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Family Offices and AIFMD II: The View from Luxembourg

Family offices restructuring alternative investments will have to rethink their strategies as tighter Alternative Investment Fund Managers Directive (AIFMD) II regulations loom. Johannes Höring, head of AIFM, provides the view from Luxembourg.

Complying with the EU’s AIFMD has never been a big concern for many family offices. But a new generation seeking to restructure their investments may find itself increasingly affected. Some family offices, driven by a need to create reporting efficiencies and optimize tax, are looking to restructure their alternative investments.

The search for better returns in difficult market conditions has led many family offices to incorporate investment funds into their core strategy. Meanwhile, rising compliance costs and requirements arising from new legislation will require family offices to reassess their investment models and strategies.

Many family offices have been creating standalone funds, reserved alternative funds, and even regulated strategies such as the Luxembourg Specialized Investment Funds. This means they must decide whether it makes sense to create their own supervised funds management company (ManCo) or authorized alternative investment fund manager (AIFM). But creating a ManCo or an AIFM from scratch requires deep pockets—firms have to invest in operational and compliance infrastructure, apply for regulatory approval, and manage the corresponding risks and liabilities.

It also requires more resources than most family offices have, while taking a significant amount of time. European and U.S.-based family offices may fall under AIFMD in certain circumstances. As a result, they will need to carefully design the structure of investments and co-investments in Europe to manage overall exposure. So, when a non-EU family office co-invests with European investors, for example, the vehicle will fall under AIFMD regulation.

How will the proposed changes to AIFMD regulations affect family offices?

Proposed changes to the current AIFMD regulations—AIFMD II—could mean even tighter checks and requirements for fund managers when they take effect in 2024.

Among key proposals in the updated directive are new rules for fund management delegation. Current regulations allow self-managed investment vehicles or their management companies to appoint third-party investment managers and advisers. The Luxembourg fund industry is largely based on this model. Under the new proposals, the European Securities and Markets Authority (ESMA) must be notified if the alternative fund delegates more to non-EU countries than to itself.

There are also rule changes for loan origination funds, which are increasingly popular with investors. While the AIFMD II proposals broaden fund managers’ remits by adding originating loans to their list of activities, they also introduce further restrictions. For example, AIFs cannot provide loans exceeding 20% of the fund’s capital to a single borrower that is a financial institution or collective investment undertaking. It also prevents funds from lending to their fund manager or their staff, their depositary, or an entity to which the fund manager has delegated functions.

There is also a new requirement for alternative funds to retain 5% of the notional value of loans they originate and subsequently sell on the secondary market. However this may change, according to the Council of the European Union’s recent response to the proposals.

What does AIFMD II mean for Luxembourg?

The proposals will be crucial for Luxembourg’s private debt market, whose assets grew by about 40% in 2021 to a total of EUR 181.7bn, according to the Association of the Luxembourg Fund Industry (ALFI).

As AIFMs are required to analyze fully, understand, interpret, implement, and remain in compliance with the revised regulatory and compliance directives, the impact on internal resources, which may already be stretched, could be significant.

While AIFMD II may create additional reporting requirements for businesses, it can also be an opportunity for the Luxembourg fund industry, requiring more people and an even stronger financial services infrastructure. The Undertakings for the Collective Investment in Transferable Securities (UCITS) directive proved a huge success, while the AIFMD allowed Luxembourg to market its funds across the EU. AIFMD II could have a similar impact.

The drive to create a degree of harmonization between the UCITS directive and the AIFMD could result in an EU product that can be marketed easily to other places. As the largest funds industry in Europe, Luxembourg offers family offices a variety of regulated and unregulated vehicles—such as the Société en Commandite Simple (SCS), Société en Commandite Spéciale (SCSp), and Reserved Alternative Investment Fund (RAIF)—all of which can be easily marketed across the EU.

In addition to offering a robust regulatory regime, Luxembourg stands out when it comes to sustainability, ranking seventh in the 2022 edition of the Global Green Financial Index.

How CSC can help with AIFMD

CSC’s Luxembourg team, which has been authorized as an AIFM by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg since 2017 and is classed as a Chapter 16 ManCo under the 2010 UCI law, offers services designed to comply with the AIFMD.

For clients active in the alternative investments field—including private equity, venture capital, real estate, long and short equity and debt strategies—CSC offers AIFM services, depositary, fund administration, capital markets, and corporate services.

Our services include:

  • Risk management and valuation
  • Distribution and distribution oversight
  • Pre-marketing
  • Pre-notification
  • Portfolio management
  • Portfolio management oversight
  • AIFMD reporting

CSC provides a cost-effective, long-term outsourcing solution for EU and non-EU alternative investment funds.

Why CSC?

CSC provides knowledge-based solutions for every phase of the business life cycle, helping businesses form entities, maintain compliance, execute transaction work, and support real estate, M&A, and other corporate transactions in hundreds of U.S. and international jurisdictions.

We work with some of the world’s largest banks and commercial lenders to reduce risk in their lien portfolios, improve their transaction speeds, and create a secure environment for their financial processing needs. We also provide solutions for secure real estate document preparation and recording.

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