Emmanuel Gutton, Director of legal and tax, Alfi
Maren Stadler, Funds partner, Clifford Chance
Claude Niedner, Partner and chairman, Arendt & Medernach
Diana Dumitru, Director, client services – private equity, Vistra
Jeremy Albrecht, Managing director, head of continental Europe, UK and Ireland, client coverage, RBC Investor & Treasury Services
Nicolas Xanthopoulos, Partner, advisory and consulting group, Deloitte Luxembourg
Funds Europe – What exactly is the difference between a fund board and the board of a management company (ManCo)? What are the responsibilities of each and how do they fit together?
Luxembourg, like other fund jurisdictions, has seen intense scrutiny on fund governance in recent years. Fund boards – often staffed by representatives from the fund management companies that promote the funds – are more likely nowadays to have members who are independent.
But this scrutiny has also extended to management companies. Commonly known as ManCos, these are the legal entities that take responsibility for the management of a fund – the fund management in a broader sense than just that of portfolio management. There has been an explosion in third-party – or “outsourced” – ManCos to specialist providers, including fund administration firms.
So, how do the governance duties of a ManCo and fund board differ?
The board of the ManCo is responsible for ensuring that proper fund administration and marketing of a Ucits and/or alternative investment fund (AIF) takes place. The monitoring of portfolio risk management is also within their sphere, said Diana Dumitru, director, client services – private equity, at specialist administrator Vistra.
Governance by the fund board, on the other hand, centres mainly on ensuring fund operations remain in line with a fund’s investment strategy, she said.
“In other words, it is running the oversight of the fund calculation and performance, and compliance with the investment strategy,” Dumitru added.
Jeremy Albrecht, head of continental Europe, UK and Ireland, client coverage, at RBC Investor & Treasury Services, pointed out that the fund board looks to defend the best interests of a fund’s investors – adding that a responsibility of the fund board is to ensure that the ManCo is performing its duties properly.
“The beauty of the model is that all actors provide oversight of each other,” he said.
The fund appoints a management company to take care of all operational and regulatory aspects of a fund, said Claude Niedner, partner and chairman at law firm Arendt & Medernach. A ManCo needs to have substance, to support the main objective of the fund board – which is to protect the interests of the fund investors.
He added that the management company, however, is a service provider to the fund and that the board of directors of the management company is acting in the best interest of the management company.
“Fund board members can be confronted in court for actions initiated by any party involved in the fund.”
Emmanuel Gutton, director of legal and tax at the Luxembourg funds industry association (Alfi), mentioned that a key element is that the management company is appointed by the fund. The board of the management company has to ensure that the management company can accomplish its duties towards the fund on the basis of contractual arrangements. He also said that the fund board is ultimately responsible for any issues towards the investors in the fund.
Nicolas Xanthopoulos, partner, advisory and consulting group, Deloitte Luxembourg, explained that the fund board appoints the ManCo to execute the day-to-day activities. “The fund board is not carrying out the daily activities; rather, they ensure that the ManCo operates the different delegated activities as agreed.”
The fund board remains the main responsible body, he added. “Fund board members can be confronted in court for actions initiated by any party involved in the fund.”
Niedner highlighted one particular responsibility of the fund board, namely the anti-money laundering-related aspects – aspects, he says, “where I believe they are, if I may say so, on the hook … they need to make sure that this is properly applied, and that is a specific responsibility they cannot delegate out”.
Maren Stadler, fund partner at Clifford Chance, said that in Luxembourg, the general partner in a partnership model could delegate all management functions of a fund to the management company – such as fund management and risk, and portfolio management. The general partner keeps the unlimited liability only.
“This is something that has been introduced into Luxembourg law some years ago and may work very efficiently for asset managers, avoiding an allocation of tasks between the general partner and the management company,” she said. “The same applies for FCPs [Fonds Commun de Placement], where all functions are combined within the management company, and no separate fund board exists.”
Funds Europe – When a traditional investor makes its first allocation to private markets and selects a fund manager, what are their next steps and what common challenges are there along the way?
The first issue, according to Albrecht, is to face the fact that private assets funds contain comparatively less liquidity than that which many investors in mainstream asset classes would be used to.
Investment methods when entering private market funds are different from allocations to liquid funds. At the beginning, an investor in a private assets fund makes a commitment to place a certain amount of money into the fund. Subsequently, there are capital calls on that money when finance is needed to make direct investments.
“The understanding of the mechanism and constraints implied by such funds will be key to making it a good experience for investors,” said Albrecht, who went on to highlight the shift towards the ‘retailisation’ of private capital funds.
“Even though retail is not always pure retail, the minimum thresholds for investments are lowered. It therefore means there is a new type of investment available to a new type of investor, and there is therefore a new type of investor available to private-markets asset managers.
