Market participants met in the Grand Duchy in September for the Global Investor Luxembourg Roundtable.
- Rob Lowe, head of business development UK, Pictet Asset Services
- Kieran Dowling, head of relationship management, Northern Trust Luxembourg
- Dusan Gladovic, legal and regulatory manager, Luxembourg Private Equity and Venture Capital Association
- Claus Mansfeldt, chairman & managing director, SwanCap Investment Management
- Sebastien Danloy, head, continental Europe & offshore and CEO of RBC Investor Services Bank
- Chaired by Pádraig Floyd
Industry experts gathered in Luxembourg to discuss the changing European fund market
Chair: What do you think will be the immediate impact of and the opportunities that will come from Brexit?
Rob Lowe: The lack of clarity enabling institutions to offer solutions to their clients and to their business model has been a frustration. If you look at a lot of the organisations that are affected by Brexit itself — whether fund manager related or not — there are only a couple of simple answers that they’re seeking:. whether they can sell their products if they’re a UK-based manager in, say, Germany and what is the tax implication of doing that? Once those questions are resolved, organisations will be in a position to put strategic decision making in place. Until a deal is struck, it’s wait and see.
Dusan Gladovic: I agree with the lack of predictability, but the legal framework that will follow Brexit is probably the biggest issue for the private equity and venture capital sectors. According to Invest Europe, one third of all private equity capital in Europe is managed by London-based firms, so we don’t expect them all to relocate, but we understand if they are now looking into Luxembourg as an alternative.
Given that PE investments are illiquid by their nature, capital invested in UK funds cannot be exited that quickly in case those UK funds suddenly become non-EU funds. What we are seeing right now is that UK firms that are already established in Luxembourg are strengthening their presence. We also see firms that are setting up offices for the first time here, to make sure they keep their access to European investors post-Brexit.
Claus Mansfeldt: The immediate impact is on distribution. The key area that people have already prepared for, is to ensure they can continue to take on investors across borders and to manage their money. That’s why, in the private equity space, practitioners are making sure that they are compliant in Europe, as with the AIFM Directive. We don’t do a huge amount of fundraising in the UK ourselves, so far, but it remains a technical point we have to address. Otherwise, the impact that we have seen has been on deal making, so whenever we have an investment case involving a UK company we have to have a slightly prolonged discussion about the Brexit factor, what the impacts might be, especially on downside scenarios. Maybe it’s all discounted, but we have to just spend a lot more time on that.
Kieran Dowling: The consistent message we are hearing here is one of uncertainty, so I will not dwell on that. Northern Trust instead wanted to create certainty for its current and future clients, so we established our Brexit programme shortly after the UK referendum result, with the objective to re-domicile our EU passporting bank, currently based in the UK, to Luxembourg. Subject to securing the required regulatory permissions, we have a target for completion prior to the UK’s withdrawal from the EU. While our UK office will remain our headquarters for the EMEA-wide business, it also reinforces how important Luxembourg is to Northern Trust. As the second-largest fund market globally, we see it as very much a growth market for us. We’ve certainly experienced an increase in alternative asset opportunities - specifically we’ve seen an increase in the UK-based managers looking to create new private equity vehicles when in the past they may not have considered Luxembourg. When reading a recent FT article, noting a 10% increase in the Luxembourg asset management workforce with firms relocating jobs from London, there’s clearly a lot of opportunity for our industry. There are some challenges, too, and we’re trying to minimise those from a client perspective through our Brexit programme.
Sebastien Danloy: The European Commission has said the UK’s withdrawal would effectively void UCITS and AIFMD’s application in the country, meaning that UK managers would be treated as a third country post-withdrawal. Activities will become more challenging for UK asset managers as its becoming more inevitable they will lose passporting rights and may have to rely on NPPR, which may expire in the near future. Since the 2016 referendum result, we’ve seen an increase in clients setting up registering / employing Luxembourg based fund managers and /or the establishment of parallel fund structures – the latter being prevalent in the private capital space.
Chair: What are the kinds of regulatory pressures that people will face in the coming years?
Dusan Gladovic: There is the implementation of the Anti-Tax Avoidance Directive across Europe, then you will have tax intermediaries directive. The latter rules that if you are a tax adviser to a firm you will have to report to the authority if you are advising on a structure that has been set up with the main goal of avoiding taxes. These new tax rules will be implemented over the next two years.
However, not all regulations are a threat – most regulations create costs related to adjustments in the short run, but prove to be quite beneficial in the long run. Think of the General Data Protection Regulation – we all have to comply with it, but we all benefit from it as well. Nevertheless, I would agree that in the sector of alternative investments there might be too much restrictions in deploying investments.
