With the publication in March of a report (PDF 511 KB) by the European Commission, an important dialogue has begun in earnest under the Capital Markets Union (CMU) initiative: how to remove unnecessary or disproportionate barriers to the cross border-distribution of funds? Although the removal of some of these barriers is likely to be a long game, firms need now to play an active part in the debate, to shape the European UCITS market for the next decade.
CMU is a key initiative for Europe. Broadening financing options for business and increasing the opportunities for investment requires significant change across a range of complex interconnected issues, both regulatory and structural. So far, the European Commission has tackled mainly the regulatory barriers, with specific proposals to help loosen the financial system, and provide improved access to capital markets for SMEs.
True to its promise to look beyond pure regulatory measures, the Commission’s March report targets the barriers to investment, from national approaches and measures. Stopping short of naming and shaming, the Commission highlights that Member States need to do more on financial markets integration for capital markets activity to improve. However, some of the key national barriers are deep-rooted and achieving real change will be a challenge for all stakeholders.
The debate is especially timely as the industry now faces potentially the single biggest impact on cross-border fund distribution in a generation – Brexit. Brexit is not just about the future of London as a financial centre or of the UK-based investment and fund management industry. Firms within other EU Member States and elsewhere will be impacted. The loss of the fund and management company passports in the UCITS Directive and the AIFMD will have different impacts in the retail and professional market places.
According to Commission statistics, about 80 percent of UCITS and 40 percent of AIFs are marketed across borders, but one-third of these are marketed into only one Member State, usually the state in which the investment manager is domiciled. Another third are marketed into no more than four other Member States.
The Commission’s research findings were that the cross-border fund market is successful but remains geographically limited: “The reasons for this may include the concentrated fund distribution channels in individual Member States, cultural preferences and a lack of incentives to compete across borders”. Other reasons include the additional national requirements imposed by Member States when transposing the AIFMD and UCITS Directive.
The Commission has identified six categories of national barriers. Their proposed removal will test Member States’ commitment to CMU and to the principles of harmonization enshrined in the UCITS and AIFMD Directives.
Meanwhile, ESMA has made it clear that retail investors should receive the same level of protection, independent of the location of the firm providing the service. This is seen as important both to the free movement of services within the EU in general and to the success of the CMU initiative in particular.
Critics of CMU have argued from the outset that national self-interests are the greatest obstacle to Europe having more vibrant capital markets. This concern is already resonating strongly in the debate about cross-border fund distribution.
There are conflicting views among European and national officials. Some believe the figures in the Commission’s report demonstrate that the 30 year old UCITS passport has created the most cross-border market within Europe. Others cite the much higher number of funds, the lower average fund size and higher cost ratios compared with the US as evidence that the single market is not working properly. They say that poorer economies of scale of European funds disadvantage European investors. If funds can do business more easily across borders, they can achieve larger economies of scale and compete to deliver better value and innovation for consumers.
Views differ not only about to what extent there is a problem but how to address it. Some national regulators, for example, have been heard to argue that a fund should not be allowed to export into other Member States if it is not first sold in its own Member State. The same regulators have suggested that all marketing literature should be required to seek pre-approval by each host Member State before it can be issued. Others rightly note that an ex-ante approval process would not sit well with a truly pan-EU market.
It seems that at the heart of some of these comments is a degree of distrust between national regulators. Some say that all Member States need strong gatekeepers, implying that they think others are not. It is not clear how these views will be addressed other than over time and with greater powers given to ESMA to accelerate supervisory convergence.
Neither is there a magic wand to address the strong national bias among, in particular, retail investors or the predominance of certain types of distribution channels in different Member States. Digital distribution platforms and different generational approaches may smooth out this bias over time.
Firms have an opportunity to frame the debate and adjust the tone of the narrative. Suggesting specific practical changes that will ease operational costs and inefficiencies will be welcomed by officials in Brussels as they seek to navigate this seemingly simple yet politically challenging debate.