Regulatory report flags potential risk areas for Irish fund managers

The  Central Bank, which applies a risk-based approach to the supervision of the asset management and investment funds sector, will set its priorities for the year around the areas of concern identified in the report (105-page / 2.1MB PDF). For fund managers, the principal risks identified by the Central Bank are those associated with leverage and liquidity, conflicts of interest, delegation and outsourcing, sustainable finance, and cybersecurity.

The Central Bank identified liquidity mismatch and excessive leverage as a systemic risk to the financial sector. Liquidity mismatch occurs when a fund’s redemption profile does not match the liquidity of its investments and excessive leverage arises when a fund is vulnerable to economic shocks. To mitigate this risk, the Central Bank reminded asset managers to ensure that the liquidity and leverage of their investment fund portfolios is regularly reviewed and stress tested.

“Fund managers should ensure that the dealing frequency of funds is aligned with their portfolios’ liquidity and that they have appropriate liquidity risk management frameworks,” the Central Bank said. “This includes the use of liquidity management tools where asset sales are required and that remaining investors are not exposed to a portfolio with diminished levels of liquidity.”

The Central Bank cited conflicts of interest as an area of enhanced risk and reminded firms of the requirement to closely govern their funds to avoid potential conflicts of interest. It also highlighted transactions between related parties as a particular area of concern which could “lead firms and their employees to prioritise their own interests over the interests of their clients or others”.

While observing an increase in the delegation and outsourcing of activities within the funds and securities markets, the Central Bank identified the activities of ‘white label fund management companies’ – which are managers that provide a platform for firms to set up funds and to whom investment management functions are often delegated – as an area of specific risk.

In a pointed comment to white label fund managers, the Central Bank said: “While all regulated entities must ensure appropriate oversight of delegated/outsourced activities, the [Central Bank] has observed a lack of oversight and scrutiny by white label fund management companies of their business partners’ structures where such partners have been appointed investment manager.”

In relation to sustainable finance, the Central Bank noted that material risks include greenwashing, green ‘bleaching’ – where asset managers play down the sustainability credentials of their funds to avoid triggering additional regulatory requirements – and concerns regarding the reliability on sustainable investments due to data limitations. It highlighted the need for accurate sustainable finance disclosure and its continued monitoring of greenwashing, where investment firms overstate the green credentials of their products.

“To support the transition to net zero, it is imperative that investors are fully informed, and in no way misled, regarding the stated sustainability credentials of financial products,” the Central Bank added.

The report also identified cybersecurity as a further area of enhanced risk, highlighting the need for managers to have robust IT governance frameworks in place to identify, manage and mitigate the risks of cybersecurity incidents occurring.

Conor Durkin, a Dublin-based investment funds expert at Pinsent Masons, said: “Firms are advised to review the key risk areas identified by the Central Bank and check that there are no gaps in their current policies, procedures or operating processes meeting the expectations of the Central Bank.”