Cross-border fund mergers were mooted as a means to consolidate smaller funds, but how viable is this process? Nicholas Pratt reports
When Ucits IV was first drafted it was billed as an efficiency package for the single European market in investment funds. Central to the efficiency drive was the provision of cross-border fund mergers. Reducing the number of smaller funds that exist in different domiciles by consolidating them into larger cross-border funds means the market will become more efficient and this will lead to lower costs for investors.
But the reality may prove to be different because the feeling in the funds industry seems to be that the framework for cross-border fund mergers does not appear to be particularly effective.
The first indication that things may not work out as planned is the fact that the number of funds in Luxembourg has gone up rather than down since Ucits IV was passed into law on 1 January 2011.
This increase in the number of funds may not all be a result of backfiring Ucits legislation, however. The market is currently enjoying a period of innovation where managers all over Europe are launching new funds. Similarly, if managers do choose to consolidate their funds, Luxembourg is likely to be the most popular destination.
“It’s true that the number of funds has increased but many of these are non-Ucits funds, such as Sifs; the number of Ucits funds has stayed stable,” says Charles Muller, deputy director general of Alfi, Luxembourg’s funds industry association.
It is also very early to make definitive statements on the success of Ucits IV and its effect on funds consolidation, says Muller. Luxembourg was the first European state to put Ucits IV into effect, as of January, but for most other countries the deadline remains July. “So I think it will take at least a year for the effects of Ucits IV to be fully understood.”
Not only is there the July deadline but, says Muller, asset managers have been concentrating on the mandatory aspects of Ucits IV, such as the Key Investor Information Documents. Consequently, the opportunity to consolidate funds through cross-border fund mergers, passporting, master feeder structures and management company rationalisation are not top priorities.
But according to Jon Griffin, managing director of JP Morgan Asset Management in Luxembourg, wholesale adoption of cross-border fund mergers because of Ucits IV is unlikely to materialise. “There may be certain cases where a manager with many domestic products in various domiciles around Europe may be considering a change of strategy and look to consolidate their funds into certain well established cross-border domiciles such as Ireland or Luxembourg, but our experience is that it is easier to launch a new fund rather than convert or consolidate existing ones given the disruption to shareholders.”
Griffin adds that the lack of any common approach to taxation of such a merger event is also a problem. “Unless you treat cross-border mergers as tax-neutral events for investors then there will be limited desire for managers to consider them and, at the moment, any unified tax approach is completely off the Ucits agenda,” he says.
Even when managers have sorted out their Ucits priorities later this year, it is unlikely that many minds will then turn to the issue of fund consolidation. “There may be some managers that look to be opportunistic around introducing master feeder structures but, again, that is more about establishing new funds rather than converting existing ones,” says Griffin. “And I don’t see swathes of fund managers engaging in cross-border fund mergers.”
It is perverse that there has been an increase in the number of funds in Luxembourg, given the aim of Ucits IV to consolidate the number of funds, says Julie Patterson, director of authorised funds and tax at the Investment Management Association, the UK trade body. She also says tax is the central issue.
“Cross-border mergers will not work because of the failure to sort out cross-border tax issues. We thought something might happen but it hasn’t and this has left Ucits IV close to a dead duck in many ways.”
The difficulty is that tax issues are addressed through a different legislative and legal process. And, says Patterson, traditionally there has always been resistance within the EU to do anything Europe-wide about tax. Furthermore, any decision regarding tax changes have to be unanimously agreed between all member states, which takes time.
“Interestingly though, we have recently seen a flurry of tax legislation on cross-border dividend payments and cross-border VAT so perhaps we may yet see something regarding cross-border Ucits funds,” she adds.
While cross-border fund mergers are currently difficult to achieve, there are possibly other opportunities to achieve some efficiency through other provisions of Ucits IV, says Patterson. “We might see greater use of the funds passport. Investors do seem to be getting more acquainted with the passport concept, particularly in the retail market. And we might see some promoters rationalising their fund ranges in certain domiciles as a result.
“We might also see use of the master/feeder structures but it will take time for this to result in funds consolidation. Initially, it will involve setting up new fund structures, which in the short-term will result in a greater number of funds. So all in all, I have to say that Ucits IV is likely to be a failure in this regard.”
Aside from failing to address the tax implications of a cross-border fund merger, Ucits IV also appears to have done little to address the detailed legal issues involved, other than requiring certain mandatory disclosures to investors and setting the maximum shareholder consent requirement at 75%. Accordingly, there has been no meaningful harmonisation of the national laws that will apply in respect of fund mergers.
Dale Gabbert, head of the European and Middle East investment funds group at law firm Reed Smith, says: “A fund is first and foremost a legal entity, whether it be a unit trust, partnership or a corporate. Merging different legal forms is not straightforward, particularly where multiple jurisdictions are involved. In some countries, mergers require a court-approved process.”
The cross-border aspect adds even more complexity in that a merger could involve a common law vehicle in one jurisdiction and a civil law vehicle in another jurisdiction.
What essentially the Ucits IV directive has done is make a provision for cross-border fund mergers without doing anything to change the current legal and tax processes in place in each EU state. For example, the UK has allowed for cross-border mergers but not changed the legal process required. “These are technical legal issues that are far too complex to be dealt with by a few paragraphs in a directive,” says Oliver s’Jacob, a funds partner at Reed Smith.
Mergers are most likely to be driven by managers who want to consolidate their product lines or who have taken over other fund managers. Unfortunately, the directive disincentivises them by prohibiting managers from charging any of the merger costs to the funds or their investors, says s’Jacob. “Why would managers go through all the legal and regulatory hoops and bear the associated costs of a merger when they could just set up a new fund and charge the costs of doing so to the investors in the new fund?”
Aside from the technicalities involved, the principle behind the whole drive to promote cross-border fund mergers is a bit bizarre, says Gabbert, in that it seems to contravene the principles that guide most EU legislation: that of introducing more rather than less competition and appealing primarily to investors’ demands.
“The cross-border fund mergers aspect appears to be an afterthought of Ucits. Now and again with EU legislation you have odd pieces thrown in and this appears to be what has happened here,” says Gabbert.
Someone somewhere may have lobbied for these changes, quite possibly a fund domicile such as Luxembourg that would gain from an increase in cross-border business.
“To increase efficiency is good, but any changes should be about sufficient demand and we don’t see that,” says Gabbert.
©2011 funds europe