Closet tracking update

The Irish regulator has published the findings from its review of closet tracking.

Back in December 2018, we noted that the Central Bank of Ireland (CBI) was intending to look at over 2,000 UCITS funds to check for closet trackers1. The CBI has yesterday published the findings of its review.

Using three different analytical measures to establish whether UCITS funds appear to be closely tracking an index, the CBI identified 182 funds requiring further review. The CBI has since reviewed key documentation for each of those funds and has completed specific follow-up engagement with 62 of them. The CBI intends to continue its engagement with the remaining funds over the coming months.

The key findings of the CBI’s review so far are as follows:

  1. 57 out of the 62 funds that the CBI has currently followed-up with had not given sufficient or accurate information about investment strategy in the prospectus or KIID.
  2. There were cases of poor governance and controls by the boards of UCITS fund management companies, including (1) insufficient review and oversight of the offering documents, (2) insufficient evidence of challenge regarding the chosen strategy and (3) a lack of regular assessment to determine whether the performance was reflective of the expected active management being paid for and whether fees were commensurate with the level of actual active management and performance achieved.
  3. Questions were raised about whether the diversification benefits of certain multi-manager UCITS funds were being realised, as the CBI found cases where such funds consistently delivered a performance similar to an index.
  4. There were cases where the CBI found that target outperformance against a benchmark was less than the fee charged, meaning that, even where the fund generated a top end return, investors in affected share classes would not realise a positive return compared to the benchmark.
  5. In addition, there were cases where the past performance section of the KIID did not include benchmark disclosure.

These findings suggest that regulatory scrutiny of closet tracking will continue to intensify across Europe in the second half of 2019 and in 2020. Indeed, earlier this year, ESMA made amendments to its Q&As on UCITS KIIDs in respect of benchmarks.

In terms of the position in the UK, in May, we published an article relating to the FCA’s Policy Statement 19/4. PS19/4 contained new requirements for authorised fund managers to include a statement in prospectuses and other consumer facing documents on the choice and use of benchmarks. These requirements came into force on 07 May 2019 for new funds and are shortly due to come into force for existing funds on 07 August 2019.

Following the expiry of that deadline, a new round of FCA interest is anticipated in the autumn. That adds a degree of tension when considering the merits of making changes to avoid future issues versus the risk of these changes being characterised as recognising a previous lack of transparency.

It should also be noted that closet tracking has attracted interest from litigation funders, with one funder projecting that overcharging across the industry might amount to £6.6bn per annum.

If you have any queries about the regulatory or litigation-related implications of closet tracking, please get in touch with one of the contacts on the right-hand side of this page or your usual Simmons & Simmons contact.

You might also be interested in our recent article concerning a decision of the Norwegian Court of Appeal to reduce an active management fee for being too passive.


1 Closet tracking is where active asset managers charge investors the premium associated with active management but whose portfolios are very similar to those of a lower cost tracker fund.