On June 20, 2024, the Luxembourg Private Equity Association (LPEA) hosted a seminar in Tokyo. Here are the key takeaways from the presentations.
Luxembourg: A Small Nation with a Global Footprint
Luxembourg, with a population exceeding 660,000, boasts a diverse linguistic landscape with an average of 3.6 languages spoken per person. Notably, expats constitute 48% of its population, and the nation attracts over 220,000 cross-border workers. Despite its small size of 2,586 square kilometers, Luxembourg holds a significant position in the global financial landscape.
Luxembourg’s Strengths as a Financial Center
- Access to the EU Market: As an EU member state, Luxembourg provides seamless access to the vast EU market of 450 million consumers and a combined GDP of €15 trillion.
- Dominance in Private Equity: Luxembourg hosts operations of 18 out of the top 20 global private equity fund managers and boasts the second-largest investment fund center globally, managing $5.4 trillion in assets.
- AAA Credit Rating: Luxembourg enjoys an exceptional AAA credit rating, reflecting its robust economy and stable political environment.
Luxembourg Funds: Key Highlights
- Pioneering UCITS Funds: Luxembourg has over 36 years of experience in managing UCITS funds, showcasing its long-standing expertise in the field.
- Expertise in Alternative Investment Funds: Luxembourg boasts a two-decade track record in managing Alternative Investment Funds, solidifying its position as a global leader.
Luxembourg: A Haven for Global Private Equity Funds
Luxembourg has emerged as a preferred domicile for private equity funds, evident from the substantial assets under management (AUM) in this sector.
- Market Size: The net asset value (NAV) of PE funds domiciled in Luxembourg reached €690 billion.
- Fund Diversity: Luxembourg is home to a diverse range of funds, including 503 Private Equity Funds, 118 Fund of Funds (PE), 69 Infrastructure Funds, and 404 Private Debt Funds
Why Luxembourg Stands Out as a European Hub
- Tax Efficiency: Luxembourg offers attractive tax structures, including no withholding tax on funds, making it a tax-efficient jurisdiction for fund managers and investors.
- Diverse Legal Structures: Luxembourg provides a comprehensive “toolbox” of legal structures, catering to the specific needs of various fund strategies.
- EU Distribution Capabilities: Funds domiciled in Luxembourg benefit from streamlined distribution channels across the entire European Union.
- Political and Economic Stability: Luxembourg’s stable political landscape and robust economy provide a secure environment for long-term investments.
- Business-Friendly Environment: The nation fosters a pro-business environment, with efficient regulatory processes and a supportive ecosystem.
- Highly Skilled Workforce: Luxembourg boasts a skilled and multilingual workforce with over 35 years of experience in the fund industry.
- Exceptional Quality of Life: Luxembourg offers a high quality of life, attracting top talent and investors alike.
Prominent Global PE & VC Firms in Luxembourg
The LPEA boasts a strong membership base of renowned global PE and VC firms, reaffirming Luxembourg’s status as a global hub.
Japanese Presence in Luxembourg
Luxembourg has witnessed a growing presence of Japanese investors and financial institutions, drawn to its stability, expertise, and strategic location within the EU.
European Leadership in Alternative Funds
Luxembourg dominates the European alternative funds landscape, with 61.8% of European alternative assets domiciled within its borders.
European Institutional Investors: A Significant Source of Capital
European institutional investors play a crucial role in the private equity and venture capital ecosystem. Some of the largest European PE/VC allocators include:
- APG Asset Management (Netherlands) — $56 billion AUM, 8% allocated to PE/VC
- BPI France (France) — $39 billion AUM, 34% allocated to PE/VC
- Allianz Global Investors (Germany) — $28 billion AUM, 4% allocated to PE/VC
European Family Offices: A Growing Force
- Europe is home to 23% of the world’s billionaires and European Family Offices (FOs) manage an estimated >$150 billion in assets.
- Luxembourg’s attractive features, such as its AAA rating, EU membership, regulatory framework, and flexible structures, make it an ideal location for FOs looking to allocate capital to PE.
European Retail Investors: Untapped Potential
With a population of approximately 450 million people, European retail investors represent a significant untapped fundraising opportunity for the private equity and venture capital industry.
Parallel Fund Structures: Cayman and Luxembourg
The Cayman-Luxembourg parallel fund structure is a popular choice for fund managers seeking to attract a global investor base while optimizing tax efficiency and regulatory compliance. It involves setting up two interconnected funds, one in the Cayman Islands and the other in Luxembourg, operating in tandem.
The Players
- Fund Sponsor/GP: The entity initiating the fund and managing the investments.
- Limited Partners (LPs): The investors committing capital to the fund.
- Cayman Fund: Typically structured as an exempted limited partnership, providing tax neutrality and flexibility.
- Luxembourg Fund: Often structured as a Specialized Investment Fund (SIF) or Alternative Investment Fund (AIF), offering EU regulatory compliance and access to European investors.
- Carry Vehicle: A separate entity, often located in a tax-favorable jurisdiction, used to manage and distribute carried interest (performance-based compensation) to the GP.
The Setup
- Dual Fund Formation: The GP establishes both the Cayman fund and the Luxembourg fund.
- LP Investment: LPs have the option to invest directly into either the Cayman fund or the Luxembourg fund, depending on their individual tax considerations and regulatory requirements.
- Parallel Investment: Both the Cayman and Luxembourg funds invest in the same underlying investments, ensuring consistent portfolio performance across both structures.
- Control and Management: The Cayman fund typically acts as the master feeder, holding a majority stake in the Luxembourg fund. This allows the GP, through its management entity, to maintain control over investment decisions and operations for both funds.
- Carried Interest Flow: Carried interest generated from the underlying investments is distributed proportionally to both funds based on their respective investments. The Luxembourg fund’s share of carried interest then flows to the Carry Vehicle.
Advantages of the Cayman-Luxembourg Structure
- Tax Optimization: (I) the Cayman fund benefits from the Cayman Islands’ tax-neutral regime, shielding investors from additional layers of taxation on income and capital gains; (II) the Luxembourg fund, while subject to EU tax regulations, offers certain tax advantages for specific investor types and investment strategies.
- Regulatory Flexibility and Compliance: (I) the Cayman Islands provide a flexible regulatory environment for fund formation and operation; (II) the Luxembourg fund ensures compliance with EU regulations, including the Alternative Investment Fund Managers Directive (AIFMD), granting access to a broader European investor base.
- Investor Choice: The parallel structure caters to a wider range of investors by providing options to invest through either the Cayman or Luxembourg route, based on their specific tax and regulatory needs.
- Access to Global Markets: The structure allows fund managers to tap into both offshore and onshore investor bases, maximizing fundraising potential.
- Streamlined Operations: While operating as separate legal entities, the funds are managed cohesively, ensuring operational efficiency and consistent investment strategy.
Key Considerations
- Complexity: Setting up and administering a parallel fund structure involves intricate legal and tax considerations, requiring specialized expertise.
- Cost: The dual fund structure incurs higher setup and ongoing administrative costs compared to a single-jurisdiction fund.
- Substance Requirements: Fund managers need to be mindful of substance requirements in both jurisdictions, ensuring adequate economic presence and activity.
