Facing competition from other centres, Luxembourg has found ways to innovate, writes Jan F Wagner.

Despite the perceptions of many in western Europe, Luxembourg’s success as a financial centre is not down to its private banking industry alone. In fact, it has more to do with a financial activity that is a lot more mundane: the domiciling and administering of investment funds.

In 1988, Luxembourg recognised the enormous potential of these products – still a relatively new concept in Europe – and set up a tax and regulatory regime allowing them to flourish there.

This meant low taxes, flexible investment rules for the funds and quick product approval. Since Luxembourg was already making a name for itself in private banking, there was plenty of “seed money” to grow its fund industry.

Startling results

The results have been startling. While Luxembourg is only a major player in private banking, it is a giant in the investment fund industry. As of the end of April, its industry counted E1037bn assets under management, putting it in third place globally.

The Grand Duchy is also home to subsidiaries of more than half of the world’s leading fund providers. But it is only the administrative centre. In almost all cases, the funds’ asset managers work wherever the providers are based, be it in Europe, the US or Asia.

Tom Seale, chairman of the Luxembourg fund association (Association Luxembourgeoise des Fonds d’Investissement), observes that, as an efficient and sophisticated administrative centre, Luxembourg enables European banks to avoid overlap and cut costs when they set up funds.

“Luxembourg’s regulator also has so much expertise that the turn-around of the fund may be quicker than in the home country,” says Mr Seale. “That fund can also be offered to customers around Europe because of our EU passport [a licence to sell funds in EU countries] and our distribution teams speak the relevant European languages.”

But storm clouds have begun to appear. If, for example, tax harmonisation in the EU becomes a reality, Luxembourg will compete head-on with London, Paris and Frankfurt. This would be very tough for Luxembourg, because these places are capital markets centres, complete with their own fund infrastructure and something that the Duchy lacks: asset management.

Under attack

Luxembourg’s leadership in investment funds is, moreover, already under attack by upstarts like Dublin. Though it prides itself on pioneering the products, Dublin realised well before Luxembourg that demand for hedge funds, which seek to deliver a return irrespective of market movements, would become significant in Europe amid bearish financial markets. The Irish capital currently leads in these products after having begun to domicile, administer and list them three years ago.

Mr Seale says that Luxembourg is catching up with Dublin on hedge funds though, partly because it can distribute the products to a wider client base than Dublin, which is still very Anglo-Saxon oriented. Luxembourg now has about 100 hedge funds with more than E30bn in assets.

Yet Lucien Thiel, director of the Luxembourg banks’ association (Association des Banques et Banquiers, Luxembourg), believes that Luxembourg will have a hard time competing in the future if it remains largely a fund administration centre. “I believe that such back office duties can be done by anyone in the world, so we have to innovate to compete,” he says.

Pension plan stalls

To help matters, Luxembourg developed a plan in 2000 to persuade multi-national companies to centralise their pension schemes in Luxembourg. The idea was that companies could service their employees’ pension benefits from one place, improving efficiency and greatly reducing costs. The Duchy’s financial community was particularly excited about the idea, as it entailed the instalment of high-volume institutional funds.

But the plan has been slow to gather momentum, owing to tax barriers in the countries where multi-nationals operate their pension schemes, and Mr Seale predicts that the situation will not change much until those barriers are removed.

Even so, Luxembourg has demonstrated that it can innovate. In early May, it created an investment vehicle specifically attuned to the needs of European private equity and venture capital investors. Luxembourg’s financial community believes the new vehicle, the Sicar, should go down well with private equity investors because it has no restrictions on investing in assets – including unquoted companies, shares or bonds – anywhere in Europe and has EU and Luxembourg tax breaks.

“The new law provides private equity houses with an attractive regulated vehicle in a flexible and tax-efficient framework. It positions Luxembourg as a prime jurisdiction for the European private equity industry and will reinforce its status as an international financial centre,” says Hermann Beythan, a partner at the law firm Linklaters and an adviser to major Luxembourg banks.

Underscoring Sicar’s bright prospects, Mr Beythan notes that since its creation in mid-May, the vehicle has already attracted a few hundred million euros in assets. Now that’s the kind of creativity which should help sustain Luxembourg’s competitiveness in the funds business.


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