FIG Top 5 at 5 - 23/03/2023

1. Insurance Updates: Central Bank Insurance Quarterly Newsletter and EIOPA Supervisory Statement on unfair ‘price walking’ practices

Central Bank of Ireland - Insurance Quarterly Newsletter- March 2023

On 21 March 2023, the Central Bank of Ireland ("Central Bank") published the latest edition of its Insurance Quarterly Newsletter.

The Insurance Quarterly Newsletter includes news and insights relevant to the insurance sector and the Central Bank’s expectations and priorities around existing requirements and views on future developments.

Some key highlights from this edition include:

1. Pricing Discipline in General Insurance

The Central Bank highlights that the "changing environment with evolving claim trends, persistent inflationary pressures and shifting consumer behaviour with a challenging economic outline requires strong pricing discipline" and that, in pricing decisions, frameworks "must bring customers front of mind".

The Central Bank outlines some good practices observed in refining frameworks to "enhance pricing governance, reporting and oversight of emerging risks" in the following areas:

• General Board Oversight of Business Lines
• Dynamic Pricing Reporting
• Transparency of Current and Emerging Risks within Firms

Firms should review the details of these.

The Central Bank notes that the current Irish general insurance environment exposes firms to various emerging risks, some of which may mask or offset each other temporarily. Pricing frameworks should "transparently identify and highlight risks and trends, facilitating timely action and pricing discipline". 

2. Supervisory Priorities

On 31 January 2023, Insurance ERM published an interview with Domhnall Cullinan, Director of Insurance Supervision which covered a range of topics including Brexit, Solvency II, Climate Risk, Sustainability and Diversity. Below is a summary of the Central Bank's insurance supervision priorities across 2023, and on current risks facing the insurance sector.

• Individual Accountability – Mr Cullinan noted it will "have serious implications for insurers"…. "The intention is not that it will lead to any huge uptick in enforcement, but it may change the nature of it". (see below for detail on impact on insurers).

• Climate Change –
  • The Central Bank will be utilising the heat map for climate risk within insurers, developed in 2022, to focus its efforts on the firms in 2023 that the Central Bank views as having the highest climate exposure.
  • A natural catastrophe project this year will focus on whether NatCat modelling is adequate, whether it is properly modelled for Irish specific risks, and whether NatCat modelling takes climate risk into account.”

• Consumer Interest –
  • The Central Bank will build on the work undertaken in 2022 on value for money in unit-linked products to see if there are any outliers in terms of charging.
  • A thematic review will be undertaken on the EIOPA Supervisory Warning on Credit Protection Insurance.

• Operational Resilience – Operational resilience is one of the areas the Central Bank is concerned about in 2023. Mr Cullinan noted the importance of the Central Bank's cross-industry guidance on operational resilience (which will come into force in December 2023) and the Digital Operational Resilience Act.

• Inflation – Insurers need to be mindful of "the impact of inflation on costs, claims, operating expenses and allowances made for reserving in existing business."

• Market volatility – Market volatility remains a big issue. Mr Cullinan noted "You would have to question the market's ability to absorb further surprises in an already high-risk environment".

• Cyber Risk – Mr Cullinan noted his concern that “the Irish insurance industry doesn't find itself as (a) large provider of capacity in the international market…without appropriate pricing and adequate reserving and the right expertise to underwrite the risk.”

3. Central Bank Individual Accountability Framework (Act 2023) – Impact for the insurance sector

The Central Bank reminds firms of the 4 pillars of the Individual Accountability Framework ("IAF") and explains that it is essential that firms are "clear on roles and responsibilities in firms, particularly large and complex institutions where things can and do go wrong through systems error and individual conduct."

The Central Bank confirms that the IAF will apply to insurance undertakings.  The SEAR will apply to “in-scope firms” (i.e. all insurance undertakings including third country branches but excluding reinsurance undertakings, captives and SPVs)".

The Central Bank's consultation on the implementation of the IAF (covered in the Top 5 at 5 on 16 March 2023) also includes a proposal to introduce a new PCF-50 Head of Material Business Line Business for insurance undertakings. The Head of Material Business Line for insurance, is "an individual who has significant influence over the performance of a material line e.g. oversees the performance of that business line and the business line in question satisfies certain quantitative criteria". 

