knowledge 8 March 2023 |

Central Bank Securities Markets Risk Outlook Report 2023

Key Themes

The CBI identifies risks and sets out expectations along the following themes:

1. External Risk Environment

The CBI notes that the deterioration in the external risk environment has affected participants across the Irish securities markets and highlights action the CBI has taken in (a) its recent communication to managers of liability driven investment (“LDI”) funds (summarised in our briefing (here)) and (b) the introduction of new macroprudential measures for Irish property funds (summarised in our briefing (here)).

The CBI states that it expects less liquid funds to ensure that redemption frequency is closely correlated to underlying asset liquidity and that appropriate liquidity management tools (“LMTs”) are in place to ensure the fair treatment of all investors.

The CBI also highlights the wide range of financial sanctions imposed on Russia and Belarus by the EU in response to the Russian invasion of Ukraine. The CBI reminds firms to remain in compliance with sanctions at all times with respect to any impacted asset or investor. Our briefing (here) provides further detail on the letter issued by the CBI to fund service providers in respect of sanctions in March 2022.

The CBI expects RFSPs to:

• conduct robust stress testing, updated regularly, to take due account of market dynamics so that all funds are positioned to ensure their liquidity arrangements are sufficient to meet redemptions and margin calls;

• ensure that LMTs are being utilised when needed and that appropriate LMTs are in place;

• verify valuations of assets affected by rising interest rates and sanctions; and

• have appropriate systems and controls in place to identify relevant sanctioned instruments and individuals to ensure they are compliant with their obligations in relation to financial sanctions.

2. Sustainable Investing

The CBI notes that new regulatory developments and guidance, along with increased investor demand, are driving the integration of Environmental, Social and Governance (“ESG”) factors into fund managers’ investment considerations. In particular, the CBI highlights disclosure requirements under the Sustainable Finance Disclosure Regulation (the “SFDR”) and the Taxonomy Regulation for both manufacturers of financial products and financial advisers. The CBI notes that SFDR Level 2 obligations became applicable in January 2023 and require more detailed disclosures to be included in mandatory templates as part of an investment fund’s pre-contractual documentation. Further detail on the CBI’s SFDR Level 2 filing requirements is available in our briefing (here).

The CBI expects RFSPs to:

• ensure they adhere to their regulatory obligations regarding the correct disclosure of sustainability related information in product offerings; and

• have robust procedures and policies in place to ensure products marketed as ‘green’ or ‘sustainable’ meet the criteria to be described as such.

3. Delegation and Outsourcing

The CBI emphasises the importance of appropriate oversight of delegated activities as the nature, scale and complexity of the Irish securities markets sector grows. The CBI reiterates that it does not differentiate between delegation and outsourcing and highlights that the requirements of the CBI’s Cross-Industry Guidance on Outsourcing apply to both the delegation and outsourcing of activities. Further detail on the application of this CBI Guidance to fund managers is available in our briefing (here).

The CBI notes the contents of its ‘Dear Chair’ letter dated 7 December 2022 and highlights that it is essential that fund management companies have the capacity to take on additional business, including oversight of delegates, without compromising the expected standards set out in the CBI’s regulatory framework, or reducing the protection of investors. Our briefing (here) provides further detail on this ‘Dear Chair’ letter.

The CBI notes that delegation was also a focus in the recent ESMA Peer Review Report on NCAs’ handling of firms’ relocation to the EU in the context of the UK’s withdrawal from the EU (here) which highlighted that this topic would merit further work at EU level to foster supervisory convergence.

The CBI expects RFSPs to have regard to:

• the CBI Cross-Industry Guidance on Outsourcing;

• Market Abuse Regulation¹ and MiFID requirements, where applicable, and ensuring that a firm outsourcing activities retains ultimate responsibility for governance and oversight of the delegated activities; and

• oversight and continuous monitoring of any digital processes outsourced to third parties.

4. Other

The CBI also highlights expectations under the headings ‘market integrity’, ‘market conduct risk management’, ‘cyber security’, ‘data quality’ and ‘digital innovation’.

In respect of ‘digital innovation’, the CBI reiterates its position that crypto-assets are “highly risky and speculative” and may not be suitable for retail customers. The CBI notes that in last year’s Securities Markets Risk Outlook Report, the CBI had stated that it was “highly unlikely” to approve proposals for a UCITS or retail investor alternative investment fund to invest, directly or indirectly, in crypto-assets. The CBI states that its position remains under review and will be informed by European regulatory discussions on the topic. The CBI notes that in the case of a qualifying investor alternative investment fund (“QIAIF”) seeking to gain exposure to crypto-assets², the CBI requires the relevant QIAIF to make a submission to the CBI outlining how the alternative investment fund manager (“AIFM”) could manage the risks associated with such exposures effectively.

In terms of proposals under the Prospectus Regulation, the CBI states that is highly unlikely to approve a crypto-based proposal under the Prospectus Regulation, providing direct or indirect exposure to crypto-assets. The CBI states that its position will be kept under review and will continue to be informed by regulatory discussions and developments at EU level.

Comment

Many of the CBI expectations will be familiar to RFSPs based on last year’s Securities Markets Risk Outlook Report and CBI communications issued in the course of 2022.

RFSPs should take note of the CBI’s focus on upcoming regulatory developments, such as the digital operational resilience act (“DORA”) and the Markets in Crypto-assets Regulation (“MiCA”), and the CBI’s continued emphasis on compliance with cross-industry guidances, in particular, the Cross-Industry Guidance on Outsourcing.