With its new legislation in place, Luxembourg is making a concerted drive to attract international pensions. IPE’s roundtable, held in the Grand Duchy, brought together a wide cross-section of experts to discuss the issues, challenges and difficulties Luxembourg faces in this endeavour, as well as the tremendous potential for this business.
Our participants were: Jacques Bofferding of Banque Générale du Luxembourg representing the EFRP in the Grand Duchy, Christiane Campill of the Commission de Surveillance du Secteur Financier, Fiorenza Fabi of Invesco, Rafik Fischer of Kredietbank Luxembourgeoise and of ALFI; Geoffrey Furlonger of Lombard International Assurance, Sohail Jaffer of Premium Select Lux, Mervyn Martins of PricewaterhouseCoopers, Jean-Jacques Rommes of the ABBL and Claude Wirion of the Commissariat aux Assurances.
IPE What is is your perception of the development of retirement provision in Europe, particularly in light of the proposed directive from Brussels?
Campill We certainly believe that there will be a major development in retirement provision in Europe, simply because people are paying more attention to the subject.
For a number of years, professionals have been aware of the pensions time-bomb – as it is commonly called – but now individuals are increasingly interested, especially in Continental Europe. Some years ago, they tended to rely on first pillar pensions and did not insist on having complementary pension provisions as part of their salary package. I think that this trend will grow.
In Luxembourg, we are, of course, pleased that we have a proposal for an EC directive on pensions on the table and we adhere largely to the philosophy of that directive. While we have to wait to see what the final directive will be, the proposal we have is the beginning of the future.
Furlonger The main trends are undoubtedly shaped by Europe’s demographic problems. There is also the trend towards defined contribution(DC) away from defined benefit(DB) and there are the tax barriers and the attempts to bring these down.
But at street level, even the ordinary person is now conscious that they have got to start saving for their retirement and that they cannot rely upon the state. I think almost everybody in Europe has more or less got the message now. That is creating more and more pressure for solutions and therefore there is quite a strong tail wind which will help the EC in bringing the directive forward.
Wirion More than the intrinsic superiority of private pensions solutions,the diminishing quality of services provided by the public sector will drive people towards private schemes. I believe many people would prefer to keep public schemes if this was possible, but unfortunately demographic data will be such that it will not be possible to maintain public schemes at their present standards.
I am not over optimistic about the proposal coming from the EC and the European Commission for pan-European pension funds. We have to recall that after years of discussions at Council level a first EC proposal was drawn back by the Commission in the early nineties- an error that, in my opinion, lost us a great deal of time.
I don’t know what the future will bring, but I don’t think that reaching an agreement will be easier this time. There is still very strong resistance from some EC member countries to the text and under the French Presidency there wasn’t a single meeting organised at Council level. Finally, it is not clear whether employees will make use of the new freedom in the pension fields, once the proposal is adopted. Remember that we have had a single insurance market now for 10 years and what has happened as far as crossborder servicing is concerned? Nothing or nearly nothing.
This is not to say that the directive will not be useful. In the insurance sector, for, example, competition between operators and producers has increased significantly since the creation of the internal insurance market. Neither must we forget that, despite the fact that one of the major drawbacks of the insurance directives is that cross border business in the insurance field still represents less than 1% of the overall European insurance market. Luxembourg is one of the very few domiciles to have become quite successful in that area.
Rommes While I think that almost everything Claude Wirion has said is right, I do not share his pessimistic view that things are entirely gloomy.
First, the longer things take, the greater the pressure will be to go forward within the European Commission and in the different countries and to put in place mechanisms to solve the problems we will have with first
pillar public pensions. That will inevitably lead countries to have more second and third pillar solutions.
The time will come when these solutions will go cross border. So there is pressure because of the demographic time-bomb and because the market is not developed enough at the moment. But it will happen. It may be difficult to be optimistic over a five-year perspective, but this is a beginning and there is a future for this business.
The directive on the table today is very close to what our law of June 1999 put on paper. So we have our law, which is very close to what seems reasonable to the Commission today and very close to what the Commission thinks should be the future. That shows that, at least intellectually, we have reached the point where we could meet a demand which is not yet in the market. It would be silly for Luxembourg not to profit from such an opportunity.
