october 2007 luxembourg hedge fund services 2007 · pdf fileluxembourg hedgeweek special...

SIF legislationputs Luxembourgin the spotlight

Fund serviceproviders buildglobal reputation

Strategyclassifications bluramid Ucits III boom

Luxembourg Hedge FundServices 2007

October 2007

In this issue…03 Bold legislation pushes Luxembourginto the spotlightBy Simon Gray

05 SIFs anticipate key market trendsBy Michael Ferguson, Ernst & Young

08 Catering to a new breed of managerBy Eric Kata, RBC Dexia Investor Services

11 A competitive hedge fund jurisdictionBy Victor Chan Yin, KPMG

14 Administrators gear up for thedemands of a changing businessBy Simon Gray

16 Evolving with the alternatives sectorBy Nina Kleinbongartz, Citigroup Global Markets

19 Strategy convergence poses challengesBy Luc Leleux, Fortis Prime Fund Solutions

LUXEMBOURG Hedgeweek Special Report Oct 2007 www.hedgeweek.com | 2

CONTENTS

Special Reports Editor: Simon Gray, [email protected]

Sales Manager: Simon Broch, [email protected]

Publisher/Editor-in-Chief: Sunil Gopalan, [email protected]

Marketing Director: Oliver Bradley, [email protected]

Graphic Design (Special Reports): Siobhan Brownlow at RSB Design

Photographs: Courtesy of Luxembourg Tourist Office

Published by: Hedgemedia Limited, 18 Hanover Square, London W1S 1HX

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The motto of the Grand Duchy ofLuxembourg is “Mir wölle bleiwe wat mirsin”: We want to remain what we are. Whilethe country’s approach to financial serviceslegislation has often been rather bolder andmore innovative than it is sometimes givencredit for, Luxembourg nevertheless retains areputation for conservatism and solidity thathas served it well as Europe’s largestdomicile and servicing centre for traditionalinvestment funds.

But over the past decade Luxembourg haslooked on enviously as Dublin, its greatEuropean rival for cross-border financialservices business, has seen hedge fundadministration, a small niche business in themid-1990s, blossom into a major strand ofthe global asset management industry. Todaythe Irish Funds Industry Associationestimates the volume of hedge fund assetsadministered across the country to haveswollen to more than EUR700bn – still well

O V E R V I E W


Bold legislation pushes Luxembourg

into the spotlightBy Simon Gray

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��www.ey.com/luxembourg

Audit

Michael FergusonPartnerAsset Management LeaderTel: +352 42 124 [email protected]

Ernst & Young,a dedicated team to serve the Hedge Fund universe

Advisory

Christophe WintgensPartnerAsset Management Advisory ServicesTel: +352 42 124 [email protected]

Taxation

André PeschPartnerAsset Management Tax ServicesTel: +352 42 124 [email protected]

Key Contacts

As the world’s second largest fund centrewith more than EUR2trn in assets,Luxembourg is best known for retail products.However, the past five years have seenLuxembourg become established as adomicile and administration centre for hedgefunds as well as real estate and private equityfunds. The hedge fund administration industryalone now services more than EUR220bn inhedge fund assets, and has been growing atmore than 75 per cent year on year.

To meet demand from institutional, privateand high net worth investors for a lightlyregulated onshore legal structure, particularlyfor alternative investment products, theLuxembourg authorities established theSpecialised Investment Fund (SIF) earlier thisyear, replacing the 1991 InstitutionalInvestment Fund law.

SIFs may be established as commonfunds or investment companies (private orpublic limited companies or partnerships), ineach case as an umbrella structure withmultiple sub-funds that may pursue differentinvestment strategies. In a ground-breakingprovision designed to boost speed to market,the fund may be launched (including raisingand investment of capital) prior to approvalby the Financial Sector SupervisionCommission, as long as the application issubmitted within one month of launch.

SIFs can be offered to an expanded rangeof “informed investors”, comprising bothinstitutions and individuals, who meet certainrequirements, which may include a minimuminvestment of EUR125,000. The legislationabolishes the qualification requirementspreviously imposed on fund promoters andinvestment advisors, including minimum capitalcriteria, which in the past discouraged start-uppromoters and investment managers fromlaunching alternative products in Luxembourg.

The management of the SIF – the board ofdirectors, partners, and managers, depending

on the legal structure – do not have to beresident in Luxembourg, but must be approvedby the CSSF and demonstrate adequateexperience in the fund’s strategies. SIFs mustsimply comply with broad investment riskdiversification requirements – generalquantitative investment limits but no limitationson leverage. There are no restrictions on theappointment of prime brokers.

SIFs are not subject to tax on profits orcapital gains. They may also benefit frommany of Luxembourg’s tax treaties toeliminate or reduce withholding taxes onforeign income or capital gains. This givesLuxembourg an advantage over certainoffshore domiciles where withholding tax canbe a significant drag on performance. SIFsdo not have to publish their NAV and mayshow a condensed portfolio statement ofinvestments in its annual report.

As convergence grows between the threesub-sectors of the alternative assetmanagement industry, as well as betweentraditional and some hedge fund strategies,SIFs can accommodate multiple assetclasses, such as hedge funds, real estate andprivate equity, within a single legal structure.

