On 28th November 2024 the CBI issued a letter outlining the key findings and actions to be taken by boards of management companies (ManCos) following its review of primary and secondary market trading arrangements on Irish authorized ETFs.

With more than 70%¹ of all European ETF assets domiciled in Ireland, this letter has significant implications for the ETF industry. The CBI also sets a tight timeline of Q2 2025 for implementation of the necessary changes to fund frameworks and practices, which will naturally focus the minds of all issuers, fund boards and ManCos of Irish domiciled ETFs.  

While only eight pages long, the letter impacts a wide range of participants engaged in the oversight of Irish domiciled ETFs.

A closer look

In 2023 the Central Bank of Ireland (CBI) initiated a review of the primary and secondary market trading arrangements in place on Irish authorized ETFs. Around this period, IOSCO published a paper of global ETF principles and good practices and the IMF also issued a report flagging certain concentration risks within European ETFs.

This increased regulatory scrutiny was driven by a mixture of factors: 

• the continued rapid growth of ETFs
• the novel function and roles of authorized participants (APs) and market makers (MMs) to ETFs compared to, for example, UCITS mutual funds
• the fact that APs/MMs to the Irish ETFs are not directly regulated by the regulators of the ETFs themselves. 

The review was also consistent with a cross sectoral theme on oversight of fund delegates and fund liquidity. 

The review was primarily undertaken to ensure that the roles played by APs and MMs and oversight performed by fund boards and ManCos are sufficient to protect investors and promote the integrity of the ETF ecosystem.

The responsibility for oversight lies with the ManCo – and it's falling short on expectations

To address these shortcomings, the CBI requires the board of the ManCos to review the actions, and where appropriate, make the necessary changes.

 Some of the actions include:

• Assess current practices against Measure 4 (relates to oversight of APs/MMs including due diligence and ongoing monitoring) of the IOSCO Good Practices
• Review the key findings outlined in the Dear Chair letter especially as it relates to pre-onboarding due diligence and ongoing monitoring of APs and MMs
• Consider applying certain aspects of their delegate/outsourcing service provider frameworks when overseeing APs/MMs including governance arrangements, risk reporting, contractual arrangements, and service level agreements as well as contingency arrangements
• Boards should ensure that relevant, risk-focused reporting is provided to them on a regular basis
• Review to ensure that a sufficient number of APs and MMs are in place in consideration to the nature of the ETF to mitigate concentration and liquidity risk
• Agreements with MMs should be formalized, and such contracts noted by fund boards

Key considerations moving forward: new oversight processes, greater accessibility to order data and expanded application of the CBI’s outsourcing guidance.

Some of the key considerations include:

Enhanced due diligence for APs and MMs

Reference is made to “due diligence” of APs/MMs in a number of places in the letter pointing to using Measure 4 of the IOSCO Good Practice Guide.

The CBI’s expectations require ManCos and issuers to introduce new oversight processes, controls and reporting, going to the extent of providing a list of areas to consider such as financial health and performance, ownershipstructure or regulatory history.

Consideration will need to be made regarding which entity is primarily responsible for conducting due diligence, whether this is outsourced to a third party and at what stage in the onboarding processes this is completed. The frequency and detail of reporting to the board on due diligence activities will also need to be proportionate.

Greater issuer accessibility to order data

Another key theme relates to ongoing oversight of APs/MMs and reporting to fund boards. A key element to facilitate this is Issuers’ accessibility to order data. Given that transfer agents/order takers are the interface between the fund and APs/MMs to facilitate placement of primary market orders, it is integral that order taking systems can provide the required data set.

The responsible entity will need to consider technology system requirements for consumption of order data, its timely monitoring and where necessary escalation processes.

Certain aspects of outsourcing guidance to be extended to APs/MMs

Arguably the most significant aspect of the letter is how the CBI views the appointment of APs/MMs and their relationship with the ManCo. The letter asks that ManCos consider applying certain aspects of their delegate/outsourcing service provider frameworks when assessing APs/MMs, implying that certain aspects of the Central Banks’ Outsourcing Guide (CP138) should be considered. Boards and ManCos will therefore have to consider items such as critical or important functions which are outsourced to APs / MMs and impact tolerances. Consideration will need to be paid to which criteria from CP138 will be used, how this is recorded and the responsible party.