By Martin de Sa'Pinto:
GENEVA, Switzerland (Reuters) -- Luxembourg could draw hedge funds in their droves as European investors retreat from offshore vehicles and seek to rein in liquidity and counterparty risk in the post-Madoff, post-Lehman environment.
To meet investor demand, managers in Europe's $300 billion hedge fund industry are eyeing Luxembourg listings for eligible funds, even though tough new European Union proposals to only allow EU-registered funds to be sold may be watered down after fierce opposition from the United Kingdom and others.
"It's more the Madoff effect than the legislation effect, funds now want to come onshore, not be dependent on the offshore market," said Martin Kloeck, a director at Zurich-based fund manager Signina Capital, which manages $600 million.
"Asset managers get the Luxembourg-regulated tag, so why wait to see what new laws might tell us to do?" said Kloeck, whose company is already moving funds to Luxembourg from Cayman.
The Grand Duchy has a multi-lingual workforce and high quality fund services, comprehensive investor protection and a vigilant but flexible regulator, said a January report by professional services firm Deloitte.
It is already drawing funds from offshore centers as major asset managers like Brevan Howard and Marshall Wace register eligible funds onshore in regulated structures like UCITS III or Specialised Investment Fund (SIF) to broaden European appeal.
"It is much easier to sell UCITS- or SIF-compliant funds, they are liquid, the strategies are transparent and they provide solid investor protection," said Salvatore Imperatore, head of London-based investment advisory Pareto Capital International.
Investors turned skittish after fraud by US financier Bernard Madoff and the collapse of Lehman Brothers last year, and demand for transparent onshore vehicles has soared, said Hanna Duer, an associate at independent directors' group The Directors' Office.
The Cayman Islands, home to some 80 percent of the world's around 10,000 hedge funds, could be one major loser.
"Hedge funds and other alternative investment vehicles are now more interested in setting up onshore in Luxembourg because strict rules on liquidity and risk management, and strong regulatory oversight are what investors now want," Duer said.
That would also favor Ireland and Malta, which have like Luxembourg set up their regulatory and tax regimes to attract funds, Duer said, but Ireland's financial crisis is an issue, while Malta is still a relatively small financial center.
Despite the Grand Duchy's advantages, Association of the Luxembourg Fund Industry (ALFI) data show hedge fund assets administered there fell from $86 billion in June 2008 to under $70 billion a year later. However, the total number of funds actually rose 10 percent to 614. Also, the Lehman/Madoff effect is yet to play out as managers sift through the practicalities of moving funds.
Millennium Global is a Guernsey-based alternative asset manager that may set up several hedge funds on Deutsche Bank's Luxembourg-based funds platform.
"Our systematic macro strategy was packaged offshore and not eligible for many European investors. Now we are moving it to Luxembourg, all Europeans can invest because it is EU-regulated," said Marc Clapasson, a Millennium managing director.
He said the fund is also attracting investors from Singapore and Hong Kong who want liquid funds with transparent oversight.
"The Luxembourg fund has better liquidity and a higher regulatory standard, and it is probable that offshore investors will move onshore in the next five years," Clapasson said.
In a case that will test how robust Luxembourg's rules are, investors are suing UBS over its regulated Luxalpha funds which lost money in the Madoff fraud. They say UBS, custodian, was responsible for the assets.
HSBC faces similar claims over the Thema fund, based in Ireland. Both banks are contesting the claims.
"The responsibility of the depositary bank is quite clear under Luxembourg law, the custodian is 100 percent responsible for the assets even if it uses a sub-custodian," Duer said.
"It is very important that Luxembourg sticks to its guns over the Luxalpha affair, investors will realize the regulator is serious about protecting their assets," she said.
If that hurdle is cleared investors are likely to be even more enthusiastic about Luxembourg-registered funds.
The demands on a fund's directors are also greater than in other jurisdictions, Duer and Kloeck said. The regulator wants to see full background checks, and by law directors must be able to demonstrate good supervision and governance through a wide range of reporting.
Having stopped allocating to hedge funds during the credit crisis, many private and institutional investors say they are ready to get back in, but want safer and more regulated funds.
Says Clapasson: "The move of funds to Luxembourg is accelerating. It's a great opportunity for European asset managers to move assets home, and it's much easier to deal with Luxembourg than with offshore centers."
November 7, 2009