Luxembourg ventures beyond the back office

The Grand Duchy of Luxembourg, famous for several decades as Europe’s back office for reconciling investment trades and carrying out custody for asset managers, has entered a period of contemplation. Should the tiny landlocked country now be recalibrating its financial centre and trying to attract investment expertise?

At the headquarters of Alfi — the association representing more than 1,500 funds, the investment managers which run them and the third-party firms which serve the sector — there are signs that change is slowly stirring.

“Luxembourg is experiencing a shift from ‘doers’ in execution-focused roles, to ‘thinkers’ in higher value-added functions,” attracting more strategic, analytical, and decision-making capabilities, suggests Brita Borneff, Alfi’s business development director, describing “structural and regulatory forces” that have accelerated the transition.

These include increased complexity of financial products, implementation of the Alternative Investment Fund Managers Directive (AIFMD), the rise of automation and the ongoing digital transformation trend.

“In the wake of Brexit, a few family offices have relocated to Luxembourg,” she adds, drawn in by proximity to EU markets and advantages of a definitive rulebook, laid down in the law on family offices, passed at the end of 2012.

But the view from the country’s key practitioners and commentators is more nuanced, with some advocating for faster transformation. One recent arrival from London, Bertrand Coste, who manages a €1.2bn ($1.4bn) portfolio through his Clerville Investment Management franchise, mainly for the Schlumberger oil exploration dynasty, has become a leading agitator.

Beautiful platforms

“Luxembourg has a very conflicted view of the world, which is strange and hard to understand,” says Mr Coste, an innovative asset manager who dabbled in running long-only money, private equity and hedge funds, before settling on his specialisation of structured credit, encompassing asset-backed lending.

The country, he says, hosts “a beautiful and very efficient admin platform” for the investment industry, overseen by banks, accountants, performance analysts and middle management. But success has been limited, he believes, due to a reluctance to recruit top portfolio managers and analysts in the funds industry, preferring to stick to administrative tasks.

“They are not clear in their minds what they want to do about the very top people in family offices,” believes Mr Coste, who left London due to shrinking of the UK economy after Brexit and lack of government investment in infrastructure.

“They do not offer the higher level of salaries to attract the most experienced people,” he suggests, adding that Luxembourg can also add a broader range of private banking products to its investment menu, including Anglo-Saxon-style Trusts to augment European life insurance wrappers, which have proved popular among high net worth clients.

He is not alone in moving his operations, business and family to Luxembourg. Local practitioners talk about “20 billionaire families” which have recently arrived. Industry leaders have noticed a change among clients seeking a “safe harbour” from recent geopolitical turmoil.

“In the last couple of years, people are no longer arriving just with their assets,” says Max Kremer, partner in the private client practice at leading local law firm Arendt & Medernach. “They are actually relocating here with their families. They are buying real estate. They establish their physical family offices with people on the ground.”

Specialist arrivals

This gradual inflow of wealthy clients is encouraging banks and investment companies to increase specialist staff numbers, says Mr Kremer. “JP Morgan has relocated quite a number of private bankers from London to Luxembourg,” he adds.

“There has been tremendous development for Luxembourg in private banking. The quality has improved a lot during the last couple of years. While Switzerland is still the number one international booking centre, people also want to diversify their assets.”

Particularly notable has been the surge in Latin American private clients booking their assets through Luxembourg, accounting for up to 8 per cent of assets at some private banks. After the 2016 election of Donald Trump for his first presidential term, these clients, who typically booked assets through Miami and Geneva, added Luxembourg to their roster.

“They realised the US would no longer be as stable as they were thinking,” says Alexandre Gobert, a private client lawyer in the Arendt team.

“Latam clients do not come to us for tech structuring or succession planning,” says Mr Gobert, who witnessed an “incredible flow” from Chile and Peru during their presidential elections. “It is only for asset protection, as in their countries, you have a tendency to socialism, with risk of expropriation, of limits to the free circulation of capital.”

Yet across the board, it is the private assets which are attracting much attention from family offices. “We have a lot of clients that want to co-invest in private equity funds,” says Mr Gobert. “Every week we are receiving requests from families who want to set up their own fund.”

Luxembourg law firms can offer them a “very vast toolbox of solutions”, of corporate and non-corporate fund structures for all tastes, with varying degrees of transparency.

Private numbers

Revel Wood, a veteran financial services operator in Luxembourg and board director of Global Asset Management Solutions, admits that historically, the “ecosystem” was not well established enough to attract family offices.

