Asset Management Insights July 2022 Asset Management Insights July 2022 Asset Management Insights July 2022

On 15 June 2022, the Central Bank of Ireland published its first Financial Stability Review (‘FSR’) for 2022. The FSR outlines the key risks facing the financial system and the Central Bank’s assessment of the resilience of the economy and financial system to adverse shocks. The FSR indicates:

• A pronounced slowdown in global growth and tighter financial conditions could have adverse implications for asset prices and debt serviceability on an international basis. Global financial conditions remained accommodative but had tightened considerably since the last Review, amid monetary policy normalisation as inflationary pressures have become more persistent, and deteriorating global growth prospects.
• Cyclical vulnerabilities are emerging domestically amid rising inflation and significant capacity constraints in certain sectors. Following a rapid economic recovery from the pandemic, Russia’s invasion of Ukraine had led to lower global growth expectations and intensified inflationary pressures. Global financial conditions have tightened considerably, amid the beginning of a period of monetary policy normalisation.
• Inflationary pressures presented new challenges for borrowers, albeit from a starting point of stronger resilience over the past decade. Domestically, price pressures coupled with a tight labour market point to emerging cyclical pressures in certain sectors, including the housing market.
• Profitability in the banking sector had recovered and is set to be bolstered by the prospect of improved lending margins under tighter monetary policy and increased scale economies resulting from ongoing consolidation in the market.
• The Central Bank is updating its strategy for deploying macroprudential capital tools and will use the Counter-cyclical Capital Buffer (‘CCyB’) as its primary macroprudential capital tool for safeguarding resilience to macro-financial risks. This reflects the emerging lessons from the pandemic on the value of releasable capital buffers to better enable the banking system to support the economy when shocks hit, and is consistent with the Central Bank’s aim of ensuring resilience while reducing complexity in the macroprudential capital framework. In this respect, the Central Bank is beginning the gradual rebuilding of macroprudential capital buffers through an increase in the CCyB rate to 0.5%. This increase acknowledges a shift in the risk environment from the acute near term risks presented by the pandemic to the building of cyclical vulnerabilities, and further acknowledges the resilience required to ensure the banking system can serve households and firms in future periods of stress.
• The framework review of mortgage measures and the development of macroprudential measures for property funds continue, and is intended to conclude in H2 2022. In parallel, the Central Bank has been developing a set of macroprudential measures to limit leverage and liquidity mismatches. Relative to European comparators, property funds have higher leverage creating additional vulnerability to price falls, potentially amplifying adverse shocks to the commercial real estate market and the wider economy. 

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On 4 July 2022, the Central Bank of Ireland published a notice of intention in relation to the ESMA Guidelines on stress test scenarios under the Money Market Funds Regulation. The notice sets out that the Central Bank expects full compliance with the Guidelines from 4 July 2022. The notice also states that the Central Bank will, in due course, consult on the incorporation of a provision in the Central Bank UCITS Regulations and AIF Rulebook that all managers of MMFs adhere to the Guidelines.

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On 1 June 2022, the European Supervisory Authorities (‘ESAs’) published a joint report, providing an analysis on the completeness, adequacy and uniformity of the applicable laws and practices on the withdrawal of licenses for serious breaches of anti-money laundering and countering the financing of terrorism (‘AML/CFT’) rules. The report arises against the backdrop of recent cases that have drawn attention to the significant impact that serious breaches of AML/CFT rules may have on the sound and prudent management of supervised financial entities, as well as their ability to continue meeting the conditions for authorisation or registration. The report notes that in the past ten years competent authorities have withdrawn the authorisation or registration from financial entities for serious breaches of AML/CFT rules in 26 cases, either alone or in combination with other grounds.

While acknowledging that the withdrawal of authorisation or registration for serious breaches of AML/CFT rules is a “last resort” measure, the report advocates for the introduction, in all relevant EU sectoral laws, of a specific legal ground to revoke licences for serious breaches of AML/CFT rules, as well as for the inclusion of assessments by competent authorities of the adequacy of the arrangements and processes to ensure AML/CFT compliance as a condition for granting authorisation or registration. The report also sets out uniform criteria on the concept of a serious breach of AML/CFT rules, highlighting that the identification of a serious breach is subject to a case-by-case assessment by the AML/CFT supervisor.

