Background
In January 2021, ESMA launched a Common Supervisory Action ("CSA") with national competent authorities ("NCAs") on the supervision of costs and fees of UCITS across the EU. The aim was to assess the compliance of supervised entities with the relevant cost-related provisions in the UCITS framework and the obligation of not charging investors with undue costs. It was agreed to notably consider ESMA’s supervisory briefing on the supervision of costs in UCITs and AIFs (the "Supervisory Briefing") and Commission Regulation 583/2010 as regards key investor information. The CSA also covered entities employing efficient portfolio management ("EPM") techniques to assess whether they adhere to the requirements set out in the UCITS framework and ESMA Guidelines on ETFs and other UCITS issues ("ESMA Guidelines").
The CSSF started the CSA in March 2021 by asking 36 Luxembourg management companies managing UCITS ("IFMs") to complete a dedicated questionnaire. ESMA published the results of the CSA at EU level in a report and the objective of the CSSF’s feedback report published on 20 October 2022 (the "Feedback Report") is to inform the industry about the main observations that the CSSF made in the context of its CSA supervisory work as well as about the related recommendations for improvements.
Scope and timing
In the Feedback Report the CSSF asks all IFMs to conduct as soon as possible and at the latest by the end of March 2023 a comprehensive assessment with regard to the compliance of their policy, approach and arrangements related to costs, and to take, if applicable, the necessary corrective measures.
As the Supervisory Briefing applies both to UCITS and AIFs, the CSSF requires that the review of the pricing process is also performed by AIFMs for their AIFs under management.
The CSSF further asks all IFMs to conduct, at the latest by the end of March 2023 a comprehensive assessment with regard to the compliance of the set-up of their EPM activities in relation to the observations made by ESMA and the CSSF and to take, if applicable, the necessary corrective measures.
CSSF’s observations
Pricing Process
The Supervisory Briefing provides that management companies develop and periodically review a structured pricing process. The pricing process adopted by the management company should allow a clear identification and quantification of all costs charged to the fund.
The CSSF observed several weaknesses regarding the pricing process and confirmed that it expects IFMs regardless of their size to:
- Define and implement a structured and formalised pricing process;
- Perform an independent (i.e. from the portfolio manager) analysis of the fee structures;
- Periodically review the level of cost, at least on an annual basis, and monitor it in order to compare the estimated ongoing charges with the actual expenses incurred and, where possible, reduce the level of fees; and
- Ensure the viability and competitiveness of the fund over time by taking due care of the sustainability of the costs over time.
The notion of undue costs
Article 25(4) of CSSF Regulation 10-4 requires IFMs to act in such a way as to prevent undue costs being charged to the UCITS and its unitholders. The Supervisory Briefing sets common criteria for assessing the notion of undue costs and supervising the obligation to prevent undue costs being charged to investors. The CSSF reminds IFMs that the pricing process must take these criteria into account.
Related party transactions
The CSSF observed that, for a small number of IFMs, the identification of diverse situations of conflict of interest was not properly performed as their conflicts of interest register and/or their conflicts of interest policy do not adequately refer to related party transactions.
The CSSF therefore asks IFMs to ensure that an adequate conflicts of interest policy and comprehensive conflicts of interest register are in place to ensure an effective mitigation of conflicts of interest in related party transactions.
Quantitative findings
The CSSF identified breaches of guidelines in respect of what types of charges should be included in the ongoing charges figures in the Key Investor Information Document (“KIID”). As such, the CSSF reminds IFMs to develop and implement a documented internal approach for the definition of what charges and payments shall or shall not form part of the amount to be disclosed as ongoing charges in the KIID for supporting the disclosure in the KIID.
The CSSF observed a high level of ongoing charges in certain outlier funds with a low amount of assets under management. Pending a further analysis on this point the CSSF wishes to draw the attention of IFMs to the fact that these situations of high costs concerning funds with low Asset under Management ("AuM") must not persist for long periods. The CSSF further asks all IFMs to assess the current and foreseeable level of costs associated with their low AuM funds in order to ensure that no undue costs are charged to investors and to verify the viability of these funds in terms of their ability to provide a positive return to their investors.
USE of EPM techniques by UCITS
Of the IFMs that contributed to the CSA, 10 were selected which employ EPM techniques. The objective was to assess whether the IFMs complied with the requirements of the ESMA Guidelines.
The CSSF observed that while most IFMs had documented policies and procedures in place governing use of EPM techniques, these needed to be enhanced by addressing in a detailed manner those matters highlighted in the Feedback Report.
A certain disparity concerning the fixed fee splits operated for the securities lending transactions with practices varying. It was also noted that IFMs generally have to enhance the level of granularity of the specific documented assessment/analysis for justifying the operational costs deducted from the gross revenue earned on EPM techniques. Some IFMs could not provide sufficient quantitative information to justify the relevance of the underlying cost drivers.
On that basis the CSSF asks IFMs to enhance the control framework around operational costs/fees deducted from the gross revenues arising from EPM techniques.
The CSSF noted that the conflicts of interest policies of IFMs did not specifically cover the use of the EPM techniques. As such the CSSF asks IFMs to cover adequately the conflicts of interest arising from the use of EPM techniques.
Finally the CSSF asks IFMs to provide for an adequate and periodic involvement of the compliance and internal audit functions for verifying the compliance of the activities concerning the EPM techniques with applicable regulation.
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