MDO roundtable: The pace of change within the Luxembourg investment fund industry is accelerating at an unprecedented rate with thirty-two pieces of legislation passing through national and European forums, writes Yves Wagner.
As part of the annual MDO round table on May 15, I chaired a round table featuring Bill Lockwood, conducting officer with Franklin Templeton in Luxembourg, Michael Ferguson, partner at Ernst & Young in Luxembourg, and Paul Carr, conducting officer with East Capital on where the industry will be in three years.
Recent regulations are increasing substance requirements on firms providing management services to investment funds. This can be good news for Luxembourg, encouraging more decision makers to be based within reach of the Grand Duchy. However, increasing requirements could make other investment fund hubs more attractive in the current environment of tightening yields and increasing compliance costs.
In general terms the developments within the alternatives sector are good news for Luxembourg. “Prospects are very positive for the market, but mainly for existing actors, brand new business will take some time”, remarked Lockwood. “The big players are here to stay, we can bring in new risk management resources and put new infrastructure in place. The financial transaction tax and investor compensation directives are below the waterline issues which could cause considerable change.”
One consequence of recent regulation has been an evolution of investment structures away from self-managed models, to that of using a management company [ed. note: called a “manco”]. “I don’t know of one big fund that is not considering using a third party manco or setting up a dedicated manco”, commented Ferguson.
Each manco is either wholly owned by the fund or a “third party” where another company takes responsibility for fulfilling certain functions, typically regulatory compliance, substance and risk management. Each fund has a board of directors, and board members are also currently subject to tightening criteria, including that of being demonstrably able to show oversight of the decisions of the fund manager.
Alternative investment funds
Ferguson commented that a CEO had asked him recently if he has to move to Luxembourg to fulfill the AIFMD’s [ed. note: the new EU regulations for “alternative funds” run by professional or savvy investors] “delegation principle”, i.e., able to take responsibility for the decisions of the fund.
Ferguson’s view is that Luxembourg-based alternative investment fund managers will need to demonstrate that they have persons in Luxembourg who are actively participating and engaged in the senior management decision making process. This goes beyond the typical “overseeing” of decisions made elsewhere.
New product development is central to Luxembourg’s ongoing success although questions remain as to which niche sectors will generate a significant contribution towards total assets under management. There are currently $3 trillion in assets under management, of which $2.5 trillion are in classic products, leaving $500 billion in alternatives (such as real estate, hedge funds and private equity).
In addition the social responsibility funds sector in Europe amounts to $240 billion. Luxembourg has a 25% market share of this sector. Microfinance, carbon offset funds, other responsible investments and Islamic finance could all become important but currently are a small notwithstanding growing piece of the overall Luxembourg fund sector.
Risk management will be increasingly important and cover larger fields, the future of risk management will analyse distribution channels, increasing “know your client” checks will become commonplace. “There is not a manco in Luxembourg that is not trying to enhance their risk management teams”, remarked Ferguson.
Some have said that the Luxembourg domicile will evolve from being only an overseeing centre to providing specialist risk reporting for the funds that are being managed. However Ferguson was of the view that: “risk managers tend to congregate where portfolio managers are. Therefore it is unlikely fund houses will create a full risk management team in Luxembourg if their portfolio managers are all over the world”, but will have some risk management expertise in Luxembourg.
Luxembourg’s relationships with Asian markets are essential to attract new assets. Hong Kong and Singapore are already well known, however Indonesia (in the future) and Taiwan are also important. Mexico, Chile and Peru are also targets for the Luxembourg fund industry. Asset managers within these jurisdictions looking to benefit from the EU passport, are already increasingly turning to third party management companies for substance and risk management services. They also require know-how from independent actors that are not bound to any individual financial institution, “which is perhaps why firms like MDO have grown so much in the last few years”, I commented during the roundtable.
The general consensus was that Luxembourg must actively reach out to those markets to maintain its position as a world-leading hub, just transposing the AIFMD is not enough as Jersey, Dublin and the Netherlands have also demonstrated agility in creating sympathetic legal frameworks for new business. Tax structuring and facilitating fiscal optimization will remain key for the development of the Luxembourg fund industry.
Yves Wagner is director of The Director’s Office, which provides independent directors to fund and management companies in Luxembourg.