Background
On 17 May 2023, ESMA issued its opinion on undue costs of UCITS and AIFs (the “Opinion”). The Opinion follows ESMAs Common Supervisory Action (“CSA”) with National Competent Authorities (“NCAs”) launched in January 2021. The aim of the CSA was to assess compliance with the cost-related provisions of the UCITS framework and the requirement that investors not to be charged undue costs.
The CSSF started the CSA in March 2021 and published on 20 October 2022 a “feedback report” to inform the industry about the main observations that the CSSF made in the context of its CSA supervisory work as well as the related recommendations for improvements to the IFMs by the end of March 2023 (see our article published in our newsletter dated 18 January 2023).
In this context, the Opinion contains suggested amendments to (i) Directive 2011/61/EU of 8 June 2011 on Alternative Investment Fund Managers (the “AIFMD”); and (ii) Directive 2009/65/EC of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (recasts) (the “UCITS Directive”), which would require AIFMs and UCITs management companies:
- To act to prevent undue costs being charged to a fund and its investors; and
- To develop a pricing process.
ESMA deems that a lack of supervisory convergence leaves room for regulatory arbitrage and risks hampering competition in the EU market. Moreover, it might lead to different levels of investor protection depending on where a fund or fund manager is domiciled.
Key points covered in the Opinion
A. Clarification on the Notion of Undue Costs in the UCITS Directive and AIFMD
In its Opinion, ESMA considers the following:
- A further specification of the notion of undue costs in both the UCITS Directive and AIFMD frameworks would provide NCAs with a clearer legal basis to take supervisory and enforcement actions;
- the European Commission should clarify the eligibility of costs considering the broad “List of costs” (the “PRIIPs List”) set out in Commission Delegated Regulation (EU) 2017/653 of 8 March 2017 on key information documents for packaged retail and insurance-based investment products (the “PRIIPs Regulation”);
- European authorities should propose draft regulatory technical standards to specify the circumstances where the costs included in the PRIIPs List should be considered eligible, considering funds’ investment policies and to specify the conditions NCAs may authorise on a case-by-case basis additional cost categories not included in the PRIIPs List; and
- The assessment of costs eligibility (“Eligibility Test”) should, according to ESMA, also take account of the relevant fund type as some costs borne by some kinds of alternative investment funds and their investors are not borne by UCITS and their investors. To comply with the Eligibility Test, ESMA considers it important for fund managers to assess the appropriateness of costs on a case-by-case basis, taking account of the fund type and its investment policy.
The proposed legislative amendments to Article 14 of the UCITS Directive and Article 12 of the AIFMD, reflecting the above, are set out in full in the Opinion.
B. Development of a Pricing Process and a Framework for Redress and Sanctions
The Opinion with respect to this matter states the following:
- Assessment regarding undue costs should also cover as a part of the pricing process a consideration of the quantum of the cost (and not just whether it is undue) ESMA proposes that transactions shall take place at prices or at conditions equal to or better than market standards;
- ESMA considers that specific attention should be given to the compliance function of the fund manager to ensure internal controls and appropriate reporting to NCAs and investors of detected shortcomings and the actions to address them;
- ESMA believes that a legislative proposal should ensure that managers reimburse or indemnify investors without undue delay where undue costs have been charged including where such costs have been incorrectly calculated to investors’ detriment; and
- ESMA believes that NCAs should be empowered to impose sanctions of a minimum given percentage which should be proportionate to unduly charged fees where a manager has intentionally or negligently committed an infringement.
ESMA proposes changes to both the UCITS Directive and AIFMD introducing obligations for managers to develop a pricing process in line with the above.
Conclusions
The Opinion continues the trend towards improving the participation of retail investors in the capital markets by enhancing the fair treatment and protection of every investor whether retail or institutional.
After the issuance of the Opinion, the arguments exposed regarding undue costs were taken into consideration and reflected to a great extent (even if not textually) for the legislative proposal on the Retail Investment Strategy, which was published by the European Commission the past 24 May 2023 amending Directives (EU) 2009/65/EC, 2009/138/EC, 2011/61/EU, 2014/65/EU and (EU) 2016/97 as regards the EU retail investor protection rules and which aims is to empower retail investors, enhance confidence and trust and increase their participation in the EU capital markets.
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