In line with the investor protection mandate of the European Securities and Markets Authority (ESMA), the cost of investment products has always been a key element of ESMA’s activities. For example in 2019, it published its first annual report on “Performance and costs of retail investment products in the European Union (EU)”. This focus on the cost of investments has been sharpened further with ESMA’s publication of a Supervisory Briefing in June 2020 on the supervision of costs in UCITS and Alternative Investment Funds (AIFs) in order to promote common supervisory practice amongst EU member states. To achieve this aim, ESMA has developed criteria to support National Competent Authorities (NCAs) to “assess the notion of undue costs” and to supervise the obligation to prevent undue costs being charged to investors.
ESMA’s advocated supervisory approach takes into consideration the general characteristics of different costs charged to UCITS and AIFs. ESMA believes the notion of “undue costs” should be primarily assessed against what should be considered in the best interests of the fund and its unit holders. To this end, it should be ensured that the costs charged to the fund or its unitholders are consistent with the investment objective of the fund and do not prevent the fund achieving this objective. Furthermore, the pricing process developed by management companies should allow a clear identification and quantification of all costs charged to the fund in order to avoid hidden costs.
NCAs are expected to require that fund management companies develop and periodically review a structured pricing process. When developing the pricing policies and reviewing them periodically, firms should consider whether
- the costs are linked to a service provided in the investor’s best interest.
- the costs are proportionate compared to the market standard and to the type of service provided, particularly in relation to any potential conflict of interest resulting from payments to third parties.
- the costs paid by the fund are sustainable, taking into account the target net return of the fund.
- the costs ensure equal treatment of investors.
- there is any duplication of costs and whether costs are properly separated and accounted for.
- there is appropriate disclosure of costs.
- the pricing process and all costs charged are based on reliable and documented data in order to ensure the ability of the NCA to reproduce ex-post the calculations of the management company on a single portfolio level.
ESMA expects NCAs to review management companies pricing processes, for example through inspections, thematic reviews and assessment of investor complaints. NCA’s should review whether the above seven points are specifically addressed within a fund management company’s management process.
The Supervisory Briefing suggests that EU fund management companies should expect challenge not only on cost items but also on their proportionality compared to the market standard on an individual fund basis. Firms should consider the need to document what the market standard for an individual service is and be able to justify any costs higher than market standard. This may create challenges for some fund management companies, particularly those fund managers which are part of larger groups, who provide an integrated fund product serviced by group companies.
ESMA’s Supervisory Briefing aligns it more with the thinking of the FCA in relation to fund management cost assessment and disclosure, such as an assessment of comparable market rates for services. However, for the moment it has stopped short of the FCA’s requirement on UK authorized fund management companies to publish an annual value for money assessment.
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