Financial Services Regulation and Compliance - General Cross Sectoral May 2020

DOMESTIC

Blog by the Governor of the Central Bank

The Governor of the Central Bank of Ireland (CBI) is continuing to update his blog, covering topics such as the monetary policy response to the COVID-19 crisis, the provision of credit during the pandemic, what we can learn from history in relation to the pandemic, and the importance of transparency and accountability in central banking.

Central Bank of Ireland publishes Annual Report & Annual Performance Statement for 2019

On 27 May 2020, the CBI published its Annual Report & Annual Performance Statement for 2019. The report presents an overview of key developments and the main activities carried out by the CBI over the previous year, including in the area of financial regulation. The report also evaluates the progress that was made in 2019 on the implementation of the CBI's Strategic Plan 2019-2021. There is a mid-cycle review of the Strategic Plan scheduled for later in 2020 to ensure it remains optimal, particularly in light of the COVID-19 pandemic.

Speaking on the launch of the report, Governor Makhlouf stated that "strengthening consumer protection is at the heart of everything [the Central Bank does]" and that key outcomes of 2019 included the final report of the Tracker Mortgage Examination and eight enforcement actions. The Governor also noted that the CBI "continued to focus on strengthening the wider financial system" in 2019 and that its work "has contributed to the resilience of the financial system to the initial shock of COVID-19." Similarly, it also worked to mitigate the impact of the UK's withdrawal from the EU, which will continue to be an "important priority" for 2020.

Central Bank of Ireland publishes Gender Pay Gap Report 2020

On 27 May 2020, the CBI also published its Gender Pay Gap Report 2020. The report finds that as of 1 January 2020, the gender pay profile of t is 2.2% in favour of male employees. This is the CBI's third gender pay gap analysis and sees and overall reduction of 0.5% since the publication of the first report in 2018 and a 0.2% reduction since 2019.

Digital Finance in Europe: Central Bank of Ireland's views on technological innovation and digital finance

In an address on 14 May 2020 on Digital Finance in Europe, the Director of Financial Regulation, Policy and Risk at the CBI, Gerry Cross, shared some of the CBI's thinking on the topic of technological innovation and digital finance. Director Cross was speaking to the Department of Finance and the Directorate-General for Financial Stability, Financial Services and Capital Markets Union, at a virtual outreach event relating to the European Commission’s consultation on digital finance in the context of the Commission’s current EU digital finance consultation.

Director Cross briefly mentioned some of the range of relevant measures recently taken by the CBI in this area, including:

  • the establishment in 2018 of an Innovation Hub for engagement with Fintech companies
  • the creation of internal structures such an Innovation Steering Group and a FinTech network
  • the CBI's significant engagement in the relevant work of the European Supervisory Authorities (ESAs) and the Single Supervisory Mechanism (SSM) particularly, in the context of the European Commission’s FinTech Action Plan

The Director of Financial Regulation, Policy and Risk then set out some of the priority issues that the CBI sees in the area of FinTech and technological innovation:

  • promotion and protection of consumer interests
  • fight against money laundering and terrorist financing (AML/FT)
  • challenges to the regulatory perimeter
  • new types of participants
  • increased participation of large global non-financial participants in the financial sector
  • big data analytics

Director Cross also noted that the increased embedding of technology in financial services presents heightened Information and Communications Technology (ICT) security issues, with the potential for significantly increased impact from the crystallisation of ICT risks. He stressed that it is of the utmost importance that the increased digitalisation of financial services is accompanied by concomitant enhancement in risk management and resilience.

Director Cross's speech aligns very closely with the CBI's Enforcement and Supervision Priorities for 2020: in particular, the focus on Consumer Protection and the emphasis on:

  • supervising how firms manage technological risks
  • the use of technology and the information imbalance between consumers and firms
  • the issue of AML

EUROPEAN

ECB publishes Annual Report for 2019

The ECB has published its Annual Report for 2019. The report sets out the tasks and activities of the European System of Central Banks and reports on the Eurosystem's monetary policy.

According to preliminary estimates presented in the report, the euro area economy contracted by 3.8% quarter on quarter in the first quarter of 2020 and consumer and business sentiment indicators for April have plunged, suggested an even larger contraction in the second quarter. Growth scenarios prepared by the ECB suggested that GDP could fall by between 5% and 12% this year, with a recovery in economic activity as containment measures are gradually lifted.

In terms of inflation developments, headline inflation decreased further to 0.4% in April (from 0.7% in March) according to preliminary estimates, largely due to a drop in oil prices. Based on current oil price expectations, inflation is likely to fall further in the coming months.

The report also details the measures taken by the ECB in response to COVID-19.

European Commission launches new action plan on money laundering and terrorist financing

On 7 May 2020, the European Commission published its new action plan on money laundering and terrorist financing. The plan sets out the measures that the Commission proposes to take over the next 12 months to better enforce, supervise and coordinate the EU's rules on combating money laundering and terrorist financing. The aim is to ensure that EU rules in this area are more harmonised and therefore more effective.

