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Supplements » Luxembourg 2012

ROUNDTABLE: Deep impact: how will industry adapt? (part 1)

With at least 27 different pieces of regulation challenging the investment fund sector, our roundtable looks at how participants have been preparing. The panel also criticises co-ordination between major regulators. Chaired by Stefanie Eschenbacher.


Denise Voss, vice chairman (International Affairs, Association of the Luxembourg Fund Industry)
Vincent Heymans, partner (advisory) KPMG
Michael Ferguson, asset management leader (Ernst & Young)
Jon Griffin, managing director (JP Morgan Asset Management)
Thibaut Partsch, partner (Loyens Loeff)
Jean-Florent Richard, partner (Vilret-Avocats)

Funds Europe: Which regulations affecting Luxembourg and the pan-European investment fund industry are you currently most concerned about?

Denise Voss, vice chairman, Association of the Luxembourg Fund Industry: There are currently at least 27 different pieces of regulation or initiatives that have a direct or indirect impact on the investment fund industry.

Some of the regulation that the Association of the Luxembourg Fund Industry (Alfi) is concerned about does not originate in Europe, such as the US Foreign Account Tax Compliance Act (Fatca), which could have an enormous impact on the fund industry.

In Europe, the depository liability elements of the Alternative Investment Fund Managers (Aifm) directive and the knock-on effects of this for the Ucits V directive are also an area of concern.

In terms of proposed regulation, Alfi is most concerned about two elements: the Financial Transaction Tax and the Volcker Rule.

The financial transaction tax has the potential to curtail distribution of Ucits outside Europe and to significantly reduce the assets of the European fund industry. If it is not globally imposed, then it will not result in the financial sector making a positive contribution to the rest of the economy.

On the contrary, it will drive trading activities outside Europe and to those jurisdictions that do not impose such a tax.

In 1984, Sweden imposed a financial transaction tax and with great expectations for revenue of SEK1.5 billion (€0.17 billion) per annum but annual revenues averaged only SEK50 million. And worse, the volumes of trading in Sweden reduced 85% in the first week after the introduction of the tax, while the option trading market completely disappeared. After six years, not surprisingly, the tax was abolished. Trading volumes returned and grew substantially in the 1990s.

As it currently stands, the financial transaction tax would result in additional cost to the end investor, including individual savers and those participating in pension plans. The proposal would give rise to multiple taxation through the value chain of investment. Retail investors would be hit hard and would be left with significantly less of their pension for retirement.

The Volcker Rule is a proposal within the Dodd-Frank Act to reform the financial sector in the United States. It restricts US banks and non-US banks with US activities from making certain kinds of speculative investments. It prohibits those banking entities from acquiring or retaining ownership interests in hedge funds or private equity funds.

While US mutual funds are not caught by the rule, there is no exclusion for non-US retail funds, such as Ucits funds. This would result in US banks – or non-US banks with activities in the US – from not being able to brand their investment funds with their name.

It would seriously limit their ability to seed Ucits funds at the appropriate level. Alfi believes that, at a minimum, the definition of funds – what they call ‘covered funds’ under the Volcker Rule – should be amended to exclude European regulated retail mutual funds, as is the case for its counterparts in the United States.

Vincent Heymans, partner (advisory), KPMG: Markets in Financial Instruments Directive (Mifid) II jeopardises the industry and, more specifically, the open-architecture model. We already had strong discussions with the European Commission when Mifid was first presented and in the end we reached a reasonable compromise. Now the commission has taken a much stricter position.

This may restrict the number of funds proposed to the investor and even exclude the smallest investor from the investment fund.

It seems the European Parliament is open to a discussion on this inducement question and it could eventually abandon the pure ban on inducements. If the authorities want to go for further clarification and further transparency on the inducement, the industry is open to this. However, this would have to be applied equally across all the financial industry so that the asset management sector is not stigmatised by European authorities.

Michael Ferguson, asset management leader, Ernst & Young: From a ‘macro’ point of view, the industry is firstly concerned about the volume of regulation and versus the perceived real ‘value-added’.  At times investors may be led to believe that this regulation will completely eliminate all possible risks, which is obviously not realistic.

Regulation should be primarily focused on creating greater transparency and disclosure, making markets fair and more efficient, and not about removing all possible risks. Different levels of risk will always exist and this is why we have different levels of return. Of course, this risk needs to be identified, measured, managed and disclosed.

There is also concern at the apparent lack of co-ordination between the different pieces of regulatory reform, though there have been recent attempts to try to improve his especially between the Ucits, the Aifm  and the Mifid directives.

