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MEDIA ECONOMIQUE ET FINANCIER
16 TH ALFI & NICSA GLOBAL INVESTMENT FUNDS FORUM
CLAUDE KREMER
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Luc Frieden, Minister of the Treasury
Editorial
Message FROM Mr Luc FRIEDEN, Minister of the Treasury In May of this year, the total amount of assets under management by the Luxembourg investment fund industry passed the symbolic threshold of 2,000 billion euros, registering a 25% growth in comparison to the previous year, and thereby consolidating the GrandDuchy’s leadership position for the third year in a row: Luxembourg indeed firmly remains the first domicile for investment funds in Europe and the second domicile worldwide after the United States. The associations of the two largest investment fund communities, the Association of the Luxembourg Fund Industry (ALFI) and the National Investment Company Service Association (NICSA) of the United States, are gathering professionals from all over the world at the 16th ALFI/NICSA conference to discuss key industry issues and trends with a special focus on global distribution patterns. Globalisation makes ever larger amounts of money available for ever more varied investment opportunities. Entirely new markets are emerging in response to the spectacular pro gress of giant economies like China, India, Russia
and others. In fact, India alone requires 350 billion euros over the next five years for infrastructure developments in support of current growth rates. Overall increasing wealth in many parts of Asia is feeding the substantial demand for diversified and high-yield savings products. Latin American governments are introducing radical pension reforms under the pressure of demographic changes in order to encourage private investors to get actively involved in shaping their own long-term financial security… these and numerous other examples confirm that markets are rapidly evolving and that it is crucial to be watchful for opportunities as they arise. The 16th ALFI/NICSA conference is a highly relevant platform for the investment fund community to analyse current trends and to accordingly adapt and extend the existing offer. Investment funds are indeed perceived by more and more institutional and retail investors as the best vehicle to assist them in achieving ambitious financial targets. To fulfil the growing demand, the United States and
Luxembourg investment fund industries come to play very complementary roles. While the United States domicile primarily serves a large domestic market, Luxembourg – due to a long standing international orientation – has been specialising in cross-border fund distribution all over Europe and beyond. In this regard, the relationship between the two largest domiciles is excellent and the United States are not surprisingly the number one foreign fund promoter in Luxembourg. As Minister in charge of the financial centre, I am strongly convinced that important inputs for the strategic orientation of a financial centre come from the industry itself. I take a certain pride in affirming that synergies between the Luxembourg authorities and representatives of the financial sector have been exemplary in this regard and have repeatedly brought about timely and beneficial alignments of the legal and regulatory framework with changing investment trends. In this perspective, I look forward to the valuable debates of this – and hopefully next year’s – prestigious ALFI/NICSA conference. PAPERJAM – Special ALFI & NICSA Forum
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E d i t o r i a l
C l a u d e K r e m e r ( AL F I )
Message from Luc Frieden, Minister of the Treasury
24 “ Trying to square the circle”
Ashu Suyash
(Fidelity Fu nd Man agement – India)
At a tipping Point?
ContentS ALFI & NICSA Forum
3 EDITORIAL Message from Luc Frieden, Minister of the Treasury
6 CLAUDE KREMER (ALFI) “Trying to square the circle” In the many fields of legislative work under way, the new president of the ALFI is aware of the difficulties involved in making the diverging points of view of the different professionals meet.
14 Exhibition Plan 16 Agenda 18 NICSA – The American Mutual Funds Industry The challenges and opportunities confronting the American mutual funds industry have never been more exciting. 20 The rating jungle – “Past performance is no guarantee of future results” Investment fund rating is essential to assess a vehicle’s performance. However, trying to systematically define quality positively might lead to unexpected counter-performances. Hence, this shall not be the only criterion investors should rely on. 22 Markets insight “Poland has excellent cards” Philippe De Brouwer, Head of KBC TFI (Poland), talks about the country’s economic perspectives and business challenges
24 The Indian mutual fund industry – At a tipping Point? The dramatic growth of the Indian mutual fund industry has come on the back of the extended bull run in the markets. “Will investors then move away from mutual funds if the markets turn?,” asks Ashu Suyash, of Fidelity Fund Management (India).
34 The start of the MiFID era – What’s in it for fund managers? John Parkhouse, Investment Management Leader at PwC Luxembourg, and Emmanuelle Henniaux, Partner, take a look at the impact to be induced as from November 1, 2007 by the transposition of the MiFID directive into Luxembourg regulation.
26 Anti-Money laundering – A justified industry concern This article presents the main innovations of the ALFI/ABBL/ALCO Practices and Recommendations aimed at reducing the risk of money laundering and terrorist financing in the Luxembourg fund industry.
36 Market Insight – “Surveying the Funds Distributors” Last April, RBC Dexia Investor Services Bank, which provides global custody, fund and pension administration and shareholder services, launched its first European survey on fund distributors’ operational challenges.
28 Analysis – Selected US Mutual Fund Regulatory Issues What is the latest news from Washington on the US mutual fund industry? Mike Downer, of Capital Research and Management Company, tells more.
40 Investment Fund Governance – Fill the time gap Robert DeNormandie, founder of The Directors’ Office, compares the evolution and practice of the investment fund industry governance in both the USA and in Luxembourg/Europe.
30 Islamic Fund Industry – Key developments and opportunities for Luxembourg Due to increased competition in western countries, fund managers are now looking for new opportunities to attract assets and target the Islamic market in the Middle East, which enjoys an impressive money flow (supported mainly by the high price of energy).
42 Private Investors in Germany – Effects of the new Flat Taxation on Investment Income On July 6, 2007, the German Federal Council (Bundesrat) voted the Corporate Tax Reform 2008 (Unternehmensteuerreform 2008). The reform is intended to strengthen competitive advantages of the German marketplace.
32 Cross-Border distribution – An unchallenged market success Jean-Paul Gennari, Managing Director at UBS FSL, comments on the issues, operational impacts and growing complexity of crossborder distribution.
PAPERJAM – Special ALFI & NICSA Forum
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C l a u d e K r e m e r ( AL F I )
“ Trying to square the circle” In the many fields of legislative work under way, the new president of the ALFI is aware of the difficulties involved in making the diverging points of view of the different professionals meet. part of his time during these first months of a mandate which begins under the best auspices. Mr Kremer, you are succeeding to Tom Seale who knew unanimous success during his four years of presidency. It’s no small challenge… “It’s true that Tom Seale established very high standards and has set the mark very high. He has successfully built a lot over these four years, with an exemplary professionalism and sense of leadership, and it will be difficult to do better. At the same time it is better to succeed some body who has been so successful than to pick up the pieces of an industry in poor health. This said, there are still new challenges to take up. We know the weight of the task. What motivated you at the time of applying for the position of president of ALFI? “The challenges that the association must take on and, more widely, the fund industry, have very broadly become regulatory challenges, whether European or national. On a European level, we have just managed to set up the UCITS III, as the transition period expired in February, and we are already con fronted with UCITS IV. In 2002, UCITS III wid ened, in relation to the first directive of 1985, the range of harmonised funds to funds of funds, monetary funds, tracker funds and funds inves ted in derivative instruments. At the same time, a new European statute for management [>>ù8]
Illustration: Thomas Brodahl (Stolen.la)
On May 23, members of the Association of the Luxembourg Fund Industry (ALFI) elected a new president in the person of Claude Kremer, Court lawyer, and partner in the Arendt & Medernach law firm, one of the largest in Luxembourg. At the head of one of the most powerful asso ciations on the financial market, he succeeds to Tom Seale, who reached the end of two consecu tive mandates during which the Luxembourg investment fund industry experienced impres sive expansion, global assets of the unit trusts recording 125% growth in four years to attain 2,000 billion euros (see box on page 10). It is therefore in a very favourable context, as well as being at the point of important legisla tion and regulation expiration dates, that Claude Kremer takes the reigns of the association, with the legitimate ambition to endorse the continu ity of the work already accomplished by his predecessor, while adding his own personal touch to it, as much as possible. President of the legal committee of the ALFI since 1995 and a member of its board of direc tors since 1997, he was also, in other respects, one of the experts appointed by the European Commission in charge of preparing the white paper on enhancing the legislative framework for investment funds aimed at producing a new proposal for a UCITS IV directive, planned, at the latest, for the beginning of 2008. It would therefore be difficult to be closer to the heart of a subject, which will take up a large PAPERJAM – Special ALFI & NICSA Forum
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CAREER PATH
25 years of experience It was in 1982 that the new president of the ALFI began his professional career. Soon to become 51 years old, Claude Kremer is a partner in the Arendt & Medernach firm and has been a member of the Luxembourg bar since 1982. Therefore, he has experienced the expansion of the Luxembourg investment fund industry right from the start, and through the continuation of the transposition in 1988, of the first UCITS directive. He quickly became a member of the ALFI and was elected to the board of directors in 1997. He has already been president of the association’s legal committee. His “domestic” involvement also reaches the Com mission de Surveillance du Secteur Financier (CSSF), within which he is a member of consultative committees concerning unit trusts, pension funds, risk capital investment company securities. “I have been rooted in the financial market for 25 years, which is one reason that motivated me to be a candidate for the presidency, he explains. When you know, like I do, what this market was 25 years ago, you’re in a better position to know what it will become in ten years time”. But his expertise goes much further than these boundaries, as in 2006, the European Commission appointed him as a member of their group of experts created to report on the methods to improve efficiency in the European investment fund market. A lecturer in international tax law at Luxembourg University, Claude Kremer also co-wrote the work, Organismes de placement collectif et véhicules d’investissement apparentés en droit luxembourgeois (Editions Larcier, Brussels). || J.-M. G.
[<<ù6] companies was introduced, ruling the conditions of exercising their activities. Following this, the European Commission published a green paper, then a white paper, proposing the means of establishing enhance ments in the efficiency of investment funds on a European scale. All this resulted in this draft directive, enti tled “exposure draft”, which practitioners already qualified as the UCITS IV. This exposure draft was published in March 2007 and a public debate took place at the end of April in Brussels. This was a real challenge. As a professional having worked in this career for 25 years, I will attempt to actively guide work in this European field and to ensure that these dossiers are negotiated in the best interests of the Luxembourg investment fund industry. On a national level, the ALFI’s aim must be to ensure that the legislation and regulation are con tinually updated and modernised. It’s a challenge in which, in my capacity as a lawyer, I can play a role. On this subject, I take the recent example of the leg islation in specialised investment funds, in whose elaboration the ALFI played a determining role.
Does this new responsibility risk having an impact on your main occupation as a lawyer? “I am aware of the volume of work that the presidency of an association such as the ALFI represents. That said, things must not be blown out of proportion either. I am not entering unknown territory. My involvement in the ALFI over the past (see box on the left) has already been considerable. My assignments will most certainly be different now, but I know that I can count on the other members of a board of directors that I hope to be actively involved and lean on a well-structured secretary-general. This secretary-general, which is permanent, is today made up of 15 people who are also ready to take up daily responsibilities. Recent changes introduced in the composition of the secretarygeneral should also be mentioned.
