Integration, Interconnection, Innovation: some current themes in European Financial Regulation - Gerry Cross, Director of Policy & Risk

14 March 2018 Speech

Central Bank of Ireland

Speech delivered to Barclays Capital Conference in London


Good afternoon.

It is a pleasure to be here. My thanks to Barclays for the invitation.

I was asked to provide a regulator’s perspective on some of the key current issues and on some of the developments that we are likely to see in the coming period.

Rather than simply run through a list of topics, I thought I would step back and see if there were some cohering themes bringing the various regulatory discussions together. And what I found is that in fact there are three themes that may be argued to run through at least a significant number of the current regulatory developments.

You will all be familiar with the “four eyes” principle of risk management. What I want to talk about today can be summarised as the three “i”s. The three “i”s being “integration”, “interconnection” and “innovation”. These are the three themes that I think can be said to under lie a great deal of the regulatory discussion currently underway in Europe.


First of all “integration”.

European regulatory discussions at the current moment are significantly influenced by the question of enhanced financial integration. This has a number of components. But the two major ones currently are the completion of Banking Union and advancing Capital Markets Union.

In order to move towards the completion of the Banking Union, and in particular to support progress on the proposal for a European Deposit Insurance Scheme (EDIS), as well as to complete the post-Crisis regulatory reform programme, the European Commission has put forward its Risk Reduction Package, proposing amendments to the CRR/CRD and to BRRD.

At the Central Bank, we very much welcome a number of aspects of these proposals as being important pieces of the jigsaw in completing the post-crisis regulatory reform agenda. Particularly important in this regard are the proposals for implementation of the net stable funding ratio (NSFR), the leverage ratio, and the proposals referred to as the fundamental review of the Trading Book (FRTB). All of these address issues that were at the heart of the dynamic that led to the crisis. So it is very important that they are addressed.

We did have material concerns about certain other aspects of the proposals - for example in respect of cross-border capital waivers and supervisory powers - that we felt did not properly reflect the challenges that we as national regulators and supervisors face in maintaining appropriate levels of soundness and stability in the system. We think that some good progress has been done during Council negotiations and are hopeful that acceptable solutions are in the process of being agreed.

On the resolution side, subordination of MREL liabilities is required to ensure that banks can be resolved effectively using the bail-in resolution tool. It is critical to ensuring that the “no creditor worse off” (NCWO) principle is not breached and that the risk of legal challenge is minimised. The current BRRD did not require subordination, nonetheless it could be imposed on a case by case basis. In light of the finalisation of the FSB’s TLAC Term Sheet – which requires a certain level subordination, the revised BRRD in the RRM package proposes to introduce this requirement.

The TLAC Term Sheet provides that subordination can be achieved by three different means, and the BRRD amendments despite prescribing a form of subordination that could be described as a cross between statutory and contractual, also permits subordination to be achieved by structural means, which is the preferred form of subordination of the Central Bank of Ireland.

Good progress has been made on the Risk Reduction Package. We are hopeful that the current Bulgarian Presidency can reach a Council General Approach in the coming period.

One of the objectives of the Package of CRR/CRD and BRRD amendments has been to provide a significant degree of further risk reduction to support the risk sharing that the EDIS (European Deposit Insurance Scheme) proposal represents.

At the Central Bank of Ireland we are very supportive of EDIS. This is for the simple reason that both as a supervisor (national and member of the SSM) and as a resolution authority (national and member of the SRM) our aim is to promote stability and soundness and consumer protection. To the extent that there remains irresolution of the “European in life, national in death” issue, our job will be more difficult than it should be. It is important that we have coherence in this respect running right the way through banks' lifecycle.

Let me turn briefly from Banking Union to Capital Markets Union and the role of non-bank finance in the funding of the EU economy.

The Central Bank of Ireland is very supportive of the CMU project.

Capital Market Union seeks to:

  • improve access to financing for all businesses and infrastructure across Europe'
  • increase and diversify sources of funding
  • enhance opportunities for investors
  • make markets work more effectively and efficiently especially cross border.

In terms of where we have got to, some good progress has been made.

The agreement on the Simple Transparent and Standardised (STS) securitisation package is welcome. While there are one or two aspects that we would have done differently, overall the identification of a mode of securitisation which is high quality, non-complex, and transparent and which can therefore deserve a preferential treatment is very much to be welcomed. This should allow banks’ balance sheets to be optimally, and of course safely, used in providing funding to the economy.

In respect of prospectus requirements, the revisions to the level one framework have been agreed. Things have now moved onto level 2. There the challenge continues to arrive at an approach, which balances well proportionality on the one hand, and appropriate investor protection in respect of investments, which do of course have material risks associated with them on the other.

Under Solvency II, a new asset class of "qualifying infrastructure investments" has been developed and established. Such investments can provide stable, lower risk, and longer-term investment profiles for undertakings. To reflect this a preferential treatment has been provided for under the Solvency II rules. This is welcome because it is an approach grounded in the accurate reflection of the risks. As the CMU project moves forward it needs to remain on this risk-reflective line. The temptation needs to be resisted to prioritise short-term gains at the cost of longer-term soundness. We have seen where that can lead.

