Focusing on investor outcomes: some regulatory themes for the funds sector - Gerry Cross, Director of Policy & Risk

21 November 2019 Speech

Gerry Cross

Speech delivered at Irish Funds UK Symposium

Good morning. It is a pleasure to be here this morning. I would like to thank Irish Funds for inviting me to speak at this event today.1

I would like to discuss a number of topics related to the regulation and supervision of the funds and asset management sector that are high on our agenda at the Central Bank of Ireland 

In our three year strategic plan – covering the period 2019 to 2021, we set out how the Central Bank of Ireland sees its mission. We say there that we serve the public interest by safeguarding monetary and financial stability and by working to ensure that the financial system operates in the best interests of consumers and the wider economy. We say that we seek to achieve a trustworthy and resilient financial services system that sustainably serves the needs of the wider economy and its customers, where regulated firms and individuals adhere to a culture of fairness and high standards.

We are a regulator that is deeply integrated in the European System of Financial Supervision. Therefore the focus of our regulation is on delivering on our objectives both domestically and in relation to the European economy and the European investor, and indeed beyond that.

I call this out because it gives you a good sense of what motivates us and what aspects we take into account in setting our priorities and deciding what issues are important for us to focus on.

The concepts that are set out here – the best interests of customers and investors; serving the needs of the economy; resilience; trustworthiness and fairness; and sustainability – these are objectives which not only provide strong guidance to how we see our role, they also give a good sense of what we expect of the firms and entities that we regulate.

The investment fund and asset management sector brings significant benefits to a very large number of investors. Its ongoing growth and development not only represents important diversification in the funding of the economy, one of the outcomes that has been sought in the wake of the global financial crisis, it also supports the goals of Capital Markets Union, including making capital markets and their benefits more accessible to investors of all types. To ensure the ongoing and enhanced achievement of these benefits, and to avoid the negative outcomes and harm that can arise when actors in the sector fail to maintain high quality conduct and standards, there are a number of aspects that are currently on our agenda at the Central Bank of Ireland.

Fund Governance

Central to ensuring that our regulatory aims are achieved for the funds sector is the issue of the governance and management of individual funds and, from that, of the sector as a whole. The funds sector, both internationally and in Europe, has a unique overall structure with very significant levels of outsourcing. This brings many benefits. It means that, done properly, investors can gain the benefits of specialisation, diversification, and economies of scale. This can significantly enhance the outcomes they enjoy. But it also brings challenges. In particular it makes it centrally important that there is high quality, effective governance of the fund, with the outsourcing and delegation of activities very well managed, and an approach that ensures that the interests of the fund’s investors are enhanced and never compromised by virtue of the relative complexity of the overall structural arrangements.

Six years ago the Central Bank of Ireland commenced a review of the effectiveness of governance in the funds authorised and supervised by the Central Bank. This became known as the “CP86” review. It culminated in the introduction of a revised framework of rules and guidance - for newly authorised funds in 2017 and for existing funds in 2018. These were designed to enhance the level and quality of governance and oversight carried out by fund management companies as a whole. Amongst other things, the CP86 framework set out clearly our expectations of directors of funds and those responsible for the oversight of designated activities such as asset management, risk management, distribution, administration, etc.

Sufficient time has now passed since the introduction of the revised framework for us to examine how it is being implemented. This period has also included a period of elevated authorisation activity which saw a large number of new firms, including fund management companies, seek authorisation in Ireland as a result of Brexit. This latter has provided for a good deal of engagement on the implementation of the CP86 standards. As a result we have gained important insights and seen different questions raised. These have come both from our engagement with applicants for authorisation and from discussions with our peer regulators across Europe who also see this as a centrally important issue.

So over the recent period we have begun an assessment of how CP86 is being implemented across the sector. As a first step we have carried out a survey of authorised fund management companies, including self-managed investment companies. This will be followed shortly by onsite inspections across a selected sample of entities.

We are aiming to conclude this work during the course of 2020. Our aim is to determine whether CP86 is being implemented in a way that delivers the improvements intended. If not, we will be taking the steps needed to ensure that it does.

