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 5 March 2020 the Central Bank of Ireland’s Deputy Governor, Sharon Donnery, gave the keynote speech at the Official Monetary and Financial Institutions Forum (OMFIF) Gender Balance Index 2020 launch. Making the case for the necessity of diversity for businesses, policymakers and boards, Ms Donnery noted the association between a lack of diversity at senior levels and some of the problems that contributed to the financial crisis, such as groupthink, insufﬁcient challenge, poorly assessed risk, and problems with culture. Ms Donnery also spoke to the evidence that demonstrated how diversity can lead to improved outcomes in terms of governance, decision-making and productivity, in addition to the quality of decision making, and enhancing worker productivity.
Ms Donnery noted that in 2017 the Central Bank of Ireland started to publish data on gender diversity at senior levels in regulated firms, and has committed to publishing this data on an annual basis. The latest report for 2019, to be published in March, shows that for those firms subject to the CBI corporate governance code and required to have diversity policies in place, over one in four applicants to senior roles were made by female candidates, up from one in six in 2012. However, Ms Donnery also noted the substantial differences in role holders across sectors, with over one in four senior role holders in the insurance sector being women, with only one in eight for asset management firms.
This follows a separate speech to the European Financial Forum's 30% Club delivered on 17 February 2020 by the Central Bank of Ireland’s Director General of Financial Conduct, Derville Rowland. Ms Rowland also addressed the under-representation of women at senior levels in business, including regulated firms, and cited research indicating that companies in the top quartile for gender diversity on executive teams were 21% more likely to outperform on proﬁtability, while companies in the top quartile for ethnic/cultural diversity on executive teams were 33% more likely to have industry leading proﬁtability.
Ms Rowland emphasised that the need for diversity at senior levels extended beyond gender, and that the Central Bank expects regulated firms to show more ambition in implementing change to achieve this through targets and measures, building better pipelines of talent and identifying and reducing barriers to change in order to improve the diversity of experience, thought, background and other attributes at senior levels.
The Central Bank considers diversity as a leading indicator of elevated behaviours and culture risks, and for that reason, intends to keep focus on this issue in the years to come. In April, the findings of a diversity and inclusion thematic assessment of the insurance industry will be published, along with best practice guidelines for the wider industry. This follows the work carried out by the Central Bank in 2018 which resulted in the publication of a report on the behaviour and culture of Irish retail banks. It also follows calls made by the European Banking Authority in February to introduce a more balanced composition of management bodies in institutions, following a benchmarking report revealing that, as of September 2018, over 40% of institutions had not adopted a diversity policy.
On 12 March 2020, the Central Bank’s Governor, Gabriel Makhlouf, gave a speech at the European Financial Forum in Dublin. Despite positive growth in the Irish economy in recent years, Mr Makhlouf noted that significant risks remain, which currently include the coronavirus and the future trading relationship with the EU. With respect to the latter, Mr Makhlouf stated that consumers, businesses and regulators should expect and plan for more frictions and divergence in the years to come.
In managing the challenges on the horizon for the next ten years, Mr Makhlouf announced the publication of a paper updating the Central Bank’s approach to prudential impact models under its PRISM framework (see below), and advised that the Central Bank’s review of the 2012 Consumer Protection Code was underway. With respect to the Central Bank’s review into domestic property funds, announced in December 2019, Mr Makhlouf advised that it will form a judgement in respect of how well placed this segment of the funds sector is to absorb adverse shock in the future.
Mr Makhlouf also supported the calls of European Central Bank Vice President de Guindos for the development of a broader macroprudential framework for the non-bank sector to ensure it can sustain ﬁnancing of the real economy under different economic conditions and mitigate pro-cyclical risk-taking, excessive leverage, liquidity, and maturity transformation. Mr Makhlouf also cited the investment funds industry as being a good example of the importance of a coordinated national and European approach to supervision in order to ensure that adequate protections are in place for all EU consumers.
