The Luxembourg alternative investments industry goes from strength to strength, with regulated and unregulated AIF assets under management exceeding €1.5trn as of last September. Growth also brings challenges in terms of adaptation to scale, compliance and efficiency, both for asset managers and for the service providers that make up the ecosystem underpinning the sector's expansion.
Many of the issues have been familiar for some time. Now more than ever, recruiting and retaining skilled staff is vital but increasingly challenging, compounded by Luxembourg's well-known high cost of housing and the surge in inflation over the past year. Meanwhile, the industry's growth is bringing new demand for outsourced services. With around 47% of Luxembourg real estate investment funds overseeing assets of less than €100m, according to a survey by ALFI last September, more specialist funds are turning to third-party providers for operational assistance.
To counterbalance the challenges of recruitment in Luxembourg, service providers are increasingly looking to use resources abroad to complement their local teams, improving the industry’s ability to absorb its ongoing asset growth. There is also continuing room for improvement of operational efficiency in the alternative assets industry, as digitalisation and enhanced automation of routine tasks replace manual processes and improve the overall quality of service provided.
Valuing private market assets
Participants in the alternative investment sector are also grappling with the variable liquidity and hard-to-value nature of private market assets, particularly when markets are stressed - a repeated issue over the past three years. Recent issues have included the spill-over effect from widespread market disruption at the onset of the Covid-19 pandemic, as well as the implications for commercial real estate assets and their rental yield stemming from the seemingly permanent shift to working from home: up from 5% of paid working time in the US to 27% in January, and probably more in some European countries.
While the real estate fund sector appeared resilient last year, ALFI cautioned that companies should be wary of drawing rigid conclusions at a time when ongoing geopolitical uncertainty appears greater than at any point in recent decades. Outsourcing offers asset managers flexibility but also requires open and regular communication with fund teams and other in-house staff to deal with unexpected issues as they arise.
Bank account opening still a frustration
Some operational issues are persistent – like difficulties in opening bank accounts, an essential step in the operation of any alternative fund or SPV. L3A members continue to report that banks in Luxembourg have become increasingly cautious about taking on new customers and have longer lead times for opening new accounts.
Although the AIFMD permits bank accounts to be opened with third-country EU or non-EU banks, maintaining substance in Luxembourg is a key focus of international fund promoters. L3A believes this should have the full support of Luxembourg’s banking sector, and its members are keen to work more closely with institutions to facilitate more efficient access to bank accounts in the grand duchy.
In this regard, our Bank Account Opening Working Group has brought together asset managers, fund administrators, banks and other stakeholders in an attempt to resolve the issue. A core element of its charter is to ensure administrators uphold the highest standards. All our members are committed to providing the full range of required supporting documentation, from evidence of source of funds to FATCA self-certification, to help smooth the account opening process.
Dealing with new regulation
The alternative fund sector continues to face fresh burdens arising from changes to its regulatory framework, including the impending revision of the AIFMD. There is also the European Commission’s proposed third Anti-Tax Avoidance Directive, dubbed 'Unshell' because it targets entities with minimal or no substance for tax purposes, and which requires unanimous approval from member states to be adopted. In January this year, the European Parliament proposed amendments under which the legislation would apply to EU-domiciled entities that derive more than 65% of their income from passive sources, such as interest, royalties and dividends, and whose day-to-day management and decision-taking is outsourced.
The rules incorporate carve-outs for regulated entities, including UCITS and AIFs, but fund clients or outsourcing providers may face complications with the use of holding companies, special purpose vehicles and other unregulated intermediary structures. Should the Parliament’s amendments be adopted by the EU Council, ATAD III could come into force at the beginning of 2024, but applicable retrospectively from January 2022.
Democratisation of alternative investment
A key operational challenge for the alternatives sector will arise rather sooner, with the revision of the European Long-Term Investment Fund regime expected to start application around the end of this year. It is intended to open up alternative strategies to HNWI, mass affluent individuals and even retail investors, and will require the sector to conduct investor due diligence on a scale hitherto unknown in the alternatives sector, as well as ongoing investor relations management functions.
While the changes are intended to increase significant inflows into long-term investments, if successful, they will present major challenges to service providers, especially transfer agents and providers of central administration. However, it helps that many of the same providers already deal with investor bases measured in tens of thousands, in multiple languages and jurisdictions, for UCITS funds - something other jurisdictions will struggle to match.