Asset Management Insights July 2020 Asset Management Insights July 2020 Asset Management Insights July 2020

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.

Central Bank of Ireland Updates

• Central Bank of Ireland emphasises importance of investor protection during COVID-19
• Central Bank of Ireland highlights increased monitoring of market-based finance
• Central Bank of Ireland issues market abuse questionnaire to issuers
• Central Bank of Ireland confirms application of ESMA statement in respect of open access requests under MiFIR
• Central Bank of Ireland sets out expectations concerning due diligence on-site visits by fund service providers to outsourcing service providers and delegates
• Central Bank of Ireland warns that firms must enhance measures to protect consumers when selling complex investment products

European Supervisory Authorities Updates

• EBA consults on new regulatory framework for investment firms
• ESMA renews decision requiring net short position holder to report positions of 0.1% and above
• ESMA publishes 2019 annual report and updates 2020 work programme
• ESMA responds to European Commission’s consultation on EU digital finance strategy
• European Commission publishes report on Alternative Investment Fund Managers Directive
• High-Level Forum on capital markets union publishes final report
• EFAMA reports that European AIFs continued to attract net new money in Q1 despite COVID-19
• EFAMA calls for global principles to address market data costs
• EFAMA responds to ESMA consultation on draft RTS under the Benchmarks Regulation (BMR)
• EFAMA responds to ESMA consultation paper on MiFID II / MiFIR review report on the transparency regime for non-equity instruments and the trading obligations for derivatives
• EFAMA responds to ESMA consultation paper post-risk trade reduction under EMIR

Other Articles

• Irish Funds publishes paper on liquidity challenges
• Irish Funds and EFAMA responds to European Commission’s review of the Non-Financial Reporting Directive
• Irish Funds responds to draft ITS under the Regulation for the cross-border distribution of funds

On 5 June, in a speech to the Association of Compliance Officers in Ireland, Derville Rowland, the Central Bank of Ireland’s Director for Financial Conduct, stressed the central role played by compliance officers in ensuring that the right culture is embedded in firms, and ensuring staff have the ability to speak up where appropriate. This is against the backdrop of the Central Bank’s recent actions to ensure that investors in securities markets are protected, including:

• emphasising the importance of funds managing liquidity risk effectively and in a manner transparent to their investors;
• clarifying the application to the Irish market of a range of measures taken by ESMA at an EU level; and
• emphasising the need for firms to ensure that communications to their clients prominently explains the potential disadvantages and risks to investment, and specifically those products that may have previously been considered suitable for sale to retail clients, which may no longer be the case in the present climate.

Ms Rowland also emphasised that in light of the heightened risk of unfair sales practices emerging during the COVID-19 pandemic, firms must ensure that sales staff are not incentivised into meeting targets that may result in unsuitable sales to clients.

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On 11 June, the Governor of the Central Bank of Ireland, Gabriel Makhlouf, gave a speech addressing the rise of market-based finance in Ireland and the increased scrutiny applied to that sector by the Central Bank in recent times. Noting that corporate bond funds were particularly susceptible to large outflows in March of this year, Mr Makhlouf stated that a key risk for the corporate bond market stems from potential credit rating downgrades, and that the Central Bank will continue to monitor the markets for such developments. Mr Makhlouf also highlighted the vulnerabilities of money market funds in the wake of COVID-19, and the substantial increase in redemptions experienced due to the pandemic.

Mr Makhlouf stated that the stresses experienced as a result of COVID-19 highlighted the underlying structural issues relating to certain segments of the funds sector, and noted the Central Bank’s continued focus on mitigating the risks in respect of liquidity mismatch and leverage. In order to address these issues, Mr Makhlouf highlighted the need to develop macroprudential tools to be applied to market-based finance, and the potential development of an international framework for the imposition of ex-ante macroprudential leverage limits, and to ensure the consistent availability and use of liquidity management tools across the EU. These sentiments were echoed in a later speech delivered by the Central Bank’s Deputy Governor, Sharon Donnery on 17 June, where she stated that “over time, the question over the extent to which structural vulnerabilities from liquidity mismatches and leverage in the global funds sector contributed to market disruption will need to be addressed”.

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On 16 June, the Central Bank of Ireland issued a questionnaire to all issuers of equities on the regulated market of Euronext Dublin concerning compliance with their obligations under the Market Abuse Regulation. Responses provided will be used to inform future supervisory work, including the selection of participants for further assessment on the extent to which they comply with the MAR requirements to recognise, manage and (for issuers) to publicly disclose inside information in compliance with their statutory obligations.