Fischer I am absolutely optimistic about the repercussions of the public pension situation in Europe for the Grand Duchy of Luxembourg. This has already started!
If you look at the question, not from the type of vehicle structure but from the asset management side, I think the revolution has taken off.
So, if you look at developments in Sweden for first pillar provisions, as an example, Luxembourg is very eagerly looking at how best to invest the monies that they have collected. So here we have an opening for asset management mandates. This is what I see in Europe’s Latin markets in Italy, France and in Spain, which have traditionally invested heavily in domestic bonds.
So here we see a huge amount of pension fund money right now flowing into the Luxembourg investment fund industry. The direct, real term, immediate repercussions for Luxembourg are already there and they are huge. This trend of demand especially from Europe’s Latin markets will go on and has enormous potential. We might not have the money at once in the Luxembourg international pension fund vehicles. But it is reaching the Luxembourg investment fund industry.
Bofferding When we speak in an international context, I think the EU has the single market as its objective, but labour mobility has not really been achieved and that is something which is very important. European companies cannot be as competitive as they could be and they are probably less cost efficient than they could be.
Fabi The European directive is very important because all the states have to think about the second pillar. In Italy and some other countries, while the second pillar law exists, the second pillar market is not that big because people don’t know that they have to build their second pillar pension. So there is a problem of information and education.
What is very interesting in the directive is when they say that the cost of pension funds is very high and that is true where there are not a lot of members. So international pension funds could perhaps be a solution as costs would be reduced since there would be many more members per scheme, and this allows the assets to be invested in the best way.
Jaffer In the European context, one of the biggest markets for private pensions is the German market. There are proposals in the Parliament to be enacted in 2002 which will enable consumers to have private pensions. However, I think that here, as with other things, much will go to the pioneering spirit of Luxembourg and its ability to take the lead.
Multinationals will definitely be attracted to creating pan-European pension schemes because of the needs of executive mobility.
Much of the money in Luxembourg is really money which is here for savings and retirement, so I would be fairly optimistic about the ability of Luxembourg to attract new flows through its legislation. I think the EC directive is highly interesting but it will take time for it to have an impact and, in the meantime, business has to be done.
Martins I am concerned when a lot of references are made only to vehicles. Luxembourg is in the forefront of creating an environment for pension funds to flourish. Your view of what is going to happen in five, 10 or 15 years depends on how optimistic you are, but I think that we have enough tools to take advantage of the opportunities that are in the legislation now.
I think that Unilever’s pension plan is a good example, as is the Alliance one and there are a lot of projects in the pipeline on the same basis.
It is fair to say we have may not have the ultimate solution. I think we will do what the fund industry did in the early days and take opportunities and set up initiatives which creates interest and a snowball effect. We’ve certainly got the chance to do so.
Bofferding I may have thought that the legislation came too early and the market wasn’t there. While UCITS funds are looking for pension fund money, we must remember that much of the money flow into Luxembourg funds is for retirement savings. While pension fund vehicles do not yet exist on the European level, they do exist in Luxembourg.
Fischer I want to stress that the investment fund money in Luxembourg is long term saving money. So, whatever the markets are doing, you have an average every month of LFr500bn(E12.5bn) new net money in flow, part of which is basically put aside for retirement purposes.
Furlonger I wish to point to a potential problem I see for Luxembourg. The European Federation for Retirement Provision (EFRP) is working on a European vehicle which it has presented to Ireland, Holland and the UK and I think that this could be a potential danger for Luxembourg if is is not part of the equation. It involves mutual recognition by those three countries which have by far the majority of pension fund assets in Europe. I can see multinationals setting up a mini pan-European pension for UK, Dutch and Irish employees. If that happens then the Luxembourg vehicle doesn’t look at all attractive as there isn’t the same tax recognition. There should be efforts to get Luxembourg into the equation.
