Fit for the future: some current issues in the regulation of Irish investment funds - Gerry Cross, Director of Policy and Risk

04 October 2018 Speech

Gerry Cross

Speech at the Dublin Fund Administration Forum - Bloomberg


Good morning ladies and gentlemen.  It is a pleasure to join you at the Dublin Fund Administration Forum, organised by Bloomberg. I am delighted to be able to speak to you on a number of key issues relevant to the regulation of the Irish investment funds sector.

While I propose to cover a number of issues of current relevance to the fund sector in Ireland, there is a cohering theme: fitness for the future.

The world around us is changing rapidly and will to continue to do so. The way things work today will not be the way they work in 5 years, probably not in 3 years, and maybe not even in 1 year.

So my theme today is the changing context of the Irish funds sector, and how that is reflected in regulation.

Scanning the future horizon

One thing that we know for sure given the events of 10 years ago and since, is that regulators cannot predict the future. So it would be hubristic of me, to say the least, to try and tell you what the future will look like 5 years from now.

But what regulators can do, and what we must do, is identify the dynamics and trends that are currently visible or predictable, and that will determine what that future will look like.

So let me try and identify a few key dynamics that we are currently seeing and to suggest what that might mean for the unfolding future. When I have done that, then we can look at some of the regulatory implications which will be necessary to prepare for that future.

Continuing growth. The fund industry in Ireland continues to grow. Assets in Irish domiciled funds have increased from approximately €650 billion in 2008 to approximately €2.5 trillion at the middle of this year. Assets under administration have increased from around €1.4 trillion to nearly €5 trillion during the same period.

Brexit. The UK is leaving the European Union. I am going to leave to one side the question of hard Brexit versus soft, orderly versus disorderly. That is an issue that has had and will continue to have a great deal of airtime. And rightly so. My point is a more straightforward one. As of less than six months from now and into the foreseeable future, with a very high probability, the UK will no longer be in the EU. Even with the best of transition periods, as of the 29th March 2019, the UK will be a third country. That fact has a range of implications.

The UK’s diminishing EU voice. The first is that the UK will no longer be the major force that it has been in EU financial services law making and regulation. It’s voice and its views, a voice and views that on many occasions have been very similar to our own, will no longer be at the table, or certainly not in the same way, when it comes to making the rules that govern financial services in Europe, including of course the Irish funds sector.

A challenge for Ireland. So when it comes to some of the important perspectives that we have shared strongly with the UK - the importance of open international capital markets, a belief that a cohering purpose of regulation should be to address market failures, the idea that it doesn’t matter greatly where something is done as long as it is done well and to high standards - well the voices arguing these perspectives will be that much less strong than before. Of course, these will still be very strong themes, as they are views shared by many. Still, we will all have to work harder to make sure that they continue to be as impactful as we would like them to be. And we will have to accept that some aspects of how they have shaped financial service provision in Europe are likely to change.

The need for new alliances. A corollary of this point, the diminished presence of the UK in European financial services rulemaking, is that we in Ireland as we engage in policy making and regulation in Europe are going to have to build new alliances and strengthen existing ones. That of course takes work and effort. It also requires identifying, consolidating and enhancing the common ground we share with different counterparties across Europe. And that will involve a whole new dynamic, a range of give and take, greater in some instances than has been the case up until now.

A more dispersed EU financial sector. A third impact of Brexit, is that the shape of the financial services sector in the EU is going to change dramatically. The global financial services centre that London is will no longer be in the EU. The result will be that financial services provision within the Union will become much more dispersed. We are seeing this already. Financial services providers are relocating their EU business from London. But not to any single Centre but to a number of different locations amongst which Ireland features strongly, but still clearly as one amongst a number.

The need for supervisory consistency. This dispersion of activities gives rise to significant implications. In particular it provides a real challenge to European policy makers: how to make sure in the context of this dispersion of financial services across a number of centres and with the UK authorities no longer playing a leading role, that there is strong consistency of approach to the supervision of financial services. We can expect to see loud and legitimate demands for greater consistency and coordination of supervisory practices.

Protecting the EU consumer. And this brings us to another very important point, the need to ensure that the national authorisation and supervision of financial services that are provided to a European population works well, effectively and to the benefit of investors and consumers. It will continue to be legitimate for those jurisdictions whose citizens are the recipients of financial services provided by firms supervised in other jurisdictions to seek assurance that the interests of their citizens are being well protected.

