Last year was the busiest on record for financial regulators, as the pandemic and Brexit uncertainty dominated headlines. Not surprisingly, many of their original plans quickly took a backseat as global markets reacted and attention shifted to crisis management, liquidity and firm resilience. Much of that looks set to continue this year too.
Brexit continues to loom large over financial markets as well, and some of the finer details around equivalency still hang in the balance – nearly five years after the historic vote.
Overall, therefore, UK and EU regulators are likely to focus on three major areas this year: operational resilience and governance; fund liquidity; and fees. Let’s take a closer look at what it means for your firm.
Operational resilience and governance
Whereas 2020 saw most financial firms able to weather the storm, thanks in large part to unprecedented central bank largesse, regulators will again place a heavy emphasis on operational resilience this year.
France’s AMF was early out of the blocks in publishing its supervisory priorities for 2021 last week. What’s immediately obvious is that the Covid-19 pandemic still very much dominates regulators’ attention, and the AMF took the opportunity to reaffirm its commitment to ‘engage all its resources to overcome the health and economic crisis’.
This includes monitoring ‘issuers in their financial operations and disclosure to ensure that investors are properly informed.’ It will ‘contribute to the regulatory changes made in response to the market turmoil of spring 2020,’ as well as participating in regulatory reviews and the transition to sustainable finance.
That echoes many of the concerns of The Malta Financial Services (MFS) Authority, which published its supervisory priorities for 2021 late last year. Credit risk management and business model viability in the wake of Covid-19 are major considerations, especially for banks.
Elsewhere, the Central Bank of Ireland (CBI) will continue its work on CP86, having sent a Dear Chair letter to fims last October. The letter outlined a number of shortfalls when it comes to organisational effectiveness, the performance of managerial functions, and delegate oversight.
Although the third and final guidance on CP86 had been released in 2016, a review last year found that ‘a significant number of previously authorised Fund Management Companies (FMCs) have not yet fully implemented the framework. Many were able to evidence the introduction of only limited changes following implementation of the Guidance.’
Moreover, it said, ‘A FMC must be able to clearly demonstrate ongoing and effective management of all activities, including high quality and effective oversight of those activities performed by delegates. It must be able to clearly demonstrate that its governance structure, including its entity-specific second line of defence, is sufficiently resourced to achieve this.’
Non-compliant firms must ‘urgently remediate’ any shortcomings, the CBI said, while all FMCs are required to ensure that a board-approved compliance action is in place by the end of March 2021, at the latest.
Firms may have weathered the sharpest drawdown in history reasonably well in 2020 (with a large helping hand from central banks of course), but that doesn’t mean that fund liquidity won’t be a major issue on the regulatory agenda in 2021.
ESMA will be keen to understand how its inaugural Liquidity Stress Test (LST) guidelines, which came into force on 30 September 2020, panned out. With ample time to get ready, ESMA and local National Competent Authorities (NCAs) will be keen to make sure that firms are adapting well. And with the FCA considering similar legislation as well as a new 180-day redemption rule for property funds, fund liquidity stress testing will continue to be high up on the regulatory agenda for a long time to come it seems.
More recently, ESMA warned fund managers last November to improve readiness for future adverse shocks, and managers can expect a lot of ongoing fund liquidity reports and studies to be carried out by ESMA and NCAs in 2021.
That’s prompted some managers, and sometimes their ManCo companies, to consider whether the type of vehicles and strategies they offer are suitable for particular asset classes and investors – particularly retail investors.
While this renewed focus, including the 180-day redemption rule in the UK, may help avoid high-profile fund blow-ups, industry experts warn that it risks locking less sophisticated investors out of illiquid assets such as real estate, and could spell the end of property funds altogether.
It will be interesting to see how things play out – and whether some funds adopt a private equity-type approach going forward.
Another perennial theme that’s likely to dominate in 2021 are fund fees, particularly for UCITS. Fund fees have long been a favoured topic of ESMA, which late last year identified costs, performance and data quality as strategic supervisory priorities.
Like fund liquidity, it’s all about protecting investors – and retail investors in particular – with ESMA wary that some asset managers may be using different countries’ frameworks in order to arbitrage the rules, including rules around costs.
In January this year, therefore, ESMA announced that it was launching a Common Supervisory Action (CSA) looking at the supervision of costs and fees of UCITS across the EU.
The CSA will be conducted over the course of 2021, and the overall aim is to assess:
- How far ESMA authorised firms comply with the relevant cost-related provisions in the UCITS framework and the obligation not to impose charge undue costs to investors; and
- Whether firms which use Efficient Portfolio Management (EPM) techniques adhere to the requirements set out in the UCITS framework and in the relevant ESMA Guidelines.
That means more pressure on UCITS in 2021 and beyond. Although regulators take a positive view of the UCITS directive overall, UCITS will remain a major focus.