Administrators in Luxembourg gear up for the demands of a changing business
With a substantial majority of the more than EUR2trn in assets of Luxembourg-domiciled and regulated funds administered in the grand duchy represented by traditional funds, the country's alternative investment services sector - unlike Ireland's, for instance - has kept a relatively low profile in recent years. But with the already impressive level of growth in the sector having received a visible boost from the launch of Specialised Investment Funds in February, hedge fund administrators are starting to become a more visible part of the financial services landscape.
That's down in part to Luxembourg's success over the past couple of years in attracting work from funds established in other jurisdictions, mostly the offshore domiciles of the Cayman Islands, British Virgin Islands and Bermuda, which accounted for some 35 per cent of the EUR160bn in hedge fund assets administered in the country at the end of 2006. Many members of the industry attribute the emergence of this business directly to the relatively recent decision by the Luxembourg Stock Exchange to accept offshore funds for listing, a key element in making what are largely unregulated vehicles palatable to institutional investors.
The statistics do not take into account a surge in the volume of funds established under the European Union's Ucits III legislation, which governs cross-border distribution of retail funds, that are using the greater investment flexibility available under the directive to offer hedge fund-like strategies, using derivatives and some leverage. Accommodating these funds is expanding the skill base available to Luxembourg administrators for the servicing of alternative products.
The strength of the country's traditional fund services sector means that there is an extensive range of providers established locally, many of which are starting to use their existing structure and resources to expand into the alternatives field. 'It is an advantage for Luxembourg that there are already many custodian banks servicing existing Ucits funds,' says KPMG Luxembourg director Victor Chan Yin. 'If fund promoters want to set up other types of structure such as private equity or real estate, they already have a foot in the country. It may be easier for them because they already know Luxembourg and the market players.'
Today there are at least 38 administrators of single-manager hedge funds and funds of hedge funds, most of which also service Ucits funds but including a number of providers such as Citco and HSBC (formerly Bank of Bermuda) that are primarily focused on alternative rather than traditional funds. The Luxembourg Fund Industry Association (Alfi) is making a concerted effort to highlight the importance of the sector in its expanding efforts to market the industry abroad.
'Alfi has criss-crossed the globe over the past four years in its very successful series of roadshows,' says Michael Ferguson, a partner and leader of the asset management practice at Ernst & Young in Luxembourg. He notes that these efforts are set to redouble in the future as the financial services sector and the government put in place new structures to promote the industry.
'Through government-sponsored trade and economic missions, Luxembourg has been extremely active over the past five years in communicating to the financial services world what it is all about, including explaining what the country has done (and will continue to do) to retain its position as the world's second largest investment fund centre,' Ferguson says. 'The government is in the process of establishing for the first time an agency responsible for promoting all sectors of the Luxembourg financial services industry.'
Now, industry members say, the administration sector can boast a range and availability of skills capable of meeting the demanding standards of the largest alternative fund managers. Several of the leading players in Luxembourg, like RBC Dexia Investor Services and Fortis Prime Fund Solutions, have built on the foundations of well-established traditional fund businesses established by predecessor institutions Banque Internationale à Luxembourg and Banque Générale du Luxembourg respectively.
RBC Dexia is the product of the combination of the hedge fund administration businesses of Royal Bank of Canada and Dexia, while Citigroup Global Markets recently added a considerable store of global hedge fund expertise with the acquisition of Bisys. All three businesses benefit from sharing not only IT platforms and resources but administration expertise across their international networks.
For example, says Luc Leleux, director of business development at Fortis Prime Fund Solutions, the group's fund administration network comprises some 16 locations around the world, including major operational centres for alternatives in Dublin, the Isle of Man, Cayman and Hong Kong as well as Luxembourg. Outside the grand duchy Fortis has as much as USD240bn in alternative assets under administration and is ranked the biggest fund of hedge funds administrator in the world.
'All the production centres use the same technology,' Leleux says, 'Advent Geneva for fund accounting, like most of the major players in the alternatives world, and Koger's NTAS for transfer agency. Since Fortis Prime Fund Solutions Luxembourg is plugged into the group's global IT infrastructure, if necessary certain administrative functions can be carried out in other jurisdictions where this is permitted by the regulator.'
Eric Kata, director of business development for alternative investment, says RBC Dexia Investor Services uses client-facing staff in France and London as well as Luxembourg to answer the need of customers to have direct contacts close at hand, while drawing on resources elsewhere in the business.
'Our French clients want to be serviced from France, and our London-based clients want to be able to discuss matters quickly with colleagues in London,' he says. 'We are extending our capacity to different parts of the group in order to be able to service our clients where it's possible as close to them as possible, and we are planning to develop this in Asia and Australia in the future.'
Nina Kleinbongartz, product manager for alternative investments in Europe with Citigroup Global Markets, sees great benefits ahead for the business from synergies with Bisys, following the announcement of the acquisition in May. 'Citi is one of the five largest fund service providers in Luxembourg, and we support more than 100 fund distributors active in more than 50 countries,' she says. 'We are looking to expand the whole range of funds we service, which encompasses traditional, alternative, exchange-traded, pension and structured funds. We are in a strong position following the acquisition of Bisys, whose technology platform will enable us to leverage our expertise in all areas.'
