Asset Management & Investment Funds: EU & International Developments – February 2023

SFDR Level 2 

The SFDR Level 2 has been updated to include nuclear/gas in accordance with the Complementary Climate Delegated Act (made under the Taxonomy Regulation), as discussed in our January bulletin. The amendments involve updates to the SFDR pre-contractual disclosure and periodic reporting templates (the annexes). This triggers a need for funds disclosing under SFDR Articles 8 and 9 to update their pre-contractual disclosures to the updated annexes. The CBI approach to updates is discussed under Irish practice developments

ESMA UCITS Q&A

ESMA updated its Q&A on the Application of the UCITS Directive with a new question 5e in the section dealing with issuer concentration section rules. It clarifies that the term “body” in Article 52(1)(b) means “credit institution” as mentioned in Article 50(1)(f) of the UCITS Directive.  (Therefore, the term 'body' does not include any other counterparty which is not a credit institution.) This clarification only applies in the context of Article 52(1)(b) and should not affect the meaning of the term 'body' in other instances of the UCITS Directive.

ESMA report on Trends, Risks and Vulnerabilities (TRV)

ESMA published its first Trends, Risks and Vulnerabilities (TRV) Report of 2023. Overall, risks in ESMA’s remit remain high and investors should be prepared for further market corrections.

Verena Ross, Chair, said:

“The confluence of high risks across the ESMA remit and fragile market liquidity may test the resilience of the financial system against possible future shocks.”

The second half of 2022 was dominated by the slowdown of economic activity, high inflation, global tightening of financial conditions, the geopolitical environment and the materialisation of peripheral risks linked to leverage and liquidity, together with growing concerns over business practices in the crypto space.  These remain the defining drivers of risk in EU financial markets currently.

Main findings included:

  • Overall risk assessment: Contagion and operational risks are considered very high, as are liquidity and market risks. Credit risk stays high and is expected to rise, reflecting the growing concerns over public and corporate indebtedness. Risks remain very high in securities markets and for asset management. Risks to infrastructures and to consumers both remain high, though now with a worsening outlook, while environmental risks remain elevated.
  • Market environment: The tightening of financial conditions globally has weighed on economic activity, while inflation remains very high. Volatility in energy markets stayed elevated despite a general decline in prices. Structural vulnerabilities expose markets and participants to the risk that shocks to markets could be amplified by liquidity supply and demand imbalances.
  • Securities markets: Equity prices were volatile in 2H22 with markets partially recovering 3Q22 losses based on news flow around relatively stable inflation and positive corporate earnings.
  • Asset management: The EU fund sector has seen outflows and low performance across most fund types in 2H22, as assets under management experienced their sharpest decline since the global financial crisis. Maturity mismatches in commercial real estate funds persist, and the impact of the UK gilt market turmoil on leveraged liability-driven investment funds in 2H22 confirmed existing concerns over fund liquidity risk management and excessive leverage, as well as contagion risks given strong systemic interconnections.

European Sustainability Reporting Standards

ESMA issued an opinion on the first set of draft European Sustainability Reporting Standards (ESRS Set 1) developed by the European Financial Reporting Advisory Group (EFRAG). ESMA found that ESRS Set 1 broadly meets the objective of being conducive to investor protection and of not undermining financial stability.

ESMA identifies some technical issues which should be addressed in order to bring ESRS Set 1 from broadly capable to fully capable of meeting that objective. These include possible improvements of the level of consistency between the requirements of the Corporate Sustainability Reporting Directive (CSRD) and other pieces of EU legislation, clarifications of definitions and terminology and further guidance on the materiality assessment process. The European Commission will consider ESMA's opinion alongside opinions submitted by the EBA, EIOPA and other public bodies and adopt ESRS Set 1 into delegated acts by 30 June 2023.

Please see our Spotlight paper on sustainability reporting standards. In this second instalment, we take a look at preparation, presentation and structure of the sustainability statements.

ESMA report on EU MMFs

ESMA published its first market report on European Union (EU) Money Market Funds (MMF).

This report covers the period from March 2020 to June 2022. It gives a market-level view of EU MMFs, based on supervisory information collected by National Competent Authorities (NCAs) and ESMA.

