NEW YORK - Selling mutual funds offshore holds great potential, but it is complicated and requires local expertise, agreed mutual fund executives at a forum here last month.
Inconsistent tax laws and inaccessible distribution channels make a strong case for establishing, managing and marketing offshore funds locally through joint ventures or alliances, said speakers at the Offshore Funds Forum, June 28th and 29th. Eventually, foreign investors will want global brand names and expertise and it will be possible for U.S. mutual fund companies to enter offshore markets independently or through acquisitions, speakers said. But for the time being, mutual fund companies wanting to do business abroad are beholden to local partners and tastes, they said.
The forum focused on distributing mutual funds abroad and was sponsored by International Business Communications of Southborough, Mass., which organizes investment management and marketing conferences.
Taxes are one of the foremost concerns when setting up an offshore fund, conference speakers said. It is necessary to research how a country's tax codes apply to investments and investors in a fund, they said.
Foreign countries impose a variety of investment restrictions that can affect investment management and marketing of a product, said David Thelander, corporate vice president and general counsel of Montgomery Asset Management of San Francisco.
Selling mutual funds in Europe is particularly complicated because each country has its own tax code, and laws vary widely depending on where the fund and the investor are domiciled, said Lawrence Lafer, director in charge of documentation and client support at Deutsche Bank of New York.
"We had to look at taxes in each country at many different levels - the type of fund, earnings, dividends, foreign holdings and capital gains on distributions and redemptions," said Lafer.
Also, the idea that the European Union's UCITS (Undertakings for Collective Investment in Transferable Securities) Directive has created a passport to do business throughout Europe is a fallacy, said Richard Warne, vice president of global services at Chase Manhattan Bank of New York. Mutual funds still must register, maintain a physical presence, and keep records in each country in which they do business, he said. In addition, each country has its own marketing and distribution regulations, he said.
The idea of a "pan-European" market is also a delusion because Europeans want products designed for and marketed to each of their very distinct cultures, said Lafer. A fund company would do well to draw on the strength of its global brand name but tailor its investment products to each market, much like Coca-Cola sells worldwide, said Deborah Smith, a vice president with State Street Bank & Trust Company of Boston.
A fund is subject to U.S. taxation if it receives any gains, dividends or interest from U.S. stocks or securities, said Joseph Newberg, a partner with Hutchins Wheeler and Dittmar of Boston. Funds must also file U.S. taxes if even one of the partners is domiciled in the U.S., he said. As a result, foreign entities may not want to have any U.S. partners, he said.
And if the fund is subject to U.S. taxes, the tax rate will not be favorable, he said. The IRS taxes gains of foreign funds at the higher rate of short-term rather than long term capital gains, he said.
Distribution is another major concern when selling funds offshore, said Gary Gordon, managing director of Chase Manhattan Bank of New York.
"Distribution is our first concern, then country, then product, and then regulatory issues," he said. "We live by the credo that distribution drives product."
Sergio Rivera, vice president of marketing at Morgan Stanley Dean Witter Asset Management of New York, agreed that distribution is critical, and often illusive.
"There are regulatory barriers, and in some cases, local oligopolies between banks and asset managers," he said. "The barriers to entry are not always apparent, and you have to understand who is hooked up with who."
The key is to select well-connected distributors and cultivate those relationships, Rivera said.
"Treat your distributor as a market insider," he said. "They have the potential to help you with local regulations, filing with local authorities and with client service and marketing."
Another major obstacle U.S. mutual fund companies have encountered in trying to do business abroad is a lack of technology standards, Rivera said. A fund company aspiring to do business abroad may have to assist foreign partners in this area, he said.
The speakers also said that foreign investors and distributors are not as sophisticated as U.S. players, and if a fund complex wants to do business abroad, it has to be prepared to patiently educate both investors and business partners, Rivera said.
"The head of a central bank may not understand something as simple as a benchmark or a money market fund," he said.
Still further complicating doing business overseas will be the fact that the SEC and other regulators will become increasingly involved in offshore funds. That will occur particularly because the Internet makes it possible for mutual funds to sell inventory anywhere in the world, said Barry Barbash, former director of the SEC's division of investment management from 1993 to 1998 and now a partner with Shearman & Sterling of Washington, D.C.
Until now, the SEC has done little to regulate funds offered by U.S. companies offshore and has expressed interest only when foreign investors have claimed to have been defrauded, Barbash said. The SEC has also paid scant attention to offshore funds offered to U.S. citizens and again has only been interested in cases in which these investors have claimed to be defrauded.
E-commerce is about to cause an escalation in SEC involvement and that of other regulators, Barbash said.
"E-media takes you everywhere and puts you in the tentacles of all of the regulators," Barbash said. "The Internet extends the minefield beyond the SEC to include the Federal Trade Commission, the Department of Labor, state regulators and foreign entities. You can expect to be hit every which way by regulators, and there will be litigation over e-delivery."
Selling mutual funds through the Internet also "creates uncertainty for taxpayers and tax collections . . . on both the state level and international level," said Newberg of Hutchins Wheeler and Dittmar.
"Different interpretations may well prevail regarding the authority of a jurisdiction to impose withholding tax, income tax, sales tax and value-added tax on the same transaction," he said. "Nobody really wants to create double taxation of the same transaction. But confusion and conflicting interpretations in multiple jurisdictions can certainly cause this to happen for now."
To avoid violating regulations and incurring unexpected taxes, companies should include disclaimers on web sites clearly indicating jurisdictions in which the fund has been authorized to sell, said Barbash. The SEC made such a recommendation last October, he said.