New growth opportunities for an expanding global funds industry
By Marc-André Bechet, ALFI
Broadening and diversifying Luxembourg’s footprint as a global funds jurisdiction
Luxembourg is in a quite unique position as a global funds jurisdiction compared to other financial centres in the European Union.
The country enjoys an unrivalled political and economic stability. It benefits from a triple A rating with a stable outlook, which has been re-confirmed in September by the three rating agencies Fitch, Standard & Poor’s and DBRS Morningstar. Luxembourg is one of the ten countries worldwide with a triple A rating. Debt to GDP, although on the rise as a consequence of the current crisis, will soon reach 26 per cent but remains well below debt levels in the EU.
The legal system is combining legal structures which originate from civil law and common law jurisdictions alike. In the “legal toolbox” which asset managers can avail of in the Grand Duchy, the common limited partnership (“SCS”) and the special limited partnership (“SCSp”), a limited partnership without legal personality, are recent additions which have proven extremely powerful in the structuring of private equity and venture capital investment vehicles.
Luxembourg offers a large variety of structuring opportunities for PE/VC vehicles, such as the investment company in risk capital (SICAR), the specialised investment fund (SIF), the reserved alternative investment fund (RAIF), and the limited partnership as just mentioned.
The RAIF (Reserved Alternative Investment Fund) structure, introduced by the law of 2016, allows asset managers to set up Luxembourg-domiciled funds that are not subject to regulatory approval by the Luxembourg supervisory authority, the Commission de Surveillance du Secteur Financier (“CSSF”). A RAIF is however “indirectly” supervised as it must be managed by an authorised AIFM. Main benefits are quick time-to-market, flexibility in the categories of asset classes a RAIF can invest in, and the availability of the marketing passport under the AIFMD.
As of July 2020, there were close to 4,000 limited partnerships (SCS and SCSp) in Luxembourg, qualifying as Alternative Investment Funds. With 1,087 funds and 42 billion euros AUM, the RAIF has become a vehicle of choice in the PE/VC space.
Next to its three official languages including French and German, the use of the English language is widespread. Asset managers can deal with the CSSF and the authorities in English. Articles of incorporation and funds’ offering circulars do not need to be translated.
Luxembourg is obviously not a distribution market in itself. From the very days of UCITS, and more recently with the AIFMD, the Grand Duchy has positioned itself as the preferred domicile for investment funds with a global distribution reach. Today, 80 per cent of the top 30 asset managers across the world have set up funds in Luxembourg. 58 per cent of all cross-border funds1 are Luxembourg-domiciled, being marketed in 70+ markets. Asset managers from 35 different jurisdictions2 have established a management company and/ or an AIFM in Luxembourg. Some asset managers prefer to appoint a 3rd party management company when establishing their first fund structures. Recent newcomers include asset management firms from Vietnam and Brazil.
Brexit: Implications for Luxembourg as an international asset management centre
London and Luxembourg are long-standing partners. With 17.1 per cent of AUM3, UK asset managers represent the second largest group of initiators of Luxembourg funds. These investment funds (UCITS and AIFs) benefit from European marketing passports.
The UK is in fact a very important distribution market, with Luxembourg clearly a leader among overseas funds. Roughly 25 per cent of funds distributed in the UK are overseas funds. As at 31 December 2019, there were 8,862 funds/ sub-funds distributed in the UK. From this total, 4,341 are Luxembourg-domiciled4, which thus represents 49 per cent of all overseas funds registered in the UK.
The vast majority of UK asset managers already had a presence in the Grand Duchy before Brexit, but some additional 30 firms, essentially in the management of alternative funds, have in the meantime set up their own operation in Luxembourg.5
Unlike in other segments of the financial sector such as the clearing of derivatives, trading venues or CSDs, the concept of equivalence plays little if no role when it comes to the management and marketing of EU and non-EU funds. Indeed, the UCITS directive and the AIFMD already offered pre-Brexit a relatively clear framework. ALFI’s feedback from its members is that virtually all firms have taken the necessary steps to anticipate the impact of Brexit.
From January 2021 onwards, UK-domiciled funds will qualify as non-EU AIFs. These funds may still be marketed to European investors under the National Private Placement Regimes, if any, of each individual EU Member State. But they will no longer benefit from the marketing passport of the AIFMD.
