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Transcript of "Taxation and the Competitiveness of UK Funds"
1. Taxation and the Competitiveness of UK Funds October 2006 KPMG LLP (UK)
Contents 1 Executive summary 1 1.1 Introduction 1 1.2 The growth of UK domiciled funds lags behind Luxembourg and Ireland domiciled funds 1 1.3 The UK market is approaching a tipping point 2 1.4 The EU domicile of choice for more complex products is not yet established 2 1.5 Taxation has a significant influence on fund domicile 3 1.6 Luxembourg and Ireland tax regimes are viewed more favourably than the UK 3 1.7 Fund domicile influences the location of other investment management functions 4 1.8 Recommendations 5 2 Introduction 7 2.1 Background to this report 7 2.2 Methodology 8 2.3 Scope of the report 10 2.4 Structure of the report 11 3 Profile of the European investment funds market 12 3.1 Development of the market 12 3.2 Current state of the market 12 4 The fund domicile decision 17 4.1 Summary 17 4.2 Factors influencing the fund domicile decision 17 4.3 Explanation of key factors 19 5 Fund taxation issues 21 5.1 Summary 21 5.2 Rating of tax regimes 21 5.3 Detailed comparison of tax regimes 22 5.4 Evaluation of the UK funds tax regime 28 5.5 Key areas to change in the UK tax regime 29 5.6 Characteristics of an ideal UK tax regime 35 6 Impact of fund domicile on the UK investment management industry and wider economy 36 6.1 Summary 36 6.2 Impact of fund domicile on administration 36 6.3 Impact of fund domicile on other investment management functions 37 6.4 Economic impact arising from the fund domicile decision 38 7 Recommendations 42 7 Summary .1 42 7 Recommendations .2 43 © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Abbreviations AIF Authorised Investment Fund AITC Association of Investment Trust Companies AUT Authorised Unit Trust CCF Common Contractual Fund CESR Committee of European Securities Regulators CIV Collective Investment Vehicle (see Section 2.3) ECJ European Court of Justice EFAMA European Fund and Asset Management Association ETF Exchange Traded Fund FA Finance Act FCP Fonds Commun de Placement FUM Funds Under Management HMRC HM Revenue and Customs HMT HM Treasury ICTA Income and Corporation Taxes Act 1988 ICVC Investment Company with Variable Capital IMA Investment Management Association NURS Non-UCITS Retail Scheme OEIC Open-Ended Investment Company PFPS Pension Fund Pooling Scheme PFPV Pension Fund Pooling Vehicle QIS Qualified Investor Scheme SDRT Stamp Duty Reserve Tax SEC Securities and Exchange Commission © 2006 KPMG LLP the UK member firm of KPMG , SICAV Société d'Investissement à Capital Variable International, a Swiss cooperative, and the Investment Management Association. All rights reserved. Printed in the United Kingdom. UCITS Undertaking for Collective Investment in Transferable Securities UUT Unauthorised Unit Trust VCIC Variable Capital Investment Company © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Foreword It gives us great pleasure to present this firms managing in excess of 60 percent This would not only strengthen the UK report on behalf of the Investment of UK authorised funds. investment management and financial Management Association (IMA) and service sectors, but would also benefit By most measures, the research has KPMG LLP (UK). the wider UK economy. A successful concluded that the UK tax regime for industry results in the retention and The UK remains a vibrant and leading funds is not competitive compared to growth of UK based administration- investment management centre, with a Ireland and Luxembourg. There are related jobs that are currently being lost significant and strong domestic market. It specific technical tax reasons for this to other domiciles. Furthermore, a is still the location of choice for most of view, but also a pervasive lack of simpler taxation position for funds would the core investment management confidence and trust in the UK tax be more easily understood by the public, activities within Europe, and is the system. supporting the Government objective to leading European location for hedge fund UK based investment managers are increase UK public confidence in the UK managers. However, the last 10 years frustrated by this situation, and there is a savings market and helping to facilitate have seen significant growth in the feeling amongst managers that urgent greater savings towards retirement. number of funds and assets based in positive action is required if the UK Luxembourg and Ireland, in part at the We believe that the UK authorities are industry is successfully to defend and expense of the UK. showing a renewed willingness to grow its position in the future. While engage with such issues, as shown for Between 1995 and 2005 fund assets there exists significant opportunity to example by the announcement in the domiciled in Ireland and Luxembourg build on current market strength, 2006 Budget of a new initiative to grew 31 and six times respectively, while through selling UK domiciled funds into promote the UK as a financial centre. the UK saw only a three-fold increase. In the EU (as a small minority of UK based The recommendations in this report are addition, in the last two years there has managers have already done) and offered as a constructive