“Safeguarding the best interests of investors in a changing landscape” - Derville Rowland - Director General, Financial Conduct

Speaking At the Irish Funds London Symposium

Good morning ladies and gentlemen. It is a pleasure to be with you in London.

It was Harold Wilson who is accredited with the saying that “a week is a long time in politics”. After the events of the last thirty-six hours or so, I think you will agree that the saying could do with a bit of updating…

The world is moving at an ever-faster pace across so many fields, from politics to finance and more, as this room knows only too well.

This morning, I want to say a little about how the funds industry is adapting to that change – and how regulators like the Central Bank of Ireland are similarly adapting in order to protect the best interests of investors.

Wilson, of course, famously knew a thing about referendums on Europe. Having promised to renegotiate the British terms of entry if Labour were returned to power in the 1974 election, he took the results of the renegotiation to a referendum of the British people a year later.

67% voted in favour of staying in the EEC, as it was then known. Forty-one years later, the public effectively reversed that decision, electing to leave the European Union. While that decision was the right of the British people, its impacts, as we have seen, will be wide-ranging and significant.

To avoid cliff-edge effects, implementation of the Withdrawal Agreement and its associated process would obviously represent a far superior outcome to no deal. In all scenarios, effective contingency planning will be critical and must continue in order to mitigate impacts as they arise. 

Conscious of the significant events that form the backdrop to today’s conference, a few words on Brexit and issues relating to funds is appropriate. I will then turn to the importance of Capital Markets Union (CMU) from a regulator’s perspective, and what is required to help achieve it. Brexit, of course, makes the CMU project even more important while at the same time raising additional challenges. Finally, I will detail some of the other ongoing work at regulatory level to safeguard investors.

Brexit

In his latest book, ‘On Grand Strategy’, the distinguished Yale historian John Lewis Gaddis reflects on lessons in leadership from the ancients to modern times.

He focuses, in particular, on leaders who grow overconfident, and cites the salutary lesson of the Athenian statesman Pericles, who, over time, “began trying to control flows: the winds, the currents, the rowers, the rockets, the people, their enemies… Even fortune, he came to believe, would follow his orders…”

The flows and winds of Brexit will not all be within our control.

So while the publication and Cabinet approval of yesterday’s Withdrawal Agreement is a significant step, the process continues and much detail will need to be worked through.

While we all aspire to the smoothest possible exit with the least possible consequences, aspiration alone is not enough, and of course, there are variables that may not be anticipated. In real and practical terms, we have to focus on what we can do to mitigate the major risks.

Brexit has placed an obligation on all of us to undertake contingency planning for a range of scenarios, including those which are more likely than others. In that regard, I very much welcome the strong lead from the European Securities and Markets Authority (ESMA) – of which the Central Bank is a member - in pressing the importance of resolving the issue of agreeing Memoranda of Understanding (MOUs) with the UK regulators and their determination to push for a coordinated solution.

This is a vital issue and ESMA is working very hard to address it. Others are very much focussed on the political negotiations, and we are mindful of the need to respect that process.

Nevertheless, our clear objective, like other regulators, is to prepare for and mitigate significant cliff-edge effects to the greatest extent possible, regardless of the outcome of the political negotiations.

This is a vital objective in terms of protecting investors from the impact of any disorderly interruption of portfolio management mandates.

CMU – establishing a genuine single market

One of the great paradoxes of Brexit is that it has both slowed progress on the Capital Markets Union agenda and also rendered it imperative to deliver.

A key objective of CMU is to facilitate cross-border investment in the belief that enhanced integration – a genuine single market where investors are able to invest their funds, without hindrance, across borders – will improve the economic welfare of European citizens. Notwithstanding that CMU may now be more difficult to achieve, I believe we still have the means – not just the aspiration – to achieve it.
In order to progress that goal, regulators and industry must address a number of issues along the way.

It will be a process of incremental progress, step by step, in order to reach the goal of deeper, better functioning capital markets.

A lot has already been achieved and 2018 has seen further progress. Positive steps to date have included the agreement of a framework to further develop the securitisation market. The Prospectus Regulation has also been agreed, while under Solvency II, a new asset class of "qualifying infrastructure investments" has been developed and established.

This year, the Commission published its Fintech Action Plan, with the core objective of making European financial markets more integrated, safer and easier to access.
The plan recognises that new technologies are changing the finance industry and the way consumers and firms access services. New technologies have the potential to advance the CMU and the Digital Single Market and to increase retail participation in financial markets.

Fintech, however, also presents challenges such as cybersecurity risks, data, consumer and investor protection and market integrity issues. Ensuring that the best interests of investors are safeguarded in increasingly complex financial markets is a critical role for regulators, but also for industry.

We are also seeing greater emphasis by investors on the sustainability performance of companies when making investment decisions. In the European context, the Commission adopted a package of measures on sustainable finance in May, another important step along the road.

In July 2018, ESMA received a formal request from the Commission to provide technical advice on the integration of sustainability risks and factors in the UCITS and AIFM Directives. This is to be delivered to the Commission by 30 April 2019.

