Our Strategic Workplan in Securities and Markets Supervision - Colm Kincaid, Director of Securities & Markets Supervision

Remarks delivered to the Association of Compliance Officers in Ireland

Introduction

Good afternoon. It is a pleasure to be here to speak to you today and I am very grateful to the Association of Compliance Officers in Ireland (ACOI) for the opportunity to do so. The ACOI performs a hugely important role in supporting and developing the community of compliance officers in Ireland and the Central Bank of Ireland is very supportive of its work. It is great to see the work the ACOI is doing to continue to foster the role of the compliance officer and there is a strong confluence of interests between the Central Bank as regulator and the compliance officer community.

This is why I have chosen today, and an event at the Association, to speak to you about the Central Bank of Ireland’s Strategic Plan 2019-2021 and what we have planned in the field of securities and markets supervision to support that plan. In particular, I will outline the strategic initiatives we have prioritised in our work, and hopefully over the course of doing so give you some insight into why we have chosen to focus on these areas. I hope you will also incorporate these priorities into your own work and the priorities of your organisations.

The Central Bank’s Strategic Plan 2019-2021

Coming a decade after the onset of the financial crisis, the Central Bank’s Strategic Plan 2019-2021 (published in late 2018) comes at the end of a range of national and EU policy reforms and on the back of a huge amount of work by the Central Bank, government and other public bodies to deal with the fallout of that financial crisis. The remarkable recovery of the Irish economy has been accompanied by an expansion in our role as a location for financial intermediation. In 2018, we granted 1,117 fund authorisations (more than any previous year) and approved 1,052 prospectus documents. It is also worth noting that this comes off the back of Ireland having had in 2017 the highest figures for prospectuses approved in Europe, with a total of 653. We are also seeing a marked growth in the number, scale and complexity of the securities market participants and venues which we have to supervise (for example we are now looking at a number of MiFID II Systematic Internalisers in the low double figures where previously we had none).

This period of economic repair and recovery has also been accompanied by a shift to a more intrusive supervisory philosophy, including in the field of conduct supervision. This is evidenced in our decision in 2017 to establish a dedicated Financial Conduct Pillar within the Central Bank¹, in which sits my own area – the Securities and Markets Supervision Directorate. This Directorate is charged with supervising conduct on securities markets, including through granting or withdrawing various market permissions (such as the authorisation of funds and approval of prospectuses), monitoring and supervising securities market activity for compliance with regulations and responding quickly and decisively in the event of misconduct or market disruption.

Thinking of the role of compliance officers specifically, the growth in EU and Irish financial services legislation since the financial crisis has been remarkable, as the legislature seeks to ensure that the regulatory framework keeps up with financial innovation and elevated concerns about misconduct. In the field of securities market supervision, for example, just one of our key rule frameworks, MiFID II, is estimated at over 1.5 million paragraphs when all of the various levels of requirements are factored in. And this legislative reform continues at pace. In the Securities and Markets Supervision Directorate of the Central Bank alone, we have 5 new statutory mandates to operationalise between now and January 2021. This is particularly challenging when you consider that this does not include significant updates to existing securities markets legislation, such as the Prospectus Regulation, or the continuing elaboration on the interpretation of existing legislative requirements through guidance and Q&As and the various implementation exercises that come with that. In the years to come, it will be interesting to see how these various components of the legislative framework interact and the behaviour and market changes they drive.

The Central Bank’s Strategic Plan calls out two very specific challenges that call for particular strategic focus: The first is Brexit, with its attendant risks and the potential quantum shift in the scale of our international financial services sector as firms migrate their business from the UK to the EU 27, with many choosing Ireland as their preferred location. The second is the implementation by the Central Bank of a new approach to financial conduct regulation, including in the sphere of wholesale securities markets.

Finally, consistent with the prudence at the heart of our Mission, our Strategic Plan includes a focus on stabilising our operational budget, including in the context of our regulatory levies. This means we will increasingly adopt what we refer to as a ‘One Bank’ approach to our work, recognising how intertwined our prudential, conduct regulation and central banking mandates are. This will also maximise the potential from the fact that here in Ireland we have all these mandates housed within a single organisation, with the access to people, skills, knowledge and capacity to flex that comes with that. The Strategic Plan also places an emphasis on investment in the delivery of our data strategy to support our widening mandate and One Bank way of working.

