Asset Management & Investment Funds: EU & International Developments - Apr 2021

Corporate Sustainability Reporting Directive

The European Commission published proposals to extend the scope of entities that are required to report non-financial, including sustainability, information under the Non-Financial Reporting Directive (NFRD). 

The reporting rules introduced by the NFRD apply to “public interest entities”, meaning listed companies, banks, and insurance companies. The rules apply to companies that are large (i.e. they are not SMEs), as defined in the Accounting Directive, and have more than 500 employees. Only about 11,000 companies were covered by the NFRD.

The Corporate Sustainability Reporting Directive (CSRD) proposal will extend the scope of these requirements to include all large companies, whether they are listed or not and without the previous 500-employee threshold. This change would mean that all large companies are publicly accountable for their impact on people and the environment.  In addition, the Commission is proposing to extend the scope to include listed SMEs, with the exception of listed micro-enterprises.

The European Financial Reporting Advisory Group (EFRAG) will be responsible for developing the draft standards. EFRAG recently published technical recommendations and a roadmap for the development of EU sustainability reporting standards.

The CSRD would ensure alignment with other EU initiatives on sustainable finance, in particular the Sustainable Finance Disclosures Regulation (SFDR) and the Taxonomy Regulation. This proposal would ensure that companies report the information that investors and other financial market participants subject to the SFDR need. Specifically, that means that the reporting standards would include indicators that correspond to the indicators contained in the SFDR.

The proposal would, for the first time, introduce a general EU-wide audit (assurance) requirement for reported sustainability information.

Listen to a summary of what to focus on next for SFDR from Ann Shiels, Knowledge Lawyer, part of the Soundbite Series.

ESMA updates UCITS and AIFMD Q&As for its performance fee guidelines

ESMA updated its

• Questions and Answers on the application of the UCITS Directive (section XI)
• Questions and Answers on the application of the AIFMD (section XV)  

ESMA added two new Q&As in respect of its guidelines on performance fees in UCITS and certain types of AIFs. The Q&As provides clarification on the crystallisation of performance fees and on the timeline of the application of the performance reference period. In considering this development, readers will be aware that:

• ESMA's guidelines on performance fees in UCITS and certain types of AIFs do not apply to QIAIFs
• ESMA's guidelines on performance fees in UCITS and certain types of AIFs must be read in the context of Regulations 40 and 74 of the CBI UCITS Regulations. As referenced under Irish developments, the CBI will consider those aspects of the ESMA guidelines, not currently provided for due to the legislative constraints, in future revisions of the CBI UCITS Regulations and of the AIF Rulebook.

The Q&As on the application of the AIFMD also clarify the scope of the of the application of those guidelines to European Long-Term Investment Funds (ELTIFs). The Q&A confirms that to the extent that an ELTIF is:

• marketed to retail investors
• is not a closed-ended structure
• is not a venture capital/private equity or real estate AIF

It must comply with the provisions of these guidelines if it is charging a performance fee.

ESMA's third annual statistical report on the cost and performance of EU retail investment products (to end 2019).

​ESMA published its third annual statistical report on the cost and performance of EU retail investment products.

ESMA finds that the costs of investing in key financial products, such as UCITS funds, retail alternative funds, and structured investment products (SRPs) remain high and diminish the investment outcome for final investors. The reporting period is to 31 December 2019, and UK is included as it is an EU Member for the reporting period.

The main findings:

Fund costs: UCITS costs only marginally declined over time. For one-year investments they were 1.4% in 2019 compared to 1.5% in 2018 on average across asset classes.

Volatile returns: Average gross UCITS fund performance depends on market developments and varies significantly over time. It amounted to 7.7% in 2019, while it reached no more than +0.2% in 2018 for a one-year investment. The market impact of COVID-19 falls outside the reporting period.

Retail investors: Retail clients pay on average around 40% more than institutional investors across asset classes. A ten-year investment of €10,000 in a portfolio composed of equity, bond and mixed funds led to a gross value of around €21,800 and €18,600 after costs. Around €3,200 in costs were paid by the investor.

Risks: Higher risk exposures entailed higher costs irrespective of the asset class.

Active and passive funds: The evidence on cost structure showed that costs were higher for active equity and bond UCITS compared to passive and UCITS ETFs, ultimately implying net underperformance of active equity and bond UCITS, on average, compared to passive and UCITS ETFs. Top-25% active equity UCITS over performed compared to the top-25% passive and related benchmarks, at shorter horizons. However, the cohort of UCITS changes over time making it complicated for investors to consistently identify outperforming UCITS.

ESG funds: ESG outperformed non-ESG equity UCITS mostly due to sectoral factors. According to the evidence, actively managed ESG funds showed lower costs than non-ESG, not supporting the view that there is systematic greenwashing by ESG funds.

Retail AIFs: Retail AIFs, similar to UCITS, showed high return volatility. While being negative in 2018, gross annualised returns in 2019 were 12% for fund of funds and 9% for the residual category “others" that includes investment primarily focused on equity and bonds. Net returns confirm what has been observed for gross returns, being 11% for fund of funds and 7% for others.

SRPs: The analysis on costs and performance scenarios for SRPs showed that total costs were largely attributable to entry costs and varied substantially by country and payoff type. Moreover, there was little difference in simulated returns between moderate and favourable performance scenarios.

Transparency: There is limited comparability across Member States. Heterogeneity and data availability issues persisted, as well as lack of harmonisation in national regulation. 

ESMAs third annual statistical report on the AIF sector (to end 2019)​

ESMA issued its third annual statistical report on the AIF sector. The sector increased by 15% in 2019 to €6.8tn in net assets from €5.9tn in 2018.

The main risks faced by the sector relate to a mismatch between the potential liquidity of the assets, and the redemption timeframe offered to investors, especially for real estate funds and funds of funds. For hedge funds, the issue of leverage is key at more than 900%, in a sector valued at €354bn in net asset value (NAV), including €269bn for hedge funds with UK AIFMs. The AIF sector was heavily impacted by the COVID-19 related market stress during the first quarter of 2020, and while outside the reporting period, a snapshot of the main event is included in the report.  

EU Member States can allow non-EU asset managers to market alternative funds at national level under the National Private Placement Regime (NPPR), even though such funds cannot subsequently be passported in to other Members States. The market for such non-EU funds is comparatively large: The NAV of non-EU AIFs marketed under NPPRs' rules amounts to €2.1tn, i.e. more than one-fifth of the AIF market. NPPR fund marketing is concentrated in a small number of Member States, and 98% of investors are professional investors.

The reporting period is to 31 December 2019, and UK is included as it is an EU Member for the reporting period. The statistics in this Report, therefore, present the EU market as the EU28, including the UK.

IFR Draft Regulatory Technical Standards on Investment Policy Disclosure by Investment Firms

The EBA issued a Consultation Paper on investment policy disclosures by investment firms. This is part of the EBA work plan on the implementation of the Investment Firms Directive (IFD) and the Investment Firms Regulation (IFR). The new IFD/IFR framework is due to come in to force 26 June 2021. 

The IFR sets out the requirement for investment firms to disclose information on the proportion of voting rights attached to shares held, voting behaviour, use of proxy advisor firms and voting guidelines. The purpose of disclosing this investment policy is to provide transparency on the influence of investment firms over the companies in which they hold shares with voting rights. You can read more about the key requirements of the RTS under consultation here.

The Second Shareholders Rights Directive (SRD2) contains related disclosure requirements.