If you haven’t found time to revisit Luxembourg—a tiny European state governed by a Grand Duke—in fifteen years, you may not recognize it now.
For decades, the country’s capital, called Luxembourg City, was a sleepy medieval city whose tranquil streets were home to a secretive finance industry.
But now its roads regularly resemble a jammed metropolitan highway—signs of a finance industry resurgence that has become far more visible.
“My dad’s generation is particularly bitter about this,” says Nathalie Weiss, a marketing manager at Vodafone, who grew up in the country. Her father is frustrated with the overcrowding on the roads, but she’s delighted with the renaissance, she admits. And in any case—she doesn’t expect an imminent slowdown.
“Especially with developments like Brexit, that doesn’t look like it’s going to happen any time soon,” she says.
As Britain prepares to leave the EU, companies are jostling to ensure that business is not disrupted. Many are choosing Luxembourg as a base within the bloc, putting the country on track to be a relocation runner-up, alongside places like Ireland, France and Germany, which all have vastly larger populations.
The country offers companies a lucrative ecosystem. But the companies offer Luxembourg something, too—a chance to be a fully-fledged financial capital, just years after unflattering revelations about its tax system, known as the “LuxLeaks” scandal, drew a furious global backlash.
Birth of a finance hub
The Grand Duchy of Luxembourg, as it is officially called, is a small constitutional monarchy sandwiched between Germany, France and Belgium, with a Grand Duke instead of a king.
Home to about 600,000 people in an area slightly smaller than Rhode Island, it is best known for its imposing medieval castles, multilingual citizens (they speak French, German and Luxembourgish), and historically secretive finance industry.
Until the 1960s, steel production dominated the country’s economy. But when the EU introduced rules in the 1980s making it easier for asset managers to sell mutual funds to retail investors, the government embraced the changes more quickly than larger financial hubs did, sowing the seeds for the growth of a globally influential finance hub.
That embrace, however, coupled with an infamous system of tax loopholes, led to a reputation of a tax haven for multinationals and the super-rich. In 2014, the “LuxLeaks” revelations identified hundreds of companies, many of them household names like Amazon and FedEx, as receiving massive tax breaks.
Amazon in a statement at the time said that it had “received no special tax treatment from Luxembourg” and that it is “subject to the same tax laws as other companies operating [there].”
A FedEx spokesman at the time said the logistics company serves hundreds of countries and territories and is often required to establish legal entities in many of them, and had not used its entity in Luxembourg to reduce its tax base.
Following the backlash, the country adopted strict new rules on banking secrecy, and the finance industry has tried to reinvent itself as a thriving, transparent center for capital markets in a post-Brexit world. It’s starting to reap the benefits: today some of the world’s best-known tech companies, including eBay, Skype, and Paypal, have their European headquarters in Luxembourg and others are relocating to the country almost every month.
All the while, Luxembourg has remained a major asset management hub: the country is the second-largest market outside of the U.S., with an estimated 4 trillion euros ($4.5 trillion) worth of assets domiciled in the country.
A continental runner-up
The U.K.’s 2016 vote to exit the European Union later this year could mean that British financial firms lose their “passporting rights” that allow companies in EU member states to service clients across the bloc.
Many banks have already chosen hubs like Dublin, Frankfurt, Paris, and Amsterdam to secure a foothold in the EU post-Brexit, but Luxembourg’s capital is outstripping rivals many times its size.
According to an analysis published earlier this year by think tank New Financial, 275 firms in the U.K. have already moved or are moving some of their business, staff, assets, or legal entities from the U.K. to the EU in preparation for Brexit. Around 250 of those companies chose specific “post-Brexit hubs” for their EU business.
While Dublin ranked No. 1 with around 100 relocations, Luxembourg scored a solid second with some 60 relocations—nearly a quarter of the Brexit-related moves.
The Brexit shift has mainly bolstered two traditional areas of the finance industry: asset management and insurance, where the Duchy already has a well-established global presence.
