Other people’s money

With compulsory super filling its coffers, Australia’s funds management industry has become the fourth largest in the world. Already managing a trillion dollars in assets and growing fast, it’s sophisticated, capable and cost competitive.

Yet less than 3 per cent of its revenue comes from exports - that is, foreigners paying us to manage their money.

It’s hard to think of a parallel in finance elsewhere, but there’s certainly a parallel in our own past. In the 1960s we had capable and competitive manufacturing industry also assisted by government policy.

But while manufacturers and policy makers in Japan, Korea and Taiwan turned their eyes towards world markets, their Australian counterparts remained complacent.

It took us till the late 80s to reduce protection and start learning to export.

In funds management the policy issues are quite different. We have no protection to dismantle. But the basic story is similar. We think of exports as a nice bit of icing on the cake but we’ve not focused on them like others.

Exporting isn’t easy.

A global fund is domiciled in one country, holds assets in other countries, and may have investors from several other countries as well. Throw in the network of bilateral tax treaties and the complexities are enormous.

Given this complexity, global funds management should really be thought of as a co-product between funds management firms and their regulators (including taxation authorities).

Of course tax authorities and regulators must continue delivering on their central mission - vouchsafing market integrity and tackling tax evasion and avoidance. But the regulators of the most successful financial exporters manage to do this while still paying assiduous attention to the needs of their global fund managers.

If this sounds like a rationalisation for tax avoidance - it’s not. You see, just as we exempt exports from GST (like other countries) so there is a general understanding that global funds should be “tax transparent”.

Thus, while a manager should of course pay company tax on their profits on managing a global fund, the investments in the fund should not themselves be directly taxed. After all, they may already have borne company tax at source and will bear income tax in the investors’ home countries. Taxing the investments in the fund as opposed to the profits on managing the fund simply sends them elsewhere.

Like other countries Australia recognises these basic arguments. So we’ve spent the last few years trying to extricate investments in Australian domiciled global funds from inadvertent taxation. But it’s slow going. The devil’s in the detail, with difficult tradeoffs sometimes necessary between tax neutrality for global funds and preventing avoidance elsewhere in the tax system.

Meanwhile we’re up against countries like Luxembourg and Ireland whose regulators have specialised in the game for decades. They’re small countries hosting huge global funds. So if there’s a tension between their financial exporters’ needs and domestic considerations, guess whose interests win out?

Starting with virtually no funds management sectors of their own, Luxembourg and Ireland offered generous tax breaks to attract global funds. This gave them the incentive and also the information necessary to build tax and regulatory regimes that were highly responsive to those funds’ needs.

Thus when a special holding company structure within Luxembourg was struck down for breaching the EU constitution, a new regime was re-introduced just four months later.

Ireland worked with global funds to produce an innovative regime which is more tax transparent than companies and trusts for pooling super funds - so called Common Contractual Funds (CCFs). Some firms tell us that with a similar regime we’d manage billions more in pension assets right now. But it’s a chicken and egg problem. Our industry is chock full of global funds, but they’re busy managing Australia’s money. The complex regulatory problems faced by global funds are solved first and faster in Ireland and other financial entrepôts.

We’re still beavering away on tax transparency. But changes must run the gauntlet of lengthy reviews. That’s understandable. Still, delay and uncertainty is often a show stopper.

When setting up a global fund firms get advice on details - say, whether a particular transaction crystallises a capital gain. In Australia they’re often told “probably not”. Meanwhile Ireland’s regulators answer “no”, with precedents to back them up. Where do you think the fund ends up domiciled?

Still, at a time of labour shortage more jobs in finance will mostly mean fewer jobs elsewhere. What’s so special about finance jobs? How about the fact that finance employees get paid nearly twice as much as the Australian average - and still far more controlling for higher skill levels.

That helps explain why, from about the time Luxembourg and Ireland become financial centres, their economic trajectories headed sharply north. Ireland went from being the poor man of Western Europe to being Europe’s second wealthiest economy. The wealthiest? Luxembourg by a country mile.