Upon the request of our director-general Robert Hoffmann, Camille Thommes was pro moted to this position on July 20, 2007, although this change was initially planned to only take effect from January 1 of next year. Robert Hoff mann will remain senior counsel with special assignments, at national and international lev els. Charles Muller was named assistant direc tor-general. Elsewhere, we have just appointed a new legal and tax director in the person of Daniel Dax, former legal adviser with the Bourse de Luxembourg. What is the margin of manœuvre available to you today in the elaboration of the legislative and regulatory frameworks which are taking shape? “We want to take a constructive part in the European debate. That said, the directives often foresee flexibilities and options that you must know how to identify so as to use them to their advantage. We must also ensure that, in negoti ating these texts, the interests of the Luxem bourg fund industry are preserved. At a national level, experience has shown that the process of legislative formation follows a very pragmatic development. I have already cited the recent legislation in specialised investment funds, which has been the fruit of a very success ful collaboration between the ALFI and the CSSF and which has enabled the creation of legislation which conforms to market expectations. Generally speaking, we want to maintain a permanent dialogue with the authorities so as to communicate our needs to them, which may change and evolve. Amongst the “national” fields, the revision of the subscription tax concerning funds particularly springs to mind. Tom Seale admitted to us that this was one of the points which he regretted not having been able to do better on. Do you think you will be able to finish the work that he started? “This constitutes in all cases one of our recurring worries. We must convince the government that a
PAPERJAM – Special ALFI & NICSA Forum
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How would you define the style of the presidency which will be yours? “I am, by my very nature, a believer in team work. The board of directors is already the first circle in which we must work. We have intro duced something new here, with the creation within it of a strategic committee made up of a smaller number of members, representative of the different professions. This committee will work like a think tank in charge of identifying the “vital” fields, outlining them and following their development. The functioning of technical committees is Luxembourg, Europe… Your trading area being reorganised in parallel. Dossiers that extends further than this, however… “Of course, and we need to systematise penetra concern us have changed and become more tion into markets, which do not yet know Luxem complex and more multi-disciplinary. Many of bourg well enough. I am thinking especially of the them involve more than a single committee at new markets in Eastern Europe, where there is an any one time. So we have to find a way of making enormous potential. Many investors can be found them interact with each other. These technical there with a vocation to invest in funds and there committees will provide a pool of technical fore potentially in Luxembourg products. competences for the association to use. The Asian market is also very important. In Hong Kong, Singapore or even Taiwan, there is However, the UCITS IV remains an essential huge recognition of Luxembourg products. But dossier. At the beginning of the year, the this recognition must be further established European Commission published an exposure more intensely. draft which in the mean time has been the subject of a public debate encompassing all What about the funds not covered by the the interested parties. What is the position of UCITS directive? the ALFI on this voluminous subject? “We must also assure their promotion. For “In the main, there are some very good ideas hedge funds, private equity, real estate funds, the and valid solutions found here to improve effi potential is there. The new law on specialised ciency of the European investment fund market. funds offers an excellent legal framework. It But obviously, there are also some points, which would be advisable to implement it and make it need to be improved upon. concrete. This would take place notably through The exposure draft identifies six important the intensification of promotional visits, which fields: a simplification of the notification pro are more than ever of primordial importance. cedure for funds in host member states where they are distributed, a European passport for That makes quite a few front-line combats to management companies, a cross-border regime lead. Is there a priority? for fund fusion, a pooling of assets, a new and “No, we must work in all these fields at the same simplified prospectus, and stronger coopera time. This is exactly why we have a board of direc tion between control authorities. tors of 24 members whose diversity is one of its For the notification procedure, everybody advantages. The most varied competences are agrees that we are on the right track. Notifica found here so as to be able to do battle on all fronts. tion periods, currently of two months, will be supplementary reduction in this tax is a good thing. Up until now, this tax has not stopped Luxembourg from becoming what it is, but it’s a nuisance. I am convinced that a further reduced tax, applied to a volume of growing assets, would be better. Luckily, we already have, to our credit, some satisfaction in the subject, with reductions obtained over the last years, and I remain confi dent that one day we will be able to definitively dispense with this tax.
Record
A symbolic peak Assets of Luxembourg unit trusts exceeded 2,000 billion euros at the end of May 2007. The month of May 2007 will stand in history as that in which the unit trusts sector in Luxembourg reached, for the first time, the 2,000 billion euro mark in terms of managed net assets. Continuous development of stock markets over the last few years, before the small dose of depression this summer, obviously widely contributed to accelerating the sector’s growth. Thus for 2005 and 2006, financial markets have contributed 37.7% to recorded growth. But the great innovation, which has always prevailed in terms of products has equally been very favourable to the sector’s development. Funds promoters in Luxembourg have always designed innovative and diverse unit trust products, responding to different market cycles (such as unit trusts accompanied by a guarantee, monetary unit trusts, funds of funds, absolute return unit trusts, mixed strategy unit trusts, etc.). The possibilities of structuring products in Luxembourg (legal structures of the unit trust or open- or closed-end investment company type, multiple-section funds, classes of stocks or shares…), have also enabled promoters in Luxembourg to structure their unit trusts according to their production and distribution needs. Pooling structures have also followed the integration of financial markets. On June 30, these global net assets amounted to 2,047.022 billion euros, representing a rise of almost 11% since the beginning of the year and nearly 24% over 12 months. Since January 1, capital net investment has been 130.6 billion euros. Considered over the past 24 months, this capital net investment comes to over 500 billion. On June 30, the number of unit trusts and specialised investment funds taken into account was 2,352, representing a total of more than 10,000 sections. || J.-M. G.
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Statistics
Worldwide growing trends In August 2007, the EFAMA, the European Fund and Asset Management Association released its Q1 2007Worldwide Investment Fund Statistics. In the first trimester 2007 the investment fund assets rose worldwide by 3.4% to 17.06 trillion euros. “All fund categories experienced an increase in net assets,” the EFAMA commented. Both the balanced funds (5.6%) and the money market funds (3.5%) recorded the highest asset growth. If during the period the “net cash flow to invest ment funds worldwide remained robust,” according to the release – at 368 billion euros compared with 361 billion euros in the fourth quarter of 2006 – the equity fund inflows declined to 90 billion euros, from 116 billion euros in the previous quarter. However, both bond and balanced funds posted higher inflows at 53 billion euros for each category, whereas “flows to money market funds matched the pace of the second half of 2006 with net inflows of 102 billion euros.” At the end of March 2007, assets of equity funds represented 48% of the whole investment fund assets composition worldwide. Both the bond and money market funds counted respectively for 18%, whereas the balanced funds represented 10% of the total. Looking at the worldwide distribution of investment fund assets, “the United States and Europe held the largest share in the world market at end-March 2007, 47% and 34.5% respectively,” the EFAMA explained, ranking far before Australia (4.7%), Japan (3.1%) and Brazil (3.0%). Compiled by the EFAMA together with the Investment Company Institute and on behalf of the International Investment Funds Association, an organisation of national investment fund associations, the data collection includes statistics from 42 countries. || M. A.
shortened, and once a fund has been launched, fragmentation which is worrying at the level of it will have to be recorded in the host country investor protection. Then there is a tax problem. If a management within three days. It’s one of the text’s strong company established in State A created a fund in points. State B, the fund would risk being taxed twice, The other points, on the contrary, are not firstly in State B, where it was established, and secondly in State A, in other words in the place attracting such unanimity… “The most delicate and controversial subject, where, in the absence of harmonised tax laws, already within the group of experts in 2006, is the tax authority of State A could consider that the European passport for management compa the real head office of the effective fund man nies. The main international managers are in agement is found. Personally, I find it difficult to imagine how a favour of it being put in place, because that will enable them to obtain substantial savings of complete passport could work in practice, taking scale. But the question remains of knowing in into account the difficulties mentioned above… All this should obviously be balanced with what measure these economies will have reper managers’ concerns to respond to the needs of cussions on the investor. Two options are being discussed. Firstly, a cost reductions, which are far from negligible. If complete passport, in which case, with the help managers are not able to manage their funds at of this passport, a management company of a reduced costs, they will have trouble in making member state would be able to create a fund in non-regulated products compete such as invest another member state, without there being the ment certificates or products subject to a more least administrative substance in the fund’s flexible harmonised regime, like certain life domicile! insurance products. The other option consists in a partial passport: the fund could be created and managed outside Are we witnessing, in this schema, a battle of the borders, but a certain number of essential influence: the fund managers lobbying against administrative functions would remain tied to the others, with the ALFI at the head? the fund’s domicile. “The exposure draft takes up again, very Debate surrounds the choice between one or broadly, the thoughts of the group of experts the other of these options. The ALFI has always who, already at the time, were divided on the said that they are not opposed to the idea of a subject. Certain managers are favourable to the passport, but that problems that it could lead to complete passport while others find a partial should be taken into account. passport perfectly acceptable. There is therefore no unanimity between players. Is that why you are more in favour of a partial Control authorities of the main “production” passport? centres of harmonised funds, in other words, Lux “The fact of taking away all administrative embourg and Ireland, also want to make sure they substance from the funds’ domicile creates two retain a legitimate seizure on their funds, so as to problems. Firstly, there is a regulatory prob be able to efficiently and properly watch over lem: the control authority from the domicile them! The same worry is shared by fund auditors. country of the fund would be able to oversee So we are faced with a difficult subject. Some the fund, yet the control authority of the coun times it feels like we are trying to square the cir try where the management country would be cle to satisfy all the expectations and to take into situated would be able to oversee the afore account all the constraints”. mentioned. There is a real danger of regulatory || Interview by Jean-Michel Gaudron
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16 th ALFI & NICSA Global Investment Funds Forum Exhibitors Plan
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T h e 1 6 t h AL F I & N IC S A G l o b a l In v e st m e nt F u n d s F o r u m
Conferences programme TUesday, 25 September 2007
8.00 – 9.00 a.m.
11.10 – 12.05 a.m.
Registration and breakfast
Heading to Eastern and Central Europe: New horizons Moderator: Martin Vogel Managing Director, Member of the Management Committee AM, Bank Julius Baer & Co., Zurich
9.00 – 9.15 a.m.
Opening remarks Barbara Weidlich President, NICSA, Marlborough
Gert Rautenberg Managing Director, European Fund Services, Luxembourg
3.30 – 4.00 p.m.
break
Claude Kremer Chairman, ALFI
Panelists: Philippe De Brouwer Chief Executive Officer, KBC Towarzystwo Funduszy Inwestyjnych, Warsaw Christophe Girondel Managing Director, Nordea Investment Funds, Luxembourg
3.55 – 5.10 p.m.
The impact of cross-border growth on administrators Moderator: Noël Fessey Managing Director, Schroder Investment Management (Luxembourg)
9.15 – 9.20 a.m.
Chairperson’s introduction Martin Vogel Managing Director, Member of the Management Committee Asset Management, Bank Julius Baer & Co., Zurich
Heinz Macher Head of Legal, Taxes and Compliance, Raiffeisen Capital Management, Vienna
9.20 – 9.40 a.m.
12.15 – 1.45 p.m.
Keynote speaker
Luncheon (host: Ernst & Young and State Street)
9.40 – 10.40 a.m.
2.00 – 2.30 p.m.
