Revisions to AIFMD and UCITS V draw a mixed response
In 2018, the European Commission (EC) announced adjustments would be made to the Alternative Investment Fund Managers Directive (AIFMD) and UCITS V in response to criticism that existing securities and insolvency laws were not homogenised on an EU-wide basis. The proposals introduce further safeguards on asset segregation throughout the whole custody chain, and demand that reconciliation processes be strengthened between the depositary’s own internal accounts and records and those at the custodian provider(s).
These provisions could increase pressure on depositaries, something which may add to fund managers’ costs. Other changes could follow as a result of the KPMG European Commission Survey conducted in 2018. This report notably highlights that some of the AIFMD depositary rules are being interpreted differently across the EU, while some rules on asset segregation are seen as unnecessary. It further adds that the amount of data required by regulators is thought to be disproportionately high, according to some market participants.
In the short term, it is unlikely that an EC-led review of AIFMD will take place until the new Commission is formed at the end of 2019.
Nonetheless, the European Supervisory Authorities’ (NCAs) did issue a statement addressing market concerns regarding the end of the UCITS’ exemption from PRIIPS. It implied that this exemption may be extended in what would offer some relief. As a result, UCITS managers would not need to file a PRIIPs KID (Key Investor Document), a client reporting template which risked duplicating the existing KIID (Key Investor Information Document). The PRIIPs KID was also heavily criticised by market participants including the Investment Association (IA) who argued the calculation methodologies underpinning it potentially skewed transaction cost and performance scenario reporting.
Moving the distribution goalposts
The frequency with which managers of UCITS and AIFs distribute funds on a cross-border basis has not met regulatory expectations. The EC’s proposal in March 2018 highlights that most European asset managers simply prefer to concentrate their capital raising efforts in the local market, with very few firms actually distributing products beyond their own borders. The lack of harmonised rules for cross-border distribution of investment funds – despite the availability of the pan-EU marketing passport – is primarily a result of NCAs gold-plating AIFMD and UCITS’ rules.
The EC - as part of its Capital Markets Union (CMU) plan - is addressing the issue. The trialogue process has begun in Brussels and the measures under discussion include:
- Creating standardised authorisation processes across the EU
- Better alignment of regulatory charges
- Removal of the requirement for managers to appoint a local agent in countries where funds are being distributed.
Although the rules may reduce some of the requirements associated with cross-border distribution, they heavily curtail pre-marketing by restricting the ability of firms to share certain documents with prospective clients in jurisdictions where they are not registered as AIFMs.
EMIR: It is finally here
Centralised clearing of over-the-counter (OTC) derivatives through CCPs (central counterparty clearing houses) has been a policy objective for global regulators ever since the financial crisis. Inside the EU, mandatory clearing of OTC instruments – such as interest rate swaps and credit default swaps – has been incrementally phased in under the European Market Infrastructure Regulation (EMIR), a process that began in 2016. At present, clearing is compulsory for any financial institution – including asset managers - whose aggregate average outstanding gross notional amount of OTC instruments exceeds EUR 8 billion.
“In June 2019, the clearing threshold will be reduced and will apply to any financial counterparties with holdings in OTC instruments of below EUR 8 billion. This is obviously a major development for the industry. In that context, some advocacy actions are currently being carried out to give more time to those impacted financial institutions which may not be entirely familiar with how the clearing process works.”
In parallel, the EMIR Regulatory Fitness and Performance (REFIT) programme is about to be finalised in Brussels. One of the points being discussed is the way in which clearing threshold should be calculated. Some experts have requested it should be calculated on a group-wide level instead of on an individual fund basis.
Money market fund reform in Europe
Published in 2017, the EU’s Money Market Fund Regulation (MMFR) applies to all MMFs and imposes new liquidity, risk management and transparency obligations. MMFR applies to existing funds but also to new funds. Beginning in the first quarter of 2020, MMFR will demand that impacted firms disclose quarterly reports to their national competent authorities (NCAs).
Sustainable finance: new regulations in the making
The EC is intent on requiring asset managers and institutional allocators to consider sustainability risks when making investments as part of its Action Plan on Sustainable Finance, a policy blueprint released in March 2018. The authorities are also planning on introducing a taxonomy to enable customers to benchmark the green credentials of their asset managers. However, the European Securities and Markets Authority (ESMA) has acknowledged it would not adopt a prescriptive approach when applying the rules.
An ESG disclosure template for investors has been discussed although the precise details have not yet been ratified by regulators. Currently, there are no EU-wide requirements for institutions to disclose details about their ESG investments, but regulators in some Member States have imposed their own reporting standards. Nonetheless, EU regulators are assessing how they could incorporate ESG provisions into existing rules such as AIFMD, MiFID II and UCITS V to prevent fragmentation and arbitrage. ESG risks could even be assimilated into the Capital Requirements Regulation 2 (CRR 2), thereby incentivising banks to support ESG investments and financing.
Hitting back on fees
Asset management fees have been a focus for regulators for some time, most notably the UK Financial Conduct Authority (FCA) which made its views on the high charges levied by active managers clear in its Asset Management Market Study.
The issue has now been taken up at a European level. In its recently published Annual Statistical Report, ESMA criticised UCITS’ fund fees as a drain on performance, which often resulted in cheaper, passive products delivering better returns than their active peers. ESMA’s comments could be a precursor for further cost transparency requirements.
Read our detailed update on all regulations impacting financial markets in Q4 2018, here