IFSC banks circle their wagons as Elderfield tries to tame 'Wild West'
The Financial Services Centre's German banks have been particularly reluctant to accept regulation, writes Mark Keenan
LAST weekend, foreign sailing ships of the sort that once brought big world commerce to Dublin were again tethered before Gandon's Custom House -- the city's original international trade centre.
Its modern equivalent, the IFSC, swarmed with strollers and the vacant lots beneath Anglo Irish Bank's still-born headquarters were transformed into a carnival. Amid the dodgems and merry-go-rounds, revellers occasionally looked up to marvel at the skeletal shell.
The "tombstone to the Celtic Tiger" (as it was christened by a commercial court judge), has just been bought by the Central Bank and will soon house its 1,500-strong complement of staff.
Among those set to occupy the stale husk of bad boy banking will be Matthew Elderfield's squad of regulators and finance sheriffs who know that the 'Tombstone' -- set square as it is in the midst of the IFSC's 250 banks and financial firms -- is the perfect spot from which to hone Ireland's new-fangled, hands-on regulatory banking regime.
Despite taking a goring from the world financial crisis, the IFSC flagship still generates a billion in corporate taxes each year and almost the same again in payroll taxes for the national exchequer.
But for the international companies that once made so much hay in pre-crash era Dublin -- and many of them originally embarked here for its famous "light touch" regulation -- the carnival might seem to be well and truly over. They certainly won't relish the proximity of their inquisitive new neighbours.
With Mr Elderfield's minions already running hither and thither through their affairs, they're a long way from 2005 when the 'New York Times' famously described an unfettered IFSC as the "wild west" of international finance.
Since his appointment to clean up Dodge City in October 2009, Mr Elderfield has been making steady and determined headway in creating "assertive regulation backed by a credible threat of enforcement".
"We have taken a risk-based and proportionate approach to addressing the gaps (in basic regulatory structure). New corporate governance standards are now in place aimed at raising standards by encouraging greater focus on governance and a broadening of the gene pool of Irish corporate life by bringing more diversity and experience onto boards," is how he put it not so long ago.
"We have introduced a new, assertive, risk-based supervisory model -- we call it PRSM -- which is tailored to the impact and risk a particular firm poses and therefore allows us to apply a proportionate supervisory effort. And new Fitness and Probity standards have been introduced."
Having shown his steel, most notably in his "show me the money" stand-off with the Quinn empire and even his controversial assertion that his staff could do with a better education, Mr Elderfield has proved he is tough to trifle with, something the Germans at the IFSC long ago discovered.
Behind the scenes, a quiet war has been going on for almost three years between the regulator and the foreign-owned banks based at the IFSC -- with the all the stuffy boardroom formality and sang froid that international bankerdom can muster.
To help pay for the Central Bank's new staff and a never used IFSC headquarters, fees charged to the various IFSC banks have been doubled -- just one of the sore subjects currently festering among the bosses of the IFSC's foreign-owned operations.
The rub for Mr Elderfield has been getting the balance right between a regulatory system that permits innovation and one that veers into flagrant "light touch." Those in pinstripes will obviously have a very different view.
The latest issue to simmer the international banks is the Central Bank's new probity requirements -- which must be complied with by at the end of this year. Through these, certain staff at high levels must answer stiff questionnaires to vouch for their own personal financial positions. Essentially, the regulator gets to say which big shots you employ and which ones you don't. Big world banks are not used to such intimately personal probity probings -- especially from a backwater regime in a bailout state.
This perceived localised impertinence comes on top of Basel 3, the most recent installation of the international Basel Accords, which call for universally strengthened capital requirements and new regulations for liquidity amid the global regulatory backlash.
As the Elderfield roundheads increasingly rummage through their drawers, the Dublin-based foreign captains have become more and more reticent.
The cavalier element among them might hanker after the good old days when Central Bank mandarins kept to themselves in their dusty old Dame Street tower. Days when smart bankers like themselves could circumvent a potentially tricky Dame Street meeting simply by scheduling it close to 5pm -- knowing that the only thing the Stephenson tower occupants were known to be zealous about in those days was going-home time.
A senior executive in one foreign-based bank adds: "The Central Bank people felt unfairly blamed for the banking crisis. Now they're complete sticklers for every rule in the book. It's not the presence of the regulations that are contentious as such, rather how the regulations are enforced. A lot of the foreign-owned banks feel it's making business more difficult and some have even been talking about pulling out."
