On 4 June 2020, ESMA published a supervisory briefing aimed at promoting convergence on the supervision of costs in UCITS and AIFs across the EU. While the briefing is aiming at National Competent Authorities ("NCAs") – setting out considerations that NCAs should take account of when supervising cost related issues – it also details for managers of UCITS and AIFs ("Management Companies") what compliant implementation of UCITS and AIFMD cost provisions1 entails.
To promote convergence in relation to the supervision of costs in UCITS and AIFs, ESMA has developed criteria to support NCAs in:
- assessing the notion of "undue costs" – supervising the pricing process of the Management Company; and
- supervising the obligation to prevent undue costs being charged to investors.
Supervising the pricing process of the Management Company
ESMA states that the notion of undue cost should be primarily assessed against what should be considered the best interest of the fund or its share/unitholders. It is necessary to ensure that:
- the costs charged to the fund or its share/unitholders are consistent with the investment objective of the fund and do not prevent the fund to achieve this objective, particularly – but not limited to – where these costs are paid to third parties, including depositary costs;
- the pricing process adopted by the Management Company allows a clear identification and quantification of all costs charged to the fund, whether those are paid to the Management Company or to third parties (e.g.: depositary, external valuer, broker) and/or directly paid by the investors (e.g.: entry and exit costs), in order to avoid hidden costs.
NCAs are expected to require Management Companies to develop and periodically review a structured pricing process addressing:
- whether the costs are linked to a service provided in the investor's best interest;
- whether the costs are proportionate compared to market standards and to the type of service provided particularly in the context of potential conflict of interests relating to payments to third parties, intragroup delegation or depositary functions;
- whether the fee structure is consistent with the characteristics of the fund;
- whether the costs borne by the fund, including those paid to third parties, are sustainable taking also into account the expected net return of the fund;
- whether the costs ensure investors' equal treatment and are not of material prejudice to the interests of any class of share/unitholders or potential share/unitholders except for AIFs not distributed to retail investors disclosing a preferential treatment in their rules or instruments of incorporation where such a preferential treatment is allowed under the applicable legislation;
- whether there is no duplication of costs and costs are properly separated and accounted for. To this purpose, a clear distinction between the costs charged to the fund and those paid directly to the Management Company and/or the depositary and/or any other third party should be made;
- whether a cap on fees is applied and clearly disclosed to investors;
- in case of UCITS and relevant AIFs, if the fund charges performance fees, whether the performance fee model and its disclosure is compliant with the ESMA Guidelines on performance fees;
- whether all costs are clearly disclosed to investors in line with applicable EU rules as well as any additional rules applied at national level; and
- whether the pricing process and all charged costs are based on reliable and documented data, in order to ensure the ability of the NCA to reproduce ex post the calculations made by the Management Company on a single portfolio level.
According to ESMA, NCAs should supervise that the payment of any fee or commission is aimed at remunerating a service provided to the fund/its investors and does not impair compliance with the Management Company's duty to act in the best interests of the share/unitholders. In order to ensure that this is the case, NCAs should monitor that the Management Company develops a pricing process that:
- clearly sets out responsibilities within the Management Company in determining and reviewing the costs charged to investors;
- in case of the existence of conflicts of interest, it ensures that the risk of damage to investors' interest will be prevented;
- is clearly documented and periodically reviewed.
Supervising the obligation to prevent undue costs being charged to investors
NCAs are expected to review Management Companies' pricing processes as part of their supervisory activity to ensure that undue costs are not charged to investors. The review of the processes should be carried out in one or more of the following stages:
- fund's authorisation stage;
- off-site supervision;
- on-site inspections;
- approval of material changes to the fund (which would require the NCA's approval and prior information to investors, as well as the possibility to the investor to redeem at no additional charges);
- thematic reviews; and/or
- assessment of investors complaints
As part of their supervisory activities, NCAs should cover:
- cost disclosure and transparency – ensuring that (i) the existence, nature and amount of the costs/fees are clearly disclosed to investors in a manner that is comprehensive, accurate and understandable; and (ii) the charged costs are consistent with funds' rules, documentation, offering documents; and
- business conduct, strategic risk and reputational risk.
ESMA expects the outcome of any supervisory action where undue costs charged to investors have materialised to include an assessment of the possibility of:
- investor compensation, where allowed under the national provisions;
- reduction of fees;
- review of disclosure documents; and/or
- communication of good and poor practices by NCAs to market/stakeholders/press, which should assist in acting as a deterrent against managers charging undue costs to investors.
Management Companies should review their pricing processes to ensure that the matters set out in ESMA's supervisory briefing are addressed.
Originally published 12 June, 2020
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