ESMA updates its UCITS Q&As in respect of rebates and fees

On 26 November 2021, ESMA updated its Q&As on the Application of the UCITS Directive by including a question on rebates and fees in a new Section XII (Costs and fees).

(For the first time, the answer is provided by the European Commission - Article 16b(5) of the ESMA Regulation requires ESMA to forward any questions on the interpretation of EU law to the Commission and to publish the Commission’s response, albeit noting that only the Court of Justice of the European Union is competent to authoritatively interpret EU law.)

The new question asks the Commission to confirm that:

• the restrictions set out in Article 29 of the UCITS Level 2 Commission Directive do not apply to a rebate arrangement where the ManCo pays these rebates from its own resources; and

• a ManCo can pay fees from its own resources to separate investors (for example, through the use of side letters with institutional investors, which buy investment fund units on behalf of their clients), where the ManCo prevents undue costs being charged to the UCITS and its unit-holders.

The Commission’s answer in each case is ‘no’.

The provisions on fees or commissions paid or received to/from a third party set out in Article 29 are intended to ensure that a ManCo acts honestly, fairly and professionally and to safeguard the best interests of the UCITS and fair treatment of its investors.

Since management fee discount arrangements entail payments to certain investors based on the fees charged by the ManCo to remunerate investment management and/or administration activities, they should be regarded as payments for the activity of the investment management and administration of the UCITS.

This means that they must meet the conditions laid down in Article 29(1)(b), namely:

"(i) the existence, nature and amount of the fee, commission or benefit, or, where the amount cannot be ascertained, the method of calculating that amount, must be clearly disclosed to the UCITS in a manner that is comprehensive, accurate and understandable, prior to the provision of the relevant service;

(ii) the payment of the fee or commission, or the provision of the non-monetary benefit must be designed to enhance the quality of the relevant service and not impair compliance with the management company’s duty to act in the best interests of the UCITS;”

As a result, such arrangements must be transparent and the ManCo must demonstrate that the arrangements:

• will “enhance the quality of the relevant service” for the UCITS – this refers to the quality of the UCITS services to the benefit of all investors and not simply to those investors which benefit from the arrangements; and

• will “not impair compliance with the management company’s duty to act in the best interests of the UCITS”.
  The “Duty to act in the best interests of UCITS and their unit-holders” is set out in Artcile 22 of the Level 2 Commission Directive, which requires the ManCo to (a) treat all unit-holders fairly, act in the best interest of the unit-holders and (b) refrain from placing the interest of any group of unit-holders above others.
  Consequently, a ManCo must be able to show that all investors pay their fair share in the functioning of the fund (taking into account management fee discounts) and the UCITS cost structure without the arrangements having a negative impact on other investors.