November 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.
Contents
Central Bank of Ireland updates
ESA updates
- ESMA to work on ESG disclosures
- ESMA publishes 2023 work programme
- Securitisation Regulation
- Review of ELTIF Regulation
Industry and other updates
Central Bank of Ireland updates
1. Supervisory strategy and outlook
On 30 September 2022, the Central Bank of Ireland’s Head of Funds Supervision Division, Darragh Rossi, delivered a speech on supervisory strategy and outlook, addressing the Central Bank of Ireland’s strategy, which came into effect in January 2022 and had four connected themes, namely: (i) transforming; (ii) open & engaged; (iii) future-focused; and (iv) safeguarding.
Mr Rossi noted that the funds sector had transformed markedly in the last number of years, with total AUM in Ireland now exceeding €3.5tn, up from €1tn 10 years ago, with the number of funds at well over 8,000, up from 5,000 over the same period. Mr Rossi also noted the significant structural changes to the sector, driven by, among other things, Brexit, the influence and role of the European Securities and Markets Authority (‘ESMA’) in setting supervisory focus, and expanding regulatory initiatives.
Mr Rossi also noted the move away from the self-managed fund structure in the last three years, with a fall of 90% during that period, which has resulted in significant growth in a small number of management companies managing a larger number of funds with potentially more complex relationships with AUM in the region of €540bn. He also noted the level and extent to which fund management companies are providing MiFID services, such as Individual Portfolio Management.
Having regard to the above, Mr Rossi advised that the Central Bank was evolving its approach to how it supervises the funds sector, to include:
- A greater focus on data-led supervision and use of thematics/sector analysis;
- Increased focus on potential systemic risks from funds; and
- Increased emphasis on fund management companies when considering underlying fund risks.
Mr Rossi also advised that the Central Bank would continue to prioritise funds with a retail focus, and over the coming months would continue to engage with stakeholders around future enhancements to its authorisation process, initially focussing on UCITS and Retail AIFs, and then engaging with QIAIFs. In terms of being future-focused, Mr Rossi identified the key risks and areas of focus for the Funds Division over the next 12-18 months, namely:
- Recognising the geo-political and economic environment in which the funds sector operates;
- A focus on sustainable finance, to include fund and firm disclosures, the integration of sustainability risks within firms’ risk management frameworks; and
- Portfolio-level analysis to understand changes which funds are undertaking as they adapt their investment policies and strategies.
Finally, with respect to digitalisation, Mr Rossi advised that the Central Bank must find ways for digital assets to appropriately interact with the traditional finance system, noting the proposed Markets in Crypto-Assets Regulation, and the commencement of information-sharing between regulators in this area.
2. Central Bank’s regulatory philosophy
On 2 November 2022, the Governor of the Central Bank of Ireland, Gabriel Makhlouf, delivered a speech touching on a range of areas, including the philosophy of finance, the economics of financial regulation, the regulation of financial markets, as well as the Central Bank of Ireland’s regulatory approach before addressing the need to re-think the regulation of the non-bank sector, specifically investment funds.
Governor Makhlouf noted that the investment funds sector is too big to ignore, with self-evident risks to financial stability, as well as to investors, consumers, and the community as a whole. In this regard, he advised that policymakers and regulators needed to accelerate steps to ensure that their frameworks protected financial stability and investor/consumer protection. Governor Makhlouf noted that for Ireland, it was planned to introduce leverage limits for property funds connected to the domestic economy, but noted that urgent global and European coordination was needed in this area.
ESA updates
3. ESMA to work on ESG disclosures
On 27 October 2022, ESMA announced that it was changing its EU strategic supervisory priorities to include ESG disclosures alongside market data quality, replacing costs and performance for retailing investment products. ESMA advised that it and the National Competent Authorities (‘NCAs’) intend to accompany the growing demand for ESG-related financial products and foster transparency and comprehensibility of ESG disclosures across key segments of the sustainable finance value chain, to include issuers, investment managers and firms.
