15 January 2020 Speech
Derville Rowland, Director General, Financial Conduct at the Central Bank of Ireland, speaking at the Association of Compliance Officers of Ireland, Chartered Accountants House, Pearse Street, Dublin.
I would like to thank the Association of Compliance Officers of Ireland for inviting me to address you today.
I am particularly pleased to have the opportunity to speak so early in the new year about the role of Financial Conduct regulation and to share with you our key priorities for 2020.
But first a little history.
The roots of modern banking can be traced back to 12th century Italy when the merchants of Venice developed the concept of credit.
Instead of bartering goods or exchanging gold and silver coins, the new system relied on pieces of paper which were no more than promises to pay.
It is no surprise therefore that the word credit traces its roots back to the Italian “credito” – meaning “trust”.
But trust in those promises had very soon to be backed up by regulation – judging by the fact that rules governing money exchange and banking appear early in the Italian statutes.
The records show that, as far back as 1111, the money exchangers of Lucca were required to take an oath not to steal, commit fraud or falsify.1
It is clear therefore that the birth of modern finance, and the benefits it brought to society, were predicated not just on the commercial acumen of innovative financial services providers.
Customers also needed re-assurance that the financiers in whose hands they were placing their money – or on whose promises they were relying for future payment – would conduct themselves in a trustworthy manner.
History suggests that together with openness – to trade, capital and people – regulation and compliance have also been key determinants for the success of financial centres and the benefits they provide.2
The Role of Financial Services in Our Economy and Society
Getting the regulation of financial services right is important, when you consider the huge role these services play in our lives.
Lenders can help borrowers to buy something they need today on the promise that they will pay the lender back in the future – whether it be a car, home or business loan.
Life and pension companies help their customers protect themselves against certain known and unknown risks they may face in the future.
And capital markets provide a valuable service connecting government and commercial enterprises (both large and small) with investors willing to provide the funds for important infrastructural and capital projects.
As the Irish economy has expanded, the financial services industry in Ireland has expanded too – including to users of financial services across the globe. As one example, investment funds incorporated in Ireland now have more than €3 trillion in assets under management and investors in up to 90 jurisdictions.
Private individuals, pension funds, insurance companies and governments here and around the world depend on these services to provide for their future and that of their customers or citizens.
Strong Conduct Regulation a Must
Consumer and investor protection is embedded in every area of the Central Bank’s work. It is at the heart of our mission.
Consumer and investor protection begins with the financial services providers. Firms are responsible for selling their customers products that meet their needs both now and in to the future. There is, therefore, an onus on firms to have effective cultures and set the right standards.
These standards must be reflected in every business area, from corporate governance structures to individual accountability; from strategy-setting to product development; from risk management to people management; and from internal challenge to how whistle-blowers are treated.
Conscious of the devastating consequences that misconduct can have, the Central Bank regulates financial conduct with the aim of ensuring that the best interests of consumers and investors are protected and that markets operate in a fair, orderly and transparent manner.
We take a risk-based approach to supervision, focusing our energies on the firms and products according to the level of risk they pose to consumers and investors, while leaving some flexibility to deal with emerging issues that may surface during the course of the year.
Recognising the financial sector is increasingly interconnected and complex, we consistently evolve our system of supervision for the regulated financial services sector as a whole, from updating our rulebooks to harnessing data more effectively.
The Central Bank adopts a multidisciplinary approach to its work, bringing together the full suite of policy, supervisory and enforcement expertise when tackling complex issues. A good example is the Tracker Mortgage Examination, where a multi-disciplinary team of Central Bank experts designed a redress and compensation scheme that returned almost €700 million to consumers who had been denied a tracker mortgage or put on the wrong rate.
We will continue to enhance this multi-disciplinary approach going forward.
We will also continue to work with the other parts of the State’s consumer protection framework – such as the Financial Services and Pensions Ombudsman and the Competition and Consumer Protection Commission – to fulfil our role.
