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In its push for reinvention, the UK funds regime could learn a lot from Ireland and Luxembourg.
The UK has a hugely successful asset management industry, but is a much less popular investment fund domicile than several other European countries. Luxembourg had a 9% share of the global investment fund domicile market at the end of Q3 2020, second only to the US, according to the European Fund and Asset Management Association (EFAMA). Ireland was third with 5.9%, Germany had 4.6% and France 3.8%. With a share of 3.1%, the UK also lagged behind China, Japan and Australia.
There are two key reasons for this. First, there is a long-held, widespread perception that regulation and the UK’s tax regime are unfriendly to funds and that the UK offers a limited range of options to managers. The second problem is the UK’s departure from the EU – but this may also offer new opportunities.
In January 2021, the UK Treasury published a Call for Input document (now closed), part of a broad review of the funds industry. It asked 38 questions on tax, regulation and other opportunities for reform, including reducing or removing tax on authorised funds, creating unauthorised tax-exempt fund structures for investment in alternatives, new tax treatment of real estate investment trusts (REITs); and VAT changes.
The document also asked respondents about proposed new fund structures, including a long-term asset fund (LTAF): an authorised, open-ended structure for investment in illiquid assets such as venture capital and infrastructure. It asked how new unauthorised fund vehicles, including some aimed at professional investors in alternative assets, called an onshore professional fund (OPF) elsewhere, might operate.
One responder was NatWest Trustee and Depositary Services (NWTDS), which suggests that the government should emphasise the UK’s high standards of governance and investor protection.
Mark Crathern, head of NWTDS, says: “The UK has a strong reputation for fund governance, but more needs to be done to market the jurisdiction as a dynamic funds domicile. As an independent and increasingly data-driven depositary, we see that a key part of the UK’s attractiveness is its reputation for robust oversight, and safeguarding of investors’ best interests. Enhancing and emphasising these protections will help the government to promote the UK and send the message that it is open for business.”
Others in the UK funds industry feel there is no time to waste in promoting the jurisdiction in a post-Brexit era. “We’ve seen a lot of asset managers relocating operations to Ireland and I put that down to Brexit,” says Gayle Bowen, partner, head of the Dublin office and leader of the Irish asset management and investment funds practice at Pinsent Masons. The number of Irish domiciled funds has grown from about 6,000 in 2016 to almost 8,000 today, according to the Irish Funds Industry Association.
"What’s important for investors is predictability and stability. You don’t want any surprises on how these entities are going to be taxed. In the UK we tend to chop and change a bit”
Erika Jupe, partner, corporate tax practice and head, international tax practice group, Osborne Clarke
“A lot of funds have been migrating to Ireland and to Luxembourg,” says Alison Riddle, partner in the financial institutions group in legal firm Osborne Clarke’s London office.
But the right reforms could allow the UK’s funds industry to reinvent itself. “Brexit [offers] an opportunity for the UK to define an innovative and responsive framework for investment funds … while supporting the UK’s ambition to become the global centre for responsible and sustainable investment,” says Chris Cummings, chief executive of The Investment Association (IA).
Lessons for the UK
If that is to be the case, what can the UK learn from the success of Luxembourg and Ireland? Luxembourg draws strength from its geographical location and a long-established industry, says Luc Courtois, partner and head of the Luxembourg investment funds practice at legal firm NautaDutilh: “We have very long experience and great expertise in funds, so you can find what you want in terms of structure, in terms of tax.”
Erika Jupe, partner in corporate tax practice and head of the international tax practice group at Osborne Clarke, highlights the willingness of Luxembourg’s Financial Sector Supervisory Commission (CSSF) and its government to develop a tax regime “to make that jurisdiction one of the go-to places for funds”.
“What’s important for investors is predictability and stability,” she continues. “You don’t want any surprises on how these entities are going to be taxed. In the UK we tend to chop and change a bit.”
Ireland also offers a full range of UCITS (Undertakings for the collective investment in transferable securities), AIF (alternative investment fund), ETF (exchange traded fund) and private equity fund products; and has access for distribution and passporting across the EU. Arguably, its tax regime is even more appealing than that in Luxembourg. It is also an English-speaking domicile – an attraction for some UK and US funds. Ireland’s 2020 Investment Limited Partnership Act means alternative investment managers now have a limited partnership option.
The UK should seek to emulate the agility and flexibility available in Luxembourg and Ireland, says David Young, partner and head of the UK asset management and investment funds practice at Pinsent Masons. “Until now the UK has had quite a limited range of vehicles,” he says.
In its response to the Call for Input, the IA argued for further development of the OPF. One contractual form of the OPF is the professional investor fund (PIF) concept, developed by the Association of Real Estate Funds (AREF) and the IA.
The PIF is a closed-ended fund, treated as an alternative investment fund for regulatory purposes, but offering the flexibility of an unregulated collective investment scheme. Registration would be similar to that used for UK limited partnerships, so it would offer quick market access without prior Financial Conduct Authority approval. Income would be taxed on the share attributable to each investor, with CGT payable by investors selling PIF units, but not on portfolio-level gains. Supporters claim the PIF would be an ideal vehicle for funding infrastructure, but it could also be used to invest in other asset classes.
Tracey Wright, partner at Osborne Clarke leading on tax in real estate and infrastructure, likes the idea. “At present, where professional investors wish to hold UK real estate in transparent collective ownership vehicles they may typically look to one of the Channel Islands property unit trusts,” she explains. “There is no equivalent in the UK: the choice is a partnership or a regulated Authorised Contractual Scheme [ACS] – neither is seen as fit for purpose, due to the regulatory burden or tax complexities.
“The PIF is a proposal for an unauthorised contractual scheme for professional investors … [so] a fully regulated vehicle is not needed. It could remove the need to use offshore property unit trusts and possibly also Irish or Luxembourg contractual schemes, especially in structures where investors and assets are UK based and would prefer to keep the structure onshore.”
For the truly mobile international fund manager, the UK continuing to lag behind Luxembourg, Ireland and other domiciles may be of little consequence. But successful reinvigoration of the UK funds regime would offer some companies operational and strategic benefits; and would stimulate further competition and innovation in the wider funds industry.
At the time of writing, with the Call for Input closed, we await news from the Treasury on a timetable for change. Whatever form that takes, there are reasons for those working in the UK funds industry to feel optimistic about the potential for the UK to become a more competitive fund domicile – and to be concerned if it fails to do so.
“There’s no [inherent] right to have the core base in the UK,” says Young. “Lots of asset managers have set up hubs in Dublin and Luxembourg and to a lesser extent in the Netherlands. The risk [for the UK] is to the portfolio and risk functions, the core of the industry. The more these functions move, the more support functions will move. So this is really a time to focus, from a UK perspective. The current review is probably a once-in-a-generation chance to get the government to think about addressing the laws and structures we have.”