The fund formation panel (with speakers from the United States, Luxembourg and Germany) along with audience participation, discussed a variety of recent trends on international fund formation.
1. The magic question: Is there an ideal investment funds structure for certain asset classes or investor types?
With a view to market fund units to institutional investors, overseas funds usually have flexibility to adapt to individual investor requests, e.g., by setting up feeder fund structures. That flexibility allows tailoring to individual European fund investors requests. Further, overseas fund structures often do not have leverage restrictions and depositary bank requirements do not apply.
As an important restriction, it is to be taken into account: Raising money in the EU is since 2013 a fully regulated activity subject to approval by the domestic investment fund supervisory authority. The resulting requirement is that raising money without having European AIFM-licence needs to be done completely from outside the European Union. The sole exception is reverse solicitation, i.e. the EU customer by own initiative approaching the overseas fund asking for an investment opportunity into a specific fund.
As an alternative, the European Union allows for unregulated fund initiators to enter into service agreements on fund raising with fully regulated local service companies. Especially in the investment fund jurisdiction Luxembourg such fully regulated service companies are active.
Further, Luxembourg is steadily engaged to optimise the available fund structures in case a local investment fund is the preferred option for the investor (e.g., the new RAIF).
2. Trends on Investments by EU Insurance Companies, Pension Funds and Professional Pension Schemes (Versorgungswerke)
Solvency II influences investment strategies by EU insurance companies as it introduces new risk weightings (capital charges) that insurance companies must apply when calculating their Solvency Capital Requirement (SCR).
The general trend is that Property/Real Estate will likely benefit from Solvency II, as insurance companies have to make only a capital charge of 25 percent of market value of the assets.
In comparison, for Type 1 Equities the capital charge is under Solvency II increased to 39 percent of market value of the assets. Respective investments include: equities listed on EEA/OECD regulated markets, specific social entrepreneurship and venture capital funds.
For Type 2 Equities the capital charge is under Solvency II even increased to 49 percent of market value of the assets. Respective investments include: equities listed in non-EEA/OECD countries, non-listed equities and other alternative investments.
So it becomes increasingly important to discuss with investors which type of qualification and corresponding capital charge they’re aiming for with their fund investment.
With respect to German investors, there is the peculiarity of tax exempt pension funds and professional pension schemes (Versorgungswerke). Here, different considerations apply with respect to fund structuring requirements, which should be followed up on an individual basis.
3. Selected Trends for German Fund Structures
Pertaining to German investors, the following central topics were discussed:
4. Prepare for Brexit: Pressure by ESMA on Investment Firms and ManCos
The European Securities and Markets Authority (ESMA) is preparing the national competent authorities (e.g., Ba-Fin or CSSF) for Brexit with requirements on (i) regulated investment firms and (ii) investment management. The goal is to avoid regulatory and supervisory arbitrage risks. ESMA assumes a hard Brexit, i.e. that UK would become a “third country.”
4.1 The new supervisory law requirements refer to supervisory convergence in the area of investment firms:
a) Authorization: Investment firms relocating from the United Kingdom to the European Union will have to apply for a new MiFID license. Granting of such license will be subject to complete authorization procedure (without any transitional periods, grandfathering, etc.).
b) Substance: Investment Firms are to dedicate appropriate human and technical resources as well as adequate governance and internal controls for day-today management. Outsourcing is to be restricted.
i) Management should maintain a meaningful presence in the chosen jurisdiction.
ii) Outsourcing, especially if in service to providers in non-EU countries, should be limited to the end that investment firms are consistently able to effectively supervise service providers, and management of those investment firms is still able to fully perform risk management.
iii) No letter-box investment firms to be created.
4.2 The new supervisory law requirements also refer to supervisory convergence in the area of investment management:
a) Sound governance: At least two senior management members should implement and manage an effective governance structure and internal control mechanism. The head office and registered office are to be within the same Member State.
b) Calibration of governance structures and internal control mechanisms: Authorized entities are to scale their procedures, mechanisms and organizational structures to the size, nature, scale and complexity of their business.
i) Authorized entities must be in a position to effectively supervise their service providers.
ii) Delegation to non-EU entities triggers additional scrutiny by regulatory authority.
iii) No full delegation of portfolio management or risk management function allowed.
From left to right: Christian Behring, Behring, Khan & Co. LLP; Marc Oehler, Savills Investment Management; Ian M. Schwartz and Dr. Kian Tauser, both
McDermott Will & Emery