Digital transformation is a topic that has been very present at the level of portfolio companies, but which is now also gaining ground among private equity firms themselves. One of the trends that we have witnessed is the increase of first-time funds and “niche players” that focus on a particular industry or type of portfolio company. The market is getting crowded and one way or another, PE firms have to find a way to compete and differentiate themselves from each other.
Kieran Dowling: The first six months of this year have been demanding for our clients and it’s impacting multiple stakeholders - fund managers, management companies, asset servicing firms, etc. — we’re all in the same boat working with either local industry associations or regulators to make sure we are guiding our clients through regulatory change.
Transparency and data protection innovations are two important themes for Luxembourg asset servicing providers as they respond to new regulations. In the private equity asset class, blockchain and distributed ledger technology (DLT) are extremely important initiatives. Last year, Northern Trust announced the first deployment of a blockchain solution for the private equity market. Through this process, we worked with many stakeholders - regulators, auditors, asset managers, general partners, limited partners, with the aim to provide a secure, transparent and efficient way to bring all the relevant parties in the value chain together to access a single ledger of information.
Dusan Gladovic: I welcome that, as there is still an enormous amount of manual paper pushing and payment sign-off up and down organisations.
Claus Mansfeldt: As a practitioner, I guess substance is key, so substance-lite is becoming difficult. In the latest circular the CSSF has clarified their interpretations even further, where they are quite literally limiting the number of mandates you can have as a director, and then also a limit to how many AIFMs you can be a conducting officer of. That will impact some of the services operations here. There will be a bit of a shakeout there, and that is probably not a bad thing, as people have to know what they’re doing in quite some depth, and perhaps one cannot criticise that as an objective.
Red tape is a bit irritating and laborious and you wonder whether it really adds value to the investors, etc, but at the end of the day the spirit of it with a focus on transparency, I think, is creating the right sort of outcome.
Sebastien Danloy: No one in financial services is immune to the regulatory framework. Clearly Mifid II and GDPR are top of mind given they were implemented this year. Regulation exists to ensure the underlying investor / customer has some protection which is a good thing. So any institution that has individuals as their end customer is the most affected – that’s pretty much all financial services companies in one way or another.
Chair: Blockchain promises much as it could revolutionise administration and financial services as part of the process rather than being touched by human hand.
Kieran Dowling: You’re absolutely right, it’s removing what is quite a manual process to something that’s highly automated, where all key participants in the process can see all the information in real time, so extremely transparent and it creates a much smoother and more marketable product.
Rob Lowe: Automation does offer a huge opportunity, whether it’s DLT of some description or blockchain itself. I can see a point in time where right from an initial investor subscription - all the way through to producing an NAV on behalf of a fund, however liquid or whatever the pricing frequency, significant automation can be achieved One important consideration is to think about client needs. All of us are here to service clients, and so ultimately client needs should be first and foremost in our thinking. Indeed, if blockchain cuts costs and overall TERs to portfolio managers and that can be passed on to end investors, then that’s only a good thing.
Sebastien Danloy: Rapidly changing technology, increased competition and evolving client expectations are reshaping the workplace and the nature of our work. When it comes to robotics, artificial intelligence (AI), etc, there are different areas where these technologies can be applied. AI can be well-implemented in areas with simplified and repetitive tasks such transaction and workflow monitoring, processing, checking and validation of transactions/exceptions; coordination of reporting dissemination. These technologies prove to be more cost effective, help to increase efficiency and accuracy across the business, and can be applied across the different areas of investor servicing. Data is perhaps the most talked about area currently. It is no secret that margins are being squeezed on the traditional asset servicer, so they need to continue to be a valuable partner to their clients.
Claus Mansfeldt: One of the concrete things here in Luxembourg is to set up a UBO (ultimate beneficial owner) type of directory. This is all about knowing your client (KYC) and anti-money laundering (AML). The initiative is good, so that once you have a safe repository where you have qualified yourself as an investor and met all the criteria and proved beyond doubt who you are, that will be done in a place rather than having everybody in the industry scrambling around for bits of paper. There is an interesting opportunity for intermediaries, or maybe even a government-run agency, to have a trustworthy central repository and you can get approvals within seconds. However, it contradicts regulation as an asset manager is ultimately responsible, so you cannot rely on it. It needs interplay between industry and regulators that it could actually add to the security of the AML chain.
Rob Lowe: That’s perhaps where the industry should welcome and support fintech innovation when it comes to automation. A lot of start-ups have looked at UBO registers which would help all of us around the table today.. I believe we’ll see some consolidation with acquisitions of fintechs and start-ups that support exactly that requirement across the industry. I don’t think it will be a first mover approach, but generally be adopted long-term. This is where fintech can add real value long-term.
