09 Jul 2012, Daniela Klasén-Martin , Georg Lasch , Camille Thommes , Régis Veillet , Risk magazine
Daniela Klasén-Martin is managing director of DCG and DCG Management Company. Starting her career in 1992 in Stockholm and then Paris, Klasén-Martin has been active within the Luxembourg funds industry since 1997. She joined DCG in 2010 to head the Luxembourg office after having spent four years with a leading provider of governance, independent directorship and management company services, and nine years with a leading global asset manager. Klasén-Martin is active on Association of the Luxembourg Fund Industry committees, and she has spoken at conferences and written articles on the topics of fund governance, risk management and the Alternative Investment Funds Managers Directive.
Georg Lasch is head of client development for BNP Paribas Securities Services, Luxembourg. He is in charge of sales, relationship management and client service teams for asset managers, alternative asset managers, asset owners and banks in Luxembourg.
Camille Thommes is director-general of the Association of the Luxembourg Fund Industry (Alfi). He is a member of several advisory committees to the Luxembourg Supervisory Authority, of the Haut comité de la Place Financière set up by the Ministry of Finance, and he represents Alfi on the Board of Directors of the European Fund and Asset Management Association, as well as other non-profit organisations.
Régis Veillet is head of sales and client relationship management at Société Générale Securities Services in Luxembourg. He deals with depositary bank, fund administration and transfer agent activities.
Custody Risk: Has Ucits IV met your expectations so far?
Daniela Klasén-Martin, DCG: It is important that Luxembourg was an early player in Ucits IV, and it was important to defend the ground of Luxembourg and ensure competitive advantage. We run a management company service and think about the competition from different jurisdictions, particularly in regard to the passport. When global institutions are making a choice of whether to use a management company in France, in the UK or in Luxembourg, they may see the advantage of using the Luxembourg management company because Luxembourg funds represent a strong part of the fund world. Also, because it is important to keep the management company, the controls and the governance in the country that runs the fund. When the decision has been made to keep the management company in another country, we still see demand for value-added services in Luxembourg such as governance and risk management.
Georg Lasch, BNP Paribas Securities Services: Most of the fund sponsors have spent the last 24 months adapting to the regulation, adapting their prospectuses to regulation and putting in place the necessary minimum adaptation to Ucits IV – be it some of the risk management principles on the management company side or the implementation of the Key Investor Information Document (Kiid). Some of the innovative parts of Ucits IV – master feeder and the management company passport – are being underused. Although we have seen the first master feeders coming up with masters in Luxembourg and elsewhere, it is clearly a minority.
Custody Risk: Why are master feeders being underused?
Georg Lasch: As always with regulation, organisations wait until the very last minute to act, mainly because the regulation becomes clearer as we approach the compulsory implementation. There are also more support services offered as providers redefine their service offering. In the first part of Ucits IV implementation, organisations have focused on the essential, the compulsory, part. Now that this has been done, we expect to see fund sponsors using the toolbox of Ucits IV to improve their products and reach economies of scale across domestic and cross-border products through master-feeder solutions.
Custody Risk: Are some of the benefits of Ucits IV likely to make more of an impact later in 2012?
Georg Lasch: We have always expected master feeders to come after the initial wave because people are still reacting to the regulation. The strategic impact of Ucits IV in its offering to revamp fund ranges and revamp organisation across Europe is a far-reaching change in an organisation and, hence, takes a longer time. So we have always expected master feeders to be more fashionable in 2012–2013, and we are not seeing huge changes through Ucits IV at this stage.
Régis Veillet, Société Générale Securities Services: In 2011, we expected Luxembourg to come out a winner of Ucits IV because we saw the two blocks that Ucits IV were offering were to the advantage of Luxembourg. However, it has not taken off as fast as we expected. Why? First, Luxembourg was so early with Ucits IV that we didn’t realise others were just lagging behind, and their strategies were not totally mature. Another reason is the financial crisis. The second half of 2011 was very difficult for clients, so they probably had other priorities. However, we are starting to see a lot of interest for master feeders, as expected. Surprisingly, we are seeing interest for cross-border mergers. Initially, Société Générale thought cross-border mergers might take more time because of fiscal issues.
