Back to Basics | Private funds in Luxembourg

Published in December 2021

In brief

The Luxembourg funds market has grown exponentially over the past decade: as of 2020 it had reached a value of over €5 billion, three times its 2006 value, and with over 15,000 investment funds it is now the second largest fund-domicile jurisdiction in the world after the USA.

Luxembourg has historically been quick to grasp any opportunity to enhance competitiveness through speedy and smart legislation, being the first to implement both the European Directive on undertakings for the collective investment in transferable securities (UCITS) and alternative investment fund managers (AIFMD) into national law.

Luxembourg funds can be split in three broad categories:

1. regulated funds which are subject to authorization and supervision by the Commission de Surveillance du Secteur Financier (the CSSF) such as UCITS, specialized investment funds (SIFs) and investment companies in risk capital (sociétés d'investissement en capital à risque) (SICARs);
2. semi-regulated funds such as the reserved alternative investment funds (RAIFs) or unregulated AIFs that are required to appoint fully authorized AIFMs and which are not directly regulated at product level but indirectly supervised through the prudential supervision of their AIFM by the regulator; and
3. unregulated funds, including alternative investment funds (AIFs) which are managed by registered (de minimis) AIFMs.

The term ‘private funds’ has been attributed by market practice to the last two categories (ii) and (iii), being the semi-regulated and unregulated funds or so-called “fonds d’investissement alternatifs non réglementés”. Private Funds are popular in the asset management industry primarily for their speed to market and low establishment costs relative to regulated funds, but they are still subject to certain regulatory restrictions.

Legal structures for private funds

Luxembourg law, particularly the Luxembourg law of 10 August 1915 on commercial companies, as amended (the 1915 Law), provides for a variety of legal structures that can be used for the formation of Private Funds, notably:

• Corporate structures such as the public limited liability company (société anonyme – SA), a simplified public limited liability company (société par actions simplifiée or SAS) or the private limited liability company (société à responsabilité limitée – SARL);
• Partnership structures such as the simple partnership (société en commandite simple, or SCS), a partnership limited by shares (société en commandite par actions, or SCA) or a special limited partnership (société en commandite spéciale, or SCSp) (collectively, the Luxembourg Partnerships).

Luxembourg Partnerships have been the “go to” vehicle for private fund structures for many years now as they offer investor familiarity, freedom from corporate law overrides, limited liability for investors and a generally more favorable tax regime. Since its introduction into Luxembourg, the new SCSp has increased in popularity. Luxembourg Partnerships, in particular the SCSp and to a lesser extent the SCS, have become the most popular private equity fund vehicles in Luxembourg. The SCSp and the SCS are modelled on the successful Anglo-Saxon limited partnership regimes and offer familiar features to investors used to investing through England, Scotland, the Channel Islands, Delaware and other common law jurisdictions. By contrast the SCA offers a hybrid of corporate and partnership characteristics.

The principal difference between the SCS and the SCA regimes on the one hand, and the SCSp regime on the other, is that the SCS and SCA have legal personality separate from that of its partners whereas an SCSp does not have legal personality and must act through its general partner. Unlike many limited partnerships however, the SCSp is legally entitled to hold and register assets and open bank accounts in its own name. Additionally, the SCS and SCA are required to prepare annual accounts, whereas the SCSp is not.

Key features of Luxembourg partnership

The partners: a limited partnership – whether an SCS or an SCSp – is a partnership that is established by contract for a limited or unlimited term between one or more unlimited partners (or general partners) with unlimited and joint liability for the obligations of the partnership and one or more limited partners whose liability is limited to the amount committed to the partnership. In contrast with a SCA, there is no requirement for a minimum capital in order to form these partnerships.

Registration: in contrast to English limited partnerships, an extract of the notarial deed or private instrument (i.e. the limited partnership agreement) establishing the Luxembourg Partnership must be lodged with the Luxembourg trade and companies register (Registre de Commerce et des Sociétés, the RCS) within one month of establishment of the Luxembourg Partnership. Such extract must also be published in the Luxembourg official gazette. The limited partnership adopted on establishment may be a short form “dummy” agreement or the full form final agreement.

Regulation: Luxembourg Partnerships qualifying as alternative investment funds are required to be managed by alternative investment fund managers within the meaning of AIFMD. However, those managed by entities qualifying as sub-threshold AIFMs under AIFMD may simply register their general partner as the manager with the CSSF, and vehicles not qualifying as alternative investment funds (for example certain joint venture vehicles) may be managed by their unlimited partners without any regulatory permissions. The advantages of beginning with unregulated or sub-threshold vehicles include:

• a fast set-up as no regulatory approval is required from the CSSF;
• no requirement to comply with the AIFMD rules (notably no requirement to appoint a depositary bank or an auditor);
• contractual freedom in terms of relationship between the partners, (although the 1915 Law still provides for certain mandatory provisions on the operation of Luxembourg Partnerships, e.g. certain restrictions on limited partners, publication formalities, consent and voting matters).

An unregulated SCS or SCSp may subsequently be converted into a regulated or semi-regulated vehicle such as a RAIF, SIF or SICAR if, for example, external fundraising is foreseen and an EU marketing passport is sought. This would require, amongst other things, the appointment of an AIFM under the AIFMD regime along with the additional required service providers (depositary and auditors).

Rise of the RAIFs

Luxembourg Partnerships regulated as RAIFs have become popular private fund vehicles since their introduction in 2016. A private fund established as a RAIF offers similar structuring flexibility to the more heavily regulated SIFs (e.g. umbrella structures, variable capital, a specific tax regime) without being subject to prior approval by the CSSF, which significantly reduces the time to market.

A RAIF may be established under either a contractual ‘common fund’ form (FCP), a corporate legal form such as an SA or SARL, a corporate partnership limited by shares (SCA) or a partnership form (SCS or SCSp), either with variable or fixed capital (SICAV or SICAF).

Whilst the RAIF regime is comparatively “lite” by regulatory standards, several constraints remain, including:

• a requirement for interests in the RAIF to be offered only to “well-informed investors” (in short, sophisticated investment professionals);
• a minimum capital base of net assets, which must not be less than EUR 1,250,000, and which must be reached within twelve months from the establishment;
• an external AIFM which manages the RAIF;
• the appointment of a depositary and an approved statutory auditor;
• the requirement for the RAIF to have an offering document;
• minimum content requirements regarding the RAIF’s annual report;
• valuation rules regarding the RAIF’s assets; and
• investment and leverage rules regarding certain types of assets.

Looking ahead: The UK-Luxembourg nexus

Brexit has undoubtedly strengthened the hand of Luxembourg’s fund management industry as UK AIFMs have been unable to continue using the coveted EU marketing passport to place interests in Europe and many sponsors have moved to establish AIFMs in Luxembourg to secure future use of the passport.

However, London’s pre-eminence as a global investment management hub has been recognized by both the European and Luxembourg authorities through cooperation agreements allowing portfolio and investment management to be delegated by Luxembourg AIFMs to UK domiciled portfolio and investment managers. The emerging symbiotic regime of cooperation looks promising for both the UK and Luxembourg as it continues to play to their respective strengths as centers of asset management expertise and fund domicile, servicing and distribution.