Remarks by Director of Securities and Markets Supervision, Patricia Dunne, at PwC event
06 December 2022
Speech
Good afternoon, it is great to have the opportunity to speak to you today and I want to thank PWC for inviting me.
Today I’m going to discuss the Central Bank’s latest work on fund management company effectiveness (so called CP86) and give you an indication as to what the latest survey results are telling us about the structure of the sector and what to expect in terms of next steps. I will also briefly talk to sustainable finance topics in light of the forthcoming deadline for compliance with the disclosure requirements under the EU Sustainable Finance Disclosures Regulation (SFDR). Finally, I will look to 2023 and beyond, calling out some of the key risks and supervisory priorities for the Central Bank and how these will inform our expectations of, and engagement with, the sector.
The Central Bank has communicated extensively about our expectations of the Irish funds sector, the primacy of investor protection and our focus on ensuring firms are appropriately governed, well-run and operating to the highest standards. We recognise the positive steps taken in these areas across the sector over the last number of years.
Today, the funds industry in Ireland is significant and continues to grow year-on-year. Assets under management (‘AUM’) in Irish domiciled funds have increased from €650 billion in 2008 and currently stand at around €3.8 trillion. This growth has accelerated in recent years; since 2018, there has been a €1.4trn increase in the assets under management. The number of Irish authorised funds is around 8,500. This ongoing growth and development represents important diversification in the funding of the economy and supports the goals of Capital Markets Union, including making capital markets and their benefits more accessible to investors of all types. However, it is also crucial that the sector’s resources, expertise and substance develop in line with the growth to avoid the negative outcomes and harm that can arise for investors and to wider financial stability when actors in the sector fail to maintain high quality conduct and standards.
Fund Management companies Effectiveness
With this in mind, the Central Bank’s fund management company framework was introduced to ensure good governance and organisation, effective management and appropriate oversight in fund management companies for the protection of investors, the integrity of the market and to promote stability.
The framework sets out the Central Bank’s expectations in respect of the governance, management and oversight requirements and arrangements within fund management companies, in particular with regard to organisational effectiveness, delegate oversight, resourcing and the performance of managerial functions. The framework makes it clear that a fund management company can only operate effectively when it has an appropriate level of resources.
Irish fund management companies must be able to demonstrate that they are in control of and manage all aspects of the business they are responsible for, irrespective of whether activities are delegated to a third party or a group entity.
Thematic review
You will no doubt all be familiar with the in-depth thematic review of fund management companies that the Central Bank began in 2019, the findings of which were communicated by way of industry letter (PDF 614.8KB) in 2020. While there were a number of positive elements highlighted at that time, there were also shortcomings identified.
In June 2022, the Central Bank conducted a follow up industry survey to assess how the governance, structure and resources in fund management companies had evolved as firms took action to address the findings communicated in the industry letter.
Today I would briefly like to reflect on what the survey results are telling us.
Fund Management Companies Review – Driving Change
The results show that progress has been made and we’ve seen encouraging signs that the step change we have sought is starting to take place. It’s clear that the review in broader terms has driven significant change in the Fund Management Company landscape in Ireland in terms of how fund management companies structure their business and also how they organise themselves. When considering the results of the survey, it is helpful to do so under the broad themes of Changing Landscape and Corporate Governance and Resourcing.
In terms of the Changing Landscape, the survey results show that the sector has changed materially in terms of scale, structure and complexity over the past 3 years:
- At the time of our initial review in 2019, there were 358 Fund Management Companies (‘FMCs’) in scope. Our most recent survey was completed by 148 fund management companies, signalling a significant decrease in the number of firms operating in Ireland, despite sizeable growth in AUM. The most significant change has been the 90% decrease in the total number of Self-Managed Investment Companies (‘SMICs’) currently operating in Ireland. This has come about due to large-scale restructuring, predominantly as a result of migration of business to third party fund management companies and, to a lesser extent, redomiciliations, liquidations and consolidations.
- The decline in self-managed fund structures has resulted in significant growth in those fund management companies providing services to third party funds. The scale of firms operating this business model has grown significantly since 2019, with AUM among this group of firms now in the region of €540bn. It is essential that these firms have the capacity to take on this additional business, and we expect to see corresponding increased resources and expertise as the nature, scale and complexity of third party fund management companies grows.