Whether it is master feeders or cross-border mergers, it is mainly – but not always – to the advantage of Luxembourg. Most of our clients are looking for masters in Luxembourg. When they are thinking about cross-border mergers, it is merging a third country fund into a Luxembourg fund – this is positive. For the management passport, we are not seeing much interest yet and much needs to be clarified around taxation.
Camille Thommes, Association of the Luxembourg Fund Industry (Alfi): What you said about Luxembourg being too quick to implement Ucits IV – I’m not sure that is the case. It has more to do with the fact that some other member states are lagging behind. For the time being, there are still 10 countries in the European Union that have not fully implemented the directive. This raises concerns for players that want to benefit from one or the other efficiency measure. The European Securities and Markets Authority (Esma) issued an opinion and provided some recommendations on how you would need to deal with those situations, such as if you notify your product in a country that hasn’t transposed the directive or what happens with cross-border mergers if one of the funds is located in a jurisdiction that hasn’t implemented the directive?
Notification is still in the early days. Furthermore, we still have some tax constraints to overcome. This cannot be solved as quickly as expected. With regard to the management company, there are tax considerations that needed to be addressed such as the situation of a management company in one jurisdiction managing a fund in another jurisdiction, and the potential tax implications resulting from that. How would the tax authorities of the management company act? Where does mind and management take place? So, if several jurisdictions made changes to their respective tax laws stating that, even if a fund management company in country A manages a fund in country B, the tax authorities would not consider that mind and management would take place at the level of the management company.
Custody Risk: How has the Kiid been progressing?
Georg Lasch: From a provider perspective, there are many organisations producing a Kiid and disseminating it, and some securities services providers are offering Kiid services to clients. It is a new service that is well defined by the regulations, including its production, and clients are now asking for it.
We see two issues. One is on the retail side when the funds are directly distributed to retail clients and where the management company has to ensure the person at the end has received the Kiid. The other issue is the cost of producing Kiids once or several times a year for every share class. Larger fundraisers or fund sponsors are thinking about reducing share classes as Kiids need to be produced at share-class level and not just at sub-fund level. While the share class is an easy way to adapt the product to a market, to a distribution currency or to different types of clientele, in terms of management commissions, etc., the introduction of this additional fixed cost for producing the Kiid is creating another small barrier to adapting the product to the end-consumer. That is negative; I favour a Kiid at the sub-fund level rather than at the share-class level, the additional cost will lead to a more general offering to the end-client and may be less adapted than what we have seen in the past.
Daniela Klasén-Martin: This is an additional challenge from a management company perspective. You are right, there are many service providers offering Kiid services, competing on fees. The offer and the range of cost is very valuable but it remains an increased cost. In theory, and in the long run, the Kiid wasn’t to constitute an additional cost as it was set to replace the simplified prospectus. In practice, it constitutes an additional investment as it requires additional, regulatory information, such as the synthetic risk and reward indicator (SRRI) and the ongoing charges figure, which is different from the total expense ratio (TER). The SRRI has to be recalculated and a new Kiid issued if it is higher than the initial risk category for four consecutive months, which I believe may result in additional costs, in particular if the risk profile of the fund is not correctly assessed at inception.
With regard to the ongoing charges figure, there are still matters to clarify concerning its calculation and how it differs from TER. Some service providers will need to calculate both the TER and the ongoing charges figure. For any change in these measures, you will need to produce a new Kiid, so we will see more of a burden on the management company, which may end up in the ongoing charges figure/TER in one way or another.
Custody Risk: What has been the impact of the eurozone crisis on the funds industry in Luxembourg?
Régis Veillet: The whole eurozone is still being negatively impacted by the crisis. It is clear to eurozone clients what is happening and they can make distinctions between countries and financial institutions, but when you start speaking with non-eurozone bodies, then the real difficulties start. Organisations outside of the eurozone tend to confuse what is happening in Europe, and group Greece in with the rest of Europe.
As a service provider, we have changed the way we approach clients. We have had to explain the eurozone crisis. We had to explain about Luxembourg, about our exposure to government bonds, about our capital ratio and about our plans to face the crisis. This has changed the way we are approaching business. Two years ago, no one asked us about the Tier I ratio of the bank. Now, it is impossible to imagine going to a meeting with a prospective client without those figures in mind. There is an opportunity for Luxembourg here because it is seen as a safe haven in Europe by those who understand the differences within Europe.
