Asset Management News March 2010 - PwC · 2015. 6. 3. · Asset Management News March 2010 ETFs to...

News

Asset Management

*connectedthinking

March 2010

Asset Management

Featured inside:

ETFs to become building blocks

Regulators on UCITS hedge funds

Asia’s new growth

European real estate’s slow recovery

Insights & views from PricewaterhouseCoopers’global asset management practice*

Section A:Returning to growth

04 ETFs to become asset management’sbuilding blocks

06 UCITS hedge funds – balancinginnovation and investor protection

08 Asia’s asset managers look forwardto growth

10 Distribution channels in jeopardy

12 Pensions reform – what does it meanand how will it impact me?

13 Growth becomes more complex forEurope’s administrators

Section B:General stories

Asia:

14 J-BIEM – a new Japanese bondincome tax exemption regime

Europe:

16 Europe’s real estate industry in for‘long, slow haul’ to recovery

17 Managing exposures effectively,post crisis

18 European domiciles seek to temptfunds onshore

20 Compliance matters in Italy

North America:

22 Preparing FIN 48’s uncertain taxpositions

23 Carried interest legislation movesa step closer

24 Building transparent valuationprocesses

25 Seeking transparency throughdue diligence

2 PricewaterhouseCoopersAsset Management News March 2010

Contents

Asset Management News is now online.

Visit us at www.pwc.com/amnews

Take Asia, for example. The region’s recovery already appearsfar healthier than elsewhere and business volumes areapproaching pre-crisis levels. Fund managers are lookingforward to significant growth in fields such as pensions andwealth management.

In real estate, where our Emerging Trends in Real Estate®Europe 2010 shows values and rents stabilising, there aresimilarly locations that appear more favourable than others,even just within Europe.

What is clear is that 2010’s recovery is not simply a return tobusiness as usual. In tomorrow’s asset management world,efficiency will be more important – hence our view that ETFswill become the industry’s building blocks. And regulators willplay an increasingly important role in channelling growth,especially for alternative sub-sectors such as hedge funds.

Such a recovery rewards intelligent management strategy andtactics more than ever. The successful will be those thatnavigate the geographical, regulatory, taxation and productissues most skilfully.

PricewaterhouseCoopers 3Asset Management News March 2010

Kees HageManaging Editor PricewaterhouseCoopers (Luxembourg)+352 49 48 48 [email protected]

IntroductionJust like the broader economy that it serves, the asset management industry is returningto growth. Yet this growth is far from uniform – there are pockets of flourishing activity and areasof continuing weakness.

Section A: Returning to growth

Exchange Traded Funds (ETFs) are a rapidly growing suite of investment vehicles thathas only recently approached its potential for revolutionising both institutional and retailasset management business lines, including specialty asset management sectors suchas alternative investments.

The increasingly broad use of ETFs – as fundamental building blocks in theimplementation of investment strategy – has far-reaching implications for assetmanagement firms, their service providers and investors. Each of these constituencieswill require new tools, methods and capabilities to market, analyse, process and reporton investment portfolios that leverage ETFs.

As usage of ETFs continues to expand, asset management businesses might alsowitness additional fee pressure from clients and intermediaries. This could, in turn,have implications for their overall profitability, as well as the implied efficiency at whichthey (and their service providers) operate.

A steady evolution

The benefits of ETFs are generally well known across both institutional and retail assetmanagement businesses. They include ease of diversification, market or sectorreplication, tax efficiency, liquidity, transparency and attractive expense ratios.These characteristics have led to broad usage of ETFs in their most basic form –as a market proxy. Stated another way, ETFs have been one of the early tools of assetmanagement’s “alpha-beta separation” trend, which has replicated marketperformance (beta) at low cost, and separated the investment capital used to pursueabove market performance (alpha).

In this context, ETFs have been used effectively as the beta component in both passiveand blended investment strategies. Indicating this success, global ETF assets have(at the time of this article) surpassed US$1 trillion, which significantly exceeds manyearlier estimates.

Despite this history of success, many market participants – particularly those involvedwith the investment process such as chief investment officers, portfolio managers,researchers and investment consultants – believe that there is still considerable roomfor ETF growth beyond their use as basic market proxies. From a product perspective,this is corroborated by our observance of four general categories of ETF:

1.Market Proxy

2. Index-Enhanced

3.Portfolio of ETFs

4.Active ETFs


ETFs to become assetmanagement’s building blocksAfter their success as passive investment vehicles, ETFs are set to become the fundamental buildingblocks of active asset management. They will present both strategic and operational challenges.

Jay A BurstellPricewaterhouseCoopers (US)+1 646 471 [email protected]

Gary MeltzerPricewaterhouseCoopers (US)+1 646 471 8763 [email protected]

The benefits of ETFs are generally wellknown across both institutional and retailasset management businesses.

Market Proxies aim to replicate a marketperformance as quantified by an existingindex (eg, S&P 500). Index-EnhancedETFs seek to replicate new, or pseudo,indices that purport to track the marketmore accurately due to differentcomposition (eg, weighting byfundamentals such as dividends orearnings, as opposed to marketcapitalisation). For example, marketcap-weighted indices are believed tooverweight overvalued stocks andunderweight undervalued stocks, therebyincreasing risk and lowering return.Portfolios of ETFs, logically, imply thatexposure to most (if not all) asset sectorscan be represented by underlying ETFsas opposed to individual securities.Given that a primary component ofoverall return is produced by the assetallocation (versus individual securityselection), Portfolios of ETFs should beable to capture this “allocation return”at low cost. Lastly, Active ETFs seek toreplicate (to varying degrees) the activitiesof an actively managed investmentprocess. This is accomplished bydynamically re-constituting the index toreflect active security selection andaccompanying trading activity. And whiletheir expenses ratios may be higher thanthose of passive ETFs, relative to theirafter-tax returns they are still compelling.

From an investor or market perspective,there are several substantial segmentsthat have yet to be penetrated by ETFsand that present significant opportunity.Examples include defined contribution(DC) pensions, variable annuities, retailwraps and separately managed accounts,and insurance asset management.Additionally, of course, there is theactively managed, traditional, registeredmutual funds market. In particular, theregistered mutual funds market hasalways positioned itself as beyond theimpact of ETFs (including from a feeperspective), due to its active investmentprocess. However, Active ETFs’ closereplication of active investment processesis serving to blur the historical distinctionbetween ETFs and mutual fund products.

ETFs to become essential

Given the individual and collective sizesof these markets, there should besufficient scale of opportunity to compelleading asset managers and serviceproviders to make the necessarycommitments to ETF productmanufacturing and servicing. In sum, we

believe that the asset management sectorwill continue to evolve rapidly to a modelthat leverages ETFs as its fundamentalbuilding blocks, underlying both passiveand active investment strategies across abroad suite of investor segments.

For example, if institutional investors canreadily capture their desired risk-adjustedreturns from portfolios of ETFs atmaterially reduced fees, then usagetrends are likely to continue and ETFproduct manufacturing will meet thisdemand. Supporting this is ourobservation that ETF productdevelopment for the institutional businesshas been high on most chief investmentofficers’ agendas for the past three tofour years. With attractive product nowcoming to market, the new challenge isfinding the right pricing point (relative totraditional separately managed accounts),such that the asset manager cangenerate sales, while controlling the feestructure, margin and cannibalisationimpacts on their product lines.

As is the case with most productengineering-led innovation in financialservices, operational and systemcapabilities have been observed tolag significantly. For example, eventhe efficient processing of structuredproducts and derivatives remains achallenge, including at many largefinancial institutions. In the case ofETFs, there are several deviationsfrom traditional fund processing thatmight cause complications. Examplesinclude the ability to strike end-of-daynet asset values for ETFs trading acrossmultiple exchanges globally, theregulatory need to monitor for “wash-sales” and increased reconciliationrequirements on the cash componentsof fixed-income ETFs.

Active ETF products also presentoperational difficulties. They requireprocessing platforms that canreconstitute underlying indices assecurities are selected and traded. This isa significantly higher operational hurdlethan the current end-of-day, batch-oriented practices employed by mutualfund servicers – so the transition to thismodel could be difficult. Given that thefees charged for ETF products might berelatively low, there could also be acorresponding need for improvedefficiencies across the operational valuechain from front- to back-office, in orderto support margins.

Lastly, as ETF utilisation is still anemerging trend, personnel and requiredskills might not be widely available andcould prove challenging to obtain. This islikely to impact manufacturers, servicersand clients as they seek to upgrade theircapabilities.

The need to adapt

While ETFs might not supplant alltraditional investment vehicles in theshort term, financial institutions willneed to adapt their product lines andoperational, platform and staff capabilitiesto accommodate their growing role.This will be particularly true if ETFexpense ratios remain attractive relativeto the after-tax returns of traditionalproduct alternatives such as mutualfunds. Given the ability of ETFs to be thefundamental building blocks of theinvestment process – at low cost – theyare likely to penetrate most investorsegments over time.

Failure to adapt to their usage mightlead to less competitive product lines,fee structures and servicing offerings,thereby increasing the prospect of clientand asset attrition. Given the high cost ofgathering and/or replacing clients andassets, this argues for a sharp focus onETFs in the asset manager’s currentbusiness strategy and operationalplanning.




