“The role of financial regulation in building resilience, anticipating risk, and protecting citizens – in steady times and through shocks” - Speech by Director General, Financial Conduct, Derville Rowland

Speech delivered at FSI Executive Board engagement

I’m pleased to be with you today to give an overview of the Central Bank’s financial regulation priorities for 2022.

I’m going to start, however, by saying a few words about Ukraine.

This is, first and foremost, a human tragedy. The loss of life and human suffering as a result of the invasion are at the forefront of our minds.

The escalating sanctions imposed on Russia by the EU and the US at political level are a clear statement of unity.

The tragic events in Ukraine are also likely to have broader macro-financial implications at a global level. Indeed, some of these are already evident.

There is a range of channels through which the conflict – or any further escalation of the conflict – could transmit to the global economy and financial system. Energy and commodity prices, for example, have already surged, with implications for the cost of living and inflation. There could also be abrupt shifts in market sentiment, with implications for global financing conditions.

As a small, highly globalised economy, we are particularly sensitive to developments in the rest of the world. Notwithstanding the fact that Ireland’s direct exposures to Russia are relatively modest in the context of the overall size of the financial system, these second round effects will have implications for Ireland.

The outlook at this stage is subject to very high levels of uncertainty, both in terms of potential geo-political outcomes and – because of that – potential macro-financial outcomes.

At the Central Bank, we have been closely monitoring developments in Ukraine and assessing potential impacts on the economy and financial system. Throughout this crisis, we will retain an unwavering focus on delivering our mission: to serve the public interest by maintaining monetary and financial stability, while ensuring that the financial system operates in the best interests of consumers and the wider economy.

In Shakespeare’s famous soliloquy, Hamlet speaks of:

“The heartache, and the thousand natural shocks

That flesh is heir to…”

Ukraine is the world’s latest heartache.

But shock is something to which, sadly, we are becoming more and more accustomed.

The great financial crisis. Brexit. A global pandemic. And war in various parts of the world, Ukraine being the latest.

Today I’d like to explore financial regulation partly in that context, and its role in building resilience, anticipating risk, and protecting citizens – in stable times and through periods of shock.

Central Bank strategy

All of these are key elements to the Central Bank’s strategy, built around four core themes.¹

The Safeguarding theme reflects fulfilment of our mandate to maintain price stability and financial stability and ensure that the interests of consumers and investors are secured.

Under the Future Focused theme, we are working to ensure the financial system adapts well to the backdrop of rapid change and disruption, so that the interests of citizens and the economy are served by change, innovation and competition.

Through the Open and Engaged theme, we are focused on enhancing our engagement with our full range of stakeholders at home and abroad, including yourselves, to better explain our approach and better understand your challenges, concerns and perspectives.

Finally, by Transforming, we are focused on being more agile, enhancing our skills and capabilities, and making even better use of technology.

Turning to financial regulation specifically, the Central Bank’s vision is for a resilient and trustworthy financial system, which sustainably serves the needs of the economy and citizens, in which firms and individuals adhere to a culture of fairness and high standards.

The importance of resilience:

A resilient system has the capacity to respond to shocks large and small, and to innovate appropriately over time.

In the decade and more that followed the financial crisis, significant progress was made in rebuilding the resilience of the system and restoring trust and confidence in its functioning.

That resilience served the economy, consumers and investors effectively as the worst economic and financial effects of the Covid-19 pandemic were mitigated. But as the Governor of the Central Bank has noted, it has been drawn upon heavily through the pandemic and, over time, we will need to replenish it to respond to new challenges and new shocks.²

The financial system relies on trust and confidence. Effective regulation and supervision are therefore required to ensure that the financial system as a whole is operating in a trustworthy way. Global interdependencies stress the need to implement global standards in a timely and consistent way. The value of the Basel III framework for banks and the Solvency II 2020 review for insurers are therefore very significant.

