INVESTMENT SERVICES & CAPITAL MARKETS
European Commission adopts Delegated Regulation correcting MiFID II Delegated Regulation
On 21 April 2021, the European Commission adopted a Delegated Regulation (Amending Delegated Regulation) correcting Delegated Regulation (EU) 2017/565, which supplements MiFID II as regards organisational requirements and operating conditions for investment firms and defined terms.
To be fully compliant with MiFID II, the Amending Delegated Regulation corrects: (i) Article 1 paragraph 1 to clarify that it requires the application of Article 64(4), Article 65 and Chapter VIII of that Regulation instead of Article 59(4), Article 60 and Chapter IV; and (ii) errors that appeared in several cross-references in the Annex I, more precisely under ‘Client assessment’, ‘Order handling’, ‘Client order and transactions’, ‘Reporting to clients’, ‘Communication with clients’ and ‘Organisational requirements’. The Council of the European Union and the European Parliament will consider the draft Amending Delegated Regulation. If neither the Council nor the EP object, it will be published in Official Journal and will enter into force on the twentieth day following that of its publication.
ESMA final report on SME growth markets under MiFID II
On 7 April 2021, ESMA published its final report on the functioning of the regime for SME Growth Markets (GM) under MiFID/MiFIR, which contains recommendations and possible amendments to the MiFID II framework to the SME GM regime which are needed to improve the attractiveness of the regime.
The report suggests that the SME GMs regime in the EU, as it stands, has been relatively successful, with 17 multilateral trading facilities registering as SME GMs to date. ESMA’s proposals include:
- that the European Commission take into account a potential harmonisation of requirements for SME issuers in the context of the discussion on the establishment of the European Single Access Point;
- an amendment of Article 78(2)(h) of Delegated Regulation (EU) 2017/565 in order to require firms to make financial reports in the year prior to admission to trading public where available, which could help investors to retrieve helpful information; and
- to extend the issuer non-objection requirement in the first part of Article 33(7) of MiFID II concerning the admission to trading of an instrument already admitted on SME GMs to any trading venue. ESMA believes that such extension would be beneficial in reducing the risks of fragmentation of liquidity.
ESMA has submitted the report to the European Commission and the European Commission is expected to take it into consideration for further legislative proposals on the MiFID II SME GM regime.
ESMA updates MiFID II and MiFIR Q&A on market structures issues
On 6 April, ESMA updated its Q&A on market structures topics under MiFID II and MiFIR. ESMA has introduced changes to one of its Q&A on tick sizes to reflect the amendment introduced in Article 49(1) of MiFID II which excludes Large in Scale transactions from the mandatory tick size regime.
ESMA publishes data for the systematic internaliser calculations for equity, equity-like instruments, bonds and other non-equity instruments
On 30 April 2021, ESMA published data for the systematic internaliser quarterly calculations for equity, equity-like instruments, bonds and for other non-equity instruments under the Markets in Financial Instruments Directive (MiFID II) and Regulation (MiFIR).
ESMA publishes results of the annual transparency calculations for non-equity instruments
On 30 April 2021, ESMA published the results of the annual transparency calculations for non-equity instruments, which will apply from 1 June 2021. These calculations include the liquidity assessment and the determination of the pre- and post-trade size specific to the instruments and large in scale thresholds.
ESMA makes new bond liquidity data available
On 30 April 2021, ESMA published new data for bonds subject to the pre- and post-trade requirements of MiFID II and MiFIR through its data register. ESMA published the latest quarterly liquidity assessment for bonds available for trading on EU trading venues. For this period, there are currently 651 liquid bonds subject to MiFID II transparency requirements.
ESMA issues latest double volume cap data
On 30 April 2021, ESMA updated its public register with the latest set of double volume cap (DVC) data under MiFID II.
European Commission report on whether trades that directly result from post-trade risk reduction services should be exempted from the clearing obligation for OTC derivatives under EMIR
On 12 April 2021, the European Commission published a report to the European Parliament and the Council of the EU on whether trades that directly result from post-trade risk reduction services should be exempted from the clearing obligation for OTC derivatives under EMIR.
