TALKING HEADS: Blue sky thinking

Key figures in the Luxembourg fund industry speak to Funds Europe about topics such as cross-border distribution, the delegation of fund management and the potential impact of Brexit.


Where are the main inefficiencies in cross-border fund distribution and what steps, if any, are being taken to combat them?
Arguably it is very difficult today as an actor in this industry to succeed without the requisite operating scale. That can be measured in terms of AuM [assets under management], breadth of product, distribution or capacity to keep investing in your business.

Scale is not necessarily always good if you consider one measure such as the abundant oversupply in the 30,000 or more European mutual funds – there are too many funds and many are too small to be economically viable in the future. This is why the European Commission is hopefully planning in the broader context of the Capital Markets Union (CMU) to remove national barriers and requirements that today make it difficult or costly to market funds across EU country borders in a harmonised manner. Removing those barriers should help build economies of scale and ultimately benefit investors through lower-priced products.

In recent months we have also seen a great deal of focus on delegation and outsourcing rules in the context of Brexit. The work of Esma [the European Securities and Markets Authority] has, quite rightly, focused on ensuring that EU member states require that firms have sufficient substance within management companies when it comes to risk management and compliance.

If this work were to lead to new restrictions on the ability of investment management companies to delegate activities like portfolio management to non-EU jurisdictions, this would be irresponsible. Delegation, under strict controls and supervisory agreements, allows investors to enjoy both the safety and soundness of a robust set of EU rules (Ucits/AIFMD) and access to global markets/investments.

Ucits have become a globally competitive product because of the openness of the structure and ability to delegate fund management to centres of excellence across the globe. This in turn attracts more investment into Europe. We should not risk the safe and open-model framework that is Ucits, and threaten its success as the global gold standard for retail investment funds.


Luxembourg for Finance has said it intends that Luxembourg will continue be a partner for UK asset management firms after the UK leaves the EU. How can this be achieved?
The first important aspect is to arrive at a politically agreeable solution and relatively quickly remove the uncertainty.

Using common sense and common ground, it is essential for both Europe and the UK to operate a well-functioning capital market. The fund industry plays an important role in getting funding to the private and public sector. In addition, it is managing the assets of many millions of European pensions savers.

Luxembourg is the centre in Europe and the world in terms of fund management. The UK is Europe’s largest centre when it comes to investment management and raising capital.

Working together post-Brexit without making severe change to this fragile ecosystem is mutually important for Luxembourg, Europe and the UK.

I experience that most asset management companies are preparing for a harder Brexit, setting up European distribution. The industry, however, expects that a workable investment delegation model will be possible.

Coming back to the political aspects, it is key to focus on areas of working together, using what has been established for many years and still works, rather than looking for differences and obstacles.

I am personally confident that even with the current hard positioning I experience, a workable model will be found by the politicians or eventually by the industry.


Where are the main inefficiencies in cross-border fund distribution and what steps, if any, are being taken to combat them?
Inconsistency in the information that is provided across different markets and in different languages is not just inefficient, it is a major threat to the funds industry. Industry practices that mislead investors erode their trust, so consistency of fund information is absolutely critical.

Imagine the scenario where a client compares different products using their key investor information documents (KIIDs).

The investor chooses a product which matches her needs and then Googles it to find out more. She comes across a factsheet and a prospectus, but she is not sure if they are all up to date because the performance figures in the KIID and the factsheet do not match, and the objectives of the fund are slightly different in all three documents.

The investor is confused and decides not to invest in the product. In fact, she feels misled and decides to abandon her search for a fund and put her savings into a bank account instead. Instead of feeling supported in her independent research and being able to profit from the fund’s performance, the investor feels frustrated with the low bank return and with the fund industry.

Asset managers need to control the information about their funds, whatever the format and in whatever language. Seqvoia allows asset managers to control consistency from the source document: the prospectus. Rather than produce documents and check them afterwards, asset managers can leverage the prospectus, extracting data and narratives to produce documents that are then consistent with the source and with one another.