On 28 February 2020, the Central Bank’s Director of Financial Stability, Vasileios Madouros addressed the annual conference of the Irish Fiscal Advisory Council on how the financial system can play a key role in the transition to a low-carbon economy and how central banks are working together to build a climate-resilient financial system.
Mr Madouros referred to the need for investors to understand the carbon footprint of their investments through a common understanding of what was ‘green’, and referred to the recent work undertaken at an EU level in the development of a uniform taxonomy on sustainable activities, and disclosure requirements under the Sustainability Disclosures Regulation.
Mr Madouros advised that central banks, including the Central Bank of Ireland, were shifting their focus, and will increasingly embed climate-related risk issues into their financial stability assessments and supervision. This will require increased levels of data from regulated firms themselves. Consequently, all regulated firms, and in particular asset management and investment firms, can expect increased focus by the Central Bank in this area in the coming years.
On 25 February 2020, the Central Bank published a notice of intention to expand the number of PCF roles, to include: Chief Information Officer (General)(PCF-49), Head of Material Business Line (Banking)(PCF-50), and Head of Market Risk(Banking)(PCF-51).
The notice of intention also states that the Central Bank will split the PCF-39 role for UCITS self-managed investment companies and management companies into six new PCF roles aligned to the specific managerial functions set out in the Rules and Guidance, specifically:
· PCF-39A – Designated person with responsibility for capital and financial management;
· PCF-39B – Designated person with responsibility for operational risk;
· PCF-39C – Designated person with responsibility for fund risk management;
· PCF-39D – Designated person with responsibility for investment management;
· PCF-39E – Designated person with responsibility for distribution;
· PCF-39F – Designated person with responsibility for regulatory compliance.
The rationale for splitting these roles is to correspond to the specific managerial functions set out UCITS Regulations, AIF Rulebook and the Fund Management Companies Guidance. The Central Bank has advised that persons in situ on the date the amended regulations come into effect will not be required to seek approval to continue to perform one of these new PCF roles. However, regulated firms will be required to review their assessment under Section 21 of the Central Bank Reform Act 2010 in respect of persons in situ, and to submit confirmation of such an assessment to the Central Bank. This process will commence after the amended Regulations come into effect, and a period of six weeks will be provided to submit this confirmation.
The Central Bank has invited comments from stakeholders regarding these proposals by 26 March 2020.
On 21 January 2020, the Central Bank published its first edition of the EMIR Q&As, which aims to answer queries posed by Irish-regulated firms regarding its application as well as the Irish Regulations. This first edition provides 10 answers, including on the submission of a request for intragroup exemptions and in respect of the clearing threshold. It is expected that this document will be updated regularly in the months ahead.
In February 2020, the Central Bank published its PRISM Impact Review, providing revised prudential impact models across various sectors, including asset management. ‘PRISM’ is the Central Bank’s risk-based supervisory framework introduced in 2011, by which financial service providers’ prudential risk is determined by assessing the degree of damage that would be caused to consumers and/or the economy if it were to fail (impact), as well evaluating the likelihood of it failure due to the materialisation of supervisory risk.
The revised models include new metrics based on historic data to better represent the actual impact of financial service provider failure. Whereas previously the size of a firm was the key driver of prudential impact, the proposed new metrics capture various other dimensions, such as substitutability, connectivity, and the scale and spread of financial service provider failure. Where a firm is considered to have a higher impact, this will be reflected in the intensity of supervision applied.
The Central Bank will write to fund service providers and asset managers during H1 2020 to inform them of their impact category following this review. As data collected as part of the review will be required on an ongoing basis, some asset managers and fund service providers will be requested to submit previously provided data on an ongoing basis.
