European funds regulatory burden risks consumer harms, says expert

Mark Shaw of Pinsent Masons, who specialises in investment funds regulation, said that while European regulators are pushing asset managers to cut the cost of investing in retail investment products, this is coinciding with an increase in regulation – and associated costs – that asset managers operating in Europe are grappling with.

The cost of compliance in Europe, he said, is out of step with comparable costs in the US and other funds markets globally and, when coupled with other inflationary pressures, is “creating an existential crisis for the asset management industry” in Europe.

Shaw was commenting after the European Securities and Markets Authority (ESMA) said EU funds “do not exhaust the economies of scale commensurate with the EU’s single market”, reporting that, despite seeing a decline in the costs of investing in certain financial products, “the cost levels of funds in the EU remain high by international standards”.

The ESMA report provided an analysis of costs to retail investors in relation to undertakings for collective investment in transferable securities (UCITS), retail alternative investment funds (AIFs), and structured retail products (SRPs), but Shaw said the regulatory focus on costs – and cost pressures on industry, more generally – apply across the entire European funds market.

“There has been downward cost pressure on asset managers for years,” Shaw said.

“For example, the UCITS market is very cost driven because the total expense ratio (TER) is the only comparator between funds that can be guaranteed – i.e. while past performance is no guarantee of future performance, costs are fairly certain. If you look at what makes up the TER in a UCITS fund, some of it is made up by the costs of compliance at the fund level – fund costs and fund service providers – and also management fees. However, the regulatory burden associated with each of these elements has also increased – they were already comparatively high for UCITS compared to US mutual funds, but this has only been added to with requirements under, for example in EU terms, the Sustainable Finance Disclosure Regulation, Digital Operational Resilience Act, MiFID II, and new regulations around anti-money laundering and terrorist financing,” he added.

Shaw said the increased cost pressures are also coinciding with performance issues that European asset managers have experienced in recent years, citing the difficulties asset managers that actively manage investments have had in achieving comparable investment performance as passive investments and benchmark products.

Shaw said: “Funds and their service providers are being hit at every level. There does not appear to be recognition of this in the comparisons ESMA seeks to draw with the position in the US.”

Shaw said a recent report by Ignites Europe highlights the practical effect that cost pressures are having on Europe’s asset management industry.

According to Ignites Europe, research from Fitz Partners has found that firms have, on average, cut the number of independent directors sitting on fund boards by 11% in the past year, on cost grounds.

“This research provides contemporary evidence of the link between the increased cost pressures the industry is dealing with and how their response to that has the potential to increase governance risks and, in turn, lead to poor consumer outcomes,” Shaw said.

“The response industry needs to see to the increasing cost pressures they are facing is not a singular focus from regulators on them reducing investment costs but rather a more holistic approach that involves the streamlining of regulation to help them reduce compliance costs. Only that action will support European competitiveness and avoid a race to the bottom that increases the risk of harm to retail investors,” he added.