Policymakers in the UK have confirmed their intention to keep the UK market open to overseas funds, which is a welcomed development.
To avoid any disruption, the UK government and the FCA implemented a Temporary Permissions Regime (TPR) which enables relevant firms and funds which passport into the UK, to continue operating in the UK when the passporting regime ceases to exist on 31 December 2020. All Luxembourg investment funds registered for distribution have made use of the TPR mechanism. The TPR is obviously a short-term facility to bridge the gap until new legislation is passed and effectively implemented in the UK.
The UK Government (HM Treasury) launched a Public Consultation on the Overseas Funds Regime (OFR) post Brexit, to which ALFI responded in early May. ALFI generally agrees on the approach taken, in particular the concepts of outcomes-based equivalence set out in this Consultation. The main challenge for overseas funds will obviously lie in the additional requirements (such as the requirement to comply with FCA PS18/8 on the Assessment of Value) that the UK legislator, being no longer bound by EU legislation, may impose on overseas funds.
A major point of attention in the relationship between the UK and the EU post Brexit is the delegation of portfolio management. Delegation is explicitly permitted in the UCITS Directive and AIFMD. Cooperation agreements between EU Member States and third countries must be in place in case of delegation, which will be the case.
The designation of delegates in and outside the EU is subject to strict requirements of initial and ongoing due diligence, and oversight of delegates. A framework with the required protections and safeguards is already in place. As a result, there is a wide consensus in the industry that they are no reasonable grounds to revisit the delegation framework in the context of the reviews of the AIFMD and UCITS Directive.
Capitalising on the surge in investors’ appetite for sustainable/ESG fund products
ALFI has always viewed responsible investing as one of the three main pillars of its mission, next to fostering the development of UCITS and Alternative Investment Funds. ALFI is also one of the founding members and a close partner of the Luxembourg labelling agency, LuxFLAG.
In its survey on the European Responsible Investing Fund Market 2019, KPMG showcases the steady increase in responsible investing both in terms of number of funds and assets under management. According to KPMG, from 2016 to 2018, the number of RI funds in Europe increased by 27 per cent while assets went up by 12.5 per cent to reach the mark of EUR 500 billion.
While at the time this only represented a small proportion of 3 per cent to 4 per cent of the assets of all European funds, sustainable/ ESG considerations have become one of the key investment criterion for both retail and institutional investors. Morningstar reported in August 2020 that flows into sustainable funds more than doubled in Q2 2020 compared to Q1 2020, with 54.6 billion US dollars net inflows.
This can be explained by an increasing demand from investors as a result of the Covid-19 pandemic, bringing sustainability at the forefront. The European Commission’s regulatory agenda, with the disclosure and taxonomy regulations being rolled out in 2021, is also a game-changer. It will require each and every single fund, not just those with an ESG focus, to comply with new disclosure requirements, including on the adverse sustainability impact.
As a confirmation of the above trend, LuxFLAG recently announced that the total number of labels has reached an all-time high with 303 investment products from 10 different jurisdictions, managed in 17 countries by 98 asset managers and 128 billion euros AUM. The number of labelled investment products has grown by 92 per cent since Q3 2019, reflecting the strong growth in sustainable investing.
On a broader note, Luxembourg was the first European country to launch a Sustainability Bond Framework, which is the first in the world to fully comply with the new recommendations of the European taxonomy for green financing. Luxembourg also became the first European government to issue a “sustainability” bond on 7 September 2020, raising 1.5 billion euros. The issue was 8 times oversubscribed.
The Luxembourg Green Exchange (“LGX”) is the world’s first and leading platform dedicated exclusively to sustainable financial instruments. It is an essential actor in Luxembourg’s strategy to position itself as one of the leading financial centres in sustainable finance. One of key concerns of asset managers is the lack of sustainability data. As a response to this market need, LGX recently created the LGX DataHubwhich allows asset managers to analyse previously unstructured pre- and post-issuance information on Green, Social and Sustainability Bonds, including but not limited to, all those displayed on LGX.
The expansion of private debt and real assets as growing alternative fund sectors
ALFI has been commissioning or carrying out annual surveys on the three main alternative asset classes enjoying significant growth in Luxembourg: private equity, private debt and real estate.