Luxembourg has a history of anticipatingmarket trends and delivering practicalsolutions. For example, it has played a leadingrole in the creation of sophisticated Ucits IIIfunds, remains proactive in signing doubletaxation treaties, and now has implementedthe SIF, all developments that support thegrowth of a thriving financial centre.

Over the first six months of the newregime, SIF approvals by the CSSF haveaveraged one per working day, a pace thatmay speed up further as promoters, advisersand regulators gain experience with the post-ante authorisation process. The message isclear: the SIF is meeting demand frominvestors and advisors for a lightly regulatedand flexible onshore vehicle. ■

E R N S T & Y O U N G


SIFs anticipate keymarket trends

By Michael Ferguson

Michael Ferguson is a partnerand head of asset managementwith Ernst & Young inLuxembourg

short of the more than EUR2trn in fundassets serviced in Luxembourg at the end ofAugust, but an amount far too imposing tobe ignored.

In fact, far from ignoring alternativeinvestments, Luxembourg has for severalyears been seeking ways to gain traction inthe sector, and with some success. Helpedby a series of circulars from the industryregulator, the Financial Sector SupervisionCommission (CSSF), offering greaterflexibility in areas such as risk diversification,there has been growing use of Part II of thecountry’s 2002 funds legislation – the firstpart of which introduced Ucits III funds intoLuxembourg law – as a vehicle for hedgefunds, or more commonly funds of hedgefunds.

However, there were continuingrestrictions on the growth of the businessthat ultimately stemmed from Luxembourg’senduring vocation as a centre for traditionalmutual funds, not least a requirement forapproval of a fund’s promoter that placedemphasis not only on the good name of thefirm and its principals but its track record. Arule designed for asset managers sellingretail products across Europe madeLuxembourg less than welcoming to fledglinghedge fund managers freshly breaking outon their own from an investment bank.

“In the past, we were in a difficult positionwith the small and medium-sized hedge fundmanagers, for example traders wanting tocreate their own CTA funds investing infutures and options,” says Eric Kata, directorof business development for alternativeinvestment at RBC Dexia Investor Services in

Luxembourg. “The promoter requirementswere too strict and made it difficult for themto be recognised as a suitable assetmanager.”

By contrast, Luxembourg has been aprime beneficiary of the flexibility offered tomanagers under Ucits III to use derivativesand a certain degree of leverage in pursuit ofstrategies, such as equity market neutral andlong/short equity, that previously wererestricted to classic hedge funds andsophisticated investors. The current fad for130/30 vehicles and similar ‘short extension’strategies has helped to make so-calledabsolute return funds one of the mostbuoyant areas of the Ucits fund universe thatLuxembourg dominates.

At the same time, the country took animportant step to encourage the servicing ofnon-domiciled funds in the grand duchywhen the Luxembourg Stock Exchangeeased its rules to make it possible for fundsestablished in the Cayman Islands andBritish Virgin Islands to be listed. Belatedlythis move redressed the advantage offeredby the Irish Stock Exchange as a majorlisting centre for offshore funds, whichencouraged promoters to have themserviced in the same jurisdiction.

Luxembourg also quietly carved out asignificant role in the European markets forproperty and private equity vehicles. Thelaunch in June 2004 of the risk capitalinvestment company or Sicar for venturecapital and private equity investments helpedto position the jurisdiction handily for theglobal buyout boom of the past three years,while it is also reckoned to be the world’s

O V E R V I E W


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With its long-standing background as thelargest centre for the domicile and servicingof traditional mutual funds outside the US,Luxembourg has approached the hedge fundindustry from a different perspective thanoffshore centres such as the Cayman Islandsand British Virgin Islands, or even Ireland.The jurisdiction’s role is coloured by itsculture and experience, while the alternativemanagers who use Luxembourg are also adifferent breed, with different strategies to tapbroader markets.

Whereas in the past hedge funddistribution has been carried out principallythrough private placements, Luxembourg’sexpertise in cross-border distribution is nowset to come into its own as new players inthe market, notably big institutions, are keento take advantage of that capacity ratherthan limit themselves to the privateplacement channel. The key to thisdevelopment is the surge in establishment offunds that use the flexibility offered by UcitsIII vehicles to offer alternative strategies to apan-European market.

This shift in strategy reflects to an extenta change in the type of managers enteringthe market. Whereas in the past start-upswould typically be launched by tradersleaving the prop desk of an investment bankto build their own businesses, today it isincreasingly big financial groups that arelooking to extend their strength in traditionalasset management and distribution toalternative products.

RBC Dexia Investor Services inLuxembourg is increasingly beingapproached by institutions looking for anadministrator with the capacity to handlestrategies that employ a wide range of OTCand listed derivatives to generate alpha.Today they have the option of usingLuxembourg’s new Specialised InvestmentFunds vehicle, but many of these managers

prefer if possible to use new or existingUcits III structures to offer products such as130/30 funds or hedge fund indices,sometimes alongside their existing long-onlyrange.