The report explains that Article 85(3)(c) of EMIR mandates the European Commission to report to the European Parliament and the Council on whether trades that directly result from post-trade risk reduction services (PTRR services), including portfolio compression, should be exempt from the clearing obligation referred to in Article 4(1) of EMIR.
Specifically, Article 85(3)(c) requires the European Commission to take into account the three following aspects, namely: (i) the extent to which PTRR services mitigate risk, in particular counterparty credit risk and operational risk; (ii) the potential for circumvention of the clearing obligation if an exemption was to be granted; and (iii) the potential disincentive to central clearing if an exemption was to be granted.
Securities Financing Transactions Regulation (SFTR)
ESMA updates statement on the implementation of Legal Entity Identifier requirements for third-country issuers under the SFTR reporting regime
On 13 April 2021, ESMA updated its statement on the implementation of Legal Entity Identifier (LEI) requirements for third-country issuers under the SFTR reporting regime.
The updated LEI statement maintains ESMA position as described in its original statement that was published on 6 January 2020 and provides an extended timeline for the reporting of LEIs of third-country issuers of securities used in securities financing transactions until 10 October 2022. The updated statement also sets out the expectations towards Trade Repositories and counterparties, as well as the relevant supervisory actions to be carried out by authorities.
ESMA updates SFTR Q&A on data reporting
On 23 March 202, ESMA updated its Q&A on SFTR data reporting to simplify the reporting of securities financing transactions when an external portfolio manager is used. The update complements ESMA’s guidance on reporting under SFTR.
EMIR and SFTR
ESMA final report highlights need for increased efforts on EMIR and SFTR data quality
On 15 April 2021, ESMA published its final report on EMIR and SFTR data quality. The report covers the progress made to date in improving EMIR data quality for regulatory and supervisory use and concludes that, while good progress has been made, additional efforts are needed by national competent authorities (NCAs) and ESMA to further improve EMIR data quality. The report is the first review of data quality since the introduction of the EMIR and SFTR reporting regimes. It also reviews the quality of data reported by trade repositories and gives an overview of actions taken by both ESMA and the NCAs to improve data quality.
ESMA Board of Supervisors’ conclusions including views exchanged with the UK Financial Conduct Authority (FCA)
On 9 April 2021, ESMA published a summary of conclusions of the meeting of its Board of Supervisors on 23 February 2021. The conclusions include minutes of an exchange of views with Nikhil Rathi (CEO of the FCA) on the future cooperation between the FCA and ESMA. In particular, views were exchanged on the: (i) importance of international standards and their consistent application; (ii) EU’s and the UK’s commitment to promoting sustainable finance; (iii) status of the amendments to the Packaged Retail and Insurance-based Investment Products Regulation and its implementing acts; and (iv) Swiss LIBOR.
The Board agreed to undertake a similar dialogue twice a year.
ESMA annual report – Retail clients continue to lose out due to high investment products costs
On 14 April 2021, ESMA published its third annual statistical report on the cost and performance of European Union retail investment products.
In the report ESMA finds that the costs of investing in key financial products, such as UCITS funds, retail alternative funds, and structured investment products (SRPs) remain high and diminish the investment outcome for final investors.
Clear and understandable information about the impact of costs on the returns that retail investors can expect to receive is key to allowing investors to make informed investment decisions. Ensuring this information is made available is a key element in meeting ESMA’s investor protection objective.