Over the period under review ending September 2019, growth rates for all three asset classes (regulated funds only) were well above that of mainstream funds: + 14.5 per cent for private debt, + 17.71 per cent for RE and + 19 per cent for PE (regulated/ non-regulated). In contrast, for the past 12 months up to end of September 2019, UCITS’ AUM grew by + 8.02 per cent. This trend is set to continue in 2020.
There is now evidence that the AIFMD “brand” and the three asset classes gain traction not only in the EU, but also increasingly outside the EU – both in terms of asset managers creating AIFs in Luxembourg and non-European institutional investors investing in these products.
Asset managers typically choose Luxembourg for AIFs that have a multi-country investment approach and/ or that are distributed cross-border, in effect for the most complex and sophisticated structures; this is a recognition of the Luxembourg eco-system and expertise of all stakeholders across the entire value chain.
Some key facts and trends:
• Asset managers: increasing interest from non-EU, in particular North American (18.3 per cent compared to 11 per cent in 2018);
• 46 per cent distributed in 2 to 5 countries, increasing use of AIFMD passport (against NPPR) – see survey link.
Private Equity Fund
• Average size significantly increased from 132 million to 200 million euros;
• Number of funds with over 1 billion euros has doubled in 12 months, with nearly large fund houses now active in this segment and present in Luxembourg;
• Unregulated investment vehicles (RAIFs and limited partnerships) now account for 51 per cent of all PE funds – see survey link.
Private Debt Funds
• In the last two years alone, AUMs of private debt funds have increased by 40 per cent from 40 billion in 2017 to 56 billion euros in 2019 (regulated funds only). It should be noted that there is a significant part of the segment in Luxembourg that is structured as unregulated entities – see 10 reasons link; see survey link;
• Luxembourg debt funds can originate, participate or syndicate loans and accommodate all types of debt strategies, including loan origination investments in secondaries, mezzanine, and distressed debt, subject to the requirements set out by the CSSF in its FAQs (section 22 on loan origination.
The growing attractions for fund managers of Luxembourg as a physical location
The Grand Duchy is home to no less than 170 different foreign nationalities representing a staggering 47.4 per cent of the total population, with an even higher percentage for the City of Luxembourg.
Quality of life – climate, housing, infrastructures, international schooling, health services, sporting facilities – is an important consideration for expats deciding to pursue their career in the Grand Duchy. The City of Luxembourg ranks 9th in the Global Liveability Report 2020 and thus maintains its place in the top 10, which it already occupied in previous years.
Luxembourg ranks 2nd out of 128 countries in terms of political stability and safety according to the INSEAD & OMPI Global innovation Index, 2016. It ranks 4th best city for the level of its healthcare services in the EU Flash Eurobarometer, Quality of Life in European Cities.
It has a wide selection of multilingual schooling options and a vast selection of state-subsidised fee-paying schools to cater for the growing expat community. And it ranks 2nd best city with the highest level of sporting facilities in the EU according to the EU Flash Eurobarometer 419, Quality of Life in European cities.
The Luxembourg government reckons that public transport requires further investments. In 2020, Luxembourg became the first country in the world to make all public transport free. n
1. Refinitiv and PwC Analysis, 31 December 2019.
2. CSSF, 2019 Annual Report.
3. Source: CSSF, 31 July 2019.
4. Source: Refinitiv and PwC analysis, 31 December 2019.
5.. Source: Luxembourg for Finance.
Deputy Director General, ALFI
Marc-André Bechet is Deputy Director General, Director Legal & Tax of ALFI, the Association of the Luxembourg Fund Industry. He joined the association in September 2014. Before joining ALFI, Marc-André Bechet was Head of the Investment Funds Services at Banque Degroof Luxembourg, responsible for fund administration and custody. He was also a member of Banque Degroof’s Management Board. Prior to joining Banque Degroof, Marc-André Bechet worked for 18 years at RBC Investor Services Bank S.A. in Luxembourg, where he held various senior positions including Head of Custody and Network Management, and Head of Business Development and Relationship Management, Legal and Compliance. Mr. Bechet holds a Master’s degree in Business Administration from the University of Ottawa (Canada) and a Master’s degree in Finance from the French business school ESCP in Paris. He speaks English, French, German and Luxembourgish.