One of the most striking features of the Luxembourg alternative funds sector, and the private equity business in particular, is the continued influx of service providers originating from longer-established industry centres, such as the Channel Islands. This trend reflects a consensus in the industry that over the past decade the grand duchy, previously better known for traditional retail funds, has developed a critical mass of private equity activity and expertise.
“One thing that’s very encouraging is the increasing number of new service providers such as Augentius coming to Luxembourg from offshore locations,” says Benjamin Lam, an audit partner and head of private equity at Deloitte Luxembourg. “It’s a very strong signal that it is becoming the administration location of choice for the private equity industry.
“Service providers asked about their reasons for coming to Luxembourg say it is very much driven by their clients, which are setting up structures here. Even before the EU [Alternative Investment Fund Managers] directive is in place, more people are realising it’s better to put their structures in jurisdictions that are well recognised, such as Luxembourg.”
Another recent arrival is Ipes, like Augentius a specialist private equity administrator that has roots in the Channel Islands; established in Guernsey in 1998, it has offices in Jersey and London, and established a Luxembourg subsidiary at the end of last year. The firm is currently operating with a chartered accountant’s licence that enables it to work with unregulated entities while it awaits authorisation to service regulated funds from the industry regulator, the Financial Sector Supervisory Authority (CSSF), which is expected imminently.
“Ipes decided to establish the office in response to demand from clients with a need for Luxembourg vehicles,” says managing director Simon Henin. “It’s also a development that widens our network of offices, as many administrators are doing, in order to be able to offer a high-quality pan-European service to structures that involve a number of different jurisdictions.
“Luxembourg is an expanding centre, and although the quality of service providers is good, there is still space in the market for specialists, especially in private equity. Our strategy here as in other jurisdictions is to establish a substantive business using our tried and tested operational model and experienced staff drawn from both the local market and from the group. For example, the presence in the office of someone who has already worked with Ipes in Guernsey helps to ensure the Luxembourg office offers the same service experience to our clients.”
Henin says the grand duchy’s long-standing and broad role in the European and global fund industry is an important factor attracting private equity fund work to Luxembourg. He adds: “There is a great variety of structures available, both unregulated vehicles and regulated funds such as SIFs and Sicars, and the legal framework is responsive to regulatory and market developments.
“For example, the country has a large number of double taxation treaties that facilitate efficient tax structures, and the tax administration makes itself available to answer questions about clearance or confirmation. If there is a specific transaction about which you want to be certain of the tax treatment, usually the tax advisor can easily access the tax administration to confirm that their understanding of the law is correct. All the big four firms are well represented for a small country, and there is a good mix of specialist local lawyers and big international law firms.”
An established name in Luxembourg’s alternative fund services sector that has returned to the local market after a brief absence is Prime Fund Solutions, a business that remained with the Dutch state-owned Fortis Bank Nederland after BNP Paribas acquired most of the former Fortis group’s activities in the Benelux countries, taking the administration business’s corporate structure in Luxembourg and client roster with it.
A new entity, a Luxembourg branch of Fortis Prime Fund Solutions Bank (Ireland), was established last December and was already winning clients before the business’s future was settled on May 10 with the announcement that after six months of negotiations, Credit Suisse had agreed to buy the worldwide Prime Fund Solutions group.
Managing director Claude Noesen says that building up private equity activity is a priority for Prime Fund Solutions in Luxembourg, although it has been temporarily subordinated to the urgent demand for servicing of Ucits funds that follow hedge fund-style strategies. “Private equity is already very well served here in Luxembourg, so to win business in this market we have to offer something very special to the funds – something that we are keen to do,” he says.
“We are in the process of acquiring one of the best systems available in the private equity field, which is currently being rolled out first in Hong Kong and will be arriving in Luxembourg very shortly. Eventually we will service the whole alternative environment, including sophisticated Ucits, hedge funds, funds of hedge funds, managed accounts and private equity.”
Noesen says the relatively small scale of the new Prime Fund Solutions operation appeals to most managers, especially start-up funds, which can be serviced in a more bespoke manner. That said, he acknowledges that the backing of a global financial services giant in Credit Suisse has proved very useful in reassuring potential clients about the solidity of the business and that substantial resources stand behind it.
“Having a strong balance sheet and credit rating, a global presence and a diversified business base as a financial services institution is absolutely key,” says Chris Adams, global product head for alternative funds in the Luxembourg branch of BNP Paribas Securities Services. “For large universal banks with a very broad and diverse mix of corporate, investment, retail, asset servicing and asset management businesses, the stability provided by the diversity of their businesses means that on the whole they haven’t suffered some of the shocks during the crisis experienced by even very large businesses that have more concentrated product lines.
“For instance, the Fortis transaction provided us with a large retail client base in the Benelux region that is immensely valuable to us at all levels of our business. There’s a huge diversity of exposure across those areas. The benefits of that scale in relatively mature, stable businesses are immense.”
