Asset Management Insights November 2021 Asset Management Insights November 2021 Asset Management Insights November 2021

On 8 November 2021, the Governor of the Central Bank of Ireland, Gabriel Makhlouf, delivered a speech at the Economic and Social Research Institute on the subject of macroprudential policy in Ireland in which he noted that the Central Bank would conduct a review across three pillars of the macroprudential framework: borrowers, banks and non-banks.

Governor Makhlouf advised that the Central would consider the market-based finance sector in Ireland as part of this review, in particular Irish-domiciled investment funds, which had grown considerably in size and importance over recent years. Governor Makhlouf noted that exposures of the Irish non-bank sector were largely international in nature, but that linkages to the domestic economy were growing, especially through exposures to the domestic commercial real estate market. While the diversification of financing channels for CRE away from domestic investors towards international investors and a reduced reliance on debt financing intermediated by Irish retail banks had increased risk-sharing and reduced domestic interconnectedness, it also increased the sensitivity of the Irish CRE market to global shocks.

Accordingly, Governor Makhlouf advised that in the coming weeks the Central Bank would publish a consultation paper on potential measures to limit leverage and liquidity mismatches in the property fund sector. These measures will aim to strengthen the resilience of this form of financial intermediation, guarding against the risk that financial vulnerabilities in the sector amplify adverse shocks in future times of stress, in order to better equip the sector to serve as a valuable and sustainable source of funding for economic activity. Governor Makhlouf advised that the Central Bank would proceed cautiously, but with determination, in this area.

Further, given the international nature of the non-bank sector in Ireland, Governor Makhlouf noted that a key priority for the Central Bank was the development and operationalisation of a macro-prudential framework for non-banks at a global level, which should be internationally coordinated. Against that background, Governor Makhlouf considered that the recently published FSB policy proposals to enhance money market fund resilience was the first in a body of work that aimed to address the vulnerabilities identified in the Holistic Review of the March 2020 Market Turmoil.  (See below for further details of the FSB proposals.).

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On 9 November 2021, the Director General of the Central Bank of Ireland for Financial Conduct, Derville Rowland, delivered a speech at the Managed Funds Association Global Summit, addressing a range of topics relevant to the asset management industry, namely the Central Bank’s strategy, priority work areas for ESMA and the international regulatory community, including the European Commission’s ongoing review of the AIFMD. Ms Rowland also noted the significant size and continued growth of the investment funds industry, particularly relative to the size of the Irish economy, with AUM in Irish domiciled funds of €3.3tn, and almost 8,000 investment funds authorised in Ireland.

Ms Rowland advised that the Central Bank placed vital importance on being at the heart of the European System of Financial Supervision (‘ESFS’), and as such strongly supported the progress made at an EU level to enhance regulatory convergence and in the development of a common supervisory approach.  Having regard to the items on the EU and international regulatory agenda, Ms Rowland highlighted the importance of effective liquidity management for the protection of investors, the maintenance of market integrity, and the reduction of systemic risk. Ms Rowland noted that the vulnerabilities in the sector highlighted by the COVID-19 pandemic needed to be addressed by regulatory reform, and to that end, recalled the steps taken by regulators, including scrutinising the robustness of liquidity management and the implementation of current requirements. These steps also include ESMA conducting a Common Supervisory Action on UCITS liquidity management, and the European Systemic Risk Board recommendation on liquidity risks in investment funds.  At an international level, Ms Rowland noted that the Central Bank was actively engaged in workstreams at the FSB and IOSCO relating to Money Market Funds (‘MMFs’) and liquidity management practices of open-ended funds generally and noted that work in this area would continue into 2022, with regulators progressing further initiatives.

With respect to Ireland, Ms Rowland noted that the Central Bank was conducting a significant body of work in respect of costs and fees charged by UCITS investment funds via the ESMA Common Supervisory Action. This topic was chosen because of the major impact they can have on long-term investment returns, and the critical importance for investors of having comparable information on costs of investment products. Separately, Ms Rowland noted the need to accelerate regulatory action in the area of sustainable finance and noted that the implementation of several EU legislative requirements (such as the Sustainable Finance Disclosure Regulation (‘SFDR’); Taxonomy Regulation; amendments to UCITS Directive, AIFMD and MiFID II; the proposal for a Corporate Sustainability Reporting Directive (‘CSRD’) and elements of the European Commission’s new sustainable finance strategy) would be a key area of focus for the Central Bank into 2022.

