The largest investment funds centre in Europe, and the world’s second biggest after the US, Luxembourg is highly sensitive to risks and opportunities related to financial services, which represent the small country’s number one export.
The key geopolitical risks which the Grand Duchy is looking out for include the rise of populism, teamed with consequently more inward-looking nation states. These factors, acknowledges Denise Voss, chairman of Luxembourg funds industry association Alfi, will continue to drive market volatility, which is always a challenge for the investment industry.
But the opportunities presented by ageing demographics and the rise of the middle class in emerging markets including Brazil and China, will benefit Luxembourg more than most other financial centres, she believes.
“No other fund centre has asset managers from as many countries and investors residing in so many countries, who can invest in as many different strategies through funds,” she stated, opening the recent Alfi conference.
“Luxembourg Ucits and alternative funds are providing key solutions to the demographic time bomb.”
Ucits funds, created in 1985 for EU cross-border distribution, represent more than 80 per cent of the country’s total managed assets, which have more than doubled since 2010 to reach €4.2tn ($4.7tn). Luxembourg Ucits are distributed in 75 countries and are today recognised as a global brand. Two thirds of Ucits funds distributed internationally are based in Luxembourg, and the unique diversification of the investor base is itself a growth driver.
Alternative agenda
Alternatives also offer just as much growth potential, says Ms Voss. Most new funds being set up today are alternative products, mainly private equity and real estate, as well as private debt. Raifs [reserved alternative investment funds], a streamlined structure which the Grand Duchy introduced in 2016 to meet managers’ and investors’ needs, have proved particularly popular, growing to almost 600 in number.
Brexit has also been an important growth driver over the last three years. Fears of consequences from a hard Brexit have driven more than 50 UK financial firms, such as M&G, to build presence in Luxembourg and get a licence, according to KPMG. UK fund firms have transferred more than €130bn in assets to the financial centre.
Despite these important short-term catalysts, long-term growth opportunities are the most persuasive. Only 11 per cent of European households invest in mutual funds, with similar percentages replicated around the world, outside the US, where mutual funds have a longer history. These figures show ample opportunity for further penetration of the Luxembourg brand, provided regulators get their strategy right, believes Ms Voss.
“Regulation must continue to support strong investor protection, but without unnecessary and costly burdens on the industry,” she says, lamenting the review of powers of European supervisory authorities (Esas), aimed at strengthening their role.
“Europe seems to have a regulatory mode that’s difficult to turn off,” she tells PWM. This takes up time that could be used to focus on customers. It also introduces uncertainty, which could badly impact the image of Europe’s asset managers, leaving the doors open to competition. If this regulatory overkill had taken place in an immature industry 20 years ago, “we might have killed Ucits”, she adds ominously.
The mutual funds industry must also make itself more relevant to younger generations – through the type of financial education Alfi is fostering – helping it attract both investors and employees. This new cohort of investors is also demanding an “excellent user experience” through digitalisation, currently hampered by manual processing procedures. This can be speeded up and costs reduced through technologies such as blockchain, being enabled by laws recently passed in the Luxembourg parliament.
“Anything that can make the sale process faster or cheaper is going to be very popular,” says Charles Muller, former KPMG Luxembourg partner and now an independent civil rights attorney. To keep margins, asset management companies must pressurise others in the value chain to reduce prices, with blockchain helping manage costs, he says.
These investments in technology are crucial for fund houses, if they are to remain relevant, observes Jervis Smith, head of investor services for Luxembourg at Citi. “The younger generation may bypass the mutual funds industry, because it is too laborious and takes too long to get everything done and go straight to other areas of investments that become much harder to regulate,” he says.
They may decide, for example, to buy shares from African crowdfunding websites.
Funds must provide “world class service” in order to profit from growth opportunities in regions such as developing countries, benefiting from rising wealth and an expanding middle class.
“Ucits funds are still the preferred vehicle for fund distribution in Taiwan, Hong Kong and Singapore, but Asian client service expectations are much higher than in Europe, and if we cannot provide world-class service, people will start to look at other, perhaps local options,” warns Mr Smith.
Offshoring
One of today’s key concerns for Luxembourg’s practitioners and authorities is how to provide high-tech, low-added value services without having to recruit vast numbers of new workers.
They have long realised that the mutual fund industry occupies a disproportionate part of the country’s infrastructure resources, which support 600,000 residents plus 200,000 cross-border workers.
