Asset Management Insights June 2021 Asset Management Insights June 2021 Asset Management Insights June 2021

On 19 May 2021, the Central Bank of Ireland’s Director General of Financial Conduct, Derville Rowland, delivered a speech on “Covid-19, funds sector, and sustainably serving the economy” at the Irish Global Funds Conference. In her speech, Ms Rowland addressed the impact that COVID-19 has had on the financial services industry, and noted that in light of the events of the last year, including the significant turbulence experienced in the funds sector, money market funds and liquidity management practices in the funds sector were currently under the Central Bank’s consideration. Further, the experience of COVID-19 has further highlighted the need to develop of a comprehensive macroprudential framework for the non-bank sector, which remains a priority for the Central Bank.

Ms Rowland also addressed the Central Bank’s expectations of the Irish funds sector, noting the ‘enhanced scrutiny’ applied by the Central Bank to certain funds in 2019, and the recent in-depth thematic review of fund management companies concerning governance, management, oversight and control, and the consequent remedial action plans developed by individual firms.  Further, Ms Rowland addressed the recent letter issued to UCITS managers following ESMA’s CSA (see above), which outlined the actions now required to be taken by all Irish UCITS managers on foot of those findings.

Ms Rowland also highlighted, inter alia, the need for diversity at senior management and board level across all firms, having regard to the Central Bank’s recently-published data on PCF roles in the financial sector. Further, in respect of ESG issues, Ms Rowland highlighted the “very significant role” for the investment management sector in the transition to a sustainable economy, noting that the Central Bank expected all industry participants to move forward to ensure compliance with the various new sustainability requirements. 

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On 2 June 2021, the Central Bank of Ireland published its Annual Report 2020 and Annual Performance Statement 2020-2021. In relation to asset management and investments supervision, the report notes that the Central Bank’s supervision activities were particularly focused on the operational resilience of the sector and the continuity of services, which contributed to a number of important supervision outcomes, namely:

• Core risk assessments across key risks such as IT, governance and operational risk;
• Proactive engagement with supervised entities on their preparedness for Brexit and risks presented to their business models;
• The completion of the algorithmic trading thematic review to assess the governance and risk management frameworks in place for algorithmic trading firms;
• Enforcement actions to promote compliance with regulatory requirements;
• A skilled person review on risk management, compliance and control functions; and

The conclusion of a thematic review on Fund Management Company (‘FMC’) Effectiveness Guidance, further to which the Central Bank has required prompt remediation by those firms where shortcomings were identified, with all other FMCs required to critically assess their daily operations against the requirements, taking into account the findings of the review, and implementing the necessary changes to ensure full and effective embedding of all aspects of the Central Bank’s requirements and guidance.

The report also sets out the Central Bank’s strategic priorities for 2021 across the regulated financial services sector, which it will address through a number of activities, namely:

• Maintaining its focus on the financial and operational resilience of firms and markets, in particular investment funds, and to develop, in association with European and international partners, a comprehensive macro-prudential framework for the non-bank sector.
• Focusing on strong governance and risk management capabilities in firms and markets to improve culture and decision-making and to ensure that risks are identified, managed and effectively mitigated. These include risks arising from disruptive change, such as technological and market innovation, as well as climate-related financial risks.
• Striving to deliver effective supervision of AML/CFT.
• Strengthening the client assets regime for a broader landscape of entities holding client assets.
• Ensuring that firms identify risks/threats to the long-term sustainability of their business models and advance digital and business strategies to support business model sustainability and transformation;
• Strengthening the consumer protection framework through a review of Consumer Protection Code;
• Developing regulations in relation to recovery planning for firms;
• Introducing a Senior Executive Accountability Regime (‘SEAR’) to have a clearer focus on accountability within firms. 

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On 26 May 2021, ESMA published its response to the European Commission’s targeted consultation on the functioning of the European Supervisory Agencies (‘ESAs’). The review comes just two years following the culmination of the latest review of the ESAs in late 2019, which in ESMA’s view, meant that it was too early to meaningfully assess the full impact of most of the changes consequently agreed by the co-legislators. However, in light of COVID-19 and Brexit, ESMA acknowledges that the environment in which it now operates has changed dramatically in just a short period of time, which presents new challenges for it, national competent authorities, and market participants.

