The Cayman Islands-Luxembourg parallel fund structure is slowly becoming the preferred product for private equity fund managers looking to obtain access to the Asian, US, and European market. In essence, parallel funds co-invest and  divest alongside the main fund, investing on a pro-rate based on their capital commitments. The operational conditions of a parallel fund is similar to those of the main fund. A parallel fund includes a common investment policy, featuring the same asset targets. The only difference between parallel funds and the main fun lies in the regulatory or operational frameworks. 

For any fund structure under the Alternative Investment Fund Managers Directive (AIFMD), there should be an appointed alternative investment fund manager (AIFM) and a depositary in place. In case a parallel fund is set up as a Luxembourg limited partnership (SCS), it must be domiciled in Luxembourg, have its own Luxembourg depositary, and managed by a general partner based in Luxembourg. These are the basic functions and requirements to operate an overall fund. 

Things to Remember when Structuring Up a Parallel  Fund 

• Under this operating model, the fund manager must remember that the master and parallel funds are two separate vehicles from a legal standpoint. 
• Pointer mentioned above needs to be clearly defined in the Limited Partnership Agreement, as well as communicated by the various parties and service providers involved. 
• The roles assumed by an alternative investment fund manager (AIFM) and the central administrator for the net asset value calculation and tax reporting are integral, requiring extensive knowledge of the parallel fund structure for the proper application and implementation of the parallel fund operating structure. 

Parallel Fund Investment Decision Making Process

• The Alternative Investment Fund Managers Directive and OECD interventions against base erosion and profit sharing (BEPS) will generate an overlay of various requirements that can have significant influence on the investment decision-making process applicable to any investment fund. 
• It will be challenging for a non-EU fund manager with full Alternative Investment Fund Managers Directive authorization to invest alongside a non-EU master fund, to fully understand the consequences of such stringent requirements. 
• One of the most significant consequences of overlaying requirements is the duplication of the decision-making process of an alternative investment fund manager to display and exercise full power of authority on behalf of the parallel fund. This is true even when they practice the the same assets as the master fund.

Luxembourg Parallel Fund Formation 

• Luxembourg utilizes a pragmatic approach to the implementation of the Alternative Investment Fund Managers Directive (AIFMD). 
• Initiators can choose from different options when setting up an alternative investment fund manager, ranging from self-managed alternative investment funds to third-party alternative investment fund managers, dedicated for asset managers who opt not to create their own alternative investment fund platform. 
• In case a third-party alternative investment fund manager is used, a key man provision is considered, which in turn will play a crucial role in the investment decision-making process while easing the ultimate decision of an alternative investment fund manager.

Net Asset Value Calculation and Allocation of Financial Performance

On income and expenses

• Maintain identical or comparable returns on all parallel funds requires managers to define clear allocation of rules on income and expenses, as well as the appropriate processes in place. 
• Expenses are recharged by the master fund to the parallel fund through current accounts. 
• Appropriate measures need to be implemented over the re-invoicing process and over related party lending agreements. 

On valuation of a parallel fund’s investments

• The overall performance of an investment fund is primarily driven by the fair value of its investments. 
• A parallel fund holds minority interests. Its investments or assets consists of equity contributions integrates into the underlying special purpose vehicles. 
• For net asset value calculation, assets are measured at fair value using a net equity pick-up strategy based on International Financing Reporting Standards (IFRS). This includes the fair valuation of underlying real assets and pro rate based in respective commitments. 
• It is imperative that the alternative investment fund manager must have a clear understanding of intended assets of a parallel fund before developing a valuation policy. 
• There should be a comprehensive and detailed overview of structuring and how a parallel fund may invest into various commitments. 
• Alternative investment fund manager ensures that a valuation policy must be consistent with the recognition and measurement principles applicable in the preparation of accounts. 
• It may be useful to obtain the services of an external auditor and the central administrator of the fund to review the valuation policy. 
• It is the responsibility of an alternative investment manager to ensure that allocation of participating interests between the master fund and parallel fund to ensure allocation of participating interests between a master and parallel funds as properly updated in the corporate legal documents of an underlying special purpose vehicle. 

On tax considerations

• An investment fund established as a Luxembourg limited partnership (SCS) will be fiscally transparent for tax purposes. Furthermore, they will not be subject to Luxembourg corporate income tax and net wealth tax in its own name. 
• Taxation will be assessed at the level of the limited partners in their respective domiciles and Luxembourg withholding tax would not be assessed on the distributions made by the parallel fund. 
• The fund manager is responsible for facilitating and providing all information related to tax fillings to be filled out by investors. 
• The general partner of a Luxembourg limited partnership will be a fully taxable income and does not benefit from any special tax regime. 
• All costs are invoiced directly to the Luxembourg limited partnership as par of the agreed upon free arrangements. 

Regardless of the challenges, we are seeing more master and parallel fund structures being established in Luxembourg. This type of structure will need a redefinition of the existing operating model as well as the delegated activities, but remains to have twin objectives of having a solid internal environment with cost efficiency to boot. Given all parties are aware of the existing issues and agree and establish an operating modern and a service level agreement for all processes in advance, a parallel fund will operate smoothly. This will enable fund managers to deliver accurate and precise financial information to investors on time. 

Damalion realizes the great potential of parallel fund structures. As it represents a growing trend in the funds industry due to its tailored solutions, we offer specialized services to investors requiring assistance in the management and structuring of parallel funds in Luxembourg. Our Damalion experts will help discuss and design all aspects of Luxembourg parallel fund structure. Our global service network will help you navigate the challenges, offering practical solutions at each stage of the structuring process. Reach out to a Damalion expert today to learn more.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.