IT IS easier, in contemporary Ireland, to say where the bottom line is not than where it is. It is not at refusing to put people in locked wards in mental hospitals because otherwise there is no staff to care for them, or insisting that a child with learning difficulties should be helped before the damage becomes irreparable.
But there are two things on which official Ireland draws the line, two areas on which the Government will use all of its remaining sovereign powers. One is low corporation tax. The other is the protection of the International Financial Services Centre (IFSC).
Last week, the Taoiseach made it clear that Ireland will align itself with David Cameron and the City of London in the struggle over plans to introduce an EU-wide tax on financial transactions.
Similarly, in spite of everything that’s happened, we’ve had strong noises coming from John Bruton (president of the IFSC’s lobbying group) and from others in the industry warning against “over-regulation” of the sector.
According to the Sunday Times, "since the publication of tough new regulations last September . . . representatives of the IFSC have been in secret talks with [Financial Regulator] Matthew Elderfield in an effort to get some of them relaxed."
Let’s back up here for a minute. The IFSC is unquestionably an important national asset, employing over 30,000 people and contributing over €2 billion in taxes. Most of what it does is perfectly legitimate and some of it is socially beneficial.
But we also have a problem. Part of the attraction of the IFSC for some foreign financial companies was the heavy hint of “light-touch regulation”. This made the IFSC the location for three major international frauds. It created Ireland’s disastrous reputation as the “Wild West of European finance”. And it added greatly to the catastrophic failure of domestic banking regulation for which we are paying such an appalling price: how could we seriously regulate Irish banks while sending out the message internationally that we’d turn a blind eye in the IFSC?
But, many people will be thinking, that’s all in the past. It isn’t. How many people know that the IFSC still has a huge and practically unregulated shadow banking system, one which regulators struggle to understand, let alone control?
Remember those crash courses in banking we all had to take when the system imploded? Remember that at the heart of the crisis was securitisation: the practice of bundling up loans and selling them on as if they were assets? Guess what? The IFSC is still a major world centre for the practice of this magic trick.
Securitisation became taboo after the crash. But here’s the thing: the use of securitisation in the Irish system has increased. In 2006, at the height of the boom, the Irish banks had shifted €17 billion of loans off their balance sheets by securitising them. By last year, that figure had more than doubled to €36 billion, according to the Central Bank.
Securitisation is done through creatures called financial vehicle corporations (FVCs). Within the euro zone, Ireland is by far the biggest location for FVCs. There are 800 of them in the IFSC, as compared to fewer than 600 in the next biggest location, the Netherlands. These FVCs make up an extraordinary 16 per cent of the entire Irish financial sector – as compared to 4 per cent in the euro zone as a whole. As of the first quarter of last year, FVCs in Ireland held assets of €546 billion.
This money is largely made up of the stuff that engineered the crisis: residential mortgages turned into securities, collateralised debt obligations (CDOs) and all that dark alchemy by which, as the Central Bank blithely expresses it: “The majority of assets on the balance sheet are loans”.
A significant slice of this business, moreover, involves a double magic trick: “CDOs holding securities other than shares are often engaged in what is termed ‘re-securitisation’, i.e., they hold debt securities which are the product of a securitisation.” And many of the assets that are not in this form are shares and equities held as part of a transnational merry-go-round.
For reasons that are beyond me, the bulk of these assets seem to be Portuguese. The Central Bank’s description of what’s going on is not reassuring: Portuguese banks “often utilise a Portuguese-resident FVC which issues ‘securitisation fund units’ (equity) to an Irish-resident FVC which issues the debt securities backed by the Portuguese loans to investors.”
I’m not suggesting that any of this is unlawful or illegitimate. But it has two features that ought to be alarming. Firstly, it’s very hard to understand, even for professionals: the Central Bank notes that “the high degree of diversity and complexity within the FVC sector will continue to present challenges from an analytical point of view.”
Secondly, it is virtually unregulated. If those two things don’t ring a bell, you haven’t been paying attention to the origins of the financial crisis. The benefits of the IFSC have to be weighed against the disastrous consequences of a feral financial system. Taxing and regulating that system is a vital national interest for us too.