How EU fund rules leave gaps in investor protection

PAVIA, Italy (Reuters) - Pietro Maffi routinely checks his financial statements and has a good understanding of how his savings are being managed. At least he thought he did until he read the small print.

Pietro Maffi, a software engineer from Italy, poses over his investment statements during an interview with Reuters in a cafe in Pavia, Italy, September 21, 2016. REUTERS/Danilo Masoni

Maffi, a software engineer from the northern town of Pavia, invests in funds managed by Banca Mediolanum BMED.MI, an Italian bank. He knew one of those funds was based not in Italy, but in Ireland. What he didn't know until recently was that the fund uses a fee structure that is not allowed in Italy, and is out of line even with Ireland's own investor protection guidelines, which are non-binding.

That structure meant the fund generated 34.7 million euros in performance fees for Mediolanum in 2015, according to company filings, while the value of Maffi’s account fell 0.5 percent.

“The problem is there are so many papers to go through and it’s difficult to spot all details,” Maffi said as he pored over documents looking for performance fees charged to his account.

Massimo Doris, chief executive of Mediolanum, told Reuters that the bank’s fee structure was “perfectly legal” and that the Irish central bank had approved its funds. The Central Bank of Ireland declined to comment on specific cases.

Maffi’s difficulties illustrate how Europe’s 21 trillion euros ($23 trillion) asset management industry can shop around for regulators, creating gaps in investor protection. Managers can choose to have their funds overseen in another European Union (EU) country that allows them to charge fees that wouldn’t be permitted at home. It means they can legally circumvent the rules imposed in their own country.

Under EU single-market rules, funds regulated in one member nation can be marketed across all of the bloc’s 28 countries despite differences in rules. Ireland and Luxembourg are the two most coveted jurisdictions, with both offering tax advantages.

In addition, Ireland has regulatory guidelines on fees that are not binding; and Luxembourg has no specific regulations on fees of its own, but says it applies the principles from the International Organisation of Securities Commissions (IOSCO).

Mediolanum chief Doris said the Italian firm had decided to set up funds in Ireland because of the Central Bank of Ireland’s speedy approval process. He said Mediolanum had not based funds in Ireland in order to exploit looser fee regulation. Doris said fees were a significant issue, but long term performance was more important. “It’s much, much, much more important how you guide clients,” he said.

However, he said after receiving Reuters questions that the bank was now reviewing its fee structure.

As well as going beyond Italian regulations, Mediolanum’s fee structure does not follow the non-binding guidelines in Ireland. Doris said he had not been aware of the Irish guidelines, noting that they had only been published on the central bank’s website last year.

He said Mediolanum would take a decision on its fee policy within a few months. The review was triggered by a recent update to “good practice” guidelines on fees from the IOSCO. “If we’re going to adjust to the new IOSCO recommendations, it’s certain that we would also be in line with the Central Bank of Ireland’s guidelines,” Doris said.

Katie Philpott, a spokeswoman for the Central Bank of Ireland, said any arrangements on the payment of performance fees should be consistent with its guidelines. “You have raised issues of a specific nature which, where appropriate, the central bank will follow up with entities directly,” Philpott wrote in an email.

Under the EU system, any member state can stop funds from being sold in its home market if it believes managers have moved funds abroad in order to bypass its stricter rules. However, the watchdog overseeing Italian financial markets –the Commissione Nazionale per le Società e la Borsa (Consob) - declined to comment when asked if it was concerned about Italian funds being based abroad and charging fees that would not be allowed at home.


Performance fees are levied in addition to standard annual fees for managing funds. Maffi said regulators should require fund managers to spell out fee structures and their impact clearly rather than put them in the lengthy detail of a fund prospectus. His savings vehicle, the Coupon Strategy Collection LH fund, explained the performance fee in the last part of a 270-page prospectus, and in a separate investor document published once a year.

The fund charged a fee of 0.8 percent of the fund’s gross asset value if it exceeded a specific investment hurdle each month. But the hurdle was set low: the fund had to make gains of more than the euro interbank lending rate – which has been below 0 percent for 17 months.

One of Mediolanum's worst performing funds last year was its Challenge Emerging Markets Equity Fund SA, which fell 8.3 percent in 2015. It charged a 1.42 percent performance fee, using the same euro interbank lending rate, Euribor 3 EURIBOR3MD=, as its benchmark. It was able to charge the performance fee because during certain months of the year its performance was positive.

If based in Italy, Mediolanum’s emerging markets fund could not have charged a performance fee in 2015 because Italian investor protection rules require such fees to be calculated on the performance of at least one year.

Luca Enriques, corporate law professor at Oxford University and a former commissioner at Consob, said regulatory disparities at a national level need to be ironed out with EU-wide enforcement.

“The only way to avoid such dysfunction would be to centralize regulation and enforcement of the rules with ESMA (the European Securities and Markets Authority),” he said. He added that the rules would need to offer appropriate investor protection and be effectively enforced.

ESMA declined to comment on whether fragmented regulation had harmed investors. It said its role in “developing a single rulebook for EU financial markets and ensuring the consistent application of those rules across the EU, ensuring common approaches, will contribute to enhancing protection for EU investors.”

At present a large number of funds take advantage of the different rules in different jurisdictions. More than 6,000 investment funds have been set up in Ireland’s capital, Dublin. More than 14,000 funds are domiciled in Luxembourg.

Reuters looked at funds in Italy because it has a large and relatively unsophisticated market of retail investors. Many Italian savers have been encouraged by local managers or advisers to invest in funds based in Ireland or Luxembourg. Reuters has not studied the fee policies of major fund managers elsewhere in the EU.

Shares of Italy-based managers have been sensitive to issues concerning performance fees. Mediolanum made 326 million euros in performance fees last year, or 0.46 percent of its overall assets under management, a larger proportion than many other big European managers. That sum was nearly one fifth of Mediolanum’s total revenues.

Italian fund managers Azimut AZMT.MI and Banca Generali BGN.MI, which have based many of their funds in Luxembourg, charged performance fees of 0.43 percent and 0.31 percent, respectively, as a proportion of assets under management. Banca Generali said it started to base funds in Luxembourg eight years ago because at the time clients paid higher tax on funds based in Italy. Azimut declined to comment.

For the UK's Henderson Group HGGH.L, performance fees were 0.11 percent of assets under management; for France's Amundi AMUN.PA, 0.01 percent; and for Switzerland's GAM Holding GAMH.S, 0.07 percent.

($1 = 0.8928 euros)

Additional reporting by Maria Pia Quaglia; Editing by Mark Bendeich, Simon Robinson and Richard Woods