FIG Top 5 at 5 - 25/07/2024

1. Industry Briefing on MiCA - Remarks by Deputy Governor Derville Rowland

On 18 June 2024 Deputy Governor of the Central Bank (“Central Bank”) Derville Rowland gave a speech at a Central Bank industry briefing on MiCA.

Governor Rowland highlighted the significant developments and innovations that have taken place in the financial services sector over the last number of years, most notably, blockchain technologies. In recognition of the EU’s desire to embrace these innovations and to promote the digital transition, Governor Rowland notes the introduction of the European Commission’s (“Commission”) digital finance package in 2020 which included the following:

• a digital finance strategy; and
• legislative proposals on crypto-assets and digital resilience.

Countries across the EU are now on the verge of implementing the Markets in Crypto-Asset Regulation (“MiCA”). Governor Rowland emphasised the importance of MiCA in the regulation of crypto activities in Europe and also noted that Europe is leading the way on the regulation of the crypto sector globally. The EU will have a harmonised regulatory framework for the crypto sector that introduces prudential and conduct obligations for issuers of e-money tokens, asset-referenced tokens, and for crypto-asset service providers. There are also obligations for offers to the public of crypto-assets other than asset-referenced tokens or e-money tokens.

As regards the journey so far, Governor Rowland pointed to the challenges that have been experienced in terms of culture and conduct leading to problems for consumers. With the introduction of MiCA, Governor Rowland stated that she is hopeful that it “will contribute towards building a better culture within the crypto sector, a culture where consumer protection and good governance is at the heart of all decision making, which will ultimately strengthen the industry and the firms operating within.”

In her speech, Governor Roland focused on four main themes as follows:

1. The Central Bank’s focus on technological innovation
   In welcoming the benefits that technological innovation brings, Governor Rowland highlighted the Central Bank’s objective of ensuring that the regulatory environment enables the potential benefits of innovation for consumers, businesses and society to be realised, while the risks are effectively managed and mitigated.
2. The growth of digital assets
   Governor Rowland was keen to discuss the Central Bank’s view on the risks and culture associated with the crypto sector. She emphasised the Central Bank’s mandate to protect consumers and recognised it as being “at the heart of what we do.” Governor Rowland stated that for the crypto sector to succeed, compliance and a customer centric approach should not be seen as a cost of doing business, but rather, they have the potential to be a competitive advantage. 
   As regards, risk management, Governor Rowland highlighted the fundamental role it must play in delivering on new obligations under MiCA, crucial to maintaining trust, integrity and stability within the sector. As regards explicit expectations, Governor Rowland stated that the Central Bank expects to see standards of professionalism, honesty, integrity and accountability to deliver fair outcomes that have the interests of consumers and investors at heart.
3. The value of guardrails
   Governor Rowland pointed to the Central Bank’s concern that consumer and investor protection risks are inherently high in some crypto and services. Where the Central Bank sees higher inherent conduct and consumer protection risks in products, it will have higher expectations of firms to adhere to high standards, taking a “sceptical view on business models where profitability is driven from the heavy marketing, offering and distribution of unbacked crypto to retail customers for speculative purposes.”
   The importance of governance and safeguarding of client assets were also pointed to as critical considerations for the Central Bank, regardless of the services, the target customer base, or whether it is retail focused or aimed at institutional clients.
4. The role of regulation and the Central Bank’s work at an EU level
   Governor Rowland points to the Central Bank’s expectation that MiCA will be an iterative process that  will be tailored over time to address emerging activities and risks in the crypto sector. The work done by the Central Bank as regards engaging with peer regulators and the European Supervisory Authorities (“ESAs”) to ensure the necessary coordination and consistency across Europe was also highlighted. This work is focused on the completion of the following:
   - the level 2 and level 3 texts noting that the ESAs have sought and continue to seek stakeholders’ input on the proposed level 2 and level 3 texts through their consultation processes; and
   - the more detailed regulations, technical standards and guidelines.  
   Not only will a convergent approach ensure clarity and consistency for industry and regulators but it will help prevent arbitrage or jurisdiction shopping based on actual or perceived differences in approach.

Next Steps

Governor Rowland stated that the Central Bank is seeking to engage with the crypto sector and to facilitate open and constructive engagement. It is hoped that this will enable the Central Bank to outline its approach to implementing MiCA, providing the crypto sector with greater clarity and transparency on the next steps.

