1. Central Bank of Ireland: Securities Markets Risk Outlook Report for 2023
On 2 March 2023, the Central Bank of Ireland ("Central Bank") published its Securities Markets Risk Outlook Report for 2023 ("Report").
The Report outlines the key risks and areas of focus for markets supervision and sets out the Central Bank's expectations of what regulated financial service providers ("RFSPs") and market participants should do to effectively identify, mitigate and manage those risks.
Patricia Dunne, Director of Securities and Markets Supervision at the Central Bank, emphasised that "it is essential that regulated firms and market participants recognise and respond to (…) new market conditions and adapt their risk management and compliance frameworks in order to protect investors and promote orderly markets".
At a high level, the Central Bank's expectations include:
- External Risk Environment: Market participants are expected to be cognisant of rapidly changing market dynamics and ensure appropriate stress testing is in place to ensure the smooth functioning of their operations.
- Sustainable Investing: To safeguard the flow of investment capital toward sustainable activities, market participants must ensure that investment products classified as green or sustainable meet such criteria.
- Market Integrity: To protect the integrity of and trust in Irish securities markets, market participants must have robust frameworks and control environments to comply with the provisions of the Market Abuse Regulations.
- Market Conduct Risk Management: Market participants must have processes in place to identify, mitigate and manage the conduct risks inherent in their business.
- Delegation and Outsourcing: The utilisation of delegated and/or outsourced services must be accompanied by appropriate levels of governance and oversight.
- Cybersecurity: To meet heightened cybersecurity risks, market participants must ensure they have adequate governance structures and tools in place to deal with those risks.
- Data Quality: As data becomes increasingly important, market participants should ensure that sufficient attention and resources are deployed to data quality initiatives.
- Digital Innovation: Market participants must take steps to ensure that their risk frameworks incorporate risks arising from the implementation of new technologies.
For a more detailed consideration of the Report, please see our recent Insight available here
2. Central Bank of Ireland- Dear CEO letter on MiFID Structured Retail Product Review
On 3 March 2023, the Central Bank of Ireland ("Central Bank") published a Dear CEO letter containing supervisory guidance on the MiFID Structured Retail Product Review (the "2023 Letter"). The 2023 letter is a follow-up to the Central Bank's ‘Dear CEO’ letter on Structured Retail Products ("SRPs") ("2022 Letter") published in April 2022 following a series of targeted reviews of SRPs. The 2023 Letter is relevant to firms who currently (or plan to) manufacture or distribute SRPs and/or produce marketing material for SRPs.
The 2023 Letter notes that the Central Bank is publishing this further supervisory guidance to supplement the 2022 Letter and to "provide clarification to firms on complying with the relevant MiFID II investor protection requirements and meeting the expectations set out in the SRP Letter". These clarifications and expectations are based on the Central Bank's engagement with firms and its observation of marketing practices since the issuance of the 2022 Letter.
The 2023 Letter takes a Q&A format which specifically addresses how firms should interpret the expectations set out in two aspects of the 2022 Letter including (1) Decrement Index and (2) Presentation of back-testing.
Decrement Index
Question: How should firms interpret the following expectations set out in the 2022 Letter in relation to the disclosure of the use of a Decrement Index and the associated impact and risks?
- Where firms conclude, following appropriate governance and robust challenge, that the use of a decrement index is appropriate and justified, a specific warning should be included in a prominent position in the marketing communications to inform investors of the potential negative impact on their return.
- The product documentation should fully explain the feature, how it works, and how it will impact upon the client’s potential return in different scenarios, including under stressed conditions.
Answer: The Central Bank notes that in marketing material for SRPs that use a decrement index, firms should:
- include a prominent warning on the front cover of the marketing material and on the page on which the decrement index is described in further detail. This should be early in the marketing material or brochure and in a prominent location. Warnings should also be in a separate text box for visibility (the Central Bank includes examples of such warnings in the 2023 Letter).
- In cases where the fixed dividend deduction of [%] / [fixed point value] is higher than the actual dividends paid, firms should, use one or more example scenarios to illustrate how this can cause a ‘drag’ on performance in a stable market. These scenarios should illustrate the cumulative effect of this drag on performance over the lifecycle of the product. The scenarios should be based on the most recently available data.
