February 2021

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

1. Central Bank of Ireland Interim Director of Policy, Risk, Asset Management and Investment Firms addresses new prudential regime for investment firms under IFR/IFD

On 27 January, the Central Bank of Ireland’s Interim Director of Policy, Risk, Asset Management and Investment Firms, Gerry Cross, delivered a speech to the KPMG Investment Firms Regulation and Directive Webinar, in which he addressed the changing landscape for applicable firms under the Investment Firms Regulation (‘IFR’) and Investment Firms Directive (‘IFD’).

Mr Cross discussed the changing landscape in which investment firms operate, noting the increased role of the non-bank sector in the past 10 years, the accelerated evolution of the financial sector in Ireland due to Brexit, as well as the impact of rapid technological change in driving business models and service offerings. Mr Cross also commented on the findings arising from the Central Bank’s thematic review of a number of algorithmic trading firms in their incorporation of MiFID II RTS 6 requirements, which included varying levels of maturity across governance, control and risk management frameworks, and stated that the Central Bank would continue to drive higher standards of governance and oversight of technology.

In respect of the IFR/IFD framework, Mr Cross addressed the extent to which third country firms should be able to have access to EU markets, and the key features under the framework, which he considered to be aligned to the Central Bank’s approach to regulation, namely: (i) an outcomes focus; (ii) a risk-based approach; and (iii) proportionality. Under the framework, investment firms will be divided into different classes, essentially depending on their size, scale and activities. In this respect, and to achieve a proportional regime, Mr Cross noted that a so-called ‘K-factor’ capital requirements framework has been developed for ‘Class 2’ investment firms, a set of observable proxies that represent the risks or harm that an investment firm might cause to itself or others, with scalars to reflect the size of the firm, and with a focus on the importance and scale of client assets. Mr Cross also noted that IFR/IFD remuneration and governance requirements would depend on a firm’s classification and balance sheet size.

In respect of the application of the Central Bank’s national discretions under this regime, Mr Cross referred to the Central Bank’s recently published consultation paper on this issue (‘CP135’), which closes on 26 March 2021.

Given the forthcoming application date of 26 June 2021, Mr Cross stated that the Central Bank expected firms’ preparation for the IFR/IFD had been discussed at board level, with implementation projects stood up, having considered which IFR investment firm class it will be, and having completed a comprehensive analysis of all relevant aspects of the IFR/IFD and how they will impact on the firm’s business model.

2. Central Bank of Ireland established fast-track filing process and publishes Q&A for UCITS and AIFs as part of the implementation of the Sustainable Finance Disclosures Regulation (‘SFDR’)

In January, the Central Bank of Ireland published a short Q&A document ahead of the application date of the SFDR on 10 March 2021. The SFDR requires financial market participants and financial advisers, including UCITS management companies and Alternative Investment Fund Managers (‘AIFMs’), to make pre-contractual and ongoing disclosures to end investors in respect of the integration of sustainability risk, the consideration of adverse sustainability impacts, the promotion of environmental or social characteristics, and sustainable investment.

To facilitate the orderly implementation of the SFDR, the Central Bank has established a fast-track filing process for pre-contractual document updates based on the SFDR Level 1 text, under which UCITS and AIFMs will be able to certify compliance with the SFDR. Filings can be made from 11 January to 10 March 2021.

3. Central Bank of Ireland publishes 37th edition of AIFMD Q&As

On 2 February, the Central Bank of Ireland published the 37th edition of its Questions and Answers on the AIFMD. Four new Q&As (1136–1139) address issues concerning Depositaries of Assets other than Financial Instruments (‘DAoFI’), and Q&A 1140 concerns the scope of the term “issuing body” under the AIF Rulebook.

4. Central Bank of Ireland publishes issue 1 of markets update for 2021

On 19 January, the Central Bank of Ireland published the first issue of its market update for this year. Of particular note is that the Central Bank encourages industry to respond to the International Organisation of Securities Commissions (‘IOSCO’) exchange-traded funds survey to enable IOSCO to understand the activity of ETFs, market makers and liquidity providers during the period of market volatility in March/April 2020. The submission deadline is 1 March 2021.

European Commission and ESMA updates

5. ESMA consults on appropriateness and execution-only under MiFID II

On 29 January, the European Securities and Markets Authority (‘ESMA’) launched a public consultation on guidelines on the application of certain aspects of appropriateness and execution-only requirements under MiFID II. While the consultation paper will be primarily of interest to competent authorities and investment firms subject to MiFID II, it is also addressed to AIFMs when providing investment services.

