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.
European Commission and ESMA updates
Industry and other updates
On 1 December, the Central Bank of Ireland’s Director of Securities and Markets Supervision, Colm Kincaid, delivered a speech in which he addressed the role of the funds industry in the protection of consumers. Given the need for vigilance in protecting investors’ interests in the present environment, Mr Kincaid stated that the Central Bank seeks to ensure that the funds and wholesale securities markets satisfy a number of principles, with which the Central Bank expects firms to have regard to when conducting their business activities, namely:
Mr Kincaid also addressed the need for financial products and services to become more financially sustainable, in addition to the need to protect investors’ best interests and the reputation of ‘green finance’ by avoiding the risk of greenwashing. In light of the forthcoming implementation of the Sustainable Finance Disclosure Regulation (‘SFDR’), Mr Kincaid also noted that the Central Bank will shortly communicate with firms in relation to certification under the Regulation’s technical standards.
Mr Kincaid also highlighted financial crime as an area in which the standards applied by the industry needed to be raised, in particular with respect to the controls and processes operated by individual firms, which cannot be managed by generic policies or process owned by other group entities.
Finally, Mr Kincaid noted the extent to which the vulnerabilities that had emerged during the COVID-19 pandemic fell squarely within the priority areas in which the Central Bank had been engaged for some time, and in respect of which firms needed to take specific action, in particular:
Mr Kincaid emphasised the need for investment funds to properly implement the CP86 framework, noting that time and again the root of the issues encountered by the Central Bank was a failure to implement the CP86 framework properly. In this regard, the Central Bank has required all firms to prepare an action plan by end Q1 2021 to remedy industry-wide deficiencies in implementation, with an industry-wide review in 2022 to benchmark progress.
Publication of the thematic review of compliance by MiFID-authorised investment firms with the MiFID ‘Best Execution’ requirements for consumers
On 10 November, the Central Bank of Ireland published the outcome of a Thematic Review of compliance by MiFID-authorised investment firms with the MiFID ‘Best Execution’ requirements for consumers, in which it was found that some firms could not demonstrate effective oversight and monitoring of how their best execution requirements were being fulfilled. The review also identified deficiencies in firms’ best execution frameworks, governance and assurance testing that must be addressed in order to raise investor protection standards across the industry. Notwithstanding this, some good practices were also observed. The main findings of the review were:
The Central Bank states that these findings do not reflect consumer-focussed cultures where clients’ outcomes are at the forefront of firms’ business models and strategies, and therefore requires firms to review and address these findings in the context of their own best execution arrangements in order to mitigate all consumer protection risks.
On 17 November, the Central Bank issued a letter to the management of all regulated financial service providers (‘firms’) setting out its expectations for firms to take appropriate action to address the significant issues identified by thematic inspections concerning their legal obligations under the Fitness and Probity (‘F&P’) regime. This follows thematic onsite inspections undertaken in a sample of firms in the banking and insurance sectors subsequent to the issuance of ‘Dear CEO’ letters to all firms in April 2019 highlighting the importance of compliance with the F&P regime, standards and guidance.
The inspections evaluated the processes in place to manage compliance with the F&P regime, and identified a number of common issues and shortcomings in certain thematic areas:
The Central Bank has once again placed emphasis on the importance of compliance with the F&P regime, which exists as a cornerstone of the regulatory framework in Ireland, and considers it “wholly unacceptable” that shortcomings in this area continue to be identified.
Firms should therefore carefully consider the contents of this letter, to be read in conjunction with the letter of April 2019, and assess and take appropriate action to address any F&P shortcomings identified in their respective firms. In light of the proposed introduction of a Senior Executive Accountability Regime (‘SEAR’) in 2021, it is likely that the area of governance will remain a key priority on the regulatory and enforcement agendas in the coming years.
On 23 November, the Central Bank of Ireland issued a consultation paper (‘CP132’) on proposed regulatory guidance relating to the scope of permissible features for share classes of closed-ended AIFs. The Central Bank is proposing to limit the availability of these features to closed-ended AIFs authorised as Qualifying Investor AIFs (CE QIAIFs) that have strategies generally relating to private equity, venture capital and real estate, and which generally do not invest in issuers or non-listed companies in order to acquire control over these.
The consultation paper proposes to permit a CE QIAIF to issue share classes that permit:
The deadline for submissions is 22 December 2020.
On 20 November, the European Commission launched a public consultation on a draft Delegated Regulation under the EU Taxonomy Regulation relating to the technical screening criteria for determining the conditions under which economic activities qualify as contributing substantially to climate change mitigation and adaptation, and whether economic activities cause no significant harm to any of the other environmental objectives under the Regulation. The Annexes to the Delegated Act set out the screening criteria across a range of nine economic activities, including: agriculture and forestry; manufacturing; energy, transport, construction and real estate; and professional, scientific and technical activities.
