Remarks to the SuperReturn CFO/COO Regulation and Compliance Summit, 18 September 2019
Good afternoon. I am very grateful to the organisers of this week’s SuperReturn Regulation event for the opportunity to speak to you today about what we are seeking to achieve as regulators of securities markets, and how regulators and industry can best engage on some of these important topics.
Specifically, I was asked to speak to the subject of ‘a regulator on regulation’. So, let’s start at the beginning – what is the purpose of regulation?
What is the purpose of regulation?
As industry professionals, you will know the scale and complexity of the legislation that governs activity on securities markets. The MiFID II regime alone has been estimated at more than 1.5 million paragraphs, and that is now just one of several regimes on such a scale. I am sure that the legislative regime for funds adds up to a similarly impressive number of paragraphs, but I have not seen that anyone has got around to counting them.
So what is all this activity seeking to achieve – what does good look like and how close are we to it?
As a Central Bank within the EU and the eurozone, with both a prudential and conduct supervisory mandate across virtually all sectors of financial services, at the Central Bank of Ireland we have a very particular perspective on this question, and how the various features of our mandate interlink to support one another. Our mission is to serve the public interest by safeguarding monetary and financial stability and working to ensure that the financial system is operating in the best interests of consumers and the wider economy.
Within this overall public service mission, we had occasion last year to try to articulate what good looks like when it comes to our supervision of securities markets specifically. We concluded that a proper and effectively supervised securities market was one that satisfies five principles:
- It has a high level of protection for investors and market participants.
- It is transparent as to the features of products and their market price.
- The market must be well governed (and comprise firms that are well governed).
- The market must be trusted, by both those using the market to raise funds and those seeking to invest.
- The market must be resilient enough to continue to operate its core functions in stressed conditions and to innovate appropriately as markets evolve.
And if I had to lift out one concept from these principles it is that of Trust.
So, in asking how close are we to ‘what good looks like’ in the regulation of securities, on the ‘trust’ axis I would say we have some way to travel.
Yes, we have introduced a lot of rules that were needed to reform the framework. Yes, we have also beefed up how we supervise this framework, and yes as regulators we have become more assertive and imposed tougher penalties for contraventions. However, I would say that it still remains the case that one of the most powerful forces affecting trust in financial markets and their participants is, quite simply, how regulated financial service providers conduct themselves.
So, how should we tackle this?
Our Strategic Outlook
It is inevitable perhaps that, when we come to look at this question, our outlook is heavily influenced by the events of the last financial crisis and its aftermath. It is also fair to say that, be it MiFID II, EMIR, SFTR or other measures, we are only now seeing the full suite of post-crisis reforms taking effect. It is also fair to say that more remains to be done here to develop an EU capital market to serve investors and the wider economy.
We are at a critical point therefore in terms of both taking stock of how successful we have been in enhancing the regulatory framework in the wake of the last financial crisis and considering the resilience of that framework for the years ahead.
This was certainly the perspective we took at the Central Bank of Ireland in framing our Strategic Plan for 2019 to 2021 (Central Bank, 2018). There are a few aspects of that plan which I want to mention because they give insight into our thinking on the topic I have been asked to speak to today.
Financial Conduct Regulation
Strengthening Our Approach
The first of these is that, in recognition of the fact that the conduct of market participants is core to building trust, we have committed to strengthening our approach to conduct risk regulation.
To do this, we realise that we need a more systematic risk-based approach to how we supervise conduct on securities markets, and in particular on wholesale securities markets. The growth in the scale and complexity of our supervisory mandate, and our finite resources, necessitate such an approach.
There are three reasons for this growth in scale and complexity, and they are not unique to the Central Bank of Ireland:
- The first is the legislative framework. In recent years, landmark EU reforms like MiFID II and EMIR have greatly expanded the scope of securities market regulation and what is required of national conduct supervisors. All these mandates continue to grow, in each case coming with a series of mandated tasks and monitoring obligations. For example, in my own area in the Central Bank of Ireland, we will operationalise five new EU legislative mandates between now and January 2021 (and that is just one area of the Central Bank).