Bofferding You have two types of multinationals – those that are multinational and operate centrally and then you have those that do not centralise, they don’t want to control everything from their headquarters. Obviously the EFRP tries to achieve this key objective of a single market and to encourage labour mobility. When they see obstacles they like to remove them. Those multinationals with many expatriate employees need the mobility and want the cost efficiencies. It is the UK and US multinationals which are hottest in this area, while on the Continent you do not have this to the same extent.
Clearly, we are going to make the point that Luxembourg, given that it has a law, should have the chance to join this set of countries as part of the first group.
IPE Looking at the pensions developments and the opportunities for Luxembourg, are we talking about something that can be as good for Luxembourg in the long run as UCITS has been?
Rommes We aim to have a legislative framework that is favourable to the financial sector as a whole in Luxembourg, this is why we have drafted the pensions law. But not every law that we put in place will bring in 10% of the Luxembourg budget to the state.
‘Will we one day be where we have reached with UCITS?’ I like questions like that being asked, but I do not know the answer. If we do not try on many occasions to have such laws as we did with UCITS, and as we do with others, then we will have lost before we begin. So that is why we do it and why we will continue improving the law.
Fischer The investment fund industry stands close to one trillion euros. This would be difficult to achieve on the pension fund side in the short term and, even if one day we achieve this sum in pension funds, I wonder where we are going to be on the investment fund side -I suspect it is going to be much higher.
Coming back to what I said, basically I don’t care if it is the Luxembourg pension fund vehicle as such which is generating the inflows of money towards Luxembourg because I feel even the domestic pension vehicles are going to generate substantial inflow of assets to Luxembourg. Continental Europe still has the problem that a large number of corporations still don’t have supplementary pension schemes. It is not like the investment fund side, where everyone has savings. On the pension fund side, we see that a huge number of corporations do not provide supplementary pensions and this has to change to make a large quantity of assets available.
So I do not think the basics are yet in place to generate the same growth that we have had in the investment fund industry. Is there potential? Yes definitely, but in size nothing comparable at least in the medium term; but in the long run we will have to see.
Wirion While I am pessimistic when it comes to rapid progress being made at the European level, I am confident that the overall movement away from state to private pensions will continue, be it second or third pillar pensions, and I think this offers huge opportunities for Luxembourg.
For Luxembourg operators, the second pillar is still a field of activity that remains to be explored. Luxembourg insurers already play a very active role. Of course, it is not easy to quantify precisely third pillar premiums among the overall premium income of the insurance sector. It is, however, worth mentioning that, over the last 10 years, the premium income has grown 40 fold and it seems obvious that much of this income is due to an ageing population which has money to invest for retirement.
On the second pillar level we see Luxembourg to be one of the few places which will have an important role to play. In the immediate future it will not be the case that all pension funds are internationally managed. Evolution will take time and Luxembourg will get a small part of the business, but even a small part will be huge business and so it will be very important for the financial sector in Luxembourg.
Bofferding We never thought that we would teach the British, Irish, Dutch what pension funds are. That was never our intention. Our traditional markets in Luxembourg are, first and foremost, the Belgian, French and German markets. It is true that we have to look at what the British, Dutch and Irish want to do and that is very important for us. But they are not the real challenge. We are not going to convince them easily. It is other countries that we have to convince first.
Furlonger US multinationals could be attracted to Luxembourg because a priori they do not have any bias towards any one European country. US multinationals will do what they think is logical, and what will save them money. If use of Luxembourg legislation represents the best solution for provision of employee benefits, then they will come to Luxembourg.
It is marvellous that Unilever was the firstcompany based in an important European country to give a vote of confidence, but we haven’t really seen the American multinationals here yet. When that ball starts to roll there is a potential source of big business for Luxembourg.
Bofferding I’d like to refer to the second pension scheme that was set up. This came from the United Arab Emirates, where prior to 1998-1999 there were no mandatory complementary pension schemes but then the law changed to make second pillar provision mandatory. However, there were no vehicles specifically designed to receive second pillar contributions. We were fortunate enough to have a law specifically designed for this.
