‘The Global Policy Landscape and Market Trends for the Asset Management Industry’ - Speech by Derville Rowland at the Managed Funds Association Global Summit 2021

Introduction

Ladies and gentlemen, it is a pleasure to address this Global Summit today.

I will cover a number of topics relevant to the asset management industry, namely the Central Bank of Ireland strategy, priority work areas for the European Securities and Markets Authority (ESMA) and the international regulatory community, including the European Commission’s ongoing review of the Alternative Investment Fund Managers Directive (AIFMD).

First, however, I thought it might be useful to give an overview of the investment funds sector from a European and Irish perspective. Total net assets of European investment funds reached €19.6 trillion this year. These assets were managed by 34,615 UCITS and 29,608 Alternative Investment Funds.  This is higher again when discretionary mandates are included and amounts to around €27 trillion.¹

In Ireland, the investment funds industry is significant and continues to grow year-on-year. Relative to the size of the economy, Ireland has one of the largest non-bank financial sectors in the world. Investment funds form the largest part of the non-bank financial intermediation sector in Ireland. Assets under management in Irish domiciled funds stand at €3.3 trillion with almost 8,000 investment funds authorised in Ireland.  These figures demonstrate the scale and global importance of the sector.

However, what they do not capture is the critical role which the sector plays in supporting the real economy, empowering citizens, households and businesses across the globe by providing access to professionally managed, diversified, collective investments.  In line with broader trends in the European asset management sector, we expect the Irish funds sector to continue to grow into the future.²

Central Bank new strategy

In the Central Bank’s approach to the funds sector, we place vital importance on being at the heart of the Europe System of Financial Supervision (ESFS).  Let me explain why. Some time ago at a previous event, I referenced the 1950 Schuman declaration, which paved the way for the establishment of the European Union (EU).³ It famously stated that:

“Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity.”

The Europe System of Financial Supervision is a fine example of that sentiment.

This supervisory architecture, with the European Supervisory Authorities and the European Systemic Risk Board at its centre, is a cornerstone of the comprehensive reforms initiated in Europe since the outbreak of the great financial crisis. The rationale for setting up the ESAs was to ensure closer cooperation and exchange of information among national supervisors, facilitate the adoption of EU solutions to cross-border problems, and advance the coherent interpretation and application of rules.⁴ Progress has been significant and sustained, with National Competent Authorities (NCAs) like the Central Bank playing a critical role in fostering greater regulatory convergence across the Union and supporting the successful delivery of the ESAs’ mandates. At the Central Bank, we strongly support the progress made to enhance regulatory convergence. We see it as vital that regulators learn from each other and that we develop a common supervisory approach to EU-wide priorities and problems. This is of particular importance in a sector like asset management, which, as a result of its scale and reach, has significant cross-broader activities and interlinkages. In our interconnected world, the ESAs and the NCAs, by working together, deliver better outcomes for investor protection and market integrity than if they were working in isolation.

ESMA and international agenda

In keeping with this commitment to being at the heart of the ESFS, I have recently been elected as Chair of ESMA’s Investment Management Standing Committee (IMSC). The IMSC is a standing committee tasked with recommending supervisory practices and policy development in the area of investment management to ESMA’s Board of Supervisors.

The committee plays an important role in the fulfilment of ESMA’s mandate to safeguard the stability of the EU's financial system by enhancing the protection of investors and promoting stable and orderly financial markets. The Central Bank is committed to effectively contributing to the international regulatory agenda on asset management, which is an important element of ESMA’s wider work plan in the coming period.

In that regard, I think it is important to highlight some key issues that are on the agenda from both an ESMA and international perspective.

Firstly, I want to start with liquidity. Effective liquidity management is important for the protection of investors, maintaining market integrity and reducing systemic risk, all of which supports financial stability. The importance of effective liquidity risk management is key at all times but has been reinforced by the period of stressed liquidity conditions witnessed across many markets in the wake of the COVID-19 market shock.

While the investment funds sector broadly demonstrated sufficient operational resilience throughout the pandemic, the episode highlighted certain vulnerabilities – particularly the potential for the collective behaviour of investment funds to add to market-wide pressures in periods of stress. This in turn may give rise to market integrity and financial stability concerns.