4. AXA Life Europe DAC – Key messages

On 8 December 2022, the Central Bank reprimanded and fined AXA Life Europe DAC €3,640,000 in respect of three breaches under the European Communities (Life Assurance) Framework Regulations 1994 (S.I. No. 360 of 1994) (1994 Framework Regulations), the Corporate Governance Requirements, and the Solvency II Commission Delegated Regulation (EU) 2015/35 (Solvency II Delegated Regulation).

The Central Bank highlights the following key messages from the enforcement action:

• It is important that firms identify, assess and manage the risks to which they are or might be exposed, to ensure that they can meet their commitments to consumers.
• Firms must also manage conflicts of interest appropriately and establish and apply robust mechanisms for doing so. 

5. Forthcoming Information Requests

• A questionnaire will issue to selected non-life (re)insurance undertakings, as part of an examination of how Nat/Cat risks are being modelled and managed, including how modelling is being adapted and revised to take climate change risks into account (as per the comments made in the Insurance ERM interview).
• Information requests may also be issued to firms within scope of planned thematic inspections, for example in relation to a ‘deep dive’ on operation resilience frameworks.
• In relation to consumer protection, requests for information will be issued in support of a planned assessment of firms Risk Management Frameworks and in relation to the Differential Pricing Regulations.

Key observations from the digitalisation survey launched in Q4 2022 will be published in early Q2 2023.

6. EIOPA Statement on Governance in Third Country Branches

In February 2023 EIOPA published a Supervisory Statement on the use of governance arrangements in third countries. The Central Bank notes that both EIOPA and the Central Bank "will closely monitor market developments regarding the use of third country governance arrangements following the publication of the Supervisory Statement".

7. Sustainable Insurance: CP151 – Guidance on Climate Change Risk

The Central Bank intends to publish the Feedback Statement to the consultation on Guidance for (Re)Insurance Undertakings on Climate Change Risk ("CP151") on 27 March 2023. The Central Bank will further engage with industry post-publication to support the understanding and implementation of the Guidance.

8. Planned Review of Firms’ Risk Management Frameworks

The Central Bank notes that while the absence of consumer-focused culture is a key cross-sector risk, it has seen instances in the insurance sector where "ineffective internal oversight and controls have resulted in decision making that has fallen below the standards and the consumer-centric approach expected by the Central Bank".

As a result, the Central Bank has decided to undertake a review to "assess the appropriateness of insurance firms’ risk management frameworks and in particular how they manage and mitigate the risks posed to consumers". The review will include:

• a desk-based review of certain firms’ processes and procedures, including control functions, consumer monitoring and reporting, risk identification and management;
• followed by on-site walkthroughs; and
• interviews to understand firms’ framework design and effectiveness".

This review will be conducted throughout 2023. The Central Bank will engage with in-scope firms in the coming weeks and months.

EIOPA supervisory statement on Differential Pricing Practices

On 16 March  2023, the European Insurance and Occupational Pensions Authority ("EIOPA")published a supervisory statement on differential pricing practices which clarifies EIOPA's supervisory expectations to pre-empt unfair differential pricing practices. In a press release, EIOPA notes that the statement underlines that:

• insurance providers falling under the scope of the Insurance Distribution Directive ("IDD") shall always act honestly, fairly and professionally in accordance with the best interests of their customers; and
• product oversight and governance processes should cover pricing techniques and ensure that these techniques do not adversely affect customers.

In view of the above, EIOPA states that insurance manufacturers "can continue to offer premium discounts to attract and retain customers, but they should have adequate governance and product oversight measures in place to ensure that customers are not treated unfairly".

The supervisory statement also identifies certain ‘price walking’ practices that do not comply with the relevant regulation and includes examples such as "repeated premium increases based on the customer’s low propensity to shop around or change provider because of price increases".

EIOPA noted its expectation that competent authorities "assess the adequacy and fairness of manufacturers’ product oversight and governance procedures, sales processes, marketing and communication materials as well as customer complaints related to differential pricing practices and to take appropriate action in line with national regulation".

2. “Review of the Consumer Protection Code: securing customers’ interests” - Remarks by Gerry Cross, Director of Financial Regulation – Policy & Risk at the Central Bank of Ireland

On 22 March, Gerry Cross, Director of Financial Regulation at the Central Bank of Ireland ("Central Bank") delivered a speech at an Insurance Ireland event in which he discussed the ongoing review of the Central Bank’s Consumer Protection Code (“CPC”).