New business is coming from institutionsthat are existing clients and from traders andmanagers leaving bigger groups to launch theirown operations, but also from asset managerswhose traditional funds are administered by aservice provider that is not capable ofsupporting them in their expansion into thealternatives sector. RBC Dexia is gainingbusiness from this kind of client because of itsacknowledged strength in terms of IT systemsand the expertise of its staff.

In addition there are still Luxembourg-based investment managers that continue toadminister their own long-only funds, but it’squite a different matter to put in place aplatform to service alternative products. Itinvolves investing in new IT systems that canhandle OTC derivatives and in a team thatunderstand the products and instruments.Traditional fund managers must decidewhether instead to outsource to a providerthat already has the required experience andexpertise. For the kind of institutions that arenow launching alternative funds, it’s vital thatthey are serviced properly.

RBC Dexia is benefiting today from far-sighted decisions taken a few years ago toinvest in the expertise and systems requiredto take on business such as the new waveof Ucits III alternative products. The nextchallenge is to recognise the direction of theindustry, drawing on relationships with clientsto maintain a good understanding of themarket and prepare for changes in thefuture. One of the great benefits of being oneof the largest third-party administrators inLuxembourg and worldwide is that it is theclients that drive the business in the rightdirection. ■

R B C D E X I A


Catering to a newbreed of manager

By Eric Kata

Eric Kata is director ofbusiness development foralternative investment withRBC Dexia Investor ServicesLuxembourg

leading domicile for unregulated real estatestructures, although this is hard to verify.

However, the holy grail of the Europeanalternative investment sector has long beento develop an investment structure capableof challenging the Cayman mutual fund asthe vehicle of choice for hedge fundsworldwide. Within the past three years, asthe number of Cayman funds has soaredpast 8,000, practitioners and regulators injurisdictions including Gibraltar, Guernsey,Ireland, Jersey and the Isle of Man have alldeveloped new products that seek to erodeCayman’s advantage in terms of cost,simplicity and speed to market.

Luxembourg’s contribution to thisscramble to produce a structure that wouldcapture the imagination of the market wasthe Specialised Investment Fund, broughtinto being by an act of parliament ofFebruary 13 this year. The SIF sought toaddress the concerns of hedge fundmanagers with features such as the absenceof promoter approval, a flexible approach torisk diversification that largely eschewedquantitative investment restrictions, measuresto facilitate the use of prime brokersalongside custodians, and limitations onreporting to suit managers’ desire to keeptheir strategies and positions confidential.

But what really caught the eye about theLuxembourg SIF was the absence of anyrequirement for the fund to receiveauthorisation from the regulator before itstarted raising money from investors ormaking investments. Instead, the legislationsimply requires the promoter to submit itsapplication to the CSSF within a month ofthe launch of the fund.

This provision was designed to reassurefund promoters that they would not face anyregulatory hold-ups delaying the launch oftheir fund, and perhaps even more to send amessage that Luxembourg intends to ensurethat requirements designed to protect retailinvestors will no longer restrict thedevelopment of products aimed at aprofessional and institutional market. At thetime the SIF was viewed as the Europeanvehicle coming closest to the Caymanmodel, although subsequently Jersey hasunveiled plans for unregulated funds that donot even require the local audit sign-offstipulated in Cayman.

What is certain is that the SIF has beenwarmly embraced in the marketplace and thenumber of vehicles being launched is growingat an impressive rate. According to the CSSF,no fewer than 337 SIFs were on the books atthe end of August, although this total includedaround 200 legacy vehicles established underLuxembourg’s 1991 legislation on institutionalfunds as well as about 140 new SIFs. Thesefunds, old and new, accounted for someEUR96.8bn in assets, an appreciable figurewhen compared with a combined total ofEUR160bn for hedge fund and fund of hedgefund assets administered in the jurisdiction atthe end of 2006.

That’s not to say that all, or even mostSIFs now being established are hedge fundvehicles. “Many types of product can beestablished under the SIF law, includingtransferable securities funds, money marketfunds, real estate funds, hedge funds andprivate equity funds,” says NinaKleinbongartz, product manager foralternative investments in Europe at CitigroupGlobal Markets in Luxembourg.

“The opportunity to choose between the[contractual] FCP and [corporate] Sicav legalstructures is beneficial for the real estateindustry, because previously only the FCPstructure was available.” In the first monthsof the SIF regime, she notes, real estateaccounted for some 40 per cent ofapplications; a large proportion of thepromoters of these funds are from Germany.

The steady growth in the number of SIF

O V E R V I E W


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One of the misconceptions aboutLuxembourg is that it is a newcomer to thehedge fund industry with the launch of theSpecialised Investment Fund vehicle earlierthis year. In fact the country already has aflourishing presence in the sector, with 38administrators of hedge funds and funds ofhedge funds, according to the fund industryassociation Alfi.

Luxembourg had total hedge fund assetsof EUR160bn under administration at the endof last year, of which EUR104bn is domiciledand administered in Luxembourg, and therest consisting mainly of Cayman, BVI andBermuda funds serviced by Luxembourgadministrators. Overall, the volume of assetsserviced by the industry here grew by 57 percent during 2006.

