Luxembourg is no stranger to Islamic finance, and the Grand-Duchy has long been on the map as a Shariah compliant fund domicile and Sukuk issuance center. But as the country strives to diversify its financial services sector, it has stepped up its efforts to make a concerted play towards attracting the Islamic market. And with its prowess as a global financial hub, an accommodating framework and respected reputation, Luxembourg offers an exciting opportunity for Shariah compliant offerings to cross-pollinate with conventional channels. Could this represent not just a new gateway into Europe, but the long-awaited bridge into the mainstream market?
At last week’s IFN Europe Forum 2014, which was moved from London to Luxembourg for the first time this year on the back of the keen interest and strong support shown by the country’s players and regulators alike, the authorities came out with their strongest statement so far in favor of the Islamic finance industry: reiterating their goal of making Luxembourg the leading global destination for Islamic funds. Described by the minister of finance, Pierre Gramegna, as “cross-border by definition,” Luxembourg benefits from its position at the heart of the European single market, as well as its dominance of the UCITS fund market and its ‘AAA’ rating guaranteeing security and reputation (with the maintenance of the triple-A rating actually written into the coalition agreement of the new government).
Gramegna explained to Islamic Finance
news (see exclusive interview, p.34) that the country’s financial services sector rested on four pillars of private banking, investment funds, insurance and loan structuring. However, the country is keen to diversify out from these and the two key channels through which it hopes to do so are renmimbi activities (with an MoU signed on the 1st July between the Central Bank of Luxembourg and the People’s Bank of China for a new renmimbi clearing bank in Luxembourg) and Islamic finance. Currently in Beijing, the minister is about to embark upon a tour of the Middle East in order to build ties and create future partnerships with key Muslim jurisdictions in the region.
This is important for the country, as it has suffered somewhat from the introduction of new transparency laws that will implement automatic information exchange and remove bank secrecy. Although Gramegna assured IFN that banking assets had not decreased and he did not expect any material impact to arise from the new regulations, the emphasis on diversification suggests that the impact of the new rules could be an issue – and many market players have expressed their concerns to IFN.
Fouad Rathle, senior vice president at Luxembourg-based GarantiBank and president of The Institute (formerly IFBL), a banking training academy in Luxembourg, highlighted his concerns. “In the past Luxembourg has relied a great deal on banking secrecy. With normalization and elimination of banking secrecy as far as tax optimization is concerned, this has meant that some foreign investors or depositors have gone. How many we don’t know, but a sufficiently important number to lower the ability of many banks and profitability. So as a strategic gamble, it would be of interest to replace these clients. Luxembourg is actively looking for other clients, and one of these areas could easily be Islamic banking clients.”
However, other bankers are more optimistic. Ammar Dabbour, the founder of Excellencia Investment Management noted that: “It depends what you are selling. If you are selling Luxembourg on bank secrecy, on tax facilities, then it is going to affect you because when you lose those tax advantages you will lose clients. But if you are selling a core business proposition – which for us is Shariah compliance – and you target customers based on the quality of your product, then this should not be an issue.”
A concerted effort
Nevertheless, Luxembourg is making a targeted attempt to diversify and redirect its strategy. Part of this is a renewed focus on larger investors, family offices and institutional clients. “If we are looking at the Gulf area, there is a convergence of interests,” explained Fouad. “And many of these large Gulf investors are interested in Shariah compliant instruments. For Luxembourg, there is no problem with this – we can easily devise products that are Shariah compliant. So it is a no-brainer, to provide these investors with a material incentive to come over here.”
The only difficulty so far is one of material needs – finding enough experts to grow the sector, and persuading players to spend money to enter the market. “To set up a fund takes money and time, so it’s a chicken and egg situation. But I think people are beginning to see that the rewards of an Islamic fund outweigh the costs of set-up.”
To this end Luxembourg has positioned itself consciously differently as a financial hub than locations such as New York and London, and Gramegna noted that in fact it was more in competition with Singapore along with offshore jursidictions such as the Cayman Islands.
“The point is that London and Luxembourg are really completely different markets now, with different advantages – and this is what they are now playing up,” agreed Bishr Shiblaq, the head of the Dubai office of Luxembourg-based law firm Arendt & Medernach. “Luxembourg is very much a fund domicile, it is the leading fund domicile in Europe, while London has a very different approach as a banking hub.” And the jurisdiction has dramatically raised its international profile in recent years, to put itself firmly on the map in terms of international asset management interest.
“The perspective from the GCC is changing,” commented Bishr. “Before, Luxembourg was very much unknown – when we established our office six years ago in the region people would not speak about Luxembourg, they would speak about establishing their funds in the Cayman islands, British Virgin Islands, and we were competing with those domiciles in terms of establishing investment structures.”
But since the financial crisis Luxembourg, with its robust framework and regulatory strength, has become increasingly popular. Changes to regulations, for example in the UAE, have also encouraged participation and distribution of funds. “I think most players in Luxembourg have seen an increase in investment structures, as people recognize the advantages that Luxembourg can offer,” mused Bishr. “It depends on the kind of structure they are using – obviously if there is no foreign component then looking at Luxembourg doesn’t really make sense. But as soon as you look at the international distribution of a fund, and introduce a tax element, then it becomes a really important player for Islamic structures – Luxembourg has one of the largest networks of tax agreements and treaties in the world.”
