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PEI Fund Structures Supplement - 2011
PEI Fund Structures Supplement - 2011
com
Lead sponsor: Pepper Hamilton Co-sponsors: Capolino-Perlingieri & Leone Loyens & Loeff P + P Pllath + Partners
Robert D. Brown
Managing Director & Global Head of Limited Partner Service Advent International
Patricia S. Grad
Principal Head of Investor Relations Irving Place Capital
Jason Ment
Partner General Counsel & CCO StepStone Group LLC
Jim Rutherfurd
Partner Fund Investor Relations 3i
Charles W. Bauer
Managing Director EnCap Investments L.P.
Online
www.peimedia.com/irny11
Email
regny@peimedia.com
Phone
+1 212 633 2905
PEI_IRC_forumAd202x202.indd 1
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Supplement Editor Jenna Gottlieb jenna.g@peimedia.com Senior Editor, Private Equity Amanda Janis amanda.j@peimedia.com Editor, Private Equity International Toby Mitchenall toby.m@peimedia.com Editor, PrivateEquityInternational.com Christopher Witkowsky christopher.w@peimedia.com
Contributors Nicholas Donato nicholas.d@peimedia.com Hsiang-Ching Tseng daisy.t@peimedia.com Editorial Director Philip Borel philip.b@peimedia.com Head of Marketing Paul McLean Paul.m@peimedia.com Head of Production Tian Mullarkey tian.m@peimedia.com
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Talking points
The Institutional Limited Partners Association continues to change the game for LP-GP negotiations. The trade group recently released an updated version of its Private Equity Principles that includes more information about carry clawback best practices and expanded context around the purposes of key guidelines. The guidelines are resonating with GPs, finds Jenna Gottlieb
The investor-friendly terms and conditions guidelines that were drawn up in 2009 by the Institutional Limited Partners Association (ILPA) were meant by the group to encourage better communication and negotiations among GPs and LPs.The Private Equity Principles aimed to standardise and simplify reporting, with the ultimate goal of creating consistency, accuracy and expediency in partnership financial reporting. Demonstrating that the guidelines were a work in progress, the trade group recently released an updated version of its Private Equity Principles that included more information about carry clawback best practices and expanded context around the purposes of key guidelines. The revisions to the guidelines were all part of the plan, explains ILPA executive director Kathy Jeramaz-Larson. The first set of guidelines was issued in 2009 and it was indicated at this time that ILPA was not finished, says Jaramaz-Larson. The new round came about after we were soliciting GPs that were unable to comment on the first round. We had a roundtable meeting in February last year with GPs and LPs and out of that we were encouraged to take the ILPAs Private Equity Principles and get more explicit about expectations. She adds: The need for LPs and GPs to better
Having things standardised makes it easier for smaller teams to understand the information and process it
communicate about expectations and practices is still there and the guidelines are really meant as a way to spark dialogue about terms. Game changer Private equity GPs have certainly felt the effect of the guidelines dissemination: many of them have spent the last year negotiating with LPs who have started showing up at meetings with the ILPA guidelines in hand. Considering the popularity of the guidelines among investors, big name private equity firms began to endorse ILPAs principles. Apollo Management, Coller Capital and Hermes Private Equity are a few firms that have supported the principles. In total, 140 industry organisations have thrown their weight behind the principles. In March, Kohlberg Kravis Roberts lent its support to the Private Equity Principles. The news comes at a time when KKR is currently courting investors for its 11th flagship North American fund, which is targeting between $8 billion to $10 billion. For KKR, however, neither its current nor future funds will adhere to every term on the LP wish list put forth by ILPA, according to a spokesperson.The endorsement is a commitment of our general support for the efforts of ILPA and
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more than just providing the amount other industry supporters to strengthen The need for LPs and GPs of the capital call or the distribution, the basic tenets of the principles with according to Tim Recker, chairman of the goal of improving the private equity to better communicate about ILPA. The information you need to deal industry for the long-term benefit of all of expectations and practices is with a capital call notice is more detailed its participants, said KKRs co-founders than you realise, Recker says. It can and co-chief executives, Henry Kravis and still there and the guidelines be a significant back office headache to George Roberts, in a statement. appropriately address the information. Just as GPs are getting behind the are really meant as a way to Providing consistency is a good idea, Private Equity Principles, ILPA has spark dialogue says one GP based in New York. This released a new set of guidelines. In is something were on board with. It January ILPA issued the first of five promotes efficiency internally and pleases investors, he explains. reporting templates to improve uniformity and transparency and Theres nothing to complain about. reduce expenses in administering and monitoring private equity investments. Whether GPs endorse the ILPA guidelines or not, any firm hoping to raise money had better find a copy of the amended guidelines and Good calls new templates and read them carefully. n The first template focuses on capital calls and distribution notices and was developed in consultation with general partners. ILPA chose to tackle capital calls and distribution notice reporting because it CLAWBACK REVISIONS was an issue on which both general partners and limited partners asked for help, said Jeramaz-Larson. [This was an issue] where the New components in the updated Private Equity Principles have been included industry was looking to create some efficiencies on the LP and the to allow funds to adopt the guidelines more effectively.They also include an GP side, she said about the first template. appendix on carry clawback best practice guidelines: Reporting generally speaking, the information a GP shares with Best approach is all capital back waterfalls (European style) as this will minimise excess carry distributions its LPs about the fund performance and investments has long been an area of concern for LPs. Complaints about reporting have ranged If deal-by-deal carry, then an NAV coverage test (generally from the quality of information the GP provides to the amount of at least 125%) should be performed to ensure sufficient information shared. margin of error on valuations LPs enthusiastically embraced the new guidelines as standardisation Interim clawbacks should apply, triggered both at defined of reporting would not only help LPs, but GPs as well, says one LP intervals and upon specific events (i.e. key-man, insufficient source. From a GPs point of view, you get fewer calls from LPs. NAV coverage) You shouldnt have 50 people saying, I need it in this format, the The clawback amount should be the lesser of excess carry LP source said. For LPs, especially those organisations with small or total carry paid, net of paid taxes. However, there private equity teams, having standardised reporting will definitely are often errors in the stipulated formulas which have a ease some pressure, the source says. Having things standardised material impact on fund cash flows: The tax amount should makes it easier for smaller teams to understand the information not simply be subtracted from the amount owed under and process it. the clawback and the clawback formula should take the Specifically, reporting around capital calls and distributions is preferred return into account
