ESMA wants clarity on “undue costs” under UCITS and AIFMD, which may feed into beefed up “value for money” rules under EU Retail Investment Strategy

ESMA has published an Opinion setting out suggestions to the European Commission for possible clarifications of the legislative provisions under UCITS and AIFMD relating to “undue costs”. The initiative was prompted by one of the findings of ESMA’s 2021 Common Supervisory Action on costs and fees, which showed divergent market practices as to what industry reported as “due” or “undue” costs in funds. ESMA deems that further specification will provide market participants with more clarity and NCAs with a clearer legal basis to take supervisory and enforcement actions where needed to protect investors.

ESMA is hoping that its proposals will be picked up in the legislative process for the EU’s Retail Investment Strategy (RIS). The Commission is expected to make its legislative proposals in the RIS next week. The enhancements proposed by ESMA could sit alongside other legislative changes which (according to a leaked draft of the RIS proposals) would see new “value for money” requirements introduced into product governance requirements for manufacturers and distributors of retail financial instruments across all sectoral legislation (i.e. UCITS, AIFMD, but also MiFID II and the Insurance Distribution Directive). The draft Commission proposals also envisage creating a reporting system for relevant costs so that “benchmarks” can be established and published by the EU authorities (using this data). The requirement then would be for product manufacturers and distributors to use these “objective” benchmarks to demonstrate that their products offer “value” based on their performance and costs.

These proposals are significant, and they tally in some respect with changes introduced in the UK under the new FCA Consumer Duty, which includes new rules on the “price and value” outcome for retail customers, which firms within the distribution chain will need to meet. As such, UK Consumer Duty implementation (and the preceding price and value rules for UK authorised funds in the FCA’s COLL rules) may provide some useful indication for firms that may become subject to the enhanced EU requirements in due course. However, the initial European “value” proposals seem to go much further by mandating the use of EU determined “objective” benchmarks within firm’s value assessments.

Proposed approach

In its Opinion on “undue costs”, ESMA expresses the view that, as a first step, the Commission should clarify the eligibility of costs in light of the list of costs included in the PRIIPs Regulation. ESMA’s reasoning is that this will have the benefit of providing clarity on the topic to fund managers and will also ensure that all costs charged to the fund and its investors are appropriately disclosed.

The assessment regarding the eligibility of the cost (“eligibility test”) should also take into account the type of fund, as there are some costs that can be borne by some types of AIFs and their investors, but not by UCITS and their investors. For this reason, and to ensure that the eligibility test is meaningful, ESMA considers that it is important for the fund manager to assess the appropriateness of the costs on a case-by-case basis in light of the (i) type of fund and (ii) its investment policy.

Furthermore, as the PRIIPs list is very broad, and in order to ensure legal certainty on what should be considered as an undue cost and provide local authorities with a stronger legal hook to undertake enforcement actions, ESMA could be empowered to develop draft RTS under UCITS and AIFMD in order to:

• specify the circumstances in which the costs included in the PRIIPs list should be considered as undue/not eligible, also taking into account the investment policy of the funds; and
  
  
• specify under which conditions local authorities may authorise on a case-by-case basis additional cost categories which are not included under Annex VI Part 1 of the PRIIPs KID Delegated Regulation.

Section 4 of the Opinion sets out the details of the proposed policy approach.

Timing and next steps

ESMA is confident that the Opinion can be taken into consideration by Commission’s upcoming legislative proposals on the Retail Investment Strategy, on which Commission draft proposals are expected next week.

The RIS proposals will then go through the EU legislative process, which generally takes at least one year to complete, and which may be delayed as a result of the European Parliament elections in May 2024.

Once finalised, the RIS legislative changes will need to be implemented in Member States. The Commission proposal allows 12 months for Member State implementation, and a further six months before the revised requirements would apply to firms.

Watch out for our client note and webinar on the RIS package following publication of the Commission proposals.

Documents

The Opinion dated 17 May 2023 is available here.

ESMA’s press release is available here.