Recently a posse of big German banks called for the centralisation of banking supervision under the ECB in order to "remove the influence of national politics in supervision" and to bring a "European level of supervision to banking". It was ostensibly a call to take lax banking away from profligate countries like Spain (and presumably, Ireland). We can also wonder if such a move would ease those pesky frisking of their outpost regions by local enforcers like Mr Elderfield.
The same German banks fired the first warning shot across Mr Elderfield's bows in 2010. In a strongly worded letter, the Germans threatened to pull out of the IFSC altogether if he pressed ahead with certain reforms in the banking sector -- notably those concerning corporate governance.
"The marketing of the IFSC is at present a difficult task. Perceived over-regulation would make it impossible," they fumed in 2010.
The German banks have also been sniffy about their directors being subjected to the same probity shakedowns as those of more obviously errant Irish-based banks. Also getting up their nose is Mr Elderfield's demand for non-executive directors to exert more influence at board level.
"Irish non-executive directors generally are recruited according to their skills, which compliment those of the shareholder representatives on the board. This inevitably leads to a lesser degree of non-executive director independence than may be proposed by the governing codes," the letter asserted.
Mr Elderfield pushed on with his governance rules, and thus far they're still here. Round one to him.
Mark Yeandle, of the City of London-based financial think- tank Z/Yen Group, adds: "The Germans are "pulling out" of the City of London every year, because the taxes are too high or the regulations or too severe -- they moan about absolutely everything. But we ignore them and they stay anyway. It's a tactic they use.
"But London is a world leading centre and Dublin, as a much smaller hub, is far more susceptible to bullying. That said, wherever an economy gets into trouble because of the financial base, there's always a regulatory knee-jerk. You do have to be careful that you don't over-regulate."
Pat Farrell represents the Irish Banking Federation, which recently kicked off very publicly against the Central Bank last week over claims that Irish banks weren't lending to business. He says things have calmed down somewhat between the regulator and the international banks since 2010. "Admittedly there had been a quite fraught atmosphere until maybe a year ago. But since then there have been some concessions made and I don't think that at this point, anyone is about to pull out of Ireland."
Despite the IFSC's foreign-owned companies claiming difference from their sullied Irish counterparts, there is also a history of dirtied bibs in their ranks.
In 2005, Dublin-based Cologne RE played a pivotal role in a sham scheme to inflate the reserves of US insurance giant AIG -- the scandal that originally brought the IFSC its international "wild west" monicker. US Investigators heard that "Cologne RE was seen as an ideal location for the fraud because Dublin "did not report to anyone" and so avoided the "North American problem" of financial regulation.
In 2007, German bank Sachsen LB needed a bailout when it was discovered that its two Dublin-based investment vehicles had insufficient assets to cover their liabilities.
There was the Depfa bank scandal. The subsidiary of Hypo real Estate ran into trouble in 2008, eventually prompting a bailout by the German government that is still the biggest in Irish banking history.
The regulator still won't reveal what action, if any, had been taken against Unicredit's IFSC subsidiary in 2007 when whistleblower banker Jonathan Sugarman, then its risk manager, shopped his bank to the Irish regulator after alleging that its liquidity reserves were 20pc below the legally required limit. Sugarman has since claimed the regulator's office did nothing about it.
Meantime, 16 executives from the parent company, including the CEO, are going on trial in Italy for cooking the books in that year.
So what did Mr Elderfield first make of Dublin when he arrived here from Bermuda back in 2009? Was there much cleaning up to do?
"I think the "wild west" moniker was unfair. I suppose it has to be seen in the light of the nervous international environment at the time and the difficulties in global banking impacting on some of the international banks which had operations at the IFSC.
"But there were some regulatory issues at the IFSC and we are working to tackle these. Change was needed and that change is being implemented."
He cites an absence of effective standards for corporate governance and fitness and probity. "There was a need for a more assertive supervisory approach, where regulators challenge firms on important issues."
Mr Elderfield asserts that his proposed regulations aren't always cast in stone and when a reasonable argument has been made against his changes, he takes heed.
"We consulted widely with firms before we introduced new corporate governance and fitness and probity standards. We weighed up carefully all the responses we received and where a good case was made, we adjusted our standards.