However, until the establishment of the SIFstructure the growth of the industry wasconstrained by the requirements of the existingfund legislation. Traditionally Luxembourghedge funds were established as Part II fundsunder the fund legislation, subject to guidancefrom the regulator, the Financial SectorSupervision Commission (CSSF), on theinterpretation of investment restrictions, alongwith the requirement that that the promoterneeded to be highly reputable and have anextensive track record. This was a problem forsmall boutique managers setting up hedgefunds for the first time.

A new avenue for the provision ofalternative funds was opened up by theadoption in 2002 of the Ucits III directive, whichmade it possible to offer certain hedge fundstrategies, such as convertible arbitrage andlong/short equity, through funds establishedunder Part I of the new legislation. This hashelped to expand the range of Luxembourg-based products and made it possible todistribute these funds under a Europeanpassport, although the requirement forpromoter approval by the regulator still exists.

The passage of the SIF legislation hasbrought considerably greater flexibility. Notablythe new vehicle offers a wider definition ofsophisticated investors entitled to invest inhedge funds, subject to a minimum investmentlimit of EUR125,000. The legislation offersvarious advantages to promoters, including theability to launch a fund without prior approvalfrom the CSSF, which offers considerablebenefits where speed to market is essential.

These changes have closed thecompetitiveness gap between Luxembourgand other centres for the domicile andservicing of alternative funds. The countryhas already demonstrated its expertise inhedge fund servicing, while many of thefunds currently administered in the countrybut domiciled elsewhere could now be setup under the new legislation.

The opportunity exists to build upon thisbase of expertise. For example, there is lessreason now for a promoter to set up a fundin Cayman when by doing so in Luxembourgthey can offer a product more attractive toEuropean institutional investors. Oneindication of the success of the SIF is thatmore than 140 new funds had already beenapproved or were in the process of beingapproved within the first six months of thenew regime.

Nor has this been achieved by abandoningthe principle of effective regulation, althoughthe level of supervision has been adjusted totake into account the greater expertise ofinstitutional investors. In its recent riskdiversification circular, the CSSF insists onadequate disclosure in a fund’s offeringmemorandum to ensure that shareholdersand potential investors are fully aware ofwhat they are investing in. Finally, SIFs mustbe submitted to the CSSF for approval withina month of launch, and funds also need aLuxembourg administrator and custodian,which are themselves regulated. ■

K P M G


A competitive hedgefund jurisdiction

By Victor Chan Yin

Victor Chan Yin is a partnerwith KPMG Luxembourg

applications over the past few months maywell be down in part to service providersbecoming more comfortable with a regimewhich in theory could leave them exposed,although not legally responsible, if a fundthat had already launched fundraising andinvestment then saw its application forauthorisation denied by the regulator.

While law firms, custodians andadministrators may not be directlyaccountable to the CSSF for the conformityof SIF funds to the regulatory requirementsahead of the approval process, there are inreality checks and balances that will greatlyreduce the likelihood of problems, accordingto Victor Chan Yin, a partner with KPMG inLuxembourg.

“Of course promoters will not take the riskof their funds not being approved,” he says.“In practice service providers often go to theCSSF if they have new types of product.

Discussions will take place to make surethere won’t be any problems withauthorisation, but with time and experienceservice providers will be able to say yes forcertain types of strategy because they havedone it before.

“In a way, although there is no priorapproval from the CSSF, in practice there issome unofficial screening from lawyers andservice providers based on their ownexperience. They would not want to be in asituation where the fund is launched, andthen they have to dismantle everything. Theyare careful in what they are accepting andsubmitting to the CSSF.”

Michael Ferguson, a partner and leader ofthe asset management practice with Ernst &Young in Luxembourg, says: “Most playershave taken a cautious approach with thepost-ante approval process – many have hadinformal discussions with the CSSF and theiradvisers prior to launching their SIFs. Ibelieve the post-ante process will evolve overtime to become a real benefit in launchingproducts once a certain protocol hasdeveloped around its use.”

SIFs may also be attracting interest fromfund promoters because of the broaderdefinition of the sophisticated and informedclients that are permitted to invest in them.“Previously these types of fund were aimedat institutional clients,” Kleinbongartz says.“Now the definition includes private high networth clients with a minimum investment ofEUR125,000 or those with written statementsfrom their bank confirming that they qualifyas an informed investor.”

Luc Leleux, director of businessdevelopment with Fortis Prime FundSolutions in Luxembourg, believes that oncethe regime has bedded down the authoritiesmay decide to ease its provisions evenfurther, particularly regarding the minimuminvestment threshold. “I wouldn’t besurprised if after a certain period of time, theCSSF stepped back and examined how itmight amend the regime,” he says.

“For example, they might decide to reducethe EUR125,000 minimum for a well-informedinvestor to perhaps EUR50,000, which wouldreflect the continuing convergence oftraditional and alternative types of strategy. Ibelieve that in 10 years time, traditional andalternative investments will have blended,

O V E R V I E W


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and what we regard as alternatives will beincreasingly viewed as mainstream.”

