1. Director of Consumer Protection, Colm Kincaid speaks to the importance of ethics and ethical behaviour by regulated financial service providers
On 26 October 2023, the Director of Consumer Protection at the Central Bank of Ireland ("Central Bank") , Colm Kincaid, delivered his opening remarks at the Vincentian Business Ethics Conference. Mr Kincaid's remarks focused on 3 key areas – the role of financial conduct regulation; a culture of placing consumers at the heart of commercial decision making; and the challenges faced by public authorities. He noted that the core of financial services is trust, and that ethics and ethical behaviour are vital to establish that trust.
The role of financial conduct regulation
A solid, well-functioning financial system is vital to society, as in order to function, lenders must be able to provide credit to people and businesses. There has been rapid change in the industry, driven by technological developments, and such changes can be seen in consumer behaviour and expectation; in how risks manifest; and in the type of financial service products that people need. As such, the regulatory framework which governs this must also adapt. Mr Kincaid stated that there were 3 component elements to this framework which all require continuous progression:
- rules: these drive positive behaviour and provide a mechanism to hold those who breach them to account. Regulatory oversight ensures that soundness of the system is preserved and protects consumer interests;
- culture: day to day behaviour is heavily influenced by the prevailing culture, and therefore firms must have a culture of promoting ethical behaviour; and
- education: consumers require basic, ongoing information in order to be able to identify their own specific needs, and hold firms to account to ensure that they meet their ethical expectations of the consumer's individual experience.
Towards a culture of placing consumers at the heart of commercial decision making
Regulators are focusing on culture being a 'common denominator' in mitigating risks. The essence of financial regulation is supporting positive outcomes which protect investors and consumers and contribute to the economic wellbeing of the entire community. The Central Bank has underpinned the ethical aim of putting consumer interests at the heart of commercial decision making, while acknowledging the need for businesses to make profit, when developing its frameworks.
The Central Bank outlined 5 key drivers of risk facing consumers in its 2023 Consumer Protection Outlook Report, and Mr Kincaid noted that technology risks in particular raise ethical concerns. This report, alongside the Consumer Protection Code Review and the Individual Accountability Framework, Mr Kincaid noted will provide a stronger platform for ethical behaviour within regulated financial service providers.
Challenges faced by public authorities
Mr Kincaid noted that digitalisation has resulted in internalisation and consequently, 'a more blurred line between what is regulated and what is not, what is official and what is not and what is trustworthy or not'. He emphasised that public authorities should not carry the burden of solving all problems, and regulated firms can do more to foster a more ethical approach in their industries. To achieve this, responsibility should be placed openly where it belongs and each actor properly held to account for carrying out that responsibility.
Mr Kincaid welcomed the financial literacy initiative and noted that given the pace of digitalisation, consumers need to have access to better information regarding the risks they face and what options they have regarding these risks.
Conclusion
The rapid rate of change resulting from digitisation means that further enhancements to a commitment to fostering ethical approaches to business is needed. The Central Bank aims to achieve a more ethical approach by adopting a more systematic approach to supervising conduct risks and enhancing the supporting rulebook. Public authorities are also facing challenges, including the challenge to ensure clearer understanding regarding accountability and the roles and responsibilities of those involved; and the need to provide more information to consumers. It is vital that better data and tools, which understand and anticipate human behaviour, are developed.
2. Ministerial order signed into law reducing the Motor Insurers Insolvency Compensation Fund Levy
On 24 October 2023, the Minister for Finance, Michael McGrath, signed the Insurance Act 1964 (Adjustment of Percentage Rate) Order 2023 [ S.I. No. 507 of 2023] into law ("Order"). This Order amends the percentage rate set out in section (4)(a) of section 3F of the Insurance Act 1964 from 2% to 1% in respect of the Motor Insurers Insolvency Compensation Fund ("Fund") and will come into effect on 1 January 2024.
Ministerial Response
On 25 October 2023, the Minister for Finance, Michael McGrath and Minister for State of Financial Services, Insurance and Credit Unions, Jennifer Carroll MacNeill, welcomed, in a press release, the signing of the Order into law.
Minister McGrath noted that the strong financial position of the Fund has enabled the reduction in the levy, and that it represents an improvement in the motor insurance market. The reduction will equate to roughly €20 million which will have a direct effect on the cost of insurance for motorists.
Minister Carroll MacNeill commented that the 1% reduction will be an additional benefit to motorists, noting that premiums on average have fallen by 40% since 2016. This provides opportunities for new entrants, as well as incumbent insurers to expand their risk and create more competitive options for consumers.
3. ESA set criteria on independence of supervisory authorities
On 25 October 2023, the European Supervisory Authorities ("ESAs") jointly published their criteria on the independence of supervisory authorities, as part of their duty to foster and monitor supervisory independence under the revised ESAs Regulations. These follow the publication by each of the ESAs of their individual reports on the supervisory independence of competent authorities in their respective sectors. These reports factually represented the arrangements and practices reported by competent authorities without assessing the independence of individual competent authorities.
