In the latest issue of Dechert’s international capital markets team’s “In Conversation With…” series, partner Jennifer Rees and associate Nick Quarrie sit down with Arnaud Delestienne and Chiara Caprioli, director of international capital markets and member of the executive committee, and senior business development manager and sustainable finance expert, respectively, at the Luxembourg Stock Exchange (“LuxSE”), to discuss their take on developments and expectations in the capital markets. In this issue, we discuss:

• The macroeconomic climate.
• Sustainable finance.
• Market technology.
• Looking to the future.

The Macroeconomic Climate: Marketplace Context and Trends

Dechert: The LuxSE Group experienced an 8.1 percent growth in revenue in 2021 as compared to 2020, principally due to the global increase in issuances and financing activities in the wake of the COVID-19 pandemic, as well as 2021 being a record year for sustainable finance, both internationally and on the LuxSE. In 2022, we have seen disruptive international events and volatile market conditions, and the short-term outlook is for continued unpredictability, with increasing commodity prices, interrupted supply-chains and rising inflation levels. What trends have you seen and do you see developing in the near and medium term.

LuxSE: Like any other global market operator, we have observed a significant deterioration in market conditions following the start of the conflict in Ukraine. This exacerbated several macro-economic trends and challenges that were already there, such as inflation, supply-chain problems or geopolitical tensions, and this has heavily impacted the way in which the equity and debt markets function.

The impact was felt in two broad ways: decreased asset valuation and a severely limited access to capital markets investment. If you look more closely at bond markets, this combination translated into rising yields, reduced bond issuance volumes and individual transaction sizes, demand for shorter maturities and a flight to quality assets, which benefited the Sovereign, Supranational and Agency (“SSA”) sector, and financial institutions.

Perhaps one of the very few segments that has seen a good 2022 has been the covered bonds segment, which has seen a spectacular increase in issuance volumes. On the opposite side of the spectrum, corporate debt issuance volumes have suffered significantly. Based on figures from Dealogic, in October 2022, global issuance volumes in this segment were down by around 40 percent compared to the year before, which is quite dramatic.

The high yield bond sector has suffered even further, making it virtually non-existent when compared to previous years. Likewise, emerging markets issuers have been considerably affected by this adverse environment, due to their dependency on the U.S. Dollar for their foreign financing activities. Equally, the appetite for local currency issuances, both from emerging markets issuers and from mainstream names, has decreased in this environment of rising rates.

Overall, what we have seen from public statistics is that public debt markets were down by roughly 30 percent in 2022. If we look at that from a LuxSE standpoint, we can be satisfied with the way we have navigated through these rather rough waters. We have kept our position as global market leader in terms of the volume of international bond listings, a position that we have held for several years now. We are also proud to see that this sustained activity resulted in an increase of our market share to around 30 percent of new listings year-to-date in October 2022.

This market share is even higher, beyond 40 percent, if we look at specific segments, such as the SSA sector and environmental, social, and governance (“ESG”) bonds, meaning green, social, sustainability and sustainability-linked (“GSSS”) bonds. We see this as a huge vote of confidence from our clients. This is also a signal that, when things go the wrong way, markets find more comfort and value in dealing with established, solid and trusted market infrastructures.

Dechert: What actions did the LuxSE have to take (or believe may become necessary) to (i) mitigate any negative impact felt by issuers and investors as a result of the Russian invasion of Ukraine, and (ii) keep pace with financial sanctions imposed on Russian banks, persons and entities in Europe, the United States and worldwide?

LuxSE: As the national stock exchange in Luxembourg, we have a constant dialogue with our regulator, the Commission de Surveillance du Secteur Financier (CSSF), and we have had frequent interactions with the regulators since Russia’s invasion of Ukraine in February 2022. The way in which we managed the waves of sanctions that followed the invasion is what you would expect from a regulated entity like ours. Being part of the market infrastructure, we took a full-compliance approach. At times it was a struggle to understand what the real implications of the sanctions were, but that is where we had the opportunity of having this dialogue. When we applied the sanctions, which meant having to suspend or even delist securities, this was always done in coordination with the regulators. We also engaged with the relevant authorities, such as the Luxembourg Ministry of Finance, to make sure that we were acting in line with both the text and the spirit of the decisions. It was essential to keep that channel of communication open.

In addition to engaging with the authorities, we also maintained a positive dialogue with our clients when we requested more information from them, for example where there was some uncertainty around underlying assets. In these situations, we had to proactively approach our clients and we can only praise the level of support and dialogue we managed to have with them. We are confident about the way in which we have managed the crisis and the set of measures put in place.

Dechert: In light of these recent and ongoing disruptive macroeconomic events, what safeguards does the LuxSE believe will be necessary in order to insulate investors and issuers from further market volatility?

LuxSE: We do not think that we can shield clients from all the impacts of such a crisis. But we can always do what we do best, which is to operate a transparent and orderly market. That is what we are trying to stick to when it comes to these times of crisis. That means we are making sure that we are close to our clients, that we are providing the type of first-level support that they expect, that we are doing a close follow-up on the issuance process and that we are constantly innovating in terms of new solutions. To that effect, we launched a new service in October 2022 called “FastLane” designed to make our clients’ lives easier, particularly for those that are seeking a listing on our Euro multi-lateral trading facility (“Euro MTF”). Regulated by the LuxSE itself, the Euro MTF is a full-listing market and the largest exchange-regulated multi-lateral trading facility (“MTF”) for the listing of debt securities in Europe. The recently introduced “FastLane” regime permits sovereign issuers and issuers that are listed on an EU-regulated market (or equivalent) to benefit from lighter requirements when listing on the Euro MTF, providing a faster admission process.

The forms of innovation that we bring to the market are also about making our operating platform more robust and resilient. We are currently investing significantly into cyber security protocols, given that this threat has taken on another dimension in the current context. Similarly, we recently completed our transition to the cloud architecture. All of these things make the LuxSE platform more reliable. This is one of the things we can do in terms of infrastructure in these turbulent times to help our clients be confident that they can rely on our systems and services.

Dechert: What are the Unique Selling Points (“USPs”) of the LuxSE?

LuxSE: We believe that at LuxSE we have many USPs to put forward. In terms of service levels, with the range of listing options that we offer to our clients, we are able to address the needs of different issuance segments:

• We position our EU regulated market, the Bourse de Luxembourg, as a gateway to European investors. This has been leveraged by sovereigns, supranational issuers, listed corporates and others who want to benefit from our positioning at the center of Europe.
• We also have an attractive alternative, the Euro MTF, which is the first, and remains the leading, MTF in Europe in terms of listing debt instruments, with a very strong reputation gained over the years. For example, it benefits from the recognition of the European Central Bank for bonds that are listed there to qualify as collateral.
• We also offer a third listing solution, the Securities Official List (“LuxSE SOL”). This allows issuers to register their securities on the official list without having them admitted to trading, which addresses the specific needs of certain types of issuers.

We are therefore confident that we have been able to demonstrate our agility and ability to adapt and meet the needs of the market.

We also offer flexibility through the services we provide. We operate in multiple languages and offer a platform that supports multi-currency listing and trading, as well as several post-trade models. Moreover, we have a very stable operational and commercial team with strong expertise, which we can leverage when exploring new structures. We are able to assist issuers and advisors seeking to clarify or test certain concepts early in the issuance process.

Finally, we would highlight the evolution we have gone through in terms of driving the sustainable finance agenda. We launched the first platform dedicated to sustainable finance, the Luxembourg Green Exchange (“LGX”) in 2016, which has since become a global leader in its field. This platform also benefits from value-added services launched in response to newly evolving market needs and ranging from educational services, such as the LGX Academy, to data services, such as the LGX DataHub. These contribute to creating much more than a leading platform for sustainable securities. LGX is a place where we are able to raise the visibility and profile of issuers while, at the same time, addressing the evolving needs of investors, who, at the moment, have to meet onerous regulatory requirements and have difficulty accessing and analyzing unstructured and often incomparable data.

Sustainable Finance

Dechert: That brings us neatly to our next topic for discussion, namely sustainable finance. Can you tell us more about the sustainable finance services offering of the LuxSE?

LuxSE: We have launched two products in response to market demand:

• The first, the LGX DataHub, focuses on data. The LGX DataHub combines normalized ESG data for the full spectrum of GSSS-labelled bonds, listed both in Luxembourg and elsewhere. The LGX DataHub currently provides a centralized data source of approximately 150 data points for more than 9,000 outstanding bonds (10,000 bonds when matured bonds are included). This product is primarily aimed at investors and asset managers, assisting portfolio management when deciding which securities to buy, sell and hold, as well as with compliance with reporting requirements for compliance and risk teams. Research centers and issuers have also used the LGX DataHub, including, recently, the Organization for Economic Co-operation and Development (OECD), which used data from the LGX DataHub to inform a report on the state of the GSSS universe in emerging markets, which was published in the run up to the 2022 United Nations Climate Change Conference (COP27). We are also in discussions with a number of central banks who are interested in analyzing data from a systemic risk perspective.
• The second product is the LGX Academy, which we launched in May 2020. The LGX Academy was originally conceived to offer in-person courses on sustainable finance matters, but the pandemic forced us to reconsider the format. This was a blessing in disguise because we have been able to reach a much wider audience than we would have done with a traditional format – especially participants from emerging markets that wish to accelerate the sustainability journey of their organizations. We provide both standard online courses on products, labels, regulations, taxonomies and principles and also fully customized courses, accommodating course participants from around the world and from a wide range of sectors.

Dechert: The LuxSE has a reputation for developing and pioneering ESG-linked securities on its marketplaces and we have seen the green, social and sustainable bond market grow significantly in recent years. Can you tell us more about LuxSE’s approach to sustainable finance?

LuxSE: The LGX platform is the world’s biggest platform for sustainable debt securities. In order for a security to be eligible for display on the LGX platform, the security must be structured in one of four formats, based on the International Capital Market Association’s (“ICMA”) green, social, sustainability or sustainability-linked bond principles and guidelines.

We have also pioneered the practice of admitting to the LGX platform general corporate purpose bonds of issuers that we consider to be climate-aligned or “pure-players”, based on the climate-aligned issuer methodology published by the Climate Bonds Initiative (“CBI”). The CBI reviews the list of eligible climate-aligned issuers on a yearly basis by analyzing their revenue streams. The issuers can be private or public companies and the minimum threshold to be considered climate-aligned is to have at least 75 percent of revenues derived from unambiguously green activities. Solar panel producers or railway companies, as the classic examples, meet these criteria.

The reason for admitting these types of bonds to LGX, in a separate section from the labelled (GSSS) products, is that we want to offer the market an opportunity for investment that might otherwise be invisible. Bonds issued by climate-aligned issuers might not be tagged as green or sustainability-linked but still contribute to positive environmental objectives and may fit with certain investors’ ESG mandates.

Overall, we have more than 1,500 bonds on the LGX platform, worth more than €830 billion in total. We have also expanded the platform to funds. We want to give visibility to funds that, similarly to bonds, are being transparent about their ESG investments. Eligible funds will be funds that self-classify as falling under the scope of either article 8 or 9 of the Sustainable Finance Disclosure Regulation, or “SFDR”, the European regulation for sustainability risk disclosures. One qualification is that, whether it is a bond or a fund, it will have to be listed on one of our markets before it can be displayed on the LGX platform.

Dechert: One of the more recent, innovative ESG products introduced to the global capital markets is gender bonds, as Dechert discussed in an OnPoint published in July 2022. What is the LuxSE’s experience with gender bonds and how does the LuxSE differentiate between different types of bonds?

LuxSE: Focusing on bonds that allocate 100 percent of the proceeds to projects promoting gender equality can be restrictive. We are taking a slightly more nuanced approach in helping the market identify bonds with an intentional gender component by flagging those bonds that are issued under social, sustainability or sustainability-linked frameworks and that have a strong gender component, be it at the level of the use of proceeds or the sustainability-linked performance targets and relevant key performance indicators (“KPIs”). For use-of-proceeds bonds, given frameworks are often targeting broad investment categories and knowing issuers will not necessarily be able to allocate the proceeds to all of the categories, we have decided to tag bonds only after the first allocations are made public on the condition proceeds have partially or completely been invested in gender-related projects.

