Since September 2005 The Netherlands has seen new investment funds legislation and regulations. On January 1 2006 the Dutch capital tax was abolished and further changes in Dutch law regarding investment funds have been officially announced since then. These regulatory and tax developments are both part of a Dutch government effort to improve The Netherlands' position in the international investment funds arena alongside, or surpassing, countries such as Luxembourg and Ireland.

A Dutch fund for joint account (or FGR) is the most common contractual fund structure in The Netherlands. The FGR is getting increasing attention from hedge funds, and often features in the international pension fund pooling debate. Both Dutch and non-Dutch funds now benefit from a highly relaxed private placement regime.

Investment funds legislation

The Dutch investment funds market is regulated by the provisions of the Investment Institutions Supervision Act 1990 (Wet toezicht beleggingsinstellingen 1990 or IISA), which has two main objectives: (1) to procure the integrity of the Dutch financial services market for investment funds generally; and (2) to protect the interests of investors in investment funds in particular. The IISA provides safeguards by imposing licensing, prospectus and other requirements and by maintaining a strict marketing regime in terms of geographical scope. The private placement possibilities have become extensive since this regime was revised on September 1 2005.

The IISA (core provision and scope)

The IISA prohibits the marketing of participations in investment funds unless the manager of the relevant investment fund is licensed under the IISA, or a safe harbour or exemption applies. The prohibition is of a general nature and so not only applies to the fund manager but also to everyone who markets the relevant investment fund (this includes distributors and might in certain circumstances include online brokers). The prohibition aims to prevent fund managers approaching the market without being screened and without a prospectus or other forms of information material being made available.

The prohibition applies whenever investment funds are marketed in or from The Netherlands. So the IISA not only applies to Dutch fund managers or Dutch marketing entities, but it also applies to non-Dutch fund managers that market their funds to Dutch investors, either through a Dutch branch office or on a cross-border basis.

Before September 1 2005, the IISA licence requirement applied to investment funds rather than to their manager. An impractical implication of this was that every time a new investment fund was set up, the fund and its manager would have to go through the licensing procedures, which would take at least two months. The revised IISA now applies the licence requirement to the fund manager, which means that the fund manager will only need to follow a licensing procedure once, after which a rather straightforward notification procedure can be followed each time the manager wishes to launch a new fund. This notification procedure will not take more than two weeks. The revised IISA now provides for the necessary flexibility for managers that manage various investment funds.

Types of investment funds under the IISA

The generic term investment fund is used to cover investment companies and contractual funds. The IISA defines an investment company as a share-issuing vehicle that has collective investment as its purpose, and a contractual fund as any other type of vehicle without legal personality established for the purpose of collective investment. The contractual fund category is intentionally defined in a broad manner to capture all kinds of collective investment arrangements, regardless of their specific structure. In The Netherlands, the most commonly used contractual fund is the FGR.

The FGR

The FGR is created by agreements between the parties involved: the manager, the trustee and the participants (that is, the investors). The manager is the main party. It is mostly the originator of the FGR or a party fronted by the sponsor. The manager is charged with everything concerning the investment process and is often the person carrying out most or all of the market-facing activities. The trustee (bewaarder) plays a more passive, though important, role. The trustee holds the assets on behalf of the FGR. The FGR cannot do this itself as it is not a legal entity and so is not eligible to hold any rights or incur any liabilities. The trustee holds the assets in its own name but for the risk and account of the participants. Under an FGR arrangement, a Dutch trustee will obtain legal ownership of the assets (at least as a matter of Dutch law). There will be no beneficial ownership for the participants (the beneficial ownership concept is not known under Dutch law – other than recognizing non-Dutch beneficial ownership structures pursuant to the Hague Convention on the Law Applicable to Trusts and on their Recognition) and the term trustee might therefore be rather misleading. Participants in an FGR will only have economic ownership. The trustee does not hold the assets on trust (as the concept is used in the UK and the US). It is, among other things, for that reason that most FGRs rather use the term depository or custodian for the entity taking on this role.

Besides holding the assets in its name, the trustee is also charged with supervising the manager. This is not a general supervisory obligation but an investment-specific one. The trustee is required to approve every investment transaction proposed by the manager to ensure that investments are made within the FGR's investment objectives, restrictions and other parameters set by the FGR (in the prospectus or elsewhere). This supervisory role is expressed in the requirement that trustee and manager may only dispose of the assets jointly. Technically speaking, this means that the manager has to consult the trustee and get approval from the trustee for each and every transaction that the manager wishes to enter into. There are practical solutions for this. In practice, the trustee will periodically (for example, every week or month-end) review the manager's investment activities and will verify whether these have been carried out in accordance with the investment objectives and restrictions. The trustee is furthermore under the obligation to ascertain that the sale, issue, re-purchase and redemption of participations in an FGR are carried out in accordance with applicable regulations and the terms and conditions of the FGR. Also, the trustee is required to monitor that that calculation of the net asset value is done in accordance with the terms and conditions. The participants will not acquire shares but participations in the FGR. This is more an economic than a legal feature. The participations will entitle the participants to a pro rata share of the assets, mostly only redeemable in cash and not in kind. In legal terms, this entitlement is a claim vis-à-vis the trustee. The contractual arrangement usually comes about by creating terms and conditions (to some extent comparable to the articles of association of a company). These terms and conditions will, among other things, impose obligation both on the trustee and the manager and will form the contract between the trustee and the manager on the one hand and each participant on the other hand. This contractual arrangement could be supplemented by the terms of a subscription agreement (often containing participant representations and warranties) and the fund's prospectus.

