Asset Management & Investment Funds: EU & International Developments – August 2023
Asset Management & Investment Funds: EU & International Developments – August 2023
European Sustainability Reporting Standards
On 31 July 2023, the European Commission adopted the first set of the European Sustainability Reporting Standards (ESRS) for use by companies subject to the reporting requirements of the Corporate Sustainability Reporting Directive (CSRD). The requirements will be phased in over time depending on the entity classification under the CSRD from 2024 to 2029, beginning with large public entities already subject to the Non-Financial Reporting Directive (NFRD).
UCITS and AIFs and the majority of fund managers are currently exempt from the CSRD sustainability reporting obligations. The ESRS are, however, expected to increase the availability and quality of data available for fund managers to meet their SFDR disclosure requirements to the extent their funds under management invest in companies within scope of CSRD (i.e. it is expected to increase the number of companies within scope of sustainability reporting requirements from c.11,000 to c.44,000 and improve the quality of sustainability-related disclosures required from these companies).
At the heart of the CSRD is the introduction of the ESRS. Companies that are required to report under the CSRD will be required to provide a range of sustainability information in compliance with the ESRS in their annual reports together with their financial reporting. The information reported under the ESRS is intended to assist investors to evaluate the sustainability performance of companies in which they invest by ensuring that companies across the EU report comparable and reliable sustainability-related information.
The first set of ESRS contains 12 separate standards. Ten topical standards that relate to specific environmental, social or governance matters, and two cross-cutting standards, applying across all sustainability matters. The European Financial Reporting Advisory Group is expected to produce technical guidance relating to the first set of ESRS and will publish sector specific standards for key sectors for consultation at a future date. The European Commission sought to ensure that the ESRS reporting framework aligns with the structure of international sustainability reporting frameworks. This includes, but is not limited to, the Task Force for Climate related Financial Disclosures (TCFD) recommendations and the International Sustainability Standards Board (ISSB) IFRS sustainability standards.
Industry concerns have been raised regarding the lack of alignment between reporting requirements under the ESRS and SFDR requirements. In addition, the ESRS includes phasing-in periods for companies in relation to certain disclosure requirements of relevance to fund manager SFDR disclosure requirements. This means that fund managers may not have timely access to the information they require from relevant companies, whereas SFDR disclosure requirements are already in effect.
The ESRS, contained in a delegated regulation, are now subject to a two-month scrutiny period (extendable by two months) by the European Parliament and the Council.
The European Commission has adopted an adequacy decision relating to the transfer of personal data from the EU to the US which takes place under the EU-U.S. Data Privacy Framework (the DPF). The DPF is the successor to the EU-US Privacy Shield (the Privacy Shield) which was invalidated by the CJEU’s Schrems II ruling in July 2020.
The DPF allows personal data to flow from the EU to companies in the US that participate in the DPF without the need for additional data protection safeguards (such as standard contractual clauses or binding corporate rules). You can read more detail on the DPF here.
US companies can certify their participation in the DPF by committing to comply with a detailed set of privacy obligations (such as purpose limitation, data minimisation, data retention, as well as specific obligations concerning data security and the sharing of data with third parties).
The safeguards that have been put in place by the US Government in the area of national security (including the redress mechanism) apply to all data transfers under the GDPR to companies in the US, regardless of the transfer mechanism used. These safeguards also facilitate the use of other tools, such as standard contractual clauses and binding corporate rules.
For transfers of personal data to the US using standard contractual clauses or binding corporate rules, a transfer impact assessment is required (per Schrems II). In this context, the adequacy decision will assist data exporters when considering public authorities’ ability to access and use transferred personal data.
This will ease the compliance challenges in respect of the transfer of personal data from the EU to the US.
FSB thematic peer review on MMF reforms
The Financial Stability Board (FSB) has requested feedback from stakeholders as part of its thematic peer review on money market fund (MMF) reforms by 8 September 2023. The review will assess progress made by FSB member jurisdictions in assessing and addressing MMF vulnerabilities in their domestic markets. We expect publication of the peer review by end 2023.
