Exploring Japan’s Evolving Investment Landscape: European Fund Structuring Options – Fund Finance #JapanFinance

This article forms part of a series of articles
examining the opportunities Japan presents for investment managers
and investors. Our previous articles¹ explored fund
structuring options in the Cayman Islands, principally focusing on
the Cayman Island Unit Trust and Exempted Limited Partnership. In
this article, we focus on the key advantages of structuring a fund
in Ireland and Luxembourg as well as considering the different fund
structuring options that these jurisdictions offer.

Japanese investors are progressively increasing their exposure
to private equity, infrastructure, real estate and other
alternative asset classes. This move towards alternative
investments is influenced by a combination of factors, including
the reemergence of inflation in Japan, the pursuit of higher yields
and the implications of a declining population.

When seeking exposure to alternative assets in Europe, Japanese
institutional investors are continuing to look to Ireland and
Luxembourg for a variety of fund structuring options. Ireland and
Luxembourg are the two largest fund domiciles in the European Union
(“EU”), allowing Japanese institutional investors access
to the EU internal market.

Structuring Funds in Ireland and Luxembourg – The Key
Advantages

Ireland and Luxembourg are at the forefront of the investment
funds industry in the EU, the numerous advantages they offer
include:

• Investor familiarity – a vital consideration when
  fundraising. Both jurisdictions have proven track records in fund
  structuring for the past 30 years and Japanese investors have
  invested in Irish and Luxembourg funds for decades.




• Flexibility – Ireland and Luxembourg have expertise in
  establishing the widest possible range of international funds
  allowing investment managers to design product ranges with
  reference to their own and their clients’ needs.




• Internationally recognised, open and tax efficient
  jurisdictions.




• Full market access to Europe including access to the AIFMD
  marketing passport which allows Alternative Investment Funds
  (“AIFs”) to be marketed freely across the European
  Economic Area. In addition, Irish and Luxembourg domiciled AIFs may
  be distributed globally and used to gain access to the main
  Asia-Pacific markets, subject to local marketing requirements.




• Experienced professional service providers with expertise in
  the investment funds space.




• Innovative products and technology. Both the Irish and
  Luxembourg asset management industries recognise that technology is
  the key to remaining at the forefront of the European investment
  fund industry.




• Commercial and flexible legislation with long traditions as
  leading fund domiciles. The regulatory environment for investment
  funds in Ireland and Luxembourg is founded on the principles of
  openness, transparency and investor protection and both countries
  are recognised as leading fund domiciles.




• Well-established, respected and sophisticated legal
  systems.

Ireland

Ireland offers a range of vehicles that can be used for
investment fund structuring including the Unit Trust, Irish
Collective Asset-Management Vehicle (“ICAV”), Investment
Limited Partnership (“ILP”) and Common Contractual Fund
(“CCF”). The legal structure of choice in Ireland for
Japanese managers has traditionally been the Unit Trust which is
very similar in nature to the domestic Japanese investment trust.
There has also been an increasing number of Japanese managers
opting for the ICAV and ILP.

Each of the Irish fund structures discussed above may be
authorised by the Central Bank of Ireland as a qualifying investor
alternative investment fund (“QIAIF”), pursuant to the
Alternative Investment Fund Managers Directive (“AIFMD”).
QIAIFs are generally not subject to any regulatory, investment or
borrowing restrictions and can facilitate the widest range of
investment strategies.

In each of the below options, the alternative investment fund
manager (“AIFM”) may delegate discretionary portfolio
management to a regulated overseas (including a Japanese)
investment manager, subject to certain requirements.

Unit Trust

Japanese institutional investors have found that an Irish unit
trust structured as a QIAIF has the ability to accommodate the
range of alternative investments they are seeking to allocate
capital towards.

A unit trust is created by way of a trust deed entered into
between a management company (in the case of a unit trust as a
QIAIF), an AIFM and an Irish regulated depositary which acts as
trustee. A unit trust does not have separate legal personality
under Irish law and, instead, contracts are entered into in respect
of the unit trust by its AIFM or, in certain cases, by its
depositary. Unlike traditional trust structures which vest the
powers of the trust exclusively in the trustee, the powers of the
Irish unit trust are split between the AIFM and the depositary,
with ultimate management authority held by the board of directors
of the AIFM.

It can sometimes be beneficial to Japanese investors to
establish an Irish domiciled special purpose vehicle company
(“SPV”) through which an Irish unit trust will invest.
There are a range of options for establishing such an SPV.
Typically, it is established as a private limited company or a
designated activity company, and can be structured in a tax
efficient manner, to act as a “liability blocker” by
interposing a separate legal entity between the unit trust and
underlying investments, in order to limit the AIFM’s personal
liability. This is important if the unit trust will invest in
private funds to gain exposure to European alternative
assets.²

A QIAIF unit trust structure investing through a SPV is very
similar in nature to the ‘PE Type Unit Trust’, which is a
very popular tried and tested Cayman Islands structure among
Japanese investors seeking exposure to alternative assets
globally.³

ICAV

The ICAV is a corporate vehicle tailored specifically for Irish
investment funds, established through registration and
authorisation by the Central Bank of Ireland. As a corporate
vehicle the ICAV has a distinct and separate legal personality
(i.e. it may enter into contracts itself, can own property etc).
The ICAV can be structured to suit all major investment strategies
and can accommodate traditional as well as alternative investment
policies. It can also avail of a full suite of liquidity options
making it suitable for hedge funds, real estate funds,
infrastructure strategies, lending vehicles, private equity funds,
managed accounts and hybrid funds. ICAVs can also be established as
part of global master-feeders, co-investment or joint-venture
structures and use a full range of underlying SPVs and subsidiaries
to hold investments.

The ICAV may also “elect” to “check the box”
and be treated as a pass-through entity for US federal tax
purposes.

ILP

The Irish Limited Partnership (“ILP”) is a regulated
common law partnership structure. It is Ireland’s flagship
partnership vehicle for use as an investment fund and typically
selected by managers availing of closed-ended strategies in real
estate, private equity, credit, infrastructure, sustainable finance
and related asset classes. The ILP is a tax-transparent vehicle in
respect of all its income, gains and losses. All of the assets and
liabilities of an ILP belong jointly to the partners in the
proportions agreed in the partnership agreement. Similarly, the
profits are directly owned by the partners, again in the
proportions agreed in the partnership agreement.

An ILP is not subject to legal risk-spreading obligations,
making them extremely useful for single asset funds and / or funds
with very concentrated positions. There are no restrictions on the
use of financing by the ILP, its subsidiaries or its alternative
investment vehicles with full security packages available to
lenders over all assets, including contractual call rights in any
master feeder structure. Full flexibility for an ILP to utilise
subscription financing, margin lending, NAV and other types of
facilities including total return swaps and other derivative
arrangements.

ILP may avail of a full suite of liquidity options so may be
structured as open-ended, limited liquidity or closed-ended
schemes, while redemption gates, deferred redemptions, holdbacks,
in-kind redemptions and side-pockets can all be facilitated.

CCF

The Common Contractual Fund (“CCF”) is a tax
transparent contractual arrangement enabling assets to be pooled in
a regulated fund vehicle managed for the benefit of its investors,
who share in the property of the fund as co-owners in proportions
reflecting the assets or cash subscribed by each investor. Under
Irish law, the CCF is an unincorporated body and has no separate
legal personality. Instead, not unlike the unit trust, the CCF is
formed by a deed of constitution entered into between an
Irish-domiciled and regulated management company and an Irish
domiciled and regulated depositary.

Luxembourg

The Luxembourg regulatory framework, widely known for its
flexibility in fund structuring, offers a wide range of legal forms
for AIFs that can meet diverse investor and manager needs. AIFs can
be set up in corporate, partnership or common contractual (FCP)
form, and may avail of one of a number of different product labels
(or ‘regulatory regimes’), such as the reserved alternative
investment fund (“RAIF”) or the specialised investment
fund (“SIF”), based on the specific requirements of
individual managers and their clients and investors.

Depending on the chosen regulatory regime, an AIF may be
directly supervised and authorised by Luxembourg’s financial
regulator, the Commission de Surveillance du Secteur
Financier (“CSSF”), or, alternatively, may be
unregulated, or regulated indirectly through its authorised
AIFM.

In each of the below options, the AIFM may delegate
discretionary portfolio management to a regulated overseas
(including a Japanese) investment manager, subject to certain
requirements.

A) Legal and organisational forms

Limited Partnerships

Luxembourg limited partnerships are formed by one (or more)
general partner(s) with unlimited liability and one (or more)
limited partner(s) with limited liability and are notable for their
structuring flexibility and significant contractual freedom.

Three distinct types of partnership can be formed in Luxembourg:
the common limited partnership (société en
commandite simple (SCS)), the special limited partnership
(société en commandite spéciale
(SCSp)) and the corporate partnership limited by shares
(société en commandite par actions
(SCA)).

The SCS and the SCSp are modelled on the Anglo-Saxon limited
partnership regimes and are mostly used for closed-ended,
alternative investment strategies. By contrast the SCA is a hybrid
entity that exhibits a number of corporate and partnership
characteristics. The principal difference between the limited
partnerships is that both the SCA and SCS have separate legal
personality, while the SCSp does not have legal personality
distinct from that of its partners and the fact that, while SCS and
SCSp are considered tax transparent, the SCA is a tax opaque
vehicle.

Limited partnerships are typically set up as standalone
structures. However, a limited partnership may be comprised of
compartments and take the form of an umbrella fund if it opts in to
one of Luxembourg’s so-called ‘product’ labels such as
the RAIF, SIF or even SICAR.

Public Limited Company

The public limited company (société
anonyme (SA)) is subject to ordinary company law and to the
rules of any product label it chooses to adopt. It may be
structured as an umbrella fund with multiple compartments and is
often suitable where an AIF is marketed to semi-professional or
retail investors. An SA may be formed by a single founding
shareholder whose liability is limited to the amount of its
investment, and it possesses separate legal personality distinct
from that of its shareholders.

