Luxembourg for Finance (LFF), the public-private agency responsible for promoting Luxembourg as a financial centre, has released its five-year vision for the Grand Duchy’s financial development. Bob Currie talks to chief executive Nicolas Mackel about its content and objectives.
After four years as deputy chief of mission in Luxembourg’s embassy in Washington, and a later term of service as Luxembourg’s consul general in Shanghai, Mackel has the political skills to put a positive gloss on most strategic announcements.
But we agree in advance to review this proposal with a critical eye, discussing where this steps beyond its predecessor – ‘LuxFin2020: a Vision for the Development of the Luxembourg Financial Centre’ (LFF, 2016) – and where Luxembourg needs to raise its performance.
The new release shares a number of high-level principles with its predecessor, including its ambition to be the “EU onshore location of choice” for financial services. It aims to foster innovation and to promote Luxembourg as a leader in digital financial services – a goal reflected in the creation of the Luxembourg House of Financial Technology (LHoFT) in 2016 and a series of initiatives facilitating collaboration between government, private sector financial companies, fintech and the academic sector.
But ‘2025 Ambitions: Shaping a Sustainable Future’ steps beyond this, providing some noteworthy additions and points of departure. Capturing the spirit of self-reflection that guided the design process for the new strategic plan, Mackel anticipates my first question.
“What are the big issues in front of us that we did not identify in the LuxFin2020 document? There are two prominent issues,” he says.
“One is the need to make finance sustainable – not through creating a separate specialist market for green and ESG products, but by embedding financial provision in sustainable objectives. There is an urgent need to push sustainable finance into the mainstream, no longer as a niche product but as a principle that underpins all financial sector activity.
“A second priority is to encourage long-term investment – to deliver financial products and a supporting infrastructure that enable people to save for the future, whether this is to prepare for retirement, meet education or healthcare needs, or to meet other lifetime savings requirements.”
Making sustainability mainstream
It is now 23 years since the Kyoto Summit of the UN Convention on Climate Change, so concerns around environmental sustainability are nothing new to policymakers. However, data from State Street Global Advisors shows that Europe’s investors lag their US counterparts in ESG exposure levels, with 27% of investors in the US incorporating ESG factors in at least half of their investments, while in Europe and Asia-Pacific, the equivalent figures are just 17% and 15% respectively (SSGA, ‘Performing for the Future: ESG’s Place in Investment Portfolios, Today and Tomorrow’, page 7).
These are disappointingly low percentages after years of public campaigning around sustainability objectives. “After Kyoto there was limited sense of urgency,” Mackel responds. “But things are changing now. Every political party is under pressure to include a commitment to sustainable development in its manifesto goals – and high-profile figures such as Greta Thunberg are pushing hard to ensure that policymakers fulfil the promises they have made.”
Luxembourg has been taking small but significant steps to force the pace in sustainable finance. A third of all green bonds issued in 2019 were listed on the Luxembourg Green Exchange (which now lists 610 securities valued at more than €216 billion) and, in June 2019, the World Bank chose to list all of its 174 sustainable development bonds on the LGX. These are modest numbers when measured against aggregate global financing requirements, but they are important as a statement of intent.
“There is a long way to go, but this presents a major opportunity,” says Mackel. “If we are serious about meeting the 2% goal on climate change under COP21 provisions, then it is important to address the way that our economies operate. Factories need to be refitted and there is a need to rethink the way that goods are produced and consumed. Therein lies the opportunity – in providing sustainable means to finance factory redesign, for example.”
To back his optimism, he points to the forceful stance taken by BlackRock CEO Larry Fink in his recent ‘Dear CEO’ letter, written to companies in which BlackRock invests on behalf of its clients. “There are few politicians that have that level of leverage,” says Mackel. Alongside the pressure exerted by millennials and the demand for change coming from institutional investors, this will be important in driving the sustainable finance agenda forwards.
Climbing the value chain
The 2025 Ambitions report makes numerous references to Luxembourg’s aim to climb the value chain by attracting additional front-office functions. Over time, it has established itself as a regulatory, risk-oversight and compliance centre, with asset management and asset servicing firms building teams in Luxembourg that serve as their regulatory control towers. Particularly since the global financial crisis, these functions performed in Luxembourg have become increasingly important to the global operation of these groups.
But Luxembourg does what it does relatively well – and given the progress it has made in attracting investment flow and administration business over the past 20 years, is there real advantage to be gained from seeking expansion further up the value chain?
“Luxembourg does what it does rather well – but the question is whether that model is sustainable,” says Mackel. “We have slowly climbed the value chain, advancing from a focus on back-office expertise to providing strong middle-office capacity on the back of regulation, compliance and risk management. Having chosen to specialise in these areas since the global financial crisis, Luxembourg has advanced step by step as a regulatory nerve centre.”
The UK’s exit from the EU has also encouraged relocation of investment advisory functions and some portfolio management units to Luxembourg. Private equity firms are bringing their deal-making functions. With this, Luxembourg has seen a progressive expansion in its front-office expertise. “Digitalisation will continue to eat away at the foot of the value chain and we are confident that continuing to climb this ladder is the correct strategy,” he says.
