Undue costs in AIFMs and UCITS – ESMA publishes an Opinion

On 17 May 2023, ESMA published an Opinion, “On undue costs of UCITS and AIFs”.

This contains suggested amendments to the AIFMD (and the UCITS Directive), which would require AIFMS and UCITS ManCos:

• to act to prevent undue costs being charged to a fund and its investors; and
• to develop a pricing process.

We expect these suggestions to be reflected in legislative proposal on the Retail Investment Strategy (RIS), which we anticipate the European Commission (the Commission) will publish next week.

Background

In January 2021, ESMA launched a Common Supervisory Action (CSA) on the supervision of costs and fees of UCITS across the EU (see our summary here) with a view to assessing compliance of supervised entities with cost-related provisions in the UCITS framework, in particular the obligation not to charge investors with undue costs.

The CSA showed divergent market practices on what was reported as “due” or “undue” costs and this persuaded ESMA that defining the notion of “undue costs” more specifically would provide greater convergence.

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

The new Opinion makes a number of suggestions to the Commission on possible clarifications of the legislative provisions under the UCITS Directive and the AIFMD relating to the notion of “undue costs”.

In particular:

• ESMA proposes additions to Article 12 of the AIFMD requiring AIFMs to maintain and operate a pricing process. (Equivalent amendments would be made to the UCITS Directive, in particular, Article 14.);
• the pricing process would clearly demonstrate that all charged costs are due and allocate clear responsibilities to the management body for determining and reviewing the costs charged to investors;
• the Opinion recommends that the Commission should clarify the eligibility of costs in the light of the list of costs (the PRIIPs List) set out in Annex VI of the PRIIPs KID Delegated Regulation. The text of Annex VI is set out in Section 5 of the Opinion;
• the assessment to determine eligibility of costs should take into account type of fund and fund managers should consider costs on case by case basis as part of pricing due diligence, depending on type of fund and its investment policy;
• quantum should also be considered – a transaction incurring costs for a fund should take place at prices or at conditions equal to or better than market standards;
• costs should not exceed the figures disclosed to investors in pre-contractual documentation;
• ESMA should develop RTS to specify circumstances;
  • when a cost in the PRIIPs List would be considered undue or not eligible; and
  • in what conditions an NCA could authorise additional cost categories not included in the PRIIPs List.
• the compliance function should perform ongoing monitoring and regular evaluations of policies and procedures in place to avoid undue costs, with deficiencies being reported to the NCA on an annual basis and disclosed to investors; and
• where undue costs have been charged, managers should reimburse or indemnify investors without undue delay – this would include cases where costs have been wrongly calculated to the detriment of investors.

Next Steps

The Commission is expected to publish a legislative proposal on the RIS next week.

We expect the recommendations set out in ESMA’s Opinion to be reflected, to a great extent (even if not verbatim), in the Commission’s adopted text.