Welcome to our monthly KPMG Asset Management Insights newsletter, which has been designed to keep you up to date on topical issues within the Asset Management sector.
On 3 December 2019, Michael Hodson, the Central Bank of Ireland’s Director of Asset Management and Investment Banking, outlined the Central Bank’s supervisory priorities for 2020. Mr Hodson noted that new convergence measures continued to be rolled out across the EU, with the Central Bank participating in ESMA’s 2020 common supervisory action on liquidity management by UCITS, which is expected to help ensure consistent application of EU rules on UCITS liquidity management, and ultimately enhance the protection of investors across the EU.
Having regard to Central Bank’s supervision priorities for 2020, the Central Bank will seek to ensure the successful implementation of the Investment Firms Regulation and Directive (IFR). Secondly, having regard to the current size of the Irish market-based finance sector (€4.4tn as of Q1 2019), the Central Bank will undertake a review of the Irish Client Asset Regime, and intends to engage with industry through consultation, particularly on any revisions that may be necessary. Finally, there will be continued focus on the market-based finance sector to ensure the actual risks from non-banks are well-understood. This will mean a focus on reducing data gaps in order to strengthen the Central Bank’s supervisory and analytical capabilities, as well as playing a leading role in the EU and global policy discussions.
With respect to ongoing supervision activities, the Central Bank will target the following areas in particular during 2020:
On 9 January 2020, ESMA published its Strategic Orientation document for 2020-22, which sets out its future long-term focus and objectives, and reflect its expanded powers following the review of European Supervisory Authorities, and EMIR 2.2, increasing supervisory convergence.
Among the priorities identified is the continued focus on a risk-based approach to supervisory convergence using tools such as Common Supervisory Actions, in addition to peer reviews. ESMA states that it will also seek to build its reputation as a direct supervisor for securitisation repositories, securities financing transactions, critical benchmarks, data service providers and third country central counterparties.
Having regard to the economic challenges facing the EU, ESMA states that it will actively promote the development of a large retail investor base to develop capital markets, and will advocate for more proportionate and standardised disclosures for SMEs. ESMA notes that risk assessments will be the starting point for its priorities and for setting the regulatory agenda, and it will seek to utilise the growing volume and granularity of regulatory data in its direct supervision and in the development of its stress-testing activities.
In order to build a common EU supervisory and enforcement culture, ESMA will develop a principles-based Union Supervisory Handbook, which will be gradually phased in, prioritising those areas where enhanced coordination across the EU is required. In this respect, it is clear that high and consistent standards of supervision across all national competent authorities is a fundamental guiding ambition for ESMA.
The Disclosure Regulation applies to investment firms providing portfolio management, alternative investment fund managers (AIFMs), UCITS management companies, in addition to other categories of ‘financial market participants’. The Regulation introduces additional rules relating to disclosure, transparency, reporting, and internal policies on the sustainability of products and risks, and will apply from 10 March 2021. A number of supporting regulatory technical standards are required to be developed by the ESAs by 30 December 2020 in support of the Regulation’s implementation.
The Low Carbon Benchmarks Regulation amends the existing Benchmarks Regulation which affect supervised entities using benchmarks, and effectively creates two new categories of low-carbon benchmark: the ‘EU Climate Transition Benchmark’ and the ‘EU Paris-aligned Benchmark’. Benchmark administrators which provide such benchmarks must comply with the Regulation by 30 April 2020. A technical expert group will now assist the Commission in the selection of those entities that are eligible for inclusion in these benchmarks, in addition to advising on which sectors are to be excluded because they do not have measurable carbon emission reduction targets with specific deadlines that are aligned with the objectives of the Paris Agreement.
Regarding the possible development of on-venue trading for contracts not cleared with a CCP and the challenges for the trading venues and counterparties exempted from the Clearing Obligation (CO) and subject to the Derivatives Trading Obligation (DTO), Irish Funds agreed with ESMA’s interpretation that, before EMIR Refit, the legal framework indicated a policy intention to align the scope of counterparties subject to the CO and DTO.