Has the introduction of the Luxembourg Reserved Alternative Investment Fund been a success?
Just over 18 months since its creation, the Luxembourg Reserved Alternative Investment Fund (Raif) has become a commonly used investment fund regime in Luxembourg.

Initially intended as a flexible vehicle in terms of investment strategy offering quick access to market, Raifs do not need approval by the Luxembourg financial regulator, the CSSF: a notification to the local regulator by its mandatory AIFM is all that is required.

Out of all the fund projects we were contacted for at Banque de Luxembourg since Raifs were introduced, around 25% are Raifs. Structures with illiquid asset classes such as private equity and real estate frequently chose this fund regime.

Our experience seems to underline the popularity of Raifs and that they are possibly the best solution for many fund initiators. However, some of the myths about Raifs need demystification. A Raif is not necessarily the quickest and cheapest vehicle to access the market.

Depending on the nature of the asset classes and the intended distribution, Sifs (Specialised Investment Funds) may be a better option. Particularly when it comes to fund projects with assets under €100 million and a reasonably diversified investment portfolio.

Launching a sub-fund within an existing Sif platform could result in significant savings in terms of implementation costs, similar running costs and time to market. While new Raifs require legal structuring and the due diligence of all parties involved in the fund, adding a sub-fund to an existing Sif may provide considerable leverage of tasks already performed and partially compensate for the necessary approval delays with the regulator.

However, for funds intended to be distributed to a restricted circle of investors, the Raif seems to be the perfect fit. There are good days ahead for Raifs.


Luxembourg for Finance has said it intends that Luxembourg will continue to be a partner for UK asset management firms after the UK leaves the EU. How can this be achieved?
There is no doubt that the UK, and London in particular, will remain a global financial centre after Brexit (if it actually happens).

Luxembourg’s focus should not be on competition with the City, but rather continuing to be a privileged partner to our London colleagues in areas where Luxembourg has been traditionally strong and helpful to the City’s banking and asset management community.

Co-operation between the Grand Duchy and the UK in the financial sector has been growing for decades in the fund and asset management services area, in the banking and private wealth sector and in insurance products.

The focus should not be forcing a choice between Luxembourg or the UK, but rather further developing the existing synergies between the two countries and potentially creating new ones.

Let’s treat the UK not as a competitor, but as one of our biggest clients and help it through the Brexit process.

We can do this, for example, by defending the delegation model of investment management at EU level, by keeping our borders open to UK citizens and UK companies, by favouring a ‘soft’ Brexit with mutual recognition of regulatory bodies and processes and avoiding the rise of unnecessary barriers.

Of course, the ‘passport’ may disappear and create difficulties for UK-based financial undertakings, but it will do so also for Luxembourg providers and financial players. In my view, it is in the Grand Duchy’s self-interest to plead a smooth and soft Brexit outcome.


What are the top one or two regulatory changes of the Luxembourg financial regulator, the CSSF, of the past year and what is important about them?
I see two important and related acts by the CSSF:
   •  A willingness to take enforcement action in the field of customer due diligence and the fight against money-laundering, terrorist financing and tax evasion.
   •  The continued build-up of supervisory activity, including on-site inspections.

The regulator’s willingness to take enforcement action in the field of AML/CTF/tax sends a simple message to the industry: comply rigorously with the law.

This is a difficult activity for financial firms to get right – it’s complicated – but one of the recurring challenges that firms face regardless of jurisdiction is of counterparties (often other financial firms) telling them that their customer due diligence standards are too strict, and somehow “not market standard”.

The CSSF’s public action helps firms to see where the standard has been set in Luxembourg, and encourages compliance.

The CSSF’s growing supervisory programme has a similar effect. It’s important that investors, financial firms and the global college of regulators feel confident about Luxembourg as a place where regulation is genuinely respected and where compliance is tested by the national authority in co-operation with relevant supra-national and foreign authorities.