The main findings in the report are the following:
- Fund costs: UCITS costs only marginally declined over time. For one-year investments they were 1.4% in 2019 compared to 1.5% in 2018 on average across asset classes;
- Volatile returns: Average gross UCITS fund performance depends on market developments and varies significantly over time. It amounted to 7.7% in 2019, while it reached no more than +0.2% in 2018 for a one-year investment. The market impact of COVID-19 falls outside the reporting period;
- Retail investors: Retail clients pay on average around 40% more than institutional investors across asset classes. A ten-year investment of EUR 10,000 in a portfolio composed of equity, bond and mixed funds led to a gross value of around EUR 21,800 and EUR 18,600 after costs. Around EUR 3,200 in costs were paid by the investor;
- Risks: Higher risk exposures entailed higher costs irrespective of the asset class;
- Active and passive funds: The evidence on cost structure showed that costs were higher for active equity and bond UCITS compared to passive and UCITS ETFs, ultimately implying net underperformance of active equity and bond UCITS, on average, compared to passive and UCITS ETFs. Top-25% active equity UCITS overperformed compared to the top-25% passive and related benchmarks, at shorter horizons. However, the cohort of UCITS changes over time making it complicated for investors to consistently identify outperforming UCITS;
- ESG funds: ESG outperformed non-ESG equity UCITS mostly due to sectoral factors. According to the evidence, actively managed ESG funds showed lower costs than non-ESG, not supporting the view that there is systematic greenwashing by ESG funds;
- Retail AIFs: Retail AIFs, similar to UCITS, showed high return volatility. While being negative in 2018, gross annualised returns in 2019 were 12% for Fund of Funds (FoFs) and 9% for the residual category “Others” that includes investment primarily focused on equity and bonds. Net returns confirm what has been observed for gross returns, being 11% for FoFs and 7% for Others;
- SRPs: The analysis on costs and performance scenarios for SRPs showed that total costs were largely attributable to entry costs and varied substantially by country and payoff type. Moreover, there was little difference in simulated returns between moderate and favourable performance scenarios; and
- Transparency: There is limited comparability across Member States. Heterogeneity and data availability issues persisted, as well as lack of harmonisation in national regulation.
This report aims at facilitating increased participation of retail investors in capital markets by providing consistent EU-wide information on cost and performance of retail investment products. It also demonstrates the relevance of disclosure of costs to investors, as required by the MiFID II, UCITS and PRIIPs rules and the need for asset managers and investment firms to act in the best interest of investors, as laid down in MiFID II, and the UCITS and AIFM Directives.
Alternative investment funds
ESMA report highlights liquidity concerns for alternative investment funds
On 8 April 2021, ESMA its third annual statistical report on the Alternative Investment Fund (AIF) sector. The report has found that the sector increased by 15% in 2019 to EUR 6.8trn in net assets from EUR 5.9trn in 2018.
The main risks faced by the sector relate to a mismatch between the potential liquidity of the assets, and the redemption timeframe offered to investors. This is particularly the case for real estate funds and funds of funds.
For hedge funds, the issue of leverage is key at more than 900%, in a sector valued at EUR 354bn in net asset value (NAV), including EUR 269bn for hedge funds with UK AIFMs.
The AIF sector was heavily impacted by the COVID-19 related market stress during the first quarter of 2020, and while outside the reporting period, a snapshot of the main event is included in the report.
- The size of the EU AIF universe continued to expand to reach EUR 6.8tn in NAV at the end of 2019, a 15% increase from 5.9trn in 2018. The growth of the EU AIF market results from the launch of new AIFs in 2019 and positive valuation effects;
- Funds of Funds (FoFs) account for 15% of the NAV of EU AIFs, at around EUR 1tn (+22% compared with EUR 841bn in 2018). At the very short end, investors can redeem 39% of the NAV within one day, whereas only 29% of assets could be liquidated within this time frame. If large redemptions were to occur, AIFs would face challenges due to this liquidity mismatch;
- Real Estate Funds account for 12% of the NAV of AIFs, at EUR 802bn. They continued to grow, albeit at a more moderate pace (+9% in 2019 after +35% in 2018). Compared with 2018, the proportion of retail investors was stable (21%) but remains high compared with other AIF categories. RE funds are exposed mostly to illiquid physical assets which take time to sell, so liquidity risk in RE funds remains a concern;
- The size of the EU Hedge Fund sector remained stable in 2019 at EUR 354bn, or 5% of all AIFs. However, when measured by gross exposures, HFs account for 62% of AIFs since they rely heavily on derivatives. Leverage is very high at more than 900% after adjustments, and particularly so for some strategies highly reliant on derivatives;
- Private Equity Funds account for 7% of the NAV of all AIFs, or EUR 456bn, and experienced the largest growth in 2019 (+28% compared with +66% in 2018). They follow a range of strategies and are almost exclusively sold to professional investors;
- Other AIFs account for 60% of the NAV of EU AIFs, at around EUR 4tn (+15% compared with +6% in 2018). The category covers a range of strategies, with fixed income and equity strategies accounting for 68% of the NAV and an additional residual category amounting to 29%. Other AIFs are mainly sold to professional investors, although there is a significant retail investor presence; and
- EU Member States can allow non-EU asset managers to market alternative funds at national level under the National Private Placement Regime (NPPR), even though such funds cannot subsequently be passported in to other Members States. The market for such non-EU funds is comparatively large: The NAV of non-EU AIFs marketed under NPPRs’ rules amounts to EUR 2.1tn, i.e. more than one-fifth of the AIF market. NPPR fund marketing is concentrated in a small number of Member States, and 98% of investors are professional investors.
