Luxembourg is the largest fund domicile in Europe, with a market share of 27% at the end of 2019 (source: EFAMA Fact Book 2020). Managers, sponsors and investors profit from the broad range of alternative investment vehicles that the Luxembourg legislative environment has to offer.
With the early implementation of Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers (AIFMD), Luxembourg became a gateway to Europe for alternative funds, using its experience in UCITS distribution and its trusted relationship with the local regulator.
Luxembourg has been steadily developing its alternative funds sector by introducing new tools to adapt to market demands (in particular, the RAIF and two types of partnerships).
Moreover, Luxembourg has cultivated a business-friendly environment with specialised service providers that adapt perfectly to the needs of the fund industry and react rapidly to the new regulatory requirements of their clients. Luxembourg also benefits from the responsiveness of the Luxembourg legislator to practitioners’ needs, having an accessible and multilingual regulator and an established relationship between the authorities and the alternative investment industry, being a stable and trusted jurisdiction, and having established experience in servicing alternative assets.
Furthermore, Luxembourg also benefits from a favourable and predictable tax environment (notably, tax-neutral fund vehicles, full access to EU tax directives, a wide double-tax treaty network, the lowest VAT rate in the EU, and comprehensive VAT exemption on management services).
Nowadays, most top global private equity and real estate companies and top hedge fund managers have a constantly growing presence in Luxembourg.
Luxembourg alternative investment funds (AIFs) may be set up as regulated or unregulated structures, closed-end or open-end funds, contractual or corporate vehicles. Depending on the regulatory regime opted for, managers also have the possibility to choose between standalone fund structures and platforms with multiple compartments.
Private equity and real estate managers often set up their closed-end AIFs as unregulated limited partnerships. Luxembourg company law allows unregulated limited partnerships to be structured in very similar ways to Delaware or Cayman partnerships. Such partnership structures are used to establish parallel AIFs that give access to the European AIFMD marketing passport.
Whereas only 60 new specialised investment funds (SIFs) supervised by the regulatory authority of the financial sector in Luxembourg (Commission de Surveillance du Secteur Financier or CSSF) were set up in 2019, more than 300 unregulated reserved alternative investment funds (RAIFs) were established in 2019 (source: EFAMA Fact Book 2020).
AIFs may further be set up as UCIs under Part II (Part II UCIs) of the Luxembourg Law of 17 December 2010 on undertakings for collective investment (UCI Law) or as investment companies in risk capital (SICARs).
The most commonly used structure for unregulated partnerships is the special limited partnership (SLP), which does not have a legal personality. Managers may also choose a common limited partnership (CLP), which does have a legal personality.
RAIFs and SIFs can take either a corporate form or a contractual form as a mutual fund (FCP). They may be set up as a standalone fund or a platform with multiple compartments. The corporate form with variable capital (SICAV) remains the most-used way to set up a RAIF or SIF. As corporate form, managers often choose, aside from limited partnerships, the form of a public company limited by shares (SA) or a corporate partnership limited by shares (SCA).
SICARs would typically take the form of an SCA, an SA, or a limited partnership. SICARs can be structured as standalone funds or with multiple segregated compartments.
Private equity and real estate managers typically use special purpose vehicles (SPVs), often incorporated in the form of private limited companies (SARL), to structure their investments.
Unregulated Limited Partnerships
Unregulated limited partnerships are not subject to any specific product law and are therefore not obliged to comply with any investment restrictions or risk-spreading requirements. Furthermore, unregulated limited partnerships are not subject to authorisation by the CSSF.
RAIFs are governed by the Law of 23 July 2016 on reserved alternative investment funds (RAIF Law) and can invest in all types of assets, either directly or via controlled intermediate companies subject to minimum risk-spreading requirements aligned with those of SIFs. RAIFs should appoint an authorised AIFM, but are not themselves subject to authorisation by the CSSF.
SIFs are governed by the Law of 13 February 2007 on specialised investment funds (SIF Law), and can invest in all types of assets. In accordance with the risk-spreading principle set out in CSSF Circular 07/309, a SIF may not invest more than 30% of its assets or commitments in securities of the same type issued by the same issuer, nor respectively in one property.
SICARs are governed by the Law of 15 June 2004 relating to the investment company in risk capital (SICAR Law) and may only invest in risk capital. Risk capital is the direct or indirect contribution of assets to entities in view of their launch, development or listing on a stock exchange. Investments made by a SICAR must be high risk and must contribute to the development of the entities in which they are invested. Funds of fund investments are allowed for SICARs provided that they fulfil the same criteria. A SICAR is not required to comply with any risk-spreading requirement and, as a result, a SICAR may invest in a single target company.
Pursuant to the International Organisation of Securities Commissions (IOSCO) final report dated February 2017, Luxembourg is one of the most important markets for loan funds in Europe. Ever since, the loan fund market in Luxembourg has been in constant development.
In addition to loan participation investments, Luxembourg funds are also permitted to originate loans, and the majority of debt fund managers include loan origination as part of their strategy.
Luxembourg investment fund vehicles engaging in loan origination are not subject to any specific loan fund rules. The CSSF will base their review of regulated investment vehicles that are engaging in loan origination on the basis of the ESMA opinion on loan origination dated 11 April 2016 (ESMA/2016/596).
Unregulated investment vehicles should be careful not to fall within the scope of the Luxembourg Law of 5 April 1993 on the financial sector (1993 Law), ie, to avoid engaging in any business of granting loans to the public. If the manager has any doubts as to whether the respective loan origination investment strategy falls within the category of granting loans to the public, it may obtain a confirmation letter from the CSSF; or, analyse whether the jurisdiction of the borrower permits such alternative lending.