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Core elements
Pepper Hamilton explores the US tax issues fund managers and their limited partners must consider when structuring to invest in the natural resource and energy sectors. By Julia Corelli, P. Thao Le, Stephanie Pindyck-Costantino, Christopher Rossi and Laura Warren
In recent years, investment in the natural resource sector has increased, due in part to investors desire to diversify their portfolio, from both a risk profile and asset class standpoint, by investing in a space that is thought to be weakly correlated to public equity markets.The natural resource sector includes items such as timber, metals, crops, and alternative energy sources like wind and solar power. To capitalise on this increased investor demand, private equity funds, including US-based private equity funds of funds, are seeking to exploit direct and indirect investment opportunities in the natural resource and energy sectors. Investments in companies operating within the natural resource sector, both within and outside the United States, can present challenges for investors due to the operational nature of the companies and the fact that many of the companies are deemed to hold real estate. This article addresses potential US tax consequences that US investors in a domestic private equity fund may encounter when investing (directly or indirectly through offshore or onshore feeders) in a company in the natural resource and energy sectors, the potential structures that may be employed to mitigate adverse tax consequences, and additional consideration under the Investment Advisers Act of 1940 (Advisers Act) associated with these structures. Certain funds may need to take into account specific rules or regulations to which certain investors may be subject, for example tax-exempt investors subject to the Employee Retirement Income Security Act of 1974 (ERISA). Tax drivers Typically, there are three general categories of investors: (i) taxable US persons1 (high-net-worth individuals and non-exempt institutional investors); (ii) tax-exempt US persons, including pension funds, IRAs, endowments and foundations; and (iii) non-US persons (foreign persons).The latter two investor types usually have significant sensitivity to fund income attributable to a trade or business because such income may cause the investor to incur tax. For example, while US tax-exempt investors are generally not subject to federal income tax on capital gain as well as dividend interest and royalty income, they are likely to have to pay tax on income derived from an unrelated trade or business (UBTI), and if they employ structures to avoid UBTI, may trigger tax on dividends, royalties and income effectively connected with a US trade or business (ECI) and/or attributable to the disposition of a US real property interest (USRPI), pursuant to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) and Section 897 of the Internal Revenue Code of 1986, as amended (Code).2 UBTI.A US tax-exempt investor is usually exempt from tax on capital gains, dividends, interest, and royalties but will be required to pay federal income tax at the highest corporate rates3 on income derived from an unrelated trade or business.Thus, the investment focus of a US tax-exempt investor is often the avoidance of UBTI. A fund will generate UBTI if it: (i) invests in an operating partnership (usually a limited liability company) directly or through another fund or pass-through entity; (ii) incurs debt to fund the acquisition of a security or investment, whether to bridge a capital call or to leverage an investment (debt financed income); or (iii) is treated as a dealer, to the extent of dealer activity. ECI. Foreign investors are generally not subject to federal income tax on capital gain or interest income that constitutes portfolio interest. Foreign investors are subject to 30 percent withholding tax on dividend income, unless a lower rate is provided in an applicable treaty. Foreign investors are taxed as US persons with respect to income effectively connected with a US trade or business and a fund must withhold regardless of cash flow (generally at a 25 percent rate). Additionally, a foreign investor that is a
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ABC GP L.P.
(DE LP)
Portfolio Investments
An offshore feeder taxed as a corporation is not a tax-efficient UBTI blocker or ECI blocker if the fund generates income from a US trade or business. Such income will constitute ECI to the offshore feeder and therefore, the fund will be required to withhold at a rate of 35 percent (most offshore feeders are formed in non-treaty jurisdictions) on such income. Moreover, there will be FIRPTA implications to the extent real property or a USRPHC is involved. A fund utilizing the offshore feeder structure and desiring to invest in the natural resource and energy sectors will at the outset need to plan for alternative structures that are flexible enough to address multiple structuring considerations. Many natural resource and energy-related companies are formed as pass-through entities to provide for flow-through treatment of the tax benefits, mainly in the form of deductions and tax credits. As a result, investment by private equity funds in such companies will typically be beneficial to US taxable investors who want the flowthrough treatment (which may come at the price of additional state tax reporting obligations); however, the investments often generate UBTI and ECI for tax-exempt and foreign investors. Although these investments are tax-efficient for US taxable investors, certain investors may find that
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GP Taxable Investors
LPs
LP
LP
enjoy pass-through tax treatment, including the pass-through of tax benefits, if any. However, it also may result in additional reporting obligations to such investors. The second method imposes a blocker structure between the fund and the portfolio company. This blocks all investors in the fund and generally eliminates the pass-through tax benefits associated with partnerships, as well as any tax benefits specific to the type of investment. This structure is helpful for funds with taxable investors that are not inclined to file multiple state tax returns and to calculate or report complicated tax benefits. Because the blocker corporation is below the fund, there is a corporate-level tax on all income generated from the investment. On exit, the corporate-level tax may be avoided if an agreement can be reached to ensure that the blocker corporation is purchased on exit, rather
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Taxable Investors
GP
LPs
LP LP
Portfolio Investments
The third option contemplates a blocker structure under the fund (as in method two) and in addition, a parallel AIV taxed as a partnership through which the taxable investors may elect to invest. This method is effective for funds that have both (i) US-taxable investors that are not inclined to file multiple state tax returns or to calculate or report complicated tax benefits and (ii) US-taxable investors that desire passthrough treatment and do not mind additional reporting requirements. This method is also effective to facilitate a funds investment in another fund with a natural resource or energy focus (New Resource Fund) and that has a blocker structure already in place. In such case, (i) the tax-exempt investors would be brought onshore through a passthrough AIV that invests in the fund, (ii) the fund would invest in the New Resource Funds blocker structure, and (iii) the electing US-taxable investors of the fund would go into the New Resource Fund through a pass-through parallel AIV. The New Resource Funds blocker structure may employ a leverage mechanism to reduce the corporate-level tax, but there will generally not be an ability to sell the blocker corporation.
