Asset Management & Investment Funds: EU & International Developments - Apr 2020

ESMA final guidelines on performance fees in UCITS and certain types of AIFs

The European Securities and Markets Authority (ESMA) published its final guidelines on performance fees in UCITS and certain types of AIFs. ESMA’s guidelines aim at harmonising the way fund managers charge performance fees to retail investors, as well as the circumstances in which performance fees can be paid. UCITS and in-scope AIFs who already have, or who are considering launching, funds with performance fees will need to consider the new guidelines. The guidelines will be translated into the official EU languages and will apply two months after those translations are published on ESMA’s website. Listen to an audio summary of this guidance or read our detailed insight on the ALG website here.

Environmental, Social and Governance

Taxonomy On 15 April, the EU Council adopted the regulation on a sustainable investment taxonomy. See the press release here. The adoption was largely unproblematic due to the preceding negotiations which were extensive. As the Parliament had previously adopted a position at first reading, the taxonomy regulation in its current form must be adopted by the European Parliament at second reading before it can be signed, published in the OJ and enter into force. 

ESA consultation on ESG disclosure rules

The European Supervisory Authorities (ESAs) issued a Consultation Paper on proposed harmonised ESG disclosure standards for financial market participants, advisers and products. UCITS management companies, internally-managed UCITS and AIFMs are financial market participants (FMPs). UCITS and AIFs are financial products.

The consultation closes 1 September 2020. The EU Regulation on sustainability-related disclosures in the financial services sector (SFDR) requires the ESAs to develop Regulatory Technical Standards (RTS) on the content, methodology and presentation of ESG disclosures both at entity level and at product level. The RTS must be delivered by 30 December 2020, apart from one RTS related to information in the field of social and employee matters which is due by 30 December 2021.  The consultation also contains proposals for technical standards under the Taxonomy Regulation on the do not significantly harm (DNSH) principle.

Entity-level principal adverse impact disclosures. The principal adverse impacts that investment decisions have on sustainability factors must be disclosed on the website of the entity, and the proposals set out rules for how this public disclosure should be done.

Product level ESG disclosures. The sustainability characteristics or objectives of financial products must be disclosed in their pre-contractual and periodic documentation and on their website. The proposals suggest rules for how this disclosure should be carried out, ensuring transparency to investors regarding how products meet their sustainability characteristics or objectives. The standards also set out the additional disclosures that should be provided by products that have designated an index as a reference benchmark. The product level proposals set out suggested provisions for disclosing how a product based on sustainable investments complies with the DNSH principle

Under the SFDR, there are more disclosure obligations for financial products which promote ESG or have sustainable investment as their objective. Consequently the ESA consultation has more content of relevance for UCITS management companies, UCITS and AIFMs that have or plan to launch these kind of products. For those that do not distribute or do not plan to distribute these kinds of products, the consultation is still relevant because the website and pre-contractual disclosure obligation around adverse impacts of investment decisions on sustainability factors applies to all FMPs. 

The ESA consultation and draft RTS contain a considerable amount of information and the ESAs acknowledge the challenges encountered in preparing them.

3 draft regulations on benchmarking. The Commission published three draft delegated regulations relating to benchmarking. The consultation period closes on 6 May 2020. 

European Commission consultation on renewed sustainable finance strategy. The European Commission opened a consultation on a renewed sustainable finance strategy, closing 15 July 2020. This builds on the Commission's 2018 action plan on financing sustainable growth. The renewed sustainable finance strategy will provide a roadmap with new actions to increase private investment in sustainable projects and activities to support the different actions set out in the European Green Deal and to manage and integrate climate and environmental risks into the financial system. The initiative will also provide additional enabling frameworks for the European Green Deal Investment Plan.

IOSCO report on sustainable finance and role of securities regulators and IOSCO. The International Organization of Securities Commissions (IOSCO) published a report on sustainable finance and the role of securities regulators and IOSCO. The report provides an overview of current regulatory and industry initiatives relating to sustainable finance. It also sets out a detailed analysis of the most relevant international initiatives relating to ESG and third-party frameworks and standards. IOSCO identified recurrent issues where improvements need to be made. ESG challenges may be exacerbated by the fact that many issuers and asset managers operate cross-border and may be subject to different regulatory regimes and involved in multiple regional or international third-party initiatives with inconsistent objectives and requirements. IOSCO will establish a Sustainability Task Force to promote the objectives of addressing transparency and promoting investor protection.