Fund structures established as SIFs, RAIFs or unregulated limited partnerships are not subject to any asset eligibility requirements and may therefore generally be used to invest in cryptocurrencies and non-traditional assets.
Further to any fund product-specific requirements, regulated investment fund structures that will invest in any virtual currencies may, in accordance with a CSSF warning of 14 March 2018, only be addressed to professional investors within the meaning of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments (MiFID II).
The approval process of the CSSF to set up a new Luxembourg regulated alternative fund follows a prescribed process:
The whole process typically takes two months for a file of average complexity.
Launching new sub-funds within existing umbrella funds (for SIFs, SICARs and Part II UCIs) follows a similar structure but only with respect to the sub-fund. Therefore, the process of approval takes much less time.
If time-to-market is crucial for the promoter, an unregulated fund can be set up instead. The CSSF approval process does not apply in such a case, which means that such a fund can be launched as soon as constitutive documents as well as the arrangements with the service providers are in place.
FCPs should be managed by a Luxembourg management company authorised in accordance with Chapter 15 or 16 of the UCI Law. The management company should not necessarily act as AIFM and may appoint an external AIFM to perform the portfolio management and risk management of the FCP.
RAIFs are required to appoint an authorised Luxembourg AIFM or an AIFM that is authorised in another EEA state, by exercising the AIFMD management passport rights.
Portfolio management is often delegated to a non-Luxembourg investment manager (see 3.6 Outsourcing of Investment Functions/Business Operations).
Generally, AIFs do not have any staff. AIFs set up in a corporate form have directors or managers whose number and role depends on the corporate structure. In the case of regulated AIFs, the CSSF requires the appointment of at least three directors or managers which it must then also approve.
AIFs are rarely set up as self-managed vehicles and internally managed AIFs. Such self-managed AIFs are subject to further substance requirements determined by the CSSF. In particular, self-managed AIFs have to appoint at least two conducting officers who must, in principle, reside permanently in Luxembourg. This does not, however, prevent the conducting officers from being domiciled in a place permitting them, in principle, to travel to Luxembourg every day.
The central administration of SIFs, RAIFs, Part II UCIs and SICARs must be based in Luxembourg:
Unregulated limited partnerships are not required to have their central administration in Luxembourg. However, from a corporate law perspective, unregulated limited partnerships should ensure that their main decision centre is in Luxembourg so as not to jeopardise the nationality of the partnership.
In addition, an AIF must appoint a Luxembourg depositary which is, among other things, responsible for the safekeeping of assets. The eligible depositaries are Luxembourg credit institutions and also Luxembourg investment firms that fulfil certain requirements laid down by the 1993 Law, as amended.
According to Article 4(1) of the law of 12 November 2004 on the fight against money laundering and terrorist financing (AML Law), the professionals “shall appoint, where appropriate, among the members of their management body or effective direction, the person responsible for compliance with the professional obligations as regards the fight against money laundering and terrorist financing”. This obligation is further expanded upon in Article 7(2) of the Grand-Ducal Regulation of 1 February 2010 providing details on certain provisions of the amended AML Law, which mentions that the appointment of an anti-money laundering/combating the financing of terrorism (AML/CFT) compliance officer needs to be made at management level. In addition, the person responsible for the control of compliance must have sufficient anti-money laundering experience and knowledge of the Luxembourg and European legal framework. This person must furthermore dedicate sufficient time to their function, and is required to be located on a more or less permanent basis in Luxembourg.
Portfolio management is often delegated to a non-Luxembourg investment manager (see 3.6 Outsourcing of Investment Functions/Business Operations).
In relation to investment services provided to eligible counterparties and professional per se clients, Article 32-1 of the 1993 Law provides for a temporary regime in accordance with Article 46(4) of MiFIR, ie, in the absence of an equivalence decision at the level of the European Commission. Pursuant to this regime, a third-country firm wishing to provide investment services and activities to eligible counterparties and professional per se clients based in Luxembourg may be authorised to do so without having established a branch, provided that:
Additional to requirements in the specific product law and under the AIFMD concerning the delegation of functions, the CSSF requires third-country firms to formally request approval from the CSSF to use the third-country access regime of Article 32-1 of the 1993 Law.
The CSSF clarified in their Circular 20/743 when the investment service is considered to be provided in Luxembourg and that Article 32-1 of the 1993 Law does not apply where an investment service is provided based on reverse solicitation.
Alternatively, AIFMs may appoint investment advisers who do not have decision-making powers. Where the investment adviser is established in a third country it also has to analyse whether it falls under Article 32-1 of the 1993 Law.
Corporate income tax (CIT) and municipal business tax (MBT)
The net profits of a financial participation company (SOPARFI), a SICAR or a SICAR-like RAIF (ie, a RAIF subject to the SICAR tax treatment), established as an opaque fund, are subject to CIT and MBT at a maximum aggregate rate of 24.94% for the fiscal year 2020 if the fund is established in Luxembourg-City. However, such funds are typically exempt from CIT and MBT with regards to:
The net profits of an ordinary CLP or SLP, as well as those of a SICAR or a SICAR-like RAIF established as a CLP or SLP, are not subject to CIT given that the CLP and SLP are tax transparent for CIT purposes. Accordingly, profits realised by the CLP and SLP are deemed to have been immediately realised by their partners, irrespective of any actual distribution thereof. A CLP and SLP are only subject to MBT if:
The Luxembourg tax authorities have further clarified in a circular letter that a CLP or SLP that qualifies as an AIF is deemed not to carry out any commercial activity.
Funds established under the SIF or SIF-like RAIF regime are not subject to CIT or MBT, but only to an annual subscription tax of 0.01% calculated on their net asset value.
Withholding Tax (WHT)
The distribution of dividends by a CLP or SLP is recognised and performed for corporate reasons only, but such distribution is disregarded for tax purposes. Consequently, such dividends are not subject to WHT.
