Microfinance funds domiciled in Luxembourg are mushrooming with many efforts being made to stimulate the sector further. But these funds still face the problem of cross-border distribution. Angele Spiteri Paris reports.
The microfinance sector in Luxembourg is crackling with activity – the subscription tax on these funds has just been abolished, more microfinance vehicles are being set up, new assets are being gathered and the Luxembourg labelling agency is in the process of adding a social criterion for these funds to fulfill.
But for all the activity in the sector, the microfinance buzz is currently forced to remain regional. At present, these funds cannot be passported across Europe, making pan-European distribution practically impossible – at least for now.
Microfinance investment vehicles (Mivs) invest directly or indirectly in the microfinance sector. Microfinance refers to small-scale financial services, for both credits and deposits, that are provided to people in the developing world who are too poor to be served by regular banks, in most cases because they are unable to offer sufficient collateral.
Muhammad Yunnus, a Bangladeshi banker and economist who pioneered the concept of microfinance, said: “ [Microfinance] is based on the premise that the poor have skills which remain unutilised or underutilised. It is definitely not the lack of skills which make poor people poor… charity is not the answer to poverty.”
Microfinance funds can invest in the sector either by offering loans themselves or by investing in other Mivs that offer loans to this part of the population.
The number of Luxembourg-domiciled microfinance funds has grown exponentially over the last few years. For example, between June and November last year, the Luxembourg Fund Labelling Agency (Luxflag) labelled seven Mivs. A total of eight Luxembourg funds have been assigned the microfinance label.
Daniel Dax, general manager of Luxflag, says: “The label is delivered on a yearly basis. All the funds, even those that joined years ago, have to resubmit an application every year. This is to make sure that they fulfil the criteria on a permanent basis and not just at the launch of the fund.”
The microfinance sector in Luxembourg is clearly burgeoning.
Dax says: “There are a total of 28 microfinance funds and six microfinance investment companies specialised in risk capital – so called Sicars – in Luxembourg. We only consider 27 of these though as seven of them are securitisation vehicles which are not regulated.
“The number of regulated funds grew from 16 in October. Therefore, in 2009 five new investment vehicles were set up and registered with the supervisory authority.
“Probably there are even more funds in the pipeline, which are not yet registered with the supervisory authority. This shows that the asset class is very attractive to investors who are very responsible.”
Anne Contreras, a lawyer at Arendt & Medernach, says: “There is definitely an ongoing demand for setting up microfinance funds in Luxembourg.”
Statistics from the Consultative Group to Assist the Poor (Cgap) show that assets of the top ten microﬁnance investment funds, globally, grew by 32% in 2008. Microﬁnance was also one of the few asset classes with a positive return in the horror year that was 2008.
Euro-denominated microfinance fixed-income funds returned an average of 5.5% in 2008 and were forecast to return 3.5% in 2009. But along with the financial benefits, the sector fulfills the growing client demand for socially responsible investment.
The social dimension of microfinance funds has always been important but Luxflag is out to make sure it is given the focus it deserves. Dax says: “We are looking to re-edit and review the criteria [which define the microfinance label]. We revisited the standard criteria and the most important change is that we added a social criterion to the list… this social criterion will be mandatory as of 2011.”
Laëtitia Hamon, business development officer at Luxflag, says: “We realised when talking to our funds and associate members that there was an interest in adding a social criterion. We will ask the funds to report and explain to us how they integrate social performance in their policies – due diligence, monitoring and reporting.”
This new criterion will be road-tested in 2010, during the next wave of label applications in March, before it becomes compulsory next year. “We can see how they [the funds] react,” says Hamon.
Dax adds: “These investors have a legitimate interest to ask for a financial return but they are also looking for something else – the social dimension. They want to make sure that they get the value they are looking for but that it is used and invested in a way that creates a social impact, not only in economical activity, but also making sure there are social benefits for certain groups of people.”
In Luxembourg, labelling agency Luxflag has only been around since July 2006, but microfinance funds existed in the Grand Duchy a good while before they began to be officially labelled.
Contreras from Arendt & Medernach says: “Luxembourg has really shown its involvement in microfinance for quite a long time… the advantages of Luxembourg as a financial centre generally have shown to be quite adequate for the microfinance sector as well.”
The Dexia Micro-Credit Fund was created in 1998 and was the first commercial investment fund designed to refinance microfinance institutions specialised in financial services to small companies in emerging markets. The fund had US$524m (€383m) in assets under management at the end of last year.
This fund is now managed by BlueOrchard, one of the world’s largest microfinance asset managers with over $800m in AuM.
