The European Securities Markets Authority (ESMA) recently released its 2020 Annual Report. It is EMSA’s 10th annual report, marking their entry into their second decade of existence. Like many ESMA publications, the report is dense in its detail and covers a wide range of topics. Word count is not cited as one of their measures of success, but it is fair to say that ESMA are one of the world’s most prolific regulators in terms of regulatory publications. The annual report mixes some of the obvious big-ticket items of 2020 like the COVID-19 pandemic and Brexit with some insightful observations about ESMA’s future with many useful “direction of travel” commentaries contained relating to its future strategic priorities.
Here are the Top 10 things you need to know about the future of ESMA:
1. Under New Management
Both ESMA Chair Stephen Maijoor and its Executive Director Verena Ross have now served their maximum mandated terms and are stepping down. Maijoor originally became chair of the European Securities and Markets Authority (ESMA) in April 2011 and his term was extended five years in 2015, alongside Veronica Ross, who served as ESMA’s executive director. Both were well respected, pragmatic, and quite open and available in terms of market engagement. It remains to be seen whether the new leadership takes ESMA in any different direction, but what’s for sure is they have tough acts to follow.
2. More Direction Supervision
We previously highlighted the new regulatory “superpowers” that ESMA had been granted with a view to building supervisory convergence across all E.U. member states. It has started to flex these new direct intervention muscles in recent times. Under the guise of regulatory harmonization, national competent authorities have seen ESMA take a more “hands-on” approach on a number of issues which previously might have been dealt with on a country by country basis. There are multiple recent instances and examples including EMIR and the oversight of Central Counterparties (CCPs), Common Supervisory Actions (CSAs) on undue costs for funds, MIFID 2 suitability rules and UCITS fund liquidity, or even direct intervention on the wire card financial reporting failure – ESMA are beginning to autonomously intervene more frequently.
What is certain is that ESMA appear to have a desire to be more rather than less involved in direct supervision of the E.U. market. What this means for national regulators and for asset managers operating in Europe is less certain but remains an area worth monitoring.
3. A Need for Greater Proportionality
One of the common criticisms of E.U. asset management regulation is that while it is often comprehensive, its demands often has a disproportionate impact on smaller market participants and/or new market entrants. The ESMA report speaks to the fact that they are cognizant that proportionality must be considered more with a view to ensuring that the myriad E.U. rules are not too burdensome for smaller firms and new entrants in order to foster greater competition and customer choice as well as customer protection.
The proportionality principle is not new having been used in remuneration rules and in aspects of both UCITS & AIFMD regulations however it appears ESMA recognize that in terms of new technology providers and with a view to fostering innovation – there may be a requirement to more liberally utilize the provision.
4. Reduce Regulatory Fragmentation
ESMA has a despite to continue down the path of reduced regulatory fragmentation and increased harmonization. This goal is best manifested in its “Single Rule Book”. I often have a rye smile when the single rule book is mentioned, mainly because while a noteworthy goal – the current nature of E.U. regulation means that there is all manner of local kinks and wrinkles at a local country level, many of which are so ingrained that it is extremely difficult to iron them out. We recently highlighted the work on removal of certain cross border distribution barriers which took more than a decade to get into a better place. There are a multitude of other areas of E.U. asset management which would benefit from similar barrier removals however imposing and policing the application of common supervisory cultures and practices across all E.U. member states is not easy. Local market conventions as well as national competent authority desire to play a role mean that this is a debate which will continue well into ESMA’s second decade.
5. ESG is Everywhere
In short, ESMA note in the report once more that sustainability will be incorporated to all aspects of the major E.U. asset management regulations. SFDR continues to be the primary area of focus for managers operating in the E.U. but there are a host of other core regulations such as MIFID, UCITS, and AIFMD which will also be recalibrated to enshrine ESG/sustainability principles – When it comes to E.U. funds, ESG truly is everywhere.
6. COVID Fallout Continues
We largely remain locked in a period of pandemic restrictions and much of the regulators’ work directly related to lessons learned from the pandemic fueled disruption continue to play out. ESMA will continue to assess issues such as oversight of remote workforces, fund liquidity, and use of technology across financial service supply chains and operating models. The whole regulatory reaction to the pandemic can be summed up by a much greater focus on “operational resilience” and all that underpins it and it is a concept that will remain a source of much scrutiny in the coming years.