Kata believes that SIF business willcontinue to flow into Luxembourg at a rapidpace as the regime becomes more broadlyknown and understood as an alternative to aCaribbean domicile. “The door is open ashedge fund managers suddenly realise thatBVI or Cayman funds are not the onlypossible solution for them,” he says.“Luxembourg is a good alternative now forsmaller managers and for the hedge fundcommunity as a whole.”

He is echoed by Kleinbongartz, who says:“Cayman does not offer the regulatedproduct as Luxembourg does, the proximityto other European countries, themultilingualism of staff and multiculturalenvironment, the experience in due diligenceand compliance expertise. Various countrieswill continue to impose reporting or otherregulations governing the distribution offunds in their territory, with whichLuxembourg has a great deal of experience.Domiciles like Cayman with minimalrequirements have greater difficulty inresponding to local regulators.”

It’s perhaps telling that complaints fromfund professionals are much more mutedthese days on the subject of the subscriptiontax levied on fund assets, once an area ofheated debate between the industry and theLuxembourg government, especially afterDublin grabbed the lion’s share of the pan-European money market fund businessbecause the tax ate heavily into their wafer-thin margins.

SIFs remain liable to the subscription tax,but at a rate of just 0.01 per cent per year onnet assets. “Given the very low level of thetax and with regard to the type ofinvestment, I have not heard of this being anissue,” says Chan Yin. Ferguson agrees,saying: “I do not believe it acts as a seriousdisadvantage. In my discussions with clientsand others, this has never been a show-stopper.

“Luxembourg investment funds have overthe years established a brand that hasenabled the opening of certain distributionchannels not available to all domiciles. Thisis a key driver for those setting up SIFs –what is investors’ perception of the proposeddomicile? The perception of Luxembourg as

a fund domicile tends to be a much moreimportant consideration than the subscriptiontax. It should also be noted that this taxdoes not apply where the SIF’s assets arefor pension funds or retirement schemes.”

Ferguson argues that the SIF is helping toadjust external views of Luxembourg as itsexpertise in the alternatives sector gainswider recognition. “A great degree ofconvergence is occurring in the assetmanagement industry, with the comingtogether of the three alternative sub-sectors,hedge funds, real estate and private equity,and to some extent between certain hedgefund strategies and traditional strategies,” hesays.

“With developments like the SIF where youcan have all three alternative sub-sectorswithin a single legal structure, Luxembourg’sclear lead in the creation of sophisticatedUcits III funds, and growing demand byinstitutional investors for lightly regulatedalternative fund products, all the indicatorsare that Luxembourg, through earlyanticipation of these market trends anddelivery of practical solutions to meet them,will continue to grow significantly over thecoming years.” ■

O V E R V I E W


With a substantial majority of the more thanEUR2trn in assets of Luxembourg-domiciledand regulated funds administered in thegrand duchy represented by traditional funds,the country’s alternative investment servicessector – unlike Ireland’s, for instance – haskept a relatively low profile in recent years.But with the already impressive level ofgrowth in the sector having received a visibleboost from the launch of SpecialisedInvestment Funds in February, hedge fundadministrators are starting to become a morevisible part of the financial serviceslandscape.

That’s down in part to Luxembourg’ssuccess over the past couple of years in

attracting work from funds established inother jurisdictions, mostly the offshoredomiciles of the Cayman Islands, BritishVirgin Islands and Bermuda, whichaccounted for some 35 per cent of theEUR160bn in hedge fund assets administeredin the country at the end of 2006. Manymembers of the industry attribute theemergence of this business directly to therelatively recent decision by the LuxembourgStock Exchange to accept offshore funds forlisting, a key element in making what arelargely unregulated vehicles palatable toinstitutional investors.

The statistics do not take into account asurge in the volume of funds established

A D M I N I S T R AT I O N


Administrators gearup for the demands ofa changing business

By Simon Gray

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Luxembourg enjoys a worldwide reputationas a centre of excellence for theestablishment and administration oftraditional investment funds, but until recentlyit was not as well known as a jurisdiction foralternative investments – even though foryears managers have been setting up fundswith an alternative investment strategyorganised under Part II (non-Ucits) of the2002 fund legislation.

Although it is starting from a relativelysmall base, Luxembourg’s hedge fundindustry has been growing swiftly throughoutthis decade, assisted by growing expertisewithin the fund services industry and greaterflexibility offered by the current fundlegislation and regulatory approach.

At the end of last year, according to theFinancial Sector Supervisory Commission, atotal of 187 hedge funds and 383 funds ofhedge funds were domiciled andadministered in the Grand Duchy, whilehedge fund assets grew by 129 per cent andfund of fund assets by 27 per cent in thecourse of the year.

Since then the industry has enjoyed aboost from the adoption of the SpecialisedInvestment Fund (SIF) legislation in February,which brought various benefits for promotersconsidering Luxembourg as a domicile. Theseinclude an advantageous fiscal regime thatexempts capital gains and income from tax;the removal of quantitative investmentrestrictions; greater flexibility in reporting andvaluation, including removal of the requirementto disclose the whole portfolio; and abolition ofthe promoter approval requirement, which ishelpful to small and start-up managers who donot have a track record.