So Brexit will give rise to many changes which will impact the future of financial services and their regulation, including the Irish investment funds sector and its regulation and supervision. But there are other, non-Brexit related forces, which are also shaping the future. I won’t mention all of them but one or two.

Capital Markets Union. The further enhancement of European capital markets and the development of a European Capital Markets Union is a policy objective which we in the Central Bank of Ireland support. The objective of expanded sources of finance, of widened opportunities for investment and of a richer sharing of risks amongst European market participants has many benefits. But for this to happen, the appetite of European society for participating in financial markets as a way of securing a better financial future for all needs to evolve. And regulation has a key role to play in that. Regulation needs to continue to provide an important foundation upon which people’s confidence in the trustworthiness of the financial sector can be founded.

A focus on enhancing confidence. And this feeds into a wider theme, upon which a strong light was shone by the tracker mortgage scandal in Ireland. There remains, 10 years on from key moments of the financial crisis, a significant deficit of confidence in the desire and determination of financial services providers to do what is best for their customers. This is something that is anathema to financial regulators. One of our first goals is to ensure that customers have confidence in the financial system and that this confidence is well founded in soundness and trustworthiness. Which means that the future of the Irish funds, as of other financial sectors, will always have as a major component regulation and oversight based on a determination to underpin well-founded trust and confidence in the sector.

Innovation. Then there is the significant factor that is financial innovation and technological advance. I am not going to say too much about this particular aspect of the future today. It is something that I and others have spoken a good deal about previously and will do again.  As you know the Central Bank has set up an innovation hub, which is operating very successfully with a steady flow of enquirers and engagements. At the same time there is  work underway in Europe. And all this is as it should be; innovation and financial technology have the potential to deliver significant benefits for the consumers of financial services. It is important that we as regulators find the appropriate ways to engage effectively with them so as to allow those benefits to be realised.

Technological change. At the same time we need to ensure that consumers and the system are protected from emerging risks associated with technological developments. It and cyber risk has been and will continue to be a key area of focus for the Central Bank and other regulators in the coming period. Again this is not something that I can spend a great deal of time on today. Deputy Governor Ed Sibley dedicated a full speech to this topic only yesterday. All of you operating in the financial services sector need to have IT and Cyber risk amongst the top items on your agenda. You must be familiar with our expectations in this regard. See for example our Cross Industry Guidance in respect of Information Technology and Cybersecurity Risks of September 2016.

Sustainable finance. Finally, in terms of identifying some key features of the future landscape, let me mention sustainable finance. This is something that in the past has been seen as an area of interest but perhaps not something that was at the centre of concerns for the financial services industry. It is fair to say that that period is coming to an end. The initiatives of the European Commission in this space during 2018, building on previous work of the FSB and the High-Level Expert Group on Sustainable Finance mark a significant moment. It is perhaps not the initiatives themselves, important though they are, that is the most significant thing to note. But rather how they have been received and how quickly they have gained traction and been the locus of a quickly developing consensus amongst policy makers and market participants that Environmental, Social and Governance (ESG) factors have moved centre stage with the debate being not about whether but how to give them best effect from a regulatory perspective and to what timescale.

So if we had to sum up what the future for the funds industry might look like, how should we do it. Something like the following perhaps: it will be evolving and subject to continuous change; it will be European with all the benefits and all the responsibilities that that brings; it will be, in the literal sense of the work, challenging - you will be challenged without remit to demonstrate how you place the interests of your customers before all else and to show clearly your delivery of value for their money; it will be technological and it will be green.

To summarize it even more concisely, the future will be different to the present. On that note and paraphrasing the words of Marshall Goldsmith that “what got us here won’t get us there” let me turn to look at just a few of the current regulatory issues that are directly related to features of this emerging future landscape for the funds sector.

Fund management - substance, quality and effectiveness

I mentioned earlier the extent to which the Irish Funds sector has grown over recent years and the very significant scale and scope that it has achieved. This was one of the facts that led us about five years ago to begin a body of work to look at the issue of the effectiveness of fund management governance and to consider whether our regulatory framework needed to be enhanced.

This body of work, which became known as “CP86” was driven by investor protection concerns and concerns to ensure that our framework as the regulator for a large part of the European and global funds industry was and remains state of the art. It was always going to be an important piece of work, but it became even more so in light of Brexit and some of the issues to which that event has given rise.

