DOMICILE: What doesn't kill us makes us stronger

Luxembourg is a stronger domicile following the challenges it faced over the last 18 months. But perhaps more needs to be done at an industry level to convey Lux’s successes as a fund haven throughout the financial crisis. Nick Fitzpatrick hosts a roundtable discussion with Martyn Cuff (Allianz GI), Michael Ferguson (Ernst & Young), Noel Fessey (Schroders), Bob Kneip (Kneip), and Charles Müller (ALFI)    lux_dom_five.jpg left to right:  Charles Müller, Martyn Cuff, Michael Ferguson, Bob Kneip and Noel Fessey Funds Europe: Luxembourg has successfully positioned itself as a flexible but robust fund centre. Its regulatory regime has been instrumental in this. But last year, in the fall-out from the Madoff scandal, Luxembourg was accused of failing to faithfully implement the Ucits rules. Has this affected Luxembourg’s standing?

Noel Fessey, Schroders: The fund industry – irrespective of domicile – faced significant challenges across every function in 2008, including the depository space. What happened in 2008 also affected the entire financial services industry, not only funds. The fact that Madoff affected some Luxembourg-domiciled funds is very regrettable but it was not a result of how Luxembourg implemented the Ucits rules, and criticisms to that end are unfair.

The funds industry, and the Luxembourg funds industry in particular, has emerged from the financial crisis with its good standing intact. Mutual funds are safe investment vehicles. They certainly provide better investment diversification and better product protection to investors than bank deposits do. They exist because – in Ucits I, III or IV – a regulatory framework has been created within Europe over the past 20 years that has served retail investors’ interests well and Luxembourg has transposed those regulations into national law very well.

Luxembourg’s success is down to the fact that Luxembourg is a fiscally, politically, jurisprudentially and socially stable place. It’s a good place to do business; it’s a place in which we find skills that are appropriate to our industry, which have been developed over a number of years.

We find not only fund promoters here but also a range of industry participants who provide supporting services. We find an environment in which we can readily exchange information with people in other similar companies, which doesn’t happen in quite the same way in larger financial centres like London. We also ­– even when the labour market is tight, as it was in 2007 – find that we have access to a broad range of skills and languages, which in a cross-border industry is particularly important.

While 2008 was a hard year for everyone, Luxembourg is recovering from it and I am sure that it will continue to be successful in the future.

Charles Müller, Alfi: To start with, Madoff was a US fraud. Nevertheless Luxembourg took it very seriously even though we were not hit out of proportion by the fraud - not when you consider that Luxembourg has over 25% of all the fund assets in Europe.

Why did we take it so seriously, then? The reason is that the Madoff fraud was the first and most serious incident within the Ucits landscape since Ucits came to life in the middle of the 1980s, so naturally we wanted to deal with it immediately and appropriately.

The CSSF, Luxembourg’s financial regulator, looked into the behaviour of Luxembourg-based service providers in detail and made its position very clear. Alfi, the Luxembourg funds industry’s trade association, also created a Madoff taskforce that looked at what could be done in order to avoid this situation occurring again in the future. Importantly, though, work by the European Commission and Cesr [the Committee of European Securities Regulators] has clarified that Luxembourg did implement Ucits diligently.

The problem that has to be solved at a European level is the question about the role and responsibilities of the fund depository. It is now clear in the eyes of the EC and of the French authorities that problems do not lie within the realm of how Ucits laws are implemented by a member state, but more specifically within the realm of how Ucits fund depositary rules are harmonised across European member states. The same applies now to the Alternative Investment Fund Managers Directive (AIFM) that is coming up.

Looking at net sales and funds under management, you will see that Madoff has not harmed Luxembourg.

Michael Ferguson, Ernst & Young:
The Luxembourg regulator has in my view established a fair balance between regulation and pragmatism. If you look at some of the key regulatory developments within both the Ucits and the alternative investment worlds over the past few years, Luxembourg has led the way. We sometimes need to remind ourselves and our audience of this.

