Happy Friday, Funds Family!

Last week, we learned why U.S.-based fund managers may choose to raise money via offshore fund structures. This week, we’ll examine some of the most popular foreign jurisdictions.

🦁 Luxembourg: A European Hub for Investment Funds

Luxembourg has solidified its position as a leading European hub for investment funds.

✅ Benefits of forming a Luxembourg fund

• EEA Passporting: A Luxembourg fund can be marketed across the European Economic Area (EEA) under the European Union’s Alternative Investment Fund Managers Directive (AIFMD) Marketing Passport, facilitating efficient access to a broad investor pool. The Marketing Passport allows solicitation across EEA member countries without requiring time-consuming jurisdiction-by-jurisdiction registration.

• Investor Recognition: Luxembourg is widely recognized as a preferred jurisdiction for investors in Europe and Asia, particularly those seeking a reputable and established domicile. It is significantly easier to solicit EEA investors with an EEA-based vehicle, such as a Luxembourg special limited partnership (société en commandite spéciale), rather than trying to convince investors to come into a Delaware-based limited partnership.

• Regulatory Clarity: The Luxembourg regulator (CSSF) provides clear guidance and a well-defined regulatory framework, enhancing investor confidence and streamlining fund operations.

• Tax Efficiency: Luxembourg offers competitive tax advantages for certain fund types, such as real estate and private equity.

• Experienced Service Providers: The country boasts a robust ecosystem of internationally renowned accounting, audit, regulatory, legal, and financial service providers.

⚠️ Drawbacks of forming a Luxembourg fund

Common complaints include the following:

• AML/KYC: High standards for anti-money laundering and know-your-customer diligence (AML/KYC) often delay onboarding investors and present a more stringent compliance regime than used in the United States. Many U.S. fund managers engage a local service provider to handle investor onboarding. However, even with such service providers, the AML/KYC onboarding process still can take much longer than for a Delaware-based vehicle and potentially annoy investors unfamiliar with Luxembourg’s stringent standards.

• Timing Takes Longer: From legal document review and preparation, AML/KYC diligence (e.g., sometimes it can take 10-15 business days for a fund admin in Luxembourg to go back and forth with an investor to collect all of the needed information for AML/KYC diligence), to registration approvals from the CSSF (e.g., 20 business days for review of a completed AIFMD Marketing Passport application), U.S. fund managers should consider extra time when managing a parallel vehicle in Luxembourg as these things take longer than in Delaware.

• Cost: Set-up and ongoing maintenance costs for a Luxembourg-based vehicle are more expensive than their Delaware or Cayman counterparts. For example, expenses for incorporating fund governing entities (e.g., SARLs) and maintaining legally required minimum capital accounts are significantly higher (at a minimum, around $20,000) than forming a limited liability company in Delaware. Additionally, there are added costs for engaging a third-party alternative investment fund manager (AIFM) to take advantage of the AIFMD Marketing Passport, service providers to prepare the annual accounting and required reports (which may need to be separate providers from those on the U.S. side of things due to in-country familiarity and expertise), as well as local legal counsel, administrative agents, depositories, and more.

🏝️ Cayman Islands: A Global Leader in Alternative Investments

The Cayman Islands have established themselves as a leading global jurisdiction for a diverse range of alternative investment funds, including hedge funds, private equity, venture capital, and private credit.

✅ Benefits of forming a Cayman fund

Pros include the following:

• Neutrality: No income tax, capital gains tax, or corporate tax, making it an attractive option for investors seeking tax-efficient structures across various asset classes. Tax-efficient vehicles in the Cayman Islands have become a cornerstone of many global investment strategies that attract large investments from non-taxable U.S. investors and non-U.S. institutional investors.

• Established Track Record: A long and well-respected history as a leading offshore financial center, with a robust legal and regulatory framework specifically designed for the alternative investment industry.

• Investor-Friendly Regime: A flexible and investor-friendly regulatory environment focused on efficient fund operations and attracting international capital.

• Experienced Service Providers: A sophisticated ecosystem of legal, accounting, and administrative service providers with extensive experience in structuring and administering a diverse range of alternative investment funds.

• Regulatory Flexibility: A regulatory framework that provides flexibility in fund structuring, enabling managers to tailor fund terms to meet specific investor needs and investment objectives.

• Common Law Commonality: The Cayman Islands use common law, like the United States. U.S. fund managers find greater familiarity with legal, regulatory, and compliance obligations in the Cayman Islands compared to other jurisdictions.