Who would have thought a year ago, in the immediate aftermath of the credit crunch,that there would now be such a large number of UCITS hedge funds, encompassingalmost the full range of investment strategies. There are not only relatively simple long-short equity funds, but also an increasing number of more complex macro, arbitrageand commodity vehicles.

After two years of decline in Europe’s asset management industry, such growth iswelcome. The new UCITS hedge funds are a genuine response to investor demandand, by all accounts, are attracting new assets under management. According to fundof hedge fund managers, there are now more than 300 UCITS hedge funds and thenumber is growing weekly. Demonstrating the size of the market, funds of hedge fundsmanagers now judge the market large enough to sustain properly diversified funds ofUCITS hedge funds.

Yet there is a tension between welcome innovation and the need to provide suitableprotection to UCITS funds’ retail investors. When the UCITS III Directive was amendedto allow investment in financial derivative instruments in 2001, no one imagined thatthis would introduce such a wide range of strategies into UCITS. Now, the regulatoryauthorities have to strike the right balance between promoting growth of the highlysuccessful UCITS brand and ensuring they have anticipated any threats to investors.

“What the hedge funds are bringing to the UCITS area is a great deal of what we wouldcall product innovation,” observes Grellan O’Kelly, Senior Regulator with responsibilityfor the Derivatives and Risk Management Policy Group at the Irish Financial ServicesRegulatory Authority. “We are familiar with most of the assets that are traded, but themanner in which they are managed to gain alpha is something new for us.

“I believe that the rules are strong enough and flexible enough to cope with thisinnovation. As ever, however, the hedge funds are pushing at the boundaries of gainingexposure to asset classes that you would not normally be able to gain exposure toin UCITS.”

Act within the spirit of the rules

We believe that hedge fund managers need to be careful to act within the spirit of theUCITS directives. There is some flexibility within the rules governing eligible assets andrisk management, for example. If managers are not sensitive to the regulators’intentions, there is a danger of further regulatory clarification at some point in the future– in the form of a new UCITS directive or amendments to existing directives.

Hedge fund managers are responding to demand from institutional type investors suchas funds of hedge funds, private wealth managers and small pension funds in thewake of the 2008 market crisis. The equity market collapse reminded investors of theadvantages of absolute return investments. Even though many hedge fundsexperienced losses, and were sometimes more correlated with markets than expected,most performed far better than equities. While the FTSE 100 Index, for example, lostmore than 40% between its July 2007 high and its lows in November 2008, hedgefunds tended to lose far less.


UCITS hedge funds –balancing innovation andinvestor protectionAs hedge fund managers launch growing numbers of UCITS1 funds, so regulators have to managethe tension developing between welcome development of UCITS and the need to maintain highstandards of investor protection.

Olwyn AlexanderPricewaterhouseCoopers (Ireland)+353 1 792 [email protected]

Didier PrimePricewaterhouseCoopers (Luxembourg)+352 49 48 48 2127 [email protected]

Robert MellorPricewaterhouseCoopers (UK)+44 20 7804 [email protected]

1 Undertakings for Collective Investments in Transferable Securities

Yet hedge fund investors weredisenchanted by the methods hedge fundmanagers chose to prevent fire sales ofless liquid assets. Many were preventedfrom disposing of portions of theirinvestments, imprisoned within ‘gates’,‘side pockets’ and other special purposevehicle solutions. There were also someinstances of style drift, where hedgefunds supposed to employ a particularstrategy used another, with consequentlosses.

The UCITS regulatory framework reducesthe likelihood of these things happening.The UCITS III Directive allows funds touse leverage within certain limits and toshort sell through derivative instruments.Funds may also invest in a wider rangeof instruments, including commodity andhedge fund indices. Set against suchfreedom, however, the UCITS rules havestrict parameters. Among other things,funds must: publish their top holdings;allow investors to redeem at leastfortnightly; limit leverage (through useof a value at risk calculation); implementstress testing.

Many hedge fund managers will nowfind that an increasing amount of demandfor their product comes through UCITSvehicles. In addition to those institutionalinvestors that are investing in UCITSthrough choice, others can only getaccess to hedge fund strategies througha UCITS fund due to the restrictions oftheir home country regulations.

When the Alternative InvestmentFund Managers Directive is finalised,set for July 2010, this could providefurther impetus for hedge fund UCITS.Currently proposed rules suggest thatit might become more difficult formanagers based outside the EuropeanUnion to market offshore funds within itsmember states.

Areas of risk

As the number and variety of UCITShedge funds has grown, so has concernthat innovative strategies might lead toinvestor protection issues, even a hedgefund blow up. Addressing some of thecritical areas, the Committee of EuropeanSecurities Regulators launched a Level 2Consultation focusing on riskmanagement in summer 2009, examiningissues such as the global exposure rulesand counterparty risk.

For the industry as a whole, the greatestareas of doubt surround liquidity and thesuitability of some more complex UCITShedge funds for retail investors. Someindustry participants question how manyof the UCITS hedge funds currently beinglaunched could hope to providefortnightly liquidity in a future crisis,considering that the credit crunchrendered even some money market fundsilliquid. Additionally, there are concernsthat retail investors could have littlechance of understanding the morecomplex strategies in which they mightchoose to invest. This is especiallypertinent at a time when the UCITS IVDirective is introducing the Key InvestorInformation Document specifically toimprove investor understanding.

“The AMF considers UCITS with leverageof close to two might not be suitable forless aware retail investors and should bereserved for institutional investors byimposing a minimum entry ticket of, forexample, €100,000, this is the Frenchapproach,” explains Patrice Bergé-Vincent Head of the Asset ManagementPolicy Department at France’s Autoritédes Marchés Financiers, which was theprimary architect of the sophisticatedUCITS framework that allows derivatives.“When a UCITS hedge fund with leveragethis high enters the French market, werecommend to the distributor to limit theirdistribution to professional investors.Or we recommend to them to explain therisks to retail investors so that they fullyunderstand.”

There is little doubt that the hedge fundUCITS universe will continue to grow.Hedge fund managers would be wiseto follow some simple guidelines,however, to ensure that the level ofinnovation is appropriate.

These are:

• Set a minimum investment appropriateto the type of strategy and investor.More complex strategies aimed atinstitutional investors should havehigh minimum investments to deterretail investors.

• Make sure you can clearly explain theinvestment strategy to retail investorswithin the two-page Key InvestorInformation Document – strategies thatcannot be explained might not besuitable for UCITS.

• Ensure that the proposed investmentstrategy can provide fortnightly liquidity,even in difficult markets.

The current proliferation of hedge fundUCITS is bringing alternative investmentsinto the mainstream as never before.This is a great opportunity for hedge fundmanagers, yet one that they need tograsp with sensitivity for the spirit of theUCITS directives.

This article is an abridged version of aPricewaterhouseCoopers2 point of viewon UCITS hedge funds, drawing oninterviews with European regulators.



2 “PricewaterhouseCoopers” refers to the networkof member firms of PricewaterhouseCoopersInternational Limited, each of which is a separateand independent legal entity.


In the aftermath of the financial crisis it is clear that the damage inflicted on Asia hasbeen considerably less than in Europe and North America. Asia, let’s not forget, had itsown crisis as recently as 1997-2000 and, thankfully, it seems that some importantlessons were learned.

No major financial institutions have collapsed; they have not been battered by sub-prime mortgages; and have not required government bail outs. To be sure, there havebeen some high-profile mis-selling scandals relating to exotic derivative products, andsome heavily indebted real estate organisations in Australia and Japan have failed. Yetthe damage has been comparatively minor – Asia’s brokerages and fund managers arestarting to return to pre-crisis volumes of business.

While conventional wisdom says that the West’s economic recovery will be anaemic forthe next few years, in Asia economic activity is quickly recovering. China’s expansioncontinues apace, with growth edging back up towards double digit levels, India’stransformation continues and industrial power houses such as South Korea aregenerating considerable output.

The recent spate of capital market offerings has seen the stock exchanges of HongKong and Shanghai starting to raise as much, if not more, equity capital as London andNew York. Real estate in several Asian cities hit ‘bubble’ territory during 2009 as cheapfunding was plentiful. The labour market, particularly in financial services, started torecover rapidly in 2009’s fourth quarter. New Asia-focused private equity funds aredrawing commitments approaching US$ 1 billion.

Diverse opportunities

So what does all of this mean for asset managers doing business in Asia or seeking toenter these markets? The answer is that strong economic growth and a number ofother factors are fuelling genuine opportunities.

Most importantly, wealth creation continues on a massive scale, notably in China andIndia, but also across the region. There is increasing demand for private banking andwealth management. In spite of recent accidents caused by exotic credit and equityderivatives, the wealthy are seeking higher returns from products that are oftenspeculative in nature. Over-the-counter derivatives remain popular and wealthmanagers now distribute many hedge fund products. Singapore has positioned itselfparticularly well in this segment.

Savings rates are high, with bank deposits plentiful, even at this time of historically lowinterest rates. Yet depositors will look to move into other asset classes such asequities, commodities and property, often through the European Union-regulatedUCITS funds that have established firm footholds in countries such as Hong Kong,Singapore and Taiwan. In other countries, such as China and Korea, there are locallydomiciled, internationally focused products.

