The head of the European Securities and Markets Authority, which oversees and coordinates the work of European supervisors in asset management, on Tuesday called on the industry to pay more attention to the management of increasing interest rate risks and to step up its efforts in terms of “prudent management” of investment funds.
Addressing the European Asset Management conference in Luxembourg, Verena Ross, chair of Esma, reflected particular concerns about money market funds, high yield bond funds and liability-driven investments, also known LDIs, in the wake of the steep increases in interest rates which has led to growing interest risks.
“We expect asset managers to assume the responsibility in managing their funds prudently in these challenging macroeconomic times. Open Ended funds need particular attention with regard to liquidity and leverage risk,” Ross told the conference, hosted by the Association of the Luxembourg Fund Industry.
Ross echoed earlier warnings issued by Esma. Last month, when presenting Esma’s latest risks and vulnerabilities report on 10 February, she told investors that they should prepare for further market corrections, given a “confluence of high risks”. That statement was issued well before the demise of SVB and of Credit Suisse, events that have rocked financial markets worldwide in recent days and weeks.
‘Sudden and unexpected shocks’
“If the recent past has taught us anything, it is that risks are likely to come also from sudden and unexpected shocks coming on top of the existing vulnerabilities and there obviously we are going through a difficult period again at the moment,” Ross said while speaking in Luxembourg.
“Asset managers need to prepare for further and prolonged adverse events…. supervisors need to step up their efforts in addressing assessing risks and taking adequate actually to respond to those risks that have been identified,” she said.
Overall, Ross said Europe is relatively well prepared for financial shocks, thanks largely to a new financial framework that was out in place in the European Union since the Great Financial Crisis. That framework includes major pieces of legislation such as AIFMD, MIFIR, MIFID2 and a Banking Union with tighter supervision banks and resolution framework.
“The regulatory framework for investment management has been significantly reinforced over the last 10 years. But some further regulatory adjustments are still necessary to address the remaining vulnerabilities of the investment management sector,” Ross said.
Money Market Funds
In particular, EU rules for Money Market Funds and LDIs are in need of an upgrade, Ross said. “Unfortunately, one important piece of the reforms of the EU regulatory framework is still missing and that is the review of the money market funds directive. The vulnerabilities that surfaced during the pandemic have demonstrated that legislative changes to enhance the resilience of the money market fund sector are needed sooner rather than later,” she said.
Following the steep interest rate hikes by central banks in Europe and the US, financial markets now are facing a particular type of interest rates. After some 350 basis point in hikes by the European Central Banks in eight months, the effects of these hikes are about to filter into the economy, making it more difficult for some businesses to manage their debt.
“Credit risk levels have remained high and are expected to rise reflecting the concern over public and corporate indebtedness, as borrowing and refinancing costs are increasing,” Ross said. “This is particularly a matter of concern for bond funds investing in high yield in the high yield segment, whose portfolio quality is at a five year low.”
AIFMD reforms coming
Following a 2021 European Commission proposal for the review of the AIFMD directive, important changes are now about to be agreed. Ross noted the trilogue discussions between the EU commission, council and parliament started “a few days ago” which will lead to a proposal that “addresses vulnerabilities identified by global and European bodies”.
The AIFMD update will lay out a framework for the design and use of new credit monitoring tools, harmonised rules for loan origination funds, and the creation of a brand new reporting for Ucits funds. “It will maintain the European regulatory framework at the forefront of the global regulatory agenda and make the European investment management sector more resilient, as well as increasing investor protection.”
Related articles on Investment Officer Luxembourg:
- ‘Prepare for further market corrections,’ says Esma
- AT1 bank bonds in focus as Swiss force CS write-off
- ECB unsure about next steps after hiking 300bps since July