And that concludes this year's Spring Conference hosted by ALFI. Thank you for joining us and we look forward to your company again at the Autumn conference in September. In the meantime, please see the ALFI website for details of forthcoming events at: www.alfi.lu
Have a good evening!
People love to have something to worry about, but in reality they have very little to be concerned about in today’s world. Bruno Tertrais, senior research fellow at the Fondation pour la recherche strategique in Paris, says pessimistic views of the world and of the future are unwarranted and unfounded.
“We’re living better and better, we are richer, healthier and safer than ever before,” Mr Tertrais told ALFI Spring conference delegates. The proof, he argues, is irrefutable. To start with, life expectancy has soared to over 80 from less than 20 in the Middle Ages. We have seen extraordinary declines in absolute poverty from nearly 90 per cent 200 years ago to less than 20 per cent now. “This is still too high, but good in perspective,” Mr Tertrais said. Health scares in the media are just that – scares. For instance, in the latest flu epidemic, 15,000 people died worldwide. “This is nothing compared with the flus of past,” said Mr Tertrais. “In 1958, avian flu caused a million deaths worldwide.”
Worries over the depletion of energy resources are similarly misplaced. The Peak Oil theory has panicked people across the globe, but the same concerns were expressed over coal two centuries ago. “The Peak Coal theory held there was not enough to sustain the development of Europe, but technical and market forces proved extraordinary adjustment tools.”
The world is not going to starve either. “Feeding 10bn-12bn people is not a problem,” contends Mr Tertrais. “A vast expanse of arable land still exists, particularly in Africa and Latin America. Yes, there is food price volatility and food riots. But these are actually price riots - when people are really hungry they don’t revolt.”
Severe weather events are overplayed too. “You would think weather events are more frequent and more deadly these days,” he said. “Wrong. Since the start of the 20th century the number of deaths due to weather events has fallen. Don’t confuse flooding in Australia or a heatwave in Russia with a global long-term trend.”
Despite fears of conflicts in Asia and the Middle East, wars are actually declining. There were 120 wars per decade around 1900, compared with just ten a decade now. “This is due to: the existence of nuclear weapons; the fact that democracies don’t fight each other; and global trade. Basically it is cheaper to buy than to steal these days.”
And the West is not declining as so many people wail. In fact, despite the widespread belief that China is taking over leadership of the world, democracy is on the rise. Mr Tertrais said: “Yes, there are cultural differences between East and West. But emerging markets have adopted something close to the western liberal model. The Chinese model is not attractive to most of world’s population. So the Washington consensus is not under threat.” Whereas there were only ten democratic regimes in 1900m, now there are more than 80 and 45 per cent of the world’s population lives in a democracy.
“If you read the media and the internet, you would not guess it is a less dangerous world,” said Mr Tertrais. “The fact is, the better we live and the less risks we have, the more unbearable are the remaining risks.” Politicians also help to create the perception of danger because they need a focus, a global threat. The fears are perpetuated by the information society too, which competes to find the scariest headline.
“So people have the impression that things are getting worse,” said Mr Tertrais. “We are all responsible, we all say beware of this or that. We are all wrong.”
The academic finished his presentation by offering evidence that long-term trends continue unless there is compelling reasons for them not to. In other words, an increasingly benign world should become still more benign in the future. More peace, more prosperity.
This, of course, has profound implications for investors, many of whom believe some kind of disaster is just around the corner. It isn’t, Mr Tertrais fervently believes. If he’s right, investors with a long-term view should have few qualms about taking their money from under their beds and putting it to work in the markets or private ventures.
Forthcoming OTC derivatives regulation will come as something of a shock to the buyside. The new rules demand that the vast majority of trades are officially cleared, so for the first time fund managers will have to post collateral to clearing houses. Fund managers appear to be in denial: as an instant survey at the ALFI Spring conference showed, few on the buyside have even contacted clearing houses yet. Presumably, with so much regulation crossing their desks, fund managers are unwilling to contemplate the commitment of resources to yet another rule-change.
However, for some asset managers, the regulations could actually enhance revenues. The opportunity arises from the type of collateral that funds will have to post to clearing houses. Richard Walker, executive director, SwapClear sales and marketing Europe, LCH Clearnet, told ALFI delegates: “We have a restricted set of eligible collateral that we will accept. I hope you understand our motivation for being restrictive: our first requirement is to manage a resolution. If we took commercial real estate, for instance, that would create a problem in the case of a default of a major market counterparty.”
Most clearing houses will demand “high quality” collateral, such as cash-like instruments, gold and G7 government bonds. Since these have become expensive and are, in many cases, in short supply, fund houses that have significant holdings of them will have an opportunity to lend them out to managers who do not have such eligible assets in return for significant fees. “These assets may become scarcer than in the past,” said Mr Walker. “Natural holders of these assets may find that they have considerable value as collateral.”
If the investment industry was hoping for greater clarity over the FATCA provisions, February 8 dispelled any such hopes. The proposed regulations published by the US Treasury and IRS included a raft of clauses that cloud an already opaque issue. Yes, firms in five European countries can now deal directly with their national tax authorities rather than the IRS, but that was about the only bright spot in an otherwise convoluted communique.
