What challenges do Latin American managers face in the legal structuring of an investment fund?

The legal structuring of an investment fund is a process that requires careful analysis of various legal, regulatory, and tax aspects. During this process, investment managers encounter several challenges, including determining the jurisdiction, type of fund, appropriate legal structure, selection of officials, investment management vehicle, and its future distribution.

Below, we analyse some of the aspects that Latin American investment managers consider when establishing their investment vehicles:

Jurisdiction: One of the first decisions managers face is the selection of jurisdiction, evaluating whether they need to establish a local (onshore) or international (offshore) investment fund.

In the first case, certain types of funds domiciled in countries within the region may offer specific benefits to investors from that country in terms of market access, regulatory familiarity, and tax benefits, making it an attractive vehicle for certain investment proposals.

In the second case, in Latin America, establishing offshore investment funds is a common choice due to their flexible legal framework, tax neutrality, and lower costs. Generally, Latin American investors have no restrictions in their countries on investing in offshore funds. These vehicles are also familiar to the North American market, with the Cayman Islands as the predominant jurisdiction, followed by the British Virgin Islands, Bermuda, and the Bahamas.

European options, such as Ireland or Luxembourg, are also relevant for setting up investment funds. These options are primarily attractive for managers whose investor base is in Europe, as they facilitate the fund’s commercial promotion in that market. On the downside, these funds are typically more regulated and costly than offshore funds.

Open-ended funds are liquid investment funds that allow investors to redeem their shares at any time, according to the frequency established by the fund (daily, monthly, quarterly, etc.).

These funds are regulated by the Mutual Fund legislation of the respective jurisdiction, generally establishing different fund categories depending on the number of investors, minimum investment per investor, and/or assets under management.

Closed-end funds (such as Private Equity or Venture Capital) are investment vehicles intended for illiquid investments, implying a longer-term investment. Consequently, the legal structuring in these cases differs, as redemption is not at the discretion of investors but follows the timelines established by the fund and the discretion of its directors. Until recently, closed-end funds were not regulated, but since 2019, most offshore jurisdictions have introduced regulations, making them regulated vehicles (except in a few jurisdictions, such as Canada, which has seen growing use in recent years).

An offshore investment fund is a legal vehicle that obtains a fund license issued by the regulator of the respective jurisdiction. The legal vehicles used can be a corporation, a Limited Partnership, or a Unit Trust. In Latin America, it is common practice for open-ended funds to primarily use corporations as legal vehicles, while closed-end funds are predominantly set up using Limited Partnerships.

Once the jurisdiction, legal vehicle, and type of fund are determined, the investment manager must secure the necessary officials for the fund's operation. For this purpose, the manager must select (i) legal advisors responsible for drafting the fund documentation and obtaining the license, (ii) administrators responsible for calculating the fund’s share price; (iii) auditors to audit the share calculations and fund accounting; (iv) independent directors, recommended for good corporate governance; and (v) custodian banks and brokers.

Regulated funds are typically managed by a licensed vehicle for managing financial assets. Offshore jurisdictions generally do not restrict investment management companies constituted in most Latin American countries from directly managing the fund’s investments. However, due to operational and tax factors, Latin American managers often opt to establish a licensed investment management vehicle in an offshore jurisdiction.

The marketing of the investment fund is another consideration for managers when setting up their structures. In an investment fund, investors may subscribe directly or through the bank where they hold an account. In the latter case, certain banks—especially in North America—may require agreements to allow this operation. Issuing a note program can be an efficient alternative for achieving wider fund distribution.

Determining tax aspects is a crucial factor in structuring. Although the offshore jurisdictions mentioned offer tax neutrality, it is essential to assess the tax impact across all jurisdictions involved (investors’ residence, place of investments, etc.) to define the most efficient structure.

The legal structuring of an investment fund is a complex process that requires careful planning and consideration of various factors, including those mentioned above. With a solid understanding of these aspects, Latin American managers can make informed decisions that benefit both the fund and its investors.

This article was originally published in Flexfund’s 2024-2025 annual report.