Costs associated with building an international distribution strategy out of Europe are on the rise as a result of new regulations. Stefanie Eschenbacher finds that Luxemburg and Dublin may no longer be the first choice of domicile for emerging market asset managers.
Emerging market asset managers expanding internationally face a raft of new regulations, rapidly changing a market that is already hard to serve profitably, and getting more so.
Many have already built their international distribution out of Luxembourg or Dublin, using the Ucits structure to sell funds not only into new but also back into their home markets.
Today, more than 30% of Ucits sales take place outside the EU, according to the European Fund and Asset Management Association. Most go to Asia, which is also the fastest-growing market. Other significant markets include the Middle East and North Africa, and Latin America.
Sebastien Chaker, managing director at Calastone, says Luxembourg and Ireland owe their success to the Ucits brand. “Is it just Luxembourg? No, it is the Ucits brand and its ability to distribute on a global basis,” he says.
Bradesco Asset Management, which is headquartered in São Paulo, Brazil, chose to domicile the five funds it sells outside its home market in Luxembourg.
Those include the Brazilian Equities Megatrends, the Brazilian Fixed Income, the Brazilian Hard Currency Bond Fund and the Brazilian Equities Mid Small Caps.
Ileana Salas, head of Europe and Middle East, says Luxembourg was chosen over Ireland because research among potential investors indicated it was their domicile of choice.
Salas says she does not share some of the concerns voiced in Chile, where the Risk Classification Commission decided to disapprove Ucits funds domiciled in Ireland in 2011 after the country’s rating fell below AA-.
“Of course, we take in the opinion of the Chilean pension funds as a very significant investor in Latin America,” she says. “But our research was centered on the requirements of European investors, and that was their favoured domicile.”
Ireland has also attracted emerging market asset managers. NCB Capital, which is headquartered in Riyadh, Saudi Arabia, launched two sharia-compliant Uctis funds there, the NCB Capital Saudi Arabian Equity Fund and the NCB Capital GCC Equity Fund. “We chose Ireland as they were extremely responsive and flexible in helping us to meet our objectives,” Faysal Badran, head of asset management and chief investment officer, says.
BNP Paribas Securities Services and the consultancy, Knadel, says that a consistent theme outlined by the 50 asset managers it surveyed last year was the time and cost associated with registering Ucits funds in Asia.
The survey asked asset managers of varying size from Asia, Europe and the rest of the world about their experiences of distributing Ucits funds in six markets across the region: Hong Kong, Japan, Malaysia, Singapore, South Korea and Taiwan. “Challenges remain around fragmentation, regulation and differences in culture which contribute to significant variations in take-up of Ucits in the region,” the survey concluded.
Chaker says asset managers often “struggle to realise the complexity linked to distributing funds on a cross-border basis”.
Cost of compliance, risk monitoring, legal fees and auditors add up. Though Chaker says setting up a Ucits structure and distributing it in as few as five different markets may still be cheaper than setting up five domestic funds.
In the absence of alternative cross-border fund distribution schemes, emerging market asset managers keep coming to Luxembourg or Dublin.
Rafal Kwasny, vice president, product manager, Europe, Middle East and Africa at Citi Luxembourg, says the country’s flexible regulatory framework, skilled multi-lingual work force and easy access to decision-makers are its main benefits. He says they can “outsource basically everything” in Luxembourg. Not least because of the costs associated with such a move; he says building an international distribution out of Europe is about making a long-term commitment, not a short-term investment.
Kwasny says the cost of doing business in asset management and asset servicing will increase further, something that is mainly driven by regulation.
The Foreign Account Tax Compliance Act, published in January to target non-compliance by taxpayers from the US, is one such piece of regulation.
Funds and other financial institutions will have to register with the Internal Revenue Service and introduce enhanced due diligence for new investors.
They also need to verify their entire shareholder register to identify investors from the US, gather more information on them, and report back to the tax authorities, either in Luxembourg if there will be an inter-governmental agreement in place, or the US.
Kwasny says that the master/ feeder structure under Ucits IV is an opportunity for asset managers in emerging markets. There is a potential that it will decrease the cost of getting assets.