Georg Lasch: During the crisis, rating agencies were reviewing their rating every second day in terms of downgrading countries and companies, including banks. This became very media-intensive, which helped drive the crisis effect, and it became quite different to the reports from analysts – the analysis of fundamentals of a company were ignored by some media, which created the wrong impression. If you remain calm, you help everyone to remain calm. You make people stress when you accelerate the movement. In the third quarter/fourth quarter last year, there was a crisis acceleration movement, which created a wave of panic across Europe in the investor and client space. The service provider side generated an urgent need for communication and even more transparency for our clients on asset protection, stability and safety of the provider. Very generally, clients were not relying on ratings any more and required more in-depth information on Tier 1 equity ratio, exposure to sovereign debt and its valuation. At the end, they needed to be reassured on the stability of their provider. On our side, we generated more attraction power through the known stability of the BNP Paribas Group. Finally, the global systemically important financial institutions status elaborated by the Group of 20 nations has given a sort of safety label for the systemic banks that is much appreciated by clients and will be a differentiator for the future. One thing that has changed is the safety argument is here to stay.
Custody Risk: Were clients moving money, making redemptions?
Georg Lasch: Not necessarily. The clients that were most aggressive with this were mainly Asian clients that react quite short term and were really panicked by the movement of Europe. Luxembourg has always been part of Europe and has participated in making it very strong and stable, so it has always benefited from being part of Europe. We have never been questioned and never had to explain that Europe was something positive. Last year, with the sovereign debt crisis, we were hit by this adverse effect of being a part of Europe, and it suddenly created a more negative perception of its stability. People suddenly reflected that change into their view of Luxembourg, which is not the right perception because Luxembourg is very stable. Asian investors have really slowed down their move towards creating Ucits. Although I don’t think they will create an Asian passport, it has kept money from flowing into Ucits. Hopefully it is a more delayed time movement than a structural one. The second area that has put pressure on Europe is the US. So it is mainly from the outside world that we get pressure on Europe – people investing less into the European space and, hence, into funds. We have seen net redemptions, but less heavy redemptions than we would have had in 2008.
Régis Veillet: Within a couple of days, everybody rediscovered the whole concept of counterparty risk, and we had to adapt our speech to something that has always been here but that organisations tended to skip. Some countries stood behind their financial institutions much more aggressively, and were communicating far more than others within Europe in the second part of last year. We need to be careful with this political issue around standing behind your financial industry. Europe shouldn’t forget that the financial industry is important for its economy.
Georg Lasch: Before, we never focused on the domicile as being the real added value. We thought having a Luxembourg fund was good because of what we could do and what we could offer a service provider in Luxembourg. But we have seen other markets in Europe – Ireland and others, for example – suffer from the adverse effects of the crisis when the Chilean pension fund regulator said the counterparty risk, or country risk, of Ireland was too great and too important for pension funds to be able to invest in locally domiciled funds. That was not put into force, but we have seen some countries thinking about not allowing investments in certain other countries because of their sovereign risk. And, while funds are a separate entity to sovereign risk, some have incorporated that entity into the view of the country risk, which we would never have imagined.
Custody Risk: How did Luxembourg fare in 2011?
Camille Thommes: The need to explain the situation in Europe has become increasingly important. At Alfi’s roadshows, questions have come up such as ’how is Europe doing?’ and ‘how will it solve its issues?’. This country risk has an impact on the decision of certain investors to set up a structure in a given jurisdiction.
The financial stability of a country such as Luxembourg has become a selling point. If a country runs into difficulties, this may influence some decisions that could impact the country’s business model. In Luxembourg, we are well advised to ensure that we continue to have sound public finances and that we are not running our public deficits too high. This is particularly true for a small country. Last year, we did reasonably well. Net sales remained on aggregate positive, mainly due to a positive evolution in non-Ucits, especially on specialised investment funds (Sifs). We have seen net outflows in Ucits funds of around €24 billion but we have had positive inflows in non-Ucits products of €28 billion.
We continued to increase the number of funds. Ireland did well on the Ucits side, but a very large portion of net sales of Irish Ucits funds went into a very limited number of money-market funds, promoted by certain institutions. Exchange-traded funds did well in 2011 and attracted inflows into funds of some specific companies based in Ireland.
