SIFMA, Investment Group Support Proposal in Pillar One Blueprint

December 12, 2020

Re: Asset Management Industry Comment Letter on the Public Consultation Document on the Report on the Pillar One Blueprint

Joint Submission by
The Securities Industry and Financial Markets Association Asset Management Group (SIFMA AMG)
and
The Investment Association (the IA)
In Response to the 12 October Consultation Document on Pillar One

These comments are provided in response to the OECD's public consultation document released on 12 October 2020 entitled “Reports on the Pillar One and Pillar Two Blueprints.” Our comments relate specifically to the Pillar One Blueprint. They have been prepared by the Securities Industry and Financial Markets Association Asset Management Group (SIFMA AMG)¹ and the Investment Association (the IA).² Representing much of global asset management industry, our associations support the proposal included in the Blueprint for an exclusion from the scope of Amount A for certain financial services businesses, in particular relating to asset management businesses and investment vehicles that they manage (collectively, the asset management industry).

These comments have been prepared on behalf of financial institutions operating within the asset management industry, which consists of investment management organizations, banks and insurance companies managing their own assets, and those of retail and institutional investors. The Blueprint separately analyzes the key segments of the financial services industry — banks, insurance companies, and asset management — in regards to an exclusion from the new taxing right under Amount A. However, it is quite important to note that the sale and management of investment funds involves all three segments of the broader financial services industry and it can be difficult to disentangle the value chain of investment funds from that of banks, insurance companies and asset managers. This is true whether one is looking at global financial institutions that span all areas of financial services, or smaller asset managers relying solely on unrelated intermediaries such as prime brokers, custodians and administrators, to deliver services to the ultimate consumer.

Therefore, SIFMA AMG and the IA welcome the opportunity to provide additional information on the asset management industry and confirm that consumer facing aspects of the asset management industry do not present the policy challenges of the digitalized economy that are targeted by the new taxing right envisioned in Amount A.³ This submission will explain the three types of participants in the asset management sector — fund vehicles, financial intermediaries, and asset managers — of which only financial intermediaries are consumer facing, and whom are subject to regulation like the banking and insurance industry. Specifically, financial intermediaries themselves are subject to local country regulation, generally are taxed on their profits in the jurisdictions in which they engage with customers, and thus meet the central policy rationale presented in the Pillar One Blueprint for excluding the financial services sector.

I. The asset management business

The asset management business operates through two business models.

• Indirect/Intermediated model: investors (institutional or retail) acquire shares or units of an investment vehicle or fund through one or more financial intermediaries (not from the asset manager directly), such as banks, insurance companies, and brokers. The asset manager has no relationship with the investor. The investor's relationship is with the intermediary that provides support, investment guidance and recommendations.

• Direct model: In this far less predominant model investors purchase shares or units of an investment vehicle through the asset manager (or an affiliated broker) or have an investment management agreement directly with the asset manager. These purchases generally are made through affiliated brokers.

It is important to note that regardless of which industry model is applying, as the Blueprint points out, the industry must operate in accordance with regulatory requirements that focus on investor protection, product suitability and transparency. Moreover, not all asset management products are provided to retail investors (including, for example, products and services provided to institutional investors such as pension funds, sovereign wealth funds, etc.), which is another reason why the Blueprint justifies — and we agree — that asset management services should fall out of the scope of consumer facing businesses as defined by the Blueprint.

II. The indirect model — Consumer facing operations and regulation of financial intermediaries

The predominant industry model in the retail context is the indirect model described above. Retail investors acquire shares or units in an investment vehicle through a third-party financial intermediary. The asset manager does not have direct contact with these underlying retail investors; instead, the intermediaries maintain the local presence necessary to service retail investors.