On 9 March, ESMA published its joint Annual Report for 2019 and Work Programme for 2020, setting out its main priorities for the coming year, which include:
On 17 February 2020, the European Commission launched its consultation on MiFID II and MiFIR. The consultation seeks feedback on the general experience of MiFID II, as well as potential changes to investor protection rules in order to achieve the right balance between promoting investor participation, safeguarding investors’ interests, and maintaining the competitiveness of the EU’s financial services sector. The consultation also canvasses views on the possible introduction of a new transparency tool that would allow investment managers, advisors and their clients to have access to “live” asset prices across the EU in a consolidated format, as well as more technical aspects under the current regulatory regime.
The feedback provided will inform the European co-legislators’ views regarding future legislative proposals, which the Commission expects to publish in Q3 2020. Irish Funds has advised that it will be submitting a response to the consultation and will shortly be reaching out to members for input. The consultation closes on 20 April 2020.
On 19 February 2020, the European Securities and Markets Authority (ESMA) published its first Trends, Risks and Vulnerabilities Report for 2020, identifying continued high risks and a weaker economic outlook, with markets remaining highly sensitive to geopolitical events. While the risk outlook is stable, the risks were high, particularly with respect to securities markets and retail investors.
The report notes that market risk remained high during H2 2019 due to excessive asset valuations in the context of weaker growth prospects, loose monetary policy and continuing uncertainties such as those on Brexit and on US-China trade relations. Similarly, credit and liquidity risk remained high, with continued consumer risks across investment products and retail investors remaining cautious. ESMA identifies a weaker economic outlook as well as continuing uncertainty having regard to the potential impact of the coronavirus, global trade negotiations, as well as Brexit.
On 14 February 2020, ESMA published its response to the European Commission’s consultation on the review of the Benchmark Regulation (BMR), which has been in force since January 2018 and seeks to increase the robustness and reliability of financial benchmarks. The Commission’s Consultation Paper considered areas such as critical benchmarks, the scope of the regulation, authorisation and registration procedures, supervision of climate-related benchmarks and non-EEA benchmarks.
In its response, ESMA focused on the cessation of critical benchmarks, parity between EU and third-country benchmarks, and transparency. In order to enhance the critical benchmarks framework, ESMA proposes that:
ESMA has also provided views in relation to ensuring the existence of a level playing field between EU and third country benchmarks, and proposes that different alternative approaches be taken when defining the scope of the BMR, following a risk-based approach through the exclusion of non-significant benchmarks. ESMA also suggests that in order to increase transparency of benchmark users, the list of both EU and third country benchmarks should be included in its register, together with an appropriate identification of their identity..
On 3 March 2020, ESMA Chair Steven Maijoor delivered the keynote address at the 4th annual Fintech Conference in Brussels. Mr Maijoor addressed attendees on the benefits and risks of BigTech (i.e. larger technology companies) in finance, distributed ledger technology, global stablecoins and the need for a coordinated approach by regulators to innovation and digital finance.
In particular, Mr Maijoor stated that BigTechs in finance may bring benefits such as efficiency gains and personalised services, but also risks, such as the facilitation of price discrimination, and concentration risk within the markets that may be disadvantageous to consumers. Mr Maijoor advocated for close cooperation and coordination among regulators at a European and international level.
Interested participants in the market should pay close attention to the outcome of the European Commission’s consultation on an EU framework for crypto-assets (closing on 19 March), which highlights the risks of these products to investor protection, and the challenges in applying existing rules to those crypto-assets that qualify as financial instruments or e-money. See also the ESMA Advice on Initial Coin Offerings and Crypto-Assets, as well as the European Banking Authority’s Advice to the European Commission on Crypto-Assets, both of which were issued in January 2019.
On 2 March 2020, ESMA published a report on C6 energy derivatives and related obligations under EMIR. Such derivatives have relevance for those firms trading energy derivative contracts on coal and coil, as well as for national competent authorities. The report assesses the adequacy of mandating C6 energy derivative contracts to be subject to certain EMIR obligations from which they enjoy a temporary exemption. In particular, the report refers to EMIR requirements in respect of:
The report also investigates the uses of such contracts by non-financial counterparties (NFCs) and the potential benefits of reducing counterparty and systemic risks.
