Financial Services Transfer Pricing:
Outlook for the asset management sector for 2020 and beyond
Asset managers are fundamentally transforming the very way they work.
Ralf Heussner - Partner - Tax / Transfer Pricing - Deloitte
Enrique Marchesi-Herce - Director - Tax / Transfer Pricing - Deloitte
Published on 21 January 2020
In this article, we will examine two key trends and their impact on transfer pricing that the asset management sector will need to keep on the radar for 2020 and beyond. On one side, new fee arrangements, clean share classes and the unbundling of fees will require tax departments to examine the potential impact on fee flows, existing transactions and transfer pricing policies as well as the availability of fee data for benchmarking purposes. On the other side, technology continues to be a game changer in the financial services sector, requiring massive investments, raising the question of how to structure such investments from a transfer pricing perspective with respect to the ownership and use of the resulting intangibles.
Asset managers are fundamentally transforming the very way they work – this is true for the rise of new charging structures, share classes, fund platforms and distribution models, as well as the ever-increasing importance of technology, such as artificial intelligence, big data and robo-advisors, impacting key aspects from investment management to regulatory compliance or customer experience.
CHARGING STRUCTURES AND PLATFORMS
Over the last years, regulatory changes (especially on inducement regimes) have affected the charging structure of investment funds and led to a rise in new share classes such as clean shares. Clean shares have no loads, commissions or other distribution fees, which typically pay for an investment fund’s distribution costs, and no platform fees.
One of the triggers were rule changes first introduced in 2013 as part of the Retail Distribution Review (RDR) in the United Kingdom which banned the commission payments that were received by fund managers when recommending their products. As an example, investors using an online broker will therefore often find themselves investing in commission-free
funds via so-called ‘clean’ share classes.
The investors will then typically pay a separate service fee to their broker. Similarly, those who use a financial adviser could be charged separately for services received.
MiFID II, which was rolled out in 2018, placed (among others) additional restrictions on inducements paid to investment firms or financial advisors by any third party in relation to services provided to clients. Clean share classes emerged as a MiFID II-compliant response to the ban of inducements. Nonetheless, the rise of new share classes has led to an increased complexity in operations.
In essence, there are three different charging structures that can be observed in the asset management sector:
- Unbundled: An investor only pays for investment management and fund operating expenses, and the fund and its advisor do not pay third parties who sell their funds to the public. Instead, distribution, platform and other operational fees would be charged directly to the investor under a new service-fee arrangement;
- Semi-bundled: The fund charges do not include traditional loads, commissions or other distribution fees but can include platform fees for example. Again, distribution and certain other operational fees could be charged directly to the investor under a new service-fee arrangement; and
- Bundled: Traditional share classes where the asset manager pays intermediaries out of the fee charged by the fund and that contains all fees for distribution, platforms and other operational expenses.
From a transfer pricing perspective, this implies that asset managers will need to take into consideration the impact of new fee arrangements, share classes and the unbundling of fees. Most notably, there is a potential impact on existing fee flows, transactions and transfer pricing policies (especially fee splits and the fee basis for the split). This trend could also affect the availability and applicability of both internal and external market data for benchmarking / testing purposes.
In addition, asset managers increasingly rely on fund distribution platforms. These platforms work as intermediaries between distributors and asset managers, serving administrative functions such as order routing and settlement, data processing, rebate calculations, compliance, and managing distribution agreements.
In a post-MIFID II environment, where rebates are no longer the norm in some markets, platforms are rebalancing fees more evenly between distributors and asset managers with both sides paying for the service they use. On top of this, fund distribution platforms are also increasingly replacing traditional intermediaries.
An intermediation fee is taken as a portion of a distributor rebate – when still relevant – while distributor fees and new explicit ‘platform services’ fees based on Assets under Administration are paid by asset managers. In Europe, fund platforms are trying to replace rebates with explicit fees to asset managers, charged on top of clean share classes. Again, tax departments will need to assess the potential impact on existing fee flows, transactions and transfer pricing policies.
Technology continues to be an ever-increasing game changer in the financial services sector. Examples include the rise of robotics and automation-related technologies to reduce operating costs, algorithmic models that evolve from internal risk management tools to key portfolio management tools, to robo-advisors and artificial intelligence facilitating investment decisions and product selection. The future will entail using digital technologies to automate processes, improve regulatory compliance, transform customer experience, and disrupt key components along the value chain.
This technological upheaval continues to require heavy investment and raises the question of how to structure such investments from a transfer pricing perspective with respect to ownership and use of the resulting intangibles within the group. The essential question is whether technology needs to be characterized as a key intangible for tax purposes going forward, which also requires a change to existing approaches for the tax treatment of development expenses. The result could be that an allocation of development costs via service (re-)charges is no longer appropriate but instead a license fee / royalty model needs to be introduced to remunerate the owner of the intangible(s) for the development activities.
Consequently, financial institutions will need to do the following:
- Re-examine the existence of potential intangibles in light of the broader definition under the OECD BEPS Action 8 and the use of such intangibles (also in the context of branches and attributing potential expenses or license fees under the new OECD separate entity approach);
- Revisit existing transfer pricing positions regarding remuneration for the use of intangibles, depending on the financial benefit or whether related costs should be included in internal cost recharges;
- Identify all relevant intangibles and their use in transfer pricing analysis/documentation, even if use of those intangibles is not being remunerated (with supportive argumentation for the non-remuneration);
- Track development activities, especially if performed out of certain (pioneer) locations and decide if strategically development activities should be centralized in one location to also centralize the ownership of intangibles in such jurisdiction;
- Ensure consistency between tax-related and other messaging (esp. for investor relations and regulatory purposes); and
- Review the appropriateness of existing transfer pricing documentation and inter-company agreements.
The tax function of asset managers need to be actively involved in addressing the tax implications arising from new charging structures, share classes, fund platforms and investments into technology. Tax departments will need to assess the potential impact on existing fee flows, transactions and transfer pricing policies as well as how to how to structure investments into technology from a transfer pricing perspective with respect to the ownership and use of the resulting intangibles.
Multinational organizations are operating in an environment of unprecedented complexity. The rising volume and variety of intercompany transactions and transfer pricing regulations, accompanied by increased enforcement activities worldwide have made transfer pricing a leading risk management issue.