Rarely when one writes about the competition between rivals for market share is the battle as one-sided as that over where private debt funds should be domiciled in Europe. When it comes to international funds – those that are marketed in more than one country, rather than a single large domestic market such as the UK or Germany – Luxembourg seems to be the jurisdiction that is thrashing the competition.
“Luxembourg and Ireland are really the only places in town, but I think Luxembourg is running away with it,” says Dermot Caden, Dublin-based head of European fund administration at Virtus Partners, which provides investment managers with administrative services. “I don’t think Ireland is a real competitor in this space right now.”
Caden even goes so far as to add that, for private debt, almost every single manager is setting up a fund platform in Luxembourg – even those that already have a platform in Ireland. However, it will not necessarily always be this way: when it comes to winning fund jurisdictions in general, Ireland is still a nimble competitor. The Central Bank of Ireland, which regulates private debt funds, is already working to make the country more attractive.
But for now, Luxembourg dominates, with industry participants attributing the country’s attractiveness to its longstanding partnership structure for funds.
“Luxembourg has a partnership structure that is very close to the one for English limited partners,” says Aymeric Lechartier, London-based managing director at Carné Group, the provider of governance solutions for asset managers. “This resonates with Anglo-Saxon managers.”
Caden notes that this partnership structure is the main reason why Luxembourg is a draw for all forms of illiquid assets. Managers of private debt like partnership structures for various reasons, including tax advantages. He adds that while similar partnership structures exist in the Channel Islands of Guernsey and Jersey, the regulatory landscape is not as clear and their funds are not yet deemed by the European Commission to meet the regulatory demands necessary for them to be marketed in the EU – they do not yet enjoy regulatory equivalence.
The European Securities and Markets Authority has recommended equivalence for them, but the Commission has not yet agreed to this. Carné’s Lechartier adds that Brexit has made it unlikely that this will happen anytime soon as the UK was the EU member state pushing for equivalence.
Meanwhile, some argue that the Central Bank of Ireland scored an own goal when it came to competing for private debt funds’ jurisdiction, by introducing a regulatory regime for loan origination in 2014 that was not user-friendly.
“[The regime] had a number of burdensome rules and restrictions,” says Caden, who cites the bar on commingling equity and debt under the 2014 rules, although he also notes that the Central Bank of Ireland has belatedly – in November 2016 – made commingling permissible. Christoph Lanz, an associate at Edmond de Rothschild Asset Management Luxembourg and a member of the Executive Committee of the Luxembourg Private Equity & Venture Capital Association, says Luxembourg’s strength comes from the fact that the financial services industry is of massive importance to the country, dominating the national economy. “The government has always made sure that it negotiates with other jurisdictions as much as possible,” he says. By contrast, Ireland – a larger and more diverse country – has more policy priorities to consider and balance.
Lanz adds that because of the importance of its financial services industry, Luxembourg is often quicker to negotiate double taxation treaties that allow investors to avoid paying tax in two countries – or, if their investment is routed through an offshore company, paying much tax in any country. It was, for example, among the first countries in the world to sign such a treaty with Hong Kong – in 2007, three years before Ireland.
The advantage that Luxembourg has in private debt and other illiquid investments has become entrenched precisely because of its longstanding nature. Debt fund managers choose jurisdictions not just because of the fund structures available, but also because of the local expertise available for dealing with the broad range of issues relating to a fund. Lechartier argues that Luxembourg has, over the years, built up “a bigger critical mass than Dublin” when it comes to service providers that are experts in illiquid assets, including administrators, lawyers, and accountants.
Luxembourg’s dominance in private debt has become all the more important in the wake of the EU Alternative Investment Fund Managers Directive, which came into force in 2013. This has increased the number of private debt managers looking for domiciles based in the EU because it allows the fund managers to market funds that are AIFMD-compliant across the Union – replacing reliance on a series of national private placement rules which experts expect to be phased out completely within the next few years.
However entrenched Luxembourg’s dominance in debt funds seems at the moment, the duchy is advised against complacency. One reason for this is that Ireland is increasingly competent at providing services for other, similar fund types.
“Ireland is the world centre for expertise in alternative investment funds,” says Liam Collins, a partner in the Asset Management Group at Matheson, the Dublin law firm. He cites figures from Irish Funds, the trade body, showing that 40 percent of the world’s alternative investment fund assets are administered in Ireland. The country is particularly strong in hedge fund domiciles. Collins also says that UK and US fund managers are enthusiastic about the fact that Ireland has a common law system like their own, whereas Luxembourg follows a civil law system.
Ireland has two chances to get a seat at the table when it comes to private debt funds, says Caden. One is if direct lending becomes a regulated activity under EU rules – suddenly turning the Central Bank of Ireland’s regulation of it into an advantage while making a disadvantage of the sector’s unregulated status in Luxembourg.
“The other is if Ireland develops a partnership regime and people look at it and say, ‘It’s as good as the structure in Luxembourg, Delaware or Cayman,’” adds Caden.
HOME AND AWAY
As acronyms go, the BRIDGE platform (short for Benjamin de Rothschild Infrastructure Debt Generation) is rather ingenious: it invests in infrastructure (including, where appropriate, bridges) across Europe.
The platform has two funds: a €595 million France-based vehicle launched in August 2014 for French institutions such as insurance companies, provident societies and mutuals; and a Luxembourg-based fund, launched in March 2016, which is looking to raise €650 million from other European investors. Why are two funds in different jurisdictions necessary?
“For other investors in Europe – in the UK and Germany, for example – French funds do not work,” says Lanz of Edmond de Rothschild Asset Management, who adds that many investors do not like the mutual structure of French funds for tax reasons.
Most other countries’ fund structures are also disliked by international investors while being considered perfectly serviceable by their domestic investors – partly because they are used to them. Germany’s is considered too complicated by non-Germans, for example.
As a possible exception, some international investors used to like the partnership structure of UK funds, but the big new question mark over its suitability is already drawing them away. When Brexit happens, UK-domiciled funds will no longer be eligible for marketing in the EU, unless the UK can secure an agreement for this.