The Association of the Luxembourg Fund Industry held its European Asset Management Conference on 21-22 March 2023. A panel on the second day featured an interview of Marco Zwick, director at Luxembourg’s financial regulator, the CSSF, by Maria Löwenbrück, managing director of Union Investment Luxembourg. They talked about the main focus areas of supervisory activities, sustainability, upcoming regulation and more.
In the last 12 months, inflation has climbed to historically high levels, interest rates are high, Russia continues its unjustified war in Ukraine and a few months ago, there was the mini-bond crisis in the UK. This has showed how “fragile” the market can become, said Zwick, but “looking at the sector itself, I can just say that as a regulator, we see this is very robust.”
However, last year was difficult for the industry. “Most of this is, of course, linked to market movements, which are not something which you or we could influence in any way,” noted Zwick. But “the last three months--November, December and January this year--were marked by positive inflows.”
“The positive story was the commodity side, for the reasons we know, property funds, money market funds, for which we broadly saw over the last 12 months inflows. But it was of course more difficult for equity, emerging markets, convertibles, fixed income and high-yield,” continued Zwick.
However, “volatility has now reached, at the beginning of this year, contrary to what one might think, quite normal level[s],” said Zwick, but noted that “we are unfortunately getting from one crisis to the next one,” referring to recent tumult in the banking sector, which could also have an impact on the fund industry.
Liquidity management “high on the agenda”
In response to a question from Löwenbrück about main focus areas and new supervisory activities, Zwick replied, “I think it is about liquidity management, which remains very high on the agenda.” The CSSF has relaunched its daily risk monitoring, which “some of you may suffer from.” However, it allows fund managers “to remain in constant contact with yourselves,” he argued. In this way, outliers in the data can be easily spotted.
The CSSF also looks at the reporting of large redemptions and subscriptions, and any relevant risks. “I can tell you that we see not a huge increase in redemptions, even following the last week,” said Zwick. “But the financial stability risks have not disappeared.”
The era of loose monetary policy has ended, noted Zwick. “I think where we are intensifying, really, our supervision is really on those areas which are linked to the daily behaviour of the funds, and also the exposure to Russia in particular.” The CSSF, last year, published guidance in relation to the use of liquidity management tools. “We were not complacent,” he said. But the covid-19 pandemic and Russia’s war in Ukraine are crises that are “completely different.” The magnitude is much different. “It is, to some extent, for fund managers, much more isolated, which also means that, actually, the tools used are completely different.”
“We are an industry of which we can be proud,” said Zwick, “but this also means that a lot of people look at what we do and how we deal with all these topics.” The International Monetary Fund this year will conduct its financial sector assessment programme in the grand duchy, “which certainly will also look at investment funds, as it is considered one of the big risk sectors in Luxembourg.”
Insights on sustainability and the need for investor confidence
“Sustainable finance is high on the agenda of all stakeholders, and it is here to stay over a few years,” stated Löwenbrück. Are there any examples of innovative sustainable finance products that the CSSF has come across?
“I think we did not really see a lot of innovations,” replied Zwick. “What a lot of people have been doing, and are still doing, and are trying to do very hard, is to reach a level of compliance with the regulation.” But it’s important to be “very careful” not to use new products that circumvent ESG requirements. “If we get it wrong here, we very quickly undermine the trust of investors.” Trust and confidence are key, he highlighted.
There are some initiatives at the EU level to review the Sustainable Finance Disclosure Regulation, said Zwick, as well as ongoing work on the definition of greenwashing and naming conventions for funds. “The real issue is about confidence and the trust,” he stated. “If you always have to re-explain the same thing to investors in always a different way, people will find it difficult to understand.”
“Pleased” with the latest AIFMD text proposal
After 10 years of existence, the Alternative Investment Fund Managers Directive review is now in the final stage. “From the perspective of the supervisory authority, what are your main takeaways of the current draft?” Löwenbrück asked.
“The latest draft of AIFMD, we do not dislike it. There are obviously always points where you agree more than other points,” said Zwick. “First of all, it’s safe to say, after 10 years, AIFMD has been a success in Europe, it has been a success in Luxembourg in particular.” The review is not about a “fundamental change” of AIFMD, but rather some “adjustments,” such as additional reporting requirements and substance requirements.