Advisers Act considerations In creating AIVs, fund managers will need to consider whether the AIVs will have an impact on their compliance with the Advisers Act. AIVs are considered to be private funds12 and clients of an investment adviser. Accordingly, fund managers may need to disclose information about the AIVs in their Form ADV and comply with the custody rules for the AIVs. 3 Reporting requirements. In 2010, the SEC proposed rules13 that significantly amend Form ADV to provide for enhanced disclosures and impose reporting requirements on registered investment advisers and private fund advisers that are exempt from registration under the proposed rules (exempt reporting advisers).14 The proposed rules are due to become effective on July 21, 2011. At that time, registered investment advisers and exempt reporting advisers would need to disclose on their Form ADVs information about all of their private fund clients (including the AIVs). Specifically, they would be required to disclose information about the size, investment strategy, assets and liabilities, number of investors and service providers of their private fund clients. This information must be filed electronically and will be publicly available. Custody. AIV users also should focus on the custody rules of the Advisers Act. An investment adviser is deemed to have custody of client assets if it or a related person in any capacity (such as general partner of a limited partnership) has legal ownership of or access to client funds or securities. In the typical AIV structure, a related person of the fund
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Passages to India
Pepper Hamilton discusses key considerations for structuring India-focused investment funds. By Todd Betke, Julia Corelli, Valrie Demont and P. Thao Le
While much of the developed world suffered a substantial economic downturn following the financial meltdown of September 2008, India continued to be one of the most attractive emerging markets for foreign investment, generating real growth rates (GDP) of 9 percent in 2008, 7.4 percent in 2009 and 7.4 percent again in 2010. Although there have been recent reports of foreign investors departing India due to regulatory and tax uncertainty and frustration with bureaucratic red tape, a variety of factors suggest that India is likely to remain an attractive destination for significant investments by private equity funds for the foreseeable future. Key drivers The principal drivers of foreign investment in India over the long term include the fact that it is an English-speaking, common law jurisdiction governed by a stable democratic regime. The country also features a young, educated workforce that is in position to provide business and manufacturing services at internationally competitive wages. Indias urban centers are experiencing rapid growth, and an expanding middle class with rising household incomes is producing increasingly attractive consumer markets. In addition, over the past decade, Indian businesses have become increasingly organised, moving from mom and pop sole proprietorships to corporate structures with diversified shareholders and more experienced management. Finally, Indias large and continuing investment in infrastructure throughout the country has generated growth across many sectors and now provides a strong base for additional economic activity. In short, the social and economic factors that have driven foreign investment in India over the past decade appear likely to fuel continued interest in the country, particularly for investors with the skill and experience to navigate through what is admittedly a sometimes uneven and challenging regulatory process. Three routes There are three main avenues for investing in India: through a Foreign Direct Investment (FDI), as a Foreign Institutional Investor (FII), and as a Foreign Venture Capital Investor (FVCI). Foreign Direct Investments. Foreign Direct Investments are generally permitted without any special registration of the investor with the Indian regulatory authorities. They may be made either through the automatic route, in sectors in which no prior governmental approval is required, or via the approval route in which prior governmental approval is required in certain sectors, including for certain investments in banking and financial services, telecommunications, single-brand retail, civil aviation, petroleum, defense, print media and broadcasting. In addition, Foreign Direct Investments in certain sectors may also be subject to specified caps on the maximum percentage of a companys securities that can be owned by foreign investors. Such sectors include, for example, defense (26 percent), telecommunications (74 percent), singlebrand retail (51 percent), insurance (26 percent), banking (74 percent) and print media (26 percent). Finally, a number of sectors, including gambling, certain real estate activities, multi-brand retail and certain agriculture projects, prohibit foreign investment altogether. In addition, Foreign Direct Investments are subject to certain pricing regulations under which the price for securities of listed companies issued or sold between an Indian and a non-Indian party must be determined by following certain guidelines issued by the Securities Exchange Board of India (SEBI), and the price for securities of unlisted companies issued or sold between an Indian and a non-Indian party must be set at fair market value as determined by an accredited investment bank or accounting firm using the discounted free cash flow method.
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In general, this involves formation of a Mauritius holding company that can either serve as the investment fund itself, investing directly in the securities of Indian companies, or as a feeder fund
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pa g e
13
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Passages to India
Authors
Pepper Hamilton LLP 3000 Two Logan Square Eighteenth and Arch Streets Philadelphia, Pennsylvania 19103-2799 +1 215.981.4000
Office locations include Berwyn, Boston, Detroit, Harrisburg, New York, Orange County, Philadelphia, Pittsburgh, Princeton, Washington, DC, Wilmington.
