The Grand Duchy's new government, Ucits fund governance, and costs are some of the topics debated by our industry panel. Edited by Nick Fitzpatrick.
Anouk Agnes, Deputy director general, Alfi
Bob Brimeyer, Managing director, Alter Domus Alternative Asset Funds Administration
Josée Denis, Chief executive officer Luxembourg, head of depository bank, Standard Chartered Bank Luxembourg
Keith Hale, Executive vice president, client and business development, Multifonds
Michael Hornsby, Partner, president – alternative investment funds club and Emeia real estate fund leader, EY Luxembourg
Funds Europe: What effect will the new government of Luxembourg have on the course of the financial services industry?
Anouk Agnes, Alfi: Pierre Gramegna is the new finance minister and he is the former director of the Luxembourg Chamber of Commerce. He has also held various diplomatic functions.
As the director of the Chamber of Commerce, he was also one of the members of Luxembourg For Finance. He will be quite aware of some of the issues that we in the financial sector face.
The coalition government is as committed to the long-term development of the financial centre as the previous government. They aim to consolidate Luxembourg’s status as a leading investment fund centre in Europe via legal and regulatory improvements.
They commit to not increasing the subscription tax, which was really important to us, and they would, in general, like to examine the tax regime of funds in order to make sure that investment funds based in Luxembourg remain competitive.
They are also speaking about pushing Luxembourg in the sphere of alternative investment funds within the context of AIFMD [Alternative Investment Fund Managers Directive]. More specifically, they mention promotional efforts to target private equity funds, and of reforming carried-interest taxation.
They recognise the need to supplement the resources of the CSSF in order for the CSSF to remain responsive and to guarantee efficient application processes.
They also commit to not introducing a financial transaction tax, which was extremely important to all of us.
Keith Hale, Multifonds: As it is a coalition, led by the new prime minister Xavier Bettel from the Democratic Party (DP), there are not large differences from the previous coalition led by Jean-Claude Juncker from the CSV (Christian Social People’s Party).
Bob Brimeyer, Alter Domus: All local politicians understand the importance of the financial service sector for the local economy and the importance of continuity and stability. I, therefore, don’t expect any big changes in philosophy.
Michael Hornsby, EY: The coalition is between Left and Right and Green. It is an interesting balance.
With the wave of regulatory reforms taking place in Europe, the previous government focused on making sure that there was the right balance between effective regulation and a practical approach, which is constructive and helps businesses. I think that will continue.
There are various government committees that consulted with Alfi (Association of the Luxembourg Funds Industry) and the industry, and very constructive things came out of that process. There is no doubt that Luxembourg’s intention is to remain a serious domicile for investment funds.
Josée Denis, Standard Chartered: In addition to what’s been said, I remain positive and assured that this new government is as much supportive in ensuring that Luxembourg remains a leading financial services centre, be it for banking, asset management or asset servicing. Let’s not forget the latest addition to this in the leading evolution of Luxembourg, as a key centre supporting the internationalisation of the Chinese currency, the renminbi. Since 2013, it is well intended to make Luxembourg a leading centre for renminbi and renminbi investments funds, such as the very first Luxembourg-domiciled RQFII that was authorised and launched in November 2013. Renminbi was unspoken of just a year ago. This currency and the corresponding investment fund were topics that not many of us had really considered over the past few years, when in fact, it is now the very first domicile to be used for renminbi RQFII-type products.
Luxembourg For Finance launched a renminbi newsletter and website in September 2013 and will hold the first yearly Luxembourg Renminbi Forum in February 2014.
Funds Europe: The organisation Investor Protection Europe started a campaign for investors in the Petercam L Bonds Eur Inflation-Linked fund. It has been said investor protection regulation on paper in Luxembourg is different to what is enforced. How does the panel respond to this criticism?
Hornsby: There is something like €3.5 trillion worth of assets running through Luxembourg funds. From time to time there’s always going to be one or two funds that don’t work out the way they’re supposed to. Statistically, Luxembourg has a good track record, and a good record in the overall sense of how we deal with issues.
Also, we must note that we are talking about a fraud here, not about effective regulation of normal markets and normal situations. We’re talking about criminal fraud. So in any centre, anywhere in the world, and for any regulator, fraud is a very difficult thing to detect and prevent.
Hale: In a situation like this, it’s human nature to look for somebody else to blame, so I don’t think it is fair to criticise the CSSF for lack of regulation. I expect there will be increased scrutiny as a result, but I think it’s a little bit strong to purely blame it on a lack of Luxembourg’s supervisory control.