Most intermediaries are either banks, brokers or insurance companies and, under the indirect model, a portion of their consumer facing business is the intermediation of asset management products and services. The Blueprint states quite clearly that extensive regulation of the consumer facing businesses of banks and insurance companies requires profits to arise in a particular market jurisdiction and that those profits generally will be taxed in that market location. Whether the consumer facing products and services of these banks and insurance companies relate to core business activities, such as checking accounts or life insurance products, or access to investment vehicles, there is no further need for an Amount A reallocation of such profits.

Commercially, while it is not unusual for certain investment funds (vehicles that allow investors to pool their money and invest in pooled funds, rather than buying securities directly as individuals ) and investors to be in different locations (e.g., certain products can be sold cross-border, such as the European Union's Undertakings for Collective Investment Trusts (UCITs)), intermediaries performing the distribution function generally maintain a physical presence in the jurisdictions where they have a client base. These local teams are responsible for driving local market interest and awareness, rather than relying on remote selling or advertising. Where banks and insurance companies are the local market intermediaries, for example, asset managers are also engaged locally providing services to those intermediaries. Importantly, investment products and the sale of investment products to retail investors are subject to strict local regulation. In practice, the effect of this regulation results in local to local distribution models, with direct contact between the financial intermediary and the end investor.

We note the last sentence of Para 140, which suggests some jurisdictions do not support an exclusion from Amount A for the asset management sector because it is “lightly regulated” as compared to retail banking, for example. However, as explained above, intermediaries that are the main consumer facing segment of the asset management industry, such as retail banks, insurance companies, and brokers are heavily regulated and thus are also subject to the proposed exclusion from Amount A. Therefore, the distribution of investment products to retail investors is universally a highly regulated activity, regardless of who is undertaking that activity (be it bank, insurer, etc.). That regulation results in the same outcome within market jurisdictions as we see for banking and insurance services.

III. The direct distribution model

Under the less common direct distribution model, retail investors purchase shares or units of an investment vehicle through the asset manager, generally through an affiliated broker, or have an investment management agreement directly with the asset manager. From a contractual and commercial perspective, the investor acquires such shares or units from the investment vehicle (e.g., a fund), and that investment vehicle engages the asset manager to provide investment management services. The asset manager does not control the investment vehicle. It is owned by the unit holders. In this sense, the asset manager's business is not consumer facing.

Additionally, within the asset management industry, the retail sales process is highly regulated. Sales generally cannot occur without registered broker-dealers or similarly authorized entities or personnel.

Each jurisdiction has its own unique and complex regulatory environment. There are further supranational regulations which transcend domestic legislation. For example, there are regulatory requirements under the Markets in Financial Instruments Directive II (MiFID II) that apply to any investment manager with investors physically located in the European Union. It was implemented to strengthen investor protections, require asset managers to provide retail investors with appropriate and clear guidance and warnings of the risks associated with financial instruments, and to indicate whether such instruments are intended for the retail market or more sophisticated professional investors. Likewise, these requirements mandate that asset managers ensure that products are distributed only to those investors for whom they were actually designed. These types of requirements necessarily result in a local presence to ensure sufficient information can be provided to prospective and current investors in a way that complies with the local regulatory requirements.

IV. Asset managers

For the most part, the asset manager's business relationships are with financial intermediaries or funds, in a business-to-business arrangement. The financial intermediaries engage with the investor and are responsible for maintaining their own customer relationships with the end investors. The intermediary has its own profit motive and may offer any one of a number of competing asset managers' products on its platform.

The only relevant inquiry in regards to Amount A is whether the financial intermediary should be disregarded because the asset manager is providing products and services commonly sold directly to consumers. As explained below, we believe an analysis of these products and services, to whom they are provided, how the asset manager is compensated, and the lack of contact between the retail consumer and the investment manager demonstrates that the asset manager is not consumer facing — directly or indirectly.

• The consumer ultimately engages the financial intermediary (which is regulated itself) to provide a broad suite of products and services, which may include a review of investors' financial health, financial planning and advisory, asset allocation support and investment advisory services. As part of this service offering, the intermediary may suggest one of several investment products it offers, which are ultimately made available to the intermediary by the asset managers. For providing such services, the financial intermediary is remunerated, separate and apart from the investment management fee earned by the asset manager.

