Asset Management & Investment Funds: EU & International Developments – Feb 2022

MMFs - proposed reforms and stress testing

The European Securities and Markets Authority (ESMA) issued an opinion containing proposed reforms to the money market fund framework. While the opinion contains some steps advocated by industry such as decoupling regulatory thresholds from suspensions, gates and redemption fees, it also suggests removing the possibility to use amortised costs for LVNAV MMFs. ESMA has sent its opinion to the European Commission and will work with the Commission on the review of the MMF Regulation.

The opinion includes the following policy proposals.

Addressing the threshold effects for constant net asset value (CNAV) MMFs, by:

  • removing the possibility to use amortized costs for low volatility NAV (LVNAVs) MMFs
  • decoupling regulatory thresholds from suspensions, gates and redemption fees for LVNAV/CNAV MMFs

Addressing liquidity related issues by:

  • ensuring mandatory availability of at least one liquidity management tool for all MMFs
  • amending the daily liquid asset/ weekly liquid assets ratios as well as the pool of eligible assets, including public debt assets, which can be used to satisfy these liquidity ratios
  • inclusion/reinforcement of the possibility to temporarily use liquidity buffers in times of stress

ESMA is also proposing enhancements of reporting requirements and the stress testing framework, as well as clarification of the requirements on external support and new disclosure requirements linked to the rating of MMFs.

ESMA also published the annual update of the guidelines on MMF stress tests. The new guidelines will have to be used for the purpose of the first period to be reported following the start of the application of the updated guidelines (i.e. two months after the publication of their translations). ESMA also flagged that they intend to consult with stakeholders during Q2 2022 regarding the interdependencies between the different risk factors under certain market situations and a related further update to the guidelines later in 2022.

The CBI published a research technical paper entitled “Do redemptions increase as money market funds approach regulatory liquidity thresholds?", which provides a useful addition to the debate on MMFR reform.

ESMA's implementation timeline for SFDR | TR | CSRD | MiFID | IDD | UCITS | AIFMD

ESMA published a helpful implementation timeline for the Sustainable Finance Disclosures Regulation (SFDR), the SFDR regulatory technical standards, the Taxonomy Regulation, the Taxonomy Regulation Article 8 Delegated Act, the Corporate Sustainability Reporting Directive (draft), MiFID, IDD, UCITS and AIFMD.

ESMA's Sustainable Finance Roadmap

ESMA published its Sustainable Finance Roadmap 2022-2024 with three priorities for its sustainable finance work:

  • tackling greenwashing and promoting transparency
  • building national competent authorities’ (NCAs) and ESMA’s capacities in the sustainable finance field
  • monitoring, assessing and analysing ESG markets and risks: ESMA will undertake specific activities including climate scenario analysis for investment funds and the establishment of common methodologies for climate-related risk analysis

ESMA will address its three priorities with a comprehensive list of actions across the following sectors: investment management, investment services, issuers' disclosure and governance, benchmarks, credit and ESG ratings, trading and post-trading and financial innovation. Several of these actions will also contribute to fulfilling the European Commission's 2021 Renewed Sustainable Finance Strategy.

Proposed directive on corporate sustainability due diligence

The European Commission published its proposal for a directive on corporate sustainability due diligence. This will complement the corporate sustainability reporting directive and other EU laws. It is not yet clear that this proposal will impact investment funds. This will become clear as the proposal proceeds through the legislative process.

The proposal sets out a corporate due diligence duty to "identify, prevent, bring to an end, mitigate and account for adverse human rights and environmental impacts in the company's own operations, its subsidiaries and their value chains".

The proposal will introduce duties for the directors of the EU companies covered. These duties include setting up and overseeing the implementation of the due diligence processes and integrating due diligence into the corporate strategy. In addition, when fulfilling their duty to act in the best interest of the company, directors must take into account the human rights, climate change and environmental consequences of their decisions. "Where companies' directors enjoy variable remuneration, they will be incentivised to contribute to combating climate change by reference to the corporate plan."

