Luxembourg aims to turn the initially controversial Alternative Investment Fund Managers Directive into a Ucits-like brand. The panel discusses the progress that has been made and looks beyond regulations from Europe. Edited by Stefanie Eschenbacher.
Thibaut Partsch, partner (Loyens Loeff, Luxembourg)
Antonio Thomas, managing director (RBS Luxembourg)
Camille Thommes, director general (Alfi)
Denise Voss, conducting officer (Franklin Templeton Investments)
Christophe Wintgens, partner (Ernst & Young, Luxembourg)
Funds Europe: Luxembourg is keen to develop an alternative investment fund management brand to complement its Ucits expertise. How is this evolving?
Camille Thommes, Alfi: In Luxembourg, the draft Alternative Investment Management Directive (AIFMD) was submitted to parliament back in August 2012. That draft was complemented by a fiscal package with two major provisions. One regarding the introduction of a limited partnership regime to accommodate the Anglo Saxon actors in the alternative space, and the other provides for clarifications on the treatment of carried interest.
Denise Voss, Franklin Templeton Investors: The passport is seen as an opportunity for Luxembourg. Alfi has been updating regulators and industry players around the globe for the last couple of years about the various phases and stages of AIFMD. Alfi believes that Luxembourg can leverage its experience with Ucits.
Antonio Thomas, RBS Luxembourg: We have already seen industry players looking to harmonise their service providers around alternative investment funds, as well as traditional Ucits products.
One of the main challenges for asset managers has been to take an objective look at a number of areas within their offering and ask whether depositary requirements, cross-border requirements and system requirements can all be achieved in a cost-effective and operationally effective way for alternative funds going forward. We are already investing in systems which should enable us to align fee structures and service models around our clients’ Ucits businesses and non-Ucits businesses.
Christophe Wintgens, Ernst & Young: Lawyers and consultants now are trying to convince service providers to take advantage of new taxation structures, to consider that not all of them are constraints. We try to offer additional solutions around these taxes. Once we have convinced service providers that there is something in it for them, we will meet asset managers to educate them about what they are supposed to do.
Thomas: We are already in the process of aligning our UK and Luxembourg businesses. We stress-tested our Luxembourg-based offering for Ucits IV with an external audit firm and we are doing the same for our UK-domiciled depositary business in respect of AIFMD.
Thibaut Partsch, Loyens Loeff: One element of importance is how flexible the new law is. Luxembourg has worked hard to position itself correctly. There are three elements of competition in the AIFMD – on regulated funds, management companies and regulated vehicles. Luxembourg is well placed, from a regulatory standpoint, as it has prepared itself for the race that will take place between all countries.
Voss: We are struggling to manage various pieces of regulation, not just those concerning Luxembourg and Europe. A good example of this is the US tax regulation Foreign Account Tax Compliance Act (Fatca) which has a global reach.
Thomas: Many players in this space will have a number of considerations that they need to address. One of the most frequently asked questions to all depositaries, not just us, is whether they will continue to offer certain services and activities in light of the new depositary liability requirements under AIFMD.
With respect to our management company offering in Luxembourg, we recognise that there will be some players who today offer only certain services, such as Ucits management company services, that may consider entering the dual management company or super management company space and support both Ucits and non-Ucits or AIFMD products.
These companies will probably offer a cross-border solution for the provision of substance, but may not necessarily take advantage of the management company passport. They may achieve this by using physical entities domiciled in multiple jurisdictions to support different types of schemes and thereby provide substance to these schemes, or to other management companies situated in the same or different jurisdictions. We are seeing service providers starting to review which management company and which providers to work with, especially when they take into account depositary liability.
Thommes: Considering the substantial increase of custody-related rules and liability aspects, depositary banks need to review their model and incorporate the new provisions.
Wintgens: The big service providers have started to analyse the AIFMD because they see a convergence between Ucits and the AIFMD. They will have to put new controls in place and align their processes to avoid costs. Costs are now so important that they have to ensure smooth processes. Additional revenues are expected.
Thomas: Asset managers and asset servicers now need to rethink their service models and relationships. They need to reconsider the required skill sets, service models, systems and so on. Fund boards face similar challenges, but from a different perspective and will now need to place more emphasis on how they select and monitor their delegates, the roles they play, their distribution and service models and what types of reporting they require to discharge their duties.
Partsch: More and more service providers will specialise because they will also see cost pressures as a result of increased competition. Some service providers may decide that the additional costs are too high for the return of a specific asset class. This will allow more efficiency in the long run.
