The Central Bank of Ireland (“Central Bank”) issued a letter to the Chairs of UCITS in March to share the findings of its review of management costs and fees charged to UCITS, and outlined the Central Bank’s expectations and requirement for annual review and correction.
While the review related to UCITS managers, the Central Bank has stated that it expects alternative investment fund managers to take note for the alternative investment funds they manage.
This review was carried out across all EU Member States as part of the European Securities and Markets Authority’s (“ESMA’s”) Common Supervisory Action to assess compliance with the cost-related provisions of the UCITS regulatory framework.
The Central Bank examined whether, when charging costs to fund or unitholders, managers:
(1) comply with the cost-related disclosures provisions set out in UCITS legislation in practice;
(2) act honestly and fairly in conducting their business activities and do so with skill, care and diligence in the best interests of their underlying investors; and
(3) do not charge investors with undue costs.
The review included 59 managers by way of questionnaires, desk-based reviews and virtual inspection calls. The Central Bank acknowledged the strong level of engagement and cooperation with this review, which is common in Irish financial services regulation, and which benefits the whole of the market.
Given the wide-spread levels of deficiencies, Central Bank expects these issues to be reviewed and addressed by boards as a matter of priority.
The Central Bank highlighted 6 key findings and set out the corrective action to be taken, as follows:
The Central Bank found that a significant majority of management firms reviewed did not show sufficient pricing governance structures in place to regularly (and at least annually) review pricing to identify and quantify all costs to the fund.
Action needed: clear oversight is required from senior management to regularly review pricing structures and ensure costs and fees are not unduly high.
It was also found that a majority of firms did not review costs and fees regularly, and in some cases, not since the launch of a fund. The Central Bank expects costs and fees to be reviewed annually and in light of the fund’s target, its actual performance and the role and responsibilities of service providers. In addition, the viability and competitiveness of the fund should be reviewed to ensure it can provide a positive return to investors, commensurate with the risk profile of the fund.
Action needed: fund costs and fees to be reviewed annually in light of (i) the fund’s target; (ii) its actual performance; and (iii) the role and responsibilities of its service providers. This review is to assess whether fund can return a positive return to investors in line with the risk profile of the fund.
The Central Bank’s review also found that where firms did not have documented pricing policies and processes in place, there was an over-reliance by firms on the assessments made by delegate investment managers for determining the pricing structure of the funds.
Action needed: clear policies and procedures need to be in place to design, oversee and regularly review costs and fees structures, to ensure they are operating effectively and in the best interests of investors.
ESMA’s ‘Guidelines on ETFs and other UCITS’ states that “all revenue streams arising from efficient portfolio management techniques, net of direct and indirect operational costs, should be returned to the UCITS”. From the Central Bank’s sample, a number of firms retained more revenue than their peers from their securities lending programmes. A significant majority of firms utilising efficient portfolio management (“EPM”) did not have formalised policies and procedures in place covering EPM activities. For those that did, sufficient detail was not included.
Action needed: all fee arrangements for securities lending programmes must be disclosed in fund prospectus documentation and also in the firm’s policies and procedures, and such arrangements must comply with ESMA’s guidelines. Fund documentation should clearly describe EPM strategies, risks and the fee structure for such strategy. These fee arrangements are to be reviewed as part of the annual review of costs and fees above.
A fixed operating expense (“FOE”) is a practice whereby a fixed rate is proposed by a fund management company to cover all running costs of a fund. The Central Bank found that a number of firms utilise the FOE model and confirmed they retain excess fees when the expenses are below the FOE model cap. In the majority of cases, however, the FOE was calibrated at such a high level that a firm would have been in receipt of a higher level of income than would be expected for these retail funds.
Action needed: where an FOE model is used to provide investors with protection and certainty on fund running costs, investors need to be made aware of all expenses. The FOE model must be calibrated to minimise any differential to the actual running costs to avoid undue costs being charged to investors. These FOE models should also form part of the annual costs and fees review.
The Central Bank’s review identified a number of firms where the non-discretionary investment advisor was paid a greater fee than the delegated investment manager. This practice raises concerns as to whether (i) the investment advisor is in fact the de facto discretionary investment manager and (ii) the negotiated fee is in the best interests of the investors.
Action needed: review of the role to ensure that the discretionary manager is actually in charge of investment decisions, such that any delegated investment advisor holds a non-discretionary role and is adjunct to the role of the investment manager. Fees should reflect this.
The Central Bank makes clear that it expects this letter to be considered and discussed by UCITS fund boards and for appropriate action to be taken immediately. Gaps must be addressed by the end of Quarter 3 2023.
Our Asset Management and Investment Fund team can advise on the implementation of the necessary procedures and policies and governance structures to ensure the necessary annual review of costs and fees are completed.
For further information, please contact one of our Financial Services team: David Naughton, David Williams, Katrina Smyth, Narita Woods, Mina Dawood.
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