Agefi Luxembourg - février 2025

AGEFI Luxembourg 8 Février 2025 Economie / Banques OPINION – by Prof. Dr. Bruno COLMANT, member of the Royal Academy of Belgium D onaldTrump is imposingmas- sive import tariffs onhis three main economic partners and soon onEurope. Is this a permanent measure ormerely a negotiating tool? No one knows. But let’s imagine these tariffs become perma- nent. This will inevitably lead to imported inflationintheUnitedStatesandalossof efficiencyandcompetitiveness.Indeed, protectionism provides relief for jobs and businesses in the short term. How- ever, over time, it creates inefficiencies due to the lack of international competi- tion, which is linked to the protection of import taxes. Moreover, for substitutable goods,thiswillresultinfewerAmericanimports, which should strengthen the dollar, aswas immedi- ately observed on February 3. Why? Because if the United States imports less, it will need fewer foreign currencies, reducing de- mand for these currencies and, conse- quently, drivingup thedollar’s value. Put another way, if fewer dollars are sent abroad topay for imports, theglobal sup- ply of dollars decreases, making the cur- rency rarer and thus more expensive. However, this dollar strengthening is un- favorable to U.S. exports, which Donald Trump claims to promote. So, how can we understand what is happen- ing? Is it a strategic mistake or a Machiavellian cal- culation? Trump’s economic measures lead to inflation and in- creasedU.S. pub- lic debt, notably through the tax cuts he envisions. Usually, rising debt, combined with inflation, should push interest rates up—either to curb inflation through action by the U.S. central bank (Federal Reserve), to compen- sate for the loss of purchasingpower associatedwith dollar-based investments, or because U.S. public debt would appear riskier. However, this would further strengthen the dollar, again contradicting Donald Trump’s goal of a weaker currency. In 1971, U.S. Treasury Secretary John Connally fa- mously toldEuropean allies: “The dollar is our cur- rency, but it’s your problem.” That phrase remains just as relevant today. The global monetary system is structured so thatmany countries relyon thedol- lar for trade andas a reserve currency. If Trumppur- sues a policy that strengthens the dollar while simultaneously increasing inflation and debt at home, the burden of adjustment will fall on the rest of the world. Emerging economies, which often have debt de- nominated indollars,will see their repayment costs soar, potentially triggering financial instability. Meanwhile, major economies like the European UnionandChinamust decidewhether topassively absorb the shockor retaliatewithmonetary andfis- calmeasures. Thisdynamic could lead to furtherde- dollarization efforts, challenging U.S. financial dominance in the long run. Whenwe summarize the situation, we see the sum of the contradictions: The United States is expected to experience a wave of inflation, coupled with ris- ing public debt and a stronger dollar, whereas the election campaign had promised the opposite. Unless Donald Trump forces the Federal Reserve to massivelybuyU.S.governmentbondsissuedatarti- ficially low rates or drastically lowers interest rates, thiswould implya loss of independence for theFed- eral Reserve, which is not entirely improbable. Inthatcase,wewouldendupwithadangerouscom- bination:inflationnotoffsetbyhighinterestrates,ul- timately weakening the dollar. What would be the consequence? U.S. inflationwould not decrease, but American exports would be favored. The rest of the world, which holds U.S. debt, would see its value graduallydecline, triggeringamajorfinancial shock. Other currencies would then have to depreciate in a monetarybattle,andtheUnitedStateswouldemerge victorious. Is this a science fiction scenario? Perhaps. Perhaps I amwrong, or perhaps I hope to be wrong. But one thing is sure: this scenario is not impossible. And it has been onmymind for several quarters.And I be- lievelesschampagnewillbeservedatEuropeancor- porate year-end celebrations in 2025. Donald Trump: after tariffs, a self-sabotage of the dollar? M icrofinance plays a critical role in advancing financial inclusion, providing essen- tial credit access to unbankedpopula- tionsworldwide. By the end of 2023, the globalmicrofinance sector’s total market size is estimated at $195.3 bil- lion in gross loanportfolio, reflec- ting stable year-over-year trends. South andSou- theastAsia accounted for 38.3%of the global gross loanportfolio, fol- lowedby LatinAmerica and theCaribbeanwith 33.7%, Europe andCentral Asiawith 16.9%, Sub-Saha- ranAfricawith 9.3%, and the Middle East andNorthAfricawith 1.9%. (1) Microfinance Institutions (MFIs) provide small short-term loans with relatively high interest rates to cover operational costs and associated risks. Despite an enhancement in portfolio quality and a stable risk cost, remaining below 2% (2) in 2023, interest rates continue to range from 20% to 60%, (3) levels that many may view as counterpro- ductive and harmful to the