No longer a mirage?
It is safe to say that the single European market for asset managers is moving ever closer due to developments in the last year. A real single market in asset management is something for which the Investment Management Association’s (IMA) has been actively calling for more than three years.
As far back as May 2003 an IMA report (known as the Heinemann report after its author) identified that economic benefits of at least €5bn a year would result from such a single market. And for the average investor, a market without existing impediments to cross-border trade could produce an increase in the overall size of a pension of about 9%, or €120,000.
The Heinemann report pointed out that, despite the fact the UCITS directive was agreed 21 years ago to enable investment funds to be sold cross-border within the EU, the market was still essentially local. At the time, in most EU countries over 90% of investment funds were still supplied domestically.
So why exactly was this the case? It was certainly not due to the industry’s lack of desire for a single market. The UCITS directive gave the tantalising promise of a single passport but as asset managers sought to use it they found themselves faced with roadblocks. The then EU commissioner for the internal market, Frits Bolkestein, remarked that generally the lack of a single market was like driving a Ferrari in second gear.
It cannot be disputed that the benefits for consumers of a single European market in asset management, and particularly for investment funds, are enormous. IMA has made this point repeatedly and finally there is a clear sign that the European Commission has recognised the importance of facilitating greater cross-border activity. Last July the Commission published a green paper in which it consulted on priorities for future activities, a clear sign of its commitment to increase the competitiveness and efficiency of the European funds industry. The paper encapsulates the key issues well, and they largely reflected IMA’s own priorities as submitted to the Commission in the Heinemann report.
Responses to it indicated a strong consensus on what needs to be done. It is without doubt a clear and ambitious agenda aimed at driving down costs and increasing competition to the benefit of the European investor and the industry alike.
IMA’s response to the green paper focused on providing the Commission with the practical information and data it needs to move on from agenda-setting to implementation and we highlighted a number of priorities which, if met, would mean that the single market for asset management was about 80% there.
Our five priorities are simplifying the notification procedure (a fund is given a passport under the UCITS directive, but then has to register with each individual authority in whose jurisdiction it is to be marketed – effectively requiring it to apply for a visa in each member state), enabling fund mergers, enabling fund pooling, providing a passport for the management company and harmonising the European private placement regimes.
On notification, it is staggering to note that the cost to the industry as a whole of complying with the different requirements imposed on managers who wish to register their funds to be marketed in different member states is estimated at some €20m for initial notification with ongoing costs of €25m per year.
In addition, these costs are dwarfed by many indirect costs, including opportunity costs, as well as concerns about the operational and reputational risk involved in maintaining notification across a range of jurisdictions with different requirements.
The Committee of European Securities Regulators (CESR) has issued two consultations in an attempt to tackle some of these issues. However, it has disappointed us and, we believe, failed to make sufficient progress in removing existing barriers. Regulators have not been sufficiently willing to change existing practices and CESR’s consultations have been too limited.
We believe that its proposals, while representing a certain amount of progress, would maintain a regime which still goes well beyond the spirit of the UCITS directive and falls far short of what asset managers actually require.
As strong supporters of CESR we had hoped for more progress; the European asset management industry is united in its view that existing notification requirements are the single greatest impediment to cross-border business and add unnecessary cost. It now falls to the Commission to act to achieve more radical change.
The benefits of fund mergers are clear. While, for example, the European funds industry has two thirds of the assets of the US market, there are three times as many funds. This means that we do not get the benefit of economies of scale. Research clearly indicates that total expense ratios will fall as funds under management increase.
A number of regulatory and fiscal considerations must be taken into account but there are number of precedents in EU law on which the Commission can build in order to ensure that cross-border fund mergers can happen and that a fund merger does not give rise to a taxable event in the hands of investors.
Responding to a different business model, fund pooling – which involves being able to bring together the assets of several funds and manage them centrally – can also provide for economies of scale. It is more cost efficient to manage one large pot of money than several smaller pots yet there remain obstacles to allowing managers of funds to offer local funds but run them as if they were one.
In aggregating the assets of investment funds and pension funds, managers can reduce costs in a number of ways. Larger pools will lead to lower custody fees, larger transactions will lead to lower unit costs, with more sources coming into the pool transactions can be netted thus reducing transaction costs and administration costs will be lower in basis point terms if the pool of assets is larger.
There are also a number of qualitative benefits including better operational control by facilitating a consistent investment approach and more flexible product design. Although pooling techniques are already used in a number of member states at a domestic level, different tax and regulatory regimes operate in the EU which make it difficult to pool cross-border. This is what the European authorities need to address.
The requirement for management groups to appoint a local management company with ‘substance’ in each of the jurisdictions where they operate funds adds significantly to operational costs and capital requirements.
As well as reducing costs, the ability to operate a ‘centralised’ management company should improve operational risk management and internal controls. The UCITS directive already provides for a management company passport for corporate funds and the Commission could achieve a result on this point quickly and without legislative change by enforcing this provision.
Finally, each member state currently accommodates non-UCITS funds (including, for example, hedge funds) within its own domestic product regulation. IMA is opposed to the introduction of product regulation for such funds at EU level, and would rather the focus be on the distribution of such funds. The Commission should therefore align the private placement rules, allowing non-UCITS funds to be marketed cross-border to appropriate investors, particularly institutions, without having to incur the costs of complying with a range of different rules in different countries.
These, then, are the key areas in which action is required for a single market for asset management to become a reality and we are actively engaged with the European authorities to help with this process.
A potential obstacle to implementing these priorities was the lack of clarity in what constitutes an eligible asset under the UCITS directive. CESR recognised this in January when it published its final advice on assets in which funds may invest.
This advice was not only a step in the right direction for the asset management single market but it took on board the concerns of the industry and removed overly restrictive aspects of its original advice. This should cause minimum disruption to existing arrangements while also permitting the development of innovative products and allowing greater choice for investors.
IMA very much hopes that CESR and the Commission continue to work in this way to enhance co-operation and common understanding among regulatory authorities in the interests of moving towards a truly single market for asset management.
Mona Patel is head of communications at the Investment Management Association in London