The latest joint publication from the ESAs goes further and stipulates the criteria for the independence of these authorities. They have identified 4 key principles, and the criteria for assessing the independence of competent authorities. The criteria are not binding and instead aim to provide a framework for supervisory independence which should be practically implemented under the relevant legal framework. The purpose of the criteria is to
- provide clarity on the common standards to competent authorities regarding the level of independence expected; and
- to provide a set of criteria which ESAs can use to perform independence assessments of supervisory authorities.
Principle 1: Operational Independence
All competent authorities should apply the principles of independence, transparency and accountability to their tasks, and legislation should assign clear and explicit mandates and objectives to authorities and forbid any undue influence from the supervised sector and government.
Criteria for assessing operational independence include: absence of undue influence; internal process; adequacy of legal powers and authority; delegation of tasks; operational and strategic planning; adequacy of operational resources; the functioning of the government body of supervisory authorities; appeal against supervisory decisions; and legal actions against the supervisory authority and its staff.
Principle 2: Personal Independence
All members of the governing body of the competent authority should fulfil their tasks independently and objectively, and the appointment and removal of members of the governing body should be transparent.
Criteria for assessing personal independence include: appointment of members of the governing body; selection criteria; removal of members of the governing body; and conflicts of interest including forbidden conduct.
Principle 3 – Financial Independence
Competent authorities must have access to sufficient financial resource to carry out their mandate.
Criteria for assessing financial independence: financing model; financing process; and sufficiency of resources.
Principle 4 – Accountability and transparency
Competent authorities must conduct their tasks in a transparent and accountable manner, as transparency reinforced accountability. Supervisory requirements and information regarding the supervisor's responsibilities should be disclosed publicly to support the authority's accountability.
Criteria for assessing accountability and transparency: accountability framework; objectives and priorities; accountability to government/parliament; internal governance; integrity; procedural safeguards and safeguards to prevent the inappropriate use or disclosure of confidential information.
Next Steps
It is expected that these criteria will now be used by competent authorities going forward in an effort to improve their independence. Additionally, in due course, the ESAs will be in a position to rely on the criteria to assess supervisory independence across competent authorities in the European Union.
4. Revised Directive on Consumer Credit is published in the Official Journal
On 30 October 2023, the revised Directive on credit agreements for consumers and repealing the Consumer Credit Directive ("CCD II") was published in the Official Journal of the European Union.
As previously outlined in the FIG Top 5 at 5 dated 12 October 2023, the Directive had been adopted by the European Parliament on 12 September 2023, and by the Council of the European Union on 9 October 2023.
Next Steps
CCD II will enter into force 20 days after its publication in the Official Journal, 19 November 2023. It will apply from 20 November 2026 and CCD will be repealed however it will still apply to credit agreements existing on 20 November 2026 until their termination. By 20 November 2025, member states must adopt and publish the laws, regulations and administrative provisions necessary to implement CCD II.
5. Speech by Andrea Enria reflecting on his five years as Chair of the Supervisory Board of the ECB
On 30 October 2023, Andrea Enria, Chair of the Supervisory Board of the European Central Bank ("ECB"), gave a speech at the London School of Economics in which he reflected on his five years in the role addressing the development of the Single Supervisory Mechanism ("SSM"), recent unexpected events and the current difficulties in completing the banking union.
Moving out of the SSM's start-up phase
Mr Enria began by reiterating the background against which European banking supervision arose and explained that certain components of the banking union have proven to be controversial including the establishment of financial resolution processes and the development of a European deposit insurance scheme remain. The SSM, he confirmed, had the initial responsibility of addressing banks' balance sheets, which has fundamentally been accomplished. He provided statistics regarding the decrease in non-performing loans in the euro banking sector and other indicators of balance sheet strength which suggest that the remains of the crises are ending.
The Euro banking sector is the largest in the world in terms of assets, and establishing a centralised EU framework for prudential supervision was incredibly complex. The new prudential supervisory authority introduced heavily codified methodologies and procedures. The codification was necessary to guarantee trust, equal treatment and a level playing field across 19 national supervisory cultures. Mr Enria referred to the Supervisory Review and Evaluation Process ("SREP") as 'extremely rigid', leading to criticism that it was inflexible and lacked transparency. He emphasised that such an approach was necessary to repair the banks' balance sheets, but that supervision needs to 'evolve and improve'. Mr Enria observed that when he came on board the institutional view was that a more risk focused approach was needed, while on the other hand, the banking industry called for more transparency, clarity and predictability from the supervisors. The process has since been adjusted to include a risk tolerance framework which enables supervisors to exercise discretion and adapt their priorities to the specific situation under their direct supervision.
