Response to IOSCO consultation report Elements of International Regulatory Standards on Fees and Expenses of Investment Funds

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1 Luxembourg, 23 September 2015 Response to IOSCO consultation report Elements of International Regulatory Standards on Fees and Expenses of Investment Funds Introduction The Association of the Luxembourg Fund Industry (ALFI) is the representative body of the Luxembourg investment fund community. Created in 1988, the Association today represents over 1300 Luxembourg domiciled investment funds, asset management companies and a wide range of service providers such as custodian banks, fund administrators, transfer agents, distributors, legal firms, consultants, tax experts, auditors and accountants, specialist IT providers and communication companies. The Luxembourg Fund Industry is the largest fund domicile in Europe and a worldwide leader in cross-border distribution of funds. Luxembourg-domiciled investment structures are distributed on a global basis in more than 70 countries with a particular focus on Europe, Asia, Latin America and the Middle East. We thank IOSCO for the opportunity to participate in this consultation on elements of international regulatory standards on fees and expenses of investment funds. We participate to support a policy agenda that brings clear, concise and comparable information to investors. We strongly advocate a consistent application to foster and ensure a global level playing field and to allow comparability between the different collective investment scheme (CIS) products. However, considering ongoing legislative procedures in the EU such as MiFID II 1 and PRIIPs 2 which address cost disclosures towards investors, the IOSCO consultation was probably launched a few months too early. Given the interconnectedness of markets and products, it would be counterproductive if different standards were applied at national or EU and international level. It also appears to us that a great emphasis is put on the costs and their diminishing effect on the return on the investments. However, when costs are incurred, one also has to look at the benefits received in exchange for those costs. A de-facto bias against active asset management would appear if the final rules did not allow actively managed products to display the benefits via their past performance record. Otherwise, the comparison of disclosure documents would falsely educate investors that products compete only on costs, to the disadvantage of those products that make use of more expensive strategies to achieve higher returns. Finally, we support the submission of the European Fund and Asset Management Association (EFAMA). 1 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (recast) 2 Regulation (EU) N 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs)

2 Question 1: - Are there any other developments that C5 should take into account when formulating good practices regarding fees and expenses of CIS? We think the key investor information document (KIID) produced pursuant to the rules of the EU UCITS Directive 3 should serve as a benchmark for pre-contractual disclosure requirements towards CIS investors. These rules were adopted after long discussions and intensive consumer testing, and have proved since then to meet investors expectations. Furthermore, when drafting good practices, we encourage IOSCO to take account of the ongoing discussions on disclosure requirements on costs resulting from the EU PRIIPs regulation and from the updated MiFID Directive (MiFID II), as well as of the Regulatory Technical Standards related thereto. In this context, IOSCO should bear in mind that MiFID seeks to look at total cost to investor and it, together with PRIIPs, seeks to apply similar disclosure requirements across product types. Apart from these pre-contractual requirements, both the fund s main prospectus and the annual financial statements provide more details on the charges of investment funds. However, consumer testing showed that retail investors usually prefer reading shorter documents written in non-technical language. Therefore, key information for retail investors on costs should be included in pre-sale documents, with the possibility for the manufacturer to cross-refer the fund s main prospectus or comparable document for less important details. Question 2: - If you think defining permitted and prohibited costs is useful, should this be done by the regulatory authority or the CIS operator? - What types of costs should be permitted and/or prohibited to be charged? - Are there alternatives to prohibiting certain fees and expenses and if yes, what are they and why are they effective? Sub-question 1: The ultimate objective of disclosure requirements must be to provide CIS retail investors with sufficiently clear information to enable them to take an informed decision. One way to achieve this is to disclose fees and expenses in a pre-contractual document that has to be provided to the investor before an investment decision is taken. Moreover, fund investors have access to the fund s main prospectus and to its annual financial statements. In Europe, the costs and charges that have to be disclosed in a standardised form are usually at least broadly defined by the legislator or regulator. Considering the former and current legislative framework on UCITS as opposed to the future PRIIPs rules (in particular the regulatory technical standards that are still under discussion), there is a tendency to more and more define costs that should be disclosed to the investor. This definition of a list can in our view only be done by the legislator or regulator, to ensure consistency and a level playing field between different investment products. However, due to the differences between investment products (such as investment funds, 3 Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). It is worth noting that the UCITS Directive has been amended by Directive 2014/91/EU of the European Parliament and of the Council of 23 July 2014 as regards depositary functions, remuneration policies and sanctions. However, the 28 EU Member States have until 18 March 2016 to transpose the new rules into national law. 2 P age

