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

ESMA speech on regulatory initiatives, sustainability and T+1.

The chairperson of the European Securities and Markets Authority (ESMA), Verena Ross spoke at EFAMA’s investment management forum. Ms Ross discussed regulatory initiatives, sustainability and the move to T+1. Highlights are set out below.

Regulatory initiatives

  • ESMA is working with the ECB, the ESRB, the FSB and IOSCO, leading to a number of concrete proposals, notably in the area of investment funds, with a view to strengthening the overall resilience of the financial system.

Liquidity

  • FSB are expected to issue their new recommendations on liquidity mismatch in open-ended funds by year end.
  • IOSCO should issue their guidance on anti-dilution liquidity management tools by year end.

Leverage

  • On leverage risk in non-bank financial institution (NBFI), the FSB and IOSCO are coordinating policy work to enhance the monitoring of leverage in NBFIs and address outstanding financial stability risks (including a review of policy tools that are available to authorities).  
  • On funds holding assets sensitive to interest rates, especially when they are not liquid – such as real estate funds, National Competent Authorities (NCAs) and ESMA conduct regular risk assessments in the investment fund management sector. ESMA published Guidelines on the implementation of Article 25 AIFMD. The guidelines include a set of leverage-related risk indicators that can be measured with supervisory data. When NCAs identify funds, or group of funds, posing financial stability risks, the guidelines define a number of principles to consider when designing, calibrating and implementing macroprudential leverage limits, such as those imposed last year by the CBI on Irish real estate funds.

Valuation

  • Valuation is another risk that ESMA is monitoring in the funds sector. Issues include consistent application of valuation rules, insufficient control by the management companies on the quality of external valuers and/or overreliance on external reports. ESMA conducted a Common Supervisory Action (CSA) on valuation with NCAs with a specific focus on less liquid assets, such as private equity and real estate assets, whose nature can amplify the structural liquidity mismatches of certain types of investment funds. ESMA welcomes that NCAs have planned to follow-up on some of those identified deficiencies and encourages the use of enforcement where appropriate.

Sustainability

  • ESMA welcomes the European Commission’s consultation on the assessment of the SFDR.
  • ESMA is working on comprehensibility. ESMA is about to publish its final report on the review of the SFDR Delegated Regulation. ESMA tried within the existing regime to improve the current templates by introducing language simplification and a ‘dashboard’, reflecting the results of consumer testing. Also, ESMA envisages very simple disclosures for retail investors and more comprehensive information for more sophisticated investors (e.g. the level of greenness disclosed in a simple and understandable manner) vs. more technical information relevant to sophisticated investors (e.g. PAI that would still be available and disclosed to provide full transparency).
  • ESG disclosures is an ESMA union strategic supervisory priorities (USSPs).
  • ESMA and NCAs are actively engaged in the implementation of several ESG related CSAs with more in the pipeline. In July, ESMA and NCAs launched a CSA on sustainability-related disclosures and the integration of sustainability risks in the investment management sector, the conclusions will feed into work on greenwashing and more generally help to identify where there is need for further supervisory intervention.
  • ESMA is revising existing guidelines to reflect ESG considerations to help distributors consider sustainability preferences properly.
  • ESMA, with the other ESAs, has been working on a financial education factsheet on sustainable finance which will be published at the end of this month.
  • ESMA consulted on guidelines for investment funds using ESG or sustainability-related terms in their names. ESMA will shortly communicate publicly more about the next steps related to this initiative.
  • Greenwashing - Findings from ESMA’s Greenwashing progress report show that greenwashing is driven by a multitude of structural factors including a steep learning curve for all stakeholders, scaling up the necessary skills and tools (such as IT) in implementing the necessary ESG governance, ESG data availability issues, an enforcement gap and a fast-moving regulatory framework. The progress report was meant to support a common understanding of greenwashing. It was also meant to identify points of attention for market players across the investment chain when making sustainability related claims. ESMA expects that claims are substantiated. ESMA, along with the other ESAs, will publish their final reports on greenwashing in May 2024.
  • On ESG ratings, ESMA is monitoring the progress of the ESG rating file and are hopeful that an agreement can be reached before the end of the European Parliament’s term.

Shorter settlement cycle

  • The EU fund management industry is directly and heavily affected by a changing post-trading landscape. Some third-country jurisdictions have already transitioned to a shorter settlement cycle. Others are considering shortening it. In European markets, considering the technology available and the evolution of other markets outside the EU, ESMA launched a call for evidence on shortening the settlement cycle to assess whether settlement cycles in the EU should be shortened, and if yes, how and when. This assessment has to be transversal, including parameters that directly concern the funds industry, such as the functioning of securities lending or the degree of alignment between the subscription/redemption and the settlement cycles. Moreover, the EU asset management industry is preparing to the move to T+1 in the US by the end of May next year. There are a number of industry initiatives to address these challenges and complexities and ESMA is actively engaging with EFAMA to understand the implications for EU asset managers of different settlement cycles across the Atlantic. ESMA is also using the call for evidence for the identification of possible regulatory changes that would smoothen the impact for EU market participants of the US move, to help the competitiveness of our industry and prevent negative externalities.

