Gabriel Makhlouf is right to shine a spotlight on the IFSC

Market Watch: Republic is world’s sixth-biggest jurisdiction for ‘shadow banking’

Buffeted by impeachment efforts in Congress and speculation about his health following an unscheduled hospital visit earlier this month, US president Donald Trump used Twitter on Wednesday to post a doctored image of his face on a shirtless Sylvester Stallone character Rocky Balboa and reminded Americans of a key source of affirmation of his economic policies: the stock market.

“New Stock Market Record today. AGAIN. Congratulations!” he tweeted on the eve of Thanksgiving.


The Dow Jones Industrial Average, the grandfather of stock market indices, has soared over 20 per cent so far this year, the S&P 500 has jumped by a quarter, and Nasdaq gained by almost a third – each hitting fresh all-time highs this week. Equities globally, measured by the MSCI All World Index, have also jumped by more than 20 per cent.

The strength of the gains so far in 2019 have caught most observers off guard, especially when seen against the backdrop of weakening global growth and corporate earnings, trade tension between the US and China, and all manner of geopolitical concerns – not least Brexit.


But underpinning the markets have been generally accommodating central banks, with the US Federal Reserve cutting rates for a third time this year at the end of last month and the European Central Bank (ECB) moving in September to push its deposit rate deeper into negative territory, at minus 0.5 per cent.

The ECB also restarted its quantitative easing (QE) bond-buying programme earlier this month – leaving the euro zone at the epicentre of a global phenomenon where over €15 trillion of bonds are priced in the market to carry negative yields. This is pushing investors into equities and riskier assets.

With the herd instinct in stock markets alive and well, Canaccord market strategist Tony Dwyer warned investors who have been sitting on their hands up until now to jump into the market.


“While anything can happen, our indicators simply favour not chasing the market higher on Fomo [fear of missing out],” he said.

Global central banks are also sounding warning bells – albeit using less colourful language.

“If interest rates were to remain low for a prolonged period, the profitability of banks, insurers and other financial intermediaries could come under stress and spur reach-for-yield behaviour, thereby increasing the vulnerability of the financial sector to subsequent shocks,” the US Federal Reserve said this month in the latest version of its twice-yearly report on US financial stability.

Meanwhile, the ECB used its own latest financial stability review, published last week, to highlight that low interest rates and a growing trend of investors moving into longer-term bonds, in a hunt for income, “could exacerbate potential losses if an abrupt repricing were to materialise”.

Any shock will most likely be felt most keenly – initially at least – in the non-bank financial sector, or what is known as the world of shadow banking, some areas of which played a central role in the 2008 subprime mortgage crisis.

Still, this broad field – including crowdfunding, hedge funds, money market and investment funds, as well as special purpose vehicles – has continued to grow since the crash, as mainstream banks have been forced, by increased regulation and capital requirements, to move away from certain activities.

The Financial Stability Board (FSB), an international body set up in 2010 to monitor the global financial system, estimated in February that shadow banking (a term the FSB no longer uses, because of its pejorative connotations) grew 7 per cent to $184 trillion (€167 trillion) in 2017. It marked the sixth straight year of expansion and left the industry in a position where it accounts for almost half of all global financial assets.


Ireland is the world's sixth-biggest jurisdiction for non-bank financial activities, with the size of the sector, centred in Dublin's International Financial Services Centre (IFSC) having more than doubled in the past decade to more than €4.4 trillion.

While the industry in Ireland is mostly made up of heavily-regulated, Irish-domiciled investment funds and money market funds, it also contains special purpose vehicles (SPVs) and collateralised loan obligations (CLOs) that are subject to little or no regulation.

It's interesting, therefore, that Gabriel Makhlouf devoted part of his maiden public speech as Central Bank of Ireland governor last week to non-bank financing.

“Market-based finance provides a valuable alternative to bank financing for many businesses and households, supporting economic activity. But these activities may also give rise to financial vulnerabilities, which need to be understood, monitored and addressed,” said Makhlouf.

“The key point is that the resilience of market-based finance at the current scale – both in Ireland and internationally – remains untested in times of stress.”

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 Ireland, as host to trillions of euros of global assets, has responsibilities to the wider system.

Makhlouf, who was born in Cairo and who served as a UK civil servant and head of the New Zealand treasury ministry, seems keen to ensure the State lives up to these.

It’s a welcome development.