Irish Funds shared ESMA’s concern that the application of a stand-alone DTO to small Financial Counterparties (FCs) that are exempt from the CO could result in the application of a de facto CO these entities, which it suggested would be a disproportionate response to the limited systemic risk posed, and going against the approach taken by the EU legislators and regulators prior to EMIR Refit. Irish Funds was also concerned that imposing a stand-alone DTO would impose administrative burdens and costs on small FCs that would be disproportionate to the level of systemic risk posed.
Irish Funds agreed with ESMA’s proposal supporting the alignment of the scope of counterparties subject to the DTO with those subject to the CO, and considered that maintaining the current misalignment could discourage small FCs from transacting derivatives that are in scope for the DTO, thereby increasing risk levels within the financial system.
Irish Funds stated that it was aware of suggestions that a misalignment may also arise in respect of an individual transaction where that transaction is subject to the DTO and would (save for a specific derogation) be subject to the CO. Although it had not yet identified any existing misalignments of relevance to its members, it suggested that in order to future-proof the alignment of the application of transactions subject to the DTO with those subject to the CO, consideration might be given to whether alignment can be achieved at the level both of counterparty (as proposed by ESMA) and individual transaction.
On 5 December 2019, the European Supervisory Authorities (ESAs) published draft Regulatory Technical Standards on risk mitigation techniques to be applied for non-cleared OTC derivatives, in addition to a joint statement on the introduction of fallbacks in OTC derivative contracts and the requirement to exchange collateral.
The draft RTS, now submitted to the European Commission for approval, was designed to facilitate international consistency in the implementation of the global framework agreed by the BCBS and IOSCO. This international agreement contains a phase-in for the implementation of the initial margin requirements over several years. The draft RTS provides clarification of the requirements applicable when falling below the €50m initial margin threshold, extends the last phase of implementation of the initial margin requirements by one year, and also extends by one year the current deferred application requirements for single-stock equity options or index options transactions. It also provides a temporary exemption for intragroup transactions up to 21 December 2020. The draft RTS can be read here.
With respect to the introduction of fallbacks, the ESAs consider that amendments made to legacy OTC contracts for the sole purpose of introducing fall-backs should not create new obligations, and advocate for legal certainty in this area. Consequently, the ESAs are working with the European co-legislators to determine how this might best be achieved. The ESAs’ statement can be read here.
On 5 December 2019, ESMA published a first review report on the development of prices for market data and on the consolidated tape for equity instruments. ESMA found that MiFID II had not yet delivered on its objective to reduce the cost of market data charged by trading venues and Approved Publication Arrangements.
ESMA considered the failure to develop a market-led equity consolidated tape (a technically demanding task requiring substantial investment of time and resources) stemmed from the limited commercial rewards to potential providers. Feedback provided by stakeholders suggested a divergence of opinion on data prices between vendors and users.
As a result of the review, ESMA has proposed a mix of legislative changes and supervisory guidance in order to bring about improved transparency and to ensure that market data is provided on a reasonable commercial basis. This report will be considered in light of the European Commission’s review of MiFID II on the development in prices for pre- and post-trade transparency data, and on the consolidated tape for equity instruments, to be presented by 3 September 2020.
On 11 December 2019, ESMA issued its final report on draft amendments to the Implementing Regulation specifying the main indices and recognised exchanges under the Capital Requirements Regulation (Regulation (EU) 2016/1646). ESMA states that the changes contained in the draft amendments have been introduced in order to ensure the most relevant criteria are applied to specify the main indices, and to update the list of recognised exchanges reflecting legislative and market structure changes.
The amendments aim to ensure that main indices comprise sufficiently liquid instruments, and provide credit institutions and investment firms with the option to use, as eligible collateral, instruments traded on new European exchanges, as well as instruments traded on third-country exchanges, from those jurisdictions for which the European Commission has adopted equivalence decisions.
