The Conundrum of the European Value for Money Rules 

If you sit in the US and are planning the launch of your first fund in Europe, it shouldn’t be extremely surprising to learn that you will be subject to some sort of European value for money rules. After all, Europe is notorious for the most encompassing regulation of it all when it comes at financial services.  

But if you also manage funds in the US already, chances are that the concept of value for money isn’t totally foreign to you. Value for money rules were firstly introduced there, in one with the so-called Gartenberg standards for the evaluation of excessive compensation of investment advisers.  

The American Angle. An Issue of Trust  

As plans advance to introduce European value for money rules, we will see a diversion from the approach adopted so far in the anglophone world. That is not only represented by the US but also the UK. In more general terms, where Americans and Brits tend to concentrate on aspects of feasibility and workability, Europeans are traditionally inclined to look at the intrinsic characteristics of things. More namely, with a greater focus on the products per se and their pricing, assessed by public supervisory authorities through a sector benchmark model.  

But even where the American model influenced the one in the UK, the approach on the value for money in the US remains true to the customs of that country. First and foremost, the issue is essentially one of trust. The one that mutual funds investors have towards their investment advisors, relative to their fiduciary duties in the receipt of compensation for their services. As enshrined under the Investment Company Act, a breach of the fiduciary duty in this context gives mutual funds shareholders a cause of action against their investment advisors. The Gartenberg standards seek to give more colour to the analysis of the excessiveness of fees charged by investment advisors, by establishing factors to use in the related fees assessment. Peer comparison is part of the standards but is not the only one.   

Secondly, the main remedy in this context is litigation. Rather than being concerned with offering value to consumers, the US system is relationship centric. It affords investors the possibility to correct instances of excessive compensation of investment advisers through litigation.   

In a manner that was independent from the Gartenberg standards themselves, the US system also saw some amendments to the number of independent directors that needed to be appointed on the board of a mutual fund or in the capacity of trustees. The independent directors play a pivotal role in the process of renewal of the agreements with investment advisors, same as in the assessment of compensation.  

Building Trust in the European Capital Markets 

Multiple are the forces sustaining the introduction of the European value for money rules.  

On the one hand, we had a supervisory action carried out throughout Europe on the topic of the undue costs and fees charged to UCITS and Alternative Investment Funds. That came with the proposal to also introduce a definition of undue costs within both the UCITS and the AIFMD directives, which had been missing until then.  

Concurrently, another more holistic endeavour kicked off at European level by the name of Retail Investment Strategy. Its aim is to foster participation of European households to local capital markets. In this context, the European value for money rules come as one of the privileged tools to ensure that retail investors can gain confidence in the capital markets and invest in products that can offer them value.  

Trust indeed comes into play also for what concerns the European value for money rules. However, this is not trust that a fiduciary duty is not breached by a fund manager. Rather, a more generalised trust in capital markets for European household, triggering a shift in their saving habits.  

The European Methodology 

The design of the European value for money rules reflects the variety of forces behind their introduction. To the contrary of the US system, where excessive compensation is the exclusive focus and the remedy is a cause for private action, all the remedies seem to be public in nature in Europe. Similarly to the UK, the focus here seems to offer value to consumers, where value though in Europe is anchored to a reasonable pricing of an investment product.  

In the latest position from the European parliament, we have more clarity on the concept of the industry benchmarks, to be developed by the European Supervisory authorities to assist with the pricing process of investment products. The benchmark should be used by these authorities across Europe as a supervisory tool and to identify outliers on the market. Where a product deviates from the benchmark for that category, national competent authorities will have the power to take remedial action. From requesting a justification of the reasons for the diversion from the benchmark to even requiring removal from the market of the specific product.  

In addition, the introduction of a definition of undue costs under the UCITS and AIFMD directive, as part of the Retail Investment Strategy itself, opens the way for requests of restitutions on fund managers charging excessive fees.  

Conclusions 

If you manage a fund in the US, value for money is a concern to you on two levels. Renewal of the investment advisor agreement and possibility of being sued for restitution by investors, in case of excessive compensation.  

The European value for money rules are yet to enter into force. We don’t know what the take will be from regulators across Europe, whether lenient or stricter in their application. Even where this is not the main point of the entire European value for money regulatory architecture, one of the results possible remains that fund managers charging excessive fees may have to refund investors.