Compared to many financial centres, Luxembourg is at the sharp end of sustainable finance. Almost six years ago, the Luxembourg Stock Exchange created the Luxembourg Green Exchange (LGX), the world’s first platform fully dedicated to green and sustainable bonds with over €692 billion issued across more than 1,300 securities and 235 issuers to date.
It has also launched an array of smaller initiatives under its International Climate Change Strategy 2021-2025, including the International Climate Finance Accelerator, which since inception in 2018 has provided working capital and expert support to 23 climate-focused fund managers targeting $1.4bn of assets under management setting up in Luxembourg.
However, with mandates for sustainable asset management in Amsterdam plus Paris’s sheer market size, Luxembourg can’t afford to rest on its laurels.
“Luxembourg needs to be careful if it wants to hold a leading position”, warns Arnaud Gillin, who, together with Innpact, co-created the ICFA in 2018 with the Luxembourg government. “Although Luxembourg is by far the most advanced financial centre [of these three] for regulated investment funds targeting institutional investors, it could go further--it needs to lead by example with its own assets under management.”
Gillin knows what he is talking about. His consultancy, co-founded with business partner Patrick Goodman in Luxembourg, has supported the creation of 30 impact funds totalling more than $8bn of assets contributing to United Nations’ Sustainable Development Goals. But his eyes are carefully trained on neighbouring countries. One of these is the Netherlands.
Keeping an eye on the neighbours
Amsterdam recently topped the Global Green Finance Index, a bi-annual report from thinktank Z/Yen that ranks global financial centres according to finance professionals’ assessments and 140 measures provided by organisations such as the World Health Organisation and the World Bank. According to the assessment, Amsterdam came first, Luxembourg sixth.
In 2019, Dutch banks, pension funds and asset managers agreed to reduce the CO2 emissions of investments and Amsterdam-based companies focus on circularity and sustainability across industry.
“What strikes me about Amsterdam is that its pension fund is very strong on environmental and social governance,” says Gillin. “Take the Dutch PGGM,” the Netherlands’ second-largest pension fund. “They’ve ensured that all assets from this fund go into sustainable finance.”
At present, Luxembourg’s sovereign pension fund is not exclusively invested in sustainable funds. This is an opportunity for Luxembourg to lead by example, says Gillin. Not just to improve its asset exposure, but also to invite experts in sustainable finance to manage it. “In the Netherlands they’ve set up their own team to manage the pension fund,” he says. “They’ve recruited the expertise locally.”
Bringing more smart minds into Luxembourg is crucial for sustainable finance, says Gillin. “I believe that the Luxembourg government could make a valuable contribution to bringing the brains here. One way to so this is to put out a mandate to manage sustainable assets, and demand that the team be headquartered here.”
Gillin acknowledges that there are already initiatives underway in Luxembourg to train and keep the brains in the grand duchy. “Luxembourg University has a sustainable finance section in its school of finance and the LGX has the LGX Academy, which aims to fill the gap in current sustainable finance education.” However, a mandate which supports local actors and asset managers will go even further, he notes.
A suite of services for sustainable finance
Sustainable finance is also an opportunity for Luxembourg to create a welcoming service environment for smaller funds, says Gillin. If it fails to do this, rivals Dublin and Amsterdam will be only too keen to take them.
“European regulation is becoming increasingly more complicated for funds of all sizes,” Gillin says. “The Alternative Fund Managers’ Directive, Anti-Money-Laundering [provisions] are a necessary but costly burden on funds and their services providers--particularly for smaller funds.” Microfinance and impact funds under €200m are particularly affected, according to Gillin, not only because of their size but because of the markets they target.
“Let’s say you have an impact fund setting up in Luxembourg and investing in projects in Latin America. Well, some banks will close their doors because the regulation makes it too risky for them.”
A good workaround for small funds is the Reserved Alternative Investment Fund, an investment fund that can invest in all types of assets, points out Gillin. The RAIF qualifies as alternative investment fund and is therefore not itself subject to the product approval of the Luxembourg regulator the CSSF.
However, even a RAIF still needs a depositary bank. “It’s expensive for a €200m fund to find a depositary bank,” says Gillin.
Specialist corporate services providers would be an asset. Gillin points to the example of Luxembourg’s ICFA. The accelerator programme was created in 2018 by the Luxembourg government and Innpact with the aim of making Luxembourg a centre of excellence for financial services in the climate investment sector. It works by providing prospective climate investment funds with Luxembourg-based legal, structuring, risk management and strategic support services. For financial services providers in Luxembourg, the benefit is clear. They can learn more about tailoring their support to the climate investment sphere.
“Something similar [to the ICFA] in the impact investment area would be useful. We need government support for corporate services providers to begin understanding impact investing,” says Gillin. “Otherwise the risk is that these smaller funds go to Dublin or Amsterdam where corporate services providers might be more welcoming.”
