Regulated or not? A billion dollar question?

Retour au dossier

The question to decide between regulated and unregulated funds is generally one of the first questions raised by our clients. Indeed, finding an optimal structure is a fundamental element for the success of a fund project. The decision on its regulatory form will shape the applicable rules framework.

What are the main differences between unregulated and regulated funds?

Luxembourg is the largest investment fund center in Europe and the second largest in the world after the US.

Luxembourg offers a wide range of investment fund structures either regulated or unregulated, capable of accommodating all kinds of demands from fund sponsors investing inter alia in private equity, real estate, infrastructure, debt and hedge funds as well as investors needs.

Luxembourg is the largest investment fund center in Europe and the second largest in the world after the US.
Jevgeniy Nesch

Jevgeniy Nesch,  Partner,  AKD

In brief, Luxembourg regulated non-retail funds may be set up as:

— Part II UCIs,

— SIFs (specialised investment funds),

— SICARs (risk capital investment companies).

Luxembourg unregulated non-retail funds take typically either the form of a RAIF (reserved alternative investment fund) or of an unregulated limited partnership (special limited partnership – SCSp or common limited partnership – SCS).

The main difference between the unregulated and regulated funds is the fact that regulated funds have to be approved prior to their launch and supervised during their life cycle by the CSSF, the Luxembourg regulator of financial sector. Given that, while on the one hand setting-up of a regulated fund may require additional timing and coordination efforts with the regulator, such a fund will certainly benefit from the excellent reputation of the CSSF in the funds industry, proclaims  Jevgeniy Nesch .

What are the main criteria of the unregulated funds?

In the context of an unregulated partnership (the ‘Partnership’) the fund promotor, subject to certain requirements, may either act as or appoint a small fund manager (also known as de-minimis or sub-threshold AIFM) or appoint a fully authorised alternative investment fund manager (the ‘AIFM’) with the main difference that the latter would benefit from EU marketing passport, says  Virginie Leroy .

A fund under the form of a RAIF benefits from the reputation of a well-recognized RAIF brand, regulatory and corporate flexibility as well as attractive tax regime. Depending on the RAIF’s investment strategy, the law offers the possibility to structure the fund as a risk-diversifying vehicle (SIF-like RAIF) being the default option or as a vehicle investing in risk capital assets only (SICAR-like RAIF) being the alternative. This choice will have impact on several aspects of the structure, inter alia the tax regime and eligibility of the fund assets.

Even though the RAIF is not regulated and does not need to be approved prior to its launch by the CSSF, the RAIF needs to appoint an AIFM that is fully regulated and supervised by the CSSF. Furthermore, the RAIF is also required to appoint a regulated entity acting as depositary in accordance with the European directive on AIFMs (the ‘AIFMD’) whose main function will be to safeguard the assets of the Partnership.

Speaking about the unregulated partnership vehicles, the main difference between the SCS and the SCSp is the legal personality. SCS is a legal entity, while SCSp does not constitute separate legal personality distinct from its partners. Both partnerships have two different types of partners being the general partner with unlimited liability for all the obligations of the partnership (the ‘GP’) and the limited partners whose liability is capped by the specific amount they contribute to the partnership (the ‘LPs). Practically, the GP (who is mostly set up in form of a limited liability company) take the role of the management body of the partnership while the LP role is typically taken by the investors.

Luxembourg legislation provides for exceptional flexibility in regulating relations between partners as described in the limited partnership agreement, the constitutive document of the Partnership (the ‘LPA’). Inter alia the profit distribution, the corporate governance and the investment strategy are set forth in the LPA. It creates a unique opportunity to structure the investment projects in the most suitable way to accommodate the needs of the investors and the general partner being generally the initiator of the project.

What are the main drivers for a decision on regulated or unregulated funds?

The decision on the investment fund vehicle is driven in first instance by the investors requirements. Unregulated investment funds offer an efficient and easy tool to structure and operate the project whereas regulated investment funds offer strong legal framework with the CSSF seen as experienced business partner which is from time to time preferred by certain types of investors such as pension funds or large institutional investors.

The decision on the investment fund vehicle is driven in first instance by the investors’ requirements.
Virginie Leroy

Virginie Leroy,  Partner,  AKD

Other aspects can steer the structure in one or another direction. In particular, fund size, investment strategy, manager substance and benefiting from a well-recognized brand such as Luxembourg partnership, SIF, RAIF, EuVECA, etc. play an important role in the structuring process.

Distribution, marketing strategy and cost effectiveness are also factors determining the choice of the investment fund structure.

Can we change the structure during the life cycle of the investment fund?

The excellence of the Luxembourg funds toolbox doesn’t stop at the structuring as the most fund forms can be converted ‘down-the-road’.

What fund vehicle is the best choice?

This will depend on several aspects. Bottom line is that it is like a question about good wine, it is the best, if it suits you.

Written by Virginie Leroy & Jevgeniy Nesch , Partners at AKD.