There is also a lack of co-ordination and communication between main regulators, notwithstanding that some of this regulation originated from the G20 agenda. Examples of this include the Dodd-Frank Act and especially the Volcker Rule, Fatca and so on. Also some would point out that the recent concerns expressed about Ucits products in Asia is simply down to lack of communication and coordination between with the European Union and the relevant Asian regulators.

Looking at specific regulatory reforms, such as for Mifid II, the packaged retail investment products (Prips) and the retail distribution review (RDR) in the UK, one may question how effective any of these will be and whether we need to go much further to be transformational.

One area of focus could be distribution and whether it is necessary to further split the manufacturing and distribution functions. This would have a significant impact in continental Europe where 70% of fund distribution is controlled by the banks and insurance companies, many of which offer their own branded products.

Some would argue, for example, that the significant flows out of the mutual fund industry over the past four months into special deposit accounts primarily driven by banks wishing to repair their balance sheets is a demonstration of the inherent conflict of interest within the current distribution model.

A lot has been said in the context of the Prips discussion about the importance of a level playing field between different competing savings products. However, the costs between these competing products remains very different and the value added the investor gets for this additional cost in the context of investment funds is not at all clear.

Jon Griffin, managing director, JP Morgan Asset Management: It is too late to go on about how bad regulation may be or how uncoordinated it may be, or appear, but there may be a lesson for the future which is about the effectiveness of buy-side lobbying. Politicians are driving this significant wave of regulation. Equally, the recent volatility in the markets seems to be more driven by what politicians say compared with the market fundamentals of the past.

We are in a very different place and we just need to deal with it. I cannot recall any other period where initiative budgets have been pretty much taken up by dealing with implementing new regulation.

I am sure that there are some mismatches in regulation still to be played out. For example, will measures in the US Dodd-Frank rules and Europe’s European Market Infrastructure Regulation (Emir) in terms of over-the-counter derivatives and central clearing be compatible, for example? The Volcker Rule, in its definition of ‘covered funds’, is a big problem right now. Literally, a couple of lines in the text has categorised Ucits alongside a world of other regulated funds as equivalent to unregulated US hedge and private equity funds.

I am hopeful that there will be some robust and constructive responses to the five US agencies holding the pen when the comment period closes on February 13. With an implementation commencing in July 2012 we need absolute clarity, fast.

Thibaut Partsch, partner, Loyens Loeff: Fatca and the Volcker Rule could be seen as nationalistic reactions which have been prepared and enacted too quickly. It is thus difficult to evaluate threats and opportunities as a whole.

From a Luxembourg standpoint, though, the Aifm directive could be seen as a recognition of the Luxembourg approach to alternative funds. Most of the Aifm directive principles were already included in the Luxembourg regulations, notably the requirement to have a custodian, for example.

This should be viewed as an opportunity. It shows that, contrary to other countries, Luxembourg has the people and expertise to adapt and provide for a better regulatory service for investors than other countries can do.

Jean-Florent Richard, partner, Vilret-Avocats: One point that for me as a lawyer is definitely a concern is the regulatory fragmentation. Regulation should be more coherent for investors and this is a big issue.

Furthermore, I am concerned about the increasing number of alternative Ucits. We are moving too far away from the spirit of the Ucits regime, which was designed for retail investors and to help them understand what they are buying when they bought a share in a fund.

Funds Europe: Does the panel reflect concerns that alternative Ucits could be damaging to the Ucits brand?

Ferguson: Certain Asian regulators have raised a number of questions around this so it’s up to the collective industry to ensure products such as alternative Ucits do not jeopardise the overall brand. One should, therefore, always remain alert and continuously consider what additional, if any, real value-added actions would reinforce the Ucits brand. It is also interesting to note that many fund houses have decided that these so-called alternative Ucits should not be distributed to retail investors but only to informed or institutional investors.

Griffin: If a fund gets a Ucits stamp then it is a product ready for the retail investor. To get the stamp the regulator has understood it, the lawyers have understood it, the promoter feels they can manage it, a management company believes they can control it, the administrator feels they can deal with it, the custodian will be able to work with it and the auditors can audit it.

Partsch: The priority should be about good information to investors who buy the product.

Ferguson: Of course one needs to also balance the level regulation to ensure Ucits products can remain innovative and be flexible, taking into account market developments and investors’ needs. Obviously, the risk needs to be identified, measured, managed and disclosed.

Richard: But it seems fair to say that we all feel that there is a tension between the spirit of the Ucits regime and the use of the brand by some players in the market.

Ferguson: I would say the regulatory approval process and oversight framework should be continuously reviewed for such products.

Richard: There is room for improvement and clarification there, definitely.

Partsch: Yes, mis-selling should be the main concern.

Enf of part 1.

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