While these issues were on the agenda before the pandemic, it is clear that  further regulatory reform is needed. EU regulators have taken a number of important steps to scrutinise the robustness of liquidity management and the implementation of current requirements, which are extensive. This includes ESMA conducting a Common Supervisory Action on UCITS liquidity management⁵ and the European Systemic Risk Board recommendation on liquidity risks in investment funds.⁶

Internationally, risks associated with the collective action of investment funds and their ability to contribute to systemic risk are subject to particular scrutiny following the market turmoil of last year. These risks will rightly continue to be an increased area of regulatory focus. The Central Bank actively engaged in workstreams at the FSB and IOSCO relating to Money Market Funds and the liquidity management practices of open-ended funds more generally. These workstreams investigated the extent to which the investment fund sector has the potential to add to market-wide pressures in periods of stress.

Work in these areas will continue into 2022 with regulators progressing further initiatives in this regard.  Further to this and linked to systemic risk, what has become clear is the need to develop and operationalise a complete macroprudential framework for investment funds. Our views on this are known and have been well articulated by Governor Makhlouf, and I will return to them shortly.

In addition, investor protection concerns remain central to work programmes for policy makers at an EU level and in Ireland.

Focusing domestically for a moment, the Central Bank believes that firms should contribute to a culture of high standards for investor protection. We are conducting a significant body of work in relation to the costs and fees charged by UCITS investment funds.  This is being undertaken through an ESMA-organised Commission Supervisory Action (CSA). While this is primarily carried out through NCA-led supervisory work at a national level, it is coordinated centrally by ESMA. Areas of focus for particular CSAs are determined by the ESMA Board of Supervisors and take account of ESMA’s supervisory priorities as well as emerging risks. CSAs have become an integral part of supporting convergence efforts at ESMA. As part of the CSA on UCITS costs and fees, Central Bank supervisors have been engaging with local market participants to investigate their compliance with cost-related provisions of the UCITS framework. We expect to publish findings in this regard in due course. But as an overarching comment at this point, I would note the importance of UCITS management companies having structured pricing processes in place to periodically review the level of applicable fees and costs.

In this specific case, and more generally, ESMA’s CSAs are a good example of the valuable role that European authorities can play in building a common supervisory culture among NCAs and promoting sound, efficient, and consistent supervision throughout the Union. The topic of fees and costs was chosen because of the major impact they can have on long-term investment returns. For investors, particularly retail investors, comprehensive and comparable information on costs of investment products is critical. Retail investment products have been the focus of our attention, as professional investors should have the necessary skills and resources to appropriately scrutinise the range of investment products available to them and their associated costs.

Separately, but very much to the forefront of regulatory thinking on investor protection is the topic of sustainable finance, given the growing popularity and investor demand for so called ‘green’ investment funds.⁷ ESMA and the Central Bank share the priority of addressing climate change and supporting a sound transition to a sustainable economy - a priority that is both consistent and intertwined with our statutory mandates.

We need to accelerate action around this agenda – hence the focus on legislative implementation of the Sustainable Finance Disclosure Regulation (SFDR); Taxonomy Regulation; amendments to UCITS Directive, AIFMD and MiFID II; the proposal for a Corporate Sustainability Reporting Directive (CSRD) and elements of the European Commission’s new sustainable finance strategy.

The implementation of all of those requirements, and fostering greener securities markets more generally, will be a key area of focus for the Central Bank into 2022. This will include closely scrutinising how investment funds are complying with their supervisory obligations under the SFDR and taxonomy regulation with a thematic review in this area planned for next year.

In our view, the coming years will also require further legislative and regulatory evolution in this area in order to address potential challenges in the framework. For example, I am strongly supportive of the European Commission’s planned work, including its intention to look at minimum sustainability criteria for financial products that promote environmental or social characteristics.⁸ I think further improvements to the legislative framework in this area is required in order to mitigate potential greenwashing risks.

AIFMD Review

Turning to the AIFMD Review, I know it will be of particular interest to you given the role the Managed Funds Association plays in representing the views of the alternative investment sector.

The pace and nature of change in this sector is evident. This is particularly evident in the growth of private credit and private equity funds, for example. This growth has been part of a long-term trend since the great financial crisis and reflects the enhanced role the non-bank sector is now playing in financing arrangements. More recently, the pandemic has created conditions which have supported continued growth in this area, resulting in large amounts of available capital and a continued search for yield by investors. These financing arrangements can bring substantial benefits, including diversification of financing agreements for the real economy and supporting increased investor choice.  However, it is not without risk.

As such, this growth speaks to the importance of the regulatory framework in this area.  The AIFMD Review is particularly timely.  Since its introduction, the AIFMD has had a significant and positive impact on the regulation of the alternative investment sector.  It has facilitated cross-border integration while delivering better outcomes in terms of investor safeguards and improved monitoring of potential risks to the financial system.  However, regulatory and legislative frameworks should be calibrated such to appropriately balance integration in international financial markets, taking into account the increasingly complex global context in which the asset management sector now operates. There remains important room for improvement, to address identified weaknesses and ensure the sector continues to serve the best interests of investors and support a continually evolving economy.

