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Since the beginning of the year, I cannot buy Exchanged Traded Funds (ETFs) domiciled in the United States from my broker, DEGIRO. Since my current portfolio is mostly invested in Vanguard Total World (VT), this is a big problem for me. I can now only sell these ETFs, not buy them anymore. That means that the next time I will have some money to invest, I cannot invest it anymore as I want. This is bad news for Swiss investors.
This is due to new regulations that will come into play. These regulations already affected all European investors since 2018. But Switzerland was not affected before. We are going to see what changed. This is based on several European and Swiss laws. These laws are sad news for European investors and Swiss investors. I am not a legal expert at all. So this is only my interpretation of these laws. If I am wrong or I missed something, please let me know!
In this post, we are going to see why this is happening. And we are also going to see what are the different options for us. There are several possible solutions to this issue. But none of them is perfect as we will see.
PRIIPs Regulation for European investors
It all started in January 2018, when PRIIPs regulations entered into effect. PRIIPS is a part of the bigger Markets in Financial Instruments Directive (MiFID) II law. PRIIPs or Packaged Retail and Insurance-based Investment Products is a regulation that is supposed to protect investors. I am not going to go into details about the law. I am only going to focus on the part that is the problem now. These regulations enforce that all funds provide a so-called Key Investor Document (KID). This document must give some information about the funds and some standardized advice and recommendations to investors. Supposedly, it was made to make sure that all investors have access to all the necessary information to invest in these funds.
When this law came into force, U.S. fund providers did not provide any KID document. And therefore, brokers stopped offering them to their European customers. For these fund providers where most of the clients are from the U.S., providing these documents is not a priority. This is too costly for little advantage. For instance, Vanguard already stated that they will not comply with these regulations. That means that for European customers, the only option is to use European ETFs.
This is exactly what the European Union wanted. This law has nothing to do about protecting investors. This is only a strategy by European fund providers to force European investors to invest in their sub-par funds instead of going with the better U.S. funds. Instead of providing better funds, they simply forced people to use their funds. This is really sad that something supposed to protect the investors is actually making them a disservice by forcing them to invest in poor products and reducing their investment options.
PRIIPs regulations are enforced to people from the European Economic Area (EEA). And Switzerland is not part of the EEA. Therefore, Swiss investors were not affected by this problem last year.
So why I am talking about this issue? DEGIRO just stopped offering these ETFs to its Swiss customers. I can still sell my positions. But I cannot buy any more of these ETFs. This is (probably) because of a new set of laws that will soon come into force. Let’s take look at the Swiss laws now.
FinIA/FinSA for Swiss investors
In 2018, the Swiss government voted two new laws: Financial Services Act (FinSA) and Financial Institutions Act (FinIA). Once again, I am not going to go into details of these laws. They are more or less a copy of the European laws for Swiss investors. They also enforce each fund to offer a Key Investor Documented (KID) to all Swiss investors. So, they cause exactly the same issue to Swiss investors that PRIIPS caused to European investors.
Once again, I have the same point of view on this law as I have on the other one. It is just a crude attempt to force people to invest in bad funds and block the U.S. funds instead of focusing on improving European funds.
This new set of laws will enter into force on January 1, 2020. Starting from this date, Swiss investors will not be able to invest in non-compliant ETFs and funds. This basically means that Swiss investors will only be able to invest in Swiss and European funds.
Wait a minute, that is still giving us one year, no? Yes, it should indeed give us one year before these regulations come into force for us. So why did DEGIRO already enforce this? It seems that DEGIRO decided to start to enforce them early for reasons of their own. Supposedly, they said that they believe this will protect the investors.
I think they are doing that simply to simplify their systems to have the same set of offers for all Europeans. I think this a bad move on their side. There has been no communication whatsoever about this. One morning, my products were simply closed with the message “Product is closed for the client”. This is really bad handling of the situation in my opinion.
So what can we do? I see a few solutions to this problem. Let’s see each of them.
Solution 1: Change broker?
The first solution would be to change to another broker. I already compared DEGIRO and Interactive Brokers (IB) in the past. Interactive Brokers is actually cheaper than DEGIRO when you have more than 100’000 CHF. I was already considering moving to IB once I got enough money to waive the safe custody fees. However, it may be a good time now to switch.
I have talked with several Swiss users of IB and they confirmed me that for now, we can still invest in US-domiciled funds. So I could transfer all my funds (or the money) to IB and continue investing.
However, as the two Swiss laws become applicable in 2020, that could be only a single year when this is available. After that point, I may have to find another solution anyway. Interactive Brokers already stopped offering these ETFs to European investors last year, in accordance with the law. So, I think they will follow the law in 2020 and stop offering these to Swiss people in one year.
On one side, I am wondering whether I should change to a new broker if I may face the same issue one year later. On the other hand, I have already shown that IB is cheaper than DEGIRO for me in the long-term. Moreover, I am not really satisfied with DEGIRO’s communication on that problem. So, I think I am going to change my broker from DEGIRO to IB in 2019.
Solution 2: Change funds?
