Luxembourg: A New Regime For European Venture Capital Funds

INTRODUCTION

The regulation on European venture capital funds ("EuVECA Regulation" or the "Regulation")¹ was published in the Official Journal of the European Union on April 17^th 2013² , entered into force on May 7^th 2013 and applies in all EU Member States from July 22^nd 2013.

Such framework will allow investors to compare different fund offerings and will also indicate to them the quality of the offering involved. The Regulation is complementary to Directive no. 2011/61 on alternative investment fund managers ("AIFMD").

The Regulation applies to EU managers only who meet the conditions set out below. Once registered pursuant to the EuVECA Regulation such managers may freely market qualifying venture capital funds under the designation "EuVECA" throughout the EU ³.

Unlike the AIFMD which is mandatory for managers fulfilling certain criteria, the Regulation provides only for an optional regime. In other words, managers of qualifying venture capital funds can discretionarily decide whether or not they wish to use the designation "EuVECA". On the other hand it is only available to those managers that do not require authorisation under AIFMD⁴.

OBLIGATIONS SET FORTH IN THE REGULATION

In order to benefit from the EuVECA designation there are certain requirements to be met by both the manager and the fund itself. In addition, there are marketing restrictions applicable to the use of the EuVECA label.

1. Conditions to be fulfilled by the manager

1.1. Registration

The EuVECA Regulation only applies to managers of Alternative Investment Funds⁵ that fulfill the following conditions⁶ :

• established in the European Union;
• amount of assets under management does not exceed EUR 500 million;
• subject to the light regime of AIFMD, i.e. subject to registration requirements with its supervisory authority pursuant to AIFMD but not subject to the full scope of AIFMD;
• manages portfolios of qualifying venture capital funds.

Managers intending to use the EuVECA designation shall inform the competent authority of their home Member State of their intention and shall provide them with certain information including information allowing the competent authority to assess whether the persons who effectively manage the funds are of good repute and sufficiently experienced and a list of Member States where the manager intends to establish or has established EuVECAs and where it intends to market the EuVECAs it intends to manage⁷.

The competent authority will only register the manager if the persons who effectively conduct the business of the fund are of good repute and sufficently experienced.

Managers of EuVECAs shall inform the competent authority of their home Member State where they intend to market a new qualifying venture capital fund or an existing qualifying venture capital fund in a Member State not already notified to such competent authority⁸.

After registration of an EuVECA manager, the supervisory authority of the home Member State shall notify the Member States where such manager intends to market and the European Securities and Markets Authority ("ESMA"). Similar notifications are made on the addition of (i) a new EuVECA, (ii) a new domicile for the establishment of a EuVECA, and (iii) a new Member State where the manager intends to market⁹. ESMA shall submit draft technical standards on the format of notification by February 16th 2014 to the European Commission¹⁰.

Furthermore, ESMA shall maintain a central database, publicly accessible on the internet, listing all managers of qualifying venture capital funds and the qualifying funds that they manage as well as the countries where they are marketed¹¹.

1.2.1. Professional conduct

In relation to the management of EuVECA it manages, the manager must act fairly and with due skill and diligence, apply policies and procedures to prevent malpractices, conduct its business activities to promote the best interests of the funds it manages and the investors therein, apply a high level of diligence in the selection and ongoing monitoring of investments, possess adequate knowledge and understanding of the investments, treat investors fairly and ensure that no investor obtains preferential treatment unless such preferential treatment is disclosed¹².

1.2.2. Conflict of interests

The manager shall put in place a conflict of interest policy¹³ which allows the manager to identify and avoid conflicts of interest that may arise. Particular attention is to be paid to those conflicts that may arise between the manager and employees thereof, the fund or the investors therein and another fund managed by the same manager or the investors therein. Notwithstanding the organisational arrangements taken by the manager, if such conflicts of interest cannot be avoided, then they shall be disclosed to investors to the extent that the risk of damage to investors' interests exists.

The European Commission is empowered to adopt, delegated acts specifiying (i) the types of conflicts referred to in §2 of article 9 and (ii) the steps that managers of EuVECA must take in terms of structures and organisational procedures in order to identify, prevent, manage and disclose conflicts of interest¹⁴.

