ESMA’s views on undue costs in European investment funds

On 31 May 2022, the European Securities and Markets Authority (ESMA) published its report on the Common Supervisory Action (CSA) on costs and fees for investment funds. The CSA was conducted by National Competent Authorities (NCAs) in 2021.

Broadly-speaking, the NCAs noted that while they did not identify any regulatory breaches, there is room for improvement in the application and governance of costs and fees. As a reminder, this report covers the European continental landscape and the remarks may not be applicable to each and every market. The key findings are as follows:

• Size matters: Costs continue to be higher for retail as opposed to institutional investors. In addition to smaller entities not being able to enjoy economies of scale, a benefit that can be passed down to investors in the form of lower charges, it was also established that smaller management companies sometimes have less strong pricing processes in place, when compared to entities overseeing larger assets under management (AUM). This could be attributed to these small entities not having the capability to access better, more attractive pricing offers. 

• Delegates should not overreach: In some cases, delegates have been found to have the final say on the fees and costs charged for fund management, bringing into question i) their compliance with delegation rules and ii) the adequacy of controls of the UCITS manager in setting overall costs and fees.

• No common understanding of “undue costs”: Undue costs are not defined at Level 1 and 2 and this has resulted in there being subjectivity on what constitutes an undue cost at Member State level.

• Conflicts of interest at play: Specifically in the context of related-party or intragroup transactions, there have been reported cases of conflict of interest and specific measures to mitigate these conflicts of interests have not been addressed.

• Efficient portfolio management (EPM) processes not clearly outlined: Some of the most common EPM processes and policies include that of securities lending, (reverse) repurchase agreements and buy-sell/sell-buy back transactions. It was reported that some UCITS managers could not furnish the NCA with evidence of their internal policies and procedures for EPM. Further, a lack of detailed information on the EPM in client disclosures – including information on risks, fees and performance – was noted in certain European countries covered in the survey.

• Fee splits on EPM revenues warrant deeper analysis: In some circumstances UCITS managers applied fee splits without sufficient consideration as to whether they are in line with fair market rates or in investors’ best interests.

• Compensation for investors impacted by undue costs, fees or financial errors: ESMA emphasized that where investors have been financially negatively impacted by undue costs, fees or calculation errors, that they be compensated appropriately. 

Practical implications

The report underlines that by now, all entities should have had sufficient time to comply with the supervisory briefing on undue costs which was released in June 2020. Looking ahead, the NCAs have noted that they prefer to employ bilateral engagement with fund managers as opposed to strict enforcement. Asset managers can expect NCAs to follow-up directly, conduct on-site inspections, additional assessments and corrective measures moving forward at the European level – this has been implemented in certain dedicated countries already, like Luxembourg.  

How EY can help 

The report highlights that there is room for improvement in the application of the best practice set out by the supervisory briefing. At EY, our team of experienced professionals is ready and available to help you take stock and enhance your current level of compliance concerning costs and fees. Specifically, we can assist with any of the below-mentioned services:

• Assessing the level of compliance of your pricing processes and related remediation 

• Review and benchmarking of the cost structure of your funds towards peers 

• Preparing for the “composition of costs” section within the transition to PRIIPS KID 

References:

1.  Press Release

2. Final Report on the 2021 CSA on costs and fees