On December 22nd, 1972, investment funds in Luxembourg became subject to supervision for the first time. Initially, the rules provided investors with significant protection, but over time, they have only served to increase the fees they pay.
Delegation
Delegation is one area of the industry that has become so complex that it's almost impossible to see the bigger picture. It's a cornerstone that has facilitated the industry's growth while also making it increasingly obscure.
Obscurity is precisely what regulators are supposed to prevent, so they mandated that while work can be delegated to third parties, the responsibility cannot be. This has led to a situation where overseeing your delegates has become a central activity.
The current system involves demonstrating that your delegate is an honest actor and has the capacity to perform the outsourced work. This is partly done by screening them with AML tools and collecting data from them through questionnaires.
Problem
However, the problem is that the system is highly inefficient; you might receive the same data requests from different parties, often in different formats. This means that you must allocate resources to a task with little added value.
Ultimately, it's the investors who bear the cost of the time spent on oversight.
Solution
A solution to reduce oversight costs in the industry could be for the CSSF to conduct due diligence on delegates and share the results with the industry. Approved delegates would be whitelisted, requiring no further due diligence on them.
By taking on more responsibility, the CSSF would increase fees to industry participants. These participants would cover the additional fees with the savings they make from reduced oversight work. Centralizing due diligence would, in turn, lead to lower fees for investors.
While oversight would no longer be mandatory for whitelisted delegates, many would still choose to oversee their delegates for commercial reasons. Just as in any industry, it's wise to ensure that your supplier adheres to your agreement.
With non-mandatory oversight, there would be significantly less monitoring. For instance, performing due diligence on well-known regulated entities would be seen as duplicating work and thus redundant.
Reimagining
This could serve as a starting point for reimagining the role of regulators in the fund industry on a larger scale. Any initiative that enhances trust among participants would reduce costs, increase efficiency, and lower fees for investors.
Sometimes, regulations introduce obligations that eventually become structurally challenging and no longer reasonable. If we were to start anew on a blank page, the governance system we design would differ significantly from what we have today.
Gregory Kennedy is a columnist for Investment Officer Luxembourg. His columns appear on Wednesdays. He also works as a business development manager at Finsoft Luxembourg.
