Since a couple of years, the retailisation of alternative assets appears to be a growing trend, driven by the significant outperformance of alternative investment funds, the need of funds managers to expand their investor base, coupled with the continued appetence of retail investors, who seek opportunities to diversify their portfolio and improve their investment return.
Luxembourg, which is the largest EU fund domicile jurisdiction benefiting from flexible and attractive legal regulatory and tax regimes and a significant concentration of professional service providers is keen to take advantage of this world-wide trend to raise its attractiveness.
Luxembourg legislator well understood that trend and took the opportunity of the law of 21 July 2023 aiming to modernise and improve the Luxembourg investment funds toolbox to play a part in supporting the initiative.
The law of 21 July 2023, a further milestone contributing to enlarge the investor base
The legislator has adopted the law of 21 July 2023 (the “2023 Law”) amending:
- the law of 15 June 2004 relating to the investment company in risk capital (SICAR), as amended (the “SICAR Law”);
- the law of 13 February 2007 relating to specialised investment funds (SIFs), as amended (the “SIF Law”);
- the law of 17 December 2010 on undertakings for collective investment (UCIs), as amended (the “UCI Law”);
- the Law of 12 July 2013 on alternative investment fund managers (AIFMs), as amended (the “AIFM Law”); and
- the law of 23 July 2016 on reserved alternative investment funds (RAIFs), as amended (the “RAIF Law”).
Dedicated to well-informed investors[1], alternative investment vehicles such as the RAIF, the SIF and to a lesser extent, the SICAR, provide great flexibility in regulatory requirements as to investment policy and portfolio composition, the downside being that the minimum investment threshold is high for retail investors.
The 2023 Law amends, among others, the definition of “well-informed investor” in the RAIF Law, SIF Law and SICAR Law by reducing the investment threshold from EUR 125,000 to EUR 100,000 in order to homogenize investor eligibility criteria, in line with standard European labels, such as European Long Term Investment Funds (ELTIF), European Venture Capital Funds (EuVECA) and European Social Entrepreneurship Funds (EuSEF).
The resurgence of Luxembourg UCIs
In the context of the democratization of alternative investment funds, one of the popular trends that we currently observe on the Luxembourg market is the resurgence of Luxembourg undertakings for collective investment, subject to Part II (the “UCIs”) of the UCI Law.
UCIs have been in existence for more than forty years and are not new in the Luxembourg toolbox.
The summary below is a general overview of the legal framework applicable to UCIs and does not purport to be exhaustive.
UCIs must be authorised by the Commission de Surveillance du Secteur Financier (“CSSF”), the Luxembourg regulatory authority prior to their set up. They can be incorporated as a single fund (stand-alone UCI) or as a platform with multiple sub-funds (umbrella UCI) with different investment policies, fee structures and/or remuneration policies.
In terms of distribution, UCIs may be distributed to all categories of investors without any regulatory restriction as to investor eligibility: this is currently the vehicle of choice for EU retail investors wishing to invest in alternative assets.
Although UCIs may be offered to all categories of investors, managers may apply fund-specific eligibility criteria in the prospectus and the CSSF practice is to require an appropriate minimum investment threshold being set at 25,000 EUR in order to ensure a certain level of knowledge and expertise from the retail investors.
In terms of marketing, UCIs qualify as alternative investment fund (AIF) under the Alternative Investment Fund Managers Directive 2011/61/EU as amended (“AIFMD”) and may benefit from the EU passport available for marketing to professional investors. UCIs may also be distributed to retail investors in Luxembourg and abroad under national private placement rules to the extent permitted by local legislations.
In terms of eligible underlying assets, there is no restriction[2] as to portfolio composition, it being understood that the investment objective and strategy of the UCI remain subject to the CSSF’s prior approval. UCIs are also subject to risk diversification requirements[3].
