Asset Management & Investment Funds: EU & International Developments: May 2019
ESMA advice on ESG amendments to the UCITS Directive and AIFMD
ESMA issued a final report setting out proposed amendments to the AIFMD and the UCITS Directive for the integration of sustainability risks and factors relating to environmental, social and good governance considerations. ESMA will work with the EU Commission with a view to transforming the technical advice into formal delegated acts. The changes are set out below (referencing the provision which is to be amended).
UCITS Directive
Organisational Requirements
- ManCos will be required to consider sustainability risks in structuring and operating their internal processes, systems and controls. (Article 4 of the Commission Directive 2010/43/EU on “General Requirements on Procedures and Organisation.”)
- ManCos will be required to ensure they have the necessary resources and expertise (knowledge, skills, risk management and resources) for the effective integration of sustainability risks. (Article 5 of the Commission Directive 2010/43/EU on “Resources.”)
- ManCos will be required to ensure that senior management is responsible for the integration of sustainability risks. (Article 9 of the Commission Directive 2010/43/EU on “Control by Senior Management and Supervisory Function.”)
Operating Conditions
- ManCos will be required to consider sustainability risks in their due diligence processes including, where applicable, the principal adverse impact of investment decisions on sustainability factors. This may impact the selection and ongoing monitoring of investments and risk management. Where applicable, ManCos will be required to develop engagement strategies including for the exercise of voting rights, where available, with a view to reducing the principal adverse impact of investee companies on sustainability factors. For further clarity, the Commission may decide to also add cross-references to the provisions set out in the Disclosure Regulation relating to disclosures of principal adverse impact that are required for authorised entities with more than 500 employees and that are based on a comply or explain mechanism for authorised entities with fewer than 500 employees. (Article 23 of the Commission Directive 2010/43/EU on “Due Diligence Requirements.”)
- When identifying the types of conflicts of interest whose existence may damage the interests of a UCITS, ManCos and self-managed UCITS will be required to include conflicts that may arise in relation to the integration of sustainability risks. The identification process should include, for example, conflicts arising from remuneration or personal transactions of relevant staff as well as any sources of conflicts that could give rise to greenwashing, mis-selling, misrepresentation of investment strategies or churning. Consideration should also be given to conflicting interests between funds with different investment strategies managed by the same UCITS ManCo as well as situations where there are other business relationships with investee companies, conflicting group interests, investments in entities with close links or similar circumstances. (New recital 17 (bis) to Commission Directive 2010/43/EU.)
Risk Management
- ManCos will be required to include sustainability risks in the list of material risks in their risk management policy. (Article 38 of the Commission Directive 2010/43/EU on “Risk Management Policy.”)
AIFMD
Organisational Requirements
- AIFMs will be required to consider sustainability risks in structuring and operating their internal processes, systems and controls. (Article 57 of the Commission Delegated Regulation (EU) 231/2013 on “General Requirements.”)
- AIFMs will be required to ensure they have the necessary resources and expertise for the effective integration of sustainability risks. (Article 22 of the Commission Delegated Regulation (EU) 231/2013 on “Resources.”)
- AIFMs will be required to ensure that senior management is responsible for the integration of sustainability risks. (Article 60 of the Commission Delegated Regulation (EU) 231/2013 on “Control by the governing body, senior management and supervisory function.”)
Operating Conditions
- AIFMs will be required to consider sustainability risks in their due diligence processes including, where applicable, the principal adverse impact of investment decisions on sustainability factors. This may impact the selection and ongoing monitoring of investments, having adequate knowledge and understanding and updating written policies and procedures. Where applicable, AIFMs will be required to develop engagement strategies including for the exercise of voting rights, where available, with a view to reducing the principal adverse impact of investee companies on sustainability factors. (Article 18 of the Commission Delegated Regulation (EU) 231/2013 on “Due Diligence.”)
- When identifying the types of conflicts of interest whose existence may damage the interests of an AIF or its investors, AIFMs will be required to include conflicts that may arise in relation to the integration of sustainability risks. The identification process should include, for example, conflicts arising from remuneration or personal transactions of relevant staff as well as any sources of conflicts that could give rise to greenwashing, mis-selling, misrepresentation of investment strategies or churning. Consideration should also be given to conflicting interests between funds with different investment strategies managed by the same AIFM as well as situations where there are other business-relationships with investee companies, conflicting group interests, investments in entities with close links or similar circumstances. (New recital 48 (bis) to be added to Commission Delegated Regulation (EU) 231/2013.)
