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Custody Risk: How did Luxembourg fare in 2011?

Camille Thommes: The need to explain the situation in Europe has become increasingly important. At Alfi’s roadshows, questions have come up such as ’how is Europe doing?’ and ‘how will it solve its issues?’. This country risk has an impact on the decision of certain investors to set up a structure in a given jurisdiction.

The financial stability of a country such as Luxembourg has become a selling point. If a country runs into difficulties, this may influence some decisions that could impact the country’s business model. In Luxembourg, we are well advised to ensure that we continue to have sound public finances and that we are not running our public deficits too high. This is particularly true for a small country. Last year, we did reasonably well. Net sales remained on aggregate positive, mainly due to a positive evolution in non-Ucits, especially on specialised investment funds (Sifs). We have seen net outflows in Ucits funds of around €24 billion but we have had positive inflows in non-Ucits products of €28 billion.

We continued to increase the number of funds. Ireland did well on the Ucits side, but a very large portion of net sales of Irish Ucits funds went into a very limited number of money-market funds, promoted by certain institutions. Exchange-traded funds did well in 2011 and attracted inflows into funds of some specific companies based in Ireland.

On the Ucits side, Luxembourg has a much larger exposure in sub-funds investing in equities than Ireland. These funds were particularly hit in the second half of 2011 due to the morose global economic outlook.

Georg Lasch: Luxembourg is still seen within Europe as a very stable financial environment, so it is still attracting a lot of funds. We still have growth in funds, there is no doubt about that. There is still aggregation going on into Luxembourg due to Ucits. It is just the asset level that was strongly hit by the crisis itself. The perception of the location of the Luxembourg domicile and its services is extremely positive across Europe and worldwide. Throughout the crisis, we have seen some products emerging – we have more loan funds, and we have more funds that will probably be driven by the adverse effects of the crisis. So Luxembourg has continued to be innovative within that environment.

Daniela Klasén-Martin: As a niche player, I agree. For us, the crisis has been a little less transparent. We have suffered like everyone else because inflow has been less than usual, but there have still been new funds. We have had demand on the alternative side, which we also cover. So, although the global amount of business has been lower, when you look into the products and demands, they were still there. Overall, for us, it has been balanced. It is important for us that Luxembourg has a triple A rating compared to other European countries. It is important that we have institutions that can explain to clients that they are strong. And we are dependent on that as well. But, in some ways, we are a little less exposed because questions about our balance sheet are less relevant than they are for financial institutions. Our product is not changing because of the size of the fund, it is changing based on the complexity of the fund, and that complexity has always been there. So the impact was, in my view, mitigated for niche players.

Custody Risk: What is your outlook for 2012?

Camille Thommes: It is difficult to predict 2012. We did well, we have seen net inflows so far and the sentiment is positive. But, based on the first two months, it would really be too hazardous to make projections going forward. 

Régis Veillet: It is very difficult to forecast 2012, especially for mainstream assets, but we are seeing a lot of activity in the private equity world and other alternative assets. We are seeing a lot of interest in Luxembourg as a domicile, which is seen as a relatively safe place in Europe.

Georg Lasch: In 2012 in Luxembourg, our outlook is stable to slightly positive. In September, we had a more positive outlook than now for 2012, but it is still stable to positive. It is far more positive than the view of our colleagues across Europe so, relatively, we are in a good place. We see aggregation across Europe as benefiting Luxembourg and, although Asia and the US have ‘dried up’ a little more, we see an impressive move from Latin America into Luxembourg, and that is encouraging.

Camille Thommes: Alfi recently travelled to Latin America. There are interesting developments in Brazil, with Brazilian players reflecting on setting up a Ucits product in Luxembourg for cross-border distribution. This move will allow those asset management companies to gain visibility by demonstrating their expertise in managing assets, especially in that region. As the Brazilian economy is doing well, there are still plenty of opportunities locally, but some actors see the benefit in pursuing an international strategy. In addition, local pension funds are permitted to invest part of their money into foreign products and, notably, foreign funds such as Ucits. This is an encouraging development. In Mexico, which is an important local market, we observe promising developments as well.

Custody Risk: Last November, we had the level 2 guidance from Esma on the Alternative Investment Funds Managers (AIFM) Directive. How do you see it shaping the regulation? 

Daniela Klasén-Martin: The level 2 advice was a very complete document welcomed by the industry. Luxembourg has an enormous advantage; we stand at an important crossroads where we could make the AIFM brand as strong as Ucits. In Luxembourg, we can take advantage of the strong experience that we have in running, administering and managing regulated funds. The AIFM Directive, in terms of the control requirements, is very broadly inspired by Ucits. We need to combine the expertise on the regulated funds with sector knowledge on the alternative funds. One of the most discussed issues with the AIFM Directive was about the fact that it is regulating everything else that is not Ucits – a very broad definition. You can presumably define private equity or real estate funds, but can you easily define hedge funds and other products like debt, and more? The advantage in Luxembourg is that, in addition to proven expertise in Ucits, we can show the alternative funds expertise. We need to show that we can compete on that ground with other jurisdictions like Dublin, but also offshore jurisdictions such as the Channel Islands.

There are still clarifications needed, for example, around delegation and the role of a management company. The core responsibilities of an AIFM and a Ucits management company are not exactly the same. In an AIFM management company, the core responsibilities are defined as portfolio management and risk management together. At the same time, the directive requires companies to separate these two functions, which are very much linked to each other. This is, in some ways, a contradiction and will constitute a challenge for asset managers. Despite the differences, we believe in a dual management company model to service both Ucits and AIFM. You need to obviously take into consideration the differences between the assets, and have a strong board with specific expertise – for instance, in private equity and real estate combined with Ucits knowledge. In addition, you need to have the same specific asset class expertise within the risk management and fund administration functions. If you delegate functions, then you need to delegate them to a service provider that can clearly differentiate between the servicing of private equity, of a real estate fund, of a hedge fund and of a Ucits fund.

While most service providers in Luxembourg are very well prepared, asset managers – normally coming from other jurisdictions – are completely unprepared. Many of the less regulated structures, such as Société de Participations Financières (Soparfi) in Luxembourg, could be in scope of the AIFM Directive. Coping with the directive could constitute a big challenge for asset managers used to working with such structures.

Régis Veillet: We are at a crossroads. The AIFM Directive presents a big opportunity for Luxembourg to increase its market share in hedge funds servicing. It is not all done yet, but it creates an opportunity. But there is still a lot of uncertainty. So far, Esma has given advice to the European Commission (EC), but we don’t know if it is going to take on that advice; much will depend on this. At Société Générale, we have been explaining to clients for the last 12 months about AIFM and what it would mean to them. At some point, an alignment will need to be done between Ucits and the AIFM Directive, for example, around depository liability. 

 

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