ESMA considers that in light of the 2020 Capital Markets Union Action Plan, ESMA’s mandate must continue to be appraised in order to ensure that it continues to have the appropriate tools and capabilities to drive EU supervisory convergence and ensure a level playing field among market participants. To this end, ESMA makes some general recommendations for the Commission’s consideration, namely:

• Reinforcing ESMA’s approach to supervisory convergence through regular appraisal and strengthening of its regulatory toolkit, which in recent times saw the addition of a new peer review process, Union Strategic Supervisory Priorities (‘USSP’), coordination groups, an EU supervisory handbook, and a new Questions and Answers (‘Q&A’) process.
• Consideration of the merits of granting ESMA further EU direct supervision responsibilities, building on its current role as direct supervisor and enforcer of EU credit rating agencies and trade repositories, and enhancement of its role as a gatekeeper to the EU capital market.
• Building ESMA’s data capabilities in light of its aim to increasingly become a data hub for EU securities markets in order to enhance the availability of information at EU level for regulators, investors and market participants.
• Ensuring that the single rulebook remains fit-for-purpose through further reinforcement and harmonisation of the legislative framework. 

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On 27 May 2021, ESMA published its final report on the guidelines under the Regulation on cross-border distribution of funds, specifying the requirements that funds’ marketing communications must meet, namely to:

• be identifiable as such;
• describe the risks and rewards of purchasing units or shares of an AIF or UCITS in an equally prominent manner; and
• contain clear, fair and non-misleading information which takes account of online aspects of marketing communications.

The guidelines apply to UCITS management companies (including any UCITS which has not designated a UCITS management company), Alternative Investment Fund Managers, EuVECA managers and EuSEF managers, and apply in respect of all marketing communications addressed to investors or potential investors, including when they are set up as EuVECAs, EuSEFs, ELTIFs and MMFs.

The guidelines provide examples of those materials which may be considered as marketing communications, such as messages advertising UCITS or AIFs, or messages broadcasted on any social media platform when such messages refer to any characteristics of a UCITS or AIF. The guidelines also set out those communications that should not be considered as marketing materials, including any legal and regulatory documents of a fund (such as the prospectus), or short messages broadcast online that only include a link to a webpage where a marketing communication is available, but which do not contain any information on a specific AIF, UCITS or group of AIFs or UCITS.

The guidelines apply 6 months after the date of the publication of the guidelines on ESMA’s website in all EU official languages.

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On 28 May 2021, ESMA updated it Q&A documents on the application of the UCITS Directive, as well as on the application of the AIFMD.

The updated UCITS Q&As provide 2 new answers in relation to the performance reference period for the benchmark model and in the case of funds’ mergers. In respect of the AIFMD Q&A, 6 new answers are provided in relation to reporting requirements under Articles 3, 24 and 42, and in relation to the scope of ESMA’s guidelines on performance fees. The AIFMD Q&A also provides similar answers in relation to the performance reference period in respect of the benchmark model and in the case of funds’ mergers. 

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On 28 May 2021, ESMA updated its Opinion on the collection of information for the effective monitoring of systemic risk under the AIFMD, which provides details on a set of additional information that, in ESMA’s view, NCAs could require AIFMs to report on a periodic basis under Article 24(5) of the AIFMD, namely:

• Information on the number of transactions carried out using a high frequency algorithmic trading technique, together with the corresponding market value of buys and sells in the base currency of the AIF;
• Information on geographical focus based on the domicile of investments made, expressed as a percentage of the total value of assets under management;
• Information on short positions, supplemented by an indication of whether the position is used to hedge a position with a similar economic exposure;
• Further information on risk measures, including calculation of the AIF’s VaR using either a Monte Carlo simulation, Historical simulation or Parametric VaR;
• Information on a portfolio’s sensitivity to a change in FX rates or commodity prices; and
• Information on non-EU master AIFs that are not marketed in the EU.

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On 3 June 2021, ESMA published its first risk dashboard for 2021 covering the first quarter of the year, highlighting that the main risk for EU financial markets remains the risk posed by a sudden risk reassessment amid the general decoupling of securities prices from economic fundamentals. Consequently, ESMA maintains its risk assessment at a “very high” level.

ESMA notes that valuations in EU financial markets for most market segments are either at or above pre-COVID-19 levels, and remain highly sensitive to events and are volatile. ESMA considers that credit risk is likely to increase further due to increasing corporate and public debt levels, and going forward it sees a prolonged period of risk to institutional and retail investors of further – and possibly significant – market corrections. Very high risks are seen by ESMA across the whole of its remit, and it considers that the extent to which those risks will further materialise will critically depend on market expectations on monetary and fiscal policy support, as well as on the pace of the economic recovery.