Risk Management
- AIFMs will be required to include sustainability risk in the list of material risks in their risk management policy. (Article 40 of the Commission Delegated Regulation (EU) 231/2013 on “Risk Management Policy.”)
ESMA also issued advice in the context of MiFID II. ESMA developed its report in co-operation with EIOPA, which received a similar mandate regarding Solvency II and the Insurance Distribution Directive. A separate paper on guidelines for disclosure requirements for credit ratings, including the consideration of environmental, social and governance factors, is expected by the end of July.
The EU Commission's initiatives on sustainable finance form part of its broader initiative to establish the capital markets union.
The second Shareholders' Rights Directive
The second Shareholders' Rights Directive (SRD II) is due to be implemented into national law by 10 June 2019
The Irish legislation implementing the first Shareholders' Rights Directive (SRD I) in August 2009 established requirements in relation to the exercise of certain rights of shareholders in listed companies. Irish UCITS and non-UCITS funds – today's equivalent are AIFs – were exempted from applying its requirements
SRD II has an additional focus and aims to encourage long term shareholder engagement. SRD II contains transparency provisions which are applicable specifically to AIFMs, UCITS ManCos and self-managed UCITS investment companies. One requirement is to have a shareholder engagement policy or explain why one is not in place. Another is a requirement to disclose certain information annually to institutional investors with which a certain arrangement is in place. There is no member state discretion to exempt UCITS or AIFs from these requirements. The SRD II requirements which will apply to AIFMs, UCITS ManCos, SMICs and AIFs, apply to the extent they invest on behalf of investors in shares of companies traded on a regulated market. There is a question of interpretation whether the requirements apply to the extent the investment is in "shares of companies which have their registered office on a Member State and the shares of which are admitted to trading on a regulated market situated or operating within a Member State" which would be narrower. A logical interpretation is that the former is the trigger applicable to asset managers as defined in SRD II
ESMA speeches and newsletter
Verena Ross, ESMA Executive Director delivered a speech on sustainable finance, benchmarks and regulatory priorities 2019.
Points of interest include:
Sustainable Finance Ms Ross highlighted:
- The EU ESG package of measures (discussed in previous bulletins)
- ESMA's recommendations for amendments to the UCITS and AIFMD Level 2 legislation with respect to organisational requirements, operating conditions, and risk management to integrate sustainability risks and factors (discussed above)
- The new regulation on ESG Disclosures. This Regulation sets out ESG disclosure requirements for a broad range of financial market participants (including UCITS ManCos and AIFMs) and financial products. ESMA will work on joint Technical Standards.
Benchmarks
- ESG disclosure will not be limited to these two new low-carbon benchmarks. All benchmarks, within their benchmark statement, should disclose whether they pursue ESG objectives.
Brexit
Ms Ross highlighted
- The importance of being well prepared for Brexit
- ESMA's opinion setting out general principles to support supervisory convergence in the context of Brexit and its opinion to support supervisory convergence in the area of investment management in the context of Brexit
- The work of the Supervisory Coordination Network (which allows senior authorisation and supervision experts from the national competent authorities to discuss cases that they are managing involving UK entities looking for authorisation in the EU27)
- The agreement by ESMA and national competent authorities of MoUs with the UK FCA (which only take effect in the event of a no-deal Brexit scenario)
- ESMA's work with the Commission, which issued temporary equivalence decisions, to ensure that UK CCPs and the UK CSD could be recognised and that the necessary MoUs with the Bank of England are in place.
ESMA also published a speech, delivered by Evert van Walsum, Head of the Investors and Issuers Department, on ESMA's current priorities.
Points of interest include:
- The ESAs' work on technical standards on disclosure for the proposed Regulation on disclosures relating to sustainable investments and sustainability risks. Most of the standards must be delivered within 12 months of the Regulation's entry into force, which is expected during or just after the Summer
- Having found inconsistencies, ESMA is working on common principles to harmonise how EU regulators approach performance fees and how performance fees can be structured. ESMA will continue this work to prevent the risk of regulatory arbitrage and inconsistent levels of investor protection for retail investors
- ESMA is reviewing the PRIIPs Delegated Regulation and expects to consult publicly in Q3 of 2019. The review will include proposals to review the performance scenarios section of the PRIIPs KID, which proved to show over-optimistic results in certain cases. It will also cover cost-related issues, such as the presentation and calculation of costs. It will be complemented by a consumer testing exercise undertaken by the Commission on the different possible amendments to be made to the presentation of performance scenarios. The results of this exercise will be known by the end of 2019. Proposals for changes to the PRIIPs Delegated Regulation should then be sent to the Commission at the start of 2020.