These more targeted supervisory interventions have also been reflected in the use of 'executive letters' by the ECB to banks indicating which issues they should focus their remediation efforts on. Mr Enria also noted that the ECB has 'genuinely' tried to enhance transparency surrounding their supervisory approach through the publication of Pillar 2 capital requirements of significant credit institutions to provide more understanding of the ECB's assessment of individual banks, and the methodology for setting Pillar 2 capital buffers for individual banks.
Exogenous Shocks: Brexit, pandemic, war and inflation
1. Brexit - the ECB introduced a policy of 'no empty shells' post Brexit to deal with the relocation of global banks from London to the euro zone. Mr Enria noted that he took on an excessively territorial approach to supervision within the SSM, acknowledging that good collaboration between supervisors is essential for effective supervision of international groups. The ECB has always cooperated closely with the Bank of England and the US Federal Reserve, and Mr Enria stated that the ECB desk-mapping review strengthened the SSM's reputation as an internationally open and collaborative supervisor.
2. Covid-19 was the first unexpected exogenous shock. Mr Enria highlighted that the main concern for the ECB was the tendency of the banking sector to act as a shock amplifier, with a 'knee jerk increase in risk aversion' by banks leading to a more prolonged recession. The euro area economy survived relatively unscathed, with the lowest levels of corporate defaults on record. Mr Enria provided a summary of the various steps which the ECB took throughout that period.
3. Russian invasion of Ukraine. Geopolitical tensions in the area saw serious impacts on economic growth and inflation, due to rapidly rising food and commodity prices. The ECB shifted its focus to sectoral analyses on borrowers that were most sensitive to energy prices, and to commodity trading. It also prioritised cyber risk, and pressured European banks with subsidiaries in Russia to downsize and exit the country.
4. Inflation followed the effects of the pandemic and the invasion. Interest rate and credit spread risks, as well as liquidity and funding risks became top areas of focus for the ECB. The banking events earlier this year saw some banks caught off guard by the shift in interest rate, and highlighted the importance of robust business models and sound management of interest rate risk in the banking book. Mr Enria noted that European banks avoided this turmoil due to well diversified funding structures and impactful supervision.
Endogenous challenges: supervisory effectiveness and the lack of cross-border integration in an incomplete banking union
1. Supervisory effectiveness. Much of the SSM's initial focus was on quantitative prudential requirements, with little attention being given to qualitative supervisory elements such as governance or internal controls. Mr Enria noted that this approach has 'weakened the effectiveness and reliability of quantitative requirements as the fact that a bank meets these requirements does not guarantee its viability'.
Recent banking events have seen central banks across the world examine their supervisory responses and acknowledge their weaknesses. A Report by the Expert Group to the Chair of the Supervisory Board of the ECB recommended that the ECB establish quicker, more forceful escalation processes to ensure effective follow up on qualitative supervisory measures. This was also echoed in the Basel Committee on Banking Supervision's report on the 2023 banking turmoil, and an IMF paper on good supervision. Mr Enria commented that making progress in areas such as bank governance, internal controls and business model sustainability has been difficult and many recommendations by the ECB remain open for a long time without the issues being resolved in a satisfactory manner.
2. Cross-border integration in the euro area banking sector is key to developing a missing element of the European monetary union. Banks with a fully integrated business across the banking union could easily offset losses which hit one member state, against profits they made in another. On the adoption of a European Deposit Insurance Scheme, Mr Enria explained that there have been significant difficulties in gaining political agreement on this point. Member States have battled to maintain a number of constraints within European legislation which prevent banking groups from pooling capital, liquidity and other financial resources within the euro area, and allowing them to flow across legal entities in the various Member States who are part of the banking union. Mr Enria noted that the main problem with the lack of an integrated safety net across Member States is that it leads Member States to 'ring-fence business within national boundaries'. The segmentation of banking markets along national lines, affects private risk-sharing mechanisms and increases the possibility of national deposit guarantee schemes being activated and depleted, leading to fiscal backstops being activated.
Mr Enria noted that while during his time as Chair, they had not succeeded in achieving cross-border integration, a number of steps were taken. These include:
- the publication of a Guide on mergers in the banking sector which stated that cross-border mergers within the banking union would be treated as domestic mergers;
- pursuing practical solutions for activating cross-border liquidity waivers within the banking union;
- encouraging cross-border mergers following Brexit to restructure into a legal entity incorporated in one Member State with branches in others; and
- proposing that crisis management framework could be strengthened by giving resolution authorities a wide range of options.
However, many banks have returned capital to shareholders, rather than embark on mergers and acquisitions. Mr Enria also noted that given the fact that current arrangements without the completion of the banking union have proved effective in bolstering the stability of the banking union, Member States are reluctant to engage in politically sensitive discussions. He cautions that effective supervision is not enough, and without full integration, 'a dangerous fault line' exists in the set up.