Policing the financial sector
The efficacy of the Irish Financial Services Regulatory Authority (IFSRA) is under scrutiny again following the near collapse of Sachsen LB, a state-backed German bank, as a result of credit problems at its Irish operation.
The regulator and its parent, the Central Bank, have gone to some lengths to disavow responsibility for regulating the particular Dublin-based fund at the heart of the problem, Ormond Quay.
But, as the name implies, it is undeniable that Ormond Quay is an Irish company, based in Ireland and with two Irish directors. And this company somehow got itself into a predicament so serious that the collapse of a German bank was only avoided through emergency intervention to the tune of â‚¬17.3 billion by a group of other German banks.
The fact that the Irish regulator is not technically responsible for Ormond Quay does not detract from the reality that something occurred within this jurisdiction that has cast the financial services regime here in a very bad light. The Central Bank and IFSRA cannot simply wash their hands of the matter. They must take steps to ensure no recurrence. That is the essence of their job.
The implosion at Ormond Quay is not the first occasion on which the nature of the regulatory regime has been called into question. An unregulated Dublin- based operation was a significant cog in the complex financial fraud that led to the demise of the Italian food group Parmalat. More recently, the Irish operations of Cologne Re were linked to bogus reinsurance contracts written by the group, but the Irish regulators response was at best sluggish compared to other jurisdictions.
On the face of it, there appears to be a strong case for stricter regulation of international financial services here. Iconsidering any such action, however, it is important to have regard to the role that the existing “light touch” regulatory regime has played in the development of a world-class financial services industry in a few short decades. International financial services have become a significant part of the economy and a source of well-paid jobs and considerable tax revenue for the State. And for every problem company, there are hundreds more successfully pursuing their business.
A balance must be struck between a regulatory approach, on the one hand, that encourages innovation and investment in this important sector, while on the other hand ensuring that Dublin does not become a haven for activities that might bring Ireland Inc into disrepute.
What is missing in the current set-up is any sense that the Government and the organisations it charges with achieving this balance, the Central Bank and IFSRA, are proactively weighing the potential costs against the benefits. The priority appears to be facilitating growth in and around the International Financial Services Centre. As recent events demonstrate, the risks attached to this approach - reputational and otherwise - are real.
Ireland Inc is developing a major image problem
A German bank narrowly avoided collapse this week due to an unregulated fund operated from Dublin. Justin O’Brien argues that financial centres depend on integrity
Images of Ireland are mutating in an era of globalisation. Last night, the Australian Broadcasting Corporation televised the first episode of Proof, a gritty if not altogether convincing television drama that centred on the cost of inward migration and moral turpitude.
For unfamiliar viewers, the drama was a graphic demonstration of what the Irish ambassador described recently in Canberra as the “terrible beauty” of Celtic Tiger Ireland. The images of prostitution, human trafficking and contempt towards inner city dispossession bring to mind Yeats’s valedictory masterpiece, in which he warned of the need to build an Ireland of equals, scorning those with “unremembering hearts and heads/base-born products of base beds”.
The most striking thing about Proof was not the human frailty it so graphically depicted. Rather it was the accusation that Irish society had lost its moral compass. No grouping escaped the cynicism: the daylight shootings; the toleration of (illegal) brothels in the basements of the Georgian masterpieces of the inner south; the unremitting greed; and the laziness of police, journalists and politicians alike.
The main protagonists are themselves anti-heroes: the ambitious press officer more impressed by potential elevation to government press secretary than what the government stands for; the estranged husband who wears a social conscience as an intellectual conceit and fashion accessory.
The image of Ireland portrayed was one that was slipping from day to night against a backdrop of unparalleled wealth, symbolised by the time-lapse photography of the office blocks that make-up the International Financial Services Centre, Ireland’s financial window to the world.
In 20 years, Ireland has carved out a niche position as a second-tier financial centre with first-tier pretensions. From provider of back-office functions for the London market, Dublin has become a global centre for financial engineering, particularly hedge funds, reinsurance and securitisation.
It is therefore not surprising that it has become ensnared in the global disquiet over the dangers posed to the wider financial system from the markets over-reliance on leverage.
As with the social and political systems in which they are nested, financial centres depend on integrity. Given the nascent (and therefore ephemeral) nature of the industry in Ireland, one would have expected, perhaps, the Irish regulatory system to be playing an active role in the global debate over the utility of these asset classes. There is, however, no evidence that this is taking place.
The Irish regulator - the Financial Services Regulatory Authority or Ifsra for short - takes pride in its responsiveness to industry. Significant progress has been made in establishing consultative panels, which are designed to both facilitate the better regulation framework that applies to all government department and agencies.
The agenda notes of these meetings are disclosed but not the detail of the discussion. There is, however, one exception. The inaugural meeting on February 8th notes the concern of the chief executive of the Dublin Insurance Association that " ‘gold plating’ regulatory requirements for captive reinsurers are causing companies to relocate outside Ireland".
The absence of detail makes it difficult to ascertain whether and, if so, how the regulator has communicated with industry its concerns. Likewise, it is impossible to evaluate to what extent the exercise enhances the quality of intelligence gathering.
We are left then with assertions of efficacy from the regulator itself, most notably from its annual report, published last month. It provides reassurance by the explicit endorsement of the International Monetary Fund. It is quite a stretch, however, to come to that conclusion after only a cursory examination of the documents in question.
The IMF report focused primarily at the stability of the domestic financial architecture. Although couched in diplomatic terms, there could be no disguising concern about the quality of supervision within the IFSC.
These concerns were not buried in the appendix or footnotes. They inform the executive summary.
“In the mission’s view,” it says, “there will be a need to continuously review the adequacy of supervisory regulatory resources to take account of market and regulatory developments and the growth of the international financial services sector. There is scope to undertake more robust site visits to insurers, especially as regards independent assessment of their risk management and corporate governance practices.”
Decoded, the inspection team appears to have been less than impressed by the Irish regulator’s response to a global reinsurance scandal that stretched from Sydney to New York. The scandal, which centred on the use of reinsurance contracts to manipulate corporate earnings emanated from the Dublin offices of Cologne Re, a subsidiary of the reinsurance conglomerate, General Re.
The most senior Irish executive involved, John Houldsworth, is a former chairman of the reinsurance industry trade association in Dublin. He is now awaiting sentencing in the US after admitting guilt in a plea agreement.
Later in the document, the IMF warns that “any soundness problems with the IFS institutions could result in reputational problems and even a decline in the activities in the sector (and thus lower employment and taxes, and underutilisation of existing services infrastructure)”.
A similar gloss is placed on a report published in the IMF research paper series. It notes that “an IMF research paper ranked Ireland first in the world among the world’s single regulators in terms of its independence and accountability”.
IMF research papers routinely carry a proviso that they do not reflect the opinion of the IMF as an institution. The paper in question is not sourced in the chief executive’s statement, nor is it referenced elsewhere in the document.
The interpretation of the evidence in the chief executive’s statement is exceptionally problematic. Despite the gloss, it is hardly an advertisement of the value of true disclosure - a fact that will not go unnoticed in the international financial community.
Despite or perhaps because of its success, Ireland is fast developing a major image problem.
Justin O’Brien is professor of corporate governance at the Centre for Applied Philosophy and Public Ethics (An Australian Research Council Special Research Centre) in Canberra