Many managers identify and assess the key legal and commercial costs and benefits of AIFMD passports as well as the short- and long-term regulatory and operational implications of the management of the fund by an EU-based manager. Current solutions available to UK managers to address Brexit-related risks are opportunities to consider for non-EU fund managers such as U.S. managers launching a Luxembourg fund or a Luxembourg sleeve alongside a U.S. fund. Below is a snapshot of options available to non-EU managers to consider how best placed they are to market and manage a Luxembourg fund that is most frequently set up as a partnership.
Options without an EU Manager that is authorized and supervised by the CSSF
Lower launch and operational costs are the key drivers for the two options below.
1. Non-EU sponsors may consider setting up a Luxembourg fund, with a Luxembourg general partner and a non-EU manager. Non-EU managers are classified as a “third-country manager” under the AIFMD. At the time that the AIFMD came into force, it was anticipated that management of EU alternative investment funds by third-country AIFMs would be regulated under the AIFMD by virtue of Article 3,7 which was drafted to regulate the authorisation of non-EU AIFMs intending to manage and/or market alternative investment funds in the EU in accordance with Articles 39 or 40 (i.e., third-country passporting). However, the third-country AIFM provisions of the AIFMD have never been considered, which means that the management by a non-EU manager of an EU fund is a matter of local law. Luxembourg never ‘gold plated’ the AIFMD, and in Luxembourg law non-EU AIFMs may manage Luxembourg funds, noting that consideration needs to be given to where the services are rendered (location of the manager or Luxembourg) to assess as applicable any licensing requirements, provided that the non-EU manager does not provide MiFID II/MiFIR services to other Luxembourg based-entities (e.g., as adviser to these entities which may be, for instance, holding companies owned by the fund). It should be noted that Luxembourg strengthened its position on the activities of non-EU advisers on 10 April 2019 with CSSF circular 19/716, setting out applicable regulatory requirements for non-EU firms providing investment services to Luxembourg entities or performing investment activities and ancillary services in Luxembourg.
The key advantage of this option is that the work is done directly by the non-EU manager, thus removing compliance and other requirements (e.g., in the case of a delegation, the oversight by the Luxembourg-based manager).
The major drawback to this option is the absence of any marketing passports to market the Luxembourg fund throughout Europe. In such case, the non-EU manager must apply to market the fund via national private placement regimes (NPPR), but the NPPR is not available everywhere in Europe. The application for the NPPR regime in the relevant European countries triggers costs (with the payment of an annual fee to most regulators) and a regulatory burden, but these are lesser than the costs of an EU manager as provided under Section B below.
Costs are also potentially substantially reduced, as it may be possible to avoid the appointment of a depositary (subject to NPPR requirements).
For example, in order to market in Luxembourg, two forms will need to be completed and sent to the Luxembourg Commission de Surveillance to Secteur Financier (CSSF), (being the Luxembourg supervisory authority). There is no approval process per se to market in Luxembourg, but it is strongly advised to wait for CSSF confirmation in writing before marketing in Luxembourg. In addition, the non-EU manager would become, in so far as Luxembourg compliance obligations are concerned, subject to certain reporting obligations which can be found here. In addition, if the CSSF considers it necessary for the effective monitoring of systemic risk, it may require the investment manager to communicate additional information on a periodic basis, as well as on an adhoc basis. Reports must be provided in a specific format and submitted through an encrypted channel. In practice, some investment managers with no operations in Luxembourg use a local service provider who will provide this reporting channel for their clients and do the reporting for them.
2. Non-EU sponsors may consider setting up a Luxembourg partnership with a general partner acting as alternative investment fund manager that is subject to the light registration regime. This is generally a solution of choice for smaller funds, including for EU-based management teams, to the extent that the absence of availability of marketing passports as they areavailable for an authorised EU manager are manageable. Currently, more than two-thirds of Luxembourg managers are registered as registered managers benefitting from the registration regime. The reason for this is that registered managers are quicker to set up, less expensive to run and have less burdensome obligations than full-scope EU-authorized managers.
As for the first option considered under paragraph A.1 above, a registered manager is not able to apply for marketing passports to market the Luxembourg fund throughout Europe, and therefore the NPPR regimes that may apply to the targeted investors of the fund would have to be considered carefully.
The specific advantages of this option are as for the option under paragraph A.1 above, but it also addresses requests of certain European investors for an EU-based AIFM “fully onshoreEU structure. In addition, some EU jurisdictions permit marketing by EU sub-threshold managers of a Luxembourg fund, with a regulatory burden that is lighter than their NPPR regime, and no NPPR application is required for marketing Luxembourg investors.