All of this is with a view of course to contributing to the delivery of our Mission, which we have articulated as follows:

“The Central Bank of Ireland serves the public interest by safeguarding monetary and financial stability and by working to ensure that the financial system operates in the best interests of consumers and the wider economy.”

Securities and Markets Supervision

So, turning to securities and markets supervision specifically, what areas are we focusing on to support this Strategic Plan?

The first thing to emphasise, consistent with our One Bank ethos, is that there are many cross cutting strategic themes that will impact in the field of securities and markets supervision just as they do in other sectors. These include for example our focus on the culture of regulated financial service providers and individual accountability to embed high standards of conduct within those providers. Funds and other securities market firms will have received our recent letter² reminding them of their legal obligations under the statutory fitness and probity regime. This regime will remain central to our role as gatekeeper for the financial system.

That said, there are a few specific items which I wanted to call out in the field of our work to supervise conduct on securities markets.

The first point is to note is that there are a number of distinct features of the Central Bank’s securities markets supervision work:

1. We supervise both regulated and unregulated entities.
2. Our work is highly international in its focus.
3. Our work comprises huge quantities of data, so we have a very particular need for technology.

The second point to note is that the scale and complexity of the Central Bank of Ireland’s supervisory mandate in the field of securities markets has been growing for some time now. From this, we identified within the Financial Conduct Pillar a need for a more systematic, risk-based approach to how we carry out our supervisory tasks. We also identified a need to continually enhance how we perform our gatekeeper tasks (that is assessing fund applications for authorisation, issuer applications for approval of prospectuses and the many other market permissions we oversee under the legislation), as well as a need to harness data and technology more effectively to support our work in this increasingly complex environment. 

The third point to make is that while Brexit has certainly accelerated the pace with which we have had to advance this work, the development of a more systematic risk-based approach is something we would have had to do in any event. In simple terms, Brexit would likely bring a quantum shift in the nature, scale and complexity of what we have to supervise. However, we are already in any event undergoing an increase in what is required of the Central Bank as a securities market supervisor.

There are three reasons for this growth in the responsibility of the Central Bank:

• 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. These mandates continue to grow, in each case coming with a series of mandated tasks and monitoring obligations.
• The second reason for growth is that the market we have to supervise is growing. 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. We are seeing all these new features emerge here in Ireland and we need to be able to supervise them effectively. This includes building the necessary technical skills in our team to do so.
• The third reason for this growth is the rapid evolution of international supervisory convergence and a raising of expectations as to what is required of national competent authorities in this field. The Central Bank of Ireland has been at the heart of driving forward this agenda, including (in a securities markets context) at the European Securities and Markets Authority (ESMA). Through work at ESMA, we now have a concerted momentum as a community of regulators 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.

It is worth pausing for a moment to reflect on this EU aspect. At the Central Bank of Ireland, we look not just to our responsibilities to the public we serve in Ireland but also the public we serve across the EU, particularly in those areas where Ireland is a major exporter of financial services, such as funds. An example of recent close supervisory cooperation in furtherance of this aim was the regulatory precedent established earlier this year when the Central Bank of Ireland and the Luxembourg CSSF issued a joint statement³ on a common EU supervisory approach to the cessation of the practice of ‘share cancellation’ in money market funds. This was a novel approach to supervisory convergence at an EU level and sets a precedent for how problematic issues such as this might be dealt with by national competent authorities in the future.

Our 5 Principles

In setting a strategic direction amidst all of this change and uncertainty, we thought it important to first of all articulate what we consider a proper and effectively supervised securities market would look like. This included recognising the particular nature of securities markets (as distinct from other financial services sectors) and the statutory mandates with which the Central Bank is charged in supervising conduct on securities markets.

There are many ways one can articulate the goals of supervising securities markets. However, for our purposes, we believe that a proper and effectively supervised securities market is one that:

1. Provides a high level of protection for investors and market participants.
2. Is transparent as to the features of products and their market price.
3. Is well governed (and comprises firms that are well governed).
4. Is trusted, by both those using the market to raise funds and those seeking to invest.
5. Is resilient enough to continue to operate its core functions in stressed conditions and to innovate appropriately as markets evolve.

These are the overarching principles that we use to guide our work.