ESG ratings providers – ESMA's call for evidence

ESMA published a call for evidence on ESG rating providers operating in the EU. ESMA believes that the unregulated nature of ESG ratings and data assessments poses a potential risk to investor protection.

ESMA aims to establish a picture of the size, structure, resourcing, revenues and product offerings of the different ESG rating providers that operate in the EU. ESMA also hopes to complement this picture with views and experiences from both users of and entities covered by ESG rating providers.

ESMA's fourth annual statistical report on the AIF sector

ESMA published its fourth annual statistical report on the Alternative Investment Fund (AIF) sector. The report covers the 30 members of the European Economic Area (EEA30) and shows that the sector increased by 8% in 2020 to €5.9tn in net assets from €5.5tn in 2019.

The main risk faced by the sector relates to a mismatch between the potential liquidity of the assets, and the redemption timeframe offered to investors. While at aggregate level this mismatch is unlikely to materialise, it indicates that AIFs with a liquidity deficit would face challenges if large redemptions were to occur. This is particularly the case for real estate funds and funds of funds.

Main findings are detailed below.

  • The size of the EEA AIF market continued to expand to reach €5.9tn in net asset value (NAV) at the end of 2020, an 8% increase from €5.5tn in 2019. The growth of the EU AIF market results from the launch of new AIFs in 2020 and positive valuation effects.
  • Funds of funds (FoFs) account for 15% of the NAV of EU AIFs, at around €0.9tn (+4% compared with €842bn in 2019). At the very short end, investors can redeem 40% of the NAV within one day, whereas only 14% of assets could be liquidated within this timeframe. If large redemptions were to occur, AIFs would face challenges due to this liquidity mismatch.  
  • Real estate funds (RE funds) account for 13% of the NAV of AIFs, at €766bn. They continued to grow in 2020 (+9% compared to 2019). RE funds are exposed mostly to illiquid physical assets which take time to sell, so liquidity risk in RE funds remains a concern.
  • B.rexit – following the withdrawal of the United Kingdom from the EU, the size of the EEA30 hedge fund sector has declined to only €89bn (2% of the NAV of all AIFs), from €354bn in 2019 (including the UK). Leverage remains very high, particularly for some strategies highly reliant on derivatives.
  • Private equity funds account for 6% of the NAV of all AIFs, or €363bn, and experienced the largest growth in 2020 (+29% compared with 2019). They follow a range of strategies and are almost exclusively sold to professional investors.
  • Other AIFs account for 62% of the NAV of EU AIFs, at around €3.7tn (+4% compared with 2019). The category covers a range of strategies, with fixed income and equity strategies accounting for 68% of the NAV and an additional residual category amounting to 29%. Other AIFs are mainly sold to professional investors, although there is a significant retail investor presence.
  • 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 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 €1.3tn, i.e. more than one-fifth of the AIF market. NPPR fund marketing is concentrated in a small number of Member States, and 99% of investors are professional investors.

ESMA will continue to report annually on its analysis.

ESMA report on AIF exposures to commercial real estate – 2020

ESMA published aggregated data on the exposures of AIFs subject to its supervision to commercial real estate (CRE) markets in the EU, as of 31 December 2020.

  • number of AIFs: 2083 AIFs marketed and/or managed by authorised EU AIFMs
  • NAV: €470bn, AIFs managed and/or marketed by authorised EU AIFMs
  • geographical breakdown of the investments   EEA: 90% NON-EEA: 10%
  • total value of CRE investments: €378bn (AIFs pursuing primarily a CRE strategy)

Coverage

  • At the end of 2020, 2379 AIFs were pursuing a CRE strategy of which 2083 were AIFs marketed and/or managed by authorised EU AIFMs (NAV of €470bn).
  • Within this sample, 1792 AIFs were pursuing primarily a CRE strategy, and 291 AIFs were pursuing partially a CRE strategy.  

