Address by Gareth Murphy, Director of Markets Supervision to the Irish Funds Industry Association

02 June 2011 Speech
Good afternoon, ladies and gentlemen.

Thank you for the invitation to speak at your annual conference.

This afternoon, I would like to take some time to update you on the approach of the Central Bank to the regulation and supervision of the funds industry, to mention the evolving nature of regulation in Europe especially in light of the creation of the new European Securities and Markets Authority (ESMA), and to indicate the likely direction of travel of global and EU policy for the funds industry in the medium term.

Though I have spent almost all of the last twenty years working in London, I am conscious of the significant success of the Irish funds industry during that period and its positive contribution to the Irish economy.

1. Approach to Regulation

Let me start by outlining some thoughts which inform the running of the Markets Directorate at the Central Bank.

First, I believe that the effectiveness and credibility of the regulatory regime is based on a mutual understanding between regulators and market participants. In one of my previous jobs running the Equity Derivatives Flow Desk at JP Morgan, vigorous interaction between sales-people and traders, borne out of a natural tension to do deals and manage risk, was the order of the day.

Whilst agreement may not always be possible, I believe that a strong regulator/industry dialogue enables the Central Bank to be more responsive to this dynamic and vibrant part of the Irish financial services sector. It also ensures that we have a well-informed and effective voice in Europe.

I would go further: since taking up my current role eight months ago, I believe that the professionalism and engagement of our funds team, lead by Patricia Moloney, with the support of a Risk Advisor from this industry, has played a substantial role in assisting industry participants and protecting investors whilst maintaining the integrity of the regulatory regime.

On the subject of communication – which can be fostered at many levels – I would not be true to myself (and my own particular career path via the investment banking and hedge fund industries) if I did not press you and your organisations to consider the benefit of secondments to the Central Bank as means of bringing fresh challenge to regulatory thinking and specific expertise to the supervision divisions.

Turning to the second aspect of the approach to regulation, I believe that the credibility of the regulatory regime and the sustainable health of the Irish financial services industry are mutually-aligned objectives. Whilst the Central Bank no longer has a promotional role for the development of the Irish financial services industry[i], I have no hesitation promoting the regulatory approach taken by the Market’s Directorate in the knowledge that it is an important pillar underpinning the soundness of the Irish financial services industry.

Third, the purpose of regulation is to make markets more efficient. Conscious that the interests of fund promoters, investors and other stakeholders may, at times, be ill-served by the way markets develop, I am committed to well-designed regulation which understands business models, understands competitive pressures and is implemented by smart, responsive regulators.[ii] This is a challenging task requiring strong dialogue with stakeholders – and I would commend the forthright role of IFIA in this regard. It also requires a commitment to having an influential role in Europe (especially with the creation of the European Supervisory and Markets Authority (ESMA)). Lastly, we must be prepared to compete in the market-place for new staff.

‘Cradle to grave’ supervision

In the past, the authorisation and supervision of funds has been conducted in separate divisions at the Central Bank. In the belief that there are substantial synergies in aligning authorisation staff with supervision staff, I have reorganised the Directorate so that there is now a dedicated funds division with responsibility for all matters funds-related (save for enforcement and broader policy issues). This “cradle to grave” approach centralises expertise all the time ensuring that we can fulfil our various responsibilities.

Risk-Based Supervision

In line with the domestic reform programme, the model for prudential supervision at the Central Bank is changing and we are at an advanced stage in adopting a risk-based approach to financial supervision.[iii] Put simply, this means calibrating supervisory resources in a proportionate way with the regulated entities which can do the most harm when they fail. It is not a zero-failure regime and indeed it relies on reliable mechanisms for dealing with failure in an orderly way. But it is a regime which seeks to avoid failures which could have an adverse impact on the Irish economy.

As regards the funds industry, we will focus more of our supervisory attention on those service providers and funds where failure could do the greatest damage. In particular, this requires close monitoring of the industry and current market developments, like for example, increased proliferation of exchange-traded funds, the robustness of custody arrangements or the use of leverage in UCITS. As markets change, we are conscious that we need to shift focus and adapt so that our regulatory approach is relevant.