In other words, we consider gender-focused bonds to be a subset of social, sustainability or even sustainability-linked bonds which contribute to the United Nations' Sustainable Development Goal no.5 ("SDG 5"), “gender equality”. Generally speaking, we mostly see projects within three broad categories: promoting female entrepreneurship, improving education and training opportunities, and, finally, opening up financial inclusion. We then tag the bonds with our gender-focused bond flag, which helps investors identify investment opportunities that contribute to the empowerment of women and girls across the world. Use-of-proceeds bonds can dedicate part or all of their proceeds to projects advancing gender equality objectives. For sustainability-linked bonds, the difference is that we do tag the bond when it is launched if one of the KPIs is unambiguously gender-focused. This often includes board-level representation or training targets, but it can also be something more innovative, for instance at the level of procurement targets. So far, we have 38 gender-focused bonds displayed on the LGX, from a diverse but concentrated pool of issuers.

This initiative is framed by a memorandum of understanding (“MoU”) the LuxSE signed with UN Women in May 2022 to advance gender finance. The overarching goal of the partnership is to mobilize capital flows to contribute to SDG 5, “achieve gender equality and empower all women and girls”, by helping the market identify products whose proceeds and/or targets are unambiguously directed to such goals. One of our commitments, on top of helping the market identify relevant investment projects, is to highlight best practices in structuring and disclosures for debt products that aim to reduce the gender gap.

Dechert: Are there other similar innovative products in this sector that investors should be aware of/you have seen grow in popularity?

LuxSE: There are also blue bonds. While we still consider them as a subset of green bonds, there are separate taxonomies that are being developed by multilateral development banks and in some island countries. For instance, we have been working with the Cabo Verde Stock Exchange to support the launch, in the middle of COP27, of their “Blu-X” platform, a platform similar to the LGX but mostly devoted to blue economy investments. The objective of Cabo Verde in this field is to leverage their own blue taxonomy to develop awareness and strengthen capital flows into such areas. While these are still green specific themes, they are getting their own standard legitimization in terms of product and marketing.

Market Technology

Dechert: Regulators and financial exchanges are increasingly preparing for an uptick in demand to digitalize trading and general market processes, including using blockchain technology. For example, in 2022, the UK government publicly consulted on extending the scope of certain UK regulations to include direct transactions in crypto assets (an area Dechert recently published commentary on). Through legislative updates, the EU has signaled its intention to enable the use of innovative technologies, including Distributed Ledger Technology (“DLT”), a system which allows the ledgers of securities (accounts of transactions in the securities’ trading history) to be recorded in multiple places by multiple participants simultaneously, removing the requirement for a central data store or administrative function to keep a traditional ledger of transactions.

In January 2022, the LuxSE admitted onto its Securities Official List the first financial instruments registered via a public DLT, being security tokens (digital assets issued in “tokenized” form) issued by the digital assets arm of Société Générale. What steps is LuxSE taking to keep pace with technological advances?

LuxSE: In order to flourish in this very competitive environment, it is essential that we maintain our agility and ability to innovate. This is even more relevant given that we compete with much bigger exchange groups. Hence, we need to choose our battles wisely. That is why we focus on certain niches, where we know we have the expertise, the know-how and the recognition. However, we also need to keep innovating. We have discussed sustainable finance, which is one such area, but digital assets and digitalization is another important area.

We took steps in that direction a few years back when we invested in the Origin Markets issuance platform. This platform is designed to digitalize the entire flow between issuers, dealers and infrastructures to facilitate the issuance process and shorten the time to market for issuers. We connected to the platform to offer what we call “Listing in a Click”. This means that when you are issuing and dealing in this marketplace, you can obtain all the documents you need and request your listing through a digital, fully automated workflow.

We also took the first steps into DLT in 2022 when we admitted the first three bonds and structured products that are natively issued using DLT. These native tokens were admitted on LuxSE SOL, meaning that the securities are registered on our Official List but are not admitted to trading because the current regulatory framework does not allow it. This registration comes with some benefits for investors, in terms of transparency, access to documents and possible indicative prices that are available via the LuxSE.