Cross Border Distribution of Funds - ESMA update of NCA requirements, summaries and fees

ESMA issued a reference document with hyperlinks to:

  • NCA websites where the NCA publish complete and up-to-date information on the applicable national laws, regulations and administrative provisions governing marketing requirements for AIFs and UCITS, as well as the summaries thereof.
  • NCA websites where the NCA publish and maintain complete and up-to-date list of the fees and charges they levy for carrying out their duties in relation to the cross-border activities of fund managers. 

The document contains both hyperlinks and the summaries of national rules governing marketing requirements, which were provided by NCAs. It will be updated frequently.

ESMA's first report on market trends, risks & vulnerabilities 2022

ESMA published the first trends, risks and vulnerabilities (TRV) report of 2022. In its outlook for 2022, ESMA continues to see high risks to institutional and retail investors of further, possibly significant, market corrections. The report’s main findings are set out below.

  • Market environment: Macroeconomic conditions continued to improve through the second half of 2021, although the impact of a new wave of the pandemic on the economic outlook is unclear.
  • Securities markets: The increase in global equity prices continued, and while volatility remained low, elevated price earnings ratios pointed towards potential overvaluation concerns. Energy commodity prices were particularly volatile; highlighting the potential financial risks associated with the energy transition and Europe’s climate policy objectives.
  • Asset management: Investment fund markets continued to grow, particularly with inflows into equity funds. Risks remained elevated, both in terms of liquidity risk and in terms of credit risk, while higher inflation expectations raise new concerns in relation to duration risk. Funds investing in assets protected against inflation, such as commodity funds, benefitted from increased flows.
  • Sustainable finance: The growth of ESG markets remained steady as investors continued to increase their investments in sustainable products. ESG fund assets increased by 9% in the second half of 2021, while ESG bond markets grew by 19%. Concerns over possible green asset overvaluation lingered.
  • Financial innovation: Crypto asset markets reached new records with a peak at €2.6tn in November, fuelled by investor appetite for riskier assets and growing institutional adoption. Stablecoins and DeFI continued to expand rapidly, and with them concerns over the resilience of business models as well as high product and market risks investors take.

Draft RTS: methodology for calculating the fixed overheads requirements for investment firms

The EBA published its opinion on draft regulatory technical standards specifying the methodology for calculating the fixed overheads requirements for investment firms in the context of the implementation of the Investment Firms Regulation.

It will still be some months before the RTS are in force. The RTS need to be formally adopted by the Commission and then undergo a scrutiny period before being published in the official journal.

The EBA press release is here

EU list of high risk third countries

Commission Delegated Regulation (EU) 2022/229, enters into force on 13 March 2022. The delegated regulation:

  • adds Burkina Faso, Cayman Islands, Haiti, Jordan, Mali, Morocco, the Philippines, Senegal, and South Sudan to the table in point I of the Annex
  • deletes the Bahamas, Botswana, Ghana, Iraq and Mauritius from this table

In the context of the Cayman Islands, this will trigger enhanced customer due diligence on existing and new investors and transactions involving Cayman. This may include obtaining additional information on customers, beneficial owners, and the source of funds and wealth as well as impacting ongoing monitoring.

It may also trigger a review of a fund's business risk assessment, for example if a fund invests in Cayman.

It will also impact securitisations (defined in the EU Securitisation Regulation) which use Cayman Islands special purpose vehicles (SPVs).

Cayman is addressing its strategic deficiencies identified by the FATF relating to:

  • the existence of effective sanctions where parties fail to file requisite information on beneficial ownership
  • demonstrating that it is effectively prosecuting money-laundering cases in line with the jurisdiction's risk profile (Recital 6 of the delegated regulation)

Cayman was listed on FATFs Monitoring List (or grey list) in February 2021.

Cayman government press release is linked here.

For more information please contact a member of the Asset Management & Investment Funds team.

Date published: 1 March 2022