Private Debt in Luxembourg

Luxembourg is well-established as a major center for private debt in Europe. The eighth edition of our Private Debt Fund Survey (click link for survey Private debt fund survey 2024), conducted in collaboration with the Association of the Luxembourg Fund Industry (ALFI), reveals a striking 21.5% increase in Assets under Management (AuM) for private debt from June 2023 to December 2023, reaching an impressive €510 billion. This growth has been driven by Luxembourg’s strong financial infrastructure, benign regulatory environment, and strategic location. These factors combined make it an attractive destination for a wide range of players including private equity firms, institutional investors, and corporations looking for alternative financing solutions.

Historically, private debt has only played a supporting role in the financial landscape in Luxembourg, with the focus being on traditional bank lending. However, the 2008 financial crisis changed things significantly. Regulatory reforms meant that banks implemented stricter lending criteria, which gave rise to some significant funding gaps that private debt providers could step up to fill. Private debt began to emerge as credible alternative financing option. Luxembourg, with its flexible regulatory framework and acknowledged status as a leading financial center, became an ideal environment in which private debt funds could grow, attracting both local and international investors.

• Increasing Interest in Alternative Investments
  As they seek higher yields, institutional investors, including pension funds and insurance companies, are increasingly looking to private debt as an investment option. It is an asset class which has increased its appeal due to its potential to deliver strong risk-adjusted returns as well as boosting portfolio diversification. As a result, private debt has become a more significant component of institutional investment strategies.
  
  
• Range of Financial Solutions
  The private debt sector in Luxembourg has evolved to offer a variety of investment strategies, including direct lending, mezzanine financing, and distressed debt. Such a range enables lenders to meet the needs and requirements of different client types, from small and medium-sized enterprises (SMEs) to large corporations. This has given rise to a diverse and competitive market, increasing the ability of participants to find solutions that suit their investment priorities.
  
  
• Supportive Regulatory Environment
  The regulatory framework in Luxembourg has played a key part in the growth of private debt. The principality’s flexible legal structures for investment funds, including the Reserved Alternative Investment Fund (RAIF), Special Limited Partnership (SCSp), Specialized Investment Fund (SIF), and Special Limited Partnership (SLP) support both customization and operational efficiency in developing private debt vehicles. It is an investor-friendly landscape that both attracts domestic players and appeals to international investors, increasing loan origination and participation. At the same time, Luxembourg’s regulatory regime also requires robust risk management from lenders and institutions, which increases investor confidence.

• Institutional Adoption
  The private debt market in Luxembourg is becoming increasingly institutionalized. Growing numbers of institutional investors are allocating capital to private debt, which is creating larger funds with more structured investment frameworks. This is enhancing the professionalism of the market as well as increasing its transparency, boosting its appeal to a broader range of investors.
  
  
• Growing emphasis on ESG
  The environmental, social, and governance (ESG) agenda is assuming a significantly higher profile within private debt investing. Increasingly, investors are seeking to ensure that their portfolios reflect sustainable practices, with Luxembourg at the forefront of this trend. Numerous funds are now incorporating ESG criteria into their investment processes, displaying a commitment to responsible investing and aligning with global sustainability goals.
  
  
• Technology Innovation
  Technology is rapidly being integrated into the private debt sector, transforming operational efficiency. This includes the deployment of advanced fintech solutions for data analysis, risk assessment, and loan servicing. The result is streamlined processes and better decision-making capabilities. This technological advancement brings particular benefits for the management of large and complex loan portfolios, bringing firms the ability to respond more quickly to market demands.

• Growing Market Competition
  As the private debt market in Luxembourg continues to expand, the influx of participants naturally creates greater competition to secure deals. The effect of this can be to compress yields, which makes it harder for investors to achieve desired returns and increases the associated risks for fund managers.
  
  
• Regulatory Changes
  While Luxembourg boasts a flexible regulatory environment that has supported private debt growth, any significant changes to regulation in the future could have an impact on market dynamics and investor confidence. Participants need to remain vigilant in keeping abreast of regulatory developments.
  
  
• Economic Volatility
  Like most other parts of the financial ecosystem, the private debt sector is susceptible to global economic fluctuations, including inflation and geopolitical tensions. Such factors can impact borrowers’ financial robustness, potentially leading to increased default rates and reduced market stability.

• Positive Market Outlook
  The future of private debt in Luxembourg appears bright. With continuing demand for alternative financing and increasing institutional interest, the market looks poised to expand further. With borrowers attracted to the flexibility that private debt offers, fund managers that innovate and diversify their offerings are likely to uncover new opportunities.
  
  
• Strengthening Regulatory Environment
  Luxembourg's commitment to maintaining a robust regulatory framework while also supporting innovation should further enhance its status as a leading hub for private debt in Europe. New regulations, such as the European Long-Term Investment Fund 2.0 (ELTIF 2.0) and the Alternative Investment Funds Directive II (AIFMD II), are set to create new pathways for European AIFs, stimulating exploration of non-traditional financing options. This environment is likely to attract more investors and fund managers, cementing Luxembourg’s pivotal role in the evolving private debt landscape. Our recent article on ELTIF Does ELTIF 2.0 fulfill its promise? may also be of interest.

The growth and development of private debt in Luxembourg is in many ways the result of significant shifts in the global financial landscape, namely an increased search for yield, a growth in institutional participation, and greater focus on sustainability. As the market matures, stakeholders must remain flexible and responsive in order to navigate challenges and take advantage of emerging opportunities.

Luxembourg has a deep understanding of the sector, and its well-established financial ecosystem provides a strong foundation for navigating the changes in the market. There’s also an ongoing dialogue between regulatory bodies and market participants, with key players like the Luxembourg Fund Association (ALFI) and the Luxembourg Private Equity & Venture Capital Association (LPEA) ensuring that regulations stay in line with market needs. This collaborative approach helps to create a regulatory environment that encourages growth and stability, while also supporting innovation in the sector.

During times of economic volatility, such as inflationary periods, Luxembourg’s private debt market has shown remarkable resilience. With much of the financing structured on variable terms, the market can adjust to shifting conditions, effectively safeguarding portfolio performance.

With an established foundation of innovative solutions and a robust regulatory framework, private debt is well-positioned to continue as an important feature of diversified investment strategies in the years to come. Luxembourg’s ongoing commitment to maintaining a supportive environment for private debt should underpin its sustained relevance and position in this evolving financial sector.

Our Private Debt Experts support clients in all stages of the private debt investment lifecycle. We bring value through our multidisciplinary approach where we combine cross-border expertise in tax, audit, accounting, funds services, valuation, consulting and deal advisory together with our global network. Don’t hesitate to connect with your KPMG team for more information and insights.

This article has been co-authored by Julien Bieber (Partner, Tax, Alternative Investments), Valeria Markel (Partner, Audit, Asset Management) and Aalia Razaque (Manager, Audit, Alternative Investments).