Thank you for the opportunity to speak today on this very important and pressing topic. Events like this provide an important opportunity for the Central Bank to set out details of the regulatory changes afoot.
Before turning to MiFID developments specifically, I would like to spend a few moments discussing recent internal changes at the Central Bank of Ireland. As you may be aware, effective from 1 January this year, the directorates of Asset Management Supervision (AMS) and Securities and Markets Supervision (SMS) were established. These changes were introduced to ensure that the Central Bank is well positioned to address forthcoming developments in Ireland's asset management sector, such as MiFID II and Brexit. This significant internal reorganisation should highlight the Central Bank's commitment to ensuring (i) the availability of resources and (ii) sufficient regulatory capacity to address emerging challenges and forecasted growth in Ireland's asset management industry.
Let me now turn specifically to MiFID, which, as the cornerstone of the EU’s regulation of financial markets, aims to improve competitiveness by deepening the single market for investment services and activities. With less than a year to go to implementation, MiFID II should be a key priority for every firm within its scope.
MiFID II, and the accompanying regulation MiFIR, is a wide-reaching piece of complex legislation. The MiFID II/MiFIR package represents a major overhaul of the existing law, building on and extending the scope of the existing MiFID regime which originally came into force in November 2007.
Ensuring that your firm fully understands and is ready to comply with the new requirements should be a key priority for all applicable Investment Firms and Credit Institutions. The landscape is set to change and you must be ready.
In terms of historic legislative change, the Central Bank has observed a common trend – those firms who willingly engage and adapt are those who benefit most. Proactively managing regulatory change tends to create opportunities that elude firms who view implementation as merely a compliance task.
MiFID II Delay
As I have said at previous engagements on this topic, the early decision of EU authorities to delay the implementation of MiFID II should have indicated to industry the complexity of the package and the level of work required by firms and the Central Bank to ensure its successful implementation. With just over 10 months until we go live firms should be well advanced, know the impact of MiFID II on their business and policy and procedural changes, including system enhancements, should be at the final stages of development. 3 January 2018 should be on the top of every board agenda.
Of course the changes also bring significant challenge for the Central Bank and I will speak more on our implementation projects later.
MiFID II Overview
MiFID II contains new EU-wide rules governing investment firms, credit institutions, trading venues and market structures, as well as third-country firms providing investment services or activities in the EU. It significantly broadens the scope of MiFID by bringing new activities into scope, removing or narrowing exemptions (e.g. dealing on own account) and covering new financial instruments and products (e.g. emission allowances, commodity derivatives and structured deposits). Consequently, some firms that are currently outside the scope of MiFID will need to apply for authorisation. Other changes include the introduction of a new category of trading venue, the Organised Trading Facility, along with new transparency and reporting requirements.
The MiFIR calls for the reporting of additional transaction data. New firms and instruments will come within the scope for reporting to such an extent that the amount of data received by the Central Bank set to quadruple. Thus, firms will require enhanced systems to be able to generate and submit accurate transaction reports within the stipulated deadlines.
Enhanced conduct of business rules will strengthen investor protection, formalise requirements in relation to product governance, create new requirements around inducements and increase obligations on firms with regard to suitability and appropriateness testing.
New organisational requirements, stricter systems and controls requirements on firms engaging in algorithmic and high-frequency trading, rules governing third country firms operating in the EU via a branch, new product intervention powers for competent authorities (and ESMA) as well as new supervisory and enforcement powers for competent authorities all pose significant implementation issues for both you the firm and the Central Bank.
New Supervisory and Enforcement Powers
Competent authorities will be given new or augmented supervisory and enforcement powers, necessary to fulfil their duties under MiFID II and MiFIR.
These new supervisory powers include:
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imposing restrictions in respect of commodity derivatives;
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requesting any person to take steps to reduce the size of position or exposure;
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requiring existing data traffic records held by a telecommunication operator, where there is a reasonable suspicion of an infringement;
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suspending the marketing or sale of financial instruments or structured deposits;
In relation to enforcement powers, MiFID II sets minimum administrative sanctions and measures that competent authorities must be able to impose on natural as well as legal persons in cases of breaches of specific requirements under the regime. As you will be aware, the Central Bank has existing enforcement powers under the Administrative Sanctions Procedure. These powers are likely to persist in relation to MiFID firms while being added to or augmented where necessary to meet the new minimum requirements under MiFID II.
Other enforcement powers under MiFID II include the power to issue public statements in respect of breaches; the withdrawal or suspension of authorisation; and the imposition of temporary or permanent bans on members of the management body or other responsible persons. These will, to a degree, overlap with the Central Bank’s existing powers.
