FIG Top 5 at 5
The Top 5 at 5 is a weekly update in which members of the Financial Institutions Group (FIG) identify five of the key legal and regulatory developments relevant to the financial services industry from the preceding week. Priority is given, in the first instance, to Irish based developments but the update will also include important developments in European law and regulation.
The topics chosen are dictated by the developments during the relevant period but priority is given to cross sectoral developments. The FIG Top 5 at 5 is not intended to represent all developments of note for the relevant period but rather a snap shot of some of the issues which we feel are of particular importance.
Should you have any queries in respect of the contents of the update, please do not hesitate to contact your usual Matheson LLP contact or any member of our team detailed below.
Some of the key points are outlined below:
SEAR will not apply to (I)NEDs until 1 July 2025 (though they must still be included in the Management Responsibilities Map);
- SEAR will only apply to managers of outgoing branches where a materiality threshold is exceeded. The Pre-Approval Controlled Functions (“PCF”) Regulations will be amended and guidance on the practical operation of this will be made available in the coming weeks;
- some Prescribed Responsibilities have been removed, merged, moved or amended;
- sharing of PCF roles will only be permitted in specified limited circumstances, on the basis of a case-by-case assessment;
- a new Material Business Line PCF will be introduced for insurance undertakings and investment firms, applicable to an individual with significant influence over the performance of a material business line that satisfies the certain quantitative criteria;
- the initial proposal to extend enhanced due diligence checks to CF-3 to CF-11 roles has been removed;
- self-certification is permitted by CF-3 to CF-11 roles in respect of Minimum Competency Code, Regulatory and Bankruptcy / Judgement searches;
- the first annual submission (of confirmation of the completion of the certification process for each PCF role holder, and of confirmation of the completion of the overall certification process in respect of all CFs) will relate to the 2024 calendar year and will be required in 2025;
- there is no longer an obligation to report to the Central Bank any formal disciplinary actions for breach of the Conduct Standards.
- for holding companies brought within the scope of the F&P regime, the Central Bank will provide detailed operational guidance for those persons already performing the new roles at implementation, which will include a combination of an automated process and a consolidated in-situ process, so that those persons do not have to submit an Individual Questionnaire;
- a Temporary Officer is not subject to SEAR, but will be subject to Additional Conduct Standards if they are a CF-1, which is the Central Bank’s expectation;
- where there is outsourcing of a PCF role, the role-holder should fall under the oversight of a PCF role holder within the entity (which is to be reflected in the relevant Statement of Responsibilities and the Management Responsibilities Map).
For a more indepth analysis, please see Matheson Insight: Central Bank of Ireland Regulations and Guidance on the Individual Accountability Framework.
Climate Observatory Report
On 20 November 2023, the Central Bank of Ireland ("Central Bank") published its Climate Observatory report ("Report"). The Report outlined the impact that climate change risks could have on the financial system, and highlighted that these risks will be unevenly distributed across sectors. The financial sector will be affected due to future credit, insurance and investment decisions. The banking sector will likely be affected by potential changes in borrower's ability to repay as well as changes in collateral values. The insurance sector will potentially see unexpected increases in household/business climate related claims which may increase profit volatility or future pricing and coverage decisions. For investments sector, any sudden changes in government policy could result in a carbon-aligned repricing of assets.
The Report also noted that while there is uncertainty in terms of the timing and magnitude of climate risks, it is clear that the reduction in climate related damages post-2050 will considerably outweigh the costs of reaching net zero pre-2050. In order to transition to net zero, it is clear that unprecedented amounts of financing will be required and therefore the financial sector has a significant role to play. This update will outline the data that is relevant to financial services.
Deputy Governor gives remarks at Climate Finance Week
On 21 November 2023, the Deputy Governor, Sharon Donnery gave a speech entitled 'Walking the path- the transition to Net-Zero'. In this speech, Deputy Governor Donnery gave remarks on the climate change risk landscape and the importance of financing the transition to net zero. She stressed that the transition will not be easy and that it will require real action, complex trade-offs and a significant economic shift.
Having regard to the Central Bank's recent Climate Observatory Report, she highlighted that while the CO2 intensity of the direct holdings of debt securities and listed shares of the Irish banking industry and our investment funds sector are around the average in the Euro Area, the Irish financial services sector is among the highest in the euro area in terms of corporate exposures at risk of flooding; with almost 35% of exposures located in areas prone to river flooding.
