Luxembourg is the second largest fund centre in the world after the US. Its open-minded regulator, fund-friendly legislation and regulation and developed cross-border distribution makes it a leader in Europe. Jamie Wynn-Williams reports.

There is likely to be a ‘flight to quality' in Luxembourg in 2009. Investors already spooked by the alleged Madoff fraud, Stanford Bank disaster and the ongoing financial crisis are increasingly viewing regulated funds as the better option for hedge fund investment. Particularly institutional investors are moving to onshore vehicles and approaching the larger, more regulated names in the industry.

"When investors have had their fingers burnt they tend to move to areas of quality. If you are a European bank or institution, then you are going to look at hedge funds with a regulated European domicile," concluded Kevin Mudd, CEO of KMG Capital Markets.

"Where everyone was quite happy with the likes of Caymans and Isle of Man in the past, they are going to be taking a step back from funds from those jurisdictions as a matter of security and safety. If an investor can't trust big banks and authorities like the SEC to regulate, who can they trust? It will be the more efficiently regulated domiciles like Luxembourg and Ireland that should benefit from this ‘flight to quality'," sagely noted Mudd.

Alain Guerard, vice president of JPMorgan hedge fund services in Luxembourg, agrees there is a trend in hedge funds moving to more regulated jurisdictions like Ireland and Luxembourg, and it is the investors that are now in a much stronger position to drive some of those choices. Some participants are moving their offshore vehicles onshore because there will be a great deal more focus from investors on where the fund is operating.

"I feel Luxembourg is attractive because of the framework it has for hedge funds and FoHFs as there are two types of structures or laws that can be applied. One is more restrictive and more regulated which allows distribution to a wider audience and the SIF which is a more flexible system open to qualified investors. I foresee growth in Luxembourg in 2009 driven by investor requirements," concluded Guerard.

This is good news for Luxembourg. The growth in share of the hedge fund industry has come about as hedge fund promoters are creating new products or re-domiciling hedge fund products from offshore to well respected and regulated onshore centres such as Luxembourg in order to enhance the distribution of products to institutional, high net worth and retail investors.

Another trend Guerard has seen is hedge funds using the European Union regulated UCITs products, or hybrids of UCITs funds.

"There are number of new UCITs launches taking place now from the big brand names of the hedge fund world that are exploiting the range of products that Luxembourg has to offer. Although these are not really hedge fund products, they are promoted by pure hedge funds, which is a diversification by the hedge fund community to a more long-only absolute return fund. This might attract more hedge funds to domicile in the jurisdiction so that can use the full range of funds," he said.

There has also been a huge uptake for Luxembourg's specialised investment fund (SIF) which has "helped Luxembourg keep its position as an innovative fund domicile and has underpinned much of the deterioration in the last few months", said Mudd.

His company's KMG SICAV-SIF ‘open architecture platform' was created exclusively to enable third parties to launch their own fully supported and administered Luxembourg regulated SICAV SIF funds.

With the financial crisis in full swing, Luxembourg's framework and regulation which had been perceived by some investors and promoters as a bit heavy, is now working in its favour. The Luxembourg government along with the financial regulator, the Commission de Surveillance du Secteur Financier (CSSF), has always been diligent in implementing EU directives, by adding regulation and clarification and being proactive in supporting industry consultation and new best practices. The SIF has become an integral part of this framework and helped Luxembourg stem the level of outflows since September 2008 when the country's investment fund industry saw a significant decrease in assets under management.

At December 31, 2008 total net assets of undertakings for collective investment (UCIs) and specialised investment funds in Luxembourg was down to €1.55 trillion. AUM fell 2.78% in December alone leaving the country with a 12-month net asset decline of 24.27%, according to CSSF.

The combination of Luxembourg's pragmatic regulatory developments, convergence between traditional and alternative asset classes and new marketing opportunities in regions such as the Middle East and Asia are all working in the country's favour.

Assets under administration remain largely unchanged according to some fund administrators. They say the loss of assets in the UCITs market triggered by the financial crisis has been offset by an increase in number of funds and asset volumes under Part II of the UCITs legislation and in the SIF area.