Ernst & Young has launched the 2010 edition of its Islamic Funds and Investments Report (IFIR) 2010 with a seminar in Luxembourg.  The conclusions of the report indicate that the industry must go back to the drawing board if it hopes to create economies of scale in Europe.  The key messages are that:

• the Islamic fund industry needs to evaluate new strategies to re-stimulate growth: AUM in 2009 remained flat, and new fund launches were matched by fund closures, during a period that saw the potential wealth pool grow by 20%;
• achieving scale is even more critical to ensure long term sustainability: over 70% of fund managers fall below an estimated break-even point of 80-100m USD under management; 
• introducing flexible business models could help in adapting to investors’ changing preferences: leading fund managers are actively seeking to optimise operational flexibility and market reach in terms of fee structures, geographical distribution and product offerings;
• the immediate priority is to rebuild investor trust. This includes transparency in cost and revenue structure.

The good news is that annual management fees have come under the same pressure as conventional funds, falling steadily since 2006 to average 1.15% in Q1 2010. However, the non-viable size of most asset managers is likely to lead to consolidation in the market – and more fund closures.

The Cayman Islands leads non-Islamic markets in terms of AUM, due to its historic ties with the alternative investment fund market and the fact that many Islamic investors are not used to paying tax.  However, here again a trend in the conventional market is reflected in the Islamic finance area: there is migration of funds to an on-shore, regulated domicile.  Luxembourg has picked up a lot of this business.

The two markets with serious AUM are Saudi Arabia and Malaysia, both of which have successfully tapped into the retail market.  “The other markets lack asset gathering capability” confirmed Mark Smyth of Amanie Islamic Finance Consultancy and Education, speaking as a member of the discussion panel. The implication is that this market will not achieve critical size until and unless, either, major European retail banks start to sell investment products, or, institutional investors appear in the form of private banks or takaful operators (similar to life assurance savings schemes).

The global sukuk (Islamic bond) market has been very quiet since 2009 but is picking up. The relationship between institutional investors and the sukuk market is close: takaful companies and wealth managers need liquidity in the sukuk market, and their activity would stimulate more issues.

Looking at the opportunities for Luxembourg, Elie Flatter of the Luxembourg Central Bank stated that the option of a Luxembourg sovereign sukuk issue was “still under consideration”.  In this context, an interesting comment was made concerning the regional sukuk issued by Germany’s Sachsen-Anhalt: the issue was “expensive” and “complicated to manage”.  However, it had paid huge dividends in PR terms, resulting in closer business relations with GEC countries. 

Islamic finance business in Luxembourg is picking up again, as witnessed by a show of hands from delegates present at the seminar.  Speakers noted two areas in which Luxembourg could leverage a natural advantage. One is expertise and reputation in product distribution; that is, access to the mass affluent market through cross-border marketing and to HNWI through private banks: wealth managers do not lightly select a Gulf based investment fund for their clients.  Another interesting suggestion was that Luxembourg focus more on the shariah compliant trust structure, the Awqaf. ER

Download the E&Y Islamic Funds and Investments Report (IFIR) 2010  

In this issue:

• Luxembourg reaches out to sophisticated UCITS
• US, Luxembourg, Australia and France lead in mutual fund assets
• Luxembourg to help Russia develop as a financial centre
• and more

Download the latest version here. Enjoy reading!

Find previous versions of our MediaWatch here.

With the implementation of Luxembourg’s Securitisation Act of 2004, Luxembourg has become an attractive jurisdiction for structured vehicles. Can you give us some reasons?

It is true that with the implementation of the Luxembourg act of 22 March 2004 on securitisation, as amended (the Securitisation Act 2004), Luxembourg has become an attractive jurisdiction for structured finance and securitisation vehicles.

The Luxembourg legislator has created a modern framework offering significant investor protection, a high level of legal certainty for all parties involved in the securitisation transaction, as well as great flexibility. The Securitisation Act 2004 provides originators with a modern, tax-efficient way to obtain new financing.

The restrictive view of the regulator has been relaxed regarding securitisation of commodities. What does the CSSF’s new approach look like?

Until now the securitisation of commodities has been considered by the CSSF as permissible only in very limited circumstances. The CSSF has approved structures under which a securitisation undertaking acquires commodities with a view to providing financing to a third party and where the acquired commodity serves as a guarantee for the repayment of the funds made available to that third party.

Structures where a commodity serves as an underlying asset (rather than as a guarantee) were rejected by the CSSF as they were categorised as pure investment structures and not securitisations in the sense of the Securitisation Act 2004[1].

This restrictive approach has now been considerably relaxed: the CSSF now accepts structures where a securitisation vehicle issues securities and uses the issue proceeds to purchase commodities, the performance of which will determine the return generated by the securities.

