Last week the Central Bank of Ireland published a report on the key risks and trends shaping the financial sector.
The Regulatory & Supervisory Outlook (RSO) report gives the Bank’s view on these risks and what they see as the key priorities to address them in the next two years.
From this we get a good sense of where the regulator feels the funds sector, as well as the overall financial system, is most at risk.
The Central Bank rightly notes the importance of Ireland as a global funds domicile. There are about 9000 funds authorised – worth almost €5 trillion. This is up over 20% from 2023. ESG funds represent a massive 36% of all Irish funds. We also have the largest Exchange Traded Funds sector in Europe – about two-thirds of the total assets in the euro area.
So, all in all, this is clearly a vital sector for our overall economy.
Where are the risks today?
Firstly, from a macro perspective, there’s certainly no shortage of risk out there! The Central Bank continues to highlight the elevated level of geo-political risk for financial markets. Investor sentiment is fragile, and in their view risk in some sectors is clearly mispriced today. The Bank also highlights how concentrated some assets and markets have become, and the implications this may have for the future volatility of returns.
At fund level, high on the regulator’s risk list are the interlinked dangers from liquidity and leverage. These concerns have been highlighted now for some time and remain a potential source of fund volatility and poor investor outcomes. The Bank continues to drive macroprudential measures to mitigate such risks. Another evergreen source of risk in funds for the Bank is in the area of money laundering and suspicious transactions. And there’s more work to be done here.
The Central Bank will continue to apply resources to such issues to ensure we have a resilient, successful and future-proofed funds sector.
But what’s also interesting in the report are possible emerging sources of risk for funds.
Is AI a risk for the sector? In the words of Frankie Byrne (whom nobody will remember) “These may not be your problems today – but they could be someday”.
So today while many service providers expect to use AI in the future, current usage is limited. But for the bank this falls into the emerging risk category. While AI could have a productive role there is also the potential for unwanted bias and poor investment decisions which would harm both investors and firms.
The funds sector has been very successful in the ESG space. Today, more than ever, this is an area that is having to cope with growing and powerful cross- currents. This tug of war is being played out in the funds sector.
The Central Bank notes how we have seen a downward trend in the number of the most sustainable cohort funds (“Article 9”) and a pick-up in the number of less onerous Article 8 funds. This is backed up by Citywire analysis which shows Article 9 funds in Europe on a 16-month losing streak, having experienced a cumulative outflow of €30.6bn. This leaves them in the red for the past three years. An on-going issue is the consistency and transparency of data. This adds to the threat of greenwashing and misleading or confusing investors.
Interestingly, the bank also notes a trend towards “greenhushing” where some funds may seek to downplay their ESG credentials. This is partly down to a changing political and geopolitical environment.
Given the exposure of our funds industry to this sector and this dramatically changing landscape, we need to remain vigilant.
The report covers more than just the funds sector and is essential reading for many in what is an increasingly complex and risky financial world.
Tradewinds 