On the Ucits side, Luxembourg has a much larger exposure in sub-funds investing in equities than Ireland. These funds were particularly hit in the second half of 2011 due to the morose global economic outlook.
Georg Lasch: Luxembourg is still seen within Europe as a very stable financial environment, so it is still attracting a lot of funds. We still have growth in funds, there is no doubt about that. There is still aggregation going on into Luxembourg due to Ucits. It is just the asset level that was strongly hit by the crisis itself. The perception of the location of the Luxembourg domicile and its services is extremely positive across Europe and worldwide. Throughout the crisis, we have seen some products emerging – we have more loan funds, and we have more funds that will probably be driven by the adverse effects of the crisis. So Luxembourg has continued to be innovative within that environment.
Daniela Klasén-Martin: As a niche player, I agree. For us, the crisis has been a little less transparent. We have suffered like everyone else because inflow has been less than usual, but there have still been new funds. We have had demand on the alternative side, which we also cover. So, although the global amount of business has been lower, when you look into the products and demands, they were still there. Overall, for us, it has been balanced. It is important for us that Luxembourg has a triple A rating compared to other European countries. It is important that we have institutions that can explain to clients that they are strong. And we are dependent on that as well. But, in some ways, we are a little less exposed because questions about our balance sheet are less relevant than they are for financial institutions. Our product is not changing because of the size of the fund, it is changing based on the complexity of the fund, and that complexity has always been there. So the impact was, in my view, mitigated for niche players.
Custody Risk: What is your outlook for 2012?
Camille Thommes: It is difficult to predict 2012. We did well, we have seen net inflows so far and the sentiment is positive. But, based on the first two months, it would really be too hazardous to make projections going forward.
Régis Veillet: It is very difficult to forecast 2012, especially for mainstream assets, but we are seeing a lot of activity in the private equity world and other alternative assets. We are seeing a lot of interest in Luxembourg as a domicile, which is seen as a relatively safe place in Europe.
Georg Lasch: In 2012 in Luxembourg, our outlook is stable to slightly positive. In September, we had a more positive outlook than now for 2012, but it is still stable to positive. It is far more positive than the view of our colleagues across Europe so, relatively, we are in a good place. We see aggregation across Europe as benefiting Luxembourg and, although Asia and the US have ‘dried up’ a little more, we see an impressive move from Latin America into Luxembourg, and that is encouraging.
Camille Thommes: Alfi recently travelled to Latin America. There are interesting developments in Brazil, with Brazilian players reflecting on setting up a Ucits product in Luxembourg for cross-border distribution. This move will allow those asset management companies to gain visibility by demonstrating their expertise in managing assets, especially in that region. As the Brazilian economy is doing well, there are still plenty of opportunities locally, but some actors see the benefit in pursuing an international strategy. In addition, local pension funds are permitted to invest part of their money into foreign products and, notably, foreign funds such as Ucits. This is an encouraging development. In Mexico, which is an important local market, we observe promising developments as well.
Custody Risk: Last November, we had the level 2 guidance from Esma on the Alternative Investment Funds Managers (AIFM) Directive. How do you see it shaping the regulation?
Daniela Klasén-Martin: The level 2 advice was a very complete document welcomed by the industry. Luxembourg has an enormous advantage; we stand at an important crossroads where we could make the AIFM brand as strong as Ucits. In Luxembourg, we can take advantage of the strong experience that we have in running, administering and managing regulated funds. The AIFM Directive, in terms of the control requirements, is very broadly inspired by Ucits. We need to combine the expertise on the regulated funds with sector knowledge on the alternative funds. One of the most discussed issues with the AIFM Directive was about the fact that it is regulating everything else that is not Ucits – a very broad definition. You can presumably define private equity or real estate funds, but can you easily define hedge funds and other products like debt, and more? The advantage in Luxembourg is that, in addition to proven expertise in Ucits, we can show the alternative funds expertise. We need to show that we can compete on that ground with other jurisdictions like Dublin, but also offshore jurisdictions such as the Channel Islands.
