Supervisory expectations of regulated financial services firms have steadily been increasing over the past decade or more.
In the wake of COVID-19, we are seeing a renewed emphasis on these expectations with consumer protection related concerns underpinning many of the requirements. At the same time, the growth of the investment funds industry continues to attract increasing regulatory focus arising from concerns relating to the potential impact on financial stability.
Leverage and liquidity are likely to continue to feature on the regulatory agenda over the coming months, with the Central Bank consultation on property funds representing one step towards increased macro-prudential regulation. Financial stability related concerns also informed the Central Bank’s focus on operational resilience and outsourcing, leading to the publication of its detailed cross-industry guidance in late 2021. Compliance with these guidelines will be a significant project for all regulated financial service providers in 2022.
Funds and their managers will focus on completing the mandatory disclosure templates under the Sustainable Finance Disclosure Regulation (“SFDR”) and the Taxonomy Regulation and engaging with the Central Bank on its planned thematic inspection in relation to SFDR / Taxonomy Regulation compliance. UCITS will be required to adapt to the PRIIPs KID requirements and there may be further developments relating to performance fees of UCITS and retail AIFs. We will continue to monitor the progress of the Commission’s proposed reforms of the AIFMD through the EU legislative process.
From a Capital Markets perspective, although COVID-19 is by no means a thing of the past, there are good reasons to hope that 2022 will allow us to return, in a sense, to “business as usual”. We expect that legislators and regulators will re-focus their attention on the European Commission’s flagship Capital Markets Union (“CMU”) project, the package of amendments to the Capital Requirements Directive and Regulation, the ongoing reviews of the Securitisation Regulation, Prospectus Regulation and MiFID, as well as on key trends such as the rise of ESG investing and the digitalisation of finance.
In this section, we will review a selection of the most recent pronouncements from the Central Bank and Irish and EU legislative proposals that will impact across the financial services sector, as well as a number of industry specific requirements.
Key Themes in Financial Services
Key Themes in Asset Management and Investment Funds
Following a busy end to 2021 driven by compliance with the Taxonomy Regulation Level 1 requirements, there will be further key developments and deadlines in the coming months under the EU's sustainable finance agenda.
Level 2 Requirements
It is expected that the final regulatory technical standards (“RTS”) under both the SFDR and the Taxonomy Regulation will be published in Q1 2022, providing the necessary detail and mandatory templates for fund managers to comply with their pre-contractual, periodic reporting and principal adverse impacts disclosure obligations. In November 2021, the Central Bank indicated that filings to comply with the RTS could be made at any point after 31 March 2022 and no later than 27 May 2022. Following the Central Bank statement, the application date for the RTS was delayed further from 1 July 2022 to 1 January 2023, so it may be the case that this filing deadline will be changed.
Thematic Review and Spot Checks
The Central Bank has confirmed its intention to carry out a thematic review later in 2022 of the implementation of the SFDR and the Taxonomy Regulation by fund management companies.
In the first half of this year, the Central Bank will undertake a spot-check of a sample of offering documents submitted as part of the fast-track filing to meet the 1 January 2022 Taxonomy Regulation deadline. These spot checks will include consideration of SFDR categorisations, sustainability risk disclosures and Taxonomy alignment disclosures.
The progress of the Corporate Sustainability Reporting Directive (“CSRD”) through the EU legislative process will be closely monitored by fund managers. The CSRD will revise and ultimately replace the Non-Financial Reporting Directive, extending sustainability reporting requirements to a far wider category of EU companies. These extended reporting obligations will assist fund managers in complying with their sustainability disclosure obligations, where funds under management invest in companies within the scope of the CSRD.
Minimum Sustainability Criteria
Under its Renewed Strategy for Sustainable Finance, the Commission is to consider the introduction of minimum sustainability criteria for Article 8 SFDR products. In November 2021, the Central Bank indicated its strong support for this initiative, which it believes is necessary to mitigate potential greenwashing risks. On 11 February 2022, ESMA published its Sustainable Finance Roadmap, in which it indicates its intent to contribute to the Commission’s planned work on minimum sustainability criteria, or a combination of criteria, for Article 8 SFDR products.
Preparing for PRIIPs
The application of the requirement to prepare a Key Information Document (“KID”) under the Packaged Retail and Insurance-based Investment Products (“PRIIPs”) Regulation to UCITS marketed to EEA retail investors has been delayed numerous times and will now apply from 1 January 2023.
UCITS managers must now prepare for the transition to the PRIIPS KID over the course of 2022. There are a number of significant differences between the UCITS Key Investor Information Document and the PRIIPs KID, which will necessitate the gathering of more data to meet the KID content and presentation requirements. These include the presentation of forward looking performance scenarios, different costs methodologies and more detailed costs disclosures.
