Asset Management & Investment Funds: EU & International Developments – March 2023

ESMA speech – The macro-prudential supervision of investment funds

Verena Ross, Chair, ESMA spoke on The macro-prudential supervision of investment funds – from a global debate to a balanced European regulatory frameworks, highlighting, in particular, liquidity and leverage risks to financial stability. Key takeaways and ESMA expectations are set out below.

Recent market developments in the investment management sector and ESMA views on current vulnerabilities.

• “Asset managers need to adapt to a new reality, after operating for years in a low yield and low inflation environment.”

At a regulatory level “it is crucial to identify, monitor and address the remaining vulnerabilities also in the asset management sector, and identify the possible channels of contagion to the rest of the financial system.”

• International work includes a focus on the vulnerabilities in open ended funds (OEFs) from liquidity mismatches – guidance is being developed from FSB on the design and use of liquidity management tools (LMTs) and from IOSCO on price-based LMTs (e.g. swing prices and dilution levies) as well as promoting stress testing.
• AIFMD reform includes an EU framework for the design and use of LMTs.
• MMF reform, referencing ESMA’s opinion on the review of the MMF Regulation.

Liquidity: ESMA expects managers to:

• monitor the alignment of their funds’ investment strategy, their liquidity profile and their redemption policy
• put in place accurate assessment and strong controls around the management of liquidity risk

(These obligations should also be regularly monitored through ongoing supervision by national competent authorities (NCAs))

• perform liquidity stress testing, referencing ESMA’s guidelines on liquidity stress testing

In the public sector, the enhanced use of macroprudential stress tests is also warranted: regulators could consider running formal sector-wide stress tests to identify pockets of vulnerabilities.

Leverage

• ESMA and NCAs are now performing regular monitoring of AIF leverage
• CBI introduced (Nov 2022) leverage limits on Irish real estate funds under the AIFMD, supported by ESMA

ESMA, in the context of financial stability risk monitoring, welcomes the review of the UCITS Directive which envisages the creation of an EU-wide reporting regime for UCITS.

Greenwashing developments

Priority number one in ESMA’s sustainable finance roadmap is tackling greenwashing and promoting transparency. Priority number two is building the capacity of NCAs to supervise the area of sustainable finance which will undoubtedly result in a focus on greenwashing risks and the sanctioning of offenders.

In our latest publication we consider recent regulatory developments that will inform future policy making and supervision for funds, and where sustainability-related greenwashing claims might be made in the context of a fund.

Go to publication.

ELTIF reform – effective 10 January 2024

Regulation (EU) 2023/606 (ELTIF 2.0) will apply from 10 January 2024. It will amend Regulation (EU) 2015/760 (ELTIF 1.0) as regards the requirements for the investment policies and operating conditions of European long-term investment funds (ELTIFs) and the scope of eligible investment assets, the portfolio composition and diversification requirements and the borrowing of cash and other fund rules.

Timeline

• ELTIF 2.0 will apply from 10 January 2024

Grandfathering

• ELTIFs authorised before 10 January 2024 will be deemed to comply with ELTIF 2.0 until 11 January 2029
• ELTIFs authorised ​before 10 January 2024, which do not raise additional capital, will be deemed to comply with ELTIF 2.0
• an ELTIF authorised before 10 January 2024 can choose to be subject to ELTIF 2.0, subject to notification of its NCA

Overview

ELTIF 1.0 entered into force in 2015. ELTIFs enable retail investors to invest in companies and projects that need long-term capital within an EU passportable product that incorporates robust governance, diversification and liquidity protections. ELTIFs must be managed by an authorised EU AIFM and, subject to the AIFMD notification procedure, can be marketed to retail as well as to professional investors across the EU. At December 2022, only 81 ELTIFs were registered in the entire EEA (45 in Luxembourg, 21 in France, 13 in Italy and two in Spain). The Commission completed a review leading to ELTIF 2.0 improvements.

Improvements include:

• expansion of eligible investment assets including real assets, securitisations, sustainability/ taxonomy aligned, fintech and non-EU assets
• relaxation of portfolio composition rules
• easing of diversification requirements and concentration limits
• easing of borrowing and leverage rules
• easing of rules for retail investor access (removal of minimum investment and requirement to have liquid investments worth at least €100,000)
• easing of rules for ELTIFs marketed solely to professional investors
• ELTIF 2.0 no longer requires​ EU AIFMs to undergo an additional ELTIF management authorisation

The rules on redemptions remain relatively stringent so that the ELTIF will remain more suitable for closed-ended funds than for open-ended or semi-liquid fund structures.

ELTIF 2.0 will have direct effect in the national laws of the member states.

ESMA is to develop regulatory technical standards on various topics by 10 January 2024, which can then be adopted by the EU Commission.

CBI is the competent authority in Ireland with responsibility for the authorisation of ELTIFs. We expect CBI to update process and forms in due course.

