November 16, 2017 / 11:15 AM / a year ago

EU watchdog turns up heat on 'closet indexing' investment funds

* EU to study active and passive funds as well

* UK’s FCA study in funds fees to help ESMA’s work

* EU funds stress testing guidance due in 2019

By Huw Jones

LONDON, Nov 16 (Reuters) - The European Union’s securities watchdog is turning up the heat on investment funds that charge high fees for picking stocks when in practice they track shares in a market index.

The watchdog’s move to scrutinise these funds forms part of efforts by EU policymakers to ensure consumers are treated fairly in terms of the investment fees charged on their savings.

Funds that openly track an index charge lower fees than funds which seek to outperform the broader market by using their expertise to select stocks. But some stock-picking funds charge higher fees when they are effectively index trackers.

The European Securities and Markets Authority (ESMA) said it will build up a picture of this so-called “closet indexing” based on data gathered by national regulators from across the bloc.

It will also check that national regulators are tackling closet indexing in the same way.

“From our perspective, our objective is to ensure that national competent authorities are taking convergent approaches to situations where deficiencies are identified,” ESMA Chair Steven Maijoor told a conference organised by EFAMA, the European funds industry body.

In a single market, where the cross-border distribution of funds is widespread, ESMA wants to ensure that investors are treated fairly across all member states, Maijoor said.

Thursday’s announcement marks an escalation of ESMA’s work on closet indexing. Last year, it said there might be a small but not insignificant number of funds in the EU that might be closet trackers.

ESMA had already rung alarm bells in the funds sector by announcing it will complete a study of fees and past performance of mutual funds by late 2018.

So far it has found that on average nearly 30 percent of the gross fund return was eaten up by ongoing fees, one-off charges and inflation.

“As a complimentary exercise, however, we intend to carry out more detailed analysis of the performance of active and passive funds,” Maijoor said.

The industry is gathering its own data in a bid to fend off policy action.

Britain’s Financial Conduct Authority is further down the road and is due to come up with “remedies” on injecting more transparency into fees. Maijoor said ESMA will benefit from the “significant work” done by the FCA’s market study. The European watchdog will also study performance fees charged by funds so that regulators across the EU are consistent in how they approve performance fee models.

Maijoor said ESMA will publish guidance in 2019 on “stress testing” of mutual and alternative investment funds to check if they can withstand severe market shocks.

Reporting by Huw Jones. Editing by Jane Merriman

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