In this issue we consider a number of recent Central Bank updates including its confirmation of a fast-track process for prospectus updates required under the Sustainable Finance Disclosures Regulation, the findings from its CP86 review, and its revised statement regarding certain COVID-19 flexibility measures. We also look at ESMA's recent report to the ESRB on fund liquidity, the application of ESMA's performance fee guidelines and the announcement of a common supervisory action on investment fund costs and fees, as well as some open consultations of interest.
If you would like to discuss any of the topics covered, please feel free to contact a member of our team.
Central Bank Confirms Fast-track Process for Prospectus Updates under SFDR
On 30 October 2020, the European Commission ("Commission") wrote to the European Supervisory Authorities (EBA, EIOPA and ESMA) ("ESAs") confirming a delay to the implementation of the level 2 measures ("RTS") under the Sustainable Finance Disclosures Regulation ("SFDR"). In its letter, the Commission explains that the application of the SFDR is not conditional on the formal adoption and entry into force or application of the RTS. Therefore, financial market participants and financial advisers subject to the SFDR will still need to comply with its high level and principle-based requirements from 10 March 2021. In order to provide financial market participants and financial advisers adequate time for implementation, the RTS will become applicable at a later stage.
Following the Commission's clarification, the Central Bank has confirmed that it will allow a fast track process for the amendments to prospectus documents that relate only to changes being made to ensure compliance with SFDR. The Central Bank has also confirmed that it does not intend to provide further guidance at this time as that will come, in time, from the Commission. In the meantime, however, the Central Bank, will not be reviewing the categorisation of products or the approach to compliance with other elements of SFDR and will rely on the self-certification from the fund management company until such time as the RTS are final and effective. However, the Central Bank has emphasised that the fast-track regime should not be seen as providing scope for a lesser quality of disclosure than would otherwise be produced. The Central Bank is expected to issue more detailed information regarding the fast track process will in due course.
For more information on the requirements under SFDR, please see our more detailed briefing here.
Central Bank Publishes CP86 Review Findings
On 20 October 2020, the Central Bank published the much anticipated findings of the review of its Fund Management Company Guidance ("CP86"). The Central Bank communicated its findings ("Findings") in an industry letter that all fund management companies (including self-managed investment funds) ("FMCs") should use to "critically assess" their operating models and resourcing and governance arrangements. The Central Bank expects all FMCs to review the issues identified in the Findings and to develop and progress individual action plans to address these issues and meet the Central Bank's expectations. These action plans must be approved by the board of directors of the FMC by the end of Q1 2021. The most significant findings relate to substance and governance. The Central Bank has stated that all FMCs should have a minimum of 3 FTEs (full-time employee or equivalent to full time employee) and should appoint locally based Designated Persons ("DPs") and other staff who have sufficient time to dedicate to their roles and responsibilities, including delegate oversight. FMCs will have to carefully consider their resourcing requirements and decisions and ensure that they conduct appropriate due diligence on delegates and PCF-holders.
In its Findings, the Central Bank noted that some FMCs had demonstrated that they were broadly compliant with the CP86 framework. These FMCs have resourcing and operational structures in place that support a considered and well-planned approach to implementation of the CP86 framework. Many of these FMCs were authorised following the introduction of the CP86 rules in 2017. The Central Bank found that, in its view, many FMCs authorised prior to the introduction of CP86 failed to fully implement CP86 and could only evidence the introduction of very limited changes as a result of CP86.
The key issues identified by the Central Bank related to:
- designated persons;
- delegate oversight;
- risk management frameworks;
- board approval of new funds;
- the organisational effectiveness director; and
- governance and culture.
All FMCs must carefully review the Findings and critically assess their day to day operational, resourcing and governance arrangements to make necessary changes to ensure the full and effective embedding of all aspects of CP86. FMCs must immediately develop appropriate action plans to meet the Central Bank's expectations. These action plans must be approved by the FMC board by the end of Q1 2021.
For more information, please see our detailed briefing here.
