There are many reasons why Luxembourg is a premier destination for debt funds. The sophisticated regulatory framework and solid relationships that exist between supervisory authorities and the financial sector guarantee a smooth and stress-free process of establishing a debt fund in Luxembourg.
The primary regulatory body executes its duties of efficient supervision and market management to ensure the safety and security of the financial sector. Luxembourg’s constant state of evolution takes into consideration the constant changes not only in the local but also in European and international landscapes.
Luxembourg strikes the perfect balance between smooth exchange of information between organizations that represent businesses and regulators. As the country’s regulatory framework is still expected to evolve overtime, its impact on the private debt market will be evident to investors as well. Developing alternative sources of financing other than traditional bank loans will be highly beneficial for local and foreign investors alike. Nevertheless, Luxembourg’s financial sector is in a good position and is promising as it stands to gain further from the consistent growth of its alternative investment industry that includes debt funds in the next few years.
The Private Debt Market Boom in Luxembourg
The debt fund sector in the Grand Duchy of Luxembourg is rapidly developing as lending through traditional means is becoming more challenging over time. Firstly, the cost of traditional lending for banks and similar organizations are increasing due to capital adequacy requirements which are primarily controlled by regulations. This has made it more difficult for banks to generating earnings from lending as a service. Banks developed increased prudence is also benefiting from the private debt market.
According to Prequin, the global private debt market was valued at USD 575 billion in 2016. By the end of 2020, the global private market ballooned and reached USD 848 billion with projections estimating its value to as much as USD 1.46 trillion by the end of 2025. In Luxembourg, this is an excellent growth opportunity among advisors, domiciliary providers, wealth management companies, depositaries, and fund administration professionals that excel in assisting fund managers.
According to experts, all private debt funds will be channeled through Luxembourg. The fund vehicles in the country will serve a wide spectrum of investments, from senior loans, syndicated loans, distressed debt, convertible loans, and many more. The loans themselves can finance any type of asset, ranging from real estate, private equity, infrastructure, and operational structure, providing a highly robust network for all of them.
Luxembourg can definitely service specialized funds with the added capabilities of structuring and offering them to interested parties. The country’s economic stability and innovative mindset make it an integral location for financial professionals. In fact, Luxembourg is one of the nine countries worldwide with a triple A rating as it successfully fosters political, economic, and regulatory stability, inspiring a culture that offers optimum protection among investors.
Why is Luxembourg the Ideal Destination for Debt Fund Investments
- Choose between close or open-ended funds
- Ability to satisfy prevailing time-to-market constraints
- Approved marketing passport across the EU
- Segregation of asset options
- The accommodation of different strategies, including distressed debts, secondary loans, loan origination, leverage, and other real estate solutions belonging to the same vehicle
- Wide variety of choices when it comes to accounting standards
- The attractive Luxembourg legal landscape allows for flexibility and legal certainty
- VAT exemption on management fees
- Internationally recognized stock exchange
- Sustainability standards and labels such as Green, Social, Sustainable and ESG securities
There are two primary, regulated fund vehicles in Luxembourg that are ideal for debt funds among institutional, sophisticated, and professional investors:
Specialized Investment Fund (SIF)
This is a highly appealing vehicle due partly for its flexible operating rules and extensive investment options. The laws under Luxembourg SIFs are not specific with any quantitative, qualitative, geographical, or other investment limitations, thus it can be applied to a broad range of situations.
One can establish a SIF as an umbrella fund with various compartments with each allocated to a specific investment policy (such as in the case of hedge funds, real estate, and private equity) characterized by a strict separation of liabilities and assets between compartments. By rule, a SIF are not allowed to invest beyond 30% of assets or commitments towards securities of the same kind under one issuer, with the exception of feeder funds. Lastly, a SIF is that it can only be established by well-informed investors.
SICAR or Investment Company in Risk Capital
A SICAR does not demand risk diversification from investors. Its object may be direct or indirect assets contribution among entities in view of their launch, development, or listing in a recognized stock exchange. This may include any financing solution, be it bridge finance, bond issuance, mezzanine-type financing, and equity contribution, all are identified as risk capital contributions.
A SIF and SICAR can be set-up in the following legal forms:
Corporate Company featuring capital divided into shares. A company may fall under these two classes:
- SICAF or closed-ended fund
- SICAV or open-ended collective investment strategy
Limited Partnership that offers great contractual freedom in relation to profit entitlements, voting rights, and other crucial rights applied to the general partner.
A SIF may take the legal form of a common fund or FCP. It has no legal personality and must be handled by an authorized management company.
On the other hand, alternative investment funds or AIF such as SICAR and SIF will be managed by alternative investment fund managers and may be eligible to apply and obtain European Long-Term Investment Fund. This can help boost capital from retail and institutional investors among members across EU member states.
In 2015, the Luxembourg government released a bill of law that introduced a new type of Luxembourg investment fund called the Reserved Alternative Investment Fund or RAIF.
The Luxembourg RAIF is designed to replicate the SIF but with the unique feature of not being subject to supervision by the CSSF and will solely be reserved for structuring of AIF that appoint a duly authorized Alternative Investment Fund Manager or AIFM. It has since the third quarter of 2016.
Other non-regulated funds that can be used are the Luxembourg simple and special limited partnerships called the SCS and SCSp respectively. They are AIFMD-compliant investment vehicles that are managed and authorized by a dedicated AIFM typically used for structuring an AIF with the advantage of obtaining a European marketing passport.
A prime example of an unregulated vehicle is the SOPARFI. It provides excellent flexibility when it comes to investment policy while at the same time providing investments the possibility of utilizing tax treatments that are available for Luxembourg companies.
Some of the key features of a SOPARFI are as follows:
- It is an inexpensive and flexible company to establish and incorporate
- Subject to light capitalization riles as they qualify for the Luxembourg participation exemption regime that provides substantial neutrality for eligible investments. SOPARFIs can fully benefit from the extensive double tax treaty of Luxembourg and EU Parent-Subsidiary Directive
- Subject to risk spreading limitations, including investment-type constraints or to eligible investor limitations
- Treated as an ordinary commercial company that can operate exclusively for holding and financing activities only
The most prevalent legal forms of a SOPARFI are:
- Incorporated Limited Partnership issuing shares or SCA
- Private Limited Company or SARL
- Public Limited Company or SA
Securitization Vehicles (SV)
Loan grants instead of obtaining them from the secondary market is also considered securitization and can be managed through unregulated securitization vehicles in Luxembourg given the following conditions:
- Does not allocate the funds raised from the public to credit activities on one’s own account and that important data is contained within the documentation relating to the issue
- Does not offer securities to the public nor offer securities on a continuous basis (maximum limit of three securities issues per year)
- Does not profit out of granting loans. In essence, a SV acts as a first lender and new loan originations should qualify as AIFs, falling under the AIFM law of 2013.
SVs can take the following legal forms:
- A commercial company such as public limited company (SA), private limited company (SARL) unless securities are to be issued to the public, incorporporated limited partnership issuing shares (SCA), cooperative organized as a public limited company (SCoSA)
- A securitization fund functioning as a co-ownership or a trust.
With years of expertise in debt funds and alternative investment vehicles in Luxembourg, Damalion experts aim at helping clients in achieving their goals by empowering them with sound counsel and recommendations to get their business up and running on no time. Talk to a Damalion expert today and let us help you get where you want to be.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.