- The second reason is the growth in scale and complexity of the market we have to supervise. It is growing in size (essentially we have a growing number of firms and firm types to supervise) and it is growing in complexity. Much of this complexity is driven by technology and new venue types.
- The third reason is the rapid evolution of international supervisory convergence and a raising of expectations as to what is required of regulatory authorities. This is why we continue to devote considerable resource and attention to our EU and international work.
Setting Our Expectations
A key part of regulation is of course setting the right expectations, and challenging the firms and markets that we supervise to meet those expectations. As part of our rollout of our new approach to supervising conduct in wholesale securities markets, we began by writing to firms earlier this year setting out our expectations in this regard (Central Bank, 2019)
As we noted in that letter, by comparison to retail financial services, wholesale financial services encompass complex interconnected markets, a wide range of financial products and a large and varied group of professional market participants. The scale and global nature of wholesale financial markets, their opaqueness, the sophistication of the activity involved, and the speed of change also contribute to the complexity of these markets. All of these features combine to create distinct market conduct risks to which both firms and regulators will have to pay close attention if we are to achieve a securities market that satisfies the five principles I have outlined.
Conduct Supervision of Investment Funds
I mentioned earlier the need to do more to foster an EU capital market that best serves investors and the wider economy. It is noteworthy that the EU’s largest capital market segment is its funds industry. It is also noteworthy that the largest component of the EU’s funds industry comprises the highly regulated and retail investor focused UCITS sector (IMF, 2019). There is a lesson here about how confidence in a regulatory framework can contribute to the creation of a single EU capital market. This is one of the reasons we place such a focus on assertive supervision of UCITS, including in our recent reviews on performance fees and closet indexing.
We also need a range of options outside of UCITS of course, be that Alternative Investment Funds or other capital raising options and here proportionality of regulation is key. The recent reforms of the Prospectus Regulation are a welcome example of this principle, providing a more streamlined pathway for smaller and repeat issuances, together with a single ESMA database for prospectuses.
Enhancing Organisational Capability
Another theme of our Strategic Plan that I want to mention is ‘Enhancing Organisational Capacity’.
The evolution of securities markets means that the management and analysis of large quantities of data has become a critical activity for us. I believe that how we regulators engage with data and technology will be pivotal to how effective we are as supervisors. I would go so far as to say that we have now moved past the concepts of ‘supervision’ and ‘analytics’ as discrete functions and into a more blended concept of ‘data driven supervision’ being the day to day activity of our supervisory teams (Armstrong, 2018). We will continue of course to have the necessary human interaction with senior personnel in the firms we supervise, but with ever more concrete data underpinning our discussions and verifying the representations we rely on as supervisors.
There is a corresponding necessity of course for financial service providers to also invest in technology, and the global demand for regulator, compliance and governance software has been predicted to reach almost $US119 billion by 2020 (Bloomberg, 2017). Effective use of technological innovation can bring benefits but firms must also ensure they are innovating responsibly and staying alive to any potential risks and downsides. This is a topic we have been very engaged with, both through our traditional supervisory engagements (Central Bank, 2016) and, outside of our more formal engagements, through the work of the Central Bank of Ireland’s Innovation Hub (Central Bank).
Our work as a gatekeeper
A key feature of any sound regulatory system is ensuring that only those firms and individuals who meet the appropriate standards get into the industry in the first place.
The performance of this ‘gatekeeper’ function is something we take very seriously, making sure that firms are only approved once they have demonstrated to our satisfaction that they have clearly met the required standards. This is a material and significant component of the work of a regulator and in the area of funds for example, in 2018 we granted 1,117 fund authorisations (more than any previous year).
Our challenge now is how to take the lessons and methodologies of risk-based supervision and apply them to our gatekeeper work, so that we are targeting our finite resources at the areas of greatest concern.
