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Can Hungary become the “Luxembourg of Eastern Europe”?

Due to Hungary’s optimal geographic location for the financial services sector, it has become possible for the country to become the “Luxembourg of Eastern Europe,” according to the Ministry for National Economy. However, market players asked by the Budapest Business Journal do not see this happening just yet.

“The new Hungarian government is firmly determined to make Hungary the 21st-century financial center of Central Europe with the recently released long-term and sound economic policy strategy,” the ministry said in a statement. “We intend to create an environment with taxation as well as a legal and market regulatory background which, by stimulating financial investment, could facilitate the long-term rise of the domestic savings rate, ” according to the ministry.

“The ministry says one thing, but does not support it by all means,” Péter Simon, the business development director of OTP Fund Management told the BBJ. Market players have been discussing the possibilities of making Hungary a financial hub in the eastern European region for years now. The Association of Hungarian Investment Fund and Asset Management Companies (Bamosz) is already preparing a study on the potential ways to prepare Hungary for such a task. However, the process was suspended after the changes to Hungary’s pension system destroyed market confidence.

While Hungary does not have a chance of becoming a financial center in the foreseeable future, it may become a hub in the southeastern European region in the long run, Simon said. “Although our financial sector is still more developed than that of the countries in that region, there is a lot to do, including the successful implementation of the UCITS IV directive (Undertakings for Collective Investment in Transferable Securities) and creating a competitive infrastructure for fund registration and order processing,” he stressed.

UCITS IV

Hungary is ready to implement the new EU regulations on open-ended investment funds on time, the ministry said. The primary goal of the UCITS IV directive, which will enter into force in the first half of 2011, is to facilitate the creation of a global and concentrated fund management market by helping cross-border sales and operation through standard regulation. According to Bamosz’s Secretary General András Temmel, the most likely winners of the consecutive geographic centralization – the new centralized processing hubs – will probably be the established centers of expertise, such as Luxembourg.

The introduction of the new regulation is complemented by the previously announced tax reform, which could make Hungary an attractive destination on the global fund management market, the ministry said. As of January 1, 2011, capital gains from the sale of equities are subject to a flat rate tax of 16%. Temmel also expects an increase in domestic savings as a result of the lower personal income tax rate, as well as significant development in the market of small investors.

Fund managers do not need too much preparation for the implementation of the directive, as it does not have an immediate effect on their internal operations, Temmel said. Over 90% of the investment funds operating in Hungary are regulated at national level and are not subject to the new directive, although Hungarian regulations are similar to the UCITS in many ways. “We would like to adopt, for instance, the Key Information Documents (KIDs) for non-UCITS funds, too,” he noted. OTP confirmed that it will replace the current 25–30 page simplified prospectus for non-UCITS funds with the two-page KID.

In the long run, however, Hungarian funds will probably be converted into UCITS funds, a process that will be intensified by the eventual adoption of the euro, according to Temmel. As long as the forint exists, domestic fund managers are needed on the market, he stressed. Hungarian fund managers can provide higher quality services, as they have a deeper knowledge of the local market and can react faster to customers’ needs as well as to ad hoc questions of colleagues from branches, product development manager of Budapest Fund Manager Norbert Vasas told the BBJ.

Stronger competition

OTP, similar to other market players, will face fiercer competition, as more funds will enter the Hungarian market after the implementation of the new directive, Simon said, noting that there are already quite a lot of foreign investment funds in Hungary. In order to face the new challenges, OTP aims to introduce new “creative” products in addition to simplifying its communication to investors by introducing KIDs. In addition, Simon expects increased economies of scale due to the more seamless process of merging funds.

On foreign markets, however, OTP may benefit from the new regulations, as they will override any potential obstacles posed by national regulations. OTP plans to stick to its current policy of managing a fund that invests, for instance, in the Romanian market from Romania, Simon said. Currently, only OTP and Budapest Fund Manager are distributing funds outside Hungary, as most Hungarian fund managers are too small to follow suit, with the exception of maybe Concorde Securities. “It is a question of building a good distribution network in the target country,“ noted Temmel.

Both fund managers are still at the beginning of their regional expansion. Although OTP has already set up fund management operations in four regional countries, out of the 64 OTP investment funds, only 2–4 are distributed on foreign markets. Meanwhile, Budapest Fund Manager manages assets in value of a couple of billion forints primarily in the Czech Republic, and also, as of the beginning of 2011, three funds dedicated for the Czech market and four equity fund series denominated in CZK. “The Czech market is more conservative than the Hungarian in that bank deposits are still favorites,” Vasas noted. (Gabriella Lovas)