Two versions of the amended ITS are contained in the report in light of Brexit: one reflecting a Brexit deal being achieved, and the other reflecting a no-deal Brexit in the absence of an equivalence decision for the UK. The European Commission has three months to determine whether or not to endorse the proposed amendments.
On 16 December 2019, the ESAs published joint guidelines on cooperation and information exchange, and on establishing supervisory colleges on anti-money laundering and anti-terrorism financing. These guidelines are aimed at strengthening effective supervision across regulatory authorities in this area, and set out the rules for setting up AMLF/CTF colleges, which are required to be established where firms operate in several member states. Through their establishment, the colleges aim to ensure that all supervisors have access to comprehensive information about the firms for use in their own individual risk assessments and in their supervisory approach.
The joint guidelines are addressed to national competent authorities and apply from 10 January 2020, with a view to the establishment of such colleges by 10 January 2022. The guidelines can be read here.
On 23 December 2019, ESMA reported that it had extended its recognition decisions for LCH Limited, ICE Clear Europe Limited and LME Clear Limited, three central counterparties (CCPs) established in the UK. The recognition decisions would take effect on the date following the Brexit date, under a no-deal Brexit scenario.
On 20 December 2019, ESMA reported that it the XML schema and reporting instructions initially published prior to the adoption by the Commission of the draft disclosure technical standards have now been updated to ensure alignment with the final technical standards published by the Commission in October 2019, which incorporates feedback provided by stakeholders. Links are provided below regarding each of the standards:
On 6 January 2020, ESMA published its final report and associated guidelines on supervisory reporting under Articles 4 and 12 of the Securities Financial Transaction Regulation (SFTR), in addition to amended validation rules, and a statement on Legal Entity Identifiers.
The guidelines cover the reporting obligation on counterparties to report all concluded SFTs, and the obligation on trade repositories to publish its aggregate positions, and also give clarity on the following aspects of SFTR reporting:
The survey was conducted against the background of the default by a natural person acting as a clearing member in 2018 at a CCP authorised to offer services in the EU. The survey found that no EU CCP currently has an individual acting as a clearing member; 12 CCPs expressly prohibit such persons participating as clearing members, whereas 4 CCPs do not rule out this possibility. Further, while 7 CCPs state that their rules do not allow non-financial counterparties participate as clearing members, 7 others accepted (and currently have) non-financial counterparties as clearing members. The survey also highlighted current practices used by CCPs to perform due diligence on clearing members, including: internal credit classification, warning monitoring systems, mandatory due diligence questionnaires, and onsite visits.
A new answer (Answer #83) has been provided on the reporting the results of stress tests for managed closed-ended unleveraged AIFs. The full answer can be viewed here.
2. MiFIR Data Reporting
A new answer has been provided on the reporting of reference rates not included in RTS 23 and 22 (in particular €STR (ISIN code ‘EU000A2X2A25’), which was not available at the time RTS 23 and RTS 22 were developed). The full answer can be viewed here.
3. European Benchmarks Regulation
3 new answers (7.6, 7.7 and 9.3) have been provided on the Benchmarks Regulation.
Answer 7.6 provides that an annual review of IOSCO principles by an independent external auditor is sufficient to ensure compliance with paragraph 18 of Annex II of BMR.
Answer 7.7 clarifies the role and responsibilities of a legal representative under Article 32(3) of the BMR with respect to the recognition of administrators located in third countries.
Answer 9.3 modifies an answer previously provided by ESMA, and states that the meaning of the term “where the benchmark is already used in the Union” in Article 51(5) of the BMR is “where the benchmark is already used in the Union on or before 31 December 2021”. This follows the publication of the Low Carbon Benchmarks Regulation, amending the transitional provisions of the BMR.