contribution to been greater penetration of the positioning the UK as an attractive fund the debate flowing from that previously parochial UK domestic market domicile for alternative asset funds, this announcement, and we hope they will by non-UK domiciled funds. Many in the will not happen without a proportionate form the basis for a future dialogue to industry believe that taxation is a major tax regime. The desired outcome for the ensure the maintenance of a competitive factor driving this trend. The IMA industry is a simpler tax regime able to environment for the UK investment therefore commissioned this report to compete directly with Ireland and management industry going forward. test this claim and to consider the impact Luxembourg, backed by supportive and on the UK funds industry and the wider constructive tax and regulatory economy of allowing this trend to authorities. Richard Saunders, Chief Executive, IMA and continue. In compiling this report, KPMG Jane McCormick, Head of Tax, Financial has conducted primary research with Services, KPMG LLP (UK) © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
1 Executive summary Executive summary 1.1 Introduction The IMA has commissioned KPMG to consider the influence that taxation has on the fund domicile decision, and the further impact this has on the competitiveness of UK funds and the wider UK economy. In preparing this report, KPMG has conducted interviews with 26 investment management groups and four administration companies. The investment management groups interviewed together manage over 60 percent of UK authorised funds as at 31 May 2006. 1.2 The growth of UK domiciled funds lags behind Luxembourg and Ireland domiciled funds Offshore fund centres in Luxembourg and Ireland have grown significantly in the last 10 to 15 years and are now firmly established as the leading EU locations in which to domicile funds intended for cross-border sale. The growth of Luxembourg and Ireland has been fuelled by offering either retail funds that can be sold within many European and global markets (Luxembourg) or by offering more specialist fund types targeted primarily at institutional investors (Ireland). By comparison, UK domiciled funds have grown at a far slower rate, with the underlying growth in the UK funds market being partly offset by the increased penetration of offshore funds (see Figure 1.1). In addition, UK funds do not have a significant share of the non-UK funds market. Figure 1.1 Growth in registered fund assets 1800 1600 1400 FUM (Euro billions) 1200 1000 800 600 400 200 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 UK Ireland Luxembourg Source: EFAMA and IMA (figures include UCITS and non–UCITS funds) © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Executive summary 2 1.3 The UK market is approaching a tipping point UK domiciled funds will remain, in the short term, the fund of choice for the mainstream UK market, both for historical reasons of familiarity and because there is often little tax or other differential between UK and comparable offshore funds. However, in the medium term, the position of UK domiciled funds is less secure as products continue to evolve in areas where conspicuous tax differences do exist and offshore funds gradually become more widely accepted in the UK market. Since changes were made to the offshore funds tax legislation in July 2004, which helped open up the UK market, Luxembourg and Ireland based funds’ share of net sales of the UK market has increased from one percent to 21 percent1. As firms increasingly look to optimise the number of fund ranges, offshore ranges may become the single range of choice and consequently further economic benefits would be lost to the UK. 1.4 The EU domicile of choice for more complex products is not yet established The more complex products (that this report terms alternative or progressive products, for example, property funds, hedge funds, and Undertakings for Collective Investment in Transferable Securities (UCITS) using derivatives) now represent the major industry growth area. However, managers rarely select the UK as a fund domicile for these products. This is due to a combination of actual tax differences and perception, with investment managers viewing the UK tax authorities more as an obstacle to, rather than supporter of, industry development and growth. By contrast, in other fund centres, tax and regulatory authorities are often considered more supportive of the industry, in particular facilitating new developments and innovations. This in turn enables those centres to attract new funds with the related employment and overall economic benefits. While there certainly exist preferred EU domicile locations for these products, there is as yet no clear EU domicile of choice. There is still sufficient time for the UK to establish itself as a viable fund domicile centre, particularly through the ability to leverage existing expertise and strength in core investment management and related activities for more complex products (for example, the UK is the European centre for hedge fund management, managing around 70 percent of European hedge fund assets2). 1 Source: FERI FMI 2 Source: Goldman Sachs © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
