Malta Financial Services Authority, Chairman, Board of Governors
European Parliament, MEP, Committee on Economic and Monetary Affairs
Netherlands Authority for the Financial Markets, Head Asset Management Supervision
Financial Services and Markets Authority, Belgium, Vice Chairman, International Organization of Securities Commissions (IOSCO) & Chairman, IFRS Foundation Monitoring Board & Chair, ESMA’s Financial Innovation Standing Committee & Chairman, Belgium Financial Services and Market Authority (FSMA) & Lecturer University of Brussels (ULB)
Amundi, Head of Public Affairs, Finance and Strategy
State Street Corporation, Head of Regulatory, Industry & Government Affairs
European Investors' Association, Managing Director
1. Current situation and importance of developing investment fund cross-border distribution in the EU
1.1. Current situation of cross-border fund distribution
The Chair stated that an examination of the situation of investment fund cross-border distribution in the EU shows that this is not taking place as smoothly as it could. There are a number of issues, which should be corrected. As the EU securities market develops, particularly in the context of the Capital Markets Union (CMU), it is important that cross-border fund distribution should start taking place more seamlessly than at the present time.
Statistics show that the cross-border distribution of investment funds in the EU is still relatively limited, even for UCITS. Only 57% of EU funds (UCITS and AIFs) are marketed on a cross-border basis and one third of UCITS are sold cross-border in only one Member State while another third are not sold cross-border in more than four Member States.
A representative of the industry noted that in Europe, there is some good news: the fund industry as a whole has been growing well. Since the 2008 financial crisis, in many markets, fund assets have doubled or close to tripled, although some of this is the result of stock market appreciation. An interesting, and ‘somewhat frustrating’, issue though is that of cross border distribution. The speaker has looked into cross border flows, and the ideal situation would be one of a ‘many-to-many market’ where different countries are distributing in a ‘spider web’ pattern to other markets. However, Europe is a ‘two to many market’ with Luxembourg and Dublin distributing widely across the region, and representing close to 80% of cross-border distribution.
A public representative stressed that first it needs to be recognised that Europe has a fragmented market. There are 30,000 funds in the EU, compared to 7,000 in the US; Europe has inefficiencies and a lack of economies of scale, and this needs to be addressed, as well as Europe’s regulatory obstacles. Another public authority representative disagreed, stating that the investment funds market is by far the most integrated one in the EU, and that there are not that many regulatory obstacles.
Some panellists contributed additional statistics regarding specific countries and firms.
Belgium for example is quite an open economy, a public authority representative emphasized, and there is a strong appetite among savers for investment products such as UCITS for different historical reasons, including the link with capital protected funds. Belgium is open to all kinds of products with cross border EU passports, and has a very dynamic asset management industry which exports UCITS approved by the Belgian regulator with a European passport. Funds therefore go ‘in and out’ of Belgium.
The most recent statistics from Belgium, published at the end of 2016, show that 77% of funds marketed in Belgium are funds from abroad, coming from other EU member states with the EU passport. In terms of absolute numbers, In Belgium 1,167 sub-funds are from Belgium compared to 3,859 sub-funds from other EU member states. As such, in Belgium and in many other EU countries, there is no “nationalistic reflex” from supervisors. Foreign open ended funds however only represent 29% of assets under management (AuM) of the Belgian market. The AuM of the Belgian open ended funds have risen to €121 billion while the AuM of the foreign funds totalled only €40 billion.
Another representative of the industry stated that their organisation, which is a leading European asset manager, runs slightly over 3,000 funds, and of these, about a third are UCITS funds. 85% of these UCITS funds have asked for a passport, but only 12% are marketed in more than two countries in the end. There is therefore a very limited amount of real cross border marketing in this company’s funds. Interestingly, the speaker’s organisation has put passports in place, but not for all 28 member states. In 14 member states, it has organised passporting for one, or several, funds. In 13 states, the speaker’s institution has also set up local funds; these are not exactly the same but, for 11 of them, this institution markets both local and cross-border funds.
