Central Bank Issues “Dear Chair” Letter on the Supervision of Costs and Fees Applicable to UCITS and AIFs
As part of a European Securities and Markets Authority’s (“ESMA”) Common Supervisory Action (the “CSA”) on the supervision of costs and fees of UCITS, the Central Bank of Ireland (the “Central Bank”) in 2021, conducted a review of the costs and fees charged to UCITS.
On 24 March 2023, the Central Bank issued a “Dear Chair” letter to fund management companies that sets out the main findings of the inspection, the Central Bank’s supervisory expectations in this area and identifies the key actions to be taken. A copy of the letter entitled “2021 Common Supervisory Action on the supervision of Costs and Fees of UCITS” can be viewed on the Central Bank’s website here.
While the scope of the CSA did not include a review of AIFMs, the Central Bank expects that the findings and actions of the review are also considered by AIFMs with respect to cost and fees charged to AIFs.
Key Findings and Supervisory Expectations
While the CSA did not identify material undue costs being charged to UCITS, a number of deficiencies were identified in setting the cost and fee structure for investment funds. The following is a summary of the key findings and supervisory expectations of the Central Bank:
|Central Bank Expectation|
|Policies and Procedures
|Lack of detailed and documented policies and procedures
Insufficient pricing governance structure
|Structured, formalised pricing policies and procedures with clear oversight and approval from senior management that allows for the transparent identification and quantification of all costs charged to the fund|
|Review of costs and Fees
|Failure to regularly review costs and fees||All costs, both new and existing, to be reviewed annually taking into account: (1) investment objective and strategy, (2) target and actual level of performance achieved, and (3) role and responsibilities of service providers
Periodic reviews should also be performed to ensure that the fund continues to offer investors a return commensurate with the risk profile of the fund
Review should evidence that throughout the life of the fund, the costs and fees are calculated in a fair and equitable manner, serving the best interests of investors
The viability and competitiveness of the fund should be considered in terms of the fund being capable of providing a positive return to investors. The board should further consider if the fund remains a suitable investment for investors
|Design and oversight of fee structure
|Over-reliance on delegate investment managers to determine pricing structure with limited engagement in the process by management companies
Variations in the frequency and detail of board reporting on costs and fees
|Clear policies and procedures for the design, oversight and regular review of cost and fee structures to ensure they are operating effectively and in the best interests of investors|
|Efficient Portfolio Management
|Retention of revenue from securities lending
Lack of formal and sufficiently detailed policies and procedures in place covering EPM activities
Lack of review of fees applicable to securities lending
|All fee arrangements with respect to securities lending programmes to be compliant with ESMA’s expectations and clearly disclosed in the policies and procedures of the management company
EPM disclosures within fund documentation should clearly describe the EPM strategy, the risks involved and the fee structure
Fee arrangements relating to EPM activities should be reviewed as part of the annual costs and fees review
|Fixed Operating Expense (“FOE”) Models||Retention of disproportionate excess income under a FOE model||Where a FOE is being used, investors to be fully aware of all expenses
FOE model to be calibrated so that any differential is minimised and that undue costs are not charged to investors
FOE models to be reviewed as part of the annual costs and fees review
|Non-discretionary Investment Advisor Charge||Fees paid to non-discretionary investment advisors higher than the delegated investment manager raising concerns that the investment advisor is acting with more influence and control than is appropriate||Fees paid to non-discretionary advisors to be appropriate for the services provided|
The Central Bank has advised that costs and fees should be calculated, on an ongoing basis, in a fair and equitable manner and serving the best interests of investors. The oversight and calibration of costs and fees should be made a priority for UCITS. As highlighted above, the Central Bank expects all firms managing both UCITS and AIFs to conduct a gap analysis of its findings and expectations and, where appropriate, put a plan in place by the end of Q3 2023 to address any gaps identified. The content of the letter should be discussed and considered by the board and appropriate action should be taken without delay.
 ‘ESMA’s guidelines on ETFs and other UCITS’ states that “all the revenue streams arising from efficient portfolio management techniques, net of direct and indirect operational costs, should be returned to the UCITS”.