This action follows a review conducted by the Central Bank relating to the timeliness and nature of announcements made by various industry sectors on the impact of COVID-19, with some sectors being more proactive than others. The Central Bank will issue a similar questionnaire to Euronext Dublin SME Growth Market participants later this year.

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On 16 June, the Central Bank of Ireland confirmed that it will apply the public statement issued by ESMA as regards matters it expects National Competent Authorities (NCAs) to consider in assessing open access requests under Articles 35 and 36 of MiFIR in the context of COVID-19.

On 11 June, ESMA issued a public statement clarifying the application of MiFIR open access provisions for trading venues and central counterparties for transferable securities, money market instruments and ETDs in light of recent developments. This comes following the expiration of MiFIR provisions on 3 July, which previously allowed NCAs to temporarily exempt trading venues and CCPs from the open access provisions.

The statement informs NCAs that they are expected to take into consideration, to the extent relevant, specific adverse developments when taking decisions on open access requests. These include the impact on the orderly functioning of markets, financial stability of migrating flows of transactions and changing IT infrastructure as a result of providing access. NCAs are expected to assess whether the CCP or trading venue is able to adequately implement significant changes to its risk management procedures and models, including credit risk, operational and legal risks.

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On 16 June, the Central Bank published a statement reminding funds service providers (FSPs) of the importance of maintaining strong oversight of outsourcing and delegation requirements, which should take account of the location of the relevant service provider and ensure that controls are in place to identify and address material challenges facing such locations during the COVID-19 crisis. The statement further provides that FSPs must ensure that they are satisfied with due diligence arrangements in place pertaining to delegates, for which monitoring may be carried out remotely insofar as is possible.

The statement reminds FSPs to conduct a risk assessment to identify aspects of outsourcing where appropriate due diligence may be difficult or unfeasible to achieve remotely. Where risks are identified following this assessment, firms should then consider what other steps can be taken to mitigate such risks until an onsite review is completed, having regard to the scale and materiality of the outsourced activity. Firms should also implement plans to carry out on-site visits where appropriate.

FSPs are reminded to ensure proactive engagement with the Central Bank in respect of these matters, including informing prudential supervisors of expected delays in carrying out the above, and setting out what mitigating actions are being put in place.

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On 29 June, the Central Bank of Ireland issued a letter to MiFID firms concerning the findings of a thematic inspection into firms’ compliance with the “appropriateness” requirements under MiFID II, as part of a Common Supervisory Action initiated by the European Securities and Markets Authority (ESMA). Although the Central Bank noted some positive practices, such as the existence of separate business areas for the provision of advised and non-advised services, and the use of product-specific procedures and guidance documents, a number of concerns were also identified, including:

• A failure by firms to provide evidence that they are paying sufficient attention to the application of appropriateness requirements, placing undue reliance on standardised questionnaires and ‘box-ticking’ to demonstrate compliance;
• Weak warnings which did not sufficiently alert clients to the risks of proceeding with appropriate transactions;
• Incomplete appropriateness assessment records in circumstances where the application nevertheless proceeded;
• Generic information-gathering questionnaires across a broad range of financial instruments, irrespective of specific features, risk or complexity.
• Weak processes, systems and controls, in particular the actual adherence by firms to procedures in practice, resulting in errors, discrepancies and assessments based on incomplete information;
• Poor collection of information on investor knowledge and experience, which fails to consider the significant differences in risk and complexity among financial products; and
• Unclear rationales to support appropriateness decisions taken by firms.

The Central Bank requires all MiFID firms to consider the contents of the letter and to take all remedial action necessary to ensure they are acting in the best interests of consumers when selling complex products on an execution-only basis. Entity-specific engagement is now underway where mitigation actions have been identified. 

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On 4 June, the European Banking Authority (EBA) outlined its roadmap for the implementation of a new regulatory framework for investment firms, launching a public consultation on prudential requirements, reporting and disclosures, and remuneration requirements. This follows the entering into force of the Investment Firms Directive and Regulation in 2019, and takes the form of four separate consultation papers:

• First consultation paper on prudential requirements, which includes three draft Regulatory Technical Standards (RTS) on the reclassification of certain investment firms to credit institutions, five draft RTS on capital requirements for investment firms at a solo level, and one draft RTS on the scope and methods for prudential consolidation at a group level.
• Second consultation paper on reporting and disclosure requirements, which includes draft Implementing Technical Standards (ITS) on the levels of capital, liquidity, concentration risk and the disclosure of own funds, in addition to a draft RTS on the information that investment firms are required to provide to determine whether authorisation as a credit institution is required.
• Third and fourth consultation papers on remuneration requirements, which includes an RTS on criteria to identify categories of staff whose activities have a material impact on the firm’s risk profile or assets (‘risk takers’), and a separate RTS that specifies the classes of instrument that reflect the credit quality of the investment firm as a going concern, and possible alternative arrangements appropriate for use as variable remuneration.