Across the financial sector, Brexit is pushing a redesign of Europe’s economic landscape that the grand duchy is eager to exploit. While around 60 financial companies have announced their relocation of activities to Luxembourg owing to Brexit, LFF indicates that the actual number is closer to 70 if we include those that have not yet announced their relocation publicly.
A more general consequence is that rising numbers of international institutions are opting to use Luxembourg law to structure their lending and fundraising activities. LFF cites the European Stability Mechanism, the European Investment Bank and European Atomic Energy Community (Euratom) as three examples that have opted to switch from English law to Luxembourg law for their lending or financing activity. These are, we should note, all central pillars of the European project. But the trend, nonetheless, is indicative of firms looking to establish greater legal flexibility, beyond an English common law framework, in the wake of Brexit.
At the heart of Europe
Central to Luxembourg’s rise as a “multi-jurisdictional financial centre” has been its ability to identify opportunities at an early stage and move quickly to take advantage. When, in 1984, the EU published its Ucits rules, Luxembourg was the first country to integrate Ucits into its national legislation. By the end of 2019, more than 500 fund promoters have established around 3,800 Luxembourg-domiciled funds which are distributed in 73 markets worldwide.
Collectively, these funds amount to €4.7 trillion in AuM, second only to the US in terms of market size by assets. It has also experienced strong growth in alternative investment funds, with AuM in private equity funds rising 19% year on year during 2019.
With 98 out of 100 of Europe’s largest asset managers now having operations in Luxembourg, Mackel says it is essential to offer the expertise and infrastructure that allows them to grow. “This offers a specialised workshop for financial services, providing an element in the value chain that they do not find in other financial centres.”
From a social perspective, equally important is the need to help the common person save for their own future and for the wellbeing of younger and older generations. Many EU citizens are still unfamiliar with the benefits offered by investment in pension funds and collective investments – and it is important to fill this gap in financial education.
“With ageing populations across Europe, the funding gap in EU pensions is only likely to worsen. State-managed pensions provision will not be sufficient to fill this gap and Pillar III pensions provision must step up to meet this shortfall.” Luxembourg, Mackel believes, has an important role to play in addressing this requirement. “We already identify asset management companies establishing multi-jurisdictional, multi-employer investment funds that will bring greater portability to pensions saving for mobile employees, while capitalising on the scale benefits offered by pooling of pension assets.”
Luxembourg continues to work hard to extend its status as an international financial centre and hub for product manufacture and distribution. When China slowly began to liberalise its capital market in 2011, Mackel says that Luxembourg regulators were first to liaise with the Chinese regulatory authorities – ensuring that Ucits products would be compatible with the R-QFII framework and eligible via Hong Kong-Shanghai Stock Connect. Currently, the Luxembourg Stock Exchange lists 29% of renminbi-denominated debt, more than any other trading venue outside of China. “However, the pace at which China opened up its economy was faster from 2011 to 2014 than it has been subsequently,” he observes. “Luxembourg’s recent engagement in renminbi internationalisation has reflected this momentum.”
Luxembourg’s future is closely intertwined with a strong spirit of cooperation between government, private sector financial organisations and fintech. “This culture of partnership was fundamental to why Luxembourg established the Luxembourg House of Financial Technology”, says Mackel. “The future of financial technology lies in close collaboration between the disruptors and the technology incumbents.” Since its launch in 2016, LHoFT has grown to house 67 fintech businesses, with its members raising more than €210 million in funding since 2017.
Commenting on the 2025 ambitions, Luxembourg minister of finance Pierre Gramegna predicts that digitalisation will play an even more important role than in the past. “By attracting new firms and their solutions and supporting the development of home-grown fintech innovators, Luxembourg is creating an environment to allow the financial sector to innovate and develop new products and services while generating efficiency and productivity gains,” he says.
Arguably, Luxembourg has benefited from its size and agility, enabling it to launch a creative framework of financial structures and to respond promptly to demands of international asset managers, distributors and investors. But for small, agile entities, success can come at a price, dictating that they may hit ceilings regarding their ability to recruit necessary talent or to accommodate the growth plans of fast-growing companies.
Talent is no doubt an issue. “Luxembourg’s labour market is under strain, but for positive reasons,” says Mackel. “Companies have grown dynamically, they are investing in innovation, and this demands additional talent to sustain this momentum – a talent pool that cannot be recruited only within the domestic population. For this reason, Luxembourg continues to seek and attract talented individuals from outside.”
He is less concerned that Luxembourg will be held back by lack of space to grow. “Luxembourg’s surface area is 26 times that of Paris or 1.5 times that of Greater London – and while Luxembourg currently accommodates a population of 600,000, Greater London has close to 9 million.”
To provide a competitive edge, he highlights Luxembourg’s status as (in his words) a multi-jurisdictional competence centre and the strong foundation this provides for growth. “It is this that differentiates Luxembourg from other European financial centres, but which also makes it complementary to these financial centres – sitting at the heart of Europe.”
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