Asset Management & Investment Funds: EU & International Developments - Sept 2020

UCITS Directive and AIFMD revision proposals for digital operational resilience

The EU Commission has proposed a digital finance package. The package includes a digital finance strategy and legislative proposals on digital resilience and crypto-assets.

The EU regulatory framework for digital operational resilience (DORA) includes:

  • a directive to enable and support digital finance which will:
    • update operational risk/ risk management requirements in the UCITS Directive and AIFMD
    • update operational risk/ risk management requirements in Directives 2006/43/EC (statutory audits), 2009/138/EU (Solvency II-insurance), EU/2013/36 (CRD IV-banks), 2014/65/EU (MiFID II), (EU) 2015/2366 (PSD 2) and EU/2016/2341 (IORP II- pensions)
    • provide for crypto assets qualifying as financial instruments
  • a Regulation on digital operational resilience (DORA) for the financial sector. The proposal covers
    • Digital, or Information and Communication Technologies (ICT) risk management: the requirements include specific capabilities and functions in ICT risk management, such as identification, protection and prevention, detection, response and recovery, learning and evolving and communication. Financial entities will be required to:
      • set-up and maintain resilient ICT systems and tools that minimise ICT risk
      • identify on a continuous basis all sources of ICT risk
      • set-up protection and prevention measures
      • promptly detect anomalous activities
      • put in place dedicated and comprehensive business continuity policies and disaster and recovery plans, as an integral part of the operational business continuity policy
    • ICT-related incident reporting: Financial entities will be required to establish and implement a management process to monitor, classify and report major ICT-related incidents to competent authorities. National competent authorities will have to provide details of ICT-related incidents to other institutions or authorities. National authorities would also have to give firms feedback and guidance.
    • Digital operational resilience testing: The capabilities and functions included in the ICT risk management framework would need to be periodically tested to check that firms are able to identify weaknesses, deficiencies or gaps, and to address problems. This will be achieved through a set of testing tools that will be deployed by financial entities depending on their size, business and risk profile.
    • ICT third-party risk: Financial entities increasingly depend on non-financial technology firms for their ICT services. This proposal aims to ensure a sound monitoring of ICT third-party risk. Key contractual aspects will be harmonised to ensure that financial entities monitor ICT third-party risk. The proposal would subject critical ICT third-party service providers to a Union Oversight Framework to ensure supervisory convergence.
    • Information sharing: the proposal would allow financial entities to set-up arrangements to exchange amongst themselves cyber threat information and intelligence.

The proposal will be subject to the agreement of the co-legislators, the European Parliament and the Council.

ESG: prospectus and FS disclosure templates

The European Supervisory Authorities (ESA's) issued the following mock-ups of the prospectus and financial statement ESG disclosure templates for so-called "light-green" or Article 8 and "dark-green" or Article 9 products in the form of a survey and asked for feedback by 16 October 2020.

These templates were yet "to be developed" in the ESA consultation on the EU Disclosures Regulation. The templates are Annexes to the RTS that the ESAs are, under the current schedule, due by 30 December 2020.

The final content of the templates is subject to the outcome of a concurrent consumer testing exercise and the ESAs’ final report on the draft RTS under the EU Disclosures Regulation.

ESG: ESMA SMSG recommendations on timing of ESG disclosure obligations

The Securities and Markets Stakeholder Group (SMSG) of ESMA issued advice in response to the ESA consultation on ESG disclosure standards, noting that neither the timing nor the concepts of these different pieces of legislation are fully synchronised or aligned with one another.

ESG: EU Taxonomy Regulation and Investment Funds

The Taxonomy Regulation forms part of a broader package of legislation being introduced by the European Commission as part of its Action Plan on Sustainable Finance. Our Asset Management and Investment Funds team have put together a publication which explains what the taxonomy classification system is. We also look at the disclosures in the Taxonomy regulation which are relevant for financial market participants, including fund managers, and how they impact investment funds. Go to publication. This briefing forms part of our Environmental, Social and Governance series.