“However, since Brexit there has been a significant inflow of family offices, and as a result, development of skills leveraging the strong foundation of private banking and wealth management that has existed in Luxembourg for decades,” says Mr Wood.

He points to a raft of changes since 2016, including “a significant rise in private capital structures”, leading Luxembourg to become the “world leader in expertise for private capital”.

Traditional custody banks, such as leading US player State Street, admit that it will be difficult to break old patterns of business. “This is Luxembourg,” says Riccardo Lamanna, the bank’s country head. “It is not the place where management companies are taking the bulk of their investment decisions. Those are taken where the head offices of the various asset managers are. Here we have a modern operational management company type of activity. Alpha is more for other countries.”

Yet he sees untapped potential on his doorstep. “If you’re a family office and you’ve been sitting in London, and you don’t like what’s happening with Brexit and the non-dom regimes, you may be looking at Spain, Portugal or Italy,” suggests Mr Lamanna.

“And then you see Luxembourg, our expertise in private markets, and you think, ‘If I want to set up a special purpose vehicle, all of the infrastructure is here.’ This is what Luxembourg can give to its clients.”

Ever since he arrived here from New York, 18 years ago, Mike Delano, asset and wealth management leader at consultancy PwC, has seen the country trying to attract “people in higher positions in portfolio management”, but often in vain. 

“It’s very hard to compete with the likes of Paris, London or even Frankfurt,” he admits, telling colleagues in the community not to get carried away. “I can’t say we’re going to be the next New York,” laughs Mr Delano. “But Luxembourg is slowly moving away from the back-office mentality, now that we’re offshoring some work to other jurisdictions, just from a struggle to find talented people to work here.”

Like other leading players, it is the alternative assets which he identifies as having the greatest value to clients. “Some of the largest growing asset classes that I have through my clients are private credit infrastructure and real estate,” says Mr Delano, with private equity funds having operated here since the passing of the AIFM Directive for alternative investments in 2010.

Double-edged sword

What the authorities will do next, to build on this expertise, could be crucial for Luxembourg’s future. “Political will remains the key challenge for Luxembourg,” says David Ryder, a former communications boss at Lloyds Bank, who now runs an independent consultancy in the Grand Duchy. He contrasts Luxembourg’s potential with that of Hong Kong, another leading financial centre where he once lived.

Prior to the Beijing handover in 1997, the Hong Kong Legislative Council was dominated by a pro-business cohort of electors, “which largely worked well with the phenomenal Cantonese work ethic and entrepreneurialism”, despite a lack of social welfare benefits and state pensions.

“As a result, Hong Kong had a pro-business, low-tax environment that enabled it to make the most of its position as a gateway to China and an Asian hub, while providing little if any safety net for the disenfranchised in society,” says Mr Ryder.

The Luxembourg electorate, by contrast, is dominated by local public sector workers, receiving high salaries and generous social welfare benefits and pension provision. Tax revenues, on the other hand come largely from the private sector, which employs mainly foreign workers in the booming financial services industry. This means that “business-friendly” reforms from veteran Prime Minister Luc Frieden can be scotched by public demonstrations of dissent.

“As cross-border financial centres go, Luxembourg has some massive advantages. It is in the metaphorical and physical heart of a massive economic bloc. It has a highly educated, multi-lingual workforce that can handle the multitude of cultures, laws and languages,” says Mr Ryder. “But its political dichotomy means that it can lack the responsiveness of rival financial centres like Dublin. This might have contributed to Ireland’s relative success in ETFs. Luxembourg needs to be wary of this happening with alternative investment funds and ESG-related solutions.”

Being the best at back office and compliance tasks can be a “double-edged sword”, admits Henning Swabey, chief commercial officer at Governance.com, a data management platform provider for fund servicing companies. 

 “Some global institutions can look at Luxembourg as a cost centre and a ‘computer says no’ domicile where it comes to compliance,” he believes. “Back-office offshoring, efforts at digitalisation and regulatory change have also enabled many higher value roles to be based overseas.”

The government is starting to tackle these issues by incentivising expatriates to settle, reviewing tax incentives and enhancing a share option scheme for start-ups. “These policies can help attract talent as well as capital,” he believes.

Commentators believe the opportunity is ripe for the taking, especially as established centres including Switzerland are struggling with scandals and compliance issues. “Do they want to become a leading offshore platform like Dubai or Switzerland, bringing in the top guns?” Asks Mr Coste. “They don’t know yet if they are serious. It is a beautiful territory, but it needs a bit of a wake-up call.”