For American multinationals with the experience of pension funds, having forms of financing vehicles is a big selling advantage when we go out and talk to them. What is important is that we have a law which is specifically designed for this role. It is not another type of vehicle which is simply being re-arranged to receive pension money. We now have a dedicated law and we have shown commitment to this. I think that will definitely make a difference medium to long term in favour of Luxembourg as a pensions domicile.
Martins In addition, and coming back to Europe and looking at it from the service provider’s view, attracting skilled labour is going to make the provision of pensions solutions one of the crucial things that will be offered. So it is in the interest of companies to do so. In fact, I think that it is going to be essential, so second pillar provision will be pushed quite strongly by those employers and service providers. It is going to be a driving force out there. Having the vehicles in Luxembourg may create the initial interest for attracting skilled staff.
Rommes The two financial vehicles designed for pension savings are not being created for the Luxembourg situation specifically, so we had two laws and they both have the same date - one concerning international pension funds and one concerning domestic pensions. That separation between the international vehicle on the one hand, and the national situation on the other hand is what is different in Luxembourg compared with other countries. They all look at pension funds only from their national point of view – they never look cross-border and they never generalise. They always bear their own circumstances in mind and they confuse social ambition and financial need and that is exactly what we try to separate. This is also why this pension fund legislation has no social ambition at all. That social ambition has to be put in by the beneficiaries and is very specific to that vehicle because social ambition is very complex and it depends on where people are coming from. That is why it is so flexible.
IPE How ready is Luxembourg in terms of its facilities and services to meet international demand?
Fischer Luxembourg can rely upon its huge experience on the investment fund side, although I would agree it doesn’t cover the full scope of what is required. Even if we buy in a number of services from providers abroad, for example on the liability management side, we do not have the necessary expertise in Luxembourg at the moment. But it is not a requirement to have it locally in Luxembourg.
Luxembourg is one of the few countries in the world which has dedicated professional third party service providers on a very large scale to deal with administration and shareholders of investment funds and now the pension fund business. I agree there are still elements which need to be developed further but, overall, you couldn’t imagine a better infrastructure than the one we’ve already got here in Luxembourg.
Bofferding Maybe we are very competitive and very professional in the way we handle custody and in the way we do accounting on the asset side. But on the liability side, we know that the US and other countries have developed these aspects to a fine art on the communication aspects, providing information for their beneficiaries and so on. We don’t have those types of skills in Luxembourg. We have to encourage people who are active in that area, who have special services, to come here. It is hugely important that we can include these skills in the packages that we offer.
IPE Sohail you’ve chosen Luxembourg over other places - what is your perspective?
Jaffer The reason we at Premium Select Lux chose Luxembourg for our ‘best in class’ multi-manager funds was we were already active as a group in Luxembourg with a life insurance company and secondly the real attraction for our asset management company was the flexibility in the rules and regulations, with the ability to do pooling. Very few jurisdictions offer intra-pooling and extra-pooling and, for multi-manager funds, that really provides us with economies of scale. So we decided that this was the right place to be.
Luxembourg investment funds are one of the biggest export items from here into Germany and so I think that it is probably better to be located in Luxembourg than, say, other centres like Dublin
Furlonger Luxembourg is a centre of excellence for financial services. What is perhaps missing at the moment is an understanding of the customer, the pensions market, the pensions needs of individuals and the human resource directors of multinational companies.
Martins Luxembourg is also investing in resources on the transfer agency and the service side for the members of pension funds as well as the investment funds side. What we are trying to do is to learn from the American experience to see where we can improve in terms of customer service capabilities. In particular, we are trying to compare the running of the 401k plans from the service capacity aspects – what can members obtain, what kind of services, what kind of flexibility on investments and so on. More investment is going into systems and resources and I think that is going to increase in the next two or three years to get to the level where the member -the actual customer- is clearly put first. That will complement the financial and technical skills here.
Fischer I fully agree. Five years ago, there was nobody offering this kind of service here. I would say the big three or four service providers, which between them have more than 25% of the market are all offering full capabilities to that level. But the next step is basically the electronic inter-connection, branching out through Europe in order to be able to process in real time. There is still an important amount of investment to be undertaken and the pressure will be stepped up by the time new companies come to Luxembourg. However, I think the systems will be fully geared up before the first really big multinational pension fund with 10,000 or so beneficiaries is set up in Luxembourg. So I have absolutely no hesitation in saying that we are going to be up and ready in time.
