30 April 2020

Keep calm, carry on: Five things to monitor in May 2020

The funds industry continues its interim adaption - necessary to operate sufficiently during the unfolding pandemic. However, key long-standing areas of divergence (temporarily sidestepped) are now regaining general attention. We need to focus on these during the weeks ahead.

1. PRIIPS: Key Investor Document – update uncertain

This week, it was reported that the EU Commission has now formally rejected proposals from the three European Supervisory Authorities (EBA, EIOPA and ESMA) to permit fund firms to publish historical scenarios based on Past performance data (i.e. instead of the widely disputed Future forecasting method) in their PRIIPS KIDs, i.e. starting January 2022.

The ESA proposal was reportedly their attempt to find a workable solution to the PRIIPS KID review impasse. The EC were said to reject this suggestion, as it runs contrary to the level 1 legislation objective (i.e. to enable direct comparability of retail products in other sectors). Several members of the EU Parliament had also made it clear they would block any attempt to scrap future performance disclosures, citing the C-19 pandemic as a factor in their reasoning.

In response, several fund associations and campaign groups (notably the European Fund and Asset Management Association (EFAMA), the German BVI and Better Finance) have now publicly voiced their concerns, including a press statement reiterating their collective view that “the current PRIIP KID remains fundamentally flawed and provides retail investors with misleading information”.

EFAMA has now called for the “urgent completion” of the PRIIPS KID review, saying it is “critical” to “protect retail investors and support economic recovery”. They have shared their statement with the EU Commission, MEPs and the ESAs, urging EU legislators to re-consider ESMA’s proposals (as yet unpublished).

Meantime, the countdown to the remaining UCITS grandfathering period continues (end-2021), with the PRIIPS level-1 review supposedly postponed by the EC until late 2020 (best-case scenario).

2. UCITS: Performance Fee disparity continues

In early-April, the European Securities and Markets Authority (ESMA) published guidelines in an attempt to harmonise the conditions where fund managers charge performance fees. These were issued as common requirements, to enable convergence across National Competent Authorities (NCAs). They were extended also to certain AIF products facing retail clients.

Subsequently, the Association Française de la Gestion Financière (AFG) in France opined these may lead fund managers dropping performance fees altogether i.e. in preference to higher fixed fund charges. The AFG also said that the updated ESMA guidelines are “overly restrictive” and “…go too far by imposing one model based on a reference period of at least five years”. They also highlighted that the revised ESMA model is not included in the International Organization of Securities Commissions recommendations and currently applies only in one EU member state.

However, the campaign group Better Finance has now welcomed ESMA’s new guidance, including many of its own proposals now taken on board. They cite the guidance for fund managers to charge a performance fee only in case of out-performance (i.e. vs. their own stated benchmark), while funds whose asset class are unaligned with their stated benchmark cannot charge a performance fee. They welcome also the recommendation for the high-watermark model performance reference period (i.e. set for at least 5 years).

Meanwhile, ESMA’s Common Supervisory Action (CSA) (announced earlier this year) continues – with firms being asked to complete initial (stage 1) questionnaires supplied by the local regulators in order to assess UCITS supervisory risks in their country. There are some within the industry who anticipate the CSA process may lead to additional NCA reporting (i.e. similar to AIFMD Annex IV) for UCITS fund entities in due course.

NB: an interim reminder of the pending  application of ESMA’s Liquidity Stress Testing in UCITS & AIFs guidelines, still scheduled for 30th September 2020.

3. AIFMD: level 1 legislation proposals awaited

A generic EU re-alignment of Alternative Investment Fund Managers Directive (AIFMD) was previously indicated as a contributor to the EU Commission’s strategic Capital Markets Union (CMU).

The long-running review of the AIFMD (level-1) legislation continues, with general anticipation of EC proposed amendments (including an interim consultation process).  Although expected before the end of Q2, 2020, the latest rumours suggest a three-month rescheduling, which may include additional liquidity and leverage requirements.

Meantime, the Autorité des Marchés Financiers (AMF) are reported to have obtained a mixed set of results following their recent inspection of localised asset management companies. Having reviewed respective AIF manager procedures & controls, reporting systems and the quality of the data submitted; the French regulator has detected collective issued in relation to missing data, stray reporting and insufficient procedures (covering calculation of leverage, managing liquidity, reporting required and stress testing).

4. MiFID II: consultations, felicitations

ESMA has recently delayed a number of consultations by 4 weeks, including a paper covering draft MiFID II technical standards on investment services by 3rd country firms. They had also supplied Technical Advice to the EC on the effects of product intervention measures currently applicable to the sister regulation (MiFIR) – including potential amendments to apply these in future to additional UCITS, AIFMD and PRIIPS regimes.

Meanwhile, recent research by Morningstar (covering the tax and regulation in place across 26 global countries) is reported to include a positive assessment of the MiFID II regime: “MiFID II raised the bar for every European country in this study, improving regulations for standards of disclosure and reducing conflicts of interest”.

5. Sustainable Finance / ESG: additional Disclosure now on the horizon

The same study from Morningstar also expressed high expectations in relation to Environmental, Social, and Governance (ESG) product markets, looking forward.

Separately, the ESAs recently issued a milestone consultation paper seeking feedback on their draft proposals to apply ESG factors to pending sustainable-finance disclosures regulation (SFDR) obligations.  These will face financial market participants (at entity and product level), starting 2021 and are directly linked to the landmark EU Taxonomy finalised earlier this year.

The consultation runs until 01 September 2020. Among the subjects canvassed for opinion are: A) Entity-level principal adverse impact disclosures (c/o updated firm websites). B) Product level ESG disclosures at pre-contractual, website and periodic level

NB: Templates for disclosure and reporting are not included in this consultation (they will be issued separately by the ESAs later in 2020).

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