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FIG Top 5 at 5 - 08/06/2023

DATE: 08/06/2023

1. Gerry Cross Speech – "The Individual Accountability Framework: What it Means for Directors"

On 1 June 2023, Gerry Cross, Director of Financial Regulation, Policy & Risk at the Central Bank of Ireland ("Central Bank") delivered a speech entitled "The Individual Accountability Framework: What it means for Directors" at an event hosted by the Institute of Directors.

The Director began by reiterating the background to the introduction the Individual Accountability Framework ("IAF"), outlined its four key pillars and then addressed some key themes of relevance to directors. The following is a summary of some of the Director's comments on those key themes:

Design and Implementation of the IAF

The Director explained that the IAF has been designed to support "high quality leadership and governance of financial firms". This he said will be achieved through bringing enhanced clarity to the

  1. governance of firms;
  2. allocation of responsibilities; and
  3. expectations that apply to those running the firms.

Implementation, the Director explains, will be guided by the principles of flexibility, proportionality, reasonable expectations.

The nature of the framework

The Director stressed the importance of the role of board members in the implementation of financial regulation. Regarding implementation of the IAF in particular, he outlined as follows what it should and should not be seen as:

  • it should be seen, and operate, as a framework supporting high quality governance, judgement and decision-making within firms;
  • it should not be seen as a compliance framework;
  • it should be seen, and operate, as enriching the context in which financial firms are supervised;
  • it should not be seen as a new thing to be supervised;
  • it should be seen, and operate, as bringing helpful clarity as to what is and is not expected of individuals; and
  • it should not be seen as something that will lead to a large number of enforcement cases against individuals.

The Director explained how it is the Central Bank's view that the IAF will be a significant support to directors and boards in delivering on its corporate governance obligations.

Collective responsibility

The Director confirms that the maintenance of the role of collective responsibility and decision-making within firms was a key consideration in the development of the IAF. In fact the IAF he explained has been "designed to reinforce the concept of collective responsibility as a core aspect of well-functioning firms, which will assist boards and directors, both executive and non-executive in their respective roles in the governance of firms."

Non-Executive Directors

The Director spoke to the considerations that went into the decision to include Non-Executive Directors (including Independent Non-Executive Directors) within the scope of SEAR. These included:

  • the need to ensure individuals are not dissuaded from taking on non-executive roles due to a "perception of being required to meet unduly demanding standards";
  • that the expectations set out in the SEAR are "fully consistent with their existing responsibilities under the corporate governance framework and should not impose increased obligations"; and
  • not to include them within the scope of the SEAR "would send the wrong message as to the importance of these roles".

Our Approach to Supervision

The Director then went on to outline how the IAF will help both the Central Bank and firms to explain and to understand how a firm is being run, how it is implementing its business model, and managing its risks – "in other words, the IAF will support the supervisory relationship rather than representing something to be separately supervised." This he demonstrates through the examples of not imposing a requirement to submit statements of responsibilities and responsibilities maps but rather to have them available to the Central Bank on request, as well as the fact that there is no obligation to submit details regarding the annual certification set out in the IAF but again to make it available, should it be requested.

The Director highlighted the importance of firms being able to demonstrate that they have internalised their obligations, and that they, culturally and in their decision making, have embedded an alignment with regulatory objectives. This he explains will mean that the Central Bank will need to focus less on compliance and more on outcomes. This he maintains "would be a real maturing of the supervisory relationship" something to which the IAF can make a significant contribution.

2. ECB Reports on market research and prototyping exercise confirm feasibility of a digital euro

On 26 May 2023, the European Central Bank ("ECB") published reports on its  market research exercise to obtain feedback and information on potential technical solutions for a digital euro and  prototyping exercise to test how design choices for the digital euro could be technically implemented and integrated into the existing European payments landscape.

Market Research

In January 2023, market participants were invited to take part in the market research with the aim of  obtaining feedback and gaining information on potential technical solutions, their possible cost and related planning issues for a digital euro.

The market research covered different components that would enable:

  • the issuance and redemption of digital euro;
  • the initiation, processing and settlement of transactions;
  • the management and protection of user access and user data; and
  • all necessary interfaces between digital euro components and users.

The ECB notes that the market research "indicates that there is a sufficiently large pool of European providers that are able to develop digital euro solutions" and suggests that "different types of architectural and technological design options are available to build a technical solution for a digital euro".

Prototyping Exercise

From July 2022 to February 2023, the ECB conducted a prototyping exercise on what paying with a digital euro could look like for different use cases. The exercise included the integration of user interfaces developed by different providers for each use case and a settlement system designed and developed by the Eurosystem.

The tests results demonstrate that:

  • it is possible to smoothly integrate a digital euro into the existing payment landscape, while still leaving scope for the market to use innovative features and technologies when distributing a digital euro; and
  • a digital euro could, in principle, work online and offline using different technical designs. The ECB notes, however, that the question remains as to whether an offline solution that fulfils the Eurosystem’s requirements can be delivered in the short to medium term with the existing technology.

The report also provides suggestions for further exploratory work and additional prototyping work.

Next steps

The ECB notes that both reports will feed into both the conclusions of the investigation phase and the potential next steps. The Governing Council of the ECB is due to decide in the Autumn whether to proceed with a preparation phase to develop and test the digital euro.

3. Joint Committee of ESAs consults on amending ITS on mapping credit assessments of ECAIs under CRR

On 25 May 2023, the Joint Committee of the ESAs launched a  public consultation to amend the Implementing Regulations on the mapping of credit assessments of External Credit Assessment Institutions ("ECAIs") for credit risk under Regulation (EU) 575/2013 ("Capital Requirements Regulation" or "CRR") and Solvency II.

The European Commission ("Commission") adopted Implementing Regulation (EU) 2016/1799 ("the Implementing Regulation") in 2016 laying down Implementing Technical Standards with regard to the mapping of credit assessments of ECAIs for credit risk. The Implementing Regulation was subsequently amended three times to incorporate mappings for new ECAIs, a de-registered ECAI and to reflect a monitoring exercise on the adequacy of existing mappings.

The current proposed amendments reflect:

  • the withdrawal of the registration of one ECAI and the recognition of five additional ECAIs since the adoption of the Implementing Regulations in October 2016;
  • the outcome of a monitoring exercise on the adequacy of existing mappings, namely changes to the CQS allocation for two ECAIs and the introduction of new credit rating scales for ten ECAIs; and
  • the production of mappings for two newly established ECAIs and the outcomes of a monitoring exercise on the adequacy of existing mappings, namely changes to the CQS allocation for two ECAIs and the introduction of new credit rating scales for nine ECAIs.

Next Steps

Comments to the Consultation Paper on the mapping under Article 109 (a) of the Solvency II Directive can be provided by sending an e-mail to EIOPA at 2023Public.Consultation.ECAI.Mapping@eiopa.europa.eu.

The consultation closes on 26 June 2023.

4. European Crypto Updates

EBA consults on amendments to the Guidelines on money laundering and terrorist financing risk factors to include crypto-asset service providers

On 31 May 2023, the European Banking Authority ("EBA") published a public consultation on amendments to its Guidelines on money laundering and terrorist financing ("ML/TF") risk factors ("Guidelines") to extend the scope of the Guidelines to crypto-asset service providers ("CASPs").

The upcoming Regulation on transfer of funds and certain crypto-assets ("Transfer of Funds Regulation"), includes a mandate for the EBA to issue guidelines on the risk variables and risk factors to be taken into account by CASPs when entering into business relationships or carrying out transactions in crypto assets. The upcoming Markets in Crypto-assets Regulation ("MiCA") will bring crypto-asset services and activities within the EU regulatory scope. At the same time, CASPs will become subject to EU AML/CFT obligations and supervision.

The EBA notes that "CASPs as well as other credit and financial institutions are exposed to ML/TF risks. For CASPs, these risks can be increased, due to, for example, the use of innovative technologies, instant transfers of crypto assets across the world and services that contain privacy-enhancing features".  

The EBA is proposing to amend the Guidelines to:

  • introduce new sector-specific guidance for CASPs, which highlights factors that may indicate the CASP’s exposure to the higher or lower ML/TF risk;
  • explain how CASPs should adjust their customer due diligence in line with those risks; and
  • include guidance to other credit and financial institutions on risks to consider when engaging in a business relationship with a CASP or when they are otherwise exposed to crypto assets.

Next steps

The deadline for the submission of comments is 31 August 2023. 

As reported in the FIG Top 5 at 5 of 6 April 2023, specific guidance for AML/CFT supervisors of CASPs will be delivered through the amendments to the EBA risk-based supervision Guidelines, which are under consultation until 29 June 2023.

The EBA notes that the Guidelines will be further complemented with amendments to the Guidelines to prevent the abuse of fund transfers for ML/TF purposes, and new Guidelines on policies and procedures for compliance with restrictive measures.

Council of EU publishes adopted texts of MiCA and Transfer of Funds Regulations

As reported in the FIG Top 5 at 5 of 18 May 2023, the Council of the EU (the "Council") voted to adopt the MICA and Transfer of Funds Regulation proposals on 16 May 2023. On 2 June 2023, the Council published the texts of the proposals (dated 31 May 2023).

Next Steps

The proposals now await publication in the Official Journal of the EU. As reported in the  FIG Top 5 at 5 of 20 April 2023 it is hoped that publication will occur by the end of June 2023.

5. ESAs' Progress Report on Greenwashing in the financial sector

On the 1 June 2023, the European Supervisory Authorities (European Banking Authority ("EBA"), European Insurance and Occupational Pensions Authority ("EIOPA") and the European Securities and Markets Authority ("ESMA") (collectively the "ESAs")) released their Progress Reports on Greenwashing in the Financial Sector ("Progress Report"), following a request from the European Commission in May 2022 to investigate the greenwashing phenomenon. The request asked for particular focus to be had on identifying a common definition of greenwashing, the risks that greenwashing poses to the financial sector entities, supervisory practices and how to monitor greenwashing and the gaps, inconsistencies and problems with the existing legislative framework.

While the ESAs released a joint response on the publication of the Progress Reports, each of the EBA, ESMA and EIOPA released their own Progress Reports. The Final Reports are due in May 2024 which will include proposed recommendations for changes to European Union ("EU") regulations.

To ensure consistency across different sectors, the ESAs have released a coordinated understanding of greenwashing which the ESAs describe "as a practice whereby sustainability-related statements, declarations, actions or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product or financial services. This practice may be misleading to consumers, investors or other market participants."

The ESAs identified the roles that market participants can play in greenwashing as well as the scope of circumstances where greenwashing is most likely to occur which include the receiving, spreading or triggering of misleading claims relating both to the product and the entity's sustainability profile.

EBA's Progress Report

The EBA's Progress Report provides a summary of greenwashing in the banking sector and its impact on banks, investment firms and payment service providers based on a quantitative analysis which it carried out on the subject.

It explains that the growing demand for sustainable products has meant that greenwashing may occur at any stage of the sustainable finance value chain as the industry has tried to keep up with demand. Additionally, given the level of public attention that climate change has received, firms are being held to account for both their impact on climate change and on their policies and disclosures.

The EBA Progress Report also demonstrates that greenwashing is most likely to occur at entity level where pledges about future ESG performance are made, with the majority indicating that the potential harm of this was high or very high. The least prone to greenwashing was ESG corporate resources and expertise but the potential for harm was identified as high or very high.

The EBA also found that greenwashing has been most concentrated in economic sectors such as gas, oil, mining, industrial construction, food and beverage, household goods and the financial sector. The financial sector accounted for 16% of greenwashing cases which included 1% insurance, 4% for banks and 10% for financial services.

Competent authorities and market participants believe that the greatest impact of greenwashing is seen in reputational risks, and operational and strategic business risks of banks and investment firms. While the materiality of greenwashing risks to banks is currently seen to be quite low, this is expected to increase into the future.

The EBA flags that while the sustainable finance regulatory framework is still in its early stages, and consequently the benefits of the frameworks are not yet seen, it is expected to  contribute to addressing aspects of greenwashing by tackling misleading statements and enhancing transparency on sustainability practices.

EIOPA's Progress Report

In its Progress Report, EIOPA notes that greenwashing is mostly seen in misleading claims that a particular product or entity are beneficial either to people or to the environment. This is particularly significant in the insurance sector as greenwashing may have a detrimental effect both on consumers and on providers. Greenwashing may deceive consumers into buying products with do not actually align with their preferences, and could lead to significant reputational damage for providers where the public become aware of such a greenwashing incident.

EIOPA highlights the importance of adequate supervision to tackle greenwashing, an area of priority which EIOPA and the National Competent Authorities ("NCAs") have already begun focusing on. The following statistics were noted in this regard:

  1. 10 NCAs believed that they had adequate and sufficient resources to tackle greenwashing, while 17 believed that they did not;
  2.  3 NCAs reported having identified one or more occurrence of greenwashing in their market;
  3.  5 NCAs are currently investigating potential occurrences of greenwashing;
  4.  21 NCAs have not identified occurrences of greenwashing due to resource constraints, low supply of products with sustainability features and because the relevant sustainable finance requirements are new or not fully in force; and
  5. while most NCAs believed that current supervisory mandates, powers and obligations were sufficient, 23 NCAs noted that some data or tools were missing.

Additionally, EIOPA notes that some insurance and pensions providers are also setting up governance processes to prevent and monitor greenwashing and flags the role that educating consumers, to an adequate level, on sustainability aspects and documentation can play.

Finally EIOPA acknowledges that while the EU has been at the forefront in setting up a regulatory framework tackling greenwashing "there are a number of shortcomings, inconsistencies and gaps in the framework" which were identified in the feedback it received. EIOPA concluded by indicating that it will include concrete recommendations regarding these shortcomings in its final report.

ESMA's Progress Report

ESMA's Progress Report considers which areas of the sustainable investment value chain ("SIVC") are most exposed to the risk of greenwashing. This, it indicates, "is meant to help market participants in preventing and mitigating greenwashing, and to support ESMA and NCAs in prioritising supervisory actions and regulatory intervention".

From the surveys it conducted ESMA found that misleading claims can be made in respect of many of the key aspects of the sustainability profile of a product or an entity. The Progress Report also provides sector-specific assessments for issuers, investment managers, benchmark administrators and investment service providers.

ESMA notes that greenwashing is impacted by a number of interconnected factors including:

  • challenges in implementing the necessary governance processes and tools that support high-quality sustainability disclosures and transition efforts;
  • difficulties in producing and accessing relevant, high-quality sustainability data; and
  • a fast-moving regulatory framework has created implementation challenges for both market participants and for NCAs.

To address greenwashing risks, ESMA identifies a number of actions which market participants and NCAs can take, including:

  • making substantiated claims and communicating on sustainability in a balanced manner;
  • improvements to the comprehensibility of sustainability disclosures to retail investors, including by establishing a reliable and well-designed labelling scheme for financial products; and
  • the maturing of the regulatory framework, clarifications of key concepts and better integration and engagement with the impact of sustainability.