Senior regulators gathered in Ireland to discuss delegation and ESG recently, while climate protestors demonstrated outside. Nicholas Pratt reports.

Ireland’s funds industry looked for assurances over the delegation model at the annual conference of the Irish Funds Association, held in Dublin in May.

The use of delegation – whereby self-managed investment funds and their management companies can outsource certain functions to third parties – is of concern to market participants and supervisors alike.

For funds domiciled in Ireland, there has long been a reliance on the use of third parties – particularly portfolio management services that are more likely to be carried out in London or even further afield. But regulators in the EU sometimes struggle with delegation because it means a function like portfolio management or fund accounting could slip out of their jurisdiction. This concern was amplified by the UK’s departure from the EU.

Of particular interest to fund managers and their service providers is the ongoing review of the Alternative Investment Fund Managers Directive. The AIFMD, a successful piece of European regulation that governs managers who offer alternative investment strategies, has delegation implicit in it. The AIFMD review was at the centre of a panel discussion at the Irish Funds Annual Global Conference. Representatives from the European Securities and Markets Authority (Esma), the UK’s Financial Conduct Authority (FCA) and the Central Bank of Ireland took part.

The panel recognised the industry disquiet over the scheduling of the AIFMD review, which began in 2018 with a general questionnaire on how the Directive has functioned. This resulted in a progress report issued in 2020. And in November 2021, the European Commission (EC) published its draft legislative proposals.

These proposals are now the subject of a trialogue between the EC, European Parliament and European Council, and it is hoped that an agreement can be made by the end of June 2023, when the Swedish presidency of the European Council is due to end.

Overall, the review was an opportunity to upgrade certain elements of the Directive. Key aspects are loan origination and leverage restrictions, liquidity management – and new rules on delegation.

Deeper look at delegation

Concerns about changes to the delegation model were heightened when, at the Irish Funds Symposium in London in November, the director of the Central Bank of Ireland, Derville Rowland, told delegates that the AIFMD reforms would "mark the start of a longer-term process that will take a deeper and more comprehensive look into delegation in Europe”.

However, at May’s Irish Funds event, Antonio Baratelli, head of Esma’s investment management unit, tried to assuage these concerns by stating that Esma – the European ‘super’ regulator – was focused on consistency rather than prohibition.

“Esma has suggested changes to the EU in terms of delegation, but there is a misconception as to our aims. Esma is not against delegation, but there needs to be consistency across the EU. So we have insisted on some clarifications in certain areas – such as secondment arrangements or conflicts of interest around white labelling. It is still being discussed in Brussels, but that trialogue will inform our work, and we stand ready,” said Baratelli.

“Esma has suggested changes to the EU in terms of delegation, but there is a misconception as to our aims. Esma is not against delegation, but there needs to be consistency across the EU."

The notion of consistency relates to so-called ‘gold-plating’, where one jurisdiction might fine-tune its regulatory regime to increase its competitiveness, but which might result in inefficiencies and confusion for firms’ work across EU borders.

“This is an international industry, so we support convergence and harmony and support the review in that regard,” said Patricia Dunne, director, markets supervision directorate at the Central Bank of Ireland. “Delegation and conflicts of interest around oversight and substance have been areas of focus for us for some time. In our daily supervision, we can see which companies take this seriously. In Ireland, we see an increased reliance on third parties, so this needs to be a key part of our supervision.”

It is also a subject of interest for the UK’s FCA, said Camille Blackburn, FCA director. In the FCA’s portfolio letter, sent every two years to asset managers, the number-one issue was governance. “We think it’s the most powerful tool in the system. For example, in terms of liquidity management, who is responsible for managing that risk? Who is on the board to challenge the decision-making? We ask for that information flow.”

SFDR “interim measures”

Another key piece of EU regulation that will be subject to a review (at some point, at least) is the Sustainable Finance Disclosure Regulation (SFDR) – the rules that surround sustainable investment funds and which are shaping the asset management industry’s whole approach to environmental, social and governance investing. With reference to funds being labelled as either Article 8 or Article 9 depending on their standards of sustainability, Baratelli told delegates that the regulation is about disclosure and not about labelling, but he accepted that SFDR had been used for marketing purposes.

“For the time being, we have to live with it,” he said. “We know the EU will look at the SFDR later this year, but it will take four to five years for the second SFDR to be implemented so we are looking at interim measures.”

For the CBI’s Dunne, the central issue is whether regulators have got the balance right with the SFDR. On one side is the complexity of the requirements; on the other is the aim to eradicate greenwashing and provide investor protection – an issue that has become more complex due to the inexorable investor demand for sustainable investment products.

“When new legislation comes in, there is an implementation period and a product development period, but the pace of demand for ESG products has outpaced the regulatory process.”

“When new legislation comes in, there is an implementation period and a product development period,” said Dunne. “But the pace of demand for ESG products has outpaced the regulatory process.”

If evidence was needed of mistrust of the industry in regards to any ‘green’ agenda some firms purport to have, the conference was visited by a protest from climate change pressure group Extinction Rebellion, which called on Irish Funds to expel member firms that invested in fossil fuel-linked projects.

Their presence was welcomed by some of the delegates, including George Latham, managing partner at UK-based WHEB Asset Management and a participant in a panel discussion on ESG, who said that the ESG industry was subject to “too much tummy-tickling” and encouraged delegates to engage with the protestors.

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