Axel de Ville, director of Ada (Appui au développement autonome), an NGO, says: “This was the first microfinance fund set up by a private bank. The few other funds that came before it had been set up by development organisations and development banks. To begin with, it was a very small fund. The start was very quiet.”
The micro-credit fund can be seen as the catalyst for the investment management community’s interest in the microfinance sector in Luxembourg.
One of Ada’s roles is to prepare the microfinance institutions to access the funds created by the financial community. The NGO was also instrumental in setting up a Sicav investing in smaller microfinance institutions and which will be publicly announced early March.
De Ville says: “We already have €1m invested and we will have €6m invested by the end of the year. We are in the process of transferring our historic portfolio of investments into microfinance institutions into this new fund.”
Furthermore, six banks in Luxembourg have already committed to subscribe to the fund. “The idea was to invite banks to invest in the fund and also to distribute it to their clients,” says de Ville. “The money committed shows that there is definite interest for these types of funds.”
Luxembourg is positioning itself as the ideal domicile for microfinance funds. The Association of the Luxembourg Fund Industry (Alfi) set up a dedicated microfinance working group and the Grand Duchess of Luxembourg was quoted saying: “Microfinance is a proven tool to improve the livelihood of the impoverished. Luxembourg is committed to supporting a responsible microfinance industry.”
Unique selling point
One of the Grand Duchy’s unique selling points as a hub for microfinance vehicles is the broad range of options available for fund managers looking to structure such a fund.
Dax of Luxflag says: “Luxembourg is one of the very few jurisdictions where you have a broad choice. You have different structuring possibilities for setting up a microfinance fund.”
Funds can be either: UCIs Part II funds (Undertakings for Collective Investments); Specialised Investment Funds (Sifs); Société d’Investissement en Capital à Risque (Sicars); or securitisation vehicles.
There is also a fiscal advantage. The tax d’abbonement has been abolished. This is the only tax Luxembourg funds have to pay and it has been completely lifted for microfinance funds since January 2010.
Contreras of Arendt & Medernach says: “The aim of this is to stimulate the industry and perhaps also to strengthen the engagement of the Luxembourg government towards microfinance. It will certainly enhance the market but it’s also a strong sign of Luxembourg commitment to the sector.”
But for all this positive news relating to microfinance in Luxembourg, these funds still face a significant challenge – cross-border distribution.
As the law stands at present, none of the fund structures available for microfinance vehicles can be sold across Europe without an onerous, and expensive, re-registration process.
Contreras says: “There is indeed a challenge concerning the distribution of microfinance funds abroad. In principle it is not possible to set up a a microfinance fund as a Ucits structure benefiting from the passport for the public distribution.”
This means that fund managers wanting to distribute their funds across Europe would have to register their microfinance fund all over again in each separate country – when the fund is a Ucis part II fund or a Sif.
Contreras says: “The legal structures that are most commonly used are Ucis, subject to part II of the law of 2002 relating to undertakings for collective investment, and Sifs, specialised investment funds governed by the law of 2007. These funds do in principle not benefit from the European passport. A public offer abroad requires going through a full registration through the local authorities. Otherwise the distribution of such funds must obey the local private placement rules.”
Kenneth Hay, chairman of Luxflag, explains further: “Because they are part II funds their licence to be distributed has to be gained in each individual country. They can’t be part I regular Ucits funds because the instruments in which these funds invest are not recognised as transferable securities.”
Hay’s colleague Dax says: “Some providers have authorised the funds in other countries but these are lengthy procedures. With the passport it would be much easier because there are set timeframes in which the authorities need to decide, but this [re-registration] takes a lot of time.”
Contreras says: “When a manager applies for registration of the fund, the local authorities are entitled to require the application of the rules necessary for the public distribution in their country.
“It is sometimes challenging to have the fund documentation match all those requirements from foreign authorities; these registration procedures are costly and time consuming.”
Dax says: “The dream would be to have the microfinance fund be a European-style fund [that is a regular Ucits ]. This probably will take time, especially now with the crisis and all the issues the industry had with liquidity. But one should never say never. When it will happen is a different matter.”
Although most of the financial industry viewed the proposal for the Alternative Investment Fund Managers (AIFM) directive with scepticism, for microfinance it just might provide the answer.
Dax says: “There are other ways that microfinance may get a foot in the door. The AIFM directive covers any type of fund that is not Ucits. So microfinance funds could find their way there…
“There is some lobbying activity on the way to make sure that microfinance is seen when this directive is discussed in Brussels but at the same time to avoid that all the provisions of this directive will become applicable, especially to asset management companies.”
Contreras says: “It’s too early to see whether that will be viable. Potentially though microfinance will be included in the AIFM directive.”
©2010 funds europe