3 Executive summary 1.5 Taxation has a significant influence on fund domicile Taxation efficiency and the regulatory environment are significant factors managers consider when selecting a domicile for a new fund. Within this, managers consider the approach and attitude of the tax authorities to be of equal importance to the detailed tax rules and regulations. For the more established fund types, managers will generally have experience of, and understand, the selected domicile tax regime. For such funds, the focus is on ease of process and ensuring that there are no new or predicted changes to the regime to alter their basic understanding and position. Taxation is more often considered implicitly rather than explicitly. However, taxation is of increasing importance for managers launching alternative and progressive funds, where the tax treatment is often less established and more fluid. For such funds, managers’ belief in the ability of a regime to offer a clear and certain approach and stable environment is of critical importance. 1.6 Luxembourg and Ireland tax regimes are viewed more favourably than the UK Managers view the Luxembourg and Ireland tax regimes more positively than the UK regime across most fund types. As a result, for many managers, the UK is not a competitive location for domiciling funds. A principal weakness identified by participants in the UK tax regime is the lack of certainty, stability and support from the tax authorities. The perception is that HM Revenue and Customs (HMRC) does not understand the industry, lags behind regulatory change and focuses on anti-avoidance rather than on supporting a competitive industry. As a result, the UK tax structure is much more burdensome than elsewhere. Even when the differences are nothing more than perception, with certain UK domiciled funds more tax efficient than exempt Luxembourg counterparts, the lack of certainty of tax treatment and constant change undermines the attraction of the UK as a fund domicile. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Executive summary 4 Going forward, as funds become more sophisticated and alternative, the differences between the UK and other domiciles will become more apparent, further weakening the UK position. Figure 1.2 shows how participants rated the UK, Luxembourg and Ireland tax regimes. Figure 1.2 Preferred tax regime by fund type (On a scale of 1-5, where 1 is low and 5 is high) 4.5 4.0 3.5 3.0 Rating 2.5 2.0 1.5 1.0 0.5 Mainstream 0.0 Alternative & progressive UK Luxembourg Ireland Source: KPMG / IMA Survey 1.7 Fund domicile influences the location of other investment management functions Administration functions for funds tend to follow domicile, primarily for practical operational reasons, but also due in part to regulatory requirements, which vary from location to location. Funds that are managed in the UK, but that are domiciled overseas, therefore result in a loss to the UK of the economic benefits arising from administration, employment and other indirect services (for example, provision of tax, legal, and accountancy services). This weakens both the UK investment management industry and the wider UK economy. The situation concerns investment managers because it hinders them when pursuing their commercial objectives. Funds form an integral part of the investment management value chain and the UK savings environment, and for many managers there is commercial logic in domiciling funds in the UK. If managers believe they are forced to domicile funds offshore as a result of an unfavourable tax environment, the overall UK investment management and savings frameworks will be weakened. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
5 Executive summary The UK is still the EU location of choice for core investment management activity, but by no means should the Government be complacent that this will continue. Competition from other investment centres for the core investment management function is intensifying and the potential business efficiency of co-locating funds and investment managers cannot be disregarded. Hedge fund managers are particularly flexible in this regard, with no compelling reason to locate in any particular location, including the UK. 1.8 Recommendations The UK funds industry is approaching a tipping point. The industry and the authorities should consider a number of options; not only to halt the decline of the UK’s market position, but also to position the UK to grow its share of the EU funds market going forward. 1.8.1 Encourage improved consultation and strengthened trust between the industry, HMRC and the other regulatory authorities The Ireland and Luxembourg authorities are generally both supportive of the industry and work together with it to deliver a coherent overall approach to industry issues. This is not the UK experience for many managers. The UK needs to develop the same collaborative and constructive approach, recognising that this requires better engagement from both the industry and the authorities. In particular, the industry must endeavour to understand and address or challenge HMRC concerns over tax avoidance and, where necessary, offer suggestions to help HMRC meet its goals. 