Cayman Islands and Luxembourg Funds: Options and Considerations for Managers
The structure and domiciliation of a fund vehicle are integral to the set up of a fund from multiple perspectives. Tax, investment strategy, investor base, cost and speed of set up, regulatory environment, and increasingly the perceived ‘marketability’ of the fund, all play a part in the decision making process.
This white paper by Laven Partners looks at two of the most prominent fund domiciles, Luxembourg and Cayman Islands, and examines some of the considerations managers should take into account when setting up a fund, including a comparison of exemplar costs. We also examine both the UCITS and AIFMD regimes in the context of choosing whether to establish a fund onshore or offshore and the advantages and disadvantages of both.
Onshore EU funds, notably in the UCITS format, have long been a vehicle of choice for long only asset managers. Because UCITS are regulated, they can be attractive to both retail and institutional investors. UCITS are recognised internationally and investors tend to like the enhanced transparency, risk management and liquidity offered by such funds in comparison to unregulated schemes. Strict requirements around liquidity, concentration, eligible assets and derivatives exposure mean many alternative strategies are however not suitable as a UCITS. Managers also benefit from being able to distribute UCITS throughout the EU thanks to the availability of a marketing ‘passport’ – a concept that is being extended to unregulated funds as we shall see below.
Offshore funds have traditionally been favoured by hedge fund managers, with the Cayman Islands being their predominant choice of domicile. Cayman funds are typically unregulated, meaning they are not subject to investment restrictions or other ongoing regulatory scrutiny unlike UCITS. Another attraction for managers is that the process of setting up a Cayman fund is often much quicker and more cost effective than establishing a UCITS fund. Hedge fund managers themselves are regulated in most jurisdictions.
The arrival of the Alternative Investment Fund Managers Directive (“AIFMD”) last year creates a regulatory framework for EU managers of alternative funds (in broad terms: any fund that is not a UCITS). However under AIFMD, some have warned that funds are now being regulated “through the back door” – for instance with AIFMD requiring managers to set maximum levels of leverage.
UCITS, AIFMD or both?
Choice of structure and domicile will often be dictated by the type of investors fund managers have and/or where they intend to raise funds from. Institutional investors might have the capability and appetite to invest in unregulated schemes, but may prefer a regulated UCITS scheme if the strategy and returns profile meets their needs. Many European institutional investors choose Luxembourg UCITS funds because it is a brand they are familiar with and trust. The nature of the investment strategy will also determine whether a regulated or unregulated scheme is suitable. For example, a long-only equities strategy would clearly suit a UCITS fund, whereas a real estate strategy might be constrained by UCITS restrictions around liquidity and therefore an unregulated Cayman fund may be more appropriate. Of course a full assessment would need to be made to establish whether the strategy is (or is capable of becoming) UCITS compliant. AuM is also a factor that managers should consider when thinking of launching a UCITS. If AuM is too small, the big distribution channels are unlikely to take an interest.
The debate around fund domicile is often more of an issue for emerging managers considering their first fund launch or managers looking to establish a second fund or strategy. Managers sometimes seek to replicate a successful Cayman fund by launching a similar alternative UCITS scheme. Perhaps an investor likes the strategy and wants to invest but will only do so if it is in a UCITS wrapper. A managed account may also be another option.
Managers are increasingly interested in knowing what the marketing and distribution requirements are when looking at UCITS and AIFMD. One of the key tenets of AIFMD is the phased introduction of an EU marketing passport which is similar in concept to UCITS. At the moment, the AIFMD passport is only available to EU managers of EU funds. The European Securities and Markets Authority is expected to decide whether to extend the availability of the passport to managers of non-EU funds from 2015. Until then, the only option managers have to market their Cayman funds is to use the National Private Placement Regime (“NPPR”) of each local European member state (though note NPPR is beginning to be phased out in some countries), or else try and rely on reverse solicitation (which brings its own risks).
