FIG Top 5 at 5 - 20/06/2024

1. Central Bank of Ireland Updates – Fitness and Probity and Dear CEO Letter on discretionary commission arrangements

1. Central Bank of Ireland updates its Guidance regarding Fitness and Probity Individual Questionnaire, Applications and PCF Roles

The Central Bank of Ireland (“Central Bank”) has updated its Fitness and Probity Individual Questionnaire, Applications and PCF Roles Guidance (“Guidance”) as of June 2024.

The document provides guidance for regulated financial service providers (“RFSPs”), holding companies and applicant firms in relation to submitting individual questionnaires (“IQ”) through the Central Bank’s portal for persons who are being proposed for pre-approval controlled functions (“PCFs”).

Along with some minor wording changes, the following are some of the main changes to the Guidance:

• A new section 2 has been inserted entitled “Fitness and Probity Use Permissions”. This sets out permissions for different categories of user who have access to the fitness and probity profile. The categories of users are ‘F&P Administrator’, the ‘proposer’ and the ‘applicant’;
• Section 4 entitled “Fitness and Probity Update”, had previously set out that personal details are collected in order to enhance reporting on diversity and inclusion in the financial services sector and that consent was sought in order to collect certain categories of information. However, the updated Guidance has now removed reference to consent and states that the information is for reporting purposes only and does not have any bearing on the approval process;
• Section 4 has also been updated to now require that information relating to time commitments for all positions disclosed in the IQ be set out; and
• Section 5 entitled “New PCF Application”, has been updated to include a new paragraph on “Reasons why Fitness and Probity applications may be returned as incomplete”. As of June 2024, the Central Bank will notify a proposing firm when an IQ application is returned as incomplete with Guidance as to how to remedy any deficiencies.
  

2. Central Bank of Ireland publishes Dear CEO Letter on discretionary commission arrangements in motor finance arranged through hire-purchase agreements

On 12 June 2024, Central Bank of Ireland (“Central Bank”) issued a letter to CEOs of regulated firms that provide motor finance through hire-purchase and consumer-hire agreements via credit intermediaries (“Letter”). The Letter follows a review by the Central Bank of such firms to understand the commission models in place (“Review”).

Discretionary Commission Arrangements

The Review has highlighted the prevalent use of Discretionary Commission Arrangements (“DCA”) by some firms. The Central Bank considers a DCA to be “an arrangement whereby a Firm/Product Producer allows a credit intermediary to select the interest rate charged to the consumer and where the commission paid to the credit intermediary by the Firm is linked, wither wholly or partially, to the interest rate charged”. The Central Bank identifies this practice as problematic under Provision 3.25A of the Consumer Protection Code (“CPC”).  This provision mandates that any fee, commission, or other reward must not impair a firm’s duty to act in the best interests of consumers or compliance with conflict of interest and suitability requirements.

The Central Bank found that DCAs often incentivise intermediaries to impose higher interest rates which conflicts with the intended market outcomes of Provision 3.25A.  Although this provision does not currently encompass hire-purchase and similar activities, the Central Bank plans to extend its scope by 31 July 2024.  In light of this, the Central Bank states in the Letter that it expects impacted firms to “cease the practice of DCAs in anticipation of Provision 3.25A coming into force for these activities immediately but no later than 31 July 2024”. 

Disclosure of Commission

The Review also revealed insufficient disclosure of commission details to consumers in some cases.  Building on the current obligation under section 148 of the Consumer Credit Act 1995, the Central Bank states that impacted firms “must be cognisant that we propose to apply the full Code, including provisions relating to commission and disclosure of the activity of hire-purchase”. It expects firms to proactively review their approach to disclosure of commission and if necessary, update the relevant documentation provided to consumers.

Actions Required

The Central Bank states that impacted firms must provide “Board-approved confirmation” to the Central Bank by 5 July 2024 of the following:

• that they have ceased, or will cease, using discretionary commission models;
• that the firm will undertake a review of its disclosure on commission arrangements as set out in the Letter. This review should have regard to both current and proposed Code requirements. On the back of this review, impacted firms must make any amendments necessary to documentation. This must be done as soon as possible but in any event, no later than 30 August 2024.  The outcomes of these reviews must be reported to the Central Bank by 30 September 2024.

 2. Council of the European Union agrees its position on the retail investment package

On 12 June 2024, the Council of the EU (“Council”) reached an agreement regarding the strengthening of the rules pertaining to retail investor protection. For more details on the background to the Retail Investment Package, please see the FIG Top 5 at 5 dated 1 June 2023.

It should be noted that there are two main changes proposed by the Council as follows:

1. Inducements

The Council has removed the proposed ban on inducements received for sales where no advice is provided to the investor (a ban already exists for independent investment advice and portfolio management with limited exceptions). However, in the interests of avoiding potential conflicts of interest, the Council strengthened the safeguards accompanying all inducements by specifying that the following shall apply:

• an inducement test that applies where there is no ban on inducements;
• a new uniform test specifying the duty for advisors to act in the best interest of the client; and
• enhanced transparency and disclosure about what payments are considered as inducements, their costs and their impact on investment returns.

These safeguards are further enhanced by the introduction of “overarching principles” that firms should respect when paying or receiving inducements. The principles set out that inducements should not incentivise firms to recommend particular products over others, they should not be disproportionate to the value offered and inducements paid to or accepted and retained by entities belonging to the same group should be treated in the same way as others.

The Council has agreed to review the provisions on inducements five years after entry into force.

2. Value for Money

To ensure that investment products are offered to retail clients only if they offer good value for money, a new concept regarding ‘Value for Money’ has been introduced.

It is proposed that manufacturers and distributors would assess whether costs and charges related to a product are justified and proportionate with regard to their performance, other benefits and characteristics, their objectives and, if relevant, their strategy. To this end, union supervisory benchmarks are to be developed by the European Securities and Markets Authority (“ESMA”) and the European Insurance and Occupational Pensions Authority (“EIOPA”). The benchmarks would be a supervisory tool rather than being integrated into the manufacturer’s and distributors’ product governance process. It is foreseen that such a strategy would help national competent authorities detect investments products that fail to offer value for money.

In addition, and bearing in mind that benchmarks used as supervisory tools would not be binding on manufacturers and distributors, the Council also agreed to strengthen their product governance process with a peer group system. In effect, manufacturers and distributors would compare their investment products to a peer group of other similar investment products in the European Union in order to assess whether the investment product offers value for money. Comparisons would be drawn from information on databases maintained by ESMA and EIOPA.

It is also proposed that financial product manufacturers and distributors may opt to compare their products with the relevant union supervisory benchmark, instead of a peer group.

Finally, member states whose national competent authorities have developed national benchmarks on costs and performance to detect outliers before 1 July 2024 may decide to continue to use those national benchmarks but only in relation to insurance-based investment products.

It is proposed that the value for money framework would be reviewed seven years after the start of application of the framework.

Next Steps

Interinstitutional negotiations will now commence between the Council and the European Parliament.

3. European Commission launches a targeted consultation on artificial intelligence in the financial sector

On 18 June 2024, the European Commission (“Commission”)  published what it has referred to as a targeted consultation on artificial intelligence (“AI”) in the financial sector. The stated goal is to identify the main use cases, benefits, barriers and risks related to the development of AI applications in the financial sector.

The development and use of AI in Europe will be regulated by the AI Act which is expected to enter into force in July 2024. The objective of the consultation is to inform the Commission services on the concrete application and impact of AI in financial services, taking account of the developments in the different financial services use cases.

The consultation uses the definition of AI as set out in the AI Act as follows:

 "any machine-based system designed to operate with varying levels of autonomy and that may exhibit adaptiveness after deployment and that, for explicit or implicit objectives, infers, from the input it receives, how to generate outputs such as predictions, content, recommendations, or decisions that can influence physical or virtual environments".

The consultation is comprised of a questionnaire with multiple choice questions and open answers. It has three parts as follows:

1. general questions on the development of AI;
2. questions related to specific use cases in finance; and
3. a section focusing on the AI Act related to the financial sector.

A workshop series has also been launched to be co-hosted by the Commission, the European Supervisory Authorities and national supervisors, to allow stakeholders to present projects and exchange information about latest developments.

Speaking on the day that the consultation was launched, Commissioner McGuinness explained that the new AI Act, combined with existing financial sector rules “provides a very solid basis to allow for technological innovation while managing the risks. It is now important that the authorities in charge work closely together and with the market to implement these rules in a coherent and sensible manner.” The Commissioner called on interested parties to participate in the consultation.

Next Steps

The deadline for responses is 13 September 2024. Responses are particularly sought from financial firms that provide or use AI systems, however responses from all financial services stakeholders are welcomed. 

Having regard to the progress made, the Commission will publish a report on the findings and an analysis of the main trends and issues arising with the use of AI applications in financial services.

 4. EBA publishes multiple MiCA draft RTS, ITS and Guidelines

The European Banking Authority (“EBA”) continues apace with the publication of several final reports containing draft regulatory technical standards (“RTS”), implementing technical standards (“ITS”) and guidelines under the Regulation on markets in crypto assets (“MiCA”).

On 19 June 2024, the EBA published the following final reports:

• Final report on guidelines establishing the common reference parameters of the stress test scenarios for the liquidity stress tests ref;
  
• Final report on draft RTS on supervisory colleges;
• Final report on draft RTS on the methodology to estimate the number and value of transactions associated to uses of asset-referenced tokens as a means of exchange and of e-money tokens denominated in a currency that is not an official currency of a member state; and
• Final report on draft ITS on the reporting on asset-referenced tokens and on e-money tokens denominated in a currency that is not an official currency of a member state

On 13 June 2024, the EBA published the following final reports:

• Final report on guidelines on recovery plans;  
• Final report on draft RTS on adjustment of own funds requirements and stress testing of issuers of asset-referenced tokens and of e-money tokens subject to such requirements;
• Final report on draft RTS specifying the procedure and timeframe to adjust the own funds requirements for issuers of significant asset-referenced tokens or of e-money tokens subject to such requirements;
• Final report on draft RTS specifying the liquidity requirements of the reserve of assets;
• Final report on draft RTS specifying the highly liquid financial instruments with minimal market risk, credit risk and concentration risk; and
• Final report on draft RTS specifying the minimum contents of the liquidity management policy and procedures.