Climate and environmental risks have been a supervisory priority for the Central Bank for many years, and it expects firms to identify and effectively manage the risks that they are exposed to, particularly physical climate risks and transition risks. In the banking sector, the European Central Bank have published guidance on supervisory expectations for risk management, with interim targets to be met in March 2023 and full compliance by the end of 2024. However, the Deputy Governor noted that many banks had not yet made the interim deadline. She stressed that supervisors would not idly stand by and accept this, and the Central Bank have issued binding supervisory decisions to those banks, which include potential periodic penalty payments for failure to meet requirements. The Deputy Governor noted that it is not the role of supervisors to tell banks who they can and cannot lend to, but sound risk management requires all firms to manage climate and environmental risks.
In the insurance sector, the European Insurance and Occupational Pensions Authority developed guidance for (re)insurers on supervisory expectations on how to address climate change risk in their business, and help to develop their entities' governance and risk management frameworks.
She also noted that the Central Bank will write to credit unions over the coming weeks to set supervisory expectations in that sector.
On 16 November 2023, the Chair of the European Securities and Markets Authority ("ESMA"), Verena Ross, gave a speech titled 'Innovation with protection: the next steps on the MiCA journey'. Ms Ross stated that while MiCA will be an important step in reducing the risks to investors, it will not remove all potential consumer harm. In order to protect consumers, it is vital that strong level 2 measures are developed, and that there is a 'stringent and pro-active approach to supervision and enforcement'.
Robust technical standards in the second MiCA consultation paper
Ms Ross reiterated that a consultation paper on the second package of draft Technical Standards will close to comments in mid-December. The purpose of these technical standards is to ensure that investors are informed of the offerings and of the inherent risks associated with crypto-assets as currently there are no requirements applicable to the information that crypto-assets issuers publish.
Technical standards will ensure a common format is used when providing information which will prevent clever marketing slogans being used to disguise potential risks and prevent investors from making well informed investment decisions. Standardised white papers will also enable better cross-jurisdictional analysis of global crypto-assets markets. Ms Ross noted that this will be enhanced by machine readability which will enable piles of information to be converted into a source of supervisory intelligence. The consultation paper also provided for harmonised disclosures relating to climate and sustainability which will help investors to compare how different crypto-assets impact the environment.
One of the key objectives of MiCA in protecting investors, is to consider the resilience and continuity of crypto-asset services. The proposed standards aim to address the novel operational risks arising from distributed ledgers, particularly permissionless distributed ledgers as these may fall outside the scope of MiCA and DORA. Ms Ross noted that there was a significant 'lock-in' risk associated with these ledgers, and when disruption occurs, clients may not be able to access their chain-assets for hours or days. To combat this, ESMA proposes that crypto-asset service providers ("CASPs") must take extra precautions when dealing with these ledgers in their business continuity measures.
The obligation to publish inside information acts as an important deterrent against market abuse in financial markets. Ms Ross noted that ESMA expects that the disclosed information should be disseminated in the media where the public is most likely to see it to prevent certain participants from benefitting from unfair information advantages. She also noted that most retail investors rely on social media for crypto information and ESMA offers the option for crypto-asset issuers to choose social media and other web based platforms as a method to disseminate inside information, but that this information should also be available on the issuer's website. Ms Ross also emphasised that it is vital to ensure that ESMA's supervisory capabilities do not stop at EU borders and they have requested that CASPs and trading platforms keep additional information where third country entities are involved in the transaction.
In addition, trade transparency obligations applicable to trading platforms for crypto-assets are also an important element. Ms Ross noted that ESMA has gone further than MiFIR in its proposal by including a list of pre-trade fields to be published for each order, which seeks to harmonise the content and formatted for all crypto-trading platforms. The codification of this data will simplify the process of understanding and comparison for investors and supervisors. ESMA is also consulting on targeted exemptions from pre-trade transparency for stop orders and for reserve orders which offer investor protection.
Recent actions for stringent and pro-active supervisory convergence
Ms Ross also referred to the letter which ESMA published last month which outlined ESMA's expectations for both the industry and competent authorities during the transition stage. She reiterated that ESMA's aim is to develop robust supervisory convergence before MiCA is applicable to ensure effective and uniform application of the rules, which would discourage 'forum shopping'. In order to avoid 'regulatory arbitrage' ESMA is seeking to align supervisory practices in regard to authorisation procedures before MiCA applies. It aims to achieve this by capitalising on the lessons learned from national competent authorities with existing national legislation for crypto-assets, such as Malta, as part of its Finance Standing Committee ("Committee") mandate. This Committee will also act as a forum for supervisors to share information about authorisation requests, particularly from crypto firms operating in more than one Member State, as large crypto firms have agile operational structures which mean they may engage in forum shopping, representing an elevated regulatory risk.
