While opportunities are rife, there are unique challenges associated with establishing and administering alternative vehicles in other jurisdictions, and with purchasing assets across borders. This article examines two prime target domiciles for private equity vehicles — Singapore and Luxembourg — and some of the challenges of managing funds and deploying capital across borders.
Singapore is well-positioned as a gateway to a host of under-researched investment opportunities across South East Asia. It has a vibrant asset management industry that has grown significantly over the last 25 years, and the country is renowned for its business-friendly regulatory environment.
Despite Singapore’s justified reputation for ease of doing business, fund managers expanding into the country must appreciate that it has made significant efforts to bolster its regulations to ensure the transparency and integrity of its asset management industry. Recent examples include an increased focus on anti-money laundering and know-your-customer (AML and KYC) regulations, and more frequent inspections of regulated asset managers. Keeping abreast of and complying with these regulations and trends poses an administrative burden for fund managers, but compliance is essential to avoid fines and reputational damage. In April, for example, the Money Authority of Singapore (MAS) fined the Singapore branch of a private Swiss bank SG$1 million for weaknesses in its AML regime.
Of course, all countries pose compliance challenges, which highlights how essential it is for fund managers to have access to local knowledge. It’s still possible to carry out many of the day-to-day management activities of investment portfolios remotely, but given the risks, fund managers are increasingly looking to hire an experienced on-the-ground presence to ensure regulatory compliance and effectively service local investors.
That last point is crucial. Investors from any given region present their own unique demands and expectations, just as local regulations present their own challenges. To take an obvious example, an investor from Singapore will regard a Singapore-based fund as a domestic fund, whereas a German investor will regard it as “international” or “APAC.” Similarly, a Singaporean investor and a German investor will be taxed differently by their respective domestic tax authorities on their Singapore-based holdings.
The way a fund manager structures a fund will also affect how attractive it is for the two prospective investors in our example, based on their individual tax obligations and other factors. All these considerations must be taken into account when setting up a fund across borders. We explore fund structures more in the next section.
With assets under management of approximately 5 trillion euros, Luxembourg is the largest investment fund centre in Europe, and globally it’s second only to the US. The jurisdiction is a prime location for private equity, private debt, real estate and infrastructure funds in particular.
Over the last decade and more, the Luxembourg government has fostered the country’s alternative funds industry. It quickly transposed the EU’s Alternative Investment Fund Managers Directive (AIFMD) into law, and subsequently expanded its fund-structure options to provide investors with what might be called a varied “toolbox” of choices.
To give some idea of the breadth of choices, Luxembourg structures include the reserve alternative investment fund (RAIF), the specialised investment fund (SIF), the common limited partnership (SCS), the special limited partnership (SCSp), the financial participation company (Soparfi) and others. Each has different legal forms, tax qualifications, reporting requirements and regulations. Understanding the benefits and drawbacks of these options is critical to developing a sound private equity strategy and to attracting investor capital when launching a Luxembourg fund.
When choosing a structure in Luxembourg, a fund manager must consider the investor profile, the type of investments targeted and EU passporting. Passporting rights are issued under the AIFMD and are crucial to deploying capital in the EU. Once an EU financial institution is issued a passport by the authorities of its home member state, it may provide authorised services throughout the single market. A Luxembourg-issued passport, then, enables a Luxembourg fund manager to distribute their funds to any EU member state.
It should be noted that while the AIFMD has increased administrative burdens for managers, the directive has gone down well with managers and investors, who among other things have welcomed the increased fund transparency. Consequently, the opportunities for alternative investment managers to attract capital have increased in the years since the directive, and managers who can demonstrate AIFMD compliance put themselves in a good position to succeed.
Like so many others, this principle can be applied across virtually all alternative fund and portfolio company markets. A fund manager who can convincingly demonstrate that a fund is compliant with local regulations will be in an excellent position to attract investors.
Deploying capital across borders
Prior to launching a private equity fund in any jurisdiction, the fund manager must communicate their investment strategies to relevant stakeholders, including of course investors. Fund strategies include those related to fundraising, fund types, asset locations and exit strategies.
As we’ve emphasised, many fund managers are looking across borders for returns. In some cases the fund manager, fund, assets and investors may be in different jurisdictions and time zones. Managing a fund in this kind of situation is highly complex and can be risky, particularly with regard to keeping abreast of and following changing local compliance requirements in multiple jurisdictions. These include requirements related to tax, accounting, reporting and more.
Needless to say, understanding and fulfilling these requirements is not only complex and risky, it’s time-consuming. But speed-to-market is an important differentiator in today’s increasingly competitive private equity landscape. In order to deploy capital across borders quickly, efficiently and compliantly, a fund manager must:
- Choose the right fund structure and understand its benefits and limitations, including all its tax implications, both for investors and on net revenue;
- Understand local regulatory requirements in advance of deploying capital;
- Have the administrative resources in place to fulfil compliance requirements in all relevant jurisdictions.
When managing funds across borders, the days of one person sitting in an office of a fund’s official domicile and rerouting calls to colleagues around the world are over. It is true that technological advancements enable fund managers to make investment decisions from virtually anywhere. But stricter regulatory regimes dictate that certain functions must be carried out locally. Economic substance laws, for example, demand a substantial on-the-ground presence in many countries.
It’s also important to remember that when expanding into a new market, fund managers must consider more than local regulatory obligations. Investors in different countries have different cultural expectations, which must be taken into account when marketing and managing a fund.
In our current fast-paced regulatory and economic environment, maintaining a significant on-the-ground presence in the target market — either through local hires or by hiring an experienced third-party fund administrator — is an increasingly essential element of effective and compliant cross-border fund management.
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