Wirion From the regulator’s point of view, in order to be successful, three things have to be in place. The first is the legislation and that is in place. Of course no-one can say that our legislation has reached a final stage. One feature of Luxembourg is its flexibility and its capacity to react promptly to any new opportunity the market may offer.
The second factor is efficient supervision. I think you can only be successful in attracting pension funds when there’s a feeling that Luxembourg is one of the very safest places you can find for the protection of the rights and assets of the beneficiaries.
The third aspect is easy access to all kinds of skills in addition to asset management expertise. Where it comes to the assessment of pension fund liabilities, Luxembourg is still lacking independent actuarial service providers. Of course insurance companies have made constant efforts to increase their staff dealing with the liability side of their business, but although these experts may and will contribute to the development of an international business centre, this will not be sufficient and more independent actaurial service providers will be needed. Nevertheless, I am confident that we can catch up and have the necessary infrastructure in place the day it will be needed. When the Luxembourg Actuarial Association was created some years ago, it started with only 20 actuaries, a third working with the public sector, a third in the private sector and a third, roughly speaking, were independent actuaries. Now, the Association boasts more than 80 members.
Campill I very much agree with that. Although we have finally confirmed two pension funds, we have licensed half-a-dozen liability managers- two of which are international names. There seems to be strong interest in this area of business.
IPE What sort of business and service providers does Luxembourg want to attract?
Fischer The official public policy is to attract business at the high quality end towards Luxembourg, as we do not want an economy which is really growing too fast. So I personally have my doubts if Luxembourg would be the right place to put a call-centre in place.
Wirion Today Luxembourg insurance companies offer supplementary pension benefits for people who already have sufficient, basic coverage. These people can assume more risk; they are less interested in annuities and prefer lump sum benefits and they are willing to bear the investment risk. These are well educated people – knowledgeable about products – and they don’t need the same level of protection that you do if you are offering basic retirement provision. I see the future of Luxembourg in the next five years as a provider for supplementary pension benefits for sophisticated customers. Pensions provision for the lower income segment is a more difficult market. I would not start by developing that business as a priority.
Furlonger The Germans can see a big new market especially for private pensions. Do you think that Luxembourg can have a slice of that pie? Is it really going to be the case that there are going to be customers in Germany that are going to buy up lots of Luxembourg private pension products rather than a German one? What are the panel’s views on that?
Jaffer I think that initially the thrust is going to be domestic in Germany as one would expect. But we think it will be for the affluent consumers. Certainly you will see some movement by the major multinationals who will have some of their executives and their middle managers using Luxembourg as a conduit into the pension vehicle we have here. Luxembourg will not get a share of the whole pie but even 5 to10% of the German market is worth having.
Fabi Speaking about the services given by the pension funds to their members, from what I saw in the US, all kinds of services were available to members with all kinds of information through the internet, call centres or letters. This requires a huge investment in communication to the members and that is perhaps what we should do in Luxembourg and more widely in Europe. The Americans say this is the key to success- since pension funds aren’t mandatory, you have to give this level of service otherwise the members won’t appreciate what you are doing even if you are a good investment manager.
Bofferding We are really talking about the high net worth customers for whom the service levels afterwards are extremely important in order to retain them. So there will be less emphasis on cost of the product, in fact it could be a very expensive product because they want, in a sense, to feel special . I know that sounds like a stereotype but it is actually the case. You can see it happening here in Luxembourg if you look at the investment fund industry and if you do a comparison with the fund supermarket concept of not pushing just your own products. The majority of people don’t actually choose other funds, but the fact that you do have them available is a big attraction. It gives the impression that you are providing a personalised service.
IPE It’s time to bring up the ‘T’word
‘Taxation’ and Europe. Will that frustrate all ambitions towards a Europe-wide market?
