Legal expertise makes Luxembourg an attractive place to do business

The increasing popularity of alternative investment funds (AIFs), growing demand for vehicles compliant with increased environmental, social and governance (ESG) standards, and a raft of new legislation are fuelling the demand for legal certainty among Luxembourg’s financial institutions.

In some ways, Luxembourg is Europe’s hub for AIFs, with far more AIF structures based there than in Ireland, France, Germany and even the UK. Indeed, according to a report published by the Association of the Luxembourg Fund Industry (ALFI) (96 pages / 13.8MB PDF), well over 30% of all AIF structures in the continent are domiciled in Luxembourg.

Increased anti-money laundering monitoring

One of the reasons for this is that UK and US investors have had an increasing appetite in recent years for parallel fund structures domiciled in a European jurisdiction. Regulatory constraints, especially for investors, are rising and they are no longer willing to invest in for instance, a Cayman Island-based fund structure.

As the Financial Action Task Force has made very clear, these types of jurisdictions are under increased monitoring regarding strategic deficiencies in their regimes to counter money laundering, terrorist financing, and proliferation financing. As a result, investors are demanding that promoters and initiators have AIF structures in place in jurisdictions which offer legal certainty, legal predictability and which have a decent reputation. Luxembourg is the first port of call for these investors in Europe.

The impact of Brexit on Luxembourg funds

There has also been a measurable impact from the UK’s withdrawal from the European Union. Requests from the UK, especially from management companies, to have alternative structures in mainland Europe increased because Brexit brought considerable legal uncertainty – especially in the early months and years.

Luxembourg’s established legal framework provided much-needed legal certainty in the long run and enabled potential new investors and even remaining old investors to find hubs for their investments with corresponding fund vehicles domiciled in Luxembourg. An increasing demand to create additional and new fund vehicles could be observed in the industry well before the actual occurrence of Brexit.

Reserved alternative investment funds in Luxembourg

Among AIF vehicles, the Luxembourg market has experienced an ever-increasing demand for the reserved AIF (RAIF), launched in 2016. The RAIF, in comparison to the specialised investment fund (SIF), has a very short time to market and is only indirectly supervised by the financial regulator. RAIFs must appoint a fully authorised external AIF manager (AIFM) because the fund itself is not subject to product approval from the Luxembourg regulator, the CSSF.

Because of this, the RAIF offers a very flexible regime, no direct CSSF supervision and thus a comparably short time-to-market, and these are several of the underlying major factors that make the RAIF so popular, especially for US, UK and Asian initiators who are used to a quick time to market for their fund vehicles.

The SIF is still a much demanded and a very well-known fund vehicle on the market, but their number is slowly decreasing according to the ALFI report especially for debt and real estate funds. The RAIF, and especially also the unregulated special limited partnership (SCSp), have seen a tremendous increase in demand over the last two to three years in the sphere of debt and real estate funds.

Real estate boom in Europe

Before the Covid-19 pandemic and the 2022 interest rates increase, there was a tremendous demand for real estate-related fund vehicles that were acquiring assets. Banks were willing to hand out money at cheap rates, which created a lot of opportunities. Asia, and especially mainland China, were seen as less attractive jurisdictions, and many investors focused on acquiring more assets in central Europe, especially Germany, France, and the UK. These are markets with very predictable growth rates, legal certainty, and governments which ensured a political stable environment.

Meanwhile, the passing in January of the European long-term investment fund (ELTIF) 2.0 regulation by the European parliament, even if it still remains a niche product to date, as well as the upcoming Alternative Investment Fund Managers Directive (AIFMD) II amendments and Markets in Financial Instruments Directive (MIFID) changes, signify that 2023 is a year packed with more potential legal uncertainty on the horizon. It is up to Luxembourg’s legal community to raise awareness on these pending amendments and ensure the creation of legal certainty for industry players by very much tailored legal advice.

ESG demand in Europe

In addition, client-driven demand for vehicles that are sustainable in the purest sense, meaning Article 8 or Article 9 Funds under the Sustainable Finance Disclosure Regulation (SFDR), has also grown significantly. In turn, the CSSF is becoming increasingly strict in ensuring that there is no greenwashing of existing funds that have a sustainable logo or even the name “sustainable” in the respective fund name. The financial regulator is really focusing on having clear cut sustainable investment policies in place which are compliant with the detailed requirements of Article 8 or Article 9 SFDR.

It is a client-driven market trend, but as it is relatively new, the financial regulator needs to put in place more rules to really get rid of the last bits of legal uncertainty. The CSSF is proving to be very diligent in this regard and has received a lot of input from market players. It will surely create in the near future an even more harmonised level playing field for everyone demanding an ESG structure with high levels of predictability and legal certainty. 

A version of this article first appeared on PaperJam.