Dividends distributed by an opaque fund established in the form of a SICAR/SICAR-like RAIF and a SIF/SIF-like RAIF are not subject to WHT.
Dividends distributed by a SOPARFI established as an SA, an SARL or an SCA are, as a general rule, subject to a 15% WHT, but typically these dividends:
Other withholding taxes
Liquidation proceeds, arm’s length interest (assuming the beneficiary of the payments is not a Luxembourg-resident individual) and royalties are not subject to WHT in Luxembourg.
Net Worth Tax (NWT)
Funds established as SOPARFIs are subject to NWT at a rate of 0.5% computed yearly on their net asset value as determined on 1 January (0.05% for net worth exceeding EUR500 million, with a minimum payment of EUR4,815). However, SOPARFIs are exempt from NWT with regard to qualifying participations and may reduce or avoid NWT through the creation of a specific five-year NWT reserve.
SOPARFIs, as well as SICARs and SICAR-like RAIFs, are subject to the minimum NWT amounting to EUR4,815.
SIFs and SIF-like RAIFs are subject to an annual subscription tax of 0.01% computed on their net asset value. However, various exemptions from subscription tax are available.
The incorporation of any type of fund through a contribution in cash to its share capital, as well as further share capital increases paid in cash, are generally only subject to a fixed registration duty of EUR75.
A SOPARFI that qualifies as an AIF, as well as SICARs, RAIFs and SIFs, benefit from a VAT exemption in Luxembourg for services qualifying as fund management services.
Luxembourg has a wide-reaching tax treaty network with 82 tax treaties currently in force and additional tax treaties under negotiation, review or pending coming into force.
Multilateral Instrument (MLI)
On 9 April 2019, having passed the law on 14 February 2019, Luxembourg deposited its instrument of ratification of the Multilateral Instrument (MLI) with the OECD. The MLI aims to swiftly implement certain tax treaty measures contained in BEPS (base erosion and profit shifting). For Luxembourg, the MLI came into force on 1 August 2019 and mainly resulted in the inclusion of the principal-purpose test clause and an improved dispute mechanism system within the tax treaties covered. Other provisions will be introduced via bilateral negotiations. Whether the MLI provisions for each treaty covered will come into effect will depend on whether the MLI for the other country comes into force, and on the type of taxes concerned.
SOPARFIs and opaque SICARs/SICAR-like RAIFs are tax residents from a Luxembourg tax perspective and are therefore entitled to benefit from double-tax treaties. Tax residence certificates from the tax authorities are available upon request if the entity is in good standing as regards its tax compliance. Eligibility for a tax treaty should also be checked from the perspective of the other contracting state. CLPs and SLPs are not eligible for tax treaty benefits given their tax transparency and exemption from tax. SIFs or SIF-like RAIFs established in a corporate form might benefit from tax-treaty entitlement to a limited extent.
In alternative funds, instead of the direct acquisition of assets, SPVs are quite often set up for structuring purposes in order to facilitate the administration of the investments and the financing structuring; to create a liability blocker and a cross-collateralisation blocker; for co-investment and management participation purposes and also in order to take advantage of double-tax treaties, among others, whereby the company holding the asset can be acquired or sold. The purchaser will acquire the shares of the target company and will therefore indirectly take ownership of all the target company’s assets.
The origin of promoters of alternative funds in Luxembourg is diverse. Promoters and sponsors from Switzerland, Germany, the UK, Luxembourg, France and the United States, in particular, are using Luxembourg structures to create their alternative funds.
The investor base of Luxembourg-domiciled funds is global, with the EU/EEA holding a significant share. Third-country managers are using Luxembourg funds to market their investment strategies to EU/EEA investors. Luxembourg funds are attracting more and more Asian and Middle Eastern investors and are becoming global fund platforms for international managers.
Luxembourg alternative funds are investing worldwide, but mainly in Germany, the UK, Italy and Belgium.
Debt funds are constantly growing and have become even more important over the last year, given that the COVID-19 crisis has increased the need for alternative financings. The trend to use unregulated alternative funds and parallel fund structures to market in Europe is also still continuing.
Furthermore, the following trends in the alternative investment funds market have been noted:
The main disclosure requirements in respect of alternative funds have their origin in EU law. Article 21 of the AIFM Law requires AIFMs to disclose certain information, in respect of each alternative fund they manage, to prospective investors in the EU before such prospective investors invest in the relevant alternative fund. Such information includes, inter alia:
Each Luxembourg AIFM is required to report to the CSSF on a regular basis, information regarding, inter alia, the main instruments and markets in which the assets of the alternative funds they manage are invested, along with information on liquidity and risk management in respect of the alternative funds.
AIFMs must also provide the CSSF with annual and quarterly reports on each EU alternative fund they manage or each alternative fund they market in the EU. Specific information on leverage must also be provided on a regular basis to the CSSF by AIFMs managing alternative funds that use leverage on a substantial basis.
AIFMs are also required to notify the CSSF when certain thresholds are exceeded by the alternative funds they manage in relation to the voting rights/ownership of underlying portfolio companies.
In addition, whenever an alternative fund is offered to a retail investor, the AIFM is required to provide the retail investor with a Packaged Retail and Insurance-based Investment Products Key Information Document (PRIIPs KID) before the retail investor invests in the relevant alternative fund.
Finally, specific ESG disclosure requirements will apply to all AIFs as from 10 March 2021 in accordance with regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector.
The two-year implementation period of the Alternative Investment Fund Manager Directive 2 (AIFMD 2) began on 2 August 2019, which means that all member states will be required to apply the new rules from 2 August 2021.