More Change for Money Market Funds?
The Commission is required to review the Money Market Funds Regulation (“MMFR”) by 21 July 2022. In March 2021, ESMA launched a consultation on reforms to the MMFR, intended to assess the impact of the March 2020 market disruption on money market funds (“MMFs”). In addition to the feedback provided by ESMA, which is expected to be published shortly, the Commission’s review will also be informed by the European Systemic Risk Board (“ESRB”) policy recommendation aimed at increasing the resilience of money market funds, published on 25 January 2022, as well as the Financial Stability Board and the International Organisation of Securities Commissions work in this area.
One core objective of the CSA is the consistent and effective supervision of valuation methodologies, policies and procedures of supervised entities to ensure that less liquid assets are valued fairly during both normal and stressed market conditions, in line with applicable rules. The Central Bank will engage with fund managers during 2022, likely through industry questionnaires, desk-based reviews and potentially on-site inspections for a sub-set of fund managers.
Regulatory Focus on Costs and Fees to Continue
Following the CSA on costs and fees of UCITS in 2021, the Central Bank indicated in November 2021 that it would publish findings in relation to the CSA “in due course”. The CSA aimed to assess the compliance of supervised entities with the relevant cost-related provisions in the UCITS framework and the obligation to not charge undue costs to investors. Fund managers can expect further engagement with the Central Bank on this topic focused on implementing the CSA findings.
The Commission has indicated that it is likely to complete its review by the 21 July 2022 deadline and the Council and European Parliament will then consider the Commission’s reform proposals.
Valuation in the Regulatory Spotlight
On 20 January 2022, ESMA launched a common supervisory action (“CSA”) focusing on compliance of authorised UCITS and open-ended alternative investment funds (“AIFs”) with the valuation-related provisions in the UCITS and AIFMD frameworks, in particular in relation to the valuation of less liquid assets.
Getting Governance Right
In its Securities Markets Risk Outlook Report, the Central Bank has indicated that it will continue to focus on governance, following its thematic review of fund management company effectiveness in 2020 and the requirement for fund management companies to put action plans in place to address the findings of that review by the end of Q1 2021.
The Central Bank has also expressed concerns relating to the role of investment advisors appointed to a fund and situations where investment advisors may exercise more control and influence than is appropriate.
The Central Bank expects fund management companies to provide a detailed rationale for the appointment of an investment advisor and a clear description of the role the entity will fulfil. Reports from investment managers on portfolio management should include any interaction with investment advisors during the period in question.
Will crypto assets become eligible investments?
In the Securities Markets Risk Outlook Report, the Central Bank acknowledges that, while such assets may be suitable for wholesale or professional investors, it is highly unlikely to approve a UCITS or retail investor AIF proposing any exposure (direct or indirect) to crypto-assets.
This takes into account the specific risks attached to crypto-assets and the possibility that appropriate risk assessment could be difficult for a retail investor without a high degree of expertise.
In the case of a QIAIF seeking to gain exposure to crypto-assets, the relevant QIAIF will be required to make a submission to the Central Bank outlining how the risks associated with such exposures could be managed effectively by the AIFM.
The Central Bank will keep its approach to crypto-assets under review and will continue to be informed by European regulatory discussions on the topic. There will be further consideration of the Commission’s proposed Markets in Crypto Assets Regulation (“MiCA”) during 2022. This regulation is intended to create uniform rules for crypto-assets and related activities and services throughout the EU.
Key Themes in Finance and Capital Markets
Securitisation Regulation Under Review
The European Commission ("EC") launched a consultation on the Securitisation Regulation in July 2021 on various topics:
- addressing “capital non-neutrality” (i.e., the application of significantly higher capital requirements to securitised assets than to equivalent non-securitised assets);
- streamlining and harmonising the significant risk transfer ("SRT") process;
- improving the liquidity treatment of securitisations by aligning their treatment (for the purposes of banks’ liquidity coverage ratio) with that of covered bonds;
- making disclosure requirements more targeted, by amending the disclosure templates to remove disclosure requirements which are considered duplicative or of limited value to investors;
- disclosure of information; and
- environmental performance and sustainability.
The publication of the Commission's report, and the progress of any associated proposals to amend the Securitisation Regulation, will be closely followed by the European securitisation industry. Based on the discussions to date, any proposed amendments are likely to be largely welcomed by the industry.
The finalisation of the Basel III requirements will affect the capital treatment of securitisations through the standardised approach and will also affect securitisations under the internal ratings-based approach ("IRBA"), under which risk weights will increase. This will need to be factored into the discussion about the general review of the securitisation framework.
