Luxembourg Investment Structures: Flexibility and Regulation
Special purpose vehicles are advantageous to finance major investment and implementing ambitious international projects. Luxembourg enjoys a wide range of investment vehicles that can be set up rapidly with few administrative formalities.
As they are made to measure for the specific needs of clients, these vehicles have multiple purposes : notably project finance, venture capital investment, real-estate investment, management of holdings and patents. The most demanded structures are investment companies with variable capital (SICAV : Société d’investissement à Capital Variable), the risk capital investment company (SICAR : Société d’Investissement en Capital à Risque), the SOPARFI Holding Company (Société de participations financières) and securitization funds. UCITS, UCIs and SIFs are investment funds that invest their assets on a collective basis as required by the principle of risk-spreading.
Luxembourg Investment Structures: Flexibility and Regulation
We’ll distinguish those investment structures in terms of flexibility and regulation in order to determine which regulatory regime is the most appropriate according to the envisaged project. Flexibility mainly consists of variability over asset allocation while regulation consists of the level of constraint laid down by law.
UCITS : limited asset class
UCITS are pooled investment schemes, otherwise known as investment funds or mutual funds. They benefit from a “European passport” which permits the underlying shares or units to be offered for sale throughout the European Union following authorisation of the fund in one Member State.
UCITS operations are regulated under the amended Law of 17 December 2010 on undertakings for collective investment. A UCITS may be established in a legal form of a common fund (FCP – Fonds commun de placement) or as an investment company (SICAV – Société d’investissement à capital variable or a SICAF – Société d’investissement à capital fixe). A FCP has no legal personality and must therefore be managed by an asset management company. UCITS may only invest in transferable securities and other liquid financial assets authorised by the 2010 Law.
Although subject to these rules and to liquidity requirements, UCITS have become more flexible since UCITS III (amendments adopted in 2001 to the 1985 directive) as they got the right to include the use of total return swaps to gain exposure to asset classes which cannot be directly invested in (e.g commodities).
UCIs : less liquidity requirements
Unregulated Collective Investment Schemes (UCIs) are non-main stream pooled investment schemes.
They are very different from UCITS as they mainly invest in securities other than transferable securities and other liquid financial assets. Although such schemes are not authorised nor recognised, activitied related to operations and management are still regulated.
UCIs are not subject to a defined list of eligible assets. However, they remain subject to some investment limits provided for by the CSSF. For instance, limitations on investment in non-listed securities and in other UCIs.
SOPARFI : Luxembourg holding company
The SOPARFI (Société de Participations Financières) is a fully taxable commercial company whose corporate purpose is limited to the holding of participation and related activities.
The SOPARFI is unregulated as it requires no authorisation for its incorporation and is not subject to supervision from a regulator or government body. Since the EU Directive of 30 November 2011, there is no more tax obstacles for profit distributions between parent companies and subsidiary based in different Member States.
No activities or assets are prohibited as such. It offers flexibility regarding investment policies while providing investors with the opportunity to take advantage of the Luxembourg participation exemption regime. In Luxembourg, compliance with a debt/equity ratio of 85 percent debt / 15 percent equity, or alternatively 85 percent interest-bearing loan /14 percent interest-free loan / 1 percent equity, is required when financing participations in order to avoid a requalification of interest on exceeding debt into hidden profit distributions. One benefits from a withholding tax-free repatriation of the return on the investment to the investors if the Luxembourg vehicle is financed with the arm’s length interest-bearing debt within the limit of the 85:15 debt/ equity ratio.
SICAR : no diversification requirement
The Luxembourg SICAR (Société d’investissement en capital à risque) is a tailor made investment vehicle for private equity and venture capital. It is formed to combine attractive tax status with lighter regulatory requirements and no diversification requirement (all funds can for instance be invested in one or two projects such as real estate).
The SICAR regime was established by the Luxembourg Law of 15 June 2004 (SICAR Law), as amended. In terms of regulation, the SICAR stands between publicly financed vehicles qualifying as UCITS (which are strictly regulated) and the unregulated standard taxable companies investing in shares or financing (SOPARFI) often used as private equity investments vehicles. Limited regulatory supervision and favorable tax rules aim at attracting venture capital investors. Securities issued by a SICAR are reserved to “informed investors” (knowledgeable investors or investors investing at least EUR 125,000).
Financing modes in a SICAR notably include : equity, bond issuance, mezzanine-type financing, bridge finance or similar financing, convertible debt. The articles of association of the SICAR describe how are governed dividend distributions and other reimbursements (e.g redemption of shares) to investors. This flexibility allows SICARs to distribute all their profits with a taxation tax close to 0%.
SIF : flexibility and expertise
The Specialized Investment Fund (“SIF”) is an operationally flexible and fiscally efficient multipurpose investment fund regime for an institutional and qualified investor base.
Specialized investment funds (SIFs) are the Law of 13 February 2007 (“SIF law”) as amended by the Law on 6 March 2012 and the CSSF Circular 07/309 on risk diversification requirements. Investments into a SIF are limited to institutional investors, professional investors, other types of investor who declare to be informed investors and either invest a minimum of 125,000 EUR or have an according appraisal with this respect from a bank, an investment firm or a management company.
Similarly to UCIs, SIFs aren’t subject to a defined list of eligible assets. A SIF may invest in all types of transferable securities, instruments and assets, including but not limited to shares, bonds, derivative instruments, money market instruments, portfolio companies, real estate, hedge funds, private equity funds, real estate funds, commodities, debt instruments and other instruments. A SIF may furthermore be used as a feeder fund or a fund of funds.
Securitization vehicles : cash flow transformations
Securitization is a financing process by which an originator transfers one or more assets or risks to a Securitization Vehicle in exchange for cash. The securitization vehicle is financed by issuance of securities backed by the assets (collateral) transferred and the income generated by those assets.
The Law of 22 March 2004 relating to securitization (the “Securitization Law”) lays down the legal framework, which allows creation of securitization vehicles. This law is very flexible as to the methods of assumption of risks.
Flexibility is made available by transforming cash flows and risks of the collateral pool into those of the securities issued on the pool. A famous example was the subprime loans which could be transformed into tranches of high credit quality and other tranches of low credit quality. Similarly, long-term, non-revolving securities may be carved out from short-term, revolving credit card receivables.
For more information on Luxembourg Investment Vehicles , please contact Hance Law :
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