Does it make sense for funds in the big financial centres of New York, London and Frankfurt to set up there or offshore? The issue has provoked much soul-searching for regulators, companies and politicians in the prominent financial cities of the world. Investment managers and fund administrators, for example, hold the UK’s tax regime responsible for the fact that most new investment funds for cross-border sale are now set up in other jurisdictions.
For its part, the UK’s Investment Management Association (IMA) says categorically that the UK’s tax regime is having a serious impact on the competitiveness of the country’s funds industry. Despite the UK’s traditional reputation as a leading centre for investment management, a report commissioned by the IMA from KPMG and published late last year shows the UK is now losing out to Ireland and Luxembourg in attracting new investment funds.
“In the last two years, net sales of non-UK funds have grown from 1 per cent to 20 per cent of the UK market, while sales of UK funds abroad remain very low,” says the IMA. “This trend is likely to continue as funds become more complex.” According to the IMA, between 1995 and 2005, growth in fund assets domiciled in Luxembourg was 10 times that of the UK, while Ireland’s growth was double that of the UK. Managers view the Luxembourg and Ireland tax regimes more positively than the UK regime across most fund types. As a result, for many managers, the UK is not a competitive location for domiciling funds. “A principal weakness identified by managers…is the lack of certainty, stability and support from the tax authorities.”
In the modern day regulatory environment, at least for traditional long-only investment, the question of domicile is much less of an issue than it has traditionally been. “If you set up a Ucits fund in Dublin or Luxembourg, or an oeic (open-ended investment company) in the UK, all will be subject to the same restrictions in terms of what you can and cannot invest in ,” observes Nora O’Mahony, product development director at GAM in London.
“These days the domicile of the fund is more important from a marketing and distribution perspective than for any regulatory considerations. Independent financial advisers in the UK historically have been more familiar and more comfortable with oeic onshore structures although this is beginning to change. Investors elsewhere will be more likely to opt for Luxembourg and Irish domiciled funds.”
Ian Pascal, marketing director at Baring Asset Management, echoes the sentiment, saying that it is the domicile of investors that will in effect decide the domicile of a fund. “Why do we go offshore? Typically because we want to distribute internationally,” he says. “An Irish fund, for instance, has more appeal across a wider share of the global market than a UK fund does. We sell a lot to financial institutions in Asia, Europe and Latin America, who will all happily distribute Dublin-listed mutual funds. Some will sell UK unit trusts, but it is less natural for them, and while there are exceptions to every rule, the UK is pretty reluctant to buy offshore funds.” US investors, he adds, by and large much prefer to buy their own domestic funds.
He identifies three key points to bear in mind when considering the backdrop to why funds are domiciled offshore rather than onshore. The first is habit; people are accustomed to buying Dublin funds and structures, and anyone selling internationally will sell what buyers are familiar with. If for no other reason, it simply makes life easier, and more cost-effective, given the benefits that arise from economies of scale. The second is stamp duty reserve tax within funds; he describes this as a particularly UK phenomenon, which acts as a drag on fund performance. Despite annual requests from the industry to the Chancellor of the Exchequer to scrap the duty, there is broad acceptance that this will never happen.
“I would put more money on the worst horse in the worst horse race than I’d put on Gordon Brown abolishing that tax,” says Mr Pascal. Even if the situation did change, he believes there would be no rush to move funds, given the issue of scale and the quality of the infrastructure that has been developed offshore and the fact that it is growing ever larger. The third is that although funds may be domiciled in Dublin, the investment management expertise itself remains predominantly in the principal financial centres; boiling it down to the essentials, while the back office is based in Dublin or Luxembourg, the front office stays in London.
Having relegated the importance of a fund’s domicile to an issue of relatively minor importance given that all regulated funds are subject to very similar investment rules, Ms O’Mahony asserts that a different question is much more worthy of time and attention: whether investment restrictions on regulated funds have truly benefited investors.
“If you want to be unconstrained, you’ll set up your fund in the Cayman Islands or the British Virgin Islands,” she says. “In the UK, a significant number of investors would rather have the comfort of investing in regulated vehicles. This presents the challenge of making less restrictive investment strategies accessible via regulated funds, a challenge which GAM believes it has met.”
She argues that the development of the GAM Composite Absolute Return OEIC, an authorised product, squares the circle successfully. “It uses a derivative to provide exposure to GAM’s private client absolute return strategy, which invests across a wide range of asset classes and aims to deliver stable, absolute returns regardless of market conditions.
“The FSA is now in consultation about widening access to less constrained investment techniques. We are anticipating a change in UK legislation allowing onshore hedge funds and funds of hedge funds by the end of 2007. This will be an exciting development; much more interesting than the domiciling of a fund in Dublin and Luxembourg versus London.”