Markets’ capitalisations are expanding and the tools available to trade the marketsare more plentiful. Nowhere is this truer than in China’s equity markets (includingHong Kong). China also recently announced further liberalisation measures relating tothe introduction of short selling and margin trading, both of which will boost marketturnover. The investible population available to fund managers, therefore, continuesto expand.

Fund managers can expect huge growth in Asia’s pension markets over the next twodecades. Whereas Australia and Singapore have long-established schemes with verysubstantial assets, many countries have only introduced programmes within the lastdecade. Both China and India have been slow to adopt the nationwide pension


Asia’s asset managers lookforward to growthThe asset managers of Asia are beginning to return to pre-crisis volumes of business, and are lookingforward to an era of significant opportunity.

Robert GromePricewaterhouseCoopers (Hong Kong)+852 2289 [email protected]

legislation that will provide the socialsafety nets they need. However, the first“baby steps” are being taken and this willbe an interesting space to monitor.

China remains hugely attractive in its ownright. New fund launches regularly raiseUS$1 billion or more. More than 30international fund houses now haveminority ownership of asset managementjoint ventures. These shareholdingsremain capped at 49%, however, and itwould be guessing to predict when thisrestriction might be lifted. The QDII3

programme to allow financial institutionsto invest China’s excess funds ininternational markets has grown in staturesince shaky beginnings in 2007. Theconcept is sound and the flow of cashfrom China will be substantial.

There are many more topics that onecould discuss – Japan remains one of theworld’s largest economies and capitalmarkets; Australia has had well over adecade of almost unbroken economicgrowth and its raw materials fuel China’sexpansion; Malaysia continues to build itspresence with Shariah-compliantproducts; Vietnam has ambitions toreplicate, on a smaller scale, some ofChina’s 1990s successes.

The risks

Yet Asia has risks. Economically, there aresigns China is starting to reign in the past12 months’ massive credit binge, whichcould slow economic activity and spookthe markets. And no-one should thinksucceeding as a fund manager or assetgatherer in Asia is easy. Political risksremain and newcomers need tounderstand them. They should alsoappreciate the markets’ diversity, withdifferent languages, cultures, regulations,labour laws, costs of doing business andexchange rates. Newcomers need toinvest significant management time toresearch the great opportunities and toformulate strategies.

Additionally, the landscape has becomemore competitive. The Asian capitalmarkets might be bigger than at the timeof the Asian crisis, but hundreds of newfund houses, especially boutiques, havesprung up in the last decade.

Activity shifts

As an observer from Asia, the wholefinancial services sector in the UnitedStates and Europe seems under siegefrom regulators and politicians. If evenhalf of the various proposals become law,this will influence where and howinstitutions conduct their proprietarytrading, their private equity and hedgefund trading businesses and, equally, howmuch successful individuals will be paid.Although Switzerland seems an obviousbeneficiary, it is likely that somebusinesses will locate to Asia’s maturefinancial capitals, particularly those withlow rates of taxation. Asia’s governmentsand regulators have not taken theadversarial stance adopted elsewhereand, therefore, centres such as HongKong and Singapore are welcoming talentfrom Europe and the United States. This,in itself, would fuel innovation and growthin Asia’s financial markets.

PricewaterhouseCoopers 9Asset Management News March 20103 Qualified Domestic Institutional Investor


Following the shortfalls in financial advice revealed by the global economic crisis,several countries are examining how to protect the interests of retail investors moreeffectively. Proposed wholesale changes to the regulation of retail fund distributionhave the potential to create upheaval for asset managers and distributors at a timewhen growth could be returning to the sector, and when asset managers have to dealwith a number of other pressures such as increased competition and theimplementation of other regulations.

The UK’s Retail Distribution Review (RDR), The Ripoll Report in Australia and, inEurope, both the Packaged Retail Investment Products initiative and the Markets inFinancial Instruments Directive (MiFID) revisions are causing uncertainty. Theseregulatory changes all focus on investor protection, ensuring that investors are able tomake the most suitable and appropriate investments to fit their needs.

While the breadth and depth of these proposals differ materially, in some countries theproposed changes are causing distributors/intermediaries to review their entirebusiness models and decipher whether or not they are still viable. Asset managersmight have to follow a “back to basics” approach when deciding how to adapt theirdistribution models going forward.

For example, in the UK the current draft of the RDR regulation, which is set to beintroduced in 2013, means that some established market practices will no longer beaccepted. Asset managers will not be able to influence the advice ofintermediaries/distributors by varying commissions because the new regulation would,as it is currently drafted, effectively prevent these parties from receiving retrocessionfees from asset managers. As a result, managers will no longer compete against eachother on the commission levels they offer distributors/intermediaries – instead, factorssuch as the price and quality of their products will be key.

In Australia the recommendations of the Ripoll Report, published in November 2009,might have a similar effect. The report recommends that financial advisors should havea fiduciary duty to place their clients’ interests ahead of their own, and that restrictionson advice are made prominently in marketing material.

Within the European Union, through the proposed implementation of the measuresof UCITS IV – and indeed the Committee of European Securities Regulators’ (CESR)consultation paper, ‘Inducements: Good and poor practices’, – we are seeing a similarfocus from the EU Commission on upfront disclosures, although this is not proposingchanges as far-reaching as the UK RDR. CESR’s consultation paper outlines a‘proper fees regime’, which includes all the necessary fees an investment firm mustcharge in order to provide its services without affecting the best interests of its clients.Proper fees include: custody costs, settlement and exchange fees, regulatory leviesand legal fees.

It is too early to say where this debate will end, but it has the potential to challengedistributors/intermediaries’ business models.

Challenges for asset managers

The differences in the regulatory initiatives present real challenges for asset managersin terms of the distribution of their products. For example, there is a concern in someterritories that their domestic markets might be disadvantaged as inbound business willhave to comply with local regulation, hence making it less attractive. In Europe, there isalso uncertainty as to how far the MiFID changes will go in terms of aligning Europewith the UK and, to some extent, Australia.

What is clear is that the distribution of retail investment products needs to change.Retail investors lost trust in the industry during the economic crisis, and individualcompanies need to decide how they will regain that trust and respond to the new


Distribution channels in jeopardyAdapting to changes in the way products are distributed will be key to growth for asset managers insome retail markets. To varying degrees, regulatory changes in progress in Australia, Europe and theUK will alter distribution models and product strategies.

Ken OwensPricewaterhouseCoopers (Ireland)+353 1 792 [email protected]

Thierry BlondeauPricewaterhouseCoopers (Luxembourg)+352 49 48 2005 [email protected]

Sally CosgrovePricewaterhouseCoopers (UK)+44 20 7804 0669 [email protected]

Tony CookPricewaterhouseCoopers (Australia)+61 (2) 8266 [email protected]

regulation. In our view, they now need tolook at both their current product offeringand distribution models, to identify whatprocesses and structures are in place forthe remuneration of distributors. Whatseems certain is that asset managers willneed to do more to get the attention ofdistributors and their clients. The chartopposite outlines the growth of the mainEuropean distribution channels of retailinvestment products over the pastthree years.

What is the role of theintermediary/distributorgoing forward?

In Europe, independent financial advisors(IFAs) have been consistently one of themore popular distribution channels, butthis could all change under the newregulations. The general consensus withinthe industry in the UK is that IFAs willhave the greatest challenges under RDR.Banks and, to some extent, insurers areexpected to find the new environmentless threatening, although many hurdlesstill need to be overcome. As investorsseek alternatives to traditional distributionchannels, both the asset managers anddistributors must adopt new strategies toensure that they have a product mix thatis relevant to their target market and thattheir products are distributed effectively.

In addition to responding to thechanges in the market as set out above,UK distributors (whether they areindependent entities, part of banks/insurance companies or asset managers)also need to meet professional standards(equivalent of the first year ofa bachelor degree).

This sentiment is also reflected in theRipoll Report in Australia. It recommendsthat financial advisers must provideadvice that is in the clients’ best interestsand that there must be prominentdisclosure of any restriction on the adviceor product offering.

The future model

To varying degrees, depending on thecountry in question, the asset manager-intermediary-investor relationship is set tochange dramatically. Asset managersneed to re-engineer their businessmodels to compete more intensely acrossa broad range of areas, including productquality and design, service and price.

One thing is for certain, the winners inthis situation will be those who reactquickly and proactively to these changes,either by adjusting their current strategiesand business models or implementingnew ones. Whether these futuredistribution models result in a brand newmarket structure remains to be seen.


2009

2008

2007

0% 10% 20% 30% 40%

Source: European fund market data digest2007/2008/2009 by Lipper feri

n Institution

n Funds of funds

n Direct

n Supermarket

n IFA Advised

n Pensions

n Private Bank

n Retail Bank

The introduction of compulsory pensioncontributions is ensuring that the globalpot of assets to be invested is growing.The Australian fund management industryhas more than doubled in the last decadeand with pension reform hitting the UKfrom 2012, the UK fund managementindustry is expected to grow by up to£5 billion a year.

What does it mean?

From 2012 in the UK it will becomecompulsory to auto-enrol eligibleemployees into qualifying pension plans.The individual can then opt-out if theywish. It is expected that individual inertia,plus the expansion of plans to lowsalaried staff, will lead to an additional7 million individuals with privatepension plans.