Bofferding Much of what the client wants is tax driven in Europe at the moment. So, if he has a tax advantage in investing a certain way for his pension savings that is what he will do. Many in Europe save for pensions in a tax environment that leads them to a certain investment where not too much freedom exists, which is why customer service is not as important as it should be
For tax reasons it is very different for someone saving for his pension in one European country to invest in a pension fund in another European country. That is a point that the directive does not address but we know that the EC will in the coming months.
The taxation issue is the most important, maybe more important for the development of the market than the proposed directive. So we hope that we will have some progress here, but there is room for some pessimism, because as we know on that point the different countries in Europe will apply the brakes even more than they will on matters like the investment of pension funds.
IPE Are the pensions any more tax efficient when created through insurance vehicles?
Wirion Under the current Luxembourg legislation, there is no real difference from the fiscal point of view for a vehicle set up under the insurance rules and the one falling under the banking legislation. Both are tax neutral and there is no taxation in Luxembourg when benefits are paid out to non-residents. As for tax relief on contributions, this is up to the employer’s country to decide, within the limits imposed by the principles of non-discrimination against non-resident pension providers.
The European Court of Justice can sanction tax discriminations, but it cannot impose tax harmonisation. In a world where people are moving more and more from one European country to another or are living and working in one country while enjoying their pension benefits in another country, they will not know, when they start a pension plan, what the fiscal treatment will ultimately be. The principle of non-discrimination is just a starting point, but it doesn’t give any assurance as to what the actual tax treatment will be whenever the benefits are paid out. I’m not too optimistic about rapid progress in this particular field.
Bofferding It is important that we fight here for tax deductibility on contributions. In Europe you will also have some countries which will favour taxing benefits in a lump sum or on annuities and you will see probably some “retirement tourism” just because of this.
IPE Is there a political dimension to the pensions debate that Luxembourg needs to be concerned about?
Bofferding The political dimension in pensions usually arises when the national regulators would like to provide their local economy with capital. This assumes that there is a type of pooling of assets in a particular location. But if you understand how financial markets really function, then you will notice that is just a mere framework and that the capital flows back to the local economy.
A very important point to be made when we speak about custody, you may think that to be safe, all these assets have to be in Luxembourg. We all know that this is not the case. We all have our networks of local custodians in the different markets and that is actually where the assets are.
From the service provider side, we have a very open model here enabling them to come from any country – suppose you are an asset manager today in the UK, you can manage assets for Luxembourg pension funds and if your activity is profitable at the end of the year you will be taxed locally in the UK. So I do not think there is an issue really about where the assets are domiciled.
Fischer I do not share this view entirely. We do not yet have the United States of Europe and foremost in the mind of every national politician is domestic national interest and that is a fact. If we were to aim to become dominant on the pension fund side we would clearly be faced with the same opposition that we sometimes face in the investment fund industry. The investment fund industry basically grew naturally because when it started there was nearly no investment. Also the investment fund industry in Europe was small compared to international standards, so we were growing in an industry that basically grew larger and quicker than others. But here on the pension fund side we are in a somewhat different situation because a number of European countries have big pension fund industries. So if this is perceived as an attempt to grab the existing business of other countries and to draw it to Luxembourg by having potentially fiscal preferential treatment, I am quite sure the Berlin Wall would go up at once.
Wirion For the past 10 years, insurance companies have had the freedom to deposit their assets anywhere in the EU. There are no rules obliging them to choose a Luxembourg financial institution as their custodian. Despite this, about 70% of all assets managed by insurance companies are deposited in Luxembourg. In attracting insurance companies to Luxembourg the free choice of the asset location has been and remains an important feature. This will be true for pension funds too. I am confident that in the end, even without legal restrictions, pension fund assets will come to Luxembourg because of the competitive environment and the facilities on offer. Luxembourg must and will win this business by giving good service and not just by edicting rules aimed at the compulsory deposit of assets in Luxembourg. Compulsion would be the wrong attitude and we must convince by service not by rules.
Jaffer With regard to domiciling the assets in Luxembourg, I don’t think it is a big political pressure point, since the assets in today’s world are not really physically held in Luxembourg, they are in the markets where they are going to be invested. The fact that the investment funds business has grown so significantly means this will not be a major issue in my view.