European Commission sustainable finance “April package”
On 21 April 2021, the European Commission adopted a package of measures on the EU taxonomy, corporate sustainability reporting, sustainability preferences and fiduciary duties. The package is comprised of:
- the EU Taxonomy Climate Delegated Act, which provides the first set of technical screening criteria of the EU taxonomy and a common language around sustainable activities. The criteria cover the economic activities of roughly 40% of EU-domiciled listed companies, in sectors including energy, forestry, manufacturing, transport and building, which are responsible for almost 80% of direct greenhouse gas emissions in Europe. The European Commission explains the changes it has made to the Delegated Act following consultation in its communication on the sustainable finance package. The Delegated Act will be formally adopted at the end of May once translations are available in all EU languages and will apply from 1 January 2022. A complementary Delegated Act will be adopted later in 2021 on agriculture and certain energy sectors such as nuclear power and natural gas not yet included in the Delegated Act agreed published on 21 April 2021;
- a proposal for a Corporate Sustainability Reporting Directive (please see below); and
- six amending Delegated Acts on investment and insurance advice, fiduciary duties, and product oversight and governance. The legislation incorporates sustainability considerations into frameworks for the UCITS Directive, AIFMD, MiFID II (amending EU 2017/565), MIFID II (amending EU 2017/593) , Solvency II, and the Insurance Distribution Directive.
European Commission Proposal for Corporate Sustainability Reporting Directive – sustainable finance package
On 21 April 2021, the European Commission adopted a proposal for a Corporate Sustainability Reporting Directive (CSRD) as part of its sustainable finance package. This proposal builds on and revises the sustainability reporting requirements set out in the Non-Financial Reporting Directive (NFRD), in order to make sustainability reporting requirements more consistent with the broader sustainable finance legal framework, including the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation, and to tie in with the objectives of the European Green Deal.
Compared to the NFRD sustainability reporting requirements, the principal elements of this proposal are:
- to extend the scope of the reporting requirements to additional companies, including all large companies and listed companies (except listed micro-companies). In recognition of the economic difficulties they face in light of the Covid-19 pandemic, SME requirements would apply only three years after they apply to other companies;
- to require assurance of sustainability information;
- to specify in more detail the information that companies should report, and require them to report in line with mandatory EU sustainability reporting standards. The European Financial Reporting Advisory Group (EFRAG) would be responsible for developing these standards; and
- to ensure that all information is published as part of companies’ management reports, and that companies digitally tag information such that it is machine readable and feeds into the EU single access point.
The proposal would amend four existing pieces of legislation: the Accounting Directive, the Audit Directive, the Audit Regulation, and the Transparency Directive. The European Commission will engage in discussions with the European Parliament and the Council. In parallel, the EFRAG will start work on a first set of draft sustainability reporting standards, which it aims to have ready by mid-2022.
Accompanying FAQs were published.
Common deficiencies and good practices identified through desk based reviews regarding certain aspects of the compliance function requirements of the Investment Services and Activities and Regulated Markets Law (‘the Law’)
Through Circular C441 issued on 7 of April 2021, CySEC informed Investment Firms, Fund Management Companies (both UCITS and AIFMs offering the non-core MiFID services as per sectoral legislation) about the key findings of common deficiencies and good practices identified through desk-based reviews regarding certain aspects of the compliance function requirements under the MiFID framework. Areas of concern identified by CySEC were:
- Risk Assessment, Monitoring Activities and Compliance Programme;
- Reporting Obligation;
- Advisory obligations of the compliance function.