The passages on “grandfathered obligations”, transitional rules for affiliates, the refining of the definition of a financial account and an expanded category of deemed-compliant FFIs are enough to make grown men weep. And let’s not even mention that there are 27 ways of categorising investors under FATCA.
But where there’s muck there’s brass, as the northern English saying goes. In other words, the complexities of FATCA are a headache for some but a business opportunity for others. That opportunity primarily lies with large institutions – usually, but not always banks – which have invested millions in understanding and implementing the Act and are now in a position to pass on their newly-acquired expertise (for a fee, of course).
Geoffroy Bazin, COO of the Investment Solutions Division of BNP Paribas, told ALFI delegates: “We have four or five FATCA services, including supporting the asset manager in the registration phase of classifying its funds, identifying clients of funds through a transfer agency mandate and dealing with the withholding payments through our custodian services.”
While larger institutions will have the opportunity to sell services to their smaller brethren, European and US institutions may also have the chance to provide services to Asia, which has been slow so far to respond to the FATCA challenge.
As Roger Exwood, head of product tax, EMEA, for Blackrock, says: “Large pockets of Asia think that if they tell the Americans to go away loudly and long enough, they will be left alone. As the realisation that FATCA is for everybody dawns, there could be a competitive advantage for those Europeans who have learned how to do it properly.”
The selling opportunity is further enhanced by the announcement by the IRS of bilateral agreements. “We didn’t plan for that,” said Mr Exwood. “We need to work out whether our long-term spend needs to be built around a multi-lateral system now, because other governments may also sign bi-lateral agreements.”
In addition, there is the possibility that the US will not be the only country to outsource its tax collection in this way. If others decide to follow its lead, the complexities for investment firms will multiply. “The really long game in terms of building systems is the chance that other countries want to do it too,” says Mr Exwood. “This affects whether we have a time horizon of six months, two years, or five years. People are going to come up with a variety of different answers.
At the Spring Conference, ALFI set out its response to key regulatory changes that will impact the fund management industry. Marc Saluzzi, chairman of ALFI, acknowledged the need for better regulation in the wake of the financial crisis, but also warned that excessive and poorly targeted and executed regulation would harm the funds industry and its customers.
“Our central belief is that funds are good for society,” said Mr Saluzzi (
The industry must not only defend its interests, but continue to innovate in order to continue to attract assets, Mr Saluzzi said. “Over the last 10 years, assets in the Luxembourg funds industry grew quickly from E1trn to E2trn. Now we need to back this up with further innovation.”
This includes doubling alternative assets in Luxembourg from their current level of 10-15 per cent of total assets under management. ALFI will also focus on encouraging the growth of responsible investment, including developing structures and frameworks for impact funds, microfinance funds and carbon funds. ALFI’s technical committees have been re-organised to address these areas.
Substantial amendments required to Volcker Rules, FTT and FATCA
ALFI has particular concerns about parts of the following proposed regulatory changes: the Volcker Rule (part of the Dodd-Frank Act); the Financial Transaction Tax (FTT); and FATCA. Meanwhile, the Alternative Investment Fund Managers Directive (AIFMD) is viewed positively and is likely to boost the alternatives sector in general and the Luxembourg fund centre in particular.
The Volcker Rule primarily stops US banks or banks in the US from carrying out proprietary trading, but it also restricts them from taking interests in hedge and private equity funds and stops them carrying out transactions for these entities. “The problem is that US mutual funds are not caught by the rule, but non-US funds such as UCITS are captured,” said Camille Thommes, Director General of ALFI. ALFI is working with the European Fund and Asset Management Association (EFAMA) in raising its concerns directly with the US authorities. “Hopefully we can help secure a redrafting of the rules,” said Mr Thommes.
The Financial Transaction Tax, which was designed to make the banks pay for their role in creating the financial crisis, will also have a negative impact on the fund management industry. The tax, as it currently stands, would be levied at 10 basis points on the buying and selling of a security, including units in a mutual fund. If the FTT had been applied last year, it would have cost investors E15bn in sales and redemptions taxes alone. In addition, the cost to funds of trading securities within the portfolio would have amounted to E23bn. So the total impact in a single year alone would have been E38bn. This figure excludes the costs of derivatives trading (1 basis point per transaction) and the costs that the FTT would impose through increased spread levels.
ALFI argues the FTT should not be imposed solely on European market participants, because this would place them at a significant competitive disadvantage. Mr Thommes said: “If the FTT is implemented it would seriously curtail the distribution of European funds to non-European jurisdictions, especially in Latin America and Asia, where UCITS are well established.”
Trading activities may relocate to jurisdictions outside Europe in order to escape the tax. Mr Thommes pointed to the unilateral decision taken by Sweden in the 1980s and 1990s to tax the trading of domestic securities. The anticipated revenues of SKr 1.5bn a year materialised at just SKr50m because much of the expected trading volume simply relocated to other countries.
In light of this, ALFI has asked the Commission to produce a detailed cost-benefit analysis before going ahead with the tax. In addition, it has requested that alternative methods of revenue collection are considered, such as an activity-based tax or stamp duty.
