GAAP in Lux

The Drawdown: There have been some changes made to how funds based in Luxembourg file their accounts; what’s going on? 

Nic Mueller: This all goes back to the original implementation of the AIFMD almost 10 years ago. Back then, Luxembourg’s implementation was very close to the spirit of the directive as a piece of legislation that is inherently cross-border.

Specifically, the Article on reporting requirements stated that the AIFM needs to make sure there are audited financial statements for each fund managed. Where the manager is in a different country, the Article provided clarity on which accounting standards to use, i.e. not the one of the manager’s home country but the one of the fund’s home country. 

At the same time, Luxembourg implemented its LP fund structure - the SCSp, which most private equity firms use. The SCSp and AIFMD implementation came into force at the same time. 

As a limited partnership, the SCSp structure in its purest form doesn’t need to prepare financial statements. This means you could create a limited partnership in Luxembourg but wouldn’t need to file financial statements. But, if managers did want to draw up financial statements, they can use whichever accounting standards they want, typically the standards relating to what the limited partners are most familiar with. 

Typically, LPAs state which accounting standards will be used. It has meant there’s been a level of flexibility in how Luxembourg-based funds are treated. Looking at large managers with Luxembourg funds, interpretation of these rules has been wide. 

TDD: So what has changed? 

NM: In January this year, the Luxembourg regulator said that funds based in Luxembourg managed by a regulated local AIFM must draw up their financial statements using the Luxembourg GAAP accounting standard or IFRS. So that flexibility has suddenly been taken away. 

For example, US managers with Lux sleeves would have used US GAAP standards, and now that’s no longer permitted on a standalone basis, following the Q&A of the Luxembourg regulator. 

TDD: Is this a positive or negative change? 

NM: In principle the regulator could be less concerned about the fund — they regulate the manager not the fund — but it introduces another inconsistency: the whole reason for filing financial statements is because it is part of the AIFMD, and that concerns the manager’s domicile, not the fund’s, so it would be interesting to learn how the other member states interpret the same article in a cross-border scenario.

TDD: Is the regulator tapping into a territory where it shouldn’t?

NM: The main message is that this might introduce more complexity when it comes to cross border funds. But Luxembourg has always positioned itself as being an open and efficient domicile. 

TDD: What does this mean for managers with funds based in Luxembourg?

NM: There will be an impact on workloads. Ideally you have a fund administrator based in Lux, which should mean the transition is easier. 

But if you played low substance then there will need to be a change in the way you are working; you will need someone to convert the accounts to Lux GAAP or IFRS.

It doesn’t necessarily mean this is harder for smaller managers and easier for larger ones. It could be that smaller managers used Lux GAAP from the beginning whereas larger managers on their eighth, ninth or tenth fund that always used US GAAP will find this more difficult to deal with.

TDD: What about the LPA? If managers stated they are using specific accounting standards? 

NM: It raises many questions. If the LPA says ‘we report in US GAAP’, then who pays for preparing the Lux GAAP accounts? When is this for? Which accounts does it apply to? Whilst the actual translation to local GAAP itself may not be difficult per se, the concept of having “two NAVs” is simply not very intuitive to limited partners. 

TDD: Do any other domiciles do this? 

NM: To the best of my knowledge, the Netherlands has had this view for some time. For managers with funds based in the Netherlands they have to use Dutch accounting standards. 

The US has a custody rule; there is an SEC rule around having US accounts but you can get away with it through an accounts reconciliation from domestic GAAP to US GAAP if it is a non-US domiciled fund. 

There is some variance between country GAAPs. The biggest difference used to be the notion of ‘Fair value’, but we have come a long way with world-wide standardization efforts and Luxembourg might turn to the IPEV guidance as a common denominator. So, in general the NAVs you calculate should be fairly similar but the devil is in the detail.