As institutional investors have been increasing allocations to real assets, driven by the persistent low yield environment, the appeal of private equity (PE) has inevitably been on the rise. Luxembourg has become the European epi-centre of this burgeoning industry as its reputation for quality and service precedes it.
According to consultancy Deloitte’s estimates, PE assets under management in Luxembourg have increased by 20 per cent year-on-year, benefiting from the USD436 billion in funds raised globally in 2018.
“We have seen a fairly sustained interest in launching new funds in Luxembourg from managers based around the globe,” confirms Mark Shaw, Partner at Wildgen where he heads up the London office. “There are any number of reasons for this, but a lot of managers come to us to talk about their first foray into the jurisdiction, having previously launched funds in offshore jurisdictions but now having investor requirements to come onshore. We don’t see any sign of this trend abating, and it’s not confined to the PE space, although the structures available and range of service providers mean that the jurisdiction lends itself perfectly to PE.
Luxembourg has certainly made strides over the last six or seven years to create a funds environment that is equally as appealing to PE/RE and VC fund managers who want less regulated fund structures, for speed to market purposes, as it is to traditional asset managers for regulated funds; be they SIFs or UCITS.
In terms of legal vehicles, since 2004 Luxembourg has offered the SICAR, the Société d’investissement en capital à risqué (SICAR), which has primarily been used as a vehicle to support private equity and venture capital investments. Up until 2013, Luxembourg operated quite an antiquated limited partnership regime – the société en commandite simple (SCS), which was based on the 1915 company law.
Cognisant of this, in 2013, at the time the AIFM Directive was introduced, Luxembourg’s authorities created the Luxembourg Limited Partnership Regime, allowing for Luxembourg AIFs to be treated as Luxembourg limited partnerships, which are not necessarily subject to direct supervision by the CSSF.
At the same time, a new structure in the form of a Special Limited Partnership (SCSp) was introduced. This takes the best elements of the Anglo Saxon limited partnership. Both the SCS and SCSp can be used for regulated and unregulated partnerships.
Luxembourg offers both regulated products – namely the SIF and the société d’investissement de capital à risqué (‘SICAR’) as well as unregulated products – Luxembourg limited partnerships (SCS or SCSp) and the Reserved AIF (‘RAIF’).
The Reserved AIF can be managed by an authorised EU AIFM. It can be created in the form of a company or a contractual common fund (FCP). If it is established as an investment company with variable capital it will be called a SICAV. There, it can choose to operate as a partnership (SCS or SCSp), a limited liability company, or a limited company form; whatever suits the manager best.
The RAIF can be set up in any corporate or unit trust form making it a very good solution for those who require an umbrella fund with compartments.
In addition, there is the SOPARFI (“Société de Participations Financières”). This is still used for 60 to 70 per cent of private equity vehicles. It is a fully taxable Luxembourg company and can benefit from double taxation treaties signed by Luxembourg.
Discussing Luxembourg’s evolving private equity marketplace, Alain Kinsch, co-chairman of the ALFI Private Equity Committee and Country Managing Partner of EY in Luxembourg, says: “Today, there is a good understanding of what PE really is and what its business model is. Investors understand that it’s a business model of value creation and operational performance improvement with the companies. It is also about alignment of interests between the investors and the professionals who manage the fund as well as those who manage the target companies.”
The increasing allocations of institutional investors have not just spurred asset gathering, they have also been driving progress in the technology sector.
Daniel Schmidt, CEO of technology firm CEPRES explains: “With low or even negative interest rates, yielding equity assets will partly replace fixed income investments. Actively managed private market, non-traded assets have therefore become a more substantial part of big institutional portfolios. This is, in turn, driving the trend for better systems and superior technology in order to manage them at the same level of proficiency. Without a technology-based investment process, as has been standard in traded assets for decades, the mass of the allocations coming into the private capital markets would not be investable.”
Figures from the Luxembourg Private Equity & Venture Capital Investment Fund Survey by Deloitte and ALFI show approximately 80 per cent of all PE funds raise money from institutional investors. And although Luxembourg has been active in the PE field for more than two decades, the Grand Duchy is now seeing an acceleration of a number of trends, which have been brewing for the past 15 years.
The ALFI survey highlights that very few large investment vehicles were established in Luxembourg until recently. However, as at November 2018, the number of Luxembourg PE funds above EUR500 million was steadily increasing, the number of US originated PE funds was on the rise, the majority of fund managers active in the space were reinforcing or planning to reinforce their presence in Luxembourg.
Richard van ‘t Hof, Director and General Manager, Trident Trust Luxembourg, says: “Our Luxembourg business is seeing a growing number of US managers interested in setting up private equity structures to access European investments and clients. Managers face both opportunities and challenges when crossing the Atlantic.”
