At the heart of Europe is Luxembourg, the second largest fund domicile in the world. The country is highly appealing to foreign investors due to its firm reputation of excellence efficiency, flexibility, and highly professional fund industry. The Grand Duchy is also the preferred jurisdiction for setting up parallel fund structures among European-based investors. While the main fund structures are positioned in other countries like the Cayman Islands and Delaware, one or multiple parallel funds are ideally established in Luxembourg, or vice versa.
A Brief Introduction to Parallel Fund Structures
Parallel fund structures refer to direct and indirect investments for separate conduit, holding, or similar structures alongside a main fund. In essence, the parallel fund and the main fund enforce identical and or similar investment policies and strategies. For instance, both invest following similar provisions within the same timeline, have common investment objectives, and identical risk profiles. It is also commonplace in parallel structures that commitments are made at the same time, following the same conditions and investments that are typically created on a pro-rated basis.
Legally speaking, the fundamental operations are one and the same. Investors of parallel and main funds are pooled and carry the same voting rights. The objective of investment manages in a parallel fund structure is to treat investors across all vehicles equally.
The Differences between the Parallel Fund and Main Fund
The differences are evident in the legal, operational, regulatory, and operational aspects of parallel and main funds:
- Luxembourg fund is eligible to be an Alternative Investment Fund, which means its manager is subject to the regulatory requirements under the European Parliament’s Alternative Investment Fund Managers Directive (2011/61/EU).
- Funds domiciled in other jurisdictions such as Delaware and Cayman Islands will follow a different set of regulatory requirements.
- A different set of requirements is also applicable to investors in parallel fund structures.
- While assets under management are typically pooled to determine the size of an entire fund structure, parallel and main funds differ in size.
A classic example would be this- A Germany-based insurance company is subject to German and EU regulatory requirements is deemed to adhere to a different set of rules when compared alongside a Family Office based in Singapore.
Luxembourg Parallel Fund Structure Benefits
- Allow fund initiators to attract a variety of investors in different jurisdictions.
- Majority of European investors prefer setting up funds in EU jurisdictions.
- Some investors in certain parts of Europe may be restricted to invest through non-European vehicles. On the other hand, US investors are keen on investing through a Delaware or Cayman vehicle, due to their geographical attractiveness and familiarity with the said jurisdictions.
- Luxembourg vehicles may exclude United States investors to avoid being subject to the jurisdiction’s existing specific tax rules. Consequently, vehicles set up in non-European jurisdictions avoid setting up in Luxembourg and other European countries to avoid the regulatory costs related to the Alternative Investment Manager Fund Directive (AIFMD).
- Parallel fund structures pave the way to collection of larger commitments; hence feature a more diversified investment portfolio.
- This type of structure allows for the efficient management of larger pools of investment, thus increasing profitability of an initiator and the portfolio manager.
The Main Challenges in a Parallel Fund Structure
- Since parallel fund structures consists of different vehicle types located in different jurisdictions, investment managers need to maintain proficiency of different legal and regulatory requirements.
- Due to the complexity of parallel fund structures, investment managers typically coordinate with different service provides in respective jurisdictions to ensure efficient and seamless operation.
- Upholding equal and fair treatment of investors across different vehicles. Investment managers need to maintain consistency in providing excellent support to investors. It is necessary for them to be updated with the costs to certain vehicles within a parallel fund structure.
- The distribution waterfall and voting rights are different across different parallel fund vehicles.
With all these challenges, it is imperative that investment managers should enforce a comprehensive strategy before initiating parallel fund structures. Amendments and adoptions somewhere down the line will make the operations and management of parallel fund structures more complicated.
Luxembourg- A Preferred Parallel Fund Structure Jurisdiction
Apart from being renowned for its professional and well-established fund industry, Luxembourg offers a consistent yet flexible legal and regulatory landscape. For instance, limited partnerships comply with flexible and manageable provisions. The Grand Duchy makes it easy for initiators to structure a limited partnership due to its streamlined formal and registration process.
Special Limited Partnership Structure
Luxembourg allows for the structuring of special limited partnerships without legal personality (SCSp), a legal form that most initiators are familiar with as they share similar features with Delaware and Cayman Islands partnerships.
Additionally, the Luxembourg limited partnership regime offers legal certainty. This means limited partnerships are more confident in their operations, given there is a clear set of rules that they need to follow. Partnership reforms in other European countries are relatively new, thus they offer lesser flexibility than Luxembourg.
The Grand Duchy offers the opportunity to structure fund vehicles in parallel to main fund vehicles domiciled in Delaware, Cayman Islands, and other select jurisdictions.
Diverse Portfolio Solutions
From a regulatory perspective, Luxembourg offers different products that are more appealing and suited for parallel fund structures. For instance, the Reserved Alternative Investment Fund introduced in 2016 share similarities with unregulated fund structures but are required to have a fully authorized alternative fund manager (AIFM) and depositary.
However, unlike a Specialized Investment Fund (SIF), a Reserved Alternative Investment Fund (RAIF) does not require authorization from Luxembourg’s Supervisory Authority for the Financial Sector (CSSF). A registration is the only requirement that a Reserved Alternative Investment Fund (RAIF) must fulfil. Under the Reserved Alternative Investment Fund (RAIF) regime, several sub-funds can be set-up. Under the supervision of an Alternative Investment Fund Manager, a European passport is available to fund investors.
Available Parallel Fund Structures in Luxembourg
Depending on currency and the type of investors, fund initiators may prefer the maintain single master fund in Luxembourg, featuring one or a combination of feeders in the Cayman Islands, Delaware, and other jurisdictions.
Luxembourg paves the way to simplified portfolio management, thus eliminating and errors between the main fund and parallel fund structure.
Before setting up a fund structure in Luxembourg, initiators should consider the needs and preferences of investors to secure easier and efficient fund raising.
Initiators also need to consider tax implications of having multiple fund structures on investors and investment portfolio themselves. Given the complexity of the parallel funds, investment fund managers should consider the overall costs of maintaining these structures.
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.