economic analysis of non-ucits in...

Economic Analysis of Non-UCITS in Europe Erasmus Intensive Programme 2012

Glawdys NOUBOUSSI GANMEGNE Alfred KIZALI

Faculty of Law, Economy and Finance University of Luxembourg

Erasmus IP Student Paper

(3,029 Words)

Tutor: Professor Thorsten Lehnert

Economics Analysis of Non-UCITS in Europe

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Table of Contents

Table of Contents................................................................................................................................2

1. INTRODUCTION ...............................................................................................................................3

2. NON-UCITS MARKET FUND .............................................................................................................4

2.1. EUROPEAN NON-UCITS FUND MARKET ....................................................................................4

2.1.1. Types of funds ...................................................................................................................4

2.1.2. The Volume of Net Assets under Management and the Number of Funds .........................4

2.1.3. Investment policies of non-UCITS ......................................................................................6

2.2. Luxembourgish non-UCITS market ............................................................................................6

3. Current National Regulations of Non-UCITS .....................................................................................9

3.1. Applicable Legal Framework for Non-UCITS in Luxembourg ......................................................9

3.1.1. Part II of the Law of 17 December 2010 .............................................................................9

3.1.2. CSSF Circulars .................................................................................................................. 10

3.1.3. The SIF Law ...................................................................................................................... 12

3.2. Legal forms of non-UCITS funds .............................................................................................. 12

3.2.1. SICAV (Société d’Investissement à Capital Variable) ......................................................... 12

3.2.2. FCP (Fonds Commun de Placement) ................................................................................ 13

3.2.3. SICAF (Société d’Investissement à Capital Fixe) ................................................................ 14

3.3. Licensing Requirements .......................................................................................................... 14

3.3.1. Part II fund Approval Process ........................................................................................... 14

3.3.2. SIF’s Approval Process ..................................................................................................... 14

4. Critical Analysis of non-UCITS ........................................................................................................ 16

4.1. Advantages non-UCITS ........................................................................................................... 16

4.1. Disadvantages of non-UCITS .................................................................................................. 16

5. Conclusion .................................................................................................................................... 18

Sources ......................................................................................................................................... 19


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1. INTRODUCTION

The investment fund market like others markets evolves in a legal framework which has been

fostered with the financial crisis. European funds market is one of the most important funds

market around the world. The European funds ruled by the European directive 85/611

(labeled UCITS) dominate the fund market, besides there is also non-UCITS funds.

UCITS (Undertakings for Collective Investment in Transferable Securities) is an investment

fund which meets the criteria laid down by the directive 2009/65/EC and benefits from a

passport which enables it to be sold cross-border into any other EU member state. The first

UCITS directive was adopted and published in late 1985 by the Council of the European

Communities. It has the objective to ensure more effective and uniform protection for

investors within the European community. The last amendment was the UCITS IV directive,

and the draft for UCITS V is ongoing.

Unlike UCITS, non-UCITS are opposite to UCITS. Non-UCITS funds or non-harmonized

funds are funds that do not fall under European UCITS directive, they were regulated at the

national level in the past but since the 1st of July 2012 they are regulated by the AIFM

(Alternative Investment Fund Management) directive. This directive is going to make uniform

the regulation of non-UCITS and address to the concern of a better regulation of non-UCITS

which emerged with the crisis. Unlike UCITS funds, non-UCITS funds constitute a

heterogeneous group of funds.

UCITS are usually more transparent, more restricted eligible assets, available to all investors,

less flexible and have high liquidity in comparison to non-UCITS. But these differences are

diminishing with the evolution of the legal framework.

Luxembourg is one of the leading fund market place in Europe which is also suffering from

the effects of the crisis. Luxembourg non-UCITS funds were ruled by part II of 20 December

2002 Act and 13 of February 2007 Act. They have been respectively amended by the law of

17 December 2010 and by the law of 26 March 2012 to comply with the AIFM Directive. The

demand of non-UCITS fund keeps increasing despite the crisis principally the demand of SIF

(Special Investment Fund).