In terms of structuring, UCIs may be set up in the contractual form as a common fund (Fonds Commun de Placement – FCP) or in the corporate form as (i) an investment company with variable capital (société d'investissement à capital variable - SICAV) or (ii) an investment company with fixed capital (société d'investissement à capital fixe - SICAF).
The decision as to set up a UCI under the contractual form or the corporate form is mainly based on operational, marketing and tax considerations.
The proposal of the European Commission (the “Commission”) to amend the MiFID 2 client classification regime is yet one more example of the Commission’s commitment to democratize alternative investments.
Proposal to amend the MiFID 2 client classification regime
As announced in the Capital Markets Union Action Plan of 2020, the Commission published the Retail Investment Strategy (the “RIS”) on 24 May 2023 aiming amongst other to “enhance retail investors’ trust in capital markets and help them achieve better outcomes with their investments” in the long term.
Indeed, the Commission has noticed the low level of participation in capital markets by European retail investors compared for instance to US investors and has sought to identify key factors that hinder their ability to invest in capital markets, among which are the lack of trust in capital markets, the lack of financial means increased by the fact that the minimum investment thresholds for alternative assets are frequently set too high and the difficulties to access easily understandable investment product information, to mention just a few examples.
In the meantime, since retail investors and in particular high-net-worth individuals (HNWI), including “ultra” high-net-worth individuals and family offices have the financial ability to support private market growth but are frequently excluded from such investment opportunities as they typically do not meet all eligibility criteria, the Commission proposes to amend the client classification rules in the Markets in Financial Instruments Directive 2014/59/EU (“MiFID 2”) to grant retail investors broader access to private market funds.
In a nutshell, under MiFID 2, a professional client[4] is defined as “a client meeting the criteria laid down in Annex II[5]” while a retail client[6] is defined as a “client who is not a professional client”.
Pursuant to Annex II, there are two main categories of professional clients:
- “Professional clients per se” such as credit institutions, investment firms, insurance companies, other institutional clients, which are automatically considered to be professionals; and
- “Professional clients opt-up” i.e., those clients who may be treated as professionals on request and thus, waive part or all the protection afforded to them.
The above client categorisation regime is technically not written in stone, meaning that on request, per se professionals can avail themselves of the option to be treated as retail clients whereas retail clients can opt-up to be treated as professionals provided an assessment is made by the investment firm given reasonable assurance of their ability to make their own investment decisions and understand the risks involved and provided certain criteria are fulfilled[7].
[1] A well-informed investor is an institutional investor, a professional investor within the meaning of Annex II to the Markets in Financial Instruments Directive 2014/59/EU (“MiFID 2”) or any other investor who meets the following conditions:
- he has confirmed in writing that he adheres to the status of well-informed investor; and
- he invests a minimum of EUR 100,000 (as amended by the 2023 Law) in the investment vehicle; or
- he has been the subject of an assessment made by a credit institution within the meaning of Regulation (EU) No 575/2013, by an investment firm within the meaning of MiFID 2, by a management company within the meaning of Directive 2009/65/EC relating to undertakings for collective investment in transferable securities (UCITS) or by an authorised AIFM within the meaning of Directive 2011/61/EU on Alternative Investment Fund Managers (AIFMD), certifying his expertise, his experience and his knowledge to adequately appraise an investment in the investment vehicle.
[2] Eligible assets are unrestricted meaning that UCIs may pursue private equity and venture capital strategies, hedge funds strategies, real estate or debt strategies, fund of funds strategies, etc.
[3] 20% portfolio diversification requirements subject to derogations approved by the CSSF.
[4] Article 4 (10) MiFID 2.
[5] Annex II to MiFID 2.
[6] Article 4 (11) MiFID 2.
[7]Two out of the three following criteria must be fulfilled: (a) the client has carried out transactions, in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters; and/or (b) the size of the client’s financial instrument portfolio, defined as including cash deposits and financial instruments exceeds EUR 500,000; and/or (c) the client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged.