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offsHore regimes
Safe harbour
Shifting winds are now at the back of some popular offshore financial centres, reports Nicholas Donato
xxxxxxxxxxxxx
Cosmopolitan cities like London and Paris are attractions in their own right as leading international hubs of commerce and culture. For these jurisdictions a tweak to the law here or a change in rules there may in the short-run result in some chagrin, but its a fair price to pay to be part of a large diversified financial centre buzzing with activity, argue some policymakers. However, recent game-changing developments may push EU private equity activity (and other business) to offshore financial centres. For one, its safe to assume most high-performing (and thus well-compensated) fund managers in the UK, a country which takes the lions share of buyout activity in Europe, are still left disgruntled from recently imposed tax hikes. Last year, top earners in the UK saw their income tax rate jump to 50 percent from 40 percent. Private equity managers were also hit by the countrys VAT rate rising to 20 percent from 17.5 percent earlier this year. Similar tax hikes were recently instituted in Spain and France. The combined effect could be enough to convince more than a handful of GPs to follow in the footsteps of Terra Firma Capital Partners Guy Hands and the founder of Alchemy Partners, Jon Moulton, in moving to Guernsey. The island has a 20 percent tax
on income and zero tax on capital gains. Terra Firma itself has established operations on the island and is joined by fellow buyout giant Permira. Likewise a number of firms have chosen to establish funds on the island: BC Partners, Permira, Apax Partners, Coller Capital and Kohlberg Kravis Roberts, to name just a few. Guernsey isnt the only Channel Island providing a less stringent regulatory and legal landscape for private equity players compared to other EU locations. For instance, Jerseys laws on limited partnership arrangements are flexible on the timing of capital distributions and require less paperwork when communicating with regulators. In Jersey you can set up a partnership in as little as three days, says Nigel Strachan, chairman of the Jersey Funds Association. Corporate partner Jersey is also set to provide fund managers two new forms of the limited partnership arrangement. Expected in the second quarter of 2011, the island will offer GPs the separate limited partnership (SLP) and incorporated limited partnership (ILP), both of which will have its own distinct legal personality, whereas the latter goes one step further in being structured entirely as a corporate body. Moreover it is expected by UK tax practitioners that both the SLP and the ILP will be UK tax transparent.
Carlo V. di Florio
Director, United States Securities and Exchange Commission, Office of Compliance Inspections and Examinations
Alan K. Halfenger
Chief Compliance Officer & Asst. General Counsel, J.C. Flower & . LLC
Kristin H. Johnson
Jason Ment
Partner, General Counsel & Chief Compliance Officer, StepStone Group LLC
Sara Robinson
www.peimedia.com/compliance11
Online
www.peimedia.com/compliance11
regny@peimedia.com
Phone
+1 212 633 2905
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The advantage of a distinct legal personality is the partnership being able to contract, hold property, sue and be sued purely in their own name, which is in contrast to traditional LPs which are only able to do so through their GP, highlights a legal release from Channel Islands law firm Carey Olsen. The ILP, a hybrid structure mixing the elements of a partnership and corporation, works much like a company while still retaining the essential features of a partnership. For instance in the event an ILP had to be wound up, the partnership would be governed by the more familiar and detailed insolvency provisions provided by Jersey company law. Further, as a body corporate, the ILP is a more robust fund vehicle, says James Mulholland, a London-based Jersey funds partner at Carey Olsen. One benefit is that banks may prefer lending to a fund that is an ILP for capital call financing since it is a discrete body corporate as the contracting party, which ultimately gives the banks greater security. It is also worth noting that Jersey and Guernsey limited partnership arrangements fall outside the scope of recent UK tax rules which mandate a general partner of English and Scottish limited partnerships to file tax returns for all of its LPs and disclose the identity of its investors to UK tax authorities. British law firms are telling us that new HM Revenue & Customs guidelines create a GP administrative burden and an unwelcome headache, says Mulholland. From bad to good In the past few months, however, nothing may be more important for private equitys strong presence in offshore financial centres than the regulatory efforts currently underway in the EU. After a nearly twoyear long debate, the Alternative Investment Fund Managers (AIFM) directive has preserved non-EU nations ability to market funds across the important 27-member bloc. Until at least 2018, offshore managers can continue pitching their funds to EU investors in line with national private placement regimes, subject to meeting information exchange agreements. At that point EU regulators will decide whether the national regimes will go by the wayside. If so, funds domiciled offshore will have to obtain an EU marketing passport which, after meeting various requirements, allows a fund to be offered to professional investors across all EU-member states. Third country funds marketing through private placement regimes will however need to comply with some basic transparency and reporting
provisions. A GPs home state must also avoid landing on the Financial Action Task Force (FATF) blacklist, which monitors suspected money laundering and terrorist financing activities. In fact, many argue the directives extensive requirements will be a net positive for the Channel Islands and other popular destinations for fund domiciliation. The directive, which has been watered down from more onerous previous drafts, still subjects GPs to a new era of reporting requirements and transparency measures. Among other changes, the bill will place restrictions on asset stripping portfolio companies, fund managers pay and places limits on the use of leverage. Those hungry to poach business from the EUs 54 billion private equity industry (according to EuropeanVenture Capital Association 2010 statistics) are quick to point out they have the freedom to bypass the AIFM. The directive does not apply to offshore funds which write-off any marketing campaign to EU investors, whereas it captures all EU domiciled funds, regardless of its target investor geography. Importantly, the directive also makes no rules against reverse solicitation or passive marketing. This means non-compliant funds are barred from knocking on the doors of EU investors, or whats known as active marketing, but says nothing against EU institutional investors who are the ones initiating dialogue concerning an investment in a noncompliant offshore fund. Notably, EU cornerstone investors willing to take the lead in linking up with an offshore fund can continue doing so without violating the directive. Carey Olsens Mulholland has played witness to the growing appetite for funds structured under the more flexible and lenient regulatory systems provided by offshore islands. He expects Channel-Island-based fund activity to experience a significant uptick in 2011. We are currently spending a lot of time talking to City law firms about their clients especially those who have historically used onshore structures, about moving their next fundraising offshore, and even some migrations of existing funds as well, says Mullohand, who attributes the EUs stricter regulatory landscape as a primary driver of the shift. In Guernsey alone private equity assets under management on the island have grown in value by nearly 50 percent in the last 12 months to reach 62 billion by the end of September 2010, according to Guernsey Finance. Or as Gavin Farrell from offshore law firm Mourant Ozannes puts it: No one has a fund structure based in the EU now unless they absolutely have to for EU marketing or regulatory reasons. n
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Other main changes to the Luxembourg investment fund legislation Cross sub-fund investments: A sub-fund may in future invest in one or more other sub-funds under the same umbrella (UCITS and other UCI). However, the duplication of management fees is not permitted in this context (unlike investments in another UCITS, where there is no such prohibition, though the maximum proportion of management fees charged must be disclosed). Management regulations are subject to Luxembourg law: For clarification purposes, in particular concerning the residency of common funds managed cross-border (UCITS and other UCI), the 2010 Law requires the management regulations of such common funds to be subject to Luxembourg law. Mergers of UCITS: The receiving or absorbing UCITS is granted additional flexibility for a period of six months in relation to certain investment restrictions.