Agnes: Most of the time attacks on the CSSF are politically or commercially motivated, and in some cases, like the one under discussion, it is about individual, unsatisfied investors. Petercam has refuted on their website all the allegations, and nobody knows who is right.
Luxembourg has the same regulatory framework as other jurisdictions. It is not like we have special rules. Madoff was a bad event, but the EU has learnt from it and Ucits V is proof of that. That directive will reinforce investor protection, which is at the heart of what we are all doing.
Since Madoff, Luxembourg funds have attracted €500 billion of new inflows – proof that investors still believe in Luxembourg, and especially that they still believe in Ucits. Ucits is still recognised as having a good and an efficient investor protection framework.
Denis: Asset servicers have the most direct link to investors as we service them and their distributors directly. We translate any investor protection regulation into our own service offering and corresponding operating platforms. Much emphasis has been put on ensuring that investor protection is indeed embedded into our day-to-day processes. The Key Investor Information Document is a
Funds Europe: How does Luxembourg put into effect Ucits fund governance? What are the mechanisms of delivery and why should investors have confidence in the system?
Denis: There is a dedicated Alfi Fund Governance Forum, that sets out the Alfi Code of Conduct for Luxembourg Investment Funds. As Alfi members, we are all attentive to this document and use this as a reference in our internal and external procedures in that respect. The latest edition came out in February 2014. This provides us with a toolkit for setting standards within our own organisations.
The dedicated Alfi working groups align to this Forum as a community where there are regular revisions of this ALFI code of conduct. The first editon was launched in 2009 and revised in 2013. As soon as there is more regulation related to directors, the code is reviewed. But that is only one side of its use. We also use this Luxembourg-specific code of conduct to map it to another fund domicile. I see asset manager clients mapping the Luxembourg code of conduct to other jurisdictions where a code may be non-existent or different.
Hornsby: The Luxembourg Institute of Directors – ILA – has a group that specifically looks at fund governance and now, specifically, at alternative funds, which I chair. Obviously, governance can be quite complicated in the international fund arena especially when considering the variety of different asset classes and fund styles.
However, there is a lot of work being done by and for directors in this area. Analysis is taking place of how a combination of regulations, investment strategies, the role of directors in different structures, their relationships with conducting officers, and the relationships between fund managers and advisors impact overall governance models.
On top of that there’s a lot of bespoke training available. We also look very seriously at what other jurisdictions are doing. We have analysed five or six other relevant governance frameworks from different European industry bodies and seek to bring best practices to bear in Luxembourg where relevant.
Agnes: As well as industry initiatives, there is also a whole framework in place, delivered through a CSSF circular, stating the general principles that directors and conducting officers need to ensure investors’ interests are protected at all times. The circular goes into the details regarding conflicts of interest. There is also a very clear framework supplemented by other circulars about risk management and central administration.
On top of that, board members’ CVs need to be approved by the CSSF.
Hornsby: There is a big emphasis by the CSSF on the capacity and competence of directors in general. There are new challenges, of course.
For instance, implementing the AIFMD for alternative funds, where management companies are being created with very specific regulatory purposes. Directors need to be up to speed with the technicalities of how these companies operate. They need to identify clear oversight objectives and work as a team to monitor different elements of the governance framework. There are specific challenges such as the oversight of service providers and the tracking of risk management and compliance functions.
Hale: For our clients – mainly service providers – regulation is top of their priority list, followed by additional controls and efficiency. Implementing these controls helps service providers further improve their fund governance processes. Investors ultimately vote with their feet. The continued growth of Luxembourg-domiciled Ucits demonstrates that there is an appropriate level of governance which gives investors confidence.
Brimeyer: If you were to go back probably just five years and look at the composition of boards, there would be representatives of the fund manager and representatives of the local service providers. In other words, little independence I would say.
Today, if I look at our client base probably 80% of funds have appointed an independent director. So there has been a push to implement stricter governance models.
With many of our clients the case is that they want to implement a governance model that not only complies with regulation but also delivers value to investors and makes sense in practice.
Hale: With the AIFMD, it will be really interesting to see if offshore funds register as an Alternative Investment Fund (AIF) and gain the advantage of passporting around Europe, or if they stay offshore. I suspect in the longer term many will become AIFs because investors will see a reasonable level of onshore regulation and governance as a good thing.
Hornsby: Even sovereign wealth funds, who often use large segregated mandates, are requesting the same sort of governance standards as regulated funds, which shows that they really care about this.
