The Central Bank of Ireland launched Discussion Paper 11 on 18 July 2023. The Discussion Paper details the approach to a macroprudential policy for investment funds and is seeking industry feedback on how to improve the industry’s resilience to shocks. The envisaged policy would aim to address identified systemic risks unique to the investment funds industry.

Rationale for policy intervention

The Central Bank has highlighted in its discussion paper:

• The lack of meaningful data regarding the Irish funds industry’s durability and also its flexibility in responding to market shocks
• Ireland’s status as one of the main players globally for investment funds, and
• The mammoth growth the Irish funds industry has experienced.

The rationale for macroprudential policy intervention stems, in the Central Bank’s view, from the need to address risks that are not covered by other parts of the funds regulatory framework. It also hopes to encourage a system-wide perspective in financial regulation. Discussion Paper 11 does not propose the introduction of particular policy measures; however, the Central Bank does outline potential macroprudential measures that could address important risk factors such as liquidity, leverage and interconnectedness.

Addressing liquidity

Regarding liquidity, the Discussion Paper states that more prescriptive regulatory rules will be required for certain themes and activities. These include rules which will:

• Reduce dealing frequency
• Extend redemption periods for less liquid funds
• Introduce liquid asset buffers for specific fund cohorts, and
• Require stress testing to factor in wider financial stability matters.

Leverage levels

The Central Bank has traditionally favoured leverage limits to manage the leverage levels in funds, although it has noted the operational challenges associated with their calibration and design. The Central Bank has noted the persistent issue with measuring leverage generated by derivatives, and the challenge this creates for the regulator’s understanding and analysis of the levels of leverage actually in the system. The Central Bank has identified this as a situation which would benefit from enhanced regulatory stress testing.

Tools for interconnectedness

In targeting interconnectedness, the Discussion Paper has outlined some potential tools including the following:

• A position-driven concentration limit similar to that already in place in the EU under MiFID as a limit that could be adapted to apply to certain types of investment funds.
• Measures that would apply margin rules to investment funds. These could be triggered/increased if the systemic risk posed by particular cohorts of funds was found to be increasing. These rules would mirror the ones applicable to over-the-counter (OTC) derivatives under EMIR.
• An assessment of interconnectedness risk as a key factor in the application of other measures to reduce vulnerabilities. This assessment could also inform the application of measures around liquidity mismatch and leverage of funds.

Conclusion

The imminent adoption of a macroprudential framework for the funds sector is something that should be closely monitored by those in the funds industry. The Discussion Paper makes it clear that the macroprudential policy is not intended to control asset prices or replace a fund’s own risk management practices. The purpose of the policy is to become a complementary tool, alongside other policy interventions, to help mitigate systemic risk in the funds industry. The form and function of the policy is dependent on the outcome of the consultation process and discussion papers as outlined above.

For more information on the macroprudential policy for investment funds, please contact a member of our Investment Funds team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.

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