Luxembourg’s asset servicing industry has much to be proud of with record large net inflows of various funds, and its reputation for being the first member state, on 30 March 1988, to transpose the UCITS Directive into national law. This marked an important step that helped establish the country as a leader in the field of investment funds globally and helped build its reputation for reactivity.
“The grand duchy of Luxembourg is a brand in itself and a testament to this is the enduring popularity of its UCITS product,” highlights Eduardo Gramuglia Pallavicino, head of State Street Luxembourg.
Looking at the current climate of Luxembourg’s fund industry, Gramuglia, says: “As cross-border products remain an optimal path for growth, domiciles like Luxembourg that can meet regulatory obligations confidently and efficiently are seen as a natural choice by asset managers, allowing them to mitigate risk, achieve economies of scale and reach investors globally.”
Daniela Klasen-Martin, group head of ManCo Services at Crestbridge, has described Luxembourg’s fund industry as “exciting”, explaining that having worked in the industry in Luxembourg for almost 23 years, with lots happening during this time, now is “without a doubt the most interesting time”.
Indeed, there has been lots of positive development over the last few years, with assets under management growing from €2.6 trillion in December 2013 to €4.7 trillion in December 2019.
Industry experts observe that there continues to be increased interest in establishing funds in Luxembourg as the predominant fund distribution centre in Europe. Klasen-Martins says this is thanks to the “quality brand that asset managers and service providers have shaped during the years”.
Looking at how the fund industry in Luxembourg will further grow and develop, industry experts look at the topics and trends such as the Green Exchange, Luxembourg’s relationship with the UK amid Brexit, and the increased popularity of alternative funds. We also discover the implications of COVID-19 challenges, among others, in this space.
A popular alternative
Across the asset servicing industry, alternative funds are becoming increasingly popular and this trend is also being seen in Luxembourg. An alternative investment relates to a financial asset that does not fall into one of the conventional investment categories, such as stocks, bonds, and cash.
But aside from just following the trend, Fèmy Mouftaou, the chief commercial director at IQ-EQ, cites that in particular, Luxembourg “stands out as a jurisdiction for alternative funds as it offers a unique set of investment vehicle types and forms, which can capture all structuring requirements and all appetites of global fund managers”.
The Association of the Luxembourg Fund Industry (ALFI), which represents the face and voice of the Luxembourg asset management and investment fund community, says that the growth of alternative asset classes is undeniable.
“From a macro-economic point of view, there are many factors which contribute to the success of alternative funds; the search for yield given the low-interest rate environment, the low or negative correlation to other asset classes and between these alternative asset classes, and the long-term investment horizon that pension funds, insurance companies and institutional investors adopt,” comments Marc-Andre Bechet, deputy director general of ALFI.
One challenge with alternative funds was that they were unregulated, but now they are governed by a regulatory framework, which Bechet says has the potential to develop into a global brand just like UCITS did. This is something that ALFI has noticed in particular when organising its roadshows in Asia, Latin America and the US.
Now that the industry has taken on the challenge of implementing the Alternative Investment Fund Managers Directive (AIFMD) – a regulatory framework for alternative investment fund managers (AIFMs), including managers of hedge funds, private equity firms and investment trusts – there has been a shift towards funds.
Klasen-Martin notes that this has led to the continued success of Luxembourg as a domicile for alternative funds.
Each year ALFI publishes three surveys on the main alternative asset classes in Luxembourg. Looking at the data, ALFI demonstrates that in 2019 there were robust growth rates in all three asset classes. ALFI notes that in contrast, for the past 12 months up to the end of September, assets of UCITS increased by + 8.02 percent.
Going green
Something else that country is proud of, is its Luxembourg Green Exchange (LGX), which has established some of the first real standards in the industry – changing the way green securities work forever, according to State Street’s Gramuglia.
“The initiative dedicated exclusively to sustainable financial instruments has been a first of its kind. The green exchange has created an ecosystem that brings together pure environmental, social and governance players”, says Gramuglia.