1.2. Importance of further developing fund cross-border distribution in the EU
A public authority representative stated that the asset management industry is a key player in mobilising capital from retail and professional investors into the economy. At the present time, market based finance has an increasing importance, as opposed to banking finance, and there is also a global shift where the responsibility for retirement planning lies, from employers and governments to individuals. This makes the role of asset management as an intermediary even more important.
As a result of this, the regulator felt that the cross-border distribution of investment funds plays an important role in creating a true CMU that will strengthen the European economy, as well as the economy of each individual member state. This will allow further growth of funds and more efficiency, but also will mobilise and allocate capital from the right sources to the right projects all over the European Union. This will help deliver better value and more innovative products for investors, and will also help the EU to remain competitive compared to the US and Asia.
An industry representative agreed that the CMU is essential and that investment funds play an important role in this. If this conversation were taking place two years ago, there would have been much discussion and concern about, shadow banking. The mood is now more positive. It is recognized that investment funds form an important part of a CMU and that developing sources of non bank finance is necessary. FSB statistics indicate that globally, something like 40% of financing activities take place in the non banking sector, including insurance, mutual funds and other collective investments. Europe as a whole sits at around 80% of bank financing, and as such more needs to be done to develop capital markets and investment funds in particular. In the United States, mutual funds make up 46% of US household financial assets, compared to 10% in Germany, 14% in France, and about 11% in Italy.
In April in the US, for the first time, more mortgages were originated outside the banking sector than in the banking sector. Industrial loan companies, which are collective investments that make loans, are becoming an important actor in SME lending in the US. There is much evidence that the existence of a strong fund market diversifies the financial system, and provides access to both investment instruments and loans to people who ordinarily would not be able to access these. As such, this is a ‘prize worth winning’.
2. Main barriers to fund cross-border distribution
A representative of a public authority stated that at the present time, there is generally a well functioning single market for investment funds, but there is also room for improvement. An internal market can only become successful if the interests of investors are well addressed, and financial stability is preserved. It is important to examine any unjustified hampering of cross border distribution; if these barriers could be eliminated, this could incentivise fund managers to engage more in cross border distribution, which would ultimately be of benefit to investors and would create a well-functioning internal market.
2.1. Regulatory, fiscal and industry structure related barriers
The Chair stressed that a number of barriers to fund cross-border distribution have been identified, including marketing restrictions, distribution costs and regulatory fees, administration arrangements, notification processes and taxation.
A public representative noted that there are many marketing restrictions that are set by National Competent Authorities (NCAs) in terms of how the content of communication has to be provided and these requirements differ across jurisdictions: some authorities require ex ante approval, while others require ex post. Some adopt a principles based approach, while others apply a detailed rules approach. Distribution costs also vary widely. Member States introduce special administrative arrangements for investors to subscribe, redeem and receive related payments from cross-border funds; there are also notification processes that businesses have to go through with the various Member States, which add cost and time.
Taxation is another major obstacle, and the European Parliament has been looking into this: there is a lack of access to tax treaties, it can be difficult to obtain refunds on withholding taxes and there is also some discrimination against foreign funds.
An industry representative stated that the European Commission did quite a good job last autumn, in its consultation about cross border commercialisation, in listing many of the different types of barriers that hamper the possibility of marketing throughout Europe. There are two different levels of obstacles: some are of a technical nature, and even if it might take a great deal of hard work, it should be possible to make these disappear. Others are of a more fundamental or philosophical nature, and relate strongly to the issue of investor protection. There are good reasons for paying attention to those arguments, and to state that it would be counter productive to eliminate all the barriers in that field. It is vital to maintain investor protection as the main objective, and this may lead to some fragmentation. Another public authority representative agreed that consumer protection is vital.
