Category: Member Update

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Member Update

Well-intentioned but light on substance: The ESMA review of AIFMD

In August 2020, the European Securities and Markets Authority (ESMA) published a letter to the European Commission (EC) outlining its recommendations on future potential amendments to the Alternative Investment Fund Managers Directive (AIFMD). The letter’s contents have yielded a mixed response from the asset management industry. The NCI takes a look at some of ESMA’s proposals.

Greater harmonisation

The lack of harmonisation between UCITS and AIFMD has been a source of frustration at asset managers for a long time. Accordingly, ESMA has asked the EC to align AIFMD and UCITS where possible. ESMA also said there needed to be greater consistency between AIFMD/UCITS and MiFID (Markets in Financial Instruments Directive) to ensure that entities providing similar services are subject to comparable regulatory standards. Again, this is a welcome development for the funds’ industry. Having made improvements to AIFMD’s Annex IV reporting, ESMA also said it was vital that UCITS reporting should now become more harmonised and less duplicative. The lack of reporting standardisation in member states has been a significant barrier for asset managers undertaking cross-border distribution. The implementation of a more homogenised regulatory and reporting regime for UCITS would help provide a much-needed boost to cross-border distribution and sales.

ESMA added there needs to be greater EU-wide consistency on liquidity risk management, an issue which has become more crucial following the Covid-19 crisis. “In ESMA’s view, the EC should take the opportunity to  review the availability of all liquidity management tools outlined in the European Systemic Risk Board’s (ESRB) recommendation A. In addition, the availability of tools should also be included in the UCITS directive.” Among the ESRB’s suggestions were that additional provisions be inserted into AIFMD and UCITS clarifying the roles of regulators when using their powers to suspend redemptions in situations where there are cross-border financial stability implications. For instance, there is still uncertainty as to which regulator is responsible for supervising redemptions and subscriptions– when the fund and its management company are located in different member states.

Delegation in the spotlight

Delegation arrangements at asset managers have been subject to intense scrutiny ever since Brexit. While ESMA accepts delegation promotes efficiency, it warns the practice can increase operational and supervisory risk, especially if more strategic activities take place outside of the EU. In response, ESMA said “further legal clarifications on the maximum extent of delegation would be helpful to ensure supervisory convergence and ensure authorised AIFMs and UCITS management companies maintain sufficient substance in the EU.” Although previous attempts by some member states to limit delegation were rebuffed, it continues to be an ongoing risk for non-EU investment managers.

A damp squib

While advocating for further harmonisation of UCITS and AIFMD is not a bad thing, the ESMA letter is deliberately vague. The section on reverse solicitation simply calls for greater clarity owing to the fact different member states are adopting their own interpretations. This is a sensible recommendation but ESMA provides little detail on how this should be achieved. Similarly, ESMA takes a fairly ambiguous position on the establishment of a pan-EU depositary passport – a topic which has been under discussion since the early 1990s – by  kicking the issue into the long grass. Even though ESMA’s message is generally positive, the letter is extraordinarily light on substance.  

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Not the time for deviation on ESG standards

Although interest in ESG (environment, social, governance) investing has been gathering momentum for several years now, Covid-19 has accelerated this trend exponentially. Data released by Morgan Stanley shows issuance of social and sustainable bonds topped $32 billion in April 2020, a monthly total surpassing that of green bonds for the first time ever. The market share grab by social bond issuers has been extraordinary, but it is reflective of a wider shift into ESG by investment managers.

The rise of ESG has been organic, fuelled by institutional clients becoming more aware about societal and environmental issues, and who in turn are demanding asset managers plough more resources into ESG investing. It has also been regulatory-led. The EU’s Sustainable Finance Action Plan is widely seen as being a trailblazer on ESG. Assuming deadlines are met, the European Commission has said it wants financial institutions – including fund managers – to be compliant with the new rules by 2021. 

The Brexit effect

Although the UK has said repeatedly that it does not intend to deviate from EU regulations following the Brexit transition, the government has yet to publish comprehensive legislation on sustainable finance, something which could result in ESG requirements coming into force later in the UK than in the EU. A senior official from the Department for Work and Pensions (DWP) also said the extent of the UK’s application of EU directives and regulations – such as the adoption of sustainable finance disclosure rules – would be conditional on the ease of market access following the Brexit transition.

A handful of industry associations are beginning to sound the alarm. The UK Sustainable Investment and Finance Association (UKSIF), a body that represents financial institutions with assets totalling more than £7 trillion, implored the Treasury to outline its regulatory approach on sustainable investing. This comes amid fears the UK is at risk of undermining its reputation as an ESG leader in financial services. Moreover, asset managers with cross border operations have warned they could face added costs if the UK develops ESG regulation that does not correspond with the EU’s rules. 

Standards correspond with success

The Treasury’s plans are not yet known , but it has said that more information about its ESG disclosure regime will be released in due course. The issue of the UK arbitraging with the EU is worrying, particularly on ESG standards. Right now, ESG standards are a mess, mainly because so many bodies and associations (albeit good-intentioned) have developed their own, customised standards. In addition, different regulators are pursuing their own ESG regimes, further complicating the process.  All of these conflicting rules are going to prove incredibly confusing for global investors. 

A failure to develop harmonised, sensible and easy to understand standards will undermine regulatory efforts to stamp out green-washing and ESG mis-selling, an issue which is likely to become more prevalent moving forward. It is vital that regulators and industry bodies communicate with each to create common standards to preserve the integrity of the rapidly-growing ESG market.