The Irish Funds Industry: Opportunities and Challenges - Deputy Governor Ed Sibley

Remarks at Irish Funds Annual Global Funds Conference 2019¹

Introduction

Good morning ladies and gentlemen. I am delighted to be here today, to speak at your Annual Global Funds Conference for the first time, and am grateful to Irish Funds for the invitation.

It is an important and timely event. As is evident from the breadth of the agenda, there are a host of developments, issues, challenges and opportunities being discussed that are of fundamental importance to the long term success of the Irish funds industry. 

Consequently, in my remarks today I will cover:

1. Brexit.
2. Regulatory perspectives on the industry.
3. Some of the key challenges and opportunities that are with us today or on the horizon. 

I hope that from my remarks you will understand:

• The Central Bank’s views of the importance of the sector, and how our approach is driven by this.
• The importance of international trust and confidence in the workings of the Irish funds industry, and that this is not a given – in other words, it requires continuous effort and taking a longer term view.
• That work is needed to ensure that the foundations of the Irish funds industry are strong enough for it to continue to be as successful into the future as it has been in the recent past, including with regard to the governance of individual firms.

1. Brexit

I would rather not talk about Brexit again. But that would leave the proverbial elephant in the room unremarked upon. I will, however, be brief.

The Central Bank has published reams of material on Brexit², including outlining our expectations. Many of my colleagues have spoken about the issues and our expectations. Most recently, my colleague, Michael Hodson, spoke³ at a funds event in London on 14th May and covered Brexit in detail then. In short, the issues and risks have not gone away. The UK leaving the European Union without a deal remains a plausible outcome.

Consequently, I expect you to be taking advantage of the extra time you have to prepare for the plausible worse case. This is crucially important for the funds industry, as you operate in an industry where the connections with the UK financial system are higher than most.

How would you have coped if the UK had not been stepped back from the cliff in late March and again on the 10th April? Were you reliant on a political outcome or uncertain as to how your business would cope in the event of the UK leaving the EU at either of those points? We were all hoping for the best, but there were some who were depending on it. This needs to change.

Overall, I am satisfied that the financial system as a whole is resilient enough to be able to cope with a ‘hard’ Brexit, but that is not to say that there would not be individual firm failures as a result. For those of you that still have work outstanding – and some of you do – you need to take this extended window of opportunity to make sure that it is not your firm that is insufficiently prepared. This includes ensuring that client migrations are completed as necessary.

I would also highlight three Brexit effects that are already with us:

1. The diminishing of the UK voice in the EU regulatory ecosystem – the impacts of which I will return to later.
2. Our regulatory framework and supervisory approach has and will continue to evolve to respond to the increasing scale and complexity of the Irish financial system, including most pertinently for this audience, the significant changes in the investment firms and securities markets sectors⁴.
3. The lessons we have learned in preparing for a hard Brexit will be taken forward into our ongoing supervisory efforts; including relating to: the preparedness of different sectors and firms; the further insights we have gained regarding the levels of interconnectedness and associated risks; and the need for continued enhancements in reporting and data analytics. 

2. A broader supervisory perspective on the industry

Turning now to the funds industry specifically. It plays a critical role in the functioning of the financial system – facilitating savers to prepare for their longer-term needs, including financing education or retirement and capital allocation to direct funds from savers and investors to companies and borrowers.

The Irish funds industry has grown enormously over the last 25 years. Ireland clearly has developed comparative advantages across the industry, including creating local expertise that supports provision of services on a global scale, as evidenced by Irish entities providing services to people in 90 countries⁵, and its size⁶; notably:

• There are currently over 7,000 investment funds (including sub-funds) domiciled in Ireland with €2.5 trillion in Assets Under Management.
• Ireland accounts for 58% of European ETFs (exchange traded funds) with Assets Under Management of €366 billion at end of 2018.
• Ireland has 38% of Euro Area Money Market Funds with €490 billion in Assets Under Management in 2018.
• In 2018, the Central Bank granted 1,117 new fund (UCITS and AIFs) authorisations, which is more than any previous year, and approved 1,052 prospectus documents (under the prospectus directive).

Regulatory & Supervisory Approach

Our approach to the regulation and supervision of the industry is reflective of this global scale and our financial stability, consumer and investor protection mandates. In the case of the funds industry and the wider ecosystem that it operates in, we need to consider our mandate from both an Irish and a wider international perspective. International investors and regulators need to have confidence in the resilience of the funds located in and trust in the services provided from Ireland. 

We strive to ensure that the system as a whole is appropriately resilient. This does not mean that we have a zero failure risk appetite – but it does mean that we seek to ensure that the failure of any individual entity is manageable. In other words that the system as a whole is resilient and does not respond to shocks by amplifying them.

