Asset Management and Investment Funds Legal and Regulatory Update November 2019
Welcome to the November edition of our Asset Management and Investment Funds Legal and Regulatory Update.
We hope you find this bulletin of recent developments helpful and if you would like to discuss any of the topics covered this month, please feel free to contact a member of our team.
Funds Supervision: What to Expect in 2020
Recent industry addresses* by the Central Bank have given an indication of what funds and fund management companies can expect will feature on the Central Bank’s regulatory and supervisory agenda throughout 2020. Broadly speaking, the Central Bank’s priorities for funds and fund management companies will build upon its previous supervisory work in the areas of fund governance and investor protection, while also taking account of risk and operational matters and evolving regulatory developments. Separately, ESMA has also published its supervisory work programme for 2020 with fund liquidity, closet-indexing, and fees and costs remaining on its agenda.
Some key supervisory and regulatory topics for funds and fund management companies to consider include:
CP 86 Reviews
The Central Bank intends to complete its CP86 reviews during the first half of 2020, which could result in further consultations and the issuance of an industry letter outlining good or poor practices (as well as individual risk mitigation programmes). Onsite inspections of selected fund management companies will be conducted between Q4 2019 and Q1 2020.
Focus on disclosure in fund documentation
A key focus for the Central Bank is clarity for investors in both KIIDs and prospectuses. This is evidenced by the Central Bank’s ongoing work on closet-indexing and performance fees. Following its closet-indexing review, the Central Bank expects funds and fund management companies to review and revise their prospectuses and KIIDs in line with its industry letter of 18 July 2019. The Central Bank requires these updates to be submitted by 30 March 2020, but it is recommended that any necessary updates are provided to coincide with the annual KIID update due February 2020.
Costs and Fees
The Central Bank completed its review of closet-indexing earlier this year and is in the process of engaging with identified funds on a case-by-case basis. ESMA will also continue its work on investment fund fees and costs, which will include continuing co-ordination of national regulators’ work in the area of closet-indexing. It will also include ensuring supervisory convergence in relation to the different practices across national regulators regarding performance fee structures and the circumstances in which performance fees can be paid.
The Central Bank will be continuing its work on monitoring investment fund liquidity, which it first began in January 2019 (as part of its overall Brexit preparedness work). In an industry communication issued 7 August 2019, the Central Bank highlighted the importance of liquidity risk management and liquidity stress testing emphasising that the responsibility for liquidity risk management, which includes compliance with all legal and regulatory obligations in respect of the liquidity of each fund under management, rests with the boards of investment funds and fund management companies, individual directors and the relevant designated persons. Fund documentation should be clear, accurate and consistent with legal and regulatory requirements.
ESMA has stated that a specific area of focus for it will be liquidity management in UCITS in order to assess whether there might be a mismatch between the redemption policies and liquidity profiles of some UCITS that may indicate non-compliance with the UCITS rules. In its industry communication, the Central Bank noted that the board, relevant director and designated persons, must on an ongoing basis, assess the liquidity position of each fund under management to ensure that the liquidity of the investment portfolio remains in line with that fund’s redemption policy, taking into account investors’ redemption demands.
In the context of Brexit, the Central Bank expects funds’ ongoing liquidity management to be sufficiently sensitive to market developments around Brexit and to ensure that the necessary resources, systems and governance processes are in place.
The Central Bank will also be looking in more detail at the management and use of leverage in investment funds.
Cyber-security and IT Risk
Following a thematic inspection (using a cohort of four asset management firms) to determine the adequacy of cyber-security risk management, controls and practices, the Central Bank will be issuing an industry letter, which all firms must review and, where required, take steps to remediate any identified issues or weaknesses in their cyber-security risk management practices. Fund boards and fund management companies should be ensuring that there is adequate governance and oversight of cyber-security.
The results of a themed inspection which the Central Bank conducted across both fund service providers and MiFID firms found that boards and senior management did not spend enough time reviewing control frameworks and that the risk framework document, which firms are required to have in place, was not always kept up to date. The Central Bank expects boards to ensure that control frameworks are kept up to date and that the risk framework document is reviewed at least annually. The risk framework document must reflect the particular firm’s risk environment and clearly set out how risks will be managed in line with the firm’s risk appetite. The Central Bank expects to publish an industry letter in this regard over the coming months and, once issued, all firms should review this letter and consider any necessary remedial actions.
