Global fundraising for private equity funds has seen a slowdown in the past 12-18 months, impacting the industry worldwide. However, Luxembourg has proven to be resilient and adaptable. Ocorian's Peter Corry, Head of Fund Services – Luxembourg, and Paul Spendiff, Global Head – Fund Sales discuss Luxembourg's funds industry.
Global fundraising for private equity has slowed during the last 12 – 18 months. What has this meant for Luxembourg and how has the jurisdiction adapted?
“Globally it has been one of the slowest capital raising periods of the last decade. However, there are still bright spots. Funds with an ESG aspect have been more successful in raising capital and the early adoption and familiarity of ESG within the Luxembourg fund service community has made it the ‘go to’ destination for firms reporting as Article 8, 9 under SFDR.
“Luxembourg has also historically been the destination for the larger and more established managers who have been more successful in raising funds during this period. Global asset managers have moved into and are strongly committed to the private assets market. Equally well-established specialist alternative managers have diversified their offering to a combination of private equity, private debt, infrastructure and real estate (with an ESG angle in many cases) or indeed all of the above. They’re often doing this using Luxembourg fund structures.”
Net assets under management in Luxembourg have dropped from the peak of the market in 2021 but remain ahead of pre-pandemic levels. What has supported the stability of AUM at a time when wider markets have been volatile?
“A number of factors have underpinned the market – the attractiveness of Luxembourg as a domicile to global managers looking to establish an onshore presence. Some of this flow has been driven onshore by the new ESMA pre-marketing rules making it more difficult to rely on reverse solicitation for offshore funds. In addition in difficult times, there has also been a flight to quality as firms look to minimise regulatory and operational risk in times of market stress. Fund raisers do not want to have to explain their domicile choice to their investors.
“We still see a healthy percentage of capital rolling over into the next iteration of funds provided the investment manager has a strong track record. Private assets AUM isn’t susceptible to peaks in redemptions that occasionally impact most open-ended or semi-open vehicles. Many new funds launched in the last few years are only starting to deploy capital. As of the end of 2022, nearly half of the private capital funds invested in Europe-based assets were based in Luxembourg, so there is real scale to the industry.
It remains the jurisdiction of choice for investment managers targeting Europe and further afield. Valuations are an area of focus, but by their nature, private assets funds aren’t as directly impacted by volatility in the stock/bond markets and there is the ability to take a medium to long-term view.
There’s no longer just a private equity focus in Luxembourg. Private debt has grown significantly over the last five years as has the number of infrastructure funds. We now have multiple strategies involved across the industry so we have diversification of the portfolio in Luxembourg.”
In a tighter fundraising market, what are managers looking for in a fund jurisdiction? How has Luxembourg responded/differentiated from other jurisdictions?
“In real assets, firms that can offer a full suite of services are proving more attractive to private equity firms that are looking to simplify their operations and lower their costs. Luxembourg has a prevalence of these firms. This is part of a wide and deep service pool of multi-lingual AIFMs, depositaries, fund administrators, lawyers, and consultants. The establishment of the SCS and SCSp in 2013 and the RAIF in 2017 gave greater choice to fund managers and created structures which mirrored the offshore structures in Cayman, Jersey and Guernsey that they were familiar with. This coincided with the implementation of AIFMD in 2013 which drove managers to seek EU onshore solutions. You often hear advisors refer to the attractiveness of Luxembourg’s investment toolbox and that commentary is still valid. The SCSp which is an unregulated LP has been a huge success within the AIFMD framework and is the pre-eminent fund vehicle for managers looking to establish a fund in Luxembourg.”
When GPs are choosing Luxembourg, what determines whether they opt for a RAIF, SICAR or SCSp structure? How does uptake of each option compare to 2022 levels and what is driving manager choices?
“We continue to see asset managers launching unregulated funds with the investment manager within this structure regulated via AIFMD. Institutional investors are quite comfortable with the set up often using an SCSp (a special limited partnership). The RAIF (Luxembourg Reserved Alternative Investment Fund) offers up another variation of the unregulated fund set-up and is often used to facilitate segregation of asset strategies or investors / co-investors into sub-funds. Managers do still sometimes launch a SICAR (Investment Company in Risk Capital) but funds that are directly regulated are less common nowadays.”
What role can/is Luxembourg playing in supporting ESG/Green/energy transition reporting and regulation?
“In essence, all of the key components are in place, though clearly there is always room for improvement. In order to give credence to SFDR and the reporting framework the CSSF (Luxembourg’s financial regulator, the Commission de Surveillance du Secteur Financier) needs to ensure that the labelling adopted by the AIFM (typically Article 6,8,9) reflects the reality of the impact being made by the fund. Greenwashing and a collapse of faith from investors is the biggest threat to the mass adoption of ESG-focused funds.”
What is the outlook for Luxembourg's funds industry in 2024?
“According to McKinsey Global Private Markets Review 2023: in 2022 the number of buyout and growth deals greater than $500 million decreased by 33 percent. Add-on deals, which tend to be smaller, continued to gain share as a percentage of total deals. Given that 2020 and 2021 had seen record highs for fund raising it was perhaps not surprising that there was a substantial amount of dry powder that also impacted firms' ability to go to market for new capital. Hence global private markets fundraising declined by 11 percent to $1.2 trillion. Real estate (−23 percent) and private equity (−15 percent) declined most precipitously from 2021’s record highs, while private credit (+2 percent) proved more resilient.
“Macroeconomic headwinds, including rising inflation and interest rates, coupled with negative public market performance (−17.7 percent) triggered the aforementioned decline in assets. However, as valuations become more realistic, the weight of deal pressure will eventually lead to a return to more normal transaction levels. This will be further bolstered by the rise of new sources of capital via the ELTIF and evergreen real asset structured as UCIs Part II. As the pre-eminent Real Asset fund domicile, Luxembourg will be the key beneficiary.”
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A version of this interview first appeared in Real Deals in October 2023