SARL

The private limited liability company (société
à responsabilité limitéé (SARL))
is a corporate vehicle subject to ordinary company law and to the
rules of any product label it chooses to adopt. The SARL may be
suitable where there is a need for a tax blocker or a corporate
fund, and where there are a limited number of investors and no
listing of the fund on a stock exchange is foreseen, as SARLs are
restricted by law to having no more than 100 investors.

FCP

The common contractual fund (fonds commun de placement
(FCP)) is a contractual arrangement created by contractual deed.
Under Luxembourg law, the FCP is an unincorporated body that does
not have separate legal personality and is tax transparent. The FCP
acts through its management company acting in its own name on
behalf of the unitholders. It is an undivided co-ownership of
assets that is not subject to any specific corporate law
requirements but is, instead, governed in accordance with its
constitutive document, the management regulations, and the
legislation applying to any product label which it adopts, such as
the regime applicable under Part II of the Luxembourg law of 17
December 2010 for retail and quasi-retail funds or the RAIF or the
SIF regimes for alternative investment funds aimed at a qualifying
investor base.

SICAV/SICAF

A corporate vehicle such as an SA, SCA, SCS, SARL, a cooperative
company organised as a public limited company (SCOP) or an SCSp,
can take the form of a SICAV or SICAF. The SICAV is most frequently
used in the context of collective investment funds (both for
open-ended funds and for closed-ended funds). A SICAV is an
investment company with variable capital (société
d’investissement à capital variable (SICAV)), a
company whose capital is equal (at all times) to its net assets
(i.e. the SICAV’s capital increases and decreases automatically
as a result of subscriptions or redemptions and variations in its
net asset value) and possesses its own legal personality. An
investment company with fixed capital (société
d’investissement à capital fixe (SICAF)) is a
company whose capital is fixed and that possesses its own legal
personality. Variations in capital are possible but require that
the formalities for varying the capital comply with Luxembourg
company law.

B) Regulatory or ‘product’ regimes

In Luxembourg, once the legal form of the fund has been chosen,
fund initiators have the possibility to add a product label to
bring complementary benefits or to define the structure
further.

Reserved Alternative Investment Fund (RAIF)

The RAIF was introduced in 2013 to enhance Luxembourg’s fund
offering. The prime advantage of the RAIF is that, while it is
fully AIFMD compliant, it is not required to obtain CSSF
authorisation, and hence time-to-market for a new RAIF (or a new
RAIF compartment) is very efficient (and short compared to its
(directly) regulated cousins). Investors gain comfort from the
requirement that each RAIF must appoint a fully authorised AIFM,
ensuring an indirect level of supervision at the level of the AIFM
and a licensed depositary, ensuring the safekeeping of the assets
of the fund. The RAIF is suitable for a multitude of investment
strategies, including real estate, infrastructure, private equity,
private debt and a range of other strategies. A RAIF may follow the
risk-spreading regime as is applicable to SIFs, or alternatively
qualify for the risk capital regime where, on the same basis as
applies to SICARs – see below), it is not subject to
risk-spreading obligations but can invest only in assets qualifying
as risk capital.

A RAIF may be established as either a SICAV or a SICAF, both of
which encompass a wide range of corporate forms (see above).
Furthermore, a RAIF (other than a RAIF qualifying for the risk
capital regime) may be established as an FCP, which as noted above
is a contractual arrangement with which the Japanese investor
market has great familiarity.

Specialised Investment Fund (SIF)

The SIF was introduced in 2007 and is a well-recognised and
popular product label used for a variety of alternative investment
strategies including private equity, venture capital, private debt
and fund-of-funds, among others. Although a SIF is supervised by
the CSSF, managers have a great deal of freedom in the permissible
assets and investment restrictions. This notwithstanding, the SIF
must comply with basic risk-spreading requirements: exposure to
investments of the same type from the same issuer may not exceed
30% of the assets or commitments of a SIF. A SIF may be set up as a
stand-alone fund or as an umbrella structure with compartments
whose assets and liabilities are segregated by law. As a result, it
combines investor confidence with a high degree of organisational
freedom for managers.

As is the case for RAIFs, a SIF may be established as a SICAV, a
SICAF or an FCP.

SICAR

The investment company in risk capital
(société d’investissement en capital à
risqué (SICAR)) is a dedicated vehicle for early-stage
private equity and venture capital funds. A SICAR can only invest
in assets qualifying as risk capital as defined under Luxembourg
law and must be authorised by the CSSF. The SICAR is not subject to
risk diversification rules, and benefits from favourable tax
treatment on income and gains from risk capital investments.

In addition to the options covered above, a wide variety of
Luxembourg and Irish funds can, in addition, be subject to the
ELTIF (European Long Term Investment Fund), EuVECA (European
Venture Capital Fund) and EuSEF (European Social Entrepreneurship
Fund) rules.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.