The investment fund sectors in London and Luxembourg are successfully maintaining what Chris Cummings, CEO of the UK’s Investment Association, describes as “the foundational relationship for our industry”, delegates heard at ALFI’s London Conference, held in the heart of the City on October 12.
But speakers also warned that a stable regulatory environment is essential to the health of the European cross-border fund industry that has grown up over more than three decades.
Certainly the outlook is complicated by increasing political, economic and financial turbulence, not least within the United Kingdom itself, as London-based speakers acknowledged. They urged the authorities to ensure that the government’s plans to replace or revise legislation adopted by Britain during its membership of the European Union do not jeopardise the ability of EU-domiciled funds to delegate portfolio management or other key functions to entities outside the Union – which includes the UK since the ending of its transition period in early 2021.
While Brexit has shaken up some of the fundamental features of Luxembourg’s fund industry, it is far from the only dislocating factor over the past two years, noted ALFI chairperson Corinne Lamesch. “We came out of the pandemic a year ago but since then, new crises have increased investor uncertainty,” she told delegates in her address opening the conference. “Both in Luxembourg and across Europe, funds have experienced net redemptions this year. Investors are sitting on idle cash, even though they are losing money.”
The current environment has posed new challenges to the fund industry, not least the enforcement of economic sanctions in addition to meeting the huge demand for sustainable investment products, many of which continue to enjoy net inflows, Ms Lamesch said. “Since August, intermediaries have had the very difficult task of asking clients about their sustainability preferences; now funds have an end-October deadline to update their prospectuses under the Sustainable Finance Disclosure Regulation.”
Mr Cummings notes that the UK asset management industry must cope with its own set of which, unlike those in the EU, entail a labelling system – which the SFDR is not, or at least not intended to be – but do not incorporate a green taxonomy. “Disclosure rules are still incomplete but firms are required to demonstrate their best efforts,” he said. “It’s about positioning the industry to do the right thing.”
Otherwise engaged presenting the grand duchy’s budget legislation for 2023, Luxembourg’s finance minister, Yuriko Backes, was unable to be physically present in London. Yet, in her video address to delegates she underlined the government’s recognition of the industry’s importance both economically and in the sustainability transition. “The fund industry is the most international and globalised in the EU,” Ms Backes said. “Sustainable fund inflows grew by 70% in 2021 while green bond issuance doubled from 2020, which was already a record.”
The challenges, including those relating to Brexit, also apply to financial regulators. “Life was so much simpler when the UK was part of Europe, but we are where we are,” said Mhairi Jackson, manager for funds and investment management policy at Britain’s Financial Conduct Authority. However, the UK is still open to EU and other foreign funds with the planned Overseas Funds Regime now introduced to replace EU single market passporting arrangements and due to be fully operational by December 2025.
CSSF Director, Marco Zwick, noted that Luxembourg had granted the UK regulatory equivalence status under the MiFID/MiFIR regime as early as 2020. And even if the European Commission were to make a different assessment, the current arrangements would remain in place for at least three further years. But he cautioned: “The rules are not set in stone – there could be a review in the event of a substantial change in legislation.”
The regulators in both countries are examining the role that long-term assets could or should play in investment in their respective jurisdictions for institutions such as pension schemes, but also for retail investors. The UK has just concluded a consultation on its LTAF proposal to allow retail access to illiquid assets, Ms Jackson notes, adding that investment could be restricted to a 10% ceiling for customers not receiving professional advice.
Relations between Luxembourg and the UK were the focus of a discussion between Nicolas Mackel, CEO of industry promotion body Luxembourg for Finance, and Emma Reynolds, managing director at LFF’s counterpart TheCityUK. Ms Reynolds is hopeful that the regulatory-reform proposals currently before parliament “will update legacy EU law in line with the characteristics of the UK market, but there will be no race to the bottom. We would like regulation to be tailored and proportionate, and for evolution not to diverge [from EU rules] but to remain parallel.”
Mr Mackel said professionals in the two jurisdictions would benefit from “putting behind us the acidity of the past six years and the trading of soundbites”, arguing that often the EU had more problems with UK rhetoric than its actions. He added: “We need to make progress to restore trust in order to become partners again.”
In the meantime, investment management executives are grappling with issues ranging from the industry’s constant search for talent to cyber-security issues – including emerging risks such as attacks on power infrastructure. Aviva Investors Asset Management CEO, Mark Versey, summarised a critical factor: “Costs are going up, but revenue is not. Indeed, it may be shrinking.” Meanwhile companies are rethinking their human resources strategies to attract younger people, and also other members of the workforce, such as offering term-time contracts aimed at women with children.
All this is happening against a threatening macroeconomic backdrop, noted Wei Li, global chief investment strategist for BlackRock: “The great moderation is coming to an end, and we are facing greater turbulence and tougher trade-offs. What is happening is a regime change – there will be no return to the previous status quo. Structural tailwinds that have boosted global production capacity are coming to an end, and globalisation may be going into reverse.”
Cambridge University professor of political economy, Helen Thompson, painted an even starker picture of Europe’s vulnerability to long-term energy market trends that long preceded war in Ukraine and that leave the continent with few good options to compensate for a cut-off of fossil fuel supplies from Russia. No more oil will come in the short to medium term from US shale deposits, which eased supply constraints over the past decade, and Europe now finds itself challenged to outbid (often poorer) Asian countries for finite quantities of natural gas.
“The eurozone’s energy problem is becoming a trade imbalance problem, especially with the weakening of the euro against the US dollar since 2021,” said Ms Thompson. “Oil supply is now constraining European growth. The situation is worse than in the 1970s because demand from Asia is now much more important. It’s now not clear how future demand growth can be met – although it could have been from Russia.”
Since Brexit, UK asset managers have seen their sales distribution options in Europe significantly complicated, noted Christian Hertz, head of Luxembourg management company Sanne LIS. They face a choice of setting up their own onshore MiFID regulated entity, appointing an EU placement agent, entrusting marketing to their AIFM, or self-marketing by the fund’s representatives – generally board members.
While none of these options is perfect, Mr Hertz argued that “it is an illusion to imagine that you can carry on in the same way as before. Marketing and compliance people must work out a solution.”
Nancy Saich, chief climate change adviser at the European Investment Bank, told delegates that the current decade is critical – and the contribution of the global investment industry in it – if greenhouse gas emissions are to be reduced by more than 50% to meet the 2050 target of keeping global warming to less than 1.5ºC. “The need for a transition is urgent – how close to the edge of the cliff are we?”
Kate Levick, associate director for sustainable finance at think-tank E3G, said: “We need to pivot from voluntary action to regulation. It will happen first in Europe, but it’s a global trend toward transformation of the entire economic system.” She added that a critical point was not to punish entities for their starting point, which might be as a large carbon emitter, but to encourage them to undertake the transition: “What’s important is where you finish up.”
The conference concluded by examining opportunities for the ‘democratisation’ of private assets to enable non-professional investors to enjoy the same benefits of diversification, alternative revenue streams and anti-inflation properties long enjoyed by institutions. Speakers such as Vistra Luxembourg country manager, Jervis Smith, emphasised the importance of education to ensure that retail customers understand the trade-off in terms of liquidity.
Elvinger Hoss Prussen partner, Joachim Cour, noted that halfway solutions include soft lock-ups or soft gates, while AllianzBernstein senior vice-president, Silvio Cruz, pointed to available vehicles such as real estate investment trusts. “Luxembourg Part II funds have existed for a while, and European long-term investment funds also offer a solution given the right mix of liquidity and long-term positioning,” said Cruz.