UCITS Performance Fees – Service Providers Undershoot Regulatory Expectations

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UCITS Performance Fees – Service Providers Undershoot Regulatory Expectations

September 5, 2018

On 4 September 2018, the Central Bank of Ireland published its findings of a recent thematic inspection of UCITS fund management companies to review the use of performance fees.

The purpose of the Central Bank’s thematic inspection was to establish whether the procedures used to calculate and pay performance fees in UCITS funds protect investors’ interests. The review also examined the methodologies used to calculate performance fees to assess their compliance with the Central Bank’s UCITS Performance Fees Guidance (the “Guidance”).

The Central Bank has found multiple failings in connection with the use of fund performance fees, and has raised concerns that the Guidance is not being consistently applied.

Of the funds reviewed, approximately 10% demonstrated instances of non-compliance with the Guidance.

The Central Bank’s Director of General Financial Conduct, Derville Rowland has cited that the failings which were identified “could lead to the overpayment of performance fees by UCITS and their investors“.

The Central Bank identified the following shortcomings in its report:

Performance fees were not always calculated in accordance with the Guidance and examples were cited.
Where performance fees are based on the outperformance of an index, it was unclear as to which version of the index was being used.
Poor practices were observed within Administrators in the calculation of performance fees.
Poor practices were observed within Depositaries in the verification of the calculation of performance fees.
Poor disclosure to investors that where performance fees are paid on the use of a high water mark, the fees may be accrued as a result of market movements rather than due to the performance of the investment manager.

Notably, the Central Bank has criticised fund Administrators and Depositaries for their “poor practices” in the calculation and verification of performance fees. The Central Bank will require that fund management companies review the verification procedures adopted by their Depositories to ensure that:

The verification process is carried out by the Depository on all UCITS performance fee calculations;
The verification process is performed by the Depository prior to payment; and
The verification process is performed on crystallisation by the Depositary, regardless of whether or not a performance fee is due for payment.

The Central Bank is separately contacting fund management companies to advise them of the outcome of the review. On foot of the publication, all fund management companies whose UCITS funds charge performance fees are required to review their use of performance fees for compliance with the Guidance and to advise the Central Bank of the results of their review, together with any rectification steps to be taken, by 30 November 2018. The Central Bank will also engage directly with the UCITS funds which were the subject of the review.

A copy of the industry letter arising from the thematic review, together with the Central Bank’s press release, can be found here.

The Central Bank’s review on performance fees was carried out in parallel with Consultation Paper 119, which includes a requirement for funds to charge performance fees no more frequently than once a year. Many funds currently charge performance fees monthly or quarterly. These proposals are due to come into effect by the end of 2018.