ESMA's approach is forward looking and involves several mapping exercises in cooperation with the European Banking Authority to understand both the scale of the market and how each Member State is approaching the MiCA transition. This approach enables ESMA to anticipate the volume of expected authorisation requests. Ms Ross commented that this approach will enable ESMA to improve the supervision of CASPs as well as other aspects of MiCA such as enforcement.
Preparing for MiCA implementation
Ms Ross summarised the message behind the recent ESMA letter and supervisory statement as 'time to batten down the hatches'. She noted that ESMA's work on technical standards and supervisory convergence cannot be put into practice until Member States designate and empower competent authorities. For this reason, ESMA encouraged Member States to ensure this was completed by the end of 2023, rather than the date of June 2024 set out in legislation.
The letter also focused on the risks of disorderly transition. ESMA acknowledged that any new regulatory framework requires time for the rules to socialise in the market and for competent authorities to prepare, and therefore a grandfathering clause of 18 months was introduced. ESMA expressed concerns that this period is too long and will lead to extended periods of fragmentation of regulatory regimes and calls on Member States to limit the transition period to 12 months. By reducing the transitional period to 12 months, it will minimise the timeframe where there would be a 'patchwork of different laws' in existence across Member States. This will create a more level playing field and limit harm to investors, and will also set a clear deadline for the industry to align their business practices to comply with MiCA.
Ms Ross noted that regulatory certainty will help the development of sound innovative technologies, and passporting rights have been cited as a positive feature of regulation. This practice introduces an expectation that an EU-based crypto-asset provider would not rely extensively on non-EU entities for the performance of services for EU based clients. Ms Ross emphasised that while crypto may be seen as borderless from a technological point of view, it is not borderless from a legal perspective. She also noted that come large crypto firms had made such a 'borderless philosophy part of their modus operandi' and provide global services without a formal operational presence in any single jurisdiction.
Ms Ross stressed that this setup was strongly discouraged by ESMA, who favour a firm presence and commitment to the EU regulatory framework. ESMA will also seek to limit the scope of the 'reverse solicitation' clause to genuine exceptional cases. She sends a clear warning that 'breaches of the reverse solicitation clause will be met with stringent enforcement by ESMA and the competent authorities', to protect firms who are compliant with MiCA from unfair competition and protect investors from unknowingly using unregulated firms.
On 22 September 2022, the General Board of the European Systematic Risk Board ("ESRB") issued a general warning on vulnerabilities in the EU financial system, where it identified risks to financial stability as:
- deterioration of the macroeconomic outlook;
- risks stemming from a possible sharp asset price correction; and
- the implications of such developments for asset quality.
It called for both macro-prudential and micro-prudential authorities to preserve resilience and support the real economy if and when financial stability risks materialise.
On 16 November 2023, the President of the European Central Bank ("ECB") and Chair of ESRB, Christine Lagarde gave a speech entitled 'The ESRB's first general warning one year on'. Ms Lagarde referred to the general warning as 'a clear call to action', and in her speech, addressed whether these risks had materialised and what impact the warning had on increasing the financial system's resilience.
Materialisation of Risks
Ms Lagarde recalled the extreme uncertainty that was at play when the ESRB issued their general warning, due to the Russian invasion of Ukraine, energy shortages, rising interest rates and market volatility. However, concerns regarding risks materialising simultaneously, and amplifying the impact of each other did not come to pass, while some risks have partially materialised.
The general warning raised concerns over debt servicing capacity, and high inflation has significantly impacted households' real disposable income, despite high employment. The general warning also raised concerns about asset prices which has also partially materialised as seen in the banking events in the US, the gilt crisis in the UK and price fluctuations in US Treasury bonds.
Others have not transpired. EU banks are at the highest level of profitability in a decade, non-performing loans ("NPLs") are low, and residential real estate markets have slowed in an orderly manner. Ms Lagarde, however, warns against complacency and cautions that actions must be taken to ensure these risks do not materialise over the medium term. Higher policy rates and lower lending volumes could see a rise in NPLs. There are numerous 'vulnerable nodes' in the financial system such as money market funds and investment funds, particularly investments in illiquid assets, and Ms Lagarde cautioned that contagion channels could still re-emerge.
Impact of the general warning so far
The general warning was addressed to EU and national supervisory authorities in both banking and non-banking sectors. The interactions between these authorities and the entities they supervise give rise to thousands of risk management decisions that are taken every day, making it difficult to precisely identify the impact of the warning. However, Ms Lagarde noted that its impact could be understood in two dimensions – awareness and action.
Awareness has amplified action. Policymakers and supervisors have anchored their decisions to ESRB's assessment and assisted them in pushing through necessary reforms to their macro-prudential and micro-prudential policies. The warning also helped to avert impulsive risk management decisions, and supervisors may take more time to assess whether an institution's vulnerabilities are critical, while policymakers may resist calls for reducing legislation.