It is hoped that promoters who previouslywould have had to set up in the Caribbeanwill enjoy the reputational comfort ofLuxembourg in an environment that is nowless restrictive.

The SIF structure can be used fortraditional funds as well as hedge funds, realestate and private equity vehicles. The abilityto establish a SIF as either a Sicav or anFCP is particularly advantageous for realestate funds, which account for a substantialproportion of applications introduced in thefirst six months of the regime, especiallyfrom German promoters.

The growth of Citi’s alternative investmentbusiness in Luxembourg has mirrored that ofthe sector as a whole. The group has longbeen one of the country’s leadingadministrators of traditional funds as well asexchange-traded, structured and pensionproducts, but the acquisition earlier this yearof Bisys, one of the world’s largest specialisthedge fund administrators, has given Citiaccess to a deep pool of expertise invarious centres, as well as to a proventechnology platform specially designed forthe needs of the alternatives market.

Citi also recently announced its firstLuxembourg-domiciled hedge fund client.Nexum appointed Citi to service itsLuxembourg-domiciled fund by providingfund administration, transfer agency, custody,prime brokerage services and compliancemonitoring. The solution is live and all assetshave been successfully migrated onto Citi’scommon fund administration and custodyplatform in Luxembourg.

As hedge funds become available to awider clientèle, Luxembourg is well placed tobecome a distribution centre from which toroll out hedge funds to a more retail market,especially as traditional funds start to explorethe use of alternative assets such as OTCderivatives that previously were restricted tohedge funds. As the lines between traditionaland alternative managers starts to blur, thecombined skills of Citi and Bisys enable thegroup to offer expert service on both sidesof the market. ■

C I T I G R O U P G L O B A L M A R K E T S


Evolving with thealternatives sector

By Nina Kleinbongartz

Nina Kleinbongartz is productmanager for alternativeinvestments in Europe withCitigroup Global Markets inLuxembourg

under the European Union’s Ucits IIIlegislation, which governs cross-borderdistribution of retail funds that are using thegreater investment flexibility available underthe directive to offer hedge fund-likestrategies, using derivatives and someleverage. Accommodating these funds isexpanding the skill base available toLuxembourg administrators for the servicingof alternative products.

The strength of the country’s traditionalfund services sector means that there is anextensive range of providers establishedlocally, many of which are starting to usetheir existing structure and resources toexpand into the alternatives field. “It is anadvantage for Luxembourg that there arealready many custodian banks servicingexisting Ucits funds,” says KPMGLuxembourg partner, Victor Chan Yin. “If fundpromoters want to set up other types ofstructure such as private equity or realestate, they already have a foot in thecountry. It may be easier for them becausethey already know Luxembourg and themarket players.”

Today there are at least 38 administratorsof single-manager hedge funds and funds ofhedge funds, most of which also serviceUcits funds but including a number ofproviders such as Citco and HSBC (formerlyBank of Bermuda) that are primarily focusedon alternative rather than traditional funds.The Luxembourg Fund Industry Association(Alfi) is making a concerted effort to highlightthe importance of the sector in its expandingefforts to market the industry abroad.

“Alfi has criss-crossed the globe over thepast four years in its very successful seriesof roadshows,” says Michael Ferguson, apartner and leader of the asset managementpractice at Ernst & Young in Luxembourg.He notes that these efforts are set toredouble in the future as the financialservices sector and the government put inplace new structures to promote the industry.

“Through government-sponsored tradeand economic missions, Luxembourg hasbeen extremely active over the past fiveyears in communicating to the financialservices world what it is all about, includingexplaining what the country has done (andwill continue to do) to retain its position asthe world’s second largest investment fund

centre,” Ferguson says. “The government isin the process of establishing for the firsttime an agency responsible for promoting allsectors of the Luxembourg financial servicesindustry.”

Now, industry members say, theadministration sector can boast a range andavailability of skills capable of meeting thedemanding standards of the largestalternative fund managers. Several of theleading players in Luxembourg, like RBCDexia Investor Services and Fortis PrimeFund Solutions, have built on the foundationsof well-established traditional fundbusinesses established by predecessorinstitutions Banque Internationale àLuxembourg and Banque Générale duLuxembourg respectively.

RBC Dexia is the product of thecombination of the hedge fund administrationbusinesses of Royal Bank of Canada andDexia, while Citigroup Global Marketsrecently added a considerable store of globalhedge fund expertise with the acquisition ofBisys. All three businesses benefit fromsharing not only IT platforms and resourcesbut administration expertise across theirinternational networks.

For example, says Luc Leleux, director ofbusiness development at Fortis Prime FundSolutions, the group’s fund administrationnetwork comprises some 16 locationsaround the world, including major operationalcentres for alternatives in Dublin, the Isle of



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The European asset management sector iscurrently experiencing a convergencebetween traditional and alternative assetmanagement styles. Investors are becomingmore literate on how to invest and whatinvestments could generate higher returns,more quickly and in a safe regulatedenvironment. This trend poses challenges forfund administrators and custodians, especiallyif they seek to accommodate different typesof investment strategy on the same platform.

