Asset Management Insights August 2022

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.

• New report – ESG Compliance by Design

• ESMA issues statement on the implementation of LEI requirements for third-country issuers under the SFTR reporting regime
• ESMA publishes updated AIFMD and UCITS Q&As
• ESMA proposes key risk factors for retail investors
• Voluntary disclosure of principal adverse impact under SFDR
• ESMA publishes call for evidence on pre-hedging
• EFAMA publishes latest statistics on funds for May 2022
  

Our latest report “ESG Compliance by Design” considers how designing and assuring ESG-compliant products is key to preventing reputational damage due to greenwashing in the financial and asset management industries. View the entire report here. 

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On 7 July 2022, ESMA issued a third statement on the implementation of the Legal Entity Identifier (‘LEI’) requirements for third-country issuers under the Securities Financing Transactions Regulation (‘SFTR’) reporting regime.

On 6 January 2020, ESMA issued a public statement on LEI Implementation outlining its support for the smooth introduction of the LEI requirements under SFTR. This was updated in April 2021, and the timeline for acceptance of SFT reports without the LEI of third-country issuers of securities lent, borrowed or provided as collateral in an SFT extended until 10 October 2022.

LEI issuer detail reporting

ESMA has monitored the reporting of LEI issuer details, noting that at present, around 14% of all open-ended SFTs miss an issuer LEI (compared to 16% in March 2021, and 26% in September 2020), with approximately 20% of the non-EEA securities lacking an LEI of the third country issuer in SFT reports. Given the continuing unsatisfactory level of global LEI coverage, ESMA acknowledges the potential reporting implementation issue for SFTs entered into by European investors for securities of third-country issuers.

ESMA expects that counterparties and other entities participating in SFTs that lend, borrow or use as collateral securities issued by third-country entities that do not have an LEI, liaise with those issuers with a view to ensuring that they are aware of the requirements under SFTR in order to further facilitate the use of their securities by the counterparties subject to SFTR reporting requirements.

ESMA maintains its position regarding third-country issuer LEI reporting and expects that trade repositories would not reject SFT reports of securities without a third-country issuer LEI which are lent, borrowed or provided as collateral in an SFT.

Mandatory reporting

However, ESMA notes that this does not, in any way, affect the mandatory reporting of the LEI in all other cases where it is prescribed by the regulation, including the identification of third-country entities taking part in a SFT. ESMA expects NCAs to continue not prioritising their supervisory actions in relation to reporting of LEIs of third-country issuers. ESMA also notes that it will give advance notice of at least six months to market participants regarding its position on the reporting of LEI for third-country issuers ahead of the date of application of this requirement in the SFTR validation rules. 

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On 20 July 2022, ESMA updated its AIFMD (PDF, 708KB) and UCITS Q&A documents. The updated AIFMD Q&A contains two new questions on depositaries (Section VI, Qs. 15 and 16) and one new question on delegation (Section VIII, Q. 4). In respect of the questions on depositaries:

• Answer 15 notes that, in relation to reconciliation frequency between a depositary’s internal accounts and those of any third party to whom safekeeping has been delegated, the reconciliation frequency depends not only on the dealing frequency of the relevant AIF or UCITS, but also on any trade which occurs even outside the dealing frequency. Therefore, if an AIF or UCITS with a weekly dealing frequency trades on a daily basis, daily reconciliations are required.
• Answer 16 notes that, in relation to reconciliation frequency between a depositary’s internal accounts and those of a tri-party collateral manager, the tri-party collateral manager is required to transmit the end-of-day positions on a fund-by-fund basis or, if applicable, on a compartment-by-compartment basis.

In respect of the new Q&A on delegation, ESMA notes that fund managers are responsible for compliance with the marketing communication requirements set out under Article 4 of Regulation (EU) 2019/1156, irrespective of who is the actual entity marketing the fund, and of the relationship it has with the third party distributor (whether it is contractual or not).

The same three Q&As are addressed in the updated UCITS Q&A document.

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On 20 July 2022, ESMA published an article on the development of key retail risk indicators (PDF, 420KB) (‘RRIs’) for the EU single market, proposing a conceptual framework that defines key terms, considers how to measure risks practically, and identifies sources of risk to consumers. The first selection of possible RRIs highlights risks concerning:

• inexperienced investors;
• the use of digital tools by younger investors; and
• spikes in overall trading during market stress.

The article notes that given the limited data available as well as the complexity of retail markets, a pragmatic rather than structural approach was the more realistic option for the development of RRIs, which would also be consistent with ESMA’s existing risk assessment. The article presents a provisional conceptual framework to give a practical definition of retail risk and to identify risk sources that can be used to segment the market for targeted risk analysis. Further work will be required by ESMA to refine and expand the set of RRIs and the associated methodology.

