The European Securities and Markets Authority (ESMA), the EU securities regulator, has launched a public consultation on its draft guidance to address leverage risks in the Alternative Investment Fund (AIF) sector.

The consultation is part of the ESMA response to the recommendations of the European Systemic Risk Board (ESRB) in April 2018 to address liquidity and leverage risk in investment funds.

ESMA says its draft guidelines aim to promote supervisory convergence in the way National Competent Authorities (NCAs) assess how the use of leverage within the AIF sector contributes to the build-up of systemic risk in the financial system, as well as how they design, calibrate and implement leverage limits.

ESMA says it will consider the feedback it receives to this consultation by September 1 with a view to finalising the guidelines for publication.

Steven Maijoor, Chairman, said: "In situations when financial markets are under severe stress, highly leveraged alternative investment funds can further amplify systemic risk. Considering the size of the investment fund sector, achieving supervisory convergence in NCAs' approaches to monitoring and regulating the use of leverage by alternative investment funds is of the utmost importance

"Our proposed Guidelines address the assessment of leverage-related systemic risk and aim at ensuring that NCAs adopt a consistent approach when assessing whether the condition for imposing leverage-related measures are met."

Bill Prew, CEO, INDOS Financial, an independent fund depositary and oversight business, has responded as follows.

"The consultation is in response to the recommendations of the European Systemic Risk Board (ESRB) in April 2018 to address liquidity and leverage risk in investment funds (in particular, the extent to which the use of leverage within AIFs contributes to the build-up of systemic risk in the financial system, and to give guidance on macroprudential leverage limits).

"The most eye-catching part of the proposals is a requirement that regulators ‘should impose leverage limits' on funds (or groups of funds) that they consider ‘pose risks to financial stability'.

"Whilst AIFMD has always allowed regulators to set leverage limits, to our knowledge regulators have not imposed limits since AIFMD was first introduced in 2014 – managers have been free to set the maximum level of leverage which they believe are ‘reasonable'.

"Regulators will need to base their assessments on the Annex IV regulatory reporting they receive from managers. The proposals not only focus on those AIFs that employ substantial leverage (defined by AIFMD as when an AIF's exposure calculated using the ‘commitment method' exceeds three times its net asset value), but funds with greater than EUR 500 million of ‘regulatory AUM' (i.e. gross exposure calculation of fund assets), as well as potentially other funds which fall below these thresholds.

"The proposals could apply to all types of AIFs, not just hedge funds, but private equity, real estate and other types of funds.

"The proposals do not address the findings of the ongoing IOSCO review of leverage nor any changes which may be implemented to the leverage measures as a result of the ‘AIFMD 2' review. In our opinion, these should be addressed as soon as possible in order for regulators to compare apples with apples across funds and regulatory jurisdiction.

"The current AIFMD leverage measures are still, in several areas, subject to different interpretation across the industry leading to inconsistent reporting to national regulators.'

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The European Securities and Markets Authority (ESMA), the EU securities regulator, has launched a public consultation on its draft guidance to address leverage risks in the Alternative Investment Fund (AIF) sector.

The consultation is part of the ESMA response to the recommendations of the European Systemic Risk Board (ESRB) in April 2018 to address liquidity and leverage risk in investment funds.

ESMA says its draft guidelines aim to promote supervisory convergence in the way National Competent Authorities (NCAs) assess how the use of leverage within the AIF sector contributes to the build-up of systemic risk in the financial system, as well as how they design, calibrate and implement leverage limits.

ESMA says it will consider the feedback it receives to this consultation by September 1 with a view to finalising the guidelines for publication.

Steven Maijoor, Chairman, said: "In situations when financial markets are under severe stress, highly leveraged alternative investment funds can further amplify systemic risk. Considering the size of the investment fund sector, achieving supervisory convergence in NCAs' approaches to monitoring and regulating the use of leverage by alternative investment funds is of the utmost importance

"Our proposed Guidelines address the assessment of leverage-related systemic risk and aim at ensuring that NCAs adopt a consistent approach when assessing whether the condition for imposing leverage-related measures are met."

Bill Prew, CEO, INDOS Financial, an independent fund depositary and oversight business, has responded as follows.

"The consultation is in response to the recommendations of the European Systemic Risk Board (ESRB) in April 2018 to address liquidity and leverage risk in investment funds (in particular, the extent to which the use of leverage within AIFs contributes to the build-up of systemic risk in the financial system, and to give guidance on macroprudential leverage limits).

"The most eye-catching part of the proposals is a requirement that regulators ‘should impose leverage limits' on funds (or groups of funds) that they consider ‘pose risks to financial stability'.

"Whilst AIFMD has always allowed regulators to set leverage limits, to our knowledge regulators have not imposed limits since AIFMD was first introduced in 2014 – managers have been free to set the maximum level of leverage which they believe are ‘reasonable'.

"Regulators will need to base their assessments on the Annex IV regulatory reporting they receive from managers. The proposals not only focus on those AIFs that employ substantial leverage (defined by AIFMD as when an AIF's exposure calculated using the ‘commitment method' exceeds three times its net asset value), but funds with greater than EUR 500 million of ‘regulatory AUM' (i.e. gross exposure calculation of fund assets), as well as potentially other funds which fall below these thresholds.

"The proposals could apply to all types of AIFs, not just hedge funds, but private equity, real estate and other types of funds.

"The proposals do not address the findings of the ongoing IOSCO review of leverage nor any changes which may be implemented to the leverage measures as a result of the ‘AIFMD 2' review. In our opinion, these should be addressed as soon as possible in order for regulators to compare apples with apples across funds and regulatory jurisdiction.

"The current AIFMD leverage measures are still, in several areas, subject to different interpretation across the industry leading to inconsistent reporting to national regulators.'