Why not all investors are equal in cross-border fund sales
Arguably one of the major successes of the European Union in the financial field has been the creation of common sets of rules that enable investment funds established and approved in one member state to be sold in other EU countries without having to endure another time-consuming and costly authorisation.
It’s certainly been a success for Luxembourg. As the first EU country to adopt the UCITS directive setting out the rules for funds sold to ordinary retail investors, the grand duchy was the first to attract asset managers looking for a wider market for their products, and all the other services required to create, run and market a fund, from accountants and lawyers to administrators, custodians and auditors.
The development of expertise in all these areas has elevated Luxembourg to the go-to country for investment funds in Europe – both UCITS funds and alternative vehicles that invest in hedge fund strategies, private equity, or real estate and infrastructure. Today the US is the only country in the world with a bigger fund industry than Luxembourg, whose funds are known to and trusted by investors not only in Europe but worldwide, from Chile to China.
Investor protection rules
Does that mean Luxembourg funds are available to all investors in countries around the world? Not quite. There remain a range of restrictions on the distribution of funds depending on where investors live, or in some cases their nationality – and that also applies to residents of the regions surrounding the grand duchy.
These rules are not imposed randomly. Given that investors – especially “ordinary” people - are not always adept at judging the level of risk of investments, or of determining what their own attitude to risk should be, countries set rules determining the kinds of investment that should be on offer to retail investors.
EU regulations do this to some extent, distinguishing between alternative funds aimed at sophisticated investors such as financial institutions or professional traders, and UCITS funds that as a rule are available to all kinds of investors. There are also tax rules that make certain kinds of investment unattractive to investors from a particular country, even if they are not barred from acquiring them.
Alternative Investment Funds have been subject to a common rulebook for cross-border marketing in Europe since 2013, but the legislation leaves it to individual countries to decide whether, and under what conditions, they should be open to individual investors. For instance, in Germany retail sales are subject to a minimum €200,000 initial investment for certain types of alternative fund.
UCITS funds are specifically aimed at retail investors, and in many cases they can be distributed freely in any country where the funds have been registered for sale. However, asset managers may decide to make different versions of the fund available in different countries.
One reason is investor preferences, which can vary from one market to the next. For example, in some countries most savers may prioritise income generated in the form of interest or dividends as a regular pay-out. Across the border, investors might prefer funds where income is reinvested in additional shares or units of the fund.
The reasons why a fund is offered to residents of one country but not another may be more prosaic – such as the cost of producing marketing material for a fund in the local language or meeting legal formalities applicable to the sale of funds. That may apply especially if the asset manager is not expecting high levels of sales in that particular country, nor planning to invest significantly in marketing or distribution there.
Tax may also be an issue – while there are uniform rules governing the sale of funds across the EU, member states are free to set its own tax rules, provided they do not favour local funds over those from other EU countries. The tax treatment of different types of investment can influence whether a fund will be sold to residents of a particular country or not.
In some cases, nationals of a particular country, notably Americans, may have to pay tax in their home country as well as where they live. Financial institutions that accept deposits or investments from them are required to obey special reporting requirements – so some asset managers may decline business from US customers.
This means that not all people working in Luxembourg, and in some cases living there, are covered by the same rules on investment. This may result in banks and other fund providers deciding, or being obliged, to restrict sales to certain investors. While there may be a single EU market for funds, assets managers and investors aren’t all operating on a completely level playing field quite yet.
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A share is a unit of ownership delivered by a capital company. In most cases, it is a commercial company with a limited liability. Holding one of several shares – in other words, being a shareholder – means that you own a part of the company’s capital but you are not held personally liable for the company’s debts.