The administrators say the launch of SIFs has pleasantly taken aback some of their clients who are familiar with a more conservative image of Luxembourg. 'We are making a marketing effort to explain that we have this SIF vehicle to the rest of the world, because some of our clients are surprised,' Kata says. 'When I meet clients I explain what a SIF is and what the advantage is for them. It is important that everyone in the Luxembourg community contributes to this marketing effort, which ultimately will benefit everyone.'
In the past Luxembourg may have failed to market itself sufficiently as a centre for alternative funds, Chan Yin says, but those days are long gone. 'Alfi has been on roadshows to promote the SIF for all types of alternative investment,' he says. 'Luxembourg now has a product that fully meets the requirements of hedge funds. The structures that existed previously were more geared to other types of investment than to hedge funds, but now we have a product that is at no disadvantage compared with Cayman or Ireland.'
Early signs suggest that demand for SIFs is not limited to any particular countries and regions - although German promoters have been enthusiastic early adopters - nor particular asset classes. 'It is coming from right across the globe, Europe, Asia and the Americas,' Ferguson says.
'Some promoters see the SIF as an ideal structure in which to house various alternative strategies, real estate, private equity and hedge funds, while traditional asset managers, investment banks and private banks see it as an efficient cost and operational model to create products for their private high net worth clientele. Others are converting their offshore products into SIFs as they feel that a Luxembourg SIF will add a 'brand' quality vital for their distribution.'
The introduction of SIFs may promise more business for Luxembourg but not necessarily any revolutionary new challenges for service providers. 'All the big global service providers including accountants, lawyers and fund administrators have been active in Luxembourg for many years,' Ferguson says.
'Over the past five years, as Luxembourg became a more active player in the alternative investment world, the providers have developed specialised departments to deal with non-Ucits products. These departments are run by staff experienced in dealing with all the unique characteristics of alternative fund products and are supported by various centres of competency established by their parent organisations around the globe.'
Members of the industry are keen to rebut criticism occasionally levelled at Luxembourg and its regulator, the Financial Services Supervision Commission (CSSF), for the legal requirement that central administration for both traditional and alternative funds be carried out in the grand duchy, and the insistence on appointment of a custodian, even for classic single-manager hedge funds that turn to prime brokers for many custodial functions, saying these issues do not in fact put the jurisdiction at a disadvantage as a domicile.
'I don't believe the central administration issue is a problem in terms of winning new business, when you look at the number of funds domiciled in the country,' Chan Yin says. 'In fact the requirement to carry out central administration in Luxembourg is a plus, because it brings funds under a European regulatory regime. In addition, asset managers that have set up Ucits in Luxembourg may prefer to set up other types of structure such as hedge or private equity funds here as well for ease of administration rather than having Ucits in Luxembourg and hedge funds in Dublin or Cayman.'
Ferguson agrees, saying: 'One of the reasons offered by managers for converting their offshore products to Luxembourg SIFs is that they wish to consolidate all their traditional and alternative products on a single service platform. Indeed, as well as administering locally domiciled funds, Luxembourg is increasingly administering funds from other offshore jurisdictions, indicating that it appears to be the administration centre of choice for many promoters.'
The requirement for a custodian, he adds, does not add significantly to the complexity or cost of doing business. 'The role of the custodian should be understood to be that of a supervisor - that is, the custodian should know how and where the assets are being held, but it does not have to hold the assets itself,' Ferguson says. 'Most single-manager hedge funds will have prime brokers, and many more than one, in which case assets will normally be held (or loaned onward) by the prime broker.
'Therefore the Luxembourg custodian should carry out a certain level of due diligence around the appointment of the prime broker in terms of good reputation, appropriate experience and financial resources, which for the established names should not be a big challenge, and ensure a reporting mechanism is in place on how and where the assets are being held. The fund industry is currently working with the CSSF to clarify the relationship between the prime broker and custodian by way of a circular over the coming months.'
According to Chan Yin, the debate about whether the custodian requirement made Luxembourg less attractive as a hedge fund domicile was taken into account when the SIF regime was under development. 'There will be guidance from the CSSF on what supervision the custodian will need to perform on the prime broker,' he says. 'This is an issue for single-manager hedge funds, but not other types of funds. And if the custodian and the prime broker is the same bank, there is no issue.'
Meanwhile, administrators believe that the continuing blurring of the lines between hedge funds and traditional asset management strategies can only benefit Luxembourg as a jurisdiction. Says Kleinbongartz: 'We're in a position where dedicated hedge fund managers and service providers have an advantage over other asset managers and administrators, who are starting to enlarge their scope to incorporate the derivatives side, but are still building up their expertise.
'So while from a product point of view the lines are blurring, from the provider viewpoint there's still a division between those that have the experience and those that are just acquiring it. With the acquisition of Bisys, Citi is playing in both domains. Previously we were constructing our business as more of a traditional provider that was adding derivative-type instruments and hedge funds to its range of services, while Bisys was already a specialist. The acquisition should let us tap into both markets going forward.'
Kata adds: 'Currently the biggest growth area is on the Ucits III side, but some managers have a choice to make as to whether to go in the traditional way with a Ucits fund, or to opt for a SIF, which is popular among medium-sized clients as well as big groups looking for additional have flexibility. What the SIF does is provide an interesting alternative that gives clients more choice than in the past, and creates opportunities to attract new types of client.'
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