AGEFI Luxembourg – le 19 février 2019 :
Luxembourg is renowned worldwide for its fund administration industry currently hosting at least 15 of the 20 largest global funds (including Carlyle, Blackstone, KKR, Apollo …), which have structures and / or funds domiciled in the country. The Brexit has created a major challenge for Luxembourg, as the country will have an opportunity to attract a maximum of the British market players as a consequence to the decision taken on 29 March 2017.
One of the potential consequences of the Brexit, which would see the United Kingdom leaving the single European market, would be the loss of the European passport to financial institutions that has so far enabled them to sell their products and services within the European Economic Area (EEA). It goes without saying that financial activities would be particularly affected by this loss and have already been impacted. Several investment funds have already relocated their activity in other European countries to keep the enjoyment of this European passport and continue to reap the benefits and transfer funds. Overall, the top five financial centers benefiting the most from Brexit are Paris, Luxembourg, Dublin, Frankfurt and Amsterdam. Paris and Frankfurt are focused on trading and investment banking, while Dublin and Luxembourg are specialized in investment funds and asset management. Singularly, Amsterdam is a well-known place for its technological know-how around fintech and its airport hub.
Since 2017, companies such as 3i, EQT and HSBC, located on the other side of the English Channel, have taken the steps and chosen Luxembourg to outsource their activities related to investment funds. Let’s have a look on the reasons that pushed these companies to choose the Grand Duchy. Luxembourg has a long tradition of fund administration dating from more than 20 years, which is coupled with a stable and attractive tax regime for the funds. Investment funds enjoy some form of tax neutrality, which is characterized by an advantageous tax legislation, an effective social security system (for companies, employers and employees) and one of the lowest VAT rate in Europe. Investment structures are numerous, varied and offer considerable flexibility as well as favorable tax and regulatory environment. Depending on the investment strategies, a single fund may create several sub-funds, each of which will have their own investment strategies and investors.
In 2004 and 2007, Luxembourg created two structures addressing new issues in terms of diversification, debt and investment strategy: the SICAR and SIF. These structures are not subject to capital gains tax and net wealth tax but in the case of a SIF to a subscription tax representing 0.01% of the net value of the assets held. These two structures are tax transparent for income tax and dividend withholding tax purposes. Advantages of the SICAR and the SIF regimes are an access for general partners to a regulated domicile alongside with a tax neutrality and some flexibility in structuring through various corporate and legal forms and variable capital. Reserved Alternative Funds (RAIF) should also be mentioned. They allow Private Equity funds to have a vehicle that combined characteristics and structuring flexibilities of Luxembourg regulated SIFs and SICARs qualifying as Alternative Investment Funds managed by an authorized AIFM, except that RAIFs are not subject to CSSF approval before they are launched.
To support the attractiveness of Luxembourg, a report published by the Association of the Luxembourg Fund industry in the form of a survey yields the following positive results.
• an increase of 20 percent year-to-year of the Assets Under Management (AUM) in the Private Equity industry in 2018.
• PE funds structured under the RAIF regime or as unregulated Limited Partnerships have increased by close to 20 points representing 30 percent of all Luxembourg PE funds in 2018
• an increase number of large PE funds (€500 million and above) accounting to 4 percent of the fund population
• an increased international attractiveness “8 percent of the Luxembourg PE fund population is represented by North American companies including funds such as Carlyle, Warburg Pincus and Silver Lake.”
Above results strengthen the idea that Luxembourg provides a great deal of flexibility through access to unregulated structures and Luxembourg is to be chosen for its unique concentration of experts in investment funds, specialized in all aspects of their type of structure, administration and distribution.
A period of uncertainty is clearly identifiable in the United Kingdom and the rest of the European market has benefited from it at the expense of the UK. The transactions of large caps have fallen in the UK, countering the trend of the rest of the continent. In the United Kingdom, in 2018 the value fell to €27.2bn against €41.3bn the previous year. Large cap transactions have been discontinued. In comparison, the value of European Private Equity markets reached €173bn euros last year, against €149.2bn the year before, the highest figure since 2007 according to figures published by Unquote Data and relayed by City A.M..
Note that many British investors have suspended several important transactions for fear of the consequences if a suitable agreement cannot be reached between the EU and the UK.
We can cite as an example of unsuccessful deal, the buyout which could amount to £2.9bn from the landlord shopping center Intu by a consortium including The Peel Group and the Canadian company Brookfield Property Group at the end of 2018. The main reasons cited are the lack confidence in the macroeconomic situation and the volatility of the markets.
As a consequence of this transitional period, the UK has lost its position as the leading European private equity market in transaction value for the first time since 2011. The value of transactions in the United Kingdom, which amounted to €21.4bn in 187 transactions recorded on December 7, 2018, was surpassed by the Netherlands with a value of €23.5bn. By way of example, among the 10 largest European buyouts this year, only one was in the UK, this is Zoopla’s acquisition by Silver Lake for GBP 2.2bn, according to the Financial Times.
At the time of this writing, no one can determine the outcome of the negotiations surrounding the Brexit and its effects for Private Equity. What is certain is that regardless of the outcome, the UK still has PE investors who have money to spend and Luxembourg has room to welcome them. Uncertainty will reside in the volume of transactions that could either become smaller and less frequent or continue as they are. The scenario of a Brexit with agreement or a “hard” Brexit will necessarily have a different impact on the fate of the British market, and on its European neighbors.
The first hypothesis is a “hard” Brexit and the exit of the single European market. UK relations with the European Union would be governed only by the rules of the World Trade Organization to which London should re-adhere individually therefore United Kingdom would have no more particular relationship with the EU. Another hypothesis is a consensus in the form of a « medium » Brexit: that is to say, an exit from the EU without general agreement but with negotiations by branch. Which would mean other negotiations will probably have to take place before reaching an agreement with regards to the conditions for maintaining the European passport. This model could be based on agreements similar to the ones that the European Union has with countries such as Switzerland or Norway. This situation would create additional uncertainty, which would not necessarily be welcomed for investors and UK funds.
In conclusion, uncertainty reigns over the contours of the future relationship between the United Kingdom and the European Union. Fund managers based in the UK are waiting for the decision to be taken on March 29, 2019, worried of losing their European passport, as provided by the AIFMD directive, and not having access to European investors to distribute their investment funds anymore.
Par Pascalin Ntagungira et Khaled Yahyaoui, consultants du Groupe Square
1) Luxembourg: the global fund centre, ALFI website
2) « Private equity » : la bataille du Brexit est lancée, Les Echos, 17 octobre 2018
3) « Luxembourg on the growth path », Luxembourg Private Equity & Venture Capital Investment Fund Survey, Alfi website
4) Jessica Clark, European private equity deal value rises while UK falls behind, City A.M., January 2018
5) Judith Evans, Brexit scares off would-be buyers of Intu shopping centres, Financial Times, November 2018, https://www.ft.com/content/ff4dfab0-f3a6-11e8-ae55-df4bf40f9d0d
6) Javier Espinoza, UK toppled as Europe’s biggest private equity market, Financial Times, December 2018, https://www.ft.com/content/72ef5dbe-ff88-11e8-aebf-99e208d3e521