CySEC advised entities concerned to consider the issues raised in the circular and take remedial actions where necessary.
Consolation by the Ministry of Finance of Cyprus to amend the UCI and AIF Laws
The Ministry of Finance of the Cyprus on the 20th of April announced 2 separate consultation papers with the intention of amending the UCI Law (L.78(I)/2012) and the AIF Law (L. 124(I)/2018). The proposed amendments upon coming into force will grant the CySEC the powers to extend reporting and other deadlines not provided for under EU Law in case where the CySEC considers that compliance with the aforesaid deadlines cannot be upheld due to abnormal conditions in the Republic. The consultations closed on 27 April.
Updates regarding the new prudential framework for Investment Firms (IFD/IFR) and CySEC’s Data collection exercise
On 21 of April 2021 CySEC through the issuance of Circular C442 provided updates to Cyprus Investment Firms (CIFs) regarding the new prudential regulation framework which comes into effect in June 2021.
The CySEC informed CIFs of the reporting deadlines under the new framework as well as provided the parties with the submission forms. CySEC indicated that it intends to enhance further the forms at a later stage but the said enhancements will not affect the information that needs to be reported.
The CySEC informed CIFs that it will launch a data collection exercise for the express purposes to categorise each CIF in accordance to IFR/IFD when it comes into effect in June. CIFs expected to complete the Data Collection Template and submit to CySEC the latest by 31st of May 2021.
Guidelines on disclosure requirements under the Prospectus Regulation
Through Circular 443 issued on 22 of April 2021, the CySEC wishes to inform the persons responsible for the prospectus and financial market participants, that it has adopted the European Securities and Markets Authority (‘ESMA’) guidelines on disclosure requirements under the Prospectus Regulation. These guidelines apply from 4 May 2021.
Findings of the assessment of Compliance Officers’ Annual Reports and the Internal Audit Reports on the prevention of money laundering and terrorist financing
On 21 of April 2021 CySEC through the issuance of Circular 436 informed Investment Firms, Administrative Service Providers, Fund Managers (managers of AIFs, UCITS, internally managed funds, AIFLNPs etc.) of the common and recurring weaknesses and deficiencies, relating to the content of the Compliance Officers’ and Internal Audit Annual Reports on the prevention of money laundering and terrorist financing and the relevant BoD minutes identified by CySEC during its review of the aforesaid reports. The deficiencies/weaknesses relate to:
- The content of the Annual Reports did not provide sufficient information on checks/inspections and reviews, policies and procedures to prevent AML;
- The Reports did not include specific measures/recommendations for correcting weaknesses identified and timeframes for implantation;
- The minutes of the Board of Directors approving the Reports did not include measures the entities need to take in order to correct deficiencies.
CySEC expects that all Regulated Entities take into account the above-mentioned findings when preparing the Reports for the year 2021 and onwards, in order to ensure full compliance with the Law and the Directive.
Common weaknesses/deficiencies and good practices identified during the onsite inspections performed in relation to the prevention of money laundering and terrorist financing.
On 21 of April 2021 CySEC through the issuance of Circular 437 informed Investment Firms, Administrative Service Providers, Fund Managers (managers of AIFs, UCITS, internally managed funds, AIFLNPs etc.) about the weaknesses/deficiencies and good practices identified during the onsite inspections performed in relation to the prevention of money laundering and terrorist financing.
The most common weaknesses related to the below:
- Customer Due Diligence (CDD) Measures;
- AML/CFT Risk Assessments;
- Transaction Monitoring.
Moreover, the CySEC identified a number of good practices adopted by regulated entities such as training of relevant staff, record keeping and retrieval of information on clients’ identity/economic profile/transaction history without delays. Additionally, CySEC commented that some entities were carrying out continuous monitoring of clients as well as screening clients against various sanctions’ list (e.g. EU and UN sanctions) in order to reduce AML/terrorism financing risks.
The CySEC reminded regulated entities that they need to make a constant and continuous effort to ensure that their processes for AML/CFT are adequate.