The years 2008 and 2009 have marked a drastic change in the offshore landscape and the fund industry, following a financial turmoil and tightening regulations caused, among others, by a change of government in the US and the Madoff scandal.
Faced with increasing client pressure and a distrust in traditionally popular fund jurisdictions, a number of promoters have had to carry out a thorough review of their fund range and study the commercial impacts of previous situations. This has resulted, in some cases, in an intensifying migration and relocation of foreign funds towards Luxembourg, in a quest for a jurisdiction free from reputational damage and equipped with a robust yet flexible regulatory framework.
Such migration process and its implications, for both promoters and investors, form the object of the present article.
Luxembourg became, in a short time span, one of the leading locations for investment funds. It currently stands as the largest fund services centre in Europe and the second largest worldwide, after the United States of America.
Along with its European competitors, Ireland and Malta, Luxembourg is one of the most favoured destinations for fund promoters, notably by reason of its efficient regulatory framework and competitive fund taxation system. It offers investors and promoters a broad range of legal structures that allow for the fulfilment of all types of investment projects.
Luxembourg legal structures
For the purposes of this article, I will consider three categories of Luxembourg investment vehicles into which foreign investment funds may be transformed for the purposes of their migration.
UCITS, also known as undertakings for collective investment in transferable securities, are funds which are compliant with European Directive 85/611 and the investments of which are limited to certain types of financial instruments. UCITS are designed for retail investors. Given the relatively limited scope of available investments within these funds and the extent of the legal work necessary to transform an offshore investment vehicle (formerly incorporated in the Cayman Islands for instance) into a UCITS, it is unlikely that promoters take advantage of this possibility.
UCIS, also known as undertakings for collective investment, are lighter regulated vehicles that do not benefit from the European passport, although they are also designed for retail investors.
Specialised Investment Funds (more commonly known as SIFS) were created through the enactment of the Luxembourg law of 13 February 2007. They are designed for sophisticated investors. Their lighter regulatory framework and greater flexibility in terms of investment policies and restrictions represent a competitive alternative for fund promoters that had previously elected to incorporate their structures in more lightly regulated jurisdictions. SIFS will usually represent the most favoured alternative to a Cayman Islands, Bermuda or British Virgin Islands fund.
Steps for migration
The three following alternatives are available to promoters wishing to migrate their foreign funds to Luxembourg.
1. Liquidation of the foreign fund and subsequent creation of a Luxembourg fund
This alternative involves, as a first step, the liquidation of the foreign fund in compliance with the laws of such fund’s jurisdiction of incorporation. In such a case, the assets of the foreign fund will not be transferred directly to the Luxembourg fund.
The second step will consist of the incorporation of the Luxembourg fund. Upon the completion of such incorporation, the units held in the foreign fund will be reimbursed to investors, who will subsequently be in a position to invest in the Luxembourg fund.
As this first option implies an active involvement of investors in the migration process, it is not recommended.
2. Transfer of the registered office of the foreign fund to Luxembourg (recommended option)
The transfer of a foreign corporation to Luxembourg is possible without the discontinuation of the legal personality of the transferred corporation, provided that the laws of such corporation’s jurisdiction of origin accept the continuation of the legal personality of the transferred corporation. It is therefore paramount to obtain confirmation from legal advisors in the transferred corporation’s country of origin that such transfer is indeed possible without the discontinuation of legal personality. By way of example, the laws of the Cayman Islands accept such continuation and the steps described below will be based on the transfer of a Cayman Islands investment fund to Luxembourg.
The following three steps are typically taken to achieve the purported transfer described above:
a) First general meeting of shareholders in the Cayman Islands
The purpose of such meeting will be to approve the transfer of the Cayman Islands fund’s registered office to Luxembourg and to convert the Cayman Islands fund into a Luxembourg company.
This implies that the Cayman Islands fund will acquire the Luxembourg nationality and that henceforth the Cayman Islands fund will be subject to Luxembourg law, at the exclusion of any other law, once the transfer is completed. This also implies that the shareholders will have to approve the amendments to the Cayman Islands fund’s articles of association, the increase of the number of directors to at least three (as the case may be), appoint an auditor in Luxembourg and resolve that the accounting year of the fund under Luxembourg legislation will begin on the date of transfer of the registered office.
b) Legal opinion issued by lawyers located in the Cayman Islands
This document, which is necessary to carry out all legal and regulatory procedures in Luxembourg, will have to confirm that the purported transfer of the registered office to Luxembourg will be possible without the discontinuation of the Cayman Islands fund’s legal personality.
c) Second general meeting of shareholders in Luxembourg
The purpose of such meeting will be to confirm the transfer of the Cayman Islands fund’s registered office to Luxembourg and the conversion of such fund into a Luxembourg corporation. It will also purport to amend the Cayman Islands fund’s articles of association to comply with the provisions of Luxembourg company law.
This second meeting should be held immediately after the decision to transfer the registered office to Luxembourg has been validly taken in the Cayman Islands.
3. Contribution in kind of the portfolio of the foreign fund to the Luxembourg fund and subsequent liquidation of the foreign fund by distribution of the Luxembourg fund’s shares to investors
This alternative involves the contribution of the assets of the foreign fund to the Luxembourg fund in exchange for shares in the Luxembourg fund. The foreign fund will therefore become a direct shareholder of the Luxembourg fund. The foreign fund will then be liquidated after shares of the Luxembourg fund have been issued in consideration for the contribution and will pay to its shareholders liquidation proceeds in kind, i.e., shares of the Luxembourg fund, at which time former shareholders of the foreign fund will become shareholders of the Luxembourg fund.
Impact of migration
The migration of a foreign fund to Luxembourg can be advantageous from a tax perspective.
Indeed, the migrated fund can, when transformed into a Luxembourg vehicle, benefit from 27 tax treaties entered into by Luxembourg.
In addition, the migration of a foreign fund to Luxembourg is not considered as a capital realisation event for existing investors.
Finally, the fact that the foreign fund may preserve its legal personality despite the transfer to Luxembourg is a crucial factor for promoters wishing to maintain the track record of their investment vehicles. When explaining the purported transfer to their existing clients, promoters will also be in a position to confirm (i) that such clients may continue to hold the same assets in the Luxembourg fund as the assets that they previously held in the foreign fund and (ii) in certain cases and for certain types of Luxembourg funds, that the investment policies and restrictions of the foreign fund may be maintained in the Luxembourg entity.
As investors demand increased regulation of their investment products, they have recently turned towards Luxembourg, which has gradually become a centre for fund relocation.
Actors in the investment funds market in Luxembourg have noticed an emerging trend for investment funds to be redomiciled to Luxembourg from offshore fund jurisdictions such as the British Virgin Islands, the Cayman Islands and Bermuda, considered, rightly or wrongly, as more opaque and offering less investor protection.
The above does not mean that these jurisdictions will run out of business but Luxembourg now undoubtedly forms part the diversification process of many promoters’ fund range, who wish to expand their offering to include collective investment schemes incorporated in a prime European fund jurisdiction. This can be achieved by launching mirror funds in Luxembourg (i.e., onshore funds that are similar in strategy to some or all of their offshore funds) or by creating Luxembourg funds with more conservative investment policies and restrictions to satisfy the needs of their most cautious clients.
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