Next Steps

The next step is for the EBA to submit the final draft RTS, ITS and guidelines to the European Commission for endorsement. They will then be subject to scrutiny by the European Parliament and the Council of the European Union before being published in the Official Journal of the European Union. The guidelines will apply two months after all translations have been published on the EBA website.

5. ESAs release individual Annual Reports

In recent days the European Supervisory Authorities (“ESAs”) have published their individual annual reports. The following is a high level overview of each:

EBA Annual Report

On 14 June 2024, the European Banking Authority (“EBA”) published its annual report for 2023. The report outlines the primary achievements of the EBA during that period.

Despite encountering challenges such as the war in Ukraine, disruption in the US banking system which travelled to Europe, increasing inflation and interest rates, along with the aftermath of the COVID – 19 pandemic, the EBA maintains that 2023 was a successful year for the EBA which is particularly evidenced by the following achievements:

• establishing the implementation of Basel III in the European Union (“EU”) as well as conducting an intense stress test throughout all of the EU;
• supplying data to stakeholders, as well as delivering on the Markets in Crypto Assets Regulation (“MiCA”) and Digital Operational Resilience Act (“DORA”) mandates;
• enhanced its capacity to address money laundering and terrorist financing in the EU;
• enacted the environmental, social and governance roadmap; and
• carried out risk assessments.

The EBA also worked in areas such as recovery and resolution, payment services, consumer and depositor protection, equivalence, and supervisory convergence and independence.

Next Steps

The Chairperson of the EBA commented that they will focus on  “navigating through uncertainties and challenges, and move towards a future where the banking sector remains a cornerstone of our society, able to best serves citizens”.

ESMA Annual Report

On 15 June 2024, the European Securities and Markets Authorities (“ESMA”) published its annual report for 2023.

The report includes the main accomplishments of ESMA as it commenced a new five year strategy focusing on amplifying investor protection and encouraging stable and orderly financial markets in the EU.  The following are some of ESMA’s key achievements:

• preparing for the introduction of DORA by working in tandem with the EBA and European Insurance and Occupational Pensions Authority (“EIOPA”) and exploring new areas of regulation;
• anticipating the MiCA implementation along with the National Competent Authorities (“NCAs”) by encouraging collective authorisation and supervision approaches, supplying guidance to those participating in the market, organising consultations on comprehensive rules, and converging with international bodies on regulation regarding crypto assets;
• observing retail investment markets and noting the costs and performance of retail investment products, outlining reductions in cost and differences in products across different Member States;
• initiating a new data strategy for 2023 – 2028 which was put in place to enhance market supervision and investor protection. The strategy consists of six main objectives, aiming to enhance data utilisation and encourage data driven supervision;
• examining greenwashing by releasing a progress report on greenwashing risks and supervision, collaborating with the EBA and EIOPA to define greenwashing and highlighting preliminary remediation actions.

Next Steps

In 2024, ESMA intends to prioritise cyber risk and digital resilience by placing greater importance on reinforcing firms’ ICT risk management and to utilise the five year strategy as a compass going forward.

EIOPA Annual Report:

On 14 June 2024, EIOPA published its annual report for 2023.

Considering the challenges faced by EIOPA throughout the year such as geopolitical conflicts, high interest rates, inflation and market volatility, EIOPA maintains that it was highly efficient and exceeded its goals, which it maintains is evidenced through the following key achievements:

• Sustainable finance: EIOPA added to its work in measuring operations while keeping technology costs under control. This involved enhancing the natural catastrophe dashboard, endorsing adaption measures in non - life underwriting practices in relation to climate, expanding work on greenwashing and disclosure obligations in the Sustainable Finance Disclosure Regulation.
• Digitalisation: EIOPA observed the emergence of digital technologies for example artificial intelligence and open insurance. Working alongside the ESAs, EIOPA sustained work in correspondence with policies of DORA. Additionally, EIOPA developed a digital strategy outlining how it intends to assist the public, the market and the supervisory community in transitioning through this digital transformation.
• Supervision: EIOPA carried on reinforcing the merging of supervision and supervisory methods by working to lessen harm to consumers by concentrating on value for money and the financial health of their consumers.
• Policy: Some of the main accomplishments achieved by EIOPA are supporting the appraisal of Solvency II, debates on how the insurance sector may recuperate and resolve the difficulties it is facing and providing technical guidance on the review of the IORP II Directive.
• Risks and financial stability: EIOPA proceeded to examine the risk and susceptibilities faced by the insurance and occupational sectors. EIOPA also examined the impact that inflation and interest rates have on the market as well as consumers. 

Next Steps

In 2024, EIOPA notes that it intends to proceed to ensure that “the industry is stable and well regulated, for the benefit of policyholders and beneficiaries, businesses, and the economy”.