On 28 February 2020, ESMA has begun to make available the annual transparency calculations for equity and equity-like instruments, pursuant to MiFID II/MiFIR transparency requirements. Market participants are invited to monitor the release of these calculations on a daily basis for newly traded instruments.
These calculations are based on the data provided to the Financial Instruments Transparency System (FITRS) by trading venues and arranged publication arrangements (APAs) in relation to the calendar year 2019. The calculations will be applicable from 1 April 2020 until 31 March 2021, however until then, the 2019 annual transparency calculations continue to apply.
On 10 February 2020, the International Securities Lending Association (ISLA) reported that following the submission of a letter by the Alternative Investment Management Association (AIMA), responses were received from both the European Commission and ESMA, which confirmed that non-EU AIFs were not subject to the reporting obligations under Article 4(1) of the SFTR, even if the AIFM is authorised or registered in accordance with the AIFM Directive (Directive 2011/61/EU), except in respect of SFTs concluded in the course of the operations of a branch in the Union of the Non-EU AIF.
On 5 February 2020, the European Banking Authority issued a consultation paper on customer due diligence and risk factors to be considered when assessing money laundering and terrorist financing (ML/TF) risk. The consultation follows the guidelines issued by the European Supervisory Authorities (ESAs) on risk factors and simplified and enhanced customer due diligence, which set out factors firms should consider when assessing the ML/TF risk associated with a business relationship or occasional transactions. However, since the issuance of those guidelines, new risks have emerged, as well as the introduction of the 5th Anti-Money Laundering Directive. In addition, the ESAs joint opinion on ML/TF risk in 2019 highlighted several concerns regarding identification and assessment of business-wide risk and the application of customer due diligence measures.
The consultation paper reflects proposals for the updated guidelines, and are divided into two parts. While the first part reflects generic guidelines for all firms, Title II is sector-specific, and includes guidelines for investment firms (Guideline 15) and investment funds providers (Guideline 16).
Responses to the consultation should be provided by 5 May 2020.
On 18 February, ESMA published two new Q&As on the Prospectus Regulation providing clarification on two issues. In particular:
MiFIR and MiFID II Investor Protection
On 18 February, ESMA published six new Q&As on the implementation of investor protection and intermediaries topics under MiFIR/MiFID, and included answers on MiFID practices for firms selling instruments that are subject to the BRRD resolution regime. In particular:
Implementation of CRA Regulation
On 17 February, ESMA published a new Q&A on steps to be taken by a Credit Ratings Agency in order to ensure a sufficient level of quality and transparency in the periodic review of credit ratings under Article 8(5) of the Regulation. ESMA advises that the CRA should ensure:
Central Securities Depositories Regulation (CSDR)
On 17 February, ESMA updated its Q&As on the implementation of the CSDR. The seven new Q&As clarify the implementation of the settlement discipline regime, in particular:
On 20 March 2020, the European Commission launched its public consultation on the review of the Non-Financial Reporting Directive (NFRD), which requires certain large companies to include a non-financial statement as part of their annual public reporting obligations. The primary focus of the consultation is to gather views on potential reforms to the Directive, in particular with respect to the Commission’s commitment to strengthen sustainable investment in Europe.
The deadline for submissions is 14 May 2020.
On 26 February 2020, the European Reporting Lab published a summary of how to improve climate-related reporting. Among the key messages were:
The report also notes that despite a general improvement in the quality of climate-related disclosures, companies were still at the start of what may be a long journey to improve reporting. While some are already more advanced in their journey and their awareness and reporting of climate risks and opportunities, others have only made limited progress in developing a comprehensive climate-reporting strategy.
In a letter dated 3 February 2020, the ESRB wrote to the European Commission providing information on shortcomings on the AIFMD framework, having regard to the Commission’s plans to report to the EU co-legislators on the application and scope of the Directive in early 2020. The letter notes the current size of the EU AIF market (€5.8tn NAV), and advises that increased financial intermediation by investment funds may create vulnerabilities leading to financial stability risks, in particular relating to liquidity risks, high leverage and pro-cyclical risk taking.
