Having recently reached an all-time high of over e1trillion in assets, Luxembourg is powering ahead as a leading European investment fund centre. But competition in Europe is fierce and there is no room for complacency
Luxembourg is fast catching up with France in their neck-and-neck race to become Europe's largest investment fund centre. In February, assets under management in Luxembourg domiciled investment funds passed the milestone of e1 trillion to reach an all-time high of e1.03 trillion at the end of March. Over the 12 months ending in the first quarter of 2004, this represents an increase of net assets in Luxembourg funds by almost e209bn, or over 25%.
Such strong growth might be surprising in the light of the financial scandals concerning market timing and late trading practices that shook the US investment fund sector last autumn and were reflected in a some isolated cases in Europe. The industry press, particularly in the US, called for regulatory measures - even legislation - to prevent practices likely to put the small investor at a disadvantage and put an end to conflicts of interest.
However, such measures can lead to an over-regulation that damages fund flexibility and adds unnecessary operational costs. A market economy should be able to resolve potential conflicts of interest through competition, by sooner or later eliminating those players that do not have the confidence of their clients.
A closer look at the Luxembourg investment fund figures shows that investment fund clients are aware of this fact: e112bn of the above mentioned e209bn increase in net assets arose from net new investment by institutional and private investors. This is proof of the confidence investors still have in the collective investment sector in general, and in Luxembourg funds in particular.
Despite the continuous growth of net assets under management, the Luxembourg fund industry knows that it has to resist the complacency. Competition between the international financial centres is getting tougher. Many European states are taking initiatives to make their legislative environment more attractive for investment funds. However, some governments have implemented measures to protect their industry that we consider to be unfair. The Association of the Luxembourg Fund Industry (Alfi) has opposed, and will continue to oppose, any such initiatives that constitute an attack on the principle of a free European market for investment funds.
On the other hand, the Luxembourg fund industry is paying particular attention to the shift in the balance of power in European regulation that would come about if the Lamfalussy approach were applied to the investment fund sector. Luxembourg, along with other other member states, risks seeing their degree of freedom in the regulatory domain eroded in favour of the European Commission. In fact, some healthy competition between regulatory systems of the different member states is entirely beneficial to the development of the investment fund sector.
So the investment fund sector is experiencing a period of change that is unprecedented since the 1980s. A succession of important legal and fiscal developments at both the European and national level, combined with a period of consolidation in the banking sector, has led to a profound remodelling of the industry. This, itself, has thrown up a number of opportunities for fund communities with the agility to follow and, in some instances, to lead.
The Luxembourg legislator has always striven to offer the fund industry the most modern legal and regulatory environment in the European Union. While it was the first EU member state to implement the first Ucits Directive in 1988, the country also met the deadline for the adoption of the new Ucits III Directives into national law well ahead of time in December 2002. Further to adapting the national legal and regulatory environment to the European framework, the legislator has recently implemented a series of measures to reinforce the Grand Duchy's attractiveness as a domicile for collective investment schemes.
By qualifying several professions that are closely linked to the investment fund industry as Professionals of the Financial Sector (PSF) and by submitting them to the authorisation and prudential control of the national regulator, CSSF, the legislator has facilitated the outsourcing of certain tasks to specialised service providers that have been developing in the Grand Duchy in the past few years. This meets a growing demand for outsourcing by companies that cannot or do not wish to make what is often a heavy investment in data processing and communication technology in order to cope with international distribution, the multiplication of distribution channels and an ever more demanding clientele.
These service providers include transfer agents, registrars, the managers of non-Ucits funds, communication agencies, administration agents, information technology services and firms offering company creation and management services. The new PSF must comply with the rules applicable to banks in matters of professional secrecy, must respect existing legal provisions concerning the fight against money laundering, must put in place an internal audit function and nominate an external auditor.
The Luxembourg legislator has equally taken steps to encourage the development of promising business lines.
With effect from 1 January, it exempted AAA institutional cash funds from paying the annual subscription tax (taxe d'abonnement). This initiative, which will contribute to the development of the money market sector, should be of particular interest to promoters who wish to concentrate their entire fund range in one domicile but who for tax reasons had, for instance, domiciled their cash funds in Dublin.
Alfi estimates that with some $200bn invested in this type of financial vehicle - compared with $2.4bn in the US - the European market for institutional cash funds still shows a big growth potential. Indeed, many investors are seeking a safe haven from the turbulent equity markets, and cash funds constitute an efficient and profitable alternative to individual treasury management techniques that today still have the favour of most corporate investors.
In May 2004, Luxembourg reduced to nil the annual subscription tax on pension pooling vehicles. These vehicles are investment funds that are exclusively destined to pool assets invested in the various national supplementary pension schemes of a single multinational group. This reduction, combined with the fact that Luxembourg FCPs benefit from tax transparency, is expected to create a new and highly-attractive scheme for the tax efficient and cost-effective grouping of pension funds to the profit of the end beneficiaries.
The most recent legal initiative is the adoption of a law creating a new investment vehicle specifically designed for private equity and venture capital. The société d'investissement en capital à risque or venture capital investment company (Sicar) benefits from a legal and tax structure that has been tailored to meet the particular needs of venture capital and private equity investors.
Venture capital funds have been operating in the Grand Duchy since the early 1990s. Under the supervision of the CSSF, these funds invest in the securities of non-quoted companies, in business start-ups and companies in rapid development that have not yet reached the stage of a stock market quotation. Furthermore, there exist corporate entities that are active in the venture capital and private equity business without being subject to regulation by the CSSF or other supervisory authority, because they do not collect money from the public.
The legal framework for a Sicar is more liberal than the legislation for collective investment schemes, but stricter than the law applying to companies that are not subject to regulatory control. It offers considerable flexibility in the choice of the legal structure and the manner of operating a Sicar, its capital structure, the redemption of shares and method of asset valuation.
The law also provides for an easy quotation of Sicar shares on the Luxembourg Stock Exchange. The Sicar is aimed at a relatively wide public thanks to the broad definition of an 'experienced investor'. An advantageous tax regime exempts Sicars from certain taxes and allows them, in principle, to benefit from the application of anti double-taxation treaties.
Finally, a law passed earlier this year on the securitisation of assets creates the potential for an entirely new family of products. The 'New Products' Committee within Alfi is currently studying the opportunities that could arise from this new legal framework.
The various measures outlined above illustrate the effort made to reposition Luxembourg as the domicile of first choice for non-Ucits funds as well as retail funds. It is anticipated that the wider legal and regulatory framework will contribute to reaching the Luxembourg fund industry's next ambitious target: e2 trillion in assets under management.
Assets under management in domiciled investment funds stand at e1.03 trillion, a year on year increase of almost e209bn.
Luxembourg and other EU states risk seeing their regulatory freedom eroded in favour of the European Commission.
The Grand Duchy continues to frame legislation and introduce schemes to try to remain one of Europe's leading financial centres.
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