"Covid-19, funds sector, and sustainably serving the economy” - Director General, Financial Conduct, Derville Rowland

Remarks delivered at the Irish Funds Global Funds Conference on 19 May 2021

Good afternoon.

Thank you for inviting me to speak at this important and timely conference.  Last year, this event took place, successfully, in a virtual environment and I congratulate the Irish Funds team for once again delivering an excellent virtual conference, and for assembling an interesting array of speakers and panellists.    

This time last year we were just embarking on the uncertain journey which the Covid-19 pandemic was mapping out for us. Today, while we can start to look forward with hope, we should also pause to think of the suffering of the very many members of our global community, and the on-going challenges arising from the pandemic.  

Covid-19 has had a significant impact on the global economy and by extension on the financial system. Substantial interventions from the ECB, global central banks and other policy makers were required in order to protect the economy and to preserve the integrity of the financial system.

On the basis of evidence so far the financial system has, on the whole, proved to be resilient.  That being said, fragilities identified in certain sectors of the funds industry need to be addressed. These concerns have given rise to international workstreams on money market funds and liquidity management and are well underway. It is important to ensure that we seek to prevent behaviours contributing to, rather than preventing, stress in the system. 

Before we look forward, I would like to go back a little bit further, before Covid-19, a time that seems I’m sure many, many lifetimes ago now.

The period since the Great Financial Crisis has seen, and continues to see, significant changes in the structure and functioning of the financial system. These changes reflect not just the lessons learned from that crisis - and the subsequent regulatory reform programme - but also significant and ongoing societal and technological developments.

For the funds sector, these changes have been and continue to be significant. We continue to see, for example, the increasing proportion of investment and funding carried out through investment funds; we see the very significant role of the investment management sector in the transition to a sustainable economy; and of course we know that the rapid pace of technological change has important consequences for the sector.

The title of this Conference: “Accelerated Transformation – disruption and opportunity” captures the essence of this change, and points to the challenges, possibilities and risks ahead. While it is true for the funds sector, it is also relevant to ourselves as the regulatory authority.

As we are responsible for oversight of a large part of the European and international funds sector, the Central Bank of Ireland has very close regard to this context of continuing significant change.

Our regulatory objective is a resilient, fair and trustworthy financial system, which sustainably serves the needs of the economy and citizens of Ireland and the EU. This means that we are keen to see the funds sector fulfil its potential as a means of investment and funding in the European and Irish economies.

At the same time, we want to ensure that the funds sector remains resilient; that it functions strongly in line with the principles of fairness and primacy of investors’ interests; and that overall it is in line with the effective and sustainable functioning of the economy. This approach is reflected in our current strategic plan and will be at the heart of our next strategic plan which is currently in development.

Covid-19 lessons learned

A little over 12 months ago, the financial system underwent a significant real life stress test. With the onset of Covid-19, the system was faced with the dual challenge of grappling with the impact of the pandemic on the global economy, the markets and the financial system itself, while at the same time also adjusting to the vast majority of financial firms’ staff suddenly having to work from home.

This was a real challenge to financial firms’ resilience and flexibility. In general, and on a widespread basis, the system and individual firms passed this “working from home” test convincingly. That is something from which to take reassurance, and in respect of which all of us in the financial system can - I think - take some pride.

I know that we at the Central Bank are hugely grateful for, and impressed by, how our staff have risen to the enormous challenges and difficulties of this past 14 months. I am sure that the situation is similar in many, many firms throughout the financial system. While challenging indeed, the pandemic has demonstrated the deep human qualities underpinning all that we do.

The second test related to the significant turbulence that emerged in financial markets impacting the funds sector. Here the results were not so positive. Although more negative impacts on the economy were averted as a result of the significant interventions of central banks worldwide, what we observed in advance of those interventions were redemption stresses in Money Market Funds, and in less liquid open-ended funds, consistent with first mover dynamics.  While other factors were also at play, such as margin requirements, the overall implication is that under stress these parts of the funds sector did not play a role in absorbing shocks, but rather in transmitting and amplifying the stress.

For these reasons, amongst others, money market funds and liquidity management practices in the funds sector are currently under consideration. The Central Bank is actively participating in work underway at the FSB and IOSCO on these topics. Worthy of specific note in this regard is our involvement in the Financial Stability Engagement Group, or FSEG, established by IOSCO in early 2020. This group is now looking at the implications of the Covid-19 pandemic for financial stability, and will interact with key stakeholders, in particular the FSB.