It is worth noting that although UCITS and AIFMD are two distinct ‘brands’, some of the regulations underpinning them are converging. For instance, the AIFMD introduces risk management requirements similar to those found in UCITS; while the forthcoming ‘UCITS V’ legislation will bring the remuneration regime for UCITS managers more in line with AIFMD. The emergence of alternative UCITS strategies as well as the convergence of regulations and the concept of the marketing passport is to some a further blurring of the lines.
Once some of the factors discussed above have been considered, Laven has compared the costs for setting up a fund in each respective jurisdiction to help our clients make the best choice for their structure. The purpose is to provide estimated costs for the set up stage of the funds only and excludes any ancillary costs or factors such as any incremental taxes, costs of listing on an exchange, or any external advisory costs.
Generally, one ought to be mindful of the differences between fund regimes in the Cayman Islands and Luxembourg. By way of example, fund regimes in Luxembourg are numerous and are divided in accordance with the type of assets and strategies intended to be used by fund managers. Setting up a fund in Luxembourg requires founders/fund managers to approach the CSSF up to 6 months in advance of launch date and will require ultimate approval from the CSSF. Conversely, the Cayman Islands by comparison offers a more lightly regulated environment, in which funds are subject to less strict processes to follow in setting up a fund. Generally launch times are therefore closer to 2-4 months.
This paper is for informational purposes only - by setting out such costs, this paper does not represent, imply or in any way state that the Luxembourg funds and Cayman Islands funds set out hereunder are necessarily alternatives of each other or are comparable in any way. We also do not recommend, advise, opine or in any way suggest that either a Luxembourg fund or a Cayman Islands fund are suitable fund vehicles to use, sponsor, invest in or in any way be financially involved in. The choice of fund to use, sponsor, invest in or in any way be financially involved in will ultimately depend on factors specific to each individual, such as, by way of example, the intended investment strategy, jurisdiction and preferences of investors, jurisdiction of investments, tax preferences of founders as well as latest regulation. Any investment, structuring, legal or any other decision should be informed by legal, investment or tax advice.
The costs provided are estimates, and are subject to change and will differ according to service provider. Costs may in fact turn out to be higher or lower depending on the specific requirements and characteristics of each fund and for example can be influenced by negotiations, more competitive pricing, inflation, economic factors or other factors which generally drive prices upwards or downwards.
In the Cayman Islands, open-ended funds are governed by the Mutual Funds Law (as amended). In Luxembourg, open-ended funds can either be set up in the form of a UCITS or a SIF (Specialized Investment Fund). The permissible investment restrictions and strategies vary. The question may also come down to operational and general compliance costs, having also of course in mind your investor base, investment strategy and distribution plans.
|Cost Type||Cayman Islands||Luxembourg UCITS||Luxembourg SIF|
|Legal fees||USD 30,000-50,000||USD 45,000 -70,000||USD 40,000-60,000|
|Company Incorporation||USD 2,500||USD 3,000-10,000||USD 3,000-10,000|
|Company Registry - Annual||USD 1,000||N/A||N/A|
|Registered office||USD 2,000||USD 7,000||USD 7,000|
|Director Mandate||USD 5,000-10,000 per local director (not a requirement)||USD 20,000-40,000 per local director||USD 20,000-40,000 per local director|
|Regulatory Authority - Application||USD 4,000||USD 4,000-14,000||USD 4,000-14,000|
|Regulatory Authority - Annual||USD 4,000||USD 4,000||USD 4,000|
|Administration||Minimum fees around USD 22,000-80,000 depending on asset class, number of shares classes and NAV frequency, also subject to around 5-20 bps||Minimum fees around USD 40,000-110,000 depending on asset class, number of shares classes and NAV frequency, also subject to around 5-20 bps||Minimum fees around USD 40,000-110,000 depending on asset class, number of shares classes and NAV frequency, also subject to around 5-20 bps|
|Audit||USD 15,000-25,000||USD 40,000-55,000||USD 40,000-55,000|
|Outsourced Risk Management||N/A||USD 20,000||N/A|
If the investor base is primarily international then establishing the fund in the Cayman Islands may be the best option. If however you have a predominantly retail or continental European institutional investor base, a Luxembourg UCITS may be a viable option.