INVESTMENT SERVICES & CAPITAL MARKETS
ESMA warning on Artificial intelligence in securities markets
On 1 February 2023, ESMA published its TRV Risk Analysis Report on ‘Artificial intelligence in EU securities markets’ (the ‘Report’). In its Report, ESMA warns that a widespread use of artificial intelligence (AI) comes with risks. In particular, increased uptake may lead to the concentration of systems and models among a few ‘big players’. These circumstances warrant further attention and monitoring to continue ensuring that AI developments and the related potential risks are well understood and taken into account.
The key findings are:
- asset management: increasing number of managers leverage AI in investment strategies, risk management and compliance
- trading: traders, brokers and financial institutions use AI to optimise trade execution and post-trade processes
- elsewhere: some credit rating agencies, proxy advisory firms and other financial market participants also use AI tools, mostly to enhance information sourcing and data analysis
ESMA Report on Trends, Risks and Vulnerabilities
On 9 February 2023, ESMA published the first Trends, Risks and Vulnerabilities (TRV) Report of 2023. Overall, risks in ESMA’s remit remain high, and investors should be prepared for further market corrections.
- Overall risk assessment: Contagion and operational risks are considered very high, as are liquidity and market risks.
- Market environment: The tightening of financial conditions globally has weighed on economic activity, while inflation remains very high. Volatility in energy markets stayed elevated despite a general decline in prices.
- Securities markets: Equity prices were volatile in 2H22 with markets partially recovering 3Q22 losses based on news flow around relatively stable inflation and positive corporate earnings.
- Asset management: The EU fund sector has seen outflows and low performance across most fund types in 2H22, as assets under management experienced their sharpest decline since the Global Financial Crisis. Maturity mismatches in Commercial Real Estate Funds persist, and the impact of the UK Gilt market turmoil on leveraged Liability-Driven Investment Funds in 2H22 confirmed existing concerns over fund liquidity risk management and excessive leverage, as well as contagion risks given strong systemic interconnections.
- Consumers: Investor sentiment remains weak, against the backdrop of economic uncertainty. Inflation acts as a drag on real investment returns and contributes to falling household savings.
- Infrastructures and services: Central clearing volumes grew further, as margins collected by EU CCPs for interest rate and commodity derivatives rose with rises in prices and volatility in underlying instruments.
- Market-based finance: Capital market financing decreased sharply in 2022, turning negative for the first time since the Covid-19 related market stress in early 2020. The drop in activity is linked to high investor uncertainty, tighter credit standards for firms, high corporate debt levels and a rapid increase in the overall cost of external financing in the euro area.
- Sustainable finance: Net-zero pledges have come under growing scrutiny, with the energy crisis jeopardising decarbonisation objectives. More broadly, the focus on greenwashing has increased while investors increasingly appear to differentiate between products based on their sustainability credentials, as reflected in steady net flows into SFDR Article 9 funds.
- Crypto-assets and financial innovation: Crypto-asset valuations have now fallen by almost 70% year-on-year, driven by macro-economic factors and several high-level collapses in 2022.
Delegated Regulations extending temporary exemptions regime for intragroup contracts under EMIR
On 13 February 2023, two amending Delegated Regulations containing RTS that extend the temporary exemptions regime for intragroup contracts for three years under EMIR were published in the Official Journal.
The first Delegated Regulation 2023/314, amends the RTS laid down in the margin RTS as regards the date of application of certain risk management procedures for the exchange of collateral. It extends the deferred date of application of the margin requirements for intragroup transactions set in the margin RTS to 30 June 2025.
The second Delegated Regulation 2023/315 amends the RTS laid down in Delegated Regulations (EU) 2015/2205, (EU) No 2016/592 and (EU) 2016/1178 as regards the date at which the clearing obligation takes effect for certain types of contracts. Again, it extends the deferred date of application of the clearing obligation for intragroup transactions set out in the three Delegated Regulations to 30 June 2025.
Both Delegated Regulations entered into force on 14 February 2023.
Central Securities Depositaries
ESMA assesses supervision of Central Securities Depositaries
On 15 February 2023, ESMA published its Peer Review Report on the supervision of Central Securities Depositories (CSDs) providing cross-border services or participating in interoperable links.