2. DORA Updates

1. ESAs establish framework to strengthen coordination in case of systemic cyber incidents

On 17 July 2024 the three European Supervisory Authorities (“ESAs”), the European Banking Authority (“EBA”), the European Insurance and Occupational Pensions Authority (“EIOPA”) and the European Securities and Markets Authority (“ESMA”) stated that they will establish the EU systemic cyber incident coordination framework (“EU-SCICF”), in the context of the Digital Operational Resilience Act (“DORA”). It is envisaged that this will facilitate an effective financial sector response to a cyber incident that poses a risk to financial stability by doing the following. This will be achieved, it is hoped, through strengthening the coordination among financial authorities and other relevant bodies in the European Union, as well as with key actors at international level.

Over the coming months, the ESAs will set up the following bodies in order to commence the implementation of the framework:

• the EU-SCICF Secretariat, supporting the functioning of the framework;
  
• the EU-SCICF Forum, working on testing and maturing the functioning; and
• the EU-SCICF Crisis Coordination, facilitating the coordination of actions by the participating authorities during a crisis.

A factsheet was also produced setting out the function and operation of the framework.

Next Steps

The ESAs will identify legal and other operational hurdles encountered during the initial set up and report these to the European Commission. The further development of the framework will be subject to the availability of resources and other measures taken by the European Commission.

On 17 July 2024 the three European Supervisory Authorities (“ESAs”), the European Banking Authority  (“EBA”),  the European Insurance and Occupational Pensions Authority (“EIOPA”) and the European Securities and Markets Authority (“ESMA”) published the second batch of policy products under the Digital Operational Resilience Act (“DORA”).

The package of policy products consist of four final draft technical standards (“RTS”) and one set of implementing technical standards (“ITS”) as follows:

• RTS and ITS on the content, format, templates and timelines for reporting major ICT-related incidents and significant cyber threats;
  
• RTS on the harmonisation of conditions enabling the conduct of the oversight activities;
• RTS specifying the criteria for determining the composition of the joint examination team (“JET”); and
• RTS on threat-led penetration testing (“TLPT”).
  

The guidelines published include:

• guidelines on the estimation of aggregated costs/losses caused by major ICT-related incidents; and
  
• guidelines on oversight cooperation.
  

Next Steps

The guidelines have already been adopted by the Boards of Supervisors of the three ESAs. The final draft technical standards have been submitted to the European Commission, which will now start working on their review with the objective to adopt these policy products in the coming months. The remaining RTS on Subcontracting will be published in due course.

3. Building trust in central banks and regulatory authorities - speech by Deputy Governor Derville Rowland

On 18 July 2024 Deputy Governor of the Central Bank of Ireland (“Central Bank”), Derville Rowland gave a speech at the department of public expenditure and reform’s annual management conference.

The theme of Deputy Governor Rowland’s speech was that of trust and the fundamental role that it plays in the proper functioning, not only of the Central Bank’s role, but of the whole financial system. She allied the role of trust to the programme of work in the Central Bank, overseen by the Deputy Governor, of being Open & Engaged.

The Open & Engaged Charter seeks to foster effective stakeholder engagement which has the aim of increasing transparency and accountability and, consequently, increasing trust. Deputy Governor Rowland emphasised the importance of that stakeholder engagement, setting out that it is focused on four key areas as follows:

1. Culture
   Deputy Governor Rowland noted that the Central Bank emphasises its communications and engagement culture, working with Central Bank staff to foster enhanced engagement.
2. Dialogue
   It was highlighted that the Central Bank emphasises dialogue in its communications and engagement activities with a focus on active listening and a desire to reflect community perspectives in its work.
3. Reach
   The Central Bank seeks to expand its reach by building relationships with a greater range of stakeholders, including the public, participants in the real economy and international peer regulators.
4. Insight 
   Deputy Governor Rowland pointed to the Central Bank’s objective of adjusting and improving based on what it learns as a result of the measurement of the impact and outcomes of its communications and engagement.

By being open and engaged, the Central Bank seeks to build trust in the financial system and promote a wider understanding of the Central Bank’s role.

Citing the importance of trust as regards currency, monetary policy and the wider financial system, Deputy Governor Rowland highlighted, again, the fundamental point that trust in the Central Bank itself is key. She stated that this principle is reflected in the Central Bank’s updated Communications and Engagement Strategy.  The Deputy Governor reflected on the history of the Central Bank and mentioned the former method of communication employed by the Central Bank as being one of “telling” rather than engaging in genuine two-way engagement, encompassing listening, as well as telling, and accepting informed views where relevant. She reiterated Governor Makhlouf’s previously made point that the Central Bank is “seeking to understand and be understood.”

