ESMA has published a consultation on guidelines on the assessment of leverage and related systemic risks, aimed at ensuring that National Competent Authorities (NCAs) adopt a consistent approach to the supervision of Alternative Investment Fund Managers (AIFM), managing leveraged Alternative Investment Funds (AIFs), under Article 25 of the AIFM Directive.
Under the proposed guidelines, NCAs should assess the level, source and different usages of leverage by identifying AIFs,
- using leverage on a substantial basis,
- AIFs employing leverage but not on a substantial basis, with assets above €500 million,
- other AIFs with unusually high use of leverage, which may pose risks to financial stability.
To assess leverage related risks to financial stability of the above AIFs, NCAs should include in their assessment at least the following risks;
- market impact,
- fire sales,
- direct spill-over to financial institutions,
- interruption in direct credit intermediation.
NCAs’ risk assessments should include data reported under Annex IV of the AIFM Directive.
Under the guidelines, NCAs imposing leverage limits should consider the risks posed by funds according to their investment style, risk profile and any risks posed by common exposures of a group of AIFs.
The guidelines provide guidance to NCAs on the phasing in and out of leverage limits. For example, where an NCA imposes continuous leverage limits on an AIF, those limits should be maintained, as long as the risks posed by the AIF do not decrease. NCAs should implement leverage limits progressively to avoid procyclicality.
NCAs should evaluate the efficiency of leverage limits in mitigating excessive leverage by considering the proportionality of leverage limits to the systemic risk posed by the use of leverage of the AIF and the robustness of leverage limits to arbitrage.
The consultation is open until September 1, 2020. A link to the consultation is available here.