- The results of the survey also highlight the growth in the level and extent to which fund management companies are providing MiFID services such as Individual Portfolio Management (IPM). In 2019, there was approximately €19bn in assets under management for IPM services; this figure has now increased to €432bn. Recognising this trend, we have targeted fund management companies providing MiFID services in recent supervisory work. We would highlight that with such additional business activities comes additional risks and regulatory obligations. As such, fund management companies engaged in MiFID services need to ensure that their regulatory compliance frameworks, systems and controls comply with the additional MiFID conduct of business obligations that apply to such services.
In terms of Corporate Governance and Resourcing, while the most recent survey results indicate progress made within fund management companies, they also highlight areas requiring further improvement:
- CEO - The survey evidenced a significant uplift in the number of fund management companies with a dedicated CEO. The survey found that 67% of fund management companies now have a dedicated CEO; this represents a 50% increase since our first survey in 2019. The Central Bank notes the clear benefits this change has had in its engagement with fund management companies and it is positive to see that the number of firms appointing a dedicated CEO continues to increase. As we outlined in our 2020 industry letter, the Central Bank expects that all but the smallest fund management companies have a CEO appointed.
- Director time commitments - From a sectoral perspective, on average, time committed by directors has almost doubled since 2019, reflecting another positive move. While this increased time commitment to individual directorships is welcome, directors need to be mindful of their overall time commitments to ensure it remains sustainable. This is something we will continue to monitor through our gatekeeping and supervisory engagement and, where we deem the number of directorships to be excessive, these will continue to be challenged.
- Designated Persons & Support Staff - The results have also shown positive changes in the level of resources within the Managerial Functions; since 2019, the average FTE increase per firm is three-fold, rising from 3.2 in 2019 to 10 in 2022. If we focus on the top ten fund management companies in terms of AUM, we have seen an increase of approximately 200% in resourcing of Managerial Functions. Furthermore, when we consider those firms currently within the Medium-High/Medium-Low Impact category, the average headcount per firm is approximately 23 FTE. The level of resources in fund management companies must be continuously monitored and should grow in line with the nature, scale and complexity of the business.
- INED Tenure - The number of INEDs with a tenure of greater than ten years has decreased by 7%, from 25% in 2019 to 18% in 2022. Directors should be mindful that tenure is a factor that can impact on their ability to act independently and this should be continually assessed. While this signals a move in the right direction, it still reflects a sizeable number of directors who continue to be classified as independent but have been in situ for 10 years or more. The Central Bank expects that tenure and independence continue to be considered as part of the Organisational Effectiveness Director’s (‘OED’s’) review of Board composition and forms part of related reporting to the Board.
- Board Diversity - The results of the survey indicate that there has been a marginal increase in the number of directorships held by women from 16% in 2019 to approximately 20% in 2022. A significant gender imbalance still exists at Board level and we expect fund management companies to consider diversity as part of ongoing internal governance reviews, including due consideration of factors such as skills, age, gender, culture and ethnicity.
These results highlight that the majority of our fund management companies have embraced the changes and have engaged positively with supervisors in doing so. However, there are a cohort of firms that still have some to work do to fall in line with their peers. I would ask that you take the following message back to your firms or your clients – these assessments will form part of our ongoing regulatory and supervisory engagement. We will continue to challenge firms on all aspects of their compliance with the Central Bank requirements and Guidance as and when their operations grow.
While it is evident that a lot of work has been done to date, collectively we have a lot more to do.
In terms of next steps, the Central Bank will issue a letter this week to all Fund Management Companies. This communication will set out the results that I have shared with you today.
The findings from the 2019 review and recent survey results will inform the Central Bank’s policy development, which will identify necessary changes to enhance and clarify certain aspects of the existing fund management company Requirements and Guidance.
What does the future look like for Fund Management Companies and the Funds Sector as a whole?
Open Strategic Autonomy
It is worth spending some time considering what the future looks like for the Funds Sector. Brexit has had a significant influence on shaping the Irish Funds Sector and brought increased scrutiny on the role of the fund management company.
In that context, for the Central Bank and indeed, Ireland as a whole, the UK remains an important partner and we have a long established and historic relationship with significant interlinkages and dependencies between our economies and financial sectors. The recent turmoil in the UK pension sector, and the impact on GBP liability-driven investment (LDI) funds, was a clear example of these complex interlinkages.
Investment funds authorised by the Central Bank of Ireland have aggregate holdings in UK gilts of approximately stg£267bn. Throughout this period, and in conjunction with other relevant NCAs, we engaged proactively with the managers of LDI funds to ensure they took the appropriate actions to strengthen their ability to absorb shocks. The resilience of GBP LDI funds across Europe has subsequently improved. But given the current market outlook, we do expect that levels of resilience and the reduced risk profile of GBP LDI funds should now be maintained, and do not consider any reduction in the resilience at individual sub-fund level to be warranted at this point.
