Global portfolio structuring
Many North American asset managers domicile investment funds with a Delaware-Cayman master-feeder fund which then invests globally via Luxembourg portfolio acquisitions structures.
This briefing summarises some key characteristics of such structures, as illustrated in the following, simplified chart. Ogier Legal is the only international law firm able to provide integrated advice on both the Cayman and Luxembourg aspects of these funds, working with managers' lead, US counsel.
Information on the Ogier Group and details of its regulators can be accessed via our website
Macro factors (1) - Why Delaware - Cayman?
The Delaware-Cayman, master-feeder structure is one of the most commonly used fund formation structures for North American asset managers. Both Delaware and Cayman are amongst the largest of global fund domiciles and the master-feeder structure has been developed by North American managers and their advisors to provide a trusted, flexible structure enabling aggregated private equity investment by US taxable investors, US tax-exempt investors and non-US investors.
Whereas US taxable investors would commonly elect to invest via a Delaware limited partnership (LP) feeder, US tax-exempt and non-US investors would commonly invest via a Cayman LP feeder. Both feeders would then invest via a Cayman LP master fund.
The Cayman LP feeder would be eligible to "check the box", to elect to be treated as a body corporate for US purposes whereas the Cayman LP master would elect to be treated as a partnership.
Cayman is the international-structuring jurisdiction of choice for fund formation by North American asset managers, in conjunction with Delaware onshore. It has emerged as the market preferred domicile due to a combination of macro- economic and fund-specific legal factors.
These macro factors include Cayman's respected legal system based on English common law, concentration of professional expertise and familiarity amongst asset managers. It is estimated that 75-80% of the world's opportunistic strategy funds are domiciled in Cayman and it is the world's fifth largest banking centre. Cayman also has a reputation for stability as a fund domicile, it provides a fiscally neutral aggregation platform for funds in line with international norms, is on the OECD white list, has bilateral tax information exchange agreements with most major jurisdictions and is a signatory to the OECD Convention on Mutual Administrative Assistance in Tax Matters.
These macro factors are complemented by a modern and flexible limited partnership law, as summarised further below.
Macro factors (2) - Why Luxembourg?
Similarly, Luxembourg is a leading domicile for portfolio acquisition vehicles for funds investing both into global and European portfolios. Asset classes appropriate for such structuring include:
Luxembourg's market leading position in this sector has arisen partly from its role as a founder member of the EU benefiting fully from free movement of capital and freedom of establishment within the EU. It is also one of the largest global financial centres, benefiting from investment-focussed legislation, regulatory policies and tax laws and with a significant concentration of professional service providers to the financial services industry.
Luxembourg's sophisticated financial services infrastructure, global brand recognition, full EU single market access and extensive double tax treaty network has lead to its development as a core jurisdiction for investment holding vehicles. This has resulted in the domiciling of several tens of thousands of such investment holding companies for the purpose of enabling international foreign direct investment.
Luxembourg has one of the most solid track records of economic and political stability with a Triple A credit rating, low levels of sovereign debt and one of the highest per capita GDP globally.
In parallel with these international factors, Luxembourg's domestic environment also positively supports investment, as summarised further below.
Separately from this portfolio-structuring specialisation, Luxembourg is also a leading domicile for international managers distributing to EU institutional and professional investors. Please refer to www.ogier.com (publications, Luxembourg Legal) for the briefing "Non-EU/US managers - Accessing EU institutional investors" for further information.
Micro factors (1) - Cayman Regulatory
Private equity funds which are closed-ended are not subject to registration with the Cayman Islands Monetary Authority (CIMA) under Cayman law. To be categorised as closed-ended, the limited partnership's equity interests cannot be withdrawn at the option of investors. There are no Cayman Islands statutory restrictions relating to investment policy, diversification, leverage or service providers. If open-ended or hybrid style, the fund may be required to register with CIMA under Cayman's Mutual Funds Law.
Exempted Limited Partnership
The Cayman exempted limited partnership (ELP), in common with many limited partnerships based on English law, does not have a separate legal personality. It is an unincorporated association of one (or more) general partner(s) (GP) and one (or more) limited partner(s), being the investor(s) with limited liability for the obligations of the limited partnership, limited to the amount of equity capital agreed to be contributed. The unlimited liability for limited partnership obligations borne by the general partner is commonly mitigated in practice by use of a limited liability vehicle as the general partner itself. Please refer further to "Governance" below.
Investors' limited liability derives from registration with the Cayman registrar of exempted limited partnerships by filing a notice containing certain basic details relating to the partnership and payment of a modest registration fee.