Developments and Opportunities for fund distribution in the Middle East
The Tell Tale Truth – Presentation of the 1 st European survey on fund distributors’ operational challenges Markus Postler Head of Marketing & Sales, Distribution Support, RBC Dexia Investor Services Bank, Luxembourg
- Real opportunities for Luxembourg fund promoters - A Luxembourg fund promoter’s experience Moderator: Gordon Bennie Partner, Ernst & Young, Head of Financial Services, Saudi Arabia
Panelists: Julian Presber Managing Director, State Street Bank Luxembourg
Geoffrey Cook Managing Director, Brown Brothers Harriman (Luxembourg)
Jean-Paul Gennari Managing Director, UBS Fund Services Luxembourg
José-Benjamin Longrée Managing Director, CACEIS Bank Luxembourg
2.30 – 3.30 p.m.
Harshendu Bindal Senior Director, Franklin Templeton Investment Management Limited, Dubai
10.40 – 11.10 a.m.
break
Anti-money laundering – A justified industry concern Moderator: Lou Kiesch Partner, Deloitte, Luxembourg
4.50 – 5.00 p.m.
Chairperson’s closing remark 5.45 – 7.30 p.m.
Cocktail Reception at the Philharmonie, Luxembourg Hosted by PricewaterhouseCoopers Luxembourg
Panelists: Jérôme Wigny Partner, Elvinger, Hoss & Prussen, Luxembourg
Marco Zwick Head of Compliance & Risk, Continental Europe, Schroder Investment Management (Luxembourg)
16 PAPERJAM – Special ALFI & NICSA Forum
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Wednesday, 26 September 2007
8.00 – 8.30 a.m.
Registration and breakfast
Panelists: Jacques Elvinger Partner, Elvinger, Hoss & Prussen, Luxembourg
Olivier Garnier Deputy General Manager, Société Générale Asset Management, Paris
8.30 – 8.40 a.m.
Chairperson’s introduction Denise Voss Conducting Officer, Franklin Templeton Investments, Luxembourg
Stuart Fross Partner, WilmerHale, Boston
3.10 – 3.35 p.m.
Break 3.35 – 4.20 p.m.
8.40 – 9.10 a.m.
11.50 – 12.20 a.m
HONG KONG: YOUR DOOR TO MAINLAND CHINA Stephen Po Senior Director, Securities and Futures Commission, Hong Kong
The activities of the CSSF in a Globalised Playing Field Jean-Marc Goy Counselor to the Director General, Commission de Surveillance du Secteur Financier, Luxembourg
9.10 – 9.40 a.m.
12.30 – 2.00 p.m.
update on the US Mutual Fund Industry Mike Downer Senior Vice President, Coordinator of Legal and Compliance, Capital Research and Management Company, Los Angeles
Luncheon (host: BNP Paribas Securities Services and Deloitte)
9.40 – 10.10 a.m.
Standing on the crossroads: The Indian economy in the 21 st century Ajit Singh Professor of Economics, University of Cambridge, Senior Fellow, Queens’ College, Cambridge
10.40 – 11.10 a.m.
Panelists: Guy Boden Director, Head of Research, Standard & Poor’s Fund Research, London
Don Phillips Managing Director, Morningstar Inc., Chicago
2.00 – 2.15 p.m.
MiFID’s status - The Commission’s view Niall Bohan Head of Unit 4, Asset Management, Internal Market and Services DG, European Commission, Brussels
Dr. Gabriel Burstein Global Head of Asset Management Research Lipper, New York
2.15 – 3.10 p.m.
4.10 – 5.00 p.m.
A panel discussion around MIFID Moderator: Graham Goodhew Vice President, JPMorgan Asset Management (Europe), Luxembourg
New Regulatory Trends - Market Abuse, The Transparency Directive and Distance Selling Claude Niedner Partner, Arendt & Medernach, Luxembourg
10.10 – 10.40 a.m
The Indian Mutual Fund Industry: Is it at its tipping point? Ashu Suyash Managing Director and Country Head, Fidelity Fund Management Private Limited, Mumbai
The Ratings Jungle Moderator: Henri Reiter Director, Fund-Market, Luxembourg
Panelists: Niall Bohan Head of Unit 4, Asset Management, Internal Market and Services DG, European Commission, Brussels
Hermann Beythan Partner, Linklaters, Luxembourg
John Parkhouse Partner, PricewaterhouseCoopers, Luxembourg
break
4.50 – 5.00 p.m.
Chairperson’s closing remarks 11.10 – 11.50 a.m
Corporate Governance: Compare and Contrast - Luxembourg/USA Moderator: Robert DeNormandie Director, The Directors’ Office, Luxembourg
Wolfgang Mansfeld Member of the Executive Board, Union Investment, Frankfurt
PAPERJAM – Special ALFI & NICSA Forum
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13.09.2007 14:47:25 Uhr
N IC S A
The American Mutual Funds Industry The challenges and opportunities confronting the American mutual funds industry have never been more exciting. the regulatory landscape in response to the current and prospective reality in the marketplace. Whether this is in the area of prospectus disclosure requirements or methods of prospectus distribution, the area of greater fee disclosure to shareholders, increased vigilance over potential market timing activity, or fund governance or compliance – the challenges to all participants in the mutual fund industry are significant. Along with the rest of the developed world, America is very concerned about an ageing population not having enough financial resources to enjoy their retirement years. Private pension plans have substantially been replaced by defined contribution plans.
Illustration: Thomas Brodahl (Stolen.la)
For the younger generations
Barbara V. Weidlich President, NICSA
The demand for traditional as well as non-traditional fund products and shareholder services continues to grow and expand. Retail, as well as institutional distribution methods, continue to proliferate. A more sophisticated and older shareholder is increasingly looking for advice and the institutional clients are looking for ever-growing refinement of their asset allocation. In June 2007, the American mutual fund industry had assets of 11.4 trillion dollars, according to the statistics published by the Investment Company Institute in Washington DC. Nearly 60% of industry assets and a little more than half of the 8,000 American mutual funds are equity funds. 30% of assets are invested in 1,300 taxable bond funds and nearly 600 taxable money market funds. The remaining 10% of assets are in hybrid funds, tax-free bonds and tax-free money market funds. American mutual fund investors maintain nearly 300 million individual accounts. All of this is testament to the fact that the mutual fund industry has done an excellent job with educating the investing public to diversify its assets and to allocate them well across possible investment options. Regulators and politicians are very active on many fronts. Regulators are taking a new look at older rules and regulations to endeavor to update
There has been a rapidly developing trend by mutual fund companies to offer both lifestyle and life cycle funds. Lifestyle funds permit investors to create their own risk allocation. Investors can combine a number of funds, ranging from conservative to moderate to aggressive, to accommodate their own tolerance for risk. These funds may be from one fund family, or may be assembled from various fund families. Advisors are increasingly helping investors maneuver through this challenging process. Life cycle funds, on the other hand, are targeted to the investors’ retirement date. As the retirement or target date comes closer, the fund’s asset mix is automatically shifted from a more equity-focused allocation to a more income-producing allocation. With the recently passed pension protection act, the American Congress is attempting to encourage and make saving for retirement more broadly accessible to the general public, most especially the younger generations. Automatic enrollment of all employees in defined contribution plans with appropriate investment options and appropriate default options and the added possibility of obtaining professional advice from plan sponsors presents a great opportunity for mutual funds to capture a substantial portion of this new inflow of savings. Now, a full one third of the 11.4 trillion dollar mutual fund asset pool represents retirement savings. With this new law, that could grow dramatically. The recent growth of ETFs, hedge funds and alternative investments, in general, have certainly dominated the news headlines, but that does not mean that traditional mutual funds are not also utilising sophisticated investment strategies to enhance their performance. This presents incredible challenges not only to investment managers and fund distributors, but it also challenges service providers, law firms, audit firms, technology providers and the dedicated staff of all these firms to keep up with, and keep good controls on, their processes and procedures. As we gather here in Luxembourg for the 16th year at the ALFI/NICSA conference, we are well aware that, beyond America and Europe, there are new markets to be developed and that we can collectively play a significant part in opening these new markets for our industry in many parts of the world. || Barbara V. Weidlich
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� � �� � � � � � �� � � � � � � The Rating Jungle
“Past performance is no guarantee of future results”� Investment fund rating is essential to assess a vehicle’s performance. However, trying to systematically define quality positively might lead to unexpected counter-performances. Hence, this shall not be the only criterion investors should rely on.
Illustration: Thomas Brodahl (Stolen.la)
Henri Reiter Director, Fund-Market
In the United States, Morningstar ratings are essential in fund distribution: over 80% of volumes of fund sales are top-rated Morningstar funds. This is made possible because the US markets are much more open than in Europe. Traditionally, banks and brokers sell other funds as well as their own and investors need help when making their choice. In Europe, where banks still distribute their own products to captive clients, fund ratings have played a secondary role in fund distribution until today. Fund distributors tend to communicate more on national or European awards from rating institutions than on the ratings themselves. This is probably due to the lack of knowledge of fund ratings among customers and the minor role played by funds in retirement planning. Will this change in the future? Maybe the recent concentration in the rating business will make brands more visible and free up more marketing budget to establish their standards. Much has happened in the fund-rating business over the past few months. Standard & Poor’s (funds.standardandpoors.com) sold its quantitative analysis and rating tool to its competitor Morningstar (morningstar.fr/de), leaving S&P to concentrate on the qualitative fund-rating business. Two months ago, Reuters’ subsidiary, Lipper (lipperweb.com), the world leader in fund database services to institutional investors, acquired Feri Fund Market Research as well as its fund database subsidiary in Germany. This leaves Lipper and Morningstar as the absolute leaders in quantitative data provision for European funds. Accordingly, Morningstar’s “Star Ratings” and Lipper’s “Leaders” have become the references in quantitative ratings of investment funds. Standard & Poor’s, and to some extent Fitch (fitchratings.com) and Moody’s (moodys.com), seem best positioned in the qualitative-rating business. This opens the debate about the suitability of methodologies in the light of the important changes the fund market is currently experiencing.