The peer review assessed six National Competent Authorities (NCAs) in respect of how they supervise CSDs, which make use of the freedom to provide services in another Member State.
The exercise included onsite visits to the CSSF (Luxembourg), FKTK (Latvia) and NBB (Belgium) to gain a deeper understanding of how these NCAs supervise the cross-border activities of CSDs.
The key findings are that:
- NCAs generally have satisfactory initial authorisation processes using adequate tools and procedures to assess the cross-border links.
- There is room for improvement in some NCAs’ approval processes during passporting procedures when acting in their capacity as host authority.
- NCAs should consider improving cooperation between them, notably with the home authorities of the CSDs which provide services in their jurisdiction.
- Overall, NCAs conduct ongoing supervision of CSDs in a holistic way considering the entire organisation without distinguishing between domestic and cross-border services.
- NCAs supervisory approaches should follow a risk-based approach and rely on adequate tools to monitor risks.
ESMA expects to carry out a follow-up assessment in two years to review the level of improvements achieved based on the findings and recommendations of this peer review.
AIFs and UCITS
ECON report on proposed amendments to the AIFMD and UCITS Directive
On 7 February 2023, the European Parliament’s Economic and Monetary Affairs Committee (ECON) published a report (dated 2 February 2023) stating it has adopted the European Commission’s legislative proposal for a directive amending the AIFMD and the UCITS Directive as regards delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services and loan origination by alternative investment funds. The report includes a draft European Parliament legislative resolution which sets out suggested amendments to the proposed directive.
Money market funds
ESMA report finds EU Money Market Funds market at close to €1.5 trillion
On 8 February 2023, ESMA published its inaugural market report on European Union (EU) Money Market Funds (MMF). With this report ESMA provides for the first time a comprehensive market level view of EU MMFs, based on supervisory information collected by National Competent Authorities (NCAs) and ESMA.
The main findings included in the report are:
- EU MMF sector: The EU MMF sector had €1.44tn of assets in 2021, with 89% of the funds domiciled in France, Luxembourg and Ireland.
- Sector breakdown: Low-volatility NAV (LVNAV) MMFs account for 46% of the total assets, followed by Variable NAV (VNAV) MMFs (42%) and Constant NAV (CNAV) MMFs (12%). All MMFs domiciled in France are of the VNAV type and almost exclusively denominated in EUR. MMFs in Luxembourg and Ireland are mainly in non-EU currencies and set up mostly as CNAVs and LVNAVs. MMFs authorised in other EU jurisdictions are VNAVs denominated in other EU domestic currencies and account only for a small fraction of assets.
- Asset allocation: The portfolio structure of EU MMFs remains relatively stable over time, and they are mainly exposed to the financial sector. Between March 2020 and June 2022, average exposures to credit institutions amount to 60% of total assets. Most of the EU MMFs’ government debt exposure is towards non-EU sovereigns, and during March to December 2020 LVNAVs increased their share of government bonds before starting a slow readjustment back to the pre-COVID composition.
- Liquid assets and risk sensitivity: The share of daily and weekly liquid assets remained above the regulatory minimum and increased for CNAVs at a regular pace starting in 3Q20. As of 3Q21, EU MMFs have significantly reduced the interest rate risk sensitivity of their portfolios, measured as the weighted average maturity of assets (WAM), to improve resilience to a rate rise.
- Ownership and liabilities: Professional investors hold more than 90% of EU MMFs. Financial corporations are the main unitholders of MMF shares, with insurance firms, pension funds and banks accounting together for 25% of NAV and other financial institutions, including collective investment undertakings, for 45% of the NAV. Between December 2021 and March 2022 MMFs experienced substantial outflows, partially driven by investor expectations linked to the increase in interest rates and a turning investor sentiment away from fixed income instruments in general, a trend that reversed later in 2022.
In its opinion on 14 February 2022, ESMA proposed that the European Commission should consider a number of changes to the MMF Regulation, intended to make MMFs more resilient. ESMA has also highlighted the importance of having these changes to the MMF Regulation implemented speedily.
Furthermore, ESMA will continue to monitor and analyse the risks in the MMF sector.
European Long-Term Investment Funds (ELTIFs)
Council of EU publishes text of proposed ELTIF Amending Regulation
On 22 February 2023, the Council of the EU published the text of the proposed Regulation amending the Regulation as regards the requirements pertaining to the investment policies and operating conditions of European long-term investment funds and the scope of eligible investment assets, the portfolio composition and diversification requirements and the borrowing of cash and other fund rules (ELTIF Regulation).
The Council states in an information note that it should now be in a position to approve the text, which also reflects the European Parliament’s position.
The Council is expected to adopt the Amending Regulation on 7 March 2023.
Green loans and mortgages
EBA seeks input from credit institutions on green loans and mortgages
On 13 February 2023, the European Banking Authority announced that it had launched an industry survey to receive input from credit institutions on their green loans and mortgages, as well as market practices related to these loans.
The purpose of the survey is to collect both quantitative and qualitative information that the EBA can use to advise the European Commission. The work is part of the Commission’s strategy for financing the transition to a sustainable economy. Institutions that would like to take part in the survey need to contact their national competent authority to receive the survey templates as well as information on the process. The deadline for comments is 7 April 2023.
Sustainable Finance Disclosure Regulation
Delegated Regulation incorporating nuclear and gas disclosures into SFDR RTS published
On 17 February 2023, Delegated Regulation (EU) 2023/363 (the ‘Delegated Regulation’) was published in the Official Journal.
The Delegated Regulation amends and corrects the SFDR RTS set out in Delegated Regulation (EU) 2022/1288 as regards the content and presentation of information in relation to disclosures in pre-contractual documents and periodic reports for financial products investing in environmentally sustainable economic activities.
The Delegated Regulation:
(i) incorporates nuclear and gas disclosures into the SFDR RTS;
(ii) clarifies the applicability of Article 6 of the SFDR; and
(iii) corrects errors in the cross-references in the periodic disclosures.
It entered into force on 20 February 2023, three days after its publication in the Official Journal.
Circular C549: Deprioritisation of supervisory actions on the obligation to publish RTS 27 reports after 28 February 2023 in light of the ongoing legislative procedure on the MiFID II/MiFIR review
On 2 February 2023, the Cyprus Securities and Exchange Commission (“CySEC”), issued Circular C549 to inform all Cyprus Investment Firms on its supervisory actions regarding the RTS 27 reporting obligation.
In particular, CySEC notes that the amending Law 9(I)/2022 (the amending Law, available only in Greek), which transposed the EU Directive 2021/338 into the Cypriot Law, temporarily suspended the periodic reporting obligation to the public (the so-called RTS 27 reports) on execution venues in Article 28(3) of the CIF Law until 28 February 2023.
On 25 November 2021, the European Commission published its legislative proposal on the review of the MiFID II/MiFIR, which includes a proposal to delete the RTS 27 reporting obligation. The said proposal is currently subject to a legislative procedure by the European Parliament and the Council of the EU which is unlikely to be concluded by 28 February 2023.
Following the above, ESMA issued a Public Statement dated 14 December 2022. In the said Statement, ESMA announced that it expects NCAs not to prioritise their supervisory actions towards execution venues on the obligation to publish RTS 27 reports after 28 February 2023 in the light of the ongoing legislative procedure on the MiFID II/MiFIR review.
In this regard, CySEC informs the Regulated Entities that it adopts ESMA’s approach on the relevant matter. In other words, the reporting obligation will begin to reapply from 01 March 2023 (until further notice is given). However, CySEC will deprioritise its supervisory actions relating to the periodic reporting obligation on them to publish the RTS 27 reports.
Circular C548: Guidance on Liquidity Risk Management (“LRM”)
On 10 February 2023, CySEC, issued Circular C548 through which it provides UCITS and AIFs with guidance aimed at assisting them to ensure compliance with their LRM obligations. The guidance additionally aims to mitigate supervisory risks in LRM, to further protect investors, maintain market integrity and reduce systemic risk. The guidance concerns topics such as due diligence in the selection of investments, ongoing monitoring of liquidity risk, information to investors on liquidity risk, and others.