If Luxembourg's funds industry was shaken by events of the last 18 months, you would hardly know it, finds Nick Fitzpatrick.
“Long-lasting relationships develop, mature and cement in moments of crisis,” says Mario Pirola, executive director and acting head at JP Morgan Worldwide Securities Services in Luxembourg. He’s speaking about his firm’s relationships with clients, but he could just as well be speaking about relationships as a whole between Luxembourg and the numerous fund managers and banks it supports in their activities across the world.
The financial crisis, including its chapter on the Madoff fraud, seems to have done nothing to dent Luxembourg’s standing as a fund centre. Accusations from Paris about the robustness of Luxembourg’s fund regulations in light of the fraud seemed to hurt the Grand Duchy’s feelings more than its balance sheet.
Those accusations arose after a Luxembourg-based depositary bank, UBS, was accused of failings in the safekeeping of assets for a Madoff-linked fund it had established at the request of clients. UBS denied that it had responsibility for the safekeeping.
The episode has shaken the broader world of custody banking in and beyond Luxembourg. But the money that flowed out of Luxembourg’s investment funds was more a response to the broader state of financial markets than the Madoff fraud.
In 2009 much of that money flowed back again and any mud thrown at Luxembourg seems now to have drifted out to sea on the Mosselle River.
Far from avoiding the country because of a perhaps ill-conceived concern about investor-protection laws, clients are not only returning but possibly placing even more trust in Luxembourg. Fund managers and custodians report a resurging interest in Sifs – Lux funds that are more lightly regulated than Ucits funds and popular with hedge and private equity providers.
Net sales of €84.37bn during 2009 helped build assets under management (AuM) for total funds (including non-Ucits) back up to around €1.789 trillion. This was an AuM increase of 14.7% from January 2009, although it includes market appreciation.
However, AuM had stood at over €2 trillion at the end of 2007 and fell sharply to just over €1.5 trillion at the end of 2008.
The AuM figure for just Ucits funds at the end of November 2009 was €1.4 trillion, representing Luxembourg’s market share in Ucits of 29.2%.
Jon Griffin, head of JP Morgan Asset Management (JPMAM) in Luxembourg, says: “Confidence was not shaken in the Luxembourg regulator. Madoff was involved in a significant fraud and one that originated somewhere else in the world, the outcome of which has been judged in the US courts and is still under investigation elsewhere. The Luxembourg regulator reacted quickly and I never got the feeling that people doubted the integrity of this domicile. I do not believe that clients were worried about whether Luxembourg was a safe jurisdiction to keep their assets.”
JPMAM is the largest fund promoter in Luxembourg with €254bn of assets under management in locally domiciled funds. It runs 158 funds out of Luxembourg, mainly Ucits.
Around 70% of JPMAM’s funds under management are in money market products. The firm saw large inflows during the post-Lehman Brothers turmoil as investors took shelter in cash. This resulted in its Luxembourg-based dollar money market fund becoming that largest mutual fund in Europe with $100bn (€72.9bn) in assets, says Griffin.
“A lot of corporate investors sought JPMAM money market funds as a safe place to hold their assets,” he explains.
Return to risk
Reflecting that Luxembourg is still trusted as a fund centre, Griffin says that investors are re-risking again. “We are seeing investors now moving into non-cash assets and specifically into products that present higher risk profiles like Russian, Chinese, and emerging market equities and sectors like natural resources rather than core assets like European equities.”
He suspects high-net-worth investors are behind this, while retail money waits on the sidelines.
Griffin is one of those who reports a growth in Sifs – which stands for specialist investment funds – coming on the back of renewed interest in alternative strategies
“The Sif structure is a departure for us as we have primarily provided Ucits structures. We are seeing increased demand for new Sif products coming from our normal client base.”
The Sif is a regulated product for a special category of informed investors. It does not have a European passport and is designed to compete with the Qif (qualified investment fund) in Ireland and products in other jurisdictions such as the Cayman Islands, where regulation is lighter.
Griffin adds: “If people want to get access to private equity or distressed debt, and if they are sophisticated investors and realise these are long-term investments, then the daily liquidity offered by Ucits is not appropriate. A Sif, which has its own regulation, is better.”
His colleague Pirola says: “The Sif will be a popular legal structure with hedge funds that want to launch products in Luxembourg; they add a further dimension to the choice of vehicles that can be used for alternative products.”
Luxembourg and Ucits
But it is within Ucits that Luxembourg’s fortune was made and it still largely depends on Ucits too. With a small domestic population, Luxembourg has had little choice but to develop a speciality in cross-border fund distribution, and the words ‘Luxembourg’ and ‘Ucits’ usually ride out together as one brand. Ucits is a fund standard that can be imported to other countries without, usually, any red tape as long as foreign regulators recognise it.
The strength of the Luxembourg Ucits brand globally is reflected in the origins of its 2009 fund flows.
“The success of net sales for Luxembourg-domiciled funds in 2009 has been aided by Asia,” says Lou Kiesch, head of regulatory consulting at Deloitte. “When net sales become negative Asia has always buffered the loss. Were it not for Asia, it could have been worse.”
Asia is a very big market for Luxembourg, says Kiesch. The most important Asian region is Hong Kong, where two out of three funds distributed are domiciled in Luxembourg.
But the financial crisis revealed the volatility within Uctis funds, whether they be domiciled in Luxembourg or not. As Luxembourg is so bound to the Ucits structure, there is a realisation that this volatility has to be dealt with and Kiesch is among those who think encouraging wider pension investors to take up Ucits will help.
“We look towards the example of the 401k pension model in the US. The US had positive net sales of 401k during the financial crisis. There were regular cash flows into these funds because of the longer-term nature of pension investment. Therefore cross-border pension schemes are at the top of the agenda for Luxembourg.”
But so is tackling the wave of regulation coming out of Europe, some of which is in response to the financial crisis, and some – such as the Ucits IV regulations – that is not.
Through the Association of the Luxembourg Funds Industry (Alfi), fund companies have a sympathetic ear with the financial regulator, the Commission de Surveillance du Secteur Financier (CSSF). But the overarching European regulatory regime is more difficult to influence.
Luxembourg was startled at the roll-out of the Alternative Investment Fund Managers (AIFM) Directive as much as anywhere else.
“There should have been a more public debate before the proposals were drafted, but there wasn’t,” says Jean-Michel Loehr, head of industry and government relations at RBC Dexia Investor Services, echoing a widespread feeling in the investment management world.
Loehr’s role was created in March last year in order to tighten RBC Dexia Investor Services’ focus on the regulatory environment or, as he puts it, “to sense the changes that might affect us”. As well as Ucits and the AIFM directive, these changes include Target2Securities, which are rules affecting clearing and settlement.
“I think Luxembourg will be more proactive and less reactive in future with regards to communication,” Loehr says.
“The market has learnt to communicate more, but unfortunately Luxembourg is not always heard on the basis of its market share. Luxembourg and other international fund servicing centres represent a substantial part of the funds industry and should have a more legitimate voice.”
However, he says: “We are confident about the outcome of AIFM and Ucits IV. Cross-border fund distribution is a success story and Ucits IV will increase it, and our research suggests that vast amounts of clients will continue to use international fund centres.”
Given Luxembourg’s market share in fund services, it is perhaps not surprising that the Madoff affair should have touched it, and no coincidence either that the other fund centre affected by Madoff was also a major one, namely Ireland.
Cross-border fund distribution is indeed a success story in Luxembourg and the financial crisis perhaps just shook Lux into realising its priorities, such as bringing the stable cash flows of pension funds to the Ucits market.
For now, though, those long-lasting relationships that have matured in the crisis have seen Luxembourg through its most testing time.
©2010 funds europe