Finally, with respect to the review of the AIFMD, Ms Rowland considered it important to highlight systemic risk, noting that the Central Bank has advocated for the development of systemic risk-monitoring and related powers. The Central Bank also considered as critical the existence of a well-developed EU framework to support the availability and deployment of liquidity management tools. Ms Rowland noted that any changes to the AIFMD (or the UCITS Directive) should focus on enhancing the effectiveness of fund management companies to discharge their obligations.

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On 21 October 2021, the European Supervisory Authorities (‘ESAs’) opened a call for evidence regarding the Packaged Retail and Insurance-based Investment Products (‘PRIIPs’) Regulation. This will feed into the ESAs’ technical advice to the European Commission on a review of the key information document (‘KID’) for PRIIPs. The ESAs are requesting information from stakeholders on a range of topics including:

• Use of the KID, including the number and type of products and their market share for which PRIIPs KIDs are produced and distributed;
• Operation of the comprehension alert;
• Practical application of the rules under the PRIIPs Regulation, including the amount and nature of costs per PRIIP to various market participants of complying with the PRIIPs Regulation,
• Use of digital media for delivering displaying the PRIIPs KID;
• Scope of the PRIIPs Regulation, including whether the exemption of certain products should be maintained, or whether the Regulation should be expanded to include additional financial products;
• Differentiation between different types of PRIIPs;
• Complexity and readability of the KID, and whether specific changes should be made to improve comprehensibility or readability;
• Performance scenarios and the treatment of past performance;
• PRIIPs offering a range of options for investment (Multi-Option Products); and
• Alignment between the information on costs in the PRIIPs KID and other disclosures.

The call for evidence is open until 16 December 2021, with the ESAs planning to hold a stakeholder event in Q1 2022 before finalising the advice. 

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On 22 October 2021, the ESAs delivered a report to the European Commission containing their final draft Regulatory Technical Standards (‘RTS’) on disclosures under the SFDR, relating to financial products that make sustainable investments contributing to environmental objectives. The draft RTS aim to provide disclosures to end-investors on investments in financial products in environmentally sustainable economic activities and to provide them with comparable information facilitating informed investment choices. The draft RTS also establishes a single rulebook for sustainability disclosures under the SFDR and Taxonomy Regulation (‘TR’).

The report contains a number of proposals, including (for products under Articles 5 and 6 of the TR):

1. Inclusion of pre-contractual and periodic disclosures that identify the environmental objectives to which the product contributes, and show how and to what extent the product's investments are aligned with the EU Taxonomy;
2. For measuring how and to what extent activities funded by the product are aligned with the EU taxonomy, the proposals comprise two elements, namely: (1) two graphs showing the taxonomy-alignment of investments of the financial product based on a specified methodology that calculates that alignment; and (2) an assurance provided by an auditor or a review by a third party that the economic activities funded by the products that qualify as environmentally sustainable are compliant with the criteria of the TR.

For pre-contractual and periodic disclosures, amendments are made to the mandatory templates for financial products that promote environmental and/or social characteristics or have a sustainable investment objective under the SFDR, so as to include additional disclosures for Article 5 and Article 6 products under the TR.

The European Commission will examine the draft RTS, and will decide whether to endorse them within three months. In this regard, The Commission has informed the European Parliament and Council that it intends to incorporate all the SFDR RTS (both the original ones submitted to the Commission in February 2021 as well as the ones covered in the Final report) in one instrument.

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On 21 October 2021, the European Fund and Asset Management Association (‘EFAMA’) published its latest monthly Investment Fund Industry Fact Sheet, providing data for UCITS and AIFs for August 2021. Net sales of UCITS and AIFs totalled €53bn (down from €140bn in July), with UCITS having net inflows of €72bn (down from €107bn in July), and net outflows for AIFs of €19bn (compared to net inflows of €33bn in July). Total net assets of UCITS and AIFs increased by 2.7% during the period to €21.3tn.

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On 25 October 2021, EFAMA issued a public statement expressing its relief at the proposal by the European Parliament’s ECON Committee to extend the UCITS exemption for funds (with the support of the Council). EFAMA notes that this change would require fund managers to produce the PRIIP KID from 1 January 2023, instead of 1 July 2022, as originally proposed by the European Commission. EFAMA awaits agreement and publication of all relevant changes in the Official Journal of the European Union by year-end.

