1. Some facts and figures
With 2,208,198 billion euros of net assets under management in Luxembourg investment funds at the close of February 2011, Luxembourg is the single largest investment fund centre in the European Union, and second in the world after the United States. In July 2010 the NAV of regulated Luxembourg real estate investment vehicles amounted to about EUR 20 billion, divided over 171 funds (including sub-funds of umbrella structures). Whilst most funds were launched by US, UK, German and French managers, 8% of the new real estate funds launched in 2009 had Benelux initiators. In 2008 that figure was 15%. Although the number of non-EU managers launching a Luxembourg-based fund is significant, the geographical investment strategy of the vast majority of these funds focuses on Europe (75% of them invest in EU countries).
The vote by the European Parliament on 11 November 2010 to approve the EU Directive on Alternative Investment Fund Managers ("AIFM Directive") appears set to boost the position of Luxembourg as a domicile of choice for alternative investments, which includes real estate assets. The AIFM Directive aims at regulating the managers of alternative investment funds ("AIFMs") and only to a lesser extent the alternative investment funds ("AIFs") themselves. However, the Directive also imposes a number of requirements which will apply at the level of the AIF, such as with respect to the depositary, the valuation agent, the publication of an annual report, the provision of information to investors by means of an offering memorandum or otherwise and the reporting to regulators.
This article outlines the current Luxembourg environment in which regulated Luxembourg real estate vehicles operate. It can be inferred from this outline that these vehicles are already to a large extent AIFM compliant.
2. Forms of Luxembourg regulated funds
Even though a fair number of unregulated Luxembourg real estate investment vehicles exist and are widely used, in particular for smaller investments and club deals, the market trend is clearly towards regulation. The AIFM Directive will contribute to that trend, in that will cause a large number of investment fund managers and funds to become subject to regulation.
Regulated Luxembourg real estate vehicles can take any of the following four forms:
- Public undertakings for collective investment (UCIs), which can raise funds from the public;
- Specialised investment funds (SIFs), which are UCIs that are not intended to be placed with the public;
- Risk capital Investment companies (SICARs), which are not intended to be placed with the public; or,
- Regulated securitisation vehicles, which raise funds from the public.
Real estate funds structured as securitisation vehicles are rather exceptional and will not be discussed further. The salient features of the three other fund forms are outlined below.
2.1. Common features
All three types of funds are subject to authorisation and supervision by the Commission de Surveillance du Secteur Financier (CSSF), the Luxembourg supervisory authority for the financial sector.
Custody of the assets of regulated real estate investment vehicles must be entrusted to a custodian approved by the CSSF.
Both the registered office and the central administration (i.e. the head office) of regulated real estate investment vehicles must be located in Luxembourg. Generally, a real estate investment vehicle does not undertake the central administrative duties itself, but appoints one or more administrative agent(s) in Luxembourg to perform its day-to-day bookkeeping operations, calculate its net asset value and carry out any other administrative duties.
The business operations of a regulated real estate investment vehicle must be audited by a Luxembourg external auditor approved by the CSSF.
The members of the management body of a regulated real estate investment vehicle may delegate their management functions to one or more investment managers which do not have to be located in Luxembourg. The appointment of an investment manager of a public UCI requires the CSSF's approval. That approval is not required in the case of a real estate SIF or SICAR.
All three types of funds may issue securities in separate compartments with each compartment pursuing a different investment strategy and having its own assets and liabilities (umbrella structure). The liabilities of a compartment are, by law, ring fenced against the liabilities of the other compartments.
2.2. Some features that are specific to UCIs and SICARs
Almost all new real estate investment funds launched from 2007 to 2009 are SIFs. The reason for their success is that, since they are only open to well-informed investors, their regulatory regime is more flexible than the regime applicable to public UCIs, which represent about 11% of the existing Luxembourg real estate funds. This flexibility relates to the kind of eligible assets, the level of permitted leverage, the multitude of available legal forms, the types of securities they can issue, the flexibility as to the valuation of their assets and their light prudential supervision.
Investment policy and risk diversification
Real estate UCIs can invest directly in property consisting of land and buildings, acquire shareholdings in real estate companies and hold property-related long-term interests such as leaseholds and surface ownership.
It is essential for UCIs to diversify their risks. A SIF may not invest more than 30% of its assets or commitments in a single investment. A public UCI may not invest more than 20% of its net assets in a single property.
Whilst public UCIs can raise funds from the public, SIFs are only open to "well-informed" investors. These include not only institutional and professional investors but also any investor who confirms in writing that he has the status of a well-informed investor and either:
- invests a minimum of EUR 125,000, or
- is assessed by a credit institution or an investment company as defined under EU Directive 2004/39 or a management company as defined under EU Directive 2001/107 as having the expertise, experience and knowledge to adequately appraise the investment.
SIFs must, within 12 months of their authorisation by the CSSF, have net assets (share capital plus any share premium paid) of at least EUR 1,250,000. For UCIs, this minimum must be reached within six months
Public UCIs and SIFs may be set up in the form of an FCP (fonds commun de placement), a mutual fund established by contract. An FCP is characterised by the co-ownership of assets and the lack of any legal personality of its own. An FCP is created, represented and managed by a management company (société de gestion) organised under Luxembourg law.