So our approach is proportionate, risk-based, takes a longer term view; and is in line with international norms and European requirements. 

European requirements continue to evolve and in the context of Brexit, the cross border provision of financial services, including funds is being scrutinised. As the UK voice at the EU policy table is diminished, it is crucial that the Irish Industry is a trusted portal for the European funds industry.

The cross border provision of financial services is beneficial for the economies and citizens of Ireland and the EU – in terms of choice, cost, comparative advantages, and more besides. But it is not perfectly executed, and across all industries more work is required to enhance trust in regulatory and supervisory equivalence, as this cross-border model cannot sustainably be based on regulatory arbitrage – perceived or actual.

So there is a continued need for convergence and continued improvements in the strength and effectiveness of regulation and supervision. Not all of this is popular with industry, and indeed, I recognise that there may be short-term costs to compliance, of enhancing risk management, of improving governance, and so on. And that not all regulation and requirements developed at EU level are perfectly calibrated for funds based in Ireland. But we do not have to look very far afield to see how much worse the alternative is.

The world does not stand still. The status quo is difficult, if not impossible, to maintain – and nor is it necessarily desirable. So, the alternative to convergence is divergence. Harmonised European regulation and supervision are key ingredients to financial stability and confidence in the European financial system. This does not mean that everything has to be the same but consistent implementation of the same rules using similar approaches to ensure a level playing field of high quality regulation is required. Such an approach in key areas will support the continued success of the Irish funds industry.

In this context, the Irish Funds industry needs to take care as to how it uses its powerful and effective voice – both within Ireland and in the EU. There are long-term opportunities in showing real leadership and delivering socially useful innovation to support Irish and European businesses and citizens prosper in the face of the serious challenges on the horizon, such as demographic change and climate breakdown. There are short-term risks of seeking to weaken the regulatory environment or overly resist the progress of it – risks that have crystallised time and again over hundreds of years⁷.

Governance

The reputation of the Irish funds industry is built on the foundations of strong governance. And that is why I am concerned that we are still seeing inadequacies in board oversight and wider governance issues across too many firms. To take one important example, far too many fund management companies are, in effect, ceding key decisions and control to investment management companies to such an extent that serious questions have to be raised about the substance of the firm. We have not stood for this in applications for new authorisations, and it is equally unacceptable for existing firms.

In 2019, we will be undertaking a thematic review to assess how firms have implemented the package of Fund Management Company Effectiveness⁸ measures introduced on foot of CP86⁹. The broad aim of this work will be to identify standards of industry compliance, to inform our supervisory approach and to ensure that management companies have systems of governance in place to protect investors’ best interests. We will use our full suite of tools to address any failings we identify.

International engagement

Of course, the Central Bank is committed to working effectively in international and EU fora to shape and influence the ongoing enhancement of regulatory frameworks and supervisory standards. This is consistent with our general mind-set, and our obligation to make a commensurate contribution relative to the size of the funds industry in Ireland and the potential risks it poses beyond Ireland.

Our efforts are focused on ensuring that enhancements deliver proportionate, risk-based, and effective outcomes. The Central Bank is taking a leading role in IOSCO and the ESMA supervisory boards where the regulatory agendas are set. In support of these strategic roles, we actively participate in key areas of work such as improving the understanding of international financial flows through non-bank sectors and we are currently co-leading IOSCO’s¹⁰ work on ETFs. This work has been important in building our understanding of interconnectedness and financial stability risks. It also will help with the necessary scrutiny on the flow of funds between jurisdictions.

We also devote considerable resources to our participation in ESMA¹¹, from the Board of Supervisors level to various committees and working groups. This includes participation at ESMA’s Supervisory Coordination Network (SCN). The SCN focuses on authorisation requests and supervision issues arising from firms within the asset management sector seeking to relocate from the UK. Since its formation in 2017, the SCN has proven itself to be an important vehicle in ensuring a high level of consistency in supervision across the EU27 by promoting common supervisory practices.

As with other competent authorities, the Central Bank’s approach to authorisation has been subject to challenging scrutiny. On occasion this challenge has been uncomfortable, but it has always been welcome. It has helped to ensure that our and others’ authorisation approaches are appropriately rigorous. It does not mean that our specific national requirements and approaches are the same, but does provide assurance that they are producing equivalent outcomes. And the lessons learnt from this process are also being applied to ongoing supervision.

3. Key Developments and Priorities

The theme of the conference asks a question as to whether the future of funds will be evolutionary or revolutionary. So having covered our overall views on the industry and our approach, I will spend the remainder of my remarks looking forward and consider three pertinent issues relevant to the theme, that are high on the Central Bank’s priorities with respect to the Funds industry.