How hard it is for a long-only fund managerto differentiate himself from his peers! Thesefunds perform similarly and hardly beat theindex. How can investors’ hunger for returnsbe satisfied if the expertise of long-onlyhouses is limited to long-only products?

Traditional asset managers, includingsome of the biggest European institutions,have been steadily acquiring hedge fundboutiques, but until recently, they have keptthe two separate. This is now changing astraditional managers use Ucits III pan-European retail funds to employ techniqueshitherto confined to alternative managers andvehicles such as Luxembourg Part II fundsand Specialised Investment Funds.

Regulators, the CSSF in Luxembourg tothe fore, understand these changing needsand are offering traditional asset managersnew flexibility as long as investors remainprotected. One technique available to Ucits IIIfunds, going short using derivatives, hasprompted many big investment houses tooffer 130/30 funds and similar strategies.

Meanwhile, alternative asset managers arereaching a wider audience among institutionaland sophisticated investors by using regulatedfund vehicles and eschewing the offshoredomiciles of the Caribbean and the British Islesfor EU member states such as Luxembourg.

Investors can access regulated investmentschemes that use complex alternativestrategies in a protective environment. The

launch of the SIF regime enables hedge fundmanagers to obtain a regulatory qualitystamp from the CSSF without the obstaclesthat limited the growth of the sector in thepast, such as the need for promoter approval.

Funds today, whether from traditionalmanagers going alternative or hedge fundmanagers seeking a mainstream clientele,bring together assets ranging from blue-chipequities to extremely exotic derivatives.Administrators must offer a platform that canstraddle these extremes and deliver NAVproduction whatever the fund’s asset mix.

One should not disregard the growing publicinterest in other alternatives such as privateequity and real estate, areas in which Fortis isone of the leading service providers inLuxembourg. Since the SIF legislation allowsumbrella funds containing a mixture ofalternative strategies, service providers must becapable of accommodating direct or indirectreal estate investments alongside traditionalassets and derivatives in the same structure.

How can administrators support the needsof alternative funds or hybrid structuresincluding alternative strategies? Part of it canbe achieved by a global IT infrastructureenabling a 24/7 servicing model. Thisrequires additional pricing capability toencompass automatic feeds for bothstraightforward and highly complicatedassets from diverse sources.

This is why, a few years ago, Fortiscommissioned an efficient data managementsystem that could, in addition to otherfunctionalities, obtain pricing for even themost exotic securities, and could beupgraded to handle future marketdevelopments. Delivering other value-addedservices such as securities lending and theprovision of bridge and leverage finance cangenerate more revenues for the serviceprovider, as well as for asset managers andthe vehicles they are managing. ■

F O R T I S


Strategy convergenceposes challenges

By Luc Leleux

Luc Leleux is director ofbusiness development withFortis Prime Fund SolutionsLuxembourg

Man, Cayman and Hong Kong as well asLuxembourg. Outside the grand duchy Fortishas as much as USD240bn in alternativeassets under administration and is rankedthe biggest fund of hedge fundsadministrator in the world.

“All the production centres use the sametechnology,” Leleux says, “Advent Geneva forfund accounting, like most of the majorplayers in the alternatives world, and Koger’sNTAS for transfer agency. Since Fortis PrimeFund Solutions Luxembourg is plugged intothe group’s global IT infrastructure, ifnecessary certain administrative functionscan be carried out in other jurisdictionswhere this is permitted by the regulator.”

Eric Kata, director of businessdevelopment for alternative investment, saysRBC Dexia Investor Services uses client-facing staff in France and London as well asLuxembourg to answer the need ofcustomers to have direct contacts close athand, while drawing on resources elsewherein the business.

“Our French clients want to be servicedfrom France, and our London-based clientswant to be able to discuss matters quicklywith colleagues in London,” he says. “We areextending our capacity to different parts ofthe group in order to be able to service ourclients where it’s possible as close to themas possible, and we are planning to developthis in Asia and Australia in the future.”

Nina Kleinbongartz, product manager foralternative investments in Europe withCitigroup Global Markets, sees great benefits

ahead for the business from synergies withBisys, following the announcement of theacquisition in May. “Citi is one of the fivelargest fund service providers inLuxembourg, and we support more than 100fund distributors active in more than 50countries,” she says. “We are looking toexpand the whole range of funds we service,which encompasses traditional, alternative,exchange-traded, pension and structuredfunds. We are in a strong position followingthe acquisition of Bisys, whose technologyplatform will enable us to leverage ourexpertise in all areas.”

The administrators say the launch of SIFshas pleasantly taken aback some of theirclients who are familiar with a moreconservative image of Luxembourg. “We aremaking a marketing effort to explain that wehave this SIF vehicle to the rest of the world,because some of our clients are surprised,”Kata says. “When I meet clients I explainwhat a SIF is and what the advantage is forthem. It is important that everyone in theLuxembourg community contributes to thismarketing effort, which ultimately will benefiteveryone.”