The AIFMD 2 puts forward changes which Luxembourg aims to be among the first to implement:
An additional revision of AIFMD is scheduled to introduce specific disclosure requirements for ESG and impact investments.
Alternative fund managers in Luxembourg enjoy great flexibility regarding legal structures, depending on the investments, investors or tax structuring of their managed funds.
AIFMs whose assets under management do not exceed the thresholds determined in the AIFMD, ie, the assets under management, including any assets acquired through the use of leverage, do not exceed a total threshold of EUR100 million; or the assets under management do not exceed EUR500 million where the AIFs are not leveraged and do not have redemption rights for a period of five years, are not required to comply with the obligations of the AIFMD and may only register with the CSSF. However, registered AIFMs do not have access to the marketing passport. AIFMs exceeding the threshold and sub-threshold AIFMs that opt in, are required to be authorised by the CSSF and will have access to the EEA marketing passport.
Under certain circumstances and in a case where the legal form of the AIF allows for internal management, a self-managed or internally managed AIF may itself be considered to be the AIFM. However, such form remains exceptional in Luxembourg.
In addition to the primary choice of the type of regulatory regime, managers can go further in tailor-making structuring according to their needs, eg, by appointing committees within their structures (such as investment committees).
While some promoters choose to have their alternative funds managed by group managers, others opt to purchase the services of a third-party AIFM.
Managers usually set up their AIFM as an SA, SARL or SCA.
The AIFM regime is provided in the AIFMD, which has quickly been implemented, without gold plating, in Luxembourg law by the AIFM Law.
In addition to these two primary and general legislations, AIFMs must comply with EU-delegated acts and Luxembourg regulations, as well as CSSF circulars and administrative practice.
AIFMs must first obtain the approval of the CSSF before starting their management activities. In order to obtain a licence from the CSSF, authorised AIFMs must comply with various requirements, including capital requirements, operating conditions (which include delegation of functions, rules on the mandatory depositary, remuneration policies, etc), marketing and rules in relation to third countries and transparency requirements.
Luxembourg-authorised AIFMs hold a European passport allowing them to market their managed AIFs within the EEA to professional investors.
An alternative fund manager established in a corporate form is a fully taxable entity. The net profits of such an alternative fund manager are subject to CIT and MBT at a maximum aggregate rate of 24.94% for companies established in Luxembourg-City in 2020. Furthermore, the alternative fund manager would also be subject to NWT.
An authorised AIFM should have at least two conducting officers in Luxembourg who conduct the business of the AIFM on a day-to-day basis. Conducting officers are not required to reside in Luxembourg; however, the conducting officers should have their domicile in a place allowing them, in principle, to come to Luxembourg every day.
AIFMs may establish a branch, which has to be previously approved by the CSSF. To the extent that the branch qualifies as a Luxembourg permanent establishment or the conducting officers as permanent representatives, the profits and wealth of the branch are subject to Luxembourg taxation. Appropriate transfer pricing documentation may be requested by the Luxembourg tax authorities to review the allocation of profits and wealth between the branch and the head office. Bilateral advance pricing agreements are recommended in such cases.
Regarding SICAR/SICAR-like RAIFs and SIFs/SIF-like RAIFs, as well as CLPs and SLPs, carried interest is generally structured as shares or units and therefore remains tax neutral in the hands of non-resident beneficiaries.
The main functions of AIFMs are divided into three types of activities:
AIFMs can delegate some of their functions to third parties in order to increase the efficiency of their business under certain conditions listed below. However, a delegating AIFM must never be a letterbox entity, which is the case if the AIFM is no longer in a position to supervise the delegate or no longer has the power to take key decisions.
Firstly, AIFMs must notify the CSSF and justify the entire delegation structure, demonstrating that the delegate is qualified and has sufficient resources. Where the delegation concerns portfolio or risk management (which cannot both be delegated in full at the same time), the delegate must be authorised and subject to supervision in its home country and if it is located in a third country, a co-operation agreement must be signed between the competent authorities. In practice, while risk management usually remains in Luxembourg, portfolio management activities are often delegated outside Luxembourg.
Secondly, no delegation shall be conferred on the depositary or any other entity whose interest may conflict with that of the AIFM or the investors of the AIF.
Thirdly, the AIFM remains responsible towards the AIF and its investors and should therefore monitor the delegate (or, where applicable, the sub-delegate) and be able to terminate the delegation with immediate effect, if this is in the interest of the AIF’s investors.
Also refer to 2.10 Requirements for Non-local Service Providers.
Depending on the complexity of its activities and the nature of its business, an AIFM must have adequate financial, technical and human resources as set out by the CSSF in their circular CSSF 18/698 on substance-related aspects concerning both UCITS management companies and AIFMs (Substance Circular).
The main section of the Substance Circular sets out detailed rules concerning shareholding, the minimum equity requirements, corporate bodies, administrative organisation, internal governance and internal controls.
For instance, licensed AIFMs must have at least two conducting officers dedicated to management on a full-time basis, who have sufficient competence and professional experience, and who must also be permanently based in Luxembourg or in a place allowing them to travel to Luxembourg every day, in principle, and must be contactable by the CSSF at any time.
An AIFM must furthermore have qualified staff members with sufficient experience in relevant subjects, depending on the management activities provided by the AIFM. The size of the AIFM in terms of human capital also depends on the nature of its activity.
In case of delegation, as mentioned above, AIFMs should also be able to supervise the delegates and retain the power to take key decisions.
EU/EEA-authorised AIFMs have a cross-border passport that allows them to market and manage AIFs in Luxembourg through the freedom of establishment (eg, establishment of a branch, which however does not itself benefit from the passport) or the free provision of services. EU/EEA AIFMs are not subject to any authorisations in Luxembourg or any additional requirements, since their home regulators remain competent to ensure compliance with their own regulatory requirements.
However, such EU/EEA AIFMs must notify their home regulator of their intention to carry out activities in Luxembourg and provide it with information regarding the company, including the structure, risk management, etc.
Third-country AIFMs may manage Luxembourg funds provided they are not marketed in the EU. Third-country AIFMs wishing to manage Luxembourg funds and market them in the EU need to comply with Article 45 of the AIFM Law, namely:
All types of investors, including retail investors in some circumstances, can invest in Luxembourg alternative funds, subject to restrictions and conditions for specific types of funds (see 4.2 Marketing of Alternative Funds).
Investors are mainly institutional investors such as pension funds, insurance companies, financial intermediaries, family offices or other funds, as well as eligible high net worth individuals. Geographically, Luxembourg AIFs are attractive to global investors, starting with local investors (see 4.4 Local Investors), EU/EEA investors and third-country investors.
Investor eligibility criteria depend on the type of AIF. Eligibility could be limited to institutional and professional investors, or could also target retail investors.
Part II UCIs, irrespective of whether they are AIFs, are not subject to any restrictions regarding investor eligibility in Luxembourg. Furthermore, any entity qualifying as an AIF can benefit from the AIFMD passport for marketing to professional investors within the meaning of MiFID II, while local rules apply to retail sales.
SIFs, RAIFs and SICARs are available to “well-informed” investors, a category which includes:
Managers and others involved in the management of SICARs, SIFs and RAIFs are exempt from the above-mentioned eligibility criteria.
Luxembourg is a world leader in cross-border fund distribution. Different rules apply, however, in marketing to professional or retail investors.
For marketing in the EU/EEA, funds qualifying as AIFs (including RAIFs) benefit from a passport allocated to their authorised EU AIFM and can use a simple notification procedure. Such passport is valid only for professional EU-based investors. EU/EEA AIFs can also be marketed in Luxembourg using the passport.
Marketing to Professional Investors
AIFMs are able to market AIFs to professional investors in Luxembourg subject to the following conditions:
Marketing to Retail Investors
AIFMs are able to market AIFs to retail investors in Luxembourg subject to the following conditions:
Before closed-end foreign funds that are not classified as AIFs can be marketed in Luxembourg, they need to issue a prospectus in compliance with the law of 16 July 2019 on prospectuses for securities (Prospectus Law), unless certain conditions therein apply.
Furthermore, the Regulation (EU) 2015/760 of the European Parliament and of the Council of 29 April 2015 on European long-term investment funds (ELTIFs) allows AIFMs to market an AIF to retail investors under the AIFMD marketing passport, provided that the AIFM and the AIF comply with the requirements set out in the ELTIF Regulation. Pursuant to ESMA's ELTIF register, nine Luxembourg ELTIFs have been authorised and launched up until now.
Definition of Marketing
With no guidance at EU level, marketing itself is subject to local discretion. In Luxembourg, marketing occurs when the AIF, AIFM or an intermediary of the AIF or AIFM, seeks to raise capital by actively making shares of any AIF available for sale to potential investors. To fall under the local definition, this also needs to take place in Luxembourg, or remotely targeting a Luxembourg-based investor. The various marketing scenarios are described above. There are also established examples of what would not be considered as marketing, ie:
Both local and foreign investors can invest in alternative funds established in Luxembourg, subject to the fulfilment of specific investor eligibility criteria for SICARs, SIFs and RAIFs (see 4.2 Marketing of Alternative Funds).
However, Part II UCIs which are distributed to retail investors in Luxembourg will fall within the scope of the more stringent UCITS-like depositary regime.
Local AIF investors are mainly institutional (including other funds) with local family offices playing an increasing role.
For marketing with a passport, regulator-to-regulator notification (between the home country regulator of the AIFM and the CSSF) is required under the AIFM Law, in order to start marketing in Luxembourg.
Luxembourg-regulated AIFs are automatically authorised for marketing in Luxembourg but need to take into account specific product rules. Subject to product eligibility criteria, this applies to both professional and retail investors.
When marketing AIFs to professional investors without a passport (see 4.3 Rules Concerning Marketing of Alternative Funds), the AIFM must notify the CSSF prior to any marketing activity. This is a simple notification with no need for acknowledgement of authorisation from the CSSF. Marketing can start in Luxembourg from the day of notification.
Finally, rules on marketing non-Luxembourg but regulated AIFs to retail investors in Luxembourg are set out in 4.3 Rules Concerning Marketing of Alternative Funds. Such AIFs must be subject to permanent supervision by their local authority to ensure the protection of investors and provide guarantees that such protection is at least equivalent to that in Luxembourg law for retail distribution.
Main disclosure requirements for Luxembourg alternative funds are set out in 2.18 Disclosure/Reporting Requirements.
SIFs, RAIFs and SICARs must have an issuing document, unless the SIF or RAIF has set one up under the Prospectus Law. If they are not AIFs, their issuing documents must only include the information necessary for investors to be able to make an informed assessment of the investment proposed to them and of the associated risks. In addition, the first page of a RAIF’s issuing document clearly states that it is not subject to the supervision of the CSSF. Such issuing document needs to be up to date when securities are issued to a new investor. SIFs, RAIFs and SICARS must issue an audited annual report within six months of the end of their financial year, but do not have to prepare consolidated financial statements.
With further reference to 2.18 Disclosure/Reporting Requirements, SIFs qualifying as AIFs, RAIFs and SICARS are subject to additional disclosures under Article 21 of the AIFM Law which transposes Article 23 of the AIFMD. AIFMs managing AIFs are subject to additional reporting requirements, depending among others on the type of AIF (open or closed-end) and their assets under management. Such reporting includes the following: risk profile of the AIF and related risk management, liquidity management changes and special arrangements for illiquid assets.