3 structured products, pension and insurance products), it is admittedly often difficult to define a common standard. On the other hand, the European legislator also sometimes decides that certain unjustified costs are prohibited to be charged. For example, UCITS master funds are not allowed to charge UCITS feeder funds with fees linked to the subscription or redemption of their units or shares. The same applies, with respect to subscription and redemption fees, to UCITS investing in the units of other UCITS and/or other UCIs that are managed, directly or by delegation, by the same management company or by any other company with which the management company is linked by common management or control, or by a substantial direct or indirect holding. Similarly, concerning fund mergers, the UCITS Directive specifies that any legal, advisory or administrative costs associated with the preparation and the completion of the merger shall not be charged to the merging or the receiving UCITS, or to any of their unit-holders. Moreover, the MiFID framework prohibits certain practices such as the payment of fees, commissions and the receipt of other non-monetary benefits between firms and persons other than their clients (e.g. advisory firms and distributors), unless certain criteria are met. This prohibition is also defined by the legislator and regulator to ensure that such payments and benefits do not qualify as inducements, which could cause conflicts with the client s interests and impair a firm s duty to act in the best interests of the client. The payments and benefits should instead be designed to enhance the quality of the service being provided to the client and be disclosed to the latter. As a result, we believe that defining permitted and prohibited costs for the purpose of disclosing them to retail investors can only be done by legislators or regulators, not by the CIS operator. However, regarding the question of which costs are intended to be charged to a fund and given the usual budget practice applied by fund managers, the CIS operator should be the one who has the flexibility and final responsibility for presenting a list of costs relating to a CIS to the regulator in charge. Sub-question 2: With regard to the types of costs that should be permitted and/or prohibited to be charged, we strongly encourage IOSCO to adopt rules similar to the UCITS, PRIIPs and MiFID regime in Europe, which would require IOSCO to wait for the outcome of discussions on regulatory technical standards in the coming months. It would be counterproductive if different standards applied at national or EU and international level. Regarding specific types of costs and in the understanding that paragraph 25 of the consultation paper contains examples of expenses which cannot be legitimately deducted from the fund assets, we challenge IOSCO s thinking whether costs associated with the foundation of a fund should be regarded as prohibited costs. In some EU countries the deduction of a fund s formation expenditure (which can also include administrative fees) is considered a legitimate expense only if covered by a separate charge and explicitly agreed as part of the investment contract. We believe that under these preconditions this type of costs is appropriate and should not be considered illegitimate by IOSCO s future standards. While we agree that a new type of fee or an increase in the management fee must not be deducted from the fund assets before the required approval process has been completed, we have some hesitations on statements made in paragraph 26(c). With regards to the appropriateness of breakpoints to the management fee in case of economies of scale when a fund grows in size, we caution that this depends to a large extent on a fund operator s internal structures, its specific business activities and the competitive environment. Hence, the decision on imposing such breakpoints is part of the commercial strategy of a fund operator and should not be impacted by regulatory measures and should thus be deleted from the future standards. 3 P age

4 Sub-question 3: Apart from defining permitted costs, we are not aware of alternatives to prohibiting certain fees and expenses. Question 3: - Which do you consider to be the most appropriate method of performance fee calculation currently employed and why? Are there methods other than a fulcrum fee or last in, first out that are more effective? - What other requirements might curb incentives for excessive or inappropriate short-term risk-taking? Should there be specific recommendations as to how the calculation, benchmark, and target of a performance fee are disclosed? What further disclosures could be recommended? As a general principle, any performance fee should be adequately constructed to reward the asset manager s skill and align interests between the manager and the investor. Retail investors should have some protection via regulation that the outcomes of performance fees are well constructed, however it could be left to national regulators to determine the safeguards and standards. It should be avoided to have overly prescriptive regulations that may stifle innovation and positive investor developments. Sub-question 1: The European regulatory environment relating to the calculation of performance fees is very flexible and open to interpretation. In Luxembourg, there is no law or directive providing guidance or prescribing the computation of the performance fees. The only requirement is that the calculation has to be in line with the methodology described in the prospectus. Considering the diversity of fund types, we believe best market practices are preferable to prescribed methods of calculation. Sub-question 2: We think the current disclosure requirement for performance fees in the UCITS KIID is appropriate and provides the investor with both ex-ante disclosure, as a percentage, and ex-post as the actual fee paid for the previous twelve months. This combined with a more detailed description in the fund s constitutional documents (prospectus) of how the fee is calculated provides a clear disclosure to an investor. Moreover, it is worth noting that under the amended UCITS Directive (see footnote 3) a fund s management company will have to include performance fees in its remuneration policies, which will also form part of the fund s annual report. Question 4: - Do summary documents present the right amount of information about fees and expenses and in a way that is useful for investors? We are convinced that summary documents limited to two or three pages as in Europe under UCITS and PRIIPs are adapted to the investor s needs. Consumer testing confirmed that the former simplified prospectus under UCITS III failed its objective mainly because there was no 4 P age

