Uneven road ahead for Luxembourg’s global gateway

Luxembourg’s bustling back office industry is preparing itself for an influx of new business from hedge funds, alternative strategies and emerging market products, confirms Frédéric Pérard, jovial global head of cross-border securities services at BNP Paribas.

Yet as he gazes out of his functional office block in the Grand Duchy’s bleak, drizzle-soaked hinterland, he fears the perpetually grey skies may bode ill, signalling troubles on the horizon.

Mr Pérard talks about how hedge funds were previously registered in offshore jurisdictions such as Cayman or Jersey, but are now seeking to market themselves to clients across Europe from Luxembourg under Europe’s Alternative Investment Fund Managers Directive (AIFMD).

“We are seeing a shift among people who want to distribute to European investors or globally and want to have a product perceived as safe as possible for investors,” he says.

Institutions from emerging markets, including Asian and Latin American countries, keen to establish a track record among European clients, have been increasingly registering their funds for cross-border distribution, despite some commentators claiming strong flows into emerging markets are a thing of the past.

“We are seeing big Brazilian, Chilean and Malaysian asset managers coming to us, investing with a geographical approach,” he says. “They want to build a global brand and Luxembourg is clearly an established base for this purpose.”

Previously, says Mr Pérard, who as the operational head of an international custody operation can offer a helicopter view of fund management trends, emerging market fund houses sold products domestically and developed considerable branding and marketing expertise.

“Brazil is a big country in itself and until recently was a closed market. But their managers have the expertise to package infrastructure development opportunities in Brazil,” and sell them on to foreign clients, he says. “When the government says they want to build 80 airports in Brazil, this creates finance and infrastructure needs. They can meet these by launching investment funds, distributed globally from Luxembourg.”

European asset managers are also keen to sow their seeds more widely and are prepared to venture into previously inhospitable emerging markets, provided the necessary infrastructure can be provided.

“We need to be a global player in 2014 and this is a key change for us,” ventures Mr Pérard. “Today our clients are willing to go anywhere. Before, they used to focus on their own region. Now we need to be there for them in Brazil, Russia, India and China too,” although he admits settling trades in Russia can be an awkward practice.

Further diversification into alternative assets is also expected among institutional investors, which will be reflected in new product launches and he has been in talks with several managers about launching specialist funds investing in real estate, wine, art, infrastructure and debt securitisation. European clients have also enquired about agricultural funds investing in Africa and Middle Eastern managers have shown interest in trade finance.

Yet despite these expected new areas of business, it is no longer plain sailing for the Luxembourg custodians, who have had it so good for so long.

Some of the more esoteric products pose trickier due diligence requirements, further from the standard processing practices of the European custody heartlands. “Sometimes you are dealing with countries that are on the edge, such as Bangladesh, smaller Middle Eastern states and Eastern European nations,” he says. “You don’t make a lot of money and there is a high level of risk.”

Despite the opportunities for receiving more business from fund managers, outsourcing increased responsibilities resulting from regulations such as AIFMD, there are some new kids on the block, with a strong appetite for a hearty Luxembourg lunch.

“Global depositary banks are seeing competition from fiduciary companies who can establish themselves as service providers to private equity groups,” says Mr Pérard, in a slightly worried tone of voice. “They are more expert than us on the accounting side and they may be cheaper.”

And despite the expected surge of registrations for hedge fund products, there are questions about their popularity in the long term.

“At this stage there is some business disappearing in the fund of hedge funds space and managed account platforms are not developing the way they should be,” he adds. “The global trend may pick up, but clients are more reluctant to invest in funds of hedge funds.”

Money market funds are also suffering due to low interest rates. “With overnight rates of eight to 10 basis points, if you want to take a management fee, it is difficult not to drift into negative returns,” with an added pressure of banks now pushing clients to invest into Basel III-led balance sheet-friendly products.

The European Commission’s current probe into Stable NAV (Net Asset Value) funds could also prove ominous. “The commission is looking at which assets they can invest in and how to calculate the NAV. We may see a further threat to money marked funds as a result.”