Introduction

The Central Bank of Ireland (“CBI”) convened its first sectoral engagement meeting in 2020 with the Irish Funds Industry by way of workshop at North Wall Quay last week. The workshop was generally targeted at the CBI’s authorisation and supervision framework for UCITS funds, with an emphasis on discussing industry concerns regarding the smooth functioning of the authorisation process and scrutiny by the CBI as supervisor of corporate governance and portfolio composition.

Colm Kincaid, Director of Wholesale Markets at the CBI, opened the workshop by highlighting the scale of the UCITS funds industry in Ireland with the following points:

  • The UCITS Funds domiciled in Ireland in 2020 accounts for almost €3 trillion in net assets and is expected to grow to €7 trillion by 2025
  • The number of authorisations of UCITS funds exceeded 800 in 2019 of which four applications were the subject of enhanced pre-authorisation review
  • UCITS funds now comprise the largest part of the EU Capital Markets, with Ireland as a market leader, comprising a significant exposure relative to the size of the Irish economy and giving rise to heightened scrutiny at a domestic level by CBI under its supervisory and stability mandates and also at a European level by ESMA.

Mr Kincaid noted that the key to the success of the UCITS funds model is its widespread acceptance and confidence by consumers having regard to the hard-wired requirements in the UCITS Directives on portfolio diversification, liquidity, and leverage that has been demonstrably successful over many decades, including periods of stressed economic scenarios.

Gatekeeper Principles

Patricia Dunne, Head of Funds Authorisation Division at the CBI outlined the CBI’s Gatekeeper Principles having regard to authorisation and supervision of UCITS funds and she noted the following points:

  • The CBI has a mandate to protect investors which it achieves through its pre-authorisation review and ongoing supervision of funds
  • Authorisation and supervision are two sides of the same coin and she noted that the UCITS funds model has developed to embrace elaborate strategies far beyond the original long only bond and equities strategies at the outset, thus requiring enhanced scrutiny in particular cases
  • The CBI’s role is to prevent harm to consumers and this is achieved through its role as Gatekeeper in the Authorisation Phase and also in its capacity as Supervisor.

Sonia Weafer, Head of Supervision noted that as supervisor the CBI primary role is to prevent harm to investors and this objective is pursued at the authorisation and supervisory stages and she noted that first of defence in safeguarding investors rests with the fund directors, the UCITS management company and the third party service providers.

However, in instances where the CBI detects failures in first line supervision by the fund related parties, the CBI will consider appropriate action in the interests of investors.

Enhanced Scrutiny

Rosemary Hanna, Head of Funds at the CBI, outlined the CBI’s modified application process for UCITS funds, whereby 98% of UCITS funds applications operate on an enhanced efficiency basis and gave as an example the self-certification of the terms of appointment of depositaries, with occasional spot-check reviews.

She highlighted the necessity for enhanced scrutiny in a relatively small number of cases having regard to perimeter concerns around proposed investment strategies and their substantive compliance with the UCITS requirements, making the point that it is the primary responsibility of the fund board and the third party delegates to ensure substantive compliance.

She noted two examples of instances that raised questions by the CBI in its pre-authorisation scrutiny in the interests of investors:

  • In one case, the degree of leverage was proposed at 1,000,000 times net assets, which if approved would ( of its own ) result in doubling the aggregate size of the Irish funds industry
  • In as second case, she noted that the proposed establishment expenses for an individual fund was proposed at €750,000 and this merited further scrutiny from a CBI perspective of being in the interests of investors

Areas of enhanced scrutiny

In the limited number of cases where the CBI adopts an approach of enhanced scrutiny, Ms Hanna noted that the issues that the CBI will likely focus on will include:

1. Fiduciary obligations of the board of the fund

The board of a fund is required to make a deliberate decisions in relation the establishment of the fund, its investment objective and policies and appointment of third party delegates and the CBI will be looking to fund board to demonstrate effective decision making in relation to such matters and that the CBI expects that the dund board is in place prior to making the application for authorisation by the CBI.

2. Board packs and minutes

The CBI may review proceedings of fund boards, including a comparison between draft minutes and finalised minutes to consider the deliberation undertaken by the fund board in relation to the fund’s business.

3. Securities and asset types in the interests of retail investors

In the case of daily dealing funds, the CBI would have a concern in a specific number of cases that the portfolio composition (comprising e.g. exchange traded CFDs, and illiquid CLOs etc. ) would meet the leverage and liquidity requirements of a daily dealing UCITS fund, bearing in mind that the CBI accepts that what might not be suitable in the interests of a retail investment product for sale to a retail investor might well be acceptable in the context of a fund portfolio.

4. Due Diligence undertaken on Service Providers

The CBI has noted that a number of instances where it considers that un-regulated investment advisers have exceeded their mandates and this has called into question the governance of such funds and the consideration undertaken by the respective boards in the appointment and delegation of their role as primary gatekeeper in the interests of the retail investors in those funds.

Industry Engagement

Patricia Dunne, Head of Funds Authorisation and Supervision, made the closing remarks that the CBI will look in the first instance to the board of the fund and its delegates to demonstrate substantive compliance with the UCITS requirements and would encourage funds and their boards to engage pro-actively with the CBI necessary modifications in the interests of retail investors.

Ms Dunne noted that the CBI proposes to engage with the Irish Funds Industry throughout the year with a series of further workshops and that the next likely one will focus on QIAIFS.