5 size limit, and as a result, it was simply not read by investors. Moreover, the legislative texts ensure that a review of the given rules usually takes place after a couple of years. Under the EU PRIIPs regulation, more costs will be aggregated in summary indicators than currently under UCITS. The aggregation of contingent costs such as transaction costs or performance fees with costs that are known in advance, such as management fees or audit fees, will lead to the disclosure of misleading information. Therefore, we would rather prefer the presentation of two total cost figures: on the one hand, all costs fully known ex-ante, and, on the other hand, all contingent costs that need to be estimated. The latter could then be accompanied by appropriate disclaimers so that clients are informed that this figure is only an estimate. After those two amounts of costs are calculated, they can indeed be divided by the average net assets of the costs to produce one of the proposed summary indicators (namely the total cost ratio or the reduction-in yield figure), as currently prescribed by the CESR guidelines. Question 5: - Should regulators do more and if so, what to make disclosures to investors about fees and expenses: - easier to understand? - more prominent? - more easily accessible? - Is it necessary to expand the standard Information delivered must be simple, concise and set out in clear language? Would you find it helpful to have recommendations on (for example) the use of easy-to-read formats (font size, using tables/charts/graphs) or the use of uniform terminology? - Does a standardised fee table, if applicable, provide sufficient information regarding certain fees and expenses? - Are there specific sub-categories (e.g. management fee, transaction costs) that should be disclosed separately? Sub-question 1: From an EU perspective, we think there are as such sufficient legislative or regulatory rules or initiatives that address the need to make disclosures to investors about fees and expenses easier to understand, more prominent and more easily accessible. However, for investors in non-eu jurisdictions where comparable rules do not exist we think it would be helpful if IOSCO promoted the adoption of same standards. Considering cross-border distribution of funds beyond Europe, we would encourage non-eu regulators to generally accept disclosure documents produced under the given EU rules, which would certainly have to be translated into the respective national language. Certain information indispensable from the perspective of the respective non-eu country could be disclosed in short form in an additional section or annexed. Sub-question 2: The standard Information delivered must be simple, concise and set out in clear language broadly complies with the EU standard ( accurate, fair, clear and not misleading, short document written in a concise manner ). However, as these principles are still very general, in Europe, it is usual that they are further detailed by implementing rules and regulatory guidance e.g. in the form of FAQ documents. The use of easy-to-read formats (font size, using tables/charts/graphs) and the use of uniform terminology could be promoted by IOSCO. 5 P age

6 Practitioners would much appreciate to be able to refer to a common glossary set up by regulators in which technical terms were defined. Sub-question 3: A standardised fee table as used for charges in the UCITS KIID provides in our view sufficient information regarding certain fees and expenses. Sub-question 4: As far as a categorisation is concerned, we think a distinction between entry costs, exit costs, ongoing costs and performance fees in a table as done in the UCITS KIID in Europe make sense, where needed accompanied by narrative explanations. If investors wished to get more information on costs, they could access the fund s main prospectus and its annual financial statements. Regarding the question of which costs should be included, we call again on IOSCO to wait for the outcome of discussions on regulatory technical standards under PRIIPs and MiFID, because it would be counterproductive if different standards applied at national or EU and international level. Question 6: - Should there be a standard regarding the frequency of updating of fees and expenses information in disclosure documents? - How often should historical information on fees and expenses be updated? - In which situations (e.g. where historical information on CIS does not exist) should disclosure on an anticipated basis be obligatory? - What is the most accurate or representative methodology for calculating fees and expenses on an anticipated basis (i.e. one that reduces the chance of over- estimates or under-estimates)? - How should material changes to the fees and expenses of a CIS be treated in terms of historical / anticipated disclosure requirements? - In cases where the information can only be provided on an anticipated basis to begin with, should the disclosure be updated later with historical information? Sub-question 1 and 2: We think the current UCITS rules in Europe should be taken as benchmark. As a result, practitioners would have to review the cost information in the disclosure documents at least annually, irrespective of whether the figure is based on historical or anticipated information. Moreover, a review would be carried out prior to any proposed change to the prospectus, the fund rules or the instruments of incorporation of the investment company. Last but not least, a review would be necessary prior to or following any changes regarded as material to the information contained in the disclosure document. Sub-question 3: Where historical information on fees and expenses cannot be used, it is necessary to anticipate them. This is particularly true for certain types of costs (e.g. transaction costs) that are usually 6 P age

