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Luxembourg Hedge Funds: overview of the fund vehicles

nospam@example.com (Olivier Sciales) — Wed, 18 Nov 2009 14:05:48 -0500

Luxembourg is, behind the USA, the world’s second ranking financial centre for the domicile and servicing of investment funds. Since 1959, when the first fund was established, the investment fund industry hugely expanded, counting 3,457 funds as of 30 September 2009. This success originated with the authorities' encouraging attitude to foreign capital and investment, and was considerably strengthened by its prime location in the heart of Europe - close to the main markets targeted by investment funds -, by its highly qualified multilingual workforce, as well as by its political, economic and social stability. This unique business friendly environment turns out to be of crucial assistance to mitigate the effects of the financial turmoil the investment funds world is currently going through, and indeed Luxembourg seems to be doing better than most major financial centres. As at 30 September 2009, total assets of undertakings for collective investment and specialised investment funds reached around EUR 1,773 billion. The Luxembourg government has implemented innovative fiscal measures and further reforms remain to be seen at the European level (i.e implementation of the UCITS IV Directive). Moreover, the events of the past months have lead the Luxembourg authority and government to take into consideration the security of investors.

I. Legal and regulatory framework

The 20 December 2002 law relating to undertakings for collective investments (“2002 Law”) shaped the Luxembourg investment fund market, differentiating between Undertakings for Collective Investment in Transferable Securities (UCITS, Part I of such law) and Undertakings for Collective Investment (UCIs, Part II of such law). Further to the 13 February 2007 law relating to Specialised Investment Funds (SIF) (“SIF Law”), the Luxembourg investment funds are now divided into three categories:

- Part II UCIs, 670 in September 2009;

- UCITS, 1,849 in September 2009; and

- SIF, 938 in September 2009.

A. UCITS

UCITS are designed for retail investors, and benefit from the European Passport, enabling them to be freely marketable throughout the EU countries with a minimum of formalities. Those funds are open-ended and must comply with stringent requirements set by the EU legislator in terms of eligibility of assets, risk-spreading requirements, and, more generally, in terms of substance and supervision.

Major changes in this area of the law remains however to be seen, since the proposal of the European Commission for an improved EU framework governing UCITS funds has been approved on 13 January 2009 by the European Parliament and on 22 June 2009 by the European Council. In practice this will mean the implementation of the UCITS IV Directive, which aims to liberalise the regime for cross-border retail funds.

B. UCIs

In contrast, UCIs (Part II) may only market their units in other EU countries after complying with the specific conditions stipulated by the authorities in the country concerned. The criterion defining whether a UCI is subject to Part I or Part II of the 2002 Law is the planned investment objective, as Part I applies only to UCI the sole objective of which is the investment in transferable securities, whereas a UCI may invest in activities such, inter alia, alternative investments (i.e. Hedge Funds), venture capital, and real estate.

C. SIFs

The SIF Law provides a separate statutory regime specifically designated for investment funds dedicated to sophisticated investors. The SIF is a lightly regulated and tax efficient fund which gives an on-shore alternative to consider (as compared to traditional off-shore jurisdictions such as the Cayman Islands or the BVI) when deciding on the jurisdiction for setting up a fund and the type of fund vehicle to use, and SIF are subject to each country’s distribution rules.

D. Regulatory body and control

The regulatory body is the Commission for the Supervision of the Financial Sector, (“CSSF”).

If it is subject to a continuous control by the CSSF, a fund set up under the SIF Law does not need its prior approval for being incorporated, while it is still a condition sine qua non for funds set up under the 2002 Law. Directors of a SIF are still subject to the CSSF approval.

The coming into force of the UCITS IV Directive, expected in mid-2011, should somewhat change the rule in this area, since the proposal reinforces the current provisions by providing additional tools to supervisors and enhancing supervisory cooperation.

To comply with the setting-up requirements, investors benefit from the financial facilities offered by the high-profiled Luxembourg economic environment, counting 152 banks (registered on the official list as at 28 February 2009), a broad range of international and local law firms exceedingly qualified in this field, as well as audit firms and tax advisors.

II. Constitution of a fund / legal structures available

Investment funds may take the form of an open-ended legal entity (investment company with variable capital, SICAV, 1,502 as of 30 September 2009), a closed-ended legal entity (investment company with fixed capital, SICAF, 20 as of 30 September 2009), or of a common contractual fund which has a management company (FCP, 1,926 as of 30 September 2009). All those different entities may create sub-funds, each with a different investment policy. In this context, each compartment will be deemed to be a separate entity, which implies that the assets of a compartment are exclusively available to satisfy the rights of investors in relation to that compartment.

A. SICAV / SICAF

A SICAV is a limited liability company whose capital is at any time equal to its net assets. Its capital increases and decreases automatically as a result of subscriptions or redemptions, without any formalities required. SICAVs may take different legal forms, depending on the law to which they are subject. In contrast, a SICAF is a limited liability company with fixed capital, open-ended only if the investors can buy and sell shares at their request and at a price equal to the net asset value per share. However, due to its limited flexibility, this corporate vehicle is rarely the choice of investors.

B. FCP

A FCP is a co-proprietorship whose joint owners are only liable up to the amount they have contributed. A FCP is deprived from a legal personality and must therefore be managed by a Luxembourg management company on behalf of joint owners. UCITS are managed by management companies under the conditions laid down in Chapter 13 of the 2002 Law, whereas Chapter 14 of the 2002 Law lays down the conditions under which management companies are ruling UCIs and SIFs.

C. Choosing a legal structure

The choice of whether to create a fund as a FCP or as an investment company is mainly based on tax considerations, as a FCP is tax transparent. Marketing and operational considerations are also relevant in this vehicle as a FCP, being domiciled in Luxembourg, benefits from the high standard of service provided by managers, custodians, legal and tax professionals present in Luxembourg. In contrast, the two other forms, because of their flexibility, are more often reserved for funds investing in transferable securities or derivatives, and for funds where shareholders/unitholders need to purchase or redeem their shares/units freely.

D. Formation expenses

The formation expenses will consist for all funds in a fixed registration duty of EUR 75, notary fees, legal fees, a CSSF filing duty, fixed, for 2002 Law UCIs, at EUR 2,650 for a single market UCI and EUR 5,000 for a multiple compartment UCI. In contrast, the CSSF filing duty has been fixed, for SIF Law UCIs, at EUR 1,500 for a single compartment UCI and EUR 2,650 for a multiple compartment UCI. The formation expenses may also comprise, if a listing to the Stock Exchange is contemplated, its admission fee, fixed at EUR 1,250.

E. Minimum capitalisation

The minimum capitalisation (EUR 1,250,000) required under both laws must, in case of a SIF, be reached within 12 months from the approval by the CSSF, in contrast with 6 months in case of other investment funds.

III. Investors' eligibility

Investment funds set up under the 2002 Law are available to public distribution. Hence, no restriction applies upon eligible investors, whereas the SIF Law introduces a qualified investor scheme. In this context, SIFs are reserved for well-informed investors who are able to understand and assess the risks associated with investments in such a fund, well-informed investor meaning either an institutional investor, a professional investor, or any other investor who has declared in writing that he is an informed investor and either invests a minimum of EUR 125,000 or has an appraisal from a bank, an investment firm or a management company certifying that he has the appropriate expertise, experience and knowledge to adequately understand the investment in the fund.

IV. Investment restrictions

Under the broad principle of risk spreading, all funds are subject to different rules restricting the scope of their investment policy. Those rules are quite restrictive towards UCITS, somewhat lighter concerning UCIs, and much lighter when it comes to SIFs.

A. UCITS

The 2002 Law provides for numerous restrictions upon investments by UCITS, which have been clarified in recent regulatory developments:

- Circular CSSF 07/308 lays down rules for the implementation of a risk management framework. Those rules rendered necessary that a UCITS must self-assess itself as either 'sophisticated' or 'non-sophisticated'. A sophisticated UCITS, being in the obligation of entrusting to a developed risk management unit, is able to make a significant use of derivative financial instruments, whereas non-sophisticated UCITS, with a much less developed risk management unit, can make use of derivative financial instruments only for hedging purposes. This Circular also specifies some valuation rules stating, inter alia, that overall risk exposure related to financial derivative instruments should not exceed the total Net Asset Value.

- The 8 February 2008 Grand-ducal regulation clarifies the notion of UCITS as provided in the 2002 Law, in light of the Commission Directive 2007/16/EC;

- The Circular CSSF 08/339 displays the guidelines given by the CESR in relation to eligible assets for investment by UCITS, and in this context provides additional clarifications relating to eligible assets for investment by UCITS covered by Directive 85/611/EEC, as amended; and

- CSSF Circular 08/356 describes in detail the techniques and instruments UCITS may use, including securities lending transactions. The main innovation to be noted refers to permitted collateral and permitted assets in which cash collateral can be reinvested. In this respect, this Circular specifies how collateral and assets acquired upon reinvestment of cash collateral must be safe kept in order to avoid a counterparty risk for the UCITS exceeding its legal limits.

