March 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.

Central Bank of Ireland updates

1. CBI publishes Securities Markets Risk Outlook Report

On 8 February 2022, the Central Bank of Ireland published its Securities Markets Risk Outlook Report 2021, highlighting key risks it sees as facing securities markets in 2022, as well as setting out its expectations of regulated financial service providers in identifying, mitigating and managing risks.

Concerning governance, risks relating to ineffective board oversight of delegates and third-party intermediaries remain a major factor in the regulatory deficiencies seen by the Central Bank, including for funds and fund service providers, and it notes that there has been evidence of fund managers and boards not undertaking sufficient due diligence of delegates.

Further, the report notes that a significant number of firms had not implemented a governance framework to the standard set by the Central Bank’s Fund Management Companies Guidance of December 2016. Among the deficiencies identified by the Central Bank in its 2020 thematic review of Fund Management Companies’ Governance, Management and Effectiveness were a failure by FMCs to have appropriate resources at their disposal to enable them to carry out their functions properly.

Skills and experience of staff were also found to be lacking. The 2020 FMC guidance review also found failures in appointing local designated persons with the relevant skills and appropriate seniority for their management function. Further, in many cases, the time committed by the designated person to carry out required tasks was insufficient.

The Central Bank also observed an increase in the number of self-managed investment funds appointing a third-party FMC to meet the requirements of the FMC Guidance. In this regard, the Central Bank requires third-party FMCs to critically assess the impact of proposed new business in order to ensure that they are appropriately resourced to service any additional business. The Central Bank also highlighted its concerns with respect to investment advisors being appointed to a fund and acting with more influence and control than was appropriate and has noticed an increased incidence of investment advisors acting as de facto investment managers; such a practice is not consistent with the information disclosed in the prospectus and exposes investors to increased loss.

The Central Bank has advised that it expects FSPs to ensure that boards are accountable for all aspects of governance, including having a clear organisational structure that defines and clarifies responsibilities for operational, control and reporting processes, and identifies those within the firm responsible for making key decisions. FSPs should also adhere to all legislative requirements on outsourcing, and have regard to the new Cross-Industry Guidance on Outsourcing. With respect to funds/FMCs specifically, the Central Bank expects that these:

  • Consider and address how resources and operational capacity will need to change to take account of any increase in the nature, scale and complexity of funds under management;
  • Ensure a detailed rationale is provided for the appointment and the role the entity will fulfil where investment advisors are appointed in respect of a particular fund; and
  • Receive and scrutinise, at regular intervals, the necessary reports from investment managers on portfolio management, including any interaction with investment advisors.

With respect to conflicts of interest, the report notes that a fundamental conflict of interest arises around transactions between the investment fund and connected parties, including delegates and service providers, for which the Central Bank has developed the Connected Party Transaction Rules. In this regard, shortcomings have been identified in respect of the rigour with which some depositaries and designated persons perform these duties, and there were certain cases where relevant parties were not being informed when such connected transactions have or are to be undertaken. In this regard, the Central Bank expects financial service providers, inter alia, to ensure regulatory requirements on identifying, mitigating, and managing conflicts of interest are being met, to have robust processes and procedures to identify any connected or potentially connected transactions, and to engage rigorously with their fund depositaries and designated persons when such transactions are being contemplated.

On financial innovation, the report notes that the Central Bank has seen an increase in queries on whether UCITS or AIFs may be invested in digital/crypto-assets, and in this regard, the Central Bank has previously noted that while such assets may be suitable for wholesale or professional investors, it would be highly unlikely to approve a UCITS or a Retail Investor AIF proposing an exposure (either direct or indirect) to crypto-assets, taking into account the specific risks attached to crypto-assets and the possibility that appropriate risk assessment could be difficult for a retail investor without a high degree of expertise. For funds/FMCs, the Central Banks expects that these:

  • Maintain an adequate level of oversight and due diligence over the selection of index providers for funds they manage to ensure the best outcome for investors; and
  • Ensure that dealing and settlement times for funds they manage are consistent with the liquidity profile of the portfolio of assets.

The report also addresses market dynamics, and in this regard the Central Bank expects funds/FMCs to have an appropriate risk management framework in place to identify, manage and mitigate the potential risks arising from use of leverage and liquidity risk within a fund’s portfolio, to regularly stress test their liquidity and leverage positions against plausible shock scenarios, and assess its impact on the fund’s performance and investors’ redemption requests. Funds/FMCs are also expected to have regard to the recent European Securities and Markets Authority (‘ESMA’) and Central Bank reports, letters, and public statements on liquidity risk management.

In relation to sustainable finance, the Central Bank expects firms to have regard to the supervisory expectations set out in the Central Bank’s climate change and sustainability letter issued in November 2021, focusing on five key areas, namely: governance; risk management frameworks; scenario analysis; strategy and business model risk; and disclosures.

Finally, with respect to operational resilience, firms are expected, inter alia, to understand the specific IT-related risks faced by their firms and to ensure that these are sufficiently mitigated in line with the firm’s risk appetite, as well as have a programme of risk analysis and oversight to identify and minimise sources of cybersecurity risk. Data quality will also remain a focus of the Central Bank, and firms can expect increased engagement in respect of data quality issues, which may take the form of supervisory action where firms do not have sufficient frameworks in place to meet reporting obligations and to ensure that data is reported in a complete, accurate and timely manner.

The Central Bank advises that the contents of the report will assist securities markets participants, including FMCs to assess the risks they face and to inform risk mitigation planning, and warns that it will take appropriate supervisory action where firms have not considered the report, or where behaviour is identified that falls short of its expectations.

2. Central Bank of Ireland revises “publication of national provisions governing marketing requirements for AIFs” webpage

On 4 March 2022, the Central Bank revised its publication of national provisions governing marketing requirements for AIFs webpage to include a list of information and documentation to be submitted to the Central Bank where an AIF situated in another jurisdiction proposes to market its units in Ireland to retail investors. This includes information on: the name and address of the AIF and its management company; the name and address of the depositary; the jurisdiction in which the AIF is authorised and its supervisory authority; as well as details of arrangements for marketing units in Ireland. Details of the facilities agent are also required.

Among the documentation required includes: a completed retail investor AIF application form along with an explanation of material differences to requirements for the AIF; a certificate of authorisation from the supervisory authority; a certified copy of the constitutional document; a copy of the prospectus; copies of the annual and half-yearly reports; confirmation from the facilities agent that it has agreed to act for the AIF; and any other documents materially affecting the rights of unitholders. 

ESA updates

3. ESMA prioritises fight against greenwashing in Sustainable Finance Roadmap

On 10 February 2022, ESMA published its Sustainable Finance Roadmap 2022-2024. The roadmap identifies three priorities for its sustainable finance work, and builds upon ESMA’s Strategy on Sustainable Finance published in 2020, namely:

  1. Tackling greenwashing and promoting transparency;
  2. Building National Competent Authorities’ (‘NCAs’) and ESMA’s capacities in the sustainable finance field; and
  3. Monitoring, assessing and analysing environmental, social and governance (‘ESG’) markets and risks.

With respect to its first priority, tackling greenwashing and promoting transparency, ESMA advises that the combination of growing demand for ESG investments and rapidly evolving markets creates room for greenwashing, which has the potential to detrimentally impact investors looking to make sustainable investments. ESMA notes that investigating this issue, defining its fundamental features and addressing it with coordinated action across multiple sectors, and finding common solutions across the EU, will be key to safeguarding investors. Specifically, ESMA proposes to address this issue through a number of follow-up categories of actions, namely:

  1. Organising case discussions focused on greenwashing issues among NCAs to establish a shared understanding of key concepts, and to understand how greenwashing differs from other types of mis-selling.
  2. Providing guidance to the market and NCAs on how to apply various rules in the sustainable finance single rulebook, e.g. by developing guidance on the level-2 measures under article 8 of the Taxonomy Regulation.
  3. Developing a common understanding of NCAs’ supervisory role in the area of sustainable finance and specifically on greenwashing.
  4. Contributing to further completing the EU single rulebook on sustainable finance while promoting its consistency with international initiatives.
  5. Collecting and studying empirical evidence regarding the functioning of ESG markets and products, and cases of greenwashing, to better understand current and developing market practices.

With respect to building NCAs’ and ESMA’s capacities, it is envisaged that this will be done through a multi-year training programme and by facilitating active sharing of supervisory experiences among NCAs. It is also proposed to develop common supervisory standards on key ESG-related matters, e.g. through a Common Supervisory Handbook.

Finally, having regard to monitoring, assessing and analysing ESG markets and risks, ESMA’s objective is to identify emerging trends, risks and vulnerabilities that can have a high impact on investor protection and on financial markets stability. ESMA will undertake specific activities such as climate scenario analysis for investment funds, CCP stress testing, and the establishment of common methodologies for climate-related risk analysis together with other public bodies.

The Roadmap sets out a comprehensive list of planned actions across relevant sectors, several of which will also contribute to fulfilling the European Commission’s 2021 Renewed Sustainable Finance Strategy.

4. ESAs actions for regulatory framework in the digital age

On 7 February 2022, the European Supervisory Agencies (‘ESAs’) issued a joint report in response to the European Commission’s call for advice on digital finance, setting out proposals to maintain a high level of consumer protection, and to address risks arising from the transformation of value chains, platformisation and the emergence of new ‘mixed-activity groups’.

The recommendations relate to the following topics:

  1. The need for a holistic approach to the regulation and supervision of the financial services’ value chain, which may be done through regular assessments to determine whether financial institutions exhibit dependence on certain providers that may not be captured by the proposed regulation on digital operational resilience for the financial sector, and represent a risk to financial stability.
  2. Strengthening consumer protection in a digital context, including through enhanced disclosures, complaints handling mechanisms, mitigants to prevent mis-selling of tied/bundled products, and improved digital and financial literacy. One recommendation highlights the need to prevent financial exclusion, which could include further analysing the use of data in AI/machine learning models and potential bias leading to discrimination and exclusion.
  3. Promoting convergence in the classification of cross-border services.
  4. Promoting further convergence in addressing AML/CFT risks in a digital context, including assessing, as a matter of priority, whether to subject all crowdfunding platforms to EU AML/CFT legislation.
  5. Ensuring effective regulation and supervision of mixed activity groups, with a recommendation suggesting updates to, and potentially the expansion of, consolidation rules in order to ensure effective coverage. The ESAs also see merit in the Commission exploring ways to foster an enhanced cooperation framework between financial data, cyber, consumer protection and competition authorities, with a number of possible frameworks suggested.
  6. Strengthening supervisory resources and cooperation between financial and other relevant authorities, including on a cross-border and multi-disciplinary basis; and
  7. The need for the active monitoring of the use of social media in financial services, noting that there may be a need for regulators and supervisors to adapt their external communications to reach financial market participants that seek information predominantly through digital channels.

5. ESMA warns consumers of risk of significant market corrections

On 15 February 2022, ESMA published its latest trends, risks and vulnerabilities report, noting that it continues to see high risks to institutional and retail investors of further, and possibly significant, market corrections.

The report notes that the recovery of EU financial markets had slowed following the resurgence of the pandemic at the end of 2021, which led market participants to revisit their growth and market expectations. The report also notes that ESMA maintains its assessment of “very high” market and liquidity risks; “high” credit, contagion and operational risks; as well as elevated environmental risks. However, ESMA notes that there is scope for a reduction in risk levels if past improvements in the economic environment and the relatively low volatilities in the market prove to be resilient. This will critically depend, in particular, on the ability of markets to deal with geopolitical tensions building up in eastern Europe and to withstand a reduction in public policy support on the monetary or fiscal sides without material disruptions.

With respect to asset management, investment fund markets continued to grow in H2 2021, with inflows in particular into equity funds. Euro-area investment funds managed €18.6tn of assets in H2 2021, up from €16.5tn the previous year, attributable to both valuation effects and investor flows.  However, both liquidity risk and credit risk remained elevated, while higher inflation expectations raised new concerns for duration risk.

While the likelihood of materialisation of credit risk had decreased in the short term, portfolios remained vulnerable to a deterioration in credit risk and risk appetite by investors, amid stretched valuations in fixed income markets. Liquidity risk remains an ongoing concern, particularly for corporate bond funds, as highlighted by ESMA’s assessment of corporate bond fund preparedness to future adverse shocks. Funds investing in assets protected against inflation, such as commodity funds, benefited from the increased flows, and ESMA expects that inflation risk will primarily affect fixed-income funds with a long duration. Finally, the report notes that money market fund reform proposals seek to address the vulnerabilities that emerged during the COVID-19-related stress (see below). 

6. ESMA proposes reforms for resilience of money market funds

On 14 February 2022, ESMA issued an Opinion setting out proposed reforms to the regulatory framework applicable to money market funds (‘MMFs’) under the Money Market Funds Regulation, aimed to improve their resilience. This arises from the significant liquidity issues faced by EU MMFs during March 2020, which saw large redemptions from investors on the liability side and a severe deterioration of liquidity of money market instruments on the asset side. Based on the assessment of key issues faced by MMFs during the COVID-19 crisis, ESMA has identified several vulnerabilities of MMFs that the proposed amendments to the MMF regulatory framework, and the MMF Regulation, aim to address, namely: (a) threshold effects for constant net asset value (‘CNAV’) MMFs, and specific first-mover advantage-related issues applicable to these funds; and (b) liquidity related issues, including liquidity transformation-related issues.

The ESMA Opinion takes account of feedback provided as part of the recent ESMA consultation on the review of the MMF regulation, as well as policy proposals published by the Financial Stability Board in October 2021, and the ESRB recommendation on reform of MMFs, published in January 2022. Among the proposals include the removal of the possibility to use amortized costs for low volatility NAV (‘LVNAVs’) MMFs, and secondly, by decoupling regulatory thresholds from suspensions, gates and redemption fees for LVNAV/CNAV MMFs.

The proposals also seek to address liquidity-related issues by:

  1. Ensuring the mandatory availability of at least one liquidity management tool (‘LMT’) for all MMFs so that investors effectively bear the costs of redemptions. This would be clearly presented in the documentation to the investor. The LMTs should be activated by the manager of the MMF and not by the NCAs.
  2. Amendments of the daily liquid asset / weekly liquid assets ratios, as well as the pool of eligible assets, including public debt assets, which can be used to satisfy these liquidity ratios, to ensure that MMFs are better able to meet periods of heightened redemption requests without destabilising underlying money markets.
  3. Inclusion/Reinforcement of the possibility to temporarily use liquidity buffers in times of stress, by making it possible to relax, for a limited period of time, the liquidity requirements set out in Articles 24 and 25 of the MMF Regulation.

In addition, ESMA is proposing complementary reforms aimed to enhance MMFs’ preparedness for a crisis. These include enhancements to MMF reporting requirements and the MMF stress testing framework, as well as clarification of the requirements on external support, in addition to new disclosure requirements linked to the rating of MMFs.

As a next step, the European Commission will review the adequacy of the MMF Regulation under the relevant review clause.

Industry and other updates

7. EFAMA publishes on European Commission’s proposal on MiFIR

On 14 February 2022, the European Fund and Asset Management Association (‘EFAMA’) published a position paper indicating its support for most aspects of the European Commission’s proposal on MiFIR establishing a blueprint for a consolidated tape (‘CT’) for EU capital markets, which was published in November 2021. However, EFAMA did voice reservations about the proposed revenue model for CT providers, as well as noting the need for an explicitly defined market surveillance body to enforce data standards and reduce the provision of poor quality information.

Furthermore, on the proposed market structure reform, EFAMA notes that the proposed transparency requirements were far-reaching, and not always supported by evidence, and suggested that these will result in less diversity, choice and competition in Europe’s capital markets. EFAMA also has concerns that the proposed reforms would reduce Europe’s attractiveness for global investors, place EU firms at a disadvantage to their non-EU peers, and would not seize the opportunities around increasing investor confidence and facilitating digital transformation.

However, in respect of market data costs, EFAMA would like the proposals to go further and to reflect ESMA’s recent recommendations, including that market data be provided on the basis of costs be reflected in the Level 1 text, and to delete those provisions in the delegated regulations that allow data providers to charge for market data in proportion to the value it represents to the users.

8. EFAMA publishes on European Commission’s AIF and UCITS review

On 25 February 2022, EFAMA published a position paper setting out its views on the European Commission’s decision to adopt a targeted approach in its review of the AIFMD and UCITSD. EFAMA considers that this focus on targeted improvements recognises the role the framework has played in encouraging the growth in the European AIF market over the past decade and its resilience even throughout recent market stresses.

However, EFAMA did have some comments and suggestions in a number of areas, namely:

  • It strongly welcomed the list of liquidity management tools included in the directives, noting that liquidity risk management remains the responsibility of the manager, and that the removal of this function, or the imposition of prescriptive triggers for the activation of LMTs gives rise to pro-cyclical effects.
  • EFAMA agreed that loan originating funds can provide a tangible benefit for the real economy, yet it was of the view that the rationale behind introducing rules specific to loans was unclear. It cautioned that certain rules in fact contradicted established market practice and would have the effect of reversing the growth of this industry, potentially making such products less accessible and attractive.
  • EFAMA welcomed ESMA’s proposed review on opportunities for the sharing of meaningful data between different regulators, including giving NCAs access to data reported by managers to national central banks. However, it noted that any proposal to introduce a supervisory reporting regime for UCITS funds should recall the stringent rules applicable to those funds.
  • EFAMA welcomed the acknowledgement that delegation is an important factor for the success of the European fund industry, and that the amendments proposed would increase transparency and supervisory convergence. However, such a proposal, ESMA noted, should specify that delegation rules should not apply to tasks for which the management company did not bear responsibility.
  • EFAMA also welcomed the decision not to introduce a depositary passport, and strongly supported the decision to extend the depositary regime to include “investor” Central Securities Depositaries in the custody chain to guarantee consistent liability standards.
  • With respect to disclosures, EFAMA considered the existing rules to be sufficient, and that the addition of new rules would serve to create confusion. It also noted that AIFMs require flexibility to tailor information to specific needs of investors, and that mandatory disclosures – such as established by MiFID – may lead to the disclosure of non-relevant information.
  • Finally, EFAMA noted the need for grandfathering in the proposed rules, and to allow sufficient time for implementation.

Industry and other updates

9. EFAMA publishes latest statistics on funds

On 24 February 2022, EFAMA published its latest monthly Investment Fund Industry Fact Sheet, providing data for UCITS and AIFs for December 2021. Net sales of UCITS and AIFs totalled €86bn (up from €71bn in November), with UCITS having net inflows of €49bn (compared to net inflows of €79bn in November), and net inflows for AIFs of €37bn (compared to net outflows of €8bn in November). Total net assets of UCITS and AIFs increased by 2.2% during the period to €22tn.

For 2021 as a whole, net sales of UCITS and AIFs rose to €866bn in 2021 (up from €650bn in 2020). Net sales for equity funds surged to a record €399bn during 2021, with bond sales amounting to €177bn. Multi-asset funds also saw a significant rise in demand in 2021, with net sales of €186bn, while money market funds stopped attracting new money in 2021, and recorded negative outflows of €2bn.

Further, on 2 March 2022, EFAMA published its latest quarterly statistical data release describing the trends in the European investment fund industry in Q4 2021. Net assets of UCITS and AIFs grew by 5.4% in the quarter to €21.9n, attracting €232bn in net inflows, with net sales of equity funds slowing further in Q4 to €39bn, down from €58bn in Q3. The report also notes that European households’ appetite for investment funds continued in Q3 2021, and for the third quarter in a row, net acquisitions by European households were above €50bn.

Contact us for more

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

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