Cayman law applies contractual freedom as the defining principle in relation to exempted limited partnerships. There is therefore no prescribed form or content for the limited partnership agreement (LPA). Contributions, allocations and distributions are freely agreed in the LPA. There is no minimum capital on formation and partners can contribute cash, assets or services. It is possible to unitise partnership interests. The general partner holds all of the assets on trust for the partnership and conducts the partnership's business but with the freedom to delegate portfolio management and other matters.
In common with many limited partnership models, the fundamental protection of investors' limited liability is premised on a limited partner not taking part in the management of the partnership in its dealings with third parties. Cayman law however, recognises the need to safeguard appropriate internal consultation with investors and related matters and provides statutory safe harbours that specifically further protect investors' limited liability in a wide variety of such circumstances, including acting on investment committees.
Following amendment of the exempted limited partnership law (ELP Law) in 2014, it is now possible for a limited partnership formed in another jurisdiction to act as a sole GP of the Cayman limited partnership, whereas previously only foreign bodies corporate were able to be registered in Cayman to act as the GP.
This amendment also updates a GP's formal duties in relation to multi-vehicle structures. Although the requirement of good faith remains, the GP is no longer restricted to act exclusively in the interests of the particular, individual partnership in question but, where the LPA expressly permits it, may also take other legitimate interests into consideration (for example, the interests of other funds in the structure).
Cayman ELP can pay distributions to investors from any accounting source, not restricted to realised, distributable profits. The profit allocation and criteria for distributions are matters for the partners, to be set out in the LPA. There continues to be a claw back risk in respect of distributions made to investors in advance of the insolvency of a Cayman ELP, but the scope of the claw back has been significantly narrowed following the 2014 amendments.
Cayman law balances legitimate investor commercial confidentiality with international information exchange responsibilities. Thus, neither the LPA nor any limited partner details are filed on any public registry. The register of partnership interests is only open to inspection by partners (and otherwise only with the consent of the GP). The filing required with the registrar of exempted limited partnerships includes the GP's details, the name, term and general business description of the partnership. Internal information rights as between partners is determined by the LPA. The CIMA and other public authorities may require and exchange information from time to time pursuant to international tax information exchange agreements (based on the standard OECD model) or inter-regulator co-operation agreements, for example, pursuant to the EU Alternative Investment Fund Managers Directive (AIFMD).
Micro factors (2) - Luxembourg Portfolio acquisition companies
The following key characteristics contribute to the attractiveness of Luxembourg portfolio acquisition companies to private equity funds investing both globally and in EU-situate assets:
Luxembourg’s companies law for unregulated investment companies benefits from a high degree of flexibility. Private investment companies (sociétés à responsabilité limitée) provide limited liability for shareholders and directors. Directors’ duties are to act as bon père de famille which, in a corporate investment context, can be seen as broadly similar to English law fiduciary duties, to act honestly and in good faith, in the best interests of the investment company and applying its investment policy, exercising the care, diligence and skill that a reasonably prudent business person would apply in relation to their own business.
Equity investment into Luxembourg private holding companies benefits from relative flexibility, provided a minimum paid-up share capital of €12,500 is maintained. Various share types may be issued including preference shares and asset-tracking shares whose economic rights correlate to specified pools of the company’s own assets. For further information, please refer to our client briefing at www.ogier.com (publications Luxembourg Legal) "Foreign direct investment - Structuring the equity".
In addition to equity subscription, portfolio holding companies are also commonly part-funded by intra-group debt financing, structured in accordance with international norms and commonly subordinated to the bank finance creditors of the issuing company. Such intra-group finance will commonly include a blend of fixed interest, variable interest and convertible debt finance. Provided debt securities are not offered to the public or on a continuous basis, no regulatory consents are required for their issue.
Portfolio acquisition finance
The Luxembourg financial collateral law 2005 provides a robust, reliable and user-friendly legislative environment for secured bank lending to leverage the acquisition of portfolio assets. Aspects of this include the ability to take fully enforceable security over all the principal types of collateral in such structures including shares, securities, intra-group receivables and bank accounts. In each case perfection of security is easily effected and without requiring registration on any public register. Similarly, security taken over financial collateral of this nature may be expeditiously enforced (if required) by the secured creditor, acting by
private action and with no requirement for any court order or other public authority intervention.
Security granted over such collateral is expressly exempted from the risk of transactions entered into during “hardening periods” being set aside on a subsequent insolvency of the obligor (in the absence of fraud). There is no prohibition on the grant of security which also constitutes financial assistance for the acquisition of the obligor’s own shares in relation to such private investment companies (S.à r.l).
