Ed Sibley: Prudential regulation, the international financial services
sector, and priorities in Ireland for 2018
Remarks by Mr Ed Sibley, Deputy Governor (Prudential Regulation) of the Central Bank of
Ireland, at the FSI Financial Services Forum, Dublin, 8 December 2017.
* * *
In my remarks today, I will cover three broad areas relevant to internationally focused financial
services firms. Firstly, I will describe our objectives and approach to prudential regulation,
secondly, I will consider some of the key challenges the international financial services sector
faces, and thirdly, I will outline some of our priorities for 2018.
Within these broad areas, you will hear:
the Central Bank's prudential regulation priorities for delivering on its mandate of
safeguarding stability and protecting consumers;
that while much progress has been made in improving the safety of the financial system,
more work is required to address issues that still remain; and
that even as we are still dealing with legacy issues from the last financial crisis, significant
headwinds and risks are on the horizon.
Regulatory and supervisory approach
The core work of the Central Bank is focussed on delivering a financial system that is
wellmanaged, well-regulated, and sustainably serves the needs of the economy and consumers over
the long term. Given the international nature of much of the Irish financial services system, this
objective includes consideration of our responsibilities regarding European financial stability.
Indeed, in comparable ways to your firms, the Central Bank is also part of the complex European
financial services ecosystem - playing an active role in the European framework of regulation
1
and supervision . Within that framework, the Central Bank operates a robust and effective
approach to supervision that underpins our aim of enhancing the standing and reputation of the
Central Bank (such that it is trusted by the public and respected by our peers), and the wider
reputation and long-term attractiveness of Ireland as a financial services centre.
Delivery of our overarching vision for the financial services system requires that we deliver
effective, intrusive, analytical and outcomes-focused supervision. This is risk-based and
anchored by our PRISM supervisory methodology. Our supervisory effort involves our day to day
supervisory team engagement with regulated firms; in-depth and intensive inspections; and high
quality analysis designed to support and challenge the supervisory work.
We undertake this work with the aim of ensuring that regulated firms:
have sufficient financial resources, including under a plausible but severe stress;
have sustainable, capitally accretive business models, over the long-term;
are well governed, have an appropriate culture, with effective risk management and control
arrangements in place, which are commensurate with their nature, scale and complexity;
and
can recover if they get into difficulty, and if they cannot, are resolvable in an orderly manner
without significant externalities or taxpayer costs.
Distilling our supervisory approach and objectives into a few lines is relatively straightforward.
Delivery of the approach, and for regulated firms to be operating in line with our objectives is less
so, particularly in the context of the continued developments and changes to regulatory
frameworks, which I will come onto in one moment. Nonetheless, it is what I expect of my teams,
and it is what I expect of the firms that we supervise, whether they are focused on the domestic
economy or internationally focused.
In the 10 years since the onset of the financial crisis, multiple reforms have sought to address
the root causes of the crisis and other issues. Indeed, there continues to be reforms of the
reforms, and regulatory reform packages have started to sound like extended movie franchises.
While not yet reaching the number of iterations as the Fast & the Furious franchise, we are still
embedding recent changes such as Solvency II, and implementing further changes, notably
2 3
MiFID II and PSD 2 . We are close to agreement on Basel III. In parallel, accounting standards
4 5
continue to be updated, with a 1 January 2018 effective date for IFRS9 and IFRS17 coming into
force from 1 January 2021 for Insurance firms.
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Further change is on the way with Capital Markets Union (CMU) , an important response to the
challenge of achieving more diversified sources of funding of the European economy, wider
opportunities for investors, and broader risk sharing. The objective to diversify the funding mix,
reducing reliance on traditional funding models, is a valuable one.
7
The recently proposed revision of the ESA's framework is also relevant . Negotiations are
continuing under the Estonian Presidency on the European Commission's Risk Reduction
Measures package. This package constitutes the EU's completion of the Basel III and FSB
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reform agenda and revises parts of the CRD / CRR and BRRD frameworks .
