How Europeans can invest in US-ETFs

Introduction

The EU MiFiD regulation prohibits brokerage firms to sell funds to European retail investors, which do not provide certain regulatory documents, such as a Key Information Document (KID). Notably, differences in US and EU regulation make it impossible for US-ETFs to provide such documents. Among other reasons, this is because EU regulation requires forward looking statements, while US regulation does not allow ETF provider to make such statements. Moreover, European ETFs have generally slightly higher fees (though there is a trend of further decreasing fees), so American ETF provider (such as iShares and Vanguard) actually have little incentive to offer US-ETFs to European investors if they can create European-based ETFs with slightly higher fees.

Five ways to purchase US-ETFs

Let us emphasize that EU regulations DOES NOT MAKE IT ILLEGAL for European retail investors to own, to hold or to buy foreign ETFs. The regulation only affects brokerage firms that are not allowed to sell such products to typical retail investors. Still, there are ways for European retail investors to acquire shares of US-ETFs:

1. Open a brokerage account with a non-European address. The easiest solution is to get a brokerage account that does not enforce the EU regulation. This is possible by opening an account with a non-European address. In our experience, the easiest solution is to open an Interactive Brokers account with a non-EU address and in particular an Interactive Brokers Lite account if one has a US address.

2. Open a brokerage account with a non-European company. If you do not have a non-European address, you might be able to open an account with a brokerage firm that does actively operate within Europe, while still offering service to European clients. While Interactive Brokers has non-European subsidiaries, they will only accept clients with European addresses within their European subsidiaries (which then falls under EU regulation preventing clients from buying US-ETFs). However, there are US firms, such as Tradestation and Tastyworks, which are based in the US and which do accept European clients without adhering to the EU regulation. Therefore, this allows EU customers to buy directly US-ETFs, as of writing (August 2021), but of course this may change in the future in case the EU is able to enforce its regulation for these firms.

3. Get an exemption (treated as "elective professional client"). European investors can circumvent the EU regulation by applying for an exemption with their brokerage firm. Retail clients can request to be treated as "elective professional clients" if they meet the following requirements (as outlined in the EU Directive MiFiD II, Annex II):

   • Any such waiver of the protection afforded by the standard conduct of business regime shall be considered to be valid only if an adequate assessment of the expertise, experience and knowledge of the client, undertaken by the investment firm, gives reasonable assurance, in light of the nature of the transactions or services envisaged, that the client is capable of making investment decisions and understanding the risks involved.

   • In the course of that assessment, as a minimum, two of the following criteria shall be satisfied:

     • the client has carried out transactions, in significant size (in practice, this is regularly interpreted as 200,000 EUR or greater), on the relevant market at an average frequency of 10 per quarter over the previous four quarters,

     • the size of the client’s financial instrument portfolio, defined as including cash deposits and financial instruments exceeds EUR 500 000,

     • the client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged.

   • As an example, see the details about re-categorization for customers with Interactive Brokers (UK), Interactive Brokers (Ireland), Interactive Brokers (Luxemburg) and Interactive Brokers (Central Europe).

4. Buy US-ETFs indirectly through options. The EU restrictions on US-ETFs does not affect to sale of options on the respective ETFs. Therefore, a European broker can allow European retail investors to buy and sell options (put and call options) on US-ETFs. Typical options expire weekly, monthly or quarterly and there exist options for most major US-ETFs. Therefore, European investors could sell cash-covered in-the-money put options shortly before their expiration, which are almost certain to be exercised. This leads to an indirect purchase of the underlying US-ETF in multiples of 100 shares (as each option contract requires the purchase and sale of 100 shares). This approach is a bit cumbersome, but perfectly legal and in full compliance with current EU regulation. In practice, this only makes sense to for large account values, as buying US-ETFs in multiples of 100 shares often requires individual investments of large amounts. We still list this method, as it might be useful to know for some investors (and quite feasible for ETFs trading around 10 USD).
   Example: A European investor would like to invest in VTI (Vanguard Total Stock Market) covering the US market. The shares are currently trading at 230 USD each. Today expires a put option with strike price 240 USD, which gives the owner of the option the right (but not the obligation) to sell 100 shares of VTI for the strike price of 240 USD (so 10 USD more than the current trading price) to the entity that sold the option (that has the obligation to buy at this price). As the option is close to expiration, it will trade close to 10 USD per share, i.e., as one option represents 100 shares, the put option will cost close to 1000 USD. A European retail investor could now sell one such option and would immediately receive 1,000 USD. If VTI trades by the end of the day still below 240 USD, the owner of the option will very likely exercise the option and so the retail investor is forced to pay 24,000 USD to receive 100 shares of VTI. This transaction is counted as typical sell transaction through the broker, but rather settlement of the option contract and therefore not affected by EU restrictions. In effect, the European investor will have paid 24,000 USD for the shares, but previously received 1,000 USD for selling the option. Therefore, the effective price will be 23,000 USD, but with the small catch that the 1,000 USD of income (from selling the option) will be taxed immediately and the cost basis of the ETF will be at 240 USD per share. It is therefore advantageous to sell options just slightly above the strike price.

5. Hire a financial management firm. There are financial advisors who will be able to setup an account for you, through which they can buy US-ETFs for you. In practice, they will manage your account, so you will be typically less flexible and this service comes at an additional cost of often 0.5-1.5% p.a., but if none of the other options work for you, this may still be an option.

Potential pitfalls

• Are there problems with bequeathing stocks to the next generation for non-US tax residents (for example, German citizens living in Germany who hold US-ETFs or stocks)? It is often said that US holdings could be problematic as an inheritance.
  This problem is a priori not related to having foreign ETFs, but applies to any direct investments in the US. It is therefore imperative to check the precise treaty conditions to ensure that there is no excessive US tax for inheriting US assets if non-US persons are involved. In the case of German tax residents (as an example), the situation only becomes problematic at very large amounts as explained below.
  The key message: Based on the US-German tax treaty, this should only be a problem if the total inheritance exceeds 11,700,000 USD with even higher limits for your spouse. The situation may be different for people who are not German tax residents. In the following, let us review the most important rules.
  (1) For investments up to 60,000 USD of US assets, there is no US tax on inheritances of people who are NOT US tax residents.
  (2) Note that US stocks, US funds and other assets (such as properties etc.) count as US assets. Indirectly held US assets, such as through an ETF based in Europe, do NOT count as US assets.
  (3) The US-German tax treaty on inheritances gives German tax residents a fraction of the US tax-free amount of 11,700,000 USD where the fraction corresponds to the part of US assets in the total inheritance. Therefore, as long as the total inheritance value is below 11,700,000 USD, there will not be any US tax (as in this case, the tax-free amount is necessarily equal or larger than the respective US assets). For example, if the total inheritance is valued 10,000,000 USD with 3,000,000 USD in US assets. In this case, the tax free amount corresponds to 30% of 11,700,000 USD, which equals 3,510,000 USD and is thus more than the 3,000,000 USD in US assets.
  (4) The tax-free limits are even higher for spouses. First, only 50% of the US assets are included in the calculation and on top of this the remaining value of US assets is reduced by 11,700,000 USD. Only what remains is then included in the calculation of (2), so for spouses only US assets valued much higher than 23,400,000 USD will lead to a taxation in the US.
  In summary, US inheritance taxes for German tax residents only become relevant at amounts, where one has enough money to think about more elaborate structures to organize inheritances.