- In cases where the SRP uses a fixed dividend deduction in the form of a fixed point value (as opposed to a %), also be cognisant that this drag on performance will be accelerated where the index falls below its initial level and a sustained fall in markets will accelerate the decline in the value of the index. This should be clearly reflected in the firm’s example scenario illustrations.
Presentation of back-testing
Question: How should firms interpret the following expectations set out in the 2022 Letter in relation to the presentation of back-testing information?
- The Central Bank considers that where firms are using past performance representations that only capture periods of positive client outcomes, this may not reflect the true likelihood of future capital loss for clients. As such, firms should consider how it is appropriate and in the best interests of clients to present past performance in this manner going forward.
- The Central Bank expects firms to ensure that the presentation of historical data is not misleading, particularly where it uses overlapping periods with a large number of simulations in only positive market conditions, as there is a heightened risk of creating an unrealistic or unfair perception of the risk of capital loss.
- The Central Bank expects that the risk of capital loss must not in any way be diminished, downplayed or masked by the firm’s presentation of past performance information.
- Firms are expected to ensure that all information presented is balanced, accompanied by prominent and clear warnings, and consistent with the risk profile of the product.
Answer: In ‘capital at risk’ SRPs where the return of investor’s capital is dependent upon market performance, the presentation of large numbers of overlapping back-testing simulations, presenting overwhelmingly positive outcomes and illustrating minimal instances of capital loss, has the potential to be misleading for investors.
Firms may continue to illustrate the performance of the underlying asset over an appropriate period. However, where the selected period predominantly displays positive performance and shows little or no cases of capital loss, firms should avoid presenting a large number of overlapping simulations.
3. Central Bank of Ireland - New Fitness & Probity Application Process
On 7 March 2023, the Central Bank of Ireland ("Central Bank") announced changes to the Fitness & Probity ("F&P") application process. The changes will go live on 24 April 2023.
The Central Bank is updating the Central Bank Portal to facilitate the submission of Pre-Approval Controlled Function ("PCF") applications.
Individual Questionnaires ("IQs") will no longer be submitted via the Central Bank's Online Reporting System ("ONR"), but will instead be submitted via the Central Bank Portal.
The Central Bank has published a document which provides detailed information on the changes and outlines the key dates for firms to be aware of, such as the transition process from ONR to the new portal and the new process for submitting a PCF Application.
New IQ
The Central Bank has advised that a new IQ has been developed and must be used for PCF applications submitted from 24 April 2023. This will be published, together with new guidance on the process, on 30 March 2023.
The principal changes to the IQ are:
Section 1.A – Proposer Preliminary Questions: Will the applicant be performing the PCF role(s) in an outsourced capacity?
Section 1.B – Applicant Preliminary Questions: Does the applicant currently work for the proposing entity or an entity related to it?
Section 2- Personal details: Information from F&P Profile will be displayed.
Section 3 – Experience / Qualifications / Training / Memberships: Applicant to outline how s/he: is competent to perform role, has a good knowledge of the business of firm and has a good knowledge of the regulatory environment.
Section 5 – Reputation and Character: Applicant to explain circumstances of any disclosures, in addition to uploading relevant documentation. There is also a new question regarding remuneration clawbacks for alleged wrongdoing.
Section 6 – Central Bank Approvals: PCF Information on Central Bank system will be pre populated to the IQ.
Section 10 – Applicant Declaration:
- Revisions to Employer Reference questions;
- Explain how the role can be performed if it not proposed to be full time role; and
- Confirmation that the applicant was not performing role prior to approval.
Section 11 – Proposer Declaration:
- Is the appointment in line with internal targets on diversity?
- How has the firm satisfied itself that the applicant can perform role, if not full-time?
- How has the firm satisfied itself that there are no conflicts of interest?
- State the reasons why the matter disclosed in section 5 are not considered to affect the applicant’s suitability to perform the role.
Immediate actions for firms
The Central Bank notes that proposers, points of contact and applicants that have not yet registered as a Portal User should now register on the Central Bank Portal and link their Portal Profile to any existing ONR profiles they have. The Central Bank has provided guidance on the process to assist firms.
4. Insurers' input sought on digital innovation
Against the background of the influence of digital innovation on a rapidly changing insurance market, the European Insurance and Occupational Pensions Authority ("EIOPA") on 7 March, launched a digitalisation market monitoring survey. EIOPA has indicated that the survey is needed to ensure it keeps pace "with these fast-moving developments and make sure that the regulatory and supervisory frameworks reflect the opportunities and risks that come with digitalisation".
