The governor of the Central Bank of Ireland (CBI) has called for tighter regulation of “hidden leverage” in the funds sector to prevent major financial shocks caused by too much borrowing.
Gabriel Makhlouf said at a conference that “the sector is too big to ignore” and that unlimited leverage for funds represented a financial stability risk that must be dealt with.
“Traditionally, the regulation of investment funds has been largely about developing and enforcing investor protection rules,” he said in an address to the CBI’s financial system conference in Dublin.
“But we have to learn from history. The lessons of the global financial crisis, the Covid-induced market shock of March 2020, and the UK’s recent LDI issue are clear.
“There is clearly hidden leverage, interconnectedness and channels of propagation that we do not yet fully understand, and vulnerabilities building up in the non-bank sector.”
Ireland has the third-largest funds sector in the world with 10,000 entities holding assets of €5.6trn and is therefore a critical forum for new regulation of funds in Europe.
The Irish financial system here is heavily weighted towards the non-bank sector, which is made up of investment funds, money market funds and special purpose vehicles used for global investing.
Mr Makhlouf said regulators needed to look at the sector as a whole rather than individual funds and entities to protect the financial system generally and to shield consumers from systemic problems.
“Consumer and investor protection is founded on the existence of a stable financial system and regulators need to be aware of the big picture, avoiding the temptation to focus on narrower and perhaps more straightforward ways of providing that protection,” he said.
“Tackling systemic risk requires a macroprudential perspective that targets the collective action of fund cohorts, not idiosyncratic risk management issues at individual funds.”
The Central Bank is planning to introduce borrowing limits on property funds involved in the domestic economy.
Regulators are understood to be considering a rule preventing such funds from borrowing more than 50pc of their total asset value.
The CBI conducted a consultation on the proposed changes a year ago and a decision on the final policy is expected soon.