AZ Global Asset Management has been operating out of Luxembourg since the late 1990s with most of its US$35 billion assets under management lying in its Luxembourg UCITS funds. The firm recently launched a new global Sukuk fund with around US$55 million in assets under management, commercialized through two sub-funds of its Luxembourg UCITS compliant umbrella funds, AZ Fund and AZ Multi Asset. “Obviously the Luxembourg domiciliation combined with a fully UCITS compliant infrastructure raises the bar for investor protection and ticks all the boxes for the fund once that is distributed in Europe and away (notably with institutionals),” explained CEO Georgio Medda to IFN. “The CSSF has also a good track record in terms of Islamic funds and that makes the whole authorization process easier as the underlying principles are well understood.
“The biggest challenge for a holistic company like ourselves was to plug an Islamic sub-fund into an non-Shariah compliant umbrella fund, which has been possible as the CCSF allows for integrating the prospectus in all the relevant parts enabling for the full respect of the Shariah.”
This strength in regulatory governance combined with flexibility in terms of product offering has seen a growing trend towards firms moving their funds out of their current homes and redomiciling in Luxembourg. For example, Emirates NBD has several Islamic sub-funds which IFN has learned are in the process of migrating from Jersey to a new funds platform in Luxembourg; while several smaller Islamic funds and some Cayman Islands funds are also believed to be moving over.
Most recently, IFN learned that EIIB-Rasmala plans to migrate all its funds from across the globe onto the Luxembourg platform. Speaking to IFN the managing director of EIIB-Rasmala, Harris Irfan, confirmed that: “We are moving everything to Luxembourg, including from Dublin and also from the Cayman Islands, where most of our funds are domiciled.” The driving factor behind this decision was regulatory strength. “A lot of international financial institutions are talking to us now, and that drives the level of regulatory discipline that is required to an order of magnitude higher. That is why we are migrating all our funds to Luxembourg – because it is a world class regulatory environment.”
“The key is distribution,” pointed out Bishr. “You have distributional hurdles if you are in certain jurisdictions, in particular for the UAE. Their regulator, the Emirates Securities and Commodities Authority (ESCA) has made it much easier to distribute Luxembourg UCITS even onshore in the UAE.”
This has resulted in a trend for Shariah compliant fund service providers to increasingly move towards Luxembourg and establish themselves to provide services for the fund and banking industry. “I think we will see more and more funds move towards Luxembourg and hopefully some very good funds established here by the end of the year,” said Bishr.
But it is not just Islamic funds moving to Luxembourg that will drive the platform. Robert Scharfe, the head of the Luxembourg Stock Exchange, emphasized to IFN the importance of bridging the gap between the Islamic and conventional markets, and suggested that a key channel through which to do so was the potential confluence between Shariah compliant funds and ESG (environmental, social and governance) funds. He highlighted the current gap between the Islamic offering and investor behavior, pointing out that the EUR300 billion (US$409.79 billion) in responsible investment assets, including EUR200 billion (US$273.19 billion) in ESG fund assets, represented. “There is colossal scope for cross-sectoral expansion into ethical investment for priciniples-based Shariah funds.”
“Asset managers are increasingly integrating principles-based investments into their allocations,” he noted. However, he also warned that currently the Islamic funds industry faced ongoing structural challenges including a lack of scale, limited product offering and a lack of standardization across the Shariah screening process.
If Islamic asset managers were able to bridge this gap and step into the ethical investment space, the faster acceptance of products by non-Muslim consumers would lead to a better choice of product and better performance – while a broader understanding of social and corporate products outside the Muslim world would not only diversify opportunities but contribute to more stable financial markets. “Islamic finance is closer to our minds than you might have thought,” insisted Scharfe.
This has translated into a commercial proposition that is apparently irresistible to Islamic practitioners. “Luxembourg is very open-minded,” explained Ammar. “They are used to dealing with firms on an international level. They know what Islamic finance is. They really consider it as a business model and as a business opportunity – and that is really encouraging. At the end of the day when you are doing a project, you want the authorities to be looking in the same direction.” And its regulatory support is bolstered by its international reputation and quality. “It is known as one of the best places in the world to deal in finance. From Luxembourg you are everywhere in Europe. The flag of Luxembourg is a sign of quality.”
In fact, the players IFN spoke to struggled to find any negatives at all. “We have really analyzed the legal framework in detail and we cannot find any substantial issue,” confirmed Bishr. “I am trying to find a negative but I can’t think of any. If you speak to anyone who is trying to establish themselves here, the authorities are extremely open-minded – even to the extent where we have been perhaps surprised that they have been so welcoming. This is very much the nature of Luxembourg – it is open to business, and the discussions aren’t political. I think that has been the problem perhaps in other European jurisdictions – that where they have approached it from a political angle, for Luxembourg it is purely a commercial discussion.”
It appears as if Luxembourg has built a clear path for itself as a fund domicile of choice for the Shariah compliant industry, by leveraging its own strengths as an international financial center with flexibility for innovation couple with an unrivalled regulatory robustness. All that remains is for the industry to recognize the advantages that the platform can offer – and with the current trend of fund migration, it looks as if that is already well on the way. — LM