Cross-border Distribution: Getting the Basics Right
Europe’s fund management industry has seen spectacular growth over the last two decades, with assets having accumulated eight-fold since 1996. Capital invested in UCITS and AIFs (Alternative Investment Funds), the two leading EU fund structures, now stands at 14.1 trillion euros.
Europe's fund management
Europe’s fund management industry has seen spectacular growth over the last two decades, with assets having accumulated eight-fold since 1996. Capital invested in UCITS and AIFs (Alternative Investment Funds), the two leading EU fund structures, now stands at 14.1 trillion euros1.
Flows into UCITS have been driven by the relative simplicity at which these products can be distributed and passported cross-border; effective regulatory oversight and their strong brand appeal to end investors. Capital raising by AIFMs has been strong, but AIFMD (Alternative Investment Fund Managers Directive) compliant funds have only existed for three years in contrast to UCITS’ three decades, meaning they have yet to acquire the recognition of the latter. It is hoped AIFMs will eventually compete on a more level playing field with UCITS in terms of cross-border distribution success and broad investor appeal.
Societe Generale Securities Services (SGSS) held a series of roadshows outlining how managers of EU regulated funds can best distribute their products cross-border, and identified some of the challenges they need to be aware of.
Choosing the Right Domicile
88%2 of cross border funds are domiciled out of either Luxembourg or Ireland, and this is a direct result of the rise of UCITS and AIFs. Both jurisdictions have robust and experienced service provider communities and appropriate regulatory regimes buttressing their reputations among investors and managers as leading fund domiciles in the onshore market.
Their global influence has also been supported through the success of ManCos, entities which allow portfolio and risk management to be delegated back to third country managers. This outsourcing arrangement has meant managers worldwide can establish UCITS or AIFs economically as they are not obliged to have a physical EU presence. ManCos have been a key facilitator in the globalisation and democratisation of the UCITS and AIF brands.
Managing inconsistencies in harmonisation
The AIFMD and UCITS passport should – in theory – allow an onshore EU fund to distribute cross-border without restrictions or regulatory barriers at a local level. The reality, however, is more trying as AIFMs and UCITS managers frequently find themselves confronting inconsistencies in practices and regulations across the EU 28.
“Despite regulatory harmonisation, a number of local rules still exist which managers must comply with, and this sometimes affects the efficiency of the distribution process,” said Regis Veillet, head of business development cross-border fund solutions at SGSS Luxembourg.
Despite regulatory harmonisation, a number of local rules still exist which managers must comply with, and this sometimes affects the efficiency of the distribution process
Head of business development cross-border fund solutions at SGSS Luxembourg
Many of these barriers are fairly unremarkable requiring managers to carry out banal tasks such as translating registration documents into a jurisdiction’s native tongue, for example.
Other local regulators have gold-platedAIFMD and UCITS, and demand managers provide extensive information to domestic agencies over-and-above what is necessitated in the original Directives. The absence of tax harmonisation across EU markets can also be problematic for managers distributing into certain countries.
The management of those inconsistencies and local rules therefore requires firms to stay alert as to what is happening across their market footprints. “Cross-border distribution can be complex, but through SGSS, we can provide managers with access to our network of paying agents, making the process simpler,” said Veillet.
Reacting to Brexit
Financial markets resent uncertainty, and Brexit is causing precisely that for asset managers. In principle, a full withdrawal from the Single Market means UKUCITS managers and AIFMs will no longer be able to passport freely across the EU, and the same will likely hold true for EU managers distributing into the UK. A few other outcomes are, however, possible.
Cross-border distribution can be complex, but through SGSS, we can provide managers with access to our network of paying agents, making the process simpler
An equivalence deal could allow the status quo for UK-based AIFMs and UCITS managers to be preserved, but it does have vulnerabilities. Stuart Cureton, head of asset managers and insurance sales and relationship management UK and Ireland at SGSS, highlighted equivalence can be revoked at limited notice by the EU rendering the set-up unworkable.
One alternative would be for the UK to negotiate a bilateral treaty arrangement with the EU, similar to the Swiss model. However, such a deal would not confer automatic passporting rights. “A Swiss asset manager will typically distribute through an intermediary which has an Irish or Luxembourg passport, or it may negotiate for the fund to be passported presuming it has some physical presence in an EU member state,” said Andreas Stricker, partner at Pericles Group.
In response to the uncertainty and possible delays to Brexit, UK and EU managers may need to strengthen operations and headcount in each other’s jurisdictions respectively if they want unimpeded market access. “In a worst-case scenario, firms could have to launch parallel funds in the UK as well as in the EU,” said Chanchal Samadder, head of equity ETFs at Lyxor Asset Management.
A simpler contingency plan would be for a UK manager to appoint an onshore ManCo, although ESMA (European Securities and Markets Authority) is scrutinising this model as part of its brief to contain the ascent of letterbox entities post-Brexit. “Given the significance of the funds’ world to the Irish and Luxembourg economies, it is hoped that ESMA will adopt a pragmatic position on the status of ManCos,” said Michael Clifford, general manager at SGSS in Ireland.
A viable distribution strategy needs to be progressive, and cognisant that existing channels operated by banks and IFAs (independent financial advisors) are likely to be overtaken by cheaper online D2C (Direct to Consumer) platforms and robo-advisors in the next few years. D2C has been given a boost by the inducement bans introduced under MiFID II (Markets in Financial Instruments Directive II).
"When MiFID II is implemented in Europe and inducement bans are introduced, this may lead to an increase in independent advisors. However, surveys are showing in the Netherlands, for example, that fewer people are obtaining paid for investment advice as they feel confident in their own ability to select the correct funds. In addition, the introduction of investment managers own sophisticated robo-advice platforms could see the cost of distribution decreasing. If distribution costs do fall, then investors may see performance increasing off the back of a drop off in charges,"
said Ross Thomson, director, Ireland Branch, at FundRock Management.
Distribution chains could also face disruption or disintermediation at the hands of a leading tech brand, a development already underway in China where the Alibaba fund has become the world’s largest MMF (money market fund).
Alibaba’s success was down to its entrenched digital footprint in the millennial market. A failure to embrace digitalisation will make it harder for traditional providers to win mandates from millennials, a demographic which will routinely monitor social media intra-daily. Simultaneously, a Deloitte report said this same demographic group’s wealth could reach $24 trillion by 2020, making them a strategically important target for asset managers.
"Consumer habits are changing and young people simply do not trust the same types of brands as previous generations did. Instead, younger people may find it more appealing to acquire funds through iTunes or Amazon. This has already happened in China with the Alibaba fund," commented Veillet.
Choosing a reputable domicile and working with a qualified service provider such as Societe Generale Securities Services that can assist with all of the regulatory convolutions and complexities across the EU 28 is a solid starting point for UCITS managers and AIFMs looking to distribute cross-border.
However, the next two to three years are likely to pose serious challenges for managers - whether it is Brexit or technological disruption – making it essential for them to have sensible strategies in place to minimise the risk of any challenges to their businesses.
1 - EFAMA
2 - PWC