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Magazine Issues » September 2020

Luxembourg jurisdiction roundtable: Cross-border questions

Funds Europe – The UK is aiming, post-Brexit, to retain rights to sell financial services throughout the EU through the concept of ‘enhanced’ equivalency – where both the EU and UK would regard each other’s financial regulation as achieving broadly similar outcomes. How could the current model of the delegation of fund management activities from Luxembourg to the UK be affected by this from January 2021?

Thommes – If I look at the assets in Luxembourg funds, roughly 17% at least from the regulated space, is in funds that are held by initiators of UK-based origin. We have seen throughout Brexit firms relocating or transferring assets to Luxembourg. There is no general equivalence regime, so not even a sectoral regime, because we have roughly 39 specific equivalences foreseen in, I think, 16 pieces of legislation. The equivalences also do not all provide access to the European market, only 12 of them. 

What we see in the investment fund space is already a possibility given to delegate certain functions to other jurisdictions, be it on the portfolio or management side, or on the risk management side. Only recently, the European Commission published what they called a ‘readiness notice’ where they reconfirmed that the delegation of certain functions to providers established in the UK may be undertaken, provided that they are in compliance with the respective directive.

Where delegation concerns portfolio management, there needs to be a cooperation in place between the supervisory authorities of both jurisdictions. One element that needs to be fixed is that the UK will be a third country or is a third country going forward. Esma will need to adopt a position on that. 

Grenner – On the alternative funds side, at least for private equity, real estate and infrastructure, many asset managers in the UK have taken their measures already, for example by setting up a second AIFM here in the EU where before the AIFM was sitting in London only. 

Some have relocated their AIFM to Ireland for the language convenience. We’ve also seen quite a few setting up a separate AIFM in Ireland or Luxembourg. The majority simply didn’t want to run the risk of being negatively surprised at the end of this year. 

Many of them also said, ‘We have the solution all prepared, ready in our drawers and we are going to take it up and actually do it, if we think that there is going to be a hard Brexit.’ 

Enhanced equivalency will need to come. The UK is too important as a country not to introduce something to that end. For alternative assets in particular, the UK is absolutely key. 

Funds Europe – What is the outlook for the private equity/real estate sector in Luxembourg? Have increasing levels of leverage in deals and the rise of covenant-light deals in recent years made the alternatives sector more vulnerable in times, like now, of market downturn?

Brimeyer – When I look at how the last couple of years have been in private equity/real estate, and I would include private debt and infrastructure as asset classes, we’ve seen phenomenal growth. 

As Alter Domus, we are focusing only on that activity, and we are very bullish. Luxembourg is well placed to provide a good home for these kinds of structures and service these funds. 

From a macroeconomic point of view, there is a big need for these types of funds to continue operating, to provide interesting investment opportunities for pension funds, insurance companies, etc. 

I would say the fundamental business model of those funds is still very valid, even more today than it was yesterday. I think the industry has shown a high level of resilience in the crisis as well. 

Some funds have been a little bit under valuation stress, especially in the real estate space where it’s very difficult to measure the longer-term impact that the crisis will have, but in general we are very bullish about the industry. I think we have a good story in Luxembourg. 

Grenner – Shorter- and mid-term wise, I don’t think that interest rates are going to go up, definitely not in the next couple of years, so the drive into alternative funds will remain valid. I share the view that more money is going to flow into alternative funds. We have only seen the tip of the iceberg on what’s going to happen with regard to the real estate industry. You just have to look at Luxembourg’s real estate sector, but I guess in London it would be the same. The restaurant sector is negatively affected, offices are affected, habits are changing. I heard from clients in the US that people are moving out of New York into the suburbs, again something we had about 50 years ago. I think Luxembourg will also be touched by that.

On the subject of increasing leverage in deals, we are far from the levels that we saw before 2008/09 – I am not worried about that at all for the moment: it’s far from levels where there is high systemic risk, and on top of it, banks and other institutions are far better prepared than they were in 2008. I’d be more interested to see how the real estate sector is going to cope: are we going to convert offices into residential, or what’s going to happen on that front? That’s a far more interesting question in the short term. 

Mouftaou – Real estate is going to be a challenge, as Anja has mentioned. Certainly some funds that manage residential and commercial real estate have faced cashflow issues with shops being closed in many countries, impacting their rental income. 

Strategy is also a challenge. What will be the future trends of the real estate market? With the rise in teleworking likely to continue, is the trend going to be towards residential or commercial? Do we need to start thinking about the conversion of the portfolios? 

In terms of private equity, I don’t expect a big peak again in the number of fund managers coming to Luxembourg to set up funds, but I can see that the well-known Luxembourg fund-structuring toolbox will continue to offer many possibilities to capture new trends arising from the crisis. Also, the rise of the private debt sector, coming primarily from the US, is reaching Luxembourg and we’re seeing more and more fund structures targeting the asset class.

Thommes – Definitely the alternative segment is on the rise. This has also been confirmed by studies done by Preqin on the outlook of the alternative sector up to 2023. We’re certainly one of the beneficiaries of servicing those clients, be it in the private equity, real estate, infrastructure loan and debt funds where we have very strong positioning. We have seen over the years an increasing number of service providers servicing those clients with expert knowledge, so I would say the ecosystem around servicing that segment is top-notch in Luxembourg.