The 2024 Alternative Investments Substance Survey

At a glance: sophistication prevails

We are still witnessing the consolidation and sophistication trends of the alternative industry that we observed in FY22 and FY23. This ongoing shift is mostly driven by the growing international pressure on substance requirements and the tightening tax and regulatory landscape.

As a result, quantitative substance is definitely not sustainable anymore. The direct effect of the above is that a significant number of industry players are leveraging the regulatory substance of AIFMs to support their structures from a tax perspective in FY24. We identified several practical examples of this in our full survey. Considering that the EU ATAD 3 initiative on tax substance is still pending, we lack a consensus from EU Member States on what constitutes appropriate substance for alternative structures across the EU. As a consequence, players are struggling to find the right solutions in a situation where the proportion of tax audits did not materially decrease, according to our findings.

Running a sustainable business model, thus remains a key tax consideration for asset managers, as evidenced by the increased focus on tax health checks and the implementation of operating manuals or internal policies in our survey. Although the number of FTEs per participant is relatively stable in our FY24 sample, we have only observed a marginal increase in the number of SPVs managed per FTE. At first sight, it may suggest that we have reached an appropriate SPV per FTE ratio and hence a reasonable operating model. However, the majority of our players are still seeking additional resources in Luxembourg while still relying on outsourcing.

Finally, we cannot talk about substance and business models without considering the global footprint of our participants and the competition with rival jurisdictions. This is why we are also exploring Luxembourg’s positioning and competitiveness relative to other jurisdictions. We have gathered exciting insights on the topic.

The Luxembourg footprint of investment structures remains strong in FY24

Looking at our FY24 sample, we observed a rise in the number of SPVs managed by the participants and a higher proportion of Luxembourg alternative investment vehicles.

Despite such growth, the number of FTEs did not fundamentally change this year and remains stable compared to FY23. As a result, the average ratio of SPVs managed by one FTE only increased marginally.

The intention to hire has increased, however this trend is also influenced by the increasing complexity of the regulatory environment, which continues to drive demand.

Leveraging regulatory substance through AIFM setups remains key

Overall, the absence of a Luxembourg-based AIFM would impact the level of qualitative substance that is generally reported by our participants. Indeed, leveraging of the regulatory substance through the expertise and skillset of the AIFM’s FTEs would strengthen substance from a tax perspective.

If we look at the typical Luxembourg platform, employees could be legally employed by different entities – primarily either a “ServiceCo” (32%) or the AIFM itself when there is one (38%). These employees would then generally be shared across various Luxembourg SPVs within the fund structure, depending on the economic rationale, the investment at stake or the operational needs.

While certain players compartmentalize AIFM employees away from the SPVs structure, we notice a rise in the number of situations where the AIFM is directly involved in the SPVs management. This is notably why we are saying that tax substance is leveraging on regulatory.

1. The proportion of staff primarily employed by the AIFM as opposed to the ServiceCo increased by 7% in FY24 compared to FY23, as illustrated in the graph below:

2. The proportion of FTEs performing activities both for the AIFM and SPVs stands at 74% this year, up from 59% in 2023.

3. When employees from the ServiceCo or the AIFM are shared across SPVs, this is primarily done through a global employment contract or a split-and-recharge mechanism.

The decision-making process of SPVs appears to be sound and appropriate

We tested the board of directors of both master Luxembourg entities and Luxembourg intermediate or bottom entities to understand the decision-making process of SPVs.

Our findings indicate that the average board composition and decision-making process of Luxembourg entities appear to be sound and appropriate:

• There is always a majority of board members in the SPVs who are professionally resident in Luxembourg.
• The level of outsourced board membership remains below 20% this year.
• Over 62% of the sample relies on independent directors for their SPVs, allowing them to leverage external competencies and expertise.
• A clear trend is the appointment of conducting officers from the AIFM as board members of the Luxembourg SPVs (notably among small-sized and medium-sized players) to upgrade the consistency and expertise of the board. This reinforces the point we concluded earlier regarding employee involvement and qualitative substance.

Challenges and the way forward

The Luxembourg fund industry has encountered numerous challenges over the past year, reflecting the complexities of operating in a dynamic and ever-evolving financial landscape. These challenges have been shaped by both local and international factors, impacting various aspects of the industry, from regulatory compliance to talent acquisition.

Based on discussions with our participants, we understand that the increasing weight and complexity of regulations, the struggle to recruit, and the rising cost of doing business rank among the top three challenges this year, out of seven commonly reported.

To remain competitive against other jurisdictions, Luxembourg needs to enhance its attractiveness moving forward. This is why the asset management community has been advocating for the simplification and improvement of the Luxembourg framework.

That being said, we have found that:

1. Generally, there is a strong level of confidence in Luxembourg as an investment hub, with 95% of participants indicating they would still consider Luxembourg if they needed to (re)determine a location for their fund platform.
2. All our participants are multi-jurisdictions and some of them are also operating platforms in other jurisdictions like Ireland or the UK.
3. We have not yet measured any significant use of UK Qualifying Asset Holding Company (QAHC) as a pan-EU type of holding entity. This should be monitored further.

Conclusion

As described above, the Luxembourg sophistication trend persists and has even improved to a certain extent when looking at the business models we tested this year. Luxembourg platforms are maturing and are more equipped to tackle substance considerations than in the past.

Industry players also demonstrated their self-awareness of substance related considerations. This is reflected in a higher proportion of participants implementing governance processes or substance manuals, as well as a high level of players performing ongoing health checks of their structures. This is further explained by the still rather high level of tax audit rates this year.

Looking ahead, it now remains to be seen what future substance-related regulations will emerge, particularly concerning ATAD 3. These developments will certainly further shape the business models within the fund industry.

Want to know more? Contact our expert