Review on disclosure of costs by asset managers

Our recently concluded review identifies that while most asset managers calculate transaction costs in accordance with the relevant rules, we found problems with the way some calculate transaction costs and how prominently and clearly they disclose them.

This review also found that asset managers generally do not disclose all associated costs and charges and these are therefore not sufficiently clear to the end investor. Where full cost disclosures are made, there are inconsistencies between different documents and websites, and customers can therefore find the information difficult to understand.

We conclude that asset managers may be communicating with their customers in a manner that is unfair, unclear or misleading and as such, investors can be confused and misled as to how much they are being charged.

Who this review applies to

There are several EU directives and regulations which apply to how asset managers calculate and display costs and charges. This review and its findings are relevant for:

• undertaking for collective investment in transferable securities scheme (UCITS) managers and their corresponding key investor information documents (KIIDs)
• operators of relevant non-UCITS retail schemes (NURS) and NURS-KII documents
• key information documents (KIDs) produced by fund managers for other funds under the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation
• disclosures in other marketing material, some of which may be subject to the Markets in Financial Instruments Directive (MiFID II)

For non-UCITS retail schemes (or NURS), the fund manager or the investment company may draw up either a KID under the PRIIPs Regulation or a document which meets the requirements of the modified version of the Key Investor Information (KII) Regulation for KII-compliant NURS (in our Handbook, such a document is called the ‘NURS-KII document’).

Why we conducted this review

A key finding of our Asset Management Market Study[1] last year was weak price competition in the sector. This was partly a result of ineffective disclosure of costs and charges. We know that disclosure does not itself always make customers engage and published research on this in our Occasional Paper[2] in April 2018. Our research highlighted that even where retail investors can see charges, they may not pay sufficient attention to them or understand how they affect investment returns. Nevertheless, we consider that clear and understandable disclosure remains a vitally important factor in price competition.

We know firms have concerns about how certain aspects of the PRIIPs Regulation operate. To consider these further, we issued a call for input. This asked firms, trade bodies and consumers to provide their experiences of the new requirements for calculating and disclosing transaction costs, as well as other elements of the PRIIPs Regulation. We have now provided feedback to the PRIIPs call for input[3].

Separately, we also undertook a wide-ranging review into the general state of firms’ compliance with costs and charges disclosures. This work identified a number of issues with the way firms are calculating and displaying costs and charges under applicable requirements. These issues are unrelated to concerns with the operation of the PRIIPs Regulation, which are the focus of our current supervisory work.

What we did

In January 2018, MiFID II and the PRIIPs Regulation introduced new requirements for disclosing costs and charges. These aimed to make it easier for consumers to understand the total costs of investment products and services and required firms to disclose all costs and charges.

In light of these new requirements and amid concern about poor cost disclosures, we undertook a review that assessed costs and charges through two work streams:

1. The first looked at transaction costs. We reviewed a sample of 16 firms to see what they were doing to comply with the PRIIPs Regulation (for in-scope products), the methodology asset managers used to enable distributor firms to comply with the cost disclosure element of MiFID II and how transaction costs are disclosed.
2. The second was a desk-based review of the effectiveness and consistency of 26 product cost disclosures across various information sources, including documents such as the UCITS KIIDs, PRIIPs KIDs, as well as factsheets and firm websites. It also compared these disclosures with information published by third party firms, including distributors and data providers. The purpose of this review was to assess whether consumers could easily understand the cost disclosures they get and could easily compare disclosures both across different communication types and between products.

This review focused on asset managers in their capacity as manufacturers of investments. It only looked at distributor firms to assess whether cost disclosures were markedly different between these two groups of firms. We have also assessed the conduct of distributor firms in terms of the effectiveness of their cost disclosures and have published the results of this work[4].

Transaction costs workstream

We asked 16 small, mid and large-sized asset managers to tell us how they were calculating transaction costs and give us the underlying data they used in their calculations. Some of these products were ones for which manufacturers are now producing PRIIPs KIDs and some were products for which a UCITS KIID was being prepared. For these UCITS products, transaction costs are calculated and then given to distributors, who need them to meet MiFID II cost disclosure requirements.

Most of these asset managers calculate transaction costs in compliance with the relevant requirements. However, we identified problems with several of the firms and products sampled. These issues increase the risk that firms understate the cost of investing and therefore that customers could be misled.

What we found

• Incorrectly applying the PRIIPs requirements: some firms are incorrectly using the arrival price methodology when calculating transaction costs for primary issues. As a result, they are effectively crediting investment products with a negative transaction cost each time they subscribe to a new issue. They should instead be adjusting these to have no associated transaction cost, as per the ESMA Q&A.[5] We are concerned that this practice may decrease the perceived cost of investing through an artificially reduced transaction cost figure.
• Using the anti-dilution levy incorrectly: this tool should only be used to reduce dilution. However, we identified instances where its use is artificially reducing transaction costs at the expense of customers who subscribe into or redeem out of a product. In some cases, the levy applied is greater than the total explicit plus implicit trading costs. This more than offsets all transaction costs and results in an overall negative transaction cost figure.
• Ineffective oversight of outsourced arrangements: some asset managers opt to outsource the analysis and calculation of transaction costs, sometimes to overseas jurisdictions. Firms are required to take reasonable care to organise and control their affairs responsibly and effectively, whether these activities are undertaken in-house or outsourced. There are also specific requirements which apply to authorised fund managers who outsource certain activities. Failure by an outsourcer to adhere to rules or requirements remains the responsibility of the authorised firm. We identified a few instances where firms were failing to effectively oversee an outsourced activity for calculating transaction costs.
• Transaction costs in underlying funds disclosed under ‘other ongoing costs’ for UCITS products: some UCITS which invest in other collective investment schemes disclose the charges for the trading of these underlying funds under their ‘other ongoing costs’. They therefore do not disclose separate transaction costs. While this approach is consistent with existing guidance, it helps explain why some UCITS products are reporting a transaction cost figure of zero.

