The expansion of the alternative investment fund sector in Europe is one consequence of the 2008 financial crisis and subsequent debt crisis. The resulting tightening of access to credit has forced recourse to alternative sources of investments and financing for developing new projects in the real economy. In parallel, since several years, assets such as government bonds no longer offer attractive returns on savings.

The EU has worked on various legislative initiatives in order to create an appealing, whilst protective, framework for alternative investments in Europe, starting with the implementation of AIFMD in 2013.

With its EU passport, the AIFMD strongly encourages managers to set-up their operations in Europe and professional investors to invest into EU alternative investment funds.

Luxembourg is playing a key role in this European agenda, with well-established fund infrastructure. Luxembourg is usually one of the first movers when it comes to transposing EU legislation and always tries, at the same time, to renew, update and upgrade its own legislation and product offering accordingly, so as to always stay at the forefront of the industry.

At the same time as the transposition of the AIFMD, Luxembourg has modernised company law and created a new legal form – the special limited partnership – in order to compete with the leading alternative fund jurisdictions and to address the needs of the market. Subsequently, Luxembourg has created a new regulatory wrapper – the reserved alternative investment fund – in order to grant an attractive regime to non-supervised (hence quicker to set-up) fund vehicles.

A second key step in the EU’s Capital Markets Union (CMU) plan was the opening of alternative investment funds to retail investors, beginning with the creation of three EU alternative investment fund labels since 2015, which enabled the marketing of such funds to retail investors under an EU wide passport.

On 24 May 2023, the EU Commission adopted a Retail Investment Strategy, which is part of its longstanding journey of boosting the injection of capital into the European economy under, notably, the CMU plan.

EU citizens need opportunities to make savings and investments that are both attractive and safe. Combining those two criteria is, however, a challenge when it comes to alternative investment funds, given that they generally present higher risks due to the nature of their investments, the lack of liquidity, the long-term holding period, the return uncertainty, the recourse to leverage and the use of complex and cross-border structures.

This is why, to mitigate the risks and ensure maximum protection, the EU legislator has imposed very stringent conditions and restrictions on fund managers wanting to market alternative funds under one of the EU fund labels to retail investors.

Unfortunately, some of these conditions and restrictions appeared, in practice, to be incompatible with the purpose and features of alternative investment products and therefore the EU fund labels have not been very successful.

The EU has reassessed the way investors (and retail investors in particular) can be protected and launched a new CMU plan in 2020 resulting in different initiatives.

The ELTIF regime was amended in March 2023, creating some flexibility in its requirements (in particular in terms of investment scope, composition of portfolio and redemption rights).

At (almost) the same time, Luxembourg amended the laws applicable to its investment fund vehicles and managers, aligning its offering with the EU’s direction of travel.

We believe that greater democratisation of alternative investments has occurred because, in parallel, there are different safeguards being implemented at EU level to ensure that clear information is given to retail investors, comprehensive disclosures are made to them, products and managers are under higher scrutiny by the regulators and more transparency is requested from them.

The wave of EU Directives and Regulations of the past decade (AIFMD, MiFID, AML, SFDR, CBDF, SFTR, EMIR, DORA, MICA - to name a few) may be a necessity (or depending on the perspective an opportunity) to boost alternative investments in Europe, so as to become the most reputable and safest place to invest into or through.

The EU’s journey will continue, in particular with the Retail Investment Package issued in May 2023, which contains several proposals around investors’ protection to be implemented over the next few years, and with the current review process of certain existing EU frameworks.

There may be a risk that smaller asset managers affected by this regulatory wave may not be able to afford the cost of offering such investment products to retail investors with a consequent reduction in competition in the market.

The challenge for regulators is to produce regulation which is sustainable in the long term (especially in times of difficult market conditions) an actually benefits the end investors.

To conclude, existing EU initiatives offer the potential to allow asset managers to grow their alternative asset offerings and for investors to grow their investment returns. Luxembourg’s proactive response to them may signal that the regulators will take into consideration the reality of the markets and balance the various stakes at hand in implementing the measures.

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