1.8.2 HMRC to promote a better internal understanding of the industry An underlying industry frustration has been the belief that HMRC is neither focused on, nor sufficiently understands, the investment management industry. There should be greater focus by HMRC on investment management as a sub-set of financial services and the creation of a structure to enable this to happen. 1.8.3 Address the property fund conundrum Industry participants are keen to provide UK domiciled open-ended property funds for a range of UK investors, but can be forced to domicile such funds offshore due to current tax rules. HMRC should work with the industry to agree and implement an appropriate tax regime for these funds. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Executive summary 6 1.8.4 Seriously consider abolition of the Stamp Duty Reserve Tax (SDRT) Schedule 19 Finance Act (FA) 1999 regime This funds-specific SDRT regime adds complexity to the UK tax regime. It creates an additional compliance burden for managers, as well as making UK funds harder to understand and therefore less attractive to investors when marketed offshore. HMRC should consider abolishing this regime, together with introducing appropriate anti-avoidance measures. This report estimates that this regime yields the Government around £40 million per annum. 1.8.5 Allow authorised funds to trade without incurring a corporation tax charge The UK tax regime distinguishes between trading and investment activities, subjecting the former to corporation tax at fund level. HMRC should consider removing this distinction. This could, if thought necessary, be accompanied by the introduction of a targeted anti- avoidance measure to help ensure that it would be applicable only for funds that are operated on an arm’s length basis (perhaps along the lines described by the UK’s investment manager exemption at section 127 FA 1995 and Schedule 26 FA 2003). 1.8.6 Pending the European Court of Justice (ECJ) decisions, consider full tax exemption at fund level The taxation of funds was identified by survey participants as a significant negative component of the UK tax regime, and it is recognised that UK funds find it difficult to compete on equal terms with tax exempt offshore funds. However, there is no clear consensus supporting a tax exempt status for UK funds, largely due to the impact that this could have on UK funds’ ability to access the benefits of tax treaties. The outcome of current ECJ cases could significantly reduce any treaty benefits, and if this is the case, the industry should seriously consider working with HMRC to grant funds tax exempt status. This report estimates that the corporation tax yield from funds is around £85 million per annum. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
7 Introduction Introduction 2.1 Background to this report In 2005 the IMA and Corporation of London commissioned Oxera Consulting Limited to assess the competitive position of the UK as an investment management centre and the major influences that may affect this position in the future. The ensuing report ‘The Future of UK Asset Management: Competitive Position and Location Choice’ concluded that core investment management and marketing / distribution activities appeared to be quite securely located in the UK and that investment management firms generally expected no significant shifts of business out of the UK at least in the next few years. However, the report also found that when deciding where to set up Collective Investment Vehicles (CIVs), managers are increasingly looking offshore: “The UK has already missed out on a considerable proportion of the market for investment funds. Even if the management of the funds remains located onshore, the development of offshore centres has employment and revenue consequences for the UK. Luxembourg and, in particular, Dublin have seen substantial growth in activities associated with the support and servicing of funds, and have developed as ‘centres of excellence’ in these activities. Offshore fund domicile is therefore a matter that deserves close attention by the UK authorities3. ” The report states that taxation has had a significant influence on this decision: “The one area in the asset management industry where the role of regulation and taxation has been significant relates to collective investment funds…Taxation and / or regulation are critical to the choice of where to domicile funds. Collective investment funds managed from the UK have increasingly been established in, or shifted to, offshore locations for these reasons3. ” In the light of these conclusions, the IMA commissioned KPMG to analyse the tax provisions that impact the fund location decision and to consider further the extent to which fund domicile matters for the UK fund industry and wider economy. 