UK CCPs given time limited equivalence

The European Commission adopted a time-limited decision to give financial market participants 18 months to reduce their exposure to UK central counterparties (CCPs).

The Commission noted that the heavy reliance of the EU financial system on services provided by UK-based CCPs raises important issues related to financial stability and requires the scaling down of EU exposures to these infrastructures.

The temporary equivalence decision aims to protect financial stability in the EU and give market participants the time needed to reduce their exposure to UK CCPs.

ESMA announced that three UK CCPs – ICE Clear Europe Limited, LCH Limited, and LME Clear Limited – will be recognised as third country CCPs eligible to provide their services in the EU, after the end of the transition period following the withdrawal of the UK from the EU on 31 December 2020.

In line with the Commission's equivalence decision, ESMA's recognition decisions will take effect on the day following the end of the transition period and continue to apply while the equivalence decision remains in force, which is for 18 months until 30 June 2022.

The 18 month timeframe will allow ESMA to conduct a comprehensive review of the systemic importance of UK CCPs and their clearing services or activities to the EU and take any appropriate measures to address financial stability risks.

Capital Markets Union Action Plan

The European Commission published a revised CMU Action Plan, setting out 16 legislative and non-legislative measures aimed at delivering on three main objectives:

  • to support a green, inclusive and resilient economic recovery
  • make the EU an even safer place to save and invest long-term
  • integrate national capital markets into a genuine single market

ESMA paper on closet index funds

ESMA published a Working Paper on Closet Indexing Indicators and Investor Outcomes, The study finds that investors can expect lower net returns from closet indexers than from a genuinely actively managed fund portfolio. The study looked at annual fund-level data for the period 2010 to 2018, finding that investors saw both lower expected returns and higher fees when they invested in closet indexers compared with active funds. Overall, the net performance of potential closet indexers was worse than the net performance of genuinely active funds, as the marginally lower fees of potential closet indexers are outweighed by reduced performance. A summary of this study was also included in ESMA's Trends, Risks and Vulnerabilities report

ESMA TRV report

ESMA published its second Trends, Risks and Vulnerabilities (TRV) Report on 2 September 2020.

The report analyses the impact of COVID-19 on financial markets during the first half of 2020 and highlights the risk of a potential decoupling of financial market performance and underlying economic activity, which raises the question of the sustainability of the current market rebound.

Of relevance to asset management and investment funds is ESMA's risk assessment on deterioration of liquidity, redemption flows and suspensions until April 2020 and commentary on the effect on ETFs and MMFs.

Under the Risk Analysis section there are articles on financial stability and interconnectedness in the EU funds industry and investor protection as well as costs and performance of potential closet index funds.

Interest rates reform 

ESMA delivered a City Week 2020 Speech on interest rates reform

  • €STR: ESMA expects the high liquidity of EONIA derivative markets to gradually move to the €STR derivative markets in the next months, ahead of the EONIA end-date in January 2022. 
  • The EU Benchmarks Regulation (Article 28(2) requires EU supervised entities to incorporate fallback provisions in their EURIBOR contracts. Relevant protocols are currently being published by trade associations, while the Working Group on Euro Risk Free Rates is about to finalise key recommendations on EURIBOR fallback provisions.
  • The need to prepare for LIBOR discontinuation. The Bank of England and the FCA confirmed that firms cannot rely on LIBOR being published after the end of 2021. The LIBOR transition effort needs now to accelerate.

Legislative initiatives to strengthen the LIBOR transition. The European Commission recently published a proposed law to amend the existing EU Benchmarks to ensure an orderly cessation of LIBOR in the EU and to increase legal certainty around the discontinuation of this rate in relation to contracts involving EU parties. This may become EU Law by the end of 2020. A similar legislative initiative has been taken by the UK Government. 

For more information in relation to any of these topics please speak with your usual contact on the A&L Goodbody Asset Management & Investment Funds team.

Date published: 29 September 2020