7 difficult to determine in advance. In this case, we think a general narrative description as opposed to an explicit estimated figure would be preferable. Sub-question 4: Regarding the most accurate or representative methodology for calculating fees and expenses on an anticipated basis (i.e. one that reduces the chance of over-estimates or under-estimates), several options exist, but they depend on the nature of the respective costs. For example, the EU regulators are currently working on methodologies for calculating transactions costs and performance fees. Therefore, we again encourage IOSCO to wait for the outcome of discussions on regulatory technical standards under PRIIPs and MiFID. It would be counterproductive if different standards applied at national or EU and international level. We also refer to our answer to question 4 regarding the use of summary indicators. Sub-question 5: We encourage regulators to agree on a common definition of material changes (accompanied by practical examples) that entail a review or update of the cost information. In this context, we also refer to our answer to question 17. Sub-question 6: We refer to our answer to sub-questions 1 and 2, which explains when information is needed to be revised. Question 7: - Is it desirable to add a standard recommending the use of electronic media for fees and expenses disclosure documents? What are the reasons for your view? - How can the CIS and the CIS operator ensure that electronic disclosures are received and accessed by investors? - What could constitute approval from investors? Sub-question 1: We believe the use of electronic media for disclosing fees and expenses disclosure documents has to be recommended. The main rationale behind our view is the reduction of communication costs to the fund and thus to the end investor, as well as the real-time availability of information. We would also recommend to define the content of electronic media, and to consider the possibility to set-up a single and centralised source of data (possibly free of charge) for retail investors. This approach should not diminish the usual requirement to provide disclosure documents to retail investors on paper where the product is offered, free of charge, on a face-to-face basis. Sub-question 2: A key differentiator is the timing for informing the final investor on fees and expenses, prior or post placing the order. If the latter applies, it is enough to disclose the amount in the contract note. 7 P age

8 If the investor must be informed before placing the order, we would suggest to apply rules similar to the EU PRIIPs regulation. This means that a specific document disclosing, among other things, fees and expenses would have to be made available on the CIS operator s website. The person advising on, or selling, the CIS usually a bank which acts as intermediary between the investor and the CIS operator, which has a contractual relationship with the investor and which cooperates with the CIS operator on the basis of a distribution agreement would be required to provide the investor with the disclosure document and be responsible for ensuring that it is duly received and accessed by the investor. As a result, where a distribution agreement is in place, the final responsibility towards retail investors rests with the distributor (intermediary), and the CIS operator has only to perform standard due diligence controls over the appointed entity. We would also suggest to subordinate the execution of each order to the acceptance of the above mentioned conditions. Sub-question 3: We would consider that, for example, ticking the relevant boxes could constitute approval from investors. Question 8: - Should there be a standard definition of what transaction costs are? If so, which types of cost should be included in, or excluded from, such a definition and why? - What are the most effective ways of determining the value and impact of transaction costs in a CIS? Sub-question 1: We believe that there should be consistency within different legislations worldwide with regards to a definition of transaction costs to ensure a level playing field. In Europe, guidelines and regulations exist that are aiming at harmonising reporting and disclosure of costs of funds, including transaction costs. We would recommend the use of consistent terminology and fear that the term transaction costs could be confused with custody transaction costs. Therefore, we propose a term such as market transaction costs for differentiation purposes. We refer to the EU UCITS Directive, which added transaction costs under the information to be included in and published by the annual reports of UCITS. These costs are costs incurred by a UCITS in connection with transactions on its portfolio. In our view, transaction costs should fulfil the following criteria: 1. they are costs that are directly linked to the acquisition or sale of investments; 2. investments concerned are transferable securities, money market instruments, derivatives or any other eligible assets (spreads on fixed income securities or derivatives are excluded); 3. transactions relating to securities lending are excluded as they are not acquisitions or sales; 4. offsetting transaction costs should be acceptable (e.g. swing factor), provided the offsetting criteria are in line with the criteria applied for the determination of transaction fees (i.e. bid and offer spreads included in the swing factor may not be considered, as they are not included in transaction costs). A note to the financial statements would need to explain the principles that have been applied in this respect. Ideally, transaction costs 8 P age