Investor outcomes

Trust and confidence is necessary for any financial market or product to be successful. This means not simply that investors and customers are dealt with in a manner consistent with legal requirements, but beyond that they are treated in a manner that is reasonable and fair. And that the outcomes they receive are in line with legitimate and reasonable expectations. Now to be clear, this does not mean that they must always receive a large return on their investment or that there can never be losses. Of course not. What it does mean is that outcomes should be in line with the risk appetite that an investor has expressed or, depending upon the degree of sophistication, could reasonably be expected to have. And it means that financial firms should not take advantage of information asymmetries or combinations of complexity and capacity, or any other feature, to provide the investor with less than a fair deal. Unless and until there is strong confidence amongst investors that they can rely on regulated financial market firms to always ensure a fair deal, the financial sector will not fulfil its potential to effectively support a well-functioning economy. A failure to adhere to high standards, even if it is amongst a relatively small number of firms or funds, can undermine confidence levels more widely.

Performance fees

As you will be aware, earlier this year the Central Bank concluded a thematic review of UCITS performance fees. The review investigated the methodologies and parameters applied in the calculation of UCITS performance fees to examine if they were in line with Guidance issued by the Central Bank. While a number of good practices were observed across the majority of the sample, in approximately 10% of the sample of sub-funds reviewed, instances of non compliance with the Guidance were identified. A total of over €1.5m has already been refunded to 636 shareholders and risk mitigation programmes were issued to individual UCITS and fund service providers, where required. In addition, the Central Bank’s Guidance on UCITS performance fees have been codified in the updated 2019 Central Bank UCITS Regulations.  This provides us with an enhanced footing on which to take action against firms for breaches of performance fees requirements in the future. 

During this time we have also been active in supporting the work within ESMA on performance fees and strongly support the proposal for ESMA guidelines, which will ensure a common approach across Europe on this important issue.  ESMA identified  different practices across National Competent Authorities (NCAs) regarding the charging of performance fees and the circumstances in which performance fees can be paid.  This creates risks of regulatory arbitrage and inconsistent levels of investor protection.  As a result, ESMA decided to carry out further convergence work and issued a consultation paper for Guidelines on performance fees in UCITS.  The proposed guidelines are closely aligned to the Central Bank’s approach.  The consultation closed on 31 October 2019 and ESMA will now consider the responses received.

Closet tracking

There has been for some time now a focus on the issue of closet tracking, including ESMA’s 2016 statement on the matter. In July last, the Central Bank published the outcome of its review of Irish UCITS. The review was an extensive one and involved a detailed data analysis of the 2,550 Irish authorised UCITS funds, classified as actively managed as at March 2018. 182 UCITS funds were identified for further review. The review has highlighted broader issues around the effectiveness of investor disclosure and the legitimate expectations of investors in respect of the service provided by fund managers.  Supervisors have engaged with an initial cohort of these UCITS and related risk mitigation programmes have been issued. This supervisory activity will continue into 2020 and enforcement action in the future is not being ruled out.

The findings were set out in an industry letter, and, as is normal practice with the output of any thematic review, we will consider if any changes or supplementary domestic rules or guidance will be necessary in this area. We will also continue to work with our ESMA colleagues to ensure that clarity and consistency of the various regulatory obligations.

Errors in investment funds

Another area of ongoing work relates to how errors in investment funds are dealt with.  At present, there is no specific regulatory framework in Ireland for dealing with such errors.  A consultation paper (CP130) was published on 9 September 2019 which sets out a proposed approach for a framework on the treatment, correction and redress of errors in investment funds.  The proposed framework recognises that a Fund Management Company is ultimately responsible for ensuring that the error is appropriately rectified2 and the depositary has a role in ensuring that this is the case. Given the importance of this issue, a two-stage consultation process is planned for developing this framework. The publication of CP130 was the first stage and outlines the general approach proposed by the Central Bank. During the consultation period, which runs until the 9 December, the Central Bank will host workshops with industry and investor representatives to discuss the practical implications of the proposed framework. The second stage will involve a further consultation based on a review of the feedback received. This second consultation will set out the detailed requirements and guidance which will form part of the final regulatory framework.  This is an important area for regulatory authorities and industry alike as investors must have confidence in how errors are addressed, including that any errors are resolved in a fair and transparent manner, with redress being payable where this is appropriate.

Costs and performance

As well as our domestic work on investor outcome issues, we are also contributing to a number of ESMA work streams linked to this issue. ESMA’s first annual statistical report on costs and performance of retail investment products was published in January of this year and documents the significant impact of costs on the final returns investors achieve, particularly for UCITS funds (ESMA, 2019). ESMA work in this area is likely to continue to focus on the importance of fee and performance transparency. This is aligned with the Central Bank’s point of view as we believe for investors to have trust in capital markets and to make informed choices about where to put their money, comprehensive and comparable information on costs and performance of investment products is key.