Automation of regulatory processes

Risk-based supervision also requires efficient modes of engagement and monitoring. You will all be aware of the volume of paper consumed in interactions with the Central Bank. Work is underway to automate various processes including fitness and probity questionnaires and electronic reporting.[iv]

Very shortly, we will write to all Fund Service Providers’ (managers, administrators and trustees) to tell them that regulatory returns should be filed electronically from the end of August 2011. Funds (themselves) will be included in the next phase. Later this year, Individual Questionnaires will be submitted on-line and handled by a dedicated Fitness & Probity team. Next year, work will commence on automating aspects of the authorisation and post-authorisation applications.

The resulting efficiency gains should sharpen our regulatory focus and enhance our responsiveness to stakeholders, including members of the funds industry.

2. Ongoing Regulatory Reforms


With just one month to the deadline, we can now look forward to the arrival and implementation of UCITS IV. For many months now we have reminded industry firms of the need to be UCITS IV compliant (where relevant) from 1 July and we are continuing to process the revised business plans of our existing UCITS management companies.

Of course the Central Bank itself must be prepared to implement UCITS IV from 1 July and we will ensure that we are best-in-class amongst our EU regulatory peer group in our readiness to fulfil our responsibilities.

Not only will the necessary legislation be in place but the regulatory regime around it will be fully developed. We are almost at the end of this process and we are confident that following the recent consultation process, comprehensive documents will be issued, setting down how the new requirements will be applied to Irish management companies and self-managed investment companies.

I would like to take this opportunity to remind industry representatives of the importance of ensuring that each business plan submitted by UCITS management companies must be of a sufficiently high standard to ensure that the Irish industry meets its obligations by the deadline.

This is not to say that we have found answers to all of the questions which have arisen in relation to UCITS IV. There are outstanding issues such as measurement of leverage, disclosure of leverage and diversification requirements. Discussions are ongoing with our ESMA colleagues on these matters as we strive for an approach which creates a level playing field.

Lastly, some changes to the Central Bank’s Non-UCITS Notices are also required, notably a new regime for non-UCITS money market funds. As agreed within ESMA, all European authorised money-market funds will be subject to the ESMA guidelines established last summer.

Minimum Activity Requirements

Minimum activity requirements stem from our need to be able to adequately regulate firms which have outsourced certain activities. We will also introduce changes to those minimum activity requirements which apply to Irish authorised funds as part of the UCITS IV package. The UCITS and Non-UCITS Notices will be amended to remove the minimum activity requirements that apply to Irish investment funds. Administration companies and management companies who carry out administration and who delegate these activities must comply with a set of outsourcing requirements published by the Central Bank. These requirements will help to ensure that firms maintain adequate control and oversight over the outsourced activities.

While the passport for UCITS management companies caused the most controversy during the UCITS IV negotiations, it has not received much attention of late as all stakeholders have focussed on practical implementation issues. Therefore it is difficult at this time to gauge how extensively the management company passport might be used and in which jurisdictions. We will work with our ESMA colleagues to put in place the necessary procedures to facilitate the smooth operation of the management passport.

Alternative Investment Fund Managers Directive (AIFMD)

With regard to the Alternative Investment Fund Managers Directive, extensive work is taking place in preparing ESMA’s advice to the European Commission. Once implemented in 2013, the AIFMD will change the way in which many non-UCITS managers currently carry out their business. In the case of Irish regulated funds, these changes will not be overly significant as the funds are already subject to a national regime. Of course there are implications for Irish non-UCITS funds and their managers which are not currently subject to regulation. Even if these entities are not caught within the scope of the Directive they will be subject to registration and ongoing reporting to the Central Bank.[v] ESMA has established four task forces to provide advice to the European Commission. The Central Bank is represented on each of these and chairs the group dealing with scope issues. Notwithstanding the drain on resources within the Funds Division, we believe it is hugely important to assist in the development of an appropriate regulatory regime for our non-UCITS managers and non-UCITS funds.

Currently the most important issues which are being explored within the groups are those relating to (i) the appointment of the depositary, (ii) the role of the external valuer and (iii) capital. The calculation of the threshold below which managers fall outside the scope of the Directive is also important and this is linked to the calculation of leverage which is being addressed principally with regard to reporting to supervisors and to investors.

The role of Irish fund administrators in the context of the AIFMD provisions regarding the appointment of an external valuer is far from clear. I am aware that fund administrators do not regard themselves as valuers per se, however it would appear that other authorities consider that this is their function. We will ensure that this matter is discussed at ESMA and identified in ESMA consultation papers on Level 2 measures. It is important that this issue is resolved in the coming months.