Unexpected events Let’s consider the question of whether added value fund ratings stand to gain in importance in the future. Do quantitative measures of past performance and volatility provide sensible guidance to investors? Or do they rather rely on qualitative analysis, which looks deeper into the products and perhaps gives a better indication for future performance? Imagine you are a strong and proud bull living on a ranch in Andalusia under the cork trees, enjoying the Spanish sun and looked after by a friendly campesino. The longer you live, the stronger you get, and the more confident you feel about life in the future. In an analogy with finance, you could say that you become more bullish every day. Then, one day, still a pretty young fellow, a friendly rancher turns up
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120 115 110 105 100 95 Source: Lipper
0 85
22 .0 7.2 0
04 22 .10 .20 04 22 .0 1 .2 00 5 22 .0 4. 20 05 22 .0 7.2 00 5 22 .10 .20 05 22 .0 1 .2 00 6 22 .0 4. 20 06 22 .0 7.2 00 6 22 .10 .20 06 22 .0 1 .2 00 7 22 .0 4. 20 07 22 .0 7.2 00 7
80
with a van, puts a rope around your neck and drives you to a bull fight arena where you will be tortured to death in a cruel game. The blue line on the graph above illustrates our bull’s fate. As time passes, the animal gets stronger because it is running free. It gets much stronger than other bulls that live in stables in northern countries for most of the year, represented by the red line. The reader has certainly deduced that, as bullfights do not exist in northern countries, the risk of being involved in such an event is much lower. In fact, in comparison with the Spanish bull, getting killed in a bullfight is a rather rare occurrence. Such occurrences also exist in financial markets, and the graph above also depicts what happened to one of the biggest European fund promoter’s money market funds during the second week of July 2007. The blue line represents the performance of the fund against the performance of all other money market funds, represented by the red line. Interestingly, the money market fund, which dropped by nearly 20% in just a few days, had the best rating with all quantitative rating agencies. This is not astonishing as the fund largely outperformed most of its peers with scarcely more volatility. Clearly, what quantitative ratings cannot measure is the type of rare event the fund was to face in August. With hindsight, the rating was without any doubt misleading for the investor convinced about the security of his investment. Today we are experiencing developments in the fund promotion business that are diluting the distinction between UCITS funds and hedge funds. With the new UCITS III directive, funds sold to a large public may use certain strategies and investment vehicles previously only used by hedge funds. The new 130/30 funds, which use limited leverage and short selling techniques, as well as different types of absolute return and money market funds, have become slightly more risky, while expanding the range of opportunities on offer to investors. We think that this is a positive development. In the end, too much consumer protection leads to a situation where regulators prevent investors from making money. On the other hand, the risk of rare events, like the one depicted above, impacting investments is growing. It is therefore even more doubtful that quantitative fund ratings will be criteria which are as reliable for fund purchases in the future as they were in the past. Sometimes, though not very often, when showing a fund with an excellent past performance to an investor, he argues that the fund might be too expensive, as it has already made considerable gains (investors tend to buy past performance). This is often a very intelligent objection, mostly made by people with some kind of experience with stock investments, although funds cannot be compared with direct investments.
Indeed, there are situations where the best performers become the worst, especially when market conditions turn or alter.
For a fund’s biopsy The weakness of quantitative ratings lies in the fact that they do not look into a fund, and confine themselves instead to data analysis. In order to be able to assess the risk associated with “rare” events and to be able to extrapolate to some extent on the future, you have to analyse the fund’s portfolio. To be able to do this, a number of conditions need to be fulfilled: – The fund must be transparent. While this should be the case for UCITS funds, it is not general practice in the hedge fund world. – The analyst must be a confirmed finance professional and familiar with all vehicles the fund invests in. – Time should be taken to conduct a serious analysis. – As fund investments and managers constantly change, regular monitoring is recommended. Qualitative ratings try to achieve the above. While quantitative raters are able to screen the whole fund universe, it is impossible for qualitative analysts to do this as the number of funds is much too large. The time and skills needed to analyse a fund’s quality simply make such an effort unrealistic and hugely expensive. In practice, funds therefore have to apply and pay in order to be rated. Only a very small percentage of European funds are rated by Standard & Poor’s, for example. Even if we do not doubt the objectivity of a rating, which the fund has to pay for, only the better funds seek such a quality label. The weakest point in qualitative ratings is the fact that they try to define quality positively. Modern medicine concedes that if during a biopsy no cancer cells are found, this does not mean that the patient does not have cancer. This is because a biopsy makes it possible to analyse only a sample of cells and not every cell constituting the body. But, if only one tumorous cell is found, the cancer diagnosis is 100% positive. Analysing an investment fund is very similar to diagnosing cancer. The analyst may grant an AAA rating to a fund having missed the cancer cells or the cancer may develop a few days after he made the biopsy. Even worse, the diagnosis of cancer he might make will never become public as fund rating agencies do not publish negative results: this differentiates fund ratings from credit ratings as the former only deliver AAA, AA or A quality ratings. To conclude, ratings of all kinds are first and foremost indicators of the quality of an investment fund, but should never ever be the only criteria an investor should rely on when making an investment. However, they do provide information that can be of some comfort, similar to the comfort the negative cancer diagnosis brings the patient. || Henri Reiter
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M a r k e t s i ns i g h t
“ Poland
has excellent cards ”
Illustration: Thomas Brodahl (Stolen.la)
Philippe De Brouwer, Head of KBC TFI, talks about the country’s economic perspectives and business challenges.
Philippe de Brouwer CEO of KBC TF1, Poland
Graduated in theoretical physics, then in commercial engineering, Philippe De Brouwer joined KBC Asset Management in 2002. He is now CEO of KBC TFI, the KBC group’s funds management arm in Poland. Mr De Brouwer, is Poland indeed such a dynamic place? “Since I came five years ago, the city has amazingly changed: so many new buildings, rebuilt streets... The mentality has changed a lot. The younger generation is very open to learn English, works hard, and has helped the whole atmosphere change. Warsaw is no longer a grey place; it’s a dynamic and colourful place. This is the ideal climate to start new businesses. How is the economy holding up? “The GDP is growing fast and stable, the highest of the region. Poland has excellent cards indeed. It has an exceptional central geographical place in Europe, it is on the main crossroads between East and West as well as on the North-South axis with an excellent access to the Baltic, it is the largest unified market in central Europe, it has a good education system, it has millions of people working in other countries and eventually returning part of their wealth. Certainly, Poland’s growth and changes started slower than in the neighbouring countries, but it is a sustainable and almost unstoppable growth.
What are the main challenges for Poland in a growth perspective? “Even if the growth is inevitable for some of the reasons cited above, there are plenty of factors that need urgent modification. Poland should urgently invest in infrastructure, adapt the legal system, and make administration simpler. Just a few examples: Warsaw-Gdansk is only 370 km, but by train it takes four hours and it is not faster by car. Setting up a company is one of the slowest and most complicated processes in Europe. Authorities hardly use computers and citizens and companies spend annually maybe millions of man-hours to get one document from the authorities, have it stamped by a second and deliver it to a third authority. Another issue, and probably more dangerous than the issues mentioned before, is the labour market. Poland has had an outflow of about two million working people since entry into the EU, whereas the economy has grown by 15% since then. Companies have moved their business from Western Europe to Poland mainly for the cheap and highly skilled workers. They will cope with a higher labour price… but they cannot cope with the absence of labour; but it is not possible to hire workers from Ukraine, for example, because officially Poland has an unemployment rate of 13%, but most of these “unemployed” people are working in Western Europe or have almost no qualifications! How does all this reflect in the stock market? “We seem to be ending a historical period of four years of sustained growth, and four years in which small companies systematically outperformed the big ones. The WIG20 (20 biggest companies) rose in those years by 263.7% and the mWIG40 (40 average companies) by 492.6%. It is normal that in periods of economical growth smaller companies perform well since they can more dynamically adapt to new opportunities, but an average PB value of 4.01 is indeed very high. I expect that the stock market will continue to grow this year. Will that influence the savings market? “The savings and investment market will continue to be strong regardless of the short-time sentiment on the stock exchange. Economic growth is in an upwards momentum and will continue to be the driver. Poland has not only a lot of strong cards to play but also has a gap with the surrounding countries that has to be narrowed. Both dynamics will support economic growth and provide income for Poles. I would rather say that in the coming decade it will be the savings and investment market that will support the stock exchange and not so much the opposite. The fund market has grown year on year by 82%, that will probably be less in the near future, but certainly a double-digit growth is to be expected. What other tendencies can one expect? “The Polish market for savings and investments is making in one decade changes that in Western Europe took about three decades. Probably the most important change, which will benefit both investors and fund managers is the belief that the fund manager should foresee the stock exchange and invest only in the one winning asset of tomorrow will change into a more mature approach: the approach where the investor tries to define his investment goals, and select a portfolio appropriate for his goals and risk appetite.”
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Striving for perfection.
Business process outsourcing solutions for the financial industry.
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T H E I N D IA N MU T UAL F U N D I N D U S T R Y
AT A TIPPING POINT? The dramatic growth of the Indian mutual fund industry has come on the back of the extended bull run in the markets. “Will investors then move away from mutual funds if the markets turn?”, asks Ashu Suyash, of Fidelity Fund Management (India). The Indian mutual fund industry has grown at a scorching pace of 30% year-on-year over the last few years. While this figure is an indicator of the manner in which Indian investors are beginning to take to mutual funds as their route to investing, there is another set of numbers, which show that the market is by no means close to being saturated. Far from it, the Indian mutual fund story is just unfolding and the industry is at a very nascent stage. Traditionally, India has been a country of savers and this is reflected in the fact that the country’s household savings rate is a staggering 32% of GDP, one of the highest in the world. Of this, only 4% goes into capital markets and the allocation to mutual funds is just 2%. The Indian mutual fund industry recently crossed the milestone AUM of 100 billion dollars, which is 10% of India’s GDP of over a trillion dollars. That’s the potential of the market. But before we talk about the potential, let us take a step back to understand this industry. The Indian mutual fund industry had its beginnings in the setting up of the Unit Trust of India in 1964. The Unit Trust of India was an Indian government-owned asset management company and it was the only player in the market right through the late 1970s. It was only in the early 1980s that government-owned banks were allowed to set up their own asset management companies and it was the mid-1990s before the mutual fund industry was opened to private and foreign players. The industry saw its first round of growth around the tech boom of 1999-2000 but it proved to be short-lived with the downturn that followed. The rapid growth in the industry began in 2003-04 and has continued at a stunning year-on-year growth rate of 30%. Assets under management have grown from 30 billion dollars in 2005 to 100 billion dollars today. With India’s currency not fully convertible, the Indian mutual fund industry is largely a domestic industry. The 33 asset management companies – some wholly Indian, some foreign and others joint ventures – operating in India manufacture and market products that can be sold only to Indian investors. And these funds can invest only in the Indian equity market. It is only recently that regulations have been put into place allowing Indian mutual funds to invest in global equities in a limited manner. There is a latent demand among Indian investors to diversify their portfolios geographically and we have seen a tremendous response to our Fidelity International Opportunities Fund, which we launched earlier this year and which was among the first few funds giving investors the opportunity to invest beyond the shores of India.
A key element of the Indian mutual fund industry and which has, no doubt, contributed to its success, concerns distribution. The Indian mutual fund industry benefits from an open architecture distribution, which includes banks – both private Indian banks and foreign banks – as well as independent financial advisers (IFAs) and broker-dealers. Few investors come to asset management companies independently and, for now, the direct market is very limited with only a small number of selfdirected investors. The dramatic growth of the Indian mutual fund industry has come on the back of the extended bull run in the markets and that throws up a question as to whether investors will move away from mutual funds if the markets turn. And so, is the Indian mutual fund industry truly at a tipping point?
Disposable incomes are rising I would argue, yes. Even if the markets are corrected, there are a number of arguments to support my belief that we are at a tipping point. Firstly, let’s look at India’s demographics. India has a very young population with half of it at less than 25 years of age. With this demographic profile, the mutual fund industry is going to be driven by the accumulation phase of these investors for an extended period of time. Consider also the fact that disposable incomes are rising. And while the consumption-led cycle is driving markets, the household savings rate is not flagging either. At 32% of GDP currently, it shows a clearly increasing trend from the 19% it was in the mid-1990s. Of this, today, the mutual fund industry gets just 2%. The opportunity this represents is undeniably tremendous. One of the reasons for the small percentage of savings flowing into mutual funds is that a significant proportion of the population hold their money in banks or in cash at home. Add to that the sizeable amount that is held in physical assets – real estate and gold, of which India is one of the largest consumers. This throws up some challenges that the mutual fund industry must address. Clearly, the most important task at hand remains growing the market. As an industry we need to work towards a deeper and wider penetration of the Indian market. With the maturing of the industry and more and more players coming in, there is, in any case, a growing outreach that covers a greater geography. A few asset management companies are also bringing down the minimum investment amounts in a bid to attract more investors. On the distribution side,
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adding new channels is helping. Government-owned banks and Indian Post, with their unrivalled branch networks, have begun selling mutual funds too. But the key to bringing greater numbers of investors into the mutual fund fold remains investor education. It has been the cornerstone of Fidelity’s marketing strategy in India together with easy-tounderstand products executed simply. Our investor education efforts have focused on key themes like equities as an asset class outperforming other asset classes in the long term, asset allocation and how time in the market and not timing the market is important. Imparting investor education around providing a basic understanding of mutual funds and how they provide a route to wealth creation will give the Indian investor the confidence to invest in funds and will help move him from bank deposits and physical assets.
Unlocking the wealth Illustration: Thomas Brodahl (Stolen.la)
Equity and fixed income funds dominate the Indian mutual fund industry. But it is into physical assets like real estate and gold that up to 48% of India’s savings go. To unlock this wealth, alternate asset class funds may help and we have now seen the first of the gold ETFs being launched and some real estate funds being discussed. With these initiatives, I believe, the tipping point for the Indian mutual fund industry is more clearly within our sight than it has ever been as all indicators point to exponential growth in the coming years. || Ashu Suyash Ashu Suyash Managing Director and Country Head Fidelity Fund Management (India)
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12.09.2007 18:17:33 Uhr
Marco Zwick Head of Compliance & Risk, Continental Europe Schroder Investment Management (Luxembourg)
Illustration: Thomas Brodahl (Stolen.la)
Lou Kiesch Partner, Deloitte
An t i - M o n e y l a u n d e r i n g
A justified industry concern This article presents the main innovations of the ALFI/ABBL/ALCO Practices and Recommendations aimed at reducing the risk of money laundering and terrorist financing Considering the fact that “exemption” versus “delegation” of identification is defined under the Luxembourg AML regulations, it has become necessary to define the application of these concepts to international fund distribution by means of setting up a risk-based approach to be consistently applied at both the country and distributor risk level. The proposed methodology aims at classifying countries into “equivalent”, “low risk”, “medium risk”, “high risk and very high risk” jurisdictions, on one hand, and to distinguish individual distributors by their status of regulation and adherence to equivalent “know your customer” (KYC) requirements, on the other hand. It was felt useful by industry participants to rely on the outcome of these risk assessments in order to determine the circumstances under which (i) professionals would be exempted from the identification of final investors and thus be allowed to open omnibus/nominee accounts, or (ii) the delegation of the material execution of KYC requirements is permissible. Exemption of identification in this sense means that the process of identification can be waived since the investor is specific. It implies that the professional will not need to seek copies of the identification documents of the subscribing parties provided that the customer is a domestic or a foreign financial institution subject to equivalent identification requirements to those set out under Luxembourg requirements. With regard to regulated distributors in “medium risk” countries, the innovation consists in making it possible for professionals to operate omnibus/nominee accounts for local distributors, provided that the regulatory KYC gaps are filled by way of a contractual equivalence supported by regular due diligence reviews. Another innovation is that identification requirements can as of now be delegated to non-regulated professionals. The condition is that the distributor or its representative contractually sub-delegates its identification requirements. With regard to the identification of investors via incoming payments form or cheques drawn on banks located in equiva-
lent jurisdictions, it is rather an obligation to verify that final investors have been previously identified by another bank located in an equivalent jurisdiction than simply relying on incoming funds from cash correspondent banks and clearing houses.
Setting up remote and distant distribution channels The cross-border distribution success of the Luxembourg fund industry is largely due to setting up remote and distant distribution channels. In order to cement this success in the future, professionals and their boards need to cautiously assess the exemption and delegation criteria; they need to ensure that the risk-based approach is rigorously applied before appointing any sub-distributors which do not benefit from the exemption status. Other professionals widely impacted are central administrators. They can fully rely on the same exemption and delegation criteria as distributors. In case the delegation or exemption is not applicable, the central administrator needs to either fully identify the subscriber and/or the beneficial owner or they need to perform an in-depth verification of the provenance of the incoming funds. The main purpose here is to avoid outgoing third party payments. When issuing the Practices and Recommendations aimed at reducing the risk of money laundering and terrorist financing in the Luxembourg fund industry, trade and professional associations have taken the responsibility for adapting the already advanced national legal and regulatory framework to the specificities of their business in order to comply with future European requirements. By laying down the basis for a same level playing field in terms of the fight against laundering and terrorist financing, financial actors will thus succeed in avoiding competition on grounds of differing interpretations of anti-money laundering and “know your customer” requirements. || Lou Kiesch and Marco Zwick
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applying IT to the finance industry
13/09/07 10:45:19
An a l y s i s
Selected US Mutual Fund Regulatory Issues What is the latest news from Washington on the US mutual fund industry? Mike Downer, of Capital Research and Management Company, tells more. Mike Downer heads the legal and compliance group at the Capital Research and Management Company, investment adviser to the largest group of US mutual funds, American funds, with over 1.25 trillion US dollars in long-term assets. Several current issues relating to the regulation of mutual funds in the US as well as the organisation’s views regarding them are discussed below. In 1980, the US Securities and Exchange Commission adopted “rule 12b-1”. This rule permits any mutual fund that has adopted a “plan of distribution” in accordance with the procedures set forth in the rule, to use its assets to pay distribution expenses, including sales compensation to financial intermediaries. Since the rule’s adoption, over 70% of funds have adopted plans of distribution. Funds pay approximately 12 billion US dollars in fees through these plans each year.
Review of Rule 12b-1 (permits funds to pay distribution expenses) The Commission is currently reviewing rule 12b-1 to determine whether repeal or revisions would be appropriate. Some of the Commission’s staff for years have argued that rule 12b-1 fees should not be permitted to be used as an alternative for front-end sales charges. Instead, they have advocated externalising these expenses for all investors. Capital Research and Management believes that this approach would be harmful to many investors, particularly smaller shareholders, because they could be disadvantaged from an economic and tax standpoint. This was underscored during an extensive discussion at a Commission-sponsored round table regarding rule 12b-1 held on 19 June 2007. (See www.sec.gov/spotlight/rule12b-1.htm for more information regarding the 12b-1 round table and www.sec.gov/comments/4-538/4538414.pdf for our comment letter regarding the Commission’s review.)
Simplified Disclosure Efforts The Commission is currently working on a proposal for a simplified, plain language disclosure document for mutual funds that “would provide better information about investment objectives, strategies, risks, and costs.” This information would be made available online or in writing, depending on the preference of the investor. The staff of the Commission are also encouraging mutual funds to voluntarily experiment with an internationally used computer language called “XBRL” to
make disclosure “interactive.” We support efforts to simplify disclosures to mutual fund investors and have submitted our own proposal to the Commission in this regard.
Call for Repeal or Revision of Section 28(e) (permits soft dollar arrangements) Recently, the Chairman of the Commission, Christopher Cox, wrote to key members of the US Congress requesting that they consider legislation to repeal or substantially revise section 28(e) of the Securities Act of 1934. This law provides a safe harbour for so-called “soft dollar” arrangements between broker-dealers and investment advisers. These arrangements permit mutual funds to pay for things other than executing brokerage transactions such as investment research. Interestingly, this letter came on the heels of a lengthy Commission release that clarified a number of issues relating to section 28(e) but did not recommend repeal or revisions. We believe that section 28(e) practices are so ingrained in the US securities markets that repeal or substantial revisions would be needlessly disruptive to investors, would likely increase real trading expenses, and could negatively impact market liquidity. Moreover, the elimination of section 28(e) could necessitate increases in investment management fees at some fund groups because their advisers would be forced to pay cash for the investment research needed to conduct their activities.
Retirement Plan Issues Last year, the US Congress enacted the most significant retirement plan reform legislation seen in the past 30 years. This legislation, the Pension Protection of 2006, recognises the importance of defined contribution plans, such as 401(k) plans, in the US retirement plan market. It seeks to enhance the adequacy and effectiveness of these plans through provisions that would, among other things, make enrollment in a 401(k) plan automatic and provide default investments designed to ensure an appropriate mix of equity and fixed income investments for each plan participant. Accordingly, this has contributed to the growing popularity of “target date retirement” mutual funds. The increasing dominance of defined contribution plans in the US retirement plan market has also led to an increased focus on the dis-
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Illustration: Thomas Brodahl (Stolen.la)
closure of fees and expenses provided to both plan sponsors and participants with respect to these plans. The existing disclosure requirements were developed in an era when defined benefit plans were the major source of retirement benefits. Since the majority of 401(k) plan investments are held in mutual funds, new disclosure requirements could significantly impact mutual funds. In an effort to remedy the need for improved disclosure relating to fees and expenses in defined contribution plans, there has been significant legislative activity, among the regulators and in the courts. For example, there have been Congressional hearings, and a bill mandating extensive new disclosure requirements was recently introduced in the US House of Representatives. In addition, the Department of Labor has proposed regulations expanding disclosure of plan expenses. A number of class action lawsuits also have been filed against both plan sponsors and plan service providers. These lawsuits allege, among other things, that the fees and expenses of 401(k) plans have not been adequately disclosed. The resolution of these pending legislative and regulatory litigations may take a number of years. We support the goals of the Pension Protection Act and efforts to provide meaningful disclosures to retirement plan participants. || Mike Downer
Mike Downer Senior Vice-President, Coordinator of Legal and Compliance, Capital Research and Management Company, Los Angeles
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Gordon Bennie Assurance & Advisory Business Services Partner Ernst & Young Riyadh (Kingdom of Saudi Arabia)
Illustration: Thomas Brodahl (Stolen.la)
Elie Flatter Assurance & Advisory Business Services Manager Ernst & Young Luxembourg
Is l a m i c F u n d In d u s t r y
the Key developments and opportunities Due to increased competition in western countries, fund managers are now looking for new opportunities to attract assets and target the Islamic market in the Middle East, which enjoys an impressive money flow (supported mainly by the high price of energy). There are huge opportunities for the Luxembourg fund industry to tap into this promising market by efficiently filling the gap between fund promoter and distributor and therewith offering profitable value to the fund manager. According to The Islamic Funds & Investment Report (Ernst & Young, 2007), the universe of Islamic funds grew by a compound annual growth rate of 22% between 2000 and 2005 and the total number of funds is forecast to have reached more than 400 by 2006, amounting to more than 200 billion US dollars. The average fund size has increased to 284 million US dollars in 2006 compared with 230 million dollars in 2005. There is an important flow of money missing a broad range of investment opportunities. As a result, most of the Islamic funds are relatively small and roughly 50% of them have less than 50 million US dollars of assets under management. A significant portion of Islamic funds is concentrated in equity investments despite gaps across other asset classes (sector specific, fixed income, hedge funds). Islamic fund promoters are spread in major international markets: 50% in the Middle East, 30% in Europe and North America, and 20% in Asia. The market of Islamic investment funds is dominated by Saudi Arabia followed by Malaysia and the UAE. The Islamic market requires both expertise (complexity of the Islamic authorised investment, the governance of Islamic investment funds involving Shari’ah Supervisory Board, fast-moving Islamic markets) and credibility (strong, reputable presence, long-term focus and in-depth understanding in the market) to successfully distribute investment funds. As a result, the business model of Islamic funds is based on cooperation and a cost-effective outsourcing scheme between portfolio managers and local established banks. Depending upon the fund manager’s structure and resources, there are several ways to be successful in attracting assets and in distributing investment funds through institutions with good access and relationships in the Middle Eastern markets.
