One year after the liftout of Quilvest Luxembourg Services S.A., Gen II Co-Founder and Managing Principal Norman Leben outlines how the investment is paying off as domestic fund managers look to Europe to diversify their investor bases.
Gen II Fund Services completed its acquisition of Quilvest Luxembourg Services S.A. last December. Since then much has changed, as the COVID-19 pandemic has accelerated working remotely, forced sponsors to analyze their core competencies, spurred necessary technology enhancements and implementations, and only reinforced transparency demands among limited partners.
Norman Leben, in a wide-ranging discussion, highlighted the original thesis behind the Gen II investment to acquire the Quilvest operations and touched on how the private equity landscape continues to evolve one year later.
Q: It’s been a year since Gen II executed a liftout to acquire the PE and real estate administration operations of Quilvest. Looking back, can you discuss the drivers behind the deal and how those have played out over the past 12 months?
LEBEN: This was a strategic investment for us and reflects both the growth of Gen II over the last 11 years and the growth of our clients. As it currently stands, a very large proportion of our client base has either already raised money in Europe, is in the process of doing so currently, or soon will be based on their future roadmap.
At a high level, three core drivers really informed our thesis behind the Quilvest liftout. The first consideration, just given our clients’ interest in Europe right now, was that this investment provided instant scale and deep in-house experience to service both private equity and real estate funds in Europe.
Another factor is that almost universally, our clients that have expanded into Europe have utilized Luxembourg fund structures to do so. This speaks to both the favorable tax regime in the country as well as the disciplined regulatory environment, providing a high degree of investor confidence. Sponsors raising money through a Luxembourg investment structure have to use a CSSF-licensed Luxembourg administrator. So the Quilvest liftout provides a compelling avenue through which we can demonstrate our value proposition, particularly among large global fund managers based in the U.S. who, to date, haven’t considered outsourcing but are compelled to embrace these services in Europe.
Finally, Luxembourg represents a key piece in our ability to provide a true one-stop shop for global fund managers. Private equity operations have become incredibly complex over the last decade. Regulatory demands are more pressing; LPs require more information and transparency than ever before; and GPs require more data to better operate and manage their own businesses. Each of these competing demands have helped to make the case for outsourcing non-core, back-office functions. Increasingly, LPs are aggressively pushing their fund managers in this direction. But GPs don’t want to manage different vendor relationships across multiple jurisdictions. They want one culture, seamless interactions, and continuity and consistency. Our Lux operations, today, allows us to expand the continuum across which we can meet our clients’ evolving needs.
This is a long way of saying that what we’ve discovered over the past year is that these factors do indeed resonate. We currently service over $6 billion of assets under administration through Gen II Luxembourg Services SARL. And for our clients that have not yet raised capital in Europe, we’ve had a number of conversations that suggest it’s only a matter of time before their interest turns to action. GPs in the U.S. have traditionally viewed Europe as being heavy handed when it comes to regulations and oversight. With our deep expertise and knowledge, we can help smooth over these barriers to entry, so we anticipate the fund managers we work with will begin to show an even greater appetite for global expansion.
Q: What are the biggest misconceptions when it comes to private equity fund administration in Luxembourg?
LEBEN: Generally speaking, there was a longstanding perception that fund managers turned to Luxembourg as a tax-avoidance strategy. That’s not the case at all. Often Luxembourg is confused with Lichtenstein, which has historically been considered a tax haven for foreign investors. However, to managers active in Luxembourg, particularly cross-border investors, the country’s draw traces back to the fairness of the tax regime and similarities to the U.S. as it relates to flow-through entities so investors aren’t being taxed twice on the same income or capital gains. Along with the rest of the European Union, Luxembourg has adopted the Anti-Tax Avoidance Directive (ATAD II), which expanded the scope of ATAD I and largely follows the OECD’s recommended framework around BEPS[Base Erosion and Profit Shifting].
It’s not a misconception necessarily, but many will often overlook the structuring flexibility of the jurisdiction. Fund managers have at their disposal a whole range of wrappers to choose from for Luxembourg-domiciled funds. Smaller funds, for instance, may gravitate to a Specialized Investment Fund (SIF), Special Limited Partner (SLP or SCSp) or SICAR wrappers [Sociétés d'Investissement à Capital-Risque], each of which fall under the CSSF’s jurisdiction. Larger funds, alternatively, may opt for a RAIF wrapper (Reserved Alternative Investment Fund), under the Alternative Investment Fund Managers Directive (AIFMD), or alternative structures, depending on the specific strategy, the LPs being targeted for a fund, or other factors.
The point, though, is that the primary appeal for GPs is that Luxembourg provides a disciplined, credible, and business-friendly backdrop. This helps to explain why the country sits as the No. 2 jurisdiction for private equity assets behind only the U.S.
Q: Are there any recent developments on the regulatory front that GPs should be aware of?