UCIs also be set up as a SICAV (société d’investissement à capital variable) or SICAF.(société d’investissement à capital fixe).
A SICAV is an investment company with a variable share capital that is always equal to its net assets. This allows for permanent changes to the SICAV’s share capital without requiring a notarial deed.
A SICAV that is subject to the UCI Law may only be incorporated as a public limited liability company (société anonyme or SA). A SICAV that is subject to the SIF Law may in addition be incorporated as a partnership limited by shares (société en commandite par actions or SCA), a private limited liability company (société à responsabilité limitée or Sàrl) or a cooperative company set up as a public limited liability company (société coopérative organisée sous forme de société anonyme or SCSA).
A SICAF is an investment company with a fixed capital. As a consequence, every change in the SICAF's share capital requires a notarial deed and the shares must have a stated nominal value. Neither the UCI Law nor the SIF Law prescribes a particular corporate form for a SICAF. In practice investment funds rarely take the form of a SICAF.
In addition to the above, public UCIs and SIFs may also be established in any other corporate form or under a fiduciary contract, provided that their exclusive object is the collective investment of their funds in order to spread the investment risks.
Mutual funds (FCPs) are fiscally transparent and are therefore not subject to Luxembourg income or net wealth tax. Although investment companies operating as limited companies with a fixed or variable capital (SICAFs or SICAVs) are as a rule to be treated as resident taxpayers, they are specifically exempt from income and net wealth tax.
Instead, an annual subscription tax of 0.01% or 0.05% of the fund’s net worth is payable by the fund. The rate at which the subscription tax is levied depends on the type(s) of investment carried out by the fund and on the type(s) of investor in the fund. The annual subscription tax has been set at one basis point (i.e. 0.01%) for the SIF, with certain exemptions being available. To avoid double taxation, funds that exclusively hold units in other investment funds are exempt from the subscription tax.
Luxembourg UCIs qualify as taxable persons for VAT purposes. Management and portfolio advisory services rendered to a UCI are, in principle, VAT exempt.
2.2.2. Real estate SICARs
Investment policy and restrictions
The SICAR’s object must be the investment of funds in assets representing risk capital. The concept of "risk capital" is characterised by two elements, namely: (i) a high risk associated with the relevant assets; and (ii) an intention to develop target entities.
The risk capital criterion with respect to real estate investments is assessed by the CSSF on a case-by-case basis by taking into account a string of elements. Simply put, one could say that an opportunistic type of investment strategy should as a rule be acceptable.
As the SICAR Law does not permit a SICAR to hold real estate directly, an indirect investment by the SICAR via entities that hold or invest in real estate assets, as well as the contribution of capital to real estate companies, is possible.
The SICAR Law does not contain any investment rules or restrictions and does not impose any particular borrowing limits. In particular - and this is a salient difference with the UCIs - the SICAR Law does not require any risk spreading (i.e. the real estate SICAR is allowed to indirectly invest 100 % of its net assets in one single property).
Like SIFs, SICARs are reserved for well-informed investors.
The SICAR must, within 12 months of its authorisation by the CSSF, have net assets (share capital plus any share premium paid) of at least EUR 1,000,000.
A SICAR may be set up as an SA, a limited partnership (société en commandite simple or SCS), an SCA, a Sàrl,or an SCSA. A SICAR may be set up with a fixed or variable share capital. In the latter case, the capital of the SICAR must at all times be equal to its total net asset value. This allows for permanent changes to the SICAR’s capital without requiring a notarial deed. The capital of a SICAR can be represented by registered or bearer shares or units depending on the legal form adopted. At least 5% of the shares or units must be paid up at the time of issue, except for a SICAR incorporated as an SCS, to which this requirement does not apply..
SICARs in the form of an SCS are deemed transparent for Luxembourg tax purposes. Consequently, a non-Luxembourg resident partner of the SCS should not be taxable in Luxembourg.
SICARs in the form of an SCA, Sàrl, SA or SCSA are, as a general rule, fully subject to corporate income tax (including a solidarity surcharge) and municipal business tax (aggregate rate of 28.80% for SICARs established in the City of Luxembourg). However, income from portfolio items consisting of securities and income resulting from the sale, contribution or liquidation of such securities as well as income arising from funds held pending investment in risk capital for a period of 12 months immediately preceding the risk-capital investment are tax exempt. As a result, SICARs should in practice only be taxable on ancillary income.
Luxembourg SICARs qualify as taxable persons for VAT purposes. Management and portfolio advisory services rendered to a SICAR are, in principle, VAT exempt.
We see a natural trend, which may or may not be boosted by the AIFM Directive, for institutional players such as insurance companies and pension funds to be compelled to invest in onshore structures for internal compliance reasons. Moreover, there is a widespread belief within the industry that although the AIFM Directive will not bar access by European investors to non-EU funds, it will reinforce a broader shift toward regulated onshore real estate fund structures. This will in particular be true for real estate managers that pursue a global or pan-European distribution policy.
As the Luxembourg regulatory environment, through its experience with real estate UCIs and SICARs, is already geared up for the implementation of the AIFM Directive, we expect Luxembourg to benefit from this trend and foresee a further increase in the use of the types of vehicles described above in the coming years.