10 January 2019

No deregulation for investment funds

In 2019, we expect further regulatory changes in the investment fund sector, mainly concerning reporting and stress testing. The European Securities and Markets Authority (ESMA) is now finalising guidelines on stress test scenarios for money market funds. It will also become necessary to get ready for an extended reporting duty regarding securities financing transactions (SFTs).

Filip Horák
Kristýna Tupá

In the long run, the European Union has been tightening the regulation of funds: the hot topic of sustainability in capital markets or the debate on disclosures for investors in qualifying investor funds are just an example. In the US, the trend is quite the opposite: as surprisingly the financial crisis was not followed by mass requests for pay-outs from funds, a loosening of the rules for investment funds is yet again on the table. This approach is strongly opposed by the European Central Bank (ECB), which has repeatedly called for stricter regulation: the interconnectedness of the banking and the fund sectors and risks arising from derivatives trading and SFTs are seen as the biggest threats.

A number of major European banks are connected with entities of the fund sector; this is perceived by EU bodies as a systemic risk. The pressure on limiting this interconnection is likely to grow, also in light of the predicted upcoming recession and related efforts to maintain financial stability. This may bring more duties for the entities involved, in particular in the area of conflicts of interest (as we have seen for group product distribution under MiFID II), reporting, etc.

According to statistics, up to 7% of funds trade in credit default swaps (CDS), and SFTs are also widely used in the investment fund sector. Under certain circumstances, this may lead to a lack of liquidity for such funds. European regulatory bodies are therefore stipulating extensive reporting duties in the SFT regulation, further specified by an implementing regulation in December 2018.

The regulation does not bring just reporting duties: for entities engaged in repurchase transactions, buy-sell back transactions, margin trading transactions, etc., it will also directly affect trading and internal processes.

Disclosures will now have to contain information on the composition and characteristics of the loan and the collateral, information on counterparties and other entities involved, information on whether the collateral is available for reuse or has been reused, etc. Although the reporting duty will only apply from 2020, entities involved should start getting ready for the new requirements.

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