We have also underway currently the legislative process in respect of the Pan-European Personal Pension Product proposal as well as negotiations on the proposed new prudential framework for investment firms. Both of these are initiatives of which the Central Bank of Ireland is broadly supportive though with a clear need to ensure that the legislative process delivers high quality outcomes on a number of key aspects.

2018 will also see a number of further initiatives under the CMU banner. Last week saw the Commission launch both its FinTech Action Plan and its Action Plan on Sustainable Finance. This week has seen proposals for a European regulatory framework for crowdfunding; a proposal for an EU covered bond's framework; and a proposal on cross-border distribution of investment funds.

Capital Markets Union was always going to be a programme of incremental progress across a wide swathe of subject areas. In this respect, I would say that we are seeing what we would have hoped and expected to see.


Turning now to innovation. Financial innovation will be a key focus of regulatory attention during the coming period. It would be so in any event. But the publication of the European Commission's Action Plan on fintech last week means that it will be clearly embedded in regulatory agendas at every level across the EU.

This is very welcome. Financial regulation is for the most part focused on identifying and addressing the risks that can arise - whether they be to financial stability, prudential soundness, orderly markets, or consumer and investor protection.

But financial services and markets are dynamic and fast moving. Innovation is a key feature of how they function. And with technology being at the heart of financial service and a technological revolution ongoing, it is clear that the relevance of this topic for financial regulators is enormous.

Innovation has the capacity to bring great benefits for consumers, the economy and society in general. And it is essential to the effective functioning of a competitive economy. And here is where a challenge lies for financial regulators. For one might summarise the situation as follows: innovation is good, but not all innovations are good, and not all good innovations are done well. So for regulators the challenge is to facilitate good innovation, to seek to prevent or limit innovations that are detrimental to the goal of well functioning financial services and markets, and to ensure that the associated risks are well-managed.

Over the period ahead we will see a great deal of discussion of the best ways of achieving this challenging set of objectives. We will see discussion of the mandates of financial regulators and how they should reflect the benefits of innovation and competition. We will see consideration of innovation hubs and facilitators, sandboxes and soundboxes, and the various approaches that regulators might adopt to respond effectively to the opportunities and challenges of technological innovation.

All of this is very much to be welcomed. At the Central Bank, these are questions that we have been focused on for some time now. As have many other regulators. We are very pleased that this discussion will now also be taking place at a coordinated European level.


My third “I” is interconnection. And under this heading I want to turn to Brexit. For one of the key questions that Brexit raises is what will be the interconnection between the financial sector in the EU27 post-Brexit and the UK financial system.

This is a topic that could on its own be the subject of this whole speech, and many more. So let me just say a few words on the general picture. And then focus in on one particular aspect: expectations of banks re-locating to EU-27.

During 2017 and continuing throughout this year we have seen and will continue to see significant activity by financial firms currently located in the UK moving business to the territory of the EU27 as a means of addressing the very real risk of the loss of passporting rights post-Brexit Relocation by firms (state of play). In Ireland, as in other key locations, we are seeing a great deal of activity in this regard. We see this activity across the full range of firm types and activities. At the Central Bank, we were well-prepared for this and the authorisation activity proceeds apace in an orderly and well-structured manner.

This time last year there appeared to be a real risk of material divergences emerging between jurisdictions in the context of relocation activities. This was a material concern for CBI as we had started our preparations early and had worked hard to develop an approach based on a good balance of rigour and pragmatism. It was and remains important that we avoid any weakening of standards, while at the same time recognising that Brexit was not something that had been decided on by financial firms and that therefore a degree of pragmatism should be brought to bear particularly in terms of timing aspects.

In order to address the concern of regulatory divergences and the risk of arbitrage, we engaged closely with SSM and ESAs in order to develop agreement on European-wide approaches to the key topics that were arising. In my view the work of these bodies has been very well done and, indeed, game changing. Much of the heat is now gone out of the arbitrage issue, without ignoring of course the importance of ensuring that we continue to work hard to maintain consistent approaches as new issues arise and the work on key issues develops and deepens.

A key focus of regulators is on preparedness of financial firms for Brexit and on potential cliff effects. We expect firms to have plans in place to deal with the risk of a no-deal Brexit in March 2019. Such an outcome remains a real risk and we expect firms to prepare for it, including clear timelines and trigger points for the actions that they will take. It is also important that we as regulators give close consideration to the possibility of financial stability and/or consumer impact effects of a no-deal Brexit at the end of March 2019. This something that both ourselves, other regulators, and the European Supervisory Authorities are looking at. A key question is to work out in detail how different effects could feed through to firms, the financial system and consumers. And how those effects might best be addressed. This work is ongoing.

Let me now focus in on one question in the Brexit context that I know there is considerable interest in amongst this audience. That is the question of what are the expectations on a bank that wishes to relocate activity from the UK to the Eurozone in preparation for Brexit?

