Shaping Luxembourg's financial landscape: 80 years of the CSSF

With a remarkably solid legal and fiscal framework, Luxembourg is considered today the 3rd most international financial centre in the world, the second largest investment fund centre and the leading alternative fund hub in Europe, according to data provided by the development agency Luxembourg for Finance. At the heart of this financial powerhouse stands the Commission de Surveillance du Secteur Financier (CSSF), the country’s financial watchdog and a key pillar in shaping its reputation for stability and trust.

Although the CSSF would formally come into existence only in 1998, its roots date all the way back to 1945, when Luxembourg, like much of Europe, was emerging from the devastation of the Second World War. That year marked the foundation of the Commission de contrôle aux banques (CCB), with the task of restoring order and credibility to Luxembourg’s badly damaged banking system.

The post-war foundations

After the end of the Second World War, international agreements like the Bretton Woods Conference of 1944 would set the stage for a new global financial order. In Luxembourg, the German occupation had suppressed all Luxembourgish banks, and all accounts in Reichsmarks would necessarily have to be converted. The CCB was therefore created to supervise these reforms and with the daunting task of rebuilding the banking system from scratch. The first commissioner appointed was French-born lawyer and banker Pierre Werner, who would in later years also serve as Prime Minister of Luxembourg in two occasions.

Almost two decades later, the local financial industry received an involuntary American boost, when the U.S. Congress passed the Interest Equalization Tax of 1963. With the goal of decreasing the balance of payments deficit in the United States, this tax on the purchase of foreign securities made them less appealing. However, this inadvertently accelerated the growth of the Eurobond market, with the Bourse de Luxembourg issuing the first-ever bond in US Dollars outside the United States for Autostrade from Italy in the same year.

The growth of the fund industry would come with its own challenges and headaches as well. Legal experts would first have to find a suitable mechanism for investors to freely enter and exit funds at any moment, circumventing the indivision regime established in the Civil Code.

But the need for increased surveillance and stronger, industry-specific regulations would become evident with the infamous case of Geneva-based Investor Overseas Services (IOS), a Canadian-American financial group that aggressively sold mutual funds to retail investors. The group’s overexpansion, lack of oversight and reliance on continuous inflow of investor money eventually led to its collapse in 1970 when the stock markets crashed.

Having the CCB also been alerted by the Securities and Exchange Commission (SEC) of irregularities against American stock exchange law, the IOS scandal led to the liquidation of all entities in the group and the Grand-Ducal decree of 1972, which allowed for an investment fund to be dissolved by a court at request of the CCB.

The 1972 decree was drafted as a matter of urgency by commissioner Albert Dondelinger, under whose leadership the CCB would oversee a period of international growth for Luxembourg's financial sector. A prominent figure in the field, Dondelinger would later serve as president of the Association des Banques et Banquiers, Luxembourg (ABBL) and head of the Singapore branch of Banque Internationale à Luxembourg (BIL), which closed in 2015.

Institutional evolution

With time, changes in the international economy would bring the need for institutional reforms. The Bretton Woods system that had regulated international monetary management for almost three decades had started showing signs of instability towards the end of the 1960s, with an artificially overvalued US dollar within the context of the Vietnam War and threats from West Germany and France to abandon the system.

In his 1970 three-stage plan for European economic and monetary union, Prime Minister Pierre Werner proposed as a final goal the introduction of a single European currency in a period of 10 years, which would not see the light due to economic instability throughout the decade. In August 1971, a series of economic measures in the United States that came to be known as the “Nixon shock” included the non-convertibility of US dollars to gold, and the Bretton Woods system ceased to exist in practice.

But if the end of Bretton Woods and the imminent European monetary integration had led the Werner government to rethink the future of monetary policy, the 1982 devaluation of the Belgian franc was the tipping point. Since the signature of the Belgium-Luxembourg Economic Union in 1921, both countries had agreed to set their currencies at a fixed parity, which is why the unilateral decision to devaluate the franc by the Belgian government also had its negative effects in Luxembourg and led the authorities to study the transition to an autonomous monetary institution.

The creation of such institution had already been studied and assessed negatively in 1925 by Hjalmar Schacht, then president of the Reichsbank. Small and modest in nature, Schacht concluded, a purely Luxembourgish currency would inevitably be subject to international speculation. A new assessment was made in 1982 by Jelle Zijlstra, former governor of the Nederlandsche Bank, but this time he concluded that Luxembourg had the capacity of creating a fully autonomous and independent monetary institution.

This is how the Institut Monétaire Luxembourgeois (IML) was created in 1983, in charge of the issuance of monetary signs, the surveillance of the financial and banking sector and the international representation of the country in monetary matters.

The final transition to a fully functional and autonomous central bank would come in April of 1998 with the launch of the European System of Central Banks (ESCB), as mandated by the Maastricht Treaty of 1992. That year marked the end of the IML, as its functions were split between the newly created Central Bank of Luxembourg for monetary policy, and the CSSF for the surveillance of financial institutions.

Towards a greener, more transparent future

Today, the CSSF stands as a cornerstone of Luxembourg’s financial stability, overseeing a sector deeply integrated with European and global markets. Recent shocks like the Credit Suisse collapse tested the strength of institutional frameworks such as the Systemic Risk Committee, of which the CSSF is a member. On the ever-challenging fight against money laundering and terrorist financing, the latest evaluation by the Financial Action Task Force (FATF) praised the country’s solid AML/CFT framework.

Challenges for the future include digital and green transitions aligned with the EU’s evolving regulatory landscape and careful vigilance on greenwashing. Two major regulatory updates, the Digital Operational Resilience Act (DORA) and the Markets in Crypto-Assets Regulation (MiCA) address issues like cyber risk and stability for crypto-assets and related activities and services, respectively. The institutional landscape in the future may also include a Capital Markets Union and a Savings and Investments Union, as suggested by former Italian Prime Minister Enrico Letta.

It all started eight decades ago, with the hard work and collaboration of a group of people who built the foundations for a robust and reliable financial centre out of thin air. The future calls for even greater adaptability in the face of innovation, integration, and global complexity.

Nicolas Orrico is a Doctor at Law and Social Sciences (JD) from the University of the Republic and a Certified Anti-Money Laundering Specialist (CAMS) accredited by ACAMS.