EU institutions are continuing to negotiate numerous ongoing policy initiatives that directly or indirectly impact fund managers in the new environment of MiFID II which has not resulted in interruptions to ongoing regulatory activity.
The European Commission is currently undertaking a review of the UCITS framework for mutual funds and the AIFMD framework for alternative funds, alongside proposals to facilitate the cross-border distribution of funds. The EU policy discussion is also venturing to newer policy themes around sustainable finance, fintech and liquidity & leverage in funds.
This briefing note provides an overview of ongoing negotiations, expected legislative proposals and more distant themes that are likely to dominate the EU policy discussions of relevance to asset managers in 2018.
Ongoing EU negotiations
An overview of dossiers where negotiations between EU institutions are currently ongoing.
The European Commission continues to work on giving European Supervisory Authorities (ESAs, the EBA, ESMA and EIOPA) more powers on consumer and investor protection. Over the past few years, many national competent authorities (NCAs) have increasingly sought additional powers to control and restrict the sale and advertisement, mostly through digital means, of financial services and products.
In its Consumer Financial Services Action Plan of March 2017 the European Commission expressed its concern that national regulatory differences and ‘gold plating’ by Member States may distort competition to the detriment of new entrants and undermine the European system of ‘passporting’ for regulatory licences.
The European Commission illustrated this potential new role for ESAs by involving ESMA and EIOPA in the current investigation into the fees, costs and real performance of long-term retail investment products. In October 2017, it indeed requested the ESAs to issue recurrent reports on the cost and performance of the main categories of retail investment, insurance and pension products.
Giving new powers in the area of consumer protection is, however, at the limits of EU law as consumer protection is a shared competence between the EU and Member States. This area may therefore be one of the most complex ones in the review of the ESAs.
Delegation and outsourcing
Included in the 2017 legislative package, ESMA now has the ability to scrutinise every new UCITS and AIFMD authorisation which involves the delegation or outsourcing of material key functions to non-EU entities. While ESMA would not be able to block decisions by, for example, the Central Bank of Ireland (CBI) or the Luxemburg CSSF, it would nevertheless be able to increase the pressure on these.
The question of delegation has become critical in the context of Brexit and the relocation of certain asset managers from the United Kingdom to other European Member States.
ESMA is likely to adopt a stricter approach to delegation and outsourcing than the CBI and CSSF, as became clear from the ESMA opinion of July 13, 2017 on Investment Management in the context of Brexit, in which it pointed out the risks of letter-box entities arising from the use of outsourcing arrangements or of non-EU branches for the performance of services with respect to EU clients.
A notice on asset management released in February 2018 outlined the legal implications of a situation in which the UK and EU don’t reach a deal on transitional arrangements and no equivalence decisions are adopted under the various pieces of EU financial regulation.
In it, the European Commission said that where the delegation concerns portfolio management or risk management and is conferred on an undertaking established in a third country, a cooperation agreement between the competent authority of the home Member State of the UCITS management company or AIF manager and the supervisory authority of the undertaking carrying out the delegated function in the third country will be necessary.
Supervision of non-EU benchmark administrators
As part of its new powers under EU Benchmarks Regulation, ESMA now directly supervises non-EU benchmark providers whose benchmarks are used in the EU.
This particularly impacts non-EU asset managers managing their own benchmarks who are used for ETFs distributed to EU investors. These changes are made to the EU Benchmarks Regulation which will apply as of the 1st of January 2018.
OTC derivatives and post-trading (EMIR/RRCCP/EMIR Supervision)
On May 4, 2017, the European Commission proposed changes to the regulation on EMIR (regulation on European market infrastructure) , seeking to simplify reporting requirements and easing the overall burden on financial firms. This reform is expected to be completed during 2018.
The European Commission also published in June 2017 a proposal seeking to strengthen the EU supervision
of non-EU clearing houses clearing large amounts of euro-denominated products. Depending on the outcome of negotiations, this proposal could impact cross-margining efficiencies across asset classes, the cost of clearing and the liquidity and pricing of derivatives.
Finally, the negotiations on the EU proposal on the recovery and resolution of CCPs published in November 2016 are continuing. The proposal contains recovery tools for CCPs such as variation margin haircutting which could have significant impact on the trading positions held by asset managers with European CCPs, impacting the hedging of portfolios.
Opening the European private pension market
In June 2017, the European Commission made a proposal for Pan-European Personal Pension Products (PEPP).
Many asset managers see this as an opportunity to make headways into the personal pension market, particularly in certain EU Member States where pension systems are less developed.
The objective is for the PEPP to mirror the simplicity of the UCITS regime. One of the key points in the negotiations will be whether providers are required to offer a product guaranteeing the invested capital and a certain return. This requirement would make it more challenging for asset managers to offer the product.
Future EU legislative proposals
An overview of legislative initiatives the European Commission is expected to publish in 2018.
Cross-border distribution of funds
The European Commission, building on its consultation of 2016, has now published a legislative proposal to facilitate the distribution of UCITS and AIFMD funds across all EU Member States aimed at removing regulatory barriers.
The proposal will be limited in scope and will focus on streamlining reporting requirements, regulatory filing fees and introducing a limited harmonisation of marketing and pre-marketing requirements. ESMA will be given the power to publish on its website a database listing the regulatory fees or charges levied by the national competent authorities.
