Luxembourg has become the first to transpose the AIFM Directive. Keith Burman says this is not the first time the Grand Duchy has been ahead of the curve
European real estate funds will embark on a new chapter in July 2013, as fund managers begin to feel the full impact of new EU legislation affecting the alternative funds industry.
While the Alternative Investment Fund Managers Directive (AIFMD) creates an overall framework intended to tighten oversight of alternative investment vehicles, including real estate funds, the ways in which individual EU member states choose to transpose the directive into national law present fund managers with choices when making decisions about the appropriate domicile for their funds. The AIFMD has stimulated significant European debate and some criticism since it was first prepared by the European Commission in April 2009. It is intended to provide clear and harmonised regulations for alternative investment fund managers in Europe and beyond, and introduces a European “passport” for managers to market funds across the region.
Luxembourg has moved quickly to take the lead in this area and has already deposited its own enabling legislation with Luxembourg’s parliament, targeting this bill to be passed into law this year – a notable achievement. The step reflects the importance Luxembourg attaches to its role in the European cross-border financial services market and, together with its highly developed fund services infrastructure, promises to strengthen its position as a favourable environment for real estate fund managers and institutional investors alike.
Luxembourg is far more than a domestic market; it’s a vibrant cross-border financial centre with a sophisticated infrastructure of mobile multinational managers, a highly experienced tax and audit community and a large network of administrators and depositary banks. For today’s real estate fund managers and institutional investors, its depth of resources represents a benchmark for the industry.
Luxembourg has served as an active base for regulated institutional real estate funds, in addition to other alternative investment vehicles, since 1991. Growth in this sector has been especially brisk over the past 10 years, rising from fewer than 20 funds in 2002 to more than 230 in 2012 (comprising both single real estate funds and sub-funds of umbrella structures.
Growth in net assets under management for Luxembourg-based real estate funds has travelled a similar trajectory over the same period. Luxembourg now vies with the UK as the top domicile for real estate funds included in the European Association for Investors in Non-listed Real Estate Vehicles (INREV) database, representing 20% of the participating real estate funds. In addition, it serves as the domicile for more than 30 real estate funds of funds.
Luxembourg’s record in real estate is in line with its legacy in the UCITS investment funds market where, in terms of assets under management, it has grown over the past two decades to become the world’s leading fund domicile after the US.
As real estate fund managers consider the implications of domicile in the run-up to the AIFMD, it is wise to keep this legacy in mind. Luxembourg has consistently taken the lead in integrating or anticipating new regulations, and then building on them to fashion an innovative and forward-thinking financial regime.
For example, Luxembourg helped to give birth to the European cross-border mutual funds industry, acting as a pioneer in transposing the first UCITS directive into national law. In 2010, Luxemburg again become the first country to integrate UCITS IV into its local legislative framework.
Luxembourg also foresaw the benefit of paving the way for regulated institutional alternative investment vehicles. These took the form of Investment Companies in Risk Capital (SICARs) in 2004, and Specialised Investment Funds (SIFs) in 2007, ahead of the regulatory curve.
The same propensity for financial innovation and speed has led Luxembourg to seize the opportunity to be first to enact its own AIFMD-driven enabling legislation seven months before the EU-wide directive takes effect. It helped significantly that Luxembourg was not starting with a blank slate.
Long-standing local practice – owing in part to ideas contributed by the Association of the Luxembourg Fund Industry (ALFI) – anticipated measures that later became important features of the AIFMD. For example, it has been standard practice in the past 10 years for real estate funds operating in the Grand Duchy to appoint a depositary, apply specific limits on leverage and use independent real estate valuers. Meanwhile, some real estate fund managers on a broader Europe-wide basis have found certain features – such as being compelled to appoint a depositary – something of a stumbling block.
Although Luxembourg did not put its existing framework forward to the AIFMD drafters as a template, the focus of the AIFMD on many of the same fundamental principles already mimics much of the Luxembourg law. As a result, the gap between pre-directive and post-directive practice in Luxembourg may be significantly less than for some other member states, which might face a greater departure from their current rules.
Luxembourg’s broad experience both of the regulatory environment and of a wide variety of alternative funds means it is in an advanced state of readiness for AIFMD.
Signalling Luxembourg’s forward-looking stance, the Grand Duchy is leaving in place the existing legislation for fund managers that are currently out of scope of the AIFMD. Those managers that qualify for an exemption can continue to operate Luxembourg funds as they currently do.
This provision applies, for example, to fund managers falling below the de minimis threshold for AIFMD registration of €100m (leveraged) or €500m (unleveraged). Thus, vehicles of high-net-worth fund managers that are below the AIFMD thresholds can choose to continue making use of their existing vehicles – either regulated or unregulated – and launch further vehicles in the future, subject to private placement, in line with rules in place today. Of course, these vehicles can also elect to opt in and qualify for the EU-wide distribution passport.
In the medium term, Luxembourg provides considerable regulatory certainty for real estate fund managers looking to establish new products over the next five years, as Europe gains experience from the AIFMD. As surveys of institutional investors continue to report a favourable view for increasing allocations in alternatives – and particularly in real estate – Luxembourg’s importance as a real estate fund industry centre looks likely to grow.
Among the operational changes necessary to comply with the new AIFMD framework, all retail and most institutional real estate funds either based or sold in Europe will, over time, need to allow for:
• Mandatory manager authorisation;
• New requirements for corporate governance and business operations;
• Focus on risk and liquidity management;
• Specific disclosures to regulators and investors;
• Appointment of a depositary to safe-keep assets and oversee fund operations.
Keith Burman is co-chair of the ALFI real estate fund sub-committee and the AIFMD working group, and senior managing director at State Street Luxembourg