Brexit and the discussions around it in Europe have brought back into sharp consideration questions around substantive presence, effective supervision, and the operation of delegation and outsourcing in the funds sector. This discussion has been triggered by the fact that the UK, a leading centre of funds and asset management activities will become, as of the 29 March 2019, a third country.

It was in a way then a happy coincidence that the major work that was carried out under CP86 came to fruition during the very period where these issues were being considered closely again at the European level. It has allowed us both to influence that discussion and also to demonstrate how in Ireland funds-related activities are regulated to a high standard. And that those standards are kept under continuing review and improvement to ensure that they continue to meet the changing landscape and that they are driving ever higher standards of investor protection.

As you know, after appropriate transition, CP86 came fully into effect on 1 July 2018. The rules and guidance introduced as a result of CP86 make clear that the running of a fund management company is not something that can be undertaken without dedicating the appropriate level of resources to that task. They make clear that the role of the directors and the role of designated persons, those tasked with the day-to-day running of the fund management company, are separate and distinct roles.

As you will all be aware our guidance on time commitments was developed to ensure that individual directors are not so cumulatively committed that they do not have the time available to fulfil their obligations towards each of the entities for which they have responsibility, and ultimately of course to the investors in the funds managed.

Designated persons are responsible for the management of the company on an ongoing basis. How much time, how many people are needed to do this depends of course on the nature, scale and complexity of the fund or funds being managed. There is no right number; you always have to look at the facts of the case. Brexit has brought us examples of authorisations where significant numbers of staff on the ground are necessary and of others where, because the amounts are relatively small and the business very straightforward, lower levels of staffing are required.

I would note however that Brexit has changed the landscape in another way. ESMA has set up a Supervisory Coordination Network (SCN), tasked with ensuring that consistent approaches to authorisations are being taken in each jurisdiction. This is something we very much welcomed, as the risk of regulatory arbitrage in the early days of Brexit when some relocating firms sought to find light touch regulatory options, was significant. But the operation of the SCN not only means that we have to identify the right approach for each individual applicant, we also have to be able to demonstrate to our European colleagues that we have done so. And vice versa. And the good news is that as we do so, we all learn from each other as to the best ways of addressing some of the challenging supervisory issues that each of has been facing, up until now, individually. As this process continues and we exchange views and discuss, and learn more, than it can be expected that all of our approaches will develop and evolve.

As I said earlier, the fact that we had the CP86 rules and guidance recently developed and in place has meant that we were very well positioned to engage effectively with the new ESMA processes and to share with others the learning that we have developed and the thinking that had been done here in Ireland.

For further discussion of CP86 and its implementation, I would refer you to recent speech by my colleague Michael Hodson, Director of Asset Management Supervision at the Central Bank.


An issue which is an important aspect of both CP86 and of the fund industry in general is that of the delegation of activities. Delegation is the feature of the funds industry that has allowed it to become truly international harnessing the abilities of a globally dispersed range of participants to the benefit of investors and the economy. It has allowed the effects of diversity, specialism and competition to be harnessed to the benefit of investors and those seeking investment alike.

But of course such delegation is not without its very important challenges and obligations. In particular it is essential that those who are running the fund to which investors are subscribed are at all times running that fund and ensuring that all delegation is carried strictly in accordance with the mandate of the fund and according to the standards and requirements to which that fund is subject.

This was another key focus of our CP86 work to ensure that the rules and guidance were up to date and effective in ensuring that this is in fact achieved. A key aspect of those rules and guidance is making sure that while activities may be outsourced, responsibility for those activities may not. CP86 requires fund management companies to have sufficient resources and the effective organisation needed to ensure that this is achieved.

European Supervisory Authority “ESA” Review proposal

Let me turn now to the subject of the current proposal for changes to the role and governance of the European Supervisory Authorities - the so-called ESAs review. This legislative proposal was put forward by the European Commission with the intent of updating the ESAs structure to reflect the current context - the ongoing work to improve the functioning of European financial services, including the efforts to develop a Capital Markets Union in the EU; the departure of the UK; and the fact that now 10 years after the epicentre of the global financial crisis there are still things to be done to make sure that Europe is as resilient as possible in the face of future crises.