Part II UCIs are subject to UCITS-like disclosure requirements and need to provide investors with a semi-annual report as well as an annual one.
For AIFs offered to MiFID II-type retail investors, a PRIIPs KID must also be provided.
The issuing document of SIFs, Part II and SICARs UCIs is reviewed by the regulator.
Unregulated limited partnerships, managed and marketed under the AIFMD, should make the respective information required in Article 21 of the AIFM Law (equivalent to Article 23 of the AIFMD Law) available to potential investors prior to their investment.
Luxembourg resident investors are generally subject to income tax and net worth tax depending on their tax regime in Luxembourg. Exempt resident investors include those investing in UCIs, SIFs, SIF-like RAIFs and SPFs.
Non-resident investors which do not have a Luxembourg permanent establishment or permanent representative to which or whom the interests in the fund are allocated, are generally not liable for any Luxembourg income or net wealth tax, except in limited cases when investing in a SOPARFI.
Luxembourg entered into a so-called Model I Intergovernmental Agreement with the USA and implemented FATCA through the Luxembourg law of 24 July 2015 (FATCA Law). Luxembourg entities that qualify as Luxembourg Reporting Financial Institutions (FFIs) fall within the scope of FATCA. Luxembourg custodial institutions, depository institutions, specified insurance companies or investment entities are FFIs and are subject to registration with the US IRS, due diligence with the identification of reportable account holders and annual reporting obligations. Luxembourg FFIs need to report the relevant information concerning reportable accounts and account-holders to the Luxembourg Tax Authorities (LTA).
The OECD Common Reporting Standard (CRS) is largely inspired by FATCA. The Luxembourg law of 18 December 2015 transposed the CRS. Although similar to FATCA with three principal obligations (ie, registration, due diligence and reporting), the CRS requires a significant upgrade of due diligence and reporting processes, and is new in terms of the volume of information and number of account-holders in scope.
Luxembourg FFIs, while remaining liable, are allowed to delegate FATCA and/or CRS obligations to a third-party service provider.
For both FATCA and the CRS, the LTA may issue different penalties to Luxembourg FFIs that either do not respect the due diligence rules or have not put in place mechanisms to report information.
The recent international consensus is that integrating environmental, social and governance (ESG) considerations into financial decision-making will lead to increased investment in longer-term and sustainable activities. Sustainable finance takes into account ESG considerations in the process of financial decision-making, aiming towards a financial system that supports sustainable growth. Environmental considerations refer to climate change mitigation and adaptation, as well as related risks, such as natural disasters. Social considerations include issues such as inequality, inclusiveness and labour relations. Governance refers to the management of public and private institutions, covering employee relations and executive remuneration.
ESG at the Core of the Financial System
The United Nations 2030 Agenda for Sustainable Development introduced in September 2015 (UN Agenda), followed by the adoption of the Paris Agreement on Climate Change (Paris Agreement) later in the same year, created a path towards the development of a more sustainable economy and society. Adopted by all UN member countries, the UN Agenda presented a collection of 17 global goals (including no poverty, zero hunger, sustainable cities and communities and climate action) designed to be a blueprint to achieve a more sustainable future for all. The Paris Agreement includes a collective commitment to align financial flows in such a manner that will result in a low-carbon and climate-resilient environment.
In March 2018, the EC adopted an action plan on sustainable finance (EU Action Plan), aiming to reorient capital flows towards a more sustainable economy. A couple of months later, the EC proposed a package of legislative measures (discussed here) in an effort to fill out this vision. A technical expert group on sustainable finance (TEG) was established in July 2018 to assist the EC in developing, in line with the legislative proposals, a unified classification system for sustainable economic activities, an EU green bond standard, methodologies for low-carbon indices, and metrics for climate-related disclosure.
Luxembourg is the European leader in responsible investment fund assets, accounting for 34% of responsible funds across Europe and 35% of all assets under management in socially responsible investment mandates, ranking among the top green financial centres in the global Green Finance Index published in 2020. Luxembourg is also undisputedly the green bond capital of the world, as over 50% of all green, social and sustainability bonds worldwide are listed on the Luxembourg Green Exchange (LGX), the world’s first trading platform exclusively for sustainable financial instruments. The Luxembourg Finance Labelling Agency (LuxFLAG) has launched a dedicated Climate Finance quality label to ensure the effective climate focus of investment funds in the implementation of their investment policy, and specific Green Bond labelling as a means to boost green investments. The Luxembourg Climate Finance Accelerator, set up in 2018, helps fund managers specialising in climate action by offering various forms of financial and operational support during the launch phase of a new fund structure.
The Association of the Luxembourg Fund Industry (ALFI) has also been raising awareness about sustainable finance over the past years. The ALFI Responsible Investing Technical Committee produced guidance on sustainability disclosures in January 2020, with the objective of providing guidance to asset managers pertaining to the ESG regime. Luxembourg also launched the Luxembourg sustainable finance roadmap drawing up an inventory of existing initiatives in Luxembourg in the field of sustainable finance and laying the foundations for a sustainable financial strategy, contributing to the UN Agenda and the objectives of the Paris Agreement.
Key Legislative Developments
The Disclosure Regulation
Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector (Disclosure Regulation) published in December 2019 marked a new milestone in the journey towards a more sustainable financial sector. The majority of the disclosure requirements under the Disclosure Regulation will apply from 10 March 2021, and upcoming regulatory technical standards will soon be developed to address specific obligations therein.
The Disclosure Regulation broadly applies to:
It can also apply to non-EU asset managers; eg, the manager of a non-EU AIF marketed in the EU on a private placement basis will be in-scope for certain aspects of the Disclosure Regulation. The Disclosure Regulation does, however, offer limited exemptions from its scope, such as investment firms which provide investment advice, provided they employ fewer than three people.