Mr Cross opened by stressing the central role the CPC plays in ensuring that the financial system operates in a way that secures the best interests of the consumers and users of the products and services that it provides. He confirmed that "achieving this goal is at the heart of the Central Bank’s mandate."

The following is a brief note on the contents of his speech:

Mr Cross provided a brief history of the CPC and how it has evolved to address various circumstances over the years. He set out the reasons why the review of the CPC has been launched and confirmed that there is a strong coherence and mutual reinforcement between the new Individual Accountability Framework ("IAF") and the CPC.

Mr Cross then examined the concept of securing customers’ best interests which is detailed in the Discussion Paper of the CPC review. Securing of customers’ best interests has two critical components:

• effectively functioning markets providing choice and availability; and
• firms acting in their customers’ best interests

He explains that given its "fundamental importance", it is a key focus of the Central Bank's engagement, by developing and sharing a full understanding of the nature of the obligation or duty in the CPC.

• It is vital that customers’ interests are secured at all stages of their relationship with their financial service provider.
• While it is required that firms act in the best interests of their customers, it is also important for firms to seek to deliver a reasonable return for their shareholders based on a sustainable, resilient business model.

Mr Cross then posed the question - How should business model imperatives be aligned with customers’ interests? He answers this by saying that while competition is necessary to ensure customers have a range of services at their disposal, firms must place the best interests of their customers at the centre of their business model and their decisions.

He noted that despite first appearances, the two imperatives are not only consistent and coherent, they are also, when understood correctly, "mutually supporting and reinforcing" and outlined three aspects which display the relationship between the two.

9. Alignment of the business model with the interests of customers: "Transparently and effectively orienting commercial interests with customers’ best interests", meaning that:

• the business delivers on the reasonable expectations of customers;
• there is high quality transparency including on pricing related matters;
• the customer is meaningfully able to exercise choices to switch or exit;
• the customer is adequately supported through changes linked to financial services transformation including the move to digital distribution of products and services; and
• the business responds appropriately to customers’ frailties and patterns of behaviour.

10. Consumer-focus in firms’ ‘decision-making’:

Firms’ decision-making should always be aligned with securing the customer’s interests. Decision-making processes in a consumer focused culture include careful consideration of impacts on customers (including vulnerable consumers).

11. Responsibility of consumers to take appropriate steps to secure their own interests:

Subject to all of the obligations that are placed on financial firms to act in their best interests, consumers are still expected to make their own decisions.

Guidance on securing customers’ interests

As part of the CPC review. the Central Bank is planning to introduce guidance on securing customers’ interests. Some of the aspects that might be included in such guidance have been outlined in the Discussion Paper to the CPC review which Mr Cross reiterated.

With regard examples of the application of the obligation to secure customers interest, Mr Cross highlighted a number of recent examples including in the areas of:

• Differential pricing in the insurance sector: This practice showed that firms’ were not acting so as to secure their customers’ interests, in particular by taking advantage of consumer behaviours. The Central Bank introduced rules and guidance on this practice and is currently carrying out an analysis of how this is being implemented by firms. A report on this will be published in early 2024.

• Bank account migration: The Central Bank has engaged with the banks both individually and collectively on their obligation to secure customers’ and potential customers’ best interests (following the exit of KBC and Ulster Bank from the Irish market). The Central Bank notes that progress has been positive but it is important that "a strong focus on securing customers’ interests continues to govern this work".

• Banks' changes to retail service provision: There has been a trend in retail banking services, aligned with increased digitalisation, towards reduced physical presence through branch closures and the withdrawal of branch cash services. Mr Cross noted that it is clear that there is a requirement under the CPC that "firms take full account of the interests of their customers" and cited the Retail Banking Review which contains a detailed recommendation for CPC amendments concerning this issue. Mr Cross noted that the implementation of this recommendation will be addressed as part of the CPC review.
  

• Selling investment futures to retail investors: In considering risks of a product or service which is similar to others the firm provides, "firms should be using their understanding and experience of one product to better protect customers accessing similar products". Mr Cross gave the example of the Central Bank's restrictions on the sale of contracts for difference to retail investors in 2019 to address concerns about the risk to investors from these products. He highlights "firms should never be waiting for the Central Bank to intervene before they take the necessary steps to effectively protect their customers’ best interests".

In conclusion he noted that "significant transformation is taking place in financial services, impacting consumers" and in reviewing the CPC the Central Bank is "focused on driving better outcomes for consumers by ensuring that firms have a consumer focus as they evolve their business models and processes through digital transformation".

