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February 2020

In the last two editions, we commented on the new European agenda and the relentless focus on investment funds. Over the last four weeks there have been yet more regulatory outpourings targeted at or impacting the asset and fund management sector, which underline our key message: that the way in which the industry operates is under continued and deepening regulatory scrutiny, across all aspects of the business.

IOSCO's 2020 work programme (PDF 132 KB) includes a number of issues of direct relevance to asset and fund managers. Meanwhile, the MiFID II/MiFIR review consultation process has kicked off in earnest, the supervisory focus on liquidity management within investment funds is intensifying and there may be another twist in the PRIIP KID debate.

IOSCO's 2020 work programme

IOSCO will continue its work in a number of key areas: a thematic review of the implementation of the 2018 Liquidity Risk Management Recommendations; plans for data collection to measure leverage trends in funds; and analysis of the ETF market, both market-facing and investor-related issues. Three other areas of work are of direct relevance to the sector.

Last year, IOSCO engaged with the industry to gain a better understanding of potential areas of risks where artificial intelligence and machine learning (AIML) is being used by market intermediaries and asset managers. IOSCO will consult in early 2020 on guidance for regulators on issues to consider when regulating market participants that use AIML, with a final report expected by the end of the year.

IOSCO is developing a thematic analysis of the impact of the growth of passive investing on equity capital markets. The analysis will: (i) provide an overview of the increase in passive investing and its drivers; (ii) examine in more depth its impacts on market efficiency and corporate governance; and (iii) the consequences of the interplay between active and passive funds with regard to how investors collectively pay for efficient and effective equity markets. A report to the IOSCO Board in late 2020 will discuss these analyses and identify potential implications of passive investing for financial regulation.

IOSCO recognises that the rapid growth in digitalisation, especially social media, has changed the way financial products are marketed and distributed, providing new opportunities for domestic and cross-border offerings. In 2020, IOSCO intends to develop a toolkit of policy measures to address and mitigate the risks posed by online cross-border marketing and distribution, and guidance on enforcement approaches.

MiFID II/MiFIR review

On 17 February, the European Commission launched its long awaited public consultation on the review of the MiFID II/MiFIR regulatory framework. The consultation is designed for online response and is mainly a multiple choice questionnaire.

The Commission's stated objectives of the review are:

  • To rationalise information available to investors and intermediaries and make EU financial markets more transparent by:
    • targeted re-calibration of the product distribution process
    • increased transparency by introduction of the consolidated tape

  • To improve the competitiveness and functioning of the EU financial markets by:
    • increasing SME research coverage
    • fostering more commodity derivatives trading denominated in euros

Beyond these high level objectives, the consultation does not give a clear indication of likely rule changes. However, there are hints of what the Commission might be considering.

The Commission states that investor protection rules should strike the right balance between boosting participation in capital markets and ensuring that the interests of investors are safeguarded at all times during the investment process. It also says that information should be short, simple, comparable, and thereby easy to understand for investors. It asks:

  • How to improve retail consumers' direct access to simple investment products (e.g. certain plain-vanilla bonds, index ETFs and UCITS funds)?
  • How useful are the information documents received by professional clients and eligible counterparties ('ECPs') before making a transaction ('ex-ante cost disclosure'), is paper-based information needed, and is there a need for an EU-wide information database on existing investment products?
  • About the possible creation of an additional client category ('semi-professional investors') to encourage participation of wealthy or knowledgeable investors in the capital market.
  • Could the product governance regime be improved, and if so how?

Questions relating to the investment research payment rules focus on SME impacts, not on the rules more generally. Various options are suggested to improve access to information on SMEs, including a European database (c.f. the US “Edgar” system).

The consultation closes on 20 April and the Commission says its aims to adopt amendments in Q4 2020. This is an ambitious timeline and does not appear to differentiate between Level 1 and Level 2 rule changes, which require a different level of involvement of the Parliament and Council. In any event, the final rule changes are not likely to come into force until at least 2021.

Increasing supervisory focus on investment funds

ESMA has proposed an extension of its ability under MiFIR to restrict and prohibit the sales and marketing of financial products to UCITS and AIFs. Such powers would enable ESMA to suspend the marketing, sale and distribution of funds it deems unsuitable for retail investors. It notes that this would avoid the risk of “regulatory arbitrage” between MiFID firms and fund management firms.

ESMA has launched a Common Supervisory Action (CSA) with national competent authorities (NCAs) on the supervision of UCITS managers' liquidity risk management, to be conducted during 2020. A number of NCAs have already swung into action and some are also reviewing the current regulatory toolkit. In Spain, for example, the CNMV is looking into swing pricing as a method to manage liquidity shortages in funds that hold illiquid assets. The European Systemic Risk Board (ESRB) has said it wants the Commission to “operationalise” tools that exist but have never been deployed by national authorities, which would allow them to require a fund to suspend dealing.

Product disclosures and distribution

Another ESMA CSA has been launched on the application of MiFID II suitability rules across the EU, to gauge intermediaries' progress in implementing the rules. This CSA will also be conducted during 2020.

The Commission is now expected to undertake a wider review of how a range of regulations - including MiFID II, the Insurance Distribution Directive and the PRIIP KID Regulation - regulate retail distribution issues such as product disclosure, investor protection and suitability. The review is likely to consider which rules do and do not work, and areas that overlap, contradict each other or are superfluous. It is not clear whether, and if so how, this review will overlap with the ongoing work by the ESAs on seeking to make the PRIIP KID fit-for-purpose.

Questions for CEOs

  • In what ways do we, or distributors of our products, use artificial intelligence or machine learning? Have we identified the risks?
  • How do we identify and mitigate the risks involved in distribution and marketing via digital channels, both domestically and cross-border?
  • Are we fully engaged with the MiFID II/MiFIR review process? Are we doing any forward-thinking about areas of the rules that might change and what that would mean for our business?
  • Have we thoroughly reviewed our liquidity risk management process across all our funds? Are we fully in line with regulators' expectations? Can we evidence how we identify and manage risks to fund investors?