If Luxembourg is among the jurisdictions leading the global shift toward sustainable finance, that shouldn’t be a surprise – it’s been actively pioneering initiatives targeting social responsibility, environmental protection, and measures to curb climate change for years, in some respects dating back to before the global financial crisis prompted the industry to re-examine its driving motivations and the impact of its activities.
As long ago as 2006, seven Luxembourg organisations – government ministries, financial sector professional bodies and institutions, and the European Investment Bank – created the non-profit Luxembourg Finance Labelling Agency[i] (LuxFLAG) to certify the responsible investment credentials of funds and other financial instruments. LuxFLAG’s initial focus was microfinance funds, then a little-known segment of the industry mostly concentrated in the grand duchy; today it has expanded its scope to a much broader range of categories including ESG, green bonds, the environment, and climate finance.
One of LuxFLAG’s founder organisations, the Luxembourg Stock Exchange, has also played a ground-breaking role in the emergence of green and sustainable criteria as a key element of the capital markets. In 2007, it listed the world’s first socially responsible bond from the European Investment Bank, followed by the first security to be designated a green bond, issued by the World Bank.
Development Of The Luxembourg Green Exchange
More than a decade later, the exchange lists more than half of the world’s sustainable bonds and almost half of the green bonds. In September 2016, it launched the Luxembourg Green Exchange[ii] (LGX), a listing platform for securities aligned with the United Nations’ Sustainable Development Goals as well as the Paris Agreement climate change targets. The LGX now accounts for more than 900 securities and US$500bn in assets.
It has continued to enhance its platform and services with the creation last year of the LGX Academy[iii] to provide training to current and aspirant members of the industry; the LGX Data Hub[iv], which provides previously unstructured pre- and post-issuance information on green, social responsibility and sustainability bonds; and the Solactive LGX Green Bond Impact Index[v], a joint initiative with German index provider Solactive to provide a benchmark composed of selected Luxembourg-listed bonds that exclusively fund projects with a positive environmental or climate impact.
The development of such initiatives has been encouraged by Luxembourg’s government which adopted sustainable finance as one of the central goals of the coalition government that won a second term in 2018. In October that year, it published the Luxembourg Sustainable Finance Roadmap[vi], drawn up in partnership with the UN Environment Programme Finance Initiative on the basis of a consultation with members of the financial industry and other civil society stakeholders.
Sustainable Finance Strategy
The roadmap sets out recommendations for a comprehensive and far-reaching sustainable finance strategy, drawing on Luxembourg’s existing strengths as an international financial centre and in coordination with EU initiatives, to contribute to the UN’s 2030 Agenda for Sustainable Development and the Paris Agreement objectives. Its specific aims are to ensure that investors enjoy a comprehensive and transparent offering of sustainable investment opportunities; to support asset managers in establishing, managing and distributing sustainable products; to help sustainable businesses access long-term funding; and to evaluate the impact of sustainable financial products to create clarity and confidence and curb greenwashing.
In furtherance of the roadmap’s goals, in January 2020 the Luxembourg Sustainable Finance Initiative[vii] was established by the government, industry promotion and development association Luxembourg for Finance, and the High Council for Sustainable Development, an independent advisory body to the government representing civil society. The non-profit association is responsible for designing and implementing a Sustainable Finance Strategy to raise awareness of, promote and help develop sustainable finance initiatives in the grand duchy.
In September 2020, Luxembourg’s finance ministry unveiled the Sustainability Bond Framework, becoming the first European country to adopt such a model, and launched Europe’s first sovereign sustainability bond, a €1.5bn issue displayed on the LGX platform. The framework is compliant with the International Capital Market Association’s 2018 principles on green, social and sustainability bonds, and incorporates eligibility criteria in line with the final report of the Technical Expert Group on the European Union’s Taxonomy Regulation as well as being designed to comply with the draft European Green Bonds Standard.
Reduction In Tax For Sustainable Assets
At the beginning of this year, the government also introduced a reduction in subscription tax on investment fund assets. The measure lowers the tax rate for Undertakings for the Collective Investment in Transferable Securities (UCITS) and funds established under Part II of Luxembourg’s investment fund legislation, as well as their sub-funds, from the standard annual rate of 0.05 per cent of net assets to 0.04 per cent where at least 5 per cent of assets are invested in qualifying sustainable activities, in graduated steps down to 0.01 per cent where at least 50 per cent of assets are invested in qualifying activities.
