Asset Management & Investment Funds: EU & International Developments - Mar 2021

Taxonomy Regulation- ESMA advice under Article 8

ESMA published its Final Report on advice under Article 8 of the Taxonomy Regulation, which covers the information to be provided by non-financial undertakings and asset managers to comply with their disclosure obligations under the Non-Financial Reporting Directive (NFRD). This follows its earlier consultation. The EBS and EIOPA also issued their proposals on this topic.

The recommendations define the key performance indicators (KPIs) disclosing how, and to what extent, the activities of businesses that fall within the scope of the NFRD qualify as environmentally sustainable under the Taxonomy Regulation.

ESMA’s proposals set out further detail on the three KPIs set out in Article 8(2) of the Taxonomy Regulation for non-financial undertakings and those provided by asset management companies that fall within scope of the NFRD:

• Non-financial undertakings – the proposals set out the definitions that should be used for the calculation of the turnover KPI, the CapEx KPI and the OpEx KPI. These are complemented with the minimum information that should accompany these disclosures and the methodology, including the level of granularity, for the reporting of the three metrics.
• Asset managers – the proposals set out the KPI that asset managers should disclose, the methodology to be applied to that KPI and recommendations for the development of a coefficient methodology to assess Taxonomy-alignment of investments in investee companies that do not report under the NFRD.

ESMA also proposes that non-financial undertakings and asset managers use standardised templates for their reporting under Article 8 in order to facilitate comparability of these disclosures and enhance their accessibility to investors that will reuse this information.

You can read more about the Taxonomy Regulation here:

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Taxonomy Regulation - consultation on disclosures

A consultation paper (CP) under the Taxonomy Regulation issued by the joint European Supervisory Authorities (ESAs). The CP seeks input on draft regulatory technical standards (RTS), regarding disclosures of financial products investing in economic activities that contribute to an environmental investment objective. These economic activities are defined by the Taxonomy Regulation.

This is of interest to investment funds because so-called "light-green" or Article 8 and "dark-green" or Article 9 funds under SFDR will have more pre-contractual and financial statement disclosure requirements from 1 January 2022 and 1 January 2023 on the six taxonomy environmental objectives.

The ESAs also propose to standardise the presentation of the disclosures by amending the templates for the pre-contractual and periodic disclosures proposed in the draft RTS under the SFDR, by adding a new section that includes the disclosures required under the Taxonomy Regulation. The CP includes a consolidated version of the combined SFDR and Taxonomy RTS.

The proposed draft RTS aim to:

• facilitate disclosures to end investors regarding the investments of financial products in environmentally sustainable activities
• create a single rulebook for sustainability disclosures under the SFDR and the Taxonomy Regulation. This will be done by amending the draft RTS under the SFDR, to minimise overlapping or duplicative requirements between the two regulations

The ESAs’ proposal on how and to what extent activities funded by the product are taxonomy- aligned, consist of two elements:

• a graphical representation of the taxonomy-alignment of investments of the financial product and a key performance indicator calculation for that alignment; and
• a statement that the activities funded by the product that qualify as environmentally sustainable, are compliant with the detailed criteria of the Taxonomy Regulation

The closing date for feedback on the consultation is 12 May 2021. Consumer testing on the amended templates will take place in April. It is likely that the ESAs will issue a final report with draft RTS by late June or early July 2021.

You can hear more about the latest ESG developments by viewing a recording of our webinar on our eLearning and knowledge platform KnowledgePlus, detailed below.

ESMA CSA on UCITS liquidity risk management highlights areas for vigilance

ESMA published the results of the 2020 Common Supervisory Action (CSA) on UCITS liquidity risk management (LRM).

• The CSA showed that the overall level of compliance with the applicable rules is satisfactory in most cases, but there is scope for improvement in liquidity management for some UCITS.
• The exercise also highlighted areas where ESMA will work to further promote convergence.
• NCAs are following up with market participants to address the supervisory findings identified in the CSA at the individual and collective level.

Summary of areas for improvement (detailed in the report)

• Some adverse supervisory findings were identified, particularly linked to documentation, procedures and methodology.
• In some cases, the liquidity assessment before investing should be strengthened, as well as the data reliability verification and the internal control framework.