ESMA’s newsletter-fourth edition issued on 7 May 2019.
It contains a:
- Full list of April publications
- Reminder that ESMA's Board of Supervisors meet in May
- A full list of speaking appearances by ESMA staff can be found here
- In April, ESMA adopted four positive opinions on proposed product intervention measures by national competent authorities. The newsletter takes a closer look at some key questions
- Public holidays. ESMA will be closed for public holidays on the 1, 9, 30 and 31of May
- ESMA consultations can be found on the ESMA consultations page
Brexit and TPR - further extension
The UK FCA's Temporary Permissions Regime (or TPR) allows EEA investment funds and EEA fund managers that market EEA investment funds in the UK under a passport to continue temporarily marketing in the UK after exit day in the event of a no-deal Brexit. This has been discussed in some detail in previous editions of the bulletin.
The FCA made a number of extensions to the notification window for the TPR from the initial deadline of the end of 28 March 2019 to the end of 11 April 2019, to the end of 30 May and, most recently, until the end of 30 October 2019. This latest more lengthy extension may mean that promoters may have new sub-funds authorised for entry into the TPR prior to the UK's exit and it will be important to ensure that any TPR update notifications are completed within the window.
The FCA set up a TPR webpage which is a valuable source of information.
EuSEFs and EuVECAs
Commission Delegated Regulation (EU) 2019/819 supplementing the European Social Entrepreneurship Funds (EuSEF) Regulation with regard to conflicts of interest, social impact measurement and information to investors in the area of EuSEFs comes into force on 11 June 2019 and applies from 11 December 2019.
Commission Delegated Regulation (EU) 2019/820 supplementing the European Venture Capital Funds (EuVECA) Regulation (345/2013) with regard to conflicts of interest in EuVECAs comes into force on 11 June 2019 and applies from 11 December 2019.
EU Legislative Proposals
The following EU legislative proposals are expected to be published in the official journal of the EU over the coming months. Many of these proposals have been discussed in previous bulletins.
- Directive and Regulation on the cross-border distribution of collective investment funds
- Regulation on disclosures relating to sustainable investments and sustainability risks
- The ESFS legislative reform package
- Directive on the protection of persons reporting on breaches of Union law (Whistleblowers' Directive)
- Directive on the prudential supervision of investment firms (the Investment Firms Directive or IFD)
- Regulation on the prudential requirements of investment firms (the Investment Firms Regulation or IFR).
New EU Regulation on the screening of Foreign Direct Investments
On 19 March 2019, the European Union formally adopted Regulation (EU) 2019/452 of the EU Parliament and of the Council establishing a framework for the screening of foreign direct investments into the EU (the Regulation). The Regulation covers a broad category of foreign investments affecting “security or public order” and will apply broadly from 11 October 2020. For more information, read our summary here.
AML/ CTF
Delegated regulation on group-wide AML and CTF policies for credit and financial institutions.
Delegated Regulation (EU) 2019/758 supplementing 4AMLD with RTS for the minimum action and the type of additional measures credit and financial institutions must take to mitigate ML/TF risk in certain third countries enters into force on 3 June 2019 and applies from 3 September 2019.
Article 45 of 4AMLD sets out requirements for the implementation of group-wide policies and procedures for AML/ CTF. Where the law of a third country does not allow implementation of group-wide policies, Article 45(5) states that firms must ensure that their branches and majority-owned subsidiaries in that third country apply "additional measures" to handle effectively the risk of ML/TF. This may occur, for example, when the sharing of customer-specific information within the group conflicts with local data protection or banking secrecy requirements. The RTS specify the additional measures that firms should take to comply with Article 45(5).The Regulation lays down a set of additional measures, including minimum action, that credit institutions and financial institutions must take to effectively handle the ML/TF risk where a third country's law does not permit the implementation of group-wide policies and procedures at the level of branches or majority-owned subsidiaries that are part of the group and established in the third country.
Council Regulation (EU) 2019/796 concerning restrictive measures against cyber-attacks threatening the EU or its Member States
On 17 May 2019, the Council of the European Union adopted Council Regulation (EU) 2019/796 concerning restrictive measures against cyber-attacks threatening the EU or its Member States. The Regulation contains targeted sanctions (including asset freezing) against malicious cyber activities from outside the EU that undermine the EU's integrity, security and economic competitiveness, including increasing acts of cyber-enabled theft of intellectual property.
For more information in relation to this topic please contact a member of the Asset Management & Investment Funds team.
Date published: 31 May 2019