The investment fund industry is central to Luxembourg’s embrace of sustainable finance. The world’s second largest fund domicile after the United States, it is the biggest cross-border distribution hub within the EU’s single market, and funds from the grand duchy are also dominant in Asian markets such as Singapore, Hong Kong and Taiwan, as well as in the Middle East and Latin America. The country is home to investment products from the world’s largest mainstream asset managers serving retail investors as well as, increasingly, providers of specialised real estate, private equity, private debt and infrastructure offerings.
As a result, aside from the efforts on the part of the financial services industry and the authorities to develop the country’s sustainable finance expertise and experience, Luxembourg is a natural choice for established managers launching dedicated green and socially responsible investment products or adapting existing funds to ESG criteria.
Complying With The SFDR
This means that the grand duchy’s fund industry has been on the frontline of efforts to fall into line with the EU’s Sustainable Finance Disclosure Regulation (SFDR) ahead of the March 10 deadline for compliance – complicated by the European Supervisory Authorities’ delay in finalising the regulatory technical standards (RTS)[viii] setting out details of the information to be disclosed.
The standards are designed to strengthen protection for investors by improving environmental, social and governance disclosures on the main adverse impact of investment decisions and on the sustainability characteristics of a wide range of financial products, in response to investor demands for sustainable products and protection against greenwashing. The authorities say they are seeking to strike a balance between achieving common disclosures for all the financial products covered by the SFDR and recognising that they will be included in documents that vary significantly in length and complexity.
The industry has benefited from the approach of Luxembourg’s financial regulator, the Financial Sector Supervisory Authority (CSSF). In the run-up to implementation of the SFDR, the regulator created a fast-track procedure for asset managers or management companies to submit amendments to their prospectuses or offering documents for approval ahead of the deadline.
In their final report incorporating the regulatory technical standards in February, the European Supervisory Authorities – the European Banking Authority, European Securities and Markets Authority and European Insurance and Occupational Pensions Authority – proposed delaying the standards’ implementation until the beginning of next year.
Ongoing Uncertainty On Implementation
The proposed delay aims to give financial market participants and advisers sufficient time to gather the information needed and adjust their practices to apply the requirements of the standards, and to provide for the alignment of the SFDR application with amendments to the EU’s Taxonomy Regulation, as well as the application of periodic reporting under the SFDR.
The RTS still await adoption by the European Commission, after which the European Parliament and European Council could yet raise objections that could lead to changes to the standards. However, the CSSF has urged industry members to take advantage of the interim period of more than nine months to prepare to implement the standards.
The Luxembourg regulator says it is awaiting the Commission’s response to the supervisory authorities on key areas of uncertainty relating to interpretation of the SFDR. These comprise:
Erring On The Side Of Caution
The ongoing questions about the timing, content and interpretation of the regulation point to the challenges still ahead for Luxembourg’s fund industry arising from the EU’s sustainable finance legislation, including the Taxonomy and Benchmarks regulations. For now, it appears that asset managers are erring on the side of caution by allocating funds to the SFDR Article 6 category of funds that do not make any sustainability claims (whether they assess sustainability risks or explain why they are not doing so), or funds with environmental or social impact category under Article 8, rather than tackle the greater complexity of sustainable investment strategies under Article 9.
In addition to the outstanding SFDR implementation issues, this is attributed in part to the acknowledged gaps in availability of the data that asset managers or their management companies need to obtain from their portfolio companies, especially for retail funds. But industry participants and regulators underline that the adaptation to sustainable finance transparency rules is very much a process rather than a change from one day to the next.
However, given the country’s years of experience in developing environment, climate and socially responsibility initiatives, the commitment of the government authorities and industry organisations to developing expertise in the sector, and the ability to learn from best practice among the many leading asset managers that use the grand duchy as a fund hub, industry members are confident that, as in other areas of the international financial services industry, Luxembourg is well placed to maintain its global leadership in the emerging environment where sustainable financing is shifting from the specialist fringes to the mainstream.
Olivier is Head of Investment Management at Chevalier & Sciales (www.cs-avocats.lu) in Luxembourg, specialising in investment funds. He has been recommended in several legal guides, including Who’s Who Private Funds 2021, Legal 500 2021 and Leaders League 2021.