In this paper, we will first present an overview of the non-UCITS fund market (European and

Luxembourgish), then the Luxembourgish regulation of non-UCITS and afterward a critical

analysis of non-UCITS.


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2. NON-UCITS MARKET FUND

2.1. EUROPEAN NON-UCITS FUND MARKET

The European non-UCITS fund market is a diversified market which has been affected by the

financial crisis and evolves with the economic conjuncture. It is characterized by the type of

funds, the volume of net assets under management and its investment policies.

2.1.1. Types of funds

EU non-UCITS funds are composed by:

Closed-ended funds

Funds not investing in transferable securities and money market instruments

Real estate funds investing in real estate or estate rights

Private equity/venture capital funds

Hedge funds

Funds not marketed in EU or restricted to non-EU citizens

Dedicated funds

From one country to another, these funds can take different names. The clients are made of

retail and well-informed or institutional investors, but some funds are dedicated only to well-

informed investors like some hedge funds and closed-ended funds.

The leading trio of this market is: Luxembourg, France and Germany.

2.1.2. The Volume of Net Assets under Management and the Number of

Funds

In the annual report of ALFI 2011-30/03/2012, Non-UCITS recorded a rise of 2.33% at the

first quarter of 2011, +1% at the second, -0.58% at the third and +3.88% at the fourth quarter;

with a result of an overall growth of 6.8% of the non-UCITS European market fund. This

mitigated growth can be explained by the sovereign debt crisis which damaged the investor

confidence and by the sustained demand (leaded by institutional investors) of non-UCITS in

spite of the crisis.

According to EFAMA (European Fund and Asset Management Association) Quarterly

Statistical release N°49 (first quarter of 2012), the total non-UCITS assets increased by 4.2%

during the first quarter of 2012 to stand at EUR 2,401 billion and the total number of non-

UCITS funds stood at 18,120 at end of March 2012.


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Breakdown of non-UCITS Assets and Number by Category1

Asset under Management in the European Investment Fund Industry (in billions

of euro)

1 www.efama.org


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2.1.3. Investment policies of non-UCITS

It determines somehow the classification of non-UCITS funds. Usually, non-UCITS invest in:

Bonds

Equities/venture capital

Real estate

Unlisted securities

Futures/options

Cash

Money market instruments and other short-term instruments

Fund of funds

Mixed transferable securities

2.2. Luxembourgish non-UCITS market

In Luxembourg, the non-UCITS market fund is composed by UCIs of part II of the 2002 Act

and SIF (Specialized Investment Fund) of 13 February 2007 Act. These acts have been

amended by the adoption of the UCITS IV Directive and the AIFM Directive.

The SIF law has been updated by the law of 26th March 2012. This law aligns the SIF regime

with the law of 17 December 2010 on UCI and with the implementation measures of the EU

Directive 2011/61/EU on AIFM.

SIF are regulated, operationally flexible and fiscally efficient multipurpose fund regime for an

international, institutional and qualified investor base2. They benefit from less restriction

compared to UCIs. They are among the leading products representing 55.7% of the number of

funds and 11.4% of the total net assets at the end of March 2012. Given that they are made for

well-informed investors (institutional, professional or any individual investor who has the

status of well-informed investor), they sustain the demand of investment products in spite of

the crisis.

They can be set up in a contractual legal form of FCP (Fond Commun de Placement) or a

corporate form of SICAV (Société d’Investissement à Capital Variable).

The Luxembourg non-UCITS types of fund are various and identified in accordance with the

investment objective pursued.

2 www.lff.lu


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Investment policy of Luxembourg SIFs as at 31 December 2011 (Number of Fund Units)3

According to ALFI’s annual reports, Luxembourg had about 3801 non-UCITS funds with

353,497 billion euro under management at the end of March 2012.

There is a multitude of countries represented in Luxembourg non-UCITS market. The

promoters are from 57 different countries. The main countries that operate actively in the

promotion of non-UCITS in Luxembourg are: USA, Germany, Switzerland, Great Britain,

France, Italy and Belgium.