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UCITS and other UCI organised as investment companies: transfer of annual reports, record date, and translation of articles of association: It is no longer necessary to send shareholders the annual report etc., together with convocations to an ordinary general meeting. The board of directors may fix a date five days before an ordinary or extraordinary general meeting as a reference point by which to measure attendance rights and quorum and majority requirements (record date). Abolition of the requirement to translate articles of incorporation drawn up in English into German or French for purposes of registration with the Luxembourg Register of Commerce and Companies. Regulatory measures: The authorisation for one sub-fund under an umbrella (UCITS and other UCI) may now be withdrawn, without entailing the withdrawal of the authorisation of one or all the other sub-fund(s) under that umbrella and/or the entire umbrella. When delegating functions to third parties, other UCI and non-UCITS management companies (2010 Law, Chapter 16) are subject to the same requirements as UCITS and UCITS management companies (2010 Law, Chapter 15). In particular, asset management functions may only be delegated to authorised investment managers subject to prudential supervision. In the case of a non-EU manager, there must also be a cooperation agreement between Luxembourg and the other national supervisory authority concerned. Management may not be delegated to the depositary. Taxation: Foreign UCITS and other UCI managed by a Luxembourg management company are expressly exempt from Luxembourg taxation. However, non-resident investors (including feeder funds) making profits from the sale of shares in a corporate UCITS or other UCI are no longer subject to taxation in Luxembourg. The following are exempt from capital duty (taxe dabonnement): UCITS or other UCI which are listed on a stock exchange/ traded on a regulated market or replicate the performance of one or more indices (this means that in particular exchange traded funds are also exempted from capital duty)
UCITS or other UCI and their sub-funds which are reserved for pension funds (this was already the case, but only for pension funds of the same group) UCITS and their sub-funds whose main objective (over 50 percent) is to invest in microfinance institutions
New legal framework for Belgian REIT and introduction of institutional REIT status The Royal Decree of 7 December 2010 on REIT (SICAFI /Vastgoedbevak) modifies the regulatory regime applicable to REITs by abolishing and replacing the royal decrees of 10 April 1995 and of 21 June 2006. A review of the former regulatory framework was necessary due to the legislative modifications of the past years, but besides these modifications, the purpose of the Royal Decree is to innovate and modernise the regime applicable to REIT. In this respect, the introduction of the status of institutional REIT (SICAFI institutionelle Institutionele vastgoedbevak) is probably the most awaited modification.The key institutional REIT changes are summarised below. The Royal Decree, which entered into force on 7 January 2011, now allows the application for the new status of regulated and nonlisted investment vehicle in real estate, namely the institutional REIT (SICAFI institutionnelle / Institutionele vastgoedbevak). The institutional REIT must be controlled exclusively or jointly by a Belgian public REIT, the other shareholder(s) (if any) being institutional investor(s). This status of institutional REIT permits the following optimisations: an asset management optimisation as it allows the REIT to group its assets per categories in several subsidiaries; a cash flows optimisation, as it allows to avoid cash-traps by having these subsidiaries subject to the same distribution obligations and accounting referral; a tax optimisation, as the conversion into an institutional REIT can replace the (time consuming) former acquisition of subsidiaries followed by their merger into the REIT to benefit from the same tax regime. Moreover this new vehicle shall allow the set-up of joint ventures between public REITs and institutional investors. Developing such joint venture in the scope of public-private partnerships is indeed one of the main goals of the Royal Decree.