We accept that price availability is not perfect across all securities and so a firm may find it difficult to calculate transactions costs where the data is not available. Nevertheless, we expect firms to comply with the relevant requirements. For the products in our sample, we identified several instances where this was not the case.

We have also fed in the findings from this review into the feedback statement for the PRIIPs call for input[3].

Effectiveness and consistency of cost disclosures workstream

Various pieces of regulation affect what information firms should disclose and in which format; including the PRIIPs Regulation, MiFID II and the UCITS KII Regulation. The interaction between them in terms of detail is not always seamless and we know that not all disclosure works equally well. However, the aim of all these various requirements is to ensure that investors are presented with information that is sufficiently clear and complete, so they can take informed investment decisions.

Firms must comply with all relevant requirements when calculating and disclosing costs and charges. Firms that produce a UCITS KIID or a PRIIPs KID may be able to publish further information about relevant costs and charges. Where they do, they must ensure that such information: (i) is fair, clear and not misleading, (ii) complies with relevant requirements (eg MiFID to the extent that it applies) and (iii) is not marketing material that contradicts or diminishes information in a KIIDs/KIDs.

This review assessed the cost disclosures for 26 products and found that many cost disclosures are unclear and often fail to disclose all related costs and charges.

What we found

• The impact of material portfolio transaction costs in UCITS is not reflected in the KIID: the UCITS KII Regulation means that where portfolio transaction costs are likely to have a material impact on returns, as a result of the strategy adopted by the product, these should be disclosed within the ‘objectives and investment policy’ section of the KIID. However, in the vast majority of instances sampled, this is not shown. In one extreme case, a 4% per annum transaction cost charge was omitted from the UCITS KIID. Firms should determine what a ‘material impact on returns’ means in each instance and make the necessary disclosures.
• Marketing communications for UCITS can provide information in addition to that specifically required by the KIID: a UCITS management company can give additional information about its costs and charges outside of the KIID provided that the information does not contradict or diminish the information contained in the prospectus or KIID. Additional information could be disclosed in other marketing materials, such as factsheets and websites and may require a fair and clear explanation of any such information. UCITS providers should assure themselves that, where significant costs and charges are not included in wider marketing material, this omission does not risk being unfair, unclear or misleading, even where those specific charges are not required in the KIID under the UCITS KII Regulation.
• PRIIPs KID disclosures being contradicted in other communications: the PRIIPs Regulation requires that marketing information should not reduce the significance of information in the KID. However, asset managers are providing disclosures in other marketing communications (such as factsheets and websites) which show lower levels of costs and charges than the KID. They could therefore contradict and undermine the importance and impact of the costs and charges in the PRIIPs KID, contravening the Regulation. In some instances, factsheets or websites do not mention costs. When they do, they often give the ongoing charge figure, which omits transaction costs, performance fees and borrowing charges which are shown in the KID. In one example, total charges in the PRIIPs KID equated to around 3% per annum but the only costs given in the factsheet was the 1.2% annual management charge (AMC).
• Even when all costs are disclosed, they are still confusing: in instances where all related charges are made available, they are often disclosed in a way we believe requires unreasonable levels of effort from customers to both find and understand. They are commonly located in separate pages or documents on a firm’s website. This is especially concerning where these additional charges have a significant impact on the overall cost of investing and therefore a material effect on returns.
• Unclear terms: some UCITS product providers still prominently refer to the AMC, despite being told in 2014 (TR 14-07[6]) that  using this figure in such a way could be considered misleading.

We want assets managers to take a holistic approach to disclosing costs. While they need to comply with the relevant UCITS, PRIIPs (and where relevant, MiFID II) requirements, they should also aim for effective and consistent costs and charges disclosures, so they are clear, fair and not misleading. In our view, the costs and charges disclosures for the products in our sample often failed to do this. All costs and charges for UCITS products were commonly not disclosed and PRIIPs cost disclosures were limited to the KID.

Conclusion

Based on our sample, where consumers attempt to undertake research themselves, the information they are currently given does not give a fair and clear account of how much they will pay when they invest in financial products. Asset managers must ensure that they comply with all relevant requirements and should consider reviewing their cost disclosures to ensure that they are clear, fair and not misleading.

Next steps

We are concerned about these observations and expect to see improvements in the coming weeks and months. For example:

• UCITS product providers must comply with all relevant requirements. They can publish further information about relevant costs and charges in other communications, such as factsheets and websites. Where these charges differ significantly from those in the KIID, these differences should be clearly explained.
• Where portfolio transaction costs are likely to have a material impact on returns as a result of the strategy adopted by the product, in compliance with the UCITS KII Regulations, this needs to be disclosed in the ‘objectives and investment policy’ section of the KIID.
• In compliance with the PRIIPs Regulation, costs and charges disclosures in materials outside the KID (ie on factsheets and websites) should not contradict, or reduce the significance of cost information in the KID. Firms should consider whether the absence of, or presentation of charges figures which are significantly lower/different than those contained in the KID, meet this requirement.
• Transaction cost calculations should comply with the relevant requirements. In particular, firms should review their practices on subscribing to new issues and the arrival price methodology as well as anti-dilution levies.

We encourage firms to review how they are disclosing their costs and charges and also how they calculate transaction costs. Further action in this area could include more detailed investigations into specific firms, individuals or practices.