The best solution consists of manufacturing and distributing Islamic funds (sponsoring, managing and distributing the fund) through an in-house network (separate brands with Islamic offerings, special branches with Shari’ah-compliant investment funds). If most fund managers manage Islamic funds but appoint distributors with a limited success, however the model remains: in June 2007, Invesco Asset Management Ltd signed a distribution agreement with Mashreq, the largest and second oldest Dubai-based private bank, to market its offshore fund range in the UAE.
Key critical success factors Most commonly applied in Muslim markets, well-established local banks (mainly Saudi Arabian) sponsor and distribute Islamic funds but outsource their management. By appropriately choosing the distribution channel, fund promoters can access the most attractive segments, namely the retail investor. The regulatory situation in the Middle East makes it difficult to register investment funds locally, unless the distributor is a local bank or another financial institution. In parallel, funds registered in the Middle East cannot be distributed in Europe until local central bank’s approval is obtained. Based on its recognised expertise, respected reputation and qualitative regulatory oversight, the Luxembourg fund industry can offer key critical success factors. The umbrella structure can address the investors’ needs for breadth of products providing various and diverse choices of risk levels and liquidity. Furthermore, the Luxembourg fund industry can provide access to multiple distribution channels through retail and private banking networks or independent funds’ wholesalers to enable Islamic investment funds to flourish and be efficiently marketed in Europe using Luxembourg as a distribution hub. || Gordon Bennie and Elie Flatter
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C r o ss - B o r d e r d i s t r i b u t i o n
An unchallenged market success Jean-Paul Gennari, Managing Director at UBS FSL, comments on the issues, operational impacts and growing complexity of cross-border distribution. According to recent statistics released by the EFAMA (European Fund and Asset Management Association), at the end of December 2006 there were over 47,000 investment funds in Europe with a net assets total of 7,574 billion euros. Of these, over 33,000 funds were UCITS with assets under management of around 6,000 billion euros. Given the nature of UCITS funds and the legislative regime, which allows them to be freely marketed to residents in countries other than those in which they are domiciled, the success of cross-border distribution of investment funds within and outside Europe is clearly huge. Research from Lipper puts the number of true cross-border funds at over 5,000 and estimates that there are somewhere in the region of 36,500 cross-border registrations. Key markets being targeted include Austria, Germany, Switzerland, Spain, France and the UK. On average, cross-border funds are therefore registered for distribution in seven countries. However, an analysis of the 50 largest fund management groups in Europe shows a much higher level of market penetration with many selling their products in over 20 countries worldwide. Indeed, UBS is one of the market leaders in this field with their Luxembourg products being registered in no less than 29 countries. Cross-border distribution of investment funds has increased gradually over the past five years with shares of foreign UCITS as a percentage of total UCITS notified in the EU rising from 49% in 2001 to 53% in 2005. In some markets, however, this percentage is much higher and a level in excess of 75% is noted in Austria, Germany, Italy and the Netherlands.
A challenge for service providers Despite the obvious benefits of such wide distribution opportunities, fund administrators are also faced with a series of challenges in achieving their business objectives, not least of all the complexities of juggling with multiple jurisdictions on a daily basis. Whilst UCITS III has gone a long way to facilitating cross-border trade, certain aspects of the practical application are perceived as creating barriers to cross-border distribution. The impact of these various difficulties frequently results in increased costs and time delays in actually taking funds to market. In the first instance, despite the many positive steps, which have been taken at European Union level, and most notably the guidelines issued by the Committee of European Securities Regulators in June 2006 on the simplification of the fund notification procedure, seeking authorisation for UCITS funds in other countries is still far from standardised across the European Union’s Member States. Whilst it is true that the process has been facilitated in many countries, which have implemented the guidelines, in others, such as Germany for example, original visa-stamped documents are still requested from applicant funds as the regulator refuses to accept self-certified copies. There is also the problem of coordinating the translation of the fundrelated documentation into the local language. Although it is clearly logical from a commercial perspective to ensure that all marketing doc-
umentation is made available to prospective investors in a language which they can comprehend, many regulators still require all fund documentation and related agreements to be submitted in both the original and the local language for the purposes of the application file. Difficulties in registration tend to be further aggravated when funds are seeking registration on an international basis. Geographic areas primarily targeted include Asia (Hong Kong, Singapore, Taiwan), South America (Chile, Peru) and, closer to home, Switzerland. The primary problem encountered is compliance with local and divergent investment restrictions, and causing funds to incur additional time and costs through engaging local lawyers to conduct a detailed analysis of the current investment policy and benchmarking it against local regulations. Often, this can result in significant changes being enforced upon the fund prior to seeking authorisation. Following fund registration, such notification must be maintained and here too the requirements may vary from country to country. This creates both challenges and risks for fund administrators, who must ensure that they monitor and implement all legislative and fiscal developments in all countries of distribution. Furthermore, the fund must also comply with any local reporting obligations, which may involve the submission of certain data to the regulatory authority. Most regulators require the financial accounts of foreign funds to be submitted, and in some countries, there are very specific requirements with regard to the content (as is the case in Switzerland). There are, fortunately, relatively few regulatory authorities who impose statistical reporting on foreign funds, however, in this area too, there are vast differences in the nature of the reporting. For example, Portugal requests information every month, Greece and Switzerland collect quarterly data, and France and Italy request data on a semi-annual basis. But it is not just the frequency of reporting, which differs – there are also considerable differences in the nature of the data requested. France requests just three headline figures on subscriptions and assets under management at fund level, whereas Italy requires no less than 18 different items of data for each sub-fund. Another headache for fund distributors is keeping abreast of the multiple, complex and constantly evolving fiscal environment. Austria and Germany in particular have very specific rules in place for ensuring tax transparency of authorised funds and these bring with them quite onerous reporting obligations. Fund administrators must put in place complex procedures and systems to ensure that tax data is accurately calculated and reported in a timely manner. Errors in calculation and delays in reporting can result in penalty taxation and it is therefore absolutely imperative that all parties involved, whether directly or indirectly, are made aware of the potential financial and reputation impacts of miscalculation. The administrative challenges faced by fund administrators in crossborder distribution inevitably have a significant impact on the practical operating environment. Firstly, there is the matter of selecting multiple counterparties to deal with the different aspects of the distribution process. Many countries
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Illustration: Thomas Brodahl (Stolen.la)
require the appointment of a local agent or representative as a condition of authorisation. In a worst-case scenario, fund administrators could find themselves dealing with as many as half a dozen counterparties in any one country – distributor, local service providers (for example, translators, publishers – shareholder notices, etc.), paying agent, fiscal agent, correspondent bank, local legal counsel. The mere management and coordination of these relationships in multiple countries of distribution can be a full-time job in itself. Directly related is the issue of the agreements governing these relationships. Whilst many fund administrators use the same entity in all their distribution countries for conducting certain functions, the agreements are far from standard and are subject to the local terms and conditions of the market in question. Distribution agreements can be vastly different, particularly where calculation of fees is concerned. Consider, for example, that France and Switzerland expressly forbid fee rebates, whereas virtually all other European countries allow the practice, and it is clear to understand why it is almost impossible to establish Europe-wide agreements.
Increased complexity for global players Going down to the next level, functional processes can be quite distinct in each country of activity. Order routing or settlement practices for subscriptions and redemptions can be markedly different from country to country. In Asian markets, a local transfer agent is generally required to be involved, whereas local settlement systems must be used in countries such as France and Germany. In addition, different local standards often coexist as regards order data. As a final point on the operational impact of cross-distribution, fund administrators clearly need to consider cultural differences when taking their products to the international stage. Success is not only dependent upon effective distribution, but also on the high quality of service provided to the end-client. Naturally, for those players operating at a global level, this implies a workforce of multilingual staff with maximum flexibility is required, in order to best serve customers around the globe and around the clock, taking into account the different time zones around the world. Despite the many measures being taken to further simplify procedures and liberalise the European market, it is still complex and bureaucratic. With clients demanding more and more services at the lowest possible price and fund administrators striving to meet their needs at the highest standards, this inevitably puts enormous pressure on costs and margins. However, there is light at the end of the tunnel and it is absolutely clear, looking at the statistics, that the cross-border distribution of investment funds is not only a successful, but also an expanding industry. There are indeed many risks and challenges facing fund administrators, however, with the right business model, an efficient distribution strategy and a pragmatic approach to local regulation, many of these hurdles can be overcome. || Jean-Paul Gennari
Jean-Paul Gennari Head of Fund Services, Luxembourg UBS Global Asset Management
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John Parkhouse Investment Management Leader, PWC Luxembourg
Illustration: Thomas Brodahl (Stolen.la)
Emmanuelle Henniaux Partner, PWC Luxembourg
T h e st a r t o f t h e M i F I D e r a
What’s in it for fund managers? John Parkhouse, Investment Management Leader at PwC Luxembourg, and Emmanuelle Henniaux, Partner, take a look at the impact to be induced as from 1 November 2007 by the transposition of the MiFID directive into Luxembourg regulation. How does the MiFID directive impact fund managers? John Parkhouse: “MiFID clearly states that it does not apply to funds, their managers and depositaries. The ������������������������������������ only caveat is that fund manage� ment companies can provide other services than fund management such as discretionary portfolio management and investment advice. MiFID’s standards will apply to the provision of these services. ����� This was necessary to ensure a level playing field between firms such as wealth managers that are subject to MiFID and management companies offering comparable services. Does this mean that we will see little implication on the fund industry? Emmanuelle Henniaux: “No, on the contrary. ������������������� Fund managers deal in securities on the capital markets through brokers. They often rely on third parties to sell their funds. When located in the EU, securities bro� kers and most fund distributors will be subject to MiFID. ������������� Thus, though fund managers are not themselves in scope, the entities they deal with both upstream and downstream will be MiFID firms. J. P.: “It is therefore critical for them to fully understand the implica� tions of MiFID both on the functioning of the capital markets and on the distribution of funds and of competing products, to ensure the business implications of MiFID are taken into account in their strategy. How does it affect fund distribution? J. P.: “The implications here are quite fundamental. Fund �������������� managers generally distribute their funds though distributors such as banks or wealth managers. The typical business model in Europe is that the distributor is generally compensated for its services by an initial commission paid by the client and by a fee paid by the fund manager out of its management fee. Under MiFID this arrangement will have to be clearly disclosed to the client while until now this was usually opaque to retail investors. As a result, the practices of fund distributors as it relates to fund selection and their com� pensation are likely to be impacted, although no-one knows as yet quite how much. �������������������������������������������������������������� The directive also places increased responsibility on the dis�
tributor to ascertain if the fund considered or recommended suits the needs of the investor and if he understands its risks. Certain ��������������������������� distributors might thus be tempted to distribute to their retail investors simpler products or products that are not in the scope of MiFID such as deposits and insurance contracts.� There ���������������������������������������������������������������� is indeed a series of products and professionals, such as insurance companies, that are not in the scope of MiFID. The main worry of the industry is that MiFID is yet another directive that widens the gap in the level-playing field between funds and alternative savings products. What is the stage of readiness of the industry? E. H.: “Most fund managers have now completed their MiFID impact assessment and defined appropriate courses of actions where needed. By ��� and large the feeling is that, though MiFID has important implications, they are limited to part of their fund management activities. ��������� However, MiFID is a huge piece of regulation. There ��������������������������������������� still remain many open questions around technical aspects of MiFID and its application to the fund industry. It will certainly take time for the industry to properly digest what arrives on November 1. At this stage, one key concern is moving too quickly and ahead of the market in terms of defining an approach and a firm strategic response to MiFID – a measured approach following emerging market prac� tices seems much the best approach today.” J. P.: “For cross-border fund promoters – most of which operate funds in Luxembourg – one of the main immediate issues is now to identify differences in the local implementation of MiFID that could impact their distribution model. Though the CESR’s work is there to foster supervisory convergence across the EU, we are already noticing differ� ences in the implementation of MiFID such as, for example, on the eli� gibility of trailers’ fees in discretionary portfolio management mandates. We anticipate that the cross-border players will need to spend conside� rable time and effort to gain an accurate picture of the local require� ments in each of the territories where they market their funds.” 1
���������� Committee ��� of ��������� European ����������� Securities ���������� Regulators
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m a r k e t i ns i g h t
“ surveying
the Funds Distributors ” Last April, RBC Dexia Investor Services Bank, which provides global custody, fund and pension administration and shareholder services, launched its first European survey on fund distributors’ operational challenges.
