Luxembourg Sets Pace for Private Credit in Europe

The Luxembourg fund sector has seen significant inflows in 2023 and in a cautionary investment climate, rather than equities or bonds, a significant proportion of this capital is going into alternative investment strategies and especially into private credit. Throughout the year, fears have grown over a potential significant correction in public markets and a major move down in equities. Private credit has been a key beneficiary of this mood and Luxembourg has been right at the centre of this activity as a primary jurisdiction for private credit in Europe.
 
With one of the large asset management firms in the European market launching a private credit fund in Luxembourg every eight days or so, it is no exaggeration to say this sector is booming, as interest rates have soared and regional banks step back from lending in a highly uncertain business climate.  Amid further disruption and volatility in the banking sector, with investors still hungry for returns, the trend shows no sign of slowing.  From a fiduciary services perspective, we have seen tremendous growth in demand for independent directors to the general partners of these funds.   

Active Markets

From a 30,000 feet view, private credit is being facilitated by global or regional asset managers who see opportunities for financing in their domestic market.  An industry with US$1.4 trillion undermanagement globally at the end of 2022, research firm Preqin expects private credit to grow to $2.3 trillion by 2027. 

Coming from outside of the traditional corporate finance world, the development of private credit has been interesting to observe, particularly the white-hot European market with asset managers in the US, the EU and London, accessing pools of funds from investors both in Europe and further afield.  The strategy saw significant growth in 2020 and 2021 and the industry has accelerated further since then.

As a highly accepted brand for all forms of financing and investment fund activity, with unparalleled global distribution capability, investors are also very comfortable with Luxembourg’s legal protections and the range of flexible corporate vehicles.  These entities are highly suitable for investment funds, with specific qualities to enable efficient management and governance suited to their particular needs, within a stable and robust regulatory framework. In similar fashion to private equity, the private credit market has gravitated firmly towards the Special Limited Partnership (SCSp) as the favoured vehicle, since Luxembourg modernised its limited partnership regimes in 2013.  It can be established easily, offers tremendous contractual freedom, has limited liability and no legal personality.  Tax transparency also means that no additional layer of taxation is levied at the fund level and this set of conditions have helped the private credit fund sector to flourish. 

Luxembourg’s modern legal framework for investment funds gives funds a greatly increased range of structuring options. These include the ability to set up regulated funds which are subject to supervision and also funds without direct supervision from the Commission de Surveillance du Secteur Financier (CSSF).  Instead, the CSSF (or the relevant other regulator in the manager’s home jurisdiction) monitors fund activities at the fund management company level. 

The ability to launch extremely fast, without the requirement for prior regulatory approval, has made SCSp's and the opt-in RAIF regime the de facto choices for private credit funds in Luxembourg. RAIFs (and SCSp's which are managed by AIFMs domiciled in the EU) can also be marketed to professional investors in the EU on the AIFMD marketing passport.  At least partially thanks to broad investor acceptance, more than 8,600 SCSp's exist and over 2,300 RAIFs have been established since the product launched in 2016.  While not all of these funds invest in the private credit space, a large number do.

Risk Appetite and Efficient Lending

Different private credit strategies have emerged as the market has developed, including direct lend, distressed credit, mezzanine, real estate, infrastructure and special situations funds. Where the fund is managed by a private equity manager, contractual arrangements will include pledges on the business or a conversion mechanism whereby the fund will take over the business in the event of default.  The manager will already have the expertise to run the business, or can find the right people to do so after a takeover, however there is no appetite among the banks to have such assets on their books. 

Essentially, in a high interest rate environment, at any time when there is a risk of interest rates rising or remaining at elevated levels and for as long as credit is not easily available, the market opportunity persists for private credit funds to capitalise. The funds are more receptive to this risk and can participate while banks are averse to lending or simply move too slowly. Although banks are creeping back into the picture, there is no doubt it is a difficult business climate.  While the banks are protecting capital, funds in the private credit space are able to churn out multi-billion euro transactions at a rapid pace.  Deals that incorporate conversion to equity have also become very common but these are difficult for the banks to utilise without creating a specific type of bond.

Essentially, it is the ability of private credit funds to lend on a highly efficient basis, without the need for endless credit committees, which allows these funds to act fast and seize opportunities by making credit available to the borrowers or acquiring distressed debt at attractive pricing.  Through this market, industry leaders such as Morgan Stanley and Goldman Sachs have access to the users of capital in a novel way.  There has always been the need for various forms of capital raising and private credit is now a well-established mechanism, allowing for example, a firm in Turkey to build a new factory when banks don’t want to lend.  As private credit funds take up the slack, dominating the funds scene in Luxembourg in the meantime, the trend looks set to continue. Whether the capacity of borrowers to continue to repay at elevated rates for extended periods can be maintained, is something that will be monitored closely as the economic cycle plays out.  This should affect all players, although funds tend to lend at higher rates than banks. It is also likely that further potential failures are still embedded in the lending space that are not revealed until the tide goes out and further contraction in that market may lead to additional opportunities for alternative providers of credit, including debt funds.

The Maples Group in Luxembourg

At the centre of Europe, Luxembourg provides a gateway to EU investors with access to the EU fund marketing passport through the AIFMD. Alongside Ireland, it is a politically stable jurisdiction and fully compliant with all international AML requirements.  Luxembourg is also a sustainable finance leader, as well as one of the few remaining Triple A-rated financial centres. As a jurisdiction, Luxembourg has also built up a weight of intellectual capital within the private credit and debt space, which institutions have come to rely on and which is hard to replicate elsewhere.

As the private credit market evolves with continued regulatory change and a strong current focus on the integration of environmental, social, and governance (ESG) factors into investment strategies, practitioners need a service provider with the knowledge, experience and scale to match their ambitions and the growing compliance demands that come with it. 

Renowned for our expertise in alternative investment funds and structured finance, the Maples Group is a leading provider of specialist fiduciary services to the private credit industry in Luxembourg, alongside fund services and legal services through our independent law firm, Maples and Calder (Luxembourg). Our professionals, acting as independent directors to the general partners of these vehicles have extensive backgrounds in the fields of law, accounting, investment banking and credit markets, bringing in-depth knowledge of complex regulatory requirements and best practice. Operating across a global network, coupling an institutional-grade infrastructure with a sophisticated approach, we deliver full solutions, including fund, legal and global entity management services, in a highly responsive manner to provide unmatched client satisfaction.