ESMA’s Q&A on the Application of the AIFMD- calculation of substantive direct or indirect holding for exemption purposes

ESMA updated its Q&A on the Application of the AIFMD with a new section XVI on exemptions.

In summary, the new Q&A concerns Article 3(2) of AIFMD. Article 3(2) of AIFMD contains an exemption for managers of smaller funds. This applies to AIFMs whose assets under management (AUM) do not exceed: (i) €100m; or (ii) €500m, subject to certain provisos. Such AIFMS are subject to registration and reporting requirements. The Q&A concerns the calculation of the AUM and the inclusion of assets which the AIFM manages by virtue of a substantive direct or indirect holding. The answer clarifies that Article 3(2)(a) AIFMD does not set a quantitative threshold above which the criterion of substantive direct or indirect holding could be considered as met. The notion of “substantive direct or indirect holding” should be assessed on a case-by-case basis by AIFMs supervisors.

Market Abuse – ESMA view on insider list proposals

ESMA sent a letter to the European Parliament and Council raising concerns with proposed changes to the insider list regime in the Markets Abuse Regulation.

The proposed changes, which were proposed by the European Commission in December 2022 as part of the Listings Act proposal, mean that insider lists would only include persons who have regular access to inside information, and not those who may have access to such information on a case by case basis. The letter outlines how the proposed changes may lead to detrimental effects for national supervisors and their ability to enforce against market abuse, as well as for issuers, who use insider lists to manage the flow and access to inside information.

MiFIR and MiFID II updates

ESMA issued its final report on guidelines on MiFID II product governance. The updates include:

• the specification of any sustainability-related objectives with which a product is compatible
• the practice of identifying a target market per cluster of products instead of per individual product (clustering approach)
• the determination of a compatible distribution strategy where a distributor considers that a more complex product can be distributed under non-advised sales
• the periodic review of products, including the application of the proportionality principle

The report includes a feedback statement summarising the responses received to ESMA’s consultation on the guidelines.

The guidelines will be translated into the official languages of the EU and published on ESMA’s website. The publication of the translations will trigger a two-month period during which national competent authorities (NCAs) must notify ESMA whether they comply or intend to comply with the guidelines. The guidelines will apply two months after the date of the publication on ESMA’s website in all EU official languages.

The European Parliament’s Economic and Monetary Affairs Committee (ECON) published a press release announcing its adoption of draft reports on the MiFIR and MiFID II reviews, including harmonised rules to enhance market date transparency, optimise the trading obligations and prohibit receiving payments for forwarding client orders. ECON supports changes concerning data quality standards and investor protection. ECON proposes that regulated markets should be able to temporarily halt or constrain trading in emergencies or if there is a significant price movement in a financial instrument and, in exceptional cases, to be able to cancel, vary or correct any transaction.

Benchmarks regulation updates

The European Commission published a call for evidence on the scope and third-country regime of the Benchmarks Regulation.

The two aims of the call for evidence are to:

• ensure continued access to non-EU benchmarks for EU businesses and investors (the current regime will limit market access to non-EU benchmarks resulting in a more limited and more expensive choice of benchmarks)
• promote EU benchmark labels as an open standard under EU supervision

Central Securities Depositories Regulation reform

ECON announced its adoption of a draft report on the European Commission’s legislative proposal for a Regulation amending the Central Securities Depositories Regulation (CSDR Refit). In the press release, ECON highlights changes it intends to make to the proposal.

• Settlement fails. ECON proposes to apply deterrent and proportionate cash penalties when a party to a transaction does not deliver a security or funds on time. Mandatory buy-in rules should apply only as a last resort measure. ECON also proposes to exclude transactions that fail for reasons not attributable to the participants, transactions that do not involve two trading parties, or when it could lead to detrimental consequences for the market.
• Third-country regime. ECON proposes that the recognition regime for central securities depositories (CSDs) established in a third country should be expanded to cover securities settlement services.
• Supervisory colleges. ECON proposes that supervisory colleges should be established whenever a CSD is of substantial importance in more than one member state and that ESMA should have a stronger role in supervisory colleges.
• Banking-type ancillary services. ECON proposes that CSDs that are not authorised as banks should be able to offer a sufficient amount of arrange foreign currency settlement through a bank account. The EBA should be mandated to draft risk mitigating requirements.

PRIIPs KID Delegated Regulation correction

A corrigendum to Commission Delegated Regulation (EU) 2021/2268, which amends the regulatory technical standards (RTS) laid down in Commission Delegated Regulation (EU) 2017/653 (the PRIIPs KID Delegated Regulation), was published in the Official Journal of the European Union.

The correction impacts the detailed methodology PRIIPs manufacturers must use to present risk in the PRIIPs key information document (KID).

AML/CFT/Sanctions