July 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.

KPMG Insights

1. New report – Charting a course for Irish asset management

Our latest report takes stock of the asset management industry, identifies key emerging trends and outlines what it means for asset managers, hedge funds and securities service providers. Read key insights from our report here.

2. Individual Accountability Framework and Senior Executive Accountability Regime

On 23 June 2022, Gerry Cross, the Director of Financial Regulation, Policy and Risk in the Central Bank of Ireland (“CBI”) provided an update on key aspects of the Individual Accountability Framework (“IAF”) and the Senior Executive Accountability Regime (“SEAR”). We have summarised the key updates in respect of the IAF and SEAR from Mr Cross here.  

Central Bank of Ireland updates

3. Central Bank of Ireland publishes first Financial Stability Review for 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. 

4. Central Bank of Ireland publishes notice of intention in relation to the application of ESMA guidelines on stress test scenarios under the MMFR

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.

ESA updates

5. ESAs publish joint report on withdrawal of authorisation for serious breaches of AML/CFT rules

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.

6. ESMA publishes risk assessment update

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.

7. EBA publishes guidelines on governance and the role of AML/CFT compliance officers

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.

8. ESMA publishes annual report

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. 

9. European Council agrees its position on updated rules for hedge funds, private debts funds and other alternative investment funds – position welcomed by EFAMA

On 17 June 2022, the European Council published a press release advising that it had reached agreement on its position on a review of the AIFMD, which aims to contribute to maintaining a competitive and attractive European asset management market and to unlock private investment to finance the green and digital transitions. The proposal has four main objectives, namely:

  1. To achieve further market integration for AIFs and therefore a broader capital market integration;
  2. To improve companies’ access to more diversified forms of financing;
  3. To strengthen investor protection; and
  4. To enhance the ability of fund managers to deal with liquidity pressure in stressed market conditions.

The Council stressed the importance of consistent harmonisation in the area of liquidity risk management, as well as the need to improve the availability of liquidity management tools, with new requirements on managers to provide for the activation of these instruments. It is intended that this will help ensure that fund managers are well equipped to deal with significant outflows during financial turbulence. The Council also supported the creation of an EU framework for loan-originating funds, supplemented with requirements to alleviate risks for financial stability, as well as to ensure an appropriate level of investor protection.

The Council position has also clarified the rules for outsourcing and the delegation of certain functions by fund managers to third parties. It also introduces new reporting requirements on delegation arrangements for improved monitoring and supervision of the EU regulatory framework. The press release also notes that other key issues for the Council are the framework for the provision of cross-border services by depositaries, as well as new risk monitoring reporting obligations for UCITS, and new transparency rules to enhance investor protection. The Council will now enter into trilogue negotiations with the European Parliament in order to agree a final version of the text.

In a press release issued the same day, the European Fund and Asset Management Association (‘EFAMA’) welcomed the Council’s adoption of its general approach. Specifically, EFAMA:

  • Fully supported the Council’s decision to maintain the central role of the asset manager in the management of liquidity risk;
  • Was supportive of the Council’s decision to exclude distribution from the scope of the delegation regime and to remove the annual notification by NCAs to ESMA. EFAMA nonetheless recommends the harmonisation of notifications to NCAs instead of introducing supervisory reporting requirements;
  • Expressed concern with the Council’s decision to maintain product-specific rules in what is designed to be a managers’ directive. In particular, EFAMA notes that the creation of a separate leverage limit applicable to any fund which originates a loan creates a cliff-edge effect which fails to have regard to the purpose and source of leverage and the extent and purpose for which the fund engages in loan origination;
  • Welcomed the proposed revisions made to allow for open-ended loan originating funds and to the risk retention requirement, though continued to question the rationale for these requirements in light of existing rules applicable to all asset classes.
  • Supported the Council’s decision to not introduce a depositary passport in the revised AIFMD regime, and also welcome the decision of the Council to require AIFMs to prove the lack of relevant depositary services in its own Member State, before taking advantage of the appointment of a depositary in another jurisdiction.

10. ESAs refer stakeholders to European Commission statement on the application of new PRIIPs rules

On 24 June 2022, the ESAs referred stakeholders to a statement published by the European Commission on the application date of new rules for the Key Information Document (‘KID’) for packaged retail and insurance-based investment products (‘PRIIPs’).