3 Source : CSSF/ALFI


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The table below shows the number of funds under the different laws and the size of the assets

managed.


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3. Current National Regulations of Non-UCITS

The Luxembourg’s fund industry is one of the leading market places for funds in the world. It

has been ranked as the second biggest market in term of assets under custody after the USA.

This position is surely gained with the country’s abilities for doing business. Some of these

abilities include the Rapidity of the country to implement European Directives into national

laws; Luxembourg was the first country in Europe to transpose the UCITS I Directive. Also

updating the national laws and issuing new circulars by the supervisory body in order to fit

with and regulate the market best practices can be listed in some of these abilities. This offers

to fund promoters a platform worldwide opened with a large selection of investment vehicles

that may be used to accommodate with their strategies and encourage them for further

investments in Luxembourg.

The legal framework of funds in Luxembourg is organized around the main “Fund Law”, that

is, the law of 17 December 2010. This law is the transposition of UCITS IV Directive. Aside

this law, there are many others which are addressed to Undertakings for Collective Investment

(UCI), the non-UCITS funds. And they intend to regulate this section of the fund market, left

to the responsibility of every European country.

The following section will mainly lay out the regulations governing non-UCITS funds with an

emphasis on their investments and diversifications rules. It will also present the legal forms

available for non-UCITS, and finally the issue of licensing requirements will be discussed.

3.1. Applicable Legal Framework for Non-UCITS in Luxembourg

3.1.1. Part II of the Law of 17 December 2010

This part of the Law is addressed to the Luxembourg non coordinated funds, that is, all UCIs

located in Luxembourg and which are not covered by the part I of the Law. Note that the sole

object of these funds is to invest in assets other than transferable securities and/or in other

liquid financial assets.

Briefly stated this section of the Law of 17 December 2010 sets out the scope and the

different legal forms that can be found as non-UCITS funds in Luxembourg.


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3.1.2. CSSF Circulars

The CSSF (Commission de Surveillance du Secteur Financier) is the supervisory authority for

the financial sector and fund industry in Luxembourg. This supervisory body issues circulars

with the aim to implement the different legal provisions, governing supervised entities and

clarify their implementation modes. These circulars are complements to the regulatory

framework.

The most important circulars as at today that are governing non-UCITS funds are the

following:

IML Circular 91/75 as amended by Circular CSSF 05/177 clarifying certain aspects of

the UCI legal framework;

IML Circular 91/136 as amended by CSSF Circular 08/350 on financial information to

be provided by public funds;

CSSF Circular 02/80 of 5 December 2002 on specific rules applicable to Luxembourg

Part II funds pursuing alternatives strategies;

CSSF Circulars 08/371 of 5 September 2008 regarding the electronic transmission of

the prospectuses and the financial reports of UCIs and SIFs to the CSSF;

CSSF Circular 11/498 of 10 January 2011 regarding the entry into force of the law of

17 December 2010 relating to undertakings for collective investment.

Eligible Investments and Investments Restrictions4

UCIs are required to invest their assets according to the principle of risk-spreading but are not

restricted as to the type of assets they can acquire. However, the investment objective and

strategy is subject to approval by the CSSF through the following circulars:

4 www.pwc.com/lu/asset-management


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The above table presents the circular CSSF 91/75 and CSSF 02/80. The first circular set out

the rule for risk diversification for funds investing in transferable securities, venture capital

funds and real estate funds. The latter circular is addressed to non-UCITS that adopt

alternative investment strategies.

Investment in Transferable Securities5

Note that the restrictions a), b) and c) are not applicable to securities issued or guaranteed by

the OECD Member States, their local authorities or public international bodies with EU,

regional or worldwide scope.

Investment in Funds (Part II fund of funds)6

5 www.pwc.com/lu/asset-management

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3.1.3. The SIF Law

The other law governing the non-UCITS in Luxembourg is the law of 13 February 2007 or

the SIF LAW. This law has been recently amended by the law of 26 March 2012 in order to

fit with the AIFM Directive.

SIF (Specialized Investment Fund) is a pure Luxembourgish product. It is developed for

institutional and well qualified investors.

