Do you think that Luxembourg is taking the right position on AIFMD, and what do you predict its effects on the country to be?
Luxembourg has embraced the Alternative Investment Fund Managers Directive (AIFMD) as key to its future success in the alternative space—a strategic opportunity for establishing itself further in this arena. So, how exactly will this be achieved? It will not just be a matter of simply implementing AIFMD, but going one step further and combining its implementation with an attractive package of legislation directed at those operating in the alternative market. Changes will cover corporate law and more specifically Luxembourg legislation related to limited partnerships, bringing the Luxembourg framework more in line with the Anglo-Saxon model seen in offshore locations such as Jersey and Guernsey.
Further significant changes will also be made in the area of tax law, in order to ensure that the new limited partnerships arrangement is fully tax neutral. Last but not least, by means of implementation of a carried interest law, a greater number of managers should be attracted to Luxembourg to take advantage of the financial centre.
In a nutshell, Luxembourg is gearing up for AIFMD to become a global brand and not just a European passport. For us, this is likely to be history repeating itself—the UCITS story take-two.
What are the tax effects of the AFIMD directive?
As is usually the case with tax, the thorny issue is that of residency, especially for AIFMD managers dealing with cross-border funds. AIFMD managers may run the risk that their fund is now subject to taxation in the country where the manager resides, instead or sometimes even in addition to the country in which the fund is established. While there are some exceptions to this, including real estate funds, which are taxed where the property is located, this may provoke a multitude of problems when it comes to tax, with implications for everything from direct tax to treaty benefits. Managers will therefore have to carefully consider tax implications when choosing where the management company will reside.
The second tax component requiring some forethought is VAT; where management companies are operating cross-border, as is often the case, steps need to be taken to ensure that VAT costs do not become too high.
There are two main ways to approach the question of VAT. Firstly, pertaining to overall (gross) VAT costs, you first need to consider the VAT rate that is due. In the EU, VAT rates range from a low of 15 percent in Luxembourg to a high of 27 percent in Hungary. Managers thus need to take the VAT rates that are applicable in their chosen location into account when choosing a home for their management company.
With regards to gross VAT, one further area worth noting is that of tax exemption. To see whether any exemptions apply, you once more have to look at tax legislation in the country where the fund is established. If exemptions are found to be applicable, this may be one way of keeping VAT costs down.
The second aspect relates to net cost and whether it is possible for the management company to reclaim any VAT that has been paid. Once more, this will depend on how each member state implements AIFMD and the fund’s input VAT recovery right should be verified.
To summarise, the matter of tax is somewhat complex and shouldn’t be taken lightly. Managers will need to take into account both the overall nominal VAT rate, as well as the net cost, or right to reclaim input VAT, before choosing where the fund will reside.
What do you think of ESMA’s final guidelines on remuneration of alternative investment fund managers?
The guidelines are very much based on those published by the EBA (CEBS) in 2010 for credit institutions and investment firms. These guidelines posed numerous difficulties for those involved at the time, especially with regards to defining the principle of proportionality, the nomination of ‘identified staff’, and the capability to pay out variable remuneration through adapted deferrals and through non-cash instruments.
As far as alternative investment fund managers are concerned, I’d expect them to face similar difficulties and challenges. The definition of the principle of proportionality will be key as it may allow them to avoid some of the more stringent requirements, including deferred payouts on non-cash instruments and the need to set up a remuneration committee.
From a general standpoint, the European Securities and Markets Authority (ESMA) did not consider many of the comments made by the industry with regards to its consultation paper, where the difficulties in transposing the remuneration guidelines from the banking sector to the alternative world were put forward.
Moreover, in order to avoid a potential circumvention of the remuneration rules, ESMA even came up with significant amendments to the guidelines with regards to the delegation of portfolio or risk management activities, where the alternative investment fund managers are requested to ensure that the entities to which these activities have been delegated are subject to remuneration requirements that are equally as effective as the guidelines or, and this is undoubtedly going to be very difficult to implement, appropriate contractual arrangements are put in place with entities to which portfolio management or risk management activities have been delegated.
A further layer of complexity is added when the new guidelines are considered in the present regulatory environment; they are one of a series of remuneration guidelines. Larger organisations that fall under several of the recent regulations will be looking for these guidelines to be somehow combined.
In this context, we certainly expect further discussion and questions on this topic in the months to come.
Do you have any predictions as to possible fee increases from custodians after AIFMD comes into play?
In the alternative market, which is a market driven by institutional investors and high net individuals, I truly believe people would be ready to pay a premium for the added value of greater protection from the custodian bank, if the increase in fees is reasonable. If the right balance is found, this may see AIFMD find a market beyond Europe to establish itself as a global brand. There’s a real appetite for higher protection around the globe and AIFMD could be the product that chases away any remaining doubts investors have over investor protection, left over by the financial crisis.
As to possible fee increases, it’s difficult to make any reasonable prediction, as there are currently very few people who are ready to shoot. For me, it’s of utmost importance for alternative investment fund managers to be in a position to appoint their custody banks right now. At the moment, this is certainly not the case as ther are currently very few custodians ready.
My expectation, however, is that the innovative nature of both the market and the directive will mean that the premium to pay on this protection will be competitive. That’s also why I believe AIFMD is going to be an overall success story.
Do you think Luxembourg is destined to be an administrative hub?
There is a conservative angle to this and then a more a progressive angle. Being the main administrative hub in Europe and worldwide when it comes to cross-border operations is a nice position to be in. We are determined to maintain our position in the market place and to build upon this market lead when tackling the alternative space.
In our approach to alternative funds, there’s a real drive to turn this into something bigger. One only has to look to the recent law implementing AIFMD to see that Luxembourg’s ambitions extend beyond administration. With the new package for the alternative market, the government is clearly aiming to attract more managers to Luxembourg. The country has a real chance to rise above its first class administrative reputation, but of course our ambitions have to be tempered to the size of our country.
What are your feelings on the state of the financial services sector in the country?
In comparison with other European centres, Luxembourg is doing well. We have been a little spoilt in the past by ever increasing growth rates and business constantly flooding in. Right now, we’re still seeing an influx of new investment management businesses and have hit a record high of €2400 billion in terms of overall funds administered and domiciled in Luxembourg. It is, however, very clear that business and operating models are changing in Luxembourg and we have to constantly adapt to these new requirements from the business side to remain on the top. The Luxembourg government is firmly backs the industry and ensures that its players have all the tools that they need to succeed. Luxembourg is expanding rapidly into growth markets such as Asia and Latin America, where it holds a market share of 90 percent upward in foreign funds. When all is said and done, we can’t really complain here in Luxembourg.
← Previous interview
Multifonds
Keith Hale
Next interview →
MYRIAD Group Technologies
Simon Shepherd
Image: Shutterstock 
