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The European Securities and Markets Authority (ESMA) has published a Market Report on the Total Costs of Investing in UCITS and AIFs (theReport).
The Report provides an assessment of the total costs charged to investors in European funds, across both AIFs and UCITS. The Report assesses the total costs of investing in such funds as the sum of product-related costs and distribution-related costs.
Background
The Report reflects the ongoing regulatory focus on costs and fees of funds, including ESMA's annual monitoring programme and its reports on undue costs (such as its supervisory briefing in June 2020 (the Supervisory Briefing), its report on regulatory supervision in May 2022, and its Opinion on undue costs in May 2023 (the Opinion)), as well as the Central Bank of Ireland's "Dear Chair" Letter on undue costs and fees from March 2023.
Directive 2024/927 (the Omnibus Directive) was published in March 2024 and set out amendments to the AIFMD and UCITS frameworks that will come into effect from 16 April 2026. The Omnibus Directive requires ESMA to submit a report to the European Parliament, the European Council and the European Commission assessing the costs charged by UCITS management companies and AIFMs to the investors of the UCITS/AIFs that they manage and explaining the reasons for the level of those costs (and for any differences between them). ESMA has published the Report in response to this requirement.
Observations
The Report finds that the majority of European distribution is conducted indirectly via traditional distribution channels, such as credit institutions and investment firms.However, the Report also acknowledges the recent rise of "neo-brokers", albeit that their market share remains around 1%.The Report notes that there has been a rapid uptake of neo-brokers, particularly among retail investors in respect of Exchange Traded Funds (ETFs) and equity funds.
While noting a high level of disparity across Europe in terms of costs, the Report sets out a number of headline observations that will be of interest to funds industry participants, including the following:
- The actual cost of investing in retail UCITS ranges between 0.5% of the invested amount for passive bond UCITS and 2% for active equity UCITS, while AIF costs range between 1.4% and 2.8%.
- Distribution represents 48% of UCITS' total costs and 27% of AIFs' total costs.There are a number of factors that can explain these differences, including the type of distributor (e.g. advisory or execution-only), the asset class of the fund (e.g. bonds or real estate), and the investment strategy of the fund (e.g. active or passive).
- Inducement agreements are widespread.On average, they amount to 45% of ongoing costs for UCITS and 34% for AIFs.
- The maximum one-off fees that are disclosed in PRIIPs KIDs do not reflect the actual fees that are ultimately paid.
Cost drivers
The Report lists the costs that may be paid by funds under two different headings: "product costs" and "service/distribution costs".The relative impact of each cost driver is given on a scale from "low" to "high", as outlined in the table below.
|
Cost drivers |
Examples |
Impact on Total Costs |
|---|---|---|
|
Product costs |
||
|
Product characteristics |
Funds entailing higher risks (e.g., equity funds; strategies focusing on high-yield fixed income products; emerging markets or real estate) incur higher costs than funds entailing lower risks. |
Medium/High |
|
Investor type |
Costs are lower for institutional investors compared to retail investors. |
Medium |
|
Management type |
Actively managed funds have higher costs compared to passive funds or passive ETFs. |
High |
|
Fund characteristics |
Costs for large funds are lower than for small funds in the case of UCITS as large funds may benefit from economies of scale. |
Medium/Low |
|
Service/Distribution Costs |
||
|
Domicile |
There are notable differences in distribution costs across member states. Market practices contribute to significant cross-country variation in fees. National regulatory specificities (where they exist) may have an impact (e.g. a ban in the Netherlands on inducements for retail investors). |
Medium |
|
Type of distributor |
Distribution costs tend to be far less heterogeneous across the EEA for neo-brokers than for more traditional channels, namely credit institutions and investment firms. While offering different distribution services, neo-brokers follow a digital-only operating model. Conversely, credit institutions and investment firms often maintain extensive branch networks, local advisory staff, and country-specific distribution models. |
Medium |
|
Type of service |
There are differences in the type of distribution services offered. Services such as investment advice, whether independent or non-independent, are still mostly concentrated in the credit institution and investment firm distribution channels and entail higher fees. Execution services are limited to carrying out investors' instructions without further guidance. This allows for significantly lower costs. |
High |
|
Investor profile |
Institutional investors pay lower distribution costs than retail investors. |
Medium/High |
|
Fund characteristics |
Asset class type, management type and fund type are drivers of distribution costs (though to a lesser extent than product costs). |
Low |
|
Amount held |
There is a negative correlation between the amount an investor holds in a fund and the costs they pay for the services. The magnitude of this relationship decreases as the amount held increases. |
Medium/High |
|
Holding period |
Among additional factors driving differences in costs, distributors in our sample indicated the holding period as one of the main reasons driving the level of costs charged to the investors. |
Low |
|
Level of inducements |
Inducements affect the overall cost structure of investment services and help to explain variations in how products are marketed and offered to investors. The amount of inducements paid may affect the level of distribution costs charged. |
High |
Undue costs
Both the AIFMD and the UCITS framework contain a provision that funds should not be charged "undue costs" but both stop short of identifying what might constitute a cost that is "undue".The Supervisory Briefing from June 2020 acknowledges that there has been inconsistency in how this been approached in different jurisdictions and the Report states that "there is a lack of convergence on the way the notion of "undue costs" is interpreted across the EU and on the supervisory approach to the cost-related provisions."
The Report goes on to say that "ESMA considers that a further legislative specification of the notion of "undue costs" would promote more convergence and offer a stronger legal basis for national competent authorities to take supervisory and enforcement actions against the relevant market participants in many cases." ESMA had previously sought (in the Opinion) legislative amendments to provide for investor reimbursement and indemnification in the event of undue costs being charged and the Report notes that the European Commission's proposal for a retail investment strategy currently includes such a provision.
Horizon scanning and actions for funds industry participants
As outlined at the outset, fees and charges have been an area of regulatory focus in recent years and we expect this to continue, as regulators and legislators seek to ensure that investors are not charged undue costs when investing in regulated products in Europe.
The Report acknowledges its own limitations and explains that distribution cost information is not fully harmonised across the different pieces of EU legislation.ESMA has noted that, without distribution cost reporting, exhaustive analysis of total costs to investors is not possible.
The Report does not provide any specific recommendations, though it is likely to be used as a yardstick by industry participants to assess the relative level of costs and fees that are charged by funds to which they are appointed.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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