ALFI PREVIEW: Evolution or revolution?

Leading firms in Luxembourg fund management tell Funds Europe their predictions for the main themes of the Association of the Luxembourg Funds Industry conference, which brings together 900 industry professionals each spring.


What will be the main theme at the conference this year?
Whether the funds sector is facing an evolution or a revolution given the heavy volume of forthcoming regulatory changes with multiple impacts on legal structures, products and operations.

Should Alfi take a lead role in guiding depositary banks under the Alternative Investment Fund Managers Directive (AIFMD)?
Depositaries play a crucial role in the value chain of the funds industry.

In the next few weeks, Alfi will meet with the Luxembourg regulator, the Commission de Surveillance du Secteur Financier, to start working on the depositary function in a post-AIFMD environment.

Also, we have scheduled an interaction with the prime brokerage community in London to explore pragmatic ways to organise their relationship with Luxembourg-based depositary banks going forward.

How can fund companies deal with the regulatory burden they face?
As no one has even tried to assess the compounded impacts of so many changes, everyone is holding their breath. Costs are increasing and margins are becoming smaller. Asset managers still have to digest the numerous recent regulations that were introduced as a response to the financial crisis.

It is Alfi’s wish that 2013 will allow asset managers to digest these regulations and concentrate on their investors’ needs and expanding their business.

Alfi will help its membership make sense of these new and important changes through training activities organised throughout 2013.


How should fund managers deal with the regulatory burden they face?
Relying on the right business partner will be key to ensuring that all regulatory measures are on the radar and appropriately addressed.

How will the onset of the Foreign Account Tax Compliance Act (Fatca) affect the Luxembourg market?
Fund companies will need to assess whether their funds are within the Fatca scope. They will need then to decide whether they register their funds as foreign financial institutions or designate their transfer agent or custodian agent to act as such. Even though the level of documentation on “know your customer” is well established in Luxembourg, further documentation will certainly need to be collected from investors.

Do you expect asset servicing fees to increase under the AIFMD?
Fund managers are under extreme cost pressure with limited partners negotiating down their management fees. There is little margin for asset servicing fees to increase. In all probability, the work overload will be absorbed mainly by efficiency measures and by a higher barrier to entry in terms of assets under management.

What are the main challenges for the Luxembourg industry in the year ahead?
The main challenge for the industry is to remain competitive and understand the needs and expectations of asset managers, while keeping in mind that they have limited resources to allocate to this new regulatory burden.


How will the onset of Fatca affect the Luxembourg market?
Substantial preparation needs to be done during the course of 2013 to be ready by January 2014. Some of the players are well advanced and have taken the necessary steps to ensure compliance, because they traditionally have exposure to the US or because they see the advantage of being first movers. Others have been waiting for the final regulation to be published. Some of the smaller fund administrators may decide to limit their exposure and investment by not taking on any mandate that could fall within its scope.

What are the likely effects of the European Market and Infrastructure Regulation (Emir)?
Emir will contribute in reducing counterparty risk by the mandatory requirement to clear “eligible” over-the-counter derivatives through central counterparty clearing houses (CCPs) and posting of collateral. However, it adds to the complexity of processes to be put in place by financial institutions, including ­fund managers, that use these instruments. It may also result in a greater demand and shortage of high liquidity, high-grade collateral, as a consequence of the requirement to post initial margins.

What are the main challenges for the Luxembourg industry in the year ahead?
The main challenge is a great opportunity as it involves ensuring new regulations are implemented in a pragmatic manner. The AIFMD is a great opportunity for Luxembourg. We have the advantage of years of experience in running regulated funds that we can combine with knowledge in specific asset classes and experience in managing and administering open-ended funds. The challenge will be to repeat the success of the Luxembourg Ucits brand and create a Luxembourg AIFM brand.


How can fund companies survive the “regulatory marathon” they are being forced to run?
A growing number are outsourcing the “marathon” to their asset servicing provider, which is often well positioned to fulfil this role because of its large client base, which permits economies of scale, and its extensive knowledge of regulatory measures gained from participation in their development.

How will Fatca affect the Luxembourg market?
Fatca is one of a number of regulatory measures that is leading the Grand Duchy to adapt some sectors of its financial industry, although no definitive bilateral agreement has been concluded. Some decisions, such as the Internal Revenue Service reporting model, are yet to be finalised. However, most fund industry players are up to speed.

Do you expect asset servicing fees to increase under the AIFMD?
Yes, because costs for the asset servicing provider will rise due to heavier administrative duties under the AIFMD, such as due diligence and cash monitoring. Meanwhile, greater risks and responsibilities may require adjustments to capital adequacy levels. On the other hand, fund companies will benefit from a regulated fund label and a European distribution passport.

Are there any types of funds you would decline to service under the AIFMD, because of increased liabilities and/or costs?
It is unlikely that a “type” of fund would be declined. An asset servicing company may, however, decline responsibility for investments in exotic locations where it is unable to guarantee the reliable nature of third-party entities in the custody chain, such as prime brokers, sub-custodians, cash account holders and valuation agents.


How can fund companies survive the “regulatory marathon” they are being forced to run?
In Luxembourg, the deep understanding and high level of competence of our professionals ease the process of complying with regulation. Most pieces of regulation are good for our industry as they reinforce our processes, our risk management and force us to be vigilant and equipped to fight against new and evolving risks.