SIF is widely used by promoters in Luxembourg for it has a low taxation regime (exemption

on VAT, capital gains and corporate income tax). The only tax paid by this investment vehicle

is the subscription tax; which is 0.01% of the Net asset Value per annum.

Unlike non-UCITS from part II, SIF has no restriction in terms of eligible assets, and its risk

diversification requirements are less stringent than the ones in application for part I and part II

funds. Details of these restrictions are explained in the CSSF Circular 07/309. Some of them

is for example, a SIF may not invest more than 30% of its assets or commitments to subscribe

securities of the same type issued by the same issuer.

It is important to note that the implementation of the AIFMD directive will highly affect the

Luxembourg non-UCITS sector as Luxembourg SICAR and SIFs were, up to now regulated

only under the domestic laws.

3.2. Legal forms of non-UCITS funds

The legal framework offers a large selection of investment that may be used to accommodate

the strategies pursued by promoters.

There are 3 types of forms of fund that can be legally set up in order to be marketed in

Luxembourg. They include the following:

3.2.1. SICAV (Société d’Investissement à Capital Variable)

It is a statutory or corporate form of fund. A SICAV is an investment company with variable

capital, that is, the company’s capital is always variable and equals to the variation of the total

amount invested by its shareholders.

Under the Part II of the 17 December 2010 and the SIF Law, SICAV structures may be open

or closed-ended. And they have to be incorporated as a Public Limited company (S.A.),


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Partnership Limited by shares (S.C.A.), Private limited liability company (S.a.r.l.) or a Co-

operative organized (SCoSA).

Note that the latter forms of incorporation are excluded for a SICAV set up under the Part II

Law; therefore, a SICAV-SIF can take all the above mentioned legal forms.

A SICAV must appoint either a management company or designate itself as “self-managed”.

And the minimum capital requirement for a SICAV is EUR 1.25 Millions. And this amount

has to be reached within six months following approval by the CSSF.

3.2.2. FCP (Fonds Commun de Placement)

It is a legal contractual fund, which is similar to a unit trust in UK. It has no legal personality

and must be managed by a management company. Investors in such fund are considered to be

the fund’s ownership and are liable pro rata of the amount invested, each one individually.

Furthermore, the minimum capital requirement for a FCP is EUR 1.25 Millions and must be

reached within a period of six months following its authorization. Likewise SICAVs, FCP

structures may also be open or closed-ended.


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3.2.3. SICAF (Société d’Investissement à Capital Fixe)

SICAF is an investment company with fixed capital. Under the Part II of the 17 December

2010 and the SIF Law, SICAF structures may be open or closed-ended. And they have to be

incorporated as a Public Limited company (S.A.), Partnership Limited by shares (S.C.A.),

Private limited liability company (S.a.r.l.) or a Co-operative organized (SCoSA).

The minimum capital requirement for a SICAF is also EUR 1.25 Millions that has to be

reached within six months following approval.

3.3. Licensing Requirements

The approval process has various time limits. The average constitutive time can vary from one

month to more than one month depending on the fund.

3.3.1. Part II fund Approval Process

A part II UCI receives CSSF’s prior approval to start its activities. CSSF will pay attention to:

The Part II UCI’s draft constitutional documents (Articles or Management

regulations), notably the full prospectus and main agreement with the service

providers;

The identity of the promoters and of the persons in charge of conducting the business.

They must show good reputation, experience for acting in such capacity. The promoter

must show good reputation, be a professional in the financial sector, be supervised in

its country of residence and have sufficient financial resources;

The identity of the directors of the fund or the managers of the management company,

which must be authorized or registered for the purpose of asset management and

subject to the prudential supervision of a regulatory authority;

The identity of the Luxembourg central administration, the Luxembourg depositary

and external auditors.

3.3.2. SIF’s Approval Process

The creation of a SIF is not subject to prior approval of the CSSF. But this privilege is going

to disappear with the Luxembourg decision to amend the SIF law; it will increase the time to

market for SIF. SIF have to provide an issuing document which is similar to the prospectus,

the only difference is that it is more concise and written in a more professional and technical

language.


