Uncertainly in the post-Brexit environment appears to be the main reason why issuers are not set to domicile ETFs in the UK despite the government exploring the idea of an ETF hub.
In January, the UK government launched a consultation to find out why the UK has not become a mainstay for the ETF industry.
Starting off its call for input by saying it “is not aware of any significant remaining barriers” to ETFs domiciling in the UK, the government’s consultation then repeats the most recited explanation for fund ecosystems establishing in the likes of Ireland and Luxembourg.
The call for input said: “The government has also been told by stakeholders that ’re-domiciling’ existing funds would involve moving assets from an entity in one jurisdiction to a new entity in the UK which would be expensive for firms and could create tax liabilities for investors, meaning this may therefore be unrealistic.”
Indeed, there is some truth to this. Not only does the UK have a corporation tax rate of 19% versus Ireland’s 12.5%, but the Irish tax regime allows for gross roll-up – whereby gains can accumulate within a fund and are only taxed when an investor exits.
On the other hand, the abolition of the Schedule 19 SDRT charge in 2014 saw the UK remove the stamp duty advantage of investing in funds domiciled overseas – with UK-domiciled ETFs previously charged SDRT at a rate of 0.5% of the value of securities purchased on the London Stock Exchange.
Likewise, although issuers often tout the attractiveness of the 1997 US-Ireland double taxation treaty – reducing withholding tax (WHT) on dividends and coupons paid by US securities from 30% to 15% – UK-domiciled funds are charged WHT at the same rate by the US, as set out by HMRC in the 2003 Double Taxation Relief Manual.
Furthermore, the Chartered Institute for Accountants in England and Wales states that the UK currently has double taxation treaties with more than 130 countries worldwide, while Ireland’s Revenue Commissioners state that its nation has 73 Double Taxation Agreements in effect.
However, the main issue with domiciling in the UK cited in KPMG’s 2006 report, Tax and the Competitiveness of UK Funds, was not any specific tax policy but rather a general lack of certainty created by the “pace of change” to the UK’s already complex tax structure – and the “style of consultation” with industry participants, along with the “overriding attitude of HMRC”.
The report said: “The most common concern with the UK tax regime is not a specific measure that can be fixed by a change in legislation. Rather, it is the overall management of the UK tax regime.”
Unfortunately, these concerns raised about the already fragmented and unstable nature of the UK tax regime – which highlighted issues surrounding “an increasing number of surprising changes” and “a number of proposed changes that were reversed” – have been exacerbated in 2021 as the UK irons out the lack of detail on financial services set out within the final Brexit deal.
Indeed, while equivalence may be achieved in essential areas such as clearinghouses, data uniformity and insurance – as the EU has agreed with other ‘Third Countries’ – equivalence across financial services appears very unlikely, a point that has already been factored in by many in the City. Equally, the decision to quit the single market means that UK financial providers have lost their passporting rights – which allowed them to serve EU consumers from anywhere within the bloc.
Baroness Nicky Morgan, former member of Boris Johnson’s cabinet, told Financial News: “I doubt we are going to get an equivalence deal with the EU.
“In many ways even if we did that would not resolve things as equivalence can be withdrawn with very little notice.”
Already, UK brokers have had to tell their EU clients that under the current rules, they will no longer be able to trade on their behalf.
Furthermore, John Liver, head of financial services regulation at EY, told Politico that Brexit uncertainty in financial services could last beyond two years while respondents to KPMG’s survey said that the UK tax regime would have to display five years of consecutive stability to be back in the fund domiciling race.
And, while these issues already seem pronounced enough, we must also consider the government’s ambition to establish new financial services clusters outside of the City – which may mean that a post-Brexit ETF hub is based in either Northern England or Scotland, rather than London.
Happily, the government’s call for input acknowledged that establishing an entirely new fund ecosystem will face the challenges of “embedded business practice, industry and investor familiarity, and inertia”.
With ‘centres of excellence’ already firmly up and running in Ireland and Luxembourg, the UK government’s primary task becomes one of changing negative perceptions – and establishing a new ecosystem through a two-step plan.
First, there is the comparatively manageable task of drawing up a blueprint for a domestic centre of excellence. If the UK government choose a Northern English city such as Hull as our hypothetical new hub, several advantages already exist – such as good connectivity (and hopefully this will continue improving), and several respected universities nearby, which could feed talent into the new ecosystem.
To establish the new centre, tax advantages could then be brought in to set it apart from other regions of the UK. Such a proposal, like the Swiss canton system, could see issuers, market-makers, brokers, and legal services encouraged to set up shop via incentives such as reduced corporation tax, tax exemptions on fees, and perhaps even facilitating gross roll-up.
Should the new domestic centre of excellence prove successful, the next step would be for the government to market this new hub overseas, and to add to the existing tax treaties and passporting arrangements that are already in place with other countries outside of the EU.
As Keshava Shastry, head of capital markets at DWS, told ETF Stream: “While EU countries are important to partner with, it is equally important to partner with countries outside of the EU as investors look for global exposures and at growth expectations in those countries.
“Also of key importance is how big developed markets are outside of the EU and their relative weighting in numerous global indices, coupled with their respective dividend yields or coupons.
“Separately, establishing smooth passporting or marketing access for products in those countries will also be valuable to increase the attractiveness of the hub, especially post Brexit.”
However, even with a strong blueprint in place, the second phase of the plan – changing perceptions of uncertainty – is both a more important and more intractable issue.
Taking notes from both the EU’s ambitions to bolster its financial services offerings, and Ireland’s ordeal establishing a world-leading fund ecosystem, such developments take decades, not years.
Establishing an ETF hub in the UK will be reliant on the government’s success in convincing fund ecosystem constituents that decades of regulatory stability is an achievable reality. And such an end may only be possible as the effects of Brexit on financial services become more set-in-stone.
Adrian Mulryan, partner at LK Shields, concluded: “Does the UK have what it takes to be an ETF hub? In terms or people, skills and tax yes. The issue now is the uncertainty on the future distribution landscape for UK funds and promoters”.