Deeper Perspective: The UK Funds Regime

Something I pride myself on is being attuned to trends and themes from news chatter, the flow of posts, articles and webinars from industry outlets.

Most recently, the spikes I’ve observed have centred around the new Irish LP, SFDR, the mainstream adoption of blockchain technology and, of course, our dear old friend Brexit.

But what’s come as something of a surprise to me is that Brexit has been almost entirely used as a platform for those offering access or a gateway to Europe - ManCos, promoting the benefits of a regional marketing passport from an EU base, lawyers and tax advisers demystifying the concept of substance, local stakeholders in Luxembourg and Ireland promoting elegant fund solutions for global distribution.

It’s not that which I find surprising, our European partners rightly see an opportunity from a difficult divorce and are perfectly entitled to exploit it. What’s so curious is the unilateral nature of activity. That very few have really paused to consider what’s being left behind, what’s on the other side of this equation and where else opportunity may lie.

HM Treasury Review of the UK Funds Regime - A “Call for Input”

At this stage, few firms have expressed an opinion on the Treasury-led review of the UK funds regime and its request for input from the industry (responses for which are due by 20th April 2021). Hats off to James Stewart, UK Funds Tax Leader at PwC, for being one of the louder voices.

Whilst some will inevitably point the finger, there seems to be such a quiet, and perhaps resigned, indifference to this call to action, it would be unfair for stakeholders to criticise the government if they ultimately fail to lay out an ambitious agenda.

Let’s take a step back for a moment though, and reflect on what prompted the review.

In the 2020 Budget, the government committed to explore potential reforms that would strengthen the UK’s position as a global asset management hub and fund domicile. This consultation (expressed as a call for input) is a significant step in informing the debate, defining the opportunity and charting the route – or perhaps a number of different routes - to realising it.

And what a welcome development it is, when you consider what’s at stake. Asset management is a fundamental pillar of the UK financial services industry, given its contribution to tax revenues, value creation across the corporate, banking, pensions and insurance sectors, not to mention individual savings and investments. It represents nearly £10trn in AUM, making the UK the largest market in Europe and the second largest globally, behind the US.

It’s refreshing to see a meaningful level of engagement from government when, for so long, many felt that financial services had become a victim of Brexit and fishing rights were considered a more valuable bargaining chip.

But despite the UK’s dominant status as a fund management centre, its ranking as a fund domicile is far less favourable.

Let’s now take a look at some of the reasons for that, what can (and should) change – using this consultation as a foundational blueprint - and what the UK industry should be aspiring to achieve.

Location, Location, Location

For the last 20 years, perhaps a little more, both Luxembourg and Ireland have experienced strong and sustained growth in both the number of funds and AUM, whilst the UK’s European market share has suffered an attritional decline.

Whatever statistics you might point to – total industry assets, UCITS assets, hedge funds and other alternative assets - it’s clear that the UK has continued to fall behind those markets and Germany as a fund domicile.

What’s more, when you take a closer look at the UK’s market share, almost three quarters of AUM in domestic funds is represented by UK investors. That contrasts markedly with Luxembourg and Ireland, in particular, which are both considered leading jurisdictions for managers seeking to establish cross-border business and distribute their funds globally. For instance, Irish funds are registered for distribution in over 90 countries across the world.

Recent product innovations, with the Luxembourg RAIF regime and the launch of the newly reformed Investment Limited Partnership in Ireland, have only increased the attractiveness of those markets for a broader range of international managers, including those of private and real assets, both of which are continuing to see phenomenal growth.

This apparent arms race to attract investment capital is not just limited to Europe, but also gathering pace globally. The Cayman Islands, The Channel Islands of Guernsey and Jersey, Singapore and Hong Kong have all introduced reforms and new regimes which aim to sharpen their competitive edge and cement their place as global asset management hubs.

And the fallout from Brexit itself is, sadly, harmful to the industry, at least in the immediate term, with UK structures no longer eligible to benefit from UCITS or AIFMD cross-border marketing passports to sell to investors across the EU. Managers have simply had no choice but to adapt their business models and establish, at great cost, a new presence (with substance) in the EU, from which Luxembourg and Ireland have been the greatest beneficiaries.

It’s now in the hands of the UK to influence a reversal of this trend, which many in the industry believe has, long before Brexit, been due to the absence of both suitable investment structures and a funds tax regime which compares favourably to that of Ireland and Luxembourg.

So what might change?

Well, HM Treasury is on the right track in recognising that reforms must apply to UK investment structures, the funds tax regime and the regulatory landscape.

Starting with fund structures, the Treasury paper recognises the strength of the domestic investment trust company market (with over £200bn in AUM), but is prepared to engage on how the regime can be improved.