As regards the question of whether the Central Bank will be able to deliver on its objective of building trust, Deputy Governor Rowland very clearly set out the difficult wider environment in which the Central Bank is operating. She quoted from the Organisation for Economic Cooperation and Development’s (“OECD”) recent work on drivers of trust in government when it stated that governments  “stand at a critical juncture, steering environmental and digital transitions while facing increased polarisation within their countries, heightened geopolitical tensions as well as the social consequences of economic developments”, noting that the same can be said for public bodies. The Deputy Governor also pointed out that we are living in an age of misinformation, only further fuelled by artificial intelligence.

The financial crisis was a recurring theme in the Deputy Governor’s speech and she mentioned the Behaviour and Culture Report into Irish retail banks and noted the multiple and serious failings towards consumers in previous years. In that regard, Deputy Governor Rowland also highlighted that the Central Bank is very much aware of the regulatory failings that contributed to the financial crisis stating that it knows what it is like when trust is lost and how difficult it is to regain it. In addition, she noted that even when a regulatory authority is implementing policy in line with its mandate, trust can still decline, further underpinning not only the importance of trust but the need to fight for it.

Next Steps

Deputy Governor Rowland set out that the Central Bank will continue to implement its Open & Engaged  approach to stakeholders, and to also continue its empirical work with others on the subject of trust in central banks and regulatory bodies.

4. Eurosystem sets policy on access by non-bank payment service providers to its central bank payment systems

On 19 July 2024, the Eurosystem (comprising the European Central Bank and national central banks of all EU Member States) published a harmonised policy to allow non-bank payment service providers (“PSPs”) to access central bank-operated payment systems such as TARGET. Included in non-bank PSPs are, payment institutions (“PIs”) and electronic money institutions ("EMIs”). This follows the enactment of the Instant Payments Regulation, which amended the Settlement Finality Directive (“SFD”) and intended to increase the number of entities permitted to participate in designated payment systems to include non-bank PSPs.

The Eurosystem welcomed the amendments to the SFD which are expected to:

• increase the efficiency of the European retail payments market;
• encourage competition and innovation in the European payments landscape;
• support the increase of instant payments within the European Union; and
• achieve a level playing field between bank and non-bank PSPs by ensuring that the latter can offer a full range of payment services without being dependent on banks for the processing and settlement of payment transactions.

From April 2025, non-bank PSPs that meet specified requirements will be permitted to access TARGET, including:

• T2 for settling payments; and
• TIPS for settling instant payments.

These requirements will be set out in the TARGET Guideline and mirror those that apply to credit institutions. The objective of these requirements is to allow for a seamless operation of T2 and TIPS by only permitting access to non-bank PSPs with the relevant safeguards in place and who have displayed their ability to meet the operational and technical requirements already applicable to current participants.

An amendment will be made to the TARGET Guideline to facilitate this change which will be aligned with the implementation date of amendments to the SFD and the Payment Services Directive (“PSD”) at the national level. 

Holding an account in a central bank payment system aims to allow non-bank PSPs to place funds to meet their settlement obligations for the current business day. This only intends to include accounts with a limited balance and funds necessary to meet such obligations. The maximum balance permitted will be set out in the TARGET Guidelines and the Eurosystem will take into account factors it considers relevant given the potential impact on price stability and financial stability.

National central banks within Europe operating payment systems other than TARGET Services will develop the terms and conditions to implement access by non-bank PSPs to their national payment systems to align with the principles outlined in the harmonised policy, considering the alternative risk profile in comparison to TARGET.

The Instant Payments Regulation also amended the PSD to introduce the option for non-bank PSPs to safeguard users’ funds in an account with a central bank, depending on the discretion of that central bank. The European Central Bank (“ECB”) is expected to make a decision with regards to whether the  Eurosystem will not provide accounts to non-bank PSPs for safeguarding users’ funds at central banks.

Next Steps

For further information and to commence the application process, non-bank PSPs should contact their respective national central bank.

5. ESRB publishes its Annual Report 2023

On 19 July 2024 the European Systemic Risk Board (“ESRB”) published its annual report (“Report”) for 2023, covering the period between 1 April 2023 and 31 March 2024. The Report is addressed to co-legislators in the EU and to the European public at large and explains how the ESRB delivered on its mandate in that time period. It is considered an important part of the ESRB’s transparency and accountability framework.

In her foreword to the Report, Christine Lagarde, Chair of the ESRB, noted that “the period under review was marked by a challenging macroeconomic environment, significant volatility in financial markets and high geopolitical uncertainty.” She also points to the importance of remaining vigilant and of maintaining, or even increasing, resilience across the financial system.