One of the key issues to be addressed by the depositary task force is to define what is meant by a “financial instrument”. Assets falling within this category will be subject to MiFID safekeeping requirements. More importantly they will be subject to a strict liability regime. Assets not categorised as financial instruments will be regarded as “other assets” and will be subject to a liability regime based on negligence. ESMA must work to ensure that it arrives at an appropriate definition in both cases because the results of this work here will impact on the future UCITS V Directive which will bring AIFMD and UCITS into sync.

UCITS V - Depository Liability

As most of you are aware, the European Commission consulted on further changes to the UCITS Directive in December last year. The proposed changes involve two areas – the role and liability of the UCITS depositary and remuneration of UCITS managers. The Central Bank’s response to this consultation focussed on the depositary issues. We welcomed many of the proposed changes, for example, the intention to align the oversight duties of depositaries of corporate UCITS with those which apply in the case of contractual UCITS and a general prohibition on delegation of oversight duties. Indeed, these currently apply in the case of Irish UCITS.

In principle, we believe that there should be a single liability standard for both UCITS and non-UCITS. However the proposals to apply the AIFMD liability regime to UCITS without those provisions which allow the discharge of liability in certain circumstances are likely to be such that most depositaries will be unwilling to act for UCITS. As there is a risk that AIFMD’s strict liability regime incentivises the transfer of liability, custodial responsibility may shift beyond our regulatory perimeter. Therefore, we are of the view that the existing depositary liability regime in the UCITS Directive is a better standard which provides a higher degree of investor protection and as such should be retained.

With regard to safe-keeping duties we agree that depositaries should be subject to the same rules for the safe-keeping of the same asset type. As I noted earlier, this is one of the reasons why ESMA must take great care in arriving at a proposed definition of financial instrument in the context of the AIFMD. Indeed it would have been preferable by far if the UCITS safe-keeping requirements had been devised first followed by rules for non-UCITS.

These issues will be outlined in a comprehensive consultation document which ESMA intends to publish for a two-month period in July – which I hope does not spoil your summer holiday plans!

Corporate Governance Code - Investment Funds and Fund Service Providers

Weak corporate governance is often a feature of financial crises and certainly has been a contributing factor to the current state of the Irish banking system.[vi] In contrast, the Irish funds industry has successfully weathered the most recent financial storm. But we must not be too sanguine. Effective corporate governance for all Irish regulated entities is a key priority on the Central Bank’s regulatory agenda.

While it is acknowledged that funds are different from other types of financial institutions, the Corporate Governance code for funds will adopt the broad principles of good corporate governance including, composition and role of the board, role of independent directors, risk management, audit and compliance monitoring along with the management of conflicts of interest.

There has been much debate on the number of directorships which individuals can hold and we expect that the final version of the code will address this in a pragmatic way. We agree that given the diverse nature of funds, an absolute limit would not be appropriate. Instead, we expect Directors to be realistic about their time commitments and that Directors will be appointed having regard for an assessment of time required.

The issue of independence has also provoked interesting discussions. The presence of promoters, investment managers, lawyers and other service providers on boards can be extremely valuable but I would argue that such directors should not be considered independent for the purposes of the code. We need a set of clear rules so that investors can take comfort that their interests are upheld.

Finally, I would like to take this time to commend the work of IFIA, under the direction of Gary Palmer, and other funds industry participants in the development of this voluntary code for the funds industry. We have had interesting discussions around the development of this code. We look forward to the outputs of the consultation process and to monitoring the subsequent take-up of the code when it is rolled out.

3. Engaging with the medium-term regulatory agenda

Before I wrap up, I would like mention some important issues which may surface on the horizon in the medium-term.

Beyond banking reform

The Financial Stability Board (FSB), representing G20 regulators, has a substantial post-crisis policy agenda. In particular, a work-stream focussing on reducing the systemic effects of the money market mutual fund industry (MMF) has been created as a result of the provision by the US authorities of an explicit guarantee to its $3.8trn US MMF industry after the Reserve Primary Fund broke the buck in September 2008. Conscious of the possible implications for the Irish financial system, I have been in active dialogue with FSB members – with whom I have strong relationships. Many Irish MMFs mimic many of the features of SEC 2a7 funds and do so within the UCITS structure so changes either to the US or to the EU regulatory regimes matter. As yet, work on possible policy changes is at a very early stage; we are contributing to that debate and I would encourage you to engage with us at the same time so that we can be vigilant to any changes which might impact the Irish financial system.