B. Non-UCITS Part II Funds

If there are no restricted eligible assets for a UCI, its investment policy is subject to the CSSF approval, and specific rules are laid down in Circular IML 91/75 (as amended by Circular CSSF 05/177), whilst others are specifically applicable to UCIs pursuing alternative investment strategies. Those rules are laid down in Circular CSSF 02/80 which states, inter alia, that:

- Aggregate commitment in terms of short selling may not exceed 50% of assets, and no more than 10% of the same type issued by the same issuer may be sold short;

- Borrowings must not exceed 200% of the net assets; and

- Counterparty risk, defined as the difference between the value of assets given as guarantee and the amount borrowed, cannot represent more than 20% of the UCI's assets per lender.

C. SIFs

SIF are not required to comply with any detailed investment restrictions or leverage rules; the SIF Law merely stating that a SIF should apply the principle of risk diversification. This principle provides that the collective investment of funds must be made in assets 'in order to spread the investment risks'. The CSSF clarified in its Circular 07/309 that:

- A SIF may not invest more than 30% of its assets or commitments to subscribe securities of the same type issued by the same issuer;

- Short sales may not result in the SIF holding a short position in securities of the same type issued by the same issuer representing more than 30% of its assets; and

- When using financial derivative instruments, the SIF must ensure, via appropriate diversification of the underlying assets, a similar level of risk-spreading.

However, the CSSF may, upon appropriate justification, grant exemptions to these rules on a case-by-case basis.

V. Reporting and audit requirements

A. Prospectus

Funds are in the obligation to issue a prospectus containing information concerning the fund and its management company. The 10 July 2005 law on prospectus for securities specified that the obligation to publish a full prospectus shall not apply to units issued by UCI other than the closed-end type. Such a fund shall publish a simplified prospectus. Offers to the public of securities representing units issued by UCI other than the closed-end type shall be subject to the sole provisions of the laws on UCI. According to the 2002 Law, both the simplified and the full prospectus must include the information necessary for investors to make an informed judgment of the investment proposed to them, and especially of the risks attached thereto. Investors should note that when the UCITS IV Directive will come into force, the simplified prospectus is expected to be replaced by a ‘key investor information’ document.

B. Issuing document

Funds subject to the SIF law are only required to produce an 'issuing document', displaying, with no minimum content, the information necessary for investors to be able to make an informed judgment about the investment proposed to them. The issuing documents and any modifications thereto must be communicated to the CSSF.

C. Financial statement

A difference to draw between the 2002 Law and the SIF Law is that the obligation to publish a financial statement is only annual in the case of a SIF, whereas an investment fund subject to the 2002 Law must publish such an audited financial statement annually and semi-annually.

Such financial statement(s) must be audited by an authorised independent auditor, member of the Luxembourg Institute of Auditors. This auditor is in the obligation, if any information provided to investors does not truly describe the financial situation of the fund, to report promptly to the CSSF. The same obligation applies if the auditor becomes aware during the audit that any fact or decision is liable to constitute a material breach of the law or regulations, or to affect the continuous functioning of the UCI.

VI. Taxation of funds

Luxembourg funds are essentially tax-exempt vehicles, and indeed Luxembourg UCITS, UCIs and SIFs do not pay Luxembourg income and capital gain taxes, nor is a stamp duty on share issues or transfers to be paid.

The Luxembourg authorities are currently working on a wide range of fiscal reforms. The first main changes have been the abolition of the fixed capital duty and of the withholding tax on dividends paid to recipients resident in countries that have concluded a tax treaty with Luxembourg as from 1 January 2009.

Under the SIF Law an annual subscription tax has been fixed at 0.01% of net assets, compared to 0.05 % for funds under the 2002 Law. It is however only of 0.01% for UCIs whose exclusive policy is the investment in money market instruments or deposits with credit institutions. Other funds, such as certain institutional cash funds and pension pooling funds, are exempted from this subscription tax, no matter under which Law they are set up under. It should be noted that investors may invest in a SIF by means of equity or debt, hence benefiting from an effective tax optimisation, and that there is no debt-equity ratio to be respected in the case of a SIF.

In order to avoid double taxation, Luxembourg has signed double taxation treaties with 52 countries, and 21 others are under negotiation or awaiting approval of the Luxembourg Parliament or the foreign country. However, it has to be emphasised that only 27 of these treaties are applicable to SICAVs and SICAFs.

VII. Stock exchange listing

A fund may be listed on the Luxembourg Stock Exchange (LSE). A few conditions have been imposed for a foreign fund to be listed on the LSE, mainly that the fund promoter must be of good repute, have adequate professional experience, and that the functions of investment manager, management company, custodian and transfer agent must be carried out by a separate entity.

The Stock Exchange maintenance fee has been fixed at EUR 1,875 for the 1st line of quotation, EUR 1,250 for a 2nd one, EUR 875 for a 3rd one, and EUR 500 for the 4th and the following lines of quotation.

Conclusion

The Luxembourg investment fund industry, largely benefiting from its location in a strong financial centre, is now an internationally recognised on-shore label for investment funds. The greatest asset of Luxembourg is undoubtedly political voluntarism, demonstrated by a constant anticipation of the need of investors - either in the transposing of European legislation or in the shaping of national legislation - in order to create a stable, protective and favourable environment according to the expected development of the market. This pragmatism on the part of the Luxembourg authorities, exemplified by the recent fiscal exemptions and by the way the CSSF dealt with the global financial turmoil, is decisive to shepherd investors in days of global uncertainty. Lastly, the increasingly important issue of transparency is covered by national and European regulations and provides new investors with an especially protective framework as compared to traditional off-shore jurisdictions such as the Cayman Islands or the BVI. For instance, the European Commission has proposed a Directive on Alternative Investment Fund Managers (AIFMs) with the objective to create a comprehensive and effective regulatory and supervisory framework for AIFMs at the European level.

Luxembourg UCITS "hedge funds"

nospam@example.com (Olivier Sciales) — Wed, 18 Nov 2009 04:55:31 -0500

For a long time, Luxembourg hedge funds and funds of hedge funds have been set up under several wrappers, namely funds submitted under part II of the law of 20 December 2002 on UCIs (the “2002” Law) and specialised investment funds (SIF) governed by the law of 13 February 2007 (the “SIF Law”). As of today, hedge fund managers are considering launching UCITS platforms (especially “sophisticated UCITS”). As widely known, UCITS funds are harmonised European retail fund vehicles that can be sold globally and which benefit from the European passport enabling investment managers to easily market their funds within the EU. The total amount invested into UCITS was around EUR 4.6tn at the end of 2008, and experts forecast that it is set to grow to between EUR 7tn and EUR 9tn by 2012. As of 30 September 2009, the assets under management (AuM) of Luxembourg UCITS were about EUR 1.39tn which represents 78% of the total AuM of all the Luxembourg undertakings of collective investments.

The UCITS framework is attracting attention from hedge fund managers mainly because of the increased demand from investors for regulated products, transparency and liquidity sought in the aftermath of the Madoff case, the benefit of the European passport, the continuous broadening of the eligible asset rules for UCITS, the strong risk management framework, the future benefits of UCITS IV (when implemented by 2011) and the implications of the recent proposed EU hedge fund Directive (AIFM Directive) for non-UCITS vehicles.

European passport

As mentioned, the European passport provides hedge fund managers with a possibility to distribute the shares or units of the fund within the EU. The European passport makes distribution easier for these fund promoters since they do no longer have to be reviewed for substance in other EU member states but only with respect to formal compliance. The new simplified notification procedure provided by UCITS IV (to be in force by 2011) shall also attract the attention of hedge fund managers since it will speed up the cross-border distribution of their funds.

Eligible assets

Hedge fund managers driven by the investor demand are looking for products which can deal with their alternative investment policy as well as replicating their hedge fund strategies.

The UCITS directive adopted in 1985 (UCITS I) (when speaking about eligible assets) did not provide a detailed definition of the term ‘transferable securities’, even though it referred to the term repeatedly. In order to ensure a uniform application of the UCITS directives as well as helping EU member states to develop a common understanding as to whether a given asset category is eligible for a UCITS, the European institutions have decided to clarify such definitions in the eligible assets directive of 19 March 2007 (the “Eligible Assets Directive”) and the CESR’s guidelines concerning eligible assets for investment by UCITS (the “Eligible Assets Guidelines”) transposed in Luxembourg by the Grand-Ducal Regulation of 8 February 2008 and the CSSF circular 08/339.