Liquidity risk and leverage

Both liquidity risk and leverage in the non-bank sector remain important issues on the agenda of the Central Bank of Ireland and elsewhere. We come at this from two perspectives: that of investor protection on the one hand, and financial stability on the other. Both of these perspectives have garnered heightened interest over recent times.

Much has been done in this area since the Global Financial Crisis. This includes: the liquidity management requirements in AIFMD; the 2017 FSB Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities (Financial Stability Board, 2017); IOSCOs update to its Liquidity Management Recommendations (IOSCO, 2018), the ESRB recommendations (ESRB, 2018) on liquidity and leverage risks in investment funds and; ESMA’s more recent work with respect to stress testing UCITS and AIFs (ESMA, 2019). While much of these post crises reforms have concluded, some elements must still be finalised. 

Recent cases, including the Woodford funds and others, have raised questions as to whether existing rules in respect of liquidity risk are sufficient. In light of this it is needed to reflect on whether the rules and guidance currently in place are sufficient or whether they need to be further developed. Are these cases simply examples of the rules not being well followed? Or does the framework itself need enhancing? It is important that there should not be a mismatch between investors’ expectations and what a fund is able to deliver in terms of daily redemption, in particular during times of stress. This is an area where you can expect to see us and other supervisors focus in the coming period.

From the macro or financial stability perspective also, the AIFMD review provides an opportune moment to reflect on the progress that has been made and to consider whether more is needed to be done in this area. AIFMD has an important systemic risk component. As well as setting out liquidity risk management requirements, including stress testing, for fund managers, it provides for significantly enhanced data gathering relevant to this issue. Similarly, on the leverage side, AIFMD also provides for the imposition of leverage limits by regulators where deemed necessary.

One thing that we have learned from the crisis is that when addressing systemic risk it is not enough to take an additive approach - reckoning that if each entity is well run and meets its individual soundness and investor protection obligations then we can be confident that risks to the system are also being effectively addressed. During good times, such an approach can disguise the externalisation of risks that can occur despite a firm being well run from its investors’ point of view. Similarly during times of stress sensible rational choices made by each entity when looked at individually may not be so when looked at from a systemic point of view. At the same time of course, we should not fall into the trap of thinking about investment funds in the same way as we think about banks. To do so would not only lead to sub-optimal results in terms of economic outcomes, it would also run the risk of failing to address the issue about which we are concerned.

We need to continue with the work to make sure that we have strongly thought through all of these issues and that we have considered the full range of both ex ante and ex post measures that might be required and available to deal with systemic risk arising from the funds sector. From an ex ante perspective we need to consider whether further enhanced liquidity rules may be indicated from a financial stability perspective.

Notwithstanding the need to consider the potential refinement of leverage measures under AIFMD, there are also other issues which must be addressed in terms of the macro prudential toolkit under AIFMD. The ESRB envisaged this when they made their recommendations (ESRB, 2018) in terms of asset management and specifically identified the need for ESMA to give guidance on the design, calibration and implementation of macroprudential leverage limits under Article 25 of AIFMD.


To conclude, there is a wide range of issues on the current regulatory and supervisory agenda regarding the funds sector.  These overlap and intertwine but underpinning all of these initiatives is a need to maintain and enhance the trust and confidence of investors and market participants in financial markets and financial products. 

I hope my comments have provided a useful insight into the Central Bank of Ireland’s thinking on some of these aspects. The Central Bank will continue to engage with  stakeholders on these matters as they progress.

Thank you for your attention.


[1] My thanks to Rory O’Connor and James O’Sullivan for their significant contribution to this speech.

[2] Appropriately Rectified is defined as “Where an error occurs, the affected fund and / or investor must be Appropriately Rectified. In this context, Appropriately Rectified means taking any necessary action to restore the fund / investor to the position that it / they would have been in had the relevant issue not arisen. This includes meeting all reporting and notification obligations and the Payment of Redress as appropriate”

ESMA, 2019. “ESMA Annual Statistical Report: Performance and costs of retail investment products in the EU” 10 January 2019

Financial Stability Board, 2017. “Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities” 12 January 2017

IOSCO, 2018. “IOSCO issues recommendations and good practices to improve liquidity risk management for investment funds” 1 February 2018.

European Systemic Risk Board, 2018. “Recommendation of the European Systemic Risk Board” 30 April 2018

ESMA, 2019. “ESMA strengthens liquidity stress tests for investment funds” 2 September 2019.

European Systemic Risk Board, 2018. “Recommendation of the European Systemic Risk Board” 30 April 2018