“We are pleased with the latest text proposal,” said Zwick. “And we also welcome the alignment, which is foreseen, between AIFMD and Ucits. It’s not a contradiction--one is a product directive, the other is the manager directive. But I think a lot of you are operating what we call super mancos, you have all the licences, and having a complete alignment of the rules makes a lot of sense.”
That being said, there were three topics that Zwick noted they had submitted as “comments.” The first point concerns depositaries and jurisdictions. “It is just difficult for us to understand, how, on one hand, you question delegation and then you take one of the key functions in terms of controlling your fund in an independent way, which is a depositary, and then you accept them to have another jurisdiction. That’s our view. Not everybody shares this view,” he noted. This comes from two jurisdictions which had problems issuing funds because they did not have a depositary in their jurisdiction, Zwick explained. It remains to be see how this will be decided.
The other two points concerned the prominent focus on white labels and the activation process of liquidity management tools.
Eltif 2.0 an opportunity, but brings risk management challenges
The new European Long-Term Investment Fund regulation, which lifts some restrictions in the previous regulation, is part of the democratisation of private assets, or making alternative funds available to retail clients, noted Zwick. “We wholeheartedly support this process,” he stated. 48 of Europe’s 84 Eltifs are domiciled in Luxembourg, “so we are very pleased about this,” said Zwick.
However, while the CSSF welcomes all this, “you will be responsible for the liquidity risk management, which we discussed before, and for risk management more broadly,” Zwick told the audience. “It also brings some challenges for yourself, because it’s a different story whether you have institutional investors or whether you have retail investors, who need to get their money, sometimes quicker than institutional investors.” He offered the example of infrastructure funds, where the asset has a very long duration.
“This is going to be challenging, but we all love challenges,” said Zwick. “We clearly see it as an opportunity to build on what has been built.”
Findings from on-site visits in 2022
The CSSF conducted 55 onsite inspections last year, said Zwick, “and the largest category of findings was related to the monitoring of delegated activities.” He added, “For the avoidance of doubt, this doesn’t mean that we have a concern that nobody is monitoring delegation. It’s just that sometimes we find that documentation may be incomplete, due diligence may not have been completely finished or documented.” Last year, the CSSF sanctioned four AIFMs in this area.
Delegating portfolio management, Zwick reminded the audience, does not mean the fund manager or portfolio manager has been absolved from best execution obligations. “Here we find, for instance, that often the report was based on reports, reading reports without second guessing. So we would expect fund management companies in Luxembourg, AIFMs, to challenge sometimes more the execution values and the prices.”
Zwick touched on the importance of complying with investment objectives when it comes to ESG, as well as anti-money laundering precautions. “The standards are absolutely looked at, by our peers in other jurisdictions, who also take some ideas which we have,” he said. Risk assessment of funds needs to include both the investor side and the investment side.
Recommendations: embrace change and maintain trust
To wrap up the panel, Löwenbrück asked Zwick for three key recommendations for asset managers and management companies regarding factors critical to succeed in the industry.
“Embrace regulatory change,” replied Zwick. “The industry has, over and over again, shown that they are really capable about embracing change, even as difficult it may be. But to take it almost like a strategic opportunity, rather than just an issue.”
His second recommendation was to embrace technological change. “I think that’s really something on which we all must do,” including the CSSF. “At the end of the day, everybody’s under cost pressure,” Zwick added. “We all want to do exactly the same. We want to improve efficiency, reduce costs, by maintaining and improving, to some extent, investor benefit and protection.”
However, he added a warning as well. “Please do not underestimate cyber risks,” Zwick underlined. “It’s something which is not so prominently addressed in our industry yet, but it’s obviously something which we see as one of the emerging threats coming up more and more. And it’s not just because of the Russian war, it’s a more general threat.”
Zwick’s third and last recommendation echoed his earlier points about the importance of trust and confidence. “The ultimate goal is to serve investors, and I think we need to protect the assets. That’s our obligation, that’s our duty. And I think without this, we will lose confidence. And we have seen how fragile confidence is these days,” he said, referring again to recent events in the banking sector. “The first to get it wrong gets it wrong for the entire industry,” Zwick stated, before concluding with an appeal “to always do what is right.”