Funds Europe: Which roles within the Luxembourg fund industry have become more prominent in recent years? Have regulations seen a rise in legal and compliance functions, as is the experience of London? And what effect is this having on salary bills?
Denis: This industry is more or less 25 to 30 years old. With this long-standing history and experience, Luxembourg now has a great pool of compliance experts in the global cross-border funds space. Such a “glocal” compliance officer profile is hard to find anywhere else and has become an ever important function across the whole value chain of asset management and asset servicing. Obviously, we have had to adapt salaries to retain and attract these experienced compliance officers.
When I started in this industry about 24 years ago, the internal controls department would visit you once a year to make sure you were adhering to best market practices in terms of legal and regulatory requirements. Today, the compliance officer has a thought-leadership role in that he/she must continuously be aware of regulatory developments that impact the fund industry.
Gathering market intelligence to continuously ensure that they are putting their organisation a step ahead of all existing/new/future regulations and, more importantly, advising the organisation on the potential impact these have on business developments and corresponding operating models.
The overall compliance structure, best market practice and the compliance officers’ profile has certainly evolved in the past ten years or so. Compliance expertise has become quite niche. Some will have expertise on legal matters, anti-money laundering rules, but perhaps may not understand a new business or a new product. They may not have that whole helicopter view and expertise on the full asset servicing suite of services from custody, depositary banking fund administration to transfer agency and distribution operations.
Brimeyer: I’m sure that if you looked at the evolution of compliance officers’ salaries over the last 10 years, it would have been a very good investment to be in that job!
Like you say, it is the importance of the role that has driven salary increases because compliance has become a very senior role.
Given increased regulations, there is a push to have more compliance people which is creating a scarcity of resources.
The industry is well equipped with the middle layer of operational compliance managers. The top people are more challenging to find.
Hale: These changes are a global phenomenon and not just in Luxembourg. Everything seems to be subject to a higher level of scrutiny that I’ve not seen before, such as the legal review of contracts that we sign.
Due to the relatively high labour costs in Luxembourg, more commoditised operational functions have been outsourced by our clients where regulation allows to locations such as India and Manila, while typically keeping the oversight, legal, compliance and key operational functions locally in Luxembourg. As a result salaries have increased on average reflecting the increased experience and expertise needed by staff, the increased level of scrutiny needed by legal and compliance functions, as well as the outsourcing of basic functions outside Luxembourg.
Denis: In the alternatives world it is tough to find a compliance officer or a risk manager that would have the breadth of knowledge to cover, say, both private equity and real estate, because there are so many intricacies. To become AIFMD compliant as a depositary bank requires a large amount of energy and work, meaning a big learning curve for the compliance officer.
Hornsby: And to emphasise the point, it is not just a Luxembourg phenomenon. European regulation has formalised a lot of roles and functions which were not formally identified in the alternative investment world, like the risk manager, the portfolio management function, and the compliance officer.
Luxembourg has ambitions in the alternative space and so there is a need to develop a highly educated workforce with the required specialist skills, and for the moment, they are in limited supply.
Hale: The alternatives world is associated with higher value and higher returns. People with skills in alternatives are usually paid better. As Luxembourg expands its focus on alternative funds, inevitably there is going to be a correlation with salary growth.
Hornsby: An advantage for Luxembourg is that we have the SIF [specialist investor fund] regime. We have been successfully running regulated alternative products now for a long time, and the AIFMD is another layer on top of that, so it’s not a complete revolution to us. We’ve had the chance to build best practices over the last 10 years, which have now been formalised under the AIFMD.
Funds Europe: In a Citi/Cerulli report, 31% of respondents said the cost of doing business in Luxembourg, specifically fund registration and various overheads, need improvement. Why is Luxembourg an expensive place to do business, relatively speaking? What effect does this have on the fund service industry?
Hale: Luxembourg isn’t the cheapest place due to the relatively high costs of staff. There is a big push from customers to drive efficiencies, not just by an increment of say 10% improvement, but by a major step-change. Getting more done with fewer people by using more efficient systems, enables the major reduction in costs required. Before the financial crisis the push was for market share at almost any cost.
Post financial crisis, the push for efficiency has become far more important. That’s how Luxembourg can remain competitive, by focusing on good governance, controls, oversight and leveraging efficient global operating models that enable efficiency and reasonable costs.
Agnes: There have been many cost studies. What also needs to be highlighted is the criteria of these studies and how you read them. These studies very often compare apples and pears because cost structures are related to fund types. Like with the previous question, the cost of doing business in Luxembourg is clearly linked to the number and the qualification of professionals that are involved in this complex regulatory environment.
