Finding solutions with funds
Can investment funds help to solve climate change and diffuse the pensions time bomb? EU policymakers believe they can. This is the backdrop to Corinne Lamesch being appointed chairperson of the Association of the Luxembourg Fund Industry (Alfi).
Investment funds put savings to work, channeling money into private and public sector investment projects that create jobs, wealth, new products and new services. However, these days, clients, politicians and voters want more.
Environmental, social and governance (ESG) criteria need to be taken more into account, concerns about retirement need addressing, and more investment is needed for start-ups and infrastructure. Hence after her appointment, Ms Lamesch identified three immediate priorities: facilitating sustainable finance, embracing the opportunities of the EU’s pan-European personal pension product (PEPP), and deepening Luxembourg’s expertise in alternative funds.
What is ethical finance?
Who could be against “ethical” finance? The global fund industry has been advocating this concept for decades, to attract investment to sustainable projects and as a way to boost the sector’s image. Yet it remains fiendishly difficult to define. What does it mean in practice to seek to minimise harm and maximise positive outcomes for the environment, society and for governance? For example, some see nuclear power as the most viable way to reverse the growth of greenhouse gas production. Others see this technology as a greater environmental risk.
What about an oil company which has invested heavily in sustainable energy research? Numerous public and private initiatives have sought to provide clarity to investors and their advisors. Luxembourg’s industry-led labelling agency LuxFLAG is an example. While this organisation makes a valuable contribution, its relatively strict criteria mean fewer than 100 funds qualify for its ESG labels.
We have a lot of work to do to help explain the challenges and promote transparency.
New ESG breakthrough attempt
If the goal is to provide incentives to asset managers to tend towards more sustainable investment, a strict approach risks falling short of potential. If the proposals are too strict, they may be ignored or might become outdated. If they are too flexible, they could become somewhat meaningless and open to criticism. Yet if they are too complex, they risk adding to confusion rather than offering a potential solution. The EU is currently seeking a breakthrough by developing a common language to enable greater understanding of this concept. The European Commission recently published a draft classification system (known as a “taxonomy”) for environmentally-sustainable economic activities.
They screened activities across a range of sectors, from energy to transport, to agriculture, to real estate, and more, identifying low-carbon practices and also “transition activities” that seek to limit greenhouse gas production. Reports have also been issued on a green bond standard, and climate and ESG benchmarks. These reports are now being studied and debated by the finance industry and political decision makers, with a conclusion and legislation hoped for by the end of the year.
Potential new niche
Ms Lamesch is keen for Alfi to contribute to the work of developing and promoting this concept, but she knows this isn’t a straightforward task. “We have a lot of work to do to help explain the challenges and promote transparency. Without widely accepted definitions, there is the risk of appearing to support greenwashing,” she added.
Success in this area could cultivate a lucrative niche for Luxembourg, as well as resulting in environmental benefits. The country is well known in the global fund industry for its expertise in decoding and implementing EU regulations.
The pensions imperative
Too few people have sufficient retirement savings. In Europe, if current trends continue, for every retired person in 2060, there will only be two people of working age, compared to four today. Inevitably, public sector pension funds will become stretched, yet the EU calculates that only a quarter of Europeans between 25 and 59 years of age have additional private cover.
The pan-European personal pension product (PEPP) is the latest attempt at a solution by EU policy makers. The PEPP will enable investment products to be linked to an individual rather than to an employer, thus adding flexibility as workers move between countries and different firms.
Also, funds will be eligible to structure pension funds under the new rules. “We are very happy with the initiative, with Luxembourg well positioned to become a hub for PEPP providers given our cross-border distribution expertise,” said Ms Lamesch. However, few analysts expect a rapid expansion, not least because questions over taxation remain unclear.
“We are well positioned to help, but it could take time, just as it did with UCITS,” Ms Lamesch noted. The relevant EU regulation was officially passed on 25th July, but further clarifying acts are required before this can come fully into force. The first PEPPs are on course to be created in late 2021 or early 2022.
Many Europeans have a way to go before they understand that they should provide for their own financial future.
Why education is needed
Regardless of this innovation, investment funds will remain the bedrock of many pension schemes, and Alfi has long been aware of the need to work to educate the public about the potential benefits. They point to just 8% of wealth in the EU being invested in mutual funds, compared to 23% in the USA.
Around a third of Europeans keep their savings in bank accounts, despite negative real interest rates. Not only does this mean these people are missing out on more healthy investment returns, but entrepreneurs are deprived of vital start-up and growth capital. “Many Europeans have a way to go before they understand that they should provide for their own financial future,” said Ms Lamesch.
This education is also needed domestically. As well as increasing understanding about Luxembourg’s creaky public pension system, Alfi needs to spread the message of what the fund industry brings to the country (including tax revenue and employment opportunities), as well as the wider benefits. “We are the leading fund centre in Europe, but when I talk to people outside of our industry, too often they don’t understand our role,” she said. Generally there’s hazy understanding, mixed with the negative connotations of the financial crisis. The CSSF is working on a national investor education strategy and Alfi will be helping.