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On 27 October 2021, EFAMA published a report on the automation and standardisation rates of fund orders received by transfer agents (‘TAs’) in the cross-border fund centres of Luxembourg (75% of cross-border market volumes) and Ireland (80% of cross-border market volumes) in 2020.

The report’s key findings highlight:

• An increase in the total volume of orders processed by the 29 survey participants (48.7m in 2020, compared to 42.2m in 2019).
• An increase in total automation rate of orders of cross-border funds to 93.2% in Q4 2020 (91.8% in Q4 2019). This was due to an increase in the use of proprietary file transfer protocols by TAs in Ireland.  The use of ISO messaging standards decreased from 62.3% to 59.4% and the use of manual processes dropped from 8.2% to 6.8% during the same period.
• An increase in the total automation rate of orders processed by Irish TAs to 95.9% in Q4 2020, (up from 94.6% in Q4 2019) as compared to 91.2% in Luxembourg. The ISO automation rate decreased from 36.6% to 33.6%, with the use of manual processes decreasing from 5.4% to 4.1% during the same period.

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On 3 November 2021, EFAMA issued a public statement expressing its support for the formation of the International Sustainability Standards Board (‘ISSB’) as announced by the IFRS Foundation, noting that the investment management industry was keen to actively engage in its governance and technical work, as it develops.

EFAMA noted that asset managers could still not fully integrate climate change considerations in their investment decisions, due to the global fragmentation of climate-related disclosures, the modest comparability of disclosed information and the absence of a single, global mandatory reporting framework. In this regard, EFAMA considers it essential that the ISSB focuses on converging the numerous existing standards into a common basis for a mandatory global sustainability reporting framework.

EFAMA also noted that it would welcome a commitment by the ISSB to widen the IFRS’ approach to materiality in sustainability reporting by including companies’ positive and negative climate impacts, on top of how environmental risks impact companies (i.e. ‘double materiality’).

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On 11 October, the Financial Stability Board (‘FSB’) published its final report setting out policy proposals to enhance MMF resilience, following the market turmoil experienced in March 2020. The report notes that MMFs are subject to two broad types of vulnerabilities that can be mutually reinforcing: (1) they are susceptible to sudden and disruptive redemptions; and (2) they may face challenges in selling assets, particularly under stressed conditions. The prevalence of these vulnerabilities in individual jurisdictions may depend on market structures, use and characteristics of MMFs.

The FSB report considers the likely effects of a broad range of policy options in order to address these vulnerabilities, grouped according to the main mechanism through which they aim to enhance MMF resilience. These include mechanisms to:

• impose on redeeming fund investors the cost of their redemptions;
• absorb credit losses;
• address regulatory thresholds that may give rise to cliff effects; and
• reduce liquidity transformation.

The report states that two sets of considerations were relevant for jurisdictions when selecting MMF policy options, namely: (1) how to prioritise specific options in the context of identified vulnerabilities, to be considered in light of existing regulations, the size and structure of the MMF sector in the jurisdiction, currency denomination, and the use of MMFs by different types of investors and borrowers in short term funding markets; and (2) how authorities can combine options to address all MMF vulnerabilities prevalent in the jurisdiction, noting that a single policy option alone may not be sufficient to address all vulnerabilities.

The report notes that FSB members are assessing, or will assess, MMF vulnerabilities in their jurisdictions and will address them using the framework and policy toolkit in this report, in line with their domestic legal frameworks. The report goes on to note that while individual jurisdictions need flexibility to tailor measures to their specific circumstances, there are also important cross-border considerations to be kept in mind. International coordination and cooperation on implementing policy reforms was therefore considered critical to mitigate spillovers and avoid regulatory arbitrage.

Finally, the report states that the FSB will, working with the International Organization of Securities Commissions (‘IOSCO’), review progress made by member jurisdictions in adopting reforms to enhance MMF resilience. This involves a stocktake by the end of 2023 of the measures adopted by FSB member jurisdictions, with an assessment by 2026 of the effectiveness of these measures in addressing risks to financial stability. Furthermore, the report notes that IOSCO plans to revisit its 2012 Policy Recommendations for Money Market Funds in light of the framework and policy toolkit in this report. Depending on the timing of IOSCO’s review, this exercise may form part of the initial stocktake by the FSB and IOSCO.

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