Sustainable finance / ESG (Environmental, Social & Governance) Investing

In the funds sector, sustainable finance or ESG investing is becoming increasingly important. As part of Capital Markets Union, it aims to promote investments that consider environmental, social and governance factors, with the aim of shifting investors’ focus to long term value creation.

As my colleague Deputy Governor – Central Banking Sharon Donnery stated last week, the Central Bank’s increasing focus on climate change reflects its far-reaching impacts and risks and the need for the Central Bank to factor these into:

• How we think about supervising banks and insurers.
• How the investment fund industry operates.
• How interlinkages across the financial sector might amplify climate risks.¹²

We have been engaging on the sustainable finance aspects of climate change for some time, dedicating resources and collaborating across the Bank to develop our policy positions, engage with key stakeholders and support the development of legislative proposals at the EU level, arising from the Action Plan on Financing Sustainable Growth¹³. More recently, we have joined the Network for Greening the Financial System and will both learn from international expertise and seek to play an active part in future developments.

Political agreement has recently been reached on two proposed regulations arising from the Action Plan for Financing Sustainable Growth, on sustainable benchmarks and disclosure requirements. This latter Regulation requires firms to disclose:

• The procedures they have in place to integrate environmental and social risks into their investment and advisory process.
• The extent to which those risks might have an impact on the profitability of the investment.
• Where institutional investors claim to be pursuing a "green" investment strategy, information on how this strategy is implemented and the sustainability or climate impact of their products and portfolios¹⁴.

A third Regulation on an EU classification system on economically sustainable economic activities – or taxonomy – is in progress with political agreement expected before year end. The first taxonomies will focus on climate change, and will allow for the disclosure of more standardised data that can drive forward other measures including an EU Ecolabel and Green Bond Standard.

ESMA has also recently published its technical advice to the European Commission on integrating sustainability risks and factors for UCITS, AIFMD and MiFID II. ESMA has advised that fund managers should be required to assess the exposure of the fund to sustainability risks and take these into account when formulating their organisational policies and procedures. 

Needless to say, the consideration of ESG issues and sustainability risks is increasingly becoming a focus for regulatory authorities and market participants generally. I anticipate that this will continue to be a growing area of focus for both the Central Bank and the wider regulatory community for some years to come.

Transformative technology

Technology has undoubtedly transformed financial services, including the funds industry, and will continue to do so. Investment decisions and how they are executed are inextricably linked to technology. To take one example, the widespread and increasing use of algorithmic and electronic trading has implications for market volatility, potentially amplifying systemic risks and may result in significant investor loss. This was certainly the case in the “Flash Crash” of May 2010, when US markets dropped 6% in value, only to rebound within minutes. The Dow Jones had an intraday point swing of almost 1,000 points and over 20,000 trades in 300 securities were executed at prices up to 60% away from pre-crash values¹⁵.

It is, therefore, imperative that governance arrangements, risk management arrangements and control frameworks are keeping pace with these developments – including regarding clear oversight, reporting, defined roles and responsibilities, clear processes and controls and effective testing. In other words, the changes may be revolutionary, but the approach to mitigating the risks are more evolutionary.

Our dependence on technology in financial services continues to increase. Too many firms are still struggling with getting the fundamentals right around general IT risk management, IT security, IT continuity and outsourcing.

Within the Central Bank we have a developed a common methodology across all financial sectors to assess technology risk within regulated firms, and are continuously updating our approach in line with regulatory developments and best practice. For 2019, we are continuing to push firms to focus on the fundamental while also enhancing their cyber and operational resilience to be able to withstand, absorb, and recover from an IT incident.

The Central Bank recognises the significant benefits that outsourcing can bring to firms and your clients, particularly in dealing with these technology related issues – which often require scale to deal with effectively. In 2016, the Central Bank carried out a review of fund administration outsourcing arrangements and today, the observations and recommendations arising from this review are a part of our formal guidance for fund administrators who outsource fund administration activities.

More recently, we completed a review of outsourcing across the wider financial services sector in Ireland. This body of work culminated in the Central Bank publishing a paper last November titled ‘Outsourcing – Findings and Issues for Discussion’¹⁶.

In brief, the findings outlined in the paper are concerning; they point to poor governance and controls around risk assessment and management of outsourcing; inadequate monitoring and reporting; a failure to consider outsourced service providers in business continuity planning and testing; and a lack of exit strategies. Notwithstanding the formal guidance in place, these issues are evident in the funds industry. This needs to change. Boards and senior management need to take significant and proactive action to address the issues identified from this body of work and to improve the standards of outsourcing, governance and risk management.

