Ireland and Luxembourg have always been the ideal jurisdictions to create a fund in Europe. The prevalence of funds for private equity structures in both countries combined with the result of Brexit means that funds are set to become more in demand. Both Ireland and Luxembourg allow managers access to UCITS (Undertakings for the Collective Investment in Transferable Securities) and AIFs (Alternative Investment Funds). It is also worth noting that the performance of UCITS in both jurisdictions remained unaffected during the Covid-19 pandemic.
Legal Structures Available in Each Jurisdiction
Although Ireland and Luxembourg are firm favourites when it comes to establishing a UCITS fund, there are several legal considerations to review when deciding on which country will be the fund’s borrower. Ireland operates under common law, and Luxembourg under civil law so both will have different legal practices in place when it comes to setting up and managing a fund.
The most common type of legal structures available in both countries are corporations, partnerships, contracts, and (in Ireland) trusts. Umbrella funds are also an option. This type of fund is a collective investment scheme that legally exists as a single entity but has several distinct compartments or sub-funds. These sub-funds may follow completely different investment policies and can have different investors for each compartment.
Irish and Luxembourg sub-funds enjoy the benefit of legislative ring-fencing. In each jurisdiction a sub-fund can be wound-up and liquidated, leaving the remainder of the umbrella structure intact. However, a sub-fund of an Irish/Luxembourg fund does not have a separate legal personality. Accordingly, care needs to be taken, in drafting the parties’ clauses, granting clauses and execution blocks, that the appropriate legal entity is expressed to be the party (with further care taken where, as is common, an investment manager is entering into the financing as an agent of the fund).
Borrowing and Investment Restrictions:
UCITS funds can offer leverage (in UCITS also called global exposure). Direct short selling is not allowed nor is borrowing except temporarily to bridge settlement mismatches between investor and fund transactions and is limited to 10% of NAV (“Net Asset Value”). However, leverage can be generated through the use of derivatives.
The operational considerations of converting a fund to UCITS status may or may not be weighty depending on the set up of the existing fund. For example, if there are no changes in investment policy, dealing frequency, fees or depository model then there may be minimal changes required from an operational perspective. Usually, at a minimum, the pre-trade and post-trade compliance checks at the management company, investment manager (and also the depositary) will need to be amended for the UCITS eligible assets and investment and borrowing limits. This may require some changes to the compliance monitoring systems.
There may be other variables to take into consideration on the operational side when it comes to converting USITs. For example, if the existing fund uses performance fee equalisation at a shareholder level, the administrator may not be able to support this in the UCITS fund.
Both jurisdictions provide lines of credit to investment funds in a manner that allows flexibility to borrowers and security for lenders. In each jurisdiction, the following EU legislation plays an important part in fund finance structures: the Alternative Investment Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”); and the EU Directive on financial collateral arrangements (Directive 2002/47/EC) (the “Collateral Directive”).
Under AIFMD, the relevant fund (Irish or Luxembourg) will have appointed an alternative investment fund manager (“AIFM”). The AIFM is responsible for the risk and portfolio management functions of the fund, and will typically delegate (under an investment management agreement) the portfolio management function to an investment manager (as an agent of the AIFM). This chain of delegated authority will be documented as part of the due diligence process. AIFMs are required to be regulated by their home member regulator (CBI, in the case of Ireland; the Commission de Surveillance du Secteur Financier (“CSSF”), in the case of Luxembourg). The depositary must be separate from the AIFM and is generally liable for the failures of its delegates.
The impact of Brexit is expected to increase the relocation of asset management activity from the United Kingdom to Ireland or Luxembourg, which will compound the importance of Ireland and Luxembourg in fund finance.
Although the laws of both Ireland and Luxembourg are different in many respects, both jurisdictions allow lenders to obtain a strong security package in relation to an Irish or Luxembourg fund.
If you’d like any assistance with your UCITS funds launch or on-boarding or have any questions about this article, please feel free to email me at firstname.lastname@example.org.
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