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March 2008 - Finance. Legal Developments by Chevalier & Sciales .

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Over the past years an increasing number of Hedge Funds, and especially Funds of Hedge Funds, have been set up in Luxembourg following registration with the competent supervisory authority (Commission de Surveillance du Secteur Financier or "CSSF").  Luxembourg Hedge Funds and Funds of Hedge Funds are subject to the same legal and regulatory requirements applicable to other Luxembourg Funds, comprising the permanent supervision by the CSSF, the obligation to appoint a Luxembourg based custodian and an auditor, the obligation to produce a monthly net asset value calculation and to publish annual and semi-annual reports. The obligations may vary depending under which form the hedge fund is set up.  Luxembourg Hedge Funds may be set up under several wrappers: UCITS Fund, Fund submitted to CSSF Circular 02/80 or Specialised Investment Fund.

1. UCITS Fund

 The Luxembourg Law dated 20th December 2002 (“2002 Law”) provides mainly in its part I for the implementation of the directive 85/611/CE as amended by directives 2001/107/CE and 2001/108/CE (“UCITS III” directives). A fund set up under such part I of the 2002 Law, commonly referred to as “Part I” or “UCITS”, is designed for retail investors and benefits from the European passport, and is thus submitted to rather protective investment restrictions. Under certain conditions, it is possible to set up a UCITS using hedge funds techniques.  The main condition is to calculate a global exposure limiting the use of derivatives applying to sophisticated UCITS: the global exposure is linked to the fund’s Value at Risk (VaR) without a predefined limitation of leverage as for “traditional” UCITS the commitment approach is applicable and leverage is limited. The UCITS may appoint a Prime Broker if the applicable counterparty risk is respected (limit of 10% for UCITS). 

2. Fund submitted to CSSF Circular 02/80

 Hedge Funds may be set up under the provisions of the CSSF Circular 02/80 (“Circular 02/80”) concerning specific rules applicable to Luxembourg undertakings for collective investment pursuing alternative investment strategies. In order to be submitted to such provisions of Circular 02/80, Hedge Funds must be set up under part II of the 2002 Law. Thus, they do not qualify as UCITS and do not benefit from the European passport offered by UCITS. Circular 02/80 does not provide for any specific eligibility requirements for investors and minimum investment or minimum holding requirements, but indicates however that the CSSF pays particular attention to the reputation, the experience and the financial standing of the Promoter of the fund, as well as the professional qualification and the experience of the directors of the management bodies and the investment managers of the fund.  The prospectus must contain a description of the investment strategy of the Hedge Fund as well as warnings on the specific risks inherent to its investment policy.  It is not prohibited under Circular 02/80 to appoint a prime broker. The custodian remains however responsible for the supervision of the Fund's assets which it can generally achieve by making sure that it receives on continuous basis appropriate information from the prime broker. Circular 02/80 also provides for the possibility to make use of securities lending, repurchase transactions and sale with right of repurchase transactions. Circular 02/80 defines the investment restrictions generally applicable to funds with alternative investment strategies and makes a distinction between Hedge Funds and Funds of Hedge Funds.      

a.      Hedge Funds

Circular 02/80 provides mainly for the possibility to make short sales, to borrow for investment purposes and to make use of derivative financial instruments. Diversification rules must be applied to ensure risk spreading. The most important applicable rules and limits are as follows:

·         The risk diversification rules in relation to long positions and short sales are expressed in percentages by reference to the assets of the Hedge Fund.

·         A Hedge Fund may borrow cash and securities for investment purposes up to 200% of its net asset value. In certain circumstances, it can be up to 400% of the net asset value.

·         The total commitments, defined as unrealised losses, resulting from short sales of securities and from derivative financial instruments may not exceed the assets of the Hedge Fund.

·         There is no maximum permitted total leverage but a maximum total leverage to be indicated in the prospectus.

