Examining New Regimes for Investment Funds

Changing times in Luxembourg and the Netherlands

ADAM MILLER, NACERA BENIKEN & MENNO VAN DEE, ERNST & YOUNG

This article examines new regimes for investment funds in Luxembourg and the Netherlands and how these regimes might prove to be attractive options for hedge fund managers. Both regimes provide on-shore investment funds with the option to have regulated funds which might be subject to less onerous regulatory restrictions and supervision. There has also been considerable effort by the two jurisdictions to streamline the formation/approval process so that funds can go to market in a more timely fashion. The above, combined with the funds advantageous tax regimes provide two interesting alternatives for hedge fund managers to consider when structuring their fund.

Luxembourg SIF regime

Luxembourg introduced a new law on Specialised Investment Funds (the “SIF Law”) in February 2007 that significantly simplifies the rules for setting up fund structures such as hedge funds, real estate funds and private equity funds. Luxembourg is the second largest investment fund centre in the world with assets of over €2 trillion and a growing administration centre for single hedge funds and funds of hedge funds. The primary driver for the SIF Law was the demand from the ‘buy side’, along with their advisors, for a ‘lightly regulated’ on-shore investment fund vehicle for all types of alternative investment products.

SIF characteristics

A fund created under the SIF law (a “SIF”) may be sold to ‘informed investors’, ie. institutional, professional and other ‘informed’ investors. The SIF may be structured as an open-ended legal entity (SICAV), a closed-ended legal entity (SICAF), or a contractual form (FCP). These different entities may create sub-funds each with a different investment policy.

There are generally no restrictions on the payment of dividends. While a SIF should apply the principle of risk diversification, there are no detailed investment restrictions or leverage rules. Exemptions from the general investment limits may be granted by the Luxembourg financial sector regulator (the CSSF) on a case-by-case basis.

With regard to taxation, SIFs are not subject to any Luxembourg taxes on capital gains or income. They are subject to an initial fixed capital duty of €1,250 and to an annual subscription tax of 0.01% levied quarterly on the net asset value of the SIF although some exemptions are available.

Luxembourg regulation & administration

As noted above, the SIF is intended to be lightly regulated. Importantly, no prior authorisation from the CSSF is required. However, the constitutional documents and related information (choice of custodian, directors and officers) must be submitted to the CSSF within one month of the formation of the structure. The CSSF subsequently informs the SIF of authorisation. The SIF must also draw up an issuing document to be communicated to the CSSF and include the information necessary for investors to be able to make an informed judgment about the investment proposed to them.

Under the SIF law, the CSSF does not require a promoter, nor will it perform checks on the status or financial position of the portfolio manager. A SIF must appoint a Luxembourg custodian. In the case of hedge funds, the SIF law does not impose any restrictions on the appointment of a prime broker. The custodian’s responsibility in relation to the appointment of a prime broker would include performance of certain due diligence procedures to ensure high reputation, appropriate experience and sufficient financial resources.

The central administration of a SIF must be situated in Luxembourg. The CSSF may permit, on a case-by-case basis, the performance of certain ‘preparatory tasks’ outside Luxembourg subject to the overall responsibility of the appointed Luxembourg central administrator.

Netherlands VBI regime

To further improve the attractiveness of the Netherlands for investment funds, the Netherlands have recently introduced a new tax exempt investment regime, the VBI, adding another option to the available tax regimes for investment funds. Given its favourable characteristics and the mature and accessible Dutch investment market, the VBI regime is expected to stimulate the Netherlands market for fund vehicles, fund-of-funds and feeder funds. The VBI regime became effective in August thisyear and has already proved a popular choice amongst fund managers.

VBI Background

Similar to the Luxembourg SIF regime, the Dutch VBI regime provides for a full exemption from corporate income tax and dividend withholding tax. In addition, there are no capital duties or annual subscription taxes. Furthermore, non-Dutch resident corporate shareholders will not become subject to Dutch corporate income tax solely because of holding units or shares in a VBI. This exclusion is intended to give the VBI regime a boost for non-Dutch investors. Companies opting for VBI status, however, would not have access to Netherlands tax treaties.

Other benefits of the VBI regime include the non-existence of shareholder requirements, financing requirements or requirements to distribute profits. This is in contrast to the existing regime which will continue to run in parallel. In addition, the VBI is free in its choice of asset managers and custodians and there is no requirement for them to be resident in the Netherlands. To be eligible for VBI status a fund must have a (semi) open-end character, meaning that the shares/units are, at the request of holders, repurchased or redeemed out of the fund’s assets. It is anticipated that umbrella funds, fund-of-funds, feeder funds and hedge funds should generally meet this condition while private equity funds or venture capital funds may not qualify as they often have a closed-end character.There is flexibility in terms of structuring the VBI as a corporate or a non-corporate entity. A VBI can be formed as a Dutch NV, a mutual fund as well as similar foreign entities which are incorporated or formed under the laws of an EU Member State, a tax treaty country with a nondiscrimination clause, the Netherlands Antilles or Aruba.

The VBI regime is open for a wide range of financial instruments. This includes not only cash, equities, bonds, money market instruments, options and futures, but also cash settled derivative contracts regarding commodities, climate variables, emission licenses, inflation rates or other economic statistics. A VBI fund must pursue risk diversification. Investment funds would generally satisfy this test. The VBI is not intended for ‘active’ investments that exceed the threshold of ‘passive’ investments such as property development. Finally, a VBI is not allowed to make investments in illiquid, non-cash assets such as real estate, although indirect investments in non-Dutch real estate are generally allowed.

Netherlands regulation & administration

Generally, a VBI fund must have a license based on the Financial Supervision Act. However, a fund with VBI status is not subject to any license or other regulatory requirements provided the VBI meets one of three exceptions: the shares in the VBI have a minimum denomination of €50,000, the VBI only markets to ‘qualified investors’ or the VBI is only marketed to a maximum of 99 non-qualified investors. Appropriate selling restriction language is required in the VBI’s information memorandum and other marketing documents if a VBI wants to benefit from the above exceptions. Where a regulated VBI fund is preferred, the existing regulatory and administrative requirements will apply. Generally the Dutch supervisor (the AFM) should take about two months to process an application for a VBI license.

To briefly summarise, both the SIF and the VBI regime may be attractive to hedge fund managers and could be considered in conjunction with appropriate advice to insure the best possible outcome.