Few domestic banking sectors have shrunk more than the Irish one since the 2008 financial crash. However, few places have seen a ballooning of financial activity outside the mainstream banks over the same 15 years quite like Dublin.
The size of the global nonbank financial intermediation (NBFI) sector — or what is often referred to as shadow banking — has surged from €72 trillion in 2008 to €212 trillion as of 2021, according to the Financial Stability Board, an international body that monitors the global financial system.
There are two main reasons. Increased regulation and expensive capital requirements placed on banks since the crisis has pushed much of their activities elsewhere. Assets in investment funds have also surged.
The Republic, one of the world’s biggest shadow banking hubs, has seen its total NBFI assets jump more than 400 per cent to €6.3 trillion over the same period, according to the Central Bank of Ireland. Assets in highly supervised international investment funds domiciled in the Dublin account for 80 per cent of the growth. But a completely unregulated market has also flourished: the world of special purpose vehicles (SPVs).
SPVs are also known as section 110 vehicles, named after a segment of 1997 tax legislation that was designed to make Dublin’s International Financial Services Centre (IFSC) an attractive place for lenders to package loans, like mortgages, and refinance them on international bond markets by way of selling bonds. This is called loan securitisation.
Tax-efficient Irish SPVs held almost €1.1 trillion of assets at the end of June, according to the latest central bank figures. That’s twice the size of the current Irish economy, measured by gross domestic product.
More than €600 billion of the assets are in entities used for securitisation. This is an important way for lenders to raise money at relatively cheap rates to continue to provide credit to households and businesses —or, as Irish banks have done in recent years, move problem loans off their balance sheets. This helps them free up capital and, in theory at least, provide more funding to the real economy.
Irish SPVs have also become the main home in Europe for repackaged loans of highly-indebted companies with low credit ratings, or what are known as collateralised loan obligations.
However, close to €500 billion of assets are held in what are known as “other” SPVs. Russian banks and oil and gas companies accounted for almost €36 billion of assets housed in such vehicles at the end of 2021, even though there had been a large drop in their use following the introduction of sanctions when Vladimir Putin’s government annexed Crimea in 2014.
The latest rounds of Russian sanctions, in the wake of the Ukraine war, have resulted in the Republic freezing €1.8 billion of assets linked to Russian parties, according to the Department of Finance.
However, Jack Power of The Irish Times reported last weekend that head of the department’s anti-money laundering unit Brenda McVeigh had said authorities here are powerless to stop the flow of Russian money moving through funds in the Republic, as sanctions are “unenforceable” in practice.
The Garda’s financial intelligence unit could receive information about SPVs suspected of breaching sanctions, but were limited in their response, she said.
“You can sit there and tell us [about] some section 110 in the funds industry or down in the IFSC, and say, ‘I know there is Russian money moving through that particular trust’, they can knock on the door, but they can’t actually do anything about it,” she said.
Is the euro zone drifting into recession?
The central bank concluded last year that half of the 66 Irish-established SPVs with some sort of link with Russia had a connection with a sanctioned entity, according to figures in a recent submission to the department as part of a Government review of the funds sector.
Most are involved in the type of lending that is subject to anti-money laundering and countering of financial of terrorism (AML/CFT) supervision — notionally, at least — even if the entities themselves aren’t regulated.
The problem is that Irish law does not put any obligations on the supervised SPVs to put systems and controls in place to ensure AML/CFT rules aren’t breached, the paper highlighted. More worryingly, the fact that most Irish SPVs are “orphan structures”, technically owned by charitable trusts for the purpose of making them tax efficient, makes it “difficult, if not impossible, to establish who is actually in control of the entity”, the paper said.
The central bank estimates that of the 3,000 section 110 companies based in the State, 5 per cent might be considered to have a high money-laundering or terrorism finance risk. A further 61 per cent would be classified as medium to high risk.
Irish SPVs, because of the international nature of the underlying assets, may bring little direct economic risks to the State.
They are, however, a nice fee earner for lawyers, accountants and other firms servicing the sector in Dublin. Irish SPEs [special purpose entity] paid €1.52 billion of professional services fees to Irish businesses last year, according to a nugget contained in a quarterly central bank report on the sector published on its website during the summer.
What SPVs bring is reputational risk, as when two vehicles linked to the German bank Sachsen Landesbank, laden with US subprime loans, blew up in the IFSC in 2007. It resulted in a €17 billion emergency German state-backed bailout, leading to criticism of the Republic at the time in German political circles.
The central bank set out eight years ago to at least find out the size and scope of SPVs. There has been some good work by researchers in the bank in the meantime, trying to shine a light on the sector. But there are no signs that it has any strong views on whether it should be regulated. This is concerning.
The furthest the bank goes in its submission to the department is that the review should weigh the value the Irish SPV sector brings to the economy against potential risks and “determine whether further legislative or policy measures are required to address these risks”.
Irish Funds, the industry lobby group, warned the department in its own submission on the funds review that if the SPVs sector was “restricted in any significant way” it may lead to other parts of the State’s international funds industry moving elsewhere.
But surely only SPVs set up for nefarious purposes need be concerned about the sector being subjected to regulation. It’s high time the Government took action.
