Czech Push to Lure Hedge Funds Eyes Luxembourg Not Cyprus

Date: Friday, April 26, 2013
Author: Peter Laca & Krystof Chamonikolas, Bloomberg

Prague is joining Frankfurt and London in a race to attract fund managers seeking European Union offices in an industry dominated by Luxembourg.

EU laws taking effect in July will force tens of thousands of hedge funds and private-equity firms from outside the bloc to establish domicile in one of the 27 member states, and the Czech Republic wants a portion of the business, Deputy Finance Minister Radek Urban said in an interview at Bloomberg’s Prague newsroom on April 24. Urban’s drawn up legislation aimed at making the nation a player in an industry that he said could bring hundreds of millions of dollars a year to the economy.

“There may be an issue of capacity backlog in Luxembourg and Ireland if tens of thousands of funds want to domicile from mid-July,” said the 48-year-old Urban, who’s politically unaffiliated. “I would really like to be among the first to have the legislation, in good quality, in place.”

The country, which joined the EU in 2004, is targeting asset managers after Cyprus agreed to a 10 billion-euro ($13 billion) bailout last month, shattering its appeal as a center for alternative-investment companies. Czech credit ratings are the highest among the EU’s post-communist members and deposits at local lenders exceed loans, making the nation’s banking industry among the best-capitalized in Europe.

The government credits its austerity policies with helping to reduce borrowing costs to record lows. The yield on the 10- year government bond was 1.63 percent at 8:56 a.m. in Prague, lower than high-rated France at 1.75 percent, data compiled by Bloomberg showed.

New Business

With Czechs’ traditional preference to keep money in banks, investment funds represent a fraction of the country’s financial industry. Domestic and foreign funds managed 235 billion koruna ($11.8 billion) of assets, according to data from the Prague- based Capital Market Association, or AKAT. That compares with 3.1 trillion koruna placed in banks, according to data from the Czech Banking Association as of September 2012.

The Czech draft law would open the country to new types of asset-management businesses, including trusts and investment companies with variable capital, known as SICAV, Jana Michalikova, who heads AKAT, said in an interview in Prague.

“Stability is crucial for this type of business, and the cost of ancillary services is much lower here than in London or Luxembourg,” Michalikova said yesterday. “We have a fairly well-functioning economy, rising credit ratings, a stable legal environment, a very strong banking sector, and the Czech National Bank is a very well respected regulator.”

The EU’s fund-management industry is led by Luxembourg, the world’s second-largest market for investment funds after the U.S. It has about 3,849 registered funds holding 2.5 trillion euros of assets as of February, data from the Association of the Luxembourg Fund Industry show.

Cyprus, Malta

Cyprus, along with fellow Mediterranean island-nation Malta, increased its market share after joining the EU in 2004 before its financial industry was shaken this year after exposure to Greek bonds hurt the local banks.

According to Urban, the Czech Republic isn’t following the model of Cyprus, whose importance as a financial hub dates to the late 1980s and early 1990s, when it became the banking center for the economies of Russia and its neighbors.

“The big difference is the quality of banks’ balance sheets, which in the Czech Republic is superb,” said Urban, who worked as an investment banker at the Czech unit of Erste Group Bank AG after starting his career at the Czech central bank. “The money under management is not our primary target, it’s the service money that is the primary target.”

Political Risk

The main pitfall to his plan may be political risk.

The Social Democrats, the leading opposition party that dominates in opinion polls, will impose special taxes on large companies and scrap a law allowing taxpayers to divert part of pension taxes to private funds, shadow finance minister Jan Mladek said in an interview with Bloomberg on Jan. 23.

Mladek praised Hungarian Prime Minister Viktor Orban for taking over about 3 trillion forint ($13 billion) of privately- managed pension assets in 2011 to help cut the public deficit. “Orban’s solution was brilliant -- he didn’t nationalize any funds, he only changed the conditions to transfer people back into the state pillar,” Mladek said.

A similar move would be more difficult in the Czech Republic where people contribute their own money to pension accounts, Urban said. Insolvency legislation also prevents assets managed by funds from being seized, he said.

“This is generally valid for pension funds, for mutual funds, for alternative funds,” Urban said. “It cannot be seized by the insolvency administrator if it’s not part of the balance sheet of the management company, and that is a very strong legal protection.”