MiFID II also introduces a more expansive reporting obligation on the Competent Authority to ESMA – some 32 new requirements. The Central Bank will be required to notify ESMA:
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of each suspension or removal of a financial instrument from a regulated market,
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when a firm has reached the threshold of a Systematic Internaliser,
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when the decision to impose sanctions has been made,
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when an MTF/OTF infringes rules, carries out disorderly trading or market abuse behaviour, to name but a few.
Much of this data will be made public on the ESMA website illustrating one of the key tenets of MiFID II – increased transparency.
The Central Bank has also begun the process of updating its registers, thereby fulfilling the requirement to publish notifications on our website of both sanctions imposed and authorisations revoked for a period 5 years. Obviously the Central Bank’s obligations are not limited to reporting to ESMA, one major element of the new legislation now requires all competent authorities to monitor the market in respect of financial instruments marketed, distributed or sold in or from the State.
Product Intervention and Product Monitoring
Product monitoring
Article 39(3) of MiFIR requires Competent Authorities to monitor the market for financial instruments and structured deposits which are marketed, distributed or sold in or from their Member State. A similar product monitoring requirement is also placed on ESMA and the EBA.
This is a general mandate in respect of product monitoring by competent authorities. As ESMA has not yet indicated an intention to produce guidance on the product monitoring requirement, there appears to be a degree of flexibility to conduct it in a way that is consistent with supervisory practices and market characteristics and proportionate to the perceived risks.
Product Intervention
Competent Authorities (and ESAs) will have the power to prohibit or restrict the sale of any financial instrument (or structured deposit) that causes serious concerns regarding investor protection, orderly functioning of the market or the stability of the financial system. Restrictions may take the form of allowing products to be marketed, distributed or sold only to certain client groups, or only where certain specified conditions are met. The powers also allow Competent Authorities and the ESAs to prohibit or restrict ‘types of financial activities or practices’ carried out by those firms within the scope of the legislation.
Questions for firms
These changes are far reaching. For firms that may not have committed adequate time or resources to MiFID II to date, time is running out - 3 January 2018 is fast approaching.
At this point in time we expect firms to have analysed and considered all of the information to hand, particularly those which may impact their business model. Where areas of change have been identified firms should be prioritising and actively developing the systems, policies and procedures that will enable them to operationalise and ultimately comply with their enhanced obligations on 3 January 2018.
You should now be in a position to answer a number of questions pertaining to the MiFID II package, such as:
▪ Product governance and distribution - (MiFID II Article 16) - Is your firm ready for the new obligations on product producers and product distributers? Do you clearly know who your target market is for each instrument and the types of clients? How will you keep track of and assess whether or not clients are compatible with the identified target market?
▪ Transaction Reporting – (MiFIR Article 26) - Does the firm intend to submit transaction reports to the Central Bank on its own behalf or through an Approved Reporting Mechanism (ARM)? What are the anticipated average volumes of transaction reports to be submitted?
Do you have an IT project in place to deal with the significant changes to the transaction reporting systems increased data reporting requirements?
In November 2016 the Central Bank’s Transaction Reporting Team held a seminar on this topic and it has continued to engage with firms on this matter. We are finalising our systems’ solution design, and, in the coming weeks there will be further engagement on timelines.
▪ Transparency - (MiFIR Arts 6 & 8) - Does any of your trading take place under a pre-trade transparency waiver? Do you use dark pools? Are you aware of the restrictions on such waivers being introduced by MiFIR (e.g. the double volume cap mechanism)? Will this restrict your ability to trade or limit the venues on which you trade? If you are a trading venue, does this limit your ability to provide an execution venue? Will you be seeking a new pre-trade transparency waiver as a result?
Does the firm intend to operate as an Organised Trading Facility? If yes, has the firm alerted the Central Bank of its intention? (MiFID II Article 20)
Will your firm meet the thresholds to be captured under the revised definition of a Systematic Internaliser? Bearing in mind that ESMA has clarified what is considered to be “frequent and systematic” and “substantial” through the introduction of OTC trading thresholds and that the scope for Systematic Internalisers has also been expanded from trading in equities to also include bonds, structured finance products and derivatives. (MiFIR Title III)
▪ Conduct
Has your firm considered the implications of the increased conduct requirements in respect of:
- Independent v non-independent advice
- Inducements - If you currently produce investment research, how are you going to be remunerated for this under MiFID II? Will clients be willing to pay for the research, in an unbundled way? How does this impact your business model?
- the Provision of Information to clients
- Product Governance and Distribution
- the higher standard for Best Execution
- New Suitability and Appropriateness requirements – firms will be required to provide suitability statements for investment advice clients and may be required to monitor ongoing suitability. Are you prepared for these changes?
- Client Categorisation
- Conflicts of Interest. The new Conflict of Interest requirements are more granular, and have specific requirements for some services. If you engage in placing/ underwriting, have you examined your business model in relation to the new requirements?