The report also notes the results of the survey on withdrawal of authorisation for serious breaches of AML/CFT rules under the AIFM and UCITS Directives, noting that there have been two cases in the past ten years where the authorisation has been withdrawn from an AIFM management company or from a UCITS investment company for serious breaches of AML/CFT rules. However, no case of an order to close the intra-EU branch of an AIFM and UCITS management company was reported. The vast majority of competent authorities reported that reported that the withdrawal of authorisation is always subject to discretionary assessment, with just two competent authorities reporting that it is not necessarily subject to discretionary assessment.

The report will now be considered by the co-legislators.

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On 9 June 2022, ESMA published its latest Report on Trends, Risks, and Vulnerabilities. The report notes that the Russian invasion of Ukraine and subsequent political and economic developments have profoundly impacted the risk environment of EU financial markets since the publication of the previous TRV report (in February 2022), and ESMA was therefore updating its risk assessment.

The report notes that as a result of the invasion and the policy responses, funds and investors with Russian exposures have faced substantial valuation issues, along with substantial asset repricing, with riskier assets falling in value. Given Russia’s and Ukraine’s role in global commodity supply, prices of commodities and related derivatives jumped and have remained volatile. This has increased margin calls for related derivatives, which can create liquidity strains thereby leading to wider impacts. Further, the report notes that inflation pressures from supply chain issues in the pandemic recovery have been compounded by the commodity supply shocks, leading to an inflation surge and widespread expectations that the long period of ultra-low interest rates is coming to an end, which is depressing real returns and could lead investors to even higher risk-taking.

Given these developments and the ongoing uncertainty, the risk to ESMA’s overall remit remains at its highest level. Relative to the last TRV report, contagion and operation risks are now considered ‘very high’, joining liquidity and market risks. Credit risk stays as ‘high’ but is expected to rise. Risks remain ‘very high’ in securities markets and for asset management, as in the previous TRV report. Consumer risks also remain ‘high’, but with an increasing outlook, with environmental risks remaining elevated.

With respect to the asset management industry, significant outflows were seen for funds with Russian exposures after the invasion, driven mainly by valuation issues related to these exposures, with greater outflows for more exposed funds. The report notes that outflows stabilised since April. From February into March, around 100 EU funds in 17 countries suspended dealings: 88 UCITS (€5.5bn in NAV), 35 AIFs (€4.7bn). As of June, since the invasion, side pockets had been used as liquidity management tools by 4 funds across 3 countries.

The next TRV report, covering H1 2022, will be published in September 2022.

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On 14 June 2022, ESMA published guidelines specifying the role and responsibilities of the AML/CTF compliance officer and of the management body of credit and financial institutions. The guidelines aim to ensure a common interpretation and adequate implementation of AML/CFT internal governance arrangements across the EU in line with the Fourth Anti-Money Laundering Directive.

The guidelines set clear expectations on the role, tasks and responsibilities of the AML/CFT compliance officer, as well as those of the management body, and provide that one member of the management body should be appointed as ultimately responsible for the implementation of AML/CFT obligations.

The guidelines also describe the roles and responsibilities of the AML/CFT compliance officer, as well as the organisation of the AML/CFT compliance function when the credit or financial institution is part of a group.

The guidelines aim to create a common understanding in respect of AML/CFT governance arrangements, and complement, but do not replace, relevant guidelines issued by the EBA on wider governance arrangements and suitability checks. The guidelines will apply from 1 December 2022.

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On 15 June 2022, ESMA published its annual report for 2021, setting out its achievements for that year in fulfilling its mandate. Among the key achievements noted by ESMA include the recognition and tiering of third-country central counterparties, the coordination of supervisory activity across the EU through its strategic supervisory priorities, and preparing for the supervision of data reporting service providers, critical benchmarks and securitisation repositories.

In relation to its risk assessment activities, the annual report notes that the following activities were undertaken in 2021 with respect to asset management:

• Stress simulation of funds in the context of COVID-19: ESMA published a joint supervisory exercise with NCAs in the form of a data-driven assessment of the impact of the liquidity crisis on funds, and an assessment of funds’ preparedness for future shocks, involving stress simulation exercises with several assumptions.
• Funds and single-name credit default swaps: ESMA published a working paper providing a comprehensive overview of the drivers of the use of single-name credit default swaps by UCITS investment funds using EU regulatory data on derivatives.
• Equity funds and derivatives: ESMA published a working paper built on data collected under EMIR, providing new insights into the types of derivatives that are traded by UCITS equity funds, inquiring into why some of them trade derivatives whereas others do not, what makes some more active traders, and to what extent trading in derivatives is a reaction to daily changes in markets. 

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