9 would be offset in their entirety on the basis that the swing or other dilution levy is in itself an estimate of the market costs. Furthermore, we believe that the definition of transaction costs used in international accounting standards could be used as standard: Transaction costs include fees and commission paid to agents (including employees acting as selling agents), advisers, brokers and dealers, levies by regulatory agencies and security exchanges, and transfer taxes and duties. Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or holding costs. (IFRS 9 B5.4.8). Sub-question 2: See our response to question 9. Question 9: - Which costs, especially implicit costs, can be accurately quantified after the event? - If they cannot be accurately measured, can they be reliably estimated instead and how useful are such estimates to investors? Could such estimates be helpful to investors in considering their investment decision making process when comparing different methodologies? What methodologies could be used? - What are the challenges of disclosing transaction costs to investors? Sub-question 1: It is challenging to accurately quantify transaction costs, in particular implicit costs, and this can vary by asset class. For asset classes where element of costs are explicit, such as equities and futures, the most appropriate solution is at present only to reflect explicit costs (i.e. commissions and taxes) rather than using a total cost approach. For asset classes such as fixed income and foreign exchange, transaction costs are generally implicit, as these costs are embedded in the quoted price. Another example is market impact costs as there is no agreed formula or benchmark. There is too much subjectivity in the calculation and too many qualitative interpretations required to properly understanding how inclusion of different elements of costs impact the overall numbers reported to clients. Estimate for such costs may be based on a number of different criteria and measured in different ways and therefore meaningful comparison could be challenging, unless common standards are put in place. Sub-question 2: Given the challenges in obtaining a meaningful and comparable value of implicit transaction costs, it can be also challenging to produce accurate estimates. We question that such estimates will be materially useful to end investors when taking a final investment decision. 9 P age

10 We are aware of different European countries initiatives to recommend methods and models of estimating implicit transaction costs, such as in France and in the Netherlands. If including implicit costs is deemed useful, we would suggest that an analysis of the different methods and best practices is conducted, to ensure adoption of a common standard. Sub-question 3: See our response to sub-question 1 above. Question 10: - To what extent can the total amount of transaction costs be predicted for future periods? Are there standards of good practice that could be applied to such disclosures? What are the risks of using past information in this context? Generally, we believe that a historical calculation methodology is the most appropriate. However, a hybrid approach may often be necessary: where actual figures and numbers are available they should be used and where not, in case of implicit cost, a standardised methodology should be used. It would be important that all methodologies were provided by regulators and consistently applied for all product and asset types. In terms of ex-ante transaction cost reporting for a fund prior to launch, we would assume that selecting a comparable scheme and providing the previous quarter (or previous four quarters, or a rolling year) transaction costs relative to assets under management would constitute a representative measure. We would leave this at the discretion of the CIS operator, as they would know best what comparable schemes and periods are most appropriate for their product. The main risks related to using historical data are material changes of the costs, i.e. taxation, or even a material change of the composition of the portfolio. If the change is material, we would recommend restating the historical data for comparability. Question 11: - What experience have CIS operators and investors had of funds which apply a single fee that includes transaction costs? Has the level of transaction costs changed as a result of introducing this model? Are there any disadvantages for investors? We have not observed that CIS operators include transaction costs in all-in fees. We believe that it could be impractical, in particular given the difficulties in assessing implicit transaction costs. We see that there could potentially be issues with regards to conflicts of interest, i.e. with regards to the level and type of transactions that the portfolio manager would execute to limit costs. More generally, there could be an overestimate of transaction costs embedded, in order to avoid frequent adjustments of the all-in fee. 10 P age