Despite the government’s best efforts, Luxembourg is struggling to keep up with demand for both transport and housing, both intensified by Brexit-driven growth, which has pushed accommodation prices through the roof.
“As technology improves and client expectations increase, the trick is to find technology solutions, such as AI and robotics, for processing, and overlaying them with human intervention for the servicing aspect,” says Mr Smith.
Over the past 15 years, to sustain growth, financial firms such as Citi have been gradually offshoring processing functions to lower-cost jurisdictions, while focusing on enhancing client service.
“If our industry wants to increase margins, we need to reduce costs. This can be either through automation, or outsourcing to lower cost jurisdictions, or both,” states Martin Vogel, CEO at MDO Management Company.
He believes services such as writing fund prospectus, fund registration, reporting and data management are all ripe for outsourcing.
Today’s search for talent focuses on qualified risk and project managers and sales people, not the back-office clerks of 20 years ago. “The beauty is that the average job profile in Luxembourg has increased in quality,” says Mr Vogel.
“The standard fund accountant that takes prices from Bloomberg and calculates NAV does no longer exist. Instead we have client relationship managers, who are paid double or three times the salary. The main challenge for Luxembourg is to continue to increase its level of job profiles and expertise required.”
All are welcome
Multinational, and multi-cultural Luxembourg has always been a magnet for EU talent, and the launch of the University of Luxembourg in 2003 was an important step for attracting and retaining young people.
“Had you asked, 20 years ago, young economics students to move to Luxembourg, they would have laughed at you,” says Mr Vogel. With its dynamic job market and high salaries, the country also attracts young career starters, especially from countries with high unemployment rates. Employment has grown 50 per cent over the past 20 years, versus 20 per cent in the EU, and annual GDP growth has averaged 3.6 per cent from 1996 until 2018.
However, graduates now aspire to work for firms such as Google, Amazon, or Baidu, rather than banks. Those with tech skills are leaning towards roles in smaller less corporate entities, such as start-ups.
These challenges led the government, in 2017, to establish the Luxembourg House of Financial Technology (Lhoft) foundation, a public-private partnership. “Our mission is to ensure the future competitiveness and sustainability of Luxembourg’s financial centre, with a core focus on technology,” explains its CEO, Nasir Zubairi.
“We are seeing a lot of interest and demand for solutions that can help reduce burdens and costs in the areas of compliance, know your customers, data management and reporting,” he says.
Other critically important areas are anti-money laundering and transaction monitoring. “By automating and reducing some of the overhead around compliance, regtech allows firms to better allocate their resources, and focus more on customer service.”
To speed up financial firms’ procurement of third-party technology solutions, which averages three years, the foundation has partnered with key players such as Temenos, Cisco, Proximum group and Deloitte, to create a procurement certification platform. This carries out due diligence, testing and certification on a standardised basis, to pre-certify tech firms.
While there are 50 firms based in the foundation’s facility, of which a third focused on regtech, the emphasis is not about attracting firms to Luxembourg. There is no competition with other financial centres, but rather collaboration to find solutions for the industry, says Mr Zubairi.
Luxembourg has also launched various initiatives to recruit new skills and talent, and the government is working with the private sector on a large-scale plan called the Digital Skills Bridge, aimed at re-skilling and training people around digital skills and know-how.
Sustainable finance is one of three key pillars of the Luxembourg fund industry, together with Ucits and alternative funds. The Grand Duchy is now prioritising building a diverse, forward-looking investment community, with expertise in these sustainable strategies, to remain relevant to younger generations.
The country first introduced initiatives around ESG, responsible investing and micro finance in 2006. Today, more than 60 per cent of micro finance fund assets are domiciled in Luxembourg, according to Luxembourg for Finance, and it has the greatest market share of responsible investment funds in Europe (39 per cent).
Luxembourg listed the world’s first green bond, and today 50 per cent of the world’s green bonds are listed on its exchange.
Final frontier
There is a very “vibrant and exciting atmosphere” in Luxembourg today, far away from the image of a dull financial centre that the country had perhaps projected in the past, says Citi’s Mr Smith.
More than 120 space exploration companies have set up their HQs in the country, which recently followed the US in passing legislation relating to space mining. “Unlike big countries, which tend to live in the past, Luxembourg is a small place, which looks to the future and keeps on re-inventing itself,” adds Mr Smith.
The country shifted from an agrarian society to a steel industry and followed this by creating a dynamic financial centre and service-based economy, while also entering the space sector.
“You can imagine Luxembourg will find something new to invest for the next stage, with ESG very much a part of it.”