Launched in 2016, LGX lists 50 percent of the world’s green bonds. Klasen-Martin identifies that the main advantages of this are that investors can freely access the documentation of the underlying products thus increasing transparency and giving the possibility to make informed decisions.
“In addition, fund promoters benefit from higher visibility, allowing them to diversify their investor portfolio and communicate about their sustainable investment strategy,” she adds.
ALFI actively supports the initiative of the European Commission to promote sustainable finance.
Bechet cites: “Luxembourg is fully committed to sustainable finance and has been an early mover in this field. Today, Luxembourg accounts for 34 percent of funds and 35 percent of total assets under management in European responsible investment funds.”
A strong relationship
Luxembourg is seeing further opportunities as a result of Brexit, as although the UK has now left the EU, Luxembourg has always had a strong relationship with the UK, according to industry experts. IQ-EQ’s Mouftaou observes: “Brexit has impacted the Luxembourg fund industry in several ways. For a start, we are seeing more and more international fund promoters now looking at Luxembourg as the preferred domicile for their fund structures dedicated to European investors.”
He continues: “The instability created by Brexit has given Luxembourg the opportunity to present itself as a stable and solid alternative environment for funds. Notably, the major global asset managers are now seeing Luxembourg as a key location in which to have an office and are also considering it for their headquarters.”
Bechet weighs in on this noting that “Luxembourg and London are long-standing partners in the asset management and fund industry: funds are domiciled in Luxembourg while portfolio management is carried out in the UK. UK asset managers are the second largest group of initiators of Luxembourg investment funds. While Luxembourg has not aggressively ‘pitched’ for business from London, fund professionals stand ready to help their UK counterparts. Brexit preparedness from both sides is ‘as good as it can get’. Some 30-plus asset managers have relocated or transferred their funds to Luxembourg, with their market share going up from 17.6 percent (2017) to 18.4 percent (2019).”
Post-Brexit, Luxembourg and London will strive to keep their markets open, with a view to giving investors the greatest possible choice of investment solutions, according to ALFI.
Unprecedented challenges
Some of the main challenges that the fund industry in Luxembourg has been facing is regulation and increasing substance requirements. Klasen-Martin explains that the expectations have been evolving recently as the Luxembourg regulator published in 2018 the circular 18/698, which gives a clear outline of what is expected in terms of substance and governance requirements.
“Launching your own AIFM can become a challenge as the regulator has set very clear demands with regards to the minimum governance required when setting up operations in Luxembourg, i.e. minimum staff, the level of seniority required and the infrastructure needed to support the day-to-day operations,” Klasen-Martin says.
Additionally, the regulator puts a strong emphasis on proper oversight on all delegations such as risk management or portfolio management, distribution but also outsourced services such as IT and accounting, according to Klasen-Martin. These requirements coupled together can present a challenging operation and a considerable investment in non-revenue generating ongoing costs.
However, outside of regulation, the world has recently been shaken with unprecedented challenges that have stemmed from COVID-19.
Looking at how the alternative funds space will respond to COVID-19, Mouftaou says: “With alternative funds, the fund lifecycle is much longer than in the UCITS space, for example. Consequently, the trend should be that alternative funds are less impacted by the fall of the liquid markets. At the same time, we can anticipate some fund managers and investors seeing an opportunity to take advantage of the market volatility to change their allocation.”
Also discussing the current pandemic, Bechet cites: “The COVID-19 crisis is a test of the resilience of our financial system, stretching it to the upper limits. So far, there is a sense that the tools in place have worked relatively well, but we are not at the end of the crisis yet.”
Bechet also notes: “ALFI has actively engaged in an open and constructive dialogue with the CSSF and the authorities in Luxembourg, as well as at European level. A number of questions have been satisfactorily addressed.”
“In these difficult times, we can only express our thanks and gratitude to all these public bodies for their swift and pragmatic reaction. Staff in the financial sector in Luxembourg and citizens, in general, have been extremely resilient, motivated and keen to follow guidance from our authorities. Let us appreciate that!” Bechet concludes.