11 Question 12: - What disclosure methods are appropriate for transaction costs? If disclosure is in a numeric form, what other pieces of information will help the CIS or its investors to understand the impact of these costs on investment returns? We believe it is important for the understanding of retail investors to provide transparency of the charges which are applied to their funds while not overloading them with detail that can be confusing and does not add to their ability to make an informed decision and to compare equivalent charges across different products. It is also important that specific guidance be given as to the calculation and disclosure of each type of cost / charge in order to ensure a standardised methodology is used across different products and to allow for comparability of products by an investor. On the UCITS KIID there was very clear guidance given by CESR 4 for the disclosure of entry / exit charges, on-going charges and other charges such as performance fees. A similar approach is needed for the calculation of transaction costs and the other additional disclosure being proposed. However, the disclosure of portfolio transaction costs will be difficult to achieve in a manner that will provide meaningful information to an investor. If this is to be done, it will be important that guidance be given to the industry on exactly how these should be calculated for each asset type to ensure a standardised disclosure methodology. It should also be made clear in the disclosure that the impact of these costs is already included in the performance of the fund as the portfolio transaction costs of a CIS are a material component of its performance. We believe that the disclosure method depends on where the transaction costs are disclosed. For instance, it would be numerical in the financial statements, whereas in other documents such as the UCITS KIID, it would be in percent of average NAV. In assessing disclosure best practice, regulators should consider the relevance of the information disclosed to the investors. In terms of overall presentation, we recommend to clearly separate transaction costs from other ongoing cost indicator (before possible merging the cost elements into an aggregated figure) as is currently being discussed in the EU. Question 13: - What is the most appropriate comparison method to ensure the transaction produced value for money? Cost measures should never be analysed in isolation and therefore it is recommended to combine them with a review of performance or risk-adjusted performance measures or with portfolio turnover ratio. Ensuring best execution is also a necessary requirement, which is for instance defined by an implementing EU UCITS Directive 5 : Execution of decisions to deal on behalf of the managed UCITS 4 CESR was the predecessor of ESMA, the European Securities and Markets Authority 5 See article 25 of Commission Directive 2010/43/EU of 1 July 2010 implementing the UCITS Directive as regards organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company 11 P age

12 1. Member States shall require management companies to act in the best interests of the UCITS they manage when executing decisions to deal on behalf of the managed UCITS in the context of the management of their portfolios. 2. For the purposes of paragraph 1, Member States shall ensure that management companies take all reasonable steps to obtain the best possible result for the UCITS, taking into account price, costs, speed, likelihood of execution and settlement, order size and nature, or any other consideration relevant to the execution of the order. The relative importance of such factors shall be determined by reference to the following criteria: (a) the objectives, investment policy and risks specific to the UCITS, as indicated in the prospectus or as the case may be in the fund rules or articles of association of the UCITS; (b) the characteristics of the order; (c) the characteristics of the financial instruments that are the subject of that order; (d) the characteristics of the execution venues to which that order can be directed. 3. Member States shall require management companies to establish and implement effective arrangements for complying with the obligation referred to in paragraph 2. In particular, management companies shall establish and implement a policy to allow them to obtain, for UCITS orders, the best possible result in accordance with paragraph 2. Management companies shall obtain the prior consent of the investment company on the execution policy. The management company shall make available appropriate information to unit-holders on the policy established in accordance with this Article and on any material changes to their policy. 4. Management companies shall monitor on a regular basis the effectiveness of their arrangements and policy for the execution of orders in order to identify and, where appropriate, correct any deficiencies. In addition, management companies shall review the execution policy on an annual basis. A review shall also be carried out whenever a material change occurs that affects the management company s ability to continue to obtain the best possible result for the managed UCITS. 5. Management companies shall be able to demonstrate that they have executed orders on behalf of the UCITS in accordance with the management company s execution policy. Question 14: - What are the most effective ways of mitigating conflicts of interest relating to soft commission arrangements? - Do lists of forbidden or permitted goods and services give enough certainty to CIS operators and investors about what can be paid for in this way? - What other steps might regulators and/or CIS operators take, to enable goods and services provided by the sell side to be paid for in an efficient way that does not adversely affect the interests of CIS investors? We believe the area of conflicts of interest is adequately covered for EU CIS in regulation via the UCITS, AIFMD and MiFID directives. Non-monetary benefits such as soft commissions (broker research, financial analysis or pricing information systems) provide important assistance for asset managers in the process of taking investment decisions or transmitting orders for execution and are 12 P age

