In June last year, the European Commission launched a consultation on the cross-border distribution of investment funds (UCITS, AIFs, ELTIFs and EuVECAs/EuSEFs)1 with the aim to identify the key remaining barriers to marketing and selling investment funds across the EU. This consultation, as one of the initiatives in support of the creation of a Capital Markets Union (CMU), highlights the importance a truly performing single market holds in allowing further growth and efficiency for funds, as well as in helping mobilize and allocate capital from the adequate sources to the right projects all over Europe, and delivering better value and innovative products to investors.
This effort to identify the remaining barriers, and the ways to eliminate them, is an initiative that has been welcomed by an important number of stakeholders both from the private sector and the public authorities’ sphere, and it has activated them in responding to the Commission’s call for input. Indeed, the goal of the European Commission to seek further ways to deepen the single market for investment funds is a widely shared one, as it is critical for widening the opportunities for European citizens to save and invest, as well as for facilitating better outcomes both for savers and the wider European economy.
Investment funds are probably one of the best examples to date of a generally well-functioning EU single market in the area of financial services. Based on the latest data of the EFAMA’s FactBook 2016,2 the share of ‘true’ cross-border funds in Europe, i.e. funds that are sold by fund promoters outside their home market, either elsewhere in Europe or in other parts of the world, made up 30% of total European investment fund assets, a considerable increase from the 18% recorded at end 2005. This trend shows the important rise in the share of cross-border funds over the last decade and the significant potential this has for the EU single market.
This being said, there is certainly significant room for improvement and further integration of the EU single market for investment funds. The Commission’s consultation document highlights that one-third of UCITS that are marketed as ‘cross-border’ are sold in only one member state in addition to their home country, and mainly back to the member state where the asset management company is domiciled. Another third are not sold in more than four member states outside their home country. Further, according to the Commission, the comparison with the US mutual funds is not in favor of the EU, as in spite of the greater number of the EU UCITS funds available for sale in Europe compared to the mutual funds in the US, the average value of an EU fund appears to be significantly less than the average value of a US mutual fund.
Measures to facilitate the cross-border distribution of funds in the European Union can play an important role in that respect, and lead to further economies of scale, to the benefit of the end investors and the competitiveness of our industry. Enabling a wider distribution of funds outside domicile member states means further competition at the EU level and at the level of domestic markets, which can increase the overall quality of products offered, allow for further innovation, and reduce costs and fees. Thus, identifying the reasons that hinder cross-border marketing of investment funds and the areas where further improvements are necessary does not just respond to the needs of particular market players, but also helps deepen the single market and strengthen the European economy.
Asset managers are faced with a wide range of barriers when deciding to distribute their funds outside their domicile jurisdiction, from regulatory to other operational barriers, which vary across different EU jurisdictions and can have different impacts and significance. Of course, each of them may have different importance and priority depending on the relevant jurisdiction or the specific case. Still, in the majority of the cases the decision to proceed or not with the cross-border marketing of a fund depends on how a number of these barriers interact and the end result they bring to the asset manager. Therefore, the analysis that needs to be made and any decisions on the actions to be taken should focus not only on how different barriers act in isolation, but also on how they interact.
With this in mind, there are a number of particular barriers that seem to have priority in terms of the need to eliminate them or minimize their impact on the cross-border distribution of funds.
A key element for the efficient distribution of funds across the single market is legal certainty as to related requirements. Legal certainty usually comes from a consolidated rulebook across the single market, common interpretations of key regulatory provisions and consistency as to how these provisions are implemented in all EU jurisdictions. In the EU, and in spite of the legal framework that has been in place for some time now (UCITS and AIFM directives), this type of legal certainty is still lacking in a number of the steps related to the funds’ distribution, e.g. lack of a common definition of marketing and pre-marketing activities, lack of a common definition of certain investor categories, multiple standards and rules related to the notification process, and different processes related to fees.
Another key element is the abuse of the flexibility provided by the EU regulatory framework which leads to the introduction of additional requirements at the national level that do not appear to address specific investors’ needs, but instead, amount to the creation of additional barriers for non-domestic firms. For instance, many member states require asset managers to appoint a local agent prior to undertaking distribution in their jurisdiction; however, it is often the case that another agent or the manager located outside their jurisdiction could take on this responsibility in an equally efficient way. Other examples include additional rules related to offering documentation, marketing activities, and discretion as to the implementation of specific rules.
Transparency and clear understanding of all rules with which market players have to comply is critical to the decision to offer units of a fund in a certain jurisdiction. Still, this is not the case in a number of areas related to cross-border distribution. Absence of clear and easily accessible information to rules such as notification rules and rules that trigger fees, as well as to standard interpretations related to marketing, etc., generates significant additional efforts. These are executed in-house or outsourced to a third party, therefore rendering the cross-border distribution more expensive and time-consuming for UCITS managements companies and AIFMs.
In terms of tax treatment, the investment management industry faces important difficulties deriving firstly from the discriminatory withholding tax (WHT) treatment between residents and non-residents, which persists in a number of member states; secondly from differences between member states in terms of tax reporting scope and format; and foremost, from inconsistent double tax treaty (DTT) access for investment funds (including cumbersome processes when double tax treaty access is granted).
Last but not least, as a significant portion of the cross-border distribution activities of EU asset managers is located outside the internal market, bringing down barriers should also include tackling those barriers posed by non-EU countries, as relates to the distribution of EU funds outside the EU. In this context, it is crucial that the EU regulatory framework remain cost-effective and proportionate in order to ensure the competitiveness of the sector when engaging with non-EU counterparties.
In tackling all of these barriers, further consolidation and clarification of rules and processes on cross-border distribution is the optimal way to enable full use of the EU single market for investment funds. Avoiding any unnecessary regulatory burden and maintaining legal certainty and stability for market participants should remain the key principles. For that reason, any proposal for legislative changes, in particular to the AIFM or the UCITS directives, should be a last-resort means for the European Commission, to be implemented only where no alternative solutions that do not involve regulatory changes would have been effective. Whenever appropriate, practical solutions that don’t impose additional requirements should be preferred, such as guidelines or Q&As that can be developed and implemented within a much shorter period of time and therefore bring about required improvements in a more expedient way.
Footnotes
1. Consultation Document, CMU action on cross border distribution of funds (UCITS, AIF, ELTIF, EUVECA AND EUSEF) across the EU, http://ec.europa.eu/finance/consultations/2016/cross-borders-investment-funds/docs/consultation-document_en.pdf
2. 2016 FactBook, Trends in European Investment Funds, 14th edition, http://www.efama.org/statistics/SitePages/FactBook.aspx