It must however be ensured that:

• the structure does not amount to a commercial activity requiring a business licence under the Luxembourg act of 28 December 1988 relating to establishment of certain businesses and business licences, as amended; and

• the structure does not give rise to further risk for the securitisation undertaking, in addition to the risk inherent to the securitised commodity.

As a general comment in relation to the above, it should be noted that the CSSF is only competent to express views on transactions carried out by securitisation vehicles falling under its supervision (that is, regulated securitisation undertakings, as specified in the Securitisation Act 2004).

However, the Luxembourg tax administration tends to apply the guidelines and criteria set out by the CSSF to all securitisation vehicles (whether or not they are subject to CSSF supervision) in order to ensure that transactions carried out by such vehicles constitute securitisation transactions within the meaning of the Securitisation Act 2004, which benefit from the very favourable tax regime provided by the Securitisation Act 2004.

In other words, non-compliance by securitisation vehicles with CSSF guidelines exposes securitisation vehicles to the risk of losing the favourable tax regime of the Securitisation Act 2004.

Was this approach influenced by practical or political considerations?

Undeniably, there is strong appetite for the type of securitisation transactions involving commodities which will be facilitated further to this change of position (and which were already allowed in other jurisdictions). Hence, the CSSF's move can be seen as a means to ensure that Luxembourg preserves its attractiveness in the field of securitisation and gets its share of the market for this type of products.

Can we say that this change of approach opens a whole new market for issuers?

This new CSSF position opens a whole new market for issuers subject to the Securitisation Act 2004. It provides originators of commodities with an interesting alternative for obtaining financing. New opportunities arising out of this change in position will strengthen the position of Luxembourg as a European hub for securitisation transactions.

Is Luxembourg already a European hub for securitisation vehicles?

Since the entry into force of the Securitisation Act 2004 (but even before that act), Luxembourg has clearly developed as a dominant platform for international securitisation transactions.

If so, what are its main competitors?

A number of European countries have implemented their own securitisation regimes. Next to France's recent new regime for fonds communs de titrisation, the main European competitors are often considered to be the Netherlands and Ireland. Without entering into a detailed analysis of the different regimes, one can say that the Luxembourg framework bears a number of advantages compared to these jurisdictions.

What makes securitisation vehicles attractive?

The popularity of securitisation undertakings derives from the favourable legal and tax regime to which they are subject. In summary, the most notable benefits are:

(i)            the possibility of creating ring-fenced compartments to which all the rights of investors in a particular series of securities may be allocated: each compartment forms an independent, separate and distinct part of the securitisation undertaking's estate and is segregated from any other compartments of the securitisation undertaking. Investors will only have recourse to the assets comprised in the compartment to which the securities they hold have been allocated;

(ii)           the Securitisation Act 2004 expressly recognises the validity of non-petition, limited recourse and subordination clauses. Any proceedings instituted in breach of this will be declared inadmissible;

(iii) the range of assets that may be securitised is extremely broad: in essence, the Securitisation Act 2004 allows for almost any asset producing a regular flow of income or any risk to be securitised. This includes risks relating to tangible (movable or immovable) assets and synthetic transactions. There is no risk-diversification requirement and no requirement as to the homogeneity of the assets to be securitised;

(iv) the favourable tax regime of securitisation undertakings which are subject to the Securitisation Act 2004: A securitisation vehicle is a fully taxable company. There is no requirement that it makes a minimum profit. All payments made by the securitisation vehicle in respect of issued securities (be they debt securities or equity securities) are fully tax-deductible expenses for the securitisation vehicle. Securitisation vehicles benefit from the wide network of tax treaties entered into by Luxembourg.

Did securitisation transactions suffer from a bad press due to the financial crisis?

Clearly, the concept of "securitisation" itself has suffered from bad press in the course of the recent financial crisis. One should however not limit the concept of securitisation to the repackaging of US mortgage loans. The scope of what can be done by way of securitisation is considerable.

Investor protection and investor information should be of paramount importance in this field. Needless to say that Luxembourg has implemented relevant EU directives aimed to ensure adequate investor information. Investor protection is also one of the key drivers of the Securitisation Act 2004. CW

Investment Company Institute, the national association of U.S. investment companies, says, “Mutual fund assets worldwide increased 0.58% to $23.015 trillion at the end of the first quarter of 2010. In total, worldwide mutual funds had $103.6 billion in net outflows in the first quarter, compared to $77 billion in net inflows in the fourth quarter of 2009.

The Worldwide Flows report shows that the U.S. accounts for 48.7% of all assets with $2.984 trillion. France ranks third with 7.5% ($1727 billion), Ireland comes in fourth place with 3.84% ($885 billion) and Luxembourg ranks second with 10% ($2321 billion).

