Brian Bollen looks at Luxembourg’s climate for foreign investors, the change of pace and direction needed for the country’s fintech initiatives, and the wider economic strain impacted by the Russian invasion of Ukraine
Luxembourg is not a tax haven. How often has each of us heard this, or a very similar assertion? The Association of the Luxembourg Fund Industry (ALFI) has made it perfectly clear that it does not regard its home territory as an offshore financial centre, and points to the official list compiled by Eurostat as evidence.
What might be stated without fear of contradiction, however, is that right now, foreign investment is a vast topic of interest in the country.
To understand more about Luxembourg’s climate for foreign investment, we cannot ignore Eastern Europe. Of course, we all know that sanctions by the US, EU and UK, among others, have now been in place for months, following the invasion of Ukraine which began on 24 February, coupled with Russia’s ensuing response in imposing its own economic measures on foreign investors.
Law firm K&L Gates can help with understanding this quagmire, as the firm’s website contains a comprehensive two-part examination of the climate for foreign investment in Russia.
Part I of this study comprises a review of the US, EU and UK sanctions. Part II considers the Russian side of the coin, and concludes that many foreign investors are caught between the proverbial “rock and a hard place” as their investments in Russia are negatively impacted by both international sanctions and Russia’s own retaliatory economic measures.
K&L Gates’ Singapore partner Raja Bose, London partner Ian Meredith, Singapore senior associate Robert Houston, and Doha senior associate Hena Sial, state they are advised, uncontroversially enough, that protecting foreign investment in Russia is likely to be a challenging exercise for the foreseeable future.
“It is also important, however, for investors to take all prudent steps to preserve information in connection with their investments in Russia urgently, considering carefully the potential of investment treaty arbitration to provide a future remedy in the event a covered investment is ultimately lost or devalued as a result of Russian economic measures.
“While in some instances insurance may offer some potential means of obtaining compensation for losses, coverage may be limited and, given the level of exposure, insurers can be expected to seek to deny coverage, forcing policyholders to seek redress through litigation or arbitration.
“In the end, seeking relief through investment treaty arbitration (with or without third-party litigation funding) may be an investor’s only remaining option,” say the K&L Gates team.
ESG
If we cast our minds back to March, ALFI held the European Asset Management Conference — the first large-scale ALFI funds event with a substantial in-person presence since the autumn of 2019.The agenda was strongly focused on the sustainability transition and its impact on the fund industry. Sustainable fund assets totalled €4 trillion at the end of last year, according to financial services firm Morningstar, but despite this, ALFI chair Corinne Lamesch noted that asset managers face a range of challenges.
Lamesch told the conference audience: “There is concern about the use of Sustainable Finance Disclosure Regulation (SFDR) categorisations under articles 8 and 9 as labels, which was not intended.
“We, at ALFI, urge all fund boards to integrate ESG factors into their business models, rather than being passive and waiting for the next round of regulation. Asset managers need to empower investors to plan for their future wellbeing, including sustainability objectives.”
Luxembourg’s finance minister, Yuriko Backes, told the same audience that while the fund industry remains a central pillar of the economy, there are clouds on the horizon, including economic uncertainty worldwide and at home, one of which, there are no prizes for guessing, begins with the letter “R”.
“Even if Luxembourg is only marginally exposed to the Russian economy and clients, sanctions will have a cost through higher inflation, rising energy costs and slower growth,” Backes said.
In this environment, CEOs of asset managers active in Europe see new challenges arising to meet changing customer demand.
“One impact of quantitative easing is a shift toward outcome-oriented investing, which involves certainty of returns but also ESG requirements,” said BNY Mellon Investment Management’s Hanneke Smits. “This requires a combination of human capital and the power of machines.”
ALFI deputy director general Marc-André Bechet indicated that while the industry complains about the burden of regulation, it remains inescapable. He noted, for example, that while the EU’s Alternative Investment Fund Managers Directive was widely decried at the outset, it now enjoys widespread acceptance among industry members. Nevertheless, he said, national markets led by France and Germany still outweigh cross-border alternative fund business.
Bechet also alluded to the fact that over the past 10 years, business costs have increased while fees have dropped — from 200 to as low as 50 basis points for active equity funds.