The EU’s legislative proposals relating to sustainable finance, which aim to integrate sustainability and ESG considerations into the investment and advisory process could apply from Q4 2020. Additionally, ESMA has provided technical advice to the European Commission on the integration of sustainability risks and factors into AIFMD and the UCITS and MiFID II Directives. The Central Bank has formed a dedicated working group to keep track of these legislative developments and to develop its own policy perspectives regarding sustainable finance. Funds and fund management companies should ensure that they are aware of these legislative proposals, particularly as regards the enhanced transparency, disclosure and operational requirements that they introduce.
* Our Regulatory Philosophy and Priorities in Funds (15 October 2019) – Colm Kincaid – Director of Securities and Markets Supervision.
INEDs – The spirit of challenge and responsibility (7 October 2019) – Michael Hodson, Director of Asset Management and Investment Banking.
AML Update: Central Register Filings and TCSP “Dear CEO” Letter
Relevant corporate entities, (including investment funds established as companies), must deliver beneficial ownership information to the Registrar of Companies and Industrial and Provident Societies (the “Registrar”) for inclusion on the Central Register of Beneficial Ownership of Companies and Industrial and Provident Societies by 22 November 2019.
In addition to collecting the name, date of birth, nationality, residential address and the nature and extent of the interest held in respect of beneficial owners, the PPS number of that beneficial owner (if they have one) must also be collected. This is required to verify identity. For beneficial owners who do not already have a PPS number, for example non-Irish resident directors who have not registered for Irish tax, a Form BEN2 (Declaration as to Verification of Identity) will be the method to be used to verify the person’s identity. Only one Form BEN2 will be required in respect of each beneficial owner and once this has been processed successfully and an RBO transaction number issued by the Registrar, that number can be used for making future beneficial ownership filings for that person.
Further information on the Form BEN2 and the filing process is available on the RBO website.
For more information, please see our previous update.
Central Bank’s “Dear CEO” Letter to TCSPs
The Central Bank has issued a “Dear CEO” letter to trust/company service providers highlighting its findings arising from its on-site inspections of those firms regarding board oversight, risk assessments, and policies and procedures. The letter also sets out the steps that such firms should take to ensure that they meet the Central Bank’s expectations in those areas.
EMIR: ESMA Clarifies Calculation Dates and Publishes Data Reporting Review
EMIR REFIT Calculation Dates
EMIR Refit entered into force on 28 May 2019 and applied from 17 June 2019. It amended the existing EMIR Regulation, which regulates OTC derivatives and applies to both financial counterparties (“FC”) (which includes investment funds, AIFMs, and UCITS Management Companies) and non-financial counterparties (including SPVs).
EMIR Refit sets out certain calculation and notification obligations for FCs, regarding the EMIR clearing obligation. Under EMIR, an FC is subject to the clearing obligation in respect of all OTC derivative contracts, irrespective of their aggregate value. EMIR Refit introduced a new category of small financial counterparty (“SFC”), which is exempt from the clearing obligation. To be classified as an SFC and benefit from the clearing exemption, FCs must calculate their OTC positions and if they come within the specified clearing thresholds (set out per asset class) then they are exempt from the clearing obligation. If the thresholds are exceeded, FCs must notify both ESMA and their national regulator (in Ireland the Central Bank).
Therefore, on 17 June 2019 (the date EMIR Refit entered into force) there was a requirement for all FCs that had previously taken positions in OTC derivatives contracts to perform the necessary calculations to determine if any of the clearing thresholds had been met. As the calculations are to be done annually, FCs should repeat such calculations on the same date in 2020.
However, there was some ambiguity regarding the timings of these calculations where FCs only began to take derivative positions after 17 June 2019. ESMA has clarified in an EMIR Q&A update that the annual calculation of the aggregate month-end average position should be on the 12 month anniversary of the date on which the FC first started taking positions in OTC derivatives contracts. On that day, those funds that exceed the clearing thresholds or choose not to calculate their positions will have to notify ESMA and the Central Bank immediately.
For more information, please see our more detailed briefing.
EMIR Data Reporting Review
ESMA has published the results of a peer review it conducted on the supervisory actions of six national regulators, including the Central Bank, regarding their approaches to enhancing the quality of EMIR data reporting. The peer review assessed how the six regulators supervised data quality under EMIR in the following areas:
- supervisory approach to EMIR data quality;
- integration of EMIR data within the regulator’s overall supervisory approach; and
- regulators’ access, assessment and analysis of EMIR data quality.
The results of the peer review indicate that the Central Bank fully met the peer review’s expectation as regards the integration of EMIR into its overall supervisory approach. However, there were some suggested enhancements to the Central Bank’s regime, including in respect of:
- exhibiting a more assertive approach to taking enforcement or administrative action against counterparties who mis-report;
- the monitoring of consistency and timeliness of reporting and the detection of cases of duplicated reporting.
