In the decade since the alternative investment fund managers directive (AIFMD) has transformed Luxembourg’s role within the private assets space in Europe, the country has grown its niche of helping fund managers achieve regulatory compliance. When considering how to take this to the next level, thoughts often turn to attracting fund deal makers to Luxembourg. However, movement in this direction has been minimal.
Digitalisation and rationalisation
Claus Mansfeldt, chair of the LPEA trade association, continues to see promise in this direction. “We know that some deal teams and portfolio managers are setting up in Luxembourg,” he said. “You don’t necessarily have to be walking the streets daily of the city where you might be doing your next transaction.” He also sees other directions where the country would be able to step up.
“More of the entire workflow can be done digitally, and that’s to Luxembourg’s advantage.” Aspects such as governance have migrated considerably to the grand duchy, particularly during the pandemic. Board meetings and their related procedures plus contractual and [anti-money laundering] work have taken place in digital formats and “the evidence is that it has worked quite well,” Mansfeldt commented.
Investor relations hub
Inspired by this, the LPEA has decided to promote the country as a centre of excellence for private equity investor relations. This activity is about managing relationships with current investors while attracting new interest.
“We have the entire value chain here,” said Gilles Dusemon, LPEA executive committee member, speaking at the Insights Fundraising conference organised by the association in October. He said this gave the country the foundations from which to grow as an investor relations hub. “We have over 600 registered investment fund managers, over 6,000 people employed in the sector, we have the custodians, the central administrators, we have the TAs [transfer agents], the risk management. And we have the product,” Dusemon noted. “The entire world is using the Luxembourg fund product, so investor relations is a huge opportunity for our industry.”
“The business model could be split between specialised hubs,” Mansfeldt suggested. “The investment management, the deal making could be in one, while the fundraising and investor relations in another.” Furthermore, he believes that investor relations is set to come to the fore: “In boom times, on the whole, the money finds the deal, and therefore investor relations perhaps doesn’t have such a huge role. But now we are clearly entering a phase where that will play a bigger part.”
A few companies have this activity located in Luxembourg, but Mansfeldt characterises this as “embryonic”. Asked to quantify how big these investor relations teams could be, he suggested they could start gradually, with 1-2 people representing about a tenth of a large firm’s investor relations activity. “But when you start your project you will add over time.”
An instinctive advantage for Luxembourg is the fundamentally cross-border nature of the work here. “Funds are being raised cross border with the Luxembourg domicile, so it’s in the DNA already, unlike some other hubs,” he said. London also has this outlook, and hence has a considerable specialisation in investor relations for the global market. However, from a European perspective, the question of Brexit is a concern. Many in the industry thought that the UK leaving the EU would have caused a faster outflow of activities of this nature, but so far this has been minimal. The LPEA sees signs of this starting to happen, however.
It appears that the pandemic and the move to remote working removed immediate pressure to change, which encouraged players to carry on using the UK as a base as per normal. “But now there is a lot more focus on the investor relations function all together,” said Mansfeldt, and this could bring firms to reconsider how these operations are organised.
Marginal gains reforms
To provide a jolt, the LPEA would like the government to make some small but significant adjustments to the regulations around the private equity business. “It’s not so much failings as there being room for improvement. We are not looking for a revolution,” said Mansfeldt. “I have a three-page list of very technical legal clarifications that our legal committee is communicating with the government.”
For example, he cites the rules around the use of distributed ledger technology and how they could be reformed. TAs and custodians are turning increasingly towards these fintech and regtech options, and the regulator has allowed such players to use blockchain-based tools. However, the fundamental laws that govern certain details of these transactions date back to before the internet was invented.
Joined up regulation
“Distributed ledger technologies are to a large extent accepted at the CSSF level, but this is not reflected in the laws,” he commented, referring to Luxembourg’s financial regulator. Details like that makes some managers hesitate. “The London lawyers, the New York lawyers will point out that there’s one thing on the regulator’s website, but there’s another thing in the law that doesn’t quite correspond.”
He added that this is a side effect of having a proactive regulator, with the CSSF being forward-looking in embracing new trends and adding to a first-mover advantage dynamic. “That’s great, but it’s the synchronisation of the regulatory interplay between the two frameworks that is also important.”
Another tweak would be lowering the minimum entry threshold for investors in private equity. Luxembourg law puts this bar at €125,000, but the likes of Ireland, Germany, the Netherlands and Italy have this at €100,000. “Anecdotally, we’ve heard some have chosen not to domicile funds in Luxembourg simply for that reason,” said Mansfeldt.
This move goes with the growth of the “democratisation” of the alternative investments sector, with these seen more widely as being relevant for a greater number of individual private investors, including in the mass affluent client segment. EU regulators have signalled their interest in moving in this direction as they aim to help entrepreneurs gain access to a wider pool of investments. Hence, Mansfeldt would like Luxembourg to go with this momentum.
“The change from €125k to €100k might not sound like much but can tip the balance away from Luxembourg,” he said. Moreover, it is also a somewhat emblematic figure that is easy to comprehend. Reform would reassert the desire of Luxembourg to be a pacesetter.
Either way, there is general industry optimism that the sector is set to grow, with the grand duchy able to take its share. Recent data from the research firm Preqin forecast that assets under management in alternative funds globally would increase from $13.7trn at the end of 2021 to $23.3trn at the end of 2027. In Europe, assets are set to nearly double to $4.1trn over this period.
As one would expect, Mansfeldt believes the attractiveness of PE investing remains despite the changed global economic circumstances. “It’s more important than ever to make a relatively significant positive real return, hence the relevance of a strategy including a significant portion of investment in private equity,” he said, citing “mid-teens” returns over the long term on average. The work has commenced on carving out a larger share of this promising activity for Luxembourg.