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Tax aspects The Royal Decree does not modify the tax regime applicable to REITs, the main characteristics being as follows: Exit tax Electing for the public or institutional REIT status leads to a step-up of the assets to their market value in the hands of the company concerned, the latent capital gain being subject to 16.5 percent exit tax. Corporate income tax and treaty protection Public and institutional REITs are formally subject to corporate income tax and are therefore granted tax residence certificates but however on a reduced taxable basis (i.e. abnormal or benevolent advantages received, certain non-reported and disallowed expenses). In other words, investment proceeds (rental income, capital gain, interest income for excess cash) are not taxable. This formal subjection to the corporate income tax should allow the REITs to claim treaty protection. Annual real estate tax Real estate assets held by the public or institutional REIT are subject to the annual real estate tax (prcompte immobilier / onroerende voorheffing). This tax is usually recharged to the tenants on the basis of the lease agreement provisions. Inbound income Belgian source dividends are subject to withholding tax at a rate of 15 or 25 percent, which is entirely creditable and reimbursable for the excess. No tax credit is available for foreign source inbound income subject to foreign withholding tax.
Outbound income The standard withholding tax rate is of 15 percent for dividends distributed by public REITs and 25 percent for dividends distributed by institutional REITs. However exemptions based on domestic law or tax treaties may apply. Dividends Dividends paid to foreign entities, which are not conducting a business or a lucrative activity and are totally tax exempt in their country of residence, benefit from a withholding tax exemption Subscription tax Public and institutional REITs are subject to a .08 percent subscription tax calculated on the net amounts invested in Belgium at the end of the preceding financial year. VAT Public and institutional REITs benefit from a VAT exemption on the management fees they are invoiced.
The Netherlands introduce a regulatory opt-in for collective portfolio management An authorisation by the Netherlands Authority for the Financial Markets (Autoriteit Financile Markten or the AFM) for managers of investment funds is presently only available if the relevant fund is open for investment by -in short- retail or semi-retail investors. It is recognised that this may be a marketing handicap for fund managers.This is particularly relevant for fund managers wishing to target institutional investors which as a matter of law or internal regulation may only invest in regulated investment schemes. In light hereof draft legislation was proposed that introduces an opt-in right for fund managers if the fund is offered to qualified investors. The opt-in right is incorporated in the FSA and entails a light regulatory regime. The opt-in right is referred to in the FSA as an application for a declaration of supervision (verklaring van ondertoezichtstelling). Fundraisings It is important to note that the regulatory opt-in is only available if the relevant fund is offered exclusively to qualified investors, including (not exhaustive): a legal entity or company which has obtained a license or is regulated to be active on the financial markets in another way; a legal entity or company which neither has a license nor is regulated in another way to be active on the financial markets
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investment funds depositary must have own funds of at least EUR 112,500. An open-ended fund must maintain a liquidity of at least ten per cent (10 percent) of its assets under management.
Status of the proposal and timing: This draft piece of legislation was adopted in the second chamber of Dutch Parliament and is presently being debated in the first chamber of Dutch Parliament. We do not know exactly when the proposed legislation will come into force, but this may be as soon as mid-2011. Key requirements: If the opt-in right is exercised the following key requirements will apply to it. Expertise and integrity: All persons involved in the day-to-day policy of a manager or depositary must have adequate expertise (deskundigheid). Such expertise is related to the type of manager or depositary concerned and to the activities that will be carried out by the persons involved. Pursuant to a change of law that is likely to be implemented very soon members of supervisory board of a manager or depositary will be included in the screening on adequate expertise. Business operations: A manager or depositary shall not be affiliated to persons in a formal or actual control structure which is impenetrable to such an extent that it constitutes or may constitute an impediment to the adequate exercise of supervision of the manager, the investment company or the depositary. Delegation or outsourcing of certain activities by the manager or depositary is generally permitted. Managers and their depositaries must have a minimum amount of own funds at their disposal. The manager must have a minimum amount of own funds of at least EUR 125,000 if the portfolio to be managed amounts to less than EUR 250 million. In case of a portfolio to be managed of an amount of more than EUR 250 million, a minimum amount of own funds of EUR 225,000 applies. The
Conduct of business A manager or depositary shall in its dealings with its clients act prudently. For managers the conduct of business rules include in particular that: (i) the manager must comply with provisions as to client communications, (ii) the manager should act in the interest of the investors and must treat the investors equally under comparable circumstances, (iii) the manager may not execute orders from clients at their expense with such frequency or of such magnitude that these transactions, in the given circumstances, apparently only serve to the benefit of the manager or its affiliates (unless at the explicit instruction of a client) and (iv) the manager must refrain from executing transactions for clients with insufficient financial resources. Requirements relating to the funds In respect of funds that do not have legal personality, the manager must ensure that an independent depositary (legal entity) will be engaged in the safekeeping of the funds assets. The said depositary may act as a depositary for multiple funds. Where a depositary acts as depositary of multiple funds, it is relevant to note that the FSA provides that the assets of a fund shall be exclusively to cover claims arising from (i) liabilities relating to the management and custody of that fund and (ii) its rights of participation (segregated assets). n
CONTACTS:
Marco de Lignie T +31 20 578 56 05 E marco.de.lignie@loyensloeff.com Loyens & Loeff Fred. Roeskestraat 100 1076 ED Amsterdam The Netherlands
www.peimedia.com/review
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gp fund commitments
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always was a certain amount, especially in recent fund, which closed towards the end the mid-market. of 2008, heavily over-subscribed, on 500 LPs want to see Whether or not these instances million. represent a wider trend toward increased Caroline Huyskes, a partner with Egeria, managers prepared to GP commitment is debatable. What is an says limited partners undoubtedly appreciated undeniable fact, however, is that for at least the large commitment. The fact that we put eat their own cooking most of our own net worth into our own fund two years GPs have been facing an incredibly shows LPs a good sign of confidence. We feel tough fundraising market. Much has been that the best place to invest our own money written about the pendulum of power is in our own funds. We know exactly where swinging towards the LPs, who during the money goes. a period of fundraising difficulty have While the GP commitment to the next been able to push for more advantageous terms and conditions. The creation of the Egeria fund may not be quite at the 20 percent Institutional Limited Partners Associations level, the team will always make up at least 10 Private Equity Principles, which codified percent, says Huyskes. a number of LP-friendly fund terms in The reasons behind an out-sized 2009, was evidence of the perceived shift GP commitment can vary. The most in negotiating power. straightforward reason is to demonstrate to LP demands to date, however, have LPs that you have faith in your own ability to focused more on fee structures and the invest the capital and make better returns than payment of carry, rather than GP fund you could make elsewhere. It is a selling point commitments. Nevertheless, a poll for the fund: LPs are reassured by your selfconducted among attendees at PEIs annual belief and the genuine alignment of interest. CFOs and COOs Forum in New York The liquid net worth of the management team in January suggested that the size of GP plays a major role in deciding the commitment commitment is indeed trending upwards. size. LPs are keen to ensure that the investment According to the survey, 35 percent of team will feel an investment loss in relative, the audience believed GPs in future would as well as absolute terms. contribute between 2 percent and 5 percent to their own funds; a Six percent is a very high number for an independent fund and further 16 percent of those surveyed said contributions would be will certainly make LPs sit up and take note, said Bruce Chapman, a London-based placement agent with Threadmark, in a prior discussion more than 5 percent. 