A tapestry of regulatory change- Remarks by Patricia Dunne, Director of Securities and Markets Supervision

Good morning, it is a pleasure to be here and thank you Iain and McCann Fitzgerald, for inviting me this morning to speak at this regulatory briefing. 

When I began thinking of some of the topics I would cover today, it was quite challenging to settle on where I would focus.  I think you will all agree we are in the midst of an almost unprecedented suite of legislative and regulatory initiatives spanning the whole investment fund ecosystem. These reach from the very building blocks of investment funds – the assets they hold - to the digital environment in which fund managers operate and include both a micro-prudential to macro-prudential focus. In the context of the numerous initiatives we are working through, either from an implementation perspective or where we are actively engaged at a European policy formation level what I will try to do today is to weave a clearer picture of what the near future has in store for the funds sector. 

UCITS

Let me start with product regulation. In his recent remarks on capital markets union Governor Makhlouf emphasised the need to provide investors with a wider range of well-regulated cost-effective products and he made a call to industry to up its game in this regard. Those comments echo similar sentiments reflected elsewhere recently, including ESMA’s report on building more effective and attractive Capital Markets in the EU.¹         

UCITS is the most important regulated investment fund product in Ireland. It is a global success story that has delivered significant benefits to both European investors and Member State economies.  UCITS represent almost 80% of total fund assets in Ireland, due in part to our position as the largest MMF and ETF domicile in Europe.  

For these reasons, the Central Bank recognises the importance of ESMA’s review of the UCITS Eligible Assets Directive and the need to bring the framework up to date given how markets and financial instruments have evolved since its introduction in 2007.  

We support an outcome that promotes high levels of investor protection recognising that UCITS are designed for retail investors, facilitates innovation and the role of UCITS as part of the EU's Capital Markets Union and Retail Investment Strategy.   It is also important that the framework evolves to give equal consideration to both asset eligibility and overall product suitability factors.

In carrying out this assessment the EAD, we should not lose sight of the critical success factors that have enabled UCITS to achieve such global status.  UCITS promote investor protection, market integration, harmonisation, transparency and the mobilisation of savings for long-term investment.  As the EU continues to develop its capital markets and empower retail investors, UCITS will play an even more significant role in the development and growth of Europe’s capital markets, while also allowing a diverse base of both institutional and retail investors meet their individual investment needs and desired outcomes. 

ELTIF

We have just seen the introduction of ELTIF 2.0 – a revised and enhanced European framework for European long-term investment funds, which is intended to address the relatively low take up under the original ELTIF framework. ELTIF 2.0 should help provide retail investors’ greater access to alternate investment strategies and assets, particularly in terms of long term, less liquid investments to fund the real economy. This was delivered earlier this year together with a new regulatory framework, which enabled the establishment by the Central Bank of a dedicated regulated ELTIF for the first time. The approach we have taken from an authorisation perspective provides a proportionate and appropriate framework for authorisation of these funds and we have seen a steady flow of engagement with the Central Bank. 

To date we have authorised only closed ended ELTIFs as we are still awaiting the final EU Regulatory Technical Standards, which deals with the establishment of open-ended ELTIFs. As we await deliberations on the RTS at an EU level, I hope the message is clear that the Central Bank is available to discuss how an open-ended ELTIF might be structured. 

Loan Origination

We are also in the midst of ongoing discussions with industry representatives in relation to the new AIFMD provisions on loan-originating funds.  For the first time a loan origination framework will be regulated at an EU level. It is a topic that the Central Bank strongly advocated for in the lead up to the AIFMD Review and we are pleased with the outcome.   Deputy Governor Rowland has already signalled the Central Bank’s intention to align its rules on loan origination with those proposed under the AIFMD revisions².  This development will result in significant changes to our existing rules – including removing the “single purpose rule” requirement, and mixed strategy funds will be able to originate loans for the first time. Furthermore, funds which originate loans will be available both to retail and professional investors. 

However key to these changes is the governance framework for loan origination that the revised Directive implements. The importance of a robust environment within which lending takes place and which is characterised by strong oversight in relation to lending activities has been a central tenet since the Central Bank implemented its own loan origination rules.  A more formal consultation on the Central Bank framework for loan originating funds is due to take place in Q4 of this year. 

Regulatory change for management companies

This brings me to the second thread; developments relating to the environment within which management companies operate, specifically the AIFMD and UCITS Directive Reviews. Amendments to these frameworks are not only attuned to international areas of focus but they also recognise the need for updates and harmonisation where possible.