Thomas: One of the debates that I have seen starting to emerge around Ucits board tables is how best to manage the delegates involved in supporting their funds. Partly, this has been driven by recent legislation but is also because the increased activity in the funds space concerning the rationalisation of products and consolidation by asset managers of their vehicles with one or perhaps two service providers or global custodians. This has meant that, in some cases, the emphasis and the importance of certain relationships has shifted.
Thommes: In the short-term, we need to get a proper understanding about the implications of the AIFMD level 2 measures, and then how we can implement them in a pragmatic manner, to ensure that alternative managers can develop their business going forward.
Voss: Delegation is considered to be one of the key areas, but the issue is which activities can be delegated and to what extent they can be delegated?
Funds Europe: To what extent should the industry be concerned that Ucits has become a more risky product under Ucits III? Where do you perceive to be the areas of concern in a sophisticated Ucits product?
Voss: Risky products under Ucits typically imply the use of derivatives. However, derivatives are often used to hedge, to reduce risk. So-called sophisticated or complex products, including guaranteed funds, are about reducing risks. On the topic of the widening of investments under Ucits III since the implementation of the law in 2002, we have seen a lot of regulatory movement towards more risk management.
Counterparty, liquidity and operating risks are all part of this movement. Regulators outside Europe and in Asia, in particular, have concerns about the use of derivatives in Ucits. But Alfi has dedicated a lot of time explaining what is involved and will continue to do so. Today, the Ucits framework is more robust than it was and with the AIFMD, even alternative funds are going to be regulated. A lot of the strategies that have been brought in under Ucits III as sophisticated Ucits, could and may be set up as regulated alternative funds.
Thomas: Large conservative players such as pension funds will feel more comfortable with a Ucits vehicle – because it is listed and regulated and, therefore, the perception is that it is less risky. However, the greatest facet of Ucits is that it is so transparent at a number of levels.
Thommes: We share the concern of the regulators when it comes to investment protection, but we believe that a categorisation of Ucits may not work to the benefit of investors and the Ucits brand. Such categorisation will have a number of consequences, the effect of which are unpredictable as regards investor behaviour, distribution models and acceptance of Ucits outside Europe. Ucits using sophisticated techniques are no less suitable to retail investors than other Ucits, provided that risks which may be associated with such investment techniques are appropriately managed and disclosed. Retail investors should not be cut out of the benefits in innovation.
Wintgens: It is also a question of education. We can have as many definitions as we wish, but what we really need to do is to explain to investors what the products mean. The mis-selling potential issues are not a Ucits-specific problem but a far wider one.
Funds Europe: Some fund managers, including T Rowe Price and BlackRock, say they will not use master-feeder funds. What has gone so wrong with this Ucits IV concept, and why?
Voss: At the moment it tends to be more expensive to set up a master/feeder fund than to simply add a share class to an existing Ucits fund. Unless an asset manager needs a locally domiciled fund in a particular market, why would they?
Wintgens: For some funds, such as pension funds and insurers, a master/feeder fund might make sense. Some of the problems with master/feeder funds, however, are that they carry a large administrative burden for asset managers, such as having to deal with operations, tax and regulation of several jurisdictions.
Thomas: Many investment houses expressed interest in master/ feeder structures, but as time moved on, it would appear that this interest has declined. There are a variety of reasons, including operational issues, tax, the need to align common service providers for the master and the feeder structures to keep costs acceptable. In respect of the players who have shown recent interest, these tend to be insurance houses looking to set up new structures which can be designed with a harmonised service provider operating model and fee structures.
Thommes: Many asset managers have started to rationalise their product range before some of the provisions of Ucits IV came into play. For example, mergers on a domestic level used to be less complicated than cross-border mergers are now. Today, asset managers have to comply with rules on cross-border mergers, even for domestic mergers.
Voss: The commission is to review Ucits IV in terms of efficiency measures and see how much has been saved in the industry. There are also issues concerning regulators outside Europe. Asset managers that don’t have a management company in the country where the fund is distributed might face questions from regulators outside the EU as the latter will want to know which EU regulator is responsible if something goes wrong.
Funds Europe: As more asset managers from emerging markets look to launch an international business, is Luxembourg’s profile high enough to attract them? Who are its main competitors?
Thommes: Roughly 5,500 cross-border funds are distributed in Asia Pacific, of which 4,000 are of Luxembourg origin. We have a market share of 72% in the Asian-Pacific region. We have contributed to develop the Ucits brand and continue in doing so by organising road shows, talking to local stakeholders and engaging with regulators.
Thomas: Luxembourg has seen considerable growth in assets from the US for Ucits and non-Ucits funds. Equally, Asian, Australian and South American investment managers looking for global distribution opportunities have increasingly established Luxembourg domiciled vehicles in recent years. It has taken almost 25 years to build the Ucits brand which is now perceived globally as a quality “kite mark” standard for robust retail investment vehicles. Luxembourg is very closely associated with the Ucits brand and so continues to grow and develop as Ucits regulation evolves.
