The European ETF industry is still experiencing significant growth and we have recently observed growing interest in the ‘Active’ ETF category. Promoters of traditional funds, not yet active in the ETF space due to their focus on active management strategies, have seen the US-led Active ETF trend filter over to Europe. Companies seeking to leverage a ‘first-starter advantage’ will likely attract a bigger portion of investors who show interest in this new investment product. With the current investor appetite for these products, it is important to consider the most suitable domicile from which to promote ETFs, and in particular the Active ETF variety.
In Europe, the two principal jurisdictions chosen for ETF domiciliation are Ireland and Luxembourg. Of the two, Ireland is the clear leader, accounting for 72% of Europe-domiciled ETFs, and its market share remains on the increase. As the runner-up, Luxembourg accounts for some 19% of ETFs with the rest mostly split between Germany, France and Switzerland.
Let’s look at the common factors in the success of the two principal jurisdictions, Ireland and Luxembourg. Both domiciles have a reputation for being politically stable with a business-friendly framework governed by respected financial regulators such as Luxembourg’s CSSF and Ireland’s CBI.
Promoters can set up their funds as UCITS in both jurisdictions, enabling them to be easily passported throughout Europe. "Both also allow funds to be structured as an ICAV (Ireland) or SICAV (Luxembourg) which again are very similar", explains Gilles Dubos, Senior Expert - ETF Solutions at CACEIS.
Finally, the steps required to launch an ETF in either jurisdiction are very similar, with a requirement for the Investment Manager to be authorised by the regulator, and an overall UCITS approval process that takes between 12 to 18 weeks.
Clearly, the two main ETF domiciles share many common features, so what really differentiates them for a promoter looking to launching an ETF?
Some differences concern taxation, so we would advise promoters to consult their tax consultant for personalised advice.
Naming conventions
The name of the ETF must provide a description of the products in which they invest, such as ‘UCITS ETF’, to make it clear for potential investors. This ruling was issued by the European Securities and Market Authority. Interpretations of this rule differ between Luxembourg and Ireland. Whereas Ireland’s CBI takes the view that if a sub-fund includes both listed and unlisted share classes, then both the sub-fund and the ETF share class must bear the ‘UCITS ETF’ tag. However, Luxembourg’s CSSF requires only the ETF share class to bear the ‘UCITS ETF’ tag. Although seemingly only a minor difference, it can have a significant impact if an issuer decides to enter the market by adding on an ETF share class to an existing mutual fund. Issuers have so far not used the option on a large scale as it may be a source of confusion for investors when the sub-fund contains both types of share class.
Luxembourg’s Subscription tax
Promoters with existing funds domiciled in Luxembourg will be aware that mutual funds are subject to Luxembourg’s ‘taxe d’abonnement’ or subscription tax, which is payable quarterly, up to 0.05%, based on net assets at the end of each quarter. While Passive ETFs are exempt, active ETFs currently appear not to be. If the Active ETF trend continues, then Luxembourg, and promoters domiciled there are at a disadvantage compared to Ireland. In order the redress any potential imbalance, Luxembourg’s Finance Minister stated in March this year at the Association of the Luxembourg Fund Industry’s (ALFI) Global Asset Management conference that he is considering a reduction in the subscription tax rate for Active ETFs. It is not yet clear if the tax rate will be simply reduced or whether Active ETFs will benefit from a full tax exemption.
Brazilian Capital Gain Tax for Irish funds
In September 2016, Brazil moved to classify Ireland as a tax haven due to their view of its corporate tax regime. As a result, the proceeds of any sale of Brazilian securities from an Irish fund are subject to capital gains tax of up to 25%. Divestments of Brazilian stocks in Luxembourg-domiciled funds are not subject to this tax and while not every fund has exposure to Brazil, it is a factor to consider.
Ireland-US Double Taxation treaty
Ireland has a major competitive advantage over Luxembourg in terms of US securities and the application of the dividend tax rate. Ireland’s double taxation treaty with the US brings the tax rate on dividends to 15% compared to the standard rate of 30% applicable for Luxembourg-domiciled funds. Considering how many ETFs have a full or partial exposure to US securities, it may be a major factor in the domiciliation decision. Passive ETFs are a highly competitive sector, with performance as the only measurable differentiator, so close attention must be paid to factors like management fee scales and dividend taxation rates, as the smallest performance advantage can become a significant differentiator.
For Passive ETF promoters following a US equity-based strategy, the obvious choice of domicile is Ireland. Clearly, the same logic applies for Active ETF promoters as it unlocks an investment performance advantage. It is ultimately the investors who benefit from this, seeking out the best return on investment in a competitive market where every basis point counts.
This double taxation factor alone explains much of Ireland’s dominance in the ETF market.
The favourable taxation environment and dominant position of Ireland in ETF domiciliation has led to a gradual concentration of ETF expertise in Ireland including supporting industries such as law firms, auditors, administrators and custodians. While Luxembourg also has a wealth of ETF expertise and adjacent industries, Ireland remains the jurisdiction that has the greatest focus on the ETF space.
There are many factors to consider when selecting a domicile and CACEIS has a range of highly qualified people able to provide insight and assistance to promoters so they can make informed decisions on the domicile that best suits their business development objectives. “In any case, whether Luxembourg or Ireland, it’s a choice between two of Europe’s most forward-looking and business-friendly distribution hubs!” concludes Gilles Dubos.
