ALFI London Conference and Cocktail

Luxembourg’s fund industry and UK’s asset managers take on challenge of turning Europe’s huge savings pool into investment

Investment fund regulation in the United Kingdom is changing, with implications for fund businesses that distribute Luxembourg products in the British market, but the grand duchy is more than ever a domicile of choice for Europe’s largest asset management industry, according to speakers at the 2024 ALFI London Conference, held in the heart of the City of London on October 16.

The 20^th annual event of its kind, the conference underlined both the global, outward-facing character of both jurisdictions and the symbiotic nature of their relationship, a characteristic that has only grown since the UK voted to leave the European Union in June 2016. Proof if it were needed was the new record of 1,700 attendees in person and online – compared with barely more than 100 for the first London conference on June 29, 2005 at the Park Lane Hotel – making it the largest international outreach initiative organised by Luxembourg’s fund industry, noted ALFI chairman Jean-Marc Goy.

He pointed out the stature of the grand duchy’s fund industry, the second largest investment fund centre in the world after the United States. At the end of July, assets under management reached EUR 6.85 trillion including all assets types, with alternative strategies now accounting for one-third of the total at EUR 2.27 trillion. A substantial proportion of that is for UK asset managers, with members of the country’s Investment Association now managing an aggregate £9.1 billion around the world, according to CEO Chris Cummings.

To Mr Goy, the industry is currently presented with a huge challenge and opportunity – the EUR 14 trillion held by European households in savings and deposit accounts rather than in more productive and potentially higher-returning investments – 40% of total financial assets, as against 25% in the US. It is not surprising that the average net financial worth per person is around EUR 50,000, compared with EUR 250,000 across the Atlantic, where investment is much more firmly engrained in the national culture. He quoted a popular US maxim: “Savings are good, but investment is better.”

From protection to engagement

Mr Cummings said the priority must be to change households’ risk appetite, shifting the focus away from the post-Global Financial Crisis prioritisation of investor protection and disclosure, to engagement between the industry and the people it serves: “Britain has become a risk-off nation, and Europe a risk-off continent.” From a current 8% pensions savings rate, he argues, the target should be set at 10%, 11% or 12%.

At least in both the Grand Duchy and the UK, the fund sector and the broader financial industry can count on a sympathetic ear in government. Luxembourg is planning to enact a broad package of changes for 2025, comprising a 1% initial cut in corporate income tax, exemption of actively-managed exchange-traded funds from the subscription tax on fund assets, broadening of the legislative framework governing distributed ledger technology and dematerialised securities, and updating of tax incentives to encourage individuals with in-demand skills to move to the country.

Meanwhile, Mr Cummings noted the new Labour government’s recognition of the critical role of asset management in the British economy, as the biggest magnet for foreign direct investment, generator of 5% of the country’s export earnings, and its provision of services to 84% of the UK population through products ranging from tax-free investment savings accounts to retirement pensions.

Thomas Seale, ALFI’s chairman from 2003 to 2007, recalled that the idea of the London conference was born amid a morose climate for the industry, with assets down around 80% from their peak following the dot-com crash and the economic upheaval in the wake of the September 11, 2001 terrorist attacks against the US. But critical changes were also underway, including Luxembourg’s adoption of the twin UCITS III management company and product directives - the genesis of the now-famous Luxembourg fund toolkit.

Legislative and regulatory innovations

The roadshow and conference initiative quickly proved a winning formula, Mr Seale said, focusing on technical discussions rather than an aggressive sales pitch. Within 12 months ALFI had staged further events in Tokyo, Singapore, Hong Kong, Boston, New York and Milan, and coming up for 20 years later the overall tally has now reached 270 roadshows.

The past two decades have seen Luxembourg extend its fields of expertise from cross-border UCITS products geared mostly to the needs of the retail market to the alternative strategies and assets that now fall under the private markets label. ALFI CEO Serge Weyland pointed to a succession of legislative and regulatory initiatives: the SICAR law in 2004 to encourage the private equity and venture capital sector, and the SIF (Specialised Investment Fund) in 2007 (introducing the concept of the ‘well-informed investor’), which now comprises 1,200 funds holding EUR 760 billion in assets.