PCF 39 'In Situ Returns' Due by 27 November 2020
As reported last month, the Central Bank published the Central Bank Reform Act 2010 (Sections 20 and 22) (Amendment) Regulations 2020 designating the new PCF-39A-F roles, each aligned to the specific managerial functions set out in the Central Bank's Fund Management Company Guidance (commonly referred to as "CP86"). Designated persons ("DPs") in situ on 5 October 2020 (the effective date of the Amending Regulations) are not required to seek the approval of the Central Bank to continue to perform one of the new PCF roles. However, funds/fund management companies must submit a list of the individuals performing each of the newly designated PCF 39 A-F roles via an "In Situ return" to the Central Bank by 27 November 2020. If the individual preforming the role changes after the new DP roles have been introduced, (i.e. after 5 October 2020), he/she will be required to seek the Central Bank's prior approval in writing to that appointment by means of a new Individual Questionnaire.
The Central Bank has published the submission template and associated guidance on its website here.
Fund Liquidity: ESMA Issues its Report to the ESRB
On 14 May, ESMA published a statement of support for an ESRB recommendation that it coordinate a focused supervisory engagement amongst EU regulators with investment funds that have significant exposures to corporate debt and real estate. The recommendation was part of a set of actions to address the COVID-19 emergency from a macro-prudential perspective.
The recommendation requested ESMA to coordinate with the national regulators to undertake a focused piece of supervisory exercise with investment funds that have significant exposures to corporate debt and real estate assets to assess the preparedness of these two segments of the investment funds sector to potential future adverse shocks, including any potential resumption of significant redemptions and/or an increase in valuation uncertainty.
On 13 November 2020, ESMA published its report on the preparedness of these funds to deal with potential future adverse liquidity and valuation shocks. The findings indicate that the funds exposed to corporate debt and real estate funds that were under review overall managed to adequately maintain their activities when facing redemption pressures and/or episodes of valuation uncertainty. The analysis of their behaviour during the market stress linked to the COVID-19 pandemic revealed that only a limited number of the analysed funds suspended subscriptions and redemptions while the vast majority was able to meet redemptions requests and maintain their portfolio structure.
However, ESMA has advised that these results should be interpreted with caution since the redemption shock linked to the COVID-19 pandemic was concentrated over a short period of time, amid significant government and central bank interventions which provided support to the markets in which these funds invest. The findings also demonstrated some areas with weaknesses which need addressing including:
- some funds presented potential liquidity mismatches due to their liquidity set up (e.g. a combination of high redemption frequency, no/short notice periods and no liquidity management tools ("LMTs") in the case of funds investing in asset classes either illiquid by nature or whose liquidity may recede during a period of market stress); and
- only a few funds have adjusted their liquidity set-up according to the pursued investment strategy and in light of the liquidity issues encountered (e.g., introduction of LMTs, adaptation of the redemption frequency and notice period).
ESMA also identified the following five priority areas that would enhance the preparedness of the relevant investment funds for potential future adverse liquidity and valuation shocks:
- ongoing supervision of the alignment of the fund's investment strategy, liquidity profile and redemption policy;
- ongoing supervision of liquidity risk assessment;
- fund liquidity profile reporting;
- increase of the availability and use of LMTs; and
- supervision of valuation processes in the context of valuation uncertainty.
In its report, ESMA notes that it will follow up with national regulators on the first, second and fifth of these policy areas to foster supervisory convergence in how national regulators supervise firms' compliance with their obligations in this area. However, ESMA states that it considers that the increase of the availability of LMTs in EU member states and further convergence in the establishment of liquidity profiles under AIFMD should be taken forward in the context of the Commission's review of the AIFMD. More generally, ESMA supports further initiatives to develop a macro-prudential toolkit for investment funds that could be developed by the ESRB in conjunction with ESMA and NCAs.
Fund Fees to Remain a Key Supervisory Priority in 2021
On 13 November 2020, ESMA announced its supervisory priorities for national regulators. In 2021, coordinated by ESMA, national regulators will be undertaking supervisory action on:
- costs and fees charged by fund managers; and
- improving the quality of transparency data reported under MiFIR.
Earlier this year, ESMA issued a supervisory briefing ("Briefing") to support national regulators in their assessments of "undue costs" and supervising the obligation to prevent such undue costs being charged to investors. Although the Briefing is non-binding, ESMA has stated that it will closely cooperate with national regulators to promote its application and will review the level of convergence reached across the EU in 2021. In its Work Programme for 2021, ESMA had already flagged that a Common Supervisory Action ("CSA") on costs and fees was planned for 2021, noting that this CSA is expected to "represent a major area of focus to increase convergence in the supervision of costs in UCITS and AIFs, including securities lending fees and costs".
