Systemic investment fund risk has been on the industry radar screen since the 2007-2008 financial crisis and continues to resonate within the marketplace during the current pandemic.
European regulatory authorities are now in the process of aligning systemic risk mitigation protocol (currently variable across EEA jurisdictions) where indicated by the European Systemic Risk Board (ESRB), whose recommendations were published back in December 2017.
As these latest measures cover the general disclosure obligations of our clients (including direct referral to key legislation and some Kneip products): this area requires our continued attention.
1. AIFMD pt1: ESMA update systemic risk opinion, Annex IV reporting guidelines
ESMA have recently published a revised opinion covering AIFMD Article 24(5) i.e. the collection of information for the effective monitoring of systemic risk. This was originally delivered to affiliated National Competent Authorities (NCAs) back in 2013 as part of their original EU mandate (i.e. article 29(1) of Regulation (EU) No 1095/2010): i.e. to “develop new practical instruments and convergence tools to promote common supervisory approaches and practices”.
As you may recall, AIFMD article 24 covers Reporting obligations to competent authorities (subsequently defined by ESMA to encompass the current Annex IV reporting template (c/o their Guidelines for Reporting obligation per AIFMD articles 3(3)(d) and 24(1), (2) and (4)).
It also positions NCAs to “require additional information” from their AIFMs to enable “effective monitoring of systemic risk” (notably in relation to those “employing leverage on a substantial basis”). NB: this links directly to ESMA’s new level 3 Guidelines on the assessment of leverage-related systemic risk (summarised per no.2 below).
ESMA now believe it is time that NCAs adopt a common approach while they approach local AIFMs to obtain the required additional information from their local AIFMs:
- The number of transactions
- Geographical focus based on the domicile of investments made
- Short positions
- Risk measures (notably Value-at-risk, Net FX delta and Net commodity delta)
- Information on non-EU master AIFs not marketed in the Union
ESMA say this would also “allow for a more comprehensive oversight of the activities of AIFMs by supplementing the reporting in such areas as risk measures and short positions.”
Meantime, ESMA have “complemented” their opinion with three new Q&As in their latest AIFMD Q&A document (page 28-29). These provide clarification on the reporting of three risk measures included in the Annex IV AIF template (i.e. NET DV01, Net CS01 and Net Equity Delta).
2. AIFMD pt2: ESMA issue Guidelines on leverage-related systemic risk
Last week, ESMA also published a new set of guidelines for the attention of their NCAs; these seek to “establish consistent, efficient and effective supervisory practices within the European System of Financial Supervision and “ensure the common, uniform and consistent application of article 25 of the AIFMD”.
Article 25 relates specifically to the use of information concerning AIFMs managing leverage funds. ESMA’s latest measures effectively represent their attempt to introduce a two-step systemic leverage risk assessment (i.e. as recommended by IOSCO in their 2019 framework) into the current regime.
Ongoing, ESMA stipulate that the NCAs should perform a quarterly assessment of leverage-related systemic risk, primarily based on periodic AIFM data received per Annex IV reporting (i.e. supplemented with the additional information highlighted per 1. above).
ESMA’s proposals were previously presented in a consultation paper (with results summarised in a Final Report in late-2020). NCAs will have to apply these guidelines from 23 August 2021 (i.e. two months after the official publication on ESMA’s website).
3. UCITS: CSSF publish Liquidity Risk Management feedback report
“The CSSF expects investment fund managers to define and implement a documented internal approach underlying the definition of what is material or not in terms of liquidity risks for supporting the disclosure in the KIID.”
Last week, the CSSF published a local feedback report in response to ESMA’s public statement presenting results of last year’s Common Supervisory Action (CSA) addressing UCITS liquidity risk management. These follow ESMA’s original paper to the European Systemic Risk Board (ESRB) outlining their recommendations for liquidity risk in investment funds.
The CSSF present their synopsis of 2020 CSA activities, stating their current bilateral engagement with certain investment fund managers (IFMs) in relation to previous CSA observations (including “the need for improvement in certain key areas”. These cover an extensive range of Liquidity Risk Management (LRM) perspectives, including documentation, procedures, mechanisms, methodology, data reliability, disclosure and governance (alongside internal and external control frameworks).
The CSSF also make specific referral of Information to the investors in the KIID (page 10-11). They confirm observations of local instances where “the liquidity risks attached to some financial instruments held by UCITS were not set out in an adequate manner in the KIID” (i.e. in order to supplement the synthetic risk and reward indicator (SRRI) in order to produce a suitable Risk and Reward profile).
NB: this directly aligns with ESMA’s previous highlighting of Disclosure issues: e.g. “…NCAs reported some cases of missing, inaccurate, or unclear disclosures on liquidity risks and LMTs to investors in UCITS KIID and/or prospectus”.
Accordingly, the CSSF now request all IFMs where necessary to “implement the necessary corrective measures for the shortcomings observed” in their specific cases. They have also instructed all UCITS managers to conduct a comprehensive assessment to evidence “the compliance of their LRM compliance set-ups” before the end of 2021.
Elsewhere, the CSSF have also updated their UCITS risk reporting guidelines (with fund disclosure including both Liquidity risk and Global exposure & leverage).