I wish to turn now to our 2020 financial conduct supervisory priorities.
Strengthening consumer protection is a key priority for the Central Bank.3 With more than 10,000 entities to regulate and supervise, it is essential we identify and prioritise addressing key consumer protection risks.
To do so, we conduct in-depth consumer research each year to ensure that the voice of the consumer is at the heart of our work. This complements our sectoral risk evaluation, which uses evidence-based analysis to identify the current and emerging risks.
We assess the risks for each sector we supervise and then prioritise those where our interventions have the greatest potential to minimise the scale and impact of consumer harm.
We will shortly publish our Consumer Protection Outlook Report which will detail the key risks we have identified.
Time would not allow me to share all of these with you today. But I would like to give you a sense of some of the key issues on our radar.
One of the key risks remains the lack of a consumer-focused culture within the financial services sector. So it won’t come as a surprise to hear we will continue to hold boards and leaders to account for embedding effective behaviour and cultures.
Specifically, we will continue to challenge the boards and senior management of the five retail banks for evidence of progress on the delivery of their behaviour and culture action plans. As you will no doubt recall, our review of the retail banks found that while some progress had been made, all had a distance to travel when it came to building a consumer-focused culture.
It is important that banks design and sell products that are suitable to their customers’ needs, are capable of delivering the promised benefits and that disclose any key risks. This year, we will complete Consumer Protection Risk Assessments on product oversight and governance at some of the main retail banks to identify risk practices, new product development processes and product management information. That’s because we want to ensure that firms understand the risks and factor in the consumer perspective when designing new products. Our findings will be communicated to the banks and we will insist they take action to address any high-risk practices identified.
We will also place particular focus on the changes brought about by technological innovation. We recognise that technology, including the use of big data and algorithms, can empower consumers, offer them better choice and value. But we also see that such changes can bring risks, including the inappropriate use of technology and information asymmetries between providers and consumers.
In that regard, we will examine the issue of price differentiation in the motor and home insurance market to understand the extent and prevalence of the practice, how insurers are using it and whether it gives rise to unfair treatment of consumers. We intend to publish an interim report on our findings at the end of the year.
In the meantime, let me be very clear: We expect the boards of insurance companies to ensure their pricing practices comply with the Consumer Protection Code and that they can stand over their underwriting strategies.
It is important that customers who are investing for the future can have confidence in the products they are purchasing. For that reason, we are going to assess whether European appropriateness and suitability requirements are being met when selling investment products.4 We will also be examining the sale of structured products by retail intermediaries.
We will continue to focus on the insurance sector including checking compliance with disclosure requirements for motor insurance.
Borrowers in Mortgage Arrears
The protection of borrowers in mortgage arrears continues to be a key priority for the Central Bank. The regulatory framework provides a significant number of protections for borrowers in arrears – regardless of who owns their loans. This is important given the strain, stress, and vulnerability of people who are at risk of losing their homes.
Significant progress has been made in terms of restructuring mortgage arrears – in a way that has minimised repossessions – and critical to this has been the implementation of alternative repayment arrangements (ARAs).
However, a percentage of cases have not been restructured, and of those that have, not all are long-term sustainable solutions.
Across the bank and non-bank sectors, engagement remains critical if ARAs are to be put in place. These arrangements should be appropriate to and sustainable for the borrower, regardless of which type of lender holds the loan.
This year, we will closely monitor compliance with the treatment of borrowers in arrears and take follow-up supervisory actions as required. As part of our supervisory work, we will continue to drive all loan owners to put in place long-term sustainable arrangements where possible for their borrowers.
And we will subject the new non-bank owners to robust authorisation and supervision.
In particular, we will challenge the pipeline of 34 firms applying for full authorisation under the Credit Servicing Act 2018 about their plans for the fair treatment of borrowers in arrears.
Naturally, Brexit will remain a key priority given the risks posed to the Irish economy, firms and consumers from the UK’s withdrawal from the EU. We will continue to push firms to put plans in place to minimise any risks to consumers. We will also continue to develop our response on issues regarding the post-Brexit environment.
Protecting Investors and Market Integrity
Given Ireland’s growing prominence in funds, and the role they play in global markets, effective funds supervision is of critical importance to us. We work at European and international level to shape and influence standard setting. This year, a key priority is to work with our colleagues in the European Supervisory and Markets Authority (ESMA) to drive EU supervisory convergence and to raise supervisory standards.
Domestically, we also recognise the need to enhance our approach to the supervision of conduct on wholesale securities markets. Here we are working hard to develop a more systematic risk-based approach to our supervision of these sectors, including having regard to international standards in this field.
This includes enhancing how we discharge our role as a gatekeeper to be ever-more risk-based, devoting more scrutiny to those applications of particular concern. It also includes implementing important new legislative mandates to strengthen the regulatory framework.
We are also scoping a thematic review that will build on the findings of our first year of deployment of our new approach to wholesale market conduct supervision. We will write to industry shortly to outline some of the key findings in relation to securities market conduct risk from that first year of deployment.
Additionally, we will target a number of particular topics in the field of funds. These include:
(i) concluding our review5 of how the sector is implementing our rules and guidance related to fund management company effectiveness;
(ii) working together with fellow regulators and colleagues in ESMA to complete a common supervisory action on liquidity management in certain investment vehicles known as UCITS6; and
(iii) commencing a review of UCITS’ use of securities lending.
The recent experience of investors in UK asset manager Woodford has raised questions as to whether existing rules in respect of liquidity risk are sufficient. Liquidity risk in the funds sector more broadly is an important issue and one that we have been closely engaged in at EU and international fora. From a financial stability perspective, we will conduct a deep dive on property funds to assess the resilience of this growing form of market-based finance.
Preventing Money Laundering and Terrorist Financing
We are all sadly all too familiar with the devastation that can be wreaked on our societies when the financial system is used by criminals, including drug dealers and terrorists.
Protecting the financial system from being abused in this way is a global regulatory priority, particularly in the EU, following a number of money laundering scandals at European banks.
A key part of our work in this area is to supervise firms’ compliance with their obligations under the Criminal Justice Act 2010 (CJA) to protect the financial system from being used by money launderers and terrorists.
Turning to our supervisory priorities for 2020, areas of particular focus will be transaction monitoring and risk assessments.
The need for effective transaction monitoring has never been greater, given the increasing volume and speed of transactions. In particular, we will focus on the IT systems utilised for transaction monitoring by higher risk firms operating across different sectors.
In the absence of effective transaction monitoring, firms may not detect suspicious activity that may warrant further investigation and the filing of a suspicious transaction report. Information provided on such reports greatly assist An Garda Síochána and the Revenue Commissioners in their investigations, resulting in the disruption of criminal and terrorist activities.
We will also focus on the design and operation of money laundering and terrorist financing risk assessments by firms. This risk assessment is the cornerstone of an effective control framework.
All firms must be aware of their compliance obligations and of the threat posed to the financial sector by money laundering and terrorist financing. Last September, the Central Bank published updated industry guidelines on compliance.7 I would encourage you to utilise them in your design and operation of your frameworks to prevent money laundering and terrorist financing.
In addition in 2020, we will be focusing on a number of specific sectors – namely Schedule 2 firms and Virtual Asset Service Providers.
Schedule 2 Firms – Failure to Register
I want to highlight the requirement – introduced in late 2018 – for certain types of firms to register with the Central Bank.
These are firms that undertake certain activities listed under Schedule 2 of the 2010 Act. The majority of the firms that perform these activities are already subject to regulation by the Central Bank. However, some firms providing services such as financial leasing or safe custody of valuable assets, such as jewellery or precious metals, may not otherwise be regulated by us.
While such firms have been subject to obligations to prevent money laundering and combat the financing of terrorism since 2010, the 2018 legislative change places an obligation on all non-authorised Schedule 2 firms to register with the Central Bank, so that we have a full list and relevant details in respect of such firms.
I would remind firms that fall into this sector, and that have not registered, that failure to register with the Central Bank is a criminal offence.
Virtual Asset Service Providers
New technologies, services and products offer efficient alternatives to classic financial products and can improve financial inclusion. At the same time, the speed and anonymity of some of these innovative products can attract criminals and terrorists.
A virtual asset is a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes. Virtual assets allow for greater anonymity when compared to other more traditional financial services transactions. This anonymity can prevent virtual asset transactions from being adequately monitored.
Additionally, given the nature of virtual assets, it is unlikely that a customer will have a face-to-face interaction with a virtual asset service provider, which further increases the risk of money laundering and terrorist financing.
The Central Bank has been developing a supervisory engagement strategy in relation to virtual assets service providers (or VASPs).8 When the EU’s Fifth Anti-Money Laundering Directive becomes law, VASPs will have to comply with the obligations in the CJA 2010 to protect the financial system from being used by money launderers and terrorists, and the Central Bank will be responsible for supervising their compliance with their obligations.
As this will be a new cohort of firms under the supervision of the Central Bank, we plan to subject VASPs to intense supervision in 2020, as we increase our understanding of their business models and service.
2020 Priorities: Enforcement
At its core, conduct is about people and how they behave. Where there are serious regulatory breaches, we take enforcement action to hold firms and individuals to account. This deters misconduct and promotes compliance and high standards in financial services.
Our fitness and probity regime aims to ensure that regulated firms and individuals operate to high standards of competence, integrity and honesty. Our aim is that only people who are fit and proper occupy senior roles at the financial firms we regulate and supervise.
Our gatekeeper role is a critical lever for us. To date, we have refused a number of applications, while 86 applications for senior positions have been withdrawn where the Central Bank has challenged the applicant.
The onus is on firms to conduct their own due diligence on individuals when making “fit and proper” assessments, and we are focused on ensuring they discharge that responsibility to the full. I want to emphasise our expectation that every person employed in the financial services sector provides full and truthful information to the Central Bank.
Turning to enforcement actions, our ongoing enforcement investigations in respect of tracker mortgage-related issues will be a key priority this year. We are examining various lender failings, including the actions of individuals, which may be relevant to establishing how and why customers lost their trackers. Where wrongdoing or suspected wrongdoing is identified, we will use the most effective powers and enforcement tools available.
Writing the Rulebook: 2020 Policy Priorities
Just like the customers of the money exchangers of Lucca back in the early 12th century, if we are to have trust in financial services, we need confidence that regulated financial service providers are governed by rules that address emerging issues. The rulebook has to keep up with the times.
In our case, that includes taking measures to update our Consumer Protection Code, continuing to address behavioural and cultural failings in the financial services sector, playing a role in tackling climate change and responding to the challenges and opportunities of technological innovation.
For that reason, we will begin this year the process of substantially reviewing the Consumer Protection Code to ensure that it reflects the changing financial services landscape. This is a complex and multi-annual project which will require extensive consultation and deliberation of policy and legislative issues.
In 2018, we set out detailed proposals for an enhanced individual accountability framework to drive effective and sustained cultural change within the Irish financial services sector.9 The shape of these reforms is ultimately a matter for the Oireachtas. We will continue to work with the Department of Finance on the development of the proposed legislation to provide a robust framework.
We will also continue to develop the Central Bank’s conduct, consumer and prudential supervisory frameworks to ensure that our approach to policy and supervision is effective and consistent with European and international best practice.
It is interesting to note that those early Venetian bankers were also in the business of managing climate risk. They had to consider whether the merchants whose voyages they funded would survive not just the threats from thieves and pirates, but also “the perils of water, wind and rocks” and return home to repay their loans.
These days, the Central Bank is increasingly focused on climate change for a number of reasons. Firstly, climate change creates risks to the ongoing soundness and stability of financial firms arising from either direct climate risks such as fire, flooding or storm events which can threaten the value of assets owned by regulated entities, investors and consumers. There are also financial stability issues relating to transitions if changes in legislation or popular sentiment giving rise to “stranded assets” such as property located in flood plains.
Secondly, there is a substantial conduct perspective to be considered as part of the transition to financing a sustainable economy. The obvious risks to consumer and investor protection arise from the “greenwashing” of financial products –a type of mis-selling that can take many forms.
The Central Bank is aware that there has been a substantial increase in the development of financial products described in some form or other as sustainable. So, the challenge for both the Central Bank and industry is to ensure that sustainable financial products are defined in an accurate and transparent manner and that investors can trust what they are receiving.
On top of existing requirements to provide clear information to consumers and investors and to sell them suitable and appropriate products, there are significant EU regulatory developments in the area of sustainable finance.
As you may be aware it was agreed at EU political level before Christmas that there will be an EU taxonomy, or classification system, in relation to what can be considered an environmentally sustainable economic activity for investment purposes. This creates a framework that sets out the criteria to be considered for a product or activity to be considered environmentally sustainable.
Importantly, the taxonomy will be vital to the development of more conduct-focused regulation such as the Sustainability Disclosure Regulation, which will introduce very significant new obligations for industry.
Broadly speaking, fund managers, MiFID and insurance firms will be required to disclose the due diligence process they carried out in relation to the “principal adverse impacts” of investment decisions they make on sustainability factors. If they have fewer than 500 employees, they can set out that they do not consider the adverse impacts of investment decisions on sustainability but they must also publish clear reasons why they do not do so. Financial advisers will be required to disclose whether they consider the sustainability factor impact in relation to the products they advise on, and if not, why not.
These disclosure obligations will start to take effect in 2021, but much detail is still to be worked out. You can expect to see a consultation paper from the Joint Committee of the European Supervisory Authorities (ESAs) around these disclosure obligations in the coming months.
As briefly set out above, the next few years will see significant regulatory changes in this field, so I would ask that you now start to consider the impact of these changes in your industry.
In conclusion, I have to say, I am attracted to the simple elegance in the laws of ancient Lucca not to steal, commit fraud or falsify.
However, since then, financial services have grown in scale and complexity and we need an ever more sophisticated toolkit to regulate the conduct of the firms providing those services. At the Central Bank of Ireland we are consistently evolving and enhancing that toolkit.
Some of our priority issues will have more immediate benefits, while others will bear fruit over the longer term.
But we meet today at the dawn of a new year – indeed of a new decade.
I hope – indeed expect – that the 2020s will be the decade when all firms and boards put conduct, culture and customers firmly at the top of the corporate agenda.
For it is only when they take conduct issues seriously that we can fully deliver on our vision of a trustworthy financial system.
As compliance professionals, you have a vital role to play in being firm and decisive in the execution of your essential duties and reminding leadership teams that they are accountable for the behaviour and culture of their firms.
1. A History of Modern Banks of Issue, Charles A Conant, 1927
2. The Future of Global Financial Centres after Brexit: an EU Perspective, Silvia Calo and Valerie Herzberg, Central Bank of Ireland
4. We will support EU supervisory convergence initiatives through thematic inspections of the requirements of the Markets in Financial Instruments (MiFID) Directive.
5. See Consultation Paper 86 on Fund Management Company Effectiveness – Delegate Oversight
6. Ucits stands for Undertakings for Collective Investments in Transferable Securities. It provides a single European regulatory framework for an investment vehicle so the vehicle can be marketed across the EU irrespective of where it is domiciled.
8. VASPs include entities that provide exchange services between virtual assets and currencies, and entities that provide services to store virtual assets.