The Luxembourg government is actively looking at a version of the ICFA, this time with a social goal. “When this happens, the marketing needs to be strong, it needs to be promoted the way regulated funds are promoted,” he says. “Luxembourg needs to think more in the range of €0-€100m funds,” he added. “These smaller actors can start their first or second fund in Luxembourg, then move to regulated.”
New investment channels
Luxembourg’s new securitisation law presents another solution for smaller initiatives in the impact space. In February 2022, the Luxembourg parliament approved several changes to the 2004 securitisation law, including the active management of securitisation vehicles linked to debt instruments. These changes could support a securitisation platform for impact investing. “When the investment strategy is too small we can bundle a few investments together into a securitisation platform,” he says. “The securitisation will save on management and administration fees, and help keep Luxembourg competitive in impact investing.”
The new securitisation law could also help Luxembourg target a large and deep investor pool--retail investors--says Gillin. This investor market is interested in sustainable investment, but cannot always access it due to its complexity and its illiquid nature. Improving access to sustainable finance for retail investors is a huge opportunity.
“In Luxembourg we can build channels for retail investors to access sustainable investment. This could be through the new securitisation law--by bundling the investments into different layers of risk and liquidity so that retail investors can access the liquid tranches. It could also be through interpreting how Ucits can invest in illiquid assets,” he added.
However, he cautions that it is not for the Luxembourg government to design the product. “The different actors in Luxembourg need to work together to innovate new products in sustainable finance,” he says. “The Association of the Luxembourg Fund Industry already has a responsible investment working group which can look at this particular topic, but we need the banks to voice their commitment too.”
The role of banks in sustainable finance is important, says Gillin. Particularly in view of Paris, another financial centre competing with Luxembourg to hold the sustainable finance crown. The French capital is already associated with action against climate change thanks to the Paris Agreement which binds its signatories to limiting the global temperature rise. However, it is also taking a thought leadership role in the sustainable finance debate.
“Paris and its ‘Finance for Tomorrow’ initiative is very vibrant in part because of the commitment of some really big players--Axa, BNP Paribas, Natixis--asset managers who can push everything to become the leading market for financing of sustainable development,” Gillin says. He points to the size of Paris. “It’s a larger market than Luxembourg in every way and it’s coming at high speed at sustainable finance.”
One thing that Luxembourg could do to compete is to harness the voice of its own banks and asset managers.
“In Paris there are visionary and high-level leaders speaking out about sustainable finance. The CEOs of Luxembourg banks must take the lead and voice their commitment in this area.”
Setting an example
Leading by example in sustainable finance is crucial, says Gillin. In 2021, global campaign network Greenpeace issued a damning report on Luxembourg’s 100 largest investment funds, claiming them to invest on average in a 4 degrees Celsius scenario and not the under 2 degrees Celsius scenario ratified by the Luxembourg government in accordance with the climate objectives of the Paris agreement. The funds, according to Greenpeace, represent 9% of Luxembourg’s €4.7 trillion of assets under management.
“Luxembourg needs to lead by example, also in its pension fund,” says Gillin. “It could follow the Dutch example and move all its pension fund assets into sustainable finance.”
Following the Greenpeace report, Innpact, the consultancy founded by Gillin, co-signed a Greenpeace open letter to the Luxembourg government. It made three demands: to reinforce criteria for sustainable investments and to better monitor it, to create better transparency on the environmental and social impact of Luxembourg financial products and to progressively reduce Luxembourg’s exposure to fossil fuels--and to integrate these three measures into the investment strategy of the sovereign pension fund.
“We [Innpact] helped complement this letter,” said Gillin. “We added to the assessment by Greenpeace that most traditional funds were not doing enough, but we also flagged the good that the Luxembourg government is doing.” Particularly the number of initiatives [including the Luxembourg Green Exchange] which promote responsible finance, and notably Luxembourg’s opposition to the classification of natural gas and nuclear as sustainable energy sources. Nonetheless we believe that leading by example means Luxembourg can play a leading role in protecting the climate.”
A next step for Luxembourg could be fundraising support for sustainable finance funds.
“If you have a €1bn fund you already have everything you need in Luxembourg,” says Gillin. “However other fund managers, particularly sustainable funds need fundraising support. This is something that the ICFA already works on, by improving the networks of the funds it works with, by creating fundraising strategies. I think companies should come to Luxembourg to build a network, work with skilled people in fundraising and get specialist support on this in the sustainability sector. It’s something we’re looking into at Innpact.”
The opportunities are endless. However for Gillin, it’s about positioning. “Luxembourg has already shown it has the tools to be more than a domicile, more than a middle and back-office place. It can be a sustainable finance centre.”
Updated to correct the total amount raised, number of securities and number of issuers on the Luxembourg Green Exchange