Asset Management & Investment Funds: EU & International Developments – January 2025

ESMA consultation on RTS for loan-originating AIFs

ESMA published a consultation paper on draft regulatory technical standards (RTS) on loan-originating alternative investment funds (LO AIFs) under the AIFMD.

Under AIFMD II, LO AIFs are closed-ended by default. However, by way of derogation, a LO AIF may be open-ended provided that the AIFM is able to demonstrate to its competent authority that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy. AIFMD II mandates ESMA to draft RTS to determine the requirements with which LO AIFs are to comply to maintain an open-ended structure. According to AIFMD, these requirements must include:

• a sound liquidity management system
• the availability of liquid assets and stress testing
• an appropriate redemption policy having regard to the liquidity profile of LO AIFs

These requirements must also take account of the underlying loan exposures, the average repayment time of the loans and the overall granularity and composition of the LO AIFs.

ESMA’s consultation represents the first stage in the development of the draft RTS and sets out the proposals for their content on which ESMA is seeking views.

The consultation response period closes on 12 March 2025. ESMA expects to publish a final report and submit the draft RTS to the European Commission by Q3/Q4 2025.

ESMA Q&As on fund names guidelines

ESMA published Q&As on aspects of the practical application of its guidelines on funds' names using ESG or sustainability-related terms. The guidelines have applied since 21 November 2024 for new funds created after that date and will apply to funds existing before that date from 21 May 2025.

Among other things, the Q&As clarify:

• Investment restrictions relating to the exclusion of companies do not apply to investments in European green bonds. For other green bonds, fund managers can use a look-through approach to assess whether the activities financed are relevant for the exclusions.
• Investment funds may not be meaningfully investing in sustainable investments if they contain less than 50% of sustainable investments.
• The exclusion relating to controversial weapons refers to PAI 14 in Table 1 of Annex I to Commission Delegated Regulation (EU) 2022/1288.

ESMA has decided to clarify the treatment of green bonds because of the imminent application of the European Green Bonds Regulation and the reference in the mandates in the AIFMD and UCITS Directive noting that sectoral legislation takes precedence.

The CBI has established a streamlined filing process to facilitate compliance with the guidelines, discussed here.  

ESMA AIFMD Q&A

ESMA published two AIFMD Q&As concerning:

• Permission of AIFMs to delegate portfolio or risk management to non-supervised undertakings established outside of the EU (Q&A 2229). In summary AIFMs are not allowed to delegate portfolio or risk management to non-supervised undertakings established outside of the EU.
• AIFMs safekeeping client money (Q&A 2230). In summary AIFMs are not permitted to hold client money, and this will not change as a result of AIFMD II.

EU funds continue to slowly reduce costs

ESMA published its seventh market report on the costs and performance of EU retail investment products, showing a decline in the costs of investing in key financial products.

Despite this decline the cost levels of funds in the EU remain high by international standards. With more than 50,000 funds and an average fund size almost ten times smaller than that of, for example, US mutual funds, EU funds do not exhaust the economies of scale commensurate with the EU’s single market. The market inefficiencies revealed by this higher cost level show the need to focus on the competitiveness of EU markets, within a future EU savings and investments union.

The key findings in the report are:

• UCITS costs decline gradually, from high levels: Costs have declined, but investors should continue to consider fund fees carefully in their investment decisions - especially since costs have not dropped for all categories of funds: ongoing costs of mixed funds and equity passive funds have been relatively stable over time. 
• UCITS performance slightly improved: Returns progressed in 2023 but remained far from their 2021 levels. The annual net performance of bond and mixed funds improved between 2022 and 2023 but remained in negative territories.
• ESG UCITS with lower costs and higher performance than non-ESG: Ongoing costs of retail ESG funds remain lower or similar to the ongoing costs of non-ESG equivalents. Overall, ESG funds outperformed their non-ESG equivalents in 2023. This hides some disparities across asset classes: non-ETF equity ESG funds outperformed, while equity ETF, fixed income and mixed ESG funds underperformed.
• AIFs are less popular with retail investors: The market for AIFs remained dominated by professional investors and is less invested by retail investors compared with the UCITS market. The share of retail investors decreased between 2022 and 2023: from 14% to 11%. In 2023, annualised gross and net performance improved significantly compared with 2022, with all fund strategies having positive returns. 
• Structured retail product costs improve but remain difficult to assess for clients: In 2023, the share of products referencing interest rates and inflation rose to around one fifth of sales volumes, a sharp increase from 2022. This trend followed higher interest rates and inflation. Costs - largely charged in the form of subscription fees - fell in 2023 for some common product types, although they vary substantially by payoff type and country. Structured retail products that matured in 2023 consistently delivered positive returns in gross terms, but these figures do not consider the incidence of costs paid by investors.