The main findings are:

  • EU MMF sector: The EU MMF sector had €1.44tn of assets in 2021, with 89% of the funds domiciled in France, Luxembourg and Ireland.
  • Sector breakdown: Low-volatility NAV (LVNAV) MMFs account for 46% of the total assets, followed by variable NAV (VNAV) MMFs (42%) and constant NAV (CNAV) MMFs (12%). All MMFs domiciled in France are of the VNAV type and almost exclusively denominated in EUR. MMFs in Luxembourg and Ireland are mainly in non-EU currencies and set up mostly as CNAVs and LVNAVs. MMFs authorised in other EU jurisdictions are VNAVs denominated in other EU domestic currencies and account only for a small fraction of assets.
  • Asset allocation: The portfolio structure of EU MMFs remains relatively stable over time, and they are mainly exposed to the financial sector. Between March 2020 and June 2022, average exposures to credit institutions amount to 60% of total assets. Most of the EU MMFs' government debt exposure is towards non-EU sovereigns, and during March to December 2020 LVNAVs increased their share of government bonds before starting a slow readjustment back to the pre-COVID composition.
  • Liquid assets and risk sensitivity: The share of daily and weekly liquid assets remained above the regulatory minimum, and increased for CNAVs at a regular pace starting in 3Q20. As of 3Q21, EU MMFs have significantly reduced the interest rate risk sensitivity of their portfolios, measured as the weighted average maturity of assets (WAM), to improve resilience to a rate rise.
  • Ownership and liabilities: Professional investors hold more than 90% of EU MMFs. Financial corporations are the main unitholders of MMFs, with insurance firms, pension funds and banks accounting together for 25% of NAV and other financial institutions, including collective investment undertakings, for 45% of the NAV. Between December 2021 and March 2022 MMFs experienced substantial outflows, partially driven by investor expectations linked to the increase in interest rates and a turning investor sentiment away from fixed income instruments in general, a trend that reversed later in 2022.

IOSCO Investment Funds Statistics Report

The International Organization of Securities Commissions (IOSCO) published its second investment funds statistics report which provides insights into the global investment funds industry. The report is based on a comprehensive collection of IOSCO members’ supervisory data as of end-2021.

In summary:

  • Leverage levels across investment funds are similar to those of the previous year, with some variations depending on the type of fund. For example, reported metrics suggest declines in the leverage of hedge funds.
  • At an aggregate level, hedge funds’ portfolio liquidity appears to exceed considerably the liquidity normally offered to investors.
  • Similar to last year, open-ended funds are not highly leveraged in terms of both derivatives use and financial leverage.
  • Open-ended funds’ portfolio liquidity as reported appears managed in line with the liquidity normally offered to investors.

AML/CFT/Sanctions

The latest delegated regulation amends the EU's list of high-risk third countries, effective 16 March 2023. Commission Delegated Regulation (EU) 2023/410 amends Delegated Regulation (EU) 2016/1675 as regards adding the Democratic Republic of the Congo, Gibraltar, Mozambique, Tanzania and the United Arab Emirates to Table I of the Annex to Delegated Regulation (EU) 2016/1675 and deletes Nicaragua, Pakistan and Zimbabwe from that table.

The Wolfsberg Group released updated versions of:

  • correspondent banking due diligence questionnaire (CBDDQ)
  • financial crime compliance questionnaire (FCCQ)
  • guidance, glossary and FAQs documents

The CBDDQ updates include a new section on fraud and additional questions related to whistleblower policy and the approval of financial sanctions policy. The declaration statement has been updated with a revised timeframe for update of the questionnaire.

The EU has adopted its tenth package of Sanctions against Russia (See European Commission Press Release), with immediate effect. The package contains new listings, trade and financial sanctions, including further export bans and import bans. It steps up enforcement and anti-circumvention measures, including a new reporting obligation on Russian Central Bank assets and reporting obligations on frozen assets (including for dealings before listings) and assets which should be frozen. There is an obligation to report more detailed information to NCAs, which in turn report it to the Commission. This enhanced reporting obligation applies from 26 April 2023.  

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

Date published: 28 February 2023