Securities and Markets Supervision – Strategic Initiatives 2019 to 2021

Having identified the key current themes in securities markets and regulation and the principles of a proper and effectively supervised securities market, we turned our attention to what we need to do to advance the Central Bank’s Strategic Plan in this context. We do this every day of course through the performance of our statutory tasks from market surveillance through the data we gather, assessing applications for authorisation, supervising funds and securities markets and reacting to information of concern. However, we considered it imperative that we have a sharp strategic focus if we are to meet the challenges presented by the context I have just outlined.

In the period 2019 to 2021, therefore, our focus will be on:

• Establishing a systematic, risk-based approach to how we supervise activity in wholesale securities markets across all of our various statutory mandates.
• Assertive risk-based supervision of the funds sector.
• Being an ever more effective gatekeeper.
• Continuing to improve how we harness data to do our work.
• Operationalising new legislation.
• The enforcement of securities market legislation.

In the period of 2019 to 2021, this will be our contribution to ensuring that the best interests of consumers and investors are protected, and markets operate in a fair, orderly and transparent manner. In all of this, we will work towards a trusted financial system supporting the wider economy, where firms and individuals adhere to a culture of fairness and high standards.

I would now like to say a few words to explain what sits underneath each of these headings.

Wholesale Market Conduct Supervision

In our Strategic Plan 2019 – 2021 we highlighted that the Central Bank was “gearing up to expand the scope of financial conduct regulation, with the Brexit-related expansion of wholesale financial trade requiring a parallel investment in wholesale conduct regulation.”⁴ 

Wholesale financial market activity conducted in and from Ireland and by branches of Irish firms in other jurisdictions has increased in scale and sophistication. The development of a strategy and framework for the supervision of conduct in wholesale markets is one of our key strategic initiatives over the next three years. Last year we embarked upon the design and implementation of a systematic risk-based approach to the supervision of conduct in wholesale securities markets. While our work in 2018 was understandably Brexit focused (in particular we deployed the new tools in the framework on large Brexit applicant firms), the framework is intended to encompass all of our securities market participants.

We also recently commenced our supervisory engagement with firms using this new framework by writing to the CEOs of existing and incoming investment firms and credit institutions on 11 March. In our Industry Expectations Letter⁵, we set out our high-level expectations in respect of how these financial service providers should identify, mitigate and manage market conduct risk. Firms have been requested to provide a copy of the letter to their boards and for the resulting discussions to be reflected in the minutes of that board meeting. We will continue to engage with industry in relation to wholesale market conduct risk over the remainder of the year and we have established a dedicated team to support this work, with the intention of conducting a mix of thematic risk assessments and targeted risk assessments of individual firms.

As we further develop our framework for wholesale market conduct supervision, we will use its concepts and design to lead and guide the creation of a coherent single framework for supervision of conduct in securities markets more generally. Key to this framework, and consistent with our overall PRISM supervisory framework, is the concept of assertive risk-based supervision including using periodic market conduct risk assessments to identify priority supervisory themes. The key priority theme for 2018 of course was the assessment of applications for authorisation in Ireland on foot of Brexit and understanding how our landscape might look post Brexit, as well as ensuring key cliff edge effects from a hard Brexit were dealt with. This year, while continuing with our focus on Brexit developments, we will widen our lens to also form an assessment of the level of conduct frameworks in place within securities market firms we already supervise.

Assertive Funds Supervision

The nature, scale and complexity of the funds industry in Ireland and its regulation continues to grow. Ensuring we are effective supervisors of our global funds industry is critical to achieving our mandate to safeguard stability and protect investors. In this strategic cycle we will build on the considerable resource devoted to achieving a significant level of professionalism in the consideration of applications for authorisation, to build an ever more assertive risk-based approach to conduct supervision of funds. This includes using the methodology and tools we have developed for wholesale market supervision to identify the right themes to prioritise and reviewing those themes in a manner that achieves concrete sustainable improvements for investors.

For example, last year, we carried out a thematic review of UCITS performance fees to establish whether the procedures used to calculate and pay performance fees in UCITS ensure that investors’ interests are protected at all times. We published our key findings in an Industry Letter⁶ in September 2018 and commenced supervisory engagement with all UCITS fund management companies where instances of supervisory concern were identified on foot of the thematic review. We are currently closing out this follow up engagement through risk mitigation programmes imposed on relevant firms and redress to investors where required.

Continuing with the priority theme of fees and disclosure, this year we also continue our review of all Irish domiciled UCITS funds that report to be actively managed to determine if they are potentially index tracking. Described as ‘closet indexing’, this activity poses a risk to investors that the fund manager may be charging the investor for pursuing an active strategy while in fact implementing a passive strategy. To date we have conducted analysis on over 2,000 Irish domiciled UCITS funds that report to be actively managed (representing over 15,000 share classes) against over 2,500 indices. We have commenced our supervisory follow-up with those firms where indications of ‘closet indexing’ have been identified and we will continue to follow through on this work as our data analysis identifies cases of concern. 

Finally, we are in the process of scoping a thematic review to assess how firms have implemented the package of measures introduced on foot of CP86. The broad aim of this work will be to identify standards of industry compliance in order to inform our supervisory approach to this important area and ensure that the requisite systems of governance are in place to protect investors’ best interests.

Effective Gatekeeping

As I noted recently⁷, Brexit has given rise to a considerable uplift in applications for authorisation and for permission to expand existing business. This involves a diverse range of firms with a wide range of business models that, when stood up, will change our landscape and require us to evolve our supervisory approaches to take account of these developments. Being an effective gatekeeper is an important first safeguard in ensuring that the securities markets and market participants are operating in a manner that supports our 5 principles for a proper and effectively supervised securities market.
Our aim over the next three years therefore is to review our gatekeeper activity adopting a risk based approach towards ensuring that our resources are deployed most effectively in this evolving market. This means identifying and focusing on those areas of scrutiny which best protect the interests of investors, while also reinforcing the responsibility of industry to ensure that they meet their statutory obligations and explain their products and offerings to potential investors in a manner that is fair, accurate and not misleading.

We have already begun this process of reviewing our internal gatekeeper processes and procedures for funds and prospectus approvals (including post—authorisation processes) combined with industry workshops to discuss operational and legislative developments. To guide us in this work we will devise gatekeeper principles to help us shape and rationalise where we decide to focus our finite resources when assessing an application, to best protect investors.

We will also of course continue with implementation of changes to our processes arising from legislation, including from the Prospectus Regulation coming into full effect on 21 July.

Harnessing Data

An additional challenge for us in terms of how we deliver on our stated priorities stems from the heavily data-oriented nature of much of what we do, and the sheer pace and scale of technology use within the sectors we supervise under our mandate. While rapid technological development is increasingly a feature across the financial services sector, it is especially acute in the field of securities market supervision, where we take in over 5 million statutory reports per day. All this information has to be combined with an equal (if not greater) volume of market-based data to create a picture that we can understand and interrogate. As has been said before, we are supervising things that the human eye cannot see and the human brain cannot comprehend. We need technology to do this job.

Moreover, we are increasingly supervising not just the conduct of individuals but the conduct of machines transacting at volume over fractions of a second, as we see the rise in Ireland and elsewhere of high frequency algorithmic trading.

Over the next three years we plan to marshal data to allow supervisors to be more systematic in their work, supporting our overall supervisory engagement and outcomes and feeding into the overall Central Bank data strategy and vision for this strategic cycle. We have already done this to good effect this year in our funds supervision work. Examples include our use of data analytics to identify target funds in our closet indexing review, as well as our monitoring of the market in the run up to the potential Brexit dates of 31 March and 12 April. We will continue to incorporate the use of analytics in other key pieces of supervisory work for this sector, including to enhance efficiency and equip our supervisors to be more intrusive.

Data is also high on the agenda from a European securities markets supervision perspective and we were strong supporters of the recent establishment of ESMA’s new Data Standing Committee, to provide a dedicated single forum to discuss these issues.

Of course, it is critical that the data we receive is accurate and reliable. In this respect, one of the areas in which we are working to improve overall data quality is through our EMIR data quality work. The improvement of data quality to enhance market transparency is a key strategic initiative for the Securities and Markets Supervision Directorate and is also key to ESMA’s agenda. Earlier this year we issued a letter⁸ to EMIR counterparties to provide feedback on the main issues identified from reviews on data quality we undertook in 2018, so that appropriate action can be taken to ensure complete, accurate and timely reporting going forward. The letter to firms was the culmination of a series of data quality checks on reported EMIR data focused on the extent to which reporting complies with the requirements under EMIR and related implementing and technical regulations and guidance. The Central Bank will pursue individual counterparties on specific matters where reporting fails to meet these standards.

Effective Enforcement of Securities Market Legislation

Running through many of our strategic initiatives for 2019 to 2021 is the theme of systematic, assertive risk-based supervision. This is consistent with the Central Bank’s overall supervisory philosophy. Part of this philosophy is of course that legislative requirements are enforced. This takes the form of ensuring that we approve individuals to pre-approval controlled functions only when they clearly demonstrate that they have met the requisite standards, to ensuring appropriate redress for investors, intervening with the use of our statutory powers to suspend trading in securities (in 2018 the securities of 10 issuers were suspended from trading under Transparency Regulations for failing to publish financial reports on time) or to suspend the redemption of units in a given fund where concerns exist. It also includes assisting fellow regulators in other jurisdictions, given the highly international nature of our work, and in 2018 we conducted over 30 specific exercises of this nature. Finally, it extends of course to the imposition of penalties in appropriate cases. In this strategic cycle, building on the assertive risk-based approach to supervision which we are rolling out across our supervisory mandates, we will take steps to improve the effectiveness of how we enforce these requirements put there to protect investors and market participants.

Operationalising Legislation

The Central Bank operates within a large and complex legislative portfolio, and no less so in the field of securities markets. We will continue to enhance our internal processes for operationalising legislation and our coordination with external stakeholders. We will also continue to commit our resources to the necessary work on these legislative mandates at ESMA.

One of the key aspects of securities markets legislation that takes a lot of our time is the implementation of new reporting requirements. This is an area where industry engagement is especially important, but it can also be one where we sometimes have to continue to develop specifications at a European level for quite some time into the process, putting pressure on regulators and market participants to get the necessary logistics in place on time. It is also an area where good engagement and good technology can save time and money for regulators and industry alike (providing savings ultimately for investors), as well as enriching the quantum and quality of data available to us. I have voiced my gratitude on a number of occasions for those firms who recently engaged with the Central Bank on the development and rollout of our new Machine-to-Machine submission channel for MiFIR transaction reporting. Complementing our existing Online Reporting System (ONR), as of last month approximately 67% of our monthly 21.3 million MiFIR transaction reports from Irish firms were received through this Machine-to-Machine channel. We will continue to build on this approach to engagement and testing for key initiatives of this nature.

Conclusion

I hope it has been helpful to provide you with this overview of the Central Bank’s Strategic Plan for 2019 to 2021, the regulatory and market backdrop to this plan and the specific initiatives we are undertaking in securities and markets supervision to support this strategy. A lot of hard work has been done since the financial crisis to mend the financial system and set us on a path to recovery. In this next strategic cycle we must work just as hard to consolidate these gains, maintain the progress regulation has made and remain vigilant to the emerging risks. Much has indeed changed in financial services but the core incentives that drive misconduct have not – nor have the consequences for all of us and our wider society when such misconduct occurs.

I want to thank the Association of Compliance Officers in Ireland for this opportunity to speak to you, and I thank you for your attention.

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I wish to thank Stephanie Kearns for her assistance with this speech

¹ Central Bank of Ireland: Central Bank Commission approves restructuring of financial regulation functions (30 May 2017).

² Central Bank of Ireland: Compliance by Regulated Financial Service Providers ("Firms") with their Obligations under the Fitness and Probity Regime (8 April 2019).

³ Central Bank of Ireland: Statement on the treatment of share cancellation under EU Regulation 2017/1131 (11 January 2019).

⁴ Central Bank of Ireland: Strategic Plan 2019 - 2021 (2018), page 5.

⁵ Central Bank of Ireland: Wholesale Market Conduct Risk – Industry Communication (11 March 2019).

⁶ Central Bank of Ireland: Thematic Review of UCITS Performance Fees (4 September 2018).

⁷ Kincaid, Colm (2019) ‘MiFID II – A year in review’, remarks delivered to the Irish MiFID Industry Association, 10 April 2019.

⁸ Central Bank of Ireland: Feedback letter on review of EMIR Reporting (20 February 2019).