Luxembourg’s specialised investment fund concept has been hailed a success. Stefanie Eschenbacher looks at the draft law intended to align these funds with the requirements of the Alternative Investment Fund Managers directive.
Last year’s 279 new additions brought the total number of specialised investment funds in Luxembourg to 1,436. Intended for sophisticated investors willing to accept a higher level of risk, the products have even rivalled the popularity of Ireland’s qualified investment funds.
Since the Law on Specialised Investment Funds was introduced in February 2007, asset managers have continued to launch such funds even during the years of the financial crisis.
Camille Thommes, director general of the Association of the Luxembourg Fund Industry (Alfi), says much of the country’s growth in new funds has, in fact, been driven by specialised investment funds.
After five successful years, however, the industry faces its first big test with the advent of the Alternative Investment Fund Managers (Aifm) directive.
Aiming to both increase the stability of the financial system and facilitate the single market, the directive imposes strict and extensive requirements on alternative investment fund managers.
Like all other funds thatare not already regulated under the Ucits directive, specialised investment funds are caught by the Aifm directive.
Charles River Associates was commissioned by the UK’s Financial Services Authority to conduct an assessment of its impact. In a 120-page document, entitled Impact of the proposed Aifm Directive across Europe, the Boston-based consultancy predicts reduced investor choice and lower returns.
Alternative fund mangers, the document says, will face substantial one-off compliance costs of up to €3.2 billion and ongoing compliance costs of around €311 million.
One-off costs may arise because of new rules on delegation and changes to legal structures, which may require a reorganisation of the business model.
Alternatives
The need for independent valuators and depositories, as well as new capital requirements, delegation problems and additional disclosure will push up ongoing compliance costs.
Charles River Associates says it has been unable to quantify the costs surrounding depository liability, but adds that these are “considered to be highly significant in terms of increased costs”.
Antonios Nezeritis, a partner at Dechert Luxembourg, says there will be an increase in costs for special investment funds and these are likely to be passed on to investors. “Whether these will be significant or not depends on circumstances,” he says, adding that asset managers will have to use economies of scale to control costs.
Alfi’s former deputy director general, Charles Muller, says the only other options for alternative investment fund managers are a conversion into a Ucits structure, re-domiciliation or closure.
Muller, who is now a partner at KPMG Luxembourg, says as specialised investment funds face stricter regulation they will become more costly.
Nevertheless, he expects them to persist.
Considering these developments on a European level, Luxembourg’s government decided to adapt and amended its legislation of specialised investment funds.
Last August, it submitted a draft law to the chamber of representatives that would amend the existing Law on Specialised Investment Funds.
Still subject to the Luxembourg legislative approval process, the draft law aims to modernise the legal framework for specialised investment funds and implement the Aifm directive.
“There will be higher costs in terms of compliance, compared with offshore funds,” Muller says. “But it will be more about adaptation of the new law.”
The vote on the draft law is expected at the end of March.
If voted, Nezeritis says it would significantly change the way specialised investment funds are regulated.
There would be changes to the regulatory approval process, new provisions with respect to portfolio management, the delegation of certain functions to third parties, risk management and conflicts of interest.
Improvements
In addition, it would introduce flexibilities already adopted for Ucits and non-Ucits retail funds by the law on undertakings for collective investments.
“I do not see any risk of rejection [of this draft law],” says Thommes, adding that it has been “tested and perfected”.
However, the parliament is expected to request clarification and more detailed explanation on some points.
“It has already been drafted in a way that it would comply with the Aifm directive,” he says.
If anything, Thommes argues, the new law will be an improvement to the existing one.
Brian McMahon, who has recently taken up his role as managing director and business development executive at BNY Mellon in Luxembourg, agrees. “Specialised investment funds have a lot of what the Aifm directive is looking for,” he says, pointing to requirements for depositories and investor protection.
McMahon, however, says neither specialised investment funds nor qualified investment funds have the passport facility to date. In return for more regulation, the Aifm directive’s new passport facility will open up new opportunities for fund managers.
This passport will allow them to offer their management services and distribute their funds in all European Union member states.
“Specialised investment funds will remain as popular as they are,” says Nezeritis. “One can even expect them to become more popular.”
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