There are still clarifications needed, for example, around delegation and the role of a management company. The core responsibilities of an AIFM and a Ucits management company are not exactly the same. In an AIFM management company, the core responsibilities are defined as portfolio management and risk management together. At the same time, the directive requires companies to separate these two functions, which are very much linked to each other. This is, in some ways, a contradiction and will constitute a challenge for asset managers. Despite the differences, we believe in a dual management company model to service both Ucits and AIFM. You need to obviously take into consideration the differences between the assets, and have a strong board with specific expertise – for instance, in private equity and real estate combined with Ucits knowledge. In addition, you need to have the same specific asset class expertise within the risk management and fund administration functions. If you delegate functions, then you need to delegate them to a service provider that can clearly differentiate between the servicing of private equity, of a real estate fund, of a hedge fund and of a Ucits fund.
While most service providers in Luxembourg are very well prepared, asset managers – normally coming from other jurisdictions – are completely unprepared. Many of the less regulated structures, such as Société de Participations Financières (Soparfi) in Luxembourg, could be in scope of the AIFM Directive. Coping with the directive could constitute a big challenge for asset managers used to working with such structures.
Régis Veillet: We are at a crossroads. The AIFM Directive presents a big opportunity for Luxembourg to increase its market share in hedge funds servicing. It is not all done yet, but it creates an opportunity. But there is still a lot of uncertainty. So far, Esma has given advice to the European Commission (EC), but we don’t know if it is going to take on that advice; much will depend on this. At Société Générale, we have been explaining to clients for the last 12 months about AIFM and what it would mean to them. At some point, an alignment will need to be done between Ucits and the AIFM Directive, for example, around depository liability.
Custody Risk: Please expand on the issue of depository liability.
Régis Veillet: It doesn’t make sense that, as a custodian and for a certain period, it looks like we are going to have more liability and responsibility for an alternative product than for a Ucits product in terms of asset restitution. As a custodian, we have been involved in AIFM discussions and we strongly believe depository banks should not be transformed into insurers. But we welcome a level playing field in Europe with the same rules for everyone.
And then it is a matter of cost benefit. Perhaps some custodians might decide to exit certain markets because of the increased liability they will have in terms of restitution of assets. For example, country A is politically unstable; the market is not functioning well, but it is growing very fast, so there is a demand from investors to invest in that market. You can imagine that some custodians could say ‘sorry, but we don’t want to be depository for assets in those countries anymore because we have liability and we are just not comfortable with that’. So will investors really benefit in the end? I’m not sure.
Georg Lasch: There is a great opportunity for Luxembourg to position itself on AIFM and create another Ucits brand. At the beginning of the 1980s, no one imagined the success of Ucits today. It is similar now, we are well positioned to take that brand into the wider world. At the same time, there is still plenty to be done in terms of the AIFM Directive around definitions and liability.
Camille Thommes: Esma has come up with its recommendations, which are non-binding to the EC. We are expecting the EC to produce the final implementing measures by June at the latest.
Custody Risk: Is it too late to lobby Esma at this stage?
Camille Thommes: You have to congratulate Esma for its excellent work. With regard to the depository issues, the level of requirements is already very high for alternative products. Some adjustments still have to be made. Notably, reporting requirements remain too cumbersome. There is an opportunity to seize with the AIFM Directive. With some asset classes we are in a challenger position, notably with hedge funds and also in other asset classes we are well positioned. For example, many of the top real estate funds are already based in Luxembourg. We have the firm ambition to make Luxembourg an attractive place to domicile and manage your AIFM fund.
Georg Lasch: Another point is going to be the question of whether some of the fiduciaries will move into the depository space. Maybe we will see banks spinning off depositories for AIFM in order to create a level playing field in case smaller firms are allowed to position themselves as depository.
Daniela Klasén-Martin: Perhaps we need to work the space and we will have more specialist providers. It is true that we have an alternative funds industry in Luxembourg, but there is still room for development. When you think about the composition of the board, that is where we will need more and more experts on the specific assets. When the board takes the responsibility of the investment management side, which you would eventually have as an AIFM or even as you have today with a Sif, then you need to have people that can understand the underlying investment and make informed decisions.
Georg Lasch: All in all, the client is still fairly ignorant. They know about the AIFM Directive, they know the headlines, but you mentioned hedge funds and private equity. Some of the specialised alternatives managers focus on AIFM, but there is a huge amount of education required. There is a gap in the funds or management companies impacted by AIFM. There is a part – the specialist alternatives part – that has that on its radar and is focusing on its implementation. But there are many clients that have structures that are not considered as pure alternatives that would fall under the directive. We need to educate them quickly to meet the 2013 deadline.