28 percent predicted the GP commitment would about the Axcel fundraise. Chapman noted that it would be very come in at between 1 percent and 2 percent; 21 percent said GP difficult for any obviously wealthy manager to raise a fund in this commitments would be less than 1 percent. environment without committing a substantial amount. Anecdotal evidence from fundraisers backs this up. Kelly Deponte, A check on the personal financial situation of investment team a partner with placement and advisory firm Probitas Partners, says that members is not uncommon, says Dermot Crean, managing partner at for a lot of investors, 1 percent is just not enough anymore. Certainly placement agent Acanthus Advisers. There is certainly more probing among the funds we are seeing, he says, GP commitments are being by limited partners on this than there used to be although there raised. LPs want to see managers prepared to eat their own cooking. n
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CONTACTS:
Dante Leone dleone@cp-dl.com Capolino-Perlingieri & Leone www.cp-dl.com Via Quintino Sella 4 20121 Milan Italy Tel: +39 02 8905 0320 Fax: +39 02 7005 27881
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Custom made
Earlier this year, the $15 billion San Francisco Employees Retirement System, a prolific investor in private equity over the years, committed $20 million to venture fund of funds Weathergate Capital for a customised investment vehicle that would invest only in the very earliest-stage startups in the venture life cycle. The commitment was a separate account for the retirement system that gave San Francisco exclusive access to entrepreneurs trying to create the next blockbuster technology company like Facebook, Groupon, Google and Amazon in the past. San Franciscos Weathergate partnership represents a customised type of account that exposes the pension to niche investments, and gives it more control over decision-making. These types of customised accounts are more popular than ever in todays environment as limited partners seek more control and look for breaks in fees and other costs. The Weathergate arrangement also fulfills one of the big reasons why LPs enter unique accounts with managers it provides access to a strategy that would be otherwise closed to an LP. But unlike more traditional fund of funds, these types
Limited partners have growing appetite for customised accounts giving them greater flexibility on economics and deal selection. While the traditional private equity fund is not disappearing, LPs are seeking more options for their alternatives exposure, finds Chris Witkowsky Without a separate account, you wont really have that one-to-one interaction with the GP
of accounts are tailored to the requirements of a single client. It gives [clients] a lot more involvement and the ability to tailor the goals for the investment programme, explains Steve Cowan, managing director of 57 Stars, which creates and operates emerging marketsfocused separate accounts. 57 Stars, known as Pacific Corporate Group International until last year when management took full control of the firm, counts the California Public Employees Retirement System as one of its clients. Often the description they will use in describing this arrangement is, we are seeking to act as an extension of the investment team, Cowan says. Separate accounts have traditionally been an option for the biggest institutions in the business, but relatively moderatesized players can get into the act as well, as evidenced by San Franciscos move with Weathergate. While sources say the traditional private equity fund model is not going away any time soon, it has certainly evolved to a point where many LPs have an array of choices to get exposure to various strategies, or breaks on costs, if they are not getting what they want from traditional fund managers.
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Perks for pensions As institutions further develop their private equity programmes, they will often seek more control in investment decisions and try to reduce fees. One investment executive at a large public pension recalls a recent discussion had with a traditional fund manager. We said, wed like to invest with you, but we dont like your economics, he says. While fund of funds have traditionally offered such products to clients, regular GPs and even some private equity consultants have been offering customised products to meet their customers needs. Cleary, people are doing more [separate accounts] because of the better economics and certain structural features like limitations on leverage and pace of deployment, says the pension staffer. US public pension plans especially benefit from separately managed accounts as they often have small staffs overseeing alternative investments and benefit from the additional help. CalPERS, for example, has a number separate accounts with
managers like 57 Stars and Apollo Global Management; Oregon and Washington States pensions are the sole LPs in two funds managed by fund of funds Fisher Lynch Capital. Oregon also entered into a fixed income managed account with Kohlberg Kravis Roberts. The massive New York State Common Retirement Fund has numerous separately managed accounts that give it access to various strategies like energy and emerging managers. New Jerseys state system, which has about $72 billion in assets, started its alternatives programme in 2005. The pension built the programme around separate accounts, according to documents from the pension detailing the programme. New Jersey has customised accounts with Credit Suisse, Neuberger Berman, Hamilton Lane, Fairview, BlackRock and Asia Alternatives. With Credit Suisse, the pension gets access to small and mid-market US investments, along with emerging managers. With Hamilton Lane, the pension gets exposure to international managers as well as large-cap buyout firms. The pension also has accounts with Fairview for access to new
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and emerging managers, and Neuberger Berman for venture funds. New Jersey declined to comment about the programme. One private equity LP who has experience with customised accounts says a big advantage, especially for institutional investors with small teams, is the education investment staff get from the managers. Without a separate account, you wont really have that one-to-one interaction with the GP, the LP said. The separate account managers are an extension of staff. [Theres opportunity to] leverage their organisation to help in other areas, not just where theyre mandated. Investment staff, for example, can spend a few days with the managers learning how to perform proper due diligence. The GPs running separate accounts are also good sources of information about other managers in the market. Institutions also benefit from the separate accounts because of cross pollination, according to one LP, meaning that investment professionals from other asset classes like real estate may also benefit from conferring with managers of separate accounts ion private equity, the LP said. All the extras can make running a separate account intensive for GPs, but from the LP perspective, the additional education and information makes it worth the extra layer of fees, the LP said. Its about accessing top managers and also helping to train staff and use [the managers] as extensions of staff.