Central Bank Preparation
MiFID II represents a significant operational challenge not only for firms but also for the Central Bank. Following the publication of MiFID II and MiFIR in 2014 the Central Bank established an Implementation Project which draws on the experience and expertise of staff from across the organisation. Owing to the sheer scale of MIFID II we added two further projects – one dealing with changes to Transaction Reporting and the other focusing on new pre and post trade transparency rules.
To date Subject Matter Experts have reviewed both the primary legislative texts and all published Level 2 & 3 ESMA texts. This has comprised of some 148 Articles, 44 RTS/ITS, and several sets of guidelines, running to thousands of pages and many dedicated staff hours. The interpretation and decision making arising from this review was subject to constructive challenge and rigorous quality assurance which has informed our work plan for 2017 and beyond.
Staff training was identified, at an early stage, as a major priority for the Central Bank. Training was developed by the Subject Matter Experts in Q4 last year and is currently being rolled out to all staff working in the MiFID sphere. The training focuses on the changes MiFID II will bring and how this will impact the firms we supervise. The topics covered are extensive and will ensure our Supervisors are well versed in the new regime before it is implemented.
In conjunction with this training Supervisors are conducting a ‘heat-mapping’ exercise to set out specifically how the new rules will impact the business models of higher impact firms on an individual basis. We strongly encourage firms to undertake a similar exercise if they have not already done so. The Central Bank will continue to challenge firms on their preparedness in the lead up to implementation and supervisors will use these heat maps to focus on particular aspects of your business.
The new rules also bring with them significant operational challenges. To date we have initiated updates to our supervisory policies, procedures and systems with this work set to continue throughout 2017. In particular, we have held some 20 IT workshops with staff from 8 different divisions to define and develop (where necessary)/enhance our systems to accommodate the new rules. For example, something simple like adding an Organised Trading Facility on our Supervision system requires input for a range of different experts including Policy, IT and indeed Supervision itself. This process has now moved into the ‘development’ stage and we envisage that user testing will begin in the early summer.
A separate and altogether more complex IT project, dealing with the changes to the transaction reporting regime, is also ongoing. The Central Bank expects to take in significantly more than the 230 million transaction reports it currently receives once the new MiFIR regime comes into play. The number of data fields will also increase from 23 to 65 with a greater level of granularity required. Firms will need enhanced systems to generate and submit accurate transaction reports within the stipulated deadlines and in the prescribed XML format. The Central Bank expects that firms are well advanced in implementing their project plans at this stage and is aware that a number of approved reporting mechanisms (ARMs) as well as software vendors are offering potential alternatives to firms.
We are currently building and enhancing our systems to receive, validate and store greater volumes of transaction data and to exchange transaction reports with other Competent Authorities. Systems’ solution design, and timeframes, are currently being finalised and we will communicate with reporting firms very shortly in this regard. At this point, it is planned that industry testing will commence towards the end of Q3 this year. It is envisaged that the Central Bank solution will offer a machine-to-machine submission channel in addition to the existing Online Reporting (ONR) system. However, I should caution that this may not be available when MIFIR transaction reporting commences and you should factor into your plans the possibility that you may have to continue to report using ONR for a period.
A third project dealing with the transparency and broader market integrity requirements has commenced, including the Bank’s access to and use of order book data from trading venues. We are currently assessing the various options open to us in how we address the requirements. The decision on whether order book information will be gathered ‘on request’ or on a ‘consistent’ basis is key here and we are finalising our thoughts on that. However, firms and trading venues still have the obligations to maintain their records in such a manner to allow them provide this information to the Central Bank when requested.
While supervisors on the ground deal with these changes, our Markets Policy team is also actively engaged, on an ongoing basis, at EU level in relation to the negotiation and finalisation of various ESMA measures required pursuant to MiFID II. At this stage, it is hoped at EU level that the majority of the legal instruments comprising the MiFID II package will be finalised by Q1 of this year.
We are determined to make these new rules work in a way which supports the provision of financial services to consumers and investors whilst delivering on the Central Bank’s mission of ‘Safeguarding Stability, Protecting Consumers.’
Transposition
The Department of Finance has primary responsibility for handling the Transposition of MiFID II into Irish law with the Central Bank providing technical advice to assist the Department. While the original deadline for transposition of MiFID II was 3rd July 2016, the transposition date has now been extended to 3rd July of this year.
Our Markets Policy team is actively engaging with the Department in respect of its planning for the transposition of MiFID II and we understand that transposing Regulations are under preparation. The Department has set out publicly its general intended approach in relation to the transposition process in its Public Consultation paper on the Member State discretions of July 2016. The Central Bank is also assessing the potential impact of MiFID II transposition on its own rulebooks and guidance in collaboration with the Department. (E.g. Client Asset Regulations)
As Market Participants will be aware, the majority of the legal instruments that will form the MiFID II package will be in the format of EU Regulations and these will have direct effect in Ireland without the need for local transposition. The Central Bank is actively engaged in relevant ESMA Committees to ensure that assistance is provided by ESMA to industry participants in the form of Q & As, where required, to promote a common EU understanding and interpretation of relevant EU legal requirements under MiFID II. The Central Bank is communicating significant EU and domestic developments in relation to MiFID II to industry via its ‘Markets Update’ bulletin and interested parties can subscribe to receive this publication on the Central Bank’s website.
