Tue, 05/08/2008 - 13:12
Already the world's second-ranking financial centre behind only the US for the domicile and servicing of investment funds, with some 11,800 funds and sub-funds and assets under management totalling EUR1.9trn at the end of June, Luxembourg is steadily extending its market dominance from traditional retail funds to the alternative investment arena.
A country with a population of nearly 500,000 in a territory of just 2,586 square kilometres sandwiched between Belgium, France and Germany, the grand duchy has in recent years developed a strong track record in alternative investment products and bespoke investment structures including hedge funds and funds of hedge funds, private equity vehicles, real estate funds, securitisation vehicles and pension pooling.
Since World War II, Luxembourg has benefited from a stable legal, political and social environment and has a longer tradition of free movement of capital than its neighbours. It offers competitive tax structures for banking and a very international (and multilingual) business environment. It benefits from strict but responsive prudential regulation alongside strict financial privacy laws.
Like all major financial centres, the county has felt the effect of the turbulent economic and financial environment, but arguably it has survived the credit crunch better than most. "A few funds needed to suspend redemptions and still more enhanced their fair-valuation procedures to cope with the dramatic changes in the underlying liquidity of instruments held," says John Parkhouse, a partner and investment management leader at PricewaterhouseCoopers Luxembourg.
"However, the number of funds impacted in this respect remains minimal, with fewer than 10 being suspended at any point in time. Generally, outflows have been more than matched by inflows into other products."
The impact of the crisis has also been mitigated by other advantages that Luxembourg enjoys over its competitors, such as the country's easy availability of manpower thanks to its. Commuters come from Paris, Frankfurt and even London to work and return home for the weekend, and many thousands more travel into work every day from adjacent regions of neighbouring countries. Because of this, human resources costs are not rising as fast as in other financial centres at the moment.
Luxembourg also has an advantage in supervision and regulation thanks to the multilingual character of its own nationals and of the many expatriates who make up more than a third of the population and more than half of the workforce. The ability to introduce legal documentation in German, French and English gives Luxembourg an international scope that explains much of its dominance as a centre for cross-border fund distribution within the European Union. The authorities are understood to be looking at extending this facility to other languages.
But the main reason for the jurisdiction's soft landing may be the impact on fund business of the introduction of Specialised Investment Funds in February last year as a vehicle for a broad range of alternative investments. "The recent market turbulence has led to a noticeable decrease in the assets under management of Luxembourg funds," says Camille Thommes, director-general of the Luxembourg Investment Funds Association (Alfi). "However, net sales have remained positive throughout the period, with strong inflows from Asia. We are also currently witnessing an important increase in new fund launches, especially in alternatives and the SIF area."
Although the first investment fund created under Luxembourg law was authorised as far back as February 1959, the fund market did not really take off until the late 1980s. In 1988, Luxembourg became the first EU member state to transpose the first Ucits (undertakings for collective investment in transferable securities) directive into national law. The modern and flexible regulatory environment thus created gave Luxembourg a competitive edge over other jurisdictions that were slower to put in place a regulatory structure for cross-border funds.
This reputation as an industry pioneer and innovator has been reinforced by the introduction of the SIF regime, which is designed to offer promoters of alternative investment funds a combination of effective supervision, flexibility and rapid time to market. According to the industry regulator, the Financial Sector Supervisory Authority (CSSF), the number SIFs have increased from 222 in January 2007 - in fact so-called institutional funds set up under an earlier regime - to 716 at the end of June this year, accounting for net assets of EUR128.6bn.
The remarkable growth of the SIF, the most notable feature of which is that its application for authorisation can be sent to the CSSF up to one month after the fund's launch, demonstrates that this light but adequate regulatory regime corresponds to what the market is looking for. "We anticipate strong demand going forward, with promoters coming from new markets," Thommes says. "For example, there is strong demand from Australia."