Employees will be encouraged tocontribute a minimum of 4% of totalearnings and employers a minimum of3% which, with a further 1% tax relief,means a total minimum contributionof 8% will be paid into pension schemesfor each member annually.

And where will the money go?

In the UK, there are several options –your current retirement benefit scheme(if it counts as a qualifying scheme), thenew NEST scheme (National EmploymentSavings Trust) or a brand new plan.Companies will need to look at theircurrent providers of pension plans andconsider their options as auto-enrolmentis phased in.

Is it going to be enough?

In Australia individuals annually save 9%into their individual plans. The ageingpopulation are now realising that this isnot enough, with the average balance atretirement less than AUD 100,000. Thisis not just about increasing saving ratesbut about giving people the means to livecomfortably through 10 to 15 years ofretirement. Will the current proposalsallow this?

There are also concerns that it will takecustomers away from traditional savingsmethods – with auto-enrolment aimed atthose individuals who currently have nosavings provision, this is unlikely.

Further concerns that employers mightbe tempted to scale down their currentpension provision package to staff andcut their contributions to 3% have notmaterialised yet, but will be something towatch out for.

As an employer, what do I needto consider?

The latest PricewaterhouseCoopers UKPensions Survey, released in the summerof 2009, found two-thirds of companieswere concerned about the impact ofauto-enrolment. So what do UKemployers need to consider right now?

• Understand the full impact on yourorganisation, not just the pensionscheme. There will be a financialimpact of auto-enrolment as wellas operational challenges to yourinternal HR and payroll processesdue to the much higher numbers ofindividuals who will now be enrolledin a pension plan;

• Analyse the pension strategy and howthis might change post-2012; considerreviewing all scheme arrangements,including both defined benefit and thedefined contribution scheme;

• Consider this in the light of your overallreward strategy, including the currentuse of share incentive plans and otherflexible benefits;

• Will your current pension scheme needamending to meet the qualifyingscheme test? Is the current schemevalue for money and meeting theobjectives of both the employer andemployee?;

• Impact of tax relief changes in theBudget 2009 mean that tax relief forpension contributions will be restrictedfor senior individuals earning more than£150,000 annually – how does thisimpact your senior management?; and

• Communication strategy for your staffon the choices available.

Remember, pension reform is coming tomany parts of the world, and we all needto be ready for it.



Pensions reform – what does itmean and how will it impact me? In many parts of the globe, pensions reform is driving significant growth in asset management. InAustralia, this has already happened and it is set to in the UK from 2012.

Heidi JohnsonPricewaterhouseCoopers (UK)+44 20 7804 6575 [email protected]

Richard SmithPricewaterhouseCoopers (UK)+44 20 7804 [email protected]

The UCITS IV Directive is a game changer and Europe’s administrators will be playinga significantly different game in the coming years. Not all administrators are the same,so different solutions will be needed to prepare them for the transformation in theirenvironment. There is, however, some commonality in what they should be consideringto ensure survival and prosperity.

Understanding UCITS IV’s impact on your clients and, in turn, on their clients is thefirst step in determining your strategic response. The goal is to develop a strategy toretain existing clients and to identify opportunities to grow with them.

Change will also create opportunities for both targeting potential clients and offeringnew services to existing clients. Spotting and quantifying strategic opportunities foradministrators arising from fund mergers, master-feeder structure changes andpassporting – and positioning to take advantage of these – is key.

Reviewing operating models

Asset servicing companies’ operating models will need to be reviewed in light of thenew environment in which the industry is operating, post-UCITS IV, AIFMD and post-financial crisis. New models will focus on efficiency and cost (possibly through use of‘base and support’, centres of excellence or distributed models) and will align to clientneeds. Management structures, processes and supporting technology systems willchange too, so as to cater for changes in the model. As operating models change,there might also be an impact on staff requirements and skill sets.

Changes in the operating model are likely to have tax implications. As well as havingto cater for changes in client tax structures, administrators will need to identify andmanage their own tax exposures from corporation tax, stamp duty, transfer pricingand VAT perspectives.

Administrators will also need local regulatory expertise in the fund or managementcompany domiciles where they operate. Additionally, they will need to understand localrules governing the point of sale and distribution process.

The role of acquisitions

Some administrators might develop acquisition strategies to address areas of potentialweakness or to take advantage of new opportunities. Others will look at divestmentand might withdraw from the industry. If acquiring, administrators should considerpotential targets, geography and exactly what they are buying. If considering divesting,a strategy should be developed to ensure that maximum value is realised from thebusiness. Others might consider the potential for development of commercialagreements or joint ventures.

What is more, fund administrators servicing alternative investments are not excludedfrom today’s far-reaching changes. As more and more hedge fund managers introduceUCITS III structures, administrators catering for alternative investments will also needto consider the potential impact on their businesses.

Of course, all of this points towards the need for a detailed review of theadministrator’s strategic plan. Determining the impact of UCITS IV, and other marketand regulatory developments, on the business and on clients will help to identifystrategic direction. Administrators should be considering this now. This is a watershedperiod and the models established today will be here for many years to come.



Growth becomes more complexfor Europe’s administratorsFollowing the UCITS IV Directive, Europe’s fund administrators are in a new world. Prospering within itrequires navigating a path through complex issues.

Ken OwensPricewaterhouseCoopers (Ireland)+353 1 792 [email protected]

Thierry BlondeauPricewaterhouseCoopers (Luxembourg)+352 49 48 2005 [email protected]

Sally CosgrovePricewaterhouseCoopers (UK)+44 20 7804 [email protected]

To increase foreign investment, the Japan Ministry of Finance has proposed a newJapanese bond income tax exemption regime (J-BIEM) as part of its 2010 Tax ReformProposal. Once passed, J-BIEM will exempt qualified foreign investors from Japanesetax on interest and redemption gains from certain Japanese bonds.

To date, the Japanese corporate bond market is largely held by domestic investors.According to statistics provided by Japan’s Financial Services Agency, as of March31, 2009, 99.4% of Japanese corporate bonds were purchased by Japanese investors,versus 0.6% by non-residents. By contrast, in the United States, non-residentspurchased 24.1% of corporate bonds and, in the United Kingdom, non-residentspurchased 61.9% of corporate bonds.

The ministry believes that J-BIEM will reduce barriers to investment and that Japanesecorporations will have better access to foreign capital.

Current taxation of foreign investors

Currently, foreign investors in bonds issued by Japanese issuers (other than certainbonds issued offshore to offshore purchasers (minkan kokugai sai), Japanesegovernment bonds and other local government bonds) are subject to Japanesewithholding tax on interest, and subject to corporate tax on redemption proceeds inexcess of their acquisition or subscription price.

The withholding tax rate on bond interest is 15%, unless reduced by treaty.A redemption gain, which might arise from the purchase of bonds with original issuediscounts, or from the purchase at a discount of non-performing or underperformingbonds, is taxed at 30% if not reduced by treaty. For the bonds already mentioned asexempt, an exemption system for interest is currently in place, but claiming theexemption means following certain cumbersome procedures.

Changes under J-BIEM

Under J-BIEM, qualified foreign investors (primarily foreign corporations, foreignindividuals and certain qualified foreign securities investment trusts, excluding partiesrelated to the issuer) will be exempt from Japanese tax on interest and redemptiongains if the bond is a book-entry corporate bond (furikae shasai) other than a profit-linked bond.

For interest, the new J-BIEM is expected to apply to interest calculation periodsstarting on or after June 1, 2010, provided that the bond has been issued (or will beissued) on or before March 31, 2013.

Section B: General stories/Asia


J-BIEM – a new Japanese bondincome tax exemption regimeProposed rules are intended to make it easier for qualified foreign investors to buy bonds.

Raymond KahnPricewaterhouseCoopers (Japan)+81 3 5251 2909 [email protected]

Akemi KitoPricewaterhouseCoopers (Japan)+81 3 5251 2461 [email protected]

The ministry believes that J-BIEM willreduce barriers to investment and thatJapanese corporations will have betteraccess to foreign capital.

The effective date for redemption gaindepends on the type of bond, but isagain generally expected to be for bondspurchased on or after June 1, 2010.Different rules apply for short-term bondsissued at a discount.

a.Simplification of procedures

As mentioned, foreign investors incertain types of bonds are currentlyexempt from interest withholding. Thecurrent procedures, however, are verycomplicated and impose burdens onQualified Financial Intermediaries.

Under J-BIEM, the compliance processfor corporate bonds (but not minkankokugai sai) will be changed, making iteasier to comply with the exemptionrules. Although details have not beenreleased, the intention is to simplify thereporting process and make it easier forforeign bondholders to comply.

b.Extended scope of qualifiedforeign investors

To qualify for exemption, the bondholdermust be a foreign corporation, individualor qualified foreign securities investmenttrust. The current definition of a qualifiedforeign securities investment trustexcludes two-tier foreign securitiesinvestment trusts and foreign securitiesinvestment trusts with Japaneseinvestors. Under J-BIEM, these trusts willnow be eligible to claim the exemptionprovided certain conditions are met.

Outlook

J-BIEM should permit Japanesecompanies to have better access toforeign capital and increase liquidity inthe bond market.