Sebastien Danloy: In the short and medium term, most of our clients are looking to ensure they remain competitive among their peers. Longer term, they are looking closely at technology enhancements and evaluate their foundational capabilities, such as robotics and smart workflows, or high-end solutions, such as machine learning or artificial intelligence. Many of them realise that they need to adapt to the new generation of investor expectations. But that adaption requires resource which is why they will inevitably look towards asset servicers in helping them.
Claus Mansfeldt: Data protection is also at odds with this in a way, so that has to be worked in, too. But, it’s not rocket science at the end of the day, so you just have to get through that and the data security topic as well.
Chair: What are clients are trying to do and how is that driving behaviour within the industry?
Dusan Gladovic: What’s really driving differentiation between private equity firms for example is higher competition. There are more and more first-time funds and new teams on the market because of the massive growth of the asset class. But they don’t try to differentiate themselves, as far as I can see through digital technologies, but by specialising in one niche area, such as cleantech, and that gives them credibility.
Claus Mansfeldt: We see on the client side a demand for better — and more timely — data. That then has encouraged market participants we have used, for example eFront or Investran, delivering better quality of data and transparency, which are all important to the clients.
Rob Lowe: I agree that we will start seeing niche — perhaps closed-ended platforms in terms of blockchain — whether healthcare, IT or telcos. Each of these will in their own way develop a set of systems that meet the requirements and we’ll see these mature over the next three to five years.
Chair: How far can these assets grow? There’s going to be quite a lot of dry powder because you can’t invest a tsunami of cash overnight. How far do you see the development of private equity, real estate, etc particularly with relation to Luxembourg?
Sebastien Danloy: I can’t say it will grow forever, but look at the overall investor behaviour over the past few years. The debate on passive versus active funds continues, but passive investment is certainly growing again. The popularity across sectors, — corporate, pensions, sovereigns and even retail — seems to be unyielding and this has been largely driven by macro-economic factors, such as the chase for yield and demographic trends like urbanisation. We’re also seeing more asset manager clients broadening their own offering and venturing into the alternative space of private capital. With the growing popularity, institutional investors in particular still require the same transparency they are accustomed to in liquid assets for investments made into private capital. As a consequence, we are seeing an increase in regulated structures so that they meet the various investment policies and criteria the institutional investors require. AIFMD being the obvious choice for EU fund structures.
Kieran Dowling: Just this year alone, our pipeline has been extremely strong in Luxembourg, and we are seeing alternative asset classes - private equity, real estate, infrastructure, etc. - driving this growth. Roughly 60% of Northern Trust Luxembourg’s new business is coming through this asset class this year, so when a recent PWC survey anticipates alternative assets to grow above $21 trillion by 2025, it’s difficult to envisage any end in sight in terms of growth. Fund sponsors continue to craft new creative solutions on the back of investor demand. Alternative investments are experiencing strong demand from institutional investors who want diversity in their portfolios, to tap into new growth streams and to plug liability gaps from a DB or DC plan perspective.
Claus Mansfeldt: BlackRock has announced it is now going majorly into private assets. One of the world’s largest mutual fund public asset management companies is going strategically into private assets across the whole spectrum. The main reasons mentioned was not only potential for premium returns, but because the public market is shrinking. Not necessarily market-cap, but the number of stocks are shrinking, and that has to do with fewer IPOs, private-for-longer trends, and of course also the tendency for the public companies to do buy-backs has also shrunk the number of available shares to buy. The Norwegian oil fund has also got very close to finally allocating towards private equity, one of the main arguments by their managers was to not be missing out on a huge segment of the economy, e.g. in the technology sector. That’s why the private segment is increasing more and more, investors are accepting this and they’re accepting that they need to be in it.
Dusan Gladovic: Private equity firms take a long perspective and are able to create value for investors and investees. The growth of alternative assets is a sign of increased investor appetite for these assets. We see an increase in the variety of investors getting into private equity, including more family offices but also private banks offering their clients pooled private equity products.
I believe the increased appetite for real assets among investors is also a reflection of their ability to exert some influence on management decisions. That’s partially indicative of a new generation of family offices with an entrepreneurial track record.
Long-term returns are a big reason. A recent FT article analysed boom cycles in the stock market and explained that annualised returns from public equity have been decreasing with every boom cycle since the 1930s.