The ESRB notes that there are some areas in which the reporting framework for the AIFMD could be improved, and the ESRB provides its detailed consideration of: (i) the suitability of the reporting framework for monitoring systemic risk; (ii) the need to operationalise existing macroprudential policy instruments, and (iii) the ongoing development of the macroprudential policy framework beyond banking in general and for investment funds in particular.
On 20 February 2020, the High Level Forum on Capital Markets Union published its interim report on the way forward for CMU. The report addresses the effects of measures taken to date, in addition to the remaining challenges ahead. The High Level Forum recommends strong and immediate political support and coordination across all EU institutions to push reforms forward, noting that the window of opportunity is closing as other jurisdictions assume a greater role in global markets. The final report will be published in May 2020.
On 25 February 2020, the European Fund and Asset Management Association (EFAMA) has today published its latest monthly Investment Fund Industry Fact Sheet for December 2019 data and its 2019 overview of net sales data of UCITS and AIFs. EFAMA notes that 2019 ended as a good year for the European investment fund industry, with net sales of UCITS and AIFs in December totalling €70bn, bringing total net assets to €17.7tn. Net sales of UCITS and AIFs were €531 billion in 2019 (€221 billion in 2018), with UCITS net sales reaching €386bn (€115 billion in 2018).
On 6 March 2020, EFAMA responded to the EIOPA consultation on PEPP Level 2 measures, which sets out EIOPA’s current approach to the regulation of key aspects of PEPP. EFAMA advised that it strongly supported the creation of a highly transparent and cost-effective PEPP, however considered that this would only be successful if it were possible for potential providers to develop a viable business case for it. In this regard, EFAMA considered that the EIOPA proposal to include the cost of advice in the 1% fee cap would make it extremely difficult to achieve this objective. EFAMA also considered that the inclusion of transaction costs in the fee cap would limit the number of portfolio transactions, with the consequent risk of missed opportunities to make gains or limit losses, which would be detrimental to PEPP savers, and unnecessarily complicate the investment process.
EFAMA also advised that it supported the EIOPA proposals concerning risk mitigation techniques, in particular that PEPP providers ensure investment strategy makes it possible to recoup the capital at the start of the decumulation phase with a certain probability, and that probability thresholds should be set by EIOPA taking account of the low returns environment. EFAMA further advocated that PEPP documentation should be designed for digital delivery and subject to rigorous customer testing.
Fund managers should keep in mind the deadline of 31 March 2020 for necessary updates to Prospectuses and KIIDs following the Central Bank’s “Dear CEO” letter issued on 18 July 2019. Further to the key findings identified, the Central Bank of Ireland required Boards of UCITS and their managers to ensure the following when considering the accuracy and content of its Prospectus and KIID, with any necessary updates to be submitted to the Central Bank by 31 March 2020:
ESMA Consultation on Draft Technical Standards on the Provision of Investment Services and Activities in the EU by Third-Country Firms under MiFID II and MiFIR
On 31 January 2020, ESMA published a consultation paper on the draft technical standards on the provision of investment services and activities in the EU by third country firms under MiFID II / MiFIR. The consultation paper arises following the introduction of changes to MiFIR and MiFID II for third country firms under the Investment Firms Regulation (Regulation (EU) No. 2019/2033) (IFR). These include new annual reporting requirements from third-country firms to ESMA, and the power to request data relating to all orders and transactions in the EU for a period of 5 years.
The proposed standards relate to the information that would be required by third countries if seeking to provide investment services within the EU, and the information to be reported annually by such firms to ESMA. This will of course be of some relevance to UK firms post-Brexit.
The deadline for submissions is 31 March 2020. ESMA expects to publish the draft technical standards and submit its final report to the European Commission in Q3 2020.
For further information on the issues mentioned above, or any related issues, please contact Frank Gannon, Head of Asset Management.