relating to transferable

securities or money market instruments, in each

case for the purpose of risk spreading,

cost-mitigation or for additional income or capital

generation, in accordance with the fund’s overall

risk profile Detailed rules apply in relation to

counterparty risk, concentration risk, eligible

collateral and valuation

Managers of Luxembourg UCITS have in

practice lawfully applied such techniques and

appropriate derivatives strategies to deliver the

value multiplier effects of leverage without being

hindered by the prohibition on borrowing and yet

respecting borrowing constraints

Risk-spreading

SIF are subject to a broad portfolio

risk-spreading requirement Although not specified in

the SIF Law, CSSF policy requires that SIF

apply investment restrictions so that no single investment represents more than 30% of the SIF’s total net assets

For SIF, this applies also to short selling in that

it cannot result in the SIF holding uncovered securities of the same type issued by the same issuer representing more than 30% of the SIF total net assets This general position is subject

to any other temporary restrictions on short selling in force from time to time When entering into derivative instruments, SIF must ensure comparable risk-spreading through appropriate diversification of the underlying assets

Exemptions apply in relation to (a) securities issued or guaranteed by an OECD Member State (or by its local authorities) or by certain supranational bodies and/or (b) investments in portfolio funds which are themselves subject to risk-spreading requirements at least comparable

to those of SIFs Other exemptions to the risk-spreading requirements may be available on a case-by-case basis

UCITS are subject to more detailed

risk-spreading / portfolio diversification requirements than the broad 30% rule applicable SIFs

Notwithstanding this, managers have found such requirements to be consistent with their strategies in practice and for UCITS’ distribution advantages to outweigh compliance with these regulatory requirements

Physical short-selling is not permitted by UCITS However, synthetic strategies utilising derivative investments of similar effect may lawfully be applied, subject to any other temporary restrictions on short-selling of general application in force from time to time

Preferred level of regulation

In summary, the distribution advantages of

UCITS do bring an enhanced level of regulation

In contrast, SIF enjoy a less prescriptive

regulatory environment but without the full investor distribution benefits of UCITS

The optimum outcome will be determined in each individual case on an assessment of the balance of these factors

Fund vehicles

Complex UCITS and SIF pursuing hedge

strategies are principally set up as either:

1 tax transparent, co-owned asset pools,

managed by a separate management

company (fonds commum de placement)

(FCP) or;

2 open-ended, variable capital investment

vehicles (SICAV).

An FCP is an undivided pool of assets,

co-owned by investors directly FCP have no

separate legal personality and are managed by a

separate, regulated management company This

management company acts in the name and on

behalf of the FCP, in the interests of unit-holders

The FCP is similar to the English law unit trust

and US mutual fund

Unit-holders have limited liability, restricted to

their agreed level of contribution Their minimum

legal rights are generally more limited than those

of shareholders Subject to any case-specific

provisions in an FCP’s management regulations

(similar in function to constitutional documents),

unit-holder rights will commonly be limited to

approval of annual accounts and to changes to

the offer document or management regulations

When used for hedge-type strategies, FCP will

be constituted on an open-ended basis

An FCP is deemed to be a Luxembourg fund if its

management company has its statutory seat in

Luxembourg

SICAV are open-ended, variable capital

investment vehicles They are generally

constituted as public limited companies (sociétés

anonymes) Having a variable capital means their

issued share capital is always, automatically

equal to their net asset value, without formality,

vote or amendment Although other fund vehicles

are legally possible for both UCITS and SIF,

such vehicles are not commonly used to pursue

hedge-type strategies

Both UCITS and SIF may be constituted as

either single asset-pool funds or with multiple,

segregated compartments Such compartments

provide ring-fenced asset (and liability) pools and

are the mechanism of choice for umbrella multi-strategy and/or multi-currency funds There are

no restrictions as to currency selection

Both UCITS and SIF have a general market capitalisation requirement of €1,250,000, with the following additional requirements: this general minimum capital must be subscribed for within