Statistics released by the Luxembourg financial regulator, the Commission de Surveillance du Secteur Financier (CSSF), showed that Luxembourg gained 10 authorized investment fund managers in 2017—the most recent official data available—bringing it to a total of 306 entities.
In its annual report published in March, the Luxembourg insurers’ association said that it had welcomed 15 new corporate members, including London’s Hiscox and RSA, growing its total membership to 84 companies. In 2017, U.S. insurer AIG said that it would be setting up a subsidiary in Luxembourg as a direct response to Brexit.
The country has also snagged a major player in the e-payments field: Alipay, the online payments business of China’s Alibaba. Already licensed in London, Alipay received an electronic money license in Luxembourg in January. Though the company didn’t directly cite Brexit as a reason for the move, many analysts at the time noted that it was likely driven by the U.K.’s expected exit from the bloc.
“ManCos” and taxes
What’s lured business to Luxembourg in the Brexit era? The country has its advantages: extensive existing finance infrastructure and tax conditions that are favorable compared to some peers, along with good connections to other transit hubs, a cosmopolitan feel, and English-language schools.
A major draw for asset managers has been the prevalence of Luxembourg’s third-party management companies or “ManCos,” which are regulated special purpose vehicles that enable businesses outside the EU to easily launch Europe-domiciled mirrors of funds managed in other parts of the world.
According to a study by professional services firm PwC, Luxembourg is today home to over 300 ManCos, a number that has increased 4.5% over the last year.
Though the country has historically been plagued with a reputation for being a tax haven, its standard rate today is broadly in line with—or even higher than—many other European hubs. For example, the combined Luxembourg City corporate tax rate is about 25%—lower than France’s roughly 33%, but far higher than Ireland’s standard 12.5% rate. Nonetheless, the Tax Justice Network, a group campaigning for tax transparency, in May published a report putting Luxembourg sixth in a ranking of 64 countries based on the ease of cutting corporate tax bills. Luxembourg’s No. 6 spot doesn’t mean its tax rate is the sixth-lowest in the world, but it does suggest that Luxembourg offers more loopholes than other countries for multinational firms trying to keep their tax bills to a minimum.
‘Bursting at the seams’
As the country looks to establish itself as a post-Brexit hub, it does face come constraints. One is the end of banking secrecy laws that underpinned much of its finance industry in the wake of the LuxLeaks revelations. New laws that went into effect in 2017 have made it easier for authorities to identify illicit cash flows and tax evasion.
Critics have said those changes might dent Luxembourg’s appeal, but government officials argue that tightening regulations and conforming to international standards will only bolster the country’s place in the global financial landscape in the long run.
Nicolas Mackel, head of Luxembourg for Finance, the country’s agency for the development of the industry, argues that the shift has increased Luxembourg’s credibility as a finance center for major companies and made its finance industry more stable.
“As a financial institution looking to relocate, you simply go where it makes sense to go,” says Mackel. “Luxembourg is a real hub for stability and that’s what businesses value.”
Luxembourg City’s size is another barrier to consider. Like other small cities that have experienced rapid growth, it is now facing the prospect of too few schools and home prices that are too high.
Nicki Crush, director at the International School of Luxembourg, says that her school has experienced an overall increase in international applications, including from the U.K. “But at this point ISL has no plans to increase its infrastructure,” she said.
In 2018, the average sale price for a home rocketed 11%, while the cost of renting soared 16% for houses and 10% for apartments, according to property portal atHome.lu.
Meanwhile, the population of Luxembourg is expected to exceed one million by around 2061 or 2062, a jump of more than 66% from today’s levels, according to the EU’s statistics agency. Brexit could intensify the situation. Even though many companies have already implemented their relocation plans, some are still waiting for more clarity before casting a decision.
Many residents say drastic action is needed for the country to maintain its competitiveness amid the demographic swelling. One proposal is to release land not originally zoned for housing and to create higher density developments like high-rise buildings.
“Luxembourg is simply bursting at the seams,” said Charles, a local taxi driver who declined to give his last name. “It’s all good and well to be known as a post-Brexit haven. But if we can’t even sort out the basics like traffic and housing then no one will want to live here. That’s just the way it is.”
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