At the end of May, the European Commission published a that is expected to bring significant changes to the Alternative Investment Fund Managers Directive (AIFMD) regarding the costs that can be charged to fund assets or borne by investors.
The proposed changes are part of the European Commission’s Retail Investment Strategy (RIS) and are aimed at ensuring that investors do not ultimately bear costs that are considered disproportionate.
These changes are largely inspired by the European Securities and Markets Authority (ESMA) recommendation of 17 May 2023.
What is Proposed?
The following new obligations are set to be imposed on alternative investment fund managers (AIFMs), particularly in the Czech context where this primarily affects investment companies authorised to exceed the so-called decisive limit:
- Preventing the Payment of “Undue Costs”: AIFMs will be required to ensure that the assets of the Alternative Investment Fund (AIF) and its investors are not used to pay “undue costs.”
- Maintain, Operate, and Review a Pricing Process: AIFMs must establish, maintain, and regularly review a pricing process that identifies and quantifies all costs borne by the AIF or its investors. This process must ensure that no unreasonable costs are charged to the fund. Additionally, in the case of retail investors, the process should ensure that any costs borne by those investors are justified and proportionate to the investment strategy, expected returns, risks, and other relevant characteristics of the AIF.
- Annual Assessment of Costs: AIFMs are required to assess, at least once a year, whether investors have been charged unreasonable costs. If such costs have been identified, the AIFM must: (a) Compensate investors for these costs; and (b) Notify the home supervisor, among other things, of the fact that unreasonable costs have been charged to investors.
- Comparison with Cost and Performance Benchmarks: AIFMs must assess, at least annually, whether the costs borne by retail investors are reasonable. This assessment will be made by comparing the costs against a cost and performance benchmark to be developed and published by ESMA (more on the benchmark below).
Similar Changes for UCITS Funds: Similar amendments are proposed for the UCITS Directive, meaning that UCITS funds will also be subject to these new rules.
Interestingly, the new regulation is also intended to apply to professional investors, with the exception of the reasonable cost and benchmark provisions. It remains to be seen whether this is the Commission’s intention or an oversight that may be corrected during the legislative process.
The proposed provisions mainly apply to managers authorised by an EU supervisor, with the majority of changes relating to Article 12 of the AIFMD, which does not apply to non-EU managers offering their investments in the EU. However, the final draft of the amending Directive may differ, and individual Member States may choose to tighten regulatory requirements and extend them to non-EU managers.
Unreasonable Costs:
The new legislation does not explicitly define “disproportionate costs.” However, it can be inferred that such costs are those that are not reasonable or necessary.
Existing legislation suggests that costs are not considered unreasonable if they:
- Are consistent with the information set out in the fund’s prospectus or constitutive legal acts (Article 23 AIFMD) and the key investor information provided under the PRIIPs Regulation;
- Are necessary for the operation of the AIF in accordance with its investment strategy or to meet regulatory requirements; and
- Are paid by investors in a manner that ensures fair treatment of all investors (except where the AIF’s prospectus or constitutive instruments provide for preferential treatment).
Other costs may be considered unreasonable or undue.
Clarification on this matter is expected to be provided through delegated acts (the so-called Regulatory Technical Standards or RTS), which should set out minimum requirements for AIFMs to prevent charging unreasonable costs to the AIF.
However, the proposal also allows for certain conditions under which supervisors could approve costs not listed in the established cost categories on a case-by-case basis. These costs could then be paid out of the assets of the fund or by investors, and would be considered reasonable.
ESMA Costs and Benchmarks:
ESMA will be tasked with developing and publishing benchmarks that allow for the comparison of costs and performance of alternative investment funds.
Common benchmarks will be developed for alternative investment funds offered to retail investors (including both special funds and qualified investor funds in the Czech Republic). The comparison will focus primarily on performance, risks, and investment strategy.
The benchmarks will “show the range of costs and performance, particularly where costs and performance deviate significantly from the average.”
If an AIF intended for retail investors deviates from the benchmark set by ESMA for the relevant product category before being marketed, it cannot be offered to retail investors until further assessment confirms that the costs are not unreasonable.
If an AIF already offered to retail investors deviates from the benchmark, the AIFM must subject the AIF to increased monitoring. If corrective action is deemed necessary, the manager must implement such action within a reasonable timeframe to ensure that the costs are not disproportionate.
The AIFM will be required to document and maintain records of its assessments, including comparisons with the relevant ESMA benchmark and justifications for any deviations.
When Will This New Measure Take Effect?
It is likely that these new measures will not be implemented before 2025. The European Commission has just published the legislative proposal, and it still needs to be reviewed by the EU Council and the European Parliament, a process that will take time.
The Commission proposes, and it is expected that the Council and Parliament will agree, that Member States will have 12 months to transpose the Directive after its publication in the Official Journal. The new regulation should then become applicable 18 months after its publication in the Official Journal.