Traditionally, the investment strategies of UCITS were limited to long / short equity. The main innovation was to extend the assets eligible for UCITS in order to enable UCITS III vehicles to invest in, inter alia, OTC derivatives (e.g. total return swaps, contracts for difference, etc.), to adopt synthetic shorting strategies (as physical shorting is not allowed), 130/30 strategies, investments in hedge fund indices, and so forth. These strategies are now possible subject to certain counterparty exposure limits in the sense that the global exposure through the use of derivatives does in principle not exceed 100% of the net asset value of the assets. Hence UCITS’ overall risk exposure may in principle not exceed 200% of the net asset value on a permanent basis.

Increased investor protection through risk management procedures

According to article 42 (1) of the 2002 Law, UCITS must implement a risk management strategy that enables them to monitor and measure the risk of the positions and their contribution to the overall risk profile at any time. The Luxembourg regulator (CSSF) has classified UCITS on the basis of their risk profile into sophisticated UCITS and non-sophisticated UCITS. A sophisticated UCITS (these are the UCITS which hedge fund managers tend to set up) are UCITS which mainly use derivative financial instruments and / or are making use of more complex strategies or instruments. According to the CSSF, a sophisticated UCITS must entrust to a risk management unit which is independent of the entities in charge of making investment decisions, the task of identifying, measuring, monitoring and controlling the risks associated with the portfolio’s positions. For instance, the following criteria need to be fulfilled by the risk management unit, namely it must have (i) a sufficient number of qualified personnel with the necessary knowledge, (ii) the necessary tools (IT and others) to do its task and (iii) conducting persons of the board (in case of a self-managed SICAV) or of the management company that are actively associated with the risk management process. Sophisticated UCITS must use the Value-at-Risk approach (VaR), which means that the potential loss that a UCITS portfolio could suffer within a certain time period is estimated. In principle (subject to derogation granted by the CSSF), a confidence interval of 99%, a holding period equivalent to one month and an effective observation period of risk factors of at least one year are amongst others the standards used for calculating the VaR.

Impact of UCITS IV

As widely known, the UCITS IV Directive has been adopted by the European Parliament on 13 January 2009 and by the European Council on 22 June 2009. The UCITS IV package aims to introduce the following amendments to the UCITS III legal regime: (1) a management company passport (allowing UCITS to be managed by a management company authorised in another EU member state), (2) a simplified notification procedure for cross-border distribution, (3) a replacement of the simplified prospectus by a key investor information document, (4) a framework for UCITS mergers and (5) master-feeder structures leading to greater pools of assets and economies of scale. All of the above measures may provide hedge fund managers with additional incentives to set up a UCITS structure as they will allow economies of scale and reduce costs (because, amongst others, of the absence of the need of a local management company and due to the simplified notification procedure for cross-border distribution).

Impact of the proposed AIFM directive (if adopted in its current form)

On 29 April 2009, the European Commission submitted a draft Directive on Alternative Investment Fund Managers (AIFM) to the European Parliament and the European Council, marking an attempt to create a regulatory framework for European alternative investment fund managers of non-UCITS funds: a common set of rules in terms of licensing and supervision. This Directive (if adopted) would apply to all managers that manage and market non-UCITS funds in the EU with AuM exceeding EUR 100m or EUR 500m if the funds are not leveraged and are not redeemable for at least five years. An important point with respect to this draft Directive is that the European passport towards third party funds (non EU domiciled funds – such as, for example, Cayman funds, BVI funds, Bermuda funds, etc.) would only enter into force three years after the transposition of the proposed Directive. In other words, the distribution of offshore funds to professional investors will only be possible after such period and will therefore restrict the possibility to raise funds in Europe. Even more stringently, non-EU AIFMs wishing to market within the EU will have to apply for an authorisation to a EU member state, which will only be granted if the country where the AIFM is based has put into place prudential regulations equivalent to those of the Directive and has tax co-operation agreements in place with the relevant member state’s regulators.

Certain hedge fund managers of non-EU domiciled funds are anticipating these proposed changes and are thinking to re-domicile or restructure their existing funds into Luxembourg UCITS funds or SIF funds. For the time being, this proposed directive has been criticised by the industry as being disproportionate and discriminatory, and amendments should be expected.

Today, hedge fund managers driven by more risk averse institutional investors are looking for more regulated vehicles with superior risk management procedures, and as such, the appeal of the UCITS legal framework accessing hedge fund strategy returns and offering wide reaching investor protection rules and investor information requirements has attracted their attention.

Should you need any further information, please contact Olivier Sciales at oliviersciales@cs-avocats.lu

Luxembourg and the draft Alternative Investment Fund Managers Directive (AIFM)

nospam@example.com (Olivier Sciales) — Mon, 03 Aug 2009 11:50:09 -0400

As part of a legislative package to tackle the financial crisis, the European Commission submitted on 29 April 2009 a Directive on Alternative Investment Fund Managers (“AIFM”) to the European Parliament and to the Council. This proposal emerged rather swiftly following a general consensus across European leaders that AIFM, which managed around EUR 2 trillion in assets at the end of 2008, should be subject to closer regulatory scrutiny.

This proposed Directive marks the first attempt to create a comprehensive and effective supervisory and regulatory framework for AIFM in the European Union (“EU”) by imposing on European investment managers of non-UCITS investment funds a common set of rules in terms of licensing and supervision. In return, AIFM would benefit from a European passport for cross-border distribution to EU professional investors.

The main innovations focus on the regulatory supervision, the disclosure requirements and the distribution of Alternative Investment Funds (“AIF”). Key elements of the proposed Directive are set out below. However, it should be pointed out that those proposals will only introduce a minimum threshold for Member States, and countries such as France and Germany will probably pass harsher requirements.

(1) Scope of the Proposed Directive

The proposed Directive would apply to all managers that manage and market non-UCITS funds in the EU, unless their assets under management do not exceed EUR 100 million, or EUR 500 million when the Alternative Investment Funds (“AIF”) managed are not leveraged and have no redemption rights exercisable during a period of five years following the date of constitution of the AIF. This constitutes a major innovation since AIF have so far been immune from any harmonized regulatory regime within the Europe Union.

All non-UCITS funds are concerned (hedge funds, venture capital funds, infrastructure funds, private equity funds, real estate funds, commodity funds, non-EU retail funds), irrespective of their type, their legal structure or their country of domicile (even outside the EU). Indeed, the Directive also regulates the marketing of non-EU funds and the authorization of non-EU AIFMs. Consequently, an AIFM wishing to market a non-EU fund may only do so if the country of origin has signed an agreement with the relevant EU Member State(s) agreeing to an effective exchange of information on tax matters complying with the standards laid down in Article 26 of the OECD Model Tax Convention[1]. In addition, a non-EU AIFM wishing to market within the EU must apply for authorization by a Member State, which will only be granted if the AIFM’s own country has in place prudential regulation and ongoing supervision equivalent to those of the Directive.

The Directive would therefore impose significant hurdles on non-EU fund managers, triggering calls from opponents of the Directive to avoid excessive protectionism. However, if granted, the authorization will be valid for all Member States, thereby allowing those managers to manage and market AIF within the EU either directly or via a branch without having to comply with each country’s particular legislative requirements

(2) Operating conditions

(i) Organizational requirements

AIFM shall only delegate activities following prior authorization of the home Member State regulator, which will have regard to the quality of the service provider. It should be noted that delegation does not affect the liability of the AIFM. AIFM must entrust a legally and functionally independent valuator with the valuation of the assets of the AIF under management, the frequency of which should be at least yearly as well as the valuation of their shares or units. The AIFM must also make sure that for each AIF it manages, a depositary is appointed in order to receive payments made by investors and book them on behalf of the AIFM in a segregated account, safe-keep the financial instruments of the AIF and verify ownership over all the assets of the AIF. The depositary must be independent from the AIFM and must be a duly authorized credit institution having its registered office in an EU Member State.

(ii) Minimum Capital Requirements

AIFM should have an initial capital of at least EUR 125,000. However, when the value of the portfolio managed (directly or by delegation) exceeds EUR 250 million, additional own funds of 0.02% must be provided.

(iii) Risk management

AIFM are required under the proposal to separate the functions of risk management and portfolio management, and to implement systems to measure and monitor all risks associated with each AIF strategy. In particular, the AIFM must implement an appropriate, documented and regularly updated due diligence process when investing on behalf of the AIF, according to the investment strategy, the objectives and the risk profile of the AIF. Lastly, the AIFM shall ensure that the risk profile of the AIF corresponds to the size, portfolio structure and investment strategies of the AIF as laid down in the AIF’s rules or instruments of incorporation.

(iv) Reporting obligation

In line with the objective to impose tighter scrutiny on AIFM, the proposal introduces regular reporting requirements towards the authorities of their home Member State. The AIFM is indeed in the obligation to provide information on the principal instruments in which it trades, and on the principal exposure of each of the AIF it manages. At the end of each quarter, the AIFM must provide a list of the AIF it manages.

In relation to investors, the AIFM must for the sake of their protection provide them with specific procedure information, including a description of the valuation procedures and the liquidity risk management. Moreover, the percentage of illiquid, hard-to-value or side-pocketed assets, as well as the updated risk profile will have to be periodically disclosed.