COVID-19: ESMA's supervisory expectations for investment funds periodic reports

On 9 April, 2020, ESMA issued a public statement on the obligation to publish yearly and half-yearly reports for:

  • UCITS management companies
  • self-managed UCITS investment companies
  • authorised AIFMs
  • non-EU AIFMs marketing AIFs pursuant to Article 42 of the AIFMD
  • EuVECA managers
  • EuSEF managers

ESMA recognises the importance of periodic reports for timely and transparent disclosure. ESMA is of the view that the burdens on fund managers associated with the COVID-19 outbreak should be taken into account by National Competent Authorities (NCAs) in a coordinated way. ESMA expects NCAs to adopt a risk-based approach and not prioritise supervisory actions against these market participants in respect of the upcoming reporting deadlines.

ESMA up-dated its risk assessment for COVID-19

ESMA updated its risk assessment for COVID-19

  • COVID-19, in combination with the valuation risks identified in ESMA's previous risk assessments, led to massive equity market corrections since mid-February, driven by a sharp deterioration in the outlook for consumers, businesses and of the economic environment
  • ESMA sees a prolonged period of risk to institutional and retail investors of further – possibly significant – market corrections
  • ESMA sees very high risks across the entire ESMA remit. ESMA's outlook on operational risks is negative given the rising reliance on remote working arrangements, even if business continuity plans are widely reported as working. To what extent these risks will further materialise will critically depend on two drivers: the economic impact of COVID-19, and any occurrence of additional external events in an already fragile global environment
  • Specifically on asset management- funds: Performance decreased across asset classes in line with market valuations. Bond UCITS and ETFs had to manage massive outflows. MMFs faced significant challenges (€120bn decline in NAV for LVNAVs between 9-23 March). A number of fund managers began to use liquidity management tools. Some ETFs showed signs of price dislocation
  • The next Risk Dashboard covering the entire 1Q20 will be published according to the regular schedule in May 2020

COVID-19 ESMA updates

ESMA launched a COVID-19 page on its website listing its COVID-19 actions (in co-ordination with the NCAs).

These include:

  • Recommendations to market participants (discussed in our March bulletin)
  • Risk update 2020 (discussed above)
  • ESMA, along with the NCAs, has taken a number of initiatives to address the effects of the Covid-19 pandemic in the following areas:
    • benchmarks regulation
    • corporate disclosures
    • fund management periodic reporting (discussed above)
    • MiFID/ MIFIR selling measures (including short selling)
    • Securities Finance Transactions Regulation measures
    • These include recommended actions by financial market participants for COVID-19 impact

ESMA published the conclusions of the ESMA Board of Supervisors calls of 13 March, 16 March, 18 March  and 20 March 2020 on 30 April 2020. The minutes reflect discussions around the actions taken by ESMA.

ESMA annual statistical report on performance and costs of retail investment products in the EU

ESMA published its second annual statistical report on the cost and performance of retail investment products in the EU. The report covers EU retail investment products in the period from 2009 to 2018 in some detail. ESMA's summary stresses impact of costs on retail investor benefits. Costs continue to have a significant impact on the final value of an investment, with retail investors paying around 40% more than institutional investors on average across asset classes.

  • Although actively managed UCITS saw gross outperformance over passive and ETFs UCITS funds, the difference was not enough to compensate for the higher costs charged by active UCITS funds. Costs were higher than 1.5% in the case of active equity UCITS and hovered around 0.6% for passive and ETFs UCITS, on average
  • For retail AIFs, the report provides information on gross performance but data on costs continues to be unavailable. Gross returns were negative for the types of AIFs with large retail investor shares: -2.1% for funds of funds and - 3.3% for the category "Other". This reflects the poor performance across asset classes, especially at the end of 2018

ESMA consultation processes

ESMA updated its Public Statement of Consultation Practices to take account of the amendments which the ESAs’ review has made to the ESMA Regulation. The statement summarises ESMA’s consultation practices, most of which have already been in place since before the amendment of the ESMA Regulation. The changes are now in place.