For more information on the Briefing and ESMA's expectations, please see our more detailed briefing here.
Central Bank Updates its COVID-19 Regulatory Flexibility Measures
As previously reported, in light of the effect of the COVID-19 pandemic, in April 2020 the Central Bank introduced certain regulatory flexibility measures for regulated firms, including funds and fund service providers, in certain specified areas. These included flexibility around the filing of periodic reports and other scheduled regulatory returns and the conducting of on-site due diligence visits. The Central Bank also clarified its expectations regarding the implementation of risk mitigation programmes and its requirements for additional information requests to assess the effects of COVID-19 on the financial sector.
On 5 November 2020, the Central Bank published a revised statement of its expectations. The Central Bank has decided that certain previously communicated measures which have since expired on their terms, will not be extended. However, certain flexibility measures afforded to investment funds and fund service providers are retained. These relate to investment funds' annual and semi-annual financial statement filings and on-site due diligence visits.
In addition, having postponed any updates to its regulatory policy framework in respect of investment firms, funds and fund management companies at the outset of the pandemic, the Central Bank has advised that these publications and updates generally have now resumed. In particular, the Central Bank expects to publish its feedback statement to its consultation on the treatment, correction and redress of errors in investment funds (" CP130") by Q1 2021.
ESMA's Performance Fee Guidelines to Apply from January 2021
On 5 November 2020, ESMA published the official translations of its guidelines on performance fees in UCITS and certain types of AIFs ("Guidelines"), thereby triggering the two month notice period within which national regulators should notify EMSA whether they comply or intend to comply with the Guidelines.
The publication of the official translations also clarifies the application date of the Guidelines. The Guidelines state that they:
- apply from two months after the date of publication of the guidelines on ESMA's website in all EU official languages (5 January 2021). Managers of any new funds created after the date of application of the Guidelines with a performance fee, or any funds existing before the date of application that introduce a performance fee for the first time after that date, should comply with the Guidelines immediately in respect of those funds.
- managers of funds with a performance fee existing before the date of application of these guidelines should apply the Guidelines in respect of those funds by the beginning of the financial year following 6 months from the application date of the Guidelines (by the beginning of the financial year post 5 July 2021).
The grandfathering period under Central Bank UCITS Regulations 2019 for funds with existing performance fees to comply with the Central Bank's requirements in respect of performance fees ends on 27 November 2020. There is some divergence between the ESMA Guidelines and the Central Bank requirements and the Central Bank is expected to communicate with industry soon in this regard.
For more information on the Guidelines, please see our previous briefing here.
Central Bank: The Impact of COVID-19 on the Funds Industry
On 25 September 2020, the Central Bank held an invitation only event to discuss the impact of COVID-19 on the funds industry. The purpose of the event was to gain insights from key firms and representative bodies on their experiences, lessons learned, and vulnerabilities identified from the COVID-19 crisis. The event also served as an opportunity for the Central Bank to provide its views on the crisis and to set out some key supervisory and policy priorities for the funds sector.
The event was comprised of three sessions:
Session 1: Macro-prudential Perspective on COVID-19 and the Funds Sector
Session 2: Reflections from Supervisory Engagements During COVID Market Events
Session 3: Potential Future Policy Developments
In the opening remarks to the event, Derville Rowland, Director General, Financial Conduct acknowledged that the funds sector had broadly demonstrated sufficient operational resilience throughout the pandemic, but that certain vulnerabilities had been highlighted and needed to be examined. She noted that further work is required to demonstrate that the funds sector is effectively managing the risks to which it is exposed, particularly in relation to leverage, liquidity and valuation uncertainty.
For a summary of some of the Central Bank's key points and observations from this event, please see our detailed briefing here.
AIFMD Review: European Commission Issues Consultation
On 21 October 2020, the European Commission ("Commission") published a public consultation on the operation of the Alternative Investment Fund Managers Directive ("AIFMD"). The consultation takes the form of an online questionnaire and comprises 102 questions across 6 main sections as follows:
- Functioning of the AIFMD regulatory framework, scope and authorisation requirements: the Commission is seeking views from stakeholders on the scope of the AIFM licence, its potential extension to smaller AIFMs and level playing field concerns in relation to the regulation of other financial intermediaries, like MiFID firms, credit institutions or UCITS managers that provide similar services.