Following the review of the AIFMD and the UCITS Directive, ESMA has been mandated to produce a report on costs linked to investment in UCITS and AIFs. For the purpose of this report, ESMA launched a data collection exercise together with the national competent authorities. This analysis will be part of an enhanced 2025 ESMA market report on costs and performance of EU retail investment products that is expected to bring new insights and more granular information on fund costs.

MMF stress testing update

ESMA published the final report on its guidelines on stress test scenarios under the Money Market Funds Regulation.

Section 4.8.5 on macro systemic shocks and section 5 on the calibration of the guidelines have been updated. The rest of the guidelines are largely unchanged.

Under Article 28 of the Money Market Funds Regulation these guidelines are updated by ESMA (with the European Systemic Risk Board (ESRB) and the European Central Bank (ECB)) at least every year to reflect latest market developments. ESMA published the previous update of the guidelines on 19 December 2023 and their translation on 6 March 2024 (the 2023 guidelines).

The guidelines (in the annex of this report) will be translated into the official EU languages and published on the ESMA website. The updated guidelines, including the new 2024 parameters, will apply two months after the translations are published. Until then, managers should use the parameters set in the 2023 guidelines and report the results accordingly.

EMIR 3.0 updates

A Regulation amending EMIR (EMIR 3.0) and a Directive amending various directives as regards the treatment of concentration risk from CCP and counterparty risk in centrally cleared derivatives (including the UCITS Directive) entered into force on 24 December 2024. EMIR 3.0 aims to address over-reliance on non-EU CCPs and to improve the attractiveness of EU clearing. Among other changes EMIR 3.0 introduces the following.

• an active account obligation applies from 25 June 2025 in respect of interest rate derivatives denominated in euro, Polish zloty and short-term interest rate (STIR) derivatives denominated in euro. In-scope counterparties who exceed the €3bn clearing threshold in the in-scope categories of derivatives will need to hold active accounts with EU CCPs and clear a representative number of transactions through these accounts
• revised clearing obligation calculation requirements
• enhanced reporting measures under article 9 of EMIR
• the equivalence condition for non-EU jurisdictions in respect of intragroup exemptions from clearing and margining is replaced
• a permanent exemption from margin requirements for single stock options and equity index options not cleared by a CCP

Certain requirements will be further specified in RTS. Member States must transpose the Directive amending the UCITS Directive by 25 June 2026.

Transition to T+1

ESMA, the European Commission and the ECB launched a new governance structure to support the transition to the T+1 settlement cycle in the European Union. This follows ESMA’s report with recommendations on the shortening of the settlement cycle. ESMA recommended 11 October 2027 as the optimal date for the transition to T+1 in the EU. In its report ESMA concluded that the transition to T+1 should be implemented in phases, with key milestones including technology upgrades, stakeholder engagement and regulatory alignment. 

The new governance structure has been designed to oversee and manage the operational, regulatory and technological aspects of this transition. Given the high level of interconnectedness within the EU capital market, a coordinated approach across the EU, involving authorities, market participants, financial market infrastructures and investors, is advisable. The key elements of the new governance model include:

• An Industry Committee, composed of senior leaders and representatives from market players. The committee will be chaired by Giovanni Sabatini. Giovanni has a long-standing experience working in securities markets both in the private and public sector. He has served as a member of the European Economic and Social Committee and held roles within IOSCO, EBF and ECSDA.
• Several technical workstreams, operating under the Industry Committee, focusing on the technological operational adaptations needed in the areas concerned by the transition to T+1 (i.e. trading, matching, clearing, settlement, securities financing, funding and FX, asset management, corporate events, settlement efficiency). Two additional general workstreams will review the scope and the legal and regulatory aspects of these adaptations.
• A Coordination Committee, chaired by ESMA and with representation from the European Commission, the ECB, ESMA and the chair of the industry committee. This committee will ensure coordination between the authorities and the industry, advising on challenges that may arise during the transition.

Shortening the trade settlement cycle from the current T+2 framework to one business day should enable faster execution, clearing, and settlement of securities transactions, as well as international alignment, benefiting the entire EU financial ecosystem.

The Commission is currently considering the merits of a legislative change mandating a potential transition to a shorter settlement cycle.