The number of mutual funds worldwide stood at 65,971 at the end of the first quarter of 2010. By type of fund, 39 percent were equity funds, 23 percent were balanced/mixed funds, 19 percent were bond funds, and 5 percent were money market funds.

By region, 55 percent of worldwide assets were in the Americas in the first quarter of 2010, 32 percent were in Europe, and 12.5% in Africa and the Asia and Pacific region.

www.ici.org/research/stats/worldwide/ww_03_10

Christophe Lentschat, the Managing Director of Apex Fund Services and Fèmy Mouftaou Director of Operations are very motivated by the opening of the local office. Christophe Lentschat says that Luxembourg fund vehicles are widely known and sought after by the world’s institutional investors. So there was a real need to open shop in the heart of Europe.

"Our clients tell us that Luxembourg is the best-known international quality label when it comes to investment funds. If you want to do international fund distribution, you don’t usually go to more domestic domiciles such as France or Germany”.

Our Investment Manager clients have the choice between three international fund centres in Europe: Malta, Ireland and now Luxembourg. “For the time being if you are very focused on costs and time, you go to Malta. If you are into hedge funds, you traditionally choose Dublin.

But if you target continental Europe or Asia and the Middle East, you’re likely to want to launch your fund in Luxembourg and this is now true for an increasingly large spectrum of products including alternative investments”.

According to Fèmy Mouftaou, the choice of Luxembourg is not only related to the European passport but also involves a psychological product acceptance dimension. An investment fund domiciled in Luxembourg is perceived as a well regulated, quality product.

The Director for Operations of Apex Fund Services comes up with a typical example of a client launching a Luxembourg domiciled vehicle. “You have a fund manager from Saudi Arabia, India or China with a local product or one from the Cayman Islands.

This investment manager, who has got solid expertise and a convincing track record, argues that he can do better than a big European or North American asset managers for investments in its own region. These people want to sell their expertise worldwide. So for them it is logical that they choose Luxembourg as a fund domicile”.

With over 12 billion dollars of assets under administration, Apex services its clients through 15 offices across the globe. Its client base consists of hedge fund, long only and private equity managers.

Christophe Lentschat says that the story of Apex began in 2003 with hedge funds for the American market. Europe and the Middle East was the next step of the adventure. Apex opened up offices in Dubai and Bahrain, and then Asia was on the map with locations in Singapore and Hong Kong.

“One day, the Apex managers realized that part of their clients with focus on emerging markets asked for Luxembourg domiciled funds, for plenty of reasons. Today, it has become harder and harder to sell offshore funds in Europe.

This means that funds are re-domiciled or a second product is launched. What I tell you is no wishful thinking; there are a lot of questions from our customers about the benefits of Luxembourg funds.”

In addition to offering services for all types of public and private Luxembourg funds, the Luxembourg office has also been appointed as fund administrator for three fund platforms that provide fast and cost effective methods for establishing Luxembourg SICAV funds.

These include a platform for the set up of UCITS compliant funds, a solution for a Luxembourg Shariah compliant fund and a platform for the re-domiciliation of offshore non-UCITS vehicles.

Christophe Lentschat underlines that Apex clients are not interested in fiscal engineering. The company is specialised in the administration of regulated funds. Besides, the managing director of Apex Luxembourg adds that he has never had a client asking him about banking secrecy. CW

www.apexfundservices.com

Among the five areas analysed, quality of life is the one where Luxembourg scores best (ranked 3rd), followed by health and political environment (7th place). Luxembourg ranks 9th in terms of economic dynamism. The only area where Luxembourg is far behind (29) is education.

None of the 100 countries under review has managed to rank first in more than one of the five areas analysed. According to the study, Finland offers the best educational system, Japan the best health system, Norway the highest quality of life and Sweden the best political environment, while Singapore is the country with the most dynamic economy.

The LSF has a lot to offer. The School’s latest promising initiative was setting up a course on Islamic Finance, a field in which the Luxembourg financial centre has already made a mark. The eight-day intensive course will be taught in Luxembourg by professors of the Malaysian University INCEIF (http://www.inceif.org/), which specialises in Islamic Finance. To start with, a class of 30 students is targeted.  If the module prooves a success, a full masters programme in Islamic Finance will be considered seriously.

Playing with the big boys

Another course that will be taught in part at the LSF and which will be monitored worldwide is a module of the “Dual Degree Executive MBA in Asset and Wealth Management”, developed by the Carnegie Mellon University Pittsburgh and the Swiss Finance Institute. By undertaking to offer the module on investment funds and fund administration, the LSF acts as a junior partner alongside the two universities. “Once they get it to fly, it will be the leading programme in the world”, Wolff says, since no one else offers a similar programme. The Luxembourg module will start in 2012.