"It is true to say that some banks had an issue with our proposal that the chairman of a subsidiary company operating in the IFSC should be independent of the parent company. We considered that objection and decided to revise our proposal. I believe in open, constructive and transparent dialogue with industry on regulatory changes and on issues that arise; this allows us to arrive at solutions that will work."
But overall it is clear that he believes the banks can take the medicine. It's a tough game of poker, however, if 30,000 jobs are at stake, as some will claim.
"I am not aware of any banks that have left the IFSC/Ireland because of regulations the central bank has introduced. We have no evidence or examples of that."
A senior source with an international bank agrees that Mr Elderfield has given leeway, particularly in the past year:
"There has been some amount of backing off from the regulator, but not much. Banks have been given individual exceptions from certain regulatory aspects. Of course no one knows who has the benefit of what exceptions."
The source claims that on a regulatory rating of one to 10, Ireland has moved from a three to a nine and more recently, back to eight.
While the stiffening of the regulatory regime may not have played such a big role as claimed, the German assertion that Ireland would become a less attractive location for international banking has already come to pass.
The Global Financial Centres Index 9gfci), published twice annually by the London-based financial thinktank Z/Yen, reflects the views of 1,400 international bankers. In 2009, Dublin featured in its top 10 of financial centres in the world. Most recently in the March study, Dublin had fallen to 46th position and, according to Z/Yen, is likely to fall further in the next survey due next month -- perhaps even taking Dublin outside the top 50 for the first time since the survey began.
There is a perception that the IFSC is at a crossroads. Some say it can cover itself by specialisation -- whether that be "green funds" through the so-called "Green IFSC" or as a European hub for sharia banking.
The founding of the promotionary group IFSC Ireland in 2010 was one ruse to improve its appeal worldwide along with closer working with the IDA to attract new employers.
Mark Yeandil, editor of the GFCI, says this is the right thing to do. "Toronto in particular has proven that getting out around the world and marketing your services to the right people does have an effect."
Unlike the IDA, however, IFSC lobbyist John Bruton's sales pitches seemed more focused on the companies already in the IFSC than new ones that might get into it. In interviews, he has stressed the importance of ensuring companies that are already in the IFSC, remain committed to Ireland.
"If the IFSC consists of 500 separate firms in a range of different sectors, these are mobile jobs. They are here by choice and they can leave by choice," he has said.
The bankers' moans also fly in the face of the fact that lightness of touch, despite the moral issues involved, cannot prevail for Ireland, particularly given that a trading partner as important as the USA is already on the warpath against lax banking havens worldwide.
As Mr Elderfield gears into the final phases of his regulatory drive and the IFSC's foreign employed bankers become more accustomed to frequent intrusions in the name of better practice, there are contrasting views as to where the future of the IFSC will go.
Mark Yeandil adds: "Despite the low ranking in our report, I think Dublin is largely making the right moves. I think in the years ahead we'll see it move slowly up into the 20s. When the IFSC opened first it marketed itself based on an educated English speaking workforce with low costs. Low rents, low wages, and low corporate tax rates. Now only the tax rates are low. But as a financial centre, Dublin still has very skilled English-speaking personnel with that important access to Europe, and it is fundamentally not as damaged as it has been portrayed."
Others are less optimistic. One banker says: "In the past when they made huge profits, the big European banks would somehow find a way of channelling as much of it as possible through Dublin to avail of the cheap corporate tax rate. Now, given massive losses at the parent companies, and their probable ability to write them forward, there's simply no good reason for them to be here. Why have a load of staff located abroad in Dublin with all the costs that entails when there's no profit to write off?"
For his part, Mr Elderfield remains staunch in his belief that reputation enabled by proper regulation is paramount.
"For the IFSC to be a continuing success, it is important to maintain a strong reputation for high standards. The IFSC and Ireland, like other jurisdictions, are facing a very big international agenda of change as a result of the financial crisis. Some of the new regulatory requirements are already clear -- for example Solvency II for insurance and implementation of Basel 3 for banks.
"But there will be other areas where new regulatory actions will emerge -- for example, shadow banking, which will impact the money market fund industry in Ireland and the securities lending and repo market. A possible banking union in the European Union, which would involve the centralisation of supervision, is another emerging issue," Mr Elderfield says.
"In my experience, industry generally is well aware of the need for change and the importance of change to ensure a successful future for the IFSC," he adds.
Thus far at least, the man is not for moving.