Luxembourg has led the way in, for example, the development of sophisticated Ucits funds. I spend a lot of time in our competing jurisdictions and can see that these jurisdictions are learning from what Luxembourg has done and achieved.

If you look at the alternative investment fund world, we now see that as a result of G2O and other discussions, most believe in a greater level of regulation. But Luxembourg again was there several years ago with, for example, the introduction of their Specialised Investment Fund legislation in 2007. This has facilitated a regulated platform for the complete range of alternatives and has been a huge success, which will, in my view, be further enhanced with the introduction of the directive on Alternative Investment Fund Managers.

Martyn Cuff, Allianz Global Investors: It is worthwhile reinforcing a few well-known points about Luxembourg in the wake of the financial crisis because it is too easy to get caught up in the emotions of a situation like that. If you consider that Luxembourg creates hundreds of thousands of fund prices and processes thousands of investor deals every day, it is notable that there have not been any other such industry scandals over the past years. This is partly due to the deep experience and controls that have been developed over many years.

Let me offer a comparison: When a high-quality car manufacturer has a product recall, does that mean people don’t trust that manufacturer any more to build great cars in the future? No, it does not necessarily mean so, especially after the initial shock recedes.

Now and again, in a very complex business world, there will be the occasional crisis. But, as usual in times of crisis, those who keep their heads while those around them don’t, and those who look sensibly at the facts and face up to realities, will be best placed to lead the way through difficult times.

People need, therefore, to stop and think about the experiences of other industries. In a complex world product recalls will happen. But when a crisis like that does come about, as Charles says, the industry has to stop and take it very seriously and Luxembourg’s approach is reflected in the Alfi Madoff taskforce, which has been looking at the whole value chain in fund management to see where improvements can be made.

Müller: The aim was to look at the value chain to see what could be improved and there were guidelines issued concerning depositories. The Alfi Code of Conduct was also updated. In addition, the Madoff taskforce was also in contact with lawyers and with investors. We created an investor forum to look at our industry from the investors’ point of view. There will be a dedicated internet site going live in March and other activities will follow.

Bob Kneip, Kneip: I think that the ultimate role of the regulator is to provide investor protection and we have to ask ourselves, as an industry, whether we are doing the right thing to protect investors. When it is a global market place yet the regulators are local, how can this be put together under one hat?

I’m quite impressed by the pragmatism of the CSSF. Luxembourg isn’t only about regulation, it’s about a cluster of people that has successfully moved on together throughout the years, perhaps due to the fact that we were the first movers in the regulatory framework when Ucits was born. It’s not only about regulation, it’s about people, it’s about competencies, it’s about the companies that set up here having these aspects altogether around this common theme of cross-border distribution. I’m not saying there isn’t another one, but I don’t know any centre or regulator who has those competencies elsewhere on the planet.

Ferguson: Certainly not in the area of international fund distribution.

Kneip: Other jurisdictions outside Europe are suffering. If fund promoters are looking for a safe, secure haven to domicile their funds and to offer their investors the best levels of protection and transparency, Luxembourg is still the first choice.

Cuff: The financial crisis and Madoff are two different things that happened to coincide, which was particularly problematic for all of us in the industry and for investors who suffered as a result of it. However, an example of a regulatory response that I am aware of is that the CSSF is looking into the details of individuals a lot more now by requiring more elaborate CVs.

I also understand the CSSF is hiring more staff and that audit firms are asking more questions around their ‘long form’ report. I think that everybody, whether you’re a risk manager, an auditor, or a fund manager, is stopping to look at what processes they have got in place to ensure they are good enough. This will also mean that the bar is raised. In any industry, one of the positives to take out of a crisis is that you’ve raised the bar as a result of it.

Fessey: To echo Charles’ point, this was a US fraud. In principle, people closer to Madoff’s operation could and should have spotted it. There were numerous red flags. However, I think that any manager that invests a substantial sum in another manager’s fund needs to take its due diligence obligation very seriously. Madoff reminds us that due diligence involves careful inquiry into the target manager; it is not simply a formality.

Operational demands

Funds Europe: Luxembourg is a major centre for fund and asset servicing. It serves both fund managers that largely outsource their operational infrastructure, and fund managers who choose to keep many functions in-house. What operational demands were put on fund managers and their asset servicing partners in Luxembourg by the financial crisis?

Fessey: Around the time of the Bear Sterns collapse, clients wanted to know which of our funds were exposed to Bear, by how much and in what form.

Demand for exposure reports accelerated through 2008 with requests about Countrywide, Freddie Mac and Fannie Mae, Lehman, Bank of America, Merrill Lynch, AIG, Citi, Royal Bank of Scotland and just about every major financial firm in Europe and the US.

Such was the extraordinary level of concern that we set up a dedicated service to answer clients’ requests for information. At one point we received a question from a large financial institution that asked, ‘What are your funds’ worldwide exposures to financial institutions of every kind, be they a bank, building society, thrift, insurance company, etc?’

The level of scrutiny around companies that were in distress in that period really became quite acute. It was intense, and I think that fund promoters that were able to answer those questions and provide information that could help their clients to understand and manage their risk will be at a competitive advantage in the longer term.

Cuff: Yes, the questions were very much about what assets were in funds and what exposures resulted from this.

Funds Europe: In the crisis how well did your service providers support you? Do they need to improve? What do you think of the possibility that custody-related costs may increase post-crisis as a result of the greater risks that custodians run now in terms of liability?

Cuff: In our situation we do run largely an outsourcing model in a number of locations, but in other locations we are in-house. I would say looking across Europe, not just in Luxembourg, our partners responded well. I’ve got a particular view of how to manage outsourcing and partnering, which is very much of a hands-on, ‘X-ray vision’ approach. By that I mean that if I give something sophisticated to someone else to do, I fully expect to remain very involved with it.

So in the crisis, the way we responded to it was to fully involve our X-ray vision approach. We put demands on providers and to be fair to our providers across Europe, they responded well to these demands in terms of timeliness.

We moved to a daily pricing committee whereas normally we run this monthly. We went daily for six months the day after Lehman Brothers failed, and we worked with our partners on the daily pricing committee until markets and panic started to calm down.

Do service providers need to improve? Yes, they always do, and they always will need to. Fund managers have a fundamental duty in my mind that even if they outsource they have to really keep their hands in the business.

So overall we were pleased with the support that we got, but I think part of that was because we took an extremely proactive approach rather than sat back and said, “How are you dealing with the crisis over there?”

Fessey: I thought that our principal service provider, JP Morgan, was superb, really absolutely spot on. They do a lot of the valuation work for us and we have a fair sized supervisory team upstairs, so we understand the process well. They provided information on time; they provided additional information as we needed it; they provided us with plenty of information about JP Morgan itself and its status through the crisis; and they kept the services open late, indeed very, very late as we needed them to, even when it created some significant data processing problems for them.

Net asset value accuracy during the crisis was as good as, if not better, than in normal years, so we didn’t pay any penalty that way. That’s really important when you’re dealing with a global distribution network and clients who are working overtime to understand their position in the middle of world financial disorder; they were not going to forgive you for a pricing error at that point in time. Everybody was going to get very nervous if you started throwing off pricing errors.

We have a number of other suppliers too and I would say that during 2008 and 2009 everybody that we work with, our main auditors PwC and our other fund service partners, had a very good year in terms of the quality of their support.

Cuff: To the second point of your question, about charging more money, I think the crisis has helped to make more transparent and bring to the top of the agenda issues that have been latent for some while. Does that mean that because these issues are now more transparent and more debated that the fees paid by fund managers to custodians should increase?

Maybe, but maybe not. I don’t think we can sit here and say no, definitely not, but I don’t think there’s an automatic response to be more sympathetic about the greater risk they are taking on. After all, is it more risk than what they took on before?

I’d like to see the definition of ‘more risk’. Is it clearer where the risk is and what the risk is? I think that’s a different point, but has this changed how the economic spoils should be shared? I don’t think there’s a one-for-one logical match there but there is a debate to be had. Is it more risky now? Or is it just that the risks are a little bit clearer?

Fessey: The risk the custodians see is in them being sued in the event that a fund turns out not to have good title to its assets, or if the assets aren’t what they purport to be.

Cuff: But the services they’re doing, the contracts they’re working to and what we are asking them to do – what’s changed?

Retail investors

Funds Europe: The crisis revealed Ucits funds to be volatile in terms of fund inflows and outflows, possibly because of how retail investors reacted to uncertainty. How exposed to the retail investor is Luxembourg?

Ferguson: Luxembourg funds did indeed suffer certain outflows and a shift from fixed income and equity to cash/money market funds as a result of the credit crisis. However when it comes to retail investor decisions, there is the never-ending question around education – and Luxembourg needs to ask what role it can and should play here. 

In addition one should remember retail investors withdrew money from funds because of, and to a great extent based on, advice received. Some of this advice came from those who wished to repair their own balance sheets.  This then leads to the question, for example, should we have an EU version of the RDR [retail distribution review]?

Fessey: I’m not sure that a European RDR is a solution to the issue of how best to communicate to investors the concept that a mutual fund is a suitable investment proposition, and potentially a better one than a bank or savings account.

Ferguson: Perhaps not but the question is, would it not lead to a greater level of transparency around how revenue flows and how connected parties are related in the distribution chain?

Fessey: Funds are probably the most transparent part of the financial services industry.

Cuff: It will be interesting to see what happens in India. India has now implemented one of the main tenets of RDR, which has changed the pricing of mutual funds and this will potentially affect the way distributors are rewarded for selling funds. Obviously Indian market dynamics are totally and utterly different to a mature market, but nonetheless it’ll be interesting to see how the Indian regulators push for these products to be bought rather than sold. We will also get some experience of that in the next couple of years in the UK too.
Fessey: Back to the point on communication and the quality of our dialogue with investors. As an industry, we prepare rather worthy, earnest but dull documents explaining mutual funds to investors. We put them on our trade association websites and hope that investors will read them. I think that we should be realistic; this approach is unlikely to stimulate the level of interest that we need to improve public understanding of mutual funds.

Müller: We have to look at where the investor is coming from, what he already knows about funds and what we can do to improve his knowledge.  There is a lot being done to understand these, also at the level of Efama [European Fund and Asset Management Association].

Before the crisis, the investor did not really care where his performance came from and so you could basically throw any fund literature at him and he wouldn't read it no matter how sexy it was. I think that is something that has to be acknowledged.

Along with the crisis there came an additional awareness on the part of investors, though.

This turnaround has had two impacts. Just informing the investor about the regulatory and legal means imposed by different distribution markets is just not good enough anymore.  It's more about doing the right thing according to each and every market that the distribution schemes, the type of investors, and the  types of products are in. We also have to be in closer contact with distributors who have to understand the products well in order to advise their clients in an appropriate manner.

Fessey: I agree with the principles about improving investor communication. But what we fail to do as an industry is to establish the emotional connection with our investors and to lay the foundations about what investing in a mutual fund can mean to them.

Funds Europe: You mentioned that funds are safer than bank deposits. Do you think people, retail and professional buyers, are as aware of the benefits of funds as they should be?

Fessey: Generally not. By putting money into a bank account you are taking risk on the bank’s balance sheet. The difference between a deposit account and a fund when a bank fails is that cash on deposit is potentially lost in the bankruptcy whereas the fund’s investments in securities – which already reduce risk considerably because they are diversified across many issuers – are protected from the bank’s failure. In that sense, during 2008 when many banks were at risk of bankruptcy, a Ucits fund offered much lower counterparty risk than a bank deposit account.

It took the extraordinary events of 2008 and the failure of banks such as IceSave to remind investors that a bank deposit is only as good as the bank, and that it is not risk free. However, while investors intuitively grasp the concept of a fund’s market risk, they can sometimes become fixed on the downside, which was understandably daunting in 2008. That helps to explain why so many preferred bank deposit accounts and why some of them unwittingly increased their risk considerably by placing money with banks who were offering unusually high interest rates because they were in such need of deposits to sustain their balance sheets.
Ucits IV
Funds Europe: How will Luxembourg make Ucits IV work? And what about the management company passport aspect to it, where a fund and the management company behind it no longer have to be in the same country? How will Luxembourg continue to distinguish itself as a major domicile in this new regime?

Müller: The Luxembourg funds industry never opposed the management company passport. We have said there are a lot of complicated issues linked to it and in light of this we would have preferred the Ucits IV proposals to have emerged without the management company passport issue ­within it.

These issues are mainly regulatory- and tax-based. For example: who is going to supervise what in the fund, and who is going to supervise what in the management company if they are in different jurisdictions? How will the two supervisors work together? 

These questions are important in the context of investor protection. The investor needs to be confident that the fund is properly supervised and there will not be gaps in the supervision because each supervisor believes that the other one is responsible for picking up on certain points.

The tax difficulties are also important. We were told by our colleagues in Efama  and by certain regulators that we were exaggerating the problem. But now that we have a management company passport all these issues are in fact coming back to the surface. We talk to asset managers who say they will not use the passport immediately because they want the regulatory and tax issues, which are still relevant within it, to be resolved first.

Ucits IV is very much about giving options to fund managers that they can use if they wish to. Ucits IV was not meant to revolutionise the world; it was meant to fix what wasn’t working and make the Ucits landscape as optimal as it should be.

So how are we preparing ourselves in Luxembourg? Alfi has six working groups, one per topic [topics relating to the proposals contained within Ucits IV, such as the master company passport and the merging of any master feeder structures with Ucits IV funds], and for the moment we are analysing the provisions to see how we will recommend that these be implemented in Luxembourg law in an efficient and business-friendly manner.

Ferguson: We as a firm have done a lot of work in this area with asset managers and have held a series of discussions with many around their Ucits IV intentions.  In our recent survey of over a hundred global investors, the initial view that has been expressed to us is that nobody is going to go for a major ‘big bang’ approach – it will be a slow lift-off.

With regards to the domicile of management companies and to the master feeder fund, without exception they see Luxembourg as continuing to be the dominant player in the international global distribution space, both from the point of view of putting the master fund here along with the management company.

Many felt initially that Ucits IV was going to reduce costs, but the view now, I think, is changing. The current view is much more about consolidating corporate governance and creating operational efficiencies. Of course there is the open question around whether any reduction in costs at the management company level will flow through to the underlying investment fund products.

When you look at the key decision about where to put the management company, cost is obviously one issue, but costs can be very broadly defined including costs of changing the infrastructure, etc, of what you have already got in place.

However, another area, that requires serious consideration, is the potential impact on the fund’s distribution – not just in the EU but probably even more importantly in the key Asian markets. Given Luxembourg’s lead as a cross-border fund distribution centre not just within the EU, but also outside of the EU and especially in Asia, I believe Luxembourg-branded domiciled Ucits will continue to play a very prominent role post Ucits IV.

As regards the product provisions of Ucits IV, such as the cross-border fund merger provision, its unlikely to bring any substantial value until the related open tax issues are sorted out and this will, in my view, take three to five years at a minimum.

The product provision of Ucits IV that I see as being of the most interest is the master/feeder element. From speaking to asset managers, there is a desire to manage greater consolidated pots of assets and at the same time enhance cross-border distribution. The master/feeder element does go some way to facilitate this. Overall as far as Ucits IV is concerned, I believe the two existing international fund centres will continue to dominate this space.

Cuff: The other centre being Ireland?

Ireland, yes of course – however, it’s no secret that France has also a strong desire to break into this space. For example, the AMF has recently announced that English documentation will be permitted for certain filings, etc. There is certainly a strong political push to try to create what I would describe as an international cross-border investment fund industry in France. I would say Luxembourg and Ireland should welcome this – it keeps us both on our toes!

Funds Europe: Do you think that recent economic difficulties in Ireland have affected its standing as a fund centre?

Ferguson: I don’t believe there is any evidence to indicate it has. The issue for Ireland at the moment is the challenge around reducing its current budget deficit – the recent budget in December ‘09 went for primarily expenditure cuts rather than tax increases. It goes almost without saying that the potential for tax increases whether personal or corporate in any jurisdiction would, for example, influence decisions where to place Ucits IV management companies, etc. For example, when I speak to some UK managers, they talk about the great uncertainty around UK tax after their next general election which is expected to be in May of this year. 

As regards Luxembourg, the authorities do not tend to make wild changes from day to day on any of these issues, tax or otherwise. There’s a great level of certainty, meaning that if you want to set up your business here in Luxembourg today, the laws, the regulations, whether it’s actually to do with Ucits investment funds, or whether it’s about tax, are not going to be dramatically different in two or three years time.

Cuff: As an industry it doesn’t help our cause to focus on competition between domicile A and domicile B. It is better to pull together and promote the funds industry as a whole. Within Allianz Global Investors we have funds domiciled in a number of European locations and we would expect Ucits IV to help us optimise our current set-up

Funds Europe: Everything relating to Ucits IV is a step towards more efficiency in the European cross-border funds market. There is surely little question about that. But how big of a revolution is Ucits IV really for the funds industry? How much closer is the industry to a single market for funds as a result of it?

Ferguson: Ucits IV should be viewed as a step in the right direction rather than a huge leap, it will hopefully further reinforce the Ucits brand. Obviously, the danger is that brands and reputations take years to build up and then can disappear in the snap of a finger. All the debate around the Ucits brand and Ucits IV may be very boring and unnecessary, but if it reinforces the brand – then that has to be good.

Kneip: In theory, as open architecture takes over from proprietary sales, opportunities increase for overseas asset managers to gain market share over local players. However, there seem to be hurdles in the way. A roundtable discussion we recently conducted with CEOs from major European fund management houses revealed that most of them think it might be more than five years before there is a fully functioning single market. They said that a lack of distribution partners and disparity in regulation and tax legislation between individual member states are the main obstacles.

While Ucits IV is a step in the right direction, one has to remember that facilitating fund registration across European markets might also create new difficulties, including reporting challenges for fund managers. In my opinion, having a single jurisdiction for funds makes the most sense, as it is more efficient and poses less questions about compliance over multiple jurisdictions.

Funds Europe: If we do arrive at a point where we have cross-border management companies and master feeders – basically all these wonderful things – will it work? Without wanting to sound rather cynical here, given some of the experiences seen in the banking crisis, it’s an open question.

Fessey: Depending on which jurisdictions are cooperating, I think cross-border management companies and master-feeder structures can work. However, I think that Ucits IV will take time to develop in practice and I think that is a good thing. Ucits III was adopted very rapidly in respect of certain changes to product rules and that created some stresses operationally, particularly as portfolio managers started to exercise their new investment powers. I’m more comfortable with a steady development of Ucits IV, which I see as an evolution of the regulatory foundation of retail products in Europe, and which is a long-term project.

I think that the UK and Luxembourg would probably work quite well together as two jurisdictions cooperating on a cross-border basis, but at the moment Schroders is not contemplating a cross-border management company because we don’t see that the reward for doing so is sufficient to overcome the challenges that we anticipate. We haven’t yet identified any particular benefit, whether regulatory or financial, marketing or anything else that creates the compelling case to make it happen. Even the amount of capital released by merging management companies is too small to make it a worthwhile prospect, and there are few cost savings to be made in operations that are already tuned to be as efficient as possible.

When it comes to cross-border management companies involving jurisdictions that Luxembourg does not have such a good relationship with, I think that it is unlikely that anything will happen any time soon.

Looking at the broader fund industry from a post-crisis perspective, I feel that some of the jurisdictions that led the call for cross-border management companies are likely to be those that are least likely to facilitate it in practice, probably citing Luxembourg’s original concerns about supervisory gaps and shareholder protection as the reason why they’re not willing to permit the import of management company services. That would be ironic.

Müller: I agree with the point about the slow take-up, but how will Ucits IV shape the service provider industry here?

Ferguson: The Luxembourg asset servicing landscape has changed quite a lot over the years. Many of the detailed processes are not necessarily performed here in Luxembourg any longer, but the client relationship and risk management oversight over the processes remain here.  The open question is whether Ucits IV will speed up the reshaping of the Luxembourg asset servicing landscape? I believe it will.

 I don’t see Ucits IV as a revolution – it’s just not going to happen that way. I think that the things that will shape the industry in the longer term will be environmental circumstances that always would have shaped it anyway.

To some degree, yes, people relocate services to other jurisdictions in pursuit of labour arbitrage opportunities. We have considered that and we have decided that our cost of production and the quality of service that we have here in Luxembourg means that this is where we want it to be. Given the size of my firm – which is a reasonably sized enterprise – the cost of pursuing an offshoring strategy simply does not pay back in the medium term.

And it comes back to questions like, why are we in Luxembourg and why are we so successful here?

Well, the time zone means we can service Asia and the Americas as well as Europe, and we can find the specialist fund service skills that we need. The international employment pool also means that we can often service clients in their own language, often reflecting their own culture, and we think that’s important.

People talk about Luxembourg being expensive, but I’ve done the maths and it’s not expensive when you take proper account of the cost of moving offshore. The cost of production in Luxembourg is actually reasonable. It’s certainly a good deal cheaper than London although the fall in the value of the pound has to some degree reduced that advantage. Luxembourg understands the funds business; it’s technically literate; there’s a know-how here that you cannot acquire easily elsewhere. And also it has an ability to improve efficiency progressively. In Schroders Luxembourg, we are much more operationally geared now than we were seven years ago and our unit cost of production is therefore much lower than it was then. Overall, we’ve had almost zero real cost increase and yet we’re supporting a much larger business.

Cuff: One thing I would add because I fundamentally agree with that point, is that I don’t see Ucits IV as fundamentally changing the service providers’ world. The only clear implication is, if you go down the master-feeder route, then clearly that is going to have an impact. If a manager has assets in domicile A and in domicile B, but domicile B is the master fund, B is going to have all of the assets while the feeder in domicile A is just a fund of funds. The logical next step in thinking is whether you have the same service provider for the master fund and for the feeder fund.

If you keep them separate, how attractive is a feeder business to a third-party service provider when actually all they’re doing is administration for one bit of a fund of funds?

If I were in charge of a service provider and I were looking at a fund manager who was in a number of jurisdictions I’d put a priority on securing their Luxembourg and Ireland business above their mutual fund business in other domiciles because of the reasons we’ve said before now.

Luxembourg beyond Europe

Funds Europe: Where is Luxembourg going next in terms of growth markets in the Far East, the Middle East and elsewhere?

We are essentially an outsourcing company and we plan to open an office in Hong Kong. This is being done because for us, like for asset managers, one of the aspects that came out of the crisis was the need to understand and be closer to clients and, in the case of fund managers, to be close to their distribution networks.

We looked at the main distribution markets for Luxembourg, at least for certain funds, and found that a lot of this activity can be done out of Luxembourg on an international level. However, it’s quite difficult to argue that we would know anything about the UK without being in the UK. The same applies to France, Germany and to the Far East.

In 2009 a lot of influence came from those countries and it seems right to support that and support our clients in their efforts to do the same. It’s totally out of the question that we should not be there, not so much to sell to locals than to support the Luxembourg funds industry in their distribution efforts throughout Asia.

 Alfi is looking at different avenues for the future success of the Luxembourg fund industry. One avenue is to make the most of  European regulations like Ucits IV and the Alternative Investment Fund Managers’ Directive. I think that’s a very important new piece of legislation.

For us the important point there, is that there will be a passport for those products that will comply with the alternatives directive. The prime location for people who want to use the passport is Luxembourg so we see this as an opportunity.

The second avenue is found among other products that are not really linked to any European regulation. An example is Islamic finance. The tax authorities in Luxembourg recently issued a new circular which will make Islamic finance in Luxembourg easier. Microfinance is an area we are looking at too, and green funds. ETFs is certainly a sector where we have to work in order to be competitive and attract ETFs to Luxembourg, so that’s another avenue of interest.

Then the third is global distribution, especially new markets. Luxembourg distributes already in many markets but there are still a lot of spots where there are opportunities. Think about China, of course. There is a memorandum of understanding between the supervisors in China and Luxembourg, and it means Chinese QDIIs can invest into Luxembourg funds.  Alsot, there is a growing opportunity in Latin America. A lot of Latin American countries were influenced by Spain. In Spain we were not blacklisted, but sort of greylisted due to the fact that there was no exchange of information on demand in the double tax treaty. The double tax treaty has now been altered and the Spanish authorities have announced that they will take us off their list and this obviously has a positive impact on views of us in Latin American countries.

We already distribute to pension funds in Chile, Peru and Colombia and there are other countries that could be interested as well.

Fessey: By and large Schroders has already expanded to cover most of the markets that we think are important for cross-border fund sales, so I think that the future for us is a question of confirming our long-term success in those markets.

I think Luxembourg will continue to strive to be more efficient. This is a natural response to the offshoring threat that we perceive here, but it is something that we need to do anyway because I think that revenues in the asset management industry in the future will be lower than they were in the past; that much is clear. Cost pressure will also probably lead to consolidation – though I hesitate to make any prediction about how and when, because not a great deal of consolidation happened in the last 18 months, or less than we might have expected. But I think that there probably will be fewer funds, promoters and service companies in the future.

Most of all Luxembourg must be ready for whatever comes next. It is important for those of us that work in Luxembourg to ensure that our fund complexes remain stable, that they are well governed, that they do what they have been established to do in terms of supporting their shareholders’ investment objectives, and that they are as safe as they possibly can be, no matter what the world and the markets throw at us. I do not think that this crisis is over yet.

Ferguson: I can only repeat pretty much of what has already been said. I also think we need to be very conscious about the convergence going on between so-called alternative and traditional investments. We have seen, for example, how all of the big institutional hedge fund managers have set up Ucits funds and that is an area and space that we need to ensure we are supporting.

When we look at the proposed Alternative Investment Fund Managers Directive – which will cover the three main sub-sectors of alternatives, being real estate, private equity and hedge funds – I think we must make sure we focus carefully on that, not just in the sense of having the appropriate legislation here, but we must also focus on the operational challenges for service providers. This will enable Luxembourg to take its fair share of the opportunities created.

Ucits has served Luxembourg very well, but we need to ensure that there is also a healthy alternative investment fund industry here. Great strides have been made in this area over the last five years. There needs to be continued focus on this given the proposed Alternative Investment Fund Managers Directive.

Fessey: Property is already well developed here and I think it has good prospects for growing stronger. I would like to sound a word of caution on Ucits hedge fund strategies, however.

As a fund centre, Luxembourg should be careful to ensure that new concepts such as Ucits hedge fund strategies are developed responsibly, with proper consideration for shareholder protection and the reputation of the Luxembourg and Ucits brands. Luxembourg should aim to develop good reputable business here, not any business at any price, and I think our regulator will be an important gatekeeper in that test of quality and reputation in the future as we expand that particular product sector.

  • Nick Fitzpatrick (chairman), editor, Funds Europe
  • Martyn Cuff, managing director, Allianz Global Investors
  • Michael Ferguson, Head of asset management practice, Ernst & Young
  • Noel Fessey, Head of European fund services, Schroders
  • Bob Kneip, CEO, Kneip
  • Charles Müller, deputy director general, Association of the Luxembourg Funds Industry (Alfi) 
©2010 funds europe

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