Industry participants have described the Financial Conduct Authority’s (FCA) proposal to grant US-listed ETFs equivalence under its post-Brexit fund regime as a political manoeuvre that will afford few advantages to UK investors and receive limited appetite from US issuers.
The FCA consultation launched last December asked asset managers whether ’40-Act’ ETFs should be able to market and distribute to UK investors of all levels under the Overseas Fund Regime (OFR), after UCITS vehicles in the European Economic Area (EEA) were granted equivalence in January.
However, industry participants warn such a move would offer few meaningful benefits to investors or asset managers.
Investors stand to gain little
“If you roll the clock back 10 to 15 years, a lot of European investors liked the idea of holding US ETFs, because at that time, US ETFs were a much larger scale and offering far lower total expense ratios (TERs) than their European equivalents,” Stephen Carson, partner at A&L Goodbody told ETF Stream.
“That distinction has reduced as the European market has matured. There is greater choice, larger funds, more competitive TERs and most of the top US products and active ETFs are available in Europe.”
In fact, the most notable distinctions between the UCITS products already granted equivalence under the OFR and ’40-Act’ equivalents are structural components rather than the exposures on offer.
For instance, physical gold and bitcoin are wrapped in US-listed ETFs whereas they are wrapped as exchange-traded commodities (ETCs) in Europe, however, the products provide functionally similar exposures to their underlying.
Even for exposures not yet available to UK investors, such as non-transparent active ETFs, these have seen limited uptake in US-listed format and the Central Bank of Ireland (CBI) regularly engages the market on its stance regarding whether the products should be allowed in UCITS format, Carson said.
On the other hand, some US-listed ETFs may be lumbered with tangible disadvantages versus their UCITS peers from a tax perspective.
“UK investors holding an Irish domiciled UCITS ETF have a reduced withholding tax burden on dividends paid by US companies and there is potentially higher withholding tax paid on dividends by US-listed ETFs offering exposure to US equities,” Carson warned.
“Investors would need to take specific tax advice before considering in US-listed ETFs, should they be listed in the UK.”
New name, same hurdle for US issuers
For US ETF promoters eyeing a route to market in the UK, equivalence under the OFR would likely be accompanied by the removal of EU disclosure requirements such as the packaged retail investment products (PRIIPs) regulation, whose introduction in 2018 “massively diminished” the European market for US-listed ETFs, Carson said.
Following the launch of the FCA consultation, a spokesperson for Charles Schwab Asset Management said the firm is “watching the regulatory landscape closely” to gauge future opportunities.
However, Peter Capper, senior adviser for international fund regulation at the Investment Association, said while a number of US issuers have withdrawn or had their ETFs removed from platforms since the introduction of PRIIPs regulation, they will have to contend with the upcoming disclosure regime which is set to replace PRIIPs and the UCITS KIID in the UK.
"US Funds and ETFs would also need to comply with UK investor disclosure requirements and it remains to be seen if there will be an appetite among US firms to adapt to these requirements," he said.
Political over practical benefit
If granting equivalence to US-listed ETFs offers few practical benefits to either investors or issuers, a natural next question would be to ask what purpose such a move would serve.
“I suspect the real reason behind the proposal is another example of post-Brexit divergence,” said Carson.
Agreeing, Capper said the topic is likely on the FCA’s wider aspiration list and could instead be one of many components discussed within the context of a potential UK-US trade deal.
