A regulatory smorgasbord

July 2021

There is no let-up for firms in the range of issues on which policymakers, regulators and supervisors are focused. New areas of rule-making are being proposed, existing rules are under review and the library of supervisory guidelines is expanding. As we discuss in KPMG's Evolving Asset Management Regulation report — Through a new lens, the pursuit of economic growth, changing investor demands and behaviours, and environmental and social concerns are influencing regulatory agendas. Good governance and appropriate investor protection remain regulatory imperatives, and regulators are concerned that lessons should be learnt from market events in March 2020. 

In this edition, we touch on sustainable finance regulation, suitability of senior management, money market fund (MMF) reform and cross-border fund distribution.

The European Commission has written to the European Parliament and Council saying that publication of the much-awaited final Level 2 rules under SFDR will be delayed in order to include rules on the additional product disclosures introduced via Articles 6 and 7 of the Taxonomy Regulation. Consequently, the Commission suggests that implementation deadline be delayed by six months to July 2022. However, given the amount of work required to comply with the detailed rules, it is important that firms continue to progress their current projects and timelines, not least because even more rules are on their way.

The Commission's new sustainable finance strategy is ambitious in both substance and timeline, although some commentators say it does not go far enough. The initiatives include ones previously heralded and new ones, and they will impact asset managers, investment funds and other regulated entities. The EU Taxonomy will expand to cover more activities and a social taxonomy is being written. Corporate reporting requirements will be extended to a wide range of listed and unlisted entities. Investors' fiduciary responsibilities and stewardship role will be clarified, and a draft EU Green Bond Standard has been issued. For more detail on these points and developments elsewhere, see here for the latest edition of KPMG's Regulatory Horizons.

ESMA and the EBA have published final joint Guidelines on harmonised criteria for the assessment of the suitability of members of the management body and key function holders, which will apply from end-2021. For asset managers, the Guidelines take into account the requirements under MiFID and the Investment Firms Directive and Regulation (IFD/IFR). They specify the notions of:

• Sufficient time commitment
• Adequate individual and collective knowledge, skills and experience
• Honesty, integrity and independence of mind (different to being independence) 
• Adequate human and financial resources for induction and training

These notions are irrespective of the size and operations of the firm. The Guidelines also cover diversity of the management body (age, gender, geographical provenance, and educational and professional background), the requirement for an individual to be identified as responsible for the firm's compliance with the Anti-Money Laundering Directive, and regular assessments of the management body. Any references to “risks” in the Guidelines should be read as including money laundering and terrorist financing risks, and environmental, social and governance (ESG) risk factors.

MMFs provide short-term funding to issuers and are used as cash management vehicles by investors. Policymakers are concerned that MMFs are subject to two broad types of vulnerabilities that can be mutually reinforcing: they are susceptible to sudden and disruptive redemptions, and they may face challenges in selling assets, particularly under stressed conditions. Market turmoil in March and April 2020 revealed systemic risks from MMFs invested in private sector debt securities, both low volatility net asset value (LVNAV) and variable net asset value (VNAV) MMFs. 

The Financial Stability Board (FSB) is consulting (PDF 1.2 MB)  on policy proposals to enhance the resilience MMFs, including with respect to the appropriate structure of the sector and of underlying short-term funding markets (STFMs). The report considers the likely effects of a broad range of policy options, by examining how these options would affect the behaviour of MMF investors, fund managers and sponsors, as well as the broader effects on STFMs, including through use of potential MMF substitutes. Options include:

• Swing pricing
• Minimum capital at risk ((MCR)
• Capital buffer
• Removal of ties between regulatory thresholds and imposition of fees and gates
• Removal of stable NAV MMFs
• Limits on eligible assets
• Additional liquidity requirements and escalation procedures

The ECB's response (PDF 134 KB) to ESMA's consultation on the framework for EU MMFs (see the April 2021 edition) notes that the current regulatory framework does not sufficiently consider risks stemming from the collective behaviour of these institutions and their impact on financial markets and the economy. In particular, “the regulatory framework is designed largely from an investor protection perspective and does not sufficiently ensure the system's resilience”. The ECB believes that the focus of reforms should be firmly on MMFs themselves. It suggests stricter portfolio requirements, removing the stable value of LNAVs, increased usability of liquidity buffers, swing pricing, improvements to stress testing and enhanced reporting.

The ESRB has also outlined (PDF 354 KB) potential reforms. It notes that, unlike in the US, there is a negligible share of direct retail investors in euro area MMFs. However, non-public debt MMFs have a large market footprint, overlapping portfolios and assets with low secondary market liquidity even in normal times. Therefore, MMFs can contribute to the spread and amplification of crises across sectors and countries. 

The ESRB will further consider the markets in which MMFs operate, MMF investors and MMFs themselves. Ahead of the review of the MMF Regulation in 2022, the ESRB will focus on policy options that would address vulnerabilities within MMFs themselves. The ESRB has identified three key desired outcomes of this work: removing first-mover advantages for investors; not limiting the proposals to LVNAV funds but considering the vulnerabilities of the entire sector; and ensuring the resilience and functioning of MMFs without the need for central banks to step in during crises. Possible policy options include:

• Asset-side: composition and concentration requirements, and enhancing the useability of liquidity buffers
• Liability-side: improved availability and use of swing pricing or anti-dilution levies, reforms to stable NAV MMFs, and introduction of notice periods, “hold-backs” or capital requirements
• Other: crisis preparedness requirements, better investor profiling to improve stress testing, use and activation of liquidity management tools by supervisors, clarifying current sponsor support restrictions, investigating the potential for privately-funded stabilisation mechanisms, and improving transparency and availability of market data

Meanwhile, ESMA has issued (PDF 632 KB)revised Guidelines on stress test scenarios for MMFs. The revisions provide new data points for liquidity discount factors, shocks to bond spreads and swap rates, and differentiated outflows from professional and retail investors. 

ESMA has issued (PDF 1.3 MB) its first report under the Regulation on facilitating cross-border distribution of funds (CBFD Regulation). ESMA found inconsistencies between member states on key aspects, with greater divergence in relation to AIFs than UCITS:  

• Many member states indicated that no national rules required the ex-ante or ex-post verification of marketing communications, or that such verifications were not part of their supervisory practice. 
• Only a few member states had adopted rules on a formal process for de-notification of funds previously notified for marketing in their jurisdiction, and there were diverging approaches, with the process relying mostly on informal exchanges and differing conditions. 
• There were diverging rules and practices as regards the obligation for UCITS management companies and AIFMs to appoint a local third-party to serve as a contact point in host Member States in order to carry out marketing activities.

ESMA also found that many additional requirements are imposed by Member States on the marketing of UCITS or AIFs in their jurisdictions:

• Certain member states have adopted national provisions on the basis of options set out in the UCITS Directive or AIFMD, particularly regarding language requirements for notifications of cross-border marketing or requiring fund prospectuses to be translated into a national official language, which ESMA says is contrary to the UCITS Directive. 
• As allowed by AIFMD, some Member States imposed additional rules for the marketing of AIFs to retail or “semi-professional” investors and of non-EU AIFs under a national private placement regime.
• Some NCAs highlighted divergences in areas not subject to EU provisions, such as imposing regulatory fees and charges relating to inwards or outwards cross-border marketing, or disclosure of information on sustainability-related aspects of the investment in marketing communications.

The above findings may be due in part to the fact that the deadline for transposing the CBFD Directive is not until 2 August 2021, but it is clear that ESMA and the NCAs have more work to do in ensuring consistency of approach.