3 Source: Page 61, Oxera, 2005 © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Introduction 8 2.2 Methodology KPMG conducted interviews with 26 investment management groups and four administration companies. A range of executives were interviewed including Chief Executive Officers, Chief Operating Officers, Heads of Product Development and Heads of Tax. In addition, KPMG conducted secondary research to challenge or to provide further support for the issues raised by the participating IMA members and affiliate members. KPMG and IMA extend thanks to those who took part in the project. Alongside the groups mentioned in Appendix 1, a valuable contribution was also made by the Depositary and Trustee Association. The sample of participants was selected to provide a mix of UK-centric and global businesses, comprising both stand-alone investment management groups and those with banking or insurance parents. Together, these groups manage 62.5 percent, in terms of Funds Under Management (FUM), of UK authorised funds as at 31 May 20064. The participants’ fund structures can be broadly categorised as follows, with the diversity of models leading to different responses to the questions. • Groups with a flagship fund range domiciled in a major offshore centre (principally Luxembourg, occasionally Ireland) that is intended for cross-border sale. Parts of the range are duplicated through funds domiciled in other countries if this facilitates distribution. This is the typical model favoured by most managers, and in particular those that are part of US groups. • Groups with a flagship fund range domiciled in the UK that is intended for cross-border sale. Managers operating this model tend to have historic ties to the UK. • Groups with a number of fund ranges domiciled across the EU that have grown piecemeal. There is no dominant range and often ranges overlap. Such managers have often acquired ranges from other investment managers and have been unable to rationalise fund ranges for tax or regulatory reasons or because local markets prefer local funds. • Groups with a flagship fund range domiciled in the UK and few funds elsewhere, because the target market is predominantly the UK or because the range was set up before Luxembourg had established itself as a funds centre. 4 Source: IMA monthly statistics © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
9 Introduction Figure 2.1 illustrates the domiciles where participants have located their funds by FUM. There is a UK bias compared with the European industry wide European Fund and Asset Management Association (EFAMA) statistics in Figure 3.2, which suggests that UK based managers are more focused on the UK market, and hence UK funds, than continental managers. Figure 2.1 Domicile of CIVs managed from the UK (% by FUM) 11% 2% 39% 26% UK Luxembourg Ireland Channel Islands / Isle of Man 22% Other Source: KPMG / IMA Survey Figure 2.2 considers the participants’ CIV assets by both domicile and asset type. The analysis is broadly in line with expectations; mainstream funds aimed at the UK market, but not progressive and alternative funds, tend to be domiciled in the UK. Figure 2.2 CIVs managed from the UK by domicile and type (% by FUM) 100 80 Percentage (%) Other progressive 60 & alternative funds Hedge funds 40 Money market funds Balanced 20 Bond Non-UK equity 0 UK equity UK Luxembourg Ireland Source: KPMG / IMA Survey © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Introduction 10 Figure 2.3 analyses the split between retail and institutional investors. The majority of investors in UK and Luxembourg funds are retail-focused, whereas Dublin has established itself as an attractive location for institutional funds. Figure 2.3 CIVs by investor type 100 80 Percentage (%) 60 40 20 Institutional 0 Retail UK Luxembourg Ireland Source: KPMG / IMA Survey 2.3 Scope of the report This report is concerned with CIVs established by UK based investment managers. The term CIV is intended to be all-encompassing and, except for insurance based products, includes all open-ended pooling arrangements, be they corporate, trust based or contractual. Although insurance groups have made a significant contribution to this report (as major investors in collectives and owners of investment management subsidiaries), funds within insurance companies are excluded from this report because the insurance products are subject to a separate regulatory and taxation regime from other pooling arrangements. All major asset classes have been covered with the exception of private equity. The structures used and tax issues faced by private equity houses were considered to be too specific for the scope of this report. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
11 Introduction The main funds managed by participants and discussed in interviews are: • Investment Companies with Variable Capital (ICVCs), i.e. open-ended corporates, including UK Open-Ended Investment Companies (OEICs) and Luxembourg Sociétés d'Investissement à Capital Variable (SICAVs). • Unit trusts (trust based schemes that are predominantly in the UK and Ireland). • Contractual schemes (for example, the Irish Common Contractual Fund (CCF) and Luxembourg Fonds Commun de Placement (FCP)). • Investment trusts (closed-ended companies that are predominantly in the UK). More detail of the fund types is included in Appendix 2. Unless the context suggests otherwise, this report treats ‘investment funds’ or ‘funds’ as synonyms for CIVs. 2.4 Structure of the report Chapter 3 provides background information on the investment funds industry. Chapter 4 considers factors influencing the decision on location of fund domicile. Chapter 5 considers specific tax factors that influence the fund domicile decision. Chapter 6 considers the impact that the domicile decision has on the UK funds industry and the wider economy. Chapter 7 draws conclusions and recommends actions. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Profile of the European investment funds market 12 Profile of the European investment funds market 3.1 Development of the market “Integrated and efficient The investment funds industry is an important part of the UK and European economy, providing significant employment in a number of locations. The European markets for industry plays a vital role in facilitating and supporting investor savings, investment funds are of providing the pooled vehicles that are for many investors (retail and strategic importance: institutional) the only way to invest in securities in a cost–effective manner. they can contribute The European investment funds industry developed on a country-by-country significantly for basis over a number of years, with the fund structure for each country retirement; they allocate reflecting the relevant domestic legal, regulatory and tax frameworks. This savings to productive led to a number of different types of investment fund across the EU with investments and they correspondingly different tax and regulatory treatments. can be a force for sound The EU recognised the inherent inefficiency this diversity created in the pan- corporate governance. ” European market (predominantly sub-optimal fund sizes), and furthered the process to harmonise funds regulations in 1985 by issuing the UCITS EU Commission, 2005 Directive5. This Directive lays down regulation that primarily governs the underlying investments a fund may invest into with the purpose of providing a degree of investor protection. Funds that comply with the regulatory standards of the UCITS Directive are eligible to be distributed cross–border within the EU. Furthermore, UCITS–compliant funds are accepted in many global markets, particularly Asia. Within the EU, UCITS dominate the fund market, accounting for in excess of 75 percent of the value of investment funds covered by EFAMA. Many jurisdictions, including the UK, also provide a regulatory framework for funds that have broader investment and borrowing powers than the UCITS Directive allows. The UK regulations classify two such fund types – Non- UCITS Retail Schemes (NURS) and Qualified Investor Schemes (QIS). As these funds have wider investment powers, the taxation issues can be more complex. 3.2 Current state of the market 3.2.1 Current market position In 2003 the IMA commissioned a study on the state of the single market for asset management (Heinemann, 2003). The headlines of this report were: • European funds are held primarily by European investors (over 75 percent). • The US market is effectively closed to the marketing of EU based funds because of the US regulatory regime, which makes it “practically impossible” (Heinemann, 2003) for European investment management funds to meet Securities and Exchange Commission (SEC) criteria. 5 UCITS and their managers are subject to the UCITS Directive (85/611/EEC) and two amending Directives that are together referred to as UCITS III. The level of regulatory protection provided by the Directive means that UCITS can be offered to retail investors in any Member State after authorisation in the home Member State subject to notification in each host Member State. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
13 Profile of the European investment funds market • There is appetite for UCITS funds in significant markets outside the EU, for example, Mexico and the Far East. • When entering major European markets, fund promoters are often forced to establish a domestic range because of distributor bias or regulatory or tax requirements. This means that the European market is less efficient than it could be. • Luxembourg has established itself as a centre of excellence for cross-border retail distribution. Ireland, on the back of its International Financial Services Centre, has established a strong reputation for certain types of institutional fund, for example, money market funds, and fund administration for both Irish domiciled funds and Cayman domiciled hedge funds. These conclusions still largely hold true. The slow, but growing, erosion of national barriers and the consolidation of the European funds market into a smaller number of centres has continued, particularly in respect of fund domiciles. This has been driven both by regulatory and market forces. “…the industry’s business Regulatory forces The 1985 UCITS Directive provided the regulatory framework to model is evolving with a harmonise EU markets, and has been moderately successful in opening growing number of global up a cross–border market for funds in the EU. A recent EU Green Paper fund management groups (EU Commission, 2005) reported that the use of UCITS product operating from Luxembourg passports doubled between 2000 and 2005, with 16 percent of sales being truly cross–border (i.e. excluding round-tripping – the practice of and Dublin to the detriment targeting investors in the same domicile as the manager via a non- of their domestic markets. domestic fund). Based on this evolution, local managers need to However, the Green Paper also concluded that the UCITS regime had not been as successful as envisaged in creating a more efficient pan- sharpen the value European investment funds market; European funds remain on average proposition of their funds to five times smaller than US equivalents, reducing economies of scale and maintain market share6. ” benefits to end customers. To address this situation, the EU Green Paper identified ways to build on existing legislation to progress towards a more efficient EU funds market. In doing so, it explicitly recognised the growing influence of offshore centres. 