This update gives a high level overview of the Report.

Financial stability risks

As already noted, risks remained high across the reporting period. The following matters were identified as contributing to this:

• subdued economic growth prospects, falling real estate prices and tight credit conditions led to concerns about borrowers’ debt servicing capacity;
• real GDP growth in the EU slowed in 2023 as the monetary policy response to the high price pressures worked its way through the real economy and the fiscal support provided during the coronavirus (COVID-19) pandemic was gradually phased out;
• high inflation, in combination with higher interest rates, had a dampening impact overall on firms’ investment and on households’ consumption decisions;
• significant volatility in the global bond market in the second half of 2023 also challenged financial stability, particularly for non-bank sectors and investors with high interest rate risk exposures; and
• the war in Ukraine, and the subsequent situation in the Middle East that emerged in the latter part of 2023, contributed to geopolitical uncertainties.
  

Banks in the EU delivered strong profits in 2023 and remained resilient to global banking stress

Some of the matters highlighted in respect of profits and resilience in the banking sector were as follows:

• EU banks’ profits grew due to higher net interest income and a decrease in non-performing loan ratios; and
• the results of the 2023 EU-wide stress test by the European Banking Authority (“EBA”) showed that EU banks would remain resilient under an adverse scenario consisting of a severe EU and global recession, rising interest rates and higher credit spreads. This resilience was also confirmed by the limited impact on EU banks of the banking turmoil in the United States in March 2023.

However, a note of caution is sounded in that regard should be had to the following:

• the full impact of high inflation and the sharp rise in interest rates will only be felt over time;
• interest margins are expected to narrow, consequently reducing the profitability of EU banks; and
• a subdued growth outlook, coupled with tight financing conditions, may lead to a deterioration in asset quality in the longer term.

The Report notes the importance of banks ensuring their resilience in order to endure shocks to an already subdued macro-financial outlook.

Stress-testing exercises

The Report notes the contribution of the ESRB to the money market fund and central counterparty stress tests conducted by the European Securities and Markets Authority (“ESMA”) in 2023, where the ESRB devised adverse scenarios.

March 2023 banking turmoil

As part of its consideration of the interplay between the prevailing economic environment and vulnerabilities across the financial system, the ESRB reflected on potential lessons learned from the banking turmoil in the United States, for example, the implications for banks of interest rate and deposit-run risks.

Cross-sectoral and cross-border work

The following was highlighted:

• the ESRB and the ECB published a joint report on a macroprudential framework for managing climate risk;
• the ESRB and the ECB considered the implications for macroprudential policy of a higher inflation and higher interest rate environment; and
• the ESRB put forward policy suggestions on financial stability risks related to cyber incidents, crypto assets and decentralised finance.

Work on banking sector-specific policies

Such work included:

• contributing to the European Commission’s ongoing review of the macroprudential framework; and
• further work is being undertaken to gain a better understanding of how the concept of a positive neutral rate for the countercyclical buffer is currently being applied by a number of ESRB members.

Common macroprudential stance framework for banks

The ESRB continued to develop the common macroprudential stance framework for banks based on the methodologies first proposed by the ESRB on 2019 and 2021. This framework makes it possible to compare, systematically and quantitatively, financial stability risks against the macroprudential policy measures taken to address them so that each country’s macroprudential policy stance can be assessed as neutral, loose or tight.

Tightening of macroprudential policies in EU member states

The Report sets out that a number of capital-based measures were taken, mostly those relating to o countercyclical capital buffers (“CCyBs”). These were aimed at tightening existing macroprudential policy stances. The Report further notes that systemic risk buffers (“SyRBs”) have declined overall since the pandemic, but this has largely been offset by the building up of countercyclical buffers of a similar magnitude on aggregate.

Regulatory reforms in the non-bank financial sector

Despite calls by the ESRB for regulatory reforms in this sector, the Report notes that little progress has been made. During the review period, the Report sets out that the following occurred:

• EU co-legislators concluded their review of the prudential rules governing investment funds, insurers and central clearing;
• the ESRB engaged with co-legislators on proposals to introduce an active account requirement to help address the concerns it had previously identified about exposures to certain clearing services provided by a number of UK central counterparties;
• the ESRB set out options for addressing risks relating to corporate debt and real estate investment funds from a financial stability perspective;
• the ESRB also published its annual EU Non-bank Financial Intermediation (“NBFI”) Risk Monitor report; and
• the ESRB noted the January 2024 announcement of the European Commission of the launch of a targeted consultation on macroprudential policies for non-bank financial intermediaries at some stage in 2024.