“It also means for the manager that instead of dealing with a pool of investors that could number 40, 80 or 100-plus, it could be 1,000-plus if this trend continues.”
“Institutional investors cannot afford to have low-single-digit-type returns. it doesn’t work. so, there is a shift towards alternative investments.”
Some 20 years ago, institutional investors were rather marginally invested in alternative assets, mentioned Niedner. They were primarily invested in listed equities, fixed income securities and money markets instruments. But institutional investors now have higher allocations to alternative investments as they chase higher returns and yields.
“They cannot afford to have low-single-digit-type returns. It doesn’t work. So, there is a shift by institutional investors towards alternative investments,” said Niedner.
He added: “There’s also an important link between asset managers and the retail side of banks, including the entire regulation which goes around it: the European Long-term Investment Fund (Eltif), which will now be Eltif II.”
The good news is that both liquid and illiquid investments are regulated in Europe under the Ucits regulation and the Alternative Investment Fund Managers Directive (AIFMD), respectively. Xanthopoulosnoted that the Ucits regime is older than the regulatory regime around alternatives, but said that in the alternatives space, the ecosystem is well developed, albeit less mature and less automated than in the Ucits world.
“However, because of this regulatory framework, there shouldn’t be any massive loops or traps for the investor acting in the alternatives space.”
A newer but common challenge since August this year relates to funds that have to consult clients about their sustainability preferences, said Alfi’s Gutton.
“We need to assess the match between the needs of investors and which investments are available. And as we all know, there are a lot of difficulties with data in the ESG and sustainable frameworks,” he said. A significant challenge, therefore, is for the correct sourcing of suitable investments to match client sustainability needs.
Dumitru said it is a challenge for investors to find the right asset managers who have the appropriate level of knowledge surrounding particular private assets, or who have the right level of access to markets and good access to information.
“Sometimes they invest a bit too much into some fund managers without even looking at the more extensive profile of the fund managers,” she explained.
Dumitru also highlighted difficulties with forecasting returns. Although academics were studying risk and return estimates from these asset class – which was helpful in developing the asset classes – there were still issues with putting theory into practice.
Funds Europe – How would you describe the regulatory ‘temperature’ in Luxembourg at present? Where is the focus of Luxembourg’s financial regulator, the CSSF, and what underpins this?
According to Xanthopoulos, there has been something of a slowdown in terms of new regulations – certainly in contrast to the tsunami that engulfed the industry after the 2008 financial crisis. However, the EU ESG regulatory framework was “keeping the industry busy”, he added.
Another key element that the CSSF is focusing on as Luxembourg’s financial regulator is anti-money laundering (AML). AML is “very high” on its agenda, said Xanthopoulos, with the multiple objectives of protecting investors, protecting the finance industry itself and protecting Luxembourg’s own reputation as a centre of fund excellence.
Albrecht highlighted a new wave of uncertainty around the topic of energy, given Russia’s invasion of Ukraine and the subsequent energy crisis. “We need to potentially relax some of the rules. Some investments like nuclear energy might actually become ESG investments,” he said.
He suggested the crisis, which has seen huge market volatility, could help to refocus regulation: “A big wave of regulation came after 2008 and the [current] crisis could be a way to identify where regulations are potentially weak and where regulators might need to adjust or reinforce regulation.”
Gutton said the CSSF is “modernising and reinforcing” some of its oversight tools and aims to further clarify some of the practices that are common in Luxembourg.
Stadler observed that the regulatory load for asset managers hadn’t reached a post-Lehman intensity at present but that the Sustainable Finance Disclosure Regulation (SFDR), the green taxonomy regulation, AIFMD II, the Eltif and MiFID II reviews were all creating a number of new legal obligations that would affect compliance.
“It’s storm-like,” she said – in other words, not as tempestuous as the post-Lehman tsunami. Fund management firms want clarity, but regulators don’t necessarily always have the answers.
Stadler added: “Another thing at the top of the agenda of the Luxembourg regulator is the supervision of fees and costs in funds to monitor what’s happening for investor protection purposes.”
Dumitru noted that from the point of view of a service provider, it was “straightforward communication with regards to the outsourcing of AML duties”. This is relevant in the case of service providers with respect to governance and conflicts of interest.
Funds Europe – What key areas of fixed income are developing through Luxembourg fund structures and what challenges do asset managers and fund administrators face?
Gutton said that private debt assets increased by more than 40% last year, with the market now exceeding €181 billion of assets under management (AuM). He described private debt as a “very strong and increasing sector for Luxembourg”.
He said about 88% of the private debt funds in Luxembourg were set up as SCSPs – a limited partnership vehicle introduced in Luxembourg in 2015. But he also highlighted the success of the Luxembourg RAIF structure, with 36% of private debt funds in Luxembourg set up this way.
Albrecht said there had been a “boom” in private debt funds and that these funds provided much-needed finance for the real economy. “With regulations imposed on banks, it was a way for some markets to find fresh liquidity.”
