The EU Commission published on 25 November a draft of updates to rules that will impact Luxembourg’s investment fund industry. One of these is the AIFMD II, an update to the existing directive dealing with alternative investment fund managers that has been in place for the past decade. Another (yet to come) is ATAD III, which aims to eliminate the misuse of so-called shell companies. Both of these could have significant impacts on Luxembourg and add to an expanding set of rules by which the sector must comply.
One of the most strongly felt impacts of AIFMD II might be new rules about the delegation business model on which the Luxembourg fund industry is largely based. The initial approach was largely a quantitative one, meaning a minimum number of people on the ground depending on the assets under management. The proposal which is now on the table is that ESMA will have to be notified if the AIFM delegates more to third countries than what it does itself. One can thus reasonably expect that conditions or restrictions will be adopted in the future.
However, since the first UCITS directive was handed down in 1985 and the first AIFM directive in 2011, Luxembourg has had to deal with new substance requirements, and the sector has responded by investing heavily, both in terms of expanding the number of people working in the field and increasing expertise.
“At the end of the day, there will be even more business in Luxembourg. More substance, more people, more expertise and more growth. I can only be optimistic,’ says Emmanuel-Frédéric Henrion, partner and co-head of the Investment Funds practice of Clifford Chance’s Luxembourg office.
At the end of the day, there will be even more business in Luxembourg. More substance, more people, more expertise and more growth. I can only be optimistic .
Loan funds
Loan funds are increasingly popular, so it is not really a surprise to see AIFMD II dealing with lending activities.
The proposal adds ‘originating loans’ to the list of activities that an AIFM may perform, with the Commission’s explanatory text adding that “this means AIFs could extend loans anywhere in the Union, including cross-border”.
The proposal prohibits AIFs from providing loans that exceed 20% of the AIF’s capital to a single borrower that is a financial institution or collective investment undertaking, and prohibits AIFs from lending to their AIFM or its staff, their depositary or an entity to which their AIFM has delegated functions.
The proposal also introduces a new requirement for AIFs to retain 5% of the notional value of the loans that they originate and subsequently sell on the secondary market.
Taxation changes
On May 18, the EU published ‘Business Taxation for the 21st Century’ which includes five measures, one of which was the DEBRA (debt-equity bias reduction allowance) initiative. The aim is to reduce leverage not only in the private equity industry, but in all types of industries, and this will clearly have an impact on the way Luxembourg funds finance their acquisitions. We cannot say yet how this will be done, but there seem to be two non-exclusive options: give an incentive to equity funding, such as notional interest, or chill the debt by limiting interest deductibility.
ATAD III
We may see ATAD III, which is connected to the related concept of substance and aims to eliminate the misuse of so-called shell companies. We have started to receive some elements of new rules, such as those relating to the type of income that vehicles receive.
‘An entity that receives passive income – interest, dividends, or capital gains – may be seen as a shell company, and these are obviously significant in Luxembourg.’ — , partner and head of the Tax and Pensions practice of Clifford Chance’s Luxembourg office.
An entity that receives passive income – interest, dividends, or capital gains – may be seen as a shell company, and these are obviously significant in Luxembourg.
Since shell companies would have to be reported to the authorities, a high number in Luxembourg would not be politically favourable, of course. Reporting might also go with strengthened controls in terms of substance and business rationale in order to be able to rely on tax-treaty protections and so on.
Growth and new opportunities
New rules imposed on the investment fund industry can lead to growth and new opportunities, as we saw with the UCITS directive in 1985. It created a new vehicle targeting retail investors that is subject to comprehensive rules. UCITS proved to be a huge success and led to the burgeoning of Luxembourg’s fund industry. Another example is the AIFMD. When the EU issued it, many from within the sector were sceptical, but it led to the EU passport which resulted in Luxembourg being able to market its alternative investment funds across the EU. Similarly, new drives to create a degree of harmonisation between the UCITS directive (for purely retail funds) and the AIFMD (for alternative funds) might sound like an imposition, but it could result in an EU product that can be marketed quite easily to other continents.