The Central Bank’s industry letter on EMIR reporting (February 2019) was highlighted as an example of good practices identified by the peer review.
In light of the further delay to Brexit, the FCA has published a statement noting that it will be extending the date by which firms and funds should notify it of entry into the temporary permissions regime to 30 January 2020. Fund managers will have until 15 January 2020 to inform the FCA if they want to make changes to their existing notification.
ESMA has also issued a statement noting that the date for Brexit in all of ESMA’s previously published measures and actions, including public statements, issued regarding the possibility of a no-deal Brexit scenario, should now be read as 31 January 2020.
Fitness and Probity Applications
The Central Bank has issued a prohibition notice barring the recipient (who was executive director of a money-lender) from performing any controlled function (“CF”) or pre-approval controlled function (“PCF”) role in relation to any regulated financial service provider for two years, on the basis that he provided “false and misleading” information to the Central Bank regarding the circumstances under which his former employment had ceased when he made an application for a PCF position. This decision highlights the importance of providing full and honest applications to the Central Bank, with the Director of Enforcement and Anti-Money Laundering stating that in the performance of its gatekeeper role, the Central Bank:
“is entitled to expect and insist on absolute candour and honesty from applicants. Full disclosure at application stage is required in order that the Central Bank can properly assess the fitness and probity of individuals before they are approved.”
Central Bank Fines Firm for Breaching Authorisation Conditions
On 21 October 2019, the Central Bank fined BVP Investments (the “Firm”) €6,000 and reprimanded it for breaching the conditions of its authorisation by holding client assets. The Central Bank found that at various times over the course of almost 12 years the Firm held client assets and also, on occasion, client financial instruments in breach of its authorisation conditions. The Central Bank noted that as a result of this breach, significant amounts of client funds were co-mingled with the Firm’s own funds in its bank accounts. The aggregate amount of client funds held by the Firm over the duration of the breach was almost €16 million, with the highest amount at any one time being over €1.5 million.
Commenting on the enforcement action, the Central Bank’s Director of Enforcement and Anti-Money Laundering said that:
“Compliance with conditions of authorisation is not optional. The Central Bank requires all regulated financial service providers to ensure that they are, at all times, in compliance with their authorisation in the conduct of their business. Failure to do so will result in robust action by the Central Bank, including investigation and enforcement action.”
The Firm was authorised under the Investment Intermediaries Act 1995 to provide services to Designated Investment Funds i.e. the promotion and administration of funds for investments under Revenue’s Employment and Investment Incentives and BES Schemes.
Consultation on Proposed Amendments to KID
The Joint Committee of the European Supervisory Authorities (“ESAs”) has published a consultation on proposed amendments to the PRIIPs KID. The proposed amendments relate to: performance scenarios; investment costs; multi-option products; and some proposed amendments to allow the requirements to be applied to UCITS that are expected to have to prepare a KID from 1 January 2022 onwards. The consultation will close on 13 January 2020, and the Joint Committee plans to submit its final proposals to the European Commission in Q1 2020.
Supervisory Statement re Application of PRIIPs Regulation to Bonds
The ESAs have also issued (24 October) a Supervisory Statement in order to promote a consistent application by national regulators of the scope of the PRIIPs Regulation to bond markets. The statement responds to uncertainty as to the scope of the PRIIPs Regulation and national regulators are recommended to apply the supervisory guidance included in the statement.
ESMA Q&A Updates
Recent ESMA Q&A Updates of interest include:
- EMIR Q&A: The updated Q&A clarify:
- the timings for the annual calculations under EMIR REFIT;
- whether counterparties not subject to the clearing obligation should also obtain representation from their counterparties as to their status. (Such counterparties are not required to obtain this representation);
- how a counterparty should determine whether an entity established in a third country would be an FC+/- or NFC+/- if it was established in the EU;
- how the derivatives should be reported in the scenario where a Clearing Member defaults and a CCP temporarily assumes both sides of the outstanding transactions;
- how to populate the fields Trading Venue and Compression for derivatives reported at position level; and
- how to report derivatives based on €STR and other benchmarks that are not explicitly captured by the EMIR ITS.
- MiFID II/MiFIR: Investor Protection Issues
- MiFID II/MiFIR: Transparency and Market Structures Issues: The updated Q&A for transparency issues clarifies that for ETFs there is only one average daily turnover band from which to choose the highest threshold to be used to calculate the average value of transactions.