Irish-based funds warned over risk to corporate bonds market

Central Bank governor Gabriel Makhlouf warned on Thursday of risks to Irish-domiciled funds invested in corporate bonds as companies globally face credit ratings downgrades amid the economic shock caused by Covid-19.

Dublin's International Financial Services Centre (IFSC) is a major international hub for global funds, and Mr Makhlouf has set a priority since taking charge of the Central Bank last September on the whole area of the country's non-bank financing sector, or what's known as shadow banking.

“The onset of the pandemic saw large outflows from funds globally. Irish-domiciled funds also experienced large outflows, particularly those with exposures to less liquid assets or assets that became temporarily illiquid,” Mr Makhlouf said in a webinar speech from Dublin.

“One of the fund segments that proved particularly susceptible to outflows in March was corporate bond funds. The corporate bond market also saw a sharp deterioration in market liquidity at the onset of the Covid-19 shock.”

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Stabilised

Mr Makhlouf said that flows of money into corporate bond funds have stabilised recently, as global central bank interventions have supported financial market functioning. “But looking ahead, a key risk for the corporate bond market stems from potential credit rating downgrades,” he said. “We will continue to monitor the markets for such developments.”

Only a tiny portion of investments in Dublin-domiciled funds relate to the domestic economy, and the risk of an entity running into trouble would cause more reputational damage than direct cost for Irish taxpayers. However, Mr Makhlouf has made it clear that Ireland, as a host to trillions of euros of global assets, has responsibilities to the wider system. The funds sector is one of the most heavily regulated areas of activity in the IFSC.

Downturn

Turning to the domestic economy, Mr Makhlouf said that the downturn since the Central Bank last published forecasts in April, predicting an 8.3 per cent economic contraction this year, “has been severe”.

The bank will publish another set of projections in early July, in line with European Central Bank (ECB) scenarios that have looked at baseline, mild and severe economic scenarios.

The central ECB scenario sees euro zone gross domestic product (GDP) falling 8.7 per cent this year, with the severe case, involving a resurgence of the virus across Europe and another lockdown, leading to a predicted 12.6 per cent contraction.

Mr Makhlouf returned to Ireland earlier this week from Greece, where he had been under lockdown since the middle of March after travelling to the Mediterranean country to visit his mother, who was ill at the time.