Next steps

• To further improve the quality of LRM processes, UCITS managers should critically review their LRM frameworks to ensure that none of these adverse supervisory findings exist in their frameworks. More generally, they should also ensure ongoing compliance with all relevant UCITS regulatory requirements, and associated EU and national guidance. The CSA results should be read in conjunction with the result of the implementation of the ESRB recommendation on liquidity risks in investment funds, which defined five priority areas for consideration. (The CBI letter on liquidity referenced under Irish developments issued in the context of the ESRB ESMA Liquidity Risk Project and findings are broadly consistent.)
• NCAs will undertake follow-up actions on individual cases to ensure that regulatory breaches as well as weaknesses identified are remedied, especially regarding the adverse supervisory findings identified.
• ESMA will work to promote convergence in the way NCAs follow-up on the supervisory findings made during the CSA.

Money Market Funds Regulation reform

ESMA issued a consultation on potential reforms of the EU Money Market Funds Regulation (MMFR). It proposes four types of potential reforms for MMFs:

• reforms targeting the liability side of MMFs such as decoupling regulatory thresholds from suspensions/gates to limit liquidity stress, and to require MMF managers to use liquidity management tools such as swing pricing 
• reforms targeting the asset side of MMFs by e.g. reviewing requirements around liquidity buffers and their use
• reforms targeting both the liability and asset side of MMFs by reviewing the status of certain types of MMFs such as stable net asset value (NAV) MMFs and low volatility net asset value (LVNAV) MMFs
• reforms that are external to MMFs themselves by assessing whether the role of sponsor support should be modified

ESMA is also gathering feedback from stakeholders on other potential changes, particularly linked to ratings, disclosures and stress testing. The consultation reflects the stress experienced by MMFs during the March 2020 crisis. Several workstreams at international level (including under IOSCO and the Financial Stability Board) have started to assess the situation faced by MMFs during the March 2020 crisis, and which policy options should be considered in response. ESMA expects to publish its opinion on the review of the MMF Regulation in H2 2021. Article 46 of the MMFR requires the EC to review, following consultations with ESMA, the adequacy of the MMFR from a prudential and economic point of view by 21 July 2022.

The impact of Brexit on benchmarks

ESMA updated its statement on the application of key provisions in the Benchmarks Regulation (BMR) in the light of Brexit to reflect the extension of the BMR transitional period to 31 December 2023. The statement sets out the EU's regulatory approach towards UK-based third-country benchmarks as well as UK endorsed and recognised benchmarks.

Following the end of the Brexit transition period, UK-based administrators that had been included in the ESMA register of administrators and third-country benchmarks were deleted as the BMR no longer applies to UK-based benchmark administrators. They now qualify as third-country administrators.

The BMR transitional period was extended to 31 December 2023 and so the change in the ESMA register does not yet impact on the ability of EU supervised entities to use the benchmarks provided by any third-country administrators, including UK ones. Accordingly, during the BMR transitional period, third-country benchmarks can still be used by supervised entities in the EU if the benchmark is already used in the EU as a reference for financial instruments, financial contracts, or for measuring the performance of an investment fund. Therefore, until 31 December 2023, EU supervised entities can use third-country UK-based benchmarks even if they are not included in the ESMA register. The extended BMR transitional period also applies to UK-recognised or endorsed third-country benchmarks.

Absent an equivalence decision by the European Commission, UK-based administrators have until 31 December 2023 to apply for recognition or endorsement in the EU for the benchmarks provided by UK-based administrators to be included in the ESMA register again.

IOSCO work programme for 2021-2022

The International Organization of Securities Commissions (IOSCO) published its work programme for 2021-2022.

The work programme identifies IOSCO's eight priority areas, the first two of which are new:

• Financial stability and systemic risks of non-bank financial intermediation activities (NBFI). It will progress a joint report to the IOSCO board and the Financial Stability Board (FSB) on liquidity risk and its management in open-ended funds by late 2021 and a report to the IOSCO board on exchange-traded funds (ETF) findings and policy proposals by Q3 2021.
• Risks exacerbated by the COVID-19 pandemic. It will deliver reports on misconduct risks, fraud and scams, and operational resilience by 2022.
• Sustainable finance. It will deliver a report on sustainability-related disclosures for issuers by the end of June 2021 and reports on sustainability-related disclosures for asset managers (including greenwashing), and environmental, social and governance (ESG) ratings and ESG data providers by the end of 2021.
• Passive investing and index providers. It will submit the final thematic analysis report on the impact of the growth of passive investing on equity capital markets to the IOSCO board in mid-2021 and it will deliver a report on conduct-related issues in index provision to the board in late 2021.
• Market fragmentation in securities and derivatives markets. During 2021, it will undertake a review on the use of supervisory colleges and other mechanisms of co-operation, with the aim of identifying good practices that authorities can use in establishing and conducting supervisory activities.
• Cryptoassets (including stablecoins). During 2021, it will carry out a review of its standards against the FSB's October 2020 high-level recommendations on stablecoins.
• Artificial intelligence and machine learning (AIML). It will publish its final report on the use of AIML by market intermediaries and asset managers in Q2 2021.
• Retail distribution and digitisation. It will publish its final report on online marketing and retail distribution in Q3 2021.

It will review and refresh its two-year work programme at the end of 2021.

IOSCO also launched a thematic review of the recommendations for liquidity risk management for collective investment schemes issued in 2018 as well as an assessment on market participants’ responses to Covid-19 induced market stress.

Speech by EU Commissioner Mairead McGuinness with her vision for the financial services sector

EU Commissioner Mairead McGuinness delivered a speech outlining a vision for the financial services sector, including recovery from the coronavirus (COVID-19) pandemic, capital markets union, sustainable finance, digital finance and Brexit. The recovery should focus on the green and digital transition

• Sustainable Finance: The EU taxonomy on sustainable activities delegated act will be somewhat delayed to allow consideration of over 46,000 responses to the consultation. A Renewed Sustainable Finance Strategy will issue later in 2021. The non-financial reporting directive will be reviewed. An EU Green Bond Standard will be presented.
• Digital Finance: The Digital Finance Package is progressing with two legislative proposals, a digital operational resilience act (DORA) and a Regulation on Markets in Crypto Assets (MiCA).
• Brexit: Commissioner McGuinness notes that the EU and the UK committed in the joint declaration to establish a framework for regulatory cooperation in financial services by March 2021. Commissioner McGuinness also notes that there cannot be equivalence and wide divergence.

AML

EBA opinion on money laundering and terrorist financing risks affecting the EU financial sector

The EBA published its opinion on the ML/TF risks that are affecting the EU's financial sector. This opinion sets out suggested actions addressed to national competent authorities (NCAs), based on the findings set out in the report annexed to the opinion. The opinion and report provide information for the European Commission’s Supranational Risk Assessment (SNRA) and risk assessments carried out by NCAs. Chapter 4.6 of the report covers collective investment undertakings/ fund managers in terms of inherent risks, quality of controls, supervisory activities, breaches identified, overall risk profile, emerging risks. In summary:

• the sector presents a moderately significant inherent risk profile
• the sector's exposure to cross-border transactions is of concern
• some controls are assessed as being poor, such as those related to transaction monitoring and STR reporting
• many NCAs had not assessed controls related to either the adequacy or the effectiveness of governance structures
• overall supervisory activity within this sector remains relatively low
• EBA invites NCAs to consider how best to address the identified weaknesses, possibly by thematic or targeted reviews (the EBAs' Risk-based Supervision Guidelines are currently being revised)
• NCAs should increase their supervisory focus on governance
• NCAs should consider whether cross-border risks are appropriately captured and given adequate weighting in their risk assessment of the sector

The EBA has issued the opinion as part of its new mandate to lead, coordinate and monitor the fight against ML/TF in the EU financial system. The EBA's role and mandate on AML/CFT is explained in a factsheet. The EBA published an interactive tool which aims to provide access the ML/TF risks covered in the opinion.

EBA revised Guidelines on ML/ TF risk factors

The EBA published Guidelines on ML/TF risk factors. After translation, these guidelines will replace the 2017 ESA guidelines on customer due diligence and the factors credit and financial institutions should consider when assessing the money laundering and terrorist financing risks associated with individual business relationships and occasional transactions. The EBA strengthened the requirements on individual and business-wide risk assessments and customer due diligence (CDD) measures, with additional guidance on the identification of beneficial owners, the use of innovative solutions to identify and verify customers' identities, and how firms should comply with requirements for enhanced CDD related to high-risk third countries. NCAs must report whether they comply with the guidelines within two months of publication of the translations. The guidelines will apply three months after publication in all EU official languages. Funds and fund service providers will likely need to update their AML/CTF policies and procedures to reflect the guidelines in due course.

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

Date published: 30 March 2021