These are our first steps and we will not stop here, because we are convinced that there is potential for DLT with certain issuers, investors and intermediaries in the value chain.

However, we do not believe that DLT will simply eliminate intermediaries and reduce the value chain in the capital markets to mere issuer-investor relations. The reality of our business is much more complex and the adoption of this technology should be leveraged by the different players to enhance their processes and could be a game-changer if it makes the entire bond issuance journey seamless and efficient for all.

Dechert: What plans does LuxSE have in order to further its digital transformation?

LuxSE: We see the push to digitalization as an industry collective effort. We believe that it can only succeed if we all collectively move in the same direction. That is why we are also contributing significantly to the work being done at the level of different associations, such as ICMA. At the national level, we are also involved with the local banking association and the local capital markets association in order to help resolve some of the challenges that this new technology brings.

Looking to the Future

Dechert: In June 2022, the LuxSE and the India International Exchange (IFSC) Limited (India INX) signed a co-operation agreement, following an MoU in November 2020, which works towards two aims: (a) to increase the visibility of Indian-listed securities in the international capital markets by admitting Indian securities on the LuxSE; and (b) to strengthen cross-border co-operation in sustainable finance, by especially focusing on advancing green finance in India. The LuxSE also entered into several MoUs and cooperation agreements with exchanges based in Africa in 2022. Why is this important and does the LuxSE have any plans to pursue similar relationships with other exchanges.

LuxSE: We have been collaborating with several exchanges across emerging markets, to help raise the understanding, knowledge and level of sustainable finance in their domestic markets. We are working with them on common industry criteria that might potentially pave the way for the development of similar infrastructures within their own models. This also leads the way to potential dual listings, meaning an emerging market issuer could in the future access the domestic investor space by way of being listed domestically but also, if criteria turn out to be streamlined and fairly compatible, benefit from a fast-track listing on our exchange. This would allow them to access a much broader pool of international capital.

That is the way in which we are starting to work with eight exchanges, five of which are in Africa, one in Latin America and two in Asia. We have signed MoUs and we are now moving to cooperation agreements, analyzing differences and similarities in listing criteria and seeing what we can work out in terms of a smoother, more integrated process.

We also have other stock exchanges that are part of LGX Academy projects as they might want to bring their infrastructure up to speed and have appropriate disclosure-related criteria for ESG products.

Dechert: Do you see many dual listings on the debt side, and do you see those currently within Europe, or are you seeing them, for instance, having a Singapore- and a Luxembourg-listed security?

LuxSE: Firstly, we have seen many dual listings because of LGX. We have seen issuers with GSSS securities listed on either their domestic market or another international market having these dual-listed in Luxembourg because of the additional visibility brought by LGX and the opportunity to use the platform as a central depository for their GSSS disclosures, such as frameworks, external reviews, investor presentations, allocation reports and impact reports. Another typical dual-listing case entails bonds issued by Chinese companies seeking exposure to European investors. Typically, domestic bonds issued by companies from mainland China are not authorized to have their securities traded outside of the domestic market. That’s where our listing without trading venue (through LuxSE SOL) comes in, allowing the bonds to be registered on the Official List, and potentially access LGX, while leaving trading for other channels. For bonds displayed on LGX, ESG disclosures need to be made publicly available in English, helping to bridge the gap between international investors and the Chinese domestic market. China has one of the world’s largest bond markets, however, the market may appear off-limits to the international investor community due to the difficulties in accessing information on traded bonds.

This is why we established the Chinese Domestic Green Bond Channel in 2018. By providing information in English about Chinese domestic green bonds traded either on Chinese exchanges or on the Chinese Interbank Bond Market (CIBM), the LGX is bridging the information gap between Chinese issuers and international investors. The LuxSE has also established cooperation agreements in terms of dual listings with exchanges in Macao and India.

Dechert’s International Capital Markets Team would like to thank Arnauld Delestienne and Chiara Caprioli, as well as the team at the Luxembourg Stock Exchange, for their contributions to this piece.