While the directive will create a single European market for funds aimed at sophisticated investors and allow managers to market their products across EU borders with minimal formalities, some of the provisions still cause dismay. Overall the legislation is viewed as adding a significantly increased regulatory burden out of proportion with any benefits it may bring in terms of investor protection or identification of potential systemic risk.
In addition, there are a couple of complications. First, although the directive sets out the regulatory framework within which funds marketed in Europe and their managers will operate, much of the detail must be filled out by secondary legislation or implementing regulations drawn up by the European Commission on the advice of the new European Securities and Markets Authority, a much more institutional body than the Committee of European Securities Regulators which it replaced.
Secondly, funds not domiciled within the EU – a large proportion of the products run by London-based managers – will not be able to qualify for an EU marketing ‘passport’ until 2015, two years after EU-domiciled funds of EU managers. Even then this will be subject to rules that have not yet been drawn up in areas such as regulatory co-operation between the fund domicile jurisdiction and any target market within the EU. Extending the passport system will itself require additional legislation and many industry members say they will believe it when they see it.
“Level one of the directive has been agreed, which means that the structure is there, and a phase of more detailed rulemaking has begun ahead of full implementation by 2013,” Butler says. “And so begins a fairly protracted implementation procedure and, to some extent, a ‘wait and see’ game leading toward full implementation by member states by 2013, which step by step will shed light on the final shape the directive will take and what this will mean for managers.
“Fears have been expressed that the directive will go too far in limiting the activities of investors and managers globally and will have a stifling effect on the industry. This will particularly affect London as many managers who up to now have had relative freedom in their activities will be under pressure to move to a regulated fund structure. Of itself, the directive is unlikely to have a material effect on London’s position in the hedge fund world, but negative factors such as tax, infrastructure and the attractions of other locations will have an impact.”
Overall, however, London has escaped “relatively unscathed’ under the final form of the EU legislation, according to Martin Cornish, who has just joined law firm K&L Gates as an investment management partner. He says: “Some of the more draconian aspects of the rules have been postponed for between three and five years, in terms of the marketing of Cayman and other funds into Europe. Those rules won’t rear their ugly head until between 2015 and 2018, which is a long time in any world.
“The new rules will increase compliance costs for sure. A lot more reporting to regulators and investors is required, so managers will find that being based here is more onerous than in the past, and more onerous than it might be in some non-EU jurisdiction. The decision for everyone will be whether they need to be here. However, I don’t expect that the rules will lead anyone to conclude that they cannot possibly conduct business here any more. It will be a bit more painful, and a bit more restrictive, and managers will have slightly higher running costs, but nothing in those rules will make it impossible for them to compete with rivals in other centres.”
Nevertheless, some industry members believe the various issues hanging over the alternative investment industry in London make it imperative to focus on marketing it effectively – at least as well as rival financial centres do. “A lot of what the UK could do to consolidate its existing fund industry base is around its branding and people’s perceptions,” says Eversheds partner Michaela Walker. “We need to do a better spin job, like Luxembourg does.”
Tax rates
Except those on the top marginal rate, every investor is substantially better off if the fund sells into the buyback. For a super fund with a tax rate of zero, the difference equates to about 2 per cent of their investment in the fund, a return not to be lightly dismissed.
Now put yourself back in the seat of our fictitious fund manager. You want to do the right thing for your investors but you also know that doing so comes at a cost. That cost has three components.
Firstly, selling into the buyback at $0.88 rather than on-market at $1.00 diminishes your pre-tax performance.
That’s a worry because you know that managed fund investors place a heavy emphasis on pre-tax returns (they’re the numbers potential investors will see published in the paper when comparing the hundreds of alternatives they have).
You want to do everything in your power to get this number up because it’s the biggest factor in determining future funds under management; typically the biggest driver of a fund manager’s revenues.
Secondly, selling into the buyback could be the difference between achieving an outperformance fee and not (based on the pre-tax return).
And finally, if you sell into the buyback you’ll suffer lower funds under management than if you sell on market because the law forces funds to pay out any income received as well as realised capital gains each year.
The conflicts are rife and the incentives arranged in such a way as to place the fund manager at odds with their investors in cases such as this.
It’s a big problem. Everyone with an indirect interest in a managed fund is affected. So if part of your superannuation is invested in a managed fund, you’ll be impacted.