Another solution is to comply with the new dumb law and switch to European-domiciled funds. We are not going to lose access to U.S. stock market indexes, only U.S. funds. There are equivalent European tracking the same indexes. However, this is not a very good solution. European funds are more expensive and smaller. And there is less choice for funds around.
For instance, the fund that I will really miss is Vanguard Total World (VT). This fund replicates the performance of the entire world market. It manages around 17 billions of dollars of stocks. And it has a Total Expense Ratio (TER) of 0.10%. It is made of more than 8000 different stocks. This is a really great ETF.
On the European side, there is no full world ETF, at least not in acceptable TER range. The closer they get is with Developed World ETF. But that still means it is necessary to own several ETFs instead of a single one.
If I had to choose one European Developed World ETF, I would probably go with iShares Core MSCI World UCITS ETF. It has around 1600 stocks in 23 developed countries and manages more than 14 billion dollars. It has a TER of 0.20%. That is twice more expensive for an inferior fund. It is not really bad of course. But it really pales in comparison to VT.
If I were to switch to the European equivalent of VT, I would probably have to hold two funds. And they would be more expensive than VT. So, I am not really convinced by this solution. Another thing that shows that these laws are not doing anything good for the investors.
To learn more, you can check out the entire ETF Portfolio with European Funds I would have used.
Solution 3: Use several funds?
The next solution I am thinking of is to use European funds but not use a World fund. It is actually possible to replicate the performance of a world fund by holding several region funds. Of course, it is still better to own the world fund if there is a good option for it. But in Europe, there is no great option of a world fund.
The Vanguard Total World (VT) ETF is composed of stocks from these regions:
- North America: 58.40%
- Europe: 18.60%
- Pacific: 13.30%
- Emerging Markets: 9.40%
- Middle East: 0.20%
- Other: 0.10%
I think we can safely ignore the last two ones and still replicate accurately the performance of the world market fund. That means we would need to hold four funds. You need one U.S. ETF, one Europe ETF, one Pacific ETF and one Emerging Markets ETF. If you really want to have better accuracy, you could also add Canada that is normally included in North America. Or you could find a North American ETF. But I did not find a good one.
It is not a great solution, but this would still beat a world ETF from European provider. It would definitely be a better TER. You can find U.S. ETF around 0.07% in Europe. And since the U.S. is about 55% of the VT ETF, this would definitely bring down the global TER.
The problem is that you have four funds instead of one. I think that simplicity should be preferred in a portfolio. This may make rebalance a bit more difficult as some funds may underperform or outperform the others. And you may have to change the allocations if there is a shift in the economy in the world. But I still think it beats having a 0.20% TER fund.
Solution 4: Be a professional investor
You may have noticed that in this post, I have talked especially about retail investors. This is because both the European laws and the Swiss laws are considering differently professional investors and retail investors.
In fact, they only apply to retail investors. So, if you are a professional investor, you can still use the good old U.S. funds! Obviously, I am not a professional investor and I doubt that you are either. However, there is a kind of loophole in the Swiss version of the law. It states that certain high net worth individuals may choose to opt-out of the law and be treated as professional investors. There is also this loophole in the European version of the law. But the conditions are slightly different.
In the law, a high net worth individual is described as one that:
- Either declare that they understand the risks of the investment by virtue of their qualification and have at least 500’000 CHF.
- Or dispose of at least two million CHF.
Obviously, this is a loophole for the rich. They do not want to hurt the rich that are in the European Union. Another stupid part of this law. I am far from filling these conditions yet. But it is not rare in the personal finance community to see people with more than 500’000 CHF. They could apply to opt-out and be considered as professionals investors.
Now, I do not know how difficult it will be to actually opt-out. And I do not know if this will make you qualified as a professional investor for taxes as well. In which case, capital gains will be taxed. That is something to consider. But it could be a very good option for people who already have a high net worth. This is something I may do in a few years.
This is really sad news for European and Swiss investors that want to invest in U.S. domiciled funds. The best alternative is to invest in European funds. But they are more expensive. And there is also less choice.
I really think that the people who crafted this law did not care about Swiss investors at all but only about European fund providers. There is no doubt that this will profit European funds. Maybe in the future, it will increase their quality and price. But I am not very confident about that. It is a local lockdown of the market. Instead of protecting the customer, they are locking him into inferior choices.
I do not yet know exactly what I am going to do now. I did not really like how DEGIRO handled this issue. First of all, I do not see why they enforced this one year in advance. Moreover, they could have communicated to their customers before enforcing those new limitations.
So, I am thinking that I will open an Interactive Brokers account sooner than I thought. My plan was to wait until I had 100’000 CHF invested to move to IB. But I am starting to believe it is better to move earlier than that.
That will give me one year where I can still invest in good funds. After that one year, I will still be able to hold these funds and invest in the European equivalents for the future. I should be able to reach 100’000 CHF invested in a bit less than one year. After that point, my fees will be very low. I think it is my best option. Of course, I will keep you up to date about what I will do and how I will do it!
To see an ETF Portfolio without any U.S. ETF, take a look at my European ETF Portolfio.
If you are considering U.S. ETFs, you may want to read about the U.S. estate tax.
What about you? What is your strategy when we will not have access to U.S. funds anymore?