FATCA has the potential to cause major concerns for fund managers. The proposed US law demands that all financial institutions report financial gains made by US citizens and entities anywhere in the world via any vehicle or structure. The time and resources necessary to both identify US individuals and entities within the value chain and then report accurately and regularly to the Inland Revenue Service (IRS) is likely to be considerable. ALFI believes both the timeframes and scope of the law make it unworkable. “If we only get the final regulations by the end of the Summer and have to implement them by July 2013, I don’t think many people will be able to comply,” said Georges Bock, a partner at KPMG and a board member of ALFI.
Applying the law to the retail fund sector does not make sense, Mr Bock believes. “Retail funds are not instruments that are particularly set up for tax fraud. We are willing to help the US tax its citizens, but retail funds are really not the place they should be looking.”
Mr Bock warned fund management firms not to believe their problems were over just because the IRS was willing to establish bilateral agreements with national tax authorities. “Yes, firms in Germany, France, the UK and so on may not have to deal directly with the IRS, but the rules would be enshrined in national laws and applied in the same way,” Mr Bock said. “So there is little advantage.”
AIFMD is an opportunity, not a threat
Finally, AIFMD, the poster-child of post-financial crisis era regulation, is viewed positively by ALFI. Its biggest benefit is the creation, effectively, of a cross-border passport for alternative managers. “It reminds us very much of UCITS,” said Claude Niedner, a partner at law firm Arendt & Medernach and a board member of ALFI. “Luxembourg developed on the basis of the UCITS passport so is well established in this respect.”
Luxembourg intends to be the first European member state to implement the Directive. A bill is likely to be passed by Parliament before the end of this year. The Grand Duchy last week updated its SIF regime to prepare for implementation, altering rules on risk management and portfolio management delegation, and creating more flexibility, such as allowing one subfund of an umbrella fund to invest in another subfund operating under the same umbrella.
While it has been clear for some time that ESMA would become an unusually powerful regulator with genuinely pan-European supervisory powers, less clear was whether its resources could cope with its sudden emergence. Questions have been asked across the financial services spectrum about ESMA’s ability to effectively carry out its duties, which include helping to implement and supervise AIFMD, short-selling rules, MiFiD, EMIR and other regulations.
The questions, it appears, are being answered. While ESMA was created at the start of last year with a staff of just 40-45 people transferred from CESR, the legacy organisation, staffing levels are rising rapidly. “In 2011, we went from 40 to 70 people,” said Steven Maijoor, chairman of ESMA, “and this year we will go to 100. Next year, we have an ambitious budget of 160 staff.”
However, the question of who funds the regulator is less settled. Currently, the majority of funding comes from member countries, even though most of its work relates to pan-European legislation and supervision. “The current mixed funding model is not a proper model,” said Mr Maijoor. “We would like to be 100 per cent funded by the EU.”
Just how powerful is the European Securities and Markets Authority (ESMA)? Created from the ashes of CESR – which was widely recognised but which had little real influence – ESMA has been charged with fine-tuning the recent swathes of rulemaking across the European Union. It has responsibilities both for writing Directives and making sure they are implemented fully and efficiently.
The extent of its power depends predominantly to what extent ESMA, which came into being last year, is truly independent of the European Commission. In the past, the Commission has tended to believe its capabilities more than equal those of regulators and supervisors. Steven Maijoor, ESMA’s its chairman, was keen not to overplay his hand, but told ALFI Spring Conference delegates that the Commission was highly likely to accept its recommendations.
He was asked in a one-to-one interview by Claude Kremer, the chairman of the European Fund and Asset Management Association (EFAMA), whether ESMA’s recommendations were binding on the Commission. Mr Maijoor answered: “The advice we gave last year on Level II of AIFMD was not an obligation. We highly recommend the European Commission to take all our advice on board and we expect it to do so, but it is an independent institution and will take its own decisions.”
However, since the work ESMA did on AIFMD, its recommendations have effectively been upgraded and renamed “technical advice”. This move, as Mr Maijoor noted, increases the weight behind it. “The force of our technical standards is stronger than the advice on AIFMD, for example. So it is heavier for the EC to deviate if they don’t take our technical standards on board.”
The Commission is doubtless “weighing” the risks of continuing to sideline third-party advice and taking idiosyncratic decisions.
ESMA’s power has not just risen vis a vis the political classes but relative to the industry it serves too. As Mr Kremer said, it can now intervene if it believes investment products are unsuitable for their intended customers or may create specific risks. It can even over-rule member states if they don’t take action over potential problem products and it can issue investor alerts. In extreme circumstances it can even ban products altogether.
While acknowledging that these powers exist, Mr Maijoor was reluctant to adopt an aggressive stance on this issue. “National supervisors should be taking the initiative,” he said, “they already have a licence to kill. But if there is a cross-border element, ESMA could take responsibility. Banning a product would be a big step philosophically for us, but we are already in a situation where we give licences to funds.”
In practice, products that could pose problems will be dealt with before launch, rather than after they have been distributed, he added. “Where there have been substantive problems in the past, it was to do with how the product was developed. So if you have the right controls around processes, the risks are reduced.”