(v) European passport

Once approved by its home Member State regulator, the AIFM shall be free to provide management services to an AIF established in any other EU Member State. Moreover, the AIFM will be able to market the AIF it manages in another Member State. However, this option shall only be possible in relation to professional investors, and retail cross-border marketing of units or shares of AIF should not be authorized by the European regulator. It should be noted that the European passport to market non-European AIF is scheduled to enter into force only three years after the transposition of the proposed Directive.

(vi) Specific obligations for AIFM managing leveraged AIF

Particular reporting obligations apply when the combined leverage from all sources exceeds the value of the equity capital in two out of the previous four quarters. In this situation, the AIFM must disclose to investors the maximum level of leverage that he may employ in relation to each AIF, as well as any right of re-use of collateral, guarantees granted under the leveraging agreement and on a quarterly basis, the actual amount of leverage in the previous quarter.

The AIFM will also have to disclose to the competent authorities of its home Member State the overall level of leverage employed by each AIF it manages.

(vii) Specific obligations for AIFM managing AIF which acquire controlling influence in companies

AIFM in position to exercise 30% or more of the voting rights of an issuer or of a non-listed company must notify the company and shareholders of that control. This obligation does not apply when the issuer or non-listed company employs fewer than 250 persons, has an annual turnover not exceeding EUR 50 million, and/or annual balance sheet does not exceed EUR 43 million.

Produced in record time, the proposal is now in the hands of the European Parliament, where it is expected to be subject to stormy political negotiations. From a Luxembourg perspective, this Directive is bearing huge opportunities, and, if ratified, could have a major impact on the alternative investment industry. Indeed, under the current proposal, the distribution of offshore funds (e.g. established in the Cayman Islands) to professional investors (as defined by the MIFID Directive) will only be possible after a period of three years following the Directive’s ratification. This could, by accelerating the re-domiciliation of offshore funds to the Grand Duchy, strengthen Luxembourg’s position as a major hub for investment funds.

However, across Europe, the project is widely criticized by the industry as disproportionate and discretionary, and it still divides important European actors, such as the United Kingdom and France. Amendments or delay in its enforcement should therefore be expected in the forthcoming months.

Should a political approval be reached by the end of 2009, the Directive could come into force in 2011.

[1] There are currently 52 such agreements (as at June 2009), and 22 others are under negotiation or awaiting approval by the Luxembourg Parliament ,

Luxembourg - SICAR changes bring new private equity boost

nospam@example.com (Olivier Sciales) — Tue, 16 Jun 2009 05:11:27 -0400

Luxembourg has long been a significant domicile for private equity vehicles but the jurisdiction has emerged as a major European centre for the industry since the introduction of the Sicar, or risk capital investment company, five years ago. Now a series of changes to the rules governing Sicars that were enacted last year promises to consolidate Luxembourg’s role, even at a time when the private equity industry is battling to adapt to a much-changed economic and financial environment.

The legislation of October 29, 2008 allows the promoters of private equity funds to create segregated compartments in a Sicar, putting the vehicle on the same basis as Specialised Investment Funds, which are widely used for a broad range of Luxembourg-domiciled alternative investment products. The changes restore the Sicar’s position as the vehicle best suited to private equity funds because unlike the SIF, it is not subject to risk diversification rules.

The private equity industry has also used financial participation companies, or Soparfis, but today Sicars have become the vehicle of choice for investments that meet the regulator’s definition of risk capital because of the greater flexibility they offer compared with SIFs and Soparfis. Sicars are fully taxable companies – although all income from transferable securities is exempt – and thus are in principle in a position to benefit from Luxembourg’s network of double taxation treaties.

Today a surge of interest from promoters of funds investing in distressed companies has helped to push to nearly 220 the number of Sicars established since the law was enacted on June 15, 2004. Luxembourg also stands to benefit in the future from the concerns expressed by the world’s largest countries about regulation in offshore financial centres, and moves to require greater transparency and oversight of alternative investment managers and their products.

Over the past two years, the Luxembourg authorities and particularly the Association of the Luxembourg Fund Industry, Alfi, have made vigorous efforts to promote the country as an international funds jurisdiction to a global audience. They have stressed the central role of the regulator, the Financial Sector Supervisory Authority (CSSF), and the requirement for funds to have a locally licensed administrator and custodian. In the current market environment, Luxembourg’s ability to offer regulated alternative investment vehicles is an important asset.

The success of the private equity sector and of Luxembourg’s fund industry in general owes much to the strength in depth of its workforce, which includes many talented professionals from the neighbouring countries of Belgium, France and Germany as well as further afield. The country has always provided a welcoming environment to skilled individuals and has become a major generator of high-quality jobs within the wider cross-border region. It also helps that Luxembourg also offers an attractive tax environment for financial and other companies, although it is certainly not the tax haven it is sometimes caricatured to be.

While the past year has seen unprecedented turbulence within the European and global fund industry, there is every reason to believe that with its proven ability to develop innovative products and – as with the Sicar – to fine-tune its offering to meet the needs of fast-moving and dynamic market, Luxembourg is well placed to build on its reputation for providing the skilled services and regulatory certainty that the private equity sector will require in the future.

Luxembourg Investment Funds Guide - UCITS, SIFs, UCIs

nospam@example.com (Olivier Sciales) — Thu, 11 Jun 2009 13:19:57 -0400

Luxembourg is, behind the USA, the world’s second ranking financial centre for the domicile and servicing of investment funds. Since 1959, when the first fund was established, the investment fund industry hugely expanded, counting 3,395 funds in April 2009. This success originated with the authorities' encouraging attitude to foreign capital and investment, and was considerably strengthened by its prime location in the heart of Europe - close to the main markets targeted by investment funds -, by its highly qualified multilingual workforce, as well as by its political, economic and social stability. This unique business friendly environment turns out to be of crucial assistance to mitigate the effects of the financial turmoil the investment funds world is currently going through, and indeed Luxembourg seems to be doing better than most major financial centres. As at 31 March 2009, total assets of undertakings for collective investment and specialised investment funds reached EUR 1,526.563 billion compared to EUR 1,530.291 billion as at 28 February 2009, i.e. a 0.24% decline. The Luxembourg government has implemented innovative fiscal measures and further reforms remain to be seen at the European level (i.e implementation of the UCITS IV Directive). Moreover, the events of the past months have lead the Luxembourg authority and government to take into consideration the security of investors.

I. Legal and regulatory framework

- UCIs, 698 in March 2009;

- UCITS, 1,840 in March 2009; and

- SIF, 858 in March 2009.

A. UCITS

Major changes in this area of the law remains however to be seen, since the proposal of the European Commission for an improved EU framework governing UCITS funds has been approved on 13 January 2009 by the European Parliament. In practice this will mean the implementation of the UCITS IV Directive, which aims to liberalise the regime for cross-border retail funds.

B. UCIs

C. SIFs

D. Regulatory body and control

The regulatory body is the Commission for the Supervision of the Financial Sector, (“CSSF”).

II. Constitution of a fund / legal structures available

Investment funds may take the form of an open-ended legal entity (investment company with variable capital, SICAV, 1,452 in March 2009), a closed-ended legal entity (investment company with fixed capital, SICAF, 18 in March 2009), or of a common contractual fund which has a management company (FCP, 1,926 in March 2009). All those different entities may create sub-funds, each with a different investment policy. In this context, each compartment will be deemed to be a separate entity, which implies that the assets of a compartment are exclusively available to satisfy the rights of investors in relation to that compartment.

A. SICAV / SICAF

B. FCP

C. Choosing a legal structure

D. Formation expenses

E. Minimum capitalisation

III. Investors' eligibility

IV. Investment restrictions

A. UCITS

The 2002 Law provides for numerous restrictions upon investments by UCITS, which have been clarified in recent regulatory developments:

- The 8 February 2008 Grand-ducal regulation clarifies the notion of UCITS as provided in the 2002 Law, in light of the Commission Directive 2007/16/EC;

B. Non-UCITS Part II Funds

- Aggregate commitment in terms of short selling may not exceed 50% of assets, and no more than 10% of the same type issued by the same issuer may be sold short;

- Borrowings must not exceed 200% of the net assets; and

- Counterparty risk, defined as the difference between the value of assets given as guarantee and the amount borrowed, cannot represent more than 20% of the UCI's assets per lender.

C. SIFs

- A SIF may not invest more than 30% of its assets or commitments to subscribe securities of the same type issued by the same issuer;

- Short sales may not result in the SIF holding a short position in securities of the same type issued by the same issuer representing more than 30% of its assets; and

- When using financial derivative instruments, the SIF must ensure, via appropriate diversification of the underlying assets, a similar level of risk-spreading.

However, the CSSF may, upon appropriate justification, grant exemptions to these rules on a case-by-case basis.