That said, we should remember that Luxembourg is an international fund centre, and that has an impact also on legal, compliance and other functions.
Imagine the complexity of the compliance function related to a Luxembourg-based fund belonging to a US manager investing in Asia and distributed in Latin America. Compliance and legal functions are definitely not the same as for a French fund operated by a French bank for French investors.
The study also mentions the cost of fund registration. The cost of this must be linked significantly to the increased fees of the CSSF. But having said that, the fees of the CSSF had not increased for more than ten years.
Brimeyer: In absolute terms, we are certainly in the upper pricing range in Luxembourg as compared to other jurisdictions; however, if you consider what you are getting for your money, the knowledge, the experience, a customised process, I am convinced that our clients get value for money.
Discussions with prospects do not end on why Luxembourg charges more than another location. We however need to be able to explain the added value they get: specific industry knowledge, no need for the GP to do shadow accounting, a range of services which goes beyond pure back office work.
Once in operation, and when they dig beyond the absolute numbers the clients quickly see the value for money they get.
Denis: On the asset servicing side, we have quite the best market practice and approach to cost structures and servicing. For a lot of asset managers that are new to this domicile, it’s a learning point for them as well because they can go and send their RFPs to 10 service providers and cost structures rate cards are mainly standardised across the market players. They know exactly what they’re getting, which functions cost what amount. Though we are all competitors across the table, we all have a very similar cost structure.
Cost is one thing, but there is substance and quality of service behind those costs in the functions we provide.
Funds Europe: Once the cross-border regime in Asia has developed, will Luxembourg lose many of its clients?
Agnes: The initiative attracting the most attention is the mutual recognition scheme in Hong Kong and China. We expect it to be extended later on to other fund centres because that is exactly what happened with QFI and afterwards also with RQFI. With RQFI especially it was limited to Hong Kong for two years, and then it was extended last year to London and Singapore.
That’s the way we see the Chinese opening their market. They try, they test, and if they see it works, they expand. That will be extremely interesting for us in Luxembourg, because as a fund centre we think we have a very good chance to be part of this second phase.
But beyond Luxembourg, it will be an important step for Ucits in general. It’s something that the Commission should take up. They should go to China and say we have a product that is recognised worldwide, and it’s obvious that if you expand, you should consider Europe with its Ucits product as a whole.
Asian fund managers, especially those with an international strategies, they will continue to require Ucits. They know the product and know Ucits is internationally recognised.
Denis: At the Alfi Asia road show in December 2013, I led a roundtable dedicated to operations with a panel of asset servicers – a blend of Luxembourg-based asset servicers with a hub in either Singapore or Hong Kong, and locally based providers. As a backdrop to this topic, we referred to the evolution of the Luxembourg Ucits global cross-border follow-the-sun model that has evolved over the last ten to 15 years.
Alongside the pan-European asset servicing model, the global model evolved as such primarily to serve Asian investors and distributors of Luxembourg-domiciled funds across Asia. With Luxembourg-domiciled funds distributed in over 70 countries today, We should not fear global fund industry evolution.
On the contrary, we can bring the experience and expertise of the last 15 years in supporting Asia distribution to also support local domestic products going forward.
For instance, as we are nearing the mutual recognition endeavour between Hong Kong and China, Chinese asset managers are considering both Luxembourg-domiciled RQFIIs as an “offshore product” versus domestic QFIs and RQFIIs to serve Chinese investors in future. The reason is they can rely on the maturity and expertise behind a Luxembourg product in order to parallel this in a domestic product.
Hale: Ucits might well be at the peak of its popularity in Asia, but not at the peak of its assets under management. It should continue to grow, alongside other domestic and new regional cross-border products. We Europeans must make sure Ucits regulation takes into account the concerns in Asia around fund products due to eligible assets and the associated risk.
It’s one thing defining regulation for Europe, but we should consider Asian investor needs, to ensure the continued growth of Ucits in the region.
Denis: The big challenge in Asia is the fund market infrastructure. You don’t have many countries that have their own market infrastructure that can support a global/local cross border fund distribution model.
Once fund distribution picks up in China, you can imagine processing thousands, maybe millions of fund transactions. How will the end-to-end transactions process be supported?
One can assume that most players will rely on the tried and tested cross-border models that were inherited from cross-border players under the Luxembourg Ucits brand – which is the follow-the-sun model.
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