6 EFAMA Fact Book: Trends in European Investment Funds, 2005 © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Profile of the European investment funds market 14 Market forces A combination of the lowering of protection barriers for national markets and the increasingly international focus of investment managers has led to the growth of EU cross-border sales. Although national markets have never been fully closed, the increased use of open architecture has further opened up these markets to non- domestic investment managers, allowing them to promote standardised, acceptable funds into different markets. The growing international nature of investment managers’ businesses has in turn led many to increase their efficiencies through optimising fund ranges and reducing associated costs by creating a single fund range that is acceptable in many markets rather than multiple fund ranges designed for each single market. The growth of Luxembourg SICAV funds has been partly driven by this trend. Changes to the UK’s offshore funds tax legislation in 2004, which made it possible for offshore sub-funds or share classes to qualify for distributor status, accelerated this development by opening up the UK market to offshore funds. As Figure 3.1 suggests, the changes have helped enable Ireland and Luxembourg based funds to increase sales into the UK. In the 31 months to 31 July 2004, sales from Ireland and Luxembourg comprised one percent of net sales. In the 19 months to March 2006, they comprised 21 percent of net sales. Figure 3.1 UK market – Net fund sales Jan 2002 – March 2006 100 80 Percentage (%) 60 40 UK net sales of 20 non-UK domiciled funds UK net sales of UK-domiciled funds 0 Jan 2002 - Aug 2004 July 2004 March 2006 Source: FERI / FMI. Data based on contribution of 27 cross-border groups, showing sales into the UK from Luxembourg and Dublin. The 27 contributors are estimated to account for around 75 percent of pan–European cross-border business. © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
15 Profile of the European investment funds market The substantial growth of offshore fund centres, particularly Ireland and Luxembourg, is evidence of the trend towards a harmonised EU market. The EU Green Paper and Commissioner McCreevy’s closing remarks at an open hearing on 19 July 20067 provide further evidence of the political support for harmonisation of an efficient market. With such support, the continued success of existing centres will depend upon their ability to create an environment that can compete successfully with offshore jurisdictions. “Indeed, market growth in offshore fund assets has significantly outstripped major mutual fund markets in Western Europe and the US for each of the last five years…Datamonitor anticipates that within Europe the drive to consolidate funds is likely to favour a smaller number of larger offshore centres (in particular Luxembourg and Dublin) where the supporting administration and fund servicing infrastructure is well established 8” . 3.2.2 Market statistics Figure 3.2 shows the size of the European asset management market for CIVs, and the split between UCITS and non–UCITS funds. Figure 3.2 Comparison of net assets of the major European markets 1800 1600 1400 Euro billions 1200 1000 800 600 400 200 Non-UCITS 0 UCITS France Germany Ireland Luxembourg UK Source: EFAMA, Trends in the European investment funds industry in the final quarter of 2005 and results for the full year 2005 (March 2006) Figure 3.2 illustrates the way that Ireland and Luxembourg, both of which have small populations and a low level of domestic investment assets, have taken advantage of the UCITS regulations to establish themselves as offshore centres and grow their investment management industries. By comparison, the funds industries of France, Germany and the UK have relied on the strength of domestic demand. 7 Open Hearing on Retail Investment Funds, Market Efficiency, Hedge Funds and Private Equity Funds: http://europa.eu/rapid/pressReleasesAction.do?reference=SPEECH/06/465&format=HTML&aged=0&language=EN&guiLanguage=en 8 Datamonitor, 2005 © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