The CSSF has developed an active and inquiring supervisory programme, operating at a distance through correspondence and increasingly through on-site inspections. That’s good for investors and for the reputation of Luxembourg as a financial centre.


What are the main challenges facing the funds industry in Luxembourg?
The main challenge facing the investment fund industry in Luxembourg is the regulatory changes within the last few years – notably MiFID II – which have altered the balance of economic interests across the value chain of investment fund business.

The increase in the responsibilities in relation to product governance considerably strengthen the integration of product manufacturing and distribution through target market assessment and exchange of sales information, which facilitate the further elaboration of the fund distribution strategy. Even though the Ucits ManCos and AIFMs are out of scope of MiFID II, they’re indirectly impacted as they are supposed to furnish information to the distributors who are in scope of MiFID. For those funds distributed within the EU, while the portfolio management is delegated by a third-party ManCo/AIFM to an investment manager outside of the EU, it might be the challenge for the manufacturer (i.e. a non-EU based fund sponsor and EU-based ManCo/AIFM) to conclude the contractual arrangement with the EU-based distributor to ensure the provision of product information which is not publicly available to the distributor.

The reinforced requirements in relation to monitoring and reporting obligations on client suitability and transactions on a pre- and post-trade basis make the fund distribution a more complex process and increase the cost of managing distribution activities for all the players involved.

The ban or repayment duty on inducements in relation to independent advice or discretionary portfolio management also has far-reaching implications for the fund distribution model in the European market.

All these factors will change the industry structure and the way in which distributors decide to approach their activities, which may lead to the consolidation among the asset managers, asset servicers and distributors in the long run.


What are the main challenges facing the funds industry in Luxembourg?
The most immediate challenge will still be regulation. Even though the great wave has passed, we are looking at the compliance aftermath. Complying with and applying MiFID II, Priips and PSD2 will be an ongoing issue for many in the industry.

There is also the entry into force of GPDR in May. Not to be forgotten is the continuing work of the European Commission on removing barriers for cross-border fund distribution. The direction that it will take on this in its 2018 proposal may be central for Luxembourg.

Less immediate but with more important implications is the fund industry’s use of technology. Cost pressures, margin compression and the need for transparency can be addressed and turned to an advantage through technology, such as the digital ledger technology (DLT) applied to the distribution of investment funds.

New entrants are pushing the boundaries of what the industry previously considered was not achievable.

To cope with regulatory issues, new tech and the various opportunities that arise, quality change management will be crucial for all actors.

In general, however, the view in Luxembourg is that these challenges are not insurmountable. The extremely innovative ecosystem that is the Luxembourg fund industry has made great efforts in the past year to future-proof itself. The industry is setting up the right infrastructure to be prepared for the next generation of business models.


Which regulations are most likely to command time and resources over the next 12-18 months in the funds sector?
The asset management industry has been busy over the past two years to prepare itself for MiFID II, which kicked in early 2018. As the relationship between investment firms (product manufacturers) and distributors of financial products is significantly impacted by MiFID II, it is expected that the distribution landscape will evolve.

The European legislative framework foresees that directives and regulations are continuously reviewed after a few years in existence. The upcoming review of AIFMD is one such example among others.

The asset management industry is eager to see progress on the CMU and in particular on initiatives that the Commission will take to dismantle barriers to cross-border distribution of investment funds across Europe. More is expected on that front in early 2018.

Furthermore, Esma and the Commission, but also other international organisations such Iosco [International Organization of Securities Commissions] and FSB [Financial Stability Board], have announced work on subjects such as the management of liquidity risks, the use of leverage, and stress testing. There is also some indication that ETFs/passive funds will be subject to particular scrutiny.

Finally, the asset management industry is actively monitoring the discussions on the ESA [European supervisory authorities] review following the publication of the Commission’s proposal on September 20, 2017. There is a broad consensus in the industry that the proposal goes far beyond what is necessary to complete the CMU as evidenced by responses to the public consultation of the Commission in May 2017 and more recently by feedback to the Commission.