Although implementation details have notbeen released, it is a welcome changeand another step in Japan’s continuingprocess to modernise its tax system tomake it easier for foreign investors toinvest. Beware, however, that these rulesapply to bonds only and not to loans.


With some credit easing and property values stabilising, Europe’s real estate industryviews 2010 with “cautious optimism”, but still faces a “long, slow haul” to recovery,according to Emerging Trends in Real Estate® Europe 2010, published by the UrbanLand Institute (ULI) and PricewaterhouseCoopers.

The seventh annual report is based on surveys and interviews with more than 600 ofthe industry’s leading authorities, including investors, developers, financiers and fundmanagers. Overwhelmingly, respondents cite the need to move forward cautiously,as Europe’s economy remains fragile and there is uncertainty over how and whenEuropean governments might wean their respective economies off the massiveinjections of state support. An abrupt withdrawal of the stimulus funds could derail therecovery, and even push the economy back into recession. Additionally, the reportnotes the looming problem of the refinancing of commercial real estate loans frombanks and CMBS conduits rolling over from 2012-2014.

Stabilising sentimentSentiment regarding investment prospects has stabilised and although sentimentregarding development continues to decline, it is a less dramatic fall than thatwitnessed last year. The key issue is the occupier side of the equation. Investors arenervous and they are concentrating on the deeper, more liquid markets.

Germany is viewed more favourably for investment and development activity than othercountries, due primarily to its broad economy. In terms of individual cities, Munich andHamburg were ranked by the report as the top two prospects in 2010 for existingportfolios, a ranking they also held in 2009.

Paris was ranked third by Emerging Trends in terms of prospects for existing portfolios,edging out London due in part to the general perception that it has a wider economicbase and is less dependent than London on the financial services sector. Intervieweespointed to the low level of vacancies in Paris, raising its ratings for investmentopportunities and, to a lesser extent, for development. Investor sentiment regardingLondon “improved significantly” from 2009, due primarily to a market correction led byan infusion of funds from the Middle East and Asia. The city ranked fourth in 2010 forinvestment in existing properties and first for new acquisition opportunities. Foracquisitions, the main focus is offices, with nearly half the respondents citing that asthe preferred asset type. Despite some scepticism over the limited extent of therebound, some interviewees indicated that they are confident enough about London tomake development plans for 2011, if not for this year.

Preferred property typesIn terms of property types, the quality of the location, building and tenant is the mainconsideration, according to the report. City centre offices, high-end street retail andshopping centres are the top commercial investment choices for 2010. Residentialinvestments are also highly rated. Although mainstream property types are preferred,niche sectors continue to have some limited appeal, including student housing, selfstorage, retirement homes, social housing, healthcare facilities and infrastructure.Green development of any kind is gaining significance, particularly with the EuropeanUnion introducing compulsory energy efficiency ratings for buildings. “It should becomepart of the DNA of our businesses,” said one respondent.

The overall sentiment is that more equity is available but it is primarily looking for“plain-vanilla real estate investments that everybody understands”, core and core-plus,“high-quality assets, already rented to very good tenants and based in the best centrallocations” in “the deeper, liquid markets of the U.K., France and Germany.” All thismeans that there is, in practice, a lot of money chasing the same relatively small poolof top quality assets.

Section B: General stories/Europe


Europe’s real estate industry infor ‘long, slow haul’ to recoveryEmerging Trends in Real Estate® Europe 2010 shows that sentiment is stabilising, although there iscaution about the progress of recovery.

John ForbesPricewaterhouseCoopers (UK)+44 20 7804 [email protected]

One of the many shocks to the financialsystem emerging from the banking crisiswas a serious wake-up call for the assetmanagement industry. Pain was feltacross the value chain – from primebrokers, asset managers, custodians,depositaries, right through to endinvestors. While the news headlinestracked banks going bust, funds closingand huge government bailouts, we alsosaw the exposure of poor practices thathad been accepted in the good times,but came home to roost in the bad.

The crisis highlighted a lack of focus onoverall exposure management, whichmanifested itself in many ways:

• A lack of understanding of contractualrelationships, both in terms of who thecontracting legal entities were and thelegal provisions of the contracts.

• Inadequate reporting and managementinformation, which did not providethe manager or investor with therequired degree of oversight andtransparency. This displayed itself inpoor understanding of how investorassets were being held and underwhat terms, e.g. legal status ofre-hypothecated assets.

• A business model that does not valueback and middle offices. Too manymodels that are cost-driven ratherthan treating these functions as part ofthe ‘value’ chain, providing oversightand security.

• A concentration risk arising fromdependency on single providers.

Each of these are concerning in theirown right but, put together, they suggestpoor governance and controls acrossthe industry. At a time when the industrywants to encourage investors backinto the market, this issue is high onthe agenda.

So who is doing what?While investors are happy to acceptsome exposure risk, they want toreduce the risk of big losses and are,consequently, questioning the duediligence processes of their advisers and

of other participants in the value chain.Some are expressing a willingness topay ‘more’ for a greater level of downsideprotection.

The regulators are focusing on thesupervisory regime and increasing itsresources. They are driving an agendafor control and recovery plans forsystemically important financialinstitutions.

Asset managers, meanwhile, arereviewing operating models and planningremedial actions where necessary. Manyare using this exercise to demonstrateenhanced governance and control,viewing it as both a hygiene factor anda potential competitive advantage.

Finally, advisers and other intermediariesare seeking to demonstrate theirawareness of the potential exposuresand the steps they are taking to enhancetheir assessment frameworks and giveinvestors ‘best advice’.

What should you be doing?Across the value chain, there is workto be done, starting with investors.They should seek to manage their overallexposures by demanding transparencyand evidence of effective governancefrom intermediaries and asset managers.This should be corroborated by evidenceof good governance through pre- andpost- investment due diligence, e.g.SAS70 control reviews.

Advisers and intermediaries need toimprove their due diligence standardsand make clear that effective oversight ispart of the value their service provides.

The asset managers themselves shouldensure that their contractual relationshipswith third parties are clearly understoodand provide them with the level ofprotection required. They shouldmaximise the ‘value’ in their ‘value chain’through an end-to-end review of theoperating model. Finally, they shouldimplement controls and reporting thatgive them the oversight and transparencythat will be demanded by investors, andthat will help avoid any nasty surprises inthe future



Managing exposures effectively,post-crisisFollowing the crisis’s exposure of poor governance across the asset management value chain, allparties are taking action to improve management of exposures.

Andy KennyPricewaterhouseCoopers (UK)+44 20 7212 [email protected]

Advisers andintermediaries needto improve their duediligence standardsand make clear thateffective oversight ispart of the value theirservice provides.

Perhaps one of the most common European fund industry topics currently is the re-domiciliation of offshore funds into the EU. On the one hand, investor pressure fortransparency and the UCITS IV passport present the “carrot” of additional fund inflowsfor onshore vehicles — on the other hand, the emerging Alternative Investment FundManagers Directive (AIFMD) and challenges to offshore domiciles may act as the“stick” making a move onshore even more compelling.

Anticipating increasing interest, Ireland and Malta have both acted to make it easier forfunds seeking to migrate. The United Kingdom is considering similar action in respectof non-UCITS funds, while Luxembourg’s existing legislation already enables funds tomove there.

Ireland and Malta change legislation

Ireland strengthened its proposition in December 2009 by passing the provisionsof the Companies (Miscellaneous Provisions) Act 2009. The legislation enables offshorecorporate funds to re-domicile to Ireland through a registration procedure. Thisprovides the opportunity to establish the fund as an onshore regulated investmentcompany, while retaining its legal identity through registration under Irish law.

Also in December, the Malta Financial Services Authority published guidelines for re-domiciling offshore funds to Malta under the Companies Act, Continuation ofCompanies Regulations, 2002, following increased enquiries about re-domiciliationprocedures in recent months from various fund managers. To date, largely insurancecompanies and securities firms have been using Malta’s re-domiciliation legislationsince it came into force in 2002, as the process also allows companies to retain thesame legal personality.

In Ireland, migrating funds will also be required to obtain authorisation with the IrishFinancial Regulator, as is the case for all Irish fund companies.

Broadly, migrating funds must:-

• Make an application to the Registrar of Companies in Ireland, together with astatutory declaration containing certain confirmations;

• Provide a schedule of charges and security interests granted by the fund as wouldhave been required if it was originally created as an Irish fund company;

• Provide a statutory declaration by a solicitor or director of the fund confirming that allrequirements have been met.

The simplified procedure is further complemented by a commitment from the IrishFinancial Regulator to allow for a coordinated authorisation process to facilitate speedto market. Notably, this will be widely welcomed by the fund industry given theauthorisation delays that can be faced.

The recent Malta guidelines allow funds to have external administrators andcustodians, in contrast to other jurisdictions which require the service providers to bepresent in the domicile of residence.



European domiciles seek totempt funds onshoreAs funds respond to investor pressure for transparency and the regulatory onslaught by movingonshore, some European domiciles have passed, or are considering, enabling legislation.