3. Central Bank of Ireland Innovation Hub Report

On 21 March 2023, the Central Bank of Ireland ("Central Bank") published the 2022 Innovation Hub Report ("Report"). The report provides an overview of the Innovation Hub in 2022 and data on the trends observed in the Innovation Hub over the past five years.

Five Years of the Innovation Hub

The following is a brief overview of the trends observed by the Central Bank in the Innovation hub over the past five years:

• Since 2018 the Innovation Hub has met, and facilitated engagements with 319 innovators, fintechs, innovation facilitators, regulated entities, and thought leaders.
• Feedback from those engaging with the Innovation Hub has been largely positive. Firms appreciate having a dedicated point of contact, where they can engage with regulators outside of the formal regulatory processes.
• The Innovation Hub has helped the Central Bank to monitor growth in the fintech sector, develop its knowledge around innovation and to understand the challenges and risks therein.

Overview of the Innovation Hub in 2022

In 2022:

• a diverse range of enquiries were made to the Innovation Hub from innovators, including firms engaged in payment activities, crypto services and Regtech solutions.
• The Innovation Hub engaged with 56 firms who innovate in financial services, with an increasing number of firms having more than one engagement with the Innovation Hub.
• There was an increase in the number of regulated firms engaging with the Innovation Hub, 29% of enquiries as compared to 20% in 2021.
• There was a proportional increase in medium and larger sized firms engaging with the Innovation Hub but the majority were small and micro sized enterprises.
• 40% of enquiries were from entities seeking to have initial discussions about the process to be authorised or registered predominately regarding MiFID, payment institution, e-money institution or crowdfunding authorisations or VASP registration.
• The Central Bank has found that early engagement by firms can assist the smooth and timely operation of the authorisation/registration process.
• The number of payment related enquiries remained steady at 31%. Notably, the engagement in the payments sector was not always authorisation related, some were more broad discussions on the topic of payments. Many of these enquiries came from firms who had previously engaged with the Innovation Hub.
• 33% of enquiries were from firms within the DLT/Blockchain, crypto or digital asset sector. There was an increase in the number of enquiries from large, established crypto asset service providers. While many queries focused on VASP registration, some firms were also considering other authorisations including e-money, and MiFID authorisations.
• 14% of enquiries came from Regtech firms, with the majority of enquiries related to AML/CFT solutions or fraud prevention tools. Many of the Regtech solutions demonstrated implemented A.I. or machine learning techniques into their solutions.

Review of the Innovation Hub

As part of the continuing review of the Innovation Hub, the Central Bank will issue a public consultation in 2023 on proposed enhancements, with any changes to be implemented over the course of the current strategic cycle 2022 to 2026.

4. European Authorities, Irish Government and Central Bank responses to the banking turmoil in the US and Switzerland

The recent banking turmoil in the US and Switzerland has shone a light on the global banking sector in a serous way for the first time since the financial crisis of 2008. The response of the European Central Bank ("ECB") and additionally the joint response of the ECB, European Banking Authority ("EBA"), and the Single Resolution Board ("SRB") to various aspects is worth noting.

European Bank exposure to Credit Suisse and Silicon Valley Bank

As regard direct exposure to Credit Suisse, ECB President Lagarde has confirmed that the balance sheets of European banks show minimal holdings in Credit Suisse ("We're not talking billions. We're talking millions here"), which has stemmed fears of any immediate impact. It is understood now that in light of this, the ECB is inquiring as to indirect exposures which European banks may have, such as risks from their trading clients losing money on the AT1 Bonds. Regardless of the outcome of these inquiries, it is not expected to be of a material nature.  Additionally, Paschal Donohoe, the head the Eurozone finance ministers, has confirmed that Europe has “no direct exposure” to Silicon Valley Bank ("SVB").

Resilience of European Banks

Since the financial crisis in 2008, significant regulatory changes have been adopted to strengthen European banks. One such change has been the adoption of safeguards to ensure the diversification of European banks. Consequently, the situation that arose in the likes of SVB or Signature Bank around over exposure to government bonds is not likely to be a systemic issue in European banks.  And although problems in SVB, Signature Bank or indeed Credit Suisse were not a question of capital, much of the regulatory changes in the EU made in recent years focused on making European banks more robust through the implementation of very stringent capital requirements. The resilience of European banks was a key message delivered by ECB President Lagarde in the wake of the CS takeover, confirming that European banks are well capitalised, have access to liquidity and have very strong balance sheets. Additionally, she confirmed that the EU “stands ready” to provide any supports required to protect financial stability, should such steps be necessary.

