Legal Eagle View

December 08, 2015


It was not until March this year that the UK welcomed its first exchange traded fund that was domiciled on its shores. That was despite the fact that former financial secretary to the treasury Sajid Javid removed the need for UK domiciled ETFs to pay stamp duty on its shares back in April 2014.

The ETF that finally broke the mould—the Commerzbank CCBI RQFII Money Market UCITS ETF—is also Europe’s first passive fund to invest in Chinese money market instruments. The launch reflects growing political relations between the UK and China, but the unique nature of the fund also signals that UK investors are unlikely to see a full range of ETFs develop in their home country, especially when you consider that the new Commerzbank ETF has only gathered around £18 million as of 20 Oct.

ETF Report UK spoke to Neil Simmonds, partner at Simmons & Simmons, about the future of UK domiciled ETFs and what that means for the investor, and why Ireland and Luxembourg remain the main European home for ETFs.

Why has the UK domicile for ETFs been slow to take off?
That is largely historic and derives mainly from the fact that the UK has never been a major domicile for the establishment of fund products for cross-border promotion.

The UK was late to the party in introducing a corporate fund vehicle—the so-called OEIC—and the taxation regime for UK funds has not helped. It is basically favourable but complex and too often subject to change with the political winds.

The UK has lost out to more culturally and politically “neutral” Luxembourg and Ireland. The UK economy is a much more complex animal than its neighbours, who have developed much stronger cross-border sales. Despite not having much voice here for the fund administration industry, we are still in the top three countries in terms of funds and assets under management.

How does the removal of stamp duty work exactly and does it affect the investor?
It basically removes the requirement to account for or charge stamp duty on the sale of fund units. Stamp duty was unnecessary. The trading that goes on inside an ETF for rebalancing—the buying and selling of assets to track an index—meant that stamp duty was a burden and a tax drag on ETFs. They are already low margin products.

Stamp duty was only part of it. The simplification of the UK tax regime was the longer term goal. But the move [in April 2014] was too little too late.

Why are Ireland and Luxembourg still the main domiciles?
They were among the first movers in developing a regime for cross border UCITS in effectively a greenfield site where no historic or political baggage held them back. The nascent fund industries in both Ireland and Luxembourg became key employers in both economies and now have correspondingly loud voices in development of domestic policy.

Retaining the requirement for fund administration and custody functions locally enabled them to build centres of excellence, as the UK has done with investment management, encouraged by the UK taxation system, which for a long time made it difficult to administer a non-UK fund from the UK.

We’ve seen db X-trackers move all of its ETFs from Luxembourg to Dublin. Why?
I can only give a general comment. The move to direct replication brings into focus the tax treaty network of Ireland versus Luxembourg.



The first ETF in the UK invests in Chinese money market instruments. Is that an interesting choice?
It is perhaps a sign of the increasing interest from international investors, notably from the UK, in gaining exposure to the Chinese economy and part of the internationalisation of the renminbi—encouraging interest in RMB denominated securities. It is fair to say there has also been a political will behind the development of closer ties between the UK capital markets and the Chinese fund management industry and vice versa.

The whole process to get the Commerzbank ETF domiciled here took six months but could take less time with a reasonable track record. In every sense, it was a novel product.

Does this rather niche ETF launch mean we’re unlikely to see the full range of ETFs—from FTSE 100 to S&P 500 ETFs—being domiciled here?
If I were to be optimistic on UK PLC, I would like to see the full range of products being domiciled in the UK. I have spoken to one of the main ETF providers about this issue and there has been a lot of encouragement from the Treasury and the Financial Conduct Authority to make more domiciles happen here. But realistically I would expect [future ETF launches] to be more niche than develop as a full range of funds, as you need a fairly good commercial reason to duplicate the fund range you have already as an issuer.

Do you have any views on the ETF structure post 24 Aug., which brought trading flaws, discounts and price swings into the spotlight?
I have no particular view, although with the general rise in AUM and increased attention on ETFs, it’s not surprising to see more detailed focus on the nuts and bolts of these funds.

Euronext has launched a competing listing venue to the London Stock Exchange here in the city. Will that improve the liquidity of ETFs listed across Europe?
Clearly competition is good for consumers but liquidity comes from increased numbers of buyers. Whether a new trading venue will offer this, or simply dilute existing buyers, is yet to be tested.



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