Andrea KellyPricewaterhouseCoopers (Ireland)+353 1 792 8540 [email protected]

Jerry DawsonPricewaterhouseCoopers (UK)+44 20 7804 [email protected]

Nicolas SchulzPricewaterhouseCoopers (Luxembourg)+352 49 48 48 4211 [email protected]

Joseph CamilleriPricewaterhouseCoopers (Malta)+356 2564 7603 [email protected]

Luxembourg and the UK’spositionsLuxembourg’s existing legislation enablesoffshore funds to re-domicile throughtransferring the registered offices ofoffshore corporate funds to Luxembourgwithout changing their legal identities.For that purpose, offshore funds musthold an extraordinary general meetingof shareholders before a Luxembourgnotary, in order to ratify the re-domiciliation in Luxembourg andto enforce the amended articlesof incorporation of the fund.Documentation, similar to the Irishprocess described above, must also beapproved by the Luxembourg regulator(the Commission de Surveillance duSecteur Financier), including, inter alia,the fund’s re-domiciliation documents(prospectus and articles of incorporation)and minutes of the extraordinary generalmeeting resolving to transfer the fund’sregistered office to Luxembourg.Once the fund has re-establisheditself as Luxembourg domiciled,it will be subjected to Luxembourgregulatory provisions.

There are initiatives in the UK to addressthe striking mismatch between the UK’sposition as a prominent hedge fundmanagement centre – home to 80% of

European hedge fund managers – andthe fact that very few hedge funds aredomiciled and/or administered there.The Alternative Investment ManagementAssociation has recently submitted apaper to HM Treasury requesting that itcommits to establishing a tax-neutral andflexible regulatory regime suitable forUK and non-UK investors. Additionally,a number of full-service hedge fundadministrators have recently set up inthe UK, improving its attractiveness asa domicile, and the considerable rise inthe euro against the pound has improvedthe UK’s cost competitiveness as anadministration centre.

Re-domiciliation of alternative investmentfunds to regulated and well-servicedOECD jurisdictions is already takingplace, with promoters taking advantageof the UCITS brand and looking to exploitthe UCITS IV Directive’s distributionopportunities. When the AlternativeInvestment Fund Managers Directivebecomes law, depending on its final form– which should be apparent in about sixmonths' time – many managers may findthat moving funds onshore becomes notjust advantageous , but necessary. Everyhedge fund manager should already havea project plan in place to assess theattractiveness of the size of the “carrot”,as well as the impending impact ofthe “stick”.


Once the fund hasre-establisheditself as Luxembourgdomiciled, it willbe subjected toLuxembourgregulatory provisions.

Asset management is a strategic industry in every country, particularly in Italy wherethe propensity to save is notably high and the legal framework ensures a high levelof safeguards for retail savers. Yet the recent past gives us examples where failures toprovide management services with care and diligence, and in the best interest ofinvestors, has undermined the asset manager’s reputation. Asset managers haveto re-think the way they manage relationships with investors, ensuring the consistentand sustainable compensation of every stakeholder. Compliance has a key role to playin this.

Fundamental pre-requisites of the compliance function are to be independent andeffective. Its ultimate objectives are to encourage behaviours that generate sustainableand significant competitive advantages, and to rebuild customer trust.

The advisory team from PricewaterhouseCoopers Italy and the Association of ItalianAsset Management Companies have surveyed leading local asset management housesabout their compliance functions. We aimed to analyse the compliance function’sorganisation following enforcement of the European Union Markets in FinancialInstruments Directive (MiFID) in 2007, addressing the consequent costs, as well as thefunction’s effectiveness and efficiency.

Key findings

The survey provides an insight into the compliance function from different perspectives,revealing respondents’ shared views and approaches concerning certain key issues:

• From an organisational standpoint, the compliance function reports directly to theBoard of Directors, or the Chief Executive Officer, or the General Manager;

• 94% of Italian asset management companies have decided to centralise thecompliance function at parent company level;

• Compliance employs an average of five people, compared with three for internalaudit, but is smaller than the risk management and management informationfunctions which, respectively, employ seven and 10 staff.

The table below illustrates the resources dedicated to control and monitoring functions,as a percentage of total headcount.



Compliance matters in ItalyIn Italy, as elsewhere, compliance is becoming a value driver in the asset management industry.

Mauro PanebiancoPricewaterhouseCoopers (Italy)+39 02 66720568 [email protected]

Percentage of human resources allocated to control functions

Source: PricewaterhouseCoopers

2%InternalAudit

14%Back Office

12%Finance

5%Risk

Management

3%Compliance

7%ManagementReporting

• 40% of compliance staff areoutsourced, as opposed to otherfunctions where staff are employed;

• MiFID enforcement, and thedevelopment of adequate systems andtools to monitor investment limits, haveabsorbed most of the staff and costsduring the recent past and participantsforecast the same trend for the nearfuture;

• With regard to perceived costs andbenefits, respondents believed that inthe recent past costs were higher thanrelated benefits, yet in the next fewyears they see the benefits increasing,justifying the high costs incurred.

See chart above about the ratio betweenbenefits and costs, as of today and in thenext three years.

The European landscape does not differfrom the Italian one, even though only41% of European asset managers have acentralised compliance function, against94% of Italian players.

New challenges

The growing complexity of thecompetitive landscape compels assetmanagers to re-think the role of theircompliance function towards anintegrated and innovative model, wherethe governance, risk management,internal audit and compliance functionsco-operate to mitigate inherent internalprocess risks. Furthermore, complianceshould act as an internal consultant fortop management, helping to assess newbusiness initiatives and being involved inkey decision processes.

The independence of the compliancefunction is becoming essential to assetmanagers’ operating effectiveness. It is,therefore, fundamental that compliancedoes not depend on operating functions,which, in turn, must have anunconstrained relationship withcompliance.

Conclusions

The survey shows that the new role ofcompliance, and the development ofbroader competencies, has not yet beenwholly accomplished by the leadingItalian asset management companies.They need to appreciate the strategicvalue of compliance in rebuilding theirstakeholders’ trust.



12%

24%

18%

12%

Benefits

Costs

HighLow

Low

Hig

hM

ediu

m

Today

34%

41%

12%

29%

0%

Benefits

Costs

HighLow

Low

Hig

hM

ediu

m

Next 3 years

18%

Source: PricewaterhouseCoopers Source: PricewaterhouseCoopers

ASC 740, or FIN 484 as it was formerly known, is attracting a lot of attention amongasset managers, as alternative investment funds that employ U.S. GAAP must nowformally document and assess their inventories of uncertain tax positions ("UTPs")5

for the 2009 financial year. The option to defer, which many asset managers tookadvantage of in recent years, is no longer available.

The adoption process has presented asset managers, particularly those with a moreinternational trading presence, with a unique set of challenges.

A common feature of many fund structures, particularly so called master funds, is their'flow through' status for US Federal Tax purposes. For such funds, many of the USFederal UTPs are investor-level issues, and therefore outside the domain of FIN 48.This is not necessarily the case, however, for many non-US UTPs. Were these UTPs tocrystallise, they would become direct tax liabilities of the fund itself because the notionof fiscal transparency is often a US tax fiction that is not necessarily respected by alltaxing jurisdictions.

For example, does the fund have a taxable presence (ie, a permanent establishment, orPE) in any of the locations in which it has investments, or where its management iscarried out? Such questions have proven very challenging for the alternativeinvestment industry. The governing law as it applies to funds is often either unclear orthere is no taxing authority precedent with respect to a particular UTP (eg, theimposition of non-resident capital gains tax), but nevertheless a technical exposurecould still exist. Analysing such positions under FIN 48 – where detection risk cannotbe assumed – can, and has, led to some unpalatable results for asset managers,particularly those with open-ended funds.

Raising awareness of tax risk

Notwithstanding the anomalies that FIN 48 can yield in the fund industry, the standarditself, in particular the requirement to assess and document a Fund's UTPs, hasarguably raised the overall level of awareness of, and sensitivity towards, tax risk andthe importance of managing it on an ongoing basis. This is a welcome development,whether spurred by FIN 48 or not, as the taxing environment has become moreadversarial and fund structures more susceptible to challenge in a world wheregovernments are seeking to repair unprecedented fiscal deficits. In this environment,asset managers can expect a more rigorous enforcement of tax rules and swifterclosure of loopholes.

The standard further has a number of disclosure requirements, which asset managersshould carefully consider. While the disclosure requirements for non-public entities arenot as onerous as they are for their public counterparts, the level and nature ofinformation disclosed by funds might have ramifications that go beyond financialreporting. By way of example, the US Internal Revenue Service has recently announced(Announcement 2010-9) a proposal that would require certain business taxpayers todisclose their uncertain tax positions (determined under ASC 740 or other applicableaccounting standards that the fund is subject to) on a schedule to be filed with theirannual tax returns. While this proposal is still at an embryonic stage, and the devil willultimately be in the detail, it is a development that funds should monitor closely to fullyunderstand the potential impact.

Proper implementation of ASC 740 should leave funds better placed to withstand theslew of anticipated tax audits across the globe, and may also foster better relationshipswith their investor base in an environment where investors, and indeed regulators, areincreasingly focused on risk management.

Section B: General stories/North America


Preparing FIN 48’s uncertaintax positionsThe U.S. requirement to disclose uncertain tax positions presents several challenges but, ultimately,should be welcomed in a testing tax environment.