• As noted in the Blueprint, the asset manager is also engaged directly with the fund vehicle, rather than the consumers/investors that invest in the fund.

• The Blueprint is accurate in explaining that the financial intermediary “makes a meaningful difference to the nature and value of the investment management services,” as noted in Para 139. The asset manager products and services, provided directly to financial intermediaries, are indifferent as to the investors' objectives, the identity of the investors and whether or not the investors utilize the asset manager's products and services, or the consumers' investment preferences. The financial intermediary often cannot disclose investor information to asset managers because of data privacy and other regulatory restrictions, or consider such investor information to be proprietary to the financial intermediary, and thus the asset manager often will be unable to access information to even identify market jurisdictions in which the ultimate consumer is located.

The asset manager's services must therefore be viewed as those that are incorporated into the services the financial intermediary offers; they should be viewed as an intermediate product in the context of the new taxing right because the intermediary is making a meaningful difference to the nature and value of the asset manager's services and products.

IV. Investment vehicles (funds)

Investment vehicles are an effective means to pool investments; as such, they should not bear tax. As Para 136 accurately points out, funds are not active businesses and “the tax neutral and passive status of funds is widely recognized under jurisdictions' domestic law, international tax principles and the OECD's own guidance.

As a basic premise, subjecting an investment vehicle to the new taxing right under Amount A would risk distorting capital markets as fund investors should be no worse off investing through a fund than if they had invested directly. Investment vehicles generate tax revenues for the jurisdictions in which the investors reside, which is generated from income earned via dividends and interest received from portfolio investments and from gains where such interests are sold. This income is taxed, depending on the jurisdiction, either annually or when the interest in the investment vehicle is sold.

We therefore support the position in the Blueprint that funds as well as asset managers be considered outside the scope of the definition of consumer facing business. In addition, we look forward to working with the OECD to develop a definition of funds that will be out of scope, and urge the OECD to develop definitional standards that are consistent with existing precedent and guidance, including the definition of funds in the OECD's own Common Reporting Standard (CRS).

V. Conclusion

SIFMA AMG and the IA appreciate the opportunity to submit these comments on the Pillar One Blueprint. We recognize and appreciate the considerable time and energy that the Secretariat and the members of the Inclusive Framework have put into understanding the unique and sometimes complex operations of the asset management sector. The Blueprint correctly establishes the characteristics of the three participants within the asset management sector, and accurately describes the principle consumer facing participant, namely financial intermediaries that consist mainly of regulated banks, insurance companies, brokers and financial advisors. Regulation of these consumer facing intermediaries necessarily requires that their profits be located in the jurisdictions in which their customers are, and these profits generally are taxed in those jurisdictions, making it unnecessary for Amount A to apply to reallocate these profits. Both conceptually and practically, this approach should apply equally to banks, insurance companies and asset managers, as their activities cannot be neatly ring-fenced, due to the substantial overlap and inter-connectedness of these business models.

In addition, we believe it is critical that investment vehicles, or funds, which are tax neutral, not be subject to Pillar One.

SIFMA AMG and the IA stand ready to continue to work with the OECD as it seeks to finalize Pillar One in 2021, including helping to develop definitions of industry participants that should be excluded from Amount A.

We thank you for your consideration of these comments. Please contact Anshita Joshi at the IA anshita.joshi@theia.org), Justin Sok at SIFMA (jsok@SIFMA.org), (Jeff Levey (Jeff.Levey@ey.com) or Rebecca Burch (Rebecca.burch@ey.com) via email if you have any questions regarding this submission.

Anshita Joshi
Head of Tax
The Investment Association
Camomile Court, 23 Camomile Street
London EC3A 7LL

Justin Sok
Managing Director, Tax
Securities Industry and Financial Markets
1099 New York Ave., NW. 6th Floor
Washington, D.C. 20001