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International shifts in tax and regulation could open up the market for new funds to be domiciled in the UK.
- While the UK is the second-largest asset management location outside the US, it currently only ranks ninth in fund domicile tables
- In the future, locations with transparent systems will be the ones to attract fund domiciles
- Luxembourg and Ireland both offer a simple regime, and the UK needs to replicate that
- What the UK does already offer is sensible regulation and supervision, a highly regarded legal system and an international workforce
The G7 deal reached in June this year paved the way for a rethink on international tax rules. Details are still being thrashed out after the consensus reached by the G7 nations, and a final agreement may be some way down the line, given that there is much at stake for a number of jurisdictions.
But the global tax genie is well and truly out of the bottle, with the idea of companies paying tax on profits generated in the countries in which they operate, rather than where they’re based, now fully part of the mainstream international policy agenda.
The countries with most at stake in this brave new world are British offshore islands, such as the British Virgin Islands, the Cayman Islands and Bermuda, and continental European locations. These locations are all centres for fund domiciles due to their low or zero tax rates on funds.
This raises a few questions: how might a final agreement on taxing on operational profits impact future decisions on where to domicile funds? And could a more level playing field affect current policy on turning the UK into a prime fund domicile destination?
One global location
The UK is the second-largest asset management location outside the US and accounts for around £8.5trn of assets managed. However, it only ranks ninth in fund domicile tables, with just 3.1% of global investment funds domiciled in the UK.
When the UK was still part of the EU's single market, it didn’t matter if funds managed here were domiciled elsewhere in the EU because everyone was operating under the same regulatory umbrella, says Dr Kay Swinburne, vice chair of financial services for KPMG in the UK. “It starts to matter when you’re not part of that system,” she says.
Dr Swinburne points out that funds are a bit of an anomaly when it comes to taxation. “For a fund ecosystem to work well, the fund itself typically needs to be exempt from taxation; then you need an efficient method by which investors – and the profit from the fund – get taxed.”
Tax is often the starting point for fund domicile decisions, but regulatory and legal considerations are also important, says Gavin Haran, head of policy for asset management at law firm Macfarlanes. Stability of rulemaking helps, he says, particularly when looking at long-term investment.
Strong rules and end-to-end governance play in the UK’s favour, says Peter Christmas, director of client management at NatWest Trustee and Depositary Services (NWTDS). “There is a certain advantage in having the lot done in the one country and under the same regulations. Oversight becomes more effective because you’re seeing everything through one lens.”
“Investors generally like the notion that funds are operating in a well-governed and transparent system. This is what the UK does”
Dr Kay Swinburne, vice chair of financial services, KPMG UK
There’s also the UK’s standing as an international financial services hub. “The UK legal system is very highly regarded, the workforce is international, and there is excellent knowledge of the funds business, given the number of people who work in the financial services industry, so we have access to a large pool of human resources,” says Christmas.
Many of the discussions at the G7 revolved around reporting and transparency. Swinburne believes that, in the future, locations with transparent systems will be the ones to attract fund domiciles. Luxembourg and Ireland both offer a simple regime, and the UK will have to be able to replicate that.
“Investors generally like the notion that funds are operating in a well-governed and transparent system. This is what the UK does in all other aspects of financial services: the one glaring piece that’s missing is the domicile of funds,” she says.
Another part of the UK’s strength lies in its strong ecosystem and infrastructure, says Haran. “The UK is seen to have sensible regulation and supervision; the Financial Conduct Authority [FCA] is seen as having good expertise and understands the market well,” he says.
Christmas observes that the UK regulatory regime is built around investor protection. “The fund manager and depositary are the two pillars of investor protection,” he explains. “In the UK, the depositary needs to be in a separate financial group – not just a separate entity – from the fund management company. That’s not the case in some other jurisdictions,” he says.
Post-Brexit, the UK has the potential to simplify regulation. Swinburne gives the example of the European Commission’s stringent Undertakings for Collective Investment in Transferable Securities Directive 2009 (UCITS) requirements, which were designed to serve what was then 28 retail markets. “You could tailor that very specifically to a market based in London, whether that’s domestic retail clients or other retail clients around the globe, rather than European retail clients,” she says.
The UK government has been looking into how to boost the UK’s standing as a fund domicile, with the Treasury consulting the industry on tax, regulation and other opportunities for reform.
This is important, particularly given the loss of passporting, says Haran. “Regulatory divergence could add to complexity and cost and make the UK less attractive,” he says, adding he would like to see more investment vehicles introduced to better compete with the wider range of fund types available elsewhere.
Most important, he says, is the creation of the long-term asset fund (LTAF). “This is a game changer because it will provide investment in economically productive growth-making areas like infrastructure and green investments.”
Christmas thinks there could be a market for a place where funds can be administered and domiciled and sold more widely than their domestic market. “We know there is a need globally for people to save more for their retirement. The number of cross-border funds can only grow as Asian and African nations start to look for more opportunities. The most advanced funds industry is in Europe: why shouldn’t the UK be able to compete with Ireland and Luxembourg?”
Swinburne sees the potential growth of UK fund domiciles as an opportunity to champion a more visionary agenda, encompassing not just the LTAF but also green financing and other new types of investment. “This is about looking forward, and for me, that’s much more exciting – to consider that the UK could potentially be the home for all these new products. I hope the UK will not just be a place of choice for domiciling funds but also for trying out innovative products as they go into these funds. If we get this right, that will make the UK stay relevant and at the heart of global finance for a long time.”