Sustainable Securitisation is on its way
The EBA Report on developing a specific sustainable securitisation framework for the purpose of integrating sustainability-related transparency requirements into the Securitisation Regulation and the forthcoming European Commission Sustainability Report on the creation of such a framework will be closely followed by the securitisation industry.
To date, we have seen substantial interest from investors and managers in ESG securitisations, particularly in the area of CLOs. Many managers have agreed to provide investors with transparency around the ESG characteristics of their portfolios on a voluntary basis. 2022 may be the year we see the emergence of a formal regulatory framework for such disclosures.
Article 45a of the Securitisation Regulation specifically states that the EBA Report should, where relevant, mirror or draw upon certain key provisions of the Sustainable Finance Disclosures Regulation (“SFDR”). Consistency between the sustainable securitisation framework and SFDR would be welcomed by market participants, who are already looking to SFDR as a source of standards for sustainability disclosure in some ESG securitisations.
Strengthening the resilience of the banking sector in relation to managing environmental, social and governance (“ESG”) risks is an important component of the Commission’s Sustainable Finance Strategy.
The Banking Package proposal will require banks to systematically identify, disclose and manage ESG risks as part of their risk management. Disclosure rules will be proportionate to size, so that smaller banks will not be unduly burdened.
The proposal provides specifically for:
- regular climate stress testing by both supervisors and banks;
- assessment of ESG risks as part of regular supervisory reviews; and
- all banks to disclose the degree to which they are exposed to ESG risks.
From 1 January 2023, newly issued transferable securities that are admitted to trading or traded on a trading venue will be required to be represented in book-entry form, either as immobilisation or subsequent to a direct issuance in dematerialised form.
From 1 January 2025, this requirement will apply to all in-scope transferable securities in issue on that date. While the requirements will not apply until 2023 at the earliest, issuers who may be affected will need to consider the impact of the requirements on their issuance processes.
As part of the ongoing wider review of MiFID II, the European Securities Markets Authority (“ESMA”) launched a consultation in September 2021 on the rules around transparency, focusing on technical issues relating to post-trade data, including the basis for any future consolidated tape.
This is part of a general approach to improving the information provided to investors and encouraging them to use the information in making their investment decisions. The EC will likely introduce proposals for amendments in 2022, particularly following the Wirecard case.
These will focus on:
- enhancing cooperation between authorities across the EU;
- enhancing coordination and governance on a national level;
- strengthening the independence of the NCAs; and
- strengthening harmonised supervision of information across the EU.
Mairead McGuinness, EU Commissioner responsible for Financial Services, Financial Stability and Capital Markets Union.
Key Risk and Regulatory Themes
The continued fall out from COVID-19 has resulted in resiliency, now and into the future, being placed high on the agenda of both businesses and regulators and the financial services sector has been no exception.
At an Irish regulatory level, we have seen operational resilience feature in several outputs of the Central Bank including its 2021 regulatory priorities, its Consumer Outlook Report for 2021, and several speeches made by its senior members. This culminated in the publication of the Central Bank’s Cross Industry Guidance on Operational Resilience on 1 December 2021.
The Guidance sets out the Central Bank’s expectations of firms in terms of implementing an effective operational resilience framework.
The 15 Guidelines are framed around three pillars of operational resilience:
- Identify and Prepare;
- Respond and Adapt; and
- Recover and Learn.
Firms are expected to apply the Guidance by 1 December 2023, at the latest. While this timetable provides firms with a good lead-in time, compliance will require participation and input from various functions within firms before substantial changes are made to documentation, processes and procedures.
Consequently, firms would be well advised to allocate resources to this, without delay. Firms should also be cognisant of the plans at a European level to put in place a comprehensive framework on digital operational resilience ("DORA").
Since the publication of the Central Bank’s Report on the Behaviour and Culture in Irish Retail Banks in July 2018, the financial services industry has awaited the formalisation of the Central Bank’s proposal for an Individual Accountability Framework (“IAF”) and the Senior Executive Accountability Regime (“SEAR”) (a key component of the IAF).
Some three and a half years on, the publication of the final text of The Central Bank (Individual Accountability Framework) Bill is still awaited, although classified as priority legislation in the government’s Spring Legislation Programme. We understand however, that the Joint Committee on Finance, Public Expenditure and Reform and An Taoiseach, which conducted pre-legislative scrutiny (“PLS”) of the General Scheme of the Bill on 3 and 10 November 2021, is in the process of finalising its report on the outcomes of the PLS. It is anticipated that the text of the Bill will follow shortly thereafter.
The Letter makes it clear that the Central Bank’s supervisory approach to this topic is informed by regulatory developments at EU level, the work of its peers and its broader supervisory objectives. Consequently, having an awareness of the direction of travel at a European level is also important for RFSPs. The letter explicitly states that these expectations will apply in a proportionate manner aligned with the nature, scale and complexity of RFSPs, something which will be welcomed, in particular, by smaller RFSPs.
