Financial Services Quarterly Report - Fourth Quarter 2019: To Compliance and Beyond: the Central Bank’s Forward View for 2020

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A recent Dechert OnPoint, No Reward for Good Behaviour: The Central Bank’s Approach to Enforcement, examined new guidance of the Central Bank of Ireland (Central Bank) regarding the enforcement process involving non-compliant firms. Returning to the theme of the OnPoint, this article reviews key features of the Central Bank’s recent announcements, to look forward to what may be expected for 2020.

In a 3 December 2019 speech1, Michael Hodson, the Central Bank’s Director of Asset Management and Investment Banking, stated that the Central Bank remained committed to a robust and effective authorisation process, driving firms to achieve a high standard of regulatory compliance. Crucially, Mr Hodson described the Central Bank’s approach as stretching “beyond” compliance.

The industry letters on Closet Indexing (Closet Indexing Letter)2 and on performance fees in UCITS (Performance Fee Letter)3 were early instances where the Central Bank highlighted supervisory issues and poor governance, reminding UCITS boards that they had ultimate responsibility for the UCITS. While these two thematic reviews focused on UCITS, they are indicative of the type of approach the Central Bank likely will apply to the investment funds industry as a whole.

Key Areas of Focus

Key areas pertaining to compliance and sanctions on which the Central Bank will focus in the coming year include:

  • Fund Management Company Effectiveness;
  • Corporate Governance;
  • UCITS Performance Fees;
  • Closet Indexing; and
  • Wholesale Market Conduct Risk

Fund Management Company Effectiveness

The Central Bank introduced the Central Bank (Amendment) Bill 2019, containing a new Senior Executive Accountability Regime (SEAR), intended to supplement the existing Fitness and Probity regime. SEAR will enhance individual accountability of senior managers. In a 16 May 2019 speech4, Gerry Cross, the Central Bank’s Director General of Financial Regulation Policy and Risk, repeated some of the statements that have become familiar to those following the Central Bank’s recent oeuvres. He indicated – raising expectations about the conduct expected of financial firms – that ineffective governance and poor corporate culture contribute to failings in the financial services industry, and that SEAR was born of a need to serve the interests of customers. Initially, SEAR will focus on the banking and insurance industries; however, the Central Bank has indicated that this regime will be rolled out to the asset management industry at a later date.

The recent launch of the Administrative Sanctions Guidance (Guidance)5 demonstrates the Central Bank’s drive to engender a culture shift among investment firms. In a 14 November 2019 speech accompanying the launch6, Derville Rowland, the Central Bank’s Director General of Financial Conduct, explained the Central Bank’s vision for a financial system that deters misconduct, and promotes compliance and high standards. Notably, the Guidance makes it manifestly clear that the Central Bank will not view favourably a firm’s attempt to mitigate misconduct by self-reporting, remediation or cooperation, unless the firm has been exemplary in its behaviour and exceeds the Central Bank’s expectations in regard to how a firm should conduct itself.

FCA Convergence

The Central Bank is not alone among European regulators in introducing senior executive accountability regimes – with effect from 9 December 2019, the Financial Conduct Authority (FCA) has adopted the Senior Managers and Certification Regime (SM&CR) in respect of firms that are regulated solely by the FCA. The SM&CR aims to: reduce harm to consumers; strengthen market integrity; and enhance accountability of individuals within a firm. In the FCA’s 2018 Consultation Paper on its approach to enforcement7, the FCA highlighted the need for consumer confidence in services, as well as improvement in the way the financial system operates. Differing from the Central Bank’s approach, the FCA encourages firms to voluntarily account for and redress misconduct. The Consultation Paper indicates that the FCA will impose lower sanctions on firms as a reward to encourage them to do so.

Corporate Governance

Hand-in-hand with the effectiveness of management is good corporate governance. With the publication of Consultation Paper 86 on delegate oversight (CP86)8 and an industry letter regarding the strict-run Fitness and Probity regime9, the Central Bank looks to improve corporate governance at every level.

Under CP86, boards are required to demonstrate compliance with policies and procedures at all times. In a 7 October 2019 speech10, Mr Hodson indicated that regulatory focus would turn in 2020 to director tenure and director diversity – to date, these have been two areas in which the boards themselves have made the sole determination.

With respect to the Fitness and Probity regime, the Central Bank has found firms to be deficient in their obligations of ongoing cooperation with the regulator, and for failure to self-report issues. In its industry letter, the Central Bank emphasised the importance of compliance obligations under that regime. Given the statements contained within the recent Central Bank speeches referenced in this article, such obligations are likely to become even more significant.

UCITS Performance Fees

Following the Central Bank’s Performance Fee Letter and its review of UCITS performance fees in September 2018, the European Securities and Markets Authority (ESMA) issued a consultation paper: Guidelines on performance fees in UCITS on 16 July 201911, intended to assist in harmonising the way performance fees are charged to UCITS and investors, as well as achieving common standards of disclosure among EU member states. The deadline for responses was 31 October 2019, with guidelines expected to be issued in Q1 2020.

ESMA’s key themes are the same as those in the Performance Fee Letter, in which the Central Bank highlighted supervisory issues and reminded boards of their obligations in respect of effective oversight. Notwithstanding any changes that may be effected by ESMA recommendations in 2020, it is likely that the Central Bank will continue to place the onus for compliance firmly on the board and senior management team of the investment firm, with sanctions for non-compliance.

Closet Indexing

The Closet Indexing Letter referred to instances of poor governance and control by boards, and warned that boards should provide full disclosure and transparency to investors in relation to UCITS management, rather than merely following an index. The importance of the board's supervision serves as a lynchpin for the Central Bank’s other policies.

Wholesale Market Conduct Risk

In March 2019, the Central Bank established a specialist team, the Wholesale Market Conduct Team, and published an industry letter on Wholesale Market Conduct Risk12, which set out the Central Bank’s expectations of how firms should identify, mitigate and manage market conduct risk. The letter’s referential standards include honesty, integrity and accountability, and it emphasises that firms and management teams must: remain proactive; incorporate market risk provisions into their policies and procedures; and train staff regarding the expectations demanded of them under the Fitness and Probity regime.

What to expect in 2020

Mr Hodson stated in his 3 December speech that, in 2020, the Central Bank intends to continue its supervisory work in the key areas of: fund management company effectiveness; errors in investment funds; liquidity risk and leverage in non-banking sector; and conducting engagement meetings and risk assessments in line with its risk-based approach to supervision.

Whatever the outcomes of the Central Bank’s reviews and continued supervision in 2020, such reviews undoubtedly will contain the hallmarks of the Central Bank’s expectations put to firms in 2019, with an emphasis on: self-management; cooperation; and driving investment firms in Ireland to do better, be better, and act in a manner beyond simple compliance.

* The author would like to thank Catherine Adams for her research for this article.

Footnotes

1) Michael Hodson, Speech delivered at EY Funds Forum 2019, Resilience in the face of changing winds.

2) Letter of the Central Bank of Ireland dated 18 July 2019 on Thematic Review of Closet Indexing. For further information, please refer to Dechert OnPoint, Central Bank of Ireland’s Thematic Review of Closet Indexing: A Shot Across the Bow for UCITS Boards?

3) Letter of the Central Bank of Ireland dated 4 September 2018 on Thematic Review of UCITS Performance Fees. For further information, please refer to Dechert OnPoint, UCITS Performance Fees in Ireland: Thematic Review.

4) Gerry Cross, Remarks delivered to ICSA Ireland Conference 2019, Governance beyond Compliance.

5) Central Bank of Ireland, ASP Sanctions Guidance.

6) Derville Rowland, Launch of the Administrative Sanctions Guidance.

7) Financial Conduct Authority, FCA Mission: Approach to Enforcement .

8) Central Bank of Ireland, Consultation on Fund Management Company Effectiveness – Delegate Oversight. For further information, please refer to Dechert OnPoint, Is the Glass Half-Full or Half-Empty? Cemtral Bank Signs Off on CP86 with a Location Rule Compromise.

9) Letter of the Central Bank dated 8 April 2019 on Compliance by Regulated Financial Service Providers with their Obligations under the Fitness and Probity Regime.

10) Michael Hodson, Speech delivered at Asset & Wealth Management Independent Non-Executive Directors’ Day, INEDs – The spirit of challenge and responsibility.

11) ESMA, Consultation Paper: Guidelines on performance fees in UCITS 12 July 2019.

12) Letter of the Central Bank of Ireland dated 11 March 2019 on Wholesale Market Conduct Risk.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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