At the end of each month, the SAFE Regulatory Radar highlights a selection of important news and developments on financial regulation at the national and EU level.
Sustainable finance: defining benchmark criteria
On 8 April 2020, the European Commission published three draft delegated regulations (CDRs) providing sustainability criteria for benchmarks. The regulations are prepared under the Regulation (EU) 2016/1011 (Benchmarks Regulation, BMR) on indices that are used as benchmarks for financial instruments and contracts or to measure the performance of investment funds. They will be finalized after the consultation period.
The first CDR sets out the minimum standards that benchmarks have to meet to be labeled as EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks. These are voluntary labels that are designed to help investors looking to adopt a low-carbon investment strategy. The regulation further establishes transparency requirements on the methodology for both benchmarks and enumerates types of companies that have to be excluded from benchmark calculations.
The BMR requires benchmark administrators to publish an explanation of how the key elements of the benchmark methodology reflect environmental, social and governance (ESG) factors. The second CDR provides the minimum content of the explanation that includes information on data and standards used.
The third CDR lays down specific factors to be disclosed depending on the type of benchmark (equity, fixed income corporate, sovereign debt, commodity, private equity, private debt and other benchmarks), the degree of exposure of the portfolio to climate-related opportunities and risks, and measures for the planning and management of resources.
Capital Markets Union: New guidelines for market risk
On 27 March 2020, the European Banking Authority (EBA) published its final draft Regulatory Technical Standards (RTS) on the new Internal Model Approach (IMA) under the Fundamental Review of the Trading Book (FRTB). These RTS have been developed according to the revised Capital Requirements Regulation (CRR 2) and constitute the first phase of the EBA roadmap towards the implementation of the market and counterparty credit risk frameworks in the EU.
The standards consist of the RTS on Liquidity Horizon for the IMA. They clarify how institutions map the risk factors to the relevant category and subcategory. Besides, it specifies the definition of small and large capitalization for equities. Large market capitalization is considered when it is equal to or greater than 1.75 billion euros.
The second RTS on back-testing and profit and loss attribution (PLA) sets out the elements of the hypothetical, actual, and risk-theoretical profit and loss calculations for the purpose of back‐testing. In detail, the standards specify that the actual and hypothetical changes in the relevant portfolio’s value should be computed based on the pricing methods, the model parametrizations and market data used by the institution in the end‐of‐day valuation process.
The third RTS clarify the criteria for assessing the modellability of risk factors under the IMA. They set out the criteria for identifying the risk factors that are modellable and that institutions are allowed to include in their expected shortfall calculations. It also specifies the requirements under which verifiable prices can be considered representative for risk factors.
The technical standards are submitted to the European Commission for adoption. The RTS have to trigger a three year period after which institutions with the permission to use the FRTB internal models are required to calculate their own funds requirements for market risk.
Capital Markets Union: ESMA publishes guidance on performance fees in UCITS and certain AIFs
On 3 April 2020, the European Securities and Markets Authority (ESMA) presented its final guidelines on performance fees in investment funds that are applicable to Undertakings for the Collective Investment in Transferable Securities (UCITS) and certain types of Alternative Investment Funds (AIFs).
The guidelines aim to help investors to understand the main features and effects of the application of the performance fee as well as to provide supervisory convergence. This technical act provides a comprehensive explanation of the general principles on performance fee calculation methods, including the assessment of the consistency between the performance fee model and the fund’s investment objective. In addition, ESMA sets the minimum pace regarding the frequency of the crystallization of the performance fee and requests that investors should be adequately informed about performance fees and their potential impact on investment return. Further, the guidelines clarify the concept of negative performance (loss) recovery.
In a two-month period after the publication, the national competent authorities (NCAs) must notify ESMA whether they comply or intend to comply with the guidelines. After that, they will come into force.
Anastasia Kotovskaia is Research Assistant at the SAFE Policy Center and currently pursuing a Ph.D. in Law at Goethe University.