Alternative sources of funding
Her third early priority is working to further growth in the alternative fund sector. The private equity funds, real estate funds and debt funds sectors have performed well, but this remains a relatively young industry in Luxembourg, and growth needs to be cemented. Unlike UCITS, where the cross-border model is pre-eminent, still much alternatives business is organised within member states. Greater efficiency and effectiveness in Luxembourg would help turn this around.
Keeping in touch with European decision makers is another key role. With a new European Commission and a new European Parliament, there is work to do to restate Alfi’s point of view. That said, no major changes of strategy are expected at the EU level, and there is satisfaction that Commission president Ursula von der Leyen has highlighted sustainable finance as a priority. Often most significant are the on-going contacts with middle ranking officials responsible for the technical implementation of regulations. Along with the Luxembourg Bankers Association, Alfi has an office in Brussels, employing two people, working with regulators and European trade associations.
We should not lose sight of the fact that regulations have been introduced to benefit investors and boost efficiency, so changes should be mindful of this.
Steady change please
Alfi hopes that when reviewing regulations, policy makers will take a gradual approach. Reviews of AIFMD, PRIIPs, MiFID, UCITS and more are on the agenda, and Ms Lamesch thinks it would be “good news” if there was a move away from big rewrites of the rules. “There is a need to pause and look at what alterations can be made to make things more efficient,” she said. “We should not lose sight of the fact that regulations have been introduced to benefit investors and boost efficiency, so changes should be mindful of this,” she added.
A symptom of the regulatory load is the length of time the CSSF can take to process requests, with delays of several months for routine procedures common. However, Ms Lamesch sees the regulator’s willingness to make improvements, not least with substantial hiring and efforts to streamline process.
In particular, she pointed to an increase in the use of guidance notes and templates to make it easier to complete forms. “We are keenly awaiting the e-desk portal which will allow e-filing that will streamline procedures,” she added. She also welcomed plans to gather statistics for the first time on how long certain processes take, with the hope this will highlight bottlenecks.
Braced for Brexit
It is in the regulatory field that losing the UK as a member of the EU is feared as a major potential long term downside of Brexit for Luxembourg and the cross-border fund industry as a whole. The creation of a pan-European industry was largely on the initiative of the UK government, so their removal from decision making bodies may have an impact. The UK’s voice has been muted since the referendum in June 2016, but so far there does not appear to have been a decisive shift in policy outlook at EU level. “We will continue to seek out allies with the same interests as ours, it’s up to us to work harder to make the case and make our voice heard,” said Ms Lamesch.
Otherwise, she believes industry is as well prepared as possible for the potential of a chaotic no-deal exit. Indeed, preparatory domestic Brexit laws have allowed for a unilateral one-year transition regime to be granted to UK firms in the case of no-deal. Firms had to register with the regulator before 15th September this year. Most firms appear to have made adequate preparations, but some may have slipped through the net. These questions are significant, as just under one-fifth of total assets in Luxembourg are in structures launched by UK-based fund managers.
There is increasing willingness of these countries to allow institutions and high net worth individuals to invest abroad.
Globalisation and diversity
An on-going role for the association is to cement Luxembourg’s reputation globally, with there still being considerable room for development in Latin America and Asia. “The level of understanding in these countries among professionals and policy makers is quite high, but still we find they want to dig deeper into the details,” Ms Lamesch noted. There is increasing willingness of these countries to allow institutions and high net worth individuals to invest abroad. Mexico is a recent example. Tweaks to regulations and new uses of existing products continually need to be explained.
Despite being the second female chair of Alfi, and this in succession, Ms Lamesch is aware that the fund business is a largely male-dominated area. “We need to attract all the talent we can, and having women in leadership positions encourages others to consider this industry for their career,” she noted. “Diversity helps generate the innovation we need to grow and develop.”
Planning for uncertainty
All of these factors and more will be taken into consideration as the association refreshes its regular five-year ambition plan. The 2020-2025 document will have to deal with a world of an uncertain macro-economic outlook, the continued pressure on fees and margins, the need to digitalise to cut costs and boost services, the need to reach out to new clients, the challenge of potential disruptors, and more.
Ms Lamesch takes the helm at a time when recent growth has been steady rather than spectacular. Since the double-digit year-on-year increases seen in 2017, net assets in Luxembourg domiciled funds have risen from €4.21 trillion in January 2018 to €4.32 trillion in May 2019. A steady performance compared with the average growth in excess of 10% per annum over the last five years, when assets grew from €2.8 trillion in mid 2014. She is aware that: “Volatility is likely to continue so we have to look for new opportunities, with sustainable finance, alternative investments and pensions being areas where we can make a positive difference.”
This interview is available in the Alfi September/October Paperjam supplement which will be available on Thursday 26 September.