ESMA also aims to gradually promote increased scrutiny of ESG disclosures through effective and consistent supervision, which implies building supervisory capabilities to fully embed sustainable finance into daily supervisory work and supervisory culture. As a result, ESMA and the NCAs have advised that they will take active steps to protect investors and facilitate investments in a credible ESG market. ESMA has advised that it has already developed and applied common methodologies and thematic reviews in this area, and that it and the NCAs have carried out a number of actions on the costs and performance for retail investment products, including a Common Supervisory Action (‘CSA’) on costs and fees under the UCITS framework, a CSA on MiFID II costs and charges, and a CSA on MiFID suitability requirements and product governance.
4. ESMA publishes 2023 work programme
On 10 October 2022, ESMA published its 2023 annual work programme (PDF, 740KB) setting out its priority work areas for the next year. The key deliverables for 2023 are:
- Enabling sustainable finance by developing remaining technical standards under the Sustainable Finance Disclosure Regulation (‘SFDR’) and working to better understand and fight greenwashing;
- Facilitating technological innovation and effective use of data by developing technical standards and guidelines in order to help the market prepare for the implementation of key new regulations in the area of digital finance;
- Continuing to report on the impact of costs and charges for retail investors and coordinate new workstreams on mystery shopping and coordinating a CSA in the area of sustainability;
- Developing technical standards on authorisation and registration of benchmark providers, and delivering the final technical standards and guidelines under the CCP Recovery and Resolution Regulation;
- Continuing to monitor market developments to assess risks, in particular the impact of commodity market developments, financial market impacts of inflation and rising interest rates; and
- Continuing risk-based supervision of all EU Credit Ratings Agencies, Trade Repositories and Securitisation Repositories as well as certain Data Reporting Service Providers, benchmark administrators and third-country CCPs. It will also work with national authorities to promote supervisory convergence and a common understanding of where major risks lie. ESMA will also prepare for the supervision of Consolidated Tape Providers.
With respect to investment management activities, specific outputs for 2023 include:
- Reporting on the outcome of the 2022 CSA on the valuation of less liquid assets;
- Coordination of a new CSA on sustainability;
- Drafting of technical standards, technical advice and guidelines as required following the review of AIFMD, PRIIPS, UCITS, MMF, EuVECA, EuSEF and ELTIF;
- Amending the regulatory technical standards on the principal adverse impact framework and certain product disclosures under SFDR;
- Drafting of regulatory technical standards on the notifications for cross-border marketing and management of AIFs and UCITS.
5. Securitisation Regulation
On 11 October 2022, the European Commission published a report on its review of the Securitisation Regulation. Whilst the report deals with, among other things, market developments, risk retention, due diligence and transparency, and sustainable securitisation, it also considers, in the context of the jurisdictional scope of the regulation, buy-side obligations with respect to AIFM investors.
In this regard, the Joint Committee of the ESAs’ opinion (PDF, 340KB) referred to a need for certain legal clarifications on AIFMs acting as institutional investors in securitisations, as it was unclear whether non-EU AIFMs that manage or market alternative AIFs in the EU would be covered by the scope of the Securitisation Regulation’s definition of an institutional investor, even if the marketing in the EU only takes place on a private placement basis. It was also unclear whether the definition of the institutional investor, subject to the extensive due diligence requirements, also encompasses ‘sub-threshold’ AIFMs. The consultation indicated a clear majority in favour of clarifications, although there were opposing views on how the clarifications should be drafted.
The Commission clarified that Article 2(12)(d) refers specifically to the provision in the AIFM directive that defines an AIFM without differentiating between entities above or below the above-mentioned threshold. The legal wording therefore clearly requires that sub-threshold AIFMs also have to be considered institutional investors within the meaning of the Securitisation Regulation. Such an interpretation was supported by the legislative intent of the due diligence requirements of Article 5, which was to protect EU investors from exposure in the future to securitisation investments without prior due diligence and a proper understanding of the acquired product.
The Commission also clarified that the legislative intent supported the Commission’s interpretation that third-country AIFMs that market and manage funds in the EU have to comply with the due diligence requirements of the Securitisation Regulation for all of their securitisation investments. In this respect, the Commission considered that if third-country AIFMs marketing funds in the EU were considered exempt from the due diligence rules, this could undermine the comprehensive investor protection that the legislators intended. The Commission will therefore consider amending the wording of Article 2(12)(d) to specifically remove any kind of legal uncertainty in a future proposal to amend the Securitisation Regulation.