Adams says one of the most important characteristics of the private equity sector at present is the volume of capital currently awaiting deployment. “The big issue particularly in more mature private equity markets is the huge volume of dry powder out there, which makes fundraising really difficult,” he says. “Until those commitments have been called, it’s tough for specialist managers in particular to raise new money. It’s not for a want of appetite on the part of investors, simply that they don’t want any more exposure until they know what will happen to their existing commitments.”
A particularly strong area of activity is real estate, where Adams identifies a significant mood of change. “Real estate managers are taking a fundamental look at their business models,” he says. “In particularly large players are moving away from independent, nationally-focused businesses and integrating them within regional or pan-European operations. That creates a lot of opportunities for companies like ours because we have that kind of international capability.”
According to Henin, Ipes is seeing a surge of new enquiries from potential clients across the various jurisdictions in which the group operates. “In some cases it’s people who’ve been fundraising and eventually reached a close, while others are looking to get back into the market, but we’ve certainly seen a pick-up in the past few months,” he says. “There’s a feeling that the time is right, after everyone spent last year waiting and seeing. Now investors are expecting promoters to start doing something to take advantage of the opportunities coming onto the market.”
Olivier Sciales, a partner with law firm Chevalier & Sciales, says recent revisions to the legislation governing risk capital investment companies appears to be bearing fruit. “Currently we are working on two projects involving multi-compartment Sicars, which were made possible by the new legislation,” he says. “We see fund promoters looking to set up Sicars because they don’t have the risk diversification rules that would be applicable with a Specialised Investment Fund. Secondly, under certain circumstances it’s more interesting from a tax perspective to use a Sicar because not all of Luxembourg’s double taxation treaties apply to SIFs.”
However, practitioners caution that care must be taken to ensure that the business environment in the grand duchy remains favourable to the fund sector and the financial services industry as a whole. “The main challenge for Luxembourg will be to maintain the high level of professional standards, given the increasing number of fund vehicles that are being established,” says Lam.
“The key priorities are to attract new talent to the country, as well as, very importantly, training. The structures now being set up cover a range of new asset classes, including renewable energy, infrastructure and forestry. You need people with ability and training to develop new competences to value these quite different assets. Some Luxembourg structures are investing in emerging markets such as Brazil, China and India, everywhere in the world. And dealing with a diverse range of investors requires good reporting systems.”
Lam adds that Luxembourg needs to redouble its efforts to make the Sicar and SIF better known abroad. “When the Sicar was launched in 2004, we were competing with well-established structures such as limited partnerships,” he says. “Luxembourg still has to do more promotion to sell its vehicles and to demonstrate that they are really suited to the industry.”
Henin notes that the high level of demand from the industry has always made it a challenge to recruit skilled staff. “That’s why a lot of people from neighbouring countries commute into Luxembourg every day for work,” he says. “But there are also state incentives for training, and with the launch last year of the Luxembourg School of Commerce and the University of Luxembourg expanding, there is greater availability of study opportunities. Previously local people had to go abroad to study at tertiary level, but step by step things are improving.”
But industry members caution that some of the factors that gave the grand duchy a head start as a centre for cross-border fund business, such as the population’s much-vaunted facility with languages, may no longer be such potent advantages as they were a decade or two ago, and that in this environment it is becoming more important for Luxembourg-based providers to keep costs under control.
Adams, who notes that “the Luxembourg economy, regulatory and legal environment have stood up very well during the crisis,” acknowledges that all providers are constantly looking at ways to stabilise or reduce their operating costs, of which salaries form a substantial proportion.
He does point out that unlike some rival fund services jurisdictions, the country has access to large pools of skilled labour in adjacent regions of neighbouring countries, which contributed an average of more than 147,000 people – some 44 per cent of the total – to Luxembourg’s workforce in 2009. “We don’t face the same physical constraints as do other jurisdictions that specialise in servicing alternative assets, and the transport infrastructure is very good,” Adams says.
Administrators and custodians in Luxembourg say they are employing a variety of efforts to keep costs under control, including carrying out certain functions in less expensive jurisdictions where this is permitted by the country’s legislation – including confidentiality rules applicable to the financial services industry – and regulation, as well as ongoing efficiency drives, automation of administrative processes, and increased focus on how they procure external services.
However, there are limits to the extent to which such efforts can compensate for the overall level in particular of salary costs in Luxembourg, which are significantly higher than in other European financial centres such as Milan or Paris. That’s especially the case for an industry where quality of service to the client is a paramount differentiator and that needs intelligent and highly-skilled staff to deal with procedures or situations that are not amenable to automated processing.
With the best will in the world, service providers are obliged to deal with counterparties that do not embrace technology to the same extent. Transfer agency instructions that arrive by fax are far from unknown. And companies with operations in Luxembourg note that the country’s high standards of regulation, which are becoming an increasing selling point for investors in the current cautious environment, do not come free.
Adams argues that how the industry manages its costs will be a key challenge for Luxembourg over the next four or five years, at a time when the business outlook is significantly tougher than a few years ago. “While a lot of new work is coming in, it’s taking longer to finalise than it used to and the competitive pressures are intense,” he says. “Over the medium term changes are called for. To succeed in this business, we have to find a way to ensure the economic model works.”