V. Reporting and audit requirements

A. Prospectus

B. Issuing document

C. Financial statement

VI. Taxation of funds

VII. Stock exchange listing

Conclusion

Luxembourg IP (intellectual property) tax regime - Luxembourg royalty company

nospam@example.com (Olivier Sciales) — Wed, 04 Mar 2009 08:37:39 -0500

I. Introduction

The Luxembourg government has introduced by a law of 21 December 2007 a new Luxembourg IP regime (“Luxembourg IP Tax Law”) that provides for a 80% tax exemption of income derived from intellectual property (“IP”) as well as capital gains realized on the disposal of such intellectual property. The aim of this law is to encourage companies to invest more in research and development and will increase the attractiveness of Luxembourg for the holding of intellectual property. We also discuss hereunder briefly the new changes to the Luxembourg IP Tax Law introduced by the Law of 19 December 2008.

II. Brief overview of the main features of the Luxembourg IP Tax Law

(a) Regime applicable to royalties (income derived from intellectual property)

The royalties received by a Luxembourg legal person or natural person as a consideration for the use of any copyright on software, any software, trade mark, design or model benefit from a 80% exemption on their net income. Net income is defined as the gross royalty income received by the legal person or individual reduced by the amount of expenses in direct connection with this income.

(b) Regime applicable to capital gains

Capital gains realized on the disposal of intellectual property (use of any copyright on software, any software, trademark, design or model) in principle benefit from a 80% exemption, subject to certain rules as set out in the Luxembourg IP Tax Law.

(i) The IP must have been created or acquired after 31 December 2007;

(ii) The expenses in connection with the IP must be recorded as an asset in the balance sheet for the first book year for which the application of the regime is demanded;

(iii) The IP may not have been acquired from a person who is qualified as an “affiliated company”. The concept of affiliated company has been clarified by the draft law. Company X is considered as an affiliated company to company Y if :

· Company X directly holds a participation of 10% in the share capital of Y

· Company Y directly holds a participation of 10% in the capital of X;

· 10% or more of the share capital of X and Y are directly held by the same company.

III. Summary of the key advantages of the proposed new regime

· The scope of IP acquired from a third party is broad; it may include any patents, any copyrights on software, trademarks, designs, models or domain names (see hereunder under section V) (other countries such as Belgium have also introduced such regime, however the scope of IP is more limited and excludes copyright, trademarks, models and designs (see Belgian law of 27 April 2007);

· Only 20% from the net income out of IP will be taxed at 28,59% which provides an effective tax burden of roughly 5.17%;

· The IP can be developed either by the company itself or acquired from a third party;

· Income derived from IP developed by the company itself can also be deducted (for an amount of 80% of the net income it would have received from a third party for the use of the patent);

· Luxembourg companies (soparfi, etc.) can in general benefit from the extensive network of Luxembourg double tax treaties as well as from the EU directive on royalty payments (as opposed to offshore jurisdictions).

IV. Changes introduced to the Luxembourg IP Tax Law by the Law of 19 December 2008

The law of 19 December 2008 has broadened the scope of the IP regime as set out in the law of 21 December 2007. These changes are the following: (1) Qualifiying IP assets held by Luxembourg companies will be exempt from the net wealth tax of 0.5% and (2) domain names are, as from tax year 2008, eligible to the 80% tax exemption on income derived from intellectual property.

V. Conclusion

This Luxembourg IP Tax Law offers an attractive regime for the holding of intellectual property through a Luxembourg company certainly taking into account that Luxembourg has an extensive tax treaty network and that Luxembourg companies can benefit from the EU directive on royalty payments.

Madoff case - decision by the CSSF to withdraw LUXEMBOURG INVESTMENT FUND from the list

nospam@example.com (Olivier Sciales) — Tue, 03 Mar 2009 19:45:26 -0500

On 3 March 2009, the Luxembourg regulator (CSSF) has announced, in view of the establishment of the responsibilities of the various intermediaries in relation to LUXEMBOURG INVESTMENT FUND, a undertaking of collective investment subject to part I of the Law of 20 December 2002 ("Luxembourg UCITS fund") and the custodian bank UBS (LUXEMBOURG) S.A., to take the following two decisions, namely (1) to withdraw LUXEMBOURG INVESTMENT FUND from the list on the basis of article 94 (2) of the Law of 20 December 2002 on undertakings of collective investments which provides that maintaining an entry on a list shall be subject to observance of all the provisions of laws, regulations or agreements relating to the organisation and operation of UCIs and the distribution, placing or sale of their units and (2) thereafter to request the judicial liquidation of LUXEMBOURG INVESTMENT FUND.

The decision to withdraw LUXEMBOURG INVESTMENT FUND from the list of authorized UCIs is based on the fact that LUXEMBOURG INVESTMENT FUND. does not observe any longer the provisions in relation to the organisation and functioning of Luxembourg undertakings of collective investments. This withdrawal has as consequence the suspension of all payments made by LUXEMBOURG INVESTMENT FUND and the prohibition by LUXEMBOURG INVESTMENT FUND to perform any acts other than conservatory acts. The decision of withdrawal will become permanent after a period of one month, except in case of appeals. As soon as the decision of withdrawal will become permanent, the CSSF will request from the Luxembourg court (tribunal d'arrondissement) the judicial liquidation of LUXEMBOURG INVESTMENT FUND. In case of a liquidation decided upon by the court, the court will appoint a liquidator to realize the assets of the SICAV.

The Luxembourg SICAR

nospam@example.com (Olivier Sciales) — Mon, 02 Mar 2009 17:53:38 -0500

The Luxembourg law of 15 June 2004 relating to the investment company in risk capital, as amended from time to time (and for the last time on 29 October 2008) (the “SICAR Law”) has created a Luxembourg vehicle (“SICAR”) whose principal object is investing in risk bearing capital issued by domestic and foreign companies. The main features and advantages of the SICAR Law are its legal flexibility and interesting tax treatment. This legal framework for Luxembourg private equity and venture capital funds has had a significant impact in European private equity deal structures. We also discuss hereunder the main changes introduced by the Law of 29 October 2008 and the guidelines issued by the Luxembourg regulator (CSSF) on the concept of “risk capital”.

I. KEY FEATURES OF THE SICAR

(a) Definition of “investment in risk capital”

The SICAR Law limits the object of a SICAR to investment in venture capital and private equity. Risk investments are defined in the SICAR Law in a broad manner as to include any direct or indirect contribution of assets to entities in view of their launch, their development or their listing on a stock exchange. Risk capital includes any investment that creates for the investor a high risk with the expectation to realize a gain whose importance is proportional to the risk borne. We discuss in section (V) in more detail the circular issued by the CSSF on the concept of “risk capital”.

(b) Legal form

A SICAR can adopt most of the legal forms used in Luxembourg, such as the company limited by shares (S.A.), the limited liability company (S.àr.l.), the partnership limited by shares (S.C.A.), etc.

(c) Eligible investors

The shares in a SICAR can only be subscribed by qualified investors who are:

Either an institutional investor ; or
A professional investor ; or
Any investor who (i) has confirmed in writing that he adheres to the status of well-informed investor and (ii) invests a minimum of 125,000 Euro in the company or (iii) has obtained a certificate from a credit institution certifying his experience and his knowledge in adequately appraising an investment in risk capital.

(d) Authorisation by the CSSF

A SICAR must be authorized by the CSSF. The authorization procedure entails:

The approval of the constitutional documents (prospectus, articles of incorporation, ancillary agreements with service providers, etc…);
Examination whether the directors are reputable and have sufficient experience (however, there is no requirement as to the financial background or capital adequacy of the directors and shareholders of the SICAR);
The approval of the institutions that will act as custodian, administrative agent and auditor.

(e) Light supervision during the life of the SICAR

Any changes to the constitutional documents must be approved by the CSSF. Only annual accounts need to be issued (no semi-annual accounts). There are furthermore no risk diversification rules and no restrictions as to the investment policy of the SICAR (other than those mentioned in the circular issued by the CSSF containing guidelines and clarifications on the criteria applied by the CSSF when assessing whether a project is eligible under the SICAR Law or not. We have discussed these guidelines under section (5).

(f) Capital requirements

The subscribed share capital of a SICAR may not be less than 1,000,000 Euro, of which only 5% needs to be paid up. This minimum must not be subscribed upon incorporation but must be reached within a period of 12 months following the authorization of the company.

II. ADVANTAGES OF THE SICAR

(a) From a corporate law perspective

No obligation to create a legal reserve. This allows investors to distribute the entirety of their profit;
No restrictions on redemption of shares or payment of dividends or interim dividends except those mentioned in the articles of incorporation. This allows investor to receive the profits on investments shortly after they have been made;
Subscribed capital needs only to be paid up to an amount of 5%;
Not subject to any debt-to-equity ratio;
Flexibility as to the issue of new securities. There are no formalities attached;
Possibility to provide for a variable share capital.