The deadline for submitting comments is 4 September 2020.

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On 10 June, ESMA renewed its decision to require net short position holders to report positions of 0.1% and above. This follows the previous decision by ESMA temporarily requiring net short position holders to report such positions of the issued share capital of companies admitted to trading on a regulated market to the relevant national competent authority.

ESMA considers that this measure will maintain the ability of NCAs to deal with threats to market integrity, the orderly functioning of markets and financial stability at an early stage and allow NCAs to address these in the event of signs of market stress. The measure applies from 17 June 2020 for a period of three months. 

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On 15 June, ESMA published its 2019 annual report setting out ESMA’s key actions taken over the pervious year. With respect to activities concerning funds, the report notes that in 2019:

• ESMA ran a consultation on performance fee guidelines for retail funds, which aimed to clarify the provisions requiring Member States to ensure that management companies act honestly and fairly in conducting business activities in the best interests of the fund, and the integrity of the market. The guidelines will be finalised in 2020;
• ESMA also published guidance on liquidity stress tests of investment funds for AIFs and UCITs, which apply from 30 September 2020 and are supplementary to the requirements on stress testing within the AIFMD and UCITS Directives, which are already applicable;
• ESMA also published two sets of guidelines on stress testing of MMFs and reporting on MMFs to NCAs.

In respect of monitoring and analysis conducted by ESMA, in its TRV Report (September 2019) it assessed the exposures of the EU funds industry to leveraged loans and collateralised loan obligations, which stood at €130bn (less than 1% of the EU fund industry’s net assets). In the same report, ESMA investigated the gross and net relative performance of actively and passively managed funds with respect to their prospectus benchmark, and also analysed the use of derivatives by EU UCITS equity funds, based on regulatory data on derivatives collected under the EMIR framework.

With respect to European long-term investment funds, ESMA conducted a public consultation concerning a draft RTS under the ELTIF Regulation, the finalisation of which is postponed until the new PRIIPs delegated acts are published.

In respect of the revised work programme for 2020, ESMA notes that it has reallocated significant resources away from planned activities in response to the COVID-19 crisis, which has caused it to conduct a full assessment of its 2020 activities against criteria of relevance for the market, urgency, and impact on stakeholders, which has resulted in potential re-prioritisation of its planned activities. Revised end dates on regulatory outputs are set out in Annex I of the revised work programme and relate to work concerning sustainable finance, credit rating agencies, investment management, securitisation and market integrity, among others.

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On 29 June, ESMA submitted a response to the European Commission’s consultation on a new digital finance strategy for the EU, accompanied by a letter from ESMA’s Chair, Steven Maijoor. ESMA’s response highlights that specific initiatives are required to remove fragmentation in the digital financial services market, such as the development of Digital Financial Identities recognised throughout the EU. ESMA’s response focuses on a number of areas, including:

• the risks and benefits to digitalisation of the financial sector, noting that while digitalisation brings increased speed, efficiency, convenience and greater economies of scale, it also brings a number of risks around data security, operational incidence, data privacy, pricing and financial exclusion of individuals;
• ensuring a technology-neutral EU financial services regulatory framework that supports innovation and allows firms to reach the scale needed, as well as safeguarding investors and ensuring financial stability;
• removing fragmentation in the single market for digital financial services through cooperation at an EU level; and
• promoting a well-regulated data-driven financial sector through data standardisation and harmonisation, security of IT-systems and legal certainty regarding pertinent responsibilities, liabilities and usage permissions. Further, given the use of AI-based tools to drive the development of the financial sector, ESMA considers that specific guidance for the EU financial sector could be welcome to complement horizontal-level EU rules.

The Commission’s digital finance/Fintech action plan is expected to be published in Q3 2020. 

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On 10 June, the European Commission published a report assessing the application and the scope of the Alternative Investment Fund Managers Directive (AIFMD) following a review across 15 Member States. The purpose of the review was to assess whether the specific rules of the AIFMD were effective, efficient, coherent and relevant, as well as whether they supported EU measures to achieve the objectives of the Directive. The report considers the impact of the Directive on: AIFs and AIFMs, investors; monitoring and assessment of systemic risk; and investment in private companies and/or for the benefit of developing countries.

