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Freshfields Risk & Compliance

| 4 minutes read

Fund managers' fees and expenses - ESMA briefs national regulators

The European Securities and Markets Authority (ESMA) has published a supervisory briefing to promote convergence in the supervision of costs in undertakings for the collective investment in transferable securities (UCITS) and alternative investment funds (AIFs).


The two fundamental European frameworks for investment funds (the UCITS directive and the AIF managers directive, as well as relevant level 2 legislation) contain rules on the prevention of so-called ‘undue costs’ being charged to funds or their investors.

In January 2019, ESMA’s first statistical report on costs and performance of retail investment products revealed a significant impact of costs on investors’ returns. 

In response, ESMA has assessed the different national approaches to the supervision of the cost-related provisions by national regulators.

What does ESMA say?

ESMA's assessment shows that there is a lack of convergence on how the term 'undue costs' is interpreted and that supervisory approaches to the cost-related provisions vary across the EU.

To avoid regulatory arbitrage and different levels of investor protection, ESMA now provides guidance to national regulators on assessing 'undue costs' and supervising the obligation to prevent undue costs being charged to investors.

Undue costs

The approach of national regulators to assessing what constitutes 'undue costs' differs across the EU. While some regulators provide an exhaustive list of permissible costs, others have compiled open lists with acceptable costs requiring management companies to specifically justify costs not included in that list.

ESMA now asks that national regulators require management companies to develop and periodically review a structured pricing process, which needs to address the following elements:

  • 'whether the costs are linked to a service provided in the investor’s best interest. It should therefore be assessed whether the costs are necessary for the fund to operate in line with its investment objective (e.g.: the fund’s investment strategy, portfolio management, transaction and settlement costs), or strictly functional to the ordinary activity of the fund or to fulfil regulatory requirements (e.g. cost of annual audit, taxes, NCA’s fees);
  • 'whether the costs are proportionate compared to market standards and to the type of service provided (e.g.: by mean of a table displaying costs of funds with similar investment strategies and characteristics in order to detect outliers) particularly in the context of potential conflict of interests in the context of payments to third parties (e.g.: legal or other type of professional consultancies), intragroup delegation (e.g. portfolio management, service provisions) or depositary functions;
  • 'whether the fee structure is consistent with the characteristics of the fund (e.g.: higher costs would normally be charged to funds with more complex investment strategies/type of assets; there should be a balance between the complexity of the activities performed and the costs borne by investors);
  • 'whether the costs borne by the fund, including those paid to third parties (e.g.: depositary), are sustainable taking also into account the expected net return of the fund, based also on its risk profile and investment strategy;
  • 'whether the costs ensure investors’ equal treatment and are not of material prejudice to the interests of any class of unitholders or potential unitholders, except for AIFs not distributed to retail investors disclosing a preferential treatment in their rules or instruments of incorporation where such a preferential treatment is allowed under the applicable
  • 'legislation;
  • 'whether there is no duplication of costs (e.g.: the same type of fee is not included in two different cost categories) and costs are properly separated and accounted for. To this purpose, a clear distinction between the costs charged to the fund and those paid directly to the management company and/or the depositary and/or any other third party should be made;
  • 'whether a cap on fees (e.g.: subscription/redemption fees), if any, is applied and clearly disclosed to investors (e.g.: expressed as a percentage of the NAV);
  • 'in case of UCITS and relevant AIFs, if the fund charges performance fees, whether the performance fee model and its disclosure is compliant with the ESMA Guidelines on performance fees;
  • 'whether all costs are clearly disclosed to investors in line with applicable EU rules (AIFMD, PRIIPs and UCITS), as well as any additional rule applied at national level;
  • 'whether the pricing process and all charged costs are based on reliable and documented data, in order to ensure the ability of the NCA to reproduce ex post the calculations made by the management company on a single portfolio level.'

Supervising the obligation to prevent undue costs being charged to investors

Furthermore, to enhance the supervisory approach with regard to the prevention of undue costs being charged to investors, ESMA expects national regulators to review management companies’ pricing processes as part of their supervisory activity at one or more stages, including the fund’s authorisation stage, off-site supervision, on-site inspections, approval of material changes to the fund, thematic review and the assessment of investor complaints.

The national regulators’ review should, according to ESMA’s briefing, cover the following:

  • Cost disclosure and transparency: 
    • the existence, nature and amount of the costs/fees are clearly disclosed to investors in a manner that is comprehensive, accurate and understandable; and
    • the charged costs are consistent with funds’ rules, documentation, offering documents.
  • Business conduct, strategic risk and reputational risk.
  • With regard to the pricing process, that it:
    • clearly sets out responsibilities among the management bodies of the firm in determining and reviewing the costs charged to investors;
    • in case of the existence of conflicts of interest, it ensures that the risk of damage to investors’ interest will be prevented;
    • is clearly documented and periodically reviewed; and
    • it addresses the elements described under 'Undue costs' above.

Finally, ESMA expects that, where undue costs are charged to investors, supervisory actions should include:

  • 'investor compensation, where allowed under the national provisions;
  • 'reduction of fees;
  • 'review of disclosure documents; and
  • 'communication of good and poor practices by national regulators to market/stakeholders/press, which should assist in acting as a deterrent against managers charging undue costs to investors.'

What can fund managers expect?

While ESMA’s briefing is neither subject to a 'comply or explain' mechanism nor legally binding, it can be expected that national regulators will follow ESMA’s call to enhance supervision of pricing processes. 

Hence, fund managers should assess whether their pricing processes sufficiently address the elements required by ESMA and that appropriate organisational measures with regard to the pricing process are in place.

Where this is not part of the process yet, it may be sensible to review existing products with regard to their compliance with the principles of the (amended) pricing processes.


europe, investment fund services, investment funds and managers