Praise for Regulators

The decisive response by both US and Swiss regulators has also played a significant role in curtailing the situation. ECB President Lagarde said in a statement on Sunday evening that she welcomed "the swift action and the decisions taken by the Swiss authorities. They are instrumental for restoring orderly market conditions and ensuring financial stability".

Treatment of Additional Tier 1 Bonds

While the circumstances underpinning the takeover of Credit Suisse by UBS are of particular concern to the global banking market, further concern has been caused by the decision, as part of that takeover, to write down to zero, Credit Suisse's additional tier 1 bonds ("AT 1 Bonds") which had a value of circa Swiss Franc 17 billion. This was done in a situation where Credit Suisse shareholders received approximately Swiss Francs 3 billion. This decision has sent shock waves throughout the sector. While it is widely acknowledged that AT1 Bonds were created to absorb losses in certain circumstances, there does not appear to have been losses here. However, as more details of the takeover came to light, it appears that provisions were included in the founding AT1 Bond documentation that allowed the Swiss regulator, under certain circumstances (which occurred here), to request such a write down.

This development challenges the established bank creditor hierarchy. In a situation where recovery is possible for shareholders, a greater recovery would be expected for those investors in AT1 Bonds. Conscious of the growing concern among bondholders that this hierarchy is no longer accepted and that similar actions could be taken in Europe, the EBA, the ECB and the SRB collectively released a statement on Monday 20 March 2023 confirming this hierarchy.  The statement explains that “In particular, common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier 1 be required to be written down. This approach has been consistently applied in past cases and will continue to guide the actions of the SRB and ECB banking supervision in crisis interventions.”

This statement, and similar statements made by the Bank of England, seem to have provided the comfort which the markets required. As Dominique Laboureix (chair of the SRB) said, fears that AT1 Bonds are  “not investable anymore” should not apply in the European Union.

Irish response

The Minister for Finance, Michael McGrath, released a statement on Monday 20 March 2023 reassuring the Irish public that the Irish banks are well capitalised. He also confirmed the creation of a subgroup of the Financial Stability Group to monitor the current situation and any implications for Ireland.

On 22 March 2023, Gerry Cross, Director of Financial Regulation at the Central Bank of Ireland ("Central Bank") delivered a speech in which he stated that these developments "remind us of the uncertainties and challenges we face". He confirmed that the Central Bank is working closely with domestic stakeholders and with their colleagues at a European level to assess the risks and what he describes as a "rapidly evolving situation". He went on to reiterate the comments made by ECB President Lagarde regarding the resilience of euro area banking sector. He confirmed that the same applies in Ireland.

5. ECJ ruling on the meaning of the provision of "information relating to the payee" under PSD 1

On 16 March, the Court of Justice of the EU ("ECJ") gave a preliminary ruling relating to a query posed to it by a Belgian court, concerning the interpretation of Article 47(1)(a) of the Payment Services Directive (2007/64/EC) ("PSD 1"). The case is referred to as ZG v Beobank SA (Case C-351/21)

Briefly, Article 47(1)(a) of PSD 1 provides that once a payment transaction made by a payer is debited from their account, the payment service provider must provide the payer with "a reference enabling the payer to identify each payment transaction and, where appropriate, information relating to the payee".

The query posed to the ECJ was 

• whether under Article 38(a) of PSD 1, the payer’s payment service provider is under a best endeavours obligation or an obligation of result regarding the provision of “information relating to the payee”; and
• whether the “information relating to the payee”, a term defined in Article 47(1) includes information from which the natural or legal person that received the payment can be identified?

The ECJ clarified that "in order to give a useful answer to the referring court, those questions must be understood as relating to the interpretation of Article 47(1)(a) of Directive 2007/64 and not to the interpretation of Article 38(a) of that directive."

The ECJ concluded that Article 47(1)(a) must be interpreted as meaning that a payer’s payment service provider is required to provide that payer, with information enabling the natural or legal person who benefited from a payment transaction debited from that payer’s account, to be identified and not only the information which that provider, after making its best efforts, has available with regard to that payment transaction.

While, PSD 1 was replaced by Payment Services Directive ((EU) 2015/2366) ("PSD 2"), a similar provision to Article 47(1)(a) is contained in Article 57(1)(a) of PSD2