The findings of the review confirm that the AIFMD is delivering on its objectives to bring the EU AIF market into a more coordinated supervisory framework, through harmonised standards and promoting high level investor protection and greater market integration, as well more than doubling total net assets of AIFs since its adoption in 2011. However, the report also identifies some areas for improvement, including enhancing utility of the AIFM passport, the streamlining of reporting requirements, as well as implementing FSB and IOSCO recommendations for leverage calculation. The report also concludes that national private placement regimes (NPPRs) that allow third-country AIFMs and AIFs to operate in Member States play an important role while the AIFMD passport for third country entities has not yet been activated.

It is likely that this report will inform any proposals to implement a revised Directive in the future. The next step in the AIFMD review process will be a public consultation, scheduled for autumn 2020. 

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On 10 June, the High Level Forum on the Capital Markets Union (CMU), comprising 28 high-level capital markets experts, published its final report on the EU capital markets union, setting out a series of recommendations which aims to drive forward the EU’s capital markets. The report proposes 17 interconnected “game changers”, measures that the EU needs to implement urgently in order to tackle the most serious barriers in its capital markets. These proposed recommendations address obstacles that are considered to have discouraged EU financial operators from taking up or scaling up financial activity, particularly on a cross-border basis, which have in turn reduced the attractiveness of EU markets for foreign investors and prevented financial operators from competing globally on an equal footing. The measures aim to tackle such obstacles by:

• enhancing trust and confidence of EU citizens in capital markets;
• simplifying existing rules and reducing legal uncertainty and enforcement measures across Member States;
• addressing high compliance costs and unintended consequences of existing legislation;
• improving access to and reducing the costs of information; and
• incentivising the use of new digital technologies.

In response to the publication of this report, EFAMA issued a press release welcoming its recommendations, noting that the report “rightly emphasises the need to foster retail investors’ participation in capital markets by developing a stronger equity culture in Europe and by ensuring that investors benefit from high-quality, reliable and fair advice, so as to promote confidence and trust in the functioning of capital markets”. EFAMA further welcomed the HLF’s call for an urgent review of the PRIIPS regulation as being necessary to address a number of significant flaws in the PRIIPs KID and to avoid jeopardising the success of the UCITS brand. However, EFAMA noted that it was disappointed that the report had not referred to the issue of data costs, which it considered as a clear impediment to the effective functioning of the CMU that needed to be addressed “head-on”. These comments featured in EFAMA’s formal feedback , provided on 30 June.

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On 9 June, the European Fund and Asset Management Association (EFAMA) released its European quarterly statistical data, which showed that UCITS and AIFs registered net outflows of €125bn during Q1, a level not seen since 2008. While net outflows from UCITS amounted to €176bn, AIFs registered net inflows of €51bn, indicating that buyers of AIFs increased their allocation to this type of funds in such stressed market conditions. Irish UCITS suffered large net outflows of €41.2bn, second only to Luxembourg (€85.6bn), followed by France (€26bn).

On 25 June, EFAMA reported a strong rebound of net UCITS sales in April, with UCITS and AIFs recording net inflows of €84bn, compared to net outflows of €306bn in March 2020.

The European data was later accompanied by EFAMA’s publication on international data for Q1 on 22 June, which showed a large drop in worldwide investment fund assets against the backdrop of large net inflows, predominantly in the United States and China.

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In a joint report released on 29 June, EFAMA, in conjunction with the International Council of Securities Associations (ICSA) and the Managed Funds Association (MFA), called for the implementation of internationally recognised principles to address excessively high market data fees and unfair licensing provisions. The report recommends that authorities consider developing a cost benchmark for producing and distributing market data, and that market data costs be subject to full regulatory scrutiny to ensure fees and licensing practices are fair, reasonable and not a burden on competition.

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On 8 June, EFAMA published a response to ESMA’s consultation on draft RTS under the Benchmarks Regulation (BMR), which provides further specificity on certain of the BMR’s requirements, including ensuring the existence of robust governance arrangements, conditions surrounding the use of methodologies for benchmarks, the characteristics of systems and controls to ensure the integrity of input data, the assessment criteria used by competent authorities when transitioning to new administrators, and the criteria under which competent authorities may require changes to the compliance statement. The response makes a number of comments, including:

• noting the importance of keeping the right balance between regulatory obligations for benchmark administrators to tackle potential conflicts of interest and risks for misconduct and avoiding excessive burden and costs;
• encouraging further reflection on the ESMA benchmark register, which it considers should be a centralised benchmark log;

Specific responses were also provided in respect of remuneration frameworks, conditions to ensure methodology compliance, and the transition of the provision of a critical benchmark to a new administrator. 

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On 12 June, EFAMA published a response to the ESMA consultation reviewing the transparency regime for non-equity instruments and the trading obligation for derivatives under MiFIR, which purpose is to simplify the current trade reporting regime by creating a uniform set of rules while trying to improve the overall trade transparency available to market participants for non-equity instruments.

