ESMA's first annual statistical report published in 2019 showed the significant impact of costs on the final return for investors. On 4 June 2020, ESMA published a supervision briefing in order to remediate to the lack of convergence of the interpretation of the notion of “undue cost” stemming from provisions contained in UCITS and AIFMD frameworks and the related supervisory practices among the national competent authorities (“NCAs”).
This briefing is also meant to give market participants an indication of NCAs’ expectations and compliance practices regarding the cost-related rules included in UCITS  and AIFM  Directives.
ESMA has developed non-binding criteria that NCAs should use in:
- Assessing the notion of “undue costs”
- Supervising the obligation to prevent undue costs being charged to investors
Undue costs should be assessed against what should be considered in the best interest of the fund and/or its unit holders. Supervisors should ensure that:
- The costs are consistent with the investment objective of the fund and do not prevent the fund to achieve this objective, in particular – but not limited to- where these costs are paid to third parties, including depositaries
- The pricing process adopted by the management company allows a clear identification and quantification of all costs charged to the fund and/or directly paid by the investors, in order to avoid hidden costs
NCAs are expected to scrutinize:
- Whether the costs are necessary for the fund to operate in line with its investment objective (e.g. portfolio management fees, transaction and settlement fees) or strictly functional to the ordinary activity or to fulfil regulatory requirements (audit fees, taxes, NCA levies)
- Whether the costs are proportionate to market standards and the type of service provided, notably in the context of potential conflicts of interest where payments are made to third parties, intragroup delegates or depositaries
- Whether the fees are proportionate to the complexity of assets, strategies and activities performed
- Whether the fees are sustainable in light of the expected net return of the fund
- Whether the costs ensure investors’ equal treatment, except for AIFs not distributed to retail investors disclosing a preferential treatment, where such treatment is allowed under the applicable legislation
- Whether there is no duplication of costs and costs are properly identified and accounted for
- Whether a cap on fees, if any, is applied and disclosed to investors
- Whether the performance fee model and its disclosure is compliant, where applicable, with the ESMA Guidelines on performance fees in UCITS and certain types of AIFs
- Whether all costs disclosures to investor comply with applicate EU and national rules
- Whether the pricing process and all charged costs are based on reliable and documented data and verifiable at a single portfolio level
NCAs should supervise the management companies’ pricing process during one or more of the following:
- fund authorization
- approval of material changes to the fund
- off-site supervision, on-site inspections, thematic reviews
- assessment of investor complaints
During their supervisory activity, NCAs should ensure, inter alia, that the existence, nature and amount of charges are clearly disclosed to investors and that the costs charged are consistent with the fund’s rules, documentation, offering document and marketing material.
NCAs are also expected to monitor that the pricing process:
- clearly sets responsibilities among the management body in determining and reviewing the costs
- prevents the risk of damage to investors’ interests in case of conflicts of interest
- is clearly documented and periodically reviewed
In case of materialization of undue costs being charged to investors, NCAs should assess the possibility to undertake the following actions:
- investor compensation, where allowed under the national provisions
- reduction of fees
- review of disclosure document
- communication of good and poor practices by NCAs to the market, the stakeholders or the press
While the ESMA briefing does not bind NCAs to comply with the recommendations, it still sets the best supervisory practice.
Therefore management companies should carefully benchmark the fee structures of the funds they manage against funds with similar investment policies. They are also expected to have proper governance in place for the determination and the review of costs charged to the funds.
Accounting procedures need to allow granular disclosures which are necessary to prevent any impression of excessive or duplicate costs being charged to investors, in particular where conflicts of interests have been identified, notably as a result of third-party payments.