Where is the sheriff as a financial El Paso looms?

Business Opinion:It is, if nothing else, a little bit embarrassing when a €17.3 billion black hole at an unknown Irish company precipitates the near collapse of a state-backed German bank.

Indeed, if some reports are to be believed, the meltdown at Ormond Quay may spell the end of the German Landesbank system as currently constituted, with a round of mergers now seen as being likely.

Awkward? Yes, particularly if you are Irish and live in Saxony. But does it amount to a systemic failure of the Irish regulatory system and do we need to look again at how the financial services industry here is developing?

The Irish Financial Services Regulatory Authority (Ifsra) understandably does not seem to think so, but the matter is worthy of further consideration.

Before doing so it is perhaps worth teasing out the background to the problems at Ormond Quay, which was a "conduit" sponsored by Sachsen LB, the state bank of Saxony. Along with most of the other German Landesbanks this bank was founded with a mandate to support local business and provide services to regional savings banks.

Until two years ago they were able to avail of state guarantees to underpin their business, but since the European Union declared the guarantees illegal they have had to rely on more and more exotic ways of earning money.

According to figures from Moody's Investors Service none of the Landesbanks rank in the top 30 European banks, but they all rank among the top 30 sponsors of conduits such as Ormond Quay.

And conduits, as we now know, are pretty high-risk businesses which invest in long-term assets by raising cash in the short-term debt markets, usually through the issue of commercial paper.

It is also the case, according to Moody's, that at least four of these Landesbanks run their conduits out of Dublin. The biggest of which is Ormond Quay.

On this basis, what happened at Ormond Quay does seem to confirm the worst fears of those who are concerned about the consequences of the light touch, pro-business regulatory regime operated by Ifsra.

They would argue that the regulator is facilitating the development of the International Financial Services Centre in Dublin as the destination of choice for second-tier financial institutions which want to undertake lucrative but highly-risky activities in an unregulated environment.

The trade-off being the generation of significant economic activity in the IFSC and elsewhere.

There is another way of looking at it and it is the view taken from the lofty heights of Dame Street.

The issuing of commercial paper is a legitimate business activity which gives non-banks access to debt markets.

It has been going on in Ireland since 1989, when the Central Bank started to allow large corporates, including multinationals, to issue debt for working capital purposes. The main regulatory requirement being that the issuer had to seek an exemption from the Central Bank for the need to have a banking licence.

In time, some of the commercial paper issuers also sought exemptions to be able to issue commercial paper and invest the proceeds in assets such as bonds.

And thus conduits were born. It was, from Ifsra's point of view, more a case of a regulatory regime evolving to match the increasing sophistication of industry.

By facilitating conduits, Ifsra was doing nothing that regulators in other competing jurisdictions were not doing.

And, indeed, everything was fine until this summer, when it became increasingly apparent that the incredibly complex money machines constructed in this unregulated space did not work as well as their inventors thought.

Although some perspective is needed here as well. It must be noted that there are 25 conduits operating out of Dublin, of which 10 are sponsored by financial institutions.

Until this weekend, problems had only come to light at one of them, Ormond Quay, albeit on a spectacular scale. And at least one other sponsor, WestLB, has had to support its conduit in recent weeks.

It is easy with hindsight to say that Ifsra was wrong not to regulate conduits more tightly, and perhaps a little unfair given that only one of them has experienced significant problems to date. Equally, it is pointless for Ifsra to quote chapter and verse as to why it had no responsibility for what went on at Ormond Quay and that the German banks have only themselves and their regulator to blame.

The inescapable fact is that a financial catastrophe of global significance happened in Dublin. If there are to be many more of them, then the IFSC will start to resemble the sort of financial El Paso that its detractors like to paint it as.