The realm of opportunity has widened for all non-EU managers under AIFMD. They’ve gained access to EU institutional investors. Apart from the private placement regime and access funds, many new choices have presented themselves. Namely, the Luxembourg parallel vehicle, which provides new avenues for the non-EU investment community. 

The design typically consists of multiple Parallel funds co-investing in the same underlying asset. The structure of the funds makes it a hassle for the manager. In addition, it requires dealing with different cross-jurisdictional vehicles whose investors demand equal treatment. 

Currently, the most attractive destination to set up Parallel funds is Luxembourg. Especially if your intention is to target European capital under Alternative Investment Fund Directive. These funds tend to be sponsored by non-EU fund managers. The vehicles invest along with a Jersey or Cayman Master fund. However, you can even benefit from more flexibility to set up your master fund in Luxembourg. Since 2016, introducing another structure has allowed investors to maintain limited liability, and greater flexibility regarding corporate law overrides. The structure at hand is a limited partnership, Luxembourg Limited Partnership (Lux LP) for short. Apart from the benefits stated, it also has access to EU AIFMD management and marketing passports. As of right now, over 1000 Lux LPs have been created.  

Creating Lux Limited Partnership (LP) operating under AIFMD

Typically, the Parallel fund’s investment and divestment run along with the Master fund. The two funds operate during the same period and on a pro-rata basis per the investors’ commitments. The Parallel funds are structurally similar to the Master fund. Except a few differences are purposely left to ensure compliance with the requirements. Investors in the EU are subject to specific tax-related, regulatory, and investment rules. 

Specific requirements must be met when establishing the fund operating model. For instance, any fund running operations under AIFMD must appoint an AIMF and a depository. In addition, a Parallel fund structured as a Lux LP must have a domicile in Luxembourg. Further, it must be managed by a Depositary and General Partner of Luxembourg.

Even though the Master and Parallel fund run alongside in design, the fund manager must treat the two separately, as the law requires. Therefore, the Limited Partnership Agreements must mention the distinction and should be understood by all the parties involved. When it comes to the investment process, the role played by AIFM is crucial. Similarly, the Central Administrator is pivotal to the tax reporting and NAV computation. Both authorities must understand the structure in-depth so that the operating model is adequately applied.  

Investment decision-making process

The measures by AIFMD and OECD against BEPS provide an outlook of all requirements crucial to an investment fund’s decision-making process. 

It becomes challenging for a non-EU fund manager to navigate the outcome of such requirements falling through. Therefore, greater scrutiny is required when setting up a Parallel fund and a non-EU Master fund. One such requirement which forms a vital part of the investment process is the duplication of the decision-making. The Board of the Parallel vehicle and/or AIFM must establish full authority over the decision-making process. The board of Parallel fund/AIFM acts on behalf of the parallel fund. By demonstrating full power, the investment rulings of a parallel remain independent from a Master. Even though, in practice, the investment is made in the same asset. 

To make the entire ordeal convenient, Luxembourg has adopted a practical approach to implementing AIFMD. A range of choices is made available when creating the AIFM. As an asset manager, you can either set up self-managed AIFs or use third-party AIFMs. The third-party AIFM option allows the asset manager to not handle their AIFM platform. Instead, a ‘key man’ is involved in the decision-making.

NAV computation and allocation of financial performance

Income and expenses:

Managers can consistently provide reliable and analogous returns by following these two practices. Firstly, distinct allocation rules for income and expenses are decided when setting up financial statements. Secondly, specific processes and controls are made a part of the entire procedure. However, even after careful planning, a manager’s job remains challenging. The approval process of a master fund expense must be maintained separately from the approval process of a parallel fund expense. In addition, strong controls must be implemented to prevent expenses from being wrongly allocated. There is a greater risk of misallocation over the re-invoicing and party lending arrangements. 

Valuation of the Parallel’s investments:

The measure of an investment fund’s performance is drawn from the investment’s fair value. 

The Parallel only holds a minority interest in the asset containing all equity contributions in the underlying SPVs. Therefore, the asset is measured at fair value when computing NAV (Net Asset Value). It’s calculated using a net-equity pick-up approach, as the IFRS specifies. The fair value is also measured on a pro-rata basis. 

The AIFM must closely familiarize itself with the structure and investment decision-making of the Parallel. Additionally, it must gain an in-depth understanding of the underlying assets to draft a valuation policy. Since the financial statements present the assets at fair value, AIFM has an additional responsibility to ensure the valuation policy aligns with the account’s recognition and measurement principles. AIFM can include the auditor and central administrator during the policy review for higher assurance.

AIFM is also responsible for ensuring that the allocation of the Master and Parallel participating interests have been adequately presented in the legal papers of the SPVs. 

Tax considerations 

A Luxembourg limited partnership fund vehicle is declared fiscally transparent, so it’s not liable to be taxed under corporate income tax and net wealth tax in Luxembourg. The fiscally transparent status allows the limited partners to be taxed at their own level. Whereas withholding tax will be observed on the distribution or redemption level. The investors can request the fund manager’s services in providing necessary information for tax filings. The general partner and their limited partners can agree on such services.

Further, the central administrator can assist the fund manager in this regard. A Luxembourg limited partnership ‘s General partner is a fully taxable company, subject to no advantage from any special tax regime.

Even though many challenges come to the surface with the management of a Parallel/Master fund, it has grown in popularity in the past few years. The structure allows for redesigning the operating model and any delegated activities. In addition, parallel funds can maintain an effective internal control environment and a cost-effective system. All the parties involved can come together and process document approval of any additions or changes to the model. Thus, this allows the fund manager to present accurate financial information promptly to the fund’s investors. 

Damalion helps you setup your parallel funds in Luxembourg. We articulate our internal competencies with our network of accredited experts so you register your investment funds, with the right solutions and management. If you would like to benefit from our independent expertise, please contact us today.