Before I comment on certain aspects of the Reviews it might be worthwhile pausing to note points of commonality between them and the European Commission’s recently published 2024 European Financial Stability and Integration Review as these serve to emphasise the direction of European regulatory thinking. For example, one of the Commission’s findings identified the need to closely monitor the increased growth of investment funds and the dependence on non-EU service providers. Since the global financial crisis, the size of the EU funds industry has increased threefold. In Ireland, we now have more than €4.4 trillion in assets under management. In recognising the importance that funds play as a source of financing of the real of economy and their role in the functioning of the financial system it is ever more important to ensure their resilience. As such, it is important to keep enhancing our ability to detect potential systemic risks emanating from investment funds, though predicting distress in sectors of the financial system is inherently difficult. This is why we need to build resilience in the sector ex ante, to ensure that cohorts of funds do not act to amplify shocks that emerge from elsewhere. This includes  there being a suite of tools available to mitigate the effects of shocks and increase resilience. Whilst decisions taken by individual fund managers in response to shocks are often rational at an individual level, these decisions can generate negative spill-over effects when aggregated across entire cohorts of funds. This is why a macro prudential perspective focused on this systemic dimension is required to complement the investor protection focus.

The concern to ensure stability is among the reasons that the AIFMD and UCITS Directive Reviews have introduced enhanced reporting for AIFMs that is also being extended to UCITS management companies and a harmonised set of liquidity management tools. There is a need to ensure that management companies are equipped to deal with liquidity pressures in times of stress. Additionally, it is important that regulatory authorities continue to close the data gaps to have a more complete and timely view of the fund ecosystem. This has resulted in a number of recent significant data “asks” of industry. We appreciate the impact this has from a business perspective, however we consider them essential in order to fulfil the Central Bank’s mandate to ensure the stability of the system and the protection of investors.  

In terms of implementing these new requirements, while it will result in a significant body of work we are hopeful that the fact the Central Bank’s rules already provide for a full suite of LMTs as well as there being familiarity with AIFMD Annex IV reporting means that the work to be done is more an adaptation of existing requirements. 

The need for additional reporting also knits its way into the discussion on delegation. This is an important topic for the Irish fund sector and forms a significant element of the revisions to the AIFMD and UCITS Directive Reviews. The provision of information on delegation arrangements relating to portfolio and risk management will be an important part of the life cycle of a management company with extensive detail being required both at the time of a firm’s authorisation and on an ongoing basis. Indeed the Central Bank is currently undertaking thematic work in this specific area. 

Implementation plans 

There is naturally a body of work to do to achieve smooth implementation of ongoing regulatory initiatives. In an AIFMD / UCITS Directive context, the Central Bank is in the process of working on implementation plans to reflect the regulatory framework to support the revised Directives. In this regard, of course it is important to acknowledge that the Central Bank’s primary role in terms of transposition of the Directives’ text into Irish law is the provision of advice to the Department of Finance with whom we are working closely. . We are separately heavily involved in ESMA workstreams in developing Level 2 measures and are considering changes to our own regulatory rules to reflect the enhancements made and any consequential changes. While ESMA published a consultation on liquidity management techniques a few days ago. We will also have to engage with Industry by way of a public consultation on our regulatory requirements which is planned to take place later this year. We welcome the engagement with industry and acknowledge the significant amount of input you provide to our thought processes. 

I couldn’t speak about implementation of regulatory changes without briefly commenting on DORA – the Digital Operations Resilience Act which will apply from January 2025. The financial services industry operates in an environment where innovation and digitalisation is increasingly a feature. The speed and scale of this technological change brings significant opportunities as well as risks and it is against this background that DORA exists. This important piece of cross-sectoral legislation seeks to address digital operational risk across the EU in a consistent manner for the first time. 

From a management company perspective it will mean that network security and information and communication technologies (ICT) systems which support the business must adhere to harmonised technical standards. This will require the development of an internal governance, control and reporting framework, which will apply across the firm’s entire operations and right up to the board who must understand and assess ICT-related risk. 

This being said, the expectations DORA places on firms is not new and have been in place under a number of guises for quite a period of time. For example, there is a degree of commonality with existing requirements contained in the Central Bank’s guidance on Outsourcing, Operational Resilience and IT and Cybersecurity Risks.

In terms of implementation, we have established a dedicated team to work with internal and external stakeholders to ensure readiness to supervise all sectors for compliance with DORA obligations by next January.

Conclusion

So, to weave this tapestry of change together – it’s very clear that we are all going to be very busy in the coming months and years! 

There is lots here for industry to grapple with. Similarly, there is much for the Central Bank to consider not only in terms of implementation of new regulation but how we approach it.   Our focus is on achieving regulatory objective to provide investors with a choice of products that fulfil their investment needs while supporting private finance and the ambitions of capital markets union.

I will pause here and thank you again for inviting me today. 

[1] ESMA - BUILDING MORE EFFECTIVE AND ATTRACTIVE CAPITAL MARKETS IN THE EU POSITION PAPER