It is both clear and unsurprising that there is some regulatory change fatigue in the system. So it
is important to consider why these changes have been needed - indeed, why regulation is
needed at all. Ultimately, this comes down to a question of trust. And without regulation and
effective supervision, financial services firms cannot be trusted to deliver what is required of
them in the way the economy needs and society expects. This is the lesson of the most recent
crisis and all crises before that. It is the lesson from the multitude of conduct failures. Regulatory
change has, among other things, been required to address gaps or weaknesses in the system
that were being exploited or at risk of being so.
We all have a job of work to do to try and restore trust in the system.
Current challenges
With one very notable exception, the internationally focused financial services firms operating in
Ireland have not experienced the same levels of failures and losses as the domestically focused
sector. This is obviously welcome, but should not be a cause of complacency. There are
significant risks and challenges that need to be addressed, including:
(i) Macro risks
The macro economic environment has improved considerably, both domestically and
internationally. Growth has returned in the Eurozone and is now well established in Ireland.
However, significant risks are evident.
Our latest Macro Financial Review will be released next week. I urge you to read it, as it covers in
some detail the progress and vulnerabilities in the Irish economy and the financial system. For
example:
Valuations for many asset classes have been increasing for a long period - from government
bonds through to bitcoin, from stock markets to real estate. Market volatility is very low. This bull
run can not last forever. Quantitative easing will end. Interest rates will rise. Asset valuations will
fall. Hopefully, this will all be orderly, but history would warn against any complacency in judging
that this time is different.
Geo political risks are also elevated. Most notably, we may all hope for an orderly Brexit, a topic I
will return to, but there is no certainty that this will be the case. Whatever the outcome, it is likely
to be negative for the Irish economy and the financial services system here and potentially
across the EU.
At the risk of generalisation, as CEO's and senior managers in international financial services
firms, the majority of you are likely to be more optimistic than your prudential regulator. In fact, in
the same way as I am paid to consider downside risk, you are incentivised to consider the
upside. Nonetheless, we all need to be prepared for the plausible worse case.
After a storm it is important that roofs are fixed, leaky pipes mended and so on. While there is a
natural tendency for a 'risk on' mentality to dominate in the current environment, repair is still
needed, and lessons of the past cannot be forgotten. Even as we are still dealing with legacy
issues from the last financial crisis, significant headwinds and risks are on the horizon.
To deliver a resilient financial system, firms need to prepare for challenging times ahead. Today,
economic conditions are more positive than in recent times. During such times it is critical for
firms to prepare for the potential downside risks and plausible shocks that include Brexit, tighter
economic conditions and on-going disruption of business models.
(ii) Pace of change
There are considerable opportunities and risks for the financial services industry arising from
technology changes. History is replete with examples of industries being transformed, created
and disrupted by technology changes. This dates back centuries, but the pace of this change
and the risks associated with it are increasing, in what seems like an exponential way.
It is beyond doubt that banking, insurance, asset management, payments, and other financial
services sectors will be disrupted by technology change. Are you ready, or is your firm or your
sector more like Kodak or Nokia?
Fintech is changing barriers to entry and blurring the boundaries between technology firms and
financial services firms. New business models, products and services are emerging, and
changing the way users interact with the system. Value chains are being disrupted. Available
data is growing exponentially. The sophistication and reliance on artificial intelligence and
machine based learning is increasing. Opportunities for innovation through digital technology are
abundant as financial services is focused on recording, analyzing, and interpreting transactions
and managing associated information flows.
So there are threats and opportunities for all of your firms. Smaller, niche players, can be more
nimble, can target specific higher margin business - cherry picking from the bigger players, but
new entrants might also arrive - including from the technology sector. Alternatively, bigger
players with larger wallets can buy technology firms, achieve economies of scale, and so on, and
can compete easily on a cross border basis.
However it arrives, there will, undoubtedly be disruption to the system and your firms. I expect
that you will be actively thinking about these issues, how they will affect your business, your
capabilities to deliver change and the services you want to provide, and ultimately what a
sustainable proposition is.
(iii) Operational risk & resilience
We are all operating in an increasingly complex environment, with a greater and greater degree
of reliance on technology, an exponential growth in data, continuous change, increasingly
organisation complexity - including through outsourcing. All of these factors increase operational
risk, and the need for greater resilience in our processes, people and systems.