population. Traditionally, MFIs have depended on develop- ment finance institutions, philanthropic funds, and banks’ loans. However, these sources remain inad- equate to meet the growing demand for microfi- nance services, with an annual borrower growth rate of 8.4%. Additionally, MFIs continue to face significant funding challenges due to limited ac- cess to capital markets and the absence of a robust and formalized riskmanagement framework. The industry has gradually recognized the need to at- tract institutional capital and implement structured finance mechanisms to bridge the funding gap. Structuredfinance/securitization has emerged as a solution to mobilize private capital for microfi- nance by converting loan portfolios into tradable securities. This structured approach enhances liq- uidity, diversifies funding sources, andwould en- ableMFIs to expand their lending capacitywithout increasing debt or diluting ownership while im- pacting their respective ecosystem. Luxembourg has positioned itself as a leading ju- risdiction for securitization and structured finance thanks to its regulatory framework and investor- friendly environment. Furthermore, Luxembourg has also become a global leader in sustainable fi- nance, withnumerous initiatives supporting green, social, and impact investing. This combination of regulatory stability, financial infrastructure, and commitment to sustainability positions Luxem- bourg as an ideal center for advancing microfi- nance securitization and impact investing. Microfinance, structured finance and securitization:A scalable fundingmechanism The practice of securitization, widely used inmort- gage, auto loans, and SME lending markets, is in- creasingly applied to microfinance portfolios. Its adoptionoffers significant advantages for bothMFIs and institutional investors, creating a structured pathway for sustainable growth. ForMFIs, securiti- zationandstructuredfinanceprovide adirect chan- nel to institutional and private capital markets, re- ducing reliance on philanthropic grants or concessional funding. Structured finance enables MFIs to significantly lower their funding costs and consequently generate a significant positive impact on the end-users benefiting from such financing. First, securitizationenablesmicrofinance institutions to access awider pool of capital by converting their loan portfolios into tradable securities. These secu- rities can then be sold to institutional investors such as pension funds, insurance companies and hedge funds that could benefit from higher-yield invest- ment opportunities.Asmore investors compete for these securities, the increased demand can drive down the cost of capital for MFIs. The liquidity provided by securitization also helps MFIs lower financing costs. By selling their loan portfolios on the secondary market, MFIs can quickly raise capital, reducing their reliance on more expensive short-term borrowing or over- drafts. This liquidity gives MFIs greater flexibility inmanaging cash flow, thus reducing the need for costly emergency financing. Once microfinance loans are pooled and securitized, the associated risks are spread across many loans and tranches. This diversification reduces the perceived risk of individual loans, making the securities more at- tractive to investors. As the perceived risk de- creases, the interest rate required by investors also tends to decrease, ultimately lowering the overall cost of financing for MFIs. In summary, well-structured securitization pro- grams help lower MFIs’ cost of funding, making microfinance lendingmore accessible and sustain- able for borrowers. Luxembourg’s position inmicrofinance and securitization ecosystems Luxembourg remains one of the leading hubs for securitization and structured finance vehicles. In 2023, and for the third consecutive year, Luxem- bourg was ranked second, behind Ireland, which recorded 1,513 FVCs in 2023 and 1,459 in 2022. In 2024, almost 100 new Luxembourg securitization vehicles were established, while liquidations de- creased, leading to a further increase in the total number. (4) By the end of December 2024, approxi- mately1,538 (5) vehicles existed inLuxembourg. Year after year, Luxembourg continues to establish itself as apreferredfinancial center from which securitization transactions can be efficiently structured. The country’s securitization lawof 2004provides awell-defined legal structure for establishing multi-compartment vehi- cles (MCVs), which fa- cilitate cost-effective and efficient securi- tization transactions. Luxembourg’s regu- latory stability en- sures compliance with EU securitiza- tion regulationswhile maintaining flexibil- ity for structuring cross- border financial transactions. The jurisdiction also offers a neutral tax environment, enhancing the at- tractiveness of securitization transactions for both originators and investors. Beyond securitization, Luxembourg is a recog- nized leader in inclusive and sustainable finance. It hosts over 50% (6) of the global assets under man- agement in microfinance investment vehicles