Following a question from the audience, the Chair invited one of the industry representatives to comment on whether the requirements of PRIIPs and MiFID create obstacles to distribution. The industry speaker replied that distribution differs between countries; distribution channels are very diverse, and Europe needs to adapt to this. Distribution requirements are indeed an area in which some barriers may be arising, but regulation has taken account of the fact that there are several different models in relation to MiFID. Two years ago, there was a significant debate about the ‘retrocession of commissions’ which is the definition the speaker prefers to ‘inducements’, as this is only a question of providing distributors with a fair remuneration. The two existing models in Europe have been incorporated into the regulation, which helps to avoid negative effects in some countries, so the issue has been properly addressed.
A public authority representative stated that regulatory obstacles are not the main reason why people in Europe still feel that the market is fragmented. There are obstacles related to taxation issues, but the main problems are related to business models, and distribution issues such as the distribution model. Europe is increasingly moving towards a ‘digital arena’; Belgium in particular is very active in this area, but nevertheless, the distribution model can still have a significant impact on the marketing of cross-border funds. The availability of physical distribution networks for fund managers in some countries could explain why funds are only marketed into certain countries, and not in other countries where there is no distribution network.
Another example of a potential obstacle is the cost of investing in the promotion and commercial development of funds in foreign countries – advertising and building up a reputation – which impacts upon the profits of promoters and acts as a disincentive to the cross-border distribution of funds.
2.2. Deficit of investor trust in cross-border products and home bias
A public representative stated that another significant barrier to fund cross-border distribution is a major deficit of trust. At present a majority of people prefer to invest in funds supervised by their own national authorities. However, if people were aware, especially given the context of very low interest rates, that there are standardised products from other EU countries in which they can have confidence, that there is a European supervisor and that these products have been properly tested, they would probably be more likely to invest some money into these foreign EU funds. Trust and confidence from investors has to be increased; there should be more than 7% of people in Europe buying investment products across the border. Besides trust, there are also cultural and linguistic obstacles. The public authority representative does not want to abolish linguistic differences, but they are an issue that needs to be addressed.
As a result of these obstacles, it is not always possible to compare fees across Europe and there is a lack of transparency regarding the performance of funds. There may be questions about the advice that people are receiving. These issues need to be recognised, because Brexit will have an impact, and if the CMU is to survive and deliver jobs and growth, the EU 27 must address them.
A public authority representative believed that comparisons between the US and Europe are not meaningful. It is wrong to believe that UCITS could only be available in the English language; the speaker noted that their country alone has three official languages. All of these products will need to be available in many languages. During and after the crisis, there were many cases of mis selling that were due to many retail consumers’ inability to understand a large part of the incorporated reference documents, which were only available in English.
The Chair noted that one of the issues that has arisen is that of compensation schemes. If an investor buys a fund in another country and has a complaint, they will be referred to that country’s compensation scheme, which may be in a different language from the investor’s. This could create confusion, and as a result investors will continue to buy funds only in their own country.
An investor representative stated that the European Investors Association (EIA) has made a survey of all of its members, in order to assess their home bias regarding investment funds. Roughly 60% of respondents said that they preferred home products; however, the remaining 40% said that they also looked cross border for their investments. 40% represents quite a significant number of people, who should be assisted in better understanding the choices that they are making.
The EIA further asked, ‘If you are looking at a fund that is not a home fund, what are you looking for?’ 85% of respondents replied ‘costs’, and the expert noted that a previous speaker had emphasized that costs in Europe are much higher than in the US; as such, it may be asked whether this 40% is looking at funds in Europe, or whether they are looking for American investments. The second most frequent request was liquidity and whether it is possible to get out of a fund very easily, and the third, with 63% of respondents opting for it, regarded ‘past performance’. If distribution information does not include a fund’s past performance, it is very difficult to benchmark it: to choose a fund, an investor needs to know what it has done, what it is going to do, what its costs are, and to understand this information.