6 months of CSSF authorisation for UCITS, with

€300,000 being paid up as at authorisation for UCITS structured as self-managed SICAV; for SIF this general market capitalisation requirement must be subscribed within 12 months of CSSF authorisation and be 5% fully paid up

Provided this minimum capitalisation requirement continues to be met, there are no restrictions regarding dividends or distributions for either UCITS or SIF, whether structured as FCP or

as SICAV (save any that may be applied in the constitutional documents on a fund-specific basis)

Both UCITS and SIF assets are valued at fair value, determined in accordance with applicable accounting standards pursuant to the constitutional documents and confirmed by their independent auditor

Detailed additional rules apply for UCITS

as to the valuation of certain assets, the responsibilities of UCITS management companies, the frequency of NAV calculation (which must be at least twice monthly), independent third party verification of NAV calculation and risk management review

Required Luxembourg service-providers

Both UCITS and SIF which are structured as FCP must appoint a regulated Luxembourg Management Company (ManCo) If structured

as SICAV, a ManCo may be appointed (but is not obligatory) If a ManCo is not appointed, the SICAV (whether UCITS or SIF) will be self-managed If so, the SICAV must also comply with ManCo regulatory requirements

All UCITS and SIF must appoint Luxembourg

regulated central fund administration, registrar

and transfer agent service providers and CSSF

approved auditors

SIF must appoint a Luxembourg regulated

custodian approved by the CSSF, whose

responsibilities are to verify title to portfolio

assets at acquisition and to provide periodic

monitoring of the continuing ownership of the

portfolio by the SIF and the related portfolio

funds-flows This does not necessarily extend to

safe-keeping of title documents

For UCITS, this portfolio and fund-flow

supervisory monitoring is carried out by the

UCITS’ depositary which must therefore also

apply such monitoring oversight to dealing

by the UCITS’ prime broker The depositary’s

appointment must be approved by CSSF

Depositaries must be Luxembourg regulated

credit institutions or branches of EU regulated

banks

Offer documents

UCITS offer documents must contain prescribed

information as to the fund and its service

providers UCITS must also use a pro-forma

key investor information document providing an

abridged summary for investors

In contrast, there are no prescribed content

requirements for SIF offer documents other than

the general requirement to include all information

necessary for investors to make informed

judgements of the investment proposition and of

the risks attaching to it The key elements of offer

documents must be updated (as required) prior

to any future closings involving new investors

In practice, where managers utilise

complementary fund vehicles in other

jurisdictions, UCITS and SIF offer documents

may be issued to investors in substantially

similar (and familiar) formats, with only limited

adjustment often being required to meet local

regulatory requirements

Reporting

UCITS must provide detailed audited annual reports and unaudited semi-annual reports to investors and CSSF, financial information is also submitted monthly to CSSF

For SIF the minimum required investor reporting takes the form of the annual report, there is no obligation to publish semi-annual reports, to submit monthly financial information to CSSF

or to prepare consolidated financial statements, although more frequent investor liaison may be adopted if considered appropriate

Stock exchange listing

Both UCITS and SIF units may be stock exchange listed on meeting the applicable exchange admission and ongoing requirements Ensuring compatibility between free

transferability requirements of the relevant exchange and applicable eligible investor requirements is required

Such listing may assist distribution either in relation to: non-EU investors; institutional asset allocation requirements; or, for SIF prior to AIFMD overlay, to utilise the EU Prospectus Directive passport for cross-border distribution (implemented in Luxembourg in 2005)

Regulatory application

Commensurate with the sophisticated nature

of SIF investors, the regulatory approach to authorisation and ongoing supervision is less extensive than that applicable to UCITS

