Luxembourg embraces SRI and alternatives

Luxembourg was the first European financial centre to see the potential of cross-border mutual funds, following directives from Brussels during the 1980s. There was an understanding developing in the Grand Duchy of how these products could transform savings and investments for institutions, wealthy investors and ordinary families.

But things have moved on since the first Ucits funds were registered here, investing in equities and bonds. These humble funds eventually embraced cash, derivatives and, more recently, alternative assets.

Currently the most popular spheres for expansion of new products are socially responsible investing and private equity. What is more, managers with head offices in London and elsewhere are looking to reallocate some of their assets around other European centres, relocating some staff and resources to Luxembourg. 

Brexit is one of the reasons for this, as it is looking more and more likely that UK-based asset managers will lose their treasured, barrier-free access to 27 consumer markets. But also costs and staff shortages elsewhere are directing fund houses to set up operations hubs in a country with room for expansion, regulations and infrastructure specifically targeted to asset management and an increasing body of expertise in fund accounting and risk management.

“It’s quite natural that asset managers which need to find a solution for Brexit, as they want to continue serving investors in Europe,  would be coming to Luxembourg and either setting up new business or increasing their footprint here,” says Denise Voss, chairman of Alfi, the country’s funds association.

In addition, she confirms the country is increasing its attractiveness to asset managers by developing expertise in sustainable finance and responsible investing. “As an industry, we need to make sure we are actually incorporating sustainable finance and ESG concepts into our investment frameworks because that’s what investors are demanding,” says Ms Voss.

Having recently posted a figure of €4.2tn ($4.9tn) under management, Ms Voss does have some other targets in mind. Currently, Luxembourg is responsible for 11 per cent of assets managed in Europe’s alternative investment funds. She plans to eventually boost that figure to 20 per cent, but admits that this “will take some additional hard work to get there”.

Luxembourg’s knowledge and skills base connected to alternative investments has grown over the last 10 years in particular, says Justin Partington, head of fund solutions at service provider SGG. “The products are in the right place and Luxembourg is capturing market share. There are other domiciles, clearly, in the market, but what Luxembourg does to stand out, is to bring all those elements together in a new packaged way, and of course continue to appeal to EU investors.”

Market data, he says, supports the case for alternatives. “There is a strong future ahead for the alternatives industry here in Europe and Luxembourg,” says Mr Partington.

While the centre built its reputation through constructing funds investing in bonds and equities, this is not where the latest interest is coming from, says Steve Bernat, CEO of service provider Carne Group in Luxembourg.

“If I look at where the most recent growth comes from in the last 18 to 24 months, I would probably say 90 per cent of that growth is coming from the alternative investment fund sector and especially in the illiquid sector, embracing private equity and real estate,” he says.

The new cohort of managers launching these funds as yet do not have an international footprint, but have increasing desires to forge a cross-border heritage after enjoying success on home territory, ventures Mr Bernat.

Many of the newcomers are US houses. “They have been very successful in the United States, but never looked abroad,” he says. In order to position themselves as managers of alternative assets in Europe, they need to be regulated under AIFMD rules to distribute products, a key reason for them to come to Luxembourg, one of the few jurisdictions to have developed a knowledge and expertise of operating under this rulebook.

“Obviously there are the large traditional asset managers, which today wander into the alternative space,” says Mr Bernat. “But then you also have those small boutique managers, who really specialise in a particular asset class, be it private equity, be it real estate, who certainly now see this opportunity to internationalise. If they have this ambition to seek a new revenue stream and come to Europe, that’s where Luxembourg is probably the perfect hub to domicile their fund structures.”

While shortage of qualified staff and high costs attached to experienced fund operators might prove a challenge, fast development of technology combined with expertise being built up in the Grand Duchy continues to provide a persuasive story for both fund managers and service providers, he believes.

As a hub which can channel money from savers and investors in developed economies to projects which need inflows in poorer, emerging countries, Luxembourg can prove that it is working towards an efficient, caring global society, rather than draining the economy of revenues, which may have been the image of the centre in previous eras, says Serge Krancenblum, CEO of SGG.

“You need an investment hub to do the connecting between the two economies, the country of the investors and the country of the investment, providing the right legal system in a stable environment,” he explains.

“Unfortunately, in many emerging economies, there are issues such as corruption,” says Mr Krancenblum. “So you have to make sure that the finance professionals and especially the investor services firms like SGG are going to make sure things are done in a legitimate, compliant manner.” 

This can be done in conjunction with enhanced due diligence specialists such as Luxembourg-based Sqope.

This new role he is suggesting for Luxembourg and its service providers is not just that of a conduit, but a regulatory-style hub, where the custodians and service providers monitor the behaviour of the fund managers as investors and their transactions, to make sure everything is above board legally. “We are part of the solution for the regulator, we are not part of the problem,” he says, while admitting that public perception is often contrary to this.

“That impression is still there, but it will change completely. With the fight against money laundering, there is now a very big difference emerging between investment hubs and tax havens,” he says. “Investment hubs are there to make the connection between different countries. People are going to see hubs like Luxembourg as a facilitation for direct investment,” he says, rather than the old story of tax dodging and “other unfair practices”.

The biggest challenge for Luxembourg’s financial centre, agrees Alfi’s Ms Voss, is winning back this public trust. “I still think we need more work to do to gain the trust back of investors and potential investors that we’re a safe place for them to place their money again, for the financial wellbeing in the future,” she says, adding that Luxembourg must continue in its task of explaining its value and its role as an investment hub to the public.

To summarise, fund managers and private bankers seeking to perhaps relocate some of their services after Brexit might look to Luxembourg for unfettered access to the European distribution market and for innovation in products in areas such as private equity and socially responsible investments.

But there is more to the story than this. Many voices in Luxembourg are looking to rebrand the entire financial services industry, having grown sick of its deservedly poor image among investors. They see a need to consign the notion of an inter-connected cartel of poor performing, high-charging fund houses to the dustbin of European history and to replace it with a socially responsible system that will work to benefit society, with the expertise centred, of course, in Luxembourg.