Finally, investors were asked whether they want to read regulated material such as the KIID or prospectus, and 48% replied that it is important that it should be there, but the information provided at present does not really answer all the questions they have. When asked ‘What are you really reading? What are you using when deciding to buy a fund?’, 58% replied, ‘The marketing material.’ As such, there is clearly a need to examine this issue, which is about more than language and culture; it is about costs, risks and performances, and these latter aspects need to be addressed very specifically.
An industry representative stated that their institution markets both local and cross border funds. Many clients tend to see proximity as an advantage, but it is important to differentiate between retail and institutional funds in this respect.
For institutional funds, there is not much of a national bias, and where this exists, it can be overcome by citing facts such as costs, past performance, or any other objective factors of performance. With retail funds, however, there is much more emotion and some psychology involved, which is why proximity makes a difference. Distributors have to know their clients; clients want to know their providers. They feel much more comfortable with an asset manager with legal documentation in their own country, supervised by their own NCA. There is also a category in between retail and professional investors, i.e. educated retail investors, but it is quite difficult to define and identify who they are. They nevertheless constitute a marketing niche.
3. Actions for improving fund cross-border distribution
3.1. Possible need for additional regulations
The Chair stated that it is generally recognised that cross-border distribution needs to be increased if CMU is going to work. There are regulatory issues and, more fundamentally, there are perception issues on the side of the investors. The Chair asked whether new regulations need to be introduced.
An industry representative replied that, regarding possible solutions for improving fund cross-border distribution, one of the questions under discussion appears to be how much of this is regulation, how much of it is supervision, how much of it is EU based and how much of it is local. The speaker is not certain whether more regulation is necessary, but there is nothing wrong with revisiting what is in place currently and fine tuning it further. There has been a great deal of legislation and rule-making over the past 30 years in Europe, including the various versions of UCITS, AIFMD, and MiFID and the related KIIDs and prospectuses, but despite these regulations progress is not yet sufficient.
There may be a need for UCITS VI, clearly identifying what the objective of this is, because the objective for the last round of UCITS was more related to financial stability; perhaps the next round should be about how to develop a genuinely pan-European market. Within the industry representative’s own business, for instance, they would like to see UCITS VI provide for a depository passport.
Another industry representative emphasised that product notification needs to be improved in particular, but it can easily be improved without requiring Level 1 regulation, which is what this person fears will be the result of on-going reviews. More needs to be done in the area of implementation to properly understand what is already in the regulation, and to achieve a smoother notification process. Technical measures exist, and these do not require much more than to be properly processed and organised.
3.2. Reviewing the supervisory approach in the EU investment funds market
3.2.1. Improving supervisory convergence
A public representative commented that one of the biggest problems with the CMU is that it is not ambitious enough. The status quo cannot stay in place, and Europe needs to find something new and deal with the supervisory element in particular. Legislation can help, but it will not change the mindset. Once the supervisory issue has been addressed, it will then be possible to move forward and try to promote greater confidence in the European investors.
Regarding supervision, one of the industry representatives did not believe that there is a reason for the funds market to be different from the automobile or pharmaceuticals markets: you can buy the same car in France as in Germany, and pharmaceuticals, which are even more sensitive than investment products, have more or less the same system. Consumer protection has to be centred on providing consumers with confidence that, if someone does something wrong, somebody will pursue the perpetrator.
A representative of a public authority stated that, from a supervisory perspective, the goal should remain the existence of a genuinely integrated market for the asset management industry. To achieve this, it is vitally important to have a successfully functioning market, and therefore market parties and investors need to have confidence in the market. Many elements that can provide supervisory convergence are already in place, and NCAs should not be afraid of challenging each other to promote trust in each other and relying on the work that has been done in other countries. Therefore supervisory convergence is still very important and the role of ESMA should be strengthened in this respect.
