Just when the Central Bank thought it had a greater understanding of Ireland's so-called shadow banking centre in the IFSC in Dublin, the hole just got bigger.
A report published on Wednesday by the Swiss-based Financial Stability Board – which was established in 2009 under efforts to avoid a repeat of the global financial crisis – into financial activities that take place outside of traditional banking shows that Ireland is home to $2.2 trillion (€2 trillion) of global shadow banking assets.
This includes €471 billion of assets that regulators know very little about.
The term “shadow banking” may have a pejorative tone, suggesting dodgy lending and borrowing practice, but essentially it’s a catchall phrase, coined in 2007, for all manner of financial activities that go on outside traditional banks. These include investment products, crowdfunding – where a large number of people contribute to a project or venture – and even where art dealers, such as Sotheby’s, lending to clients buying multimillion euro masterpieces.
Most activities are regulated and have useful – indeed, essential – functions in the modern economy. But they still pose potential risks to financial stability that the FSB and regulators are seeking to understand and monitor. Then, of course, there are activities in the darkest areas of shadow banking that international authorities are only beginning to understand.
In Ireland's case, almost half of the $3.79 trillion of total financial assets in the country, excluding banks, are held in heavily regulated, Irish-domiciled investment funds. Thousands of people are employed in the IFSC in Dublin to provide back office accountancy and administration services for investment groups such as BlackRock, Fidelity and Morgan Stanley that have based stock and bond funds here. Most are listed on the Irish Stock Exchange.
But the potential for problems in this sector is high. A number of UK property-related funds witnessed a run by investors seeking their money back last year after the Brexit vote, forcing fund managers to temporarily halt redemptions to avoid a fire sale of assets. Banks are often big lenders to such funds, showing how interconnected the world of finance is.
Regulation
A further $450 billion of Ireland’s shadow-banking assets are in money market funds (MMFs), which large companies use as most people resort to deposit accounts to place excess cash. In this case, the money is typically invested in short-term government bonds and company debt instruments. MMFs are also subject to heavy – and expanding – regulation.
Still, almost a third of Ireland’s shadow-banking universe is subject to little or no regulation, although regulators have been making big inroads in recent years to work out what’s going on.
For instance, the European Central Bank has, since 2009, required banks, companies and private equity funds behind about $430 billion of assets held in financial vehicle corporations (FVCs) involved in securitisation (essentially funding themselves by selling bonds) to file regular reports on assets and liabilities to Frankfurt. That's because of the role securitisation, particularly of US subprime mortgages, played in the global crisis in 2008.
Securitisation, done right, is an essential part of the world of finance. It allows companies to raise money in the market rather than rely on banks, which have been shrinking their balance sheets dramatically in the past decade as they face higher capital rules.
Special Purpose Vehicles
More recently the Central Bank in Dublin has forced FVC’s close cousins, special-purpose vehicles (SPVs), to start filing quarterly data since late 2015. As of the end of 2015, there were 822 SPVs, holding €324 billion of assets. However, it has to be said that half the assets contained in SPVs are also accounted for somewhere else, such as a regulated bank. So there is a degree of double-counting going on that may be eliminated in time as the Swiss-based Financial Stability Board continues its work.
SPVs and FVCs, which contain mainly overseas assets, are designed to be “tax-neutral” in themselves. The idea is that the ultimate bank or company behind them would pay tax on profits in their own jurisdiction. However, many of these are based in offshore tax havens. The Government here was forced last year to clamp down on the way so-called vulture funds had been using these vehicles in recent years to avoid tax on billions of euro of Irish property bought during the crisis.
Still, only a tiny portion of shadow-banking assets in Ireland relate to the domestic economy. As such, an entity blowing up in the IFSC would cause more reputational damage than direct cost for Irish taxpayers. But the Central Bank, like regulators elsewhere, knows it must take part in the global hunt for potential risks to financial stability.
Regulatory minefield
The latest FSB report also shows that 85 per cent of Irish shadow-banking activity is now subject to at least regular, “granular” reporting requirements, compared with 46 per cent in 2008. Progress indeed.
However, it highlighted that Ireland also has €471 billion of “other” shadow banking assets that are not the subject of any reporting. That’s only down slightly from €498 billion in 2014, when SPVs were included in the “other” category. So, the knowledge gap has got bigger, according to the FSB.
The Central Bank believes that most of the “other” assets consist of treasury operations of big multinational companies or finance-leasing companies, according to a report published by the bank late last year.
But as the world of shadow banking is only set to get bigger in the coming years, it shows that regulators internationally are running just to stand still.
