Morningstar Publishes Global Study of Regulation and Taxation in the Fund Industry, Finding Regulation to be Adequate, But Not Always Proactive

April 27, 2020

The Netherlands, Sweden, and the United Kingdom earned Top grades in the second chapter of the Global Investor Experience Study; Australia, Canada, China, Japan, New Zealand, and the United States received Below Average grades

CHICAGO, April 27, 2020 /PRNewswire/ -- Morningstar, Inc. (Nasdaq: MORN), a leading provider of independent investment research, today published the second chapter of its biannual Global Investor Experience (GIE) report. The report, now in its sixth edition, assesses the experiences of mutual fund investors in 26 markets across North America, Europe, Asia, and Africa. The "Regulation and Taxation" chapter evaluates the regulatory and tax frameworks that mutual fund investors face, assigning grades of Top, Above Average, Average, Below Average, and Bottom to each market.

Morningstar gave Top grades to the Netherlands, Sweden, and the U.K., denoting these as the most investor-friendly markets in terms of regulation and taxation. Conversely, Morningstar assigned Below Average grades to Australia, Canada, China, Japan, New Zealand, and the U.S., as fund markets where the regulatory and tax schemes need to improve. Morningstar did not assign a Bottom grade to any market, as every market in the study provides basic protections for investors.

"When it comes to regulation and taxation in the fund industry, we are looking for policy that ultimately empowers investor success, like tax incentives that encourage individual investment and effective regulation of funds that promotes transparency and limits misleading statements and conflicts of interest," said Aron Szapiro, head of policy research at Morningstar and a co-author of the study. "We found that regulators in the U.S. and Canada are generally running efficient systems. However, the pace of reform there hasn't kept up with the rest of the world, explaining why the U.S. and Canada continued to receive a Below Average grade for regulation and taxation in our study."

"Since our last report in 2017, the trend towards strong regulation that protects mutual fund investors has remained intact. We're seeing more markets take steps to motivate citizens of all backgrounds to invest for their futures through special tax incentives or regulations that encourage lower fees, like mandatory disclosures," said Andy Pettit, Morningstar's director of policy research, EMEA, and co-author of the study.

The second chapter on Regulation and Taxation is available here. Highlights include:

  • The Netherlands, Sweden, and the U.K. earned top grades in part because they provide strong incentives for ordinary people to invest, although none of the countries offer the overall best tax systems for ordinary investors. The U.K. continued the expansion of its auto-enrollment program and together with the Netherlands stood out for banning embedded commissions on most sales, and Sweden stood out for having strong governance and being a frontrunner in ESG disclosures.
  • Every European country covered by the MiFID II regulations earned at least an average grade as the regulation spurred needed reforms in areas like soft dollar commissions and increased transparency. 
  • Australia, Canada, New Zealand, and the United States lagged other markets, as they have in previous studies. These countries have adequate regulation around mutual fund operations and distribution, meeting basic standards, and the experience for investors can be quite good. Despite that, they fall short of the standard set by other markets that govern conflicts of interest and incentivize investing. In addition, Australia, Canada, and the U.S. all lag on tax policy compared with other markets in the study, creating distortions and disincentives to invest.
  • Japan fell to Below Average despite making some positive strides. Japan fell to Below Average from Average mainly due to Morningstar's revised methodology putting more emphasis on mutual fund operations and distribution policies, an area where other markets have taken major steps to shore up their regulations in recent years. Japan doesn't mandate disclosure of third-party research costs or distribution costs paid out of fund assets, and there is no requirement to disclose advisors' or distributors' conflicts of interests.
  • China falls short in encouraging people to save for retirement and opening fund markets to promote greater choice. China only has a state-managed pension scheme and no other mandated supplementary defined contribution system. Additionally, the regulation of third-party research cost disclosure and soft dollars is weak. Although China has made efforts to further open up its capital market, fund choices are mostly limited to locally domiciled funds.
  • ETFs' continued growth has given investors more choice in most markets, though distributors still have more incentive to offer open-end funds in some markets. In addition, the tax treatment of ETFs can vary. For example, in the U.S., the choice is distorted by differing tax treatments that are advantageous to ETFs, while, in New Zealand, ETFs are tax-disadvantageous for lower earners.
  • While funds in many markets continue to levy distribution fees through a fund's expense ratio, there have been some positive steps to reduce this practice. For instance, commissions have been banned in Australia, the Netherlands, and the U.K. In Hong Kong, intermediaries that receive monetary or nonmonetary benefits from fund issuers can no longer refer to themselves as independent.
  • Of the 26 markets, only Singapore and Hong Kong do not tax fund investors at all. Many markets exempt fund investors from capital gains while they hold a fund but tax at least some of the fund's income. The U.S. and Australia are notable exceptions where taxes are due on capital gains incurred by the fund, regardless of whether an investor has sold the fund or not.

The GIE study reflects Morningstar's views about what makes a good experience for fund investors. This study primarily considers publicly available open-end funds and exchange-traded funds, both of which are typical ways that ordinary people invest in pooled vehicles. As in previous editions, for this chapter of the GIE study, Morningstar evaluated markets based on four key categories: policy and tax encouragements that incentivize individuals to invest for their futures, regulatory requirements for operations and distribution, governance, and regulatory structure.

The methodology change that assigned more weight to regulation of fund operations and distribution contributed to a greater mix of higher and lower grades around the Average grade than previously and helps identify markets that, in Morningstar's opinion, are adopting best practices and those that need to improve.

This chapter follows the Fees and Expenses chapter that Morningstar published in September 2019. Morningstar expects to publish the study's other chapters later this year.

About Morningstar, Inc.

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The Company offers an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors in the debt and private capital markets. Morningstar provides data and research insights on a wide range of investment offerings, including managed investment products, publicly listed companies, private capital markets, debt securities, and real-time global market data. Morningstar also offers investment management services through its investment advisory subsidiaries, with approximately $233 billion in assets under advisement and management as of Dec. 31, 2019. The Company has operations in 27 countries. For more information, visit Follow Morningstar on Twitter @MorningstarInc.

Morningstar's Manager Research Group consists of various wholly owned subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC. The grades assigned for each market are derived from a qualitative assessment process performed by manager research analysts. The grades referenced in this release and report are assessments, thus are statements of opinions and are not to be considered as guarantees. This press release and the Global Fund Investor Experience report is for informational purposes only.

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