Makhlouf warns on investment fund regulation

It is an “absolute truth” that the investment funds industry can present a so-called systemic risk to the financial system, Central Bank governor Gabriel Makhlouf warned, as the bank plots fresh regulations for the sector.

“In the face of financial vulnerabilities cohorts of funds can amplify shocks to other parts of the financial system and the real economy,” Mr Makhlouf told a conference on Monday. “This amplification follows decisions taken by individual fund managers in response to shocks. These decisions are often rational at an individual level but, when aggregated across entire cohorts of funds, can generate negative spillover effects.”

With Ireland already a popular home for investment funds the regulator has already started to tighten up oversight of the industry more broadly. It has limited leverage levels for property funds as well as moving to boost the ability of so-called liability driven investment funds to withstand sharp movements in UK government bond prices in response to the fallout from then UK prime minister Liz Truss’s mini-budget almost two years ago. Still, Mr Makhlouf made clear his focus would remain on the investment funds sector more broadly. The Central Bank launched a consultation paper on how to regulate investment funds last July.

While regulation has traditionally focused on protecting investors in individual funds Mr Makhlouf said he was particularly focused on what he called a “system-wide perspective” that would aim to prevent a scenario where fund managers acting rationally by themselves create a wider market crisis.

“Ensuring investor protection and maintaining financial stability can work together and ultimately be of benefit to investors while ensuring the resilience of the wider sector,” he said.

Creating overarching regulations for investment funds would be “a multiyear” endeavour, he warned, adding it was “vital” that oversight of the sector “keeps pace with its growing importance from a systemic risk perspective”. Already existing regulations may also need to “evolve in order to be better able to mitigate system risk” while the Central Bank could need to develop “new tools specifically aimed at reducing the systemic risks posed by cohorts of the funds sector”.

“We have made good progress in developing a macroprudential framework for funds in recent years and we should build on this momentum,” Mr Makhlouf said. “Enhancing the resilience of the sector, given its increasing systemic importance, must remain a key priority for policymakers internationally.”