CSSF on UCITS Costs and Fees. Smaller Funds Beware….
The CSSF continues to support Luxembourg in its quest to consolidate its reputation as the go-to domicile for fund management in Europe. In short succession from the release of the Q&A on marketing communications, under the Cross Border Distribution of Investment Funds Directive, the CSSF spearheads again the European movement on investor protection with the release of its official feedback on UCITS Costs and Fees.
Defined by ESMA as one of the Union Strategic Supervisory Points, the issue of UCITS Costs and Fees is tackled proactively by the CSSF, not only maintaining an open channel of constant communication with Luxembourg domiciled ManCOs, but also imposing additional assessments to ensure that the highest standards on UCITS Costs and Fees become the norm for Luxembourg domiciled funds.
Where the findings contained in the CSSF official feedback are based on the practices of participants to the local market, they nevertheless offer a good picture of the golden standards expected to be adopted throughout Europe on UCITS Costs and Fees. The findings are also interesting for the implications that costs have on the broader evaluation of viability of funds.
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Independent Approach to Pricing Process also for small ManCOs
The approaches adopted with regards to pricing processes at ManCOs in Luxembourg take a prominent position in the CSSF official feedback on UCITS costs and fees.
Issues of pricing revolve around the tendency in small ManCOs to over-rely on pricing models provided by the various underlying portfolio managers. Bigger ManCOs, instead, are in the eyes of the CSSF more independent and objective in their approach to pricing issues, with ad-hoc committees and more formalised pricing processes and procedures, independent from the ones of the underlying portfolio managers.
The CSSF does not stop at recording the shortcomings in the operations of smaller ManCOs on this point. The CSSF official feedback delivers the expectation that also smaller players are able to develop an independent approach on pricing. In order to do so, dedicated procedures will have to be implemented for the pricing process, which will also have to take into consideration the main characteristics of the funds under management. An independent analysis of the fees, once established by the portfolio managers, will be required to be carried out by ManCOs on an ongoing basis, with involvement of senior management as well as internal control functions as required.
The key to promote effective investor protection with regards to UCITS costs and fees lies in the constant monitoring over time of funds pricing structures carried out by ManCOs. The CSSF hints at review of costs, to be made at least on an annual basis, with a view to compare estimated with actual incurred charges. The overall aim of these ongoing reviews will be to reduce the level of fees to an appropriate measure, where required, in the ultimate interest of investors.
A challenge for smaller ManCOs, with the addition of dedicated committees on pricing and related processes and procedures on pricing evaluation, to replace prior entire reliance on the pricing set by underling portfolio managers. Where the processes will require also ad-hoc personnel, this will likely translate into an additional cost for these ManCOs to be passed on its third-party managers or promoters.
Undue Costs and viability of smaller funds
The work delivered by the CSSF is part of the Common Supervisory Action initiated by ESMA on UCITS costs and fees. We refer to the main principles contained in the ESMA supervisory briefing on the supervision of costs of UCITS and AIFs – under paragraph 19 – for what concerns a more accurate indication of what undue costs are and the principles applicable in order to identify them in both UCITS and AIFs.
The interrelation of undue costs and the viability of certain funds is one of the most interesting findings of the work carried out by the CSSF, with some harsh conclusions that go beyond the expectation of mere investor protection. The analysis carried out on the point by the CSSF concentrates on so-called peer funds – meaning funds with a common investment strategy – using average ongoing charges separately identified per strategy. According to the CSSF, funds charging higher than average fees are typically the ones with lower level of AUMs, where fixed costs impact funds to a different percentage depending on their AUMs, being notably higher for funds with lower AUMs levels.
The conclusion is that when high costs are protracted for a long period of time, these will have to be considered undue costs. At the same time though, the combination of high costs and protracted period of time lends itself to broader considerations on the viability of certain funds. Based on the assumption that funds should always be evaluated for their ability to generate positive returns for their investors, the concept of undue costs is used to set a new benchmark for fund launch projects to be acceptable as well as for existing funds to be able to continue their operations.
The CSSF has not fully disclosed as of yet the finding of this analysis, which is still partly ongoing, and whilst there is a reference to average ongoing charges in its official feedback, there are no granular details as to how exactly the averages have been calculated and what comprise the fixed costs. There is also a generic reference to high costs protracted for long period of time, yet no indication as to what long period is intended to mean in practice. More details could potentially help managers and promoters in assessing whether these allegedly fixed costs are in principle likely to be further compressed or not.
Conclusions
It is not new that potential AUMs drive the appetite that ManCOs might have for fund launch projects. The conclusion whereby high costs for a protracted period of time shall be considered as undue cost is another way to look at an existing problem in our view. At the same time, a wake-up-call on heightening the standards for fund launches in Luxembourg, potentially set now more than ever to attract exclusively the best that international fund management can offer.
Get in touch here with your contacts at Veneziano & Partners to see how we can help with UCITS Costs and Fees.