The Disclosure Regulation lays down harmonised rules on transparency with a view to promoting the integration of sustainability risks into investment processes and the disclosure of such risks to investors. “Sustainability risk” is defined as “an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of an investment”.
FMPs are obliged to publish on their websites various new information such as:
Should an FMP make available a “financial product” (ie, an AIF, a UCITS, portfolios managed by investment firms) that promotes ESG characteristics, or has sustainable investment or carbon-emission reduction as an objective, additional information should be published on its website, including a description of the relevant ESG characteristics and/or ESG objective of the product, the methodologies used to assess, measure and monitor the ESG characteristics of the product and/or the impact of the product on the ESG objective and, where an index is designated as a reference benchmark for ESG characteristics, whether and how the index is consistent with those characteristics.
Both FMPs and FAs must include, in precontractual disclosures (eg, in prospectuses for AIFs/UCITS or other precontractual documentation as required by MiFID II), descriptions on:
Where a financial product promotes ESG characteristics, the disclosures must include information on how those characteristics are met, and whether and how any benchmark index referred to is consistent with those characteristics. Similar requirements arise in relation to financial products with ESG objectives. From 30 December 2022, FMPs that consider the principal adverse impacts of investment decisions on sustainability factors must also include in their precontractual disclosures a clear and reasoned explanation of whether and, if so, how, their financial products consider principal adverse impacts on sustainability factors. If they do not do this, they need to include a statement to this effect and supply reasons why they have not included an explanation.
For financial products with ESG characteristics, FMPs must also describe in periodic reports the extent to which these characteristics have been met, including, as applicable, a comparison between the product and its benchmark, or the overall sustainability-related impact of the product, with reference to relevant sustainability indicators.
FAs must publish on their websites:
Additionally, they need to publish on their websites information on how their remuneration policies are consistent with the integration of sustainability risks.
The Taxonomy Regulation
Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment (Taxonomy Regulation) published in June 2020, establishes an EU-wide classification system intended to provide a common framework to identify to what extent economic activities can be considered environmentally sustainable. Certain provisions of the Taxonomy Regulation already came into force on 12 July 2020, but many of its key provisions will not apply until a later date. The EC will soon adopt delegated Acts supplementing the Taxonomy Regulation.
The Taxonomy Regulation affects FMPs or issuers who make available a financial product (as defined in the Disclosure Regulation) which either (a) has environmental sustainability as its objective, or (b) promotes environmental characteristics. It supplements the disclosure obligations which apply to FMPs under the Disclosure Regulation and to corporates (ie, large public-interest companies with more than 500 employees such as listed companies, banks and insurance companies) under EU Directive 2014/95 as regards disclosure of non-financial and diversity information by certain large undertakings and groups (Non-Financial Reporting Directive). Where a financial product made available in the EU has sustainable investment as its objective or promotes ESG characteristics, and such a product invests in an economic activity that contributes to an environmental objective, the precontractual and ongoing disclosures related to such a financial product will need to contain:
If they do not take into account the EU criteria for environmentally sustainable economic activities, then the precontractual and ongoing disclosures related to such financial products will need to include a statement to this effect.
An economic activity is environmentally sustainable if:
The Taxonomy Regulation will also impact non-European asset managers offering financial products into the EU.
Corporates that are subject to disclosure obligations under the Non-Financial Reporting Directive will also be required to include in their annual reports (as part of their non-financial statements) information on how and to what extent the corporate’s activities are associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation.
The Climate Benchmark Regulation
Regulation (EU) 2019/2089 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks (Climate Benchmark Regulation) came into effect on 30 April 2020, amending EU Regulation 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (Benchmark Regulation). The aim of the Climate Benchmark Regulation is to increase transparency and uniformity in the use of low-carbon indices. Obligations under the said regulation take effect at different times, with most of them applying since 30 April 2020.
The Benchmark Regulation applies to the provision of benchmarks, the contribution of input data to a benchmark and the use of a benchmark within the EU.
In an effort to minimise “green washing”, the Climate Benchmark Regulation introduces two new categories of benchmarks: the EU Climate Transition Benchmarks (EUCT Benchmark) and the EU Paris-aligned Benchmarks (EUPA Benchmark). The EUCT Benchmark is an index whose underlying assets are selected, weighted or excluded in such a manner that the resulting benchmark portfolio is on a decarbonisation trajectory, ie, a measurable, science-based and time-bound trajectory towards alignment with the objectives of the Paris Agreement by reducing carbon emissions. The EUPA Benchmark is an index whose underlying assets are selected, weighted or excluded in such a manner that the resulting benchmark portfolio’s carbon emissions are aligned with the objectives of the Paris Agreement and do not significantly harm other ESG objectives.
The Climate Benchmark Regulation obliges all benchmark (or families of benchmarks) administrators, with the exception of administrators of interest rate and foreign exchange benchmarks, to provide the following disclosures:
By 30 April 2020, EUCT and EUPA benchmark administrators were obliged to document and make public any methodology used for the calculation of the benchmark, giving the information listed in Annex III of the Climate Benchmark Regulation for each of the EUCT and EUPA Benchmarks. Moreover, administrators located in the EU and providing significant benchmarks are required to endeavour to provide one or more EUCT Benchmarks by 1 January 2022. Lastly, administrators of EUCT Benchmarks are required to select, weight or exclude underlying assets issued by companies that follow a decarbonisation trajectory by 31 December 2022, in accordance with certain requirements.
On 17 July 2020, the EC adopted three delegated regulations (not yet in force) under the Benchmark Regulation specifying new disclosure rules for benchmark statements and benchmark methodologies, and prescribing minimum requirements for the EUCT and EUPA Benchmarks.