There is a welcome reference to work previously done by the UK Funds Regime Working Group in making recommendations to establish a Long-Term Asset Fund (LTAF). Multi-lateral reform will be required to tax rules, operational infrastructure and regulation if the vehicle is to fulfil its potential as a structuring solution for investors, DC pension schemes in particular, to access illiquid alternative asset classes with compelling risk/return profiles and diversification benefits. Some consider this to be a high priority initiative for the government, with the Chancellor declaring a plan to see the first LTAF brought to market some time during 2021, although that’s a long shot at this stage.

As another channel to support the growth in alternative asset classes, there will be a focus on meeting the needs of professional investors through proposals to introduce a flexible, tax-efficient unauthorised fund structure. This has potential to serve the UK on many levels, with increased competition for international business, supporting the needs of institutional investors, providing access for investment in long-term assets, funding sustainable infrastructure development and driving a post-pandemic recovery. I fully endorse the view of some commentators who have noted that emphasis should be on establishment of a professional investor fund regime which leaves open the questions of legal and structural form – whether corporate, partnership or contractual, open- or closed-ended, listed or unlisted – which should remain a decision for managers in mapping to the requirements of their investors.

Objectives for tax reform are also well-considered, and driven by the overriding themes of greater tax neutrality and simplification, both cited in the past as reasons for managers to take business elsewhere.

Some proposals under review – tax rates applied to UK funds, deemed deductions from fund distributions, amendments to the Tax-Elected Fund (TEF) regime – might be considered as nothing more than tinkering. Others, however, are far reaching, such as the option of exempting funds from tax entirely, rule changes for REITS and PAIFs, re-assessing VAT on fund management services, improvement in double taxation treaty (DTT) network terms, treatment of asset holding companies (AHCs) in alternative fund structures and a much needed overhaul of tax rules applicable to limited partnership and private fund limited partnerships.

Last, but by no means least, regulation. Though there are some tangential questions on why sophisticated investors may still have a preference for authorised funds, the Treasury paper rightly identifies the emphasis that stakeholders place on clarity and certainty over the fund launch time frame. Any reform must facilitate speed to market for the UK to compete with other European onshore markets. The Luxembourg RAIF regime and Irish QIAIF 24-hour Central Bank approval process both ensure that managers have a high degree of transparency and control around fund launch timelines, that the UK must simply align with.

There are a string of observations related to the Qualified Investor Scheme (QIS), which suggest that neither the government nor market participants have a clear sense of what purpose the vehicle is truly intended to serve, which from my perspective is even more questionable if other, more suitable vehicles are introduced as contemplated within the paper.

A New Dawn

There are many reasons to be optimistic when considering the tone of considerations raised within the Treasury paper, and the direction of travel.

But, as with any consultation, the outcome very much depends on the richness in views and thoughts of industry stakeholders who participate to create the narrative, to lay out the roadmap, to shape a vision for the future.

There’s an opportunity to effect meaningful, positive change for the UK asset management industry, beginning here. To stimulate economic recovery, to create new jobs, to attract international capital and support trade, whilst enriching the global asset management industry and taking responsibility as stewards for the UK to facilitate investment in infrastructure, business, technology that will enable us to lead on ESG initiatives and move closer towards the net zero emissions target by 2050.

There is, however, equally a risk of apathy, resignation and stumbling at a critical time if stakeholders fail to engage and inform the debate.

We must be bold in our vision, and tireless in our efforts to achieve it, if the UK is to move out from a persistent state of post-Brexit, post-pandemic fatigue to compete in the asset management industry on the world stage, against established leading domiciles (both onshore and offshore), providing greater choice for managers and investors. Yes, it begins at home. Our domestic market is a priority, but there must also be endeavour in providing solutions for firms to operate cross-border from the UK as a domicile, on a frictionless basis.

This doesn’t have to be over-engineered. In fact, simplicity is the key to success. But those of us with a vested interest have a duty to get it right.

We need a range of attractive vehicles, tax and regulatory regimes that facilitate not hinder commerce and investment, we need a framework that acts as a catalyst for innovation, supporting our thriving fintech industry and accelerating the digital assets revolution.

I agree with others who have noted that the adoption of blockchain technology and digital currencies has the ability to distinguish the UK as a market leader and, dare I say it, an industry disruptor. But, for purposes of this Treasury review, it’s the duty of government to make the conditions right for others to drive that agenda, to shape the ideas, to unlock entrepreneurial value. That only contributes to the objective of generating fund administration activity, providing valuable new job prospects for graduates and skilled workers across the country.

Whilst there must, of course, be a balance in serving the needs of different stakeholders, interests are very much aligned when it comes to the provision of competitive, efficient investment solutions across a growing spectrum of asset classes, that help UK industry and the economy to grow and flourish.

Some of our closest neighbours are already showing us how it can be done. If the model exists, and has been adopted elsewhere, it’s fair to assume that similar measures would also be warmly received here. Let’s not miss this opportunity and waste time modelling the probability of success. Let’s all help to chart the course with this review, and just get on with the job of delivering it.

Nothing ventured, nothing gained.