News came just before Christmas that Luxembourg had cancelled its subscription tax for active ETFs.
Serge Weyland, CEO, at The Association of the Luxembourg Fund Industry (ALFI) explains that Luxembourg, the second largest ETF domicile in Europe, represents about 25 per cent of the European ETF market, which has largely been focused on passive ETFs until now.
“The subscription tax for passive strategies in UCITS funds was reduced to zero over 10 years ago to create a level playing field, recognising that passive ETFs are lower fee type products that you don’t want to impair with additional tax charges,” he says.
ETFs are increasingly viewed as a distribution channel in the domicile. “There is a clear potential going forward to distribute actively managed funds,” Weyland says. “Using the strong development of platforms such as Trade Republic or Revolut which are popular with the younger generations we see changing dynamics from sales and distribution professionals and that was the motivation of what we could do in Luxembourg.
“We wanted to make it easier for fund initiators to launch in the ETF wrapper so we reduced the subscription tax to zero.”
Luxembourg offers the facility of setting up an ETF share class in an existing fund, allowing fund issuers to add a new class without having to change the name of the fund and the centre is also allowing a time delay for publishing underlying positions in active funds, similar to the semi-transparent regime in the US.
“The regulator has defined a framework which says that if you run an active strategy, it could be detrimental for investors to have full transparency of the portfolio, so there is a possibility of delaying price publishing by a month for more concentrated and less liquid positions, such as equity positions in small or mid-caps.”
With the Luxembourg solution, the authorised participants get the full transparency of the fund.
“In discussions with a number of managers we can see that this can make a big difference for them to make them decide to move ahead with the ETF wrapper. There are so many active conviction-based managers who say we won’t venture into the passive space and now with this regime they can see that the ETF needs to be seen as a distribution channel with their secret sauce protected and avoid the risk of being arbitraged.”
Dublin has seized the greater part of the ETF business in Europe, holding 70 per cent of the EUR2 trillion of assets in Europe, with Luxembourg coming in at between 20 and 25 per cent.
Weyland says that while the Irish market controls EUR1.4 trillion in ETF assets, some 60 per cent of are BlackRock assets. “It’s very concentrated and very much concentrated around funds based on the S&P 500 and the MSCI World,” he says.
“In Luxembourg, we have more diverse players and I believe that more and more we will see firms trying to reduce their exposure to one domicile – I am quite optimistic.”
Luxembourg is very strong in private assets with now a third of its EUR7 trillion of assets in the alternative space. “We see that firms want to concentrate their fund ranges and the ETF UCITS system is well-developed with the depositaries operating out of Luxembourg. It’s very easy for them to flip a switch to accommodate the ETF mechanics. It’s a business that is very much automated and the half a trillion Euros of ETF assets domiciled in Luxembourg already shows the appetite is there.”
In terms of trends in launches, Weyland says that they have seen quite a pickup in fixed income ETFs.
“I also see some interest with new products launched in the CLO space,” he says. “This is a key differentiator for us as the regulator has taken a fairly innovative stance with respect to allowing UCITS funds to have exposure of 100 per cent to highly rated CLOs.
“We have seen strong interest from corporate treasurers to use these in an ETF format to trade in and out to manage their liquidity. These products have been popular in the US and are now replicated in Luxembourg, whereas in Dublin the CBI has taken a stricter stance on CLOs, but our regulator is comfortable with teams looking at the underlying and stress testing the products to make sure the industry can make this work.
“Our exposure to alternative strategies means that we are quite comfortable with these more advanced institutional grade products.”
The UCITS structure has been in place since 1985 and some are calling for an update to its structure. ESMA is undertaking a process to review the eligible assets for UCITS but Weyland feels that from a Luxembourg perspective, they have everything they need.
“The current UCITS regime is a good one and we would advocate for further additions to eligible assets such as private debt or loans but I think the CSSF has been accommodating with assets such as CLOs. UCITS have been such a success outside of Europe with EUR5 trillion of the EUR20 trillion in assets in European funds exported outside of Europe which shows that the UCITS brand has been taken up worldwide, from Asia to Latin America.”
Weyland says that Luxembourg has to be careful not to kill that success. “We see a tendency to put further restrictions into the use of the product which would be detrimental to the quality of the product. Our view is that we should be expanding and including the scope of new opportunities.
“If Europe wants to build deeper capital markets we need to empower investors to invest and the ETF wrapper is a solution for that with young people using digital platforms.”