Thomas GroenenPricewaterhouseCoopers (US)+1 646 471 7026 [email protected]

Oscar TeunissenPricewaterhouseCoopers (US)+1 646 471 3223 [email protected]

Alan BiegeleisenPricewaterhouseCoopers (US)+1 646 471 3588 [email protected]

4 Financial Accounting Standards Board ("FASB")Interpretation No. 48, Accounting for Uncertainty inIncome Taxes, an interpretation of FASB StatementNo. 109 (‘‘FIN 48’’) was issued in June 2006,effective for fiscal years beginning after December15, 2006. FIN 48 became effective for pass-through entities for annual financial statements forfiscal years beginning after December 15, 2008.

5 FIN 48 requires funds that employ US GAAP –typically US feeder funds investing into hedge fundand private equity structures – to formallydocument and assess their inventory of uncertaintax positions, and where the level of comfort withrespect to a particular UTP is below the more likelythan not ("MLTN") threshold (broadly less than50%) then a tax accrual is potentially required,depending on materiality and the outcome of themeasurement analysis. Note, to the extent a UTPwill MLTN be sustained (more than 50%), a reservemight still be required under the measurement test.

When President Obama released hisAdministration’s proposed budget, onFebruary 1, 2010, which for the secondyear in a row included a provision thatwould change the taxation of carriedinterests, it became clear that this couldhave a far-reaching effect on the assetmanagement industry. A few monthsearlier, on December 9, 2009, the USHouse of Representatives voted to taxcarried interest similarly. Washingtoninsiders now indicate there is a significantrisk that carried interest legislation willpass in the near future, given the need forCongress to provide revenue offsets fortax legislation this year.

The term ‘carried interest’ generallyrefers to the manner in which investmentmanagers are typically compensated byhedge funds, private equity funds and realestate investment partnerships. USlegislators have increasingly focused onthe tax treatment of carried interest overthe past few years, with the view that fundmanagers should pay tax on their shareof profits at the same rates that regularemployees do on ordinary wages.Proposals to tax income earned from acarried interest as ordinary income havenow been passed three times by the USHouse of Representatives as a futuresource of revenue (expected to raiseapproximately $24.6 billion), although theSenate has not approved similar measures.

The proposed legislationPresident Obama's proposal is aimed atall service partnership interests, whereasthe House proposal is narrower. Bothproposals change the tax treatment ofincome received on a carried interest,making it equivalent to ordinary incomeand subject to the highest marginal UStax rates as well as self-employmenttaxes. Uncertainties concerning whethersuch income would be US effectivelyconnected income, as well as sourcing,are expected to be addressed in treasuryregulations that would be promulgatedunder enacted law.

The House proposal is aimed atpartnerships that provide particularservices with respect to securities, realestate, commodities and related options

or derivatives. The legislation treats netincome from an ‘investment servicespartnership’ (ISP) as ordinary income.A partner would be deemed to acquire anISP if the partner was expected to provide(or has already provided) a substantialquantity of certain services to theunderlying partnership. The coveredservices generally include investmentadvising, managing, arranging financingand any activity supporting these services.

In addition, gains or losses from thedisposition of an ISP are treated asordinary. Distributions of appreciatedproperty with respect to the ISP alsorequire that the partner recognisesordinary income. The Administration andHouse proposals, however, do not applyto allocations relating to invested capital,which generally include contributed cashand property.

Other entitiesThe proposals also apply to other typesof interests and not just partnershipinterests. The current scope of theproposed tax legislation extends toany entity where a person performsinvestment management services for suchentity, and holds an interest in such entitywhere the value is substantially relatedto the amount of realised, or unrealised,income from the assets that are thesubject of the investment managementservices. Take the example of a managerholding stock in a foreign feeder fund andperforming investment managementservices for the underlying master fund.In this case, dividends or gains from theforeign feeder stock could be treated asordinary income if the value of stock weretied to the performance of the masterfund’s assets.

ObservationsIf enacted, the proposals would have afar-reaching impact. A service partnerwho earns future income, or currently hasunrealised income attributable to a carriedinterest, would treat such income whenrealised as ordinary income, unlessattributable to invested capital. Aspreviously mentioned, to the extent the

service provider owns stock in a foreigncorporation that is a partner in a fund, theincome from holding such stock may alsoconvert to ordinary income. While suchincome might currently be ordinaryincome because the foreign corporationwould likely be a passive foreigninvestment company, the income wouldadditionally become subject to self-employment taxes. Fund managers thatelect to waive or reduce fees could beaffected. Retired partners who no longerprovide services but own carried interestswould feel the impact as well.

Another aspect to closely monitor is theeffective date of such legislation, as wellas certain transitional rules. As currentlyprovided in the House bill, unrealisedgains in a partner's carried interest thatexist at the time of the effective datewould be converted from capital gain toordinary income. Depending on the timingand transition period of any carriedinterest legislation, planning opportunitiesmight exist.

Overall, Washington insiders indicatethat there is a significant risk that carriedinterest legislation will pass in the nearfuture given the need for Congressto provide revenue offsets for taxlegislation this year. What is unclear,however, is the overall scope, effectivedate and transition rules.



Carried interest legislation movesa step closerPresident Obama’s budget makes new legislation for taxing carried interest increasingly likely,although the timing and transitional rules are unclear.

Allison RosierPricewaterhouseCoopers (US)+1 646 471 5511 [email protected]

Yen TranPricewaterhouseCoopers (US)+1 646 471 4819 [email protected]

A recently settled US Securities &Exchange Commission (SEC) enforcementaction has drawn attention to the valuationprocess. The SEC alleged prolonged andsystematically inappropriate valuations ofmortgage-backed securities owned by aregistered mutual fund, resulting in thepenalty payment of approximately US$40million to the fund’s investors.

The past two years’ market volatility hasheightened awareness of potentialweaknesses in valuation processes.Institutional investors, regulators and othersare seeking to understand more aboutvaluation processes and to judge whetherthey are impartial.

As markets pick up and real estate andinvestment advisers seek new moneyto manage, they need to demonstratethat they are complying with the highestvaluation standards practicable.Yet the diverse nature of assets undermanagement and differing operationalstructures makes establishing appropriatechecks and balances a challenge.

Senior executives and boards of assetmanagers and investment funds need toprotect their investors – and themselves –and to ensure that valuation processes arefair to all stakeholders. The questions weaddress below are aimed specifically at USinvestment advisers, but similar principlesapply in international markets.

What principles should seniormanagement and boards apply toprovide effective oversight?

Under SEC rules, investment advisers areheld to a fiduciary standard to act in theirclients’ best interests. Valuations should bebased on readily available and reliablemarket prices or, in the absence of suchprices, at fair value as determined in goodfaith by a board of directors or itsequivalent. The SEC Division of InvestmentManagement has, for the most part,embraced the exit price valuation guidancein FAS 157 (ASC 820), as well as theclassification principles of ‘observable’and ‘unobservable’ valuation inputs.

Regarding oversight, the SEC has indicatedthat the board of directors is responsible forestablishing the valuation policy. It expectsdirectors or their equivalent to exerciseindependent, objective oversight andjudgment with respect to execution of thepolicy, and related valuation and pricingprocedures.

For hedge funds, the InternationalOrganisation of Securities Commissionshas defined valuation principles, and FAS157 has raised the bar by requiring moretransparent valuations. Some hedge fundsare turning to fund administrators orvaluation experts for valuations ofinstruments not traded in liquid markets.

For private equity, FAS 157 and similarinternational accounting conventionsrequire more robust fair value determinationthan the historic practice of valuing at costor the value of the last financing round.

Real estate valuations should be executedat least quarterly, internally or externally,according to The National Council of RealEstate Investment Fiduciaries. Valuation byan independent party must be carried outat least every 36 months.

How do you determine that there iseffective independence, accountabilityand segregation of duties in theoversight and execution?

The board’s valuation committeeestablishes valuation policies andprocedures, and reviews valuation results.In volatile markets, when fair valuations

increasingly replace market prices as thebasis for valuations, the committee couldmeet more frequently.

How does the organisation and controlstructure ensure that pricing policies areconsistent across all products?

Asset managers need to promoteconsistent pricing policies, to protect themfrom the charge of favouring onestakeholder over another. A single, primarysource should be identified and the qualityshould be monitored. Where it is notpractical to do this, a process is needed tocompare results and to understand whydifferences are justified.

Do policies and procedures provide cleardirection, address difficult valuationsituations and include effectiveoperational controls?

Creating policies and procedures thatprovide employees with helpful guidanceand practical operational controls requirescareful evaluation of operations. Policiesand procedures need to be reviewedregularly to address changes in thebusiness – during volatile markets frequentreview becomes even more important.

Are senior management and the boardproperly informed of valuation risks andmitigating controls?

Key valuation risks should be defined,monitored and mitigated. Operatingmanagement should be charged withdeveloping controls that monitor theserisks, so that they are addressed in a timelymanner.

In conclusion, asset managers need toassess valuation risks, policies, operatingprocedures and related internal controlsmore frequently than ever before. In ourexperience, many firms either have notestablished an adequate valuationframework, or fall behind in assessingtrends and events that might affectvaluation methodologies.

This article is an extract from our whitepaper: Valuation Process Transparency:Demands challenge asset managersand directors.