1.2.3. Sufficient own funds

Pursuant to article 10, managers of EuVECA shall have at all times sufficient own funds and use adequate and appropriate human and technical resources for the proper management of EuVECA they manage. In addition the manager shall provide investors with information on the amount of own funds and a detailed statement on why the manager considers that the amount is sufficient¹⁵.

1.2.4. Valuation, annual report

The rules for the valuation¹⁶ of assets of a EuVECA must be provided for in the rules of incorporation of the EuVECA. The valuation procedures shall ensure a sound transparent valuation process and the asset value must be calculated at least once a year.

The manager shall make available an annual report to (i) the competent authority of the home Member State for each EuVECA it manages by six months after the end of the financial year and to (ii) investors upon request¹⁷.

The report shall describe the compositon of the portfolio of the EuVECA and the activities of the year before. It must disclose, where applicable (i) the amount of profits earned by the EUVECA at the end of its life and (ii) the amount of profits distributed during its life. The report must include the audited financial statements of the EuVECA.

1.2.5. Delegation

Any EuVECA manager is allowed to delegate its functions to third parties provided that it does not become a letter-box entity and provided that it can still be considered to be the manager of the fund. In this case, the manager's liability is unaffected by delegation¹⁸.

2. Conditions to be fulfilled at the fund level

• In order to qualify for the status "EuVECA", a fund must¹⁹:
• be an alternative investment fund ("AIF") under the AIFMD;
• be established in the territory of a Member State;
• intend to invest at least 70% of the total of its capital contributions and its uncalled committed capital in assets that are qualifying investments (as defined below); and
• not use more than 30 % of its aggregate capital contributions and uncalled committed capital for the acquisition of assets other than qualifying investments.

Managers of such funds shall not employ at the level of the fund any method by which the exposure of the fund will be increased beyond the level of its committed capital. However, the manager may borrow, issue debt obligations or provide guarantees at the level of the fund where such borrowings, debt obligations or guarantees are covered by uncalled commitments²⁰.

Recital 23 of the Regulation clarifies that the use of leverage is not permitted, in order to ensure that EuVECA do not contribute to the development of systemic risks, and that such funds concentrate, in their investment activities, on supporting qualifying portfolio undertakings (as defined below).

A qualifying investment ²¹ is any of the following instruments:

• equity or quasi-equity instruments that are issued by (i) a qualifying portfolio undertaking and acquired directly by the fund, (ii) a qualifying portfolio undertaking in exchange for an equity security issued by the qualifying portfolio undertaking, or (iii) an undertaking of which the qualifying portfolio undertaking is a majority-owned subsidiary and is acquired by the fund in exchange for an equity instrument issued by the qualifying portfolio undertaking;
• secured or unsecured loans granted by the EuVECA to a qualifying portfolio undertaking in which the EuVECA already holds qualifying investments, provided that no more than 30 % of the aggregate capital contributions and uncalled committed capital in the EuVECA is used for such loans;
• shares of a qualifying portfolio undertaking acquired from existing shareholders of that undertaking;
• units or shares of one or several other EuVECA, provided that those EuVECA have not themselves invested more than 10 % of their aggregate capital contributions and uncalled committed capital in EuVECA.

A qualifying portfolio undertaking ²² is an undertaking that meets the following requirements:

• at the time of an investment by the EuVECA, the qualifying portfolio undertaking is not admitted to trading on a regulated market or on a multilateral trading facility ("MTF") and meets the definition of small and medium-sized enterprises ("SME") as defined under Community law²³;
• is not itself a collective investment undertaking, a credit institution, an investment firm, an insurance undertaking, a financial holding company, or a mixed-activity holding company;
• is established within the territory of a Member State, or in a third country provided that the third country is not listed as a Non-Cooperative Country and Territory by the FATF²⁴ and has signed tax agreements with the home Member State of the manager of a EuVECA and with each other Member State in which the units or shares of the EuVECA are intended to be marketed.