Since a couple of years, the retailisation of alternative assets appears to be a growing trend, driven by the significant outperformance of alternative investment funds, the need of funds managers to expand their investor base, coupled with the continued appetence of retail investors, who seek opportunities to diversify their portfolio and improve their investment return.
Luxembourg, which is the largest EU fund domicile jurisdiction benefiting from flexible and attractive legal regulatory and tax regimes and a significant concentration of professional service providers is keen to take advantage of this world-wide trend to raise its attractiveness.
Luxembourg legislator well understood that trend and took the opportunity of the law of 21 July 2023 aiming to modernise and improve the Luxembourg investment funds toolbox to play a part in supporting the initiative.
The law of 21 July 2023, a further milestone contributing to enlarge the investor base
The legislator has adopted the law of 21 July 2023 (the “2023 Law”) amending:
- the law of 15 June 2004 relating to the investment company in risk capital (SICAR), as amended (the “SICAR Law”);
- the law of 13 February 2007 relating to specialised investment funds (SIFs), as amended (the “SIF Law”);
- the law of 17 December 2010 on undertakings for collective investment (UCIs), as amended (the “UCI Law”);
- the Law of 12 July 2013 on alternative investment fund managers (AIFMs), as amended (the “AIFM Law”); and
- the law of 23 July 2016 on reserved alternative investment funds (RAIFs), as amended (the “RAIF Law”).
Dedicated to well-informed investors[1], alternative investment vehicles such as the RAIF, the SIF and to a lesser extent, the SICAR, provide great flexibility in regulatory requirements as to investment policy and portfolio composition, the downside being that the minimum investment threshold is high for retail investors.
The 2023 Law amends, among others, the definition of “well-informed investor” in the RAIF Law, SIF Law and SICAR Law by reducing the investment threshold from EUR 125,000 to EUR 100,000 in order to homogenize investor eligibility criteria, in line with standard European labels, such as European Long Term Investment Funds (ELTIF), European Venture Capital Funds (EuVECA) and European Social Entrepreneurship Funds (EuSEF).
The resurgence of Luxembourg UCIs
In the context of the democratization of alternative investment funds, one of the popular trends that we currently observe on the Luxembourg market is the resurgence of Luxembourg undertakings for collective investment, subject to Part II (the “UCIs”) of the UCI Law.
UCIs have been in existence for more than forty years and are not new in the Luxembourg toolbox.
The summary below is a general overview of the legal framework applicable to UCIs and does not purport to be exhaustive.
UCIs must be authorised by the Commission de Surveillance du Secteur Financier (“CSSF”), the Luxembourg regulatory authority prior to their set up. They can be incorporated as a single fund (stand-alone UCI) or as a platform with multiple sub-funds (umbrella UCI) with different investment policies, fee structures and/or remuneration policies.
In terms of distribution, UCIs may be distributed to all categories of investors without any regulatory restriction as to investor eligibility: this is currently the vehicle of choice for EU retail investors wishing to invest in alternative assets.
Although UCIs may be offered to all categories of investors, managers may apply fund-specific eligibility criteria in the prospectus and the CSSF practice is to require an appropriate minimum investment threshold being set at 25,000 EUR in order to ensure a certain level of knowledge and expertise from the retail investors.
In terms of marketing, UCIs qualify as alternative investment fund (AIF) under the Alternative Investment Fund Managers Directive 2011/61/EU as amended (“AIFMD”) and may benefit from the EU passport available for marketing to professional investors. UCIs may also be distributed to retail investors in Luxembourg and abroad under national private placement rules to the extent permitted by local legislations.
In terms of eligible underlying assets, there is no restriction[2] as to portfolio composition, it being understood that the investment objective and strategy of the UCI remain subject to the CSSF’s prior approval. UCIs are also subject to risk diversification requirements[3].