In recent years, it has been suggested that domiciles in other regions, such as Asia, will compete with Luxembourg. This may over time become true. But Luxembourg was one of the first domiciles to be able to support Ucits in the late 1980s and has built up a solid track record which will take time for other domiciles to replicate. Luxembourg continues to be the domicile from which the majority of cross-border vehicles are distributed, which makes it an attractive choice as a centre to launch funds and gather assets.
Thommes: The Chinese authorities are thinking about opening their market to products domiciled in Hong Kong. Having said this, there is also another Asian initiative where some Association of Southeast Asian Nations countries aim for some form of mutual recognition. These are medium-term initiatives. In the meantime, we see an increased appetite for Ucits products, especially from Asian players. Those include Chinese asset managers with subsidiaries based in Hong Kong. Asset managers from Latin and South America, most notably Brazil, are also keen to set up Ucits products to distribute their expertise internationally and tap into other markets.
Wintgens: Internationally, the brand is still there. In Asia it will be difficult for participants to manage the flow of information, to manage that quality of data, to do the right reporting. With all the regulations we see, it is fair to say that Luxembourg has been involved with these developments for years. Is it the case today for Asian actors? I would say not yet. Luxembourg is often used as a hub to enter Europe and used for global distribution. Meanwhile, Spain and Portugal might have the chance to be one of these entrance doors to Europe for South American asset managers.
Thommes: We should not underestimate the ambition of some Asian centres, though. We have to continue to do promotional and educational work, try to establish partnerships, explain to them the regulatory developments taking place at European level and support their development to our mutual benefit.
Partsch: With the large market for Ucits funds, there is the question whether we can offer regulation-related services to alternatives. Especially in Asia, there is a lack of regulated alternatives.
Thommes: There is an increasing interest for regulated alternative product. Traditionally, Asian investors have favoured unregulated products. Because of incidents in the recent past, players now consider regulated products also an alternative and thus respond to institutional investors’ demands.
Funds Europe: With nearly four years of hindsight, how do you feel about the 2009 decision by the G20 to put Luxembourg on the tax haven grey list. Did that affect the country’s reputation?
Partsch: The reputation of Luxembourg today is much higher than it used to be when it comes to tax havens.
Voss: Luxembourg was the first country to be removed from the grey list in 2009. The Luxembourg government signed and is continuing to sign tax agreements in conjunction
with the standards set by the Organisation of Economic Co-operation and Development.
Thommes: Our reputation has not suffered and we continue to enjoy the trust of institutional actors when they come to select a domicile for their investment vehicles. As a founding member of the EU, we have fully complied with all regulations and directives. It is true the level of tax rates is not as high as in other countries, but that does not mean we are a tax haven.
Funds Europe: What are the key challenges and opportunities for Luxembourg in the next two years?
Thommes: The ambition is to consolidate and further increase our positioning in alternative asset classes and help fund managers to leverage the development of regulated European alternative funds. We also have the ambition to stimulate innovation in the fund industry, notably by putting an emphasis on responsible investing, that is, microfinance, Islamic finance and socially responsible investing. Furthermore, we would like to continue to foster the cross-border distribution of products and obviously to position ourselves as a key partner for the asset management industry.
Wintgens: One of the challenges is to manage a convergence between Ucits and the AIFMD in terms of process, cost, distribution and market approach, even if we know that we have deep capability to do so and that we have the international reputation to fix it. Another is how we manage the increased competition from fund domiciles in Asia and how we will leverage on these markets.
Partsch: What we need is to convince the funds community that Luxembourg is a place for alternatives. Real estate and infrastructure have already taken off in 2004, while private equity started a little later. Today, in the course of the implementation of the AIFMD, many countries want to compete and Luxembourg should confirm today that it can become the place of reference for alternative funds.
Thomas: Luxembourg is considered as the jurisdiction of choice for many fund companies, but it now needs to be seen as having providers who are the strategic partners for asset managers and investment product owners. To this extent, where providers succeed in “wrapping themselves” around key clients and linking their own growth and development to that of their clients by providing additional value-added services and support, the domicile will be seen as even more attractive.
Voss: One of the challenges for Luxembourg is the fact that there is less flexibility out there in terms of regulation and there’s much more harmonisation now at the European level. The European Securities and Markets Authority and other entities have more powers than ever before.
Thommes: Another concern is the ongoing discussion about a financial transaction tax, which would have negative effects not only on the asset management and fund industry, but foremost on the investors themselves.
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