Luxembourg is battling hard to stay at forefront of private equity industry
By Robin Pagnamenta – It may be one of Europe’s smallest countries, but Luxembourg has never lacked for ambition.
Over the past half century, the Grand Duchy has steadily built on its strengths in private banking, investing, insurance and corporate lending to play an out-sized role in the continent’s financial sector.
These days, the Luxembourg Private Equity and Venture Capital Association (LPEA) estimates that 90 per cent of all European private equity and venture capital funds are domiciled in Luxembourg – a tribute to its reputation for political stability, niche expertise and regulatory competence, which in turn has helped transform it into one of the world’s wealthiest countries.
With more than EUR5.3 trillion in net assets under management in regulated funds, traditional Luxembourg-domiciled undertakings for collective investment have experienced robust growth during the past few years.
The nation’s government and financial authorities have been keen to spot emerging new opportunities as they arise to further strengthen a sector which already employs over 50,000 people.
Of course, funds domiciled in Luxembourg pay lower taxes on their funds under management than in other EU nations – an advantage which helps investors to benefit from a bigger chunk of the payouts.
But that’s not the only advantage enjoyed by the private equity funds and asset managers who have flocked to the Grand Duchy, helping to cultivate a bustling industry of administration services, legal and audit firms as well as banks and asset management firms.
Luxembourg’s debt levels stand at just 22 per cent of GDP – one of the lowest ratios in the EU and roughly one third the level of Germany, according to Eurostat figures.
That cherished reputation for economic and regulatory stability has been another powerful factor in supporting the industry.
Yves Cheret of CSC, a fund administration specialist based in Luxembourg says there is a deep understanding of the need for stability at all levels.
“It’s not that there is no tax but the system itself is quite stable and robust, and the country itself is very stable with a triple-A rating,” he says.
“There are not a lot of countries which have had that triple-A rating for years and years and years,” Cheret says, adding that funds which domicile in Luxembourg usually do so with a time horizon of 10 years or longer.
That, he says, is simply because they are confident that the environment is unlikely to be very different over that timeframe.
He says: “If we change the system every three years, they will not like it, but they know that if they come in that system is not going to change dramatically within the next 10 years.”
Looking to the future
There have been other factors at play which have delivered a helping hand for Luxembourg.
Brexit has, of course, delivered a significant boost to the industry by triggering a boom in applications from London-based fund managers keen to establish Luxembourg funds aimed at European investors.
While that trend has slowed in recent months as financial market participants grow accustomed to the new realities of Europe post-Brexit, Luxembourg is already looking to the future.
The rise of private debt funds – fuelled in part by the new Basel Framework strictures on bank lending – as well as real estate funds and the growing popularity of funds with a focus on environmental and social governance (ESG), are all hot areas where Luxembourg is pushing hard to develop expertise and experience.
“If you look at the debt funds, they are developing quite fast because traditional lending that goes through banks is becoming more and more difficult,” says Marco Mondaini, Head of Depositary Services at Alter Domus in Luxembourg, referring to the rise of private debt funds and Luxembourg’s interest in the field.
“The cost that is linked to debt for traditional banks [is rising], mainly driven by regulation where you have to have a certain capital to lend. In a low interest rate environment that capital doesn’t produce any returns, so that’s why the banks are becoming more prudent.”
Luxembourg has astutely catered to the needs of the fund industry with a range of back office to front office services.
Legal and regulatory framework
Its multilingual and international workforce has helped to support alternative investment fund managers (AIFMs) and other third-party service providers.
But it is Luxembourg’s willingness to continually review its legal and regulatory framework to stay at the forefront of the fund management industry that has always set it apart.
Often, it has acted far more nimbly than other jurisdictions – an accomplishment made easier by its small size – handing it an important first mover advantage in creating attractive options for investors and asset managers.
For example, the creation of innovative structures, such as the SCSp (Special Limited Partnership) introduced in 2014, and the RAIF (Reserved Alternative Investment Fund) introduced in July 2016, have ensured Luxembourg has maintained its competitive edge.
The SCSp is a popular fund entity for alternative investments, including real estate. It is similar in flexibility to a traditional Anglo-Saxon limited partnership.
The RAIF, meanwhile, qualifies as alternative investment fund (AIF) and is not itself subject to CSSF product approval, ensuring a light touch regulatory approach.
Mondaini believes this innovative approach to the legal frameworks governing the fund management industry has been highly successful.
He says: “I think regulation is a constant evolution, but it’s a healthy evolution in the sense that the regulator also understands the dynamic of being pretty close to and pretty present in the market. It understands the constraints of the requirements. So I think today there is the right balance of exchange and communication between the associations representing the business, and the regulators.”