System resilience and cyber security threats are acute. Risks can crystallize instantly and
catastrophically. The evidence from our onsite IT risk inspections is that much more needs to be
done to manage this risk. For all of you, it is a question of when, not if, so you need to not only
reduce the risk of occurrence but have advanced plans for how you will deal with the risk
crystallising.
To take outsourcing as another example, while there are strong business benefits from
successful outsourcing, it does bring additional complexity into the system. It may be more
difficult to get a co-ordinated response when issues arise and to get separate firms, perhaps
unregulated, to operate in a co-ordinated manner during a time of stress. The firms may have
conflicting responsibilities between their own stakeholders. You need to be satisfied, and to be
able to demonstrate, that this additional complexity is being managed and mitigated.
(iv) Governance & risk management
As I have already alluded to, we are living in an increasingly complex, fast moving and
challenging world. Successfully meeting these challenges requires effective leadership,
governance and risk management. It is therefore of serious concern that, in too many cases, the
implementation and embedding of effective governance arrangements and risk management
frameworks in Irish financial services firms is not sufficiently robust. More than one third of the
largest firms (PRISM impact High or Medium High) have significant issues, which require
remediation in order to bring governance arrangements within our supervisory risk appetite. This
needs to change.
As does the culture in many firms - not just the retail banks. We expect institutions to critically
evaluate their culture, considering what type of culture they want to develop, how staff are
incentivised to behave, and to be held to account as to whether the culture they want is the
culture they have and how would they know if it is not.
We will also be stepping up our work from a diversity and inclusion perspective - linked to our
work on culture. It will increasingly feature in our ongoing supervision and inspection work,
supported by analytics. We expect regulated firms to meaningfully address diversity and
inclusion in the boardroom, at the executive level and the pipeline of talent needed to run the
organisation in the long-term.
Supervisory priorities for 2018
Turning now to the final part of my remarks - our supervisory priorities for next year. There are
some differences across sectors, such as:
for Banking: continued drive to reduce NPLs, supporting our Financial Conduct colleagues
on the tracker mortgage examination, implementation of PSII, the implementation of IFRS9,
and the EBA stress test;
for insurance: focus on risk transfer, cross border insurance and completing further work on
internal models;
for Asset Management and Investment Firms: the implementation of MiFID II; and
for Credit Unions: further enhancements of the regulatory framework, addressing viability
issues, restructuring and responding to the bifurcation of the sector, and credit risk.
But there are also many common priorities and there is absolute consistency in our desired
outcomes - that of delivering on our mandate of safeguarding stability and protecting consumers
and our vision of a well-managed, well-regulated financial services system that sustainably
serves the needs of the economy and consumers over the long term.
Common key areas of focus in 2018 will include:
(i) Core supervisory activity:
My number one priority is to ensure that my teams deliver an effective, intrusive, analytical and
outcomes-focused approach to supervision. We will relentlessly pursue improvements in those
areas necessary to bring financial service firms within our supervisory risk appetite. This will
include significant work on the areas I have raised earlier - governance, culture, IT risk, and
outsourcing.
(ii) Brexit:
As I have touched on earlier, Brexit will have a direct and negative impact on the Irish economy.
This impact will have knock on effects on the Irish financial services system. Even in a best-case
scenario, new frictions and duplications, with associated costs, will emerge in the European
financial services system. The loss of the UK voice from the European system of financial
regulation is also negative for Ireland.
There is considerable uncertainty and complexity for firms in dealing with Brexit, regarding, for
example contract continuity, risk transfer, appropriate governance structures and regulatory
treatment of third country branches by both the home and host state.
While some firms have robust plans that deal with a range of scenarios, other firms' plans are
not as advanced as they need to be. Some firms have not considered a scenario of a 'hard'
Brexit with no transition period. More work is required to be prepared for this plausible scenario.
With regard to Brexit related authorisations and approvals, we will continue to prioritise our
authorisation activity and continue to deliver on our commitment of being transparent, predictable
and consistent in our approach to authorisations and material business changes. Where Brexit
has a material impact on business strategy and business models, we will challenge firms to
ensure they appropriately address associated risks.
We will continue to both operate to and influence European norms of supervision. We have
engaged effectively within the SSM and with the ESAs and have been influential in the decisions
being taken on supervisory stances for the many thorny issues that Brexit is causing.