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On 28 July 2022, the Joint Committee of the three European Supervisory Authorities (‘ESAs’)(the European Banking Authority, European Insurance and Occupational Pensions Authority, and ESMA) published the first annual report (PDF, 430KB) on the extent of voluntary disclosure of principal adverse impact (‘PAI’) under art. 4(1)(a) of the SFDR. The report is based on a survey of National Competent Authorities (‘NCAs’) aimed to get a complete picture of the state of voluntary disclosures in the market. Having considered the responses provided, the ESAs have developed an indication of good examples of best practice, as well as some preliminary recommendations.

Among the preliminary conclusions reached were that the extent of compliance with voluntary disclosures varied significantly across jurisdictions and financial market participants (‘FMPs’) within the scope of the SFDR. As such, it was not possible to draw conclusions based on the size, nature and scope of activities carried out. However, the ESAs have noted that disclosures for the FMPs that do not take into account adverse impact of investment decisions on sustainability factors under art. 4 are lacking in detail, with FMPs not providing clear reasons for why this is not done, and with insufficient information on whether and when they intend to consider these. NCAs have also reported an overall low level of disclosure of the degree of alignment with the objectives of the Paris Agreement, with disclosures on alignment being vague and high-level.

Among the good examples of best practices in the disclosures cited are:

• The existence of a full PAI statement, prominent on the sustainability section of the website including, among other things, a description of principal adverse sustainability impacts, indicators applicable to investments in investee companies, identification of PAIs, prioritisation of PAIs, and the methodology and data used for the assessment of each PAI;
• The existence of a clear description of the process concerning consideration of PAI;
• The inclusion of credible decarbonisation objectives, upstream and downstream emissions, setting out the scale and timeline for action to achieve the trajectories consistent with the Paris Agreement, aligning specific investments with carbon-neutral trajectories.

The ESAs have made the following preliminary recommendations to NCAs in their ongoing supervisory actions, as well as for the purpose of subsequent annual surveys:

• Continuous market observation to identify FMPs that are not compliant with the voluntary disclosures and to ensure compliance with Article 4(1)(a) and (b) SFDR;
• Greater sample size and more details in reporting figures;
• Regular own market surveys/questionnaires;
• Offsite inspections as part of NCAs’ supervisory engagement;
• Use of IT tools to allow easier assessment;
• Additional instructions on voluntary disclosures.

The ESAs note that given that the detailed RTS on such disclosures are not yet applicable, with emerging supervisory practices on voluntary disclosures by FMPs, the good examples of best practice provided in the report are to be considered preliminary, and will be complemented further in later reports. Such reports will also cover voluntary disclosures under art. 7 SFDR, applicable from 30 December 2022.

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On 29 July 2022, the European Securities and Markets Authority (‘ESMA’) published a call for evidence on pre-hedging (PDF, 412KB), which aims to promote discussion among stakeholders and gather further evidence on the practice of pre-hedging to facilitate the development of appropriate guidance in this area.

The call for evidence arises following ESMA’s review of the Markets Abuse Regulation (‘MAR’), during the course of which mixed views were expressed on the utility of pre-hedging and its associated risks. While on the one hand pre-hedging involves a risk-management aspect, it may also fall within the scope of insider trading if a broker were to use the information received to make trades on his/her own account, including potentially trades against the client. Several market participants had asked ESMA to issue guidance on what is to be considered as MAR-compliant pre-hedging and what behaviour might constitute front-running. Guidance was also sought in respect of procedural aspects of pre-hedging, such as documentation, transparency and internal policies.

The call for evidence describes the practice of pre-hedging, as well as a list of arguments both critical and supportive of it, including the feedback received as part of the MAR review. The call for evidence also analyses pre-hedging from the perspective of MAR and MiFID II, and seeks feedback from market participants on how such provisions are currently applied, with particular focus given to those provisions governing conflicts of interest. Participants are invited to submit responses by 30 September 2022.  

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On 27 July 2022, EFAMA published its latest monthly Investment Fund Industry Fact Sheet (PDF, 412KB), providing data for UCITS and AIFs for May 2022. Net sales of UCITS and AIFs gave rise to net outflows of €36bn (compared to net outflows of €3bn in April 2022), with UCITS having net outflows of €33bn (compared to net outflows of €0.3bn in April), and net outflows for AIFs of €2.9bn (compared to net outflows of €3bn in April). Total net assets of UCITS and AIFs decreased by 1.9% during the period to €20.2tn.

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For further information on the issues mentioned above, or any related issues, please contact Jorge Fernandez Revilla, Head of Asset Management.