ESMA UCITS Performance Fee Consultation
ESMA has recently launched a consultation at EU level to develop guidelines on UCITS performance fees. Find a link to the ESMA press release where to find also the initial consultation paper here.
The aim of the exercise is to prevent regulatory arbitrage as well as ensure the same level of investor protection across Europe, given that the issue of performance fees is tackled rather differently across EU member states.
In this post, we will touch on the aims of the ESMA consultation as well as on the recent case of new legislation in Germany on performance fees, which seems to set an interesting precedent for EU cross border distribution.
ESMA Consultation, the Guidelines and the definition of UCITS performance fees
ESMA consultation provides in first instance for a technical interpretation of UCITS performance fees, as the variable management fees linked to the performance of a fund and usually payable in addition to the basic fee and whose objective is to create an incentive for the fund operator to optimise the performance of the fund.
ESMA consultation also summarises the finding of the survey carried out in 2018 on performance fees with National Competent authorities across EU. Whilst some common elements can be found in the EU wide approach to performance fees, according to the survey, mostly the fee models and computation mechanisms are found to be divergent. The overall aim of the consultation is to develop guidelines on the i) general principles on the methods of performance fee calculation; ii) consistency between the performance fee model and the investment objective, strategy and policy of a fund; iii) frequency of crystallisation and payment; iv) circumstances where performance fee should be payable; v) disclosure.
ESMA consultation acknowledges that the existing EU regulation does not go beyond the indication of high-level principles in defining performance fees, hence the need for a more organised supervisory convergence exercise to create consistency at EU level and ensure the same level of investor protection across the board.
IOSCO Principles and Good Practices
On this premise, however, ESMA bases its consultation work and the guidelines to be developed on the existing IOSCO principles and good practices on fees and expenses for collective investment schemes (find a link to this paper here).
This is important reference because it acknowledges the importance of the guidelines developed at international level on the subject as a guiding point of the discussion. The work of ESMA is seen as a deeper and more decentralised effort to capture additional issues on fees, that might have not been covered by IOSCO guidelines. In fact, IOSCO work does not purport to be exhaustive and identify accordingly any and all issues related to fees and expenses applicable to collective investment undertakings. It proposes an international view on these issues, to be complemented at more decentralised level by other authorities.
In fact, the guidelines from IOSCO were developed at the time of implementation in Europe of PRIIPs and MiFID II, and the document delivering the best practices contains a clear reference to the fact that more regulation was to complement this effort at a local level. A matter of coordination required to ensure that the same regulatory outcomes of investor protection are achieved at international level.
The German Case
The adoption of new rules on performance fees in Germany, to become effective by the end of 2019, has generated rumours, yet to be officially confirmed, that UCITS funds with performance fees not in line with the requirements of the new German legislation will be banned from marketing in Germany. This seems to be the case for the majority of Luxembourg funds according to the industry.
The position of ALFI, the association for Luxembourg Investment Funds, is very interesting and raises some points that are very valid in our view. In first instance, from a merely technical standpoint, once a fund receives the UCITS stamp it can be freely marketed across Europe without having to undergo any other form of authorisation in any host member state where marketing is intended to take place. Preventing foreign EEA UCITS funds from marketing in a member state, in this case because of a misalignment on performance fees – in other words for a matter of local law or practice – should not be technically possible. This would also frustrate the concept of the EU passport and the free movement of services across the EU.
Also, ESMA had started analysing performance fees with a view to exercise some convergence already in 2018. It was known already from the ESMA Work Program on Supervisory Convergence that a more formal consultation would be kicked off in 2019. The move from Germany seems to be untimely and misaligned with the efforts at EU level. The IOSCO good practices, according to ALFI, should be the guiding principle on the point. Germany is notorious for wanting to preserve the stability of its market. One example is the gold-plating applied with regards to the rules on national private placement regime under AIFMD, whose process is carried out entirely in German.
There seems to be unanimity in the industry in terms of aligning the performance fees to the German model, which seems to be the case already for the majority of the Irish domiciled UCITS, yet the move of German authorities fit awkwardly in the bigger scheme of things, where the consistency of the regulatory outcome, notwithstanding the actual measure adopted, should prevail.