But, he added: “Again, uncertainty is coming with the rise of interest rates. Uncertainty is never good, so we don’t know yet what the impact could be on private debt funds.”
“We need to assess the match between the needs of investors and which investments are available. and as we all know, there are a lot of difficulties with data in the esg and sustainable frameworks.”
A fixed interest return is normally a feature of publicly available vanilla bonds, said Niedner, while private debt often bears variable interest. This is an important distinction, he said, and with traditional fixed income paying low interest rates in recent years, fund providers will be watching to see how investor appetite changes as rates move higher.
Niedner pointed out how the AIFMD, after revisions, is likely to cover private debt funds. Stadler said there had been an increase in the number of securitisation vehicles established in Luxembourg thanks to a reform of Luxembourg’s securitisation law that added to their flexibility.
Funds Europe – Thomas Richter, the head of German funds body the BVI, has said that EU rules and regulations (for example, Priips investor documents) were a drag on the asset management industry to the extent that they prevented firms investing in their own development: for example, digital transformation. Would you agree?
Xanthopoulos agreed in part. Complying with regulation does consume resources and requires notable effort, given the volume and depth of European regulatory requirements. “However, I would disagree with the statement that regulation prevents firms from investing in themselves,” he added.
This, he argued, was made evident at major asset managers and asset servicers, where firms have overhauled data management strategies. He suggested that firms with efficient data management strategies that formed a core component of wider business strategy meant that any new regulatory requirement would be met by the querying of existing databases, extracting the information required, and then adding any additional information that was needed to comply with any new rules.
Firms without sufficient data management strategies were likely to be those struggling, he suggested.
Albrecht sympathised with the BVI head but, echoing Xanthopoulos’s comments, suggested there was a connection between regulatory pressure and digital transformation as firms employed technology to support compliance.
There is “one single envelope” that contains the asset manager’s budget, said Albrecht. The contents are eaten up to some extent by the costs of compliance with regulatory rules, and what remains in the envelope is spent on transformation and technology that is – at least in part – needed to comply more efficiently with existing and new regulations in the first place.
To some extent, therefore, regulation and digital transformation contribute to each other.
“What is difficult is to understand from a strategic point of view what investment we want to make. Indeed, ten years ago, you could have invested into a new system resulting in a three-year implementation project, and you would have had ten to 15 years to harvest the fruits from that investment,” said Albrecht. “[But] maybe today’s investments will be obsolete in two to three years’ time, so you need to understand where you will need to put your euros in terms of technology.”
There are other options, said Xanthopoulos. “For example, there is a lot of debate nowadays between asset managers and asset servicers as to what is core to their activities and what is non-core. We see a trend where market players invest in developing and differentiating themselves on their core activities and look to outsource that which is non-core to a specialised body.”
For a firm to focus on non-core services could result in a loss of revenue, he said, and offered limited added value that was costly to maintain.
“More and more market players explore the route to outsource these non-core activities to partners who have made these functions a core functionality of their own business and can leverage investment/resources for a wider range of clients with more efficient results.”
Gutton mentioned that in the current era, many regulations deal with disclosure requirements. “We all agree that there is a need for investors to be well informed so that they can make ‘informed’ investment decisions,” he said. So, from an asset manager’s perspective, making disclosures that are required by regulation is an unsatisfying activity when the disclosures “do not properly reflect” the reality of what is happening inside a product.
Gutton referenced the Priips KID disclosures, which critics such as the BVI said contained flawed methodologies concerning the calculation of costs. But he also said there had been recent improvements through the revision of regulatory technical standards.
Dumitru pointed out the importance of the EU listening to the opinions and recommendations of the fund associations – particularly over future regulatory initiatives and the impact on global competitiveness for EU-based asset managers.
Niedner noted that at the European level, there were regulations or proposals that genuinely centred on creating more efficient European capital markets. But this was not always the case, given the number of bodies involved in creating and influencing regulation.
Xanthopoulos said an important voice missing from the broad debate was “the voice of the people that we try to protect”. Noting that the Priips issue centred on trying to achieve more clarity on past performance and how transaction costs are calculated, he nonetheless questioned whether this additional layer of regulation was required. “Sometimes we need to step back and think whether what we’ve decided to implement serves an objective and if that objective has been correctly covered.”
Stadler queried whether this clarity would generate more returns or merely increase costs, albeit not losing sight of the fundamental principle of investor protection.
Niedner warned that the pace of new directives was quickening. “Every year, or every second year at least”, there was a new AML directive, he said. To this extent, it felt like “you sometimes have the impression that necessarily once a Directive has been adopted, the next point is working on the new Directive, without waiting to see how efficiently this Directive is actually working and then trying to improve it”.
Our Luxembourg panel took place in September, in person in Luxembourg.