- Investor Protection: this section raises questions on investor access that take into account the differences between retail and professional investors and whether there a need to structure an AIF under the EU law that could be marketed to retail investors with a passport. The adequacy of disclosure requirements are also covered including the specific requirements that could be added, changed or removed from the current rulebook. Other questions address the alleged ambiguities in the depositary regime and the lack of the depositary passport. Stakeholders are also invited to comment on potential improvements to the AIFMD rules on valuation.
- International Relations: the Commission is seeking views on how best to achieve the equitable treatment of non-EU AIFs and securing a wider choice of AIFs for investors while at the same time ensuring that EU AIFMs are not exposed to unfair competition or otherwise disadvantaged.
- Financial Stability: this section seeks stakeholder views on how to ensure that national regulators and AIFMs have the tools necessary to effectively mitigate and deal with systemic risks. Specific input is sought regarding improvements to the supervisory reporting template provided in the AIFM Regulation with a particular focus on the increased activities of AIFs in the credit market.
- Investing in Private Companies: feedback is being sought on the effectiveness of the current rules and their potential enhancement.
- Sustainability/ESG: this section seeks input on how the alternative investment sector can participate effectively in the areas of responsible investing and the preservation of the planet.
There are also questions in respect of UCITS including whether there should be a single licence for AIF and UCITS managers, harmonised metrics for leverage calculation and reporting on the use of liquidity management tools.
The consultation closes on 29 January 2021 and is the next step in the Commission's review of AIFMD. The Commission is also mandated to propose legislative amendments to AIFMD on foot of its review and in this context, ESMA has written to the Commission with a number of recommended changes to both the AIFMD and UCITS frameworks. Please see our more detailed briefings here and here for more information on the AIFMD review and ESMA's legislative proposals.
Recent consultations of interest include:
ESMA: Funds' Marketing Communications
On 9 November 2020, ESMA issued a consultation on guidelines on marketing communications under the Regulation on facilitating cross-border distribution of collective investment undertakings.
The purpose of the draft guidelines is to specify the requirements for marketing communications sent to investors in order to promote UCITS and AIFs, including EuSEFs (European social entrepreneurship funds), EuVECAs (European venture capital funds) and ELTIFs (European long-term investment funds). These requirements are that the material shall:
- be identifiable as marketing material;
- describe the risks and rewards of purchasing units or shares of an AIF or units of a UCITS in an equally prominent manner; and
- contain information which is fair, clear and not misleading.
Draft guidelines are therefore provided on:
- the identification of marketing communications as such;
- the description of risks and rewards in an equally prominent manner; and
- the fair, clear and not misleading
character of marketing communications, which includes guidance on:
- the suitability of the marketing communication to potential/target investors;
- consistency with other documents, in particular the prospectus, KIID, the constitutive documents of the fund, the periodic reports and information disclosed on the websites of UCITS management companies, AIFMs, EuVECA managers and EuSEF managers under the Sustainable Finance Disclosures Regulation;
- the description of the features of the investment;
- information on costs;
- Information on past performance and expected future performance; and
- Information on sustainability-related aspects.
The consultation closes on 8 February 2021 and ESMA intends to issue the final guidelines by 2 August 2021.
ELTIFs: On 19 October 2020, the European Commission ("Commission") launched a consultation relating to its review of the ELTIF Regulation.
The Commission is seeking feedback on issues including:
- scope of the ELTIF authorisation and process;
- investment universe, eligible assets and qualifying portfolio undertakings;
- borrowing of cash and leverage; and
- rules on portfolio composition and diversification.
The consultation closes on 19 January 2021.
Separately, ESMA has established its public register of ELTIFs, as it is required to do under the ELTIF Regulation.
Sustainable Corporate Governance: On 26 October 2020, the European Commission launched a consultation on sustainable corporate governance. Sustainability in corporate governance encompasses encouraging businesses to consider environmental (including climate, biodiversity), social, human and economic impact in their business decisions, and to focus on long-term sustainable value creation rather than short-term financial value. The consultation seeks to gather:
- the views of stakeholders on the need and objectives for EU intervention as well as different policy options;
- data that can be used to better assess the costs and benefits of different policy options; and
- additional knowledge about certain specific issues, in particular as regards national frameworks, enforcement mechanisms and current jurisprudence.
The consultation closes on 8 February 2021.
Originally Published by Arthur Cox, November 2020
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.