The Letter details that the expectations are not binding on RFSPs. However, it is worth noting that this statement is made in the context of the expectations not replacing or overriding any legal, regulatory or supervisory requirements applicable to RFSPs.
Consequently, RFSPs would be advised to consider their current practices as against the identified areas of focus and begin to make proportionate changes.
Crowdfunding Regulation Timeline
13 December, 2021 Publication of the European Union (Crowdfunding) Regulations 2021 [S.I. No. 702 of 2021] (“Crowdfunding Regulations”) giving effect to the EU Crowdfunding Regulation (Regulation (EU) 2020/1503) in Ireland and designating the Central Bank as the competent authority responsible for the authorisation and supervision of crowdfunding service providers in Ireland.
5 January, 2022 Central Bank published its Guidance Note on Completing an Application Form for Authorisation as a Crowdfunding Service Provider which provides guidance in relation to the authorisation process and Central Bank’s requirements for establishing a CSP in Ireland. Of particular note are the Central Bank’s expectations of CSP’s post authorisation.
13 January, 2022 Central Bank published its feedback statement to its April 2021 consultation on Crowdfunding Marketing Requirements - CP141, along with an Addendum to the Consumer Protection Code 2021, extending rules on advertising for CSPs to ensure enhanced protection for investors in addition to ensuring that they are informed as to potential risks.
On 20 October 2021, the government published the General Scheme of the Insurance (Miscellaneous Provisions) Bill (“Insurance Bill”) and subsequently listed the Insurance Bill as priority legislation in its’ Spring Legislation Programme.
As the name suggests, the proposed legislation seeks to address a number of pertinent issues in the area of insurance, which align with the government’s promises in the area of insurance reform.
The proposed changes range from enhancements to data collection by the National Claims Information Database, proposals in respect of the practice of “price walking”, amendments to the Consumer Insurance Contracts Act 2019 (“CICA”) and changes to the temporary run off regime (“TRR”) established under the Brexit Omnibus legislation.
In particular, the proposals relating to the CICA and the TRR are welcome developments for the Insurance sector. The proposed amendments to the CICA will resolve certain technical issues that were identified post-enactment. While the TRR related amendments will ensure that third country reinsurers currently providing reinsurance cover in Ireland pursuant to the “Reinsurance Exemption” and entities in liquidation can legally run-off their existing business within the TRR framework.
During the Insurance Bill's PLS by the Joint Committee on Finance, Public Expenditure and Reform and Taoiseach on 16 December 2021, the Minister of State in the Department, Deputy Sean Fleming explained that he was hopeful that government would be in a position to publish the bill in the New Year. As at the time of writing, it has not yet been published.
Matheson Webinar: The SFDR, the EU Taxonomy and Investment Funds – Next Steps
Today, our Asset Management and Investment Funds Department hosted a webinar discussing the current status of the implementation of the Sustainable Finance Disclosure Regulation (“SFDR”) and the Taxonomy Regulation, providing analysis and insights to over 200 attendees on the ongoing issues and actions to be taken by fund managers preparing for the upcoming deadlines.
Our partners Tara Doyle and Philip Lovegrove, together with senior associate Anthony Gaskin and professional support lawyer Brónagh Maher, outlined some of the key developments to date, including the European Commission’s Q&A published in July 2021 in response to a number of queries raised by the European Supervisory Authorities (“ESAs”) and the implications of the delay to the application date of the detailed level 2 measures or regulatory technical standards (“RTS”), now expected to apply from 1 July 2022.
The panel also discussed the various approaches to complying with the next legislative deadline, that is, 1 January 2022, when fund managers will be required to disclose under the Taxonomy Level 1 requirements how and to what extent underlying investments are in economic activities that qualify as environmentally sustainable under the Taxonomy Regulation. Recent engagements, both at a European and domestic level, between industry and regulators were discussed, including the Central Bank of Ireland’s fast-track process for filings as set out in its document published today: “Process clarifications for UCITS and AIFs pre-contractual documentation updates in relation to the Taxonomy Regulation and Level 2 measures in relation to the Sustainable Finance Disclosure Regulation” (available here), which will require impacted funds to make the necessary filings with the Central Bank by 14 December 2021.
The panel discussion wrapped up with an overview of the key changes in the most recent draft RTS published by the ESAs on 22 October 2021.
If you would like to be invited to future Matheson webinars, you can subscribe to our various mailing lists here. If you would like to access a recording of the above webinar, please contact email@example.com.
To read more about these developments, please visit our Sustainable Finance page.