and has fostered an ecosystem dedicated to financial inclusion. It should also be noted that approxi- mately 60% of microcredits pass through Luxem- bourg. (7) Public-private initiatives, such as those led by theMinistry of Finance and theMinistry of For- eign & European Affairs, support financial inclu- sion and sustainable development efforts worldwide. Luxembourg is also home to a net- work of specialized impact investors anddevelop- ment finance institutions that actively allocate capital to microfinance securitizations. The country’s financial research and innovation ecosystem further strengthens its role in microfi- nance securitization. Institutions such as the Uni- versity of Luxembourg contribute to financial technology advancements and structured finance solutions that support inclusive finance. These de- velopments position Luxembourg as a critical node in the intersection of structured finance and impact investing. Awin-win strategy for greater financial inclusion By attracting a wider range of investors, MFIs can secure better financing terms,makingmicrofinance services more affordable and impactful for un- bankedcommunities, ultimatelypromotinggreater financial inclusion and economic empowerment. For institutional investors, microfinance-backed se- curities offer an appealing investment opportunity. These structured products provide higher risk-ad- justed returns compared to traditional fixed-income assets, suchas sovereignandcorporatebonds,while also offering exposure to emergingmarket credit. As investors look todiversify their portfolios,micro- finance securitization represents a compelling asset class with low correlation to conventional financial markets. Furthermore, including microfinance as- sets in structuredfinance alignswith the “S” inESG and impact investmentmandates, helping investors meet both financial and sustainability goals. ALuxembourg-based securitization entity has, for years, structuredmultiple securitization compart- ments to finance microfinance institutions across Eastern Europe and Central Asia. The entity leve- rages Luxembourg’s structured finance expertise and legal framework to channel capital efficiently toward financial inclusion projects. By using secu- ritization, it enables microfinance institutions in emerging markets to access institutional capital, driving economic development whilemaintaining financial sustainability. In Egypt, a leading microfinance institution com- pleted an EGP 884million (approximately EUR 18 million) securitized bond issuance in late 2024. The transaction was designed to optimize its funding structure while expanding its lending capacity to underserved microbusinesses. By securitizing its loan portfolio, this institution successfully lowered its financing costs, improving the affordability of its credit offerings. This transaction has not only increased access to credit formicro-entrepreneurs, but also allowed institutional investors to gain ex- posure to Egypt’s growing microfinance sector while earning competitive returns. Both cases underscore the transformative potential of securitization and structured finance in micro- finance, highlighting its role as a scalable, market- driven solution or financing initiatives aimed at financial inclusion. Luxembourg is ideally positioned to drive the next phase of microfinance securitization, capitalizing on its expertise. Securitization and structured fi- nance provide a scalable and efficient financing so- lution for MFIs, enhancing capital efficiency, diversifying funding sources, and strengthening risk management. By aligning the cost of capital with the cost of risk, securitization and structured finance reduce financing costs, enabling MFIs to offer lower interest rates and thus fostering finan- cial inclusionandeconomic development in emerg- ing and developing countries. For institutional investors, microfinance-backed se- curities offer a promising asset class that combines attractive yields, ESG alignment and exposure to high-growth emergingmarkets.As thedemand for sustainable finance and impact investing continues to rise, Luxembourg’s role in connectingglobal cap- ital markets with financial inclusion initiatives will only grow. The continued expansion of structured microfinance transactions will further solidify Lux- embourg’s position as a global leader in innovative financial solutions, driving both social impact and strong, risk-adjusted returns for investors. Papa Saliou DIOP, Partner, Banking&CapitalMarkets, Luxembourg Securitization Leader Lydvine ZINSOU, Manager, Banking and Capital Markets EY Luxembourg 1)BaromètredelaFinanceàImpact2024|Convergences 2)BaromètredelaFinanceàImpact2024|Convergences 3)Article–MICROFINANCE-Zoomsurunsecteuràlafoispro- metteuretvulnérable 4)EYAnalysis-Thesedataarederivedfrominternalresearchconducted byourEYteams. 5)CumulatedFVCoverviewtables 6)Microfinance:smallamounts,bigimpact.-Luxembourg 7)Microfinance:smallamounts,bigimpact.-Luxembourg Structured finance and securitization: Catalysts for more inclusive finance via microfinance