ESMA Briefing on the Supervision by NCAs of Costs applicable to UCITS and AIFS

Background

On 4 June 2020, ESMA issued a supervisory briefing (the “Briefing”) on the supervision by National Competent Authorities (“NCAs”) of costs applicable to Undertakings for the Collective Investment in Transferable Securities (“UCITS”) and Alternative Investment Funds (“AIFs”).

The Briefing aims to promote convergence on the supervision of costs in UCITS and AIFs across the EU. In this regard, ESMA developed criteria to support NCAs in (i) assessing the notion of “undue costs” and (ii) supervising the obligation to prevent undue costs being charged to investors.

Supervising of the pricing process

In order to allow NCAs to appropriately supervise that investors are not charged with undue costs, ESMA advises NCAs to require that management companies develop and periodically review a structured pricing process addressing the following elements:

1. Whether the costs are linked to a service provided in the investor’s best interest;
2. Whether the costs are proportionate compared to market standards and to the type of service provided, particularly in the context of potential conflicts of interest relating to payments to third parties, intragroup delegation or depositary functions;
3. Whether the fee structure is consistent with the characteristics of the fund;
4. 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;
5. 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;
6. Whether there is no duplication of costs and costs are properly separated and accounted for. 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;
7. Whether a cap on fees (e.g. subscription/redemption fees), if any, is applied and clearly disclosed to investors (e.g. expressed as a percentage of the NAV);
8. 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;
9. Whether all costs are clearly disclosed to investors in line with applicable EU rules (AIFMD, PRIIPs and UCITS) as well as any additional rules applied at national level; and
10. 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.

Supervision obligations

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:

1. Fund’s authorisation stage;
2. Off-site supervision;
3. On-site inspections;
4. Approval of material changes to the fund (which would require the NCA’s approval and prior information to investors, as well as the possibility for the investors to redeem at no additional charges);
5. Thematic reviews; and/or
6. Assessment of investors’ complaints.

Also, the NCAs are expected to cover the following aspects:

1. Cost disclosure and transparency: (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 and documentation;
2. Business conduct, strategic risk and reputational risk.

NCAs should supervise that the payment of any fee or commission is aimed at remunerating a service provided to the fund and does not impair compliance with the management company’s duty to act in the best interest of the unitholders. By doing so, the management company must develop a pricing process that:

1. clearly sets out responsibilities among the management bodies of the firm in determining and reviewing the costs charge to investors;
2. in case of the existence of conflicts of interest, ensure that the risk of damage to investors’ interest will be prevented;
3. is clearly documented and periodically reviewed.

When supervising the pricing process, elements referred to under the section “Supervision of the pricing process” point c) i.e whether the fee structure is consistent with the characteristics of the fund should be addressed.

Finally, in situations where undue costs are charged to investors, ESMA expects that the outcome of the supervisory action should include an assessment of the possibility to request the following actions:

1. Investor compensation, where allowed under the national provisions;
2. Reduction of fees;
3. Review of disclosure documents; and/or
4. 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.