6. Review of ELTIF Regulation
On 20 October 2022, the European Commission announced that it welcomed the political agreement reached on the review of the European long-term investment funds (‘ELTIF’) regulation between the European Parliament and the Council, less than one year after the Commission proposal. Noting that this was a success for the Capital Markets Union initiative, the Commission advised that the political agreement would increase the attractiveness of ELTIFs for investors and their role as a complementary source of financing for EU companies. The Commission further noted that the ELTIF reform has huge potential for channelling investments to the EU’s energy, social and transport infrastructure, creating jobs and boosting the economy.
Industry and other updates
7. ESG ratings of Article 8 and 9 funds
On 13 October 2022, the European Fund and Asset Management Association (‘EFAMA’) published a new issue of its markets insights series on ESG ratings of Article 8 and 9 funds (PDF, 702KB). The report reflects on the ESG ratings assigned by two commercial providers to a large sample of Article 8 and 9 funds, focusing on the differences between ratings given to the same funds by these firms and between ratings of Article 8 and Article 9 funds.
Among the key findings identified were that the average ESG scores for Article 9 funds given by one provider were slightly higher than those for Article 8 funds, however the differences were quite small. With respect to the other provider, the majority of Article 8 funds score higher than ‘average’ in their ESG risk management, with that figure being higher for Article 9 funds, and 7% of Article 9 funds being ranked as ‘below average’.
EFAMA reports there being a positive correlation between ESG ratings given by both providers, but that this was quite small, with many funds with a low score with one provider doing well in the other provider’s ratings and vice versa. EFAMA notes that this was not too surprising given that rating agencies base a fund’s ESG rating on their own proprietary assessment, and that these ratings bear little relationship with the SFDR classification.
Arising from its analysis, EFAMA has made a number of policy recommendations, namely:
- Financial advisors and fund distributors should not necessarily offer only Article 9 funds to clients expressing strong ESG preferences, and regulatory rules should refrain from imposing such a requirement. They should instead verify if the fund’s ESG approach is aligned with the investor’s ESG preferences and views on risks.
- Article 8 or 9 status as well as ESG ratings, should not be used in isolation. Advisors and distributors should use additional tools, including the European ESG Template, national and international guidance, consulting services, and precontractual and periodic reporting in order to understand the ESG characteristics of a fund.
- There is a need to develop an EU regulatory framework for ESG ratings, which should have three main objectives, namely:
- imposing disclosure of the methodologies and data sources used to provide ESG ratings;
- providing a level playing field by ensuring that all major firms assigning ratings to funds domiciled in the EU are within scope, including non-EU providers generating a certain percentage of EU revenues; and
- preserving market integrity by setting specific requirements for internal controls and governance processes to avoid conflicts of interest.
- Supervisory authorities should gain a good understanding of the pricing and licensing frameworks involved to ensure a competitive market for ESG ratings that does not allow a small number of providers to set excessively high fees for their services. In the meantime, a voluntary code of conduct could be developed to provide valuable insight for the future legal framework.
8. EFAMA publishes latest statistics on funds
On 4 November 2022, EFAMA published its latest monthly Investment Fund Industry Fact Sheet (PDF, 387KB), providing data for UCITS and AIFs for August 2022. Net sales for UCITS and AIFs registered net inflows of €11bn (compared to net outflows of €43bn in July), with UCITS having net inflows of €11bn (compared to net outflows of €24bn in July), and net inflows for AIFs of €200m (compared to net outflows of €19bn in July). Total net assets of UCITS and AIFs decreased by 1.9% during the period to €19.94tn.
9. Interaction between index providers and asset managers
On 13 October 2022, IOSCO issued a survey (PDF, 187KB) directed at asset managers and index providers examining the nature of the interaction between these parties, which is intended to support the work of the IOSCO Committee by furthering its understanding of certain conduct-related index provider matters.
IOSCO has identified potential areas that require further study, including: (i) the role of asset managers in relation to indices and index providers and the role and processes of index providers in the provision of indices; (ii) the potential impact of administrative errors on investment funds; and (iii) potential conflicts of interest that may exist at the index provider in relation to the fund. The survey also seeks information from respondents on their governance and processes during exceptional market events or shocks, such as the COVID-19 market shock and the Russian market shock.
The closing date for submissions is 26 November 2022.
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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