The Report also includes an outline of the Central Bank’s supervisory priorities for the funds sector during 2022. The key points of relevance for funds and fund management companies (“FMCs”) are set out below.  (The key aspects of relevance across the debt capital markets, financial regulation, and banking and finance sectors more generally are covered in our Financial Regulation Group’s briefing here).


Board Oversight, Governance Structures and Due Diligence
Well-governed securities markets, and robust governance of regulated financial service providers, continue to be a central theme of the Central Bank’s industry engagement. The Report highlights the importance of effective governance structures, board oversight of delegates, and conducting appropriate due diligence before a fund/FMC appoints a delegate, or enters into a contractual arrangement with another entity.
The Central Bank expects funds and FMCs to ensure that their boards are accountable for all aspects of governance, including having a clear organisational structure that defines and clarifies responsibilities for operational, control, and reporting processes, and identifies who is responsible for making key decisions.
The Central Bank noted that the risks relating to ineffective board oversight of delegates and third party intermediaries remain a key factor in the regulatory deficiencies it has identified through its supervisory mandate. A case-study on a sanction imposed by the Central Bank on an FMC for breaches of governance, oversight of delegates and investment restrictions was specifically included in the Report, further highlighting the importance of robust delegate oversight. (For more information, please see our briefing here).
The Report also highlighted instances where fund boards/FMCs were not undertaking sufficient due diligence of delegates. The Central Bank expects that all aspects of the proposed relationship should be scrutinised thoroughly, such as (but not limited to) legal agreements, a delegate’s regulated status, stated expertise and prior relationships.
The Report states that findings from the Central Bank’s thematic review of its Fund Management Company Guidance (“CP86”) are closely aligned with the risk of inadequate board oversight, governance structures and due diligence. Among the deficiencies identified in that review were a failure by FMCs to have appropriate resources and a lack of skills and experience amongst staff. (For more information on the CP86 review and findings, please see our briefing here). The Central Bank also noted the increase in the number of self-managed investment funds appointing a third party FMC in order to meet the requirements of CP86. The Central Bank expects third party FMCs to critically assess the impact of proposed new business in order to ensure that they are appropriately resourced to service any additional business.
With regard to designated persons (“DPs”), the Central Bank requires FMCs to clearly identify named individuals, who are responsible for monitoring and overseeing the managerial function assigned to them. The CP86 review identified failures in appointing local DPs with the relevant skills and seniority for their managerial function, and in many cases not enough time was committed by the DP to carrying out the tasks required.
Investment Advisors Acting as Investment Managers
The Central Bank has noted an increased number of investment advisors acting in the capacity of de facto investment managers, which it states is not consistent with the information disclosed in the prospectus and exposes investors to an increased risk of investment losses. The Central Bank expects that where investment advisors are appointed in respect of a particular fund that a detailed rationale is provided for the appointment and the role the entity will fulfil. The Central Bank also specifically referred to boards regularly scrutinising the investment manager’s report, including any interaction with investment advisors during the period in question.
Once again the Central Bank has re-iterated that it sees no distinction between “delegation” and “outsourcing” and it expects all firms to adhere to all legislative requirements on outsourcing and to have regard to the new Cross-Industry Guidance on Outsourcing (the “Guidance”) published in December 2021. The Guidance applies to ‘regulated firms’ rather than regulated products. Consequently, in its feedback statement accompanying the final Guidance, the Central Bank stated that in the case of investment funds, that the Guidance will apply in a proportionate manner to the fund service providers associated with the operation of the fund and not to the fund itself. Nevertheless, the board of directors of an externally managed fund should ensure that it supports the ability of the FMC to comply with the Guidance.

Sustainable Finance

Unsurprisingly, sustainability is a key focus for the Central Bank and it expects all firms to demonstrate clear leadership on the climate issues facing their business and emphasise a culture of compliance with climate and sustainability principles. The Central Bank also expects all firms to take account of its “Dear CEO” letter, with regard to climate and other ESG issues.
Funds and FMCs should review this letter and ensure that:

  • they can comply with the Central Bank’s expectations, which apply on a proportionate basis, having regard to the nature, scale and complexity of the entity;
  • the Central Bank’s expectations are taken into account when reviewing risk management frameworks and policies; and
  • a work-plan is in place to address any gaps or issues arising from the letter.