EU regulation has seen PE managers become more structured. New laws mean they must have more governance and enhanced compliance procedures. When looking for a place to do this, Luxembourg provides an attractive platform where service providers are amenable and willing to find ways of meeting their clients’ needs.
According to Daniela Klasen-Martin, Managing Director of Luxembourg and Group Head of Management Company Services at Crestbridge, a corporate services firm: “As a service provider, you need to adapt your services into real solutions for clients. Clients ultimately want to attract institutional money into their funds and they ask us what they need to run a successful fund in Luxembourg. We’re there to follow and help our clients through this process.”
Vanessa Molloy, partner at law firm Harneys believes working with clients to give them what they want while being mindful of what works best is a careful balancing act. She says: “Often a promoter will come to us and say they want to set up their structure in Luxembourg because it’s what the investors wanted. Our job is to look beyond that and find out what is really driving the investors to ask for Luxembourg.”
Brexit has also been working to Luxembourg’s advantage with operators saying they’ve seen an influx of business in the Grand Duchy as a result of the upheaval in the UK.
“There’s been a clear influx of UK managers to the Luxembourg market as a result of Brexit,” notes Anita Lyse, Head of Real Estate at global fund administration firm Alter Domus.
“Managers are looking to use Luxembourg fund products and AIFMs because this seems to be the most solid and sustainable set-up to attract a broad base of European investors. It is becoming the world’s go-to location if you want to access European capital, and Brexit has clearly contributed to an acceleration in that trend,” she adds.
Kinsch agrees: “Clearly a lot of PE houses need to have access to the European market to be able to raise capital and Luxembourg is one of the places to do that.”
Driven by the Brexit referendum result, the industry witnessed some of its biggest names like Blackstone Group and BC Partners registering their business in Luxembourg. In further support of business flowing from the UK, Luxembourg created a transitional regime to allow UK investment firms to continue to provide cross-border services into Luxembourg following a “no-deal” Brexit.
This regime however is only available those firms with existing mandates, which have contracts in place before Brexit actually happens. UK firms will not be able to rely on the transitional regime to enter into new mandates after Brexit.
Fintech which supports the PE industry is also being encouraged in the Grand Duchy. Fintech which supports the PE industry is also being encouraged in the Grand Duchy. George Ralph, Managing Director, RFA, notes: “There is a lot of technology innovation going on in Luxembourg. One of the reasons for this is a scheme run by the government where they match the investment from a VC fund of up to EUR20 million. This is generating a lot of fintech startups in Luxembourg and an area we are working very closely within.”
In a press release, Luxembourg for Finance said: “Luxembourg attracts an increasing number of international FinTech companies wishing to serve the international financial services community in Luxembourg, which ranges from asset management and wealth management to private equity and insurance companies, or that want to leverage Luxembourg as a base to offer their services and products across the EU.”
An evolving ecosystem
The rising number of technology companies all form part of the growing financial eco-system in the country, all of which feeds the trend for private equity firms delegating certain tasks to service providers.
Kinsch also talks about the increasing attraction of outsourcing, which once again plays to Luxembourg’s strengths. He says: “It is clear is that PE houses are relying more on service providers and outsourcing functions like technology, tax compliance. So, the fact that PE has become bigger and they have to comply with AIFMD has made many players decide they don’t want to do it all by themselves, so they are using third parties more and more.”
Gavan McGuire, head of business development, Centaur Fund Services agrees: “This year, not only is the industry positioned for further growth, but the number of PE funds moving towards outsourcing their administration operations is also growing as a result of increased regulatory pressures and more complex investment strategies.”
Recruitment and staff retention always was, and will most probably always, remain a challenge in the Grand Duchy.
Lyse at Alter Domus describes how many firms are now going beyond the neighbouring countries when searching for staff. She adds: “There is a lot of focus on attracting and retaining talent, which requires a number of things. Offering a competitive salary package is all good, but far from enough. A solid learning curve, a clear career path and opportunities for personal growth, combined with flexibility and a good work-life balance are all part of the ingredients, and so is the chance for people to engage and contribute to actually shaping their workplace and the business they are in. Over the last years, we have also offered all employees the opportunity to invest in the company, which allows them to directly share the benefits of the group’s success and growth.”
A part of Luxembourg’s success has been attributed to its responsive and accessible regulatory environment, which though robust and strict has been pragmatic in its application of new EU rules. Further, firms are incentivised to set up their business in Luxembourg through a number of initiatives. For example, the share of profit derived by an alternative investment fund (AIF) and paid to employees of AIF management companies, also called “carried interest”, can be taxable at a quarter of the global tax rate, if certain conditions are met.
Kinsch concludes: “Stakeholders need to continue to listen to the PE industry and what they need in terms of funds, taxation, etc so the toolbox we put at their disposal is continuously refreshed. This is something Luxembourg has been particularly good at, but it cannot sit on its laurels and needs to continue to do this for years to come.” n