All of these are laudable aims, and ones that we at the Central Bank support. As I intimated at the beginning of this speech, it will be important in the coming period, and in the new dynamic of the UK no longer being part of the EU, that financial markets in Europe and their governance are well adapted to the changing context. There will be a strong imperative to work even harder than before to ensure that the interests of consumers and investors are very well protected wherever in Europe they are and wherever in Europe the service provider is authorized and supervised.

It will be important that we have a continually increasing levels of convergence in how supervision is carried out in different jurisdictions. And it is essential that there are high levels of confidence in that regulation and supervision so that European financial services can achieve their optimal role in supporting the European economy.

What all of this means is that it makes sense that changes should be made so that the ESAs can build further on the significant success they have achieved since their establishment in the wake of the crisis and play an even greater and more successful role in the future.

We think that the way to achieve these objectives are likely to be through an enhanced framework for the setting of agreed supervisory standards, approaches and methodologies to be implemented by national supervisors. This could be combined with strengthened processes and mechanisms for reviewing and holding national authorities to account as to how they have been implementing those agreed supervisory standards. This should be combined with appropriate safeguards to ensure that the system operates fairly and as it should. Achieving this is likely to require some development in the independent role of the ESAs, their management and staff in respect of such reviews and assessments.

This approach would see a material increase in the role of the ESAs to consistently hold National Competent Authorities to account towards the achievement of the right outcomes for the European investor and European financial stability. I think that such an approach is better than a partial one which targets particular aspects such as the proposed case-by-case assessment approach in respect of third country delegation. Such an approach risks introducing both inefficiencies and imbalance and a degree of confusion in respect of supervisory powers and accountabilities.

Fees, transparency, and fairness

I mentioned earlier the need for investors to have trust and confidence in financial services and their providers. The issue of fees and charges, and investors being clear about what they are being charged and what they are getting in return, is and will continue to be a significant part of regulatory activity in the current and future period.

Let me mention some current issues in this respect: performance fees and the so-called “closet index trackers” issue.

The benefit of performance-related fees is that they aim to align the economic interests of the fund manager with the interests of the investors in the fund. The risk is that this is not what happens in practice and that performance fees are used to enhance the fees of the fund manager at the unfair expense of the investor.

The Central Bank’s approach to performance fees is currently set out in guidance which can be found on our website. This guidance includes provisions in relation to the basis for payment of the fee, appropriateness of a benchmark and the role of depositary in verifying the fee calculation. There are also overarching prospectus disclosure requirements. We have recently concluded a consultation (CP 119) where we propose to include the provisions in the Central Bank guidance as requirements, to be set out in the Central Bank UCITS Regulations. For the most part the requirements reflect the current guidance.  However there is one additional provision, which will specify that the minimum period for performance fee crystallisation is once per annum.  This will align the Central Bank’s approach on performance fees to the 2016 IOSCO Good Practices on Fees and Expenses.

In addition, earlier this year Central Bank supervisors carried out a thematic review on the payment of performance fees by UCITS.  The review investigated the methodologies and parameters selected and applied in the calculation of UCITS performance fees to examine if they were in line with Central Bank guidance. The results from the thematic review were set out in a recent letter which is also available on our website.  In brief, while some good practices were identified, instances of non-compliance with the Guidance was identified in approximately 10% of the sample of UCITS examined.  All fund management companies of UCITS which charge performance fees have been requested to review their existing methodologies and report back to the Central Bank by 30 November 2018 and we will continue our engagement with firms on this topic to ensure that the best interests of investors are protected.

There has been much media coverage recently of “closet indexing”.  This is a situation, where a fund manager indicates that they manage their funds in an active manner while the fund’s performance in practice adheres closely to a benchmark. The risk to investors is that the fund manager may be implementing a passive strategy while charging active strategy fees. ESMA issued a statement on this in 2016, providing details on the ESMA work, with a further update provided by the ESMA Chair late last year.  The matter remains under review, both within ESMA and within national competent authorities, including the Central Bank. It is a matter which you can expect to see being subject to further close scrutiny in the period ahead as, together with other NCAs, we hone our approach to this issue.


Let me conclude here.

I hope my remarks have given you some sense of some of the key forces shaping the emerging landscape for the funds sector as seen by a regulator. And of some, though by no means all, of the regulatory developments that are taking place in response to those.

Change, as we know, is a constant. And we live in constantly changing times. The challenge for both industry and regulators is to identify the emerging landscape as early as possible and to develop our strategies and responses accordingly. Hopefully my remarks have helped a little in this regard.

Thank you.