Another public authority representative added that, while there are some issues related to ESMA, they believe that ESMA is moving in the right direction; it has a very important supervisory convergence agenda, designed to support this important and ambitious programme. If Europe believes in supervisory convergence, it needs to comply with the harmonisation of length and quality of notification in particular, and to be asking for the same kind of information. This public authority representative did not object to ‘naming and shaming’ in the area of supervision. If particular authorities are especially bad, this ought to be made known. There could also be a ‘commando team’, giving a second opinion that states that, in the framework of a supervisory convergence peer review, some members of ESMA are ‘bad students’, and naming them. This is not a problem; it is accountability.
If the CMU is to combat Euroscepticism, it must represent something positive to consumers and citizens, rather than just being the result of the fear of a decrease in consumer protection following Brexit. The public authority representative does not believe that there needs to be better consumer protection, but the level needs to be maintained, because there are many interesting things to be done in the framework of the interaction between ESMA and the NCAs. There is no competition between ESMA and the NCA, if the topic is retail markets.
3.2.2. Reviewing home / host and EU level supervisory responsibilities
A representative of a public authority stated that Brexit should allow for a more open decision making system in the EU, which will facilitate the implementation of the CMU. If Europe wants to support the evolution of the ESMA decision making system, an appropriate balance needs to be found. Some supervisory activities can be performed at the European level for the wholesale market. This is the case for rating agencies and trade repositories for which ESMA acts as the sole cross-border supervisory agency. This is the right approach, as in both cases the model had to be started from scratch and, most of the time, rating agencies do not have legal representatives in many Member States. The same should apply to CCPs.
However, concentrating supervision for retail markets in one place is not the best means of encouraging ordinary retail investors to buy more UCITS. An appropriate home host model needs to be developed. Europe needs to be willing to have a discussion about home host models and what an ‘open passport’ means. From their point of view, the NCA of the Member State where the funds are marketed is best placed to carry out the supervision of the marketing documents, because they have the most knowledge about the taxation, distribution and other characteristics of the local market. This is the best way to avoid litigation, which is one of the objectives of good consumer protection, along with banning products that are too complex and which are not suitable for distribution. Moreover, if Europe wants an effective passport a product cannot be allowed to have a passport with no distribution in its home country.
The Chair invited comments on the role that ESMA should play and whether products should go through the supranational authority.
A public representative replied that Europe needs to provide confidence and legal certainty, which will require a centralised notification process, a harmonisation of definitions, and a streamlining of the calculation of regulatory fees. This will help to deal with these issues without centralising the entire process. One way that the ECON Committee attempted to approach this issue when examining the prospectus directive was to say that, if all the information was provided in broadly the same way in an agreed form, this could reduce costs. The organisation drafting the prospectus would then have to change the very fine differences. Such mechanisms need to be put in place, because the fundamental issue is that cross border investment needs to be increased. A great deal of EU legislation has ‘patchy’ implementation, and in some jurisdictions, NCAs will want to gold plate requirements, while others with a lesser understanding will leave it as it is.
In addition, there is a dual role for central and domestic authorities: there needs to be a centralised body, but there is also a need for national inputs in order to increase trust and confidence. National bodies indeed play a significant role in increasing confidence. It is important to have such a ‘twin track’ in mind, because a CMU capital market supervisor might help to increase the trust and confidence that people have.
The representative noted that they have carried out their own research of how money can be invested cross border via the internet, which is how many investors make decisions. Effectively no pan European products were offered to them; everything offered was domestic. The public representative also searched for various other terms, such as ‘ethical investment’, and was struck by the confidence that is engendered by reading that a product is underwritten by the domestic supervisor. MiFID and MiFID II should help with this goal, as they sustain the existence of key investor protection elements. Issues relating to advice and other topics are being addressed, and progress is being made. However, the NCAs should not feel too threatened by the existence of a centralised mechanism that will increase that flow from an investor perspective, as keeping cross checks in place is desirable.