Trustees of contractual funds do not require a separate licence under the IISA but are required to comply with certain rules. Before September 1 2005, trustees could provide services to an unlimited number of FGRs. Consequently the assets and liabilities of fund x would mingle with the assets and liabilities of fund y, because acting as trustee for a contractual fund means that the trustee becomes the legal owner of the fund assets, as well as the one incurring liabilities in its own name on behalf of the fund. Acting as trustee for multiple contractual funds would therefore result in the trustee obtaining undivided legal ownership of the assets of all of the funds for which it acts as trustee, as well as undivided exposure under liabilities. And because asset segregation is not established as a matter of law, this meant that a trustee could act as trustee for both a conventional long-only fund as well as a hedge fund with short positions, resulting in exposure for the long-only fund on the short-selling hedge fund. In extreme cases, this could involve investors having to pick up the bill of a downturn in performance of a fund in which they have not invested. To eliminate this risk, the IISA now provides that investment funds that carry so much risk that their fund assets are not enough to satisfy claims should make use of a specialized trustee that will not act as trustee for other investment funds.

Contractual funds within the meaning of the IISA are not just funds for joint account. The definition in the IISA allows for all types of contractual funds to be captured by it, both Dutch and non-Dutch contractual funds (such a contractual partnerships). The IISA covers all types of collective investment vehicles, except for collective investment vehicles that primarily fund themselves by the issue of debt instruments (such as equity-linked notes). The issue of debt instruments by investment funds, or fund-like vehicles, gained in popularity in recent years because the regulatory and tax regime for this type of profit-participating note was a lot milder. However, now that the private placement possibilities under the IISA have been expanded (see below) and Dutch capital tax for investment funds has been abolished, the main reasons for choosing debt funding over equity funding no longer exist.

Safe harbours under the IISA

The IISA licence requirement for fund managers does not apply to fund managers of non-Dutch Ucits. In line with the European Ucits Directive (1985/611/EC), the IISA simply requires an incoming Ucits to notify the IISA's supervisory authority – the Authority for the Financial Markets (Autoriteit Financiële Markten or AFM) – of its intention to undertake marketing activities in The Netherlands. As per September 1 2005, the IISA now also implements Ucits III (2002/107/EC and 2002/108/EC).

Also, the IISA licence requirement does not apply to investment funds that are established in countries in which the Dutch Minister of Finance has decided that adequate supervision on investment funds exists. Under the IISA, there is a general discretion for the Minister of Finance to designate such countries. In practice, the Minister relies on the AFM to investigate the regulatory regime in countries that have indicated to the AFM that they wish to benefit from this safe harbour. Countries that have so indicated and have been appointed as such by the Minister of Finance on December 16 2005 are the US, Luxembourg and Guernsey. The decree issued by the Minister of Finance on December 16 2005 appointing these countries specifically referred to Guernsey open-end funds only and therefore excluded Guernsey closed-end funds. This has now been remedied – the decree was amended on February 20 2006 and now also allows for Guernsey closed-end funds.

Exemptions from the licence requirement

Licensing requirements were easily triggered before the September 1 2005 revision. Practically the only private placement exemption was that a licence was not required if the fund was marketed to professional investors only. Making use of this exemption has proven to be burdensome in practice, because only investors that truly invest in the course of their profession qualify as such (these are mainly institutional investors). One does not simply qualify by virtue of investment expertise but needs to be active in the market in a commercial manner. The category does not easily allow for high-net-worth individuals or family offices, and making investment funds available to this type of investors was almost impossible. The new Exemption Regulation to the IISA maintains the professional investor exemption but now provides for more private placement rules.

An exemption from the licensing requirement is now available if the fund is marketed to fewer than 100 investors in The Netherlands (not being professional investors). This exemption is not completely new as the former IISA provided for a safe harbour under the licensing rules where the fund was marketed within a closed circle. This safe harbour was, however, not easily constructed because it required a pre-existing non-financial relationship between the fund manager and investors in the fund. This requirement has now been abandoned and the mere restriction in solicitation to fewer than 100 investors will provide for an exemption. Obviously, the fund manager (or the distributor) will need to keep track of the offers made as the burden of proof that the solicitation has indeed been limited to fewer than 100 investors rests on the fund manager. Marketing in newspapers, magazines or on the internet will make it impossible to rely on this exemption, as the offer will need to be made personally.

