Asset Management & Investment Funds: EU & International Developments – February 2024

EU Retail Investment Strategy update

The Commission’s Retail Investment Strategy consists of a package of measures that aim to increase retail investor participation in EU capital markets by increasing consumer protection and ensuring digital readiness. The proposed directive also aims to improve and simplify existing frameworks. The package consists of two legislative proposals:

  • an omnibus directive amending MiFID II, the UCITS Directive and the AIFMD (among others); and
  • a regulation amending the PRIIPs Regulation.

Key amendments in the proposed directive include:

  • strengthening product governance and oversight, in particular the pricing process and introducing the principle of value for money
  • adapting disclosure rules to the digital age and investors’ sustainability preferences
  • measures to tackle bias in investment advice, including a ban on inducements for execution only sales
  • amendments to suitability and appropriateness tests
  • more proportionate “professional investor” eligibility criteria

The proposals are currently going through the EU legislative process, with the European Parliament and Council determining their respective negotiating positions. It is possible that the proposals will be approved before the June 2024 EU elections. The draft text states that member states will have to transpose the directive into national law 12 months after it enters into force, or 18 months for some provisions. The regulation will apply 18 months after it enters into force. It is unlikely that the directive and regulation will be fully in effect until at least 2026.

UK Overseas Funds Regime and TMPR extension

The UK Parliament issued a statement confirming that EEA states will be considered equivalent for UCITS under the Overseas Funds Regime (OFR) and that the current Temporary Permissions Regime (TPR) will be extended until the end of 2026.

The OFR, prescribed by s. 271A FSMA, will provide for the recognition of collective investment schemes authorised under the law of a country outside the UK, where (among other things) an equivalence assessment has been made by HM Treasury in relation to that country or territory. European economic area (EEA) States will now be considered “equivalent” under the OFR for UCITS, excluding money market funds. This will be welcome news to European fund managers who will be able to apply to the Financial Conduct Authority (FCA) to market their products to UK investors. Secondary legislation will be required to enact this equivalence decision.

The FCA’s consultation on rules and guidance to integrate the OFR into its handbook and to enable recognition of overseas funds from jurisdictions approved by the Treasury closed on 12 February 2024. The UK government has also confirmed that no additional requirements will be imposed on overseas funds (including a UK value assessment) at this time. The UK government may however consult on whether to broaden the scope of the UK sustainable disclosure requirements to include funds recognised under the OFR.

Currently EEA UCITS funds marketing in the UK via the TMPR must, upon expiry of the TMPR, obtain individual recognition under s. 272 FSMA. The TMPR which was due to expire at the end of 2025, has been extended until the end of 2026, providing UCITS within the TMPR, an extended period of time to transition to the OFR.

According to the FCA website, once regulations are made to enact the equivalence decision, the FCA will contact UCITS operators with details of the process and landing slot in which to apply for recognition under OFR and to exit the TMPR.

The FCA has asked operators of UCITS in the TMPR to ensure that any contact information they have previously provided to the FCA is up-to-date and amend it if it is not. Those operators should also check their fund population on the FCA Register and update as required.

Targeted consultation on macroprudential policies for Non-Bank Financial Intermediaries (including funds)

The European Commission (the Commission) will run a targeted consultation on macroprudential policies for Non-Bank Financial Intermediaries (NBFIs) in 2024. The aim will be to understand the business models of key NBFIs and the interconnectedness among them and between banks and NBFIs, and to identify gaps in the macroprudential framework and other factors that may contribute to the build-up of systemic risks in non-bank financial intermediation.

The Commission published a report on the macroprudential review for credit institutions, the systemic risks relating to NBFIs and their interconnectedness with credit institutions. The report notes that “the same conventional and emerging risks affecting banks, coupled with the diversity and complexity of NBFI sectors, may lead to specific vulnerabilities of NBFIs stemming from:

  1. structural liquidity mismatches
  2. the build-up of excessive leverage across NBFIs
  3. interconnectedness among NBFIs and between NBFIs and banks, which may create hidden risk amplifiers and transfer of risk from the banking to the non-banking sectors
  4. lack of consistency and coordination among macroprudential frameworks across the EU”.

The report notes that “as credit activity and risks shift increasingly from the banking to the non-banking sectors, the Commission will collect further evidence on missing tools, potential gaps in existing tools to meet macroprudential objectives and on the effectiveness and consistency of macroprudential policies for NBFIs in the EU”.