An industry representative commented that NCAs have a role to play in surmounting the barriers that exist. NCAs should have some requirements when passporting into the host country; it would be very helpful to have a list of what is expected, probably centralised with ESMA, to be able to easily understand what a fund needs to do in order to ask for a passport in a particular country.
An investor representative added that the list that this industry representative has referred to is the same as the list of information that investors want. The information needs to be accurate, timely, correct and not misleading, and if a fund can deliver that information, it can do so in all the member states, and have a conversation with all of its clients about the information. The expert noted that they are not solely criticising NCAs; they are also inviting the industry to make a significant step forward and acquire information that is more relevant to what investors are asking for.
3.2.3. Ex ante supervision of marketing materials and the improvement of prospectuses
A representative of a public authority stated that they support ex ante supervision of marketing material, which is also supported by the European Parliament in particular. In Belgium, 90% of marketing is pre-approved within 72 hours’ time, but this means that product specialists need to be involved in the supervision. According to figures produced by the Belgian ombudsman, after 10 years of ex ante supervision, the number of claims from consumers about the quality of the marketing has decreased by 70%, as doubtful advertisements can be refused. One of the most important lessons to learn from the 2008 crisis is that the lack of understanding of advertisement by ordinary investors is a problem, and to avoid mass litigation, advertisement is one of the most important aspects that needs to be supervised.
An investor representative replied that the Belgian concept of ex ante marketing material regulation or supervision is helpful. However, if the goal is CMU and for end investors to believe that there is a single European market, the public authority representative’s approach may actually hinder this goal. This is like saying that the domestic supervisor is the only party that understands the needs of investors in its jurisdiction In principle, ex ante supervision of marketing materials makes sense, but the question is how to achieve this in an appropriate way. If this is a European approach, made a responsibility of ESMA, this would become a ‘one stop shop’. The investor representative has considered whether there ought to be a ‘flying brigade’ of experts drawn from European supervisors, who become involved when it is necessary to discuss specialised topics. With ESMA responsible, the industry would be able to get its 27 necessary approvals from a single place before taking its marketing material into Member States, and then investors can ask for marketing material from European funds, no matter which country they are from, and receive a centralised document. NCAs should not feel threatened when there is a cross-border question of investor protection and investor compensation; this should make the problem much easier for them to deal with.
The public authority representative added that the length of prospectuses is another issue. Supervisors are the first to criticise long prospectuses which are favoured by legal advisers and banking trade associations, in order to lessen their own risk of litigation. In Belgium, it is required that anyone going public with an IPO puts a description of all the risks on the first page of their prospectus: not geopolitical risks, but risks related to their own solvency and market figures related to their own business. Being ‘straight to the point’ is the most important requirement of a prospectus. This does not represent a decrease in quality of information, but an increase in creating a level playing field.
A public authority representative commented that they would support the European Parliament, the European Commission and the European Council mandating that the maximum length for prospectuses should be 10 pages. Another representative of a public authority replied that this has already been approved.
3.3. Digitalisation / Fintech
The Chair asked whether digitalization and social networks could help to improve fund cross-border distribution. A public authority representative replied that their impression is that the digital distribution of funds is more limited at the present time than for other kinds of classical savings; many people like the idea of proximity when they have to buy funds, and this is another reason that can explain the cross-border figures.
A public representative considered that fintech is increasingly important. Fintechs will eliminate some of the barriers that exist, and there is a need for agreement at European and NCA level, to ensure that adequate and accessible consumer protection exists so that even people who are less digitally confident, such as older people, enjoy the same protection.
An investor representative noted that they had listened to the discussion about fintech in the banking industry that had taken place that morning during the Eurofi Seminar; the same principles should apply for investment as for digital banking. There is no reason why somebody should not be able to click on a website in their language and invest in a fund from a different Member State through their investment account, reading the important details in their own language. This requires structuring, supervisory convergence, and the willingness of NCAs, regulators and legislators to surrender some of the powers that they have to make the CMU a success.