(b) From a tax perspective

(i) At the level of the target company (with regard to the income distributed by the target company to the SICAR)

Withholding tax, if any, on income distributed by the target company to the SICAR should be reduced in accordance with the double tax treaty between Luxembourg and the country of residence of the target company;
Normally, based on the parent-subsidiary directive, no withholding tax should be levied on dividends distributed by EU target companies to the SICAR, in cases where the conditions of the participation exemption provided by the domestic legislation of the target country are met.

(ii) At the SICAR level (with regard to the income received by the SICAR)

Fully taxable at a rate of 28,59%, but:

Dividend distributions by a SICAR are not subject to withholding tax;
Income derived from transferable securities (for instance dividends received and capital gains on the sale of shares) is exempt from Luxembourg corporate income tax. Income that is not related to investment in risk capital is subject to corporate income tax of 28,59% (for example interest earned on bank deposits, management fees, etc…);
No wealth tax is due;
No withholding tax on liquidation payments;
No VAT on the management of the SICAR;
No subscription tax (taxe d’abonnement).

(iii) At investor level

Foreign investors are not subject to Luxembourg tax on any capital gain realized upon the sale of the shares of the SICAR.

III. PRACTICAL RELEVANCE (EXAMPLES) OF THE SICAR

Used as holding company for repatriation of profits as there is an exemption of capital gains realized by non-resident investors on the shares of the SICAR;
Used as holding company for subsidiaries to which the participation exemption does not apply. Based on the Law, there will always be an exemption of income from transferable securities (even if the conditions of the participation exemption have not been fulfilled);
Used as draw-down structure (intermediary financing equity company) in order to downstream cash for investments in risk capital, as there is no wealth tax of 0,5% on the net asset value.
Used for private equity structures (as alternative to other vehicles such as the Soparfi or the SIF (specialized investment fund).

IV. GUIDELINES ON THE CONCEPT OF “RISK CAPITAL”

On 5 April 2006, the CSSF issued a circular letter (06/41) (the “Circular”) containing guidelines and clarifications on the criteria applied by the CSSF when assessing whether a project is eligible under the SICAR law or not.

(a) Concept of risk capital

The purpose of the SICAR law is to favour the collection, in a vehicle specialized in risk capital, of funds contributed by well-informed investors accepting with full awareness and in expectation of a better return the increased risks most often associated with risk capital, i.e. lower liquidity, higher price volatility and lower credit quality.

Risk capital is defined in the SICAR law in a broad manner as to include any direct or indirect contribution of assets to entities in view of their launch, their development or their listing on a stock exchange. The Circular reminds that SICAR application files submitted for CSSF approval require the simultaneous combination of two elements i.e. (i) a high risk associated with the investment in the target company and (ii) the intention to develop the target company, which is broadly construed as the “creation of value” at the level of the target companies.

(b) In general

The creation of value may take different forms:

? The type of financing

Financing may be through bond issuance, bridge financing, share capital, mezzanine loans, convertible loans, etc.

? Different investment types

It may take the form of buy-offs, LBO’s, MBO’s, and management buy-ins, etc.

? No restrictions as to the exit of investors

The exit of the investors in the target company can be structured in the most efficient way from a legal and tax perspective (i.e. via a trade sale of assets or via an initial public offering).

? Risk repartition

The SICAR law does not impose any risk repartition with respect to the selected investments and it is thus possible that certain SICARs limit their investments to one or several companies active for example in a niche market or in extremely specialized sectors.

? Holding period

The CSSF stressed that the contemplated holding period of an investment is an important criterion in determining whether it is eligible to be considered risk capital. Therefore, the declared intention of the SICAR must be in general to acquire financial assets with a view of a resale at a profit.

(c) Special case for real estate investments

Whereas the SICAR law does not allow SICARs to directly hold real estate properties, the indirect investments via entities which hold real estate properties is permitted. The Circular gives criteria of eligibility of investments in private equity real estate under the SICAR Law.

The CSSF has confirmed that private equity real estate investments must be made for the purpose of creating value, which can be understood as a change to the existing conditions such as the enhancing of the valuation of the real estate by renegotiation of contracts, renewal of tenants and refurbishment of the properties. Furthermore it is necessary to demonstrate that the relevant real estate represents a specific risk, beyond the normal real estate risk attached to such real estate in a given market. Such specific risk can lay for example in the fact that it is difficult to find tenants or that the real estate is located in an unfavourable zone.

The CSSF has set out a series of criteria which will be taken into account when assessing whether a private equity real estate investment is eligible to fall within the scope of the SICAR law.

? The potential for significant profit due to the specific risks attached to the property;

? High risk/ expected return ratio;

? Identity of the management, the nature of their remuneration and procedure for selecting real estate property;

? Financial participation of the managers;

? Active development of property, limited holding period ;

? Nature of financing: significant leverage, mezzanine type of financing.

(d) Indirect investments

The Circular clarifies the types of companies that can be used in a structure of indirect investment in risk capital. The indirect investment via an UCI (undertaking for collective investment) or another private equity vehicle is acceptable provided the investment policy of the UCI restricts them to investing in assets that are eligible under the SICAR Law. However, the investments into hedge funds are not eligible as hedge funds do not pursue the creation of value for its own investments.

(e) Political risk

The geographical localization of investments in countries where there is a political risk can be taken into account when assessing whether a given investment constitutes a given risk. However, it is possible that it may be necessary to demonstrate the existence of additional risk factors so that creation value at the level of the target company can be proven.

(f) Mezzanine loan

Mezzanine financing is an eligible form of financing insofar as the financing is made to a non-listed company or to a listed company if the financing is given in view of a specific development project.

(g) Investment in listed securities

A SICAR may invest in listed securities when associated to a specific development project or if aimed at a delisting.

It should be noted that the CSSF has not set out hard rules on what does or does not qualify as a SICAR but rather guidelines and clarifications. Each SICAR project will be reviewed by the CSSF on a case-by-case basis.

V. AMENDMENTS TO THE SICAR LAW

On 29 October 2008, a law was passed amending the existing SICAR Law of 15 June 2004 with the aim to make the SICAR regime more attractive to private equity and venture capital investors.

The main amendments that have been voted are briefly set out hereunder:

Umbrella structure

The new SICAR Law has introduced the possibility to create multiple compartments. The principle of compartment segregation already well known for SIFs, securitization vehicles and UCITS funds is now also applicable to the SICAR. Compartment segregration means that the liabilities of the SICAR can be split into different compartments each of which are treated as separate entities making distinct transactions. The rights of investors and creditors are limited to the risks of a given compartments's assets. Each of the compartments can be liquidated separately without triggering the liquidation of other compartments of the SICAR. The main advantage of the umbrella SICAR is that it can issue several tranches of securities corresponding to different collateral and providing different values, yields and redemption terms. It is important that the constitutional documents of the SICAR expressly provide for the possibility to have multiple compartments and expressly outline the rules that are applicable to them. The issue document must outline the investment policy of each compartment. The shares of the umbrella SICAR may be of different value.

Minimum capital

The share premium (if any) will be taken into account for the computation of the minimum capital. The share capital increased by the share premium must be at least 1,000,000 Euro to be reached within a period of 12 months from its authorization by the CSSF.

No requirement to publish the NAV

Under the initial SICAR Law it was required to provide the net asset value to the investors every 6 months. This provision has been abolished.

Valuation of assets

The valuation of the assets of the SICAR must be based on the fair market value (rather than the foreseeable sales price estimated in good faith).

Reduction of the duties of the custodian

The SICAR Law has reduced substantially the duties of the custodian. More in particular, the following duties do not need to be fulfilled by the custodian under the new SICAR Law:

- control that the subscription price for the securities of the SICAR has been received within the time limits set forth in the constitutive documents;

- control that in transactions involving the assets of the SICAR, a consideration is paid or delivered to it within the customary time limits;

- control that the income of the SICAR is applied in accordance with its constitutive documents.

The abolition of the above control duties previously imposed on the SICAR will certainly reduce the annual costs charged by the custodian of a SICAR.

Annual report

The annual report must be provided to investors within a period of 6 months after the end of the financial year rather than be "published" as was required under the initial SICAR Law.

Limited partnership (soci¿ en commandite simple)

The SICAR can now be set up as a soci¿ en commandite simple (limited partnership) with a variable share capital.

VI. CONCLUSION

The SICAR offers in a market place renowned the world over an attractive new vehicle which also ensures that, from a Luxembourg tax point of view the vehicle is totally neutral for the investors and which reduces the regulatory burden while ensuring a minimum of protection from investors. The SICAR may become the vehicle of choice for private equity and venture capital investors. It is important in each project to carefully examine which vehicle would suit the best (Soparfi, SICAR, SIF or a securitization vehicle).