People are doing more [separate accounts] because of the better economics and certain structural features like limitations on leverage and pace of deployment
Travel companions One way separate account managers can educate their clients is to take them around the world, meeting the GPs in their portfolio and watching the due diligence process. 57 Stars is glad to take its clients on trips to meet managers, Cowan says. One large US state pension plan makes several trips each year to Europe, Asia and various regions in the US to meet with managers. Meeting with GPs in person is essential to performing appropriate due diligence on managers in the portfolio, the head of the private equity programme at the pension says. Theres a lot of back log of re-ups coming, the official says. There are lots of folks we want to dig into, we want to meet with. The pension is planning a trip to Brazil in the future to meet with managers in the region to possibly build exposure in its portfolio. The task, though, is somewhat daunting as the pension doesnt know any managers in the region and is not wellversed on the culture. This is another situation in which a separate account manager could be helpful, the official says. Beyond the economic benefits of separate accounts, the educational aspect of the relationship can be extremely beneficial to institutions struggling with small staffs looking to broaden their horizons into other strategies of the asset class. n
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ex p e rt co m m e n ta r y p + p p l l at h + pa rt n e r s
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CONTACTS:
Dr. Andreas Rodin Andreas.Rodin@pplaw.com Patricia Volhard Patricia.Volhard@pplaw.com P+P Pllath + Partners Hauptwache Zeil 127 60313 Frankfurt/Main Telefon:+49 (69) 247 047-17 Telefax:+49 (69) 247 047-30
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asia regulations
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Drawing comparisons with the West The NDRCs focus on fundraising, disclosure and risk management encourages comparison between its Cirnational standard on cular and the moves towards more stringent regulation fundraising Focus on fundraising seen from Europe and the US. But Orricks Hoo asserts As well as asking firms to submit information for review, that the similarities end there. the NDRC has issued a set of best practice guideI would say theWestern regulations are products of the lines for private equity managers to follow. As with industry-wide financial crisis, and as such many provisions have found their way into the regulations seen recently in the US from the Securities and Exchange earlier drafts and the final regulations as a reaction to political pressures, Commission (SEC) and in Europe with the passing of EUs Directive and aim at purging the financial systems of certain perceived evils, he says. on Alternative Investment Fund Managers, a key focus is fundraising. In China, however, where financial crisis was not the primary motivation for reform, Hoo believes that the Circular is more According to the new rules, private equity firms can no longer use contemplative. He points out that at this stage it lays down only broadwebsites, publications, messages, or conferences to market themselves brush principles, rather than detailed rules, and has only been applied to the general public, nor can they use commercial banks or securities to six pilot regions. companies to transmit information for them. They are not allowed It is an initial step toward regulating an industry that the West to make specific promises about returns to investors and should only initially did not regulate much and then may have gone towards overraise money from LPs who recognise and have the ability to shoulder regulation, Hoo adds. the risk although the NDRC has yet to clarify who those LPs are. As such, reaction from the industry has been moderate. In a question and answer session with Chinese reporters published on its website, the NDRC explained the reasoning behind its thrust: It lays out [some] best practices principles, and that is actually valuable One of [the problems the private equity industry has] is that to the industry because right now I think the practices are a little bit all there are no regulations around fundraising. Because private equity over the place, says Hoo. investment is relatively high risk, the capital is usually raised from People are OK with it because its not overly intrusive at least for now it doesnt look to be. These are the rational things fund manager specific targets in a private way so that only the institutional investors would already do, says OMelvenys Sussman. and high-net-worth individuals can participate. But currently, some He points out that though people want to avoid national regulation of the private equity firms in our nation hold seminars and forums to advertise their funds, and therefore let in public investors who dont as much as possible, everyone knew it would eventually happen at some have the basic ability to recognise the risk theyre taking. point, and its almost unavoidable in some respects. n
However, Hoo asserts that reputational damage is threat enough for many firms with serious private equity intentions: If you get the stigma of being a violating fund, I expect that status will affect your portfolio companies.Therefore ultimately people wont want you to invest in them, and investors may not invest in you, and that affects your business. Any GP hoping to slip under the radar of the NDRC can think again. Under Chinese company law, any new business must register with the State Administration for Industry & Commerce (SAIC), which could then alert the NDRC to any firm formed with equity investment Sussman: rules set a in mind.
Even if it remains unclear exactly who firms are able to target for capital, the guidelines have been welcomed as a long-awaited one-stop national standard for private equity fundraising. Prior to this, fundraising PPMs were drafted based on a draft of this notice as well as other unpublished guidelines. Now we have guidelines published for the content of a PPM that youre giving the prospective investors, says Sussman.
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