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Tax Transparent Fund Solutions - The Fund Administration Challenge

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The United Kingdom's Tax Transparent Regulated Fund (TTF) vehicle has provoked much discussion in the industry. It offers many benefits, such as fund rationalisation, regulatory consolidation and coping with complexity of distributions as well as allowing multiple withholding tax treatments per investor. The opportunities presented by TTF's for clients led to ISC reviewing both the appetite and provision of operating models to support these new products by the service providers.

Transaprent Sphere

What are TTFs?

The birth of UK Tax Transparent Funds in 2013 was never likely to result in a stampede by Pension Funds or Life Companies to demand funds be created overnight. While there are benefits for tax saving and asset management through scale, the logistics and costs involved in setting up and supporting such fund structures are less clear. Two years on, progress has been slow. There have been small pockets of interest from various types of investment management groups (Investment Managers, Insurance Companies, Fund Managers & Asset Owners) in considering the benefits from such schemes as set out above. They have begun to consider what their fund managers and administrators can offer them. The TTF UK structures are known as Authorised Contractual Schemes (ACS), similar to CCFs in Ireland, FCPs in Luxembourg or FGRs in Netherlands. The non-UK fund structures are more established with administration providers who are able to cope with the particular investor tax recognition issues. However, providers will need new structures and investor reporting for the ACS.

Authorised Contractual Schemes

Authorised Contractual Schemes (ACS) can be formed in either a Partnership or Co-ownership structure, with particular advantages and disadvantages to each. The Capital Gains Tax (CGT) impact of trading in underlying funds within a large hierarchical structure is more efficient within Co-ownership structure; however the lack of a recognised legal entity creates issues for securities lending activities. The Partnership option does not have the same exclusion for CGT payable at each investor change and fund re-alignments. The Partnership legal structures are either Limited or General Partnerships whereas the ACS has a deed and prospectus. Choosing the most appropriate model depends upon which future legal and administrative challenges the client is most comfortable with. After that decision both these structures will have the same data challenges and be referred to as TTF below.

Money Eggs

TTF Data Challenges

ISC visited the main service providers to discuss the various options available and identify plans the organisations had for developing their offerings. The issues covered were applicable to all parties although they each presented a slightly different viewpoint depending upon their own client experiences.

1. Data Gathering

The range of TTF investors per tax profile and jurisdictions will necessitate organisations optimising their structures to cope with a number of operational complexities. This requires interaction between the custodian, transfer agent and fund administrator platforms. It is a fundamental requirement to share data between platforms in order to ensure that withholding tax is correctly applied for each investor type at the time of each income event. The tax status of each investor needs to be clarified and periodically confirmed before entry into a TTF.

2. Data Integration

The level of data integration between actors will need to increase and become more efficient. In order to ensure the ownership of securities and resultant income entitlements can be correctly allocated to each different category, each investor's withholding tax needs to be applied based on their individual tax profiles. The transfer agent/ fund accountant will need to confirm to the global custodian, the percentage ownership of fund units by each different tax status investor type as the mix of investors change. As a result, it is important that as ownership ratios change (through investor subscriptions or redemptions) they are tracked, so that the income entitlements of each investor are adjusted. As withholding tax is applied by the global custodian based on investors' individual tax profiles, it is usual for the TTF to have separate share classes per investor tax profile. The scale benefits of TTFs needs to outweigh the complexities as the share class hierarchy means that any pricing errors will take a great deal of effort to resolve.

3. Pricing and Taxation

The challenges surrounding the pricing and taxation treatment of TTF's will necessitate the requirement for tax tables for fund administration and accounting, to reflect the way in which withholding tax attributed in the custody model needs to be accrued. Top level TTF assets will need to be placed in an opaque fund used to create the pricing of each share class on a percentage basis per investor type and country. UK ACS will benefit from advantages surrounding withholding tax treatment in tax treaties; these treatments will need to be applied where appropriate. Due to holding investors from multiple countries, this will result in the need for multiple valuation points relevant to location of investors as per current collective investment vehicles. (UK: noon, Europe: close, US: close and Asia: open)

Service Providers' Solutions

The industry has tackled TTFs with the same pragmatic approach it has used to develop approaches to other government initiatives for creating better tax transparent fund ranges. The Banks provide a service dependent upon client demand and haven't driven the market by implementing the necessary technical structures ahead of such demand. For example, data interfaces need to be efficient and comprehensive, requiring a robust data hub to support movements and reporting. Of the observations made to date from our market survey, only one provider has plans for this type of model by developing an agnostic TA model, as opposed to pre-empting demand.

Each service provider has instead launched funds by building bolt-on solutions onto their legacy platforms and using proprietary in-house solutions to meet requirement shortfalls. In order to make a truly global product, a data solution would ideally deal with three issues:

1. In the Custody space for the storage and maintenance tax reclaim treatment

2. In the TA space for investor tax status

3. In fund accounting world for multiple valuation points per country.

Where these three factors are not in place together, the result will be the usage and functional extension of existing platforms beyond their original purpose, potentially impacting on scalability and robustness of the solution.

It has taken providers considerable time and effort to link custody data and fund accounting data platforms into a single client delivery; it will now take major investment to add Transfer Agency data into the operating model.

Without closing the existing platform gaps, the support of these products will require elements of manual oversight leading to increased operational risk which in turn adds further complexity when utilising multiple share classes. It will take a client of sufficient scale to encourage their service provider to build the robust model fit for long term support and change. History however demonstrates that this is unlikely and most clients will simply demand a cost effective solution at the earliest opportunity. We could therefore face the situation where TTFs could start to transform the market with increasing numbers of fund launches while the underlying administration systems utilise the current infrastructure with tactical solutions developed to augment the process.

There are differentiators between providers with strengths based on the requirements of their respective client base. Some have strong flexible multiple valuation point pricing, others a quality tax treatment flexibility; whilst others have tried and tested support models which have been in place for some time for similar fund structures. In a review undertaken by ISC of these offerings, each Bank was keen to demonstrate their model as being the market leader and differentiating themselves from the competition. That said, the consistent approach was that all factors: Custody, Transfer Agency, and Fund Accounting should be located with the single provider. The bundled solution allows the overhead of the costs of the incomplete structures to be absorbed at a palatable level to both the client and the provider.

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