The continued success of the SIF will be important for Luxembourg as it seeks to build on its reputation within the mainstream fund market to extend its reach within the alternatives world. Didier Prime, a partner and alternatives practice leader at PricewaterhouseCoopers, says: "Although industry awareness still needs to be worked on, we are already seeing major players diverting new products originally destined for Cayman to Luxembourg and - in at least one instance - redomiciling an existing Cayman product as a SIF."
The Luxembourg regulatory environment now has a reputation it did not enjoy a decade ago for being pragmatic and business-focused. Recent regulation has provided more flexibility in the use of repo instruments and securities lending arrangements as well as pending regulation providing clarity with regard to the use of prime brokerage arrangements within Luxembourg funds.
While the planned Ucits IV legislation, which aims to liberalise the regime for cross-border retail funds further, may currently dominate the legislative agenda, other changes are in the offing. "The beginning of this year saw the implementation of the Eligible Assets Directive and a new CSSF circular on securities lending," Thommes says. "We expect the Luxembourg law on Sicars [risk capital investment companies] to be amended shortly to allow the use of multiple compartments, and the new European directive on money laundering to be implemented before the end of this year."
Although it is primarily used as a vehicle for private equity and certain types of real estate fund, the Sicar has been another major success story for Luxembourg as an alternative fund jurisdiction, with around 200 launched since its introduction in June 2004, and is now proven on the international stage. "Sicars can also be established very quickly," says Rémi Chevalier, a partner with law firm Chevalier & Sciales. "A Sicar application comes back from with comments from the CSSF within one to two weeks."
One of the major characteristics of the European fund industry over the past two years is consolidation, much of it aimed at gaining scale rather than acquiring expertise in particular areas. For Luxembourg, much of the consolidation among local players has been driven by the requirements of parent groups elsewhere.
"At the moment, this is more buy-side driven with existing players seeking to expand their breadth and depth in this space rather than players looking to exit," Prime says. "Luxembourg retains a number of boutique or in-house fund administrators, and the trend is more for them to expand their offering rather than for the group to sell up or outsource the administration of their funds. Opportunities still exist in this area as the demands of the product from a complexity and volume standpoint represent further challenges to smaller or purely in-house administrators."
Prime believes that consolidation in the hedge fund administration sector is likely to continue in a competitive global environment where controlling the cost of products and services remains vital. This in turn is influencing service providers to review their current product offering and processes to achieve economies of scale or concentrate on core activities.
Overall, market practitioners believe the future of the Luxembourg fund industry remains extremely bright. The growth of alternative funds, especially in the form of SIFs, is expected to continue. "The ongoing efforts to further enhance the infrastructure supporting the specialist asset classes that are the hallmark of the SIF will certainly be one trend we will see going forward," Prime says.
However, the benefits accruing to Luxembourg from Ucits IV will also help fund providers to develop their global business. Parkhouse says the growth of new products and product complexity within the Ucits framework is continuing as new players look to enter the market and established players continuing to increase the sophistication of their products. "Ucits IV will have implications for Luxembourg and the industry will focus on adapting to the changes which result," he says.
Prime points out that Luxembourg is benefiting from the increasing acceptance of Ucits funds worldwide, with more than 50 per cent of net Ucits sales coming from Asia last year. . "Latin America is an area of growing interest, with Brazil and even Mexico starting to emerge as distribution targets in the short to medium term," he says. "There has been strong growth in both mainstream and alternative products targeting the Middle East, a region that today remains largely untapped in terms of assets."
Meanwhile, Alfi has set as its priorities to increase standardisation and automation and to attract additional talent to Luxembourg. According to Thommes, future growth will come from new distribution markets, pan-European Ucits-style regulation for asset classes such as real estate and private equity, from the long-promised harmonised EU private placement regime and more sophisticated products, whether packaged as Ucits or SIFs. These developments, he believes, promise to consolidate the country's position as Europe's most important fund domicile.
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