The action plan is built on the following six pillars:

  • The effective application of EU rules: to monitor the implementation of EU rules by Member States; the action plan also encourages the EBA to make full use of its new powers to tackle money laundering and terrorist financing
  • A single EU rulebook: the Commission will propose a more harmonised set of rules in the first quarter of 2021
  • EU-level supervision: in the first quarter of 2021, the Commission will propose to establish an EU-level supervisor
  • A coordination and support mechanism for Member State Financial Intelligence Units: to be proposed by the Commission in the first quarter of 2021
  • Enforcing EU-level criminal law provisions and information exchange: the Commission will issue guidance on the role of public-private partnerships to clarify and enhance data sharing
  • The EU's global role: alongside the action plan, the Commission has published a more transparent, refined methodology to identify high-risk third countries that have strategic deficiencies in their anti-money laundering and countering terrorist financing regimes, and has adopted a new list of such third countries. The new methodology aims to enhance the EU's engagement with third countries and ensure greater cooperation with the Financial Action Task Force

The Commission has also launched a public consultation on the action plan. The consultation is open to authorities, stakeholders, and citizens, and runs until 29 July 2020.

European Commission announces adjusted Work Programme in response to COVID-19

On 27 May 2020, the European Commission announced that it had adjusted it Work Programme in response to the COVID-19 pandemic. Points to note for the financial services sector include:

  • The non-legislative Renewed Sustainable Finance Strategy is now to be issued in the Q4 2020 rather than Q3
  • The non-legislative Action Plan on FinTech including a strategy on an integrated EU payments market, a legislative proposal on crypto assets and cross-sectorial financial services legislative proposal on operational and cyber resilience are still expected in Q3 2020
  • The review of the Directive on security of network and information systems (NIS Directive) is still expected to be carried out in Q4 2020

EBA publishes its inquiry into dividend arbitrage trading schemes ("cum-ex/cum-cum") and announces 10-point action plan

The EBA has published the results of its inquiry into dividend arbitrage schemes, which looked into the actions of prudential and anti-money laundering and countering the financing of terrorism (AML/CFT) supervisors in dealing with such schemes.

The report sets out the EBA's expectations of credit institutions and national authorities under the current regulatory framework, including requiring them to take a comprehensive view of the risks highlighted by these cases and the adequacy of financial institutions' internal control and governance arrangements, as well as their systems and controls relating to AML/CFT.

The expectations also cover the exchange of information between prudential and AML authorities when performing reviews of institutions’ internal controls and governance; AML authorities reaching out to local tax authorities; prudential and AML authorities pursuing targeted inspections; and prudential supervisory colleges discussing such schemes.

The EBA has also published a ten-point action plan for 2020-2021 to enhance the future regulatory framework of prudential and AML requirements for dividend arbitrage schemes. Among other things, the action plan states that the EBA will:

  • strengthen its prudential guidelines on internal governance, its guidelines on the assessment of suitability of members of the management body and key function holders, and its guidelines on supervisory review and evaluation processes (SREP)
  • monitor how prudential colleges will follow up on cum-ex related guidance
  • amend its guidelines on money laundering and terrorist financing (ML/TF) risk factors, its guidelines on risk-based AML/CFT supervision, and its biennial opinion on ML/TF risks
  • monitor AML/CFT colleges for financial institutions that are exposed to significant ML/TF risks associated with tax crimes

The EBA will then carry out a second formal inquiry into the actions taken by financial institutions and national authorities to supervise compliance with these amended requirements.

The EBA has also launched an AML/CFT newsletter.

ESMA publishes first complete risk dashboard for 2020

On 14 May 2020, ESMA published its first complete risk dashboard for 2020. The assessment remains at the same level as the separate risk updated published on 2 April 2020.

According to the risk assessment, the equity markets saw very large corrections during the first quarter of 2020, due to a combination of the Covid-19 pandemic and existing valuation risks. Since then, and despite the high uncertainty and worsening economic outlook, markets have seen a remarkable rebound. This should also be viewed in light of massive public policy interventions in the EU and elsewhere.

This potential decoupling of financial market performance and underlying economic activity leads ESMA to see a prolonged period of risk to institutional and retail investors of further – possibly significant – market corrections and very high risks across the whole of the ESMA remit. The extent to which these risks may materialise will critically depend on two drivers: the economic impact of the pandemic, and any occurrence of additional external events in an already fragile global economic environment.