A sub-threshold AIFM can only be an entity with legal personality managing a portfolio of AIFs whose assets under management are either (i) assets acquired through use of leverage not exceeding EUR 100 million, or (ii) assets acquired without leverage not exceeding EUR 500 million and having no redemption rights exercisable during a period of five years following the date of the initial investment in each fund.
The process of registration is straightforward: it requires an application to be filed with the CSSF before the applicant sub-threshold manager starts its activities. This application consists of several documents including among other things an AIFM registration worksheet, certain declarations on investors, leverage, etc., directorship declarations, the AML market entry form and a questionnaire related to EMI R as well as any other documents deemed by it necessary or useful for the purposes of assessing whether the sub-threshold manager may benefit from the registration regime. In our experience, the CSSF usually asks for the copy of the AML procedures of the sub-threshold manager when assessing its file to grant the registration regime. The CSSF ensures that the registered manager complies with the requirements of the laws and regulations governing money laundering and terrorist financing such as notably the Luxembourg law of 12 November 2004 on the fight against money laundering and financing of terrorism, the Grand Ducal Regulation of 1 February 2010, the CSSF Regulation 12-02, the law of 13 January 2019 establishing a Register of beneficial owners, the Grand-Ducal Regulation of February 2019, and the Circular CSSF 19/732.
Reporting requirements are lighter than reporting obligations of an authorized Luxembourg manager. They can be found here.
Options with an authorized EU Manager
The key benefits of the two options below are legal certainty on the management and marketing of the Luxembourg fund and the access to market the Luxembourg fund in each of the targeted EU member-states (rather than complying with each member state’s NPPR, which is much more burdensome and not available in all EU member states). Having strong substance in Luxembourg and managing the fund from Luxembourg or with an EU manager is also in line with expectations from certain investors that require the management of the funds they invest in to be made from an EU memberstate only. The two options are set out below.
- Non-EU sponsors may choose for the general partner of the Luxembourg fund to appoint a third-party service provider to manage the fund, with the non-EU manager acting as investment adviser or delegatee of the service provided for portfolio management functions. This is a quick fix to benefit from any marketing passport needed within the EEA and secures management from Luxembourg. However, this solution provides some control to a service provider which would need to be comfortable with the constitutive documents of the Luxembourg fund, and there are inevitably costs associated with the provision of these services. In practice, this is a solution that is attractive to many smaller funds.
- Setting up a manager within the EU is often considered for larger funds. The licensing process takes at least six months. There are major substance requirements that apply to the EU manager in order to obtain its licence that generally include, among other things, for Luxembourg managers:
- To have its own permanent office space in Luxembourg;
- To have at least three full time employees who are permanently working in Luxembourg, with some flexibility for those managers with assets under management under €1.5bn;
- If a delegation is considered, to delegate only if (i) such delegation was not to result in the Luxembourg manager being a “letter box entity” and (ii) the terms of the delegation comply with the AIFM Directive. In practice, non-EU managers opting for a delegation of portfolio management functions from the Luxembourg manager to the non-EU managers should note that this is only available to those managers supervised by an authority that signed a cooperation agreement with the CSSF (the list can be found here.) As the UK is currently an EU memberstate, no such cooperation agreement is in place, noting that ESMA and EU regulators confirmed on 17 July 2020 the No-deal Brexit Memoranda of Understanding with the UK Financial Conduct Authority (“FCA”);
- To maintain adequate technical infrastructure and human resources to carry out its activities including, amongst other items, business continuity plan, persons in charge of accounting, permanent compliance function, permanent internal audit, permanent risk management, liquidity management, operation conditions, conflict of interest, investment in securitisations positions, valuation and remuneration;
- To comply with AML requirements as provided under paragraph A.2 above; and
- To comply with reporting requirements applicable to authorised Luxembourg managers (click here to see such requirements.)
Non-EU managers should therefore carefully the advantages and drawbacks of each of the options above for the most efficient set up of a Luxembourg fund. UK managers, who will become third-country managers from 1 January 2021 will have to consider the above options, noting that (i) they should in principle continue to manage existing Luxembourg funds subject to certain conditions and (ii) existing delegation agreements should remain legal based on the confirmation of the No-deal Brexit Memoranda with the FCA of 17 July 2020 by ESMA and EU regulators.
Feel free to get in touch with us for any further information on options available in Luxembourg to non-EU managers.