What are the main challenges for the Luxembourg industry in the year ahead?
The main opportunity is for us the convergence between AIFMD and Ucits landscapes. This convergence will not only strengthen our operational capabilities but will increase our global distribution footprint.

We have to revisit our platforms to ensure that technically we are on the edge.

How will the onset of Fatca affect the Luxembourg market?
FATCA will impact all financial industry actors and also some corporates deriving a majority of their income from financial assets. Luxembourg, as most countries in the world, will not avoid it and will be well-prepared to comply. I believe that some actors, having seriously worked on Fatca, are on track to be compliant while others are not.


Do you expect asset servicing fees to increase under the AIFMD?
We expect an increase in depositary bank fees to deploy additional controls and resources to manage the enhanced and strict liability regime. The challenge for the service providers will be to continue to find more efficiencies in their operating models to remain competitive in their fees and services overall.

Are there any types of funds you would decline to service under the AIFMD, because of increased liabilities and/or costs?
It is expected that enhanced scrutiny will be applied on each new structure equally by the service providers as well as by the regulators to ensure the increased liability risks are being managed with the appropriate controls.

It won’t be one size fits all, at least not in the beginning. As the market evolves, we will potentially see standards developing in the review and acceptance of new fund structures.

What are the main challenges for the Luxembourg industry in the year ahead?
To maintain the lead on the Ucits brand. The emerging geographies like Asia and Latin America will continue to challenge the Ucits brand with an objective to create their own regional hubs.

Although the European funds industry saw positive net sales of over €300bn in 2012, new fund launches will continue to take longer as fundraising and borrowing remains challenging, coupled with increased scrutiny from regulators.

Bedding down regulatory reforms and cost of compliance will continue to compress margins across the funds industry. This will continue to be a major challenge.


What are your clients’ main concerns regarding the AIFMD and how can you help them adapt to this regulation?
One concern is how investment funds who delegate management outside Luxembourg respond to the limitations on delegation clarified by the AIFMD. Clarification for promoters in the US and Asia of the changes ahead with regards to distribution strategies has been a frequent request as private placement and reverse solicitation are being challenged under the new regime.

How will Fatca affect the Luxembourg market?
Since the industry has known that investment funds qualify as foreign financial institutions, there has been significant speculation around the possibility of them benefiting from deemed compliant status and pushing the compliance execution to their usual service providers. Even though many outcomes remain suspended prior to the intergovernmental agreement, the final regulations released in December included helpful measures. These included the possibility to appoint a sponsoring foreign financial institution to which due diligence and reporting tasks can be centralised within a group, as well as a clarification of the allocation of responsibilities for errors in the reporting or withholding in the case of complex distribution and payment chains to investors.

What are the main challenges for the Luxembourg industry in the year ahead?
To convince EU and non-EU fund managers wishing to take full advantage of the AIFMD that Luxembourg is the destination of choice for them. Luxembourg has a strong card to play as a depositary centre of reference in servicing non-EU funds in the future.


How will Target2Securities (T2S) affect the funds industry in Europe?
It is clear that funds will be participating into T2S. Currently, aside from the domestic funds that are already on the local central securities depositary (CSD) because of the set-up of their market, there are a lot of cross-border funds that are also available on those domestic CSDs via global certificates and local agents. T2S will almost certainly increase the demand from distributors to have funds accessible through their CSDs. Let’s stay reassured that distribution will not be limited to T2S and that transfer agents’ services and flexibility will continue to be the norm and one of the backbones of the Luxembourg industry.

What are the likely effects of the European Market and Infrastructure Regulation (Emir)?
Emir sets out to promote transparency, risk management and regulatory oversight of the over-the-counter derivatives market. Investment funds that are very active in these instruments will need to prepare by ensuring they are able to effectively collateralise these transactions, have links to a trade repository if necessary and are able to meet reporting requirements.

This will require funds to access more high quality collateral and to partner with collateral management venues, to consolidate their internal pools where possible and reduce fragmentation.

What are the main challenges for the Luxembourg industry in the year ahead?
To see all the changes, both in terms of regulations and economic pressure, as a catalyst for changes that can make the industry stronger and more engaged in the future financial landscape. We need to defend the competitiveness of the funds industry across all the investment options of the market.


What will be the main themes at the conference this year?
The convergence of traditional and alternative funds is a growing trend. There is increasing institutional investor allocation to hedge funds and growth in retail absolute return funds such as alternative Ucits. These issues are being pushed along by the catalyst of new regulations, namely AIFMD. We are already seeing evidence of this convergence across our client base, with a significant growth over the past few years in alternatives on our platform alongside traditional Ucits funds.

What are the main challenges for the Luxembourg industry in the year ahead?
With the AIFMD coming to fruition and the convergence of the investment funds industry, there is a good opportunity for Luxembourg to leverage its Ucits capabilities and distribution expertise with alternatives funds and assets.

In an industry survey conducted by Multifonds last year, 72% agreed that non-EU managers would look to set up some form of European operations to take advantage of AIFMD.

However, Luxembourg will need to ensure it does so on a cost-effective basis, through the types of efficiency that are more common in traditional fund administration. Otherwise, the lower cost European centres will quickly gain market share purely because they have lower labour costs.

The real trick will be to bring the efficiency associated with traditional funds together with the flexibility associated with hedge funds.

A wider implication for Europe and not just Luxembourg is that if the cost of the new regulation is prohibitively high, this could have the opposite effect on inflows into alternatives in Europe with managers re-domiciling funds offshore, outside Europe, to save on cost.

©2013 funds europe



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