13 subject in the EU to the requirement that they enhance the quality of the service. We are therefore of the opinion that soft commissions should in any case be permitted in relation to portfolio management (in particular the provision of research bundled with brokerage services), as they are valuable to the industry as a whole, they help reduce fees to clients, and assist investment managers in providing a better service to their clients. An appropriate way to identify and avoid such conflicts would be non-exhaustive guidance of positive and negative examples. The negative list, for example, would include forbidden goods and services that solely benefit the portfolio manager such as accommodation and entertainment. A positive list would enumerate goods and services that will include, among other things, investment research and arrangements for corporate access. Such an approach will provide the necessary legal certainty to both fund operators and investors on what type of soft commissions could be paid for through soft commission arrangements. Fund boards and individual directors have a broad range of fiduciary obligations which include a responsibility towards safeguarding the assets of the fund and ensuring their appropriate use. The payment of commission is a use of the assets of the fund and fund boards and directors are entitled, indeed obliged, to consider whether that payment has been appropriate. Where the instructing party, typically an investment manager, uses client commissions to pay for services that itself receives then there is a conflict of interest which needs to be addressed. It should only be possible for investment managers and other instructing parties to make profits from the use of the fund s assets where that profit has been explicitly permitted by the fund s board and the fund s board is put in a position where it can judge whether such profit is reasonable in the circumstances. Under the forthcoming MiFID II regulations this disclosure will be made more transparent. In conclusion, the UCITS, AIFMD and MiFID conduct of business rules require firms to act in the best interest of investors and provide adequate disclosure. Question 15: - What types of disclosure concerning hard and soft commission arrangements are most useful to the board of directors of a CIS, and/or investors in a CIS? We believe the area of conflicts of interest is adequately covered for EU CIS in regulation via the UCITS, AIFMD and MiFID directives. Under MiFID II inducements (for all cases except minor non-monetary benefits paid between the sell side and buy side) will be prohibited for discretionary portfolio management. Therefore, the only remaining area is minor non-monetary benefits which are of immaterial scale. Soft commission relationships and the receipt of investment research may continue, however this will need to be accounted for and disclosed to investors. We believe that the EU regulations are restrictive in this area and the IOSCO should not seek to establish rules supra to the existing corpus of EU regulations. 13 P age

14 Question 16: - Are current disclosure requirements about fees and expenses, for funds investing in other vehicles, appropriate to assist investors in making an informed decision? - Are disclosure requirements about fees and expenses enough to manage potential conflicts of interest arising from investment in other vehicles? What other requirements might help to mitigate those conflicts of interest? Sub-question 1: We believe that specific guidelines are needed, and the current legislative framework in the EU for investment funds already ensures some transparency and restrictions on fees for fund of funds (i.e. funds investing in other funds). For example, the EU UCITS Directive (article 55 paragraph 3) provides the following: Where a UCITS invests in the units of other UCITS or collective investment undertakings that are managed, directly or by delegation, by the same management company or by any other company with which the management company is linked by common management or control, or by a substantial direct or indirect holding, that management company or other company shall not charge subscription or redemption fees on account of the UCITS investment in the units of such other UCITS or collective investment undertakings. UCITS that invest a substantial proportion of its assets in other UCITS or collective investment undertakings shall disclose in its prospectus the maximum level of the management fees that may be charged both to the UCITS itself and to the other UCITS or collective investment undertakings in which it intends to invest. It shall indicate in its annual report the maximum proportion of management fees charged both to the UCITS itself and to the other UCITS or collective investment undertaking in which it invests. In this context, we suggest that substantial proportion is further defined to ensure more consistency (e.g. funds investing more than 20% of their assets in units or shares of other funds). This provision is further detailed as follows 6 : The description of the charges shall take account of any charges that UCITS will itself incur as an investor in the underlying collective undertakings. Specifically, any entry and exit charges and ongoing charges levied by the underlying collective undertakings shall be reflected in the UCITS calculation of its own ongoing charges figure. In addition, best market practice suggests the disclosure of the following elements within the financial statements of the funds investing in target funds: - The effective management rate of fees at the level of the target fund; - For funds investing a significant portion of their assets in target funds, to calculate a synthetic TER (Total Expense Ratio) upon availability of information; - The TER variation from one year to another could also be a potential good indicator. The EU MiFID and AIFMD rules also contain strong conduct of business rules and disclosure requirements concerning fees. 6 See article 30 of Commission Regulation (EU) N 583/2010 of 1 July 2010 implementing the UCITS Directive as regards key investor information and conditions to be met when providing key investor information or the prospectus in a durable medium other than paper or by means of a website 14 P age