The survey:
The survey seeks details on:
- new business models such as digital distribution and communication channels as well as insurers’ partnerships with start-ups and big techs; and
- the extent of the use of new technologies such as blockchain and artificial intelligence and the governance measures being put in place in response to these.
Next Steps
The survey will be distributed to insurers through relevant national competent authorities.
The outcomes of the survey will assist EIOPA in detecting emerging risks for insurers and consumers and will inform its supervisory response in order to support insurers in "harnessing the benefits of financial innovation", while also protecting consumers' interests.
5. European Updates for Credit Institutions and Investment Firms
1. EBA Report on diversity practices and the gender pay gap – actions for impacted firms
This week, the European Banking Authority ("EBA") released its report on the benchmarking of diversity practices and gender pay gap ("Report") in accordance with requirements set out under Directive 2013/36/EU ("CRD IV") and Directive 2019/2034/EU ("IFD").
The Report is based on the data collated from a sample of 662 credit institutions and 129 investment firms, reflective of their positions as at 31 December 2021.
Highlights from the Report
The EBA in its supporting press release highlights the following statistics from the Report:
- 27.75% of non-executive directorships are held by women;
- only 18.05% of executive directors are female;
- gender balance in Northern and Eastern Europe is generally better than in other parts of the EU;
- 27.05% of institutions still lack the mandatory diversity policy;
- a clear positive correlation between gender balance and Return on Equity exists; and
- women earn on average 9.48% less than male executive directors and 5.90% less than male non-executive directors.
Regarding the statistics relevant to Ireland specifically, these can be viewed through the interactive document found here.
Actions for Credit Institutions and Investment Firms
Arising from these outcomes, the EBA makes a number of comments:
- further improvements of the gender balance and, more in general, of the diversity at institutions management bodies, are needed;
- all institutions must adopt a diversity policy;
- many institutions need to improve the gender diversity of their boards in the short to medium term, including through the setting of appropriate gender balance targets; and
- other aspects of diversity, e.g. regarding the educational or professional background, could be further improved in particular in larger boards.
Other points to note
The EBA also notes that competent authorities must review institutions’ diversity policies and their implementation and take appropriate measures where shortcomings are identified. Consequently, impacted firms need to respond to the actions detailed in the Report so they are in a position to demonstrate compliance, when queried by the Central Bank of Ireland.
2. Changes in train to MiFID II and MiFIR
A significant milestone was reached this week as Members of the European Parliament voted for changes to the Markets in Financial Instruments Directive ("MiFID II") and the Markets in Financial Instruments Regulation ("MiFIR"). The Economic and Monetary Affairs Committee ("ECON") agreed that updated harmonised rules to enhance market date transparency, optimise the trading obligations and prohibit receiving payments for forwarding client orders are necessary.
The following is a summary of some of the proposed changes:
- Introduction of an EU-wide consolidated tape - an electronic system which combines sales volume and price data from different exchanges and consolidates these into a continuous live feed, providing a single reference price for each asset class (shares, exchange traded funds, bonds and derivatives) across markets;
- trading venues (except smaller markets and SME growth markets) would have to provide pre- and post-trade information to a consolidated tape provider as close to real time as it is technically possible. This information should also be publicly available for a price based on a cost of producing the data and a reasonable margin;
- retail investors, academics and civil society organisations using the data for research purposes should have access to the consolidated tape free of charge;
- establish a single volume cap that limits the amount of dark trading in an equity instrument in the European Union ("EU") to 7% of total trading in that instrument;
- modify the deferral times applicable to the publication of the details of transactions in bonds, structured products, emission allowances and derivatives;
- give the European Securities and Markets Authority ("ESMA") the power to set the threshold and limits applicable to market transparency and to oversee market developments, intervening when the price formation process is threatened or the international competitiveness of EU markets is hindered;
- prohibit the receipt of payments for forwarding client orders for execution;
- member states to require regulated markets to be able to temporarily halt or constrain trading in emergencies or if there is a significant price movement in a financial instrument and, in exceptional cases, to be able to cancel, vary or correct any transaction.
ECON's report on the proposed changes to MiFID II can be found here, however, at the time of writing, its' report on the proposed changes to MiFIR was not available.
Inter-institutional negotiations will now commence.