Rob Lowe: Luxembourg plays an incredibly big role in the overall alternatives space. Despite a lot of knowledge, people quite often bundle alternatives into a pile of various different asset classes that aren’t traditional vanilla securities or investment classes which can be a mistake. Private equity is the real leader over the last few years, and Pictet asset Services are working with a number of very interesting clients with differentiated private equity strategies. Across many of these opportunities, fintech and private equity are symbiotic in many ways. Many PE investments are fintech-related because they generally stay private for longer. It’s almost a virtuous circle. The environment we’re in leads to a need to be better automated and regulatory pressures reduce, this creates more capital to be used for start-ups and private organisations, which then feeds private equity opportunities. We’ve also had a low interest rate environment which obviously supports start-ups.
Conversely, away from PE, long-short hedge fund managers have suffered over the last decade or so, so again, combining alternatives into a big pool of manager types is a disingenuous. Hedge funds have the ability to go short, and some of those strategies didn’t work so well over the previous decade or so. It may well be that a decision to remain committed to this strategy will be vindicated very soon, but we’ll see.
Kieran Dowling: The concept of a hybrid fund is becoming commonplace, providing predictable liquidity and credit quality — nobody wants to be back in that place of fire sales of 2008. Having stable cash flow is an extremely important characteristic and we’re seeing a lot of interest from the new clients for these fund solutions.
Chair: How well placed is Luxembourg to deal with that?
Rob Lowe: Luxembourg is second only to the US in terms of capabilities to support a lot of these investment strategies and asset classes. The infrastructure, willingness, skill set and really the wherewithal to make Luxembourg a success has been in place for many years. ALFI and some of the other trade bodies have done a good job in positioning Luxembourg and I don’t see the Luxembourg providers losing out to this flow of business, particularly when you consider the opportunities related to Brexit.
Claus Mansfeldt: I think safety in numbers is another reason and it’s a self-reinforcing dynamic, although some will go to Ireland and others to e.g. Amsterdam. Behind Luxembourg’s momentum is their infrastructure, where significant portions of the working population live and breathe fund management and fund administration at all levels. It’s an integral part of society and everybody knows this is part of Luxembourg’s economic DNA.
Dusan Gladovic: Luxembourg seized AIFMD as an opportunity and was successful. There will be general elections in Luxembourg in October this year, and nobody expects a change in the business-mindedness of the Government. The political stability and legal certainty are a given. Those are the big advantages of Luxembourg. Then there’s the infrastructure of service providers for the asset management industry, which is multi-lingual, with a geographic position in Europe offering easy access to other markets, and a specialistion in cross-border transactions. So, Luxembourg is here to stay.
Kieran Dowling: We also have a regulator here that is very pragmatic to new business and working with new fund managers or asset servicers. Technology will be key so we need to keep up to speed. It’s extremely important to bring all stakeholders together, to get things moving in the same direction. Our blockchain deployment for private equity was a good example of how to achieve this direction. Whilst this specific launch was from another international finance centre, it is a collaboration model which the Luxembourg industry is well-placed to emulate.
Rob Lowe: Ultimately, investors really do trust Luxembourg. Whether that’s a retiree in the north of England or a young up-and-coming lawyer in Berlin, they recognise that the domicile of a Luxembourg fund is one that they can put a lot of faith in. Malta is a good example of a market that has struggled, as has Cyprus, to be seen as a reputable domicile, and that’s key for any success.
Chair: What will be the ongoing role of Luxembourg?
Claus Mansfeldt: Apart from fund admin, Luxembourg can also play an increasing role as a meeting place where investors seek to go, i.e. not just where you seek to park your assets and administer your assets, but where you will also run some of your front office investment management. There is now more of an investor-buzz and investment opportunities are being showcased increasingly here. It May never compete with London, New York, Frankfurt, etc, but it can still be important, and there is room to do more to stimulate and encourage investors. We are seeing an increasing number of large investment organisations as well as family offices setting up in Luxembourg, such who might otherwise typically have selected e.g. London or Geneva. Luxembourg could become one of Europe’s main gateway’s to China, which is an objective supported by the government.
Another point is ESG, where Luxembourg has an organisation called LuxFLAG that is trying to set standards, in their case via ESG-ratings at the product level. This adds something to the dynamic and that’s very much supported by the government and the industry here.
Kieran Dowling: When considering a new fund domicile, a fund sponsor or existing client will clearly consider Luxembourg, due to the cross-border distribution experience in more than 70 markets. The infrastructure in Luxembourg supported by legal firms, tax advisers and asset servicers allows us to impart the experience of dealing with multiple clients and relationships which adds value for guiding new entrants to the Luxembourg market. There are challenges with distribution, whether it’s raising assets in a competitive environment or understanding what the true cost of global distribution is. There’s an opportunity here for Luxembourg to continue adding value for new fund promoters who are considering Luxembourg as a jurisdiction to launch and distribute their funds.