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The private credit market is starting to show signs of stress and Luxembourg is exposed but in a different way than many believe.

Let’s be clear: Luxembourg does not originate much of the underlying credit risk. It manages the structures. Many of the borrowers financed by private credit funds are outside Luxembourg. So, much of that risk sits elsewhere.

What sits in Luxembourg are the structures: governance, compliance, risk management, fund administration, transfer agency and depositary functions. Luxembourg vehicles, including RAIFs, are widely used for private credit strategies in Europe. This is what makes the jurisdiction particularly relevant in a stress scenario. Luxembourg is where funds are created, where investors subscribe through transfer agents, where the NAV is calculated and where key decisions are taken.

Most importantly, it is where decisions about redemptions are made. In concrete terms, Luxembourg is the place where the entire life of the fund is organized and managed. From inception to liquidation.

Traditional illiquid funds do not offer redemption. The issue comes with never semi-liquid structures, where illiquid assets are combined with periodic liquidity features. A gated RAIF for professional investors is one thing. A semi-liquid ELTIF sold to retail investors is another.

This becomes critical when liquidity is tested. Recent situations, such as those involving Blue Owl Capital have shown how quickly liquidity can become a problem when redemption requests increase. We might see cases like this over the next months.

Luxembourg may not be able to prevent the crisis. In my opinion, Luxembourg can do a lot (and it must do a lot) on avoiding a crisis of trust and credibility in the investment funds domiciled there.

In concrete, there should be no ambiguity on liquidity and disclosure to investors. Based on my experience, the level of disclosure is generally good. PPM are often very clear: they explain that the assets are illiquid and that redemptions might be limited. From a legal and formal perspective, the information is there and is clear. The little (but actually big) problem comes from the perception of the investors about liquidity. A quarterly window can be automatically associated with a real liquidity and the possibility to exit the fund when needed. In reality, this is not the case. The investor can surely request a redemption but there is no guarantee that this will happen. The clear message should be simple and fully understood: the liquidity can be limited or suspended and this should not come as a surprise to anyone.

When this happens, funds rely on specific tools to manage the situation. Regulation is already moving in this direction. The AIFMD II puts more focus on how funds manage liquidity and on tools such as gating, suspension or side pockets. However, in a scenario where many investors want to redeem at the same time, they do not solve the problem. They only help manage it. They do not create liquidity.
The AIFMD II reinforces the framework and protects investors, but it does not change the nature of the assets.

In a crisis, what is illiquid remains illiquid.

I want also to highlight that not all private credit strategies have the same level of liquidity risk. Some structures are inherently more resilient due to the nature and duration of their underlying assets.

Another very important point is the governance. In difficult moments, having a structure that is formally correct is not enough. What’s needed is: a board, an AIFM and control function that truly understand the product and that can take rapid and coherent decisions about liquidity, but also a valuation and fair treatment of the investors.

Luxembourg should prepare the investment funds before the problem arrives. This means real and strong liquidity stress test. Events of massive redemption requests, clear operative plans to use instruments such as gating, side pockets and other extraordinary measures. There should not be any improvisation during a crisis.

To sum up, Luxembourg should focus on five things:

• Making sure investors truly understand that liquidity is not guaranteed. Today, disclosure around illiquidity and redemption limits is far stronger than in the past. The issue is often no longer disclosure itself, but how investors interpret liquidity in normal markets versus stressed ones.
  
• Being ready for large redemption requests before they happen, with real stress testing and clear plans on how to react.
  
• Having governance that is able to take decisions under pressure, with boards and AIFM that understand the product and can act quickly on liquidity and valuation matters.
  
• Explaining clearly what is happening when decisions are taken, especially when limiting redemptions. Investors need to understand what is going on and not caught by surprise.
  
• Ensuring a certain level of consistency in how these situations are handled, so that investors are not surprised by different approaches across similar funds.

Finally, Luxembourg does not enter this phase unprepared. The regulatory framework is stronger than in the past, liquidity tools are clearer, and the role of the AIFM is more central. The real question is how these structures will perform under stress. In a private credit crisis, the issue is rarely perfection. It is preparedness, coherent decision-making and fair treatment of investors.
In a private credit crisis, the real risk for Luxembourg is not only fund performance. It is the loss of trust as a structuring hub.

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The views expressed in this article are personal and do not represent those of any employer, client, financial institution, or affiliated organization.
The content is provided for informational purposes only and reflects my personal research and interpretation of AML and compliance matters.