LEBEN: There are always new updates around reporting and compliance. In July, for instance, a new rule regarding the Mandatory Disclosure Regime (also known as DAC 6) went into effect, which is again aligned to the OECD’s BEPS framework. The benefit of outsourcing, however, is that GPs can leverage their administration partners’ economies of scale and various areas of extensive knowledge. Our licenses require that we stay abreast of the new regulations and interpretations so clients can focus on their core competencies -- sourcing investments, improving portfolio companies and internal operations, and securing profitable exits.
Generally, though, we’ve seen regulators in Europe – Luxembourg in particular -- focus heavily on AML and KYC compliance. This stems back to the Bernie Madoff scandal almost 10 years ago. But AML compliance in Luxembourg can be particularly burdensome for fund managers. The CSSF last year, for instance, clarified that firms need to appoint two executives, one responsible for compliance [RR] and another for monitoring compliance obligations [RC], who “must be available in Luxembourg,” have sufficient knowledge around the AML regulation, and be familiar with the investment and distribution strategies of the fund manager. It just underscores the extent to which the CSSF is scrutinizing people, processes and systems as part of their oversight. Gen II has added these services to our platform.
Q: What are some other factors that GPs should keep in mind when it comes to establishing a Lux-domiciled fund?
LEBEN: The cost of raising a fund in Europe -- both the start-up phase as well as ongoing maintenance -- will be more costly than what many sponsors and investors are used to in the U.S. In addition, completing transactions, working through all of the different levels of governance and compliance generally requires more time.
For example, opening a bank account for the first time in Luxembourg could take four to eight weeks. You need to make sure you have met all the requirements with respect to raising capital and ongoing compliance from an AIFMD prospective. These are highly specialized roles, ranging from a licensed ManCo and fund administrator to a domiciliation agent, compliance and governance support professionals, depositary agent and local directors, in addition to other roles. And to state the obvious, an experienced law firm and auditor are paramount.
It’s not necessarily unique to Luxembourg, but technology is also becoming a bigger consideration for GPs everywhere. ALFI [the Association of the Luxembourg Fund Industry], in June outlined its key priorities over the next five years. And beyond broadening access to alternative investments, another priority is digital transformation. This is designed to help resolve existing pain points for managers and support the ongoing evolution of the legal and regulatory framework.
This is another area where investment managers can really leverage the economies of scale of their fund administration partners. The pace of innovation today demands continual reinvestment to ensure that technology and systems stay current with regulatory demands and reporting standards as well as the latest technologies to incorporate automation and advanced analytics into back-office processes. It used to be that fund managers would implement a new system and not have to think about it for another five to 10 years. Those days are long gone and a lot of fund managers are still underestimating how much of a commitment this will require in the years ahead.
Q: As you’ve brought on new clients over the past year can you highlight some of the overlooked benefits for fund managers launching a Lux-domiciled fund through Gen II?
LEBEN: We have onboarded a number of clients over the past 12 months and in each case, we are able to validate our thesis around the value of providing a seamless approach to clients’ global fund programs. In our ongoing conversations with our clients, for instance, one of the biggest attributes that stands out is just having one point of contact at Gen II for funds domiciled across the U.S., the Cayman Islands and Luxembourg jurisdictions.
Of course, other considerations are also important. For instance, across the board clients appreciate the deep program knowledge that resides with a dedicated Gen II global team, who make this information accessible and available as needed. The consistency and customization around investor-facing information and branding also eases some of the middle- and front-office challenges. Coordination to disseminate investor and fund information on time -- and concurrently -- eliminates some of the more acute reporting headaches and mitigates a common operational bottleneck. And technology, which allows for transparency around the global fund platform through one intuitive system, is fast becoming one of the biggest differentiators for Gen II.
Q: Do you have any recommendations for GPs considering a Lux-domiciled fund?
LEBEN: Luxembourg provides a very robust and stable business environment. The workforce is highly skilled and the country has a healthy and stable economy and political environment. Moreover, the tax regime is fair and the regulatory environment is well-ordered. Collectively, these factors instill confidence for investors investing in Europe through Luxembourg vehicles.
It is critical to select service partners that have the appropriate experience, knowledge and reputation in the community and with the regulators. This is especially the case for funds navigating the requirements for the first time. It can be a real education.
The Quilvest liftout gave us an incredible depth of talent, which we have built upon and continue to augment with long-tenured professionals with experience servicing hundreds of LPs as our business grows. This has been invaluable to not only help GPs comply with their regulatory hurdles, but also support the required hand holding and discover new efficiencies across an unfamiliar terrain.
We never could’ve predicted that a global pandemic would stir up the outsourcing opportunity landscape. But similar to previous disruptions, be it the global financial crisis or the dotcom bubble, the pandemic is reinforcing the appeal of businesses to focus on what they do best. Along these same lines, GPs are becoming more strategic in their openness to select service partners that are better equipped to support other critical segments of their business.
One year later, the thesis behind the liftout has really come together even better than we imagined. It is facilitating our own growth and providing our clients a one-stop solution to grow their own businesses.