Asset Management Updates

On 30 of May 2023, the CBI published a speech by the Director of Financial Regulation, Policy and Risk, Gerry Cross, delivered at the Blockchain Ireland conference on the current crypto landscape and the work being undertaken by the CBI and Department of Finance (DoF) as part of the European Union (EU) legislative process to finalise the Markets in Crypto Asset regulation (MiCA).

The speech begins with Mr Cross reiterating the CBI's strategy to be ‘open and engaged’ in responding to the rapidly changing innovations that are driving success in the financial sector. He references the current challenges facing many crypto exchanges due to poor governance and the lack of business sustainability that led to a ‘crypto winter’.  He notes however, that the CBI remains positive towards the technological innovations underlying crypto and believes that if financial stability risks associated with crypto are addressed, the technology can have a positive effect to ordinary citizens and the wider economy.

In relation to the MiCA proposal, which was unanimously approved by the European Parliament (EP) in April 2023, the CBI has voiced concerns about the real risk of sub-optimal implementation of the regulation in all 27 jurisdictions of the EU after the transitional period ends. Crypto firms are looking at multiple jurisdictions across the EU to place themselves in the best position for the new regulatory regime. Therefore, it is important that the degree of rigour and emphasis with which the provisions of the regulation are applied are consistent across all the National Competent Authorities (NCAs). The MiCA regulation will become applicable to issuers of Asset Reference Tokens (ARTs) and issuers of E-Money Tokens (EMTs) ‘around July 2024’ and for Crypto Asset Services Providers (CASPs) and utility tokens at the beginning of 2025.

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On 24 of May 2023, ESMA published a report from the 2022 Common Supervisory Action (CSA) (PDF, 340 KB) with National Competent Authorities (NCAs) on the supervision of the asset valuation rules under the UCITS and AIFMD Directives.  The aim of the CSA was to investigate the compliance of supervised entities with the organisational requirements with respect to asset valuation, as well as their adherence to valuation principles and methodologies under normal and stressed market conditions. The CSA’s main findings are summarised under these five followings topics:

• Appropriateness of valuation procedures and policies: NCAs found a satisfactory level of compliance by supervised entities but noted room for improvement on the documentation of valuation policies and procedures, appropriate allocation of tasks to responsible persons and greater clarity around the valuation model used.
• Valuation under stressed market conditions: Most NCAs found that the majority of managers performed stress tests to monitor liquidity of their portfolio periodically, although issues were spotted with supervised entities following valuation policies that did not distinguish between normal and stressed market conditions.
• Independence of the valuation function: NCAs again found that most entities performed well in this criterion, with main issues arising from (a) entities that did not contain an independent valuation function, particularly from the portfolio management function and (b) smaller managers’ over-reliance on third-party data providers for the pricing of less liquid assets.
• Early detection mechanisms for errors: Analysis mainly found a broad level of compliance, with main issues arising in those supervised entities who were not appropriately formalising remedial procedures for early detection of valuation errors and full investors compensation.
• Focus on Private Equity (PE) and Real Estate (RE) assets: NCAs identified issues in aligning the frequency of the NAV calculation, asset valuation and availability of up-to-date information available for all funds invested in less liquid assets, including PE and RE funds.

The continuing deterioration of the macroeconomic outlook and tightening financial conditions pose greater challenges in ensuring a fair valuation of assets, particularly under stressed market conditions. Building on the findings of this CSA exercise, ESMA will facilitate NCAs to discuss best ways of combatting the asset valuation deficiencies, especially in stressed market conditions, and will place more focus on PE assets and RE funds which might be more exposed to revaluation risk from their reliance on long-term models and illiquidity of their assets.