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An authorization file must be submitted to the CSSF within the month following the creation

of the SIF. The authorization will be granted subject to:

Approval of the constitutional documents

Approval of the choice of Depositary and Auditor

Notification of the directors of the fund or managers of the management company

The AIFM Directive offers more opportunities to the development of non-UCITS funds

market with the European passport which enables funds to be distributed cross-borders. It will

allow more diversification between countries.


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4. Critical Analysis of non-UCITS

This section of our paper will deal with an analysis laid upon the advantages and

disadvantages of non-UCITS, for both promoters and investors.

4.1. Advantages non-UCITS

The main advantages that can be listed for non-UCITS funds are:

The investment restriction for non-UCITS funds is more flexible. Promoters or fund

managers will therefore, have greater flexibility with their investment strategies, since

there is no limit in term of asset eligibility;

Non-UCITS funds are established under domestic fund legislation rather than EU

Law. That is, they can be easily set up and the time to market will be short;

Non-UCITS funds can be marketed prior before the supervisory authority approval. In

Luxembourg for example, SIFs may start distributing its share/units to the public

before CSSF prior approval;

Unlike UCITS funds, which must be open ended, non-UCITS may be set up open

ended as well close ended

The investment return for non-UCITS is higher. Since these funds are less restricted,

they may use several strategies in order to boost their reward.

The fact that most of non-UCITS are designed for well-informed investors there are

good products which can strengthen the demand of fund even in a period of economic

turmoil.

4.1. Disadvantages of non-UCITS

Although investing in non-UCITS presents greater opportunities, these types of fund may

have also some disadvantages. Some of them include:

Unlike UCITS, Non-UCITS are established under domestic law, therefore they may

not benefit from European passport to distribute their shares/units throughout the

Europe;

It is difficult and often impossible to have information on the Investment Manager

Strategy and his portfolio;

Given that they benefited from less investment restrictions, they usually have the

propensity to take too riskier and uncovered positions.


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The initial minimum subscription investment for a non-UCITS fund is EUR 125,000

for retail investors. That is, not the large public can invest, and therefore the security

will not be liquid.

These advantages and disadvantages are increasing or decreasing in function of the evolution

of the legal framework.


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5. Conclusion

The European non-UCITS market is a diversified market whose the volume of net assets

under management and the number of funds keep increasing. Non-UCITS funds have the

opportunity to invest in different and multiple classes of assets. In Luxembourg, the non-

UCITS fund market is also growing in spite of the crisis and the SIF funds are strengthening

the demand of collective investments.

The Luxembourgish regulation of these funds is made of circulars of the CSSF, part II of the

law of 17 December 2010 and the SIF law of 13 February 2007 (usually amended with

introduction of new European directives). These laws and circulars define the eligible assets,

investment restrictions, the legal forms (SICAV, FCP, and SICAF) and diversification rules.

The regulation also defines the licensing requirements which determine the time to market, a

decisive factor for fund promoters when selecting a jurisdiction. In Luxembourg, the

regulation allows for a short time to market period in order to make the Luxembourgish fund

industry more attractive. Nevertheless, generally the regulation of non-UCITS funds in

Luxembourg is less restrictive compared to the one of UCITS.

Besides the time to market and the taxation regime, the speed of implementation of new

European directives and the adaptation of the legal framework to the mutations of the

economic environment appears like a key element in the choice of a fund jurisdiction.


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Sources:

Reports:

Annual report CSSF 2010

ALFI annual report 2011-30/03/2012

Asset management in Europe: facts and figures, 5th

annual review

EFAMA Quarterly Statistical release N°49 (first quarter of 2012)

KPMG Review: Luxembourg Regulated Investment Vehicles

Laws and circulars

Loi du 17 décembre 2010 portant transposition de la directive 2009/65/CE

Circular CSSF 02/80

Law of 13 February 2007

Law of 20 December 2002

Web pages

www.cssf.lu

www.alfi.lu

www.pwc.lu

http://www.cssf.lu/

http://www.alfi.lu/

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