ESMA speech sheds light on future challenges for fund managers

On 19 November, Verena Ross, the Executive Director of ESMA, gave the keynote the keynote speech at AIMA's Global Policy and Regulatory Forum. In it, she set out her views on two key areas which ESMA sees as being the future challenges for fund managers - delegation in light of Brexit and sustainable finance (or ESG).

Key points from the speech include:

Delegation

• Ahead of Brexit,  ESMA has been working to identify trends in the behaviour of UK firms relocating to EU 27 member states and to raise NCA awareness on the associated risks - for example, that investment managers often make use of large-scale delegation arrangements and that Brexit will likely make delegation to non-EU entities more pronounced.

• In its letter to the Commission in the context of the AIFMD review, ESMA's intention was to ensure that the key legal requirements on delegation and substance are 'clear and unambiguous'.

• ESMA accepts that delegation can bring benefits and remains aware of how important delegation arrangements are for the fund industry.

• At the same time, it recognises that large-scale delegation arrangements bring increased operational complexities and supervisory risks.

• To ensure greater legal certainty, ESMA has invited the Commission to specify in more detail the AIFMD concept that delegated investment management functions must not exceed those retained by the authorised AIFM "by a substantial margin".

• ESMA's considers it important that entities that are authorised and supervised in the EU remain ultimately in charge of the key business functions and decisions.

• ESMA fully acknowledges that delegation is (and should remain) permitted under the AIFMD and UCITS rules - it is not seeking a complete overhaul of the AIFMD substance requirements but, rather, clarification of the existing legal text.

• ESMA's letter also emphasised the need to ensure that all AIFs are subject to consistent regulatory standards, irrespective of the regulatory status or location of the delegates, especially where delegation to non-EU entities might be subject to different regulatory standards.

• ESMA 'sees merit' in giving further consideration to this issue to ensure that AIF investors safeguards in the AIFMD are not lowered through inappropriate use of delegation arrangements.

Sustainable finance

• This is a strategic priority for ESMA, which is pursuing supervisory convergence of national practices, by organising exchanges on supervisory practices among NCAs (focussing recently, for example, on ESG funds' authorisations).

SFDR level 2 proposals - the ESAs' approach and feedback received

• The aim of the SFDR and of its underlying Level 2 technical standards, on which ESMA, the EBA and EIOPA have worked, is to combat green washing by ensuring that the increased demand for sustainable products is met by sound disclosures on how a given product achieves environmental or social characteristics.

• New rules requiring financial firms to disclose the principal adverse sustainability impacts of their investment decisions is 'a ground-breaking transparency initiative at European level'.

• It is, though, clear that the ESAS' proposals for an adverse impact reporting framework, in particular, generated significant reactions.

• The ESAs have taken note of the substantive feedback received (in particular with regard to data availability) and will revise the technical standards to take this into account.

• Stakeholders commented, especially, on the number and type of indicators proposed for principal adverse impact - unfortunately, there were widely varying suggestions as to which indicators to emphasise.

• On the separate survey on product templates, it is important to remember that the ESAs are trying to design a set of disclosures that must cover very different types of products and must be included in various underlying disclosure documents.

• This means striking a balance between comprehensibility and comprehensiveness of the disclosures.

Next steps - application of SFDR Level 2

• The ESAs' final report is due by the end of January 2021.

• Application of the SFDR Level 2 measures will be delayed, but the Level 1 obligations must be applied according to the original schedule starting from 10 March 2021.

• This is necessary because of the urgency of addressing climate change disclosures in the financial sector.

• ESMA appreciates the operational challenges of applying the provisions without the accompanying technical standards fully in place and hopes to be able to communicate shortly on the exact date of the application of the technical standards and on supervisory expectations in the "interim" period.

Next steps - new consultation

• The ESAs aim to consult in January 2021 on additional taxonomy-related product disclosures arising from the Taxonomy (or Framework) Regulation.

• This will seek feedback on proposed transparency rules for how taxonomy-related products must disclose their taxonomy alignment.