European Commission publishes proposal for DAC reporting deadlines to be extended

The European Commission has published a proposal to extend reporting deadlines under the EU rules that require mandatory reporting of cross-border tax avoidance arrangements (DAC 6). Under the European Commission’s proposal, which is designed to recognise the severe disruption caused by the COVID-19 pandemic, the date from which DAC 6 applies would remain unchanged at 1 July 2020. However, a three-month deferral would operate such that:

  • the commencement date of the 30-day period for reporting cross-border arrangements would be extended from 1 July 2020 to 1 October 2020
  • the deadline for reporting historical cross-border arrangements (i.e. arrangements that became reportable in the period from 25 June 2018 to 30 June 2020) would be extended from 31 August 2020 to 30 November 2020
  • the first exchange of information by Member States would be postponed from 31 October 2020 to 31 January 2021

The European Commission also proposed the possibility of one further extension to the deferral period by a maximum of three additional months, depending on how the pandemic evolves. The proposal will next be considered by the European Council and the European Parliament. Once the wording on the proposed directive is agreed, each Member State will then need to transpose the directive into national legislation.

European Commission further expands the State Aid Temporary Framework to recapitalisation and subordinated debt measures

The European Commission has adopted a second amendment to extend the scope of the State Aid Temporary Framework adopted on 19 March 2020, following a first amendment adopted on 3 April 2020 (covered in our March and April 2020 bulletins). The amendments allow state aid to be authorised in the form of recapitalisation or subordinated debt to any non-financial companies in need.

In order to avoid undue distortions of competition in the Single Market, the following must be taken into account by States in carrying out recapitalisation measures:

  • Conditions on the necessity, appropriateness and size of the intervention: recapitalisation aid should only be granted if no other appropriate solution is available, and it must be in the common interest to intervene (e.g. to avoid social hardship and market failure due to a significant loss of employment; the exit of an innovative or systematically important company; or risk of disruption to an important service). The aid must be limited to enabling the viability of the company and should not go beyond restoring the beneficiary's capital structure to before the COVID-19 outbreak
  • Conditions on the State's entry in the capital of companies and remuneration: the State must be sufficiently remunerated for the risk it assumes through the recapitalisation aid. To ensure that the State's intervention is temporary, the remuneration mechanism also needs to incentivise beneficiaries and/or their owners to buy out the shares acquired by the State using State aid
  • Conditions regarding the exit of the State from the capital of the companies concerned: beneficiaries and Member States are required to develop an exit strategy – particularly for large companies that have received significant recapitalisation aid from the State. If the exist of the State is still in doubt six years after the recapitalisation aid to public companies (or up to seven years for other companies), a restructuring plan will be required to be notified to the Commission
  • Conditions regarding governance: beneficiaries will be subject to bans on dividends and share buybacks until the State has exited in full, and until at least 75% of the recapitalisation is redeemed, strict limitations will be placed on the remuneration of management, including a ban on bonus payments
  • Prohibition of cross-subsidisation and acquisition ban: to ensure that beneficiaries do not unduly benefit from the State recapitalisation to the detriment of competition in the Single Market, the aid cannot be used to support economic activities of companies that were in economic difficulty before 31 December 2019. Until at least 75% of the recapitalisation is redeemed, beneficiaries (other than SMEs) are in principle prevented from acquiring a stake of more than 10% in competitors or operators in the same line of business, including upstream and downstream operations

If recapitalisation is granted to beneficiaries under the schemes, Member States are required to publish details on the identity of the companies that have received aid and the amount within three months of the capitalisation. Beneficiaries (other than SMEs) are required to publish information on the use of the aid received, including on how the use of the aid supports the company's activities in line with EU and national obligations linked to the green and digital transformation.

Member States may also provide aid in the form of providing subordinated debt to companies on favourable terms. These instruments are subordinated to ordinary senior creditors in the case of insolvency proceedings, and complements the existing toolbox available to Member States under the Temporary Framework, including to grant debt with senior ranking to companies in need. Subordinated debt cannot be converted into equity whilst the company is a going concern and the State assumes less risk.

However, since such debt increases the ability of companies to take on senior debt in a manner similar to capital support, aid in the form of subordinated debt includes higher remuneration and a further limitation as to the amount compared to senior debt under the Temporary Framework. If Member States want to provide subordinated debt in amounts exceeding the thresholds, all conditions for recapitalisation measures set out above will apply.

The Temporary Framework will remain in place until the end of December 2020, and for recapitalisation measures only, until the end of June 2021. The European Commission will assess before then whether the Temporary Framework needs to be extended.

ESMA publishes report on collateralised loan obligations credit ratings

On 13 May 2020, ESMA published a thematic report on collateralised loan obligations (CLOs) credit ratings in the EU. The report provides an overview of CLO rating practices and identifies the main supervisory concerns, and medium-term risks, in this asset class which include credit rating agencies' (CRAs) internal organisation, their interactions with CLO issuers, operational risks, commercial influence on the rating process and the need for proper analysis of CLOs.

The report also highlights the impact that COVID-19 may have on methodologies. ESMA expects CRAs to continue to perform regular stress-testing simulations and to provide market participants with granular information on the sensitivity of CLO credit rating to key economic variables affected by the pandemic.

For more information on this topic please contact any member of A&L Goodbody's Financial Regulation team.

Date published: 8 June 2020