15 Last but not least, it is worth noting that the methodologies for calculating a TER or ongoing charge figures are not harmonised which could lead to inconsistent results. See also our response to question 18. Sub-question 2: We believe the area of conflicts of interest is adequately covered for EU CIS in regulation via the UCITS, AIFMD and MiFID directives. For fund of funds investing significantly in target funds managed by the same management company or by a management company belonging to the same group or which is closely linked thereto, it would be good practice to disclose this relationship in the fund s documentation (the prospectus, KIID and financial report). Finally, we think the fund of funds annual report should also mention the amount and beneficiary of rebates or trailer fees paid to target funds or the management company. Question 17: - Are you aware of problems in identifying what constitutes a change in the main characteristics of a CIS in relation to fees and expenses? - Should there be more specific standards of good practice concerning disclosure of changes, e.g. a minimum period of prior notice, and the ability of investors to respond to such changes? Please give examples of appropriate measures, if possible indicating the likely costs they would involve. Sub-question 1: We are of the view that one should distinguish between changes in the fee structure of a CIS that are under the control of CIS governing bodies, and changes that are beyond their control (e.g. transaction taxes or other tax events that do not only apply to a single CIS but globally and that occur unilaterally at governmental discretion). Moreover, we think a change should have a recurrent nature to be considered as change of the main fund characteristics. For instance, cost of litigation and penalties should not be included in this definition. Pursuant to the EU UCITS Directive and its implementing rules, so called material changes trigger revisions of KIIDs. As mentioned in our answer to question 6, we believe that guidelines on the meaning of this term would be helpful for practitioners and ensure consistency 7. Sub-question 2: In Luxembourg, regulatory guidance 8 provides the following: 7 For example, box 7, paragraph 2(b) of CESR s technical advice to the European Commission on the level 2 measures related to the format and content of the Key Information Document disclosures for UCITS (CESR/09-949) sets a threshold of 5% or more of the published ongoing charges figure 8 Circular CSSF 14/591 on the protection of investors in case of a material change to an open-ended undertaking for collective investment 15 P age

16 According to article 151(1) of the Law of 2010, the prospectus shall include the information necessary for investors to be able to make an informed judgement of the investment proposed to them. In this context, the CSSF (the regulator) assesses whether a contemplated change to the prospectus requires additional measures to protect the interests of the investors in the UCI (undertaking for collective investment). It is understood that this will not be the case of every change, but given, inter alia, that investors in UCIs are primarily retail investors, the CSSF is of the view that they have to be given sufficient time to make an informed decision about a change which is material enough to potentially affect the investors interests and impact the basis on which they made their existing investment. According to the CSSF s current administrative practice, the minimum notification period to notify investors of a significant change to the UCI they are invested in should be one month. During this one-month period before the entry into force of the significant change, investors have the right to request, without any repurchase or redemption charge, the repurchase or redemption of their units. In addition to the possibility to redeem units free of charge, the UCI may also (but is not obliged to) offer the option to investors to convert their units into units in another UCI (or, in case the change affects only one sub-fund, into units of another sub-fund of the same UCI) without any conversion charges. We think that these rules could be taken up by IOSCO as standard of good practice concerning disclosure of changes. Question 18: - Which other areas of the 2004 report, if any, do you believe should be updated and/or amended? Please provide any suggested changes to specific standards of good practice or definitions of key terms set out in Annex A, including drafting proposals and rationale. The content of the 2004 report is principle based and these principles are still valid. However, we would like to bring IOSCO s attention on the fact that the EU legislator replaced the commonly used Total Expense Ratio (TER) concept for CIS by the one of Ongoing Charges. Indeed, the TER provided only limited information for the retail investors as the calculation basis did not include all costs and expenses borne by the CIS or by investors like the entry and exit fees. When drafting guidelines, IOSCO may wish to take this aspect into account. Question 19: - Does the report cover all of the key issues on standards regarding fees and expenses of CIS? Are standards needed to address any additional issues? Please provide a summary of the issue and suggest wording for the proposed standards. We believe that the report covers all key issues on standards regarding fees and expenses of CIS, and that no standards are needed to address additional issues. At the same time we think that more examples in sections 8(ii), 8(iii) and 25 would add further clarity on permitted fees. 16 P age

17 IOSCO may also wish to consider that elements of international regulatory standards on fees and expenses of investment funds may require a harmonisation of detailed technical implementing measures, and converging supervisory practices. The latter are key to ensure that harmonised best practices are complied with and that comparability between products is effective. If national regulators had discretion to design implementing standards, it would be possible and likely that diverging practices emerged which could result in non-homogeneous data and potentially lead to significant distortion of competition, knowing that aggregated figures of fees and expenses are compared by investors. Similarly, if figures published by CIS were not subject to effective and efficient control on a harmonised basis, regulatory standards would probably not be properly applied by market stakeholders. Converging supervisory practices, as they exist in the EU as opposed to diverging national practices, are therefore a key factor for the successful application of harmonised regulatory standards. * * * 17 P age