In the past Luxembourg may have failedto market itself sufficiently as a centre foralternative funds, Chan Yin says, but thosedays are long gone. “Alfi has been onroadshows to promote the SIF for all typesof alternative investment,” he says.“Luxembourg now has a product that fullymeets the requirements of hedge funds. Thestructures that existed previously were moregeared to other types of investment than tohedge funds, but now we have a productthat is at no disadvantage compared withCayman or Ireland.”

Early signs suggest that demand for SIFsis not limited to any particular countries andregions – although German promoters havebeen enthusiastic early adopters – norparticular asset classes. “It is coming fromright across the globe, Europe, Asia and theAmericas,” Ferguson says.

“Some promoters see the SIF as an idealstructure in which to house variousalternative strategies, real estate, privateequity and hedge funds, while traditionalasset managers, investment banks andprivate banks see it as an efficient cost andoperational model to create products for their



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private high net worth clientele. Others areconverting their offshore products into SIFsas they feel that a Luxembourg SIF will adda ‘brand’ quality vital for their distribution.”

The introduction of SIFs may promisemore business for Luxembourg but notnecessarily any revolutionary new challengesfor service providers. “All the big globalservice providers including accountants,lawyers and fund administrators have beenactive in Luxembourg for many years,”Ferguson says.

“Over the past five years, as Luxembourgbecame a more active player in thealternative investment world, the providershave developed specialised departments todeal with non-Ucits products. Thesedepartments are run by staff experienced indealing with all the unique characteristics ofalternative fund products and are supportedby various centres of competencyestablished by their parent organisationsaround the globe.”

Members of the industry are keen to rebutcriticism occasionally levelled at Luxembourgand its regulator, the Financial ServicesSupervision Commission (CSSF), for the legalrequirement that central administration forboth traditional and alternative funds becarried out in the grand duchy, and theinsistence on appointment of a custodian,

even for classic single-manager hedge fundsthat turn to prime brokers for many custodialfunctions, saying these issues do not in factput the jurisdiction at a disadvantage as adomicile.

“I don’t believe the central administrationissue is a problem in terms of winning newbusiness, when you look at the number offunds domiciled in the country,” Chan Yinsays. “In fact the requirement to carry outcentral administration in Luxembourg is aplus, because it brings funds under aEuropean regulatory regime. In addition,asset managers that have set up Ucits inLuxembourg may prefer to set up other typesof structure such as hedge or private equityfunds here as well for ease of administrationrather than having Ucits in Luxembourg andhedge funds in Dublin or Cayman.”

Ferguson agrees, saying: “One of thereasons offered by managers for convertingtheir offshore products to Luxembourg SIFsis that they wish to consolidate all theirtraditional and alternative products on asingle service platform. Indeed, as well asadministering locally domiciled funds,Luxembourg is increasingly administeringfunds from other offshore jurisdictions,indicating that it appears to be theadministration centre of choice for manypromoters.”



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The requirement for a custodian, he adds,does not add significantly to the complexityor cost of doing business. “The role of thecustodian should be understood to be that ofa supervisor – that is, the custodian shouldknow how and where the assets are beingheld, but it does not have to hold the assetsitself,” Ferguson says. “Most single-managerhedge funds will have prime brokers, andmany more than one, in which case assetswill normally be held (or loaned onward) bythe prime broker.

“Therefore the Luxembourg custodianshould carry out a certain level of duediligence around the appointment of theprime broker in terms of good reputation,appropriate experience and financialresources, which for the established namesshould not be a big challenge, and ensure areporting mechanism is in place on how andwhere the assets are being held. The fundindustry is currently working with the CSSFto clarify the relationship between the primebroker and custodian by way of a circularover the coming months.”

According to Chan Yin, the debate aboutwhether the custodian requirement madeLuxembourg less attractive as a hedge funddomicile was taken into account when theSIF regime was under development. “Therewill be guidance from the CSSF on whatsupervision the custodian will need toperform on the prime broker,” he says. “Thisis an issue for single-manager hedge funds,but not other types of funds. And if thecustodian and the prime broker is the samebank, there is no issue.”

Meanwhile, administrators believe that thecontinuing blurring of the lines betweenhedge funds and traditional assetmanagement strategies can only benefitLuxembourg as a jurisdiction. SaysKleinbongartz: “We’re in a position wherededicated hedge fund managers and serviceproviders have an advantage over otherasset managers and administrators, who arestarting to enlarge their scope to incorporatethe derivatives side, but are still building uptheir expertise.

“So while from a product point of view thelines are blurring, from the provider viewpointthere’s still a division between those thathave the experience and those that are justacquiring it. With the acquisition of Bisys, Citi

is playing in both domains. Previously wewere constructing our business as more of atraditional provider that was addingderivative-type instruments and hedge fundsto its range of services, while Bisys wasalready a specialist. The acquisition shouldlet us tap into both markets going forward.”

Kata adds: “Currently the biggest growtharea is on the Ucits III side, but somemanagers have a choice to make as towhether to go in the traditional way with aUcits fund, or to opt for a SIF, which ispopular among medium-sized clients aswell as big groups looking for additionalhave flexibility. What the SIF does isprovide an interesting alternative that givesclients more choice than in the past, andcreates opportunities to attract new typesof client.” ■



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