A cautious approach to the booming hedge fund market meant that Luxembourg fell behind Dublin in offering alternative investments. Now that caution has been set aside and the Grand Duchy is hoping to catch its rival up
At the start of the hedge fund boom in the mid-1990s, the Grand Duchy of Luxembourg took a more cautious approach, allowing Dublin to emerge as Europe's first service centre for alternative investments. Now that Luxembourg has shown new commitment to this sector, can it come to dominate the European market?
Dublin gets off to a head start
Dublin was well-positioned to take advantage of the European hedge fund boom before it even began. The jurisdiction's involvement in servicing the US hedge fund market gave it experience before hedge funds caught on in Europe. When the hedge fund boom hit the European market, Dublin took advantage of its close relationships with the dominant US and UK markets. It further strengthened its position by providing the stock market listing and servicing of funds domiciled in offshore centres such as the Cayman Islands, British Virgin Islands and Bermuda.
Luxembourg's reputation as a well-established investment fund centre with rigorous regulation was perhaps a liability in the early stages of the hedge fund boom. As investors looked to diversify holdings into alternative investments, Luxembourg's conservative reputation and relatively narrow product range may have turned off fund managers who wanted to set up aggressive, unregulated investment products.
Making up for lost time
The Luxembourg hedge fund industry is busy making up for lost time. In late 2002, Luxembourg's regulator, the Financial Sector Supervisory Commission (CSSF), issued CSSF Circular 2002/80 (the 'Alternatives Circular'), creating a framework for retail and institutional hedge funds and funds of hedge funds. The circular allows Luxembourg to compete with other hedge fund jurisdictions by permitting a greater variety of alternative investment strategies while retaining the advantages of regulation.
Another encouraging sign comes from the Luxembourg Stock Exchange, which is considering listing funds domiciled in the Cayman Islands and the British Virgin Islands. This would create new servicing business for providers already catering to Luxembourg's traditional fund industry market.
The development of the hedge fund business in both Dublin and Luxembourg has been similar to that in the offshore investment fund market - beginning with institutional clients and slowly migrating to high net worth individuals and retail clients. So far, the two have approached regulation differently; Luxembourg has focused on product restrictions while Dublin has focused on allowable qualified investors in hedge fund products. Both are the result of purposeful positioning. Dublin's approach reflects the institutional character of its market, while Luxembourg's is indicative of its dominant position in retail funds.
The Grand Duchy promoters initially tested the waters of the hedge fund market by selling funds of hedge funds as an alternative to traditional investments. The success of these multi-manager products created confidence that there is a market for single-manager funds, which would likely appeal to more investors.
Hedge funds go retail
While hedge funds are most attractive in down or neutral markets, their demand is expected to grow even under improved market conditions, particularly given retail demand in Asia and Europe.
Asia was first to permit the distribution of hedge funds to retail investors in 2001 and 2002 in Singapore and Hong Kong, respectively. Recently, several European countries have followed suit. Last year, the German parliament approved the Investment Act 2003 and the Investment Tax Act 2003, which opened up the market to domestic and foreign single-manager hedge funds. This widening of in-country hedge fund regulations has also occurred in France, Italy, Switzerland and the Netherlands. Luxembourg, which is growing as a center to register and distribute funds, stands to benefit from this development because few European countries are willing to authorise funds registered in other less-regulated offshore jurisdictions such as the Cayman Islands, British Virgin Islands and Bermuda.
Luxembourg's geographical and cultural proximity to the German market and its established fund services infrastructure could make it the jurisdiction of choice for promoters seeking to capitalise on the opportunities offered by this new legislation. With limited infrastructure for hedge funds in Germany and slow development of practical regulation, such funds offered to the German market could be set up in Luxembourg.
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