Since early June, 88 applications for Luxumbourg’s specialised investment funds (SIFs) have been put before the Luxembourg regulator (CSSF) for approval. At the end of April 2007, around €83.3bn of assets were being managed by SIFs, according to the CSSF’s monthly statistics. This compares to around €690bn in existing German Spezialfonds - the SIFs nearest competitor - according to Frankfurt-based consultancy Funds@Work.
A Luxembourg SIF - also known as a Luxembourg Spezialfonds - is a multi-purpose investment fund regime for international, institutional and qualified investors. It claims to offer high investment flexibility, light supervision, a good infrastructure, good organisational adaptability and an efficient tax regime.
Walter Koob, partner at KPMG Audit in Luxembourg, says the certification regime, which is characterised by great flexibility, provides some risk mitigation through the principle of risk spreading. But in the end, the risks - like the returns - depend on the individual investment style and policy. He admits that the more ‘exotic’ the assets, the higher the potential risk of a SIF.
A minimum capital of €1.25m must be reached within a period of 12 months following approval by the CSSF, with 5% of the capital being paid on subscription. A fixed capital duty of €1,250 is due at the creation of the fund but no corporate income tax on revenue or capital gains from securities or wealth tax applies. A VAT exemption on management fees exists, as well as the benefit of certain double tax treaties when the SIF is structured as an investment company. The subscription tax is one basis point of net assets annually.
Murat Ünal, CEO at Funds@Work, believes that for private investors, SIFs will be the main competition for Germany, where Spezialfonds are only allowed for institutional investors and attract mainly local investors.
Additionally, German Spezialfonds offer less choice in investible asset classes and adhere to narrower investment guidelines and limits.
Koob says that in theory every asset class can be brought into a Luxembourg SIF. But he believes that the CSSF may be a bit more restrictive with exotic assets because valuation and risk spreading may be more difficult.
Only one financial report needs to be published per year for a Luxembourg SIF, which needs to be available within six months from the end of the period to which it relates. There is no obligation to publish net asset values. And because there is no 10% limit on borrowing in Luxembourg, investors are allowed a much higher leverage, according to Jörg Ambrosius, manager at State Street Bank in Munich.
In Germany, Koob says, Spezialfonds are restricted to 30 legal investors, while there are no restrictions in Luxembourg.
In order to compete with the SIF, the German fund industry association (BVI) is campaigning for the further liberalisation of Spezialfonds’ investment guidelines, such as permitting private investors to buy shares, in addition to already approved reforms easing investment guidelines to be implemented later this year.
The BVI’s spokesperson Frank Bock says that the development of mutual funds, or Publikumsfonds, which have boomed in Luxembourg at the expense of Germany, should act as a warning.
Koob says Luxembourg’s old special investment fund law from 19 July 1991 was based on the basic law from 1988, and had to be overhauled following the implementation of UCITS III across Europe and the expiry of the 1988 law on 13 February 2007. He says Luxembourg took that as an opportunity to modernise its law with the aim of achieving a bigger share of the European institutional fund market and creating more liberal hedge funds.
He adds: “Luxembourg also saw the chance to broaden the scope of investors and, in accordance with the EU Commission’s white paper, has now allowed other qualified investors such as high net worth individuals to invest in SIFs.”
But Clemens Schuerhoff, executive partner at Hanover-based Kommalpha Institutional Consulting says that the Luxembourg SIF law is mainly viewed from a private investor’s point of view in Germany. They can use SIFs to avoid the German flat-rate withholding tax, the Abgeltungssteuer.
But Jean-Jacques Picard, director communication at ALFI, the association of the Luxembourg Fund Industry, disagrees: “The German financial press has said it’s the Luxembourg answer to the German Abgeltungsteuer, but this is not why we have created this type of fund. We have known since 2002 that this law would come into force and at the time nobody talked about new German taxes.”
The Abgeltungssteuer is a 25% withholding tax on the profits of private German investors and will come into force in 2009. However, well-informed, private German investors who keep their money in a SIF, which does not distribute the profits, do not need to pay this tax for the moment. Nevertheless, when the investment fund pays back the money to the investors they will be taxed, says Koob, so the effect is only tax deferral.
According to the CSSF, the SIFs approved or waiting for approval have been for institutional and private investors. Koob says a lot of them are of Anglo-Saxon or French origin, in the beginning very often with plain vanilla products, but moving towards special structured products covering real estate, fund of hedge funds and art. He expects more German investors in due course, driven by private wealth managers. Picard and Ambrosius have already noticed strong interest for the Luxembourg SIF from
Germany.
Koob says that German pension funds, for example, can benefit from investing in a SIF because they can expose a small portion of their tied assets - 5% - to asset classes inaccessible to them by German law. Picard adds that the lack of a requirement for a promoter is also an advantage.
“It still has to emerge how much of a competitor Luxembourg is because the German Spezialfonds market is far more developed in terms of its high-efficiency and its services due to its 30-year existence,” says Hans-Jürgen Dannheisig, partner at Kommalpha. “German Spezialfonds are also relatively cheap when compared internationally.” Dannheisig says that investors in Germany have the option of building hidden reserves if they follow the German HGB law instead of international standards such as the IFRS, IAS or US GAAP.
But Ambrosius believes that because of the wider choice of assets available to investors in a SIF, Spezialfonds will come under pressure. He adds that investors can account for the SIF according to HGB without disadvantages, while it can also be construed as a tax-transparent vehicle and be used to create a pooling product, which cannot be done in Germany. He also points out that because a Spezialfonds can only be created via a KAG, investors are forced to pay additional administrative fees.
He says: “The future of the German Spezialfonds now very much depends on the German legislator and whether he will liberalise German investment guidelines and match Luxembourg’s. It also depends on whether the vehicle will be needed in the future because its main driver is currently taxation and the possibility to create hidden reserves.”
Ünal says that until now, Spezialfonds have been all about pooling through local solutions. But international law and issues such as asset pooling have become more and more important, and are areas where Luxembourg has advantages.
However, he says: “I don’t expect the institutional investments to go to Luxembourg-based SIFs in the short term. There will be changes in the pensions pooling area but what we have seen so far is that even jurisdictions such as Luxembourg rely on vehicles such as the Fonds Commun de Placement (FCP), which are actually mutual fund solutions.”
In short, for the time being, the investment world will have to wait and see where in Europe the future lies for the specialised investment fund.
The Luxembourg ‘Spezialfonds’
The range of assets eligible for a SIF includes equities, bonds, derivatives, structured products, real estate, hedge funds, commodities and private equity. The new SIF law only provides that risk diversification must be ensured.
As a regulated vehicle, the SIF must be approved and supervised by the CSSF. It can start activity prior to receiving approval but the application for approval must be filed with the CSSF within a month following its creation. The directors of the SIFs, the Luxembourg-based custodian bank and the auditor must be approved by the CSSF. The investment manager is not subject to CSSF approval because the SIF only deals with qualified investors.
The SIF’s central administration must be situated in Luxembourg but the asset management can be conducted outside the Grand Duchy. The vehicle can be structured as an Fonds Commun de Placement (FCP), a variable capital investment company (SICAV) or any other legal form available under Luxembourg law.
The minimum investment for the qualified private investor is €125,000 and the investor also needs a certificate stating that he is qualified, in other words well-informed, with the relevant expertise, experience and knowledge. If the investor has a certificate from a financial institution stating that he is qualified, however, he can invest less than €125,000.
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