⚠️ Drawbacks of forming a Cayman fund

Common complaints include the following:

• CIMA: U.S. fund managers have voiced that communicating with and addressing concerns of the Cayman Islands Monetary Authority (CIMA) is not as easy as with U.S. regulators.

• Investor Sensitivities: Certain investors sensitive to reputational concerns or ‘headline risk’ may choose to avoid investing through a Cayman parallel fund in light of scandals like the Panama Papers and the Cayman Islands’ rumored reputation as a tax haven (particularly among European investors). But note that the government of the Cayman Islands and CIMA have taken steps to strengthen the Cayman Islands’ reputation and address concerns from other government bodies, including the European Commission and the U.S. federal government, that have alleviated some of these sensitivities compared to the past.

☘️ Ireland: A Growing Hub for Investment Funds, Particularly Hedge Funds

Ireland has emerged as a dynamic and attractive jurisdiction for investment funds, particularly those focused on hedge funds, private equity, real estate, and infrastructure.

✅ Benefits of forming an Irish fund

Pros include the following:

• EU Passporting: An Irish fund can be marketed across the EEA under the AIFMD Marketing Passport, facilitating efficient access to a broad investor pool. The Marketing Passport allows solicitation across EEA member countries without the need to undergo time-consuming jurisdiction-by-jurisdiction registration.

• Competitive Tax Regime: Offers a competitive corporate tax rate, attractive to both fund managers and investors.

• Growing Ecosystem: A thriving ecosystem of fund service providers, including law firms, administrators, and custodians, supporting the growth of the fund industry.

• Focus on Innovation: The Irish government actively supports the growth of the investment fund industry through initiatives aimed at attracting and retaining talent and fostering innovation both in the use of technology as well as in the structure of investment funds themselves.

For hedge funds specifically, Ireland may offer certain advantages over Luxembourg:

• U.S. Tax Treaty: Ireland's tax treaty with the U.S. generally provides more favorable treatment for U.S. investors than Luxembourg's, potentially resulting in lower withholding taxes on certain types of income. Ireland's competitive corporate tax rate can be a significant advantage for hedge fund managers seeking to minimize their tax liabilities further than what may be available in Luxembourg.

• Fund Specialization: Ireland has developed a particular specialization in hedge funds, potentially translating to greater expertise and more tailored solutions for hedge fund managers.

⚠️ Drawbacks of forming an Irish fund

Common complaints include the following:

• Less Familiar than Luxembourg: While many of the same benefits and protections to investors as offered in Luxembourg, EEA investors (and indeed, global investors) are more familiar with Luxembourg as an investment entry point than Ireland.

🤔 How do U.S.-based fund managers choose a jurisdiction?

When considering parallel fundraises in offshore jurisdictions, U.S. managers should carefully evaluate the specific needs and objectives of their investors.

• 💵 Access to Capital Markets: Understand the regulatory requirements to access investors in certain markets. For example, compliance with AIFMD is essential for U.S. fund managers looking to solicit a private equity, real estate, or private credit strategy within the EEA. This means that a U.S. fund manager cannot just go out and market to EEA investors without the need for compliance with AIFMD—often in the form of either country-by-country registrations or a Marketing Passport.

• 🧑‍💼 Investor Preferences and Sensitivities: Address investor preferences and familiarities as well as take into account sensitivities about investing through certain jurisdictions. For example, an embattled board of a U.S. state-administered public pension fund for teachers may not want to invest through the Cayman Islands due to the risk of questions from supervisory committees and press inquiries about its investing activities being associated with allegations of ‘tax avoidance’ or ‘shady business practices.’

• ⚙️Operational Efficiency: Evaluate the operational and administrative requirements of each jurisdiction. For example, AML/KYC in Luxembourg is more onerous and takes longer to complete than in jurisdictions like the Cayman Islands or Delaware. Accordingly, U.S. fund managers may need to push back their timeline between marketing and closing on investors if using a Luxembourg entry point compared to a Delaware or Cayman Island access point as well as address the more intrusive informational requirements that non-EEA investors may be unfamiliar with.

• 🛡️ Regulatory Compliance: Ensure compliance with all applicable regulatory requirements in each jurisdiction. For example, while U.S. fund managers may be primarily concerned with laws governing the marketing, purchase, and sale of securities, certain jurisdictions may also have strict privacy and data handling or ESG-related obligations that need to be complied with. This is why U.S. fund managers would be well-advised to engage service providers familiar with local jurisdictions earlier rather than later in order to ensure compliance with unfamiliar laws in offshore jurisdictions.

 / WRAPPING THE CASE

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.