We will continue to dedicate our most senior and experienced supervisory and regulatory experts
to work on Brexit - as befits one of our highest priorities. We have approved an expansion in the
regulatory staff in the Central Bank to ensure we have the resources to both authorise and
supervise new entrants or changes to existing firms.
We have put in processes that are transparent, predictable and consistent. Firms that are
engaging with us will find us open, engaged and pragmatic. But they will not find that we are
willing to compromise on the need for governance and control arrangements to be
commensurate with the size, scale and complexity of operations.
(iii) Meaningful progress in the recoverability and resolvability of firms
There has been significant progress in recovery and resolution planning in the last two to three
years. However, more needs to be done by regulated firms to develop credible and executable
recovery plans, and to address impediments to resolution - including the raising of MREL for
banks, and addressing operational continuity issues. The absence of a resolution framework for
insurance firms is a concern, and will be a focus of our engagement in European forums.
(iv) Continuing to enhance our supervisory approach
I expect all of you to be seeking to both continuously improve your firms as well as responding
and anticipating the changing environment we operate in. I expect the same in the Central Bank.
We will continue to enhance our supervisory approach, including the use of the data and analysis
(reflecting the huge growth in regulatory and non-regulatory information that we need to consider
as part of our supervision).
(v) Resourcing
And finally, resourcing will remain our number one internal priority, recognising that we can only
deliver through the quality, expertise and commitment of our staff.
Conclusion
I will conclude here. The Central bank's core work is focused on delivering the financial system
the economy needs and consumers deserve. The work of regulation and supervision and your
efforts have helped deliver a safer system. But significant issues remain that need attention to
achieve our desired outcomes of regulated financial services firms:
having sufficient financial resources, including under a plausible but severe stress;
having sustainable, capitally accretive business models, over the long-term;
being well governed, with an appropriate culture, effective risk management and control
arrangements in place, which are commensurate with their nature, scale and complexity;
and
being able to recover if they get into difficulty, and if they cannot, being resolvable in an
orderly manner without significant externalities or taxpayer costs.
This is the time to fix what needs to be fixed, to refocus on consumers and to build resilience
within your firms. This will result in financial services firms who are in a stronger place to serve
the needs of the economy and consumers through an economic cycle.
1
Sibley, Ed, Innovation and insurance in Ireland: a supervisory perspective 2017.
2
MiFID II contains new EU-wide rules governing investment firms, credit institutions, trading venues and market
structures, as well as third-country firms providing investment services or activities in the EU. It significantly
broadens the scope of MiFID by bringing new activities and firms into scope, removing or narrowing exemptions
and covering new financial instruments and products.
3
The Payments Services Directive 2 (PSD2) will come into force in the EU in January 2018. Banks will be
obligated to share their customer information with third parties; such as payments firms.
4
IFRS 9 is a new accounting standard that will be effective from 1 January 2018. It introduces an expected credit
losses model (ECL) which may lead to higher impairment provisions and more volatile impairment charges
with a consequent impact on capital ratios.
5
IFRS 17 relates to the principles for the recognition, measurement, presentation and disclosure of insurance
contracts within the scope of the standard.
6
See recent update from European Commission - Reinforcing integrated supervision to strengthen Capital
Markets Union and financial integration in a changing environment. Available here.
7
Cross, Gerry. The Evolving Regulatory Architecture: A Supervisory Perspective. 2017
8
The Capital Requirements Regulation (EU) No. 575/2013 (CRR) and Directive 2013/36/EU (CRD IV) came into
effect on 1 January 2014. The CRR is directly applicable to all Member States while CRD IV has been
transposed into Irish national law via Statutory Instruments 158/2014 & 159/2014 [European Union (Capital
Requirements) (No.2) Regulations 2014]. Further information. The Bank Recovery and Resolution Directive
(BRRD) provides national resolution authorities with comprehensive and effective powers for dealing with failing
banks. This framework and related legislation enhances both the resilience and the resolvability of EU
institutions and in-scope investment firms, which will be better prepared to deal with, and recover from, a crisis
situation. Moreover, in the event that an institution does fail, the impact associated with that failure should be
minimised. Available here.