Money managers under the microscope
Lipper: Fighting fragmentation
By Merieme Boutayeb, Research Analyst at Lipper. The views expressed are her own.
The European investment funds industry has been reshaped over the last 25 years by EU directives designed to improve efficiency, strengthen competitiveness and boost distribution. However, the latest battle to reduce fragmentation of the industry is looking like a hard one to win.
The first UCITS (Undertakings for Collective Investment in Transferable Securities) directive was created in 1985 with the aim to lay the foundations for a single European retail market.
Faced with regulatory gaps and other flaws, it had only limited success and a second attempt was initiated in the early 1990s, only for that project to be aborted due to major disagreements between member states.
Thereafter, a real effort of coordination and communication by the member states allowed the UCITS III Directive to emerge in 2001, the implementation of which has been an important milestone in the history of the European investment funds industry.
We have witnessed the beginnings of a unified regulatory platform, enhanced protection for retail investors and an expanded range of products and strategies.
Nevertheless, the European fund market still suffers from fragmentation, which penalizes the performance delivered to investors. Relatively lower levels of assets under management make it difficult to benefit from economies of scale.
According to Lipper data, there are more than 26,000 funds domiciled in Europe, which together hold some 3.6 trillion euros ($5 trillion) in assets under management. That gives us an average fund size of 137 million euros.
Meanwhile, around 7,500 funds are domiciled in the US, with total assets management of 6 trillion euros and an average fund size of 806 million euros.
Comparing the U.S. and the European fund markets is revealing about the significant potential for rationalization and consolidation in Europe, and exploiting this potential is one of the key objectives assigned to the new UCITS IV directive.
There remain concerns however, over whether this objective can really be achieved.
The establishment of cross-border mergers and master-feeder arrangements are supposed to help companies to streamline their fund ranges and benefit from asset pooling. But in practice, it would seem to be problematic due to a lack of clarity at the regulatory level. The tax implications are critical and have not yet been analyzed in depth.
For a cross-border merger, the choice of domicile will depend heavily on the regulatory framework and market requirements of each member state and the operation could be costly for the fund management company, which casts serious doubt on the extent of fund mergers after July 2011.
In turn, the master-feeder arrangement will allow the optimization of the strengths of various European financial centres and offer high flexibility in terms of distribution. Fund firms will be able to provide new products that meet the expectations and specificities of the different European markets and at a reduced cost through the new directive, going against the objective of rationalization.
Another element facilitating the process of fund launches is the Management Company Passport, due with UCITS IV in July, which allows a company to remotely manage funds available for sale in another member state without having to relocate physically. This will result in significant savings in terms of both resources and time, thus encouraging companies to launch new funds in other jurisdictions.
New rules will also serve to simplify the existing transaction notification procedure across multiple centres, further easing the burden for firms with fund ranges spread across the continent.
All these points cast doubt on the effectiveness of the new directive to achieve the short-term objective of drastically reducing the number of European funds. It is crucial to clarify the tax implications of the various measures in order to optimize its application, but until that happens, investors simply won’t be seeing the kind of reductions in charges that the new rules might have promised. ($1=.7177 Euro) (Editing by Joel Dimmock)