3. Marketing

The Regulation provides²⁵ that managers of EuVECA may market their shares/units exclusively to:

• investors which qualify as professional clients in accordance with Directive 2004/39/EC ("MIFID") or which may, on request, be treated as professional clients in accordance with MIFID; or
• other investors that (i) commit to investing a minimum of EUR 100,000 and (ii) state in writing, in a separate document from the contract to be concluded for the commitment to invest, that they are aware of the risks associated with the envisaged commitment or investment.

The Luxembourg specialised investment fund ("SIF") and investment company in risk capital ("SICAR") are already restricted as to the type of investors they market to and could easily be adapted to fit these restrictions.

Prior to the investment decision, the manager shall inform potential investors in a clear and understandable manner of certain information²⁶ including the following:

• the identity of the manager and other service providers and their duties; ;
• the EuVECA investment strategy and objectives, risk profile, valuation procedure and historical performance;
• a description of how the remuneration of the manager is calculated. For Luxembourg SIFs and SICARs the provision of such information shoud not prove too difficult a task given the pre existing requirement for them to have a placement document which would include a large part of such information. There are however certain items which would be new to Luxembourg vehicles such as article 13 (i) which provides that potential investors be given information on the business support services and the other support activities provided by the manager of a EuVECA or arranged through third parties in order to facilitate the development, growth or in some other respect the ongoing operations of the qualifiying portfolio undertakings in which the fund invests or where these services or activities are not provided, an explanation of that fact.

CONCLUSION

With its existing investment vehicle infrastructure and in particular the SIF and the SICAR Luxembourg is an ideal location for managers of venture capital funds to establish their qualifiying funds. In addition the existing expertise in Luxembourg both at the level of service providers and the regulator, on cross border distribution of UCITS funds should be an advantage to those seeking a jurisdiction in which to establish their EuVECA.

It is to be noted that the EuVECA Regulation does not cover any tax aspects of the EuVECA. However, as the taxation of investors in this EuVECA is a key factor for the successful marketing of the EuVECA, the European Commission closed a public consultation, on November 5^th 2012, on removing tax obstacles to cross border venture capital investment²⁷ in order to present solutions to these barriers in 2013, but also to prevent tax avoidance and tax evasion. Although, these solutions are independent from the Regulation, they are an important complement to foster the development in the European Union of a perfectly functioning market for venture-capital and SMEs. Therefore the EuVECA and the qualifying portfolio undertakings in which the EuVECA invest will be assured to benefit from funding sources at the lowest cost.

Footnotes

^{1 Regulation (EU) No. 345/2013 of the European Parliament and of the Council of 17 April 2013 on European Venture Capital Funds.}

^{2 O.J. L 115, 25.4.2013, p. 1.}

^{3 Article 14.3.}

^{4 Article 2 (2) of the EuVECA Regulation provides that where the total assets under management of managers registered under this regime exceeds the AIFMD thresholds and where those managers are therefore subject to authorisation pursuant to AIFMD they may continue to use the designation "EuVECA" in relation to the marketing of qualifying venture capital funds in the EU provided they comply with certain conditions under AIFMD and the EuVECA Regulation.}

^{5-Article 4(1)(a) of the AIFMD defines "AIFs" as "collective invesement undertakings, including investment compartments thereof, which: (i) raise capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the beneift of those investors; and (ii) do not require authorisation pursuant to Article 5 of Directive 2009/65/EC."}

^{6 Article 2 (1).}

^{7 Article 14.}

^{8 Article 15.}

^{9 Article 16(1).}

^{10 Article 16(4).}

^{11 Article 17.}

^{12 Article 7.}

^{13 Article 9.}

^{14 Article 9(5).}

^{15 Article 13.}

^{16 Article 11.}

^{17 Article 12.}

^{18 Article 8.}

^{19 Article 3.}

^{20 Article 5.}

^{21 Article 3(e).}

^{22 Article 3(d).}

^{23 Namely an undertaking that (i) employs fewer than 250 persons and (ii) has an annual turnover not exceeding EUR 50 million or an annual balance sheet total not exceeding EUR 43 million.}

^{24 Financial Action Task Force on Anti-Money Laundering and Terrorist Financing.}

^{25 Article 6.}

^{26 Article 13.}

^{27 For further information, please click here.}

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.