This episode, and the effective interaction across the various NCAs, has emphasised again the importance of continuing to ensure a coordinated and effective response to market developments - particularly those with a cross-border dimension.
In the EU, attention is focused on the concept of “Open Strategic Autonomy” - to strengthen the EU’s resilience, while seeking to ensure it remains open to the world. While, in the UK, the focus has turned to the development of domestic regulations, and with that comes the potential of moving away from established and agreed EU frameworks.
This dynamic brings new challenges, particularly that of divergence, where a lack of consistency in approaches risks undermining the collective effectiveness of regulatory frameworks, especially in the context of capital markets, given their global nature.
In this context, given the post Brexit environment we find ourselves in, there is an intense spotlight on activities with linkages to third countries – particularly, for example, where an EU firm or fund delegates or outsources activity outside of the Union.
Delegation
Delegation is another area of particular focus – for us and in Europe. Whilst the proposals are still to be finalised, the AIFMD review is likely to bring targeted changes to the current regime to enhance the reporting of delegation activity, particularly to third countries.
When we look at Ireland, fund management companies established here manage a significant number of investment funds that are distributed with a wide footprint, not only at a domestic level but also on a European and Global scale. As such, Irish fund management companies must perform their duties to a high standard and thereby protect the interests of investors in host jurisdictions.
Ireland already has robust requirements in place to protect against letterbox entities and to ensure effective oversight of delegates by fund management companies. We continue to develop and refine our domestic rules to ensure they reflect not only EU level requirements, but that firms also meet our expectations in terms of their substantive structures, activities and risk profile in Ireland.
The proposals contained in the AIFMD Review mark the start of a longer-term process that will take a deeper and more comprehensive look into delegation in Europe. Linked to this, focus on supervisory convergence will have a significant part to play in this process, with continued emphasis on delegation and outsourcing. In particular, ESMA is expected to carry out a peer review in this area in 2024.
I know industry will be actively engaged at both national and European level on the issue of Delegation.
Your views will be vital to forming a balanced and objective approach to delegation in the future.
Sustainable Finance Disclosure Regulation (SFDR)
Before I finish, it would be remiss of me not to address sustainable finance. In addressing this topic, I am conscious that for regulators there are a number of interacting and complementary priorities. Firstly, we are concerned with the risks to regulated firms’ sound functioning, and more broadly, to financial stability, arising from increasingly commonly occurring climate events or from the transition to a sustainable economy. These are the prudential and financial stability risks associated with climate change. Secondly, but no less important, we are concerned with conduct related aspects. In particular, we want to ensure that investors are fully informed when making investment decisions. This is particularly relevant where investments or financial products are described as green or sustainable. We want to ensure that this is meaningful and accurate and based on reliable parameters that are consistently applied both within jurisdictions and across Europe.
The Central Bank recently hosted a seminar in this area and also issued an Information Note (PDF 722.63KB) on the topic. That note sets out findings from a gatekeeper review of investment fund disclosures and outlines Central Bank expectations around the implementation of the next phase of SFDR. The note is designed to inform and assist industry in ensuring that investors and the market can have a high degree of trust and confidence in green and sustainable products produced and sold from this jurisdiction. The next phase of SFDR implementation –including detailed disclosure templates to be included in funds’ prospectuses – is important in terms of the level of information that investors will now have about the products in which they invest. I expect firms’ implementation of these requirements to be well progressed and indeed most funds have now submitted their updated documentation as part of the Central Bank’s streamlined authorisation process for these updates. Investors have high expectations for the funds sector with regard to sustainable finance. It is critical that the sector is positioned to support a timely and effective transition to a more sustainable economy, and for this to happen, standards must be high.
Conclusion
Let me conclude there. I hope my remarks today have given you a good sense of how the implementation of the Fund Management Companies Guidance has evolved and progressed. The steps we are undertaking in the Central Bank are all designed to support the aim of continuing to strengthen the resilience of the funds sector, with particular focus on Fund Management Companies, while ensuring the best interests of investors are protected.
The current trend of macro-economic instability further underpins the importance of effective governance, management and oversight of fund management companies. And, while a lot has been achieved, there are challenges on the horizon which will require in-depth consideration and extensive engagement from all parties. It will be important that Industry and Regulators work together to build common approaches to deal with these collective challenges.