Another new exemption relates to the nominal value of the securities offered. This exemption is available where securities with a denomination of at least €50,000 are offered. Another exemption – which is a variation on this minimum denomination exemption – is available where the total consideration for the securities is at least €50,000 per investor. This allows for securities with lower denominations and offered as a package for a purchase price of at least €50,000. For securities without denomination this exemption means that a minimum investment amount of €50,000 will apply. Both exemptions presuppose that investors who invest in these types of instruments will avail of the necessary expertise and professionalism to form their own opinion about these investment funds. These exemptions are now typically suitable as a basis for targeting high-net-worth individuals in The Netherlands.

A final new exemption implements regulatory guidance on venture capital companies. These have always been viewed as falling outside the scope of investment fund regulation if they are involved in the management of the companies in which they invest. The legislator has now formalized the regulator's policy guidelines and exempts venture capital companies from licensing requirements provided they invest in unmarketable securities and enter into management agreements with the investee companies that allow for substantial influence on the daily management of the investee company. The legislator is of the opinion that venture capital companies that meet these criteria put their focus more on funding investee companies than on the view to let their investors share in revenues.

All of the above exemptions can be used in conjunction, which means that for instance a fund can be marketed both to professional investors as well as to non-professional investors, provided the latter category is limited to fewer than 100. These new exemptions find their origin in the EU Prospectus Directive, which – although it does not apply to open-ended funds – has been used as a model by the Dutch legislator so that the Exemption Regulation will to a large extent procure harmonization with other financial services legislation (in and outside the Netherlands).

The IISA licence

In situations where a safe harbour is not available and an exemption does not apply, fund managers of Dutch funds and non-Dutch funds that wish to market in The Netherlands will require an IISA licence. The licence will be granted to the fund manager if it demonstrates that it (and the trustee, if and to the extent applicable) complies with requirements relating to: (i) expertise and trustworthiness; (ii) financial resources; (iii) management; (iv) provision of information to potential investors and supervisory authorities; and (v) safeguards for adequate supervision. The licence will need to be applied for with the AFM, which is the main regulator under the IISA.

For non-Dutch fund managers, additional requirements will apply. For, as they are not established in one of the countries that the Ministry of Finance has designated as countries with adequate supervision on investment funds, and the fund manager is not established in The Netherlands, there will be no substance in The Netherlands for the AFM to supervise. The AFM has therefore issued a policy rule with additional requirements that need to be complied with for fund managers to become eligible for a licence, the main ones of which are that: (i) the fund manager should have organizational and/or economic ties to a financial institution in The Netherlands that is subject to supervision by the AFM or the Dutch Central Bank (De Nederlandsche Bank); (ii) at least two seats on the fund manager's managing board should be taken up by persons domiciled in The Netherlands and these persons should be contactable for the AFM; (iii) the fund's external auditor must be available and accessible in The Netherlands on the AFM's demand; and (v) the fund's administrative organization should comply with certain requirements.

Hedge funds

The IISA does not have a separate regime for hedge funds. In reporting on an analysis of the Dutch hedge funds markets carried out by the AFM in 2005, the AFM said that it sees no reason why the IISA should be amended to specifically cater for hedge funds. The AFM feels that the IISA's safeguards are adequate to address specific hedge fund concerns.

Taxation of investment funds

The 0.55% rate capital tax for Dutch funds was abolished on January 1 2006. Previously, capital tax was payable on contributions to the fund, irrespective of the form (for example, nominal capital or share premium) of the contributions. The abolishment of capital tax for funds is part of the wider initiative to make The Netherlands a more attractive jurisdiction for investment funds. Also part of that initiative is the introduction of a fully tax-exempt investment company or fund designed to be comparable to a Luxembourg Sicav. Lastly, the Ministry of Finance has also committed to review the rules governing the zero rate corporate tax regime for investment funds that qualify for the status of fiscal investment institution. This review will include possible relaxation of present requirements that are disadvantageous for non-Dutch investors, in particular those with respect to investor status and residency.

Author biographies

Robert Smits Clifford Chance Amsterdam Robert Smits is a lawyer at Clifford Chance Amsterdam, in the funds and investment management group. He specializes in the legal and regulatory aspects of investment funds, discretionary asset management, and clearing and settlement. Ate van IJlzinga Veenstra Clifford Chance Amsterdam Ate van IJlzinga Veenstra is a partner and head of the Clifford Chance Amsterdam funds and investment management group. He specializes in legal, regulatory and tax aspects of investment fund structuring, in particular institutional and retail funds, hedge funds, and private equity funds.