The statement provides that the Commission had published in the Official Journal of the EU Commission Delegated Regulation (EU) 2022/975. In this regard, the Commission has confirmed that it is intended to postpone the application date of certain PRIIPs-related disclosures to 1 January 2023 (instead of 1 July 2022 as originally foreseen), and to prolong the application of Article 14(2) of Commission Delegated Regulation (EU) 2017/653 until 31 December 2022 (instead of 30 June 2022 as originally foreseen), concerning the ability to use UCITS KID to provide specific information for the purposes of disclosures relating to PRIIPs offering a range of options for investment.

11. ESMA publishes results of its call for evidence on ESG ratings

On 27 June 2022, ESMA published a letter to the European Commission setting out its findings from the Call for Evidence to gather information on the market structure for ESG rating providers in the EU. The letter notes that the IOSCO Task Force on Sustainability had recently conducted a similar stock-taking exercise and delivered a set of recommendations for ESG rating and data providers, and that it was seeing a growing momentum amongst regulators and supervisory bodies in a number of jurisdictions to assess whether there is a need for specific regulatory intervention in this area to address issues such as transparency, governance and conflicts of interest.

Among the key findings include:

  1. The structure of the market among providers is split between a small number of very large non-EU entities and a large number of significantly smaller EU entities. EU entities providing ESG ratings can largely be characterised as small or medium-sized enterprises, with a large number of these clustered in only three member states. While the predominant business model is investor-pays, provision of ESG ratings on an issuer-pays basis was indicated in approximately a third of responses.
  2. The majority of ESG ratings users typically contract for these products from several providers simultaneously either to increase coverage, by asset class or geographically, or in order to receive different types of ESG assessments. The most common shortcomings identified by users were a lack of coverage of a specific industry or a type of entity and insufficient granularity of data. Complexity and lack of transparency around methodologies were also cited as an issue.
  3. Entities covered by these products are required to dedicate at least some level of resourcing to their interactions with ESG rating providers, although the amount is largely dependent on the size of the rated entity itself. Most of these entities highlighted some degree of shortcoming in their interactions with the rating providers, most notably on the level of transparency as to the basis for the rating, the timing of feedback or the correction of errors.

ESMA concludes that the feedback is indicative of an immature but growing market, which has seen the emergence of a small number of large non-EU headquartered providers, which bears some resemblance to the market structure currently in existence for credit ratings. There are also a large number of smaller specialised EU entities who provide a more comprehensive suite of services. 

Industry and other updates

12. EFAMA publishes latest statistics on funds for Q1 2022

On 9 June 2022, EFAMA published its trends in the European Investment Fund Industry for Q1 2022, in which it was noted that net assets of UCITS and AIFs declined by 4.5%, with €90bn in net inflows for UCITS compared to net inflows of €238bn in Q4 2021, and net outflows from AIFs increasing from €5bn to €19bn during the same period.

European households’ net purchases of investment funds stayed at a high level in Q4 2021, at €52bn, totalling €245 billion for 2021. UCITS bond and money market funds suffered large net outflows of €50bn and €119bn, respectively, during the quarter. For Ireland, total net assets at end-Q1 stood at €3.9tn, with net outflows of €9bn during the quarter.

On 16 June 2022, EFAMA published its report on international statistics for Q1 2022, in which it was noted that there was a decline in net assets of worldwide investment funds of 2.5%, with the US and Europe registering a net asset decline of 5.5% and 4.5%, respectively. There was also lower but positive net inflows into long-term funds, as well as net outflows of money market funds of €188bn, compared to net inflows of €270bn in Q4 2021.

13. EFAMA publishes latest statistics on funds for April 2022

On 27 June 2022, EFAMA published its latest monthly Investment Fund Industry Fact Sheet, providing data for UCITS and AIFs for April 2022. Net sales of UCITS and AIFs gave rise to net outflows of €3bn (compared to net outflows of €42bn in March 2022), with UCITS having net outflows of €0.3bn (compared to net outflows of €35bn in March), and net outflows for AIFs of €3bn (compared to net outflows of €7bn in March). Total net assets of UCITS and AIFs decreased by 1.7% during the period to €20.6tn.

Contact us for more

For further information on the issues mentioned above, or any related issues, please contact Jorge Fernandez Revilla, Head of Asset Management

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