Within the AIFMD Review, I think it is important to highlight systemic risk. Actions taken by investment funds and managers in periods of stress, while rational at the individual level, may be materially suboptimal at the system-wide level. While the AIFMD does currently provide for some systemic risk-monitoring obligations and related powers, further development is required. The Central Bank has advocated for this both generally and as part of the European Commission’s Consultation on the Review. The absence of such a macroprudential framework for investment funds remains, in our view, a key omission in the European regulatory toolkit.  In addition, ensuring a well-developed framework across the Union to support the availability and deployment of liquidity management tools is critical.  While this is first and foremost a micro-prudential tool by ensuring fund managers are in a position to appropriately manage their portfolios, this does have a broader macro or system-wide benefit by reducing potential idiosyncratic risk events.

The investment fund legislative framework has been designed to remove barriers between jurisdictions. From a European perspective, reducing barriers is particularly important in light of the Capital Markets Union and the need for deeper and more liquid markets, better risk diversification and more efficient capital allocation across Member States. The legislative framework has been crafted with an internationalist outlook. This is because the global nature of the European asset management sector - including delegation arrangements - allows for access to portfolio management expertise which facilitates European domiciled funds operating geographically diverse asset allocation strategies.

The global nature of the sector therefore provides investors across the world with access to products, specialism and investment advice that might not otherwise be available. As such, when managed appropriately and based on substantive oversight and control by the fund management company, delegation arrangements can bring substantial benefits to market participants and ultimately the end investor.

Therefore, in our view, any changes to the AIFMD (or the UCITS Directive) should focus on enhancing the effectiveness of fund management companies to discharge their obligations.  We look forward to publication of the Commission’s legislative proposal for the AIFMD review later this month.

Conclusion

To conclude, the pace of change within the investment funds industry and the alternative sectors specifically is clear.  If managed appropriately – both by market participants and policy makers in terms of ensuring the appropriate calibration of regulatory frameworks – this can have a very positive impact. It would ensure further provision of investor choice and help move the European economy away from its historic over-reliance on the banking sector for financing of the real economy.  Nevertheless, however, there are downside risks to which the regulatory community must be alive - particularly in terms of the wider functioning of the financial system and the potential for spillover effects.

For our part, the Central Bank will continue to work hard to deliver on our mandates, in line with the development of our new strategy, with the aim of being an open and transparent regulator.    Working together, I believe that we can create the right environment to promote a resilient and trustworthy financial system, in which firms and individuals adhere to a culture of fairness and high standards, which sustainably serves the needs of the economy and our fellow citizens.

Thank you.

¹See industry publications, such as EFAMA.

²See industry publications, such as Irish Funds.

³See remarks “Better together: Delivering Consumer Protection in Europe” delivered on 28 June 2019 at the Joint European Supervisory Authorities Consumer Protection Day 2019, The Mansion House, Dublin. Available at: https://www.centralbank.ie/news/article/speech-derville-rowland-esa-consumer-day-2019-28-june-2019

⁴See Report from the Commission to the European Parliament and the Council on the operation of the European Supervisory Authorities (ESAs) and the European System of Financial Supervision (ESFS) {SWD(2014) 261 final} available here.

⁵ESMA CSA on UCITS Liquidity Management: Available here: https://www.esma.europa.eu/press-news/esma-news/esma-assesses-compliance-ucits-liquidity-rules-and-highlights-areas-vigilance

⁶ESRB Recommendation (ESRB/2020/4). Available here: https://www.esrb.europa.eu/pub/pdf/recommendations/esrb.recommendation200514_ESRB_on_liquidity_risks_in_investment_funds~4a3972a25d.en.pdf

⁷See related media coverage: SFDR: article six funds ‘fall out of favour overnight’, dated 29 October 2021 by Ignites Europe. Available at: https://www.igniteseurope.com/c/3378824/429704/sfdr_article_funds_fall_favour_overnight?referrer_module=issueHeadline&module_order=1

Assets in SFDR funds rocket but number of funds is “unexpected”, dated 27 July 2021 by Funds Europe. Available at: https://www.funds-europe.com/news/assets-in-sfdr-funds-rocket-but-number-of-funds-is-unexpected

⁸See Communication from the Commission related to the Strategy for Financing the Transition to a Sustainable Economy, dated 6 July 2021. Available at: https://eur-lex.europa.eu/resource.html?uri=cellar:9f5e7e95-df06-11eb-895a-01aa75ed71a1.0001.02/DOC_1&format=PDF