What has become clear from the Covid-19 experience is the need to develop and operationalise a macroprudential framework for investment funds. Our views on the need for this are known, and have been well articulated by Governor Makhlouf. The Central Bank has advocated for this both generally and as part of the European Commission’s Consultation on the AIFMD Review.¹ The absence of such a macroprudential framework for investment funds remains, in our view, a key omission in the European regulatory toolkit.

Domestically, we recognise that the environment for macroprudential policy is constantly evolving, and at certain junctures, a deeper review of our frameworks is necessary. That is why this year and next we are carrying out a framework review across the three pillars of our macroprudential regime: the mortgage measures, the bank capital regime, and market-based finance.

In the latter area this may include measures such as leverage limits and options to limit liquidity mismatches, to strengthen the fund sector’s overall resilience to potential future shocks.

Considering the events last year, the scale of the sector in Ireland and the continued uncertainty we face, developing a comprehensive macroprudential framework for the non-bank sector remains an important priority for the Central Bank.

Funds and fund management

Which brings me to our expectations of the Irish funds sector. I have spoken before of the importance that we attach to ensuring that the Irish funds sector meets high expectations as a centre of EU investment and funding. In many respects this objective is of course being met. But there remains important room for improvement both having regard to areas where weaknesses have been identified and also where ongoing improvement will ensure that the sector will continue to serve the best interests of investors and support a continually evolving economy.  

The Central Bank has had a long-standing approach of closely scrutinising applications for authorisation, in particular for those funds designed for retail investors. This authorisation process has evolved over time, responding to emerging risks, product innovations, trends in the market as well as operational capabilities. 

In the latter part of 2019, the Central Bank introduced and subsequently communicated to industry a process whereby certain funds may be subject to ‘enhanced scrutiny’. This approach involves providing sufficient information to permit the Central Bank to make an informed judgement in relation to the application. This approach seeks to identify aspects of potential harm. This could be either to investors or could include systemic risk considerations arising from specific areas – liquidity and leverage, for example. Our approach is reflected in the application of a higher level of scrutiny and challenge these applications experience.

In the context of fund service providers, you will also be familiar with the in-depth thematic review of fund management companies which the Central Bank conducted in the recent past. This represented an assessment of how the sector met with the high standards expected of fund management companies in terms of strong governance, effective management and substantive oversight and control - as set out in our framework for management companies.

The end of quarter one will have seen fund management companies having agreed, at board level, a remedial action plan which reflects their critical assessment of operations as against regulatory expectations. Of course, agreeing a remedial action plan is only the first step. Fund management companies must execute these plans, and the changes must result in fund management companies which are organised in a way that meets the clear expectations of the Central Bank for this sector. Expectations, I may add, which are consistent with the evolving European regulatory landscape.²

In the context of liquidity, ESMA’s recent findings from its Common Supervisory Action (or CSA) showed that there remains some scope for improvement in liquidity management practices. The Central Bank’s findings aligned with those of other EU and EEA national competent authorities.

Yesterday, the Central Bank issued a letter to UCITS managers which outlines the actions now required of all Irish UCITS managers on foot of the CSA’s findings. This includes the need to critically review liquidity risk management frameworks and to take action necessary to address CSA findings. 

Diversity and performance

Each of these areas I’ve just spoken about - governance, oversight, risk management - rely on a strong culture and effective decision-making within firms. We believe achieving this requires diversity at senior management and board level. As diversity is interconnected with risk, resilience and financial performance, it will continue to be a priority for the Central Bank.

The Central Bank has recently published data on gender diversity in pre-approval controlled function (PCF) roles in the financial sector.³ The results showed a pronounced gender imbalance at decision-making level. Men held more than 85% of PCF roles within the insurance, banking and asset management sectors. While diversity goes far beyond the number of women in the workplace or in leadership roles, we focused on gender in part because of the data available, but also because we know that looking at gender diversity can also tell us, anecdotally, much about other facets of diversity.

The ability to achieve a good balance in terms of a firm’s diversity rests with the board. Firms must embrace diversity, not for the label it could attract, but for the significant and tangible benefits that differences of all types bring.  Different life experiences and perspectives will organically combat groupthink and unconscious bias. At a fundamental level, this can meaningfully contribute to risk and control self-assessments and for identifying potential emerging risks. Across an organisation, it can identify both risks and opportunities. Through its senior level appointments, a board will shape, or reshape a firm’s culture.

Environmental, Social and Governance (ESG)

Connected to the issue of culture and risk management, Environmental, Social and Governance issues are a strategic priority for the Central Bank. We see this as being both consistent and intertwined with our statutory mandates.⁴ 2021 and beyond is about accelerating action around this agenda.

This will be evident domestically in terms of action taken within the Central Bank. For example our now-established Climate Change Unit will intensify activity across all areas of the organisation and help to build capability, particularly in relation to the “E” in ESG.

As I noted earlier, we see a very significant role for the investment management sector in the transition to a sustainable economy. We now expect all industry participants to move forward to ensure compliance with the various new sustainability requirements.  

For authorisation, funds must now be compliant with Sustainable Finance Disclosure Regulation (SFDR) Level 1 transparency requirements. The ambitious timelines set out in SFDR Level 2, in the climate-related taxonomy product disclosures and the expected October 2022 application date for related amendments to UCITS Directive and AIFMD are challenging. However, if properly implemented the new rules will discourage greenwashing and protect consumers in this dynamic and fast evolving market. The outcome will represent the direction of capital towards more sustainable investments for the benefits of all.

In Europe, we will also continue to effectively engage with our peers, primarily through the supervisory convergence activities of ESMA, to share ESG authorisation practices and supervisory experience.

Stakeholder engagement

This brings me to a related topic – how the Central Bank undertakes engagement. The framework for interaction between regulatory authorities is well established and co-ordinated at a European and international level.  However, regulatory authorities engage with a much broader group of stakeholders than only our peers or indeed the firms we regulate. 

Domestically, while the Central Bank actively engages regularly with a wide range of relevant stakeholders, we see opportunities for improvement. This is why, over the last 18 months, the Central Bank has reviewed its stakeholder engagement across the board to identify both best practice and any gaps in this area.

In this regard, only a few days ago⁵ we concluded a consultation on four specific proposals:

• to build on existing engagement with consumers and users of financial services, with a view to enhancing mutual understanding of cross-sector issues across the financial system.
• to host a senior level, cross-sectoral industry stakeholder forum to bring together key financial sector industry stakeholders with senior people from the Central Bank, to help us understand the issues faced by businesses and households in the economy.
• to host a public Financial System Conference in 2022 in order to provide an opportunity for the Central Bank to engage with industry, civil society, consumer and business representatives at the same time; and
• to enhance our engagement with business and “real economy” representatives.

These engagements would enable stakeholders to raise issues relating to how financial regulation, and the broader financial system operates, including matters related to the development of policy. They will not replace current engagements, rather they will enhance the existing interactions taking place between the Bank and stakeholders.

Conclusion

In concluding today, we can, I believe, look forward with positivity to the opening of our economy and our lives following an extremely challenging period. We should approach this with a strategic outlook and with an appreciation of the positive elements from the last year - such as the greater use of technology to facilitate work practices.

We must also not lose sight of the approaches that have aided us well to date.  We need to learn from our shared experiences, to grow our understanding of what it means to be connected both individually, and globally. This is especially important in the area of financial services.

For our part, the Central Bank will continue to work hard to deliver on our mandates with the aim of being an open and transparent organisation which is accountable for its actions.  

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.

Acknowledgements: With thanks to Catharine Dwyer, Gerry Cross, James O’Sullivan and Cormac Staunton for assistance in preparing these remarks

[1] Central Bank response to the European Commission’s public consultation on the review of the Alternative Investment Fund Managers Directive (AIFMD).

[2] In this regard, see the European Commission’s consultation on the AIFMD.

[3] Demographic Analysis 2020 – Applications for Pre-Approval Controlled Function (PCF) roles within Regulated Firms, Central Bank of Ireland, March 2021.

[4] As provided for in the Central Bank Act 1942, section 5A our mandate is to safeguard monetary and financial stability, secure the proper and effective regulation of financial service providers and markets, and ensure that the best interests of consumers of financial services are protected.

[5] Consultation Paper 136 – Enhancing our Engagement with Stakeholders, Central Bank of Ireland, February 2021. This consultation closed on 11 May 2021.