With respect to the asset management sector specifically, the report notes that as stress receded after the beginning of the pandemic, bond funds reduced their cash holdings, while the credit risk profile of investment grade bond funds has slightly deteriorated. EU MMFs continued to expand their NAVs, although liquidity buffers deteriorated slightly, though remaining substantially above pre-stress levels and regulatory requirements. While EU-domiciled hedge funds reduced their leverage through derivatives, they increased their financial leverage through borrowings. Further, while overall interconnectedness of the financial system through bank-to-fund connections remains below pre-crisis levels across fund-types, ESMA notes that concerns over valuation of portfolio assets have clearly emerged, especially for real estate funds, while Liquidity Management Tools’ availability varies considerably across fund types and jurisdiction.

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On 18 May 2021, the European Fund and Asset Management Association (‘EFAMA’) published its response to the joint ESA consultation on taxonomy-related sustainability disclosures under the Sustainable Finance Disclosure Regulation (‘SFDR’).

The response identifies six key issues which EFAMA thinks the ESAs ought to address, namely:

• Timeline-related implementation challenges, noting that if the taxonomy-related amendments to the SFDR RTS were finalised only after the Commission endorsed the SFDR RTS submitted by the ESAs in February, the technical standards would not be endorsed as a single rulebook, but instead would result in two sets of RTS coming into force at different times, resulting in confusing interpretation by the market.
• A recommendation that key performance indicators be consistent with the forthcoming Delegated Act under Article 8 of the Taxonomy Regulation, with financial undertakings being allowed a choice of using either turnover or CapEx, depending on which indicator is more relevant to a particular sector or company.
• A recommendation that derivatives only be included on an optional discretionary basis given their complexity and the technical questions that could arise in the event of their inclusion, as well as potentially disproportionate reporting requirements.
• A recommendation that the proportion of non-assessable assets (such as sovereign bonds, cash or commodities) be disclosed in the template as a secondary indicator in a pie-chart or the accompanying narrative in order to balance the principles of comparability, conciseness and relevance.
• EFAMA commented that it didn’t see a need for statements on compliance to be audited by external or third parties as the market and standards were not mature enough to include third-party assessments.
• EFAMA recommends that the periodic disclosures Level 2 requirements should enter into application in 2023 given that investors will not have the data available for periodic disclosures in 2022.
• EFAMA recommends that while waiting for a complete taxonomy to be produced, a product should be able to positively claim a social objective, and not only in opposition to the climate taxonomy.
• Finally, EFAMA notes that due to the market concentration amongst ESG data, research and rating providers, there is a risk of high fees being charged by taxonomy data providers, leading to increased costs for end-investors, which would be detrimental for smaller asset managers and would create barriers to entry for new players and sustainable investors.

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On 2 June 2021, EFAMA published its response to the draft Delegated Act under Article 8 of the Taxonomy Regulation, welcoming the Commission’s proposal for a transitional period under Article 11 of the Delegated Act, as it considers that this will address numerous practical implementation challenges previously identified.

Notwithstanding this, EFAMA has made a number of recommendations in relation to the delegated act, namely:

• The alignment of timelines of taxonomy-related product disclosures in the SFDR, the ESG updates to MiFID II and Insurance Distribution Directive delegated acts, as well as the Ecolabel;
• The need to address the potential confusion that might be caused by quantitative taxonomy eligibility disclosure requirements during the transition period;
• The need to have consistent taxonomy alignment methodologies at both entity and product levels;
• The need to align the taxonomy of firms that are not in the scope of the NFRD; and
• Consideration of providing taxonomy alignment disclosures for Article 8 and 9 funds, with the possibility to conduct taxonomy screening of Article 6 SFDR fund portfolios on an optional basis.

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On 25 May 2021, EFAMA published its latest monthly Investment Fund Industry Fact Sheet, providing net sales data of UCITS and AIFs for March 2021, which totalled €78bn (up from €38bn in February). While UCITS recorded net inflows of €69bn (€34bn in February), AIFs recorded net inflows of €8bn (€4bn in February). Total net assets of UCITS and AIFs increased by 2.9% to €19.66tn (€19.1tn in February).

In addition, on 2 June, EFAMA published its quarterly statistical data release describing the trends in the European investment fund industry in Q1 2021. Net assets of UCITS and AIFs grew by 4.5% over the quarter to €19.6tn, attracting €201bn in net inflows.

For Ireland, net assets at end-Q1 stood at €3.5tn (€3.3 end-Q4 2020), with net sales for UCITS and AIFs dropping from €115bn in Q4 2020 to €40.5bn in Q1 2021.

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