Article 92 UCITS Directive. Overcompliance is Bad for Business
If you are reading this, chances are that you are trying to make sense of the new provisions under Article 92 UCITS directive. You wonder whether transitioning to a centralised UCITS European facilities agent makes sense for the sake of it, with the work involved in seeking board approvals, terminate contracts with existing providers, updating fund documentation etc. You may have heard already that the introduction of the Crossborder Distribution Directive made compliance with article 92 UCITS directive easier and less onerous for your UCITS funds [and their investors] but that argument alone does not seem to be enough to motivate you to change.
Part of the reason to take advantage of the new provisions under Article 92 UCITS directive is indeed cost related. And speaking of UCITS costs, pressure is mounting at European level. Reducing the costs associated with distribution crossborder in Europe of UCITS might just be a drop in the ocean. Yet, there is a strong argument that it is the right place to start when looking at making overall fund operations cost efficient.
Get in touch here with your contacts at Veneziano & Partners to see how we can help with Article 92 UCITS Directive.
ESMA Opinion on Undue Costs of UCITS
2022 ended with overt threats that smaller UCITS funds, with inefficient fund operations and high-cost structures, might be forced out of business in certain European domiciles.
We have clear indication though that the issue of undue costs of UCITS is as pressing for the not-so-small UCITS funds too. ESMA very recently reinstated its focus on the overall issue of undue costs of UCITS, with an opinion that is set to create one more compliance conundrum for UCITS managers on eligibility of UCITS costs. Whilst we discussed elsewhere the broader implications of the recent ESMA opinion on undue costs of UCITS, it remains a good backdrop for the conversation on compliance with the new version of Article 92 UCITS directive on the European Facilities Agent services.
The proposed introduction at European level of a notion of undue costs of UCITS will create greater awareness in the industry on the overall aspect of pricing policies and cost structures of funds. A new standard will be set – offering real value for money to investors. It will not only matter to be able to run a fund, but to do it efficiently. The flipside is represented by the significant compliance challenge created around the eligibility of UCITS costs in light of their quantum. Costs that are eligible on paper might become undue if incurred excessively or disproportionately to the type of strategy or operations of a UCITS says ESMA. We believe that the existing applicable regulatory framework will become another benchmark for the quantum of certain costs too, in addition to general market prices.
And where National Competent Authorities, by explicit admission of ESMA, are not and should not be considered as price regulators, the compliance function of UCITS managers will likely bear the brunt of the additional governance imposed by the heightened standard on costs.
When Overcompliance is Bad for Business
The debate on undue costs of UCITS is clearly still at inception. For the time being ESMA seems to focus on related or connected party transactions, where it should be ensured that fair market prices are applied for related costs not to be deemed undue. There is clearly more than meets the eyes in our view.
Over the course of the recent past, European authorities have made a priority to streamline certain requirements to reduce hurdles to distribution of UCITS crossborder in Europe. The Capital Markets Union and the Crossborder Distribution Directive are a testament to that. The latter introduced provisions, like the new Article 92 UCITS directive, to take stock of the recent trends of digitalisation in fund distribution with a view to make European distribution less expensive both for UCITS managers and investors.
The cost of making available local facilities falls under the broader category of passporting costs, which are per se eligible costs of UCITS. Continuing to offer local facilities under the old provisions of Article 92 UCITS directive is of course not illegal. It does not necessarily go against investor protection, if you like. A local physical premise is made available to investors in a specific domicile notwithstanding the fact that this is no longer imposed by applicable regulation. It offers to local investors more than the rules require, not less. We may want to call it overcompliance. When overcompliance attracts much higher costs than compliance with the current rules though, as it is the case for the European facilities agent service, it is bad for business. The excessive quantum of a per se eligible cost might make it undue says ESMA in its opinion.
Conclusions
Ascertaining eligibility of costs in light of their quantum is the new challenge for the compliance function on the UCITS costs front. The case of the new provisions under Article 92 UCITS is a very good example of how eligible costs can become undue because of an excessive quantum.
Success lies not only in knowing market prices and standards, but to have a clearly understanding of how the regulatory landscape evolves to make fund operations more cost efficient.
There certainly are a plethora of other examples where cost efficiencies are designed by the system to be implemented in fund operations. Yet the Crossborder Distribution Directive and the new provisions under Article 92 UCITS directive are undoubtedly a good place to start.
Get in touch here with your contacts at Veneziano & Partners to see how we can help with Article 92 UCITS Directive.