Profile of the European investment funds market 16 Figure 3.3 shows the growth of UK, Ireland and Luxembourg domiciled funds. Figure 3.3 Growth in registered fund assets 1800 1600 FUM (Euro billions) 1400 1200 1000 800 600 400 200 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 UK Ireland Luxembourg Source: EFAMA / IMA In addition to the above, as at June 2005 Ireland administered a further “The gap is just huge now. US$327 billion of funds domiciled outside Ireland9. Had the UK acted ten or Both Ireland and Luxembourg have built critical mass over a relatively short fifteen years ago the story period, to the point where they now hold leading market positions as might be different, but offshore fund centres. During the same period, the growth of the UK market things have moved on so has been much less pronounced. Participants in our survey realistically much. ” recognise that there is little likelihood of fully reversing this situation. Positive and active sponsorship and support by Governments has been “Had we set up our funds instrumental in creating a favourable environment for the funds industry in eight to ten years ago when Ireland and Luxembourg, with the Irish Government in particular being a significant factor behind the growth of the Irish market (see Appendix 3). the Luxembourg industry This in turn has facilitated much of the growth for these centres and remains a was small and fragmented, continuing positive factor for these centres, in particular in the way that it the UK might have featured encourages a joined-up approach to the industry across tax and regulatory areas. in the decision. ” Quotes from participants 9 Source: Dublin Funds Industry Association (DFIA) © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
17 The fund domicile decision The fund domicile decision 4.2 Factors influencing the fund domicile decision 4.1 Summary Participants were asked to rank in order of importance the more common This chapter considers the factors that influence the decision on where to domicile funds. The results factors that have influenced are set out in Figure 4.1. managers’ choice of fund domicile. The key findings are: Figure 4.1 Factors influencing domicile decision (weighted average) • Taxation of the fund, taxation (On a scale of 1-5, where 1 is low and 5 is high) of the investor and regulation Answer to the question as to what extent managers bear the following were identified by participants factors in mind when deciding where to locate a fund. as principal factors in fund domicile decisions. 4.5 • Participants consider these factors to have greater 4.0 importance for alternative and 3.5 progressive funds than for mainstream funds. 3.0 • Participants look for a Rating favourable tax and regulatory 2.5 regime together with a 2.0 supportive approach from Government, regulatory and 1.5 tax authorities when deciding 1.0 upon fund domicile. 0.5 0.0 Taxation Taxation Regulation Investor Location Support Location of fund of preference of admin Services of core investor function asset mgmt function Source: KPMG / IMA Survey The results highlight that: • The most important factors consistently identified by participants are taxation of the fund, taxation of the investor and regulation. • Investor preference is also of importance to a number of participants. • Location of the core asset management function has least impact on the fund domicile decision. The results are consistent with the Oxera report findings, particularly the importance of tax and regulation in the domicile decision. Further analysis of the results in Figure 4.2 shows the importance of factors by fund type, differentiating between mainstream funds (money market, bond, balanced, and UK and non–UK equity) and the more alternative and progressive fund types (Pension Fund Pooling Vehicles (PFPVs), Exchange Traded Funds (ETFs), structured / guaranteed products, QIS, property funds and hedge funds). © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,
The fund domicile decision 18 Figure 4.2 Factors influencing domicile decision (by fund type) (On a scale of 1-5, where 1 is low and 5 is high) 5.0 4.0 3.0 Rating 2.0 1.0 0.0 Taxation Taxation Regulation Investor Location Support Location of fund of preference of admin Services of core investor function asset mgmt function Money market funds UK equity Exchange traded funds Property Bond Non-UK equity Guaranteed / Hedge funds structured products Balanced Pension fund pooling vehicles Qualified investor schemes Source: KPMG / IMA Survey The results show that virtually all factors have a greater significance for alternative and progressive fund types. They also highlight that, for alternative and progressive funds, investor preference is a key factor alongside tax and regulation, although this can be closely attributed to the overall appeal and environment of a domicile, including the attitude of authorities, and specific tax and regulatory issues. In addition, the results suggest that EU member states wishing to retain and attract general funds business must establish appropriate tax and regulatory regimes that are supportive of the industry. This requirement is greater for alternative and progressive fund types, where investor preference for the overall environment of the domicile is also a key factor. With strong predicted growth in the alternative market and as yet no clear domicile of choice for these funds within the EU, opportunities still exist for member states to secure the economic benefits from becoming the domicile of choice for these funds. “Over 60 percent of fund managers believed that alternative investments (defined as hedge funds, property, private equity and capital protected / structured products) would become as important as traditional investments in their jurisdiction in the next two years10. ” 10 Source: Datamonitor Offshore Fund Management Survey 2005, page 8 © 2006 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative, and the Investment Management Association. All rights reserved. ,