Macroprudential framework for funds:

While the investment funds sector broadly demonstrated sufficient operational resilience throughout the pandemic, central bank intervention was required at global level. That episode highlighted certain systemic vulnerabilities, and gave rise to market integrity and financial stability concerns. We continue to monitor the current global market situation in that context. Our industry letter this week sets out our expectations of firms, particularly with respect to the sanctions, valuation of funds and liquidity management across the sector.

More broadly, the need to develop and operationalise a complete macroprudential framework for investment funds is clear, and we will continue to play a leading role in working with our international counterparts to develop such a framework as a priority.

Cyber resilience:

Resilience also captures the operational resilience of the financial sector, including supervision of technology-related change and cyber resilience.

The latter is particularly pertinent right now. IT and cybersecurity risks are a key concern for the Central Bank given their potential impact on firms and their customers, and the risks for financial stability.

Firms are well aware of the risks; to prepare for same, effective cybersecurity and IT governance and risk management is essential. Boards of firms should have an excellent picture of the risks their organisations are facing and how they are actively working to mitigate them.

The changing financial services landscape:

Preparedness is also critical in not just in the face of shocks, but the rapidly changing nature of the financial services sector itself.

As regulator, our view is simple: we want to enable the benefits of change, innovation and competition for consumers, investors and the economy as a whole while ensuring the risks are managed.

Authorisations:

That process starts at “the gate” – i.e., the authorisations system.

The size of the financial sector in Ireland has grown at pace in recent years, for several reasons. As the FSI notes, there are many reasons why Ireland is seen as an attractive location for financial service providers to operate in, including being part of the European single market, an open and globalised economy, a highly skilled workforce, favourable government policies and its regulatory environment. Brexit has, of course, also played its part.

This growth has resulted not alone in a larger, outward-looking financial sector but also a more complex one, including new business models driven by innovation and advancements in technology.

In an open market economy, it is important that people and companies have the right – legal and practical - to take up new economic activities. For an area such as financial services, where the legislature has laid down standards to be met in order to be authorised to provide such services, the entry point for firms into the Irish, and European, financial services market is to seek authorisation from the relevant EU national competent authority.

The role of the Central Bank, as the Irish national competent authority, is to assess applicants against those standards and to ensure that any firm authorised demonstrates clearly that it has met those standards and will continue to meet them into the future.

In applying this, we operate a forward-looking approach which seeks to ensure that we are clear about our expectations to prospective and applicant firms. The specific authorisation requirement's across sectors therefore reflect European regulatory requirement's and norms, and are-risk based, anchored in our organisational risk appetite.

Our experience has shown that where the authorisation process is done well, it mitigates risks which can emerge in supervision. Or, to put it another way, we generally find that the firms which required significant guidance or work to get to a point of authorisation are also the firms that later present compliance issues. Our approach prioritises clear communication with applicants and also involves speaking with and listening to representative bodies. It is an approach which is subject to peer review and often involves intense collaboration with peer regulators, particularly if there is an outward- facing cross-border aspect to the application.

As an open, engaged and future-focused regulator, we seek to anticipate - and support - innovation in financial services and understand, anticipate and adapt to the far-reaching changes taking place within the industry. Our objective is to create the regulatory context in which the potential benefits of innovation for consumers, businesses and society can be realised, while the risks are effectively managed.

Our focus, therefore, is to ensure firms enter and exit the market in an orderly way and to ensure that, while they operate in Ireland, they do so in accordance with the objectives of financial services regulation in line with European norms and standards – no more, no less.

Innovation hub:

In line with our strategy, we will continue to engage openly and apply clear and consistent standards and processes for firms seeking authorisation. And we will continue to encourage new entrants and start-ups to come to us with preliminary queries, to discuss on the regulatory framework, including the authorisation and registration processes and to demonstrate their product to us.