Industry Engagement
Effective communication is a critical element to ensuring trust and understanding between regulated firms and Competent Authorities. The Central Bank's Strategic Plan (2016-2018) has committed to develop and broaden the organisation’s communication channels; thereby enhancing its engagement with the public, regulated firms and relevant stakeholders.
While recognising the benefit of these industry events, they only complement proactive day to day engagement with your supervisory team. As we draw closer to 3 January 2018 MiFID II preparedness will become a standing agenda item for every engagement our supervisors will have with firms. This will give you the opportunity to update the Bank on your MiFID II implementation planning and how this is progressing.
To reiterate what I said at a similar industry event in September 2016 the Central Bank is prepared to get involved with working groups where there are areas of common concern among a group of firms, or where a common industry position may be developed. However, it is for you, the firms, to identify the areas you believe would benefit from such an approach and come together to put in place the working group. As always the Central Bank is happy to take part in these groups and, where necessary, communicate our view to firms on individual topics or points of interest.
We understand the industry’s appetite for more prescriptive guidance regarding new European legislation. As part the wider European regulatory system we will continue to encourage and engage with our European counterparts to increase and improve the level of guidance available to both industry and competent authorities as a fundamental means of ensuring supervisory convergence across member states.
Brexit
It would be remiss of me not to mention Central Bank activities following the United Kingdom’s referendum to leave the European Union. At the outset it is important to say that the Central Bank has carefully rebuilt its reputation over the last 6 years as a competent and capable regulator. We are clear on our regulatory standards and we are accountable at a European level for them.
Equally, it is important for the organisation to be pragmatic and responsive where possible. Since the referendum result, my staff are meeting a number of firms each week regarding potential authorisation applications. The commitment of the Central Bank is to facilitate engagement with entities prior to their application and to provide clear, transparent and consistent timelines for the processing of such applications. As has been stated publically by Governor Lane, locational decisions of financial firms within the euro area should not be driven by regulatory considerations. As such, the Central Bank will continue to process any application in an efficient manner while applying a rigorous assessment of the applicable regulatory standards.
Supervisory & Thematic Priorities
Looking briefly to our Supervisory and Thematic priorities for 2017, the Central Bank will undertake a number of thematic inspections relevant for the asset management industry. These will include:
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Supervisory staff conducting a Supervisory Review and Evaluation Process (or SREP) on the International Capital Adequacy Assessment Processes (ICAAPs) of low impact MiFID Investment Firms. This theme commenced in 2016 and will continue this year as it proved particularly effective for the supervision of a large population of entities.
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Compliance Function Review – Compliance is a key second line of defence to enable regulated firms manage risk. The focus of this theme will be on the general effectiveness of the compliance function, particularly the framework, outputs and resourcing of the function. When conducting these assessments, Central Bank staff will take particular account of ESMA’s guidelines in this area.
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Client Assets - A review will be undertaken examining how investment firms have implemented new governance and risk management requirements introduced by the Client Asset Regulations on 1 October 2015. The review will assess if the Client Asset Management Plan (CAMP) and the role of Head of Client Asset Oversight (CAMP) have been adequately embedded as part of the overall risk management framework of these firms.
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A review will also be undertaken looking at compliance with ESMA’s suitability (conduct) guidelines as well as firm preparedness for MiFID II. MiFID II will now place these guidelines on a statutory footing and also introduce additional elements in the suitability test (for example risk tolerance and capacity for loss). The focus of this theme will be on the information collection phase of the suitability process and assessing whether firms are seeking the correct information at the outset.
In addition to these activities, as has been publicly mentioned previously, the Securities and Markets Supervision (SMS) Directorate is considering conducting two thematic inspections specifically examining the funds sector in 2017. These themed reviews are currently being scoped however, the intention is that one of these reviews will focus on late filings of returns by regulated entities.
Going forward
To effectively tackle MiFID II, firms must structure their programme of work around the various changes outlined above and within the MiFID II legislation. This is a significant challenge given the differing sizes of the various players both in this jurisdiction and across the Union. Each firm will have its own specific challenges in terms of structure, technology and conflicting priorities.
Specifically, firms should think about how different courses of action are likely to impact their future ability to serve clients and achieve sustainable revenue in the post-MiFID II world. This is about much more than just compliance. The firms that are able to address these questions in an integrated manner will have the best chance of success in the future.