The Advantages and Challenges of Luxembourg Parallel Funds - Damalion - Independent consulting firm.

Fund managers based in Asia-Pacific and the United States are taking interest in establishing parallel fund vehicles in Luxembourg to gain access to high-net-worth investors in the European Union that will further strengthen their existing domestic alternative investment undertakings.

Luxembourg Parallel funds : principles

In this specific structure type, a parallel fund vehicle will sit alongside a non-European Union master vehicles that may include other parallel funds co-investing in the same types of assets. As parallel fund vehicles are operated and being managed the same way as its master fund, this specific vehicle brings greater efficiencies than other traditional distribution systems.

Before establishing a Luxembourg parallel fund, it is important for fund managers and investors to understand its key features and the different roles that service providers play to ensure smooth governance and operations.

  • Provisions under the Alternative Investment Fund Managers Directive offers a variety of flexible structuring solutions that investors can choose from when looking to participate in an alternative fund structure such as a Luxembourg parallel fund.
  • Fund managers must include a comprehensive discussion of the governance model inherent in the structuring of Luxembourg alternative investment funds, including parallel funds.

Differences Between the Parallel Fund and Main Fund

  • Differences between the parallel fund and main fund are mainly due to legal, operational, regulatory, and tax reasons. The fund structure in which these two funds fall under created how parallel and main funds are treated differently.
  • Simply put, a Luxembourg parallel fund will be subject to the regulatory requirements of the Alternative Investment Fund Managers Directive (AIFMD), while its main, which may be located in the Cayman Islands will be subject under a different set of legal and regulatory requirements.
  • The main fund and parallel fund may also differ in size, although the assets under management will be grouped accordingly to determine the final size of the entire fund structure.

Why Do Fund Managers Set-Up Parallel Funds in Luxembourg?

Non-European Union fund managers that are looking to broaden their investor base by including European investors choose to deploy parallel fund structures in Luxembourg for a number of reasons:

  • Parallel funds easily replicate domestic fund ranges resulting in an optimized investment process.
  • Non-European Union managers gain access to new capital from a diverse investor pool while leveraging their local funds track record.
  • Parallel funds typically use the same investment and divestment rules, profiles, and targets as the main fund, allowing fund managers to establish them quickly.
  • Promote operational efficiencies through replication of operational processes between domestic and European funds. This makes it smart and sensible structure to lower management costs.

Advantages of Deploying a Parallel Fund in Luxembourg?

  • Some investors are required to follow internal guidelines that limit them to invest in offshore vehicles, as well as regulatory and tax implications that arise from investing in either the main or parallel fund.
  • Fund managers bring the option between on-shore and off-shore jurisdictions that allows them to meet the needs of a diverse group of investors.
  • Luxembourg is a premier destination for seeking access to European capital due to its extensive alternative investment vehicle toolbox.
  • The most popular legal form for parallel funds is the Limited Partnership as it offers comprehensive functionality. For investors who are familiar with Anglo-Saxon partnerships, a Luxembourg Limited Partnership is an easy choice due to its flexibility and efficient structuring.
  • Fund managers enjoy European passporting rights, allowing them to market across Europe.
  • After Brexit, non-European fund managers have shifted to Luxembourg as their new European base.

Challenges of Setting-Up a Luxembourg Parallel Fund

Fund managers will face a few challenges in setting-up a parallel fund in Luxembourg. It is then crucial for non-European Union based fund managers to choose the right group of service providers to help set-up, manage, and supervise parallel funds in Luxembourg.

  • Despite the complexity of parallel funds, fund managers are required to provide equal treatment for all its investors.
  • Administrative burdens that commonly occur in a parallel fund set-up include dealing with different base currencies that makes reporting obligations more challenging than it already is on a normal investment set-up.
  • Adequate allocation of costs between different fund structures must be met. A fund manager is expected to balance costs from different asset pools.
  • Fund managers looking to open a Luxembourg parallel fund is encouraged to discuss the governance model before investors can invest. This is done so that investors gain clear understanding how activities such as voting rights, distribution waterfall, and expenses will be managed over time.
  • The delegation model of a Luxembourg parallel fund is more complicated. A Luxembourg-based fund manager will be appointed to handle most of the administrative tasks.
  • The appointed Luxembourg sponsor will act as an external authorized alternative investment fund manager with passporting rights. The management fee for the fund manager will be included in a parallel fund delegation structure.
  • This will be the same in a Luxembourg fund but if you, for example, have a Luxembourg fund that needs to appoint an external authorised AIFM to access the European passport, it will have a third-party service provider that will be included in the fee and delegation structure. This may make things difficult because you will need to carefully monitor the flow of fees within both structures, and the delegation structure in each fund may not be the same.
  • Maintaining larger parallel funds is not sustainable dur to the mounting costs it will generate over time. It is imperative to determine the size of a parallel fund at the onset of the structuring stage.

Other Investment Vehicle Structures in Luxembourg

Due to the flexibility of investment vehicles in Luxembourg, fund managers should consider setting-up a single master fund in the Grand Duchy, featuring one or more combination feeders at international jurisdictions like the Cayman Islands and Delaware.

Establishing a master fund in Luxembourg benefits from a simplified portfolio management as it eliminates the need to track between the main fund and parallel fund. To determine the right fund structure, initiators need to look at various factors, including the specific preferences and needs of investor. This will guarantee an easier way of raising funds as well as carefully assessing tax implications for investors and the entire investment portfolio.

To learn more about Luxembourg parallel fund structuring or you need expert guidance on which investment vehicle structure is best suited to include in your portfolio, call a Damalion expert today.

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.