Since its establishment in 2018, the Bank’s Innovation Hub has been an effective contact point for fintechs and incumbents to engage with the Central Bank on innovation. However, after four years in existence, it is timely to review the functioning of the Innovation Hub and to consider the enhancements that can be made, and we will be conducting that review this year.

Banking sector changes:

As the wider financial services sector evolves, so too do the individual sectors within it.

The retail banking sector will, of course, see significant change this year, as Ulster Bank and KBC withdraw from the Irish market, and customers migrate to new service providers.

We are focused on ensuring that customers are protected and treated fairly throughout this period of change, in line with our supervisory requirement's.

Our industry letter last year sets out our consumer protection expectations of firms in the changing retail banking landscape.³

Adopting a customer-centric approach to all issues ensures regulated entities protect customers’ interests, prioritise customer needs and outcomes and ensure continuity of access to basic financial services. We expect the banks will be proactive in their response to their customers, both new and existing, putting in place the structures, information and resourcing to help customers navigate this period of change.

We continue to engage with all relevant firms and the industry representatives in this sector to ensure that supervisory requirement's are adhered to and our expectations are met.

Driving fair outcomes for consumers and investors:

This will form part of our wider work to drive for fair outcomes and consumer and investor interests to be at the centre of financial services.

In February, we published our securities markets risk outlook report, which highlighted key risks across sustainable finance, governance, conflicts of interest, market dynamics, cyber security, data & financial innovation; and misconduct.⁴

Next week we will publish our corresponding Consumer Protection Outlook Report, which highlights five key cross sectoral risks, namely:

• Poor business practices and weak business processes
• Ineffective disclosures to consumers
• The changing operational landscape
• Technology-driven risks to consumer protection
• The impact of shifting business models

Both these reports make very clear our supervisory requirement's and expectations of firms in order to protect consumers and investors.

Distressed debt:

In the same way, we have made clear our expectations of lenders in the area of distressed debt. Despite significant reductions in recent years, about 47,000 principal dwelling households (PDHs) are still in mortgage arrears, of which 34,000 have missed at least three payments and are 90 days or more past due. This is a source of deep stress for the families and individuals concerned.⁵

Our focus is to ensure lenders have suitable supports in place to help borrowers.

This requires that firms have in place a waterfall of restructuring options capable of delivering sustainable solutions, including for borrowers in deep levels of distress. It also means that firms make use of that waterfall, and look to all of the commercial options available that might provide a solution other than the need to enforce security through the courts.

When a borrower is offered an alternative repayment arrangement (ARA), the ARA that is offered from the waterfall must have the greatest potential to resolve the borrower’s arrears position on an appropriate and sustainable basis.

Lenders should also review and enhance their approach to dealing with personal insolvency practitioners, as well as keeping their mortgage arrears strategies under review to ensure they are delivering in borrowers’ best interests.

Differential pricing:

In the insurance sector, we will implement the ban on differential pricing in the home and private motor insurance market from July this year, in order to end a practice harmful to consumers.

To support positive competition in the market, beneficial to consumers, new customer discounts will continue to be permitted subject to clear and informative disclosure to the customer.

Finally, as regards automatic renewals of insurance policies, we will require firms provide enhanced information in order to facilitate more effective opportunity to switch providers.

Review of the Code:

In addition to the above, we are, of course, undertaking a root-and-branch review of the Consumer Protection Code. Our objective is to ensure it is suitably robust to address emerging trends and risks across the rapidly changing financial services landscape, reflects the significant developments in EU consumer protection, and continues to deliver strong protections for consumers into the future.

Over the summer, we expect to publish a Discussion Paper on the review and engage widely with our stakeholders - including both the consumers and users of financial services and the financial industry which is subject to these requirement's.

Effective governance within firms – the IAF:

Effective governance is essential if the financial sector is to be resilient, trustworthy, adapt to shocks and rise to the challenges ahead.

And effective governance is at the heart of our proposals for an Individual Accountability Framework (IAF).

