#BetterFinance finds European supervisor asleep at the wheel

Following the financial crisis, nearly a decade ago, citizens were surprised to find that regulatory authorities had failed in their duty. Ten years on we see that reformed and reinvigorated supervisors are still failing in their mission to protect investors, writes Catherine Feore.   

Research by BETTER FINANCE (4 June) found that at least 30% of the main actively managed UCITS equity funds still do not comply with key disclosure requirements for benchmarks as stipulated in EU rules. At least 619 equity funds (UCITS) were found to be in breach of key EU disclosure rules. Several countries showed persistent poor enforcement. 

Better Finance's initial investigation was into the widespread mis-selling of "actively-managed" funds – with corresponding high fees – that turned out to be merely indexed. This practice known is known as “closet indexing” or ''index hugging''.  

When Better Finance replicated the study into closet indexing by the European Securities and Markets Authority (ESMA) in 2017 it disclosed the names of the 165 funds that were involved in this practice. 

Together with national competent authorities, ESMA said in 2016 that it would assess the need for further steps to ensure that all market participants comply with disclosure obligations to the full extent. The UK’s Financial Conduct Authority (FCA) recently forced 64 UK domiciled closet index funds to indemnify clients.  However, 93% of the suspicious funds were domiciled in other EU jurisdictions outside the UK, at least three national supervisors (those of Luxemburg, Germany and France) reported that they found no cases of closet indexing. The most remarkable was Luxembourg where 47% of all suspicious funds are domiciled.  

In the course of its investigation, Better Finance also discovered widespread breaches of key EU disclosure rules for investors, which it brought to the attention of ESMA. Over a year later, no action has yet been taken by the regulator.  

Neither the EU supervisor, nor national regulators have addressed the widespread infringements of information disclosure rules for the two-page “Key Investor Information Document” (KIID). Better Finance found that, out of the 165 suspicious equity funds, 67 also failed to disclose their benchmark performance alongside the past performance of the fund, thus depriving investors of the means to assess the fund’s performance against that of its own benchmark and make an informed choice. 

Further research into the issue (January-April 2018) found that these concerns have not been addressed and also found that 30% of all the main benchmarked UCITS equity funds (more than 2000) do not comply with the KIID benchmark disclosure rules. 

The picture is very mixed across Europe, 82% of offenders are from Luxembourg, the UK or Ireland. By contrast, only 1% of benchmarked UCITS equity funds domiciled in France are in breach in our view and none of those were identified as potential closet indexers. This clearly shows a serious lack of supervisory convergence within the EU. 

Guillaume Prache, managing director of BETTER FINANCE, said: “Persistent, widespread and clear breaches of EU investor protection rules in our view, as evidenced by this research,  are yet another call on EU Public Authorities to urgently and adequately stop this ongoing detriment to EU citizens as savers and investors, especially in light of the current debate on the necessary reform of the European System of Financial Supervision.”