AIFMD II

AIFMD II continues through the European legislative process. The Council of the EU and European Parliament published the final compromise text reached on AIFMD II, following political agreement in July 2023. AIFMD II introduces targeted changes to the AIFMD and aligns certain requirements between the AIFMD and UCITS Directive. Once formally approved, AIFMD II will enter into force on the 20th day after it is published in the Official Journal. Member States will have 24 months to transpose AIFMD II into national law. Further specifics of the requirements will be provided in delegated acts.

Some key areas of interest of the agreement:

  • Increased information requirements for UCITS management company and AIFM authorisations on substance including increased conducting officers’ resource requirements.
  • Increased reporting on delegation/sub-delegation.
  • Harmonised rules on the use and availability of liquidity management tools.
  • An EU framework for AIFs originating loans, defined as an AIF:
    • whose investment strategy is mainly to originate loans or
    • where the notional value of the AIF’s originated loans represents at least 50% of its net asset value.
  • A requirement for AIFMs to disclose a list of fees, charges and expenses that are borne by the AIFM in connection with the operation of the AIF, and that will be directly or indirectly allocated to the AIF. AIFMs will also be required to disclose on an annual basis all fees, charges and expenses that were directly or indirectly borne by investors.
  • The possibility to appoint a depositary located in another member state (subject to prior approval of the AIF’s national competent authority).
  • Measures to prevent possible misleading names to better protect investors.
  • ESMA to undertake work to develop a common understanding of ‘undue costs’ (aligned with the retail investment strategy).
  • Supervisory reporting.

ESMA notes on aspects of EU sustainable finance framework

On 22 November 2023, ESMA published three explanatory notes covering key aspects of the EU sustainable finance framework. The notes aim to help navigate the SF framework by setting out the relevant legal provisions in EU Directives, Regulations and Commission Delegated Regulations as well as the relevant guidance provided by the European Commission and the European Supervisory Authorities. The notes are not intended to replace relevant legal texts or to provide guidance on the application of relevant rules.

  • Concepts of sustainable investments and environmentally sustainable activities in the EU sustainable finance framework. This explanatory note explains how the concept of sustainability is inscribed in the EU sustainable finance framework. The concept of sustainability is reflected in the definition of "sustainable investments" in Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (SFDR) and the definition of "environmentally sustainable economic activities" introduced under the Taxonomy Regulation ((EU) 2020/852). 
  • "Do no significant harm" definitions and criteria across the EU sustainable finance framework. This note aims to help navigate the "do no significant harm" (DNSH) principle that is a key element in the Taxonomy Regulation, SFDR and the Benchmark Regulation (BMR).
  • ​Concept of estimates across the EU sustainable finance framework. This note explains how key EU sustainable finance legislation deals with the use of "estimates" and "equivalent information", and the conditions under which these are allowed as sources of data to prepare mandatory ESG metrics for regulated entities complying with their obligations. Different pieces of the EU sustainable finance framework impose requirements for the calculation and disclosure of various ESG metrics or sustainability indicators by financial market participants (FMPs). These disclosures and calculations play a key role in the Taxonomy Regulation, the SFDR and the BMR. This note aims to help navigate the key elements concerning estimates and equivalent information under SFDR, BMR and the TR​.

ESMA updates its union strategic supervisory priorities to focus on cyber risk and digital resilience

ESMA is changing its USSPs to focus on cyber risk and digital resilience alongside ESG disclosures.

With this new priority, EU supervisors will put greater emphasis on reinforcing firms’ ICT risk management through close monitoring and supervisory actions, building new supervisory capacity and expertise. The aim is to keep pace with market and technological developments, and closely monitor potential contagion effects of attacks and disruptions across markets and firms.

The new USSP will come into force in 2025, at the same time as the Digital Operational Resilience Act (DORA). This timeline is intended to provide supervisors and firms in Member States with sufficient time to prepare for compliance with the new regulatory requirements. Meanwhile, ESMA and national competent authorities will carry out preparatory work planning and shaping the supervisory activities to undertake under this priority.

As previously highlighted, ESMA and NCAs will continue their work on the second priority of ESG disclosures. The aim is to tackle greenwashing, increase investors understanding and embed sustainability requirements when firms advise investors. ESG disclosures will remain the focus in 2024 across key segments of the sustainable finance value chain such as issuers, investment managers and investment firms.

AML/CFT/FS  

FATF: The FATF plenary meeting in October 2023 concluded that Albania, the Cayman Islands, Jordan and Panama will no longer be subject to the FATF’s increased monitoring process. The EU list of high-risk third countries has not been updated.

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

Date published: 30 November 2023