The FSB sent a questionnaire to member jurisdictions. In addition, as part of this peer review, the FSB invites feedback from stakeholders on the following issues:
how MMF vulnerabilities differ across jurisdictions depending on MMF structure, investor composition, asset profile, or other factors
progress made by FSB member jurisdictions in addressing MMF vulnerabilities
operational and other challenges faced by the industry in implementing MMF reforms
Interconnectedness among EU investment funds - ESMA working paper
ESMA published a working paper on interconnectedness among EU investment funds. This forms part of the current narrative on the adoption of a macroprudential framework. In its recent discussion paper, the CBI highlighted the absence of high-quality data which would allow for meaningful analysis of the resilience of the funds sector to market shocks.
The paper assesses the interconnectedness within the funds sector and whether this gives rise to contagion risks in the event of market volatility which could impact financial stability. The findings include that supervisory activities aimed at reducing systemic risk can benefit from particularly considering investment funds which contribute the most to the volatility in the study, i.e. alternative and mixed funds.
The guidelines apply in relation to the information requirements for suitability and appropriateness assessments under Article 25(2) MiFID II and Articles 54 and 55 of the MiFID II Delegated Regulation, in the provision of investment advice and portfolio management to retail clients, and, to the extent relevant, to professional clients. The guidelines will replace existing guidelines on certain aspects of the MiFID II suitability requirements. The purpose of the guidelines is to clarify the application of certain aspects of the MiFID II suitability requirements, including information requirements on “sustainability preferences”, as defined in Article 2(7) of the MiFID II Delegated Regulation.
MiFID II guidelines on product governance requirements
ESMA’s guidelines on MiFID II product governance requirements apply from 3 October - two months from the date of publication of the guidelines on ESMA's website in all EU official languages. ESMA published a report on the final version of these guidelines in March 2023. The guidelines apply to firms acting as manufacturers and/or distributors of financial instruments and structured deposits. The guidelines build on the text of the ESMA guidelines published in June 2017, taking into account the following regulatory and supervisory developments:
European Commission Capital Markets Recovery Package
sustainability-related amendments to the MiFID II Delegated Directive
recommendations on product governance guidelines by ESMA’s Advisory Committee on Proportionality
findings of ESMA’s 2021 CSA on product governance
The EU adopted further financial sanctions expanding the ban of certain exports to Belarus and aligning the Belarus sanctions with the Russia sanctions regime.
There is a legal obligation to comply with EU Regulations relating to financial sanctions as soon as they are adopted. EU sanctions compliance programmes may need updating to reflect these further financial sanctions.
The Financial Action Task Force
The report on the Financial Action Task Force (FATF) mutual evaluation of Luxembourg is expected to be published soon. The FATF found that Luxembourg reached a high level of technical compliance with the FATF’s requirements and its AML/CFT regime is delivering good results.
This report will likely provide valuable information on the mechanics of AML/CFT in an investment fund context, given the importance of Luxembourg as a financial centre.
EU list of high-risk third countries
The list of high-risk third countries with strategic AML/CTF deficiencies is being updated to add Cameroon and Vietnam to the list. This reflects the outcome of FATF's plenary meeting in June 2023 at which Cameroon, Croatia and Vietnam were added to the list of jurisdictions under increased monitoring. Croatia is an EU Member State and so is not a third country. The Delegated Regulation will enter into force after a period of scrutiny by the European Parliament and the Council of the EU over a period of one month (which can be prolonged for another month). If there is no objection, it will enter into force 20 days following its publication in the Official Journal of the EU.
ESMA is withdrawing recognition decisions of three central counterparties (CCPs) established in the United Arab Emirates (UAE). The UAE was added to the EU’s list of high-risk third countries presenting strategic deficiencies in their national AML/CFT regime, in March 2023. This impacts: