Good morning ladies and gentlemen.
I want to thank you for the invitation to speak at today’s event which has been kindly organised by Pinsent Masons in conjunction with the IDA, Lincoln Recruitment, PwC and Bridge Consulting.
This morning I will spend some time discussing Brexit, the current state of play and the risks that remain. I will then discuss a number of topics that are important from a supervision and policy viewpoint before concluding with some thoughts on diversity.
So, perhaps I can start by speaking about Brexit.
I am conscious that, since the extension of Article 50 was agreed last month, a sense of Brexit fatigue is seeping in with the front pages of many newspapers becoming close to a Brexit-free zone in recent weeks.
However, Brexit has not gone away.
We came close to a no deal scenario on 29 March and 12 April and today, unfortunately, uncertainty still casts a shadow over the outcome of Brexit.
The six month extension must not focus our minds solely towards 31 October. It is a “flextension” and so it can be terminated earlier. If for instance a withdrawal agreement is ratified before this date, the withdrawal will take place on the first day of the following month and we will find ourselves in a transition period. On this, the transitional end date has not changed, even if there is an agreed deal this October, the transitional deal, as per the Withdrawal agreement, ends on 31 December 2020.
We must also be mindful that a no-deal scenario is still very plausible which creates the risk of a possible new cliff-edge date. In this regard, it is encouraging to see that some of the most material cliff-edge risks of a hard Brexit have been mitigated or at the very least, are now manageable.
For example, the MOUs agreed with the FCA has ensured that Irish AIFMS, UCITS management companies and Irish funds can delegate their portfolio management to UK investment managers; the FCA’s window for notifications under their temporary permissions regime is open until 30 May; and ESMA has decided to recognise three UK Central Counterparties (CCPs) to provide their services into the EU27 which means that there will be limited disruption to central clearing under a no-deal Brexit scenario.
Notwithstanding these positive developments, there are some risks that remain.
1) First, there is the authorisations risk. By this I mean that firms, including branches of UK firms, who did not engage with the Central Bank or other EU27 authorities well in advance of 29 March, ran the risk of a hard Brexit and not being able to continue to service their EU clients.
The extension agreed last month may have offset such an immediate risk.
Nevertheless, in the case of firms that are still considering their authorisation options, you need to be making important decisions and putting your plans into action now to mitigate this cliff effect risk.
The work of ESMA’s Supervisory Coordination Network has helped to ensure that there is a high level of consistency across the national competent authorities within the EU27. As a result, regardless of the jurisdiction that you pursue for authorisation, you should be planning for a thorough and robust authorisation process that, once engagement commences, could take up to 12 months, depending on the complexity of your business model.
2) A second risk relates to UK firms seeking to continue to provide services to EU27 based clients on a “reverse solicitation” basis.
This is something that is live at an ESMA level as highlighted in Steven Maijoor’s letter to the European Commission last September. In the letter1, the ESMA Chair recommended that a review of the MiFID II framework is undertaken in order to mitigate the effects of reverse solicitation. Moreover, one of the options put forward by ESMA is to limit the scope of services that can be provided by third country firms upon the clients’ initiative.
The Central Bank will continue to monitor developments in this space closely. But reverse solicitation is not a viable business model over the long term. For example, third country firms cannot offer services to new clients or new services to existing clients and therefore the real risk is presented whereby firms could be operating without the necessary authorisation requirements.
3) Another risk concerns the continued access of the Irish market to a CSD.
The European Commission’s granting of temporary equivalence to the UK’s legal and supervisory arrangements for CSDs together with ESMA’s approval of Euroclear UK and Ireland Limited as a third country CSD, means that the Irish market will have continued access to a CSD in the event of a no-deal Brexit. This does alleviate the short-term risk however, an alternative long-term CSD solution must be put in place.
On that note, I would like to provide a brief update on recent developments.
Last Wednesday, Euroclear published a CSD White Paper2 and the Central Bank recognises the work of the various working groups which was instrumental in getting to this stage.
The White Paper provides a clear path forward and while there are still some areas to be concluded, it is imperative that the work to build, test and implement the solution starts as a matter of urgency. To do this effectively, a clear commitment from all stakeholders is now needed. Sharon Donnery, our Deputy Governor for the Central Bank, has made it clear that “the Central Bank will continue to liaise with the relevant stakeholders to ensure a long term solution is implemented on time”.
4) And a fourth risk concerns those firms that have now received their authorisation or have gone substantially through the process and are at the final stage.
A number of firms which have been recently authorised have had conditions of authorisation included in their letter of authorisation with many of these conditions in place to accommodate transitionary arrangements in the context of Brexit. It is important that firms continue to build out their operations and comply with these conditions. While we can understand that the pace of the build out may change, firms must understand that their authorisation was granted on the basis of the information they provided and we expect that firms comply with the conditions agreed upon.
For those firms who are close to authorisation and we have communicated the last requirements, if you do not complete the process then you run the risk of the Central Bank having to revisit your application if too much time has elapsed, this will not be a good use of either your time and resources or that of the Bank.
In summary, our message here is that we will continue our work to ensure that the financial system is resilient in the face of Brexit. However industry must also play its part and this means taking all necessary steps to protect your business and your clients against the risk of a hard-Brexit scenario.
Brexit – the use of secondments
Furthermore, as the date for Brexit comes closer, we have seen numerous proposals to avoid the worst impacts of Brexit. The best proposal is of course to establish an EU27 entity with the relevant authorisation to avail of the EU passport. That is one of the main tenets of the EU: mutual recognition of Member State firms.
In the area of distribution of funds, we have seen proposals to use secondments of former UK staff into Irish entities. This can work, but only where, in the opinion of the Central Bank, there is sufficient management resource and organisational structure, and where no other risks are present, (such as, for example, conflicts of interest), so that overall the structure in relation to control and risk management satisfies the Central Bank. However, if the secondment is structured simply as a device to circumvent the EU rules then we will have no appetite to approve such arrangements. Indeed, we have not approved a number of arrangements which we saw as legalistic, technical or indeed even artificial attempts to do just that.
Supervision and Policy Developments
While Brexit is one of the key themes of the Central Bank’s strategic plan for 2019 to 2021, our regulatory brush extends across a much broader canvas.
With that in mind, perhaps I can take a few moments to discuss some key supervision and policy areas of focus for us as supervisors of the asset management and investment banking sector.
1) In recent years, the Central Bank has noted a significant rise in the scale of outsourcing activities by supervised firms.
Accordingly, last year the Central Bank completed a significant review of outsourcing practices in regulated firms in the Banking, Insurance, Asset Management and Payment Institutions sectors3. On foot of this, we published a paper entitled “Outsourcing – Findings and Issues for Discussion” in November 2018.
To be brief, the findings outlined in the paper are concerning. They point to:
- Poor governance and controls around risk assessment and management of outsourcing.
- Inadequate monitoring and reporting of outsourcing.
- A failure to consider outsourced service providers in business continuity planning and testing.
- An absence of exit strategies.
Following on from this body of work, the Central Bank hosted an industry Outsourcing Conference at our North Wall Quay premises on 30 April last. The event had over 160 attendees from regulated firms as well as outsourced service providers, industry representative bodies and other regulators.
Discussion on existing and evolving outsourcing trends and risks was facilitated via three very productive panel discussions, which dealt with: 1) The evolving landscape of outsourcing and opportunities and challenges faced by both industry and regulators; 2) The management of emerging and evolving outsourcing risks, particularly in complex outsourcing arrangements that involve offshoring and chain-outsourcing; and 3) Outsourcing and IT developments, including the growth in outsourcing to Cloud Service Providers (CSPs) and considerations for the management of sensitive data.
From a supervisory perspective, outsourcing will continue to be a focus of the Central Bank. We will continue to employ our supervisory tools to ensure that the standards of governance and risk management employed by firms of outsourcing are effective. We will also seek to ensure that firms’ outsourcing risk management frameworks evolve and develop in line with the pace of change in the outsourcing landscape and as new risks emerge.
Ultimately, regulated firms must always be cognisant that even though they outsource the activity, they always retain the responsibility for it. As such, it is for each regulated firm to ensure that they have appropriate governance and risk management measures in place in respect of their outsourcing arrangements.
Overall, the insights garnered from the outsourcing conference, together with feedback received on the discussion paper and other domestic and international regulatory developments, will inform the Central Bank’s ongoing work on outsourcing and the appropriate regulatory response to evolving outsourcing trends and risks.
2) Fund Management Company Effectiveness (better known as CP86) came into full effect on 1 July 2018 and its introduction brought about important changes to how fund management companies should structure themselves, with a heavy emphasis on the critical managerial roles (designated persons).
Moreover, you may recall that in past addresses my colleagues and I have indicated that once CP86 became fully applicable, we would be undertaking a body of work to assess how fund management companies have implemented and embedded the new requirements and related guidance into their organisations.
I would like to take this opportunity to inform you that we are currently in the process of scoping a thematic review to assess how firms have implemented the package of measures introduced on foot of CP86.
Significantly, the scope of our thematic work will be informed by the knowledge that we have obtained through our engagement at a European level and from the considerable uplift in applications for authorisation we have received due to Brexit.
As a first step we will look to issue a questionnaire to fund management companies and Self Managed Investment Companies, we will analyse the responses and this will then be followed up with desk based reviews and onsite inspections for selected firms.
3) Any depositary representatives amongst you will be very much aware that the European Commission recently published two Delegated Regulations (the Asset Segregation Regulations), which potentially will have a very significant impact for depositaries particularly in relation to record keeping and asset registration.
As these new requirements will apply to depositaries from 1 April 2020, it is important that industry is focused on preparedness and ensuring they have the necessary project plans in place to implement new arrangements ahead of this challenging deadline.
Recognising the challenges for industry, the Central Bank has commenced a process of industry engagement to assess readiness in advance of April 2020, including holding bi-lateral engagements with individual depositaries in recent weeks regarding their proposed solutions and implementation plans. Our expectation is that depositaries have specific and detailed plans in place in order to ensure compliance with the new requirements by April 2020.
4) CP119 is a consultation paper on amendments to the Central Bank UCITS Regulations and I would like to touch on how this consultation continues to progress.
The Central Bank considers it important to keep our regulatory framework related to funds and fund service providers as up to date as possible.
In this regard, the amendments included within CP119 can be categorised under four headings: (i) general amendments arising from a review of the Central Bank UCITS Regulations; (ii) amendments to UCITS Share Class Provisions to reflect the ESMA Opinion; (iii) amendments related to UCITS performance fees; and (iv) amendments arising from the implementation of the EU Money Market Fund Regulation (MMFR).
CP119 requested feedback from respondents under each of these four headings and for those in the audience who have provided input during the consultation period, the Central Bank appreciates your active contribution.
This process is currently reaching the end and is due to be published imminently. The Central Bank will keep its requirements under review at all times and welcomes ongoing discussion on how best to protect investors, while facilitating management of the costs arising.
5) The Benchmark Regulation which came into force in 2018, introduces an authorisation and supervision framework for all benchmark administrators in the EU, alongside requirements for users and contributors.
Last year, the Central Bank advised in our Markets Update publication that we were considering the authorisation and registration processes, and the third country provisions, alongside our proposed supervisory regime. This process has taken some time, but it is important that we ensure a robust framework is in place going forward.
In March of this year, a Key Facts Document (KFD) was published and this should inform potential applicants as to the type of information the Central Bank will seek prior to any formal application being made.
It is envisaged that the application forms will be available towards the end of the summer and formal applications can then be accepted. To add more colour to this point, the authorisation and registration processes will follow the procedure which we have in place for other areas. We will initially seek a face to face meeting to discuss the potential applicants business plans, a KFD will follow and once we are satisfied with the information provided the applicant may be invited to submit a formal application.
As the Regulation was borne from wholesale misconduct issues, it has been agreed that our newly formed Wholesale Conduct team in the Securities and Markets Directorate will be responsible for the ongoing supervision of the administrators with the authorisation and registration taking place in my own directorate, Asset Management and Investment Banking.
6) Finally, as many of you are no doubt aware, the new prudential regime for investment firms was agreed in April by the European Parliament. It is expected that the final texts will be published in the Official Journal of the European Union in due course.
The new framework, which is comprised of the Investment Firm Regulation (IFR) and Investment Firm Directive (IFD), involves significant changes for investment firms in the areas of capital requirements, liquidity requirements, reporting and remuneration to name but some of the initiatives. There will also be a tailored Pillar 2 regime. These changes will in turn impact on the way in which the Central Bank supervises in-scope investment firms.
The Central Bank is in the early stages of preparing for the new regime. There is an eighteen-month implementation period following the publication of the final texts. However, given the extent of the changes, I urge firms to start to consider and plan for the new requirements at an early date. It should be noted that the framework includes a new categorisation of firms, with differing regimes and requirements applying depending on the category that a firm falls under, so this will be important for firms to understand as a first step.
Before I conclude, if you can bear with me for a few moments, I would like to take you back in time.
It is September 2008, the financial crisis is taking a stranglehold on your firm and you find yourself in a board meeting with your fellow directors in Canary Wharf.
Now each of you present in the inner sanctum of this boardroom have a similar background, you have gone to school in the same area, undertaken the same master’s degree, socialise in the same bars and even follow the same football team.
So, what happens in this scenario when you are presented with the challenge of leading your firm through the depths of uncertainty? Do you succumb to a knee-jerk reaction of groupthink, of being overconfident in the surroundings of your friends? Do you bury your head in your Blackberry? Or, do you simply hope that following the status-quo and not speaking up will solve everything?
Quite possibly, I am being extreme with this illustration but I hope, at the very least, this does convey the importance of diversity within the financial services sector.
For instance, with regards to gender diversity, you may be interested to hear that recent IMF research4 has shown that if female employment equalled male employment, economies would be more resilient and economic growth would be higher. The research also found that adding one more female to a firm’s senior management or board of directors, while keeping the size of the board unchanged, is associated with an 8-13 basis point higher return on assets.
More recently, I participated in a meeting with a representative body for independent non-executive directors (INEDs) and what strikes me is just how important this role can be from a diversity viewpoint. INEDs can offer a fresh, diverse and external perspective to board discussions and the decision-making process.
In this context, it is startling to see that women are still under-represented at senior positions across the financial services sector. The Central Bank’s latest annual report on the levels of diversity across senior appointments5, highlights that within the Irish asset management sector:
- At board level, females represented 24% of the total applications received for roles in 2018 (an increase of 5% compared with 2017).
- At management level, females represented 30% of the total applications received for roles in 2018 which is static from 2017.
Of course, gender is just one aspect of diversity. It also extends to diversity of thought, background, experience, and intrinsic and extrinsic characteristics.
From a regulatory perspective, we are interested in diversity because of its importance in terms of the behaviour and culture that prevails within supervised firms and also its influence in determining how firms are run. Furthermore, low levels of diversity, leads to risks of groupthink, of overconfidence in decision making and of a lack of challenge at senior levels.
While I must acknowledge the progress that has been made to date, it is clear that there is still a road to travel and a lot more needs to be done by firms to tackle this lack of diversity.
The Central Bank, similar to other regulatory authorities such as the FCA, is playing its part by adopting a more focused and structured approach to diversity and inclusion. For example in 2017, Governor Philip Lane launched the Rainbow Network, an employee network to support LGBTQ colleagues, we have also published our gender pay report and in H2 of last year held a conference on culture, diversity and the way forward.
Looking forward, as highlighted recently by the Central Bank’s Deputy Governor General, Derville Rowland6, we intend to keep up the pressure on firms to ensure diversity in those senior roles that are central to how firms make their decisions, set their risk appetites and treat their customers.
At this juncture, let me conclude with my final thoughts.
I believe it was William Shakespeare who once said that “it is not in the stars to hold our destiny but in ourselves”.
Unquestionably, our roles within the financial services sector are by no means carved in stone. They are defined by the actions we take every day and by how we prepare and respond to the events associated with an ever-changing financial system.
Each of us here today must not forget that we have a duty of care, not only to our clients, but to the wellbeing of the sector and to take this one step further, in shaping its future for the generations to come.
Thank you for your attention.
With thanks to Adrian O’Mahony, John Canny, Michael Hennigan, Orna McNamara, Ruth Hogan-Davis and Suzanne Power for their assistance in preparing these remarks.