The deadline for feedback is 18 December 2020.
On 19 November, ESMA’s Executive Director, Verena Ross, delivered the keynote speech at the Alternative Investment Management Association global forum.
Ms Ross addressed the issue of delegation in light of the challenges posed by Brexit, and stated that ESMA expects all firms to be ready to face this new reality. With respect to the European Commission’s review of the AIFMD, Ms Ross stated that ESMA chose to devote particular attention to the area of delegation and substance requirements given the benefits in enhancing efficiency and scale, as well as gaining access to more specialised investment expertise. In this respect, Ms Ross stated that ESMA was aware of the importance of delegation requirements for the funds industry and the need to keep an open global model. However, ESMA also recognises the increased operational complexities and supervisory risks attached to large-scale delegation arrangements, and therefore considers it important to ensure that entities that are authorised and supervised in the EU remain ultimately in charge of key business functions and decisions, with sound governance and control mechanisms.
Ms Ross also addressed the ESG agenda, and noted that ESMA was pursuing supervisory convergence of national practices, focusing on preventing greenwashing, misselling and fostering transparency and reliability of non-financial reporting. The final report by the European Supervisory Agencies in response to the draft technical standards on ESG disclosures is due by January 2021, with the result that the application date of the technical standards under the disclosure regulation will be delayed; however, the obligations stemming from the Level 1 regulation must be applied in accordance with the original schedule, commencing 10 March 2021. The ESAs are planning to launch a consultation aper in January 2021 on additional taxonomy-related product disclosures under the Taxonomy Regulation, which will seek feedback on the proposed transparency rules for how taxonomy-related products must disclose their taxonomy alignment.
On 5 November, ESMA published the official translations of its guidelines on performance fees in UCITS and certain types of AIFs, finalised in April. The guidelines aim to harmonise the charging of performance fees to retail investors, as well as the circumstances in which performance fees can be paid, and specifically addresses:
With the publication of the guidelines in all EU official languages, the guidelines will apply to fund managers and national competent authorities from 5 January 2021.
On 9 November, ESMA launched a public consultation on guidelines on marketing communications under the Regulation on facilitating cross-border distribution of collective investment undertakings, which provides that fund managers, including AIFMs and UCIT management companies, shall ensure that marketing materials:
The Guidelines should apply to all communications that have a marketing purpose, having regard to the definition of ‘marketing’ under the AIFMD, and should encompass all communications that contain a direct or indirect offering or placement of units or shares of a fund to or with investors domiciled or with a registered office in the EU. Further, the proposed guidelines contain non-exhaustive lists of the types of communications that have a marketing purpose, as well as those communications which fall outside the guidelines. Amongst the areas addressed in the guidelines include:
The closing date for submissions is 8 February 2021.
On 11 November, ESMA published its second risk dashboard for 2020, which notes the continued risk of decoupling between asset valuations and economic fundamentals. ESMA notes that during Q3 EU financial markets had continued their recovery; however, there are increasing signs of strong geographical and sectorial differentiation in equity market valuations, with fixed income markets seeing large-scale valuation increases across various segments such as emerging markets, investment grade and high yield. Further, credit rating downgrades have slowed in Q3, and investment funds recorded inflows across asset classes, especially for bond funds. Taken together, ESMA considers that these developments highlight the ongoing risk of decoupling between asset valuations and economic fundamentals.
ESMA considers that the potential for a sudden reversal in investors’ risk assessment is the key risk for EU financial markets at present, and thus maintains its “very high risk” market assessment for the risks within its overall remit. Further, ESMA predicts a prolonged period of risk to institutional and retail investors of further, and possibly significant, market corrections. To the extent that such risks might materialise, ESMA considers that this will depend on three drivers, namely: the economic impact of the pandemic; market expectations on monetary and fiscal support measure; and any occurrence of additional relevant events in an already fragile global environment.
On 12 November, ESMA issued its third annual report on penalties and measures imposed by national competent authorities under the UCITS Directive during 2019. The report notes that whereas the number of national competent authorities (‘NCAs’) issuing sanctions remained stable as compared to 2016-2018 (15), the financial amount of penalties decreased slightly year-on-year.
Further, ESMA also issued its first annual report on penalties and measures imposed by national competent authorities under the AIFM Directive during 2018-2019. The report notes that during 2019, 13 NCAs imposed a total of 45 penalties, amounting to €9m. This compares with 63 penalties imposed by 11 NCAs during 2018, amounting to €4.5m.