In terms of structuring, UCIs may be set up in the contractual form as a common fund (Fonds Commun de Placement – FCP) or in the corporate form as (i) an investment company with variable capital (société d'investissement à capital variable - SICAV) or (ii) an investment company with fixed capital (société d'investissement à capital fixe - SICAF).
The decision as to set up a UCI under the contractual form or the corporate form is mainly based on operational, marketing and tax considerations.
The proposal of the European Commission (the “Commission”) to amend the MiFID 2 client classification regime is yet one more example of the Commission’s commitment to democratize alternative investments.
Proposal to amend the MiFID 2 client classification regime
As announced in the Capital Markets Union Action Plan of 2020, the Commission published the Retail Investment Strategy (the “RIS”) on 24 May 2023 aiming amongst other to “enhance retail investors’ trust in capital markets and help them achieve better outcomes with their investments” in the long term.
Indeed, the Commission has noticed the low level of participation in capital markets by European retail investors compared for instance to US investors and has sought to identify key factors that hinder their ability to invest in capital markets, among which are the lack of trust in capital markets, the lack of financial means increased by the fact that the minimum investment thresholds for alternative assets are frequently set too high and the difficulties to access easily understandable investment product information, to mention just a few examples.
In the meantime, since retail investors and in particular high-net-worth individuals (HNWI), including “ultra” high-net-worth individuals and family offices have the financial ability to support private market growth but are frequently excluded from such investment opportunities as they typically do not meet all eligibility criteria, the Commission proposes to amend the client classification rules in the Markets in Financial Instruments Directive 2014/59/EU (“MiFID 2”) to grant retail investors broader access to private market funds.
In a nutshell, under MiFID 2, a professional client[4] is defined as “a client meeting the criteria laid down in Annex II[5]” while a retail client[6] is defined as a “client who is not a professional client”.
Pursuant to Annex II, there are two main categories of professional clients:
- “Professional clients per se” such as credit institutions, investment firms, insurance companies, other institutional clients, which are automatically considered to be professionals; and
- “Professional clients opt-up” i.e., those clients who may be treated as professionals on request and thus, waive part or all the protection afforded to them.
The above client categorisation regime is technically not written in stone, meaning that on request, per se professionals can avail themselves of the option to be treated as retail clients whereas retail clients can opt-up to be treated as professionals provided an assessment is made by the investment firm given reasonable assurance of their ability to make their own investment decisions and understand the risks involved and provided certain criteria are fulfilled[7].
[1] A well-informed investor is an institutional investor, a professional investor within the meaning of Annex II to the Markets in Financial Instruments Directive 2014/59/EU (“MiFID 2”) or any other investor who meets the following conditions:
- he has confirmed in writing that he adheres to the status of well-informed investor; and
- he invests a minimum of EUR 100,000 (as amended by the 2023 Law) in the investment vehicle; or
- he has been the subject of an assessment made by a credit institution within the meaning of Regulation (EU) No 575/2013, by an investment firm within the meaning of MiFID 2, by a management company within the meaning of Directive 2009/65/EC relating to undertakings for collective investment in transferable securities (UCITS) or by an authorised AIFM within the meaning of Directive 2011/61/EU on Alternative Investment Fund Managers (AIFMD), certifying his expertise, his experience and his knowledge to adequately appraise an investment in the investment vehicle.
[2] Eligible assets are unrestricted meaning that UCIs may pursue private equity and venture capital strategies, hedge funds strategies, real estate or debt strategies, fund of funds strategies, etc.
[3] 20% portfolio diversification requirements subject to derogations approved by the CSSF.
[4] Article 4 (10) MiFID 2.
[5] Annex II to MiFID 2.
[6] Article 4 (11) MiFID 2.
[7]Two out of the three following criteria must be fulfilled: (a) the client has carried out transactions, in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters; and/or (b) the size of the client’s financial instrument portfolio, defined as including cash deposits and financial instruments exceeds EUR 500,000; and/or (c) the client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged.