The report, entitled Global Investor Experience Study: Regulation and Taxation, takes into consideration each country's regulation and taxation's impact on investors trading in and out of open-end funds.
This includes ETFs which Morningstar believes is an increasingly popular method used by investors to gain exposure to a variety of asset classes. Morningstar took into consideration the following:
- Favouring low tax burdens
- Comprehensive and understandable disclosures
- Varied distribution system
- Media coverage and educational offering
- Competitive fees
- Policies that encourage individual investments (e.g. tax breaks)
The best regulatory structure for a region is to have is a single regulator that is independent of the fund industry, according to the report.
The UK was one of only three countries to be given a top scorecard for regulation and taxation along with the Netherlands and Sweden. The reason being, these three regions offer strong incentives for ordinary people to invest, despite none having the best tax systems but all vary in accessibility for ETFs.
The UK has implemented an auto-enrolment into a retirement system for nearly all workers as well as offering additional incentives for people to invest in the form of tax-wrapped accounts.
MiFID II has been a significant factor for regulatory changes within the European Union (EU) and therefore Morningstar took this into account when scoring countries within this region. The UK and the Netherlands stood out for banning embedded commissions on most sales.
Furthermore, the EU’s requirement that funds must publish a key investor information document (KIID) impacted the availability of some non-EU ETFs, according to Morningstar. This is because ETFs domiciled outside of this region have elected not to produce KIIDs and are no longer available on trading platforms.
However, while the Netherlands graded top, the availability of ETFs in the region is limited. This is because KIID documents in Europe must be distributed in the local language, however, many US ETF providers do not issue KIIDs in Dutch. Therefore, there becomes minimal availability of US funds on the Dutch market.
Morningstar also highlighted how the Financial Conduct Authority (FCA), the UK regulator, closely monitored any regulatory breaches and were quick to act when needed. This included a £1.9m fine for Henderson Investment Funds for closet tracking, the process of mirroring the benchmark performance while charging active management fees.
Additionally, the report noted the gating of the Woodford Equity Income fund when it encountered liquidity issues.
Surprisingly, Australia and the US scored below average by Morningstar. Australia has seen its ETF market grow in popularity in recent years, however, Morningstar says it has started off a small base.
The reason for its below-average scoring is because the compulsory superannuation guarantee scheme that Australian residents participate in are not subject to adviser commissions paid from fund assets, third-party research costs and soft commissions are not disclosed to fund holders.
This, as well as capital gains and dividends being treated as income for taxation purposes, has resulted in Australia’s below-average score.
Similarly, the US scored poorly on its policy and tax encouragements to invest despite measuring strong governance levels which meant the country fell below average in the rankings.
The ETF market in the US, however, was praised for its tax benefits compared to those for mutual funds. As ETFs use a primary market for creation and redemption in exchange for a basket of securities and benefit from not needing to trade securities as frequently as active funds, they avoid having to pay extra taxes on capital gains which mutual funds would incur by selling appreciated securities.
Furthermore, it is difficult for US investors to invest in foreign-domiciled funds unless it is registered under the Investment Company Act. Other issues include overlapping and duplication between the country’s financial regulators which leads to different standards for investments held inside and outside of retirement accounts.
The Securities and Exchange Commission (SEC) has primary authority in regulating mutual funds, the Commodity Futures Trading Commission regulates derivatives tied to commodities and the Department of Labor regulates workplace retirement plans.
While the US encourages people to invest through tax incentives for retirement accounts, these accounts are linked to employers which many do not offer plans. Therefore, many Americans are investing very little to their retirement or not investing anything at all.
Other notable mentions include Germany which received an average grade because despite the regulation and taxation being closely aligned with EU regulations. Morningstar explained there is no mandatory retirement savings program and investors are subject to capital gains events realised by the fund as opposed to the time of sale.
ETFs within the EU region are typically registered and sold in Germany. ETFs are widely available through German brokers but ETFs have a limited market share but is growing gradually. A large volume of this growth comes from insurance firms wrapping open-end funds.
Additionally, Spain, which also received an average grade, has a significant difference between mutual funds and ETFs. Mutual fund investors benefit from not having to pay capital gains tax to switch to another fund. This does not apply to ETF investors making it more costly to switch between the two.
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