On 12 December 2019, ESMA published a peer review report relating to how national competent authorities (NCAs) handle suspicious transactions and order reports (STORs) under the Market Abuse Regulation (MAR). The report notes a significant increase in STORs during 2018 (11,130 in total, mostly submitted to NCAs by investment firms).
Overall, ESMA found that NCAs were performing well in the analysis of suspected market abuse reported in STORs, but also identified some areas for improvement for NCAs, including:
The Central Bank of Ireland was considered to be ‘fully compliant’ in respect of its supervision of market operators and investment firms under Article 16(1), but only ‘partially compliant’ in respect of supervision of certain financial players under Article 16(2). The Central Bank of Ireland was also considered to be ‘broadly compliant’ with respect to its responses to poor quality and non-reporting of STORs and related enforcement activity, as well as in respect of its substantive analysis and use of STORs. In all cases of less than full compliance, ESMA identifies bespoke improvements for each NCA, and will follow up with these findings.
On 12 December 2019, ESMA published its second annual report on penalties and measures imposed by national competent authorities under the European Market Infrastructure Regulation (EMIR) during 2018. The report considers compliance under with the clearing obligation for certain OTC derivatives (Article 4), the reporting obligation of derivative transactions to trade repositories (Article 9), requirements for non-financial counterparties (Article 10), and risk mitigation techniques for non-cleared OTC derivatives (Article 11).
The report notes some areas in which very divergent approaches are adopted by NCAs, including the amounts of administrative fines applicable (in some cases these can range from potentially €0 to €100m). During 2018, 36 investigations were being conducted under the four areas, although no new sanctions or penalties were imposed.
Further, while the report states that some supervisory areas are highly harmonised, such as the sources of information used by NCAs to check EMIR compliance, there were areas of challenge that may benefit from a more coordinated approach, in particular with respect to the supervision of non-financial counterparties regarding the clearing obligation, and the identification of excessive reliance on the exception applied to hedging positions. The report notes that there is room for improvement towards preventing clearing evasion with respect to third country entities trading contracts with substantial effect in the EU, which would be subject to the clearing obligation if they were established in the EU.
On 12 December 2019, ESMA issued its second annual report on penalties and measures imposed by national competent authorities under the European Market Infrastructure Regulation (EMIR) during 2018. The report notes that there were 15 NCAs that issued sanctions during 2018, with an overall decrease in the number of sanctions imposed. The Central Bank of Ireland imposed no penalties under UCITS during 2018, while countries such as Bulgaria, Croatia and Portugal each issued 7 sanctions against UCITS firms.
On 12 December 2019, ESMA published its annual report on administrative and criminal sanctions issued under the Market Abuse Regulation, relating to insider trading and the unlawful disclosure of insider information (Article 14), as well as market manipulation (Article 15).
In total, there were 13 administrative sanctions issued for breaches of Article 14, 71 administrative sanctions for breaches of Article 15, and 373 sanctions for other MAR infringements, with only one criminal sanction issued in Germany for market manipulation. There were no MAR sanctions issued by the Central Bank of Ireland.
On 11 December 2019, ESMA issued a briefing note on the implementation of the recognition regime under the Benchmarks Regulation, addressed to administrators of benchmarks located outside the EU that intend to apply for EU recognition. Where no equivalence decision is adopted by the European Commission, the BMR requires that third country benchmarks (and their administrators) be recognised or endorsed in order for them to be used by EU clients post-January 2020.
The briefing aims to assist benchmark administrators in their recognition applications, and may be updated by ESMA from time-to-time. The briefing note can be read here.
On 13 December 2019, ESMA published its second annual report on the application of accepted market practices under the Market Abuse Regulation (MAR). Accepted market practices are a matter of interest for a small number of countries and may be used as a defence against allegations of market manipulation. The report notes that to date, three accepted market practices for liquidity contracts have been established under MAR by the French, Spanish and Portuguese regulatory authorities.