Madoff case (Luxalpha SICAV) - orders imposed by the Luxembourg CSSF on UBS (Luxembourg) S.A.

nospam@example.com (Olivier Sciales) — Wed, 25 Feb 2009 15:36:06 -0500

On 25 February 2009, the Luxembourg regulator (CSSF) (Commission de Surveillance du Secteur Financier) took the following decisions towards UBS (Luxembourg) S.A. The CSSF ordered UBS (Luxembourg) S.A.:

to put into place the necessary infrastructure (i.e. all sufficient human and technical means and internal rules in order to carry out all the duties and tasks related to the function of custodian bank of a Luxembourg undertaking of collective investment in accordance with the law of 20 December 2002 on undertakings of collective investments, as amended from time to time (the "Law of 2002") and Circular IML 91/75. UBS (Luxembourg) S.A. is required to provide evidence of such adequate guarantees to the CSSF within a period of 3 months as of the date of notification of the decision of the CSSF to UBS (Luxembourg) S.A. It is important to note that the CSSF mentioned that the wrongful execution of the obligation of "due diligence" constitutes a serious breach of the supervisory duty (devoir de surveillance) of a custodian bank and can consequently constitute a violation of a contractual obligation in view of the legal provisions imposed by the Law of 20 December 2002. Article 36 of the Law of 2002 provides that "the depositary shall, be liable, in accordance with Luxembourg law to the shareholders for any loss suffered by them as a result of its wrongful improper performance thereof".
to analyse and rectify all the structures and procedures in place in relation to its supervisory duty (obligation de surveillance) as custodian bank and UBS (Luxembourg) S.A. shall pay damages in case of breaches to the above-mentioned supervisory duty as custodian bank imposed upon by Luxembourg law, without prejudice to any contractual provisions to the contrary and/or as the case may be any court decision.

The right of injuction of the CSSF is based on article 59 of the Law of 5 April 1993, as amended from time (the "Law on the Financial Sector"), which provides in paragraph (1) that "where a person subject to the supervision by the CSSF is not complying with the provisions of any laws, regulations or memorandum and articles of association relating to him, or where his management activities or financial situation are not such as to constitute an adequate guarantee of proper discharge of his commitments, the CSSF shall enjoin that person, by registered letter, to remedy within such period as it may prescribe the situation found to exist".

It is furthermore important to set out what the consequences may be in case UBS (Luxembourg) S.A. would not comply with the above orders. These can be found in Article 59 paragraph (2) of the Law on the Financial Sector which provides that "if, by the end of the period prescribed by the CSSF pursuant to the preceding paragraph, the situation in question has not been remedied, the CSSF may:

(a) suspend the members of the administrative, executive or management bodies or any other persons who, by their actions, negligence or lack of prudence, have brought about the situation found to exist or the continued exercise of whose functions may prejudice the implementation of recovery of reorganisation measures;

(b)suspend the exercise of voting rights attaching to shares held by shareholders or members whose influence is likely to operate to the detriment of the prudent and sound management of the persion in question;

(c) suspend the pursuit of that person's business or, if the situation found to exist concerns a particular area of business, the pursuit of the latter."

The CSSF is entitled on the basis of article 53 of the Law on the Financial Sector to request from any person subject to supervision by it (i.e. UBS (Luxembourg S.A.) any information which may be of assistance in the performance of its tasks. The CSSF may in light of this provision inspect books, accounts, registers or any other deeds and documents belonging to such persons.

In view of the above, it will be important for UBS (Luxembourg) S.A. to evidence proof and provide the adequate guarantees (as mentioned above)to the CSSF within the prescribed period of 3 months.

The question could also be raised what the legal impact is in court of such press releases. The legal impact in court of the content of such press release is in my opinion limited as a press release or circular issued by the CSSF must limit themselves so as to interpret the rules set out under the applicable Luxembourg laws, without being able in principle to create new rules. In other words, it is not the press release or a circular which can impose by themselves new obligations on parties but only the applicable laws. However, the interpretation made by the CSSF is an indication of how the laws could be applied in court, taking into account that the courts could always adopt a different interpretation.

Madoff case - HERALD (LUX) - decision by the CSSF to withdraw HERALD (LUX) from the official list

nospam@example.com (Olivier Sciales) — Mon, 16 Feb 2009 17:56:43 -0500

On 11 February 2009, the Luxembourg regulator (CSSF) has announced, in view of the establishment of the responsibilities of the various intermediaries in relation to HERALD (LUX) and the custodian bank HSBC SECURITIES SERVICES (LUXEMBOURG) S.A., to take the following two decisions, namely (1) to withdraw HERALD (LUX) from the list on the basis of article 94 (2) of the Law of 20 December 2002 on undertakings of collective investments which provides that maintaining an entry on a list shall be subject to observance of all the provisions of laws, regulations or agreements relating to the organisation and operation of UCIs and the distribution, placing or sale of their units and (2) thereafter to request the judicial liquidation of HERALD (LUX).

The decision to withdraw HERALD (LUX) from the list of authorized UCIs is based on the fact that Luxalpha SICAV does not observe any longer the provisions in relation to the organisation and functioning of Luxembourg undertakings of collective investments. This withdrawal has as consequence the suspension of all payments made by HERALD (LUX) and the prohibition by HERALD (LUX) to perform any acts other than conservatory acts. The decision of withdrawal will become permanent after a period of one month, except in case of appeals. As soon as the decision of withdrawal will become permanent, the CSSF will request from the Luxembourg court (tribunal d'arrondissement) the judicial liquidation of HERALD (LUX). In case of a liquidation decided upon by the court, the court will appoint a liquidator to realize the assets of the SICAV.

Should you have any questions, feel free to contact me at oliviersciales@cs-avocats.lu.

Luxembourg - Hong Kong double tax treay entered into force - international tax planning opportunities

nospam@example.com (Olivier Sciales) — Mon, 16 Feb 2009 17:29:55 -0500

The Luxembourg - Hong Kong double tax treaty has entered into force on 20 January 2009 following the exchange of the ratification documents.

I set out hereunder the main features of this treaty. The maximum withholding taxes that will be applicable are as follows:

0% on dividends if the beneficial owner is a company that directly holds at least 10% in the capital of the distributing company or the participation has an acquisition cost of at least 1,200,000 Euro;
10% on dividends in all other cases;
0% on interests; and
3% on royalties paid from Hong Kong to Luxembourg. According to Luxembourg internal law, royalties other than royalties for the use of, or the right to use, any copyright of literacy or artistic work are not subject to withholding tax.

Capital gains realised on the sale of assets are taxed in the place where the seller is resident, except if the sold asset qualifies as:

- immovable property situated in the other contracting party;

- movable property allocated to a permanent establishment in the other contracting party;

- shares of a company more than 50% of the value of which is derived directly or indirectly from immovable property situated in the other contracting party;

In other words, a sale of shares held by a Luxembourg parent company in a Hong Kong subsidiary will be only taxable in Luxembourg. In accordance with Luxembourg internal law, such capital gains will be exempted from capital gains tax if the Luxembourg company owns more than 10% of the capital in the Hong Kong subsidiary and the disposal takes place within 6 months of the acquisition of the shareholding.

Given that Luxembourg has a very favourable holding regime and an extensive tax treaty network, as well as being a member state of the European Union, Chinese and Hong Kong investors may be able to use this tax treaty as a platform for their European investments.

Should you have any questions, feel free to contact me at oliviersciales@cs-avocats.lu.

Madoff case - Luxalpha SICAV - decision by the Luxembourg regulator to withdraw the fund from the list and request of liquidation

nospam@example.com (Olivier Sciales) — Tue, 03 Feb 2009 20:07:32 -0500

On 3 February 2009, the Luxembourg regulator (CSSF) has announced, in view of the establishment of the responsibilities of the various intermediaries in relation to Luxalpha SICAV and the custodian bank UBS (Luxembourg) S.A., to take the following two decisions, namely (1) to withdraw Luxalpha SICAV from the list on the basis of article 94 (2) of the Law of 20 December 2002 on undertakings of collective investments which provides that maintaining an entry on a list shall be subject to observance of all the provisions of laws, regulations or agreements relating to the organisation and operation of UCIs and the distribution, placing or sale of their units and (2) thereafter to request the judicial liquidation of Luxalpha SICAV.

The decision to withdraw Luxalpha SICAV from the list of authorized UCIs is based on the fact that Luxalpha SICAV does not observe any longer the provisions in relation to the organisation and functioning of Luxembourg undertakings of collective investments. This withdrawal has as consequence the suspension of all payments made by Luxalpha SICAV and the prohibition by Luxalpha SICAV to perform any acts other than conservatory acts. The decision of withdrawal will become permanent after a period of one month, except in case of appeals. As soon as the decision of withdrawal will become permanent, the CSSF will request from the Luxembourg court (tribunal d'arrondissement) the judicial liquidation of Luxalpha SICAV. In case of a liquidation decided upon by the court, the court will appoint a liquidator to realize the assets of the SICAV.