The EU’s Alternative Investment Fund Managers Directive (AIFMD), proposed in 2009, is yet another challenge.
As the directive will change the depositary liability structure, Kwasny says custodians, including Citi, are reviewing their pricing structures. This is likely to increase costs further, he adds.
“We are working on all these aspects and we have to envisage that because of the custodian liability for all asset losses of portfolio cost will go up,” he says. “Custodians will provide additional services and it will have to be reflected in tariffs.”
Iris Chen, chief executive officer at China Asset Management (Hong Kong), says her Sicav was the first to be set up by a Chinese asset manager in 2010.
Like Bradesco Asset Management, China Asset Management offers international investors its local expertise. Its Luxembourg-domiciled fund range comprises the China Opportunities Fund, the China Growth Fund and the China High Yield Bond fund.
Since the launch, Chen says Chinese, Taiwanese and Korean asset managers have approached her to enquire how much the Sicav costs. “We cannot tell how much we spent altogether on this Sicav because we constantly pay for various services, not just the structure but also legal, tax consultation and administration.”
Although China Asset Management is one of the oldest and largest asset managers in China, Chen says it struggled to gain investors’ trust because the funds had no international track records.
Groupings of Asian countries have started to develop their own Ucits-equivalents with two different schemes.
As the member countries of the Association of Southeast Asian Nations are aiming to establish a single trading bloc by 2015, they have also proposed a fund passport similar to that of Ucits.
Meanwhile, finance ministers of the Asia Pacific Economic Co-Operation have established a pilot Asia Region Funds Passport structure. “[The] Asian passport is a threat, but looking at the current climate, the situation will take decades, not years,” Kwasny says. “It will not be easy for Asian countries to come to the table and agree on an Asian equivalent of [the] Ucits brand.”
Chaker adds that one of the consequences of Asia developing its own fund passport could be that asset managers choose to domicile their products in the region, instead of using Ucits products in Asia. Hong Kong and Singapore, he adds, are the most likely places to become “a hub for Ucits-style products”.
Ucits is supposedly a global brand, but it is still not accepted in all countries or, if it is, it is not the preferred choice among investors. Europe prides itself with the fact that Ucits funds can be authorised in many different countries, but some of the world’s largest mutual fund markets remain closed to them.
Ucits funds cannot be sold into the world’s largest mutual fund market, the US, nor sold in Latin America’s largest market, Brazil, or that of the Middle East, Saudi Arabia.
Asia is the second largest market for Ucits funds outside Europe, but they cannot be sold in the largest markets in the region, China and India.
Chaker says last year it became also obvious that approvals for Ucits funds in Hong Kong took much longer.
Citing a survey by the Hong Kong Investment Fund Association, Chaker says on the average fund approval time is 8.7 months for Hong Kong, 1.5 months for Singapore and 4.7 months for Taiwan. “It could be that regulators are less comfortable with the Ucits brand,” he says. “It could be a signal that Hong Kong is worried they have no control over Ucits.”
While asset managers are fretting about regulation and the increased costs attached, Kwasny says a more tightly regulated market could “be in a winning position”.
As pressure from investors grows, Kwasny predicts alternative funds to relocate from the Cayman Islands to Luxembourg or Dublin.
Anouk Agnes, director, communications and business development, Association of the Luxembourg Fund Industry, says Europe as a whole will be the first regulated alternative investment fund market.
“In 2008, many people pointed at hedge funds, arguing that they were too risky and not transparent enough,” she says.
The AIFMD is expected to be passed by Parliament in the first quarter of this year. Agnes says for Luxembourg it is about much more than just transposing it into law, because the AIFMD will include additional features that will allow alternative investment funds to operate efficiently.
The new regime for limited partnership, she says, is expected to be a major draw for private equity and hedge funds.
Most importantly, Agnes says, alternative investment funds will then be able to benefit from a passport, modelled around that of Ucits funds.
Geoffrey Scardoni, partner at SJ Berwin Luxembourg, says one of the challenges for Luxembourg is to stay competitive.
Ireland and the Netherlands all face the same challenges as Luxembourg, Scardoni says. “We need to remain competitive and flexible,” he says. “Our competitors will be in Asia – Hong Kong and Singapore.”
©2013 funds europe