Under MiFID II, investment firms providing non-advised services are required to request information on the knowledge and experience of clients or potential clients to assess whether the investment service or product envisaged is appropriate, and to provide a warning where deemed ‘inappropriate’. The execution-only framework allows for an exemption to this assessment where certain conditions are met, including that the firm issues a warning to the client. The purpose of the guidelines is to enhance clarity and foster convergence in the application of specific aspects of the appropriateness and execution-only requirements.

The 13 guidelines address the following areas:

  • Information to be provided to clients about execution-only, the appropriateness assessment, and its purpose;
  • Know your client and know your product;
  • Matching clients with appropriate products;
  • Qualifications of firm staff;
  • Record-keeping;
  • Determining situations where the appropriateness assessment is required; and,
  • Monitoring and compliance controls.

The deadline for submissions is 29 April 2021.

6. ESAs seek urgent clarifications from European Commission on the application of SFDR

On 7 January, the European Supervisory Authorities (comprising the European Banking Authority (‘EBA’), European Securities and Markets Authority (‘ESMA’), and European Insurance and Occupational Pensions Authority (‘EIOPA’)), wrote to the European Commission advising that they had encountered several important areas of uncertainty in the interpretation of the Sustainable Finance Disclosures Regulation (‘SFDR’), which have been voiced by stakeholders during the consultation process relating to draft regulatory technical standards, which are currently being finalised. The ESAs suggest that a number of priority matters would benefit from a more urgent clarification to facilitate an orderly application of SFDR from 10 March 2021, namely:

  • the application of SFDR to non-EU AIFMs and registered AIFMs;
  • the application of the 500-employee threshold for principal adverse impact reporting on parent undertakings of a large group;
  • the meaning of “promotion” in the context of products promoting environmental or social characteristics;
  • the application of Article 9 of SFDR concerning the transparency or sustainable investments in pre-contractual disclosures; and
  • the application of SFDR product rules to MiFID portfolios and other tailored products. 

7. ESMA reminds firms of the MiFID II rules on ‘reverse solicitation’ in the context of the recent end of the UK transition period.

On 13 January, ESMA issued a public statement reminding firms that under Article 42 of MiFID II, where a retail or professional client (as defined) established or situated in the EU initiates at its own exclusive initiative the provision of an investment service or activity by a third-country firm, the third-country firm is not subject to the requirements under Article 39 of MiFID II relating to the establishment of a branch.

ESMA notes that since the end of the UK transition period on 31 December 2020, some questionable practices by firms concerning reverse solicitation have emerged, such as attempts to circumvent MiFID II requirements through inclusion of general clauses in their terms of business, or though online pop-up “I agree” boxes, indicating that the transaction is executed at the exclusive initiative of the client.

ESMA reminds firms of the contents of recital 111 of MiFID II on this point, and that every means of communication used should be considered in order to determine whether a client or potential client has been subject to any solicitation, promotion or advertising in the EU on the firm’s investment services, activities or financial instruments. ESMA further reminds firms that the provision of investment services in the EU without proper authorisation in accordance with EU and national law exposes service providers to the risk of administrative or criminal proceedings, and that when using the services of investment service providers that are not properly authorised, investors may lose protection under relevant EU rules, including coverage under investor compensation schemes.

8. ESMA updates Q&As on EMIR and Prospectus Regulation

On 28 January, ESMA updated its Q&A document on EMIR implementation, amending TR Question 3b on how to report the direction of derivatives in specific cases under Article 9 of EMIR, and adding TR Question 57 on the procedure for terminating ‘dead trades’ by trade repositories.

On the same date, ESMA updated its Q&A document on the Prospectus Regulation, providing clarification on a number of points, including: the order of information in a prospectus; financial information which only covers short periods; use of the same prospectus to make several offers; disclosure requirements concerning statements prepared by an expert; the application of an exemption under Article 1(5); and the applicable disclosure annexes when drawing up a prospectus.

