Under Ucits IV, fund managers will be able to set up master-feeder structures – that is a kind of pooled vehicle where funds domiciled in various jurisdictions, the feeders, are fully invested in a single master fund.
The directive also makes provisions for fund mergers and funds of funds, where the overarching vehicle cannot invest more than 20% in any single fund.
None of these solutions are a panacea for all fund manager pooling needs but they offer new opportunities in the hope of increasing efficiency in the industry.
Asset pooling is nothing new and the industry has sought to pool assets and funds in various ways in the past to increase efficiencies.
Ellen Cramer-de Jong, partner at law firm Allen & Overy, says: “The driver of benefits from pooling is quite simply that bigger is better. Significant advantages of asset pooling are that a larger pool of assets can achieve a better performance than a collection of smaller pools, leading to increased investment yields. And a single regulatory regime means less regulatory costs.”
However, allowing managers to set up master-feeder structures under Ucits IV may not lead to a reduction in the number of funds in Europe, yet fund rationalisation is something the industry is needed.
In a report, consultancy firm Deloitte says: “The European funds market is about half the size of its US equivalent, yet it has three times the number of funds thanks to the existence of multiple platforms and duplicated ranges across territories within the EU. Aside from being administratively burdensome for companies this is also unnecessarily costly and inefficient.”
Deloitte says it is estimated that the pooling of fund assets could deliver the economies of scale present in the US and yield savings of as much as €5bn per annum, as well as result in significant tax and VAT savings both for investors and fund managers.
Kerry White, managing director for business strategy & development at BNY Mellon Asset Servicing, says: “There is a total of €5 trillion in assets under management in Ucits products, but these assets are in 43,000 funds. Furthermore, a little less than half of those funds, totalling €2.3 trillion, can be classified as cross-border in nature. So clearly there are a very large number of funds which are currently single-country funds that I would suggest are ripe for consolidation.”
So why will the Ucits IV master-feeder structures not reduce the nuber of funds?
Aaron Overy, head of pooling business development Emea at Northern Trust, says: “There is the intent to consolidate but people will still be using feeder funds. They’re not going to collate these feeder funds into a single product. They will keep existing local funds, converting them to feeders and gain scale efficiency by holding all of the assets in a single master fund. So the number of funds will not be reduced overall.”
Bernard Hanratty, head of investor services Emea at Citi Global Transaction Services, says: “Ucits IV may not actually help to reduce the number of funds. Although the fund merger provisions could reduce the number of funds, the master-feeder and fund-of-funds provisions will reduce costs as the number of funds with direct assets will reduce, but the absolute number of funds will not come down.”
Overy, of Northern Trust, says: “Fund managers will save money, since they will be solely allocating assets to the master fund. This allows them scale and is cheaper to run.”
However, these savings may not be immediately apparent. Thierry Blondeau, partner at PricewaterhouseCoopers (PWC), says: “Setting up a master-feeder structure may not be as simple as one may think – there are difficulties around currency and cut-off time, for example.”
Sheenagh Gordon-Hart, executive director of industry and client research at JP Morgan Worldwide Securities Services, says: “There will be stumbling blocks to setting up these structures. For example, if UK funds were made to feed into a Luxembourg master Sicav fund, then that fund would not benefit from any double tax treaties. The way around this problem may be to make sure the master fund is a tax-transparent vehicle, like an FCP (fonds commun de placement).”
Northern Trust’s Overy agrees. “The implementation of tax-transparent structures allows fund managers, and therefore their clients, to take advantage of any tax treaties drawn up between different countries. Were the structure not tax efficient then investors in those [feeder] funds would end up paying more tax than they were before the master-feeder structure was set up.”
Most experts agree that setting up master-feeder structures will lead to cost savings, but Blondeau, at PWC, says: “Although there are likely to be savings for the fund manager, the initial cost of such a structure may not be recouped immediately.”
It could be assumed that, once materialised, these savings will then be passed on to clients. However, this is still an open question.
White, at BNY Mellon, says: “I would hope these cost savings are passed on to investors. After all, the ultimate goal of consolidation is to improve the industry’s competitiveness and drive down cost.”