Any experienced market participant or observer knows that the traditional response by asset managers, custodians and fund administrators to such a scenario has been to focus on doing more for less: increasing assets under management and administration through organic growth and acquisition, and increasing efficiencies, both through human endeavour and increased automation.
Fintech initiatives
The continuing developments in the financial technology sector will have a role to play in Luxembourg as elsewhere, but the sector could be a victim of its own success.
The global fintech sector saw a 182 per cent increase in tech job growth for the first quarter of 2022 — with the top eight fintech ‘mega-hubs’ accounting for over 90 per cent of all new fintech jobs advertised around the globe, according to recruitment firm Robert Walters’ Global Fintech Talent Report.
This report highlights how the fintech industry is one of the fastest growing sectors post-pandemic. However, it also outlined the sector will face major hurdles this year as an acute technology talent shortage around the globe will threaten to halt the growth.
“The forecast for organisations working in the global fintech market is a very positive one, however, their growth will be dependent on their ability to recruit and retain the right technology talent,” says Toby Fowlston, CEO of Robert Walters.
“The most advanced economies have long-established that they cannot be ‘good at everything’ and instead have focused their efforts in becoming specialists in a few core areas. For example — you have Germany for engineering, China for manufacturing, and the UK for banking. But no country quite has a dominance over technology and, given the remote and mobile nature of the technology industry, it seems that all major economies are competing for a slice of the fintech pie,” he adds
Returning to the subject of Russia Claude Marx, CEO of Luxembourg financial markets regulator Commission de Surveillance du Secteur Financier (CSSF), put the Luxembourg fund industry’s exposure to that country into perspective at the ALFI event, when he stated some €18.2 billion in assets are affected, but that actually counts for less than 0.3 per cent of the sector’s total. In addition, he said that is mostly denominated in Roubles and around two-thirds consists of equities.
Marx warned conference participants of the importance of financial players notifying any sanctioned assets and investors. “It is not just about the reputation of institutions but of Luxembourg as a whole,” he voiced. “I do not want to read about it in the next International Consortium of Investigative Journalists disclosures.”
A top priority for the CSSF is overseeing the implementation of the SFDR rules, including the more detailed level 2 requirements due to take effect, belatedly, at the beginning of 2023, along with the EU green investment taxonomy.
Noting that greenwashing means not correctly reflecting the sustainability profile of an issuer or portfolio, Marx said it encompasses the regulatory breaches mislabelling, mis-selling and misrepresentation.
He urged institutions not to spend too much time trying to unravel the “inconsistencies and imperfections” of the legislation but “to focus on what is clear and well-defined, defining data sources and preparing systems.” To this, he added: “We [the regulators] will not expect the impossible.”
What’s ahead?
In the broadest sense, the sustainability of Luxembourg’s financial industry depends on its ability to attract and retain the talent it requires to meet future challenges, always a significant issue because of the country’s restricted demographic resources, but now more acute because of increasing demand for compliance, IT and now, sustainability specialists.
At the ALFI Conference, the state employment department’s director Isabelle Schlesser said: “We need to be clear about what kind of talent is needed and how we develop the capabilities of people already here. Some jobs will disappear, and others will change very much, so we should be focusing on upskilling and reskilling.”
Luxembourg’s fund industry faces an exceedingly wide-ranging set of challenges, from the burden of regulation and compliance to the demands of a complex economic transition, along with the urgent task of channelling investment into the economy at a time when the market is become more diverse and fragmented — on top of the strains of geopolitical turbulence and armed conflict in Europe. But it is in these circumstances that the need for a strong and competitive fund industry is greater than ever.
“There is little doubt that the current macropolitical and economic situation presents interesting issues for investors, custodians, fund administrators and others to consider,” noted one industry delegate at the ALFI Conference. “We will be watching developments with close interest.”
ALFI and EFAMA figures
ALFI figures show that net assets of undertakings for collective investment amounted to €5.545 trillion at the end of February 2022 (compared with €5.098 trillion at end-February 2021, a growth rate of 8.92 per cent over the 12 months); the comparable figure at end-December 2021 was €5.859 trillion).
Meanwhile, the European Fund and Asset Management Association investment fund industry fact sheet to the end of February 2022 showed the UCITS net asset total for Luxembourg was €4.6 trillion (down just over €23 billion a month earlier), while alternative investment funds totalled €939.9 billion (down €3.4 billion).