We very much see the IAF as a governance tool in the first instance - one to help firms strengthen their internal processes and to ensure that all firms and all staff know what is expected of them.

We believe it will assist the Central Bank in our mission as regulator but also, crucially, assist firms too.

Once the Bill has been enacted, which we are hopeful will be in the first half of 2022, we intend to publicly consult and engage with the key stakeholders on the implementation of the IAF.

As an open and engaged regulator, this consultation will be essential to ensure the proposed policy measures and guidance are clear, consistent, and pragmatic and to ensure effective and consistent implementation of what is a significant step forward.

Enhancing the regulatory framework:

The IAF is one example of the work we will be doing domestically and internationally to continue to enhance the regulatory framework in response to the rapidly changing – and increasingly complex – financial services landscape.

Clear, consistent, predictable and proportionate frameworks help, in turn, to continue building the reputation and credibility of Ireland as a leading financial services jurisdiction – something the FSI recognises in your own strategy.

Key pieces of work in the period ahead will include revisions to the capital requirement's framework for banks (CRR3/CRD6); revisions to the solvency framework for insurers (Solvency II review); revisions to the Alternative Investment Funds Directive (AIFMD); revisions to the Markets in Financial Instruments Regulation and Directive (MiFID II review); and work on the review of the second Payment Services Directive (PSD2 review).

I want to expand briefly on three core areas of focus in particular – capital markets, the AIFMD review, and AML.

Deeper capital markets to support the green and digital transitions:

The green and digital transitions will require very significant financing and investment – making clear the need for better, stronger and deeper capital markets.

From the Central Bank’s perspective, an effective and well-designed CMU should bolster financial stability and improve resilience; lower costs and improve choice for consumers and investors; strengthen protections available for investors, especially in cross-border transactions; and improve macroeconomic conditions by providing additional, diversified, sources of lending to firms, especially SMEs.

Advancing Capital Markets Union – and seeking to complete Banking Union – are critically important to ensure that the financial system is resilient and functions in the best interests of consumers and the wider economy, in Ireland and across Europe. The Central Bank will therefore be focused on our role in advancing both.

We will also continue to step up our work on climate change to both ensure the financial system can support the transition to a carbon neutral economy and is suitably resilient to the risks. This will mean continuing to adapt our supervision to ensure that financial firms are fully reflecting climate and transition risks in their business and that in developing and marketing green products and services they are meeting high standards of quality and disclosure.  Again, we have issued an industry letter setting out our supervisory expectations in this area.⁶

AIFMD Review:

Turning to the AIFMD Review, I know this is of significant interest to the funds sector at present and is a live debate as EU Council Working Groups are ongoing.

The European Commission’s proposal on the framework was published in Q4 2021 and aims to deliver a series of targeted reforms to the framework.

Many of these proposed changes focus on enhancing the effectiveness of fund managers to discharge their obligations and as such we are supportive of these. A number of elements of the Commission’s proposal are aligned with the existing Irish regulatory framework and supervisory undertakings – including CP86 obligations and requirement's for fund managers which originate loans.

In certain areas, the proposals will require careful consideration to ensure the right balance is struck between mitigating potential risks while ensuring the framework can operate efficiently, and in the best interests for underlying investors. For example, there are significant changes proposed in relation to reporting requirement's around delegation arrangements. Striking the right balance will be important to ensure those proposals have the desired effect.

AML/CFT:

Anti-money laundering and countering terrorist financing will be another area of core focus this year, and indeed for the foreseeable future.

Recent scandals have shown that the current EU framework to fight financial crime and money laundering is not as effective as desired. The European Commission’s AML/CFT Package therefore represents a welcome and deep-rooted overhaul of the framework and has the potential to strengthen our collective defences.

We will work closely with our European counterparts to help shape and implement the Package and the new single AML authority, which will mark a structural sea-change in the European approach to combatting this problem.

Crypto-assets and the risks to retail investors:

Crypto-assets comprise another area where the European regulatory framework must be strengthened to prevent fraud and real risk to investors, both institutional and particularly retail.

