In the field of portfolio management of collective investment funds, 2017 looks set to be the year when some existing cross-border business models are called into question as three separate debates coalesce: supervisory convergence, third-country provisions and 'Brexit'.
ESMA has been the first to throw its hat into the ring. Its 2017 Supervisory Convergence Work Programme aims to promote sound, efficient and consistent supervision across the European Union. It commits itself and the national regulators to eight cross-cutting activities and seven thematic activities, one of which covers fund management and another the third-country regimes.
A recent example of ESMA’s supervisory convergence work was its guidance that hedged UCITS share classes (other than for currency) are effectively a different pool of assets and should not be allowed – see this article for more detail. They should be separate funds or sub-funds. Any such existing share classes should be closed for investment by new investors by the end of July 2017 and for additional investment by existing investors by July 2018. Will those national regulators that currently allow such share classes amend their approach, and if they do not, what will be the reaction of other regulators?
Steven Maijoor, ESMA’s chair, has stressed to European Parliamentarians the need for greater supervisory convergence within the EU. He highlighted the fact that because the provision of cross-border financial markets services is relatively easy, activities have concentrated in financial centres that focus on, for example, asset management. As a result, a substantial share of national supervision concerns cross-border activities. The question is whether national regulators sufficiently assess and address the risks that their supervised entities might be creating outside their jurisdiction, in other parts of the EU. An example is the offering of CFDs and binary options to the retail market, which is concentrated from one Member State where firms use aggressive marketing campaigns and large call centres, he said.
Mr Maijoor also took the opportunity to observe that the U.K.’s decision to leave the EU (‘Brexit’) results in increased risks to consistent supervision. He urged national regulators not to compete on regulatory and supervisory treatment. He gave by way of practical example the ability for EU firms to delegate or outsource to a UK entity while being registered and supervised by one of the EU27 regulators. The first of ESMA’s supervisory convergence work streams is directly relevant, as will be the application of the third-country requirements, current or future.
There is a diversity of third country provisions under different EU legislative texts and some have no equivalence regime. The provisions in MiFID II, AIFMD and the UCITS Directive are all quite different, for example. ESMA is calling for clarification and consistent approaches at EU level. Meanwhile, it must do work under MiFID II/MiFIR and awaits the Commission’s decision on the non-EU passports under AIFMD.
Mr Maijoor went further and called for a fundamental review of the current patchwork of third country provisions in EU legislation, which is not fit for purpose (see our article). There is no generic framework. There are different arrangements in different pieces of legislation – which are a mixture of equivalence, endorsement, recognition or passporting – or no arrangement at all. Also, the framework is time and resource-intensive, requiring detailed assessments of other countries’ regimes and lengthy negotiations if a country is not initially adjudged equivalent.
It remains to be seen how quickly and in what way the co-legislators will respond to this call for an overhaul of the system. Certainly, it would be a major drafting and practical task to bring about greater consistency of approach. Political pressures, in Europe and beyond, may provide momentum behind the task. In the meantime, firms and market entities will wish to factor into their business planning that the delegation and third-country provisions of today may look rather different in two or three years.
1. Have we thoroughly assessed the various third-country provisions that apply directly to our business model or to the assets of our funds or in our clients’ portfolios?
2. Have we also considered any provisions that apply to our clients or counterparties or the markets into which we place orders?
3. How much optionality do we have, given our existing entities and strategies, or might we need to create some flexibility?
4. Have we factored in potential timing issues for regulatory processes or other considerations (such as tax aspects)?
5. What is our strategy for communicating with investors and regulators?