The Report also refers to the implementation of SFDR and the Level 2 measures that will take effect from January 2023, stressing the importance of dedicating sufficient resources and management focus to ensure the continued successful implementation of these measures. The Central Bank will also be conducting a thematic inspection on SFDR/Taxonomy Regulation compliance during 2022. While the scope and content of the thematic review has not yet been announced, we understand that the review may focus on fund classification.

Financial Innovation: New Products and Third Party Influence

New Products
The Report places particular emphasis on Special Purpose Acquisition Companies (“SPACs”) and crypto-assets in today’s Report. It reiterated ESMA’s public statement on its investor protection concerns in respect of SPACs, and noted that the Central Bank has limited investments in SPACs to a maximum of 10% of the net asset value for retail investment funds.
The Central Bank saw an increase in queries with regard to investment by UCITS and retail AIFs in crypto-assets. The Central Bank reiterated the position set out in its UCITS and AIFMD Q&As, which provide that the Central Bank is highly unlikely to approve a UCITS or retail AIF proposing any exposure (either direct or indirect) to crypto assets. (In the case of a QIAIF seeking to gain exposure to crypto-assets, the relevant QIAIF would need to make a submission to the Central Bank outlining how the risks associated with such exposures could be managed effectively by the AIFM).
Influence of Third Parties
The Report references an increasing influence of index providers in the design of funds, and the sale of funds through platforms/distributors that may influence dealing and settlement times that are not appropriate having regard to the liquidity profile of the portfolio.
The Central Bank expects:

  • FMCs to maintain adequate autonomy over product design and oversight on the selection of index provider including seeking evidence of initial and ongoing due diligence by the investment manager, and understanding the method and nature of index methodologies including rebalancing;
  • Funds/FMCs to ensure that dealing and settlement times are consistent with the liquidity profile of the portfolio. If the requirements for onboarding with a platform/distributor are not consistent with the characteristics and profile of the relevant investment fund portfolio, the Central Bank considers that it is not appropriate to distribute through these means.

Market Dynamics: Fund Liquidity and Leverage

The Central Bank expects funds/FMCs to have an appropriate risk management framework in place to identify, manage and mitigate the potential risks arising from the use of leverage and liquidity risk within a fund’s portfolio, including regular stress testing scenarios.
Other Points to Note: include a continued focus on data, cyber-security and operational resilience, market abuse and conflicts of interest. With regard to conflicts of interest and connected party transactions, the Central Bank identified shortcomings in the way some depositaries and DPs perform their roles in ensuring the rules around connected party transactions are properly applied. The Central Bank expects funds/FMCs to engage thoroughly with their depositaries and DPs to ensure that all parties fulfil their obligations when such transactions are being contemplated.

Supervisory Priorities

The Report also sets out some of the Central Bank’s supervisory priorities for 2022. Of most relevance to funds/FMCs are:

  • the upcoming Common Supervisory Action (“CSA”) on Fund Valuation;
  • follow-up work on the CP86 review;
  • follow-up work on the CSA on costs and fees in UCITS;
  • continued engagements with depositaries and administrators including conducting targeted risk assessments focussing on governance, operational and capital risk;
  • continuing with the planned Supervisory Review Framework project, focusing on the review of the PRISM impact rating model for funds, and related supervisory engagements; and
  • the Central Bank’s focus on supervisory convergence (through ESMA participation) international co-operation (IOSCO).

Next Steps

The Central Bank expects funds and FMCs to review the risks and supervisory priorities contained in the Report and to consider incorporating practices relevant to their business activities into their own risk assessment and mitigation programmes. The increased focus on fund/FMC governance highlights the importance of having clear and documented governance structures and ensuring effective board oversight of delegates. Boards must ensure that there are robust governance and delegate oversight procedures in place and that these are rigorously followed in practice. The examples and expectations set out in the Report reflect many of the items identified by the Central Bank in October 2020 following its thematic review of how fund management companies had implemented CP86 and is another reminder that FMC boards need to continually evaluate and critically assess their day to day arrangements to ensure the full and effective embedding of all aspects of CP86.
If you would like to discuss the foregoing in the more detail, please do not hesitate to contact any member of our team.