AML / CTF

Covid-19. EBA, calls on NCAs to be flexible and pragmatic in AML/CTF supervision including on AML/CTF inspections and questionnaires. The European Banking Authority (EBA) has called on NCAs that are responsible for the AML/CFT supervision of financial institutions:

  • To plan supervisory activities in an effective as well as pragmatic and risk-sensitive way. This may entail, for example, a temporary postponement of non-essential onsite inspections on a case-by case basis even after current restrictions on movement have been lifted, a move towards virtual meetings and inspections where appropriate, or an extension of submission dates for AML/CFT questionnaires where these are being used
  • To continue to share information on emerging ML/TF risks. The EBA notes that there is already evidence of increased levels of cybercrime, COVID-19 related frauds and scams.
  • To set clear expectations of the steps credit and financial institutions should take to mitigate the identified emerging risks. Where necessary, firms need to update their risk assessments. They also need to continue monitoring transactions, paying particular attention to any unusual or suspicious patterns in customers' behaviour and financial flows

Wolfsberg Group updated its correspondent banking due diligence questionnaire and supporting materials. The Wolfsberg Group is an association of thirteen global banks that aims to develop frameworks and guidance for the management of financial crime risks, particularly with respect to know your customer, anti-money laundering and counter terrorism financing policies.

COVID-19: FATF statement and measures to combat illicit financing. The Financial Action Task Force (FATF) issued a statement which includes:

  • A recommendation that supervisors and other law enforcement agencies share information with the private sector on ML risks, particularly those related to fraud, and TF risks linked to COVID-19. It warns that criminals and terrorists may seek to exploit gaps and weaknesses in national AML/ CFT systems while they assume resources are focused elsewhere. Financial institutions and other businesses should remain vigilant to emerging ML and TF risks and ensure that they continue to effectively mitigate these risks and are able to detect and report suspicious activity
  • An encouragement to use technology, referencing its March 2020 guidance on digital ID systems. The FATF calls on countries to explore using digital identity to aid financial transactions while managing ML or financial crime risks during this crisis

COVID-19: FATF announces extension to mutual evaluations and follow-up deadlines. On 28 April 2020, the FATF announced the extension of its assessment and follow-up deadlines in response to COVID-19. The FATF also decided to pause the review process for the list of high-risk jurisdictions which are subject to a call for action and jurisdictions subject to increased monitoring. Jurisdictions are being given an additional four months. Mongolia and Iceland requested FATF not to extend their deadlines.

EBA consultation on revised guidelines on money laundering and terrorist financing risk factors

The EBA deadline for its consultation on revised guidelines on money laundering and terrorist financing risk factors has been extended to 6 July 2020, due to the COVID-19 situation. The EBA will hold a public hearing on the draft Guidelines, via conference call, on 15 May 2020 from 2-4pm Paris time.

FATF

On 6 March 2020, the Financial Action Task Force (FATF) published guidance on digital identity. The guidance is intended to clarify how digital ID systems, such as biometric technology, the use of smart phones and distributed ledger technology can be used for customer due diligence. The FATF states that non-face-to-face customer-identification and transactions that rely on reliable, independent digital ID systems with appropriate risk mitigation measures in place, may present a standard level of risk, and may even be lower-risk.

The FATF updated its identified jurisdictions with strategic deficiencies in their frameworks to combat money laundering and the financing of terrorism and proliferation: high-risk jurisdictions subject to a call for action and jurisdictions under increased monitoring.

FATF issued a paper which identifies challenges, good practices and policy responses to new ML/ TF threats and vulnerabilities arising from the COVID-19 crisis. FATF will host a webinar to discuss the paper on 7 May 2020.

For more information in relation to this topic please contact your usual contact on the A&L Goodbody Asset Management & Investment Funds team.

Date published: 6 May 2020