Administering instead of hiding

LUXEMBOURG’S financial elite gathered recently for the grand opening of its free port, which will soon house troves of fine art, vintage wine, precious metals and other valuables, beyond the reach of any taxman. The facility is one of the three finest of its kind, along with those in Singapore and Geneva. Local moneymen hope it will add to Luxembourg’s allure as a wealth-management centre.

Aside from its multilingualism and its location at the heart of Europe, Luxembourg’s main attraction as a financial centre has been its forgiving approach to taxation, for both individuals and businesses. Yet that selling-point is under threat. Global moves towards more systematic exchange of tax information have dealt a blow to the bank secrecy that made Luxembourg a Swiss-style haven within the European Union. The country is also one of the main targets of an international push, led by the OECD and the European Commission, to close loopholes that allow multinationals to massage down their tax bills. Brussels is investigating the Grand Duchy’s arrangements with Amazon and Fiat, suspecting that they constitute illegal state aid. With the holding companies or finance and treasury operations of thousands of other firms located in Luxembourg for tax reasons, more probes are likely to follow.

All is not lost, however. Luxembourg could lose some of the firms that have located there solely because of its tax-friendliness. But others are likely to beef up their presence to head off accusations that their local subsidiaries are mere brass plates. “We’re seeing companies ask how much substance they need to stay here and keep below the radar,” says a lawyer.

Moreover, the erosion of financial secrecy has had a less wrenching impact than predicted. After dipping in 2008, the assets of Luxembourg’s private banks have climbed back to their level before the financial crisis and the accompanying assault on tax havens. As the proverbial Belgian dentists fled, the banks plugged the gap by picking up a smaller number of bigger, tax-compliant clients—typically entrepreneurs looking for expertise in financing and inheritance planning.

Luxembourg has carved out a niche serving clients that need to navigate the EU’s many national tax, legal and financial systems which, for all the harmonisation to date, remain different in many respects. It has become the EU’s main hub for several large Chinese banks, including Bank of China and ICBC. Swiss banks, too, increasingly use the duchy to serve EU clients. Even German banks send customers with complex, pan-European affairs to their Luxembourg offices.

The Chinese have another reason to beef up in Luxembourg: it has established itself as the largest centre for yuan lending, deposit-taking, investment funds and securities-settlement in the euro zone. Luxembourg’s role will be boosted further by the Chinese central bank’s recent decision to allow the yuan to be traded directly against the euro in the interbank foreign-exchange market. It is also, on some measures, the third-largest centre for Islamic funds, after Saudi Arabia and Malaysia. To show its commitment in this area, Luxembourg’s government recently issued the first euro-denominated sovereign sukuk, the Muslim version of a bond.

Luxembourg has another string to its bow, as a giant centre for the administration (but not management) of investment funds. It handles the back-office functions and distribution for nearly 4,000 funds with combined assets of €2.9 trillion ($3.7 trillion). It has benefited especially from the rise of the “UCITS” fund, a European product that is popular with retail investors in Asia. It sees new European rules on products that appeal to institutional investors, such as private equity and hedge funds, as an opportunity to offer similar services to a new set of clients. Pension-fund managers in Asia and Latin America are increasingly using Luxembourg-registered funds to make investments in the EU.

Officials like to say that funds have become Luxembourg’s “flagship” financial business. The industry is largely insulated from adverse developments on the tax front. Its growth may explain why Luxembourg and Gibraltar were the only places in Europe to make it into the top ten of a recent ranking of global financial centres, measured by whether they were likely to grow in importance.