This combination of factors relevant to bank finance parties makes the Luxembourg private investment company a highly attractive vehicle through which to structure acquisition finance for portfolio investments.
Pro-investment fiscal position
The most appropriate (and commonly used) type of private investment holding vehicle for fiscal purposes is the SOPARFI (société à participation financière). The SOPARFI is an ordinary, unregulated investment company which invests in ownership interests (or “financial participations”), in other businesses or eligible assets. There are no investment diversification requirements and no eligible investor restrictions. The SOPARFI is a normal taxable company, which therefore qualifies as such under double tax treaties and the EU Parent- Subsidiary directive. However, although generally fully taxable, the typical asset type, long-term investment period and investment level for private equity investment enables the SOPARFI to operate on a substantially tax neutral basis in relation to private equity investment. This enables correct taxation to apply at the level of the asset and at the level of the investor substantively equivalent to direct investment by the investor.
In relation to EU-situate portfolio assets, the tax neutrality relates to the transposition into Luxembourg law of the EU Parent-Subsidiary directive. This substantial neutrality is referred to as the “participation exemption”.
Under these provisions, income derived from a participating interest (such as dividends received by the Luxembourg SOPARFI from an EU portfolio company) is exempt from the SOPARFI’s Luxembourg taxable base, if the following conditions are met:
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•thepotooopanyetherhasbeenownedoraonnuouspeodfat eat12onthsasatthedatefeeantddend,ortheSPARI undetaestohodthehasoratetaonnuous12onthspeod.
Similarly, exemption is provided for capital gains of a SOPARFI on the disposal of shares in any EU-situate portfolio company where, at the time of disposal, the Luxembourg SOPARFI has held for a continuous period of at least 12 months, either (a) shares equivalent to at least 10% of the portfolio company’s issued share capital, or (b) shares whose acquisition cost was at least €6 million.
Luxembourg foreign direct investment in non-EU portfolios is similarly facilitated through Luxembourg’s extensive double tax treaty network with similar structuring and outcomes as for EU-situate investments.
Intra-group corporate financing
Standard market practice is to ensure that intra-group financing is structured with regard to internationally approved OECD principles in relation to thin capitalisation and transfer pricing. This results in a mix of funding by equity and debt investments.
Dividends paid by the Luxembourg SOPARFI on that equity funding would be subject to the standard Luxembourg withholding tax on dividends of 15% where such dividends are paid to a non-EU parent, in a jurisdiction without double tax treaty relief.
However, no withholding tax attaches to payments of interest on intra-group debt financing in this context (such payments commonly not falling within the EU savings tax directive). This funding is structured on arm’s length terms including as to interest.
In relation to capital gains, on the ultimate sale of the underlying portfolio investment, it is possible to liquidate a single-asset holding SOPARFI (or to partially liquidate the appropriate share class of a multi-asset holding SOPARFI) and to return the resulting capital value to the parent investment fund as a liquidation distribution. Liquidation distributions are not subject to withholding tax.
This approach may deliver substantial tax neutrality (ie not incurring double taxation) in relation to such investments until the value generated is distributed to the investors, in whose hands it is subject to tax in accordance with the laws of their own, home jurisdictions, with substantial economic equivalence to direct investment by them.
This combination of robust legal frameworks, appropriate investor protection, the freedom for managers to conscientiously investment manage, certainty, limited liability for engaged investors and a tax footprint substantially equivalent to direct investment by investors has given rise to the market standard usage of this structure.
Ogier Legal is the only international law firm able to advise on all Cayman and Luxembourg aspects of this structure, working closely with lead international firms in the key investor and asset manager jurisdictions.
About Ogier Legal
Ogier Legal provides international legal services. We employ over 400 people and provide legal advice on Luxembourg, BVI, Cayman, Guernsey and Jersey law through our network of offices that cover all time zones. and key financial markets.
Our highly qualified professionals deliver outstanding client service in each location. Our approach is a successful combination and we regularly win awards for the quality of our client service, our work and our people.
This briefing provides a general summary only of this area based on current law and practice in Luxembourg and the Cayman Islands at September 2014 and is subject to changes therein. Any references to the law and practice of other jurisdictions are included solely to illustrate and do not constitute advice as to such matters. This briefing does not purport to be comprehensive and is intended for information only. It does not constitute specific advice issued on a reliance basis. Such specific legal advice should be sought on each occasion.