Industry representatives interested in contributing to the upcoming work are advised to contact the T+1 Industry Secretariat here.

The first meeting of the Coordination Committee will take place on 6 February.

FSB recommendations to enhance non-bank market participants’ liquidity preparedness for margin and collateral calls 

The FSB published its final report on policy recommendations to enhance liquidity preparedness for non-bank market participants’ preparedness for margin and collateral calls in centrally and non-centrally cleared derivatives and securities markets (including securities financing such as repo). These recommendations form part of the FSB’s ongoing work to enhance NBFI resilience and follow the FSB consultation.

The recommendations are a response to “calls for regulatory adjustments to deal with liquidity strains in the non-bank financial intermediation sector arising from spikes in margin and collateral calls during market stress” and aim to build on/complement existing rules and regulations around liquidity risk management.

The eight recommendations cover “liquidity risk management and governance, stress testing and scenario design, and collateral management practices of non-bank market participants, focusing on liquidity risks arising from spikes in margin and collateral calls during times of market-wide stress”.

The FSB’s recommendations follow from recent market disruptions (including Covid-19, certain commodity market volatility and LDIs), and apply to a broad range of non-bank market participants, including hedge and other investment funds. The FSB also note “the recommendations should be applied proportionately to the underlying risks of different non-bank market participants”.

IOSCO consultations on liquidity risk management for CIS, including OEFs.

IOSCO published a consultation report seeking feedback on its revised Recommendations for Liquidity Risk Management for Collective Investment Schemes, with a focus on open-ended funds. IOSCO also published a consultation on complementary guidance for the effective implementation of the recommendations for liquidity risk management. This consultation follows on from IOSCO’s 2018 Liquidity Risk Management Recommendations emerging from the 2017 FSB Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, which was aimed to address structural vulnerabilities from liquidity mismatch in open-ended funds (OEFs). Reponses to these consultations are open until 11 February 2025. IOSCO aims to publish its final report in H1 2025.

The key proposed revisions to the recommendations correspond to the targeted revisions from the revised FSB recommendations and can be grouped into four main areas:

• categorising OEFs based on the liquidity of their assets
• encouraging investment managers to implement a broad set of liquidity management tools and other liquidity management measures
• emphasising the importance of anti-dilution liquidity management tools to mitigate material investor dilution and potential first-mover advantage arising from structural liquidity mismatch in OEFs
• incorporating new guidance on quantity-based liquidity management tools and other liquidity management measures

The accompanying Implementation guidance, sets out technical elements focusing on OEFs, such as the determination of asset and portfolio liquidity and considerations relating to the calibration and activation of liquidity management tools and other liquidity management measures.

EU platform on sustainable finance

The EU platform on sustainable finance (PSF), an advisory body to the European Commission) published a briefing note on the proposed categorisation of products under the SFDR.

The PSF makes recommendations for the European Commission as part of its review of the SFDR. This follows the European Supervisory Authorities publication of an opinion on the future of the SFDR in June 2024R. Read more here and here.

The PSF recommends categorising products with the following sustainability strategies:

• Sustainable: contributions through EU taxonomy-aligned investments or sustainable investments with no significant harmful activities, or assets based on a more concise definition consistent with the taxonomy.
• Transition: investments or portfolios supporting the transition to net zero and a sustainable economy, avoiding carbon lock-ins, in line with the European Commission’s recommendations on facilitating finance for the transition to a sustainable economy.
• ESG collection: excluding significantly harmful investments/activities, investing in assets with better environmental and/or social criteria or applying various sustainability features.

All other products would be identified as unclassified products.

The report outlines the minimum criteria for each of the three categories, including a specified number of investments that meet the core sustainability objective. Annex A provides guidance on how to identify these investments and other thresholds.

The PSF also published a draft report on activities and technical screening criteria to be updated or included in the EU Taxonomy, with a call for feedback. The draft report includes preliminary recommendations relating to:

• the review of the criteria and analysis for the Taxonomy Climate Delegated Act under SFDR
• further recommendations for climate change adaptation

Feedback on the draft report is requested by 5 February 2025.

Omnibus sustainability reporting legislation

The European Commission published a tentative agenda for meetings. The European Commission is to publish its 2025 work programme on 11 February 2025. Details of the omnibus simplification package is expected to be published on 26 February 2025. This proposed legislation will likely impact the Taxonomy Regulation, the Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD).

The President of the European Commission, signaled that the omnibus simplification package, covering  the CSDDD, CSRD and Taxonomy Regulation would "reduce bureaucracy" without "changing the content" of law.

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