Both reports show that sanctioning powers were not equally used among NCAs, and that the number and amount of sanctions issued at national level was relatively low. The Central Bank of Ireland has imposed no penalties under UCITS from 2016-2019, nor under AIFMD during 2018-2019.
In May, ESMA published a statement expressing support for the recommendation issued by the European Systemic Risk Board (ESRB) aimed at addressing the COVID-19 pandemic from a macroprudential perspective that competent authorities across the EU, coordinated by ESMA, undertake focused supervisory engagement with investment funds with significant exposure to corporate debt and real estate as being less liquid asset classes, and to report to the ESRB on its analysis and conclusions.
On 12 November, ESMA published a report setting out ESMA’s analysis and conclusions on the preparedness of the investment funds reviewed, and presents five priority areas to enhance the preparedness of funds to potential adverse shocks. The findings showed that the funds overall managed to adequately maintain their activities when facing redemption pressures and/or episodes of valuation uncertainty, and that during the market stress linked to the COVID-19 pandemic, only a limited number of the funds suspended subscriptions and redemptions, with the vast majority being able to meet redemption requests and maintain their portfolio structure. The report cautions, however, that these results should be viewed with caution since the redemption shock was concentrated over a short period of time, amid significant government and central bank interventions providing support in the funds markets. Further, concerns around the valuation of portfolio assets have emerged, in particular for real estate funds for which the crisis could have a more significant impact over the longer term.
Against this background, ESMA has identified five priority areas that would enhance the preparedness of such investment funds, namely:
In its report, ESMA notes that it will follow up with National Competent Authorities (NCAs) in respect of priority areas 1, 2, and 5 in order to foster supervisory convergence among national supervisors, to include the sharing of experiences. Priority areas 3 and 4 are considered more appropriately dealt with in the context of the AIFMD review. Against these recommendations, ESMA also notes that it supports the development and operationalisation of the macroprudential framework for non-banks, which could be taken forward by the ESRB in conjunction with ESMA and national regulatory authorities.
On 13 November, ESMA identified costs and performance for retail investment products and market data quality as new Union Strategic Supervisory Priorities for NCAs. Consequently, NCAs will undertake supervisory action, coordinated by ESMA, in the following areas during 2021:
ESMA considers costs and performance as a key part of investor protection, as unfair and disproportionate costs and fees can increase investor detriment and affect investors’ trust in financial markets.
On 25 November, ESMA issued a public statement clarifying the application of the EU’s trading obligation for derivatives under Article 28 of MiFIR following the end of the UK’s transition from the EU on 31 December 2020. This clarifies that the DTO will continue to apply without changes after the end of the transition period, as in ESMA’s view, this would not create risks to the stability of the financial regime. ESMA will continue to monitor the situation closely to determine whether markets would be sufficiently liquid to allow EU market participants to execute derivatives transactions subject to the DTO on eligible trading venues post-31 December 2020.
On 16 November, the Director General of the European Fund and Asset Management Association (‘EFAMA’), Tanguy van de Werve, delivered a speech at the 6th Cyprus International Funds Summit, addressing the European Commission’s Capital Markets Union (‘CMU’) action plan, published in September. While Mr van de Werve stated that it was very important that the entire financial services industry give the CMU its full support, and that EFAMA supported the focused approach adopted by the Commission, he expressed concern at the approach adopted with respect retirement savings, and stated that the Packaged Retail and Insurance-based Investment Products (PRIIPs) flaws must be addressed as a matter of urgency.
On 19 November, EFAMA published its first ESG-focused market insights on sustainable investment in the European asset management industry. The research conducted confirms that a wide variety of sustainable investment approaches are followed, which underlines the need to exercise caution when quantifying the size of the European ESG market.
However, the publication highlights that firm-level ESG selection strategies represented a total of €10.7tn (45%) of total AUM at end-2019 in the 16 countries assessed (which did not include Ireland). Further, the report highlights that firm-level exclusions (i.e. prohibiting certain types of investments from a firm, fund or portfolio) were one of the most basic and common forms of ESG selection strategy, with approximately €8tn of assets subject to firm-level exclusion criteria. With respect to firm-level ESG integration (i.e. the systematic and explicit integration of ESG risks and opportunities in the investment decision-making process), €8.8tn of assets are subject to an ESG integration framework, making this the most popular ESG selection strategy.
On 20 November, 14 trade associations, including EFAMA, published a paper expressing a concern that the transition period for third country benchmarks under the EU Benchmarks Regulation should not be allowed to expire at the end of 2021, and have urged the European Parliament and Council to agree to extend this transition period to end-2025 to allow for a comprehensive review of the regime.