Enhancing the quality and use of data

The increasing importance of effectively managing and using data is obviously intrinsically linked to the developments in technology I have touched on. This is as true for the Central Bank as it is for all of you. It is therefore essential that we continue to progress in developing our data analytical capabilities.

With this in mind, the Prudential Analysis and Inspections Directorate, with c. 150 staff was created in the Central Bank earlier this year, with the purpose of:

• Strengthening our analytical capability, to ensure our supervisory approach uses a wide range of information to make evidenced based decisions.
• Delivering robust and consistent inspection outcomes, underpinned by the depth of technical and practical risk capabilities.
• Further develop risk expertise, increase peer and industry level analysis, create the space to look ahead.

Of course, it is critical that the data we receive is accurate and reliable. Specifically, with respect to securities and markets supervision, one of the areas in which we are working to improve overall data quality is through our EMIR data quality work.

In February we issued a letter¹⁷ to EMIR counterparties to provide feedback on the main issues identified from reviews on data quality we undertook in 2018 and so that appropriate action can be taken to ensure complete, accurate and timely reporting going forward.

The letter to firms marked the culmination of a series of data quality checks on reported EMIR data. It focused on the extent to which reporting complies with the requirements under EMIR and related implementing and technical regulations and guidance.

Overall, while we do recognise that the quality of data reported is improving, significant issues remain. These can be substantially addressed by applying the recommendations outlined in this letter.

Conclusion

To conclude, it is impossible to do full justice to the complexity and importance of the funds industry, and the opportunities and challenges it faces in 15 minutes.

I have scratched the surface of a few key topics this morning, all of which are important to our aspiration of the Irish funds industry playing its part in a well-functioning financial system which sustainably serves the needs of the economy and its consumers and investors.

This requires that the funds industry, in aggregate, is trustworthy, resilient and well-governed; that markets are transparent, fair and efficient and that investors are adequately protected. All of you have a part to play in ensuring this is the case, now and into the future – whatever it may bring.

Thank you for your attention. 

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¹ With thanks to Steuart Alexander, Stephanie Kearns, Orna McNamara, Adrian O’Mahony, Tim O’Hanrahan, Darragh Rossi and Sonia Weafer for their assistance with these remarks.

² See Brexit Task Force Reports, Brexit FAQ – Financial Services Firms, Brexit FAQ – Consumers and How We Regulate – Authorisation.

³ Hodson, Michael: Reflections on Brexit, insights on supervision and enhancing diversity, remarks delivered to Pinsent Masons event (14 May 2019). 

⁴ Including: Multilateral Trading Facilities; Organised Trading Facilities; High Frequency Trading Firms; Systematic Internalisers; and Investment banking activity. 

⁵ Lardner, Pat: The positive contribution of the funds industry to Ireland's economy, Irish Funds (17 May 2019).

⁶ Figures obtained from internal Central Bank data.

⁷ Dagher, Jihad: Regulatory cycles: Revisiting the Political Economy of Financial Crises,  IMF Working Paper No. 18/8 (2018).

⁸ Kincaid, Colm: How Diversity and Inclusion can contribute to successful decision making in the Funds Industry, remarks delivered to the Irish Fund Directors Association Diversity & Culture Event (14 May 2019).

⁹ Central Bank of Ireland: Fund Management Company guidance.

¹⁰ International Organization of Securities Commissions (IOSCO) is the international body that brings together the world's securities regulators and is recognised as the global standard setter for the securities sector. IOSCO develops, implements and promotes adherence to internationally recognised standards for securities regulation.

¹¹ The European Securities and Markets Authority (ESMA) is an independent EU Authority that contributes to safeguarding the stability of the European Union's financial system by enhancing the protection of investors and promoting stable and orderly financial markets.

¹² Donnery, Sharon: Risks and opportunities form climate change, address to Department of Finance and Sustainable Nation Ireland Conference (16 May 2019).

¹³ European Commission: Commission action plan on financing sustainable growth (2018).

¹⁴ European Council: Sustainable finance: Presidency and Parliament reach political agreement on transparency rules, press release (7 March 2019). 

¹⁵ US Commodity Futures Trading Commission and US Securities & Exchange Commission: Findings Regarding the Market Events of May 6, 2010, Report of the Staff of the CFTC and Sec to the Joint Advisory Committee on Emerging Regulatory Issues (September 2010).

¹⁶ Central Bank of Ireland: Discussion Paper 8 - Outsourcing - Finding and Issues for Discussion (November 2018). 

¹⁷ Central Bank of Ireland: Dear CEO Letter (20 February 2019).