The application will include regulatory approval

of the offer document and constitutional documents For both UCITS and SIF, directors (and ManCo director and shareholders) must also be approved as being of good standing

with appropriate experience, as must the

selection of Luxembourg regulated custodian,

fund administrator, transfer and registrar agent

and auditor CSSF may also request any other

information or documents considered relevant

from time to time

For UCITS, CSSF also applies a promoter

policy review and approval including financial

statements In contrast, for SIF no separate

promoter review / authorisation is applied

UCITS have detailed compliance responsibilities

in relation to risk management including

as to: organisational separation from

portfolio investment management; valuation

methodologies; and global risk exposure limits

In line with anticipated AIFMD requirements,

since March 2012 SIF are required to implement

adequate risk management systems and

organisational arrangements to prevent conflicts

of interest

CSSF authorisation for SIF may take three to

six weeks depending on investment policy

and strategy Complex UCITS authorisation

commonly takes approximately the same time

On authorisation, UCITS and SIF may then

conduct their first closing

Any appointment of new directors, change

of custodian or amendment of constitutional

documents requires CSSF prior approval

Luxembourg tax

FCP are generally transparent for Luxembourg

tax, SICAV are generally opaque

UCITS and SIF are both exempt from

Luxembourg direct taxation UCITS are subject

to an annual subscription tax calculated at

0.05% per annum of the net asset value,

calculated and payable on a quarterly basis,

although this may be reduced to 0.01% (or

exempted) in certain circumstances SIF are

subject to an equivalent annual subscription tax

of 0.01% There is a negligible applicable

capital duty

UCITS and SIF both are exempt from Luxembourg income tax, municipal business tax and net wealth tax Distributions / dividends

by UCITS and SIF to investors and payment

of unit redemption monies are not subject to Luxembourg withholding tax (subject to the EU Savings Tax Directive)

Both UCITS and SIF (however structured) effectively qualify as taxable persons for VAT purposes Management and administration services provided to UCITS and SIF are VAT exempt Depositary, audit, and professional advisory services applied to UCITS and SIF are however subject to VAT

For efficient structuring, UCITS and SIF may hold portfolio investments via intermediate holding companies, depending on the geographic location of the portfolio Please refer

to our separate client briefing, “Luxembourg Unregulated Investment Vehicles” in the Luxembourg section of www ogier.com

Investors’ tax treatment depends on many individual factors including the place of such investor’s residency Investors should seek specific, independent tax advice

Author Daniel Richards Partner, Luxembourg

Key contacts for

Luxembourg

Funds

Europe, Middle East and Africa

Francois Pfister

Partner, Luxembourg

T +352 2712 2020

E francois.pfister@ogier.com

Daniel Richards

Partner, Luxembourg

T +352 2712 2011

E daniel.richards@ogier.com

Nick Kershaw

Partner, Jersey

T +44 1534 504235

E nick.kershaw@ogier.com

Michael Lombardi

Partner, Jersey

T +44 1534 504280

E michael.lombardi@ogier.com

Caroline Chan

Partner, Guernsey

T +44 1481 752215

E caroline.chan@ogier.com

William Simpson

Partner, Guernsey

T +44 1481 737166

E william.simpson@ogier.com

North and South America Peter Cockhill

Partner, Cayman Islands

T +1 345 815 1854

E peter.cockhill@ogier.com Giorgio Subiotto Partner, Cayman Islands

T +1 345 815 1872

E giorgio.subiotto@ogier.com

Asia and Australasia James Bergstrom Partner, Hong Kong

T +852 3656 6055

E james.bergstrom@ogier.com Nicholas Plowman Partner, Hong Kong

T +852 3656 6014

E nicholas.plowman@ogier.com Kristy Calvert

Managing Director +86 21 6157 5190 kristy.calvert@ogier.com Skip Hashimoto Managing Director +81 3 6430 9500 skip.hashimoto@ogier.com

Russia and CIS Marc Yates Partner, Jersey

T +44 1534 504220

E marc.yates@ogier.com Ray Wearmouth Partner, British Virgin Islands

T +1 284 852 7364

E ray.wearmouth@ogier.com