Luxembourg took the opportunity to revamp the country’s limited partnership regime, just when the alternative investment funds managers directive (AIFMD) was being implemented in the EU. However, few would have predicted the extent to which innovations such as the dual limited partnership regimes and the introduction of the reserved alternative investment fund (RAIF) would capture the interest of global asset managers, and this not just in Europe and the US, but also in Asia, the Middle East, and Latin America. At the same time, the demand for private equity investments boomed.
Alignment of factors
“These were preparations made over years which were in place before external factors aligned perfectly for Luxembourg,” Mr Arbaut noted.
“Managers in the PE sector already mainly used limited partnerships for their offshore funds,” said Mr Arbaut. “So having a flexible, robust, safe Luxembourg limited partnership regime was attractive.”
“Even after Brexit, the attraction of Luxembourg was further increased by the Cayman Islands being temporarily placed on the EU’s tax black list, which encouraged managers to look for alternatives where investors could be most comfortable. And Luxembourg was well placed to capture this,” he said.
Due to the flexibility of the Luxembourg limited partnership, a Cayman Islands or Delaware-based limited partnership can be replicated as an onshore fund. “With growing international discussions around taxation and the increasing global focus on AML/KYC, this reduced the appeal of offshore jurisdictions, in particular for EU investors,” he added. With institutional and professional investors keen to reduce reputational risk, this encouraged them to look elsewhere. “Sponsors tell us that if you want to raise mainly European money and if you want to do it via a Cayman fund, the question that often pops up from investors is ‘why don’t you use a Luxembourg fund?’”
Innovations such as the reserved alternative investment fund (RAIF) improved time to market as there is no regulatory approval to launch the fund, and this was an important innovation to help the sector grow. Yet as well, this measure was introduced with fortuitous timing: being introduced about a month after the Brexit referendum.
These factors came together so that Luxembourg has become a PE industry standard. Work continues nationally to maintain this lead, not just with feedback between the industry and government, but collaborative efforts from across the industry to share knowledge and achieve mutually beneficial growth. “We shouldn’t underestimate the efforts put in by industry bodies, such as the LPEA and the ALFI, and providers such as law firms, the auditors and other service providers who keep Luxembourg on asset managers’ radars,” he added.
We shouldn’t underestimate the efforts put in by industry bodies, such as the LPEA and the ALFI, and providers such as law firms, the auditors and other service providers who keep Luxembourg on asset managers’ radars.
Thus when green investing seizes market interest, and solutions are needed to launch funds compliant with ESG norms, managers have come to turn to Luxembourg to find answers. “The way the SFDR [Sustainable Finance Disclosure Regulation] has been implemented at EU level has been a somewhat confusing, in that when the rules came into force, there was a lack of clarity. Managers are not always sure when it means to either promote a sustainable objective or having that objective in itself,” said Mr Arbaut. “Again, the industry published some welcome guidance to help managed navigate the new rules.”
He notes that some sponsors feel as if this regulation is an additional, unwelcome burden on top of a range of other regulatory challenges, “but I think that that’s the wrong way to think about it”. This is a trend which is to a large extent driven by market appetite, and this regulation works to give clarity to the often nebulous idea of green investing. He also sees an advantage for the European fund industry being the front runner on ESG.
Care when reforming AIFMD
Which is why Mr Arbaut is wary about the planned reform of AIFMD. “We don’t know where it’s heading exactly, but from the echoes we hear, there’s a danger if Europe seeks to be overly protective,” he said. In particular, there are concerns about talk of restricting the ability of funds to delegate portfolio management functions. “I don’t think that you necessarily need to have all your knowledge and experience based in Europe, and the best managers are not necessarily based here.”
I don’t think that you necessarily need to have all your knowledge and experience based in Europe, and the best managers are not necessarily based here.
He sees this as a clear risk for private equity and the alternative space generally. “Of course, there need to be rules, boundaries and supervision of what is being delegated, but I think the model has worked well.” AIFMD has become a brand known globally even if it was viewed with some suspicion initially by some in the industry. “Changing the rules dramatically now would not be ideal,” Mr Arbaut said.