Proposals to establish a UK ETF domicile and regulatory framework would see muted uptake and spell higher costs for end investors, according to Michael John Lytle, CEO of Tabula Investment Management.
Speaking to ETF Stream, Lytle (pictured) argued while greater fragmentation could create new opportunities for smaller players, the result would be greater inefficiency for investors and the wider market.
“The idea of trying to create a UK ETF industry to rival Ireland is delusionary and taking exactly the wrong lessons away from Brexit,” he said.
“The inefficiencies this would create would ultimately cost investors through rising rather than falling fund costs and impact on management fees and competition.”
Lytle’s comments come after just one ETF – the Commerzbank CCBI RQFII Money Market UCITS ETF – has been domiciled in the UK, with no subsequent strategies following suit in the subsequent nine years.
No uptake for UK challenge to UCITS
Responding to the two-part proposal presented to the UK Department for Business and Trade, Lytle said the introduction of a UK ETF regulatory structure would add little value and offer no challenge to the popular UCITS regime.
Turning to a European country operating its own fund and ETF framework alongside UCITS – Switzerland – Lytle argued this is an example the UK should not look to emulate and there are few meaningful advantages offered by the domestic regulation.
“Swiss ETFs are only sold to Swiss investors and nobody else will buy them, so that is inherently a limited pool,” Lytle said. “The only meaningful difference between Swiss funds and other UCITS funds is unlike UCITS, they allow you to put physical assets into a fund structure, so ZKB can offer physical gold ETFs rather than an ETC, for instance.”
If the UK were to go the way of Switzerland in allowing exposures within its ETF regime currently outlawed by UCITS, such as semi and non-transparent active, he said such developments would also do little to move the needle.
“In the US, they spent an entire decade coming up with a whole series of different of semi and non-transparent structures, only for them to raise almost no assets.”
On the contrary, Lytle said the main effect of a UK rival to UCITS would be add a distribution headache for asset managers in deciding under which regime to launch ETFs.
“It would mean asset managers might launch some products in Europe and some in the UK, depending on where they believe demand will be. That does not benefit investors s they get exposure to fewer new products.”
UK domiciling not a sweet deal
While investors often extoll the virtues of the tax efficiency of Irish ETF domiciling, Lytle said the UK offering tax efficiency for UK-domiciled ETFs capturing UK assets would not be a great enough incentive to inspire widespread uptake.
He noted two domiciles – Ireland and Luxembourg – have established footholds as the domiciles of choice for UCITS vehicles being accessed by European and global investors, with the result being “a concentration of capabilities and therefore service providers and therefore cost reduction”.
Lytle reflected on a 2012 initiative by the Treasury to change tax rules to make UK-domiciled ETFs more attractive: “I remember having a conversation with the Treasury and they asked ‘if we make these things function pretty much as efficiently as an Irish fund, will people come and buy UK ETFs?’.
“I said ‘no they will not – they will have to be significantly better than a UCITS structure to convince people to set up a whole new suite of products’.”
While noting tax incentives have been the key draw for asset gathering in Swiss-regulated ETFs, he said the UK offering advantages such as stamp duty exemptions on ETF creations and redemptions involving UK equities would impact only an “incredibly small” pool of investments.
Using the long-standing iShares Core FTSE 100 UCITS ETF (ISF) as a case study, he said: “The vast majority of flows in ISF do not lead to creation or redemption. Most investors do not suffer stamp duty because they can trade the units without triggering a creation or a redemption.”
While noting ETFs are generally underutilised by UK investors and tax incentives could be a pull factor for wider adoption, he concluded issuers will be reluctant to move away from ‘centres of competence’ such as Ireland and investors may be wary of additional costs being passed on within UK-domiciled ETFs.
Final word
On the overarching case for the UK going its own way with a distinct ETF industry post-Brexit, Lytle said “further enhancing the slide towards fragmentation is just the wrong answer”.
“Most people in the financial services space see Brexit as a net negative to investors – the efficiency of markets and even to the UK’s position in Europe – because it is much better to be leading the charge in a market integrated with UK and Europe than it is to be successful in a much smaller market.
“We are not going to become Singapore on the Thames.”
For now, UK regulators appear to share the sentiment of reducing cross-border frictions, with the Financial Conduct Authority (FCA) expected to introduce the Overseas Funds Regime (OFR) this month, providing a long-term route for non-UK-domiciled ETFs to passport to the UK.