In 2024, the Commission will also consult on the review of the Securities Financing Transaction Regulation (SFTR). The SFTR aims at improving transparency on funding and lending transactions and allow for better monitoring of risks resulting from non-bank credit intermediation.

ESMA work on the EU AIF market and the risks posed by leveraged AIFs in the EU

The European Securities and Markets Authority (ESMA) published

ESMA found that: 

  • the size of the sector declined slightly (-3%) to EUR 6.8tn in 2022 and AIFs account for 36% of the EU fund industry.
  • the fall in value was mainly driven by valuation losses for funds exposed to bonds and equities amid adverse market developments in 2022.
  • Real Estate (RE) funds face multiple risks related to leverage, market footprint, valuation discrepancies and liquidity mismatches.
  • leverage for hedge funds remains very high, and this may pose a risk of market impact. However, most of them also dispose of large levels of cash to address potential margin calls, which limits the risk of fire sales.  
  • National Competent Authorities (NCAs) have reported risks posed by the Liability-Driven Investment (LDI) funds, which gain leveraged exposures to the UK government bond market. Risks have remained elevated, and the limits set after the severe stress experienced in September 2022 remain appropriate. 
  • ESMA reports on the measure taken by authorities to address the risks identified, and will continue to work with the NCAs to meet ESMA’s financial stability objective.  
  • Existing liquidity mismatches in AIFs are particularly heightened by the high share of open-ended RE funds, some of which offer daily liquidity. This vulnerability could be systemically relevant in jurisdictions where RE funds own a large share of the RE market. 

ESG Rating

The Council and the European Parliament reached a provisional agreement on a proposal for a regulation on environmental, social, and governance (ESG) rating activities. The new rules aim to strengthen the reliability and comparability of ESG ratings. Under the new rules, ESG rating providers will need to be authorised and supervised by ESMA and comply with transparency requirements, in particular with regard to their methodology and sources of information.

The provisional political agreement is subject to approval by the Council and the Parliament before undergoing the formal adoption procedure. The regulation will come into force 18 months after its entry into force.

You can read the press release here.

ESMA’s first risk monitoring report of 2024

ESMA published its first risk monitoring report of 2024, where it sets out the key risk drivers currently facing financial markets. The report found remarkable resilience of financial markets in a higher for longer interest rate environment.

You can read more here.

ESMA TRV Risk Analysis on Sustainable Finance Impact Investing

ESMA published a TRV Risk Analysis on Sustainable Finance Impact Investing which examines the question 'Do SDG [Sustainable Development Goal] funds fulfil their promises?'. The report finds that:

  • The market for ESG investing has grown substantially over the last three years. Mirroring this trend, the size of investment funds claiming to positively contribute towards achieving the SDGs tripled between 2020 and 2023
  • SDG funds remain a small market in the EU (EUR 74bn as of September 2023, less than 1% of the EU fund industry)
  • SDG funds do not appear to display greater alignment with the United Nations SDGs compared to non-SDG funds (this observation holds true regardless of the different frameworks used for measurement).

The report notes investor protection concerns as the funds claiming to contribute towards the SDGs do not appear to differ significantly from other funds in their exposure to firms signalling to concretely contribute to the UN SDGs. The report also notes that "the market for SDG funds is relatively new and lacks common reporting standards against the different goals and targets for private sector actors (as most targets are at the country level). Fund managers and supervisors are thus challenged in identifying appropriate assets".

ESMA warning for people posting investment recommendation on social media

ESMA issued a warning for people posting investment recommendation on social media. ESMA and NCAs are raising awareness of requirements established by the Market Abuse Regulation (MAR) which apply when posting investment recommendations on social media. They are also warning about the risks of market manipulation in such publications.

Under MAR, an investment recommendation can be any post, video, or any other type of public communication, including social media, in which a person gives advice or ideas, directly or indirectly, about buying or selling a financial instrument or on how to compose a portfolio of financial instruments.

Even if a person is using “non-technical” language, gives advice or ideas, directly or indirectly, about buying or selling a financial instrument or on how to compose a portfolio of financial instruments, it may constitute an investment recommendation.

ESMA sets out the applicable regulations and the consequences of non-compliance

For more information on these topics please contact any member of A&L Goodbody's Asset Management & Investment Funds team.

Date published: 27 February 2024