The EU green bond standard
An EU green bond standard is one of the central planks of the EU Action Plan as green bonds play an increasingly important role in financing assets needed for the low-carbon transition envisaged by the Paris Agreement. For the time being, there is no uniform green bond standard within the EU, although it was recommended in the final report of the EC’s High-Level Expert Group on Sustainable Finance on 31 January 2018 that such an EU green bond should be established.
Instructed by the EU Action Plan, the TEG provided detailed input on what an EU green bond standard could look like in its proposal in June 2019 (TEG EU-GBS) and in its usability guide published in March 2020 (the EU-GBS Usability Guide). The TEG EU-GBS largely mirrors the regime under the Green Bond Principles (formulated by the International Capital Market Association – ICMA), the most widely utilised green bond standard currently in the market. The EU-GBS Usability Guide provides TEG’s views to potential issuers, verifiers and investors of EU green bonds on the practical application of the TEG EU-GBS. The TEG EU-GBS could be adopted by any issuer of listed or unlisted bonds or capital market debt instrument, whether domiciled in Europe or not.
The TEG EU-GBS contains a concrete list of substantive activities that can be categorised as green by cross-referring to the Taxonomy Regulation. It requires mandatory reporting on the environmental impact of projects, in addition to how proceeds are allocated. Moreover, the TEG EU-GBS requires mandatory post-issuance verification of use of proceeds and relevant allocation reports by ESMA’s accredited and supervised external reviewers.
Despite its present voluntary "opt-in" option, the EC has recently stated that it will explore the possibility of a legally binding initiative for the TEG EU-GBS. In August 2020, Luxembourg launched its own Sustainability Bond Framework, the first in the world to fully comply with the TEG EU-GBS. Luxembourg aims to lead by example in order to support the development of a responsible capital market with the issuance of safe (AAA-rated) and liquid sovereign ESG bonds, and the Luxembourg government has already engaged a number of reputable credit institutions to float the bonds.
On 8 June 2020, the EC published a set of draft delegated acts, which, once implemented, will amend:
EU AIFMs, UCITS management companies, and MiFID II investment firms will be affected by these upcoming changes. The proposed changes will require such entities to update their existing rules pertaining to decision-making procedures, organisational structures, reporting lines and control mechanisms so that they take into account sustainability risks when complying with these organisational requirements. Additionally, such entities will need to update their existing rules on identifying and managing conflicts of interest, so they will be able to identify conflicts which may arise from the integration of sustainability risks, or a client’s sustainability preferences.
Moreover, in-scope entities under the AIFMD and UCITS regimes will need to revamp their existing rules relating to due diligence processes when making investment decisions, so as to take into account sustainability risks when investing. In addition, entities which are within scope of the Disclosure Regulation and which have implemented principal adverse impact policies, must also update their investment due diligence processes to specifically take into account their principal adverse impact policies.
MiFID II investment firms (including UCITS management companies and AIFMs that opt-in for the dual licence to perform MiFID II services such as portfolio management and investment advice) will also have to take into account their clients’ “sustainability preferences” when carrying out a suitability assessment of the products offered to such clients. Additionally, manufacturers and distributors of financial products will need to take into account the sustainability preferences of the target market, which will necessitate updating their product origination, marketing and distribution strategies.
As part of the EU Action Plan, the EC also aims to expand the EU Ecolabel, which currently exists for a range of goods and services, including financial products. Labelling of “green” or “environmentally focused” financial products has increased in recent years. For example, the LuxFLAG Climate Finance Label reassures investors that the selected investment product invests at least 75% of total assets in investments related, with a clear and direct link, to mitigation and/or adaptation of climate change or cross-cutting activities. The upcoming EU Ecolabel for financial products will serve as a new, EU-wide label, and will thus elevate market transparency and enhance consumer choice.
Future of the ESG Regime
ALFI has recently submitted its thoughts on a consultation regarding the Renewed Sustainable Finance Strategy published in April 2020, a roadmap proposed by the EGD that builds on the ten actions put forward in the EU Action Plan. ALFI suggested that mainstreaming sustainability in the financial sector over the coming decade will create certain challenges, emphasising that a lack of robust, reliable and accessible ESG data is one of the biggest issues for asset owners and managers. This could be tackled as more historical data and research accumulates internally or is provided by external data providers over the years. Moreover, concerns were raised on whether credit rating agencies will be obliged to integrate ESG criteria into their analysis of issuers’ credit worthiness. In July 2019, ESMA published technical advice on sustainability considerations in the credit rating market and its final guidelines on disclosure requirements applicable to credit ratings as a means to tackle this problem, but it remains to be seen whether EU-wide legislation will be implemented to this end. ALFI also noted that incorporating ESG factors into investment decision-making requires specialist skills and that affected entities will incur additional costs in having to recruit or develop investment talent with the appropriate mix of skills. On the other hand, as ESMA pointed out in their response to the same consultation, the ESG regime will also result in opportunities. For example, it will build resilience in the financial system by improving awareness of the risks relating to different sustainability factors, thus triggering better management and preparation to address the consequences of severe events triggered by environmental and social crises. Additionally, it will strengthen financial education by increasing financial literacy on sustainability matters, crucial for both investors and finance professionals.
For the Luxembourg asset management industry, the EC’s legislative push in integrating ESG criteria into investments is not a trend, but the continuation of long-standing efforts to promote this culture in financial decision-making. Initiatives such as the LGX, a joint climate investment platform with the EIB, a Luxembourg climate finance accelerator for fund managers, and a dedicated climate label for investment funds indicate that Luxembourg has not only proved its commitment to help raise finance to meet global climate-related challenges, but has demonstrated its ability to innovate.