The IMSC and IPISC at ESMA are actively working on this issue. So too are colleagues at the European Insurance and Occupational Pensions Authority (EIOPA).

In light of this, ESMA is developing a consultation paper focusing on the investment management-related part of the request for advice with a view to publishing it in or around Q1 2019. It is important that the Commission’s aim of embedding environmental, social and governance (ESG) considerations in the EU asset management industry is done both effectively and proportionately.

Progress can also be seen on the issue of cross-border distribution of investment funds. But if these are welcome steps along the road, we must acknowledge there are significant obstacles in our path, too.

The debate around Capital Markets Union pre-dates Brexit, but the implications of Brexit are obvious both for how ambitious Europe needs to be in terms of developing a single capital market and in terms of the scale of the challenges we face in building that single capital market.

As a regulator, we get to engage closely with a wide range of market participants who are working out how best to structure their businesses.

One point is evident across the board: firms have an appetite for complex solutions which take advantage of the different labour pools, differing infrastructure, and differing investor concentrations in different parts of the EU.

Brexit has, if anything, focused the minds of the market on these strategic issues of structure and location, and we are seeing complex and highly varied solutions.

Europe needs to discuss and determine the scale of its post-Brexit ambition for CMU on a sector by sector basis. It can probably only do that authoritatively once there is greater clarity on the extent to which it will continue to rely on London, whether in the short term or longer term.

As a regulator, the next level of ambition is not something I can or should speculate upon.

What I can say with regard to CMU is that it creates a new challenge of trust with regard to regulation within the EU. If we are to push CMU to the next level, we must also push the level of trust across Europe in the quality of regulation and supervision to new highs.

In particular, we must seek to ensure continually increasing levels of convergence in how supervision is carried out in different jurisdictions. We think that an enhanced framework for the setting of agreed supervisory standards and methodologies to be implemented by national supervisors would lead to such convergence.

It should over time be driven by a shared analysis of regulatory risk, and underpinned by appropriate information-sharing so that our regulatory colleagues can all understand what is being passported into their jurisdiction.

Furthermore, we need to be willing and able to escalate issues to each other, knowing that we have a shared commitment to high standards of intervention in the interests of the single market that overrides any jurisdictional interest.

I believe that our approach would enable the ESAs to build further on the significant success they have achieved since their establishment in the wake of the crisis, and to play an even more successful role in the future.

As a regulator with more experience than perhaps any other of what it means to be the location for services across banking, insurance and asset management which rely on the single market, it will not surprise you to hear me say that we are ready for that higher level of mutual engagement and mutual support.

Market practices and investor protection

Finally, turning to the operational elements of fund management, I’d like to update you on current regulatory initiatives under way to safeguard investors, and why they are important. There is an extensive and ongoing debate about the shift to passive investing, and what this will ultimately mean from an investor’s perspective and, more widely, from an economic perspective. Certainly, from a regulator’s perspective, there are both benefits and clear risks in this trend.

While the move to low-cost index investing is viewed as a positive trend for investors, we still need to be mindful of investor protection considerations in light of some less than desirable market practices.

Closet indexing

One such practice, which has received media attention recently, is “closet indexing”.
It is a key priority for the Central Bank to ensure that investors are not disadvantaged by funds operating in a manner that is not consistent with their disclosure.

Work is ongoing at ESMA level on closet indexing, and at national level, the Central Bank has begun analysis on 2,000-plus Irish domiciled UCITS funds that report to be actively managed. Having identified outliers, a full desk-based review of the funds documentation such as KIIDs and prospectus as well as their relevant disclosures will be assessed. Follow-up with the relevant funds that are outliers or present cause for concern will be carried out. The Central Bank welcomes additional convergence work at ESMA on this topic to further compare the experiences of National Competent Authorities (NCAs).

Zero-fee funds

The subject of charges and fee transparency remains an important one for consumers, regulators and the industry in general. Recently we have seen cost-cutting escalating to where index-fund providers are launching index funds that appear to charge no fees at all.

One of the ways these managers are able to offer a zero-fee fund is by creating their own indices to track instead of licensing a well-known index like the S&P500.

IOSCO recently raised concerns about the influence of index providers and whether there are risks that need to be looked at as indices become more tailored and bespoke.
The Central Bank sees this issue as one of growing importance and is supportive of a global regulatory initiative on this issue, potentially progressed via IOSCO.

Performance fees

Staying on the topic of fees, domestically the Central Bank recently conducted a thematic review on performance fees to examine if they are in line with Central Bank guidance. A sample of UCITS sub-funds was reviewed and the results revealed a number of good practices across the majority. However, the Central Bank also identified instances of non-compliance with the guidance in a small percentage of the sample.

On foot of this review, all fund management companies of UCITS which charge performance fees have been required to review their existing methodologies and report back to the Central Bank by 30 November.

Conclusion

In concluding, it can truly be said we live in interesting times, in a geopolitical and financial landscape that is shifting at speed and scale. This brings opportunities and challenges.

What is critical is that we manage the risks as effectively as we can. I am going to finish where I started, by quoting Harold Wilson: “I am an optimist, but I’m an optimist who carries a raincoat.”

Thank you for your attention.