·         The counterparty risk on a single lender, being defined as the difference between the value of the assets transferred to a lender as security and the amounts due to such lender, may not exceed 20% of the assets. In this context, a prime broker is considered as a single lender. A Hedge Fund may also grant additional guarantees or a pledge on its assets to such lender if such arrangements do not result in a transfer of ownership of those assets or if the counterparty risk is limited by other means. 

b.      Funds of Hedge Funds

The most important investment restrictions applicable to Funds of Hedge Funds are as follows: 

·         There is no limit as to the maximum percentage of the units/shares issued by an underlying Hedge Fund which the Fund may acquire. Thus, the Fund may hold all the units/shares issued by a Hedge Fund. However, in case the Hedge Fund is an umbrella fund, and the Fund holds more than 50% of all the units/shares issued by such umbrella Hedge Fund, the total value of the Fund's holding in such umbrella Hedge Fund may not represent more than 50% of the net asset value of the Fund.  

·         A Fund may not invest more than 20% of its net assets in one single underlying Hedge Fund. For the purpose of this 20% limit, each sub-fund of a Hedge Fund constituted as an umbrella fund is to be considered as a separate entity if the legal form and the laws and regulations applicable to it ensure the segregation of liabilities of its different sub-funds towards third parties.  

·         The aforesaid restrictions are not applicable, or are only applicable to a limited extent, in relation to investments in underlying funds of the open-ended type which operate under the principle of risk spreading and which are subject in their home country to supervision by a supervisory authority. 

·         The Fund must ensure that its underlying portfolio of Hedge Funds is sufficiently liquid to allow the Fund to meet its obligation to redeem its shares from its shareholders. There is no specific restriction or requirement for the underlying Hedge Funds to be listed on an exchange or otherwise to present any specific liquidity criteria. 

3. Specialised Investment Fund

 The Law of 13 February 2007 concerning specialized investment funds (“SIFs”) has been a great success. The total number of SIFs amounted to 617 on 31st January 2008, keeping in mind however the compulsory conversion into SIFs of the funds previously existing under the Law of 1991. A major part of SIFs constituted are real estate funds, but SIFs have also been a key element for the development of private equity and hedge funds: the main drivers are tax neutrality, flexibility for structuring and asset management.  A SIF can be offered to a wide range of investors, including not only institutional investors, but also professional and sophisticated investors. Even private individuals may qualify as sophisticated investors by a formal adhesion to this status and when investing at least 125,000 EUR (unless a credit institution gives a specific assessment). Some advantages in using a SIF instead of incorporating a Fund under Circular 02/80 may be summarized as such: 

·         A Promoter is not required for the approval of the SIF by the CSSF; 

·         Investors may invest in a SIF by means of equity or debt, allowing an effective tax optimisation; 

·         A SIF can be launched prior to the approval from the CSSF, an application with the CSSF being however necessary within a month after the launch;  

·         Though risk diversification is required as usual for investment funds, no quantitative limits are defined by the law; 

·         There is no requirement of publication of NAV, to subscribe and redeem at NAV or to issue fully paid shares for a SIF incorporated as a SICAV; 

·         Semi-annual reports and long form reports are not required for a SIF. 

4. Taxation

Investment funds pay an annual subscription tax (taxe d’abonnement) of 0,05% of their net asset value, which is reduced to 0,01% for SIFs and for certain cash funds and institutional funds, and to 0 for certain institutional cash funds and certain funds of funds.  Luxembourg has implemented the European Directive 2003/48/EC of 3 June 2003 on the taxation of savings income in the form of interest payment (Savings Directive) via the law of 21 June 2005. This law came into force on 1st July 2005.  

Non-resident investors can either opt for the exchange of information relating to income they have received in Luxembourg in the form of interest payments or accept the application of a withholding tax of 15% as of 1st July 2005 that will increase progressively up to 35% on 1st July 2011.


For more information, please visit or email Olivier Sciales at or RĂ©mi Chevalier at