9. ESMA calls for legislative action on ESG ratings and assessment tools

On 28 January, ESMA wrote to the European Commission sharing ESMA’s views on the key challenges in the area of sustainable finance, the unregulated and unsupervised nature of the market for ESG ratings and ESG assessment tools, and the need to match the growth in demand for these products with appropriate regulatory requirements to ensure their quality and reliability. ESMA notes that compared with credit ratings, ESG ratings display very low levels of correlation across providers, leading to issues down the investment value chain. The risks of high levels of capital misallocation, product mis-selling and greenwashing are also high, without appropriate legal tools to address these issues. ESMA also makes a number of proposals that could be incorporated into a potential future legal framework to address the issues it identifies, namely:

  • The development of a common legal definition for an ESG rating that captures the broad spectrum of assessment tools currently available;
  • The registration and supervision of entities whose occupation includes the issuing of ESG ratings and assessments;
  • The development of specific product requirements applicable to ESG ratings and assessments provided by such entities;
  • Ensuring that under any regulatory framework, larger and more systemic entities are subject to a full suite of organisational and conflict of interest requirements that reflect their growing importance in sustainable finance. This should be adapted to the current market structure and accommodate both large multi-national providers as well as smaller entities.
  • Noting the high level of consolidation in the market for ESG ratings and ESG rating providers, which often belong to larger groups providing services such as green bond certifications and credit ratings, and given this market structure and the overlap with ESMA’s existing mandate for CRAs, ESMA sees merit in being the authority entrusted with direct supervisory responsibilities for these actors.

10. ESMA finalises rules on standardised information to facilitate cross-border distribution of funds

On 1 February, ESMA published its final report on implementing technical standards under the Regulation on cross-border distribution of funds.

The draft ITS sets out standard forms, templates and procedures for the publications and notifications by national competent authorities (‘NCAs’) on their websites, the notification of information by NCAs to ESMA and the publication of information by ESMA on its website. This includes the information to be published on NCA websites regarding the national rules governing marketing requirements for funds, and the regulatory fees and charges levied by NCAs in relation to fund managers’ cross-border activities.

The draft ITS are now with the European Commission, which will decide whether to adopt them within three months.

11. ESMA and EAFMA highlights areas for improvement regarding ELTIF Regulation

On 3 February, ESMA wrote to the European Commission, further to the Commission’s consultation on this topic, highlighting some areas of the European Long-Term Investment Funds Regulation (‘ELTIFs Regulation’) where improvements could be made. This follows a survey recently conducted by ESMA to map the state of play of the ELTIF industry relating to AuM, fees, portfolio holdings and performance of ELTIFs.

The changes proposed by ESMA are aimed at bringing ELTIFs more in line with the needs of investors, thereby making them a more attractive investment vehicle for professional investors, and a more attractive savings placement alternative for retail investors. ESMA also considers this would also improve the access to funding for SMEs and enable the ELTIF framework to reach its purpose in the recovery of the European economy and deepening of the capital markets union. ESMA’s proposals include the following:

  • Further extending and clarifying the scope of ELTIF’s eligible assets and investments;
  • Removing the requirement for the additional authorisation of an AIFM who intends to manage the ELTIF;
  • Clarifying the specific situations targeted by Article 12 of the ELTIF Regulation regarding conflicts of interest;
  • Allowing ELTIFs to invest in less than 10 investments;
  • Developing a regime to allow an ELTIF of indefinite duration under certain circumstances;
  • Loosening the reporting requirements on the schedule for the orderly disposal of ELTIF assets;
  • Ordering of the messages presented in prospectuses and/or reducing the amount of mandatory information included in them;
  • Removing the requirement for ELTIF managers to have a local physical presence in the states where it markets ELTIFs.
  • Similarly, on 26 January, the European Fund and Asset Management Association (‘EFAMA’) also shared its response to the European Commission’s consultation on measures to be taken to improve the ELTIF regime, and made the following recommendations:
  • Turning ELTIF into an open-ended structure alongside the existing closed-ended one by removing the current limitations to its life cycle and introducing appropriate redemption terms;
  • Broadening the scope of the current eligible asset provision to include other types of funds;
  • Lowering the current €10m threshold for investments in “real assets”;
  • Removing quantitative limits, allowing investments into ELTIFs from €1,000 to reduce supply-side constraints; and,
  • Guaranteeing the tax neutrality of the ELTIF structure to make it a worthwhile investment tool.

Following the Commission’s consultation, it is expected that it will send a report to the EU Parliament and Council assessing the functioning of ELTIFs.