On 13 December 2019, ESMA published the responses received to its consultation on the Market Abuse Regulation review, which closed on 29 November. As noted in our previous newsletter, the consultation concerned a number of important issues for investment funds trading on a regulated market in the EU which fall within the scope of the Regulation.
Over 100 responses were provided as part of the consultation, which can be viewed here. Based on this feedback, a final report will be published and submitted to the European Commission in Q1 2020.
On 10 December 2019, ESMA advised that as the draft RTS required under Article 25 of the ELTIF Regulation largely depends on the cost section of the Packaged Retail and Insurance-based Investment Product (PRIIPs) KID, currently being reviewed under the PRIIPs Delegated Acts, it is preferable to postpone publication of the draft RTS until the PRIIPs Delegated Acts have been finalised. ESMA has instead published a feedback statement summarising the responses received to the consultation on the draft RTS.
On 10 January 2020, ESMA updated its list on those entities pending authorisation/registration applications by EU-based administrators under the Benchmark Regulation (BMR). The BMR became effective on 1 January 2018 and included transitional arrangements for existing administrators to apply for authorisation, the deadline for which was extended in 2019 to 31 December 2021.
On 18 December 2019, ESMA published a report of its findings on potential undue short-term pressures in securities markets. The report makes recommendations to the European Commission to take action in a number of areas, including the disclosure of Environmental, Social and Governance factors under the Non-Financial Reporting Directive, and the promotion of a single set of international standards for ESG disclosures.
The report also recommends that the Commission mandates a review of ESMA’s ‘White List’, the public statement on shareholder cooperation and acting in concert under the Takeover Bids Directive, and recommends that it considers the effectiveness of a potential shareholder vote on the non-financial statement.
In its second annual statistical report, relying on data compiled under the European Markets and Infrastructure Regulation (EMIR), ESMA has announced that the total value of the EU derivatives market in 2018 was €735tn, an increase of 11% on 2017.
ESMA states that the growth in the market was driven by an increase in derivatives and equities. OTC trading continued to account for the majority of trading in derivatives, and across all asset classes, exposures were highly concentrated in relatively few counterparties, in particular investment firms, credit institutions and CCPs. The report also highlights that the UK remained the dominant market for transactions both within the EEA, as well as with third countries. The report will be used to contribute to ESMA’s risk assessment, facilitate the oversight of firms, as well as to enhance supervisory convergence.
On 10 January 2020, ESMA published its second statistical report on EU AIFs, concluding that the AIF sector, as measured by Net Asset Value (NAV), amounted to €5.8bn, representing nearly 40% of the total EU fund industry.
Funds of funds represented the largest sector of the industry at 14%, followed by Real Estate Funds (12%), Hedge Funds (6%) and Private Equity Funds (6%). ‘Other’ AIFs accounted for 61% of the industry.
The report notes that the two sectors with the largest percentage of retail investors (Funds of Funds (31%) and Real Estate (21%)) were also the sectors linked to potential structural liquidity vulnerabilities. The report also notes that although Hedge Funds comprise only 6% of all AIFs based on NAV, they total 67% of all AIFs by gross exposure due to their increasing reliance on the use of derivatives.
ESMA has published its schedule of MiFID II/MiFIR publications under the transparency regime and systematic internalisers’ tests in order to assist firms with planning over the next twelve months. The full calendar of publications can be found here.
In December 2019, the international body responsible for establishing global banking standards, the Basel Committee on Banking Supervision (BCBS) published a discussion paper on designing a prudential treatment for cryptoassets, seeking the views of stakeholders on:
The responses will inform the Committee’s development of a prudential treatment, which if developed, will form part of a consultation paper detailing its proposals and seeking further feedback from stakeholders.
The discussion paper can be read here. Feedback is welcome from all interested stakeholders by 13 March 2020.
For further information on the issues mentioned above, or any related issues, please contact Frank Gannon, Head of Asset Management.