The paper notes that as the text of the BMR currently stands, EU supervised entities will no longer be able to reference third country benchmarks in new financial instruments, financial contracts or measurements of the performance of an investment fund after 31 December 2021, unless an equivalence decision is adopted regarding the relevant third country, or the administrator or benchmark otherwise appears on ESMA's register. The associations repeat the concerns raised by ISDA in response to the Commission’s consultation on the review of the BMR in 2019, namely:
On 24 November, EFAMA published its latest monthly Investment Fund Industry Fact Sheet, providing net sales data of UCITS and AIFs for September 2020, noting that “net inflows into UCITS equity funds remained steady in September despite concerns about rising COVID-19 infection rates and the potential impact of new lockdown measures”.
Net sales of UCITS and AIFs in September totalled €32bn, up from €30bn in August. While UCITS recorded net inflows of €12bn (€25bn in August), AIFs recorded net inflows of €19bn (€5bn in August). Total net assets of UCITS and AIFs decreased by 0.01% to €17.638tn.
In addition, on 2 December, EFAMA published its quarterly statistical data release describing the trends in the European investment fund industry in Q3 2020. EFAMA notes that “net sales of long-term funds remained robust in Q3, reflecting investor confidence during the summer that the worst of the COVID-19 crisis was already behind”, with net assets of UCITS and AIFs growing by 2.8% to €17.58tn, attracting €195bn in net inflows compared to €284bn in Q2 2020.
For Ireland, net assets at end-Q3 stood at €3.077tn (€3.024 end-Q2), with net sales for UCITS and AIF dropping from €124.8bn in Q2 to €35.9bn in Q3. Year-to-date net sales in Ireland as of end-Q3 stands at €102.bn and €17.3bn for UCITS and AIFs respectively.
On 25 November, EFAMA published a report on the experience of European money market fund managers during and after the March 2020 turmoil, drawing on key indicators and managers’ direct experience, and makes the following observations:
On 25 November, EFAMA published its reply to ESMA’s consultation on the MiFID II/MiFIR review on the functioning of organised trading facilities. EFAMA expresses concern with the clarifications proposed by ESMA, stating that ESMA appeared to have a very broad definition of ‘multilateral systems’ under MiFID II, which EFAMA considers to be too expansive and could capture a number of non-multilateral systems such as EMS, OMS, instant chats services, which allow for bilateral interactions.
EFAMA states that this approach would require such software providers to either change operating models, or would create a barrier to entry, with the potential consequent effects of reduced market competition, reduced investor choice, increased investor cost and the stifling of innovation. In EFAMA’s view, only multilateral systems that allow multiple third parties’ trading interests to interact in a system, and where genuine trade execution takes place, should be required to become trading venues.
On 26 November, EFAMA published its 12th annual asset management report, providing an overview of the European asset management industry. Among the key findings and observations identified include:
On 30 November, EFAMA, along with six other trade associations wrote a letter to the European Commissioner for Financial Stability, Financial Services and Capital Markets Union welcoming the Commission’s temporary equivalence decision from 21 September 2020 with respect to UK central counterparties, as well as the subsequent recognition decisions by ESMA of CCPs and the recent temporary equivalence decisions for UK Central Securities Depositories (‘CSDs’) under the Central Securities Depository Regulation (‘CSDR’).
However, the letter notes that equivalence decisions remain outstanding in other critical areas of financial services, including in relation to UK regulated markets under EMIR Article 2a, which the associations consider will create an uneven playing field in addition to operational challenges for EU banks and investment firms, and ultimately impact end-users and the real EU economy. The associations therefore strongly urge the Commission to issue equivalence determinations under EMIR Article 2a before the end of the transition period to ensure that EU firms can benefit from the treatment available to firms established in the UK which already an equivalence decisions for EEA exchange traded derivatives under UK EMIR Article 2a at the end of the transition period.
On 20 November, the International Organisation of Securities Commissions (‘IOSCO’) published a diagnostic report in relation to the events of March-April 2020 in the MMF sector, in addition to a thematic review assessing the implementation of certain IOSCO recommendations issued in 2012 to strengthen the resilience of MMFs around the world.
The diagnostic report describes how impacts varied considerably by MMF type, structure and currency. In the EU, euro-denominated non-public debt MMFs experienced large net outflows, albeit that this varied across funds. The report also notes that while the ECB programme did not directly benefit MMFs, it helped to restore market confidence. The analysis attempts to provide a description of the events that took place across jurisdictions, highlighting where the MMF sector remained stable and came under stress, and also suggests further analysis to strengthen the MMF regulatory framework.
IOSCO’s thematic review is based on the legislative, regulatory and policy measures in place in the nine largest MMF domiciles (including Ireland), and the implementation of IOSCO’s 2012 recommendations. The key findings from the review indicate that:
For further information on the issues mentioned above, or any related issues, please contact Frank Gannon, Head of Asset Management.