Industry and other updates

12. EFAMA responds the European Commission consultation on the review of the AIFMD

On 1 February, EFAMA published its response to the European Commission’s consultation on the review of the AIFMD. EFAMA called on the Commission to follow a set of three overarching principles when reviewing the AIFMD framework in order to ensure it is adequately revised without undermining its foundations, namely:

  1. Do not fix something that is not broken – the review should be targeted only at addressing the material shortcomings that are clearly demonstrated, and which cannot otherwise be addressed through supervisory convergence or Level 2 harmonisation;
  2. Keep the AIFMD a ‘manager’ regulation – as distinct from a ‘product’ regulation as the AIFM sector is too diverse to include product-specific rules;
  3. Focus on supervisory and enforcement convergence, through the use of the powers at the Commission’s disposal, including enforcement powers, to promote greater supervisory and enforcement convergence.

In its response, EFAMA also comments a range of other aspects of the AIFMD framework, and in particular, it notes:

  • Given the high standard of harmonisation under the framework, it sees the need for few targeted amendments through Level 2 and Level 3 to improve the effectiveness of AIFMD.
  • Cross-border marketing and investor access rules for AIFs (and UCITS) do not need to be reviewed.
  • Given that AIFs are generally aimed at professional investors, flexibility must be given to AIFMs to provide relevant and meaningful information to their investors.
  • A passporting regime for retail AIFs is not necessary in light of the low cross-border retail demand for AIF products as compared to other products, in addition to their less standardised nature, greater requirement for financial literacy, and lower suitability for the needs of retail investors.
  • The introduction of a depositary passport is not recommended.
  • The inclusion of restrictive definitions or rules in the deployment of Liquidity Management Tools is cautioned against.
  • There are opportunities for supervisory authorities to work on their own data-sharing practices by allowing more efficient sharing and cross-referencing of data already provided by AIFMs.
  • Disproportionate requirements on AIFMs should be avoided in respect of sustainable finance and ESG factors.
  • Attributing additional competences and power to ESMA via the present AIFMD review is firmly opposed, and ESMA should first rely on its recently gained tools to bring about greater convergence.
  • A proposal to merge the UCITS Directive and AIFMD into a single regime is not supported, and the existing body of norms for asset management companies is built on the recognition that fund product types differ substantially from one another, as do their investor bases, and the current difference in treatment is considered justified.

13. EFAMA responds to the European Commission consultation on the review of the CSDR

On 2 February, EFAMA published its response to the European Commission’s consultation on the review of the Regulation on improving securities settlement in the EU and on central securities depositories (‘CSDR’).

EFAMA notes that it supports the main objectives of the CSDR to increase the safety and efficiency of securities settlement, including shorter settlement periods, prudential and supervisory requirements, and the imposition of a penalty regime. However, EFAMA further notes that given that the volume of failed trades has decreased substantially in recent years, parts of the proposed disciplinary sanctions set in the regulation and implementing texts are no longer proportionate to the remaining risks, particularly given that firms already make use of contractual remedies to deal with settlement fails. EFAMA’s comments therefore focus on a number of points, namely:

  • EFAMA strongly advocates for the removal of mandatory buy-ins given its likely negative impact on the efficiency of European capital markets, and instead opts for measures that better protect investors from being impacted by downstream issues with settlement. EFAMA also comments on the negative impact the mandatory buy-in regime would have on exchange traded products (‘ETP’) primary market transactions.
  • EFAMA invites the Commission to proceed cautiously as regards any significant amendments to the CSDR text in respect of the use of new technologies, and highlights that implementing significant amendments to the CSDR framework to accommodate these could complicate and hinder the provision of securities settlement service and the entry into force of the settlement discipline regime.
  • EFAMA also seeks urgent clarification on the proposed timeline for the legislative review of the CSDR and how this may impact upon the expected application of the settlement discipline regime of 1 February 2022.

14. EFAMA reports record net sales of UCITS equity funds in November

On 21 January, EFAMA published its latest monthly Investment Fund Industry Fact Sheet, providing net sales data of UCITS and AIFs for November 2020. Net sales of UCITS and AIFs in November totalled €78bn, up from €33bn in October. While UCITS recorded net inflows of €75bn (€31bn in October), AIFs recorded net inflows of €3bn (€2bn in October). Total net assets of UCITS and AIFs increased by 4.4% to EUR 18.38tn.

Contact us for more

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