Luxembourg SIF (specialized investment fund) - guidelines on the risk diversification rules

nospam@example.com (Olivier Sciales) — Tue, 03 Feb 2009 07:25:38 -0500

On 3 August 2007, the CSSF (Luxembourg regulator) issued a circular letter 07/309 (the “Circular”) containing guidelines on the principle of risk spreading as laid out in article 1 of the Law of 13th February 2007 on specialized investment funds (the “SIF Law”).
Article 1 of the SIF law provides that:
“For the purpose of this Law, specialized investment funds shall be any undertakings for collective investment situated in Luxembourg: - the exclusive object of which is the collective investment of their funds in assets in order to spread the investment and to ensure for the investors the benefit of the results of the management of their assets….”.
In general the CSSF has upheld a flexible interpretation to the principle of risk spreading with some minor restrictions. The CSSF leaves it up to the investors of the fund to evaluate the principle of risk spreading by gathering themselves all the information they deem necessary. As a general matter, the CSSF considers that the principle of risk spreading is fulfilled if the investment policy of the fund is in accordance with the following guidelines:

An SIF can in principle not invest more than 30% of its assets in securities of the same type issued by the same issuer. These restrictions are not applicable for:
- Investments in securities issued or guaranteed by a member state of the OECD or by its public collectivities or by a supranational organization with a global or regional character;
- Investments in target UCIs whose risk spreading criteria are at least equivalent with those required for the SIF.
Uncovered sales can in principle not have as consequence that the SIF holds a covered position on securities of the same type issued by the same issuer which represents more than 30% of its assets;
When derivative instruments are used, the SIF has to ensure an equivalent risk spreading policy by an appropriate diversification policy of its underlying assets. In over the counter operations, the risk of consideration has to be limited in function of the quality and qualification of the consideration.

These guidelines apply in principle to each SIF. However, the CSSF can provide for derogations based on an appropriate justification.

Luxembourg funds - CSSF press release on the Madoff case (23 January 2009)

nospam@example.com (Olivier Sciales) — Tue, 27 Jan 2009 18:59:19 -0500

The CSSF has recently announced in its press release of 23 January 2009 that a number of Luxembourg funds and sub-funds as set out hereunder have decided to suspend their NAV as well as redemptions, subscriptions and conversions of shares / units:

- Herald (Lux)

Sub-fund US Absolute Return Fund

- Luxembourg Investment Fund

Sub-fund U.S. Equity Plus

- Luxalpha Sicav

Sub-fund American Selection

- Norvest

Sub-fund Arbitrage

- Global Fund Selection Sicav

Sub-fund Balanced Sub-fund
Sub-fund Growth Sub-fund
Sub Fund X-tra Alternative Investments Sub-fund

- Carat (Lux) Sicav

- Sub-fund Global One

- LRI Invest Alpha Stable ?

- BG Umbrella Fund

Sub-fund BG Global Classic
Sub-fund BG Global Dynamic
Sub-fund BG Global Challenge
Sub-fund BG Global Balance
Sub-fund BG Global Discovery
Sub-fund BG Stable Value

- M.A.R.S. Fund

Sub-fund One (c)

- Pareturn

Sub-fund Best Selection

The CSSF furtermore noted that the above UCIs are currently exposted up to EUR 1,7 billion.

Should you want to have more information, feel free to email me at oliviersciales@cs-avocats.lu

Continue reading "Luxembourg funds - CSSF press release on the Madoff case (23 January 2009)"

Role of the depositary in a Luxembourg UCITS fund - a general overview as a result of the Madoff case (i.e. Luxalfpha, Herald, Norvest, etc.)

nospam@example.com (Olivier Sciales) — Wed, 21 Jan 2009 18:11:51 -0500

This article intends to provide general guidance as to the role of a depositary in a Luxembourg investment fund (and more particular in relation to a UCITS fund (part I of the Law of 2002) in the form of a SICAV ("hereafter referred to as the "fund"), and does not purport in any manner to give any opinion on any cases set out hereunder or other cases related to the Madoff case.

The effect of the alleged Ponzi scheme in which Bernard Madoff was implicated – involving losses of more than $50 billion – are already widespread. A consequence is that the liability of the main actors of the investment funds involved is called into question.

Any finding of liability in the forthcoming litigations is likely to involve thorny issues. Indeed a fund requires the services of a large number of actors (the board of directors of the funds, the promoter, the depositary, the central administration agent, the auditor, etc.) and it is unclear how far in the hierarchy the (potential) liability shall extend. In any case, the diversity of the regimes of responsibility under which each actor is subject (whether it is contractual liability or not) will probably cloud the issue. Matters will also be made more complex by the wide variety of legislations that come into play as a result of the internationalization of investments.

I. Duties of the depositary

The role of the depositary bank is set out in the Luxembourg law of 20 December 2002 as amended (the "Law of 2002"), and in the circular of the IML (currently named the CSSF) 91/75 (as amended by the circular 05/177). The Law of 2002 provides that the custody of the assets of the fund must be entrusted to a depositary. However, a crucial clarification by the CSSF in Circular 91/75 provides that: "the concept of custody used to describe the general mission of the depositary, should be understood not in the sense of ‘safe-keeping’ but in the sense of ‘supervision’, which implies that the depositary must have knowledge at any times of how the assets of the UCI have been invested and where and how these assets are available". The physical deposit of all or part of the assets may be made either with the depositary itself or with any professional designated by the fund in agreement with the depositary. The general mission of a depositary is threefold, encompassing the preservation of the assets of the UCI, the control of some of its operations, and the day-to-day administration of the assets of the fund.

This means that the depositary must inter alia process the receipt of dividends, interests, etc.. However, the depositary does not have to execute itself all the duties incumbent upon it and can be assisted by third parties in the execution of transactions or can delegate to third parties the execution of transactions. However, this cannot lead to a situation where all duties are concentrated in the hands of one and the same party. The depositary must – in order to satisfy its obligation of supervision – organise its relations with the third parties in such way that it is immediately informed of all the transactions that the third parties execute in relation to the day-to-day administration of the assets which they hold.

The depositary must also:

ensure that the sale, issue, redemption and cancellation of units effected on behalf of the fund are carried out in accordance with the law and the articles of incorporation;
ensure that in transactions involving the assets of the fund, the consideration is remitted to it within the customary time limits; and
ensure that the income of the fund is applied in accordance with the articles of incorporation.

The CSSF has argued that the term "ensure" as used in the Law of 2002 implies that the depositary must not "execute" itself the tasks but must verify the execution of the tasks imposed on it. It is important to note the difference between the duties of the depositary of, on the one hand a FCP (fonds commun de placement) subject to part I of the Law of 2002 and, on the other hand a SICAV or any other UCI which has not been constituted as a collective investment fund. In case of a FCP (part I of the Law of 2002), the depositary has two additional specific supervisory and monitoring duties such as (1) carrying out the instructions of the management company, unless they conflict with the law and the management regulations and (2) ensuring that the value of units is calculated in accordance with the law and the management regulations.

II. Liability of the depositary

If anyone suffering damage must prove the depositary’s negligence in respect of its duty of supervision and the causal relationship thereof, the duty of supervision of the assets of the fund and consequently the liability for such supervision always resides with the depositary. As laid down in the Circular IML 91/75 (as amended by Circular CSSF 05/177), the depositary may, in no case, release itself from the duty of supervision and hence any provision of the articles of incorporation or any other agreement aiming to exclude or limit this liability are null and void, and under Article 34 (2) of the Law of 2002, the depositary’s liability shall not be affected by the fact that it has entrusted all or some of the assets in its custody to third parties. This has also been repeated in a press release issued by the CSSF on 2 January 2009 as a result of the Madoff case. The depositary may only be discharged from its duty of supervision when it is satisfied from the outset and during the whole duration of the contract that the third parties with which the assets of the fund are on deposit are reputable and competent and have sufficient financial resources. Importantly, the CSSF stated that it would not limit its analysis to the depositary banks concerned but would verify that all the parties involved acted with the diligence imposed by Luxembourg law.

The above elements are likely to be crucial in the litigations flowing from this groundbreaking swindling. The current regime governing the liability of a depositary is likely to be subject in the forthcoming months to substantial reforms, involving the enactment of more stringent – and probably more precise – investor protection rules. Indeed France, backed by Mr. Luc Frieden, the Luxembourg Minister for the Treasury and Budget, is currently calling for legislation to strengthen the protection of investors across Europe.

Chevalier & Sciales is a Luxembourg law firm mainly focused on Investment Funds (UCITS and SIFs), Securitizations, Corporate Law and Private Equity. For more information please visit our website at www.cs-avocats.lu or contact Olivier Sciales at oliviersciales@cs-avocats.lu.

Please note that the information contained herein is not intended to be a comprehensive study or to provide legal advice, and do not substitute for the consultation with legal counsel required before any actual undertakings. We undertake no responsibility to notify any change in law or practice after the date of this document.