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On 30 of May 2023, ESMA released a final report on the amendments to the European Commission (EC) (PDF, 540 KB) Delegated Regulation supplementing the Benchmarks Regulation (BMR) 2018 regarding Regulatory Technical Standards (RTS) on information required for authorisation and registration applications by EU benchmark administrators. ESMA commenced consultations of these amendments in November of 2022, receiving one response for which a summary has been provided for in section three of the report. Based on the feedback it has received since consultations began, ESMA is not considering any further amendments to the RTS. The focus areas of the amendments are:

• Self-declaration: Applicants will now also be required to disclose if there are any adverse findings in civil proceedings in connection with the provision of financial services, misconduct or fraud.
• Annual Reports: Applicants will need to include individual and consolidated financial statements (where applicable) for the three financial years preceding the date of the submission of its application to the extent available.
• Organisational structure: Applicants will have to disclose details of certain employees ( e.g. number of employees, temporary or permanent contract, level of experience greater or less than five years, curriculum vitae).
• Conflicts of interest: Applicants will have to supply a document outlining how the provision of benchmarks is operationally separated form any part of the applicant’s business that may create an actual or potential conflict of interest.

All of the proposed amendments to the RTS are in Annex III of the report, with a consolidated and marked-up version being featured in Annex IV. These final amendments will be submitted to the EC which will then have three months to endorse the RTS.

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On 12 of May 2023, IOSCO published a final report (PDF, 950 KB) on good practices relating to the implementation of its Principles for the Regulation of Exchange Traded Funds (ETFs) (the ETF Principles). IOSCO explains that since it published 9 ETF Principles in 2013, ETF markets have evolved and shown sustained growth in assets under management. Additionally, the ETF industry has continued to change through the launch of new products with exposures to less liquid and more novel asset classes, making their products and investment strategies inherently more complex.

In the light of these developments, it established a dedicated framework to review a broad range of new issues relating to ETFs and to identify any gaps that may now be present in the ETF Principles. Following this review, IOSCO concluded that no major gaps or regulatory issues have been identified during the review of the ETF Principles and that they persist to be appropriate and relevant. IOSCO is of the view that the ETF structure has generally remained resilient during historical stress events and no structural issues related to ETFs have been identified that have had a bearing on financial stability.

An issue which IOSCO has identified is the major differences in how ETFs operate and are regulated between different jurisdictions. To counteract these differences, IOSCO has identified a set of 11 good practices that jurisdictions could implement in order to harmonise the markets for ETFs. Theses good practices are organised under the following four categories:

• Effective product structuring
• Disclosure
• Liquidity provision
• Volatility control mechanisms

The good practices also focus on the distinctive features of ETFs, namely the trading of ETF shares in the secondary market and the associated arbitrage mechanism. IOSCO is encouraging regulators, responsible entities and trading venues to review and adopt the good practices, where appropriate, within each jurisdiction's regulatory framework. 

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On 6 of June 2023, the European Fund and Asset Management Association (EFAMA) published a joint industry letter responding to the European Commission (EC) reform based on the EU legislative framework for Retail Investment Strategy (RIS). The EC package uses an amending Directive to revise several rules in existing Directives, including MiFID II, IDD, UCITS, AIFMD and Solvency II. The letter highlights the industries support for the shift to ‘digital-by-default’ communications, streamlined disclosures and further promotion of financial literacy.

However, EFAMA and its members have also highlighted five areas of concern, as follows:

• Although the EC appears to have dropped its proposal to proceed with a total prohibition of commissions in the distribution of investment products and insurance-based investment products, there are still many prohibitions to the payments of commissions left in the RIS proposal.
• The proposed ‘best interest of the client’ test disproportionately focuses on costs and may lead to clients prioritising the cheapest product over products offering them greater value. This would be contrary to the client’s best interest.
• A significant increase in the number of new processes, policies, organisational requirements, technical disclosures and compliance obligations introduced by the RIS proposal deviates from the initial goal of reducing the information overload on clients and making access to financial services simpler.
• The proposed one-size-fits-all quantitative ‘value for money’ benchmarks disregard that value encompasses more than just costs and would go against the core goal of the investment process to offer tailored solutions to different clients’ needs.
• The proposed timeline of full compliance with and implementation of the new requirements is unfeasible from an industry view.   

The EC feedback regarding the RIS proposal is open until the 11 August 2023, with the reform package’s entry into force on the 20^th day following its publication in the Official Journal of the European Union. The new reform will apply 18 months after its entry into force. 

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