CBI issues industry letter in respect of costs and fees of UCITS and AIFs

The Central Bank of Ireland (CBI) has issued an industry letter highlighting the main findings of its inspection of costs and fees charged to UCITS as part of the European Securities and Markets Authority's (ESMA's) 2021 Common Supervisory Action (CSA). The CBI's findings should be considered in conjunction with ESMA's final report on the CSA.

The scope of the CSA was to assess compliance by UCITS management companies with the cost-related provisions in the UCITS framework. The Irish UCITS Regulations require that firms act in such a way as to prevent undue costs being charged to the UCITS and investors.

The purpose of the CBI's letter is to highlight the main findings of its inspection, set out its expectations and to identify the key actions to be taken to address these issues.

While the scope of the CSA did not include a review of AIFMs, the CBI expects that the findings and actions of its review are also considered by AIFMs with respect to costs and fees charged to AIFs.

In response to the CSA, each national competent authority (NCA) examined whether firms, when charging costs to the fund/investors:

  • comply with the cost-related disclosure provisions set out in UCITS legislation in practice
  • act honestly and fairly in conducting their business activities and do so with due skill, care and diligence and in the best interests of their underlying investors and
  • do not charge investors with undue costs

Key findings and supervisory expectations

While the CSA did not identify material undue costs being charged to UCITS, the CBI identified a number of deficiencies in setting the cost and fee structure for investment funds. The CBI's supervisory expectations based on the findings are summarised below:

  • Policies and procedures – all firms should have structured, formalised pricing policies and procedures in place with clear oversight and approval from senior management that allow for the transparent identification and quantification of all costs charged to the fund.
  • Periodic review of costs and fees – all costs, both new and existing, should be reviewed annually taking into account the investment objective and strategy of the fund, the target and actual level of performance achieved and the role and responsibilities of service providers. Throughout the life of the fund, firms should ensure that the costs and fees are calculated in a fair and equitable manner, serving the best interests of investors. This should be evidenced as part of the review process. In addition, the viability and competitiveness of the fund should be considered as part of this review in terms of the UCITS being capable of providing a positive return to investors. As highlighted in ESMA's report, periodic independent reviews of cost and fee structures should also be performed to ensure that they continue to offer investors a return commensurate with the risk profile of the fund.
  • Design and oversight of fee structure – firms are required to have clear policies and procedures for the design, oversight and regular review of the costs and fees structures to ensure they are operating effectively and in the best interests of investors. The CBI's analysis showed that in the majority of cases, 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.
  • Efficient portfolio management (EPM) – EPM disclosures within fund documentation should clearly describe the EPM strategy, the risks involved and the fee structure relating to the specific EPM techniques, which the fund is utilising. The CBI expects that fee arrangements relating to all EPM activities should be reviewed as part of the annual costs and fees review. All fee arrangements with respect to securities lending programmes should be compliant with ESMA's expectations and should be clearly disclosed in the fund prospectus or supplements, as well as being captured in the policies and procedures of the firm.
  • Fixed operating expense (FOE) models – where a FOE model is being used for the purpose of providing investors with protection and certainty with respect to the fees being incurred, the CBI expects those investors should be fully aware of all expenses. The model should be calibrated so that any differential is minimised and that undue costs are not charged to investors. FOE models should be reviewed as part of the annual costs and fees review. The CBI indicates that this will be an area of focus in future supervisory engagements.
  • Non-discretionary investment advisory charge – the CBI expects that where the role performed by an investment advisor is non-discretionary in nature, and an adjunct to the role performed by the investment manager, firms should ensure that the fee arrangements are appropriate for the services provided. The CBI highlighted that its Securities Markets Risk Outlook Report in 2022 set out its concerns in this regard, whereby an investment advisor is acting with more influence and control than is appropriate.

Next steps

As outlined in the CBI's letter, UCITS management companies and AIFMs should:

  • ensure that the costs and fees are calculated, on an ongoing basis, in a fair and equitable manner and serve the best interests of investors;
  • conduct a gap analysis of the CBI's findings and expectations, and where appropriate, put a plan in place by the end of Q3 2023 to address any gaps identified; and
  • bring the letter to the attention of the relevant boards for consideration and appropriate action without delay

While the CBI letter was sent to Irish authorised management companies, we would expect the boards of Irish funds managed by non-Irish management companies to require those management companies to also consider the CBI's findings and expectations.

The CBI included that in circumstances of non-compliance with respect to the requirements, the CBI may, in the course of future supervisory engagement, or when exercising its supervisory and/or enforcement powers, have regard to the consideration given by a firm to the matters raised in its letter. The CBI highlights that the findings from its review will inform future policy development and enhancements to the current regulatory framework for the supervision of costs and fees.

For more information on this please contact any member of our Asset Management & Investment Funds team.

Date published: 28 March 2023