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The New Wizards of Oz

Australia and Luxembourg strengthen ties by liberalizing financial service agreements and requirements

For foreign fund managers looking to attract mandates from Australia's superannuation schemes, a new arrangement between Australia and Luxembourg could make UCITS funds more accessible down under.

Australia is a routine calling point for global asset managers who have recognized the opportunities to raise capital that are available within its increasingly powerful and sophisticated superannuation schemes.

Australia's superannuation funds now manage over USD 1.5 trillion in assets, making it the fourth largest pension system in the world

Willis Towers Watson estimates Australia's superannuation funds now manage over USD 1.5 trillion in assets, making it the fourth largest pension system in the world, and its growth shows no sign of decelerating.1

Deloitte predicts Australia's superannuation funds will total USD 4.0 trillion by 2025,  and USD 9.5 trillion by 2035.2 The scale of these funds has been energized by government initiatives to encourage saving, with employers required to contribute 9.5 percent of workers' salaries into a super fund.3

Discussions between Australian financial services' regulators and Luxembourg industry groups such as the Association of the Luxembourg Fund Industry (ALFI) have eased the path for eligible fund managers to gain a greater market share of superannuation schemes' assets. As of November 8, 2016,  Luxembourg-based UCITS fund management companies and managers have been exempted from the requirement to hold an Australian Financial Services' (AFS) License in order to provide financial services in Australia.4

Equivalence is a must

Such exemptions by the Australian Securities and Investment Commission (ASIC) to foreign financial institutions are typically granted on condition that services are only provided to institutional clients, and on the basis of regulatory equivalence.

A financial institution in Luxembourg looking to market into Australia must make the application through ALFI. As ALFI confirmed, “The regulatory regime overseen by the relevant overseas regulatory authority needs to be 'sufficiently equivalent' to the Australian regulatory regime and effective cooperation agreements must also exist before relief is granted."5

Since September 2013,  ASIC and Luxembourg regulator the Commission de Surveillance du Secteur Financier (CSSF)  have had in place a memorandum of understanding on mutual cooperation of information exchange in relation to regulated entities.6

The simplification of the process for distributing Luxembourg-domiciled UCITS funds into Australia is a positive step. However, given the competitive environment, there is no guarantee that flows from superannuation funds will follow. For example, the rise of exchange-traded funds (ETFs) may be an impediment to active managers on the hunt for superannuation mandates, as the schemes view ETFs as a less expensive source of returns.7 Australian superannuation schemes are also biased towards domestic markets, which could make the entry of UCITS funds challenging.8

Pension contemplation

The potential for UCITS funds to gain traction in Australia should not be underestimated as several factors may work in their favour. Volatile equity markets and bonds that are yielding little and sometimes negative interest are resulting in some pension funds and superannuation schemes contemplating more esoteric asset managers and investments.

Key insight

Efforts to simplify UCITS distribution will further strengthen ties between the Australia and Luxembourg financial centres, and enable Luxembourg-domiciled asset managers to market their products more easily to institutional investors in Australia

Further, if equity markets move into bearish territory, it could bring an opportunity for active managers, including UCITS funds, to compete for the share of superannuation assets that ETFs currently have.

The popularity of the UCITS brand is not limited to the European Union. It also has strong support from investors and pension funds across Asia-Pacific, the Middle East and Latin America, due in part to its regulatory governance.9 The UCITS V Directive, which came into force in March 2016,  increased investor protection and transparency, and strengthened depository safeguards. Depositories are required to monitor custody asset and safekeeping arrangements, and are obliged to return a corresponding amount of assets to the UCITS fund and their investors if instruments are lost or misplaced at the custodian or sub-custodian level.10 Such regulatory protections are likely to appeal to superannuation schemes.

Entering the Australian market is a challenge for foreign fund managers, but recent developments spurred by Luxembourg-based industry bodies may ease their path. The UCITS brand, with its strong reputation and vigorous controls, may find traction among the Australian superannuation community in the years ahead.


Sources

  1. Willis Towers Watson (January 30, 2017)  Global Pension Assets Study 2017
  2. Deloitte (November 17, 2015)  The dynamics of a $9.5  trillion Australian super system
  3. Australian Securities & Investment Commission, Moneysmart (March 8, 2017)  How super works
  4. The Association of the Luxembourg Fund Industry (November 16, 2016)  Australia's Institutional Investors Get Easier Access to Luxembourg Ucits
  5. Ibid.
  6. Ibid.
  7. Global Investor Group Magazine (April 19, 2016  ) Australian Fund Industry Tough To Crack
  8. The Association of the Luxembourg Fund Industry (2015)  Beyond Their Borders: Evolution of Foreign Investment by Pension Funds
  9. The Association of the Luxembourg Fund Industry. Ibid.
  10. PricewaterhouseCoopers (February 2011)  UCITS V The Depositary's Role and Managers' Remuneration