EFAMA’s response notes that transparency for pre- and post-trading could be further improved, through targeted amendments in a number of areas, including:

• the pre-trade transparency regime for trading venues in respect of non-equity instruments;
• the post-trade transparency regime for trading venues and investment firms in respect of non- equity instruments;
• the trading obligation for derivatives (DTO); and
• the trade percentile for the determination of the pre-trade SSTI threshold.

Specific responses were provided in respect of the questions posed by ESMA.

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On 12 June, EFAMA published a response to the ESMA consultation on post-trade risk reduction (PTRR) services with regard to the clearing obligation under EMIR, which seeks feedback on how the clearing obligation affects PTRR services, and whether there ought to be an exemption to the clearing obligation for trades directly resulting from such services, and if so, the scope of same and whether it should be subject to conditions or restrictions.

EFAMA’s response notes that asset managers and funds rarely benefit from PTRR techniques due to:

• the volume of transaction by counterparty being below mandatory compression;
• transactions with counterparties having the same strategy which applies to the entire portfolio;
• some counterparties imposing offsetting provisions directly in the master agreement, limiting the right to offset;
• the risk that offsetting might cause solidarity between sub-funds, being illegal under UCITS and AIFMD and for multilateral PTRR mechanisms.

EFAMA’s response further notes that PTRR are risk mitigation tools, and as such, should be treated as technical movements in portfolio management and exempted from best execution requirements.

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On 25 June, Irish Funds published a paper titled “Fund Governance: Navigating Liquidity Challenges”, which aims to highlight some of the common challenges facing firms liquidity risk management which may be of assistance to other firms in tackling their own issues, including:

• Investor Information
• Market Data
• Multiple Asset Classes
• Fund Liquidity Profile
• Cost Transparency
• Stress Test Assumptions
• Resourcing and Governance

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On 23 June, following its official response to the consultation, Irish Funds published a comment paper in response to the European Commission’s consultation on 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 paper states that Irish Funds agrees that the NFRD needs to be updated in view of the rapidly evolving area of sustainable finance, and in particular to align the reporting obligations of investors and investees under the Taxonomy Regulation and the SFDR. Among Irish Funds’ key comments on the NFRD review include:

• the need for a targeted approach that focuses on core data and qualitative information;
• a recommendation that underlying data be publicly available and reported via a common utility;
• the need for a common reporting standard to allow for industry sector-specific elements;
• a recommendation that the NFRD regime not operate in isolation of other global sustainability disclosure frameworks already in place;
• the need for a well-defined materiality framework on an industry sector-specific basis in order to bring clarity and consistency;
• the need for the development of a specific assurance standard for non-financial disclosures to enhance integrity and credibility of information, to be developed on an international and sector-specific basis;
• the consideration of including non-financial information separate to the annual report and financial statements.

Further to the above, Irish Funds notes that it will soon publish a paper comparing some of the prevalent international non-financial reporting frameworks.

Similarly, on 22 June EFAMA issued a joint statement on the revision of the NFRD in the context of COVID-19 on behalf of an informal group on Sustainable Finance, which includes ACCA, Accountancy Europe, Association of German Banks, CDSB, Frank Bold, IIGCC, Schroders, ShareAction, and WWF. The statement provides 7 recommendations which are considered by the group as instrumental in the upcoming revision of the NFRD, namely:

1. Expanding the scope of the NFRD beyond large listed companies to cover those companies that have a significant impact on the environment and society as a result of economic activities and business models;
2. Disclosure of non-financial information in the annual management report;
3. Strengthening of social and governance aspects including human rights, employment issues, health and safety, and a description of governance processes;
4. Development of minimum mandatory reporting requirements;
5. Building on existing reporting initiatives in order to achieve comprehensive non-financial reporting;
6. Keeping up the international role of reporting standards to ensure global consistency; and
7. Ensuring legislative consistency and avoiding duplication of reporting legislation, e.g. having regard to the Disclosures Regulation for Institutional Investors, the Taxonomy Regulation, and the Shareholders Rights Directive.

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On 30 June, Irish Funds submitted a formal response to ESMA’s consultation on the standard forms, templates and procedures the competent authorities should use to publish information on their websites to facilitate cross-border distribution of funds.

The response notes that Irish Funds is in agreement with the proposed approaches contained in the ITS, with additional comments as to how these approaches might be further improved, inter alia, to enhance transparency and facilitate investor protection.

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For further information on the issues mentioned above, or any related issues, please contact Frank Gannon, Head of Asset Management. 

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