Date Published 17/07/2023
The European Securities and Markets Authority (“ESMA”), the lead regulatory authority for financial services in the European Union (the “EU”), released a new opinion on 17th May 2023 on undue costs for UCITS and AIFs, (ESMA34-45-1747) (the “Opinion”). This sets out suggestions for possible clarifications to the notion of “undue costs” to be included in the underlying UCITS legislation and under the AIFMD.
Background
ESMA launched a common supervisory action (“CSA”) in 2021 to focus on the supervision of costs and fees of UCITS across the EU. This followed the identification of the significant impact of costs on the ultimate performance of retail products, in particular, and the inherent inhibition this posed to investment by such investors. The aim of the CSA was to assess compliance with the key cost-related provisions already included in the UCITS legislation as well as to investigate the extent to which these provisions were overseen and enforced by the national competent authorities (“NCAs”) in the individual member states in practice. While primarily aimed at UCITS, similar concerns pertaining to AIFs were also highlighted. The Opinion has been prepared in light of the responses by the NCAs to ESMA’s related survey on the supervision of costs (the “Survey”) and a summary of the responses to that survey are included as an annex to the Opinion.
Updates Proposed
Some of the key findings of the Survey were that the lack of specificity on what constituted “undue” costs and charges in the relevant EU legislation and the fact that related supervisory briefings were only issued by way of guidance meant that there were significant challenges to pursuing related enforcement actions or ensuring investor compensation. In order to address these particular concerns, the Opinion recommends the updating of the UCITS directive (specifically Articles 2(1) and 14) and the AIFMD (specifically Articles 4(1) and 12). The related updates would provide greater clarity on the notion of undue costs and charges, including by requiring level 2 technical standards be drawn up specifying “due” and “undue” charges in different scenarios. This would also provide a solid basis for related enforcement actions. The proposals build on other relevant considerations, such as the list of costs included under PRIIPS. This would not only bring clarity but also address disclosure.
Next Steps
The Opinion has been addressed to the European Commission in order to encourage it to consider whether legislative updates are warranted. Accordingly, prior to the adoption of any such revised legislative provisions the terms of the Opinion are not legally binding on regulated firms. However, boards of directors of regulated EU funds, fund promoters and investment managers, as well as management companies and AIFMs (who constitute the “Responsible Persons” for the purposes of the existing related legislative provisions) would be well advised to note the potential for the provisions outlined to become mandatory and to consider pre-emptively interpreting the rules pertaining to costs in light of the clarifications proposed in the Opinion, both as a defensive safeguard and to show compliance with best practice. Subsequent to the Opinion being issued the European Commission has issued a proposal for a new directive reflecting the proposals of the Opinion as part of a new Retail Investment Package of reforms. This is currently open for comments in the consultation process. See our separate Legal update on this for more information.
Irish Dear CEO Letter
It can be noted that the Central Bank of Ireland (the “Central Bank”) had issued a “Dear CEO” Letter dated 24th March 2023 (the “Letter”) following its review of issues around the costs and fees charged to UCITS. This letter highlights the main findings of the inspection, sets out the Central Bank’s related expectations and identifies specific actions to be undertaken. The Letter was addressed to the management companies of UCITS as they have the primary obligation to ensure related compliance, however it is also stated to be relevant for AIFMs and AIFs.
The Letter is stated to be part of the follow up to the CSA and was prepared after a review of a sample of 59 firms and virtual inspection calls prior to issuing the Letter.
Findings
The Letter clarifies that various deficiencies were identified by the Central Bank in their review of the relevant firms. The key findings identified include:
- A lack of policies and procedures on costs and fees;
- Failure to ensure periodic reviews of costs and fees;
- No oversight of fee policy and overreliance on inputs from investment managers;
- Inappropriate or lack of policies around costs for Efficient Portfolio Management (“EPM”);
- Inappropriate or unclear fixed cost operating models;
- Excessive charges for investment advisors.
The Central Bank has clarified that written pricing policies are expected, and these should entail at least an annual review of fees incurred and their basis. These policies should include design, oversight, and review elements to ensure they are operating effectively and in the best interests of investors. Certain areas, such as charges relating to EPM, fixed cost operating models and charges imposed by non-discretionary “advisors” require additional oversight and consideration due to the concerns raised by related practices.
Next Steps
The Letter states that oversight and (re)calibration of costs and fees should be a priority for UCITS and that its contents should be discussed and considered by fund boards without delay. All firms managing UCITS are obliged to conduct a gap analysis relating to the findings of the Letter and where appropriate put a plan in place by the end of Q3 2023 to address any gaps identified. Fund boards should expect to be fully briefed on related matters in upcoming board meetings. Although addressed to UCITS the Letter is also stated to be of relevance for AIFs and AIFMs.
Clerkin Lynch held a seminar on this topic in conjunction with Fitz Partners and Newberger Berman in Dublin on July 5th. Contact us for the related slides.
The articles linked below may also be of interest in terms of background to this issue: