Important Update on Irish and EU Financial Services Developments
The Central Bank of Ireland ("CBI") has published an address by Mr. Gareth Murphy, Director of Markets Supervision (the "Director") at the recent Irish Funds Industry Association symposium in the UK.
The Director covered a number of key points which will be of interest to all market participants involved in Irish UCITS and AIFs.
Of particular interest to those in the AIFMD space will be the fact that the Director flagged the CBI's imminent intention to carry out themed supervisory inspections of Irish AIFMs (and internally managed AIFs) under its "4Cs test": control; capacity; capability; and (the management of) conflicts.
The 4Cs test was flagged earlier this year when the Director was the keynote speaker at our Maples Insights Investment Funds Seminar in May 2014. We have been advising our clients as appropriate on this matter since then.
These inspections have the potential to impact any of the 119 regulated AIFMs licensed by the CBI to date. Although not all will undergo a thematic inspection during 2015, the review findings are likely to lead to certain operational systems and controls changes being required by all CBI-regulated AIFMs.
The Director's address was split between: (a) recent funds policy initiatives by the CBI; and (b) current European regulatory agenda items for the funds industry. We have summarised the key points below:
Recent CBI Policy Initiatives
CP84 - UCITS collateral management
The Director explained that the intention of CP84 was to ensure that all UCITS managers proactively manage exposures to sovereign securities posted as collateral (or via reverse repo), so as to minimise the potential impact on a UCITS of any reduced creditworthiness of such a sovereign.
CP86 - Fund manager board oversight of delegates
UCITS V and AIFMD have increased the regulatory and legal burden for fund management companies. The CBI believes this burden can be mitigated by increasing resources within fund management companies, but that those resources must be under the control of the board and fully aligned with its objectives. CP86 is therefore designed to ensure that fund manager boards are conducting appropriate oversight of delegates.
The Director indicated that the CBI will consider not only the responses to CP86, but also its subjective findings from its thematic reviews (particularly its application of its "4Cs test"). The Director also recognised that there would be a need to accommodate the varying nature, scale and complexity of fund management companies operating in Ireland.
Loan origination by AIFs
The Director noted commentary from industry on the recently introduced loan origination QIAIF ("LQIAIF") regime. He explained that the CBI's prohibition on LQIAIFs engaging in multiple investment strategies was motivated by a policy concern that this could lead to a dilution of the lending expertise which it expects of LQIAIF managers.
The Director also believes that there is a growing regulatory appetite across Europe for a more harmonised approach to loan origination, for which three issues will need to be carefully addressed: investor protection; financial stability; and the financing of the real economy.
European Regulatory Agenda
Money market funds
The Director stated his concern that current drafts of the EU money market fund regulations do not properly deal with the issue of external support by fund sponsors, and that systemic risk still exists in the event of a potential investor run. The Director's preferred solution is an outright ban on external support but he acknowledged that this may be politically unpalatable. The proposal of the European Parliament's rapporteur (which would require European Commission consent for any external support) is the Director's next preferred alternative, as it would be a cumbersome process and therefore likely to deter many fund sponsors from providing such support.
The Director secondly considered the debate on whether constant net asset value ("CNAV") money market funds should be compelled to adopt a variable net asset value ("VNAV"). He noted that the SEC prioritised addressing the operational issues of accounting and tax treatment before compelling certain CNAV money market funds in the US to move to VNAV, and he emphasised that any equivalent requirement introduced at a European level should likewise first consider such tax and accounting issues to ensure that existing CNAV investors are not operationally disadvantaged.
The Director discussed ESMA's final advice to the European Commission on UCITS V and the headline issues which emerged during the consultation stage. In particular he justified the proposed requirement for third country delegates of depositories to obtain independent legal advice regarding the treatment of fund assets under local insolvency laws, and explained the options for ensuring that UCITS investment managers and depositaries "act independently".
AIFMD: Depositary Asset Segregation
The Director flagged that ESMA would consult with industry (which process has since commenced) regarding the contentious issue of asset segregation throughout the depositary's custody chain. He highlighted that ESMA needs more information on the costs and the potential benefits of requiring extra levels of segregation, and strongly encouraged stakeholders to respond.
AIFMD: Third-Country Passport
The Director noted that ESMA's most substantial funds-related issue for 2015 will be its advice to the European Commission and legislators on whether or not to extend the AIFMD passport to third countries. He expects the regulatory debate to focus on the issues of: cross border supervision and cooperation; regulatory and supervisory equivalence; mutual access between the EU and third country fund markets; and the possibility of competitive distortion.
The Director stated his view that some of those issues belong to trans-Atlantic political/ trade negotiations, and that therefore ESMA's advice should focus solely on the technical regulatory and supervisory aspects.
The next wave of regulation
The Director also discussed the broader regulatory agenda in light of the new European Parliament and European Commission. He supported the comments of the new Internal Markets Commissioner that following an intensive period of legislation in reaction to the global financial crisis, now is a good time to take stock and assess whether an appropriate balance has been struck between reducing risk and encouraging growth.
The Director also repeated his encouragement of industry stakeholders to more constructively engage with the regulatory reform agenda and to highlight the significant and positive role played by financial services in supporting the real economy.
Finally, he stressed the importance of obtaining a greater level of consistency in global regulation and corresponding reduction in regulatory arbitrage.
If you would like further information on any of the aspects summarised above, please speak with your usual Maples and Calder contact.