Overall the general warning has, in Ms Lagarde's opinion, proved impactful over the last year, and have reduced policymakers' 'inaction bias' when implementing macro-prudential policy.
On 16 November 2023, the European Parliament's ("Parliament") Economic and Monetary Affairs Committee ("ECON") published draft reports on the European Commission's legislative proposals on the proposed Payment Services Directive 3 ("PSD3") and Payment Services Regulation ("PSR"). The Rapporteur for the PSD3 report was Ondřej Kovařík, and the Rapporteur for the PSR Report was Marek Belka who tabled amendments to areas that they believed required further clarification and improvements.
Draft report on PSD3
The report explains that PSD3 is a response to the rapidly changing landscape of the payments industry, catalysed by new technologies and trends. It aims to ensure that the EU payment ecosystem remains competitive, trustworthy and robust. It states that PSD3 represents an evolution of payment services regulation, not an overhaul. The report noted that the majority of PSD2 has been transferred to the PSR, but the implementation and enforcement of these provisions will remain in Directive form and updates will be required to reflect those changes. The below is a summary of the issues that the Rapporteur identified as issues which need to be addressed by improving the text, but not departing from the objectives of PSD2.
- Authorisation and Grandfathering
- payment service providers ("PSPs") will not have to go through a full authorisation process if they are already authorised under PSD2, but will just have to provide their competent authority with the extra elements required under the updated rules, and the competent authority will make a decision on its continued authorisation. Articles 44 and 45 should be updated to clearly outline what is expected from these institutions during the transitional and implementation periods.
- Settlement Finality Directive
- Article 46 proposes that payment institutions could also benefit from the same settlement systems as credit institutions and investment firms, by amending the Settlement Finality Directive. This has also been proposed under the Instant Payments Regulation and the Rapporteur restated that the Parliament's positon is to shorten the period of time that Member States have to transpose the relevant changes to the Settlement Finality Directive after PSD3 enters into force to 3 months. Access to settlement for payment institutions as soon as feasible is a priority for the Rapporteur.
- Central Contact Points
- PSD2 allowed host Member States to establish a central contact point, where payment institutions operating in their jurisdiction, but established in another Member State, report on activities on their territory for information or statistical purposes. The Rapporteur noted that the divergent applications of this provision have created difficulties and that a streamlined approach which ensures that all relevant information is sent to one contact point, rather than a number of different ones for different information as is currently the case, is a key first step. However, the Rapporteur also noted that it is an open question as to whether these points of contact are necessary to achieve the aims of the legislation or whether they create fragmentation in the single market.
- Access to Cash
- the Rapporteur noted the importance of ensuring access to cash for consumers and has increased the amount of cashback that retailers can give to consumers as cash-back from €50 to €100. The Rapporteur also highlighted the need for transparency around ATM charges, and that the legislation will require fees to be shown at the beginning of a transaction.
- Opening of Accounts by Payment Institutions
- the Rapporteur highlighted the difficulties where some payment institutions have struggled to hold payment accounts with credit institutions due to credit institutions' refusal to open or suddenly close accounts. He highlighted the importance of strengthening the requirements for credit institutions to clearly communicate the reason for closing or refusing to open accounts held by payments institutions.
Draft Report on PSR
The Rapporteur highlighted that the purpose of PSR is to:
- address the different levels of compliance with PSD2 and the fragmentation of the single market by proposing a more harmonised approach towards payment services;
- bolster the protection of payment service users ("PSUs") from fraud;
- ensure a level playing field between non-bank PSPs and EU banks by addressing barriers facing non-banks; and enable access to transparent information on data protection and data access for PSUs.
The Rapporteur highlighted areas which he believes can be improved:
- better, more transparent information should be provided in ATMs, while conducting other types of payments, on currency exchange and mark ups on the exchange reference rates;
- improved transparency where account information service providers or payment initiation service providers access a PSU's data;
- the European Banking Authority ("EBA") should set an unambiguous list of the methods that can be used to identify another PSU;
- verification carried out by PSPs should be based on other proxies, not just the IBAN number;
- the role of the EBA should be strengthened, particularly in relation to the development of additional Regulatory Technical Standards or guidelines;
- responsibility to protect consumers from fraud should fall on electronic communications services as well as PSPs;
- PSPs should offer quick and easy phone access with human support to consumers to notify about fraudulent transactions;
- Member States should also take some responsibility and develop holistic and far-reaching education campaigns to protect consumers from fraud; and
- exchange of information on fraudulent unique identifiers should be an obligation, not just a possibility.
The Council of the European Union and the Parliament are currently considering the proposals with the aim of determining negotiating positions and reaching political agreement.