Gordon-Hart, of JP Morgan, says: “Many of the savings that managers will make as a result of implementing master-feeder structures are embedded within the funds themselves. Therefore those savings are automatically passed on to clients.
“For example, custody costs for larger funds are much lower than for smaller funds and even though the difference is only of a few basis points, this can significantly enhance performance.”
Another of the debates in the world of asset pooling is whether either ‘entity’ pooling or ‘virtual’ pooling is better than the other. Both approaches have their pros and cons.
Hanratty, at Citi, says: “Asset managers like the idea of pooling as it focuses on scalable solutions, which can speed up time to market for new products and reduce costs.
“If an asset manager has two different investment products, with different tax profiles, using virtual pooling can further speed up time to market, because you don’t have to wait for tax rulings or opinions – in virtual pools, tax transparency is assumed.”
With entity pooling, an asset manager wanting to pool investment products in different domiciles will require various tax rulings and a bilateral agreement drawn up for the tax treatment of that new entity. However, with virtual pooling, this is not a requirement.
Cramer-de Jong, at Allen & Overy, says: “A virtual pool will, in most cases, be considered tax transparent. This means that the virtual pool is ignored for tax purposes and the pool participants are deemed to have directly invested in the underlying assets.
“Any withholding tax is determined as if the pool participants were holding the pooled assets directly. In most cases tax transparency of a pool is required. In particular, this will be the case if the pool participants themselves are tax transparent or exempt from taxation.”
But Overy, of Northern Trust, says: “Virtual pooling doesn’t make sense on a cross-border basis because regulators don’t really like these arrangements.”
Citi’s Hanratty says: “The regulator of the mutual fund [in each country] has to be comfortable with the manner in which the assets are administered. The virtual pool needs to be explained.”
Cross-border virtual pooling can be quite thorny. Blondeau, at PWC, explains: “I wouldn’t say that virtual pooling is not adequate for cross-border funds, but it does raise some taxation issues.
“For example, if you have two funds, one in the UK and one in Germany, which are pooled virtually, then one would have to consider the taxation of investors into that pool from both the UK and German perspective. You would have to take into consideration the double-tax treaties each country has with other countries, which makes things quite complicated.”
Were the two countries to have the same tax treaties set up with the same countries, then setting up a cross-border virtual pool could potentially be a much simpler process, Blondeau says.
Although virtual pooling has its benefits, the use of it is still not very widespread.
Hanratty, of Citi, says: “Virtual pooling is used in Luxembourg, Dublin and marginally in the UK.” Overy, at Northern Trust, adds: “In fact, in the UK there are only a couple of instances of firms using virtual pooling.”
According to Jeremy Soutter, global head of products at Aviva Investors: “Virtual pooling is too complicated and too expensive. The tax issues don’t make the practice very attractive.”
Gordon-Hart, of JP Morgan, says: “Virtual pooling is fraught with complexities around ownership so makes stock lending and OTC derivative contracts difficult. In this model all owners and the manager and the custodian would be parties to the contract. Entity pooling is far easier to deal with.”
So, entity pooling appears to be proving more popular, but under current regulations there are restrictions about how much one fund can invest in another.
Hanratty says: “The master-feeder provisions in the Ucits IV directive enable a fund to fully invest in another fund.”
This suggests that the master-feeder structures could replace pooling structures, but in actual fact, these provisions still don’t account for all possibilities. For example, fund managers cannot have a feeder fund investing in two funds.
Blondeau says: “There is some ambiguity in the directive because fund managers have only two options – to either use the master-feeder structure and have one fund at least 85% invested in another, or to have a fund of funds structure where they cannot invest more than 20% into any single fund.”
This is one of the reasons why there will still be scope for asset pooling, in spite of new developments introduced by Ucits IV. Hanratty says: “People will be looking at how they can do this [investing in more than one fund] in a more creative way.”
However, one observer did suggest that the industry should be happy with the developments that have been made and not try to complicate matters further.
Blondeau says: “The introduction of the master-feeder structures does not mean that asset pooling will disappear. It can and will continue to be used.”
White, of BNY, says: “Ucits IV will not spell the end for asset pooling, rather it will facilitate the practice. The market is currently so fragmented that Ucits IV will make things like master-feeder structures more palatable than they are now.” ©2010 funds europe