Address by Anne Troy, Head of Investment Service Providers Supervision, to MiFID Investment Firm Directors

13 April 2010 Speech

Good morning. My thanks to you all for joining us for this workshop concerning the responsibilities of MiFID investment firms under the Capital Requirements Directive1.

I would like to offer my own thoughts on the developing regulatory regime for Investment Firms and, in particular, how we envisage that the process of engagement to be discussed today would be the basis of a new regulatory approach.

One of my first priorities is the overhaul of the regulatory model for financial services in Ireland. Our revamped regulatory approach will be rooted in a clear understanding of risk and the appropriate application of principles and rules. This approach is consistent with the EU legislation applying to Investment Firms. Both the MiFID and the Capital Requirements Directive set mandatory standards for investment firms. However, both Directives recognise that some of their requirements should be applied on the basis that smaller, less complex firms usually represent a lower degree of risk. Consistent with that, our supervisory approach will be risk-based and proportionate. Thus, our supervisory resources will be focused on firms and types of firms according to their risk profile in terms

of potential impact on the market and potential impact on consumers. This does not mean, however, that the smallest, least risky firms will receive zero attention. Rather, all firms must have in place those structures, mechanisms and processes required by law and detailed in policy, and be able to assure the new Central Bank of Ireland that they do so.

Capital adequacy is one of our main focus areas for Investment Firms and is an important factor in our perception of the risk profile of a firm. Other key areas we focus on are the client asset requirements, conduct of business, the consumer code as well as governance and internal controls. The current economic environment is challenging for many firms with reduced income and losses being made. While I understand that firms have trimmed expenditure where possible, the current environment highlights the need for a capital cushion to absorb losses on an ongoing basis. When there is no cushion left and no prospect of further capital being injected into a firm, consideration needs to be given to contingency plans for the firm to re-assess its business plan or to achieve an orderly exit from the market.

At present, we supervise in the region of 150 Investment Firms of varying size and complexity covering straightforward order transmitters, stockbrokers, spread betting firms and large asset managers. This variety is reflected in the range of capital adequacy requirements that apply to Investment Firms, depending on their authorised activities.

We are making significant additions to our staffing on the Investment Firms supervisory teams during 2010. This will enable us to have a better informed understanding of your business and the risks you face as well as being in a position to monitor compliance with the regulatory requirements. Therefore, you

should expect to have more regular contact from our supervisors in coming years, depending on the risk profile of your firm, with a greater emphasis on your business and risks than heretofore.

The EU Capital Requirements Directive, recognising that firms vary in their appetite for risk and their capacity to manage and mitigate risk, goes beyond setting out standard capital requirements. It seeks to ensure that the firms to which it applies have adequate capital to cover all reasonably foreseeable eventualities. This implies that some firms may require capital additional to the minimum required by the Directive. EU Regulators have agreed a process by which firms and their regulators may agree the prudent capital requirements of a firm. The dialogue between regulator and investment firm that is required by this process seems to us to be the ideal starting point for a new supervisory relationship between the Irish regulator and investment firms.

The process agreed by EU Regulators sets out responsibilities of firms and regulators, some of which will be addressed today. One of your responsibilities is the Internal Capital Adequacy Assessment Process, or ICAAP. Your firm has been required to have an ICAAP in place since the CRD came into full effect on January 1st 2007.

One of our responsibilities - which we will detail to you later in the workshop - is to assure ourselves that your ICAAP is indeed prudent. To do this, we will be looking for three conditions to be met. First, your ICAAP must be locally-developed and owned by your Irish regulated entity’s directors and senior management. Second, it must adequately identify, manage and mitigate against each and every type of risk your firm faces. Third, it must allocate a specific and sufficient amount of capital to each of these risks.

This assurance process is known as the SREP, or Supervisory Review and Evaluation Process. The Financial Regulator has been undertaking SREPs for credit institutions since mid-2007. In late 2009, we commenced SREPs for MiFID investment firms. A small number of firms are participating in this first iteration. We will be engaging additional firms in the process during this year.

The ICAAP and SREP, along with your governance obligations and our risk assessment system, together form the building blocks of our enhanced risk-based regulation. These will be further reinforced by other facets of our regulatory overhaul including greater enforcement measures and resources, and a solid commitment to make prudential judgements when points of contention exist between ourselves and regulated firms.

Your firm’s ICAAP is your firm’s process, and as laid down in the provisions of the CRD should be developed in a proportionate manner to reflect the nature, scale and complexity of your firm’s activities. Similarly, our oversight of your firm’s ICAAP – the SREP – is subject to this principle of proportionality.

Nevertheless, there are some “lowest common denominators” when considering ICAAPs. Regardless of the size of your firm, for instance, the review of the risks that your firm faces must be both real and comprehensive.

“Real” means that the Board and senior management of each firm must themselves identify, consider and mitigate against the risks your entity faces. It is not sufficient to jump straight to your capital position and say, “Our Own Funds is five or ten times what our Capital Requirement is, so our risks are sufficiently mitigated.”

By “comprehensive” we mean that each and every risk your firm faces, not simply your market, credit and operational risks, should be considered by the Board and senior management. It is not sufficient to say that your parent has identified the main risks for the group and of these, you consider risks C, D, and F are relevant to the Irish subsidiary. It is a matter for you to decide - what are the most material risks faced by your firm? To do this you will need to have set criteria for your firm to determine how materiality will be defined.

Our belief is that all of our MiFID firms face a degree of strategic risk, business risk and liquidity risk. Moreover, many of our regulated institutions face demonstrable, and likely quantifiable, legal risks and credit concentrations. Expect us to look closely at whether your ICAAPs are identifying and adequately mitigating against these and other risks, particularly if recent history has shown us that they do indeed exist.

Although our approach is evolving into one that is more proactive and challenging and our resources will expand to become more in-line with international standards, we are planning our engagement with firms in stages.

A rotation has thus begun which will consider a number of investment firms initially, then an increasing number as our resources and your familiarity with the process grows. In the interim, the information that you provide us concerning your firm’s ICAAP is critical and will be carefully scrutinised by our staff.

Ultimately, the new Central Bank of Ireland’s enhanced regulatory framework and this process of reviewing ICAAPs are about better understanding the risks that individual MiFID firms face.

By genuinely undertaking what is a fairly intrusive, but legally-mandated process and building and maintaining your ICAAPs, we are convinced that the risk management culture within your firms will be significantly enhanced.

At the same time, as we enter into more and more Pillar 2 dialogues concerning your ICAAPs, our understanding of the risks that you face will also improve. Together, this enhanced, risk-focused regulatory framework will help to ensure that your businesses are more than just viable and are increasingly durable.

Thanks very much for your attention.


Address given on behalf of Matthew Elderfield, Head of Financial Regulation