Luxembourg has embarked on a fightback in the battle to retain its crown as Europe’s largest investment fund domicile as exchange traded funds, in which Ireland is dominant, continue to siphon money away from traditional mutual funds.
The tiny nation has long punched well above its weight in the fund industry, with its low taxes, business-friendly regulatory environment and multilingual workforce propelling it into becoming the epicentre of the European industry despite its lack of domestic investors.
But the Grand Duchy has been forced to play second fiddle in the fast-growing ETF industry, where Ireland has seized pole position by rolling out its own package of tax efficiency, regulatory support and an ecosystem of fund administrators, custodians and legal firms.
Ireland was home to €1.6tn of ETF assets at the end of 2024, according to data from Morningstar, compared with just €266bn in Luxembourg. Worse still, the Grand Duchy’s market share has been falling, from 36.3 per cent of Ireland’s assets in 2015 to just 16.9 per cent now. Net inflows were €14bn last year, a paltry figure compared with Ireland’s €211bn.
This is despite Luxembourg retaining its role as European domicile of choice for mutual funds with €3.7tn of assets, according to Morningstar, well ahead of Ireland’s €1.6tn, although even here Dublin has been increasing its market share, with stronger inflows (or smaller outflows) in each of the past three years.
The stakes are high. Ireland’s asset management industry contributed nearly €1bn in direct tax revenue in 2023, directly employed nearly 20,000 people and generated €15bn in gross value added, according to a report commissioned by Irish Funds, the industry body.
Luxembourg’s financial sector is even more central to its economy. It accounts for more than 30 per cent of the country’s GDP, 11 per cent of employment and 20 per cent of direct tax revenues, according to the European Commission.
In the past few months Ireland has pushed to consolidate its European ETF hegemony still further by bringing its regulatory regime into line with Luxembourg in two areas where it had fallen behind.
In October, the Central Bank of Ireland, the country’s financial regulator, said it would scrap its bizarre naming rule that forced any fund manager that launched an ETF share class of a Dublin-domiciled mutual fund to label all the share classes as “ETF”, even those that were mutual funds.
There are also signs that the CBI has loosened its restrictions on ETFs investing in collateralised loan obligations after Luxembourg stole a march on it by bagging the first European CLO ETF.
However, Luxembourg has now hit back with two moves of its own.
Firstly, in January it scrapped a subscription tax, known as the tax d’abonnement. This tax was equivalent to 5 basis points a year for actively managed ETFs and retail share classes of active mutual funds (with institutional classes paying 1bp).
“We shouldn’t handicap ourselves,” said Tom Théobald, chief executive of Luxembourg for Finance, a public-private partnership between the government and Profil, the financial industry federation.
“We are the main hub for active funds [in Europe],” he added. “There is the potential for [mutual] fund managers to replicate their investment strategy in an ETF, which is another distribution channel, by adding another share class.”
Secondly, the Commission de Surveillance du Secteur Financier, the regulator, has cleared the way for active ETFs to adopt the type of semi-transparent, portfolio shielding structures that have long been permitted in the US.
These structures mean an ETF does not have to publish its full portfolio every day, a scenario some active managers fear allows other market participants to front run them and steal their “secret sauce”. Instead, the CSSF will permit ETF issuers to disclose their holdings as little as once a month, with a one-month lag.
Semi-transparent portfolio structures have not really taken off in the US, where the majority of active ETF managers have been happy to ape the full transparency adopted by passive ETFs.
But Théobald said semi-transparency was “a demand we have had from the industry”.
“It’s a discussion we have had with some of the large US players. There is definitely an interest there,” he added.
Active ETFs have yet to really take off in Europe, where they currently account for just 2.4 per cent of ETF assets, although flows are running at about three times this rate. This pales in comparison to the US, where active ETFs have grabbed 8.1 per cent of the market, and their share of flows is about 28 per cent.
A number of issuers have launched their first European active ETFs in the past year, though, including Ark Invest, BNP Paribas Asset Management, Abrdn and Robeco, while BlackRock debuted its first active equity ETFs.
Janus Henderson, which joined the throng in October, has predicted that the European active ETF market will balloon nearly 20-fold to $1tn by 2030.
Given the overwhelmingly active nature of Luxembourg’s fund industry there is some urgency in the Grand Duchy’s efforts not to let the active ETF opportunity slip through its fingers.
“We want to make sure that if it develops only a fraction of the way it has in the US that we have a good market share,” Théobald said.
Adrian Whelan, global head of market intelligence for investor services at Brown Brothers Harriman, said Ireland had “a significant head start” over Luxembourg in the battle for ETF business, given its “deep ecosystem”, its shared language with US asset managers and UK-based market makers and a tax treaty that halves the levy on US dividend income.
For American managers already running US-domiciled funds, Whelan believed “the gravitational pull” would continue to be to Ireland, but “if your critical mass is in Luxembourg it will be cheaper to do it there”, he added.