In 2013 came the EU’s Alternative Investment Fund Managers Directive (AIFMD) in response to the financial distress of the 2007-09 global financial crisis. In Luxembourg, it was accompanied by a revamping of the country’s limited partnership legislation. In 2016, the RAIF (Reserved Alternative Investment Fund) was introduced, which did away with the constraints of direct product authorisation and supervision since the manager was already subject to regulatory oversight under the AIFMD.

Mr Weyland emphasised that the investment industry has already demonstrated its ability to weather economic and financial turbulence, from the impact of the Covid-19 pandemic and lockdown restrictions in most countries to the fallout of the war in Ukraine and the near-meltdown of liability-driven investment strategies employed by UK pension schemes through Luxembourg funds. But, he added, the new European Commission and Parliament need to be aware that the cost of doing business has increased a lot over the past 10 years.

Upbeat economic outlook

Mr Seale put it more bluntly: “We need to shift focus from investor protection to investor opportunities. There is now too much regulation, and it’s open to question whether an asset manager with EUR 500 million can be viable. There is a risk of crowding out innovation and entrepreneurship.”

James Pomeroy, a global economist with HSBC Investments, had a more upbeat message: a global monetary easing cycle is underway in most countries, with just a few exceptions such as Japan, and there is almost no reason to be worried about a US recession. The manufacturing sector in America may be experiencing weakness, but with wages increasing and employment growing, spending is currently growing at an annual rate of 3%.

Meanwhile, he said, inflation in the US has “just died” – persisting only in the rental market, where the trend is taking longer to filter through, while another bright spot is India, soon to become the world’s third biggest economy. However, Europe continues to struggle: in the continent’s current engines of growth, Spain, Italy and Greece, spending from US holidaymakers is an important factor.  The outlook for the UK seems optimistic, mainly because the government has to adopt pro-growth policies to meet its fiscal rules, according to Mr. Pomeroy

Private market fundraising has been impacted by the challenges general partners have faced in exiting existing investments in the past two years, according to Alastair Yates, a managing director at Macquarie Asset Management. Limited partners have received less capital back from earlier fund vintages, and the 2022 stock market decline has left many institutions overweight in asset classes such as private equity. As a result, fundraising periods have lengthened.

More GPs chasing smaller commitments

Among the effects, said members of the fundraising panel, were GPs focusing on their existing portfolios while they waited for investor appetite to return, and greater competition between managers for smaller amounts of capital. The typical institution is being pitched to by between 200 and 400 GPs, noted James Sladden, a partner with Campbell Lutyens, while Mr Yates said managers are having to conduct greater knowledge-sharing with investors ahead of a commitment: “It’s no longer take it or leave it.”

The panellists were sceptical about how soon the democratisation of alternative fund investments would lead to a significant flow of retail capital. Managers tend to find it easier to work with a small number of large investors, they said, and Mr Sladden noted that resources can be an issue. He added: “The direction of travel is clear, but there’s a long way to go on structuring and access.”

Mhairi Jackson, manager of funds and asset management policy at the UK’s Financial Conduct Authority, pointed out that asset managers that distribute Luxembourg funds in the UK will have longer to adapt to Britain’s forthcoming Overseas Fund Regime, with the interim Temporary Marketing Permissions Regime now due to expire at the end of 2026 rather than a year earlier.

More urgent is the implementation of the European Securities and Markets Authority’s guidelines on sustainability-related fund names, which will apply from November 25 for new funds and from May 25 next year for existing ones, noted Marco Zwick, director of fund supervision at Luxembourg regulator CSSF. The UK’s product naming and marketing rules under the new Sustainability Disclosure Requirements are also imminent, coming into effect on December 2.

Embracing new technology

Both regulators emphasised their commitment to embracing new technology in the fund industry. The CSSF has authorised professional investors to invest in digital assets (but not retail market) and is examining the implications, risks and opportunities of digital ledger technology, including fund tokenisation. So far, two applications have been approved. “There is a shift from talk to action,” Mr Zwick said. Meanwhile the FCA is pursuing its own strategy on tokenisation, including digital sandbox initiatives.