At present, aside from AML/CFT regulation, crypto-assets and related products and services typically fall outside existing protection under EU financial services rules – a gap which at European level we are working to close.

Retail investors face the very real possibility of losing all their money if they buy these crypto-assets and they should be alert to the risks of misleading or aggressive advertisements, including via social media and influencers, particularly those that claim fast or high returns.

Conclusion: Thinking anew about risks and probabilities

To conclude, I want to stress that financial regulation is about supporting positive outcomes.

It is there of course to prevent abusive behaviour by financial firms and to avoid crises and instability.

More broadly, however, it is there to ensure that the financial system operates in a manner that supports the effective and sustainable functioning of the economy, so that households, firms and individuals can avail of the services they require.

In that respect, what recent and current shocks show us is the need to think more deeply about how we view risks and probabilities, and how we build resilience.

As my colleague Ed Sibley has noted, it is worth us reflecting on how we think about future events that have a near certainty of occurrence over time, but with some doubt about precise timing and impact. In other words, how well do we prepare for predictable surprises?⁸

Our strategy is built with that in mind. To give one example, we are committed to accelerating the evolution of our risk-based supervisory approach, such that it becomes more data-driven, agile and scalable. And in tandem, to enhance our supervisory execution, prioritising: (a) the interests of consumers, (b) governance, accountability, behaviours and conduct in firms, (c) financial and operational resilience in firms, and (d) anti-money laundering.

I’ve given you a snapshot of our work in 2022 and beyond– a whistle-stop tour, in effect. It goes without saying that none of our significant programme of work, nor the delivery of our wider strategy, can be done in isolation. The Central Bank will continue to focus on being a leading contributor to EU and international regulatory development, reflecting Ireland’s role as a major international financial services jurisdiction.

But our engagement will not stop there. The rapid pace of change and the expectations of our stakeholders means that we need to be well-connected with them. It will require us to explain what we are doing and what we are not doing. It will also require us to listen to individuals and businesses (and not only regulated firms) across the country so that we can understand the issues they are facing and help them to understand the actions we are taking in response.

Specifically this year, we will implement the enhancements in stakeholder engagement identified in our recent consultation (CP 136), with which you will be familiar.⁸ This includes deepening our engagement with the users and consumers of financial services, an Industry Stakeholder Forum, and a Financial Services Conference planned for later in the year.

We look forward to that engagement as we seek to deliver on our mandate of serving the public interest by maintaining monetary and financial stability while ensuring that the financial system operates in the best interests of consumers and the wider economy.

Thank you. 

¹See: https://www.centralbank.ie/publication/corporate-reports/strategic-plan

²See: https://www.centralbank.ie/news-media/press-releases/speech-managing-risk-rebuilding-resilience-governor-gabriel-makhlouf-11-feb-2021

³See: https://www.centralbank.ie/docs/default-source/regulation/consumer-protection/other-codes-of-conduct/consumer-protection-expectations-in-a-changing-retail-banking-landscape-2021.pdf?sfvrsn=4

⁴See: https://www.centralbank.ie/regulation/industry-market-sectors/securities-markets/risk-outlook-reports

⁵See: https://www.centralbank.ie/docs/default-source/statistics/data-and-analysis/credit-and-banking-statistics/mortgage-arrears/2021q2-q3_ie_mortgage_arrears_statistics.pdf?sfvrsn=5

⁶See: https://www.centralbank.ie/docs/default-source/news-and-media/press-releases/governor-letter-climate-expectations-november-2021

⁷https://www.centralbank.ie/news/article/Speech-Ed-Sibley-navigating-the-winds-of-change-18-nov-21

⁸See: https://www.centralbank.ie/docs/default-source/publications/consultation-papers/cp136/feedback-statement-to-cp136---enhancing-our-engagement-with-stakeholders.pdf?sfvrsn=2