Building transparentvaluation processesThe credit crunch revealed the inadequacy of some valuation processes. Investor and regulatorscrutiny demands that valuation frameworks are continually reviewed.

Tony EvangelistaPricewaterhouseCoopers (US)+267 330 7380 [email protected]

Richard GrueterPricewaterhouseCoopers (US)+617 530 7414 [email protected]

The headlines say it all: Defrauded fundinvestors sue; manager investigated forfraud; ponzi schemes proliferate.

Institutional investors are now seekingmore transparency from the investmentfirms that handle their assets. They havelearned that it is no longer advisable forinvestors to rely simply on the historicalperformance returns of investmentmanagers. Instead, investors need tosharpen their focus on due diligence.

Strong reputation, common businessor social relationships cannot replacethorough scrutiny. Today’s businessenvironment demands that investorsleverage their due diligence programmesto evaluate the ability of an investmentmanager’s control environment to mitigateemerging risks. They need to evaluatethrough rigorous testing of the controlenvironment’s design and operatingeffectiveness.

Due diligence essentials

While many investors have begun to takethe necessary steps, most do not possessthe review processes and resources toavoid risk and loss. Investors that candevelop a sound oversight programme,dive deeper into myriad factors andperform a comprehensive review will notonly mitigate potential risks, but mightalso yield a better-performing portfolioand enhanced reputation.

An effective manager oversightprogramme should be integrated withinthe institutional investor’s governanceframework. It should have well-documented policies and proceduresrelating to the ongoing evaluation ofthe investment manager’s controlenvironment. These should addressthe following thematic areas: identifying,prioritising and addressing risks;documenting, measuring and assessingthe effectiveness of controls to mitigatethose risks; identifying and escalatingissues identified through rigorous testing;and reporting the results of the duediligence to interested parties.

Continual due diligence of an investmentmanager should, at a minimum, addressthe following high-risk areas:

• Management integrity andcompetency

A quality review of the investmentmanager’s key personnel shouldinvestigate: history of the firm,background of senior management,investment manager’s experience ofmanaging a team, percentage of fundcapital owned by principals, locationsand respective functions of fundmanager, compensation arrangements,affiliations and strategic relationships.

• Internal anti-fraud programmes

Programmes and controls focusedon fraud prevention and detectionshould be a part of the fabric of theorganisation, and not just addedpiecemeal to meet investorexpectations.

• Portfolio management and trading

An investment manager must haveproper procedures in place to ensurethat investment decisions are madein accordance with the clients’objectives and restrictions.

• Operations

An investor should focus on thepolicies, procedures and controlsrelated to certain key operationalfunctions.

• Compliance

A functioning and properly controlledcompliance organisation is key.

• Information technology

A robust information technologyenvironment is essential to theoperating environment of aninvestment manager.

Historically, many investors performeddue diligence by meeting with theinvestment manager periodically toenquire about the controls related toinvestment processes, and by reviewingreporting. However, in today’s highlycompetitive environment for investmentdollars, the investors should not onlyunderstand the control environment butalso encourage advisers to have aninternal control attestation performed,which will enable investor due diligence tobe more comprehensive, and at a lowercost to both parties.

This article is an extract from ourwhite paper: Seeking transparency inuncertain times: Refocusing yourinvestment adviser due diligenceprogram.



Seeking transparency throughdue diligenceRelying on yesterday’s approach towards investment management due diligence will not sufficetomorrow. Investors must be proactive and more involved to make the right choices and find success.

Kevin O’ConnellPricewaterhouseCoopers (US)+1 617 530 7785 [email protected]

Global Asset Management contactsAsset Management News is produced by experts in their particular field to address important issuesaffecting the asset management industry. If you would like to discuss any aspect of this document,please speak to your usual contact at PricewaterhouseCoopers or a member of our global or territoryleadership team.


If you would like to receive copies of this newsletter or would like further information about PricewaterhouseCoopers’Asset Management publications, please contact [email protected]

Editor: Rupert Bruce

Global Asset Management Leadership Team

Marc SaluzziPricewaterhouseCoopers (Luxembourg)Global Asset Management Leader+352 49 48 48 [email protected]

Barry BenjaminPricewaterhouseCoopers (US)Americas Asset Management Leader+1 410 659 [email protected]

Brendan McMahonPricewaterhouseCoopers (Channel Islands)Global Asset ManagementPrivate Equity Leader+44 1534 [email protected]

Will TaggertPricewaterhouseCoopers (US)Global Asset ManagementTax Leader+1 646 471 [email protected]

Kees HagePricewaterhouseCoopers (Luxembourg)Global Real Estate Leader+352 49 48 48 [email protected]

Pars PurewalPricewaterhouseCoopers (UK)UK Asset Management Leader+44 20 7212 [email protected]

Robert GromePricewaterhouseCoopers (Hong Kong)Asia Pacific Asset Management Leader+852 2289 1133 [email protected]

Tony ArtabanePricewaterhouseCoopers (US)Global Asset ManagementHedge Funds Leader+1 646 471 [email protected]

PricewaterhouseCoopers (www.pwc.com) provides industry-focused assurance, tax and advisory services to build public trust and enhance value for our clients and their stakeholders. More than163,000 people in 151 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice.

This report is produced by experts in their particular field at PricewaterhouseCoopers, to review important issues affecting the financial services industry. It has been prepared for general guidance onmatters of interest only, and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive. No representation or warranty (express or implied) is given as to theaccuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers firms do not accept or assume any liability, responsibility orduty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

ArgentinaDiego Sisto+54 11 4850 4715

AustraliaMark Haberlin+61 2 826 63052

AustriaThomas Strobach+43 1 501 88 3640

BahamasDawn Jones+1 242 302 5300

BelgiumEmmanuèle Attout+32 2 710 40 21

BermudaAndrew Brook+1 441 299 7126

BrazilJoão Manoel dos Santos+55 11 3674 2224

CanadaRajendra Kothari+1 416 869 8678

Cayman IslandsNoel Reilly+1 345 914 8600

Channel IslandsBrendan McMahon+44 1534 838234

ChileRoberto Villanueva+56 2 940 0070

ChinaAlex Wong+86 21 2323 3171

CyprusCostas Mavrocordatos+357 22 555 202

Czech RepublicRichard Jones+420 2 51 152 161

DenmarkMikael Sørensen +45 39 45 9269

FinlandTuukka Lahkela+358 9 2280 1333

FranceAlain Le Barbanchon+33 1 5657 1084

GermanyStefan Palm+49 69 9585 2571

GibraltarEdgar Lavarello+350 73520

GreeceMary Psylla+30 210 6874 543

Hong Kong SARRobert Grome+852 2289 1133

HungaryDavid Wake+36 1 461 9514

IndiaGautam Mehra+91 22 6689 1155

IndonesiaMargaret Margie+62 21 521 2901

Ireland (Republic of)Damian Neylin+353 1 792 6551

Isle of ManMichael Simpson+44 1624 689 689

ItalyElisabetta Caldirola+39 2 778 5380

JapanTakeshi Shimizu+81 90 6515 1754

South Korea (Republic of)Jae-Hyeong Joo+82 2 709 0622

LatviaJuris Lapshe+371 709 4400

LithuaniaChristopher Butler+370 5 239 2300

LuxembourgJohn Parkhouse+352 49 48 48 2133

MalaysiaMohammad Faiz Azmi+60 3 2173 0867

MaltaJoseph Camilleri+356 2564 7603

MexicoEduardo Gonzalez+52 55 5263 6072

NetherlandsFred Gertsen+31 10 407 6614

New ZealandPaul Mersi+64 4 462 7272

NorwayGeir Julsvoll+47 95 26 05 40

PakistanSohail Hasan+92 21 2419322

PolandAntoni Reczek+48 22 523 4340

PortugalAntónio Assis+351 213 599 000

RussiaRichard Gregson+7 495 967 6327

SingaporeJustin Ong+65 6236 3708

SlovakiaChristiana Serugova+421 2 59 350 614

South Africa (Republic of)Pierre de Villiers+27 11 797 5368

SpainAntonio Greño+34 91 568 46 36

SwedenSussanne Sundvall+46 8 555 332 73

SwitzerlandThomas Huber+41 58 792 2436

TaiwanRichard Watanabe+886 2 2729 6704

ThailandMichael Haddon+66 2 344 1031

United KingdomPars Purewal+44 20 7212 4738

United States of AmericaBarry Benjamin+1 410 659 3400

Territory Leaders

pwc.com© 2010 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” and “PwC” refer to the network of member firms of PricewaterhouseCoopers International Limited (PwCIL). Eachmember firm is a separate legal entity and does not act as agent of PwCIL or any other member firm. PwCIL does not provide any services to clients. PwCIL is not responsible or liable for the acts oromissions of any of its member firms nor can it control the exercise of their professional judgment or bind them in any way. No member firm is responsible or liable for the acts or omissions of anyother member firm nor can it control the exercise of another member firm’s professional judgment or bind another member firm or PwCIL in any way.

Asset Management News March 2010 - PwC · 2015. 6. 3. · Asset Management News March 2010 ETFs to...

Documents

Transcript of Asset Management News March 2010 - PwC · 2015. 6. 3. · Asset Management News March 2010 ETFs to...