As a starting point, it is imperative that any new business authorised in the EU as a result of Brexit meets the high standards that are expected of any such firm authorised in the EU. They need to organise themselves so that when they are up and running their business will truly be run from here, be clearly governed by EU norms and standards, and be subject to effective supervision by European authorities.

At the same time, of course we recognise the efficiencies and benefits that can be obtained from a firm being a part of a well-integrated international group. Diversification and risk management expertise, to mention two aspects, can bring important benefits both to local entities and to the economies that they serve. This together with a recognition of the challenging timelines does form a key part of our thinking ad that of the SSM around authorisations.

It is a question of getting the balance right. The ECB and national supervisors have been clear that it is expected that new firms will, over time, become well-established banks. Setting up shell companies, which are overly reliant on other group entities from outside the EU is not what we want to see. The governance and risk management mechanisms should be matched with the nature, scale and complexity of the business model.

As you will be aware, the ECB are currently working on a booking model assessment framework, which will set out what the ECB expectations are. So, for example, in respect of relevant market risk, banks must be able, in the medium to long term, to trade locally on a permanent basis, and they must have local risk committees. They also need to trade and hedge risks not just with other group entities but with diversified counterparties. Depending on the nature of its business and any temporary arrangements, from day 1, a bank may be able to build-up this capability in line with the build-up of its operations over time.

Importantly, booking models must be supported by a strong coherent rationale. This should not be about minimising costs in the wake of Brexit but rather reflect a coherent allocation of activities across the group reflecting the location of business activities and appropriate leveraging of group expertise and efficiencies. This framework incorporates the idea of proportionality - large banks that are highly interconnected and conduct complex capital market operations will have to meet higher expectations and this will determine any transitional period to build up these operations.

In order to make sure that EU banks are independent entities, they need to establish locally independent functions and controls which report to the local board, for example in the areas of risk control, compliance and internal audit. The ECB and national supervisors expect that certain key roles should not be part of dual-hatting arrangements within the wider group. Outsourcing agreements (whether within or outside the group) should also be properly monitored by the entity’s management bodies and cannot affect the operational independence of the supervised bank with proper contingency procedures.

Banks will also need to make sure that their recovery plans reflect the risks of Brexit. New EU banks and existing banks that plan to significantly expand their activities will need to develop an EU recovery plan within three to six months after the start of operations. Banks with material exposure to the UK will also be expected to update their recovery plans to take into account the impact and risks that Brexit poses.

ESAs Review

Let me come back finally to where I started: integration. An initiative that falls squarely within that heading is the proposed reform of the European Supervisory Authorities (the ESAs).

The European Commission has put forward a number of proposals for change in the structure, role and responsibilities of the ESAS. These include increased autonomy, in particular through more powerful executive boards, and greater supervisory responsibilities, particularly in the case of ESMA.

While many of the aims of the proposal are laudable, in particular the objectives of achieving increased harmonisation of requirements and enhanced supervisory convergence, nonetheless there are a number of aspects which do give cause for concern.

In thinking about the Review package there are a number of considerations that I would suggest could be usefully borne in mind:

Firstly, the European Supervisory architecture that were implemented post-crisis has been shown to be a good one. The ESAs have delivered strongly on their objectives on the basis of a good balance between centralised and local responsibilities. In the aftermath of the crisis, there has been a lot of focus on development of the single rulebook. A very great deal has been achieved in this regard. There has also been important work on supervisory convergence. This aspect is just now however coming to full maturity in the work of the ESAs and will be a central focus in the period ahead. So, that should be the starting point: we currently have something in place that is working well.

Secondly, it is important to be very clear about the goals that we are seeking to achieve. What is done should be designed to enhance our achievement of financial stability, investor protection, and orderly, fair, and optimally functioning European financial markets - all in support of sustainably growing economy. We need to be extremely clear about how any changes proposed will enhance these outcomes. If not we risk that in respect of some areas where the current framework has delivered well we could see regress rather than progress.

Thirdly, while they have done some very good work in the area, the ESAs do not currently have a consistent consumer protection mandate strongly embedded and clearly articulated in Level 1. There is need for a cross-sectoral approach in this regard. We are supportive of measures that would address this weakness.

Fourthly, is very important that the integrity of the decision making process is strongly maintained in order to ensure effectiveness and appropriate accountability. We also need to avoid the loss of hard won expertise, high quality practices, and market credibility built up over the years. It should be avoided to introduce fragmentation or uncertainty in this regard which leaves any doubt about the decision-making authority in the context of authorisations and/or supervision. And directly related to this, it should be avoided to introduce additional levels of unnecessary process and complexity, particularly where that might give rise to further unintended and undesirable consequences.

Negotiations are currently underway on the proposals and we are hopeful that they will lead to good and improved outcomes in this very important area.


Let me stop there.

Integration, interconnection, innovation. These seem to me to be three key themes for the current period.

Thank you for your attention. I look forward to your questions.

My thanks for their contributions to this speech to Gina Fitzgerald, Lucy Mansergh and Fionnuala Carolan.