7. Brexit Still Incomplete
ESMA’s report speaks to the multitude of work conducted in advance of the expiry of the Brexit transition period on December 31, 2020 which implemented a host of suitable contingency plans to protect the E.U. from an investor protection and market stability perspective. The U.K. continues to remain frustrated that the E.U. procrastinates on granting mutual equivalence, but this in reality was always going to be the case and the nature and formation of the new relationship is likely to be an iterative process over the next number of years. The previously agreed memorandum of understanding (MoUs) on cooperation and information exchange have been concluded between the U.K. and E.U. but they need a lot more meat on their bones and will be heavily dependent on how near or far the U.K. wishes to diverge from E.U. standards. Brexit is far from finished when it comes to asset management.
ESMA like everyone else in society is currently assessing how oncoming nascent technology is going to impact them and the securities markets they oversee. Whether its use of cloud computing, distributed ledger technology, cryptocurrency, machine learning, or algorithmic trading, the pace of change and appetite from all stakeholders to leverage technology for business purposes has never been greater. It is within this change dynamic that ESMA must calibrate its policies in order to allow regulated firms and consumers to reap the benefits of their usage but also to protect customers and the wider market from the risks that unquestionably come with the adoption of new methods.
ESMA’s Digital Finance Strategy is wide ranging in its scope and ambition and includes live test cases such as Markets in Crypto Assets (MICA), the DLT pilot program, and already published new rules on Cloud Outsourcing and other technology related consultations mean we are already in the midst of adoption of formal regulation for “Fintech” across the board. While regulation can often act as a catalyst for greater customer trust and confidence and subsequent growth it can also be framed to stunt innovation and the balance between the two will be key. ESMA will also want to leverage the technology to a greater extent to conduct its own supervisory activities and have already hosted regulatory workshops with E.U. national regulators regarding use of technology tools to facilitate reporting and supervision (SupTech) which included focus on NCAs’ use of technologies such as big data and machine learning for visualization and analytics. Regulators use of technology will dictate new methods of supervision in the same way as asset managers are using technology to recast their own operating models.
9. Growing Sphere of Influence
In its first decade of existence ESMA has been a prolific author of financial regulation across the expanse of asset management policy. While their jurisdiction strictly only spans the E.U. members states and some European Economic Area (EEA) countries, the truth is ESMA’s tentacles stretch much farther. They are a highly influential regulator in terms of global standards. At times this has direct effect, such as ESMA rules which are applied to third countries for activities conducted within the E.U. but also indirectly as sometimes the ESMA rules are not applicable to a country or region however they are used as proxy by the national regulators elsewhere. ESMA is a regulatory “influencer” to use social media parlance.
SFDR is a prime contemporary example – ESMA has led the way and while others might wish to scale back on the prescription of the E.U. rules, they will use ESMA as the benchmark and row back from there. There are other areas of the market others are currently assessing such as payment for order flow in the U.S., or use of distribution retrocessions in Asia – these are issues that ESMA has already regulated for, and whether or not commentators believe that ESMA is too prescriptive, too conservative, and often the process to rulemaking takes too long, there is no question that when they set their minds to it they comprehensively address a regulatory issue like very few others in terms of detail and completeness of the rules.
ESMA will continue to drive the global agenda when it comes to the big-ticket regulatory agenda items.
10. Plus Ca Change
While ESMA cite a period of rapid change ahead, their mission and purpose remain unaffected. ESMA are focused on E.U. investor protection, orderly well-functioning market's and mitigation of systemic risks. They attempt to achieve this mission through four activities:
(i) Assessing the risks to investors, markets and financial stability
(ii) Completing a single rulebook for E.U. financial markets
(iii) Promoting supervisory convergence
(iv) Directly supervising specific financial entities
So, while the people involved, the market participants, and the nature of the business conducted in the E.U. securities markets may continue to change, it appears unlikely that ESMA’s meticulous attention to detail and ever expanding remit will be changing any time soon.