Complex UCITS

European regulators are concerned about the retailisation of complex financial products. Whereas UCITS was initially conceived of as a framework for the creation of collective investment schemes appropriate to retail investors, over time the product has adapted more and more to developments in financial innovation and the UCITS brand now encompasses a very diverse and quite complex array of products. As a result, the extent to which retail investors may rely on UCITS is being challenged.

ESMA has established a task force to consider its role in relation to investor protection.[vii] In order to develop proposals, ESMA is gathering data from competent authorities about consumer trends and financial innovation. Part of this work involves a stock-take of complex UCITS and their key features. This will also assist ESMA in fulfilling its obligations to the new European Systemic Risk Board (ESRB).[viii]

Much attention has been focussed in recent times on the growth in Exchange Traded Funds (ETFs). ETFs have seen significant capital inflows and have developed beyond the traditional physical index replicating product. Recent innovations have seen substantial growth in synthetic ETFs, which use derivatives to gain exposure to indices. Some ETFs are now using leverage and a small number are pursuing dynamic investment strategies. Even though these are listed products, there are concerns that investors are not being provided with sufficient information to distinguish these more complex ETFs from the traditional physical tracking non-leveraged product. Also, the use of collateral within ETFs tracking synthetic indices adds a new level of complexity and risk for investors to assess.

There may also be a need for improved disclosure around the significant level of stock lending being carried out by ETFs, the fee sharing arrangements arising from this activity and the type and quality of collateral taken into these funds. There are a significant number of Irish UCITS established as ETFs and we support proposals to take stock of these issues with a view to the development of appropriate disclosure regulation.

Structured UCITS like, for example, those that use total return swaps with single counterparties to gain exposure to complicated investment strategies such as long/short equity, absolute return and complex macro, are also receiving much media attention. These types of UCITS can present challenges for clear and understandable investor disclosure and the Central Bank will be paying particular attention to these funds in the context of the implementation of the Key Investor Information Document (KIID) regime under UCITS IV.

Moreover, structured UCITS also present challenges for the Central Bank in terms of ensuring that the underlying to the swap is UCITS-compliant. The underlying strategies, including those within strategy indices, can consume considerable amounts of Central Bank time and resources. We would appeal to industry, bearing in mind that these are UCITS products, to ensure that both submissions to the Central Bank and the prospectus (itself) provide clear descriptions of the nature of the product and its inherent risks.


All of us here today have a role in influencing the medium-term regulatory agenda. European policy developments are many and varied and contribute significantly to the workload of the Markets Directorate.

The formation of ESMA last January presents new challenges and new opportunities. Along with the creation of the other European Supervisory Authorities for the banking and insurance sectors,[ix] the aim of this new regulatory authority is to generate greater convergence and co-ordination within the EU.

ESMA will now have a much broader and deeper mandate for regulatory supervision than the old CESR, including important legislative and emergency oversight powers. ESMA is likely in many respects to be the most influential of the European Supervisory Authorities since its remit, encompassing securities, markets, credit rating agencies, clearing houses and fund managers, will cover a much broader scope of financial activity than that of the other two European Supervisory Authorities. Although ESMA will continue the work of CESR, it will have new powers, the most important of which is the ability to draft technical standards that are legally binding on EU Member States.[x]

ESMA alone has 43 sub-committees considering various issues as part of the emerging policy agenda. You should be aware that the Markets Directorate has given priority to funds policy work. More generally, engagement with European policy will not only continue, it will intensify.

The creation of ESMA represents a shift from National authorities towards the European centre. I would urge you all to engage with the work of ESMA by monitoring its output and responding to its consultations especially whilst it is still in its infancy and thereby have some influence in how its work evolves. To assist you in this, I am more than happy to keep IFIA members abreast of key developments (that have been announced).


I do not wish to delay you much longer (before lunch). As a parting comment, I would like to note that Ireland’s strong position in the European financial services industry has been achieved through hard work and great skill. I am keenly aware that this is a joint endeavour and I would reiterate that we are conscious of our role as a key pillar supporting the industry.

Thank you for your time.