Where are the main inefficiencies in cross-border fund distribution and what steps, if any, are being taken to combat them?
EU collective investment vehicles are currently regulated under the Ucits and AIFM Directives and, as at June 2017, the European Commission has estimated that funds marketed cross-border represented about €5.4 trillion (of a total of €13.38 trillion in Europe).

However, out of this, around one quarter were considered as ‘round-trip funds’ marketing cross-border only to one country, which suggests there is unrealised potential.

If we look at inefficiencies related to the AIFMD, Invest Europe commissioned Europe Economics to prepare a study on the ‘Evaluation of the Alternative Investment Fund Managers Directive’, published in December 2017.

The key findings were that the AIFMD has delivered minor benefits at high costs, and that pan-European marketing had become more difficult, slower and costlier, due to differences and inconsistencies between the implementation and application of the rules in each country.

It was also noted that operating costs had increased, with the most material drivers being the authorisation process, marketing rules, depositary requirements and minimum capital requirements.

Speaking at the European Financial Forum 2018 in Dublin at the end of January, European vice-president Valdis Dombrovskis commented that the share of alternative investment funds marketed in more than three countries is very low, at only 3%, and that a European Commission proposal due in the spring will seek to reduce the administrative burden and improve clarity for fund managers who want to market their funds across the EU.

I am hopeful, therefore, that an efficient system of cross-border distribution can yet become a reality.


Where are the main inefficiencies in cross-border fund distribution and what steps, if any, are being taken to combat them?
According to the European Fund and Asset Management Association, the share of funds that are sold outside their home market accounts for over 30% of total European investment fund assets, a considerable increase from the 18% recorded at the end of 2005.

However, even though 80% of Ucits are marketed on a cross-border basis, too many funds are registered in only a handful of markets, with 60% sold in less than four markets.

This means that investors’ choice of products is reduced, competition is limited, costs are higher and the overall market smaller and fragmented. As a result, the average EU fund is seven times smaller than its US counterpart.

While the Ucits directives have lowered barriers to cross-border fund distribution, hurdles remain. Europe, with its 28 potential distribution markets, means 28 different types of investors and 28 different local distribution rules. This complexity and lack of transparency needs to be addressed to steer cross-border distribution further.

While Brexit catches headlines and the industry works on what it means for its products and clients, the generation of the millennials is growing up.

The purchasing behaviour of this generation is different from their parents’. It is now urgent for asset managers to incorporate digitalisation and direct-to-consumer platforms in their distribution strategy.

Hence, entering a new distribution market is not a decision to be taken lightly. Fund houses need a strong, knowledgeable partner to help navigate through the regulations.


Which regulations are most likely to command time and resources over the next 12-18 months in the funds sector?
Whilst MiFID II was implemented on January 3, it’s fair to say that it’s still early days. The funds sector in particular is challenged by the calculation of costs and charges and is seeking guidance.

We are still in the post-implementation review phase, and we may see adjustments to the regulation over the coming months.

The sector must also dedicate the time and resources to the General Data Protection Regulation (GDPR), which comes into force in May. GDPR impacts anyone who maintains personal data of citizens in the EU, not just financial services firms.

It has a wide reach and any company selling or providing services into the EU from any other country must comply with GDPR. One of the most important features of this new regulation is the ‘right to be forgotten’, which gives an individual the right to demand that a firm deletes all of his or her records, and firms must prove that they are able to remove such data from its systems.

Beyond GDPR, fund firms in Europe are focused on the money market funds (MMFs) regulation, and the implications around the production of NAVs [net asset values], which applies to new MMFs from July 2018 and to existing MMFs from January 2019.

Moving from constant NAV funds to variable NAV funds or revised types of constant NAV funds is intended to increase investor protection and transparency.

The Capital Markets Union also has the potential to significantly impact asset management firms, particularly those based outside of the EU and doing business within it. There is no definition of the implications at this stage, but it’s one that the sector is tracking closely.

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