At the Central Bank of Ireland, we have some experience of this of course. In the case of Qualifying Investor Alternative Investment Funds (“QIAIFs”), we have a 24-hour authorisation process based on the fact that QIAIFs are targeted at sophisticated and institutional investors and meet strict criteria to qualify.
As regulators, we have a part to play in providing as much clarity as we can on the application process and our expectations. We have found the running of workshops with industry on our authorisation processes to be especially effective in this regard. This is a tool we aim to build on and develop with our stakeholders.
It will also continue to be critical that firms send in good quality applications and engage meaningfully with the comments and queries of our authorisation teams. I am sorry to say that sometimes this is not the case.
An important facet of our gatekeeper work is of course assessing the fitness and probity of individuals in senior positions in the firms we regulate. Indeed, in Ireland, the introduction of a robust statutory regime on this topic was one of the first post-crisis statutory reforms of our domestic framework (Irish Statute Book, 2010). Under this framework, and properly so, the primary responsibility for ensuring the fitness and probity of senior managers rests with the regulated entities themselves of course. This is a subject on which we communicated with all our firms earlier this year (Central Bank, 2019). We have also advocated to bolster the legislative framework for individual accountability, recognising the critical impact that the conduct of senior individuals has on the culture of the firms we regulate (Cunningham, 2019). We also see clearly how far our senior manager population is from the diversity we would like to see to manage risk effectively (Kincaid, 2019).
This week’s SuperReturn event brings together participants from around the globe. So, I would like to conclude with a few words on international engagement.
Ireland is a small, open economy with a large international financial services industry. It will not surprise you therefore to hear that we devote a considerable amount of our time to working at an EU and international level. Through this work we recognise the importance of global standards and cooperation in the field of securities and markets, not least because of the important contribution that Ireland makes to international financial services generally (Financial Times, 2019).
I would add that the international arena is a place where industry initiatives can play an especially powerful role, as we can see with the work of the FICC Market Standards Board (FSMB) and the Global FX Code (Global Foreign Exchange Committee, 2018) to name but two examples.
As an EU conduct supervisor speaking to the topic of trust, I have to take the opportunity to reinforce the importance of stronger supervisory convergence, as highlighted in ESMA’s Strategic Orientation 2016-2020.
Working together with our ESMA colleagues and fellow NCAs, there is now a concerted momentum to put in place more structured and targeted mechanisms to raise supervisory standards and drive EU convergence. We consider this work essential to the delivery of our mandate in a context where we are seeing a more fragmented, interconnected European securities market emerge, with a corresponding need for greater cooperation amongst EU national competent authorities in order to avoid regulatory arbitrage.
As with all our work of course, we have to do this with finite resources. This means that, as with our own supervisory activities, we need to adopt an ever more systematically risk-based approach to how we identify those areas where supervisory convergence is most important.
When I come then to concluding these remarks, it can be difficult to describe our role as regulators against the backdrop of the complexity of today’s securities markets and the rules that apply to them.
Or is it? My colleague Vasileios Madouros put it very well when he recently pointed out that, quite simply, our mission is to “serve the public good” (Madouros, 2019).
When we pare our mission back to this core concept we see that, amidst all the necessary technical detail of regulating such a complex industry, at its heart what we are seeking to achieve is quite straightforward. We can also see that the goals of regulation are not ones that we as regulators can deliver on our own. Regulated firms bear a responsibility – indeed they bear the primary responsibility – to ensure that their conduct fosters the trust that society places in them when it permits them to provide regulated financial services.
For our part, we will continue to strive to serve this public good through supervising the conduct of firms and individuals to ensure that the best interests of consumers and investors are protected, and markets operate in a fair, orderly and transparent manner. We are joined in this endeavour by our fellow regulators and the international bodies through which we advance and coordinate our work, and we are committed to delivering on our mission.
We are also committed to working together with those who share our goals.
And on that note, I thank you for your attention and I once again thank SuperReturn for the opportunity to speak to you all today.
I would like to thank Stephanie Kearns for her assistance with these remarks.