The Infrastructure of Securities Markets Regulation - Colm Kincaid, Director of Securities and Markets Supervision

Remarks delivered at Financial Market Infrastructure Summit

Good morning. I am very grateful to the organisers of the Financial Market Infrastructure Summit for the opportunity to speak to you today, to share some thoughts from a regulator’s perspective.

In my remarks, I will spend some time discussing EU and international developments in the regulation of market infrastructure, the role that innovation has played, and the implementation of EU legislation such as MiFID II, EMIR, SFTR and CSDR.

But first, I want to say a few words about the Central Bank of Ireland itself.

The Central Bank’s Mission

Our mission is to serve the public interest by safeguarding monetary and financial stability and working to ensure that the financial system is operating in the best interests of consumers and the wider economy. Put more simply, we serve the public good.

The Central Bank of Ireland has a very broad mandate to do this, being a central bank within the eurosystem as well as a prudential and conduct regulator across all sectors of financial services.  

We regulate over 10,000 financial service providers operating in Ireland, ranging from banks (where we also operate as part of the Single Supervisory Mechanism with the ECB), to non-bank retail lenders, to MiFID firms, to funds and fund service providers, insurance and reinsurance undertakings, payment and e-money institutions and a wide range of retail intermediaries who provide advice and other services to consumers. A considerable portion of the firms we authorise and supervise passport their services across the EEA and, indeed, provide their services around the globe.

With such a broad mandate, we have a keen interest in how the various financial services firms and sectors interact and support one another – all with the goal of ensuring that the financial system as a whole operates in the best interests of consumers and the wider economy.

To this end, when we look at supervising conduct on securities markets, we consider what we see through the lens of our five principles for a properly and effectively supervised securities market. Under these principles, we see a properly and effectively supervised securities market as one that:

• Provides a high level of protection for investors and market participants.
• Is transparent as to the features of products and their market price.
• Is well governed (and comprises of firms that are well governed).
• Is trusted by both those using the market to raise funds and those seeking to invest.
• Is resilient enough to continue to operate its core functions in stressed conditions and to innovate appropriately as markets evolve.

The role of regulation

So how well are these principles being achieved by the infrastructure for securities markets, and how is regulation contributing to that?

The first thing to point out is that the role of making sure that securities markets infrastructure does what it says it will do rests with the operators of that infrastructure. This includes ensuring that the infrastructure can continue to perform in times of market stress, as the principles I have listed state. Firms need to take as their starting point therefore, not the minimum legal requirements of regulation, but rather their obligations to their customers and the integrity of the market as a whole. This includes being transparent about the service they provide and how they make money from that