These two programmes will increase the awareness of Luxembourg in the general world of asset management. “We put Luxembourg right under their noses”. As if this wasn’t enough, the LSF “Master of Banking and Finance” programme, which is offered both in a full time and part time versions, is also of world class quality. With a tuition fee of 17,500 € and an estimated market value of 38,000 – 40,000 €, Luxembourg offers a really competitive programme not only price-wise, but also on the qualitative side. During the next two years, Wolff aims to increase the student base from an average of 20 to to up 30 students per class. Having their programme in the Financial Times listing of finance master programmes and advertising in the respected Economist magazine are important steps in the right direction.

In the medium term, Christian Wolff also hopes to split the classes of the full time programme into two, which would allow for more specialisation. Students will finish the programme with a regular masters title. The part time version, which attracts more people from the region, could then end up as an executive masters degree, providing more of an overview and focusing more on managerial aspects.

Brain gain

The effort is worth it. Part time students, who primarily come from the Greater Region, tend to stay on in Luxembourg anyway, but students of the full time programme also appreciate the advantages of the financial centre. Graduates from Brazil, Mongolia, the US and Singapore decide to begin their career here as a result of their studies in Luxembourg. “People like Luxembourg”, Wolff says. The attractiveness of the financial centre is complemented by the neutrality of the country (something that is particularly appreciated by potential Islamic finance clients), its flexible legal structures, its efficient organisation and its professional industry standards.

These are important assets, from which the LSF also benefits, in particular the community ties in Luxembourg: “The ties between the financial world and the LSF are quite close without being too close”, Wolff remarks. Although the ambition of the LSF needs to remain an academic one “with the keen desire to be relevant”, Wolff appreciates the straightforwardness of the key financial players.

To work and to contribute

This was one of the virtues, which personally made it easier for him to start his position as the Director of the LSF in 2008: “I was on a first name basis with many key people from the financial sector a few weeks after arriving in Luxembourg”.

“I am the kind of person who likes to build things”, Wolff admits. He is convinced that the LSF has incredible potential. “In eight to ten years you will find something really worthwhile here in the sense of it being one of the better departments in Europe with a lot of relevance and a lot of links”. An aggressive recruitment strategy is pushing the LSF forward in the league of world class financial educational establishments.  Although the much higher salaries of US professors – compared to Europe - can make it difficult to convince academics to come to Luxembourg, Wolff is working ambitiously on this issue. “Good professors like to teach about stuff they think about and what they’re best at”. And they can do this at the LSF. A widely developed research activity is one of the assets the department has to offer. “If you try only to be on the teaching side, it is going to be an empty shell in the end”. With its unique programmes and its relevant research activities, this will certainly not be the case for the LSF. EK

Luxembourg School of Finance:

www.lsf.lu

Financial Times Business School ranking:

http://rankings.ft.com/businessschoolrankings/luxembourg-school-of-finance/masters-in-finance#masters-in-finance

Dual Degree Executive MBA in Asset and Wealth Management

www.swissfinanceinstitute.ch/awemba.htm

We are still far from a single market in this area.  The time limitation and reclaim process on withholding tax varies from country to country and there is no common rule.

“On a global basis, the withholding tax regimes applicable in the various jurisdisctions are highly complex and represent an additional cost factor for the funds with clear impact on the fund's profitability. Competition between different funds requires supervision of the various rules and application of mitigation strategies whenever possible. On a European level, the recent ECJ jurisprudence on discrimination matters tends to provide for a common basis to harmonise certain withholding tax rules in the mid-term.” Comments Michèle Kimmel of KPMG Luxembourg's tax division.

Not all double taxation treaties signed by Luxembourg are applicable to Luxembourg funds. A full list of the 32 treaties applicable to SICAV can be found in the brochure. For a fonds commun de placement, which is considered as a transparent entity, the beneficial owner may claim tax treaty benefits, if applicable, with regard to his/her indirect investment through an FCP.  

Download a soft copy of the brochure.

Currently, the Luxembourg Stock Exchange has ten quotation lines for Qatari securities. It has long been active in the listing of international debt securities from countries such as the United Arab Emirates, Kuwait, Bahrain and Saudi Arabia and Malaysia.

About the Luxembourg Stock Exchange

The Luxembourg Stock Exchange began operating as a limited company in 1929, and has since gained extensive experience in listing and trading of securities from many different regions. Today the Luxembourg Stock Exchange has two markets — regulated and Euro MTF — with 29,878 international bond issues representing 42% of total international bonds listed on EU markets. It also lists some 7,229 shares and units of investment funds in around twenty currencies, offering a wide range of investment opportunities, as well as 250 Depositary Receipts of issuers based in emerging markets.

The Exchange’s website at www.bourse.lu provides individual investors access to market information on Luxembourg securities. Additional data are available through the Finesti portal (www.finesti.com), its subsidiary specialising in information for investment funds.