Luxembourg-Poland Business Club, October 2017

RAIF: A success story?

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For asset managers, selecting an appropriate fund domicile is an essential step. Luxembourg, as the largest domicile of investment funds in Europe and the second largest globally (after New-York), not only offers a solid structuring framework but also a flexible and innovative environment.

On 14 July 2016, the Luxembourg Parliament adopted a bill introducing a new type of alternative investment fund in Luxembourg: the Reserved Alternative Investment Fund (“RAIF”), a vehicle combining the flexibility of the Specialized Investment Fund (“SIF”) and the Risk Capital Investment Company (“SICAR”) and that conforms to the Alternative Investment Fund Directive (“AIFMD”).

The RAIF does not require prior approval or supervision from the Luxembourg regulator (CSSF – Commission de Surveillance du Secteur Financier), to the extent that it is managed by a regulated Alternative Investment Fund Manager (AIFM) responsible for risk and / or portfolio management and ensuring compliance with the AIFMD. This single-tier supervision model offers unique “go-to-market” capabilities compared to other fund regimes (onshore or offshore).

The full application of the AIFMD regime at the level of the AIFM will not only ensure asset protection for the investors but also full access to the AIFMD marketing passport, which allows authorized AIFMs to manage and/or market AIFs across Europe. In the absence of this passport, the marketing of an AIF must comply with either private placement or reverse solicitation rules. On the one hand, reverse solicitation (also known as passive marketing) refers to an investment being made through an AIF at the exclusive initiative of the investors and offers limited room for manoeuvre. On the other hand, the private placement rules are not harmonized in the EU and some countries have even closed this possibility and only allow marketing within the scope of the AIFM passport. Additionally, the future of private placement rules is uncertain and as such, its long term sustainability can be questioned.

The distribution of AIFs under the AIFMD passport should therefore be considered as the most flexible, harmonized and cost-efficient approach to access EU capital markets. In that respect it is also important to address the “third country passport” envisaged by the AIFMD and for which the European Securities and Markets Authority (ESMA) has rendered preliminary advice. In its assessment, the ESMA considered whether or not there were any significant hurdles that would prohibit the application of the passport for certain jurisdictions. Without entering into all the details, no significant obstacles were identified for the application of the passport to Canada, Guernsey, Japan, Jersey and Switzerland. In accordance with the AIFMD, this advice should now be considered by the EU Parliament, the Council and the Commission. However, asset managers in those non-EU jurisdictions are now facing a lack of action over this third country passport and there is no solid indication that the topic is going to be subject to any positive decision any time soon since the bigger political priorities, such as Brexit, are currently higher on the agenda of the European officials.

In addition, the position of the UK in a post-Brexit environment remains largely uncertain as UK AIFMs are likely to lose their EU Marketing Passport and the granting of the third country marketing passport to the UK would be subject to ESMA’s review of the UK regulatory environment. Such a review won’t be possible until the UK has put in place a replacement AIFMD regime post Brexit.

The delay in enforcing the third country passport, together with the UK post-Brexit situation, triggers a lot of uncertainty and adds pressure to an industry that is in need of predictability and legal security.

In light of the above, in central Europe, and particularly in Poland a trend towards on-shoring funds is noticeable and the Luxembourg RAIF has proved to be a successful investment vehicle over the past months, particularly for private equity and venture capital houses. There seems to be a particular interest in access to the distribution passport, as well as in structuring opportunities offered by the RAIF. This is particularly the case when the RAIF is incorporated under the form of a capital company and opts for the so-called SICAR regime, by virtue of which it becomes subject to tax but benefits from an exemption for income derived from risk capital (i.e. private equity, venture capital, real estate development)

Indeed, when a RAIF is set up under the form of a capital company and opts for the SICAR regime (RAIF SICAR), it should be treated, from a Luxembourg tax point of view, as a capital company which is subject to tax and therefore, should be considered as a qualifying recipient for the purposes of the Luxembourg withholding tax exemption. In other words, if a Luxembourg company pays a dividend to a RAIF SICAR it should not be subject to withholding tax. Based on most recent experience, it seems that most of the central Europe jurisdictions would follow a similar approach and grant withholding tax exemption to dividends paid to a RAIF SICAR (either based on domestic rules or based on the double tax treaty with Luxembourg), subject to certain formalistic conditions such as obtaining a certificate of residency.

As this tax treatment would be applicable to an intermediate holding vehicle located in either the source country or in the country of the RAIF (i.e. Luxembourg), this offers some additional flexibility in structuring decisions.

Locating a holding vehicle either in the jurisdiction of the fund or in the jurisdiction of the target may be more closely aligned with business objectives than if it were located in a jurisdiction that has no connections either to the business operations or the fund. In today’s world, where Base Erosion and Profit Shifting (BEPS) actions and the Anti-Tax Avoidance Directive (ATAD) highlight the importance of the business purpose in any investment structure, that could be an important consideration.

With close to 200 RAIFs launched since the law was passed in 2016, the RAIF is encountering great success, namely with Central European asset managers. This success story is to be continued…