Illustration: Thomas Brodahl (Stolen.la)
Also, we are dealing with an industry whose needs are becoming more sophisticated and complex every year. Based on current trends, we are seeing fund distribution servicing becoming more specific, whereas thirdparty fund distribution is gaining in popularity and outsourcing trends are accelerating. In order to continue to provide our clients with the best suite of services possible, it is extremely important for us to be able to appraise and quantify the various needs and challenges of these fund distributors. That is the main reason of the survey, which regards our core business.
Markus Postler RBC Dexia Investor Services Bank
Markus Postler, Head Marketing and Sales, Distribution Support, at RBC Dexia Investor Services Bank presents the results of a poll that targeted 150 decision-makers. Mr Postler, what are the main reasons to conduct this survey? “Within four decades, Luxembourg has become the second most important centre worldwide in the investment funds industry. Not only because of the creation of an attractive regulatory framework for investors, fund promoters and professionals in the financial sector. But also because the ‘local global players’ understood how to anticipate and adapt to the fast-changing environment within investor services. Being one of the biggest global custodian banks worldwide and leading the transfer agency business in Luxembourg, we feel obliged to act and render a service to our clients as a thought leader.
What would be the other survey purposes? “More generally, it is also vital for us as a major player to know what markets and customers want, and to know it more clearly and quickly than the competitors. The marketing research industry worldwide is measured in billions of euros. Many large companies budget millions each year for their survey and studies. But one could also say, like Barry Diller, the CEO of Fox Broadcasting, about surveys: ‘We are becoming slaves to demographics, to market research, to focus groups. We produce what the numbers tell us to produce. And gradually, in this dizzying chase, our senses lose feeling and our instincts dim, corroded by safe action.’ Are fund distributors a specific target to survey? “One could say there is a new math out in the market; take market and product breadth and use this information to form and add exceptional services around them. Finding out what future market trends may look like is a challenging and interesting task. Customer satisfaction surveys focus solely on the given products and services provided by a company. What interested us were the more likely trends of fund distributors in terms of operational needs when buying and selling funds. Now Luxembourg is well-known as an excellent service centre for fund promoters – but servicing distributors is a completely different aspect. What were the contacts and institutions you targeted? “We interviewed 150 decision-makers with institutions, which cover a wide range of services and include private banks, family offices, global banks, pension funds, funds supermarkets and platforms, asset managers, etc. In terms of geographical scope, we focused our survey primarily on the major players in Italy, France, Spain, Switzerland, Germany and the United Kingdom. These six countries make up 80% of the volume of funds ordered in Europe. The reason for us going into this geographical split was evident and necessary. The survey will help us to understand and realise why distributors in Spain, for example, have different operational needs than
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Source: RBC Dexia Investor Services
Management of investment fund sales
29% 71%
decentralised centralised
those in Germany. Take Italy, for example, which for historical reasons has been closed toward the use of third party products. As multi-manager products are becoming more prevalent in the market, the dominating distribution channels in Italy, which are retail banks with a market share of 63%, had to react. We shall also see similar growth expectations in the UK, Sweden and Spain for the use of multi-manager products.
Among the 70 respondents, 71% think that investment fund sales management is centralised in their organisation.
Which major issues and challenges stand out of the survey? “We are certainly seeing some common challenges and priorities among the survey respondents. The amount of time and complexity needed in the developing, distributing and implementing of new funds remains among the main issues featuring on the top of this list. We also had to overcome the fact that there is no common distribution landscape in Europe. Yes, banks still dominate the fund distribution landscape so far – but looking into the various countries, you can clearly identify important shifts toward other distribution channels such as family offices, independent financial advisors or pension funds. Due to this given variety, we had to ensure that the interview would be able to cover most of the aspects of the market players. Once we have analysed the responses in depth, we will be able to improve the value chain of our products and services in order to serve our clients with an even more holistic service offering. What do the results tell about the investment funds industry and more particularly about the fund distribution segment? “The results of our survey highlight so far three major trends. The most common is the open or guided architecture, which is of extremely high importance for distributors. For example, if banks and fund promoters still prioritise their in-house products, they are now more or less forced by market demand to also promote vehicles from other entities. The second trend is outsourcing: about 80% of distributors are not planning to outsource any of their activities within the coming years. The three main reasons they give for that are: first, they believe that internal solutions remain their best alternative in terms of cost efficiency; second, outsourcing might lead to staff reductions, which may therefore contribute to a negative image of the institution; and third, they don’t necessarily believe that external providers can deliver the requested services to the level of quality needed. This last point underlines the great sleeping potential of improving the service quality and communicating it adequately to the different players. And the third trend has to do with the connectivity procedures and communication habits within the sector, which remain very heterogeneous. Indeed, each institution still favours a specific PAPERJAM – Special ALFI & NICSA Forum
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Preferred way of order routing via fax 19 via SWIFT 33 via the internet Source: RBC Dexia Investor Services
41 via file transfert 24 via FIX / EMX 3 0
5
10
15
20
25
30
If Internet and SWIFT are predominantly used, fax still remains of considerable importance.
35
40
45
50
media to pass its orders (fax, STP; SWIFT, mails…), which makes the communication certainly less straightforward but also increases the transaction risks, costs and time. It is surprising that fax remains a major order routing medium used by the funds industry. “I would also like to comment on the last point about ‘communication channels’ to place the orders. Everyone in our industry knows that because many institutional players are still using faxes as their preferred method of placing orders, the industry loses hundreds of millions of euros each year. But the astonishing trend in our survey shows exactly the opposite side of the coin. The most demanded communication channel, according to our first results, is the Internet channel, followed by Swift and the semi-automated channels. And the last preferred way was the use of faxes. Interesting, isn’t it? In the light of the results, which opportunities do you see for the fund distribution segment and for the RBC Dexia Investor Services Bank? “Considering the aforementioned results, it is clear that the outsourcing issue will be of significant importance going forward. Another opportunity for us is that our product variety serves a number of different needs. As a group we serve currently 11,500 distributors. Wherever their location is outside of the Grand Duchy, distributors definitely want to access Luxembourg’s UCITS III funds. As we at distribution support focus solely on institutional distributors, we changed our business line, with the aim to provide them with a larger variety of funds and services, meaning that the fund universe we offer is 100% client-driven and had to be enlarged by the vast growing demand in exchange-traded funds and hedge funds. But it also became clear for us that there is a need for the so-called ‘one stop shop’-approach, which we can define as providing the maximum flexibility and compelling valueadded services such as legal and compliance support or analytical services. Therefore, it was not surprising to us that another of the survey’s findings was that exchange-traded funds and hedge funds will become, in the near future, the most popular fund families for institutional investors. We expect this to continue over the next several years. Order routing processes have to be adapted to these products, which are, by definition, riskier, faster moving and more flexible. We, therefore, need to be flexible as well in order to provide the adequate service for these specific fund products to distributors. Overall, one could say that Luxembourg is strengthening its role as a domicile for more complex and diversified products and services within the investor services community. The industry continues to enjoy strong growth, which will likely translate into new opportunities for the various players going forward.”
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In v e s t m e n t F u n d G o v e r n a n c e
fill the time gap Robert DeNormandie, Founder of The Directors’ Office, compares the evolution and practice of the investment fund industry governance in both the USA and in Luxembourg/Europe. The governance of investment funds in Luxembourg/Europe and in the USA may appear to be very similar. However, specific differences have played an important role in each environment, such as: - a single market throughout the USA; - significant individual investor retail base versus cross-border global distribution; - oversight by one regulator in the USA versus 27 national regulators within the European Community framework in Europe; - and 67 years of regulatory development in the USA as opposed to barely 20 years in Europe. Another factor to keep in mind when comparing the USA with Luxem bourg/Europe is the issue of a principle-based versus rule-based approach. We would suggest that this is a misleading debate as each environment relies upon both principles and detail-driven rules or guidance. In today’s investment product environment, where innovation, dynamic imagination and fast-paced development of new investment strategies and products are the norm, regulation and governance need to incorporate flexibility and be able to move quickly to adapt to the constantly changing marketplace. Principles offer each environment a way to fill the time gap between when an issue arises and when regulators can address the ramifications with specific interpretations and/or guidance. What does this mean as we compare governance of the investment fund industry in the USA and in Luxembourg/Europe?