The trend toward democratisation of private market funds has been underway for several years already, using Luxembourg vehicles including Part II funds and RAIFs before this year’s much-anticipated revamp of the European Long-Term Investment Fund (ELTIF) regime. Neil Hoyne, head of international client services at Ares Wealth Management Solutions, noted that as for institutional investors, ELTIFs offer less correlation with public securities markets, although even retail-oriented funds entail much more limited liquidity.

Arnaud Bon, alternatives advisory and consulting leader at Deloitte Tax & Consulting, pointed out that distribution strategies are quite different from the traditional private markets model of placement agents and direct marketing. He also observed that while high net worth individuals are increasingly interested in alternative fund products, they are not equally educated about their characteristics and constraints. “That makes mis-selling a key risk,” he said.

The UK government is pursuing its long-term regulatory agenda of adapting domestic rules to its own priorities, having taken a first step by ‘onshoring’ the framework it inherited from EU membership, according to Eve Ellis, a partner with law firm Ropes & Gray. She does not expect substantial long-term changes, as proportionality has always been a priority for the FCA, which now aims to attract asset managers from all over the world. But Ms Ellis says a complication for the industry is the regulator’s consumer duty rules, which apply to any funds distributed in the UK.

Carried interest taxation

On taxation, the fund industry is waiting with some trepidation for an indication of whether and how far the new Labour government might amend Britain’s capital gains tax rules and in particular the impact on carried interest, for which the UK accounts for somewhere between 42% and 54% of the European total, according to Loyens & Loeff partner Jérôme Mullmaier. The rules could in future require carried interest recipients to co-invest to keep qualifying for capital gains rather than income tax, but this would not involve a major shake-up, he said.

Sandro Pierri, CEO of BNP Paribas Asset Management, candidly acknowledged that the past 25 years have been extremely favourable for the asset management industry, with growth averaging between 7% and 8% a year and very little cost inflation. But in the coming years, he believes that amid pressure from sustainability issues, technological change and geopolitical turbulence, it will be lucky to see expansion of 4% to 5%: “Inflation and the cost of regulation and technology will eat into margins, and performance will be more dispersed between winners and losers.”

Hendrik du Toit, founder and CEO of emerging markets investment specialist Ninety One, tells a similar story, noting that over the past two years the sector has been punished by interest rates rising from practically zero to 5%. “Emerging markets are in denial,” he said. “For 30 years we have been growing at 30% annually and returned billions of dollars to our shareholders, but that won’t be repeated.”

Both are wary about the impact of sustainability issues, with Mr Du Toit warning that externalities are bound to manifest themselves at some point, adding: “Sustainability risk is political risk.” Mr Pierri concluded: “Anyone not taking sustainability risk into account is not doing their job properly.”

Extraterrestrial investment possibilities

Under the cautious but open-minded supervision of the CSSF, Luxembourg has an opportunity to become a hub for digital asset investment, according to Linklaters partner Raoul Heinen, pointing to the options for structuring funds thanks to the evolution of a service provider infrastructure. Custodians play a critical role, says Zodia Custody group chief risk officer Anoosh Arevshatian, in safeguarding the private keys that, through interaction with public keys, enable the transfer of digital assets.

The 2024 London Conference concluded with an exploration of the almost limitless scope of fund assets from Bogdan Gogulan, CEO of Luxembourg fund manager NewSpace Capital, who believes a golden age is dawning in which opportunities in the space economy are expanding from exploration to tourism and technology. He argued that the space economy will greatly impact the financial sector, from extraterrestrial commodity mining and insurance claims processing to ultra-fast data processing technologies that can drive high-speed trading. “We are on the cusp of something extraordinary,” he said.

Back on Earth, the longstanding relationship between Luxembourg and London remains a critical engine of the European and global asset management industry, notwithstanding the complications of political changes and a more uncertain economic backdrop, and there’s no indication that will change over the next 20 years.

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