ECA recommendations to enhance EU single market for investment funds

A Special Report, Investment funds EU actions have not yet created a true single market benefiting investors by the European Court of Auditors (the Report) makes somewhat uncomfortable reading for the European Commission and the EU co-legislators (the European Parliament and the Council of the EU).

The Report, which was published on 22 February 2022 and is based on an audit covering the period 2016 to July 2021, concludes that

“although EU actions have enabled a single market for investment funds to be established, they have not yet achieved the desired outcomes, as true cross-border activities and benefits for investors remain limited.

In addition, the consistency and effectiveness of fund supervision and investor protection is insufficient”.

The Report’s Key findings

• The effectiveness of the Commission and the co-legislators in their key objective of increasing the number of true cross-border investment funds has been limited – the number of such funds has grown only marginally.
• The expected gains for investors (such as lower fees or access to more products) have not materialised.
• Costs continue to be high and differ significantly from one Member State to another
• There is still no level playing field - supervisory practices vary significantly between Member States and market entry barriers persist
• Certain market realities and policy choices (such as taxation, local demand and instances where asset managers choose to distribute their investment funds) are local matters which cannot be addressed by EU law.
• Repeated revisions of the EU legislative framework may not be the appropriate tool to deepen the single market.
• The Commission has not carried out a comprehensive fitness check of the overall legal framework covering investment funds to assess how far objectives have been achieved – nor is the Commission always in a position to demonstrate the effectiveness of its legislative initiatives to enhance the existing rules.
• Ex ante impact assessments may have overestimated the potential impacts of new legislation while ex post evaluations need to be more thorough.
• Finally, the Commission’s performance measurement does not comply with its own criteria - most interim milestones and targets set for the result indicators in the Strategic Plan 2020-24 are not specific, while terms such as “increase”, “positive trend” and “decrease” are used, but without specifying how much of an increase or decrease would be considered satisfactory.

The Report’s Recommendations - overview

The report recommends that

the Commission should:

• assess the suitability of the existing framework to achieve the desired objectives
• consider proposing changes to ESMA’s governance structure and
• streamline data collection and update reporting regimes

ESMA should:

• enhance the effectiveness of its convergence work and
• in cooperation with the ESRB, improve the identification of systemic risk and
• the Commission and ESMA, together, should
• better protect investors against undue costs and misleading information.

The Report’s Five Recommendations – in more detail

Recommendation 1
Assess the suitability of the existing framework to achieve the desired objectives

By 2024, the Commission should:

• carry out a comprehensive fitness check on the legislation covering investment funds and - depending on its outcome - take measures to achieve the objectives of the single market more effectively
• improve its performance measurement by establishing appropriate indicators.

Recommendation 2
Enhance the effectiveness of ESMA’s convergence work

By 2024
the Commission should:

• consider proposing changes to ESMA’s governance structure to allow ESMA to use its powers more effectively. This could include making the participation of NCAs in ESMA's convergence work compulsory.

ESMA should:

• introduce a more structured approach to selecting convergence tools, strengthen follow-up, and use remediation tools including ‘breach of Union law’ procedures when necessary
• enhance its capacity to monitor progress by mapping supervisory practices, assessing the effectiveness of tools, and overhauling its performance measurement.

Recommendation 3 – Protect investors better against undue costs and misleading information

By 2024
the Commission should:

• better protect retail investors, in particular, through stricter rules on inducements

ESMA should:

• further refine its analysis of the performance and costs of retail investment products, especially by country of distribution and type of cost and
• develop a tool which allows investors to both obtain information about all funds on offer that respond to certain criteria and compare the costs and performance of those funds.

Recommendation 4 – Improve the identification of systemic risk

By 2025, in cooperation with the ESRB, ESMA should:

• define which fund types supervisory stress testing is necessary for
• explore how the results of existing stress tests and simulations can be used more effectively and
• develop a comprehensive model which allows for analysis of interconnectedness.

Recommendation 5 – Streamline data collection and update reporting regimes

By 2024, the Commission should:

• support ESMA and the ESRB in accessing necessary information on funds that is available to NCAs and Eurosystem Central Banks and propose a harmonised reporting regime on UCITS
• assess what additional data on funds is needed and how it should be collected to better monitor risks, keeping reporting burdens on the industry to a minimum.