The text will now move ahead in legislative procedure, being negotiated between the Council and the European Parliament. Member States are expected to express some reservations regarding the new powers given to ESMA.
AIFMD and UCITS review in 2018
The European Commission plans to launch a broader review of the AIFMD and UCITS framework end of 2018 or beginning of 2019. This move is unrelated to the legislative proposal on cross-border distribution of funds.
Both UCITS and AIFMD will need to be updated to reflect MiFID II and some of the obligations that may apply to these funds, particularly after some asset managers converted to AIFMD licenses to avoid some of the cumbersome MiFID II requirements.
UCITS will need to be updated to reflect distinctions introduced by EMIR between centrally-cleared and bilateral OTC derivatives used to hedge portfolios. We may also see a replication of the more detailed AIFMD rules on delegation in the UCITS framework.
We may also a drive to update rules on transparency of tracked benchmarks and a clearer disclosure of fees, particularly around performance fees.
Finally, some stakeholders may seek to enhance fund governance rules and particularly the representation of investors on boards through independent directors.
The European Commission has already begun a review of AIFMD, by commissioning KPMG to prepare a report into the impact and effectiveness of the directive since it came into force in 2013. The work on UCITS is not expected for 2018.
Prudential framework for MiFID Investment Firms
The European Commission unveiled a proposal in December last aimed at simplifying the prudential rules for investment firms under MiFID, based on an opinion issued in September 2017 by the European Banking Authority, which included a series of recommendations aiming to develop a single and harmonised set of proportionate requirements relevant to the nature of investment firms. The opinion notably called for the introduction of simpler prudential requirements for small investment firms that provide limited services.
The proposal particularly impacts fund managers managing individual institutional mandates. Some of the metrics introduced to calculate capital requirements look at the total assets under management (AuM) or the value of client orders handled.
Fiduciary duties for Asset Managers
Following its consultation on long-term and sustainable investments in early 2016, the European Commission will next May unveil a legislative proposal seeking to enhance the fiduciary duties of institutional investors, asset managers and some of their portfolio advisers, to ensure that they can take better account of long-term investment goals as well as long-term financial risks such as climate change in their investment strategies.
The proposal will cover in scope fund managers (UCITS, AIFMD, EuVeca, EuSef) and institutional investors (insurers and IORPs). The idea is to take inspiration from the current ESG provisions in the IORP II directive and expand it to all other types of fund and asset managers. All investment vehicles will thus have to take into account and address ESG risks in their investment strategy and disclose that. They will be allowed not to take ESG risks into account but will have to explain in their disclosure why they do not take it into account.
Future policy themes on the horizon
A look at policy themes that are being discussed and may one day lead to more concrete action.
Liquidity and leverage
Following the Financial Stability Board (FSB) report of January 2017 on Structural Vulnerabilities from Asset Management Activities, The International Organisation of Securities Commissions (IOSCO) consulted between July and September on liquidity management and risk in the context of investment funds. With rules introduced by the AIFMD in 2011 and the EU Money Market Fund Regulation agreed in 2017, the EU has already set about certain tools for regulators to monitor liquidity risk in the context of asset management.
More recently, the ETF sector has come under scrutiny from France’s financial markets regulator AMF and the Central Bank of Ireland. As part of latest legislative package on the powers of ESMA (see MiFID II and delegation), ESMA will be granted the power to conduct stress tests of sectors falling within its remit, such as the asset management sector.
In January 2017, the European Commission launched its High-Level Expert Group (HLEG) on sustainable finance, which delivered in January a report included a list of 15 policy recommendations. The priority recommendations of the HLEG were, to establish a common sustainability taxonomy at the EU level, to clarify investor duties and bring greater focus on ESG factors and to upgrade disclosure rules to make climate change risks and opportunities fully transparent.
The European Commission followed up on that report in March with the publication of its Action Plan on sustainable finance, which is a non-legislative summary of 10 initiatives inspiring itself form the HLEG report. According to this Action Plan, the European Commission will inter alia prepare a report on an EU green bond standard by Q2 2019, explore the use of an EU ecolabel framework for certain financial products and the possibility of adopting a legislative proposal on creating a category of benchmarks with low-carbon issuers.
Following the HLEG report and the Action Plan on sustainable finance, the European Commission will table a legislative proposal on the 23rd of May 2018 on an EU taxonomy for green assets.
The European Parliament is also currently preparing a non-legislative report on sustainable finance, which will be voted end of April 2018. This report will be politically important, because it will represent the official position of the European Parliament on sustainable finance ahead of the start of the legislative process on taxonomy and fiduciary duties in May 2018.
The European Commission has also published an Action Plan on FinTech, which focuses on three work streams: enabling business models to reach EU scale, supporting technological innovation and enhancing cybersecurity and resilience. The work streams are divided in different areas and underpinned by 22 specific policy actions of non-legislative nature.
While fund managers have spent the past year getting ready to comply with MiFID II, many more policy initiatives with the potential for material impact on fund managers will come at the forefront of the policy and political agenda of 2018.
It is essential for fund managers to stay informed of these developments through early warning mechanisms and to be able to quickly assess whether influencing the policy discussions is necessary. Hume Brophy is well placed to assist you in planning, executing and achieving your EU public affairs objectives on all the issues of relevance to the financial services industry with policymakers, using our knowledge, expertise and contacts to achieve tangible and positive outcomes.
Questions & comments
Aidan Hume, Senior Consultant, email@example.com