Following publication by ESMA of its final guidelines on liquidity stress testing in UCITS and AIFs (the "ESMA Liquidity Guidelines") on 2 September 2019 (see our briefing available here) and recent industry communications issued by the Central Bank, it is clear that fund liquidity is set to remain a regulatory and supervisory priority at both domestic and EU level over the coming months.
In its letter issued on 7 August 2019, the Central Bank reminded industry that 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 fund companies (funds and fund management companies (including selfmanaged investment companies)), individual directors and the relevant designated persons.
While the deadline for implementation of the ESMA Liquidity Guidelines is 30 September 2020, it is evident that the Central Bank expects fund companies and their boards to ensure that liquidity risk management is appropriately considered and addressed in the meantime.
WITH THIS IN MIND, WHAT STEPS SHOULD FUND COMPANIES AND THEIR BOARDS BE TAKING TO ENSURE COMPLIANCE WITH THESE LIQUIDITY REQUIREMENTS?
- Prepare for the possibility of a Central Bank thematic review in relation to liquidity. Topics likely to be raised include:
- how liquidity risk is monitored and details of the liquidity risk management framework;
- how liquidity risk is assessed in the product design phase, including consideration of the profile of investors and a fund's redemption policy, dealing frequency and liquidity risk management features (e.g., redemption gates, redemption charges and suspension provisions); and
- escalation procedures to the board or relevant designated person in the event of a liquidity issue or event.
- Review existing risk management policies to ensure that liquidity risk is adequately addressed.
- 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 and other relevant liquidity requirements. Boards should request regular, detailed reporting around liquidity.
- Ensure that fund documentation is clear, accurate and consistent with legal and regulatory requirements around liquidity. Liquidity risk disclosures should be reviewed and updated if necessary.
We can assist fund companies to prepare an appropriate liquidity risk management framework to reflect these requirements.
Central Bank Reiterates its Supervisory Priorities for Funds
In a number of speeches over the past month the Central Bank has reiterated its supervisory priorities for investment funds for the coming year. Briefly, the Central Bank will be focussing on:
- concluding its CP86 reviews;
- performance fees;
- liquidity risk and the use of leverage by investment funds; and
- fund errors. The Central Bank has started its work on introducing a standardised approach to the treatment, correction and redress of investment fund errors with a consultation ("CP130") which closed on 9 December 2019. A follow-up consultation to CP130 is expected in early 2020.
A more detailed update on these priorities is available in our November e-zine.
Central Bank Issues Further Guidance on Enforcement Sanctions
One of the enforcement tools available to the Central Bank is the imposition of sanctions on both regulated firms and individuals under its Administrative Sanctions Procedure ("ASP"). In its ASP Outline, the Central Bank sets out a number of factors that it may have regard to in determining the sanctions it will impose. These factors fall under four broad headings:
- the nature, seriousness and impact of the contravention;
- the conduct of the regulated entity after the contravention;
- the previous record of the regulated entity; and
- other general considerations.
On 14 November, the Central Bank published additional guidance ("Guidance") on the application of the sanctioning factors as set out in the ASP Outline. This Guidance provides further detail on the meaning and weight that may be attached to these factors and where they sit on the scale of seriousness for sanctioning purposes.
The Guidance was prepared to aid proportionality and consistency in decision making and to provide clarity to regulated entities (and the public) about the Central Bank's approach to sanctioning. It does not represent a new policy and should therefore be read alongside that already set out in both the ASP Outline and the Central Bank's Inquiry Guidelines.
For more information, please see a more detailed article by the Arthur Cox team here.
ESMA Q&A Updates
Recent ESMA Q&A updates of interest include:
AIFMD Q&A: LIQUIDITY STRESS TESTING REPORTING REQUIREMENTS FOR CLOSED-ENDED UNLEVERAGED AIFS
Under Article 16(1) of AIFMD closed-ended unleveraged AIFs are exempt from the requirement to implement liquidity risk management systems and from conducting liquidity stress tests.
However, AIFMs need to report results of liquidity stress tests for all their AIFs as part of their reporting to national regulators using the AIFMD reporting template.
ESMA has confirmed in a new Q&A that: For closed-ended unleveraged AIFs, given the mandatory character of the field in the AIFMD reporting template, AIFMs should indicate the question is "Not Applicable" and report in this field that the relevant fund is a closed-ended unleveraged AIF.
Should an AIFM decide to conduct liquidity stress tests for unleveraged closed-ended AIFs, it should report the results of the liquidity stress tests in the same field.
BENCHMARKS REGULATION Q&A
ESMA has updated its Benchmarks Regulation Q&A to provide clarification on the transitional provisions applicable to thirdcountry benchmarks (#9.3).
Following the publication of the Low Carbon Benchmarks Regulation, which amends the transitional provisions of the Benchmarks Regulation (BMR), where a benchmark provided by a non-EU benchmark administrator is used in the EU before 31 December 2021 and has not been qualified for use in the EU under the third country regime provided for in the BMR by that date, then its continued use in the EU will be permitted after 31 December 2021, until the non-EU benchmark administrator has been recognised under the third country procedures set out in the BMR. The previous date was 1 January 2020.
MIFID II/MIFIR INVESTOR PROTECTION AND INTERMEDIARIES Q&A
The updated Q&A address:
- Information on costs and charges
- ex-post information in the case of portfolio management; and
- relationship between Article 50(9) and Article 60 of the Delegated Regulation in the case of portfolio management.
- Product intervention
- The application of national product intervention measures in the case of services provided on a crossborder basis.
SECURITISATION REGULATION Q&A
On 15 November, ESMA updated its Q&A on the Securitisation Regulation. The updated and new questions provide guidance on how specific fields should be completed in the templates contained in ESMA's draft technical standards on disclosure requirements. They also provide guidance on notifications to ESMA of STS securitisations.
Securitisation Regulation: Delegated Regulation on Homogeneity of Exposures
Homogeneity of the underlying exposures is one of the requirements for simple, transparent and standardised securitisation under the new EU securitisation framework.
On 26 November Delegated Regulation (EU) 2019/1851 entered into force. The Delegated Regulation supplements the Securitisation Regulation with regulatory technical standards on the homogeneity of the underlying exposures in securitisation and sets out the conditions that the underlying exposures of a securitisation must satisfy in order to be deemed homogenous. The conditions require the underlying exposures to:
- correspond to a specific listed asset type (most of which are commonly used in the securitisation market);
- be underwritten with standards that apply similar approaches for assessing risk;
- be serviced in accordance with similar procedures; and
- for most asset types, satisfy one or more of the homogeneity factors specified in the Delegated Regulation for the applicable asset class