Common recognition in the investment fund industry First, we would suggest that while each environment has a well-developed scheme of corporate governance, there has been a common recognition of the specificities of the investment fund industry resulting in a tailoring of principles, regulation and accepted practice to this industry’s particular requirements. In each case the initial approach has often been revised and adjusted over time to reflect the evolution of the marketplace. The current discussions on how to adopt international accounting standards to the specifics of investment funds is a current example in Europe. Second, for boards of directors of investment funds in each environment, we would suggest there are several essential principles that form the foundation of the activities of the board as a whole and the board members as individuals. These would include: board member quali fication and experience; availability to appropriately fulfill board member responsibilities; recognition of the benefit of independent, non-executive, board members; and recognition that responsibility for a well-organised and supervised control framework rests with the board; and finally that this control framework incorporates all aspects of fund operations, including delegations to service providers as well as an
understanding of strategic direction and the risk management processes in place to identify, assess, measure and manage the variety of risks impacting the investment product and portfolio environments. Following on from these principles, there are many specific elements that the board will typically take into account during its deliberations. While not an exhaustive listing, these would typically include: - recognition that protection of the end investors’ interests is the primary objective of the board; - an awareness of the various elements of the control framework and recognition that controls will be undertaken at many levels (promoter, distributor, depositary, fund administrator, external auditor, fund legal counsel, etc.); - an understanding of how such controls are coordinated, integrated and supervised, including periodic reporting to the board; - oversight and management of conflicts of interest that may impact an investment funds’ operations; - periodic receipt and review of complete, timely financial and operating information, including contractual renewals, trend analyses, exception reports, and breaches of fund policies/procedures; - receipt and review of various risk metrics dealing with the investment portfolio as well as operational matters; - and an indication of how the fund is carrying out its fiduciary responsibilities as a shareholder of companies. In both environments, the board will clearly rely upon the work of others to fulfill its responsibilities. In addition to the fund promoter’s oversight activities and management reporting to the board, the assistance of others overseeing the control framework such as the chief compliance officer in the USA or the conducting officers in Luxembourg will be very useful to the board. The interest of service providers, who report regularly to fund management and to the board, to offer error-free service is a key element for the board together with the periodic oversight of the external auditor. An annual programme of the board listing the various responsibilities and the frequency of review is often useful to assist to clearly define the scope of board activities as it focuses its attention on the various service providers and individuals assisting the board in one fashion or another. Such a programme also ensures an efficient coordination of various control activities that are brought to bear upon a particular area of operation or risk when under consideration at the board level. “One size does not fit all situations” is an understatement. Careful attention to a specific investment product’s strategic direction, portfolio trading complexity, operational challenges and the investor base to which it is being distributed will be required to ensure the development of an appropriate mix of oversight and reporting procedures at the board level relating to the objectives of the product as defined in its prospectus.
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As indicated initially, the evolution of governance in each environment is unique. The US environment has had time to develop specific guidelines, including: the requirement to have 66% of independent directors on the board; the role and responsibilities of audit committees; a detailed definition of independence; the suggested presence of a “financial expert” on the board; annual documentation regarding review and approval of the investment management contract; implementation of the chief compliance officer role (hiring/firing is a board responsibility); and prohibition of affiliated transactions.
While such details may not yet be integrated into European or Luxembourg governance practices, their focus on “risk management” is perhaps further advanced than in the USA. Nevertheless, each environment’s grounding of governance in principles recognised in the global marketplace may soon lead to a narrowing of the gap between the “European” and “American” governance models. Further, a growing awareness that strong transparent governance is a benefit for investors and a possible contributor to out-performance of the marketplace may accelerate mutual consideration of these issues. Currently, OECD and IOSCO publications clearly offer a view of benchmarks for good governance that individual countries will eventually need to consider in a “comply or explain” approach. In spite of various differences, in the final analysis, we suggest the aims and goals of investment fund directors seeking to govern fund products in the USA and in Luxembourg/Europe are quite consistent, although the specific approach followed under the respective regulatory environments may differ. Governance activities are driven by a series of basic principles together with an elaborate matrix of regulation, regulatory guidance and industry practice, aiming at maintaining and supporting the growth of an industry offering a unique solution to investor needs within a framework designed to ensure effective, efficient operation and investor protection. || Robert DeNormandie
Illustration: Thomas Brodahl (Stolen.la)
Risk management: further advanced in Europe
Robert DeNormandie Founder, The Directors’ Office
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P r i v a t e In v e s t o r s i n G e r m a n y
new Flat Taxation: Effects on Investment Income
Illustration: Thomas Brodahl (Stolen.la)
On 6 July 2007, the German Federal Council (Bundesrat) voted the Corporate Tax Reform 2008 (Unternehmensteuerreform 2008). The reform is intended to strengthen competitive advantages of the German marketplace.
Jörg Roth Partner, KPMG Luxembourg
Accomplishing the reform of the corporate tax, a flat tax (Abgeltungssteuer) on investment income for private i��������� nvest���� ors ����� will ��������������� be introduced. ����� This will also have a significant effect on the funds industry. The principles of taxation for different investment products (e.g. equities, bonds, investment funds, certificates, pension vehicles) and the significance of the products will change and will therefore need to be reviewed by each investor to optimise his individual portfolio. For the investment fund industry, there will be a need to develop products to cover expected changes in market demand and to explore tax opportunities, which are available to fund investors. Overview of the flat-tax system Effective from January 1, 2009, private investors’ investment income will no longer be subject to their progressive individual income tax rate but will instead be subject to a flat-tax rate ������� of 25% ������������������ with compensatory effect (plus solidarity surcharg����������������������������������������������� e and church tax if applicable) for all investment income.
The scope of the taxable investment income is extended and includes interest and dividend income, income from silent partnerships, gains from derivatives (financial futures, swaps, options, etc.), premium from the sale of options and r���������������������������������������������������� ealised ca������������������������������������������ pital gains from all kinds of investments in securities, stocks, investment funds, irrespective of a holding period (excluding real estate). The half-income procedure for private investors with dividend income and realised gain on equity will be abolished. Transitional rules have been introduced considering the different kinds of investment income. Capital income from interest (including capital gain from bonds qualified as financial innovations), dividends and received option premiums received after December 31, 2008 and capital gain from realised gain on securities, interest bearing instruments and profits from derivative instruments if purchased or entered into from 1 January 2009 are subject to the new tax regime. Certificates (full risk bonds) are included in the scope if purchased after March 14, 2007 and sold after June 30, 2009. Realised gains from securities or derivatives purchased before January 1, 2009 still remain tax-exempt (considering a holding period of one year).The flat tax will only be levied by credit institutions in Germany acting as paying agent. Investment income paid by foreign paying agents is taxed on the basis of individual tax declarations. Income from shares of investment funds The new regulations for the flat tax are also transposed into the German Investment Tax Act. The principle of transparency and the main current regulations are, in general, maintained. Capital income is still taxable on a yearly basis (as distributed or deemed distributed income). Capital gain realised from the fund’s investments are subject to tax only if distributed or realised as included in the net asset value when the investment fund shares are sold. The new flat-tax system will in general apply to income earned and capital gain realised at the fund level after 31 December 2008, except for realised gain on securities or derivatives purchased before 1 January 2009. At the investor level, realised gain on disposal of investment fund units will be tax-exempt (considering a holding period of one year) if purchased or subscribed before 1 January 2009. Influence on the Luxembourg market The flat tax provides for significant advantages in liquidity due to a delayed taxation if the tax is not directly deducted by the German paying agent, i.e. for custody of assets kept in Luxembourg or other foreign countries where the investor has to be taxed on the basis of the annual tax declaration. This liquidity aspect could therefore affect the Luxembourg private banking sector.The investment fund sector is mainly concerned by the considerable tax advantages for investment fund shares purchased until 1 January 2009 relating to the tax exemption for realised gain. These rules are in general applicable to all investment funds including the German funds. Luxembourg may benefit from its extensive experience to effectively develop optimised investment fund products in the transition period until January 1, 2009. || Jörg Roth
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Index
Masthead
Organisations cited 62 organisations or institutions were cited on the 48 pages of this edition. The names of persons and products are not mentioned here. Companies and institutions in bold are advertisers in this edition.
A
Cover Illustration
Claude Kremer Thomas Brodahl (Stolen.la)
This publication is a special supplement to the September-October 2007 edition of paperJam
Mike Koedinger
Publication Director
b C
editorial staff
Head of Project Chief Editor Coordination Copy Editor Illustrations Layout
Advertising
Web Director/Partner Commercial Director Advertising Account Manager
www.tempo.lu Aurelio Angius Francis Gasparotto Vanessa Gourdange
editor
Tel Fax E-mail Web Courrier Office
Rudy Lafontaine Jean-Michel Gaudron Jean-Michel Gaudron, Marc Auxenfants Delphine François, Nathalie Lemaire Thomas Brodahl (Stolen.la) www.xGraphix.lu
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F
(+352) 29 66 18 - 1 (+352) 26 18 74 77 office@mikekoedinger.com www.mikekoedinger.com - www.paperjam.lu BP 728, L-2017 Luxembourg 10 rue des Gaulois, Luxembourg-Bonnevoie
© Mike Koedinger Editions SA - Luxembourg - September 2007
All rights reserved. Any reproduction or translation, in whole or in part, without prior written permission by the editor is strictly prohibited.
G H I
K L M N
P R S
T Special guest: Thomas Brodahl (Stolen.la). Originally from Bergen, Norway, he moved to Luxembourg when he was ten. He created, with Mike Koedinger, the first Restaurant.lu, a searchable database of restaurants in Luxembourg, but also Nineties.lu and various other small web projects for MKE. After three years spent in London, where he started Stolenshirts, an independent T-shirt label based on his illustrations, Thomas moved to Los Angeles in 2004 and started Stolen Inc. with his long-time collaborator, Jessey White-Cinis.
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ABBL 26 ALCO 26 ALFI 3, 6, 18, 26 Alter Domus 15 Al-Rajhi 30 Amanah 30 Arab National Bank 30 Arendt & Medernach 6 Bourse de Luxembourg 6 Capital Research and Management Company 28 Citi Islamic Investment Bank 30 Comit 27 Committee of European Securities Regulators 32 CSSF 6 CTG 35 Deloitte 26 Editions Larcier, Brussels 6 EFAMA 6, 32 Ernst & Young Luxembourg 30 Ernst & Young Riyadh 30 Ernst & Young Services 11 European Commission 6 European Union 32 Fidelity Fund Management (India) 24 Fideos 39 Fleming Asset Management 30 Fortis Banque 2, 45 Fund Market 9, 20 German Federal Council 42 Global Asset Management 30 HSBC 30 IFBL 31 International Investment Funds Association 6 Invesco Asset Management Ltd. 30 IQ Solution 43 KBC Asset Management 22 KBC TFI 22 KPMG Luxembourg 19, 42 Lipper 20 Maybank 30 Morningstar 20 National Commercial Bank (Wellington) 30 NGR Consulting 46 NICSA 3, 18 Nordea Investment Fund 13 Noriba 30 Permal Asset Management 30 PwC Luxembourg 34 RBC Dexia Investor Services Bank 36, 48 Samba Financial Group 30 Schroder Investment Management (Luxembourg) 26 Shamil Bank of Bahrain 30 Standard & Poor’s 20 The Directors’ Office 40 the Oasis International Equity Fund 30 U. S. Congress 28 U. S. House of Representatives 28 U. S. Securities and Exchange Commission 28 UBS 30 UBS Global Asset Management 32 Victor Buck Services 23 Vox 4
To contact editorial staff: press@paperjam.lu To contact advertising: info@tempo.lu
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Prime Fund Solutions Luxembourg
Getting you there.
At Prime Fund Solutions, the part of Fortis Merchant & Private Banking dedicated to servicing the traditional and alternative investment community, we are committed to building strong and lasting relationships within the global investment industry. Focusing on the future needs and opportunities in all type of investment funds, ranging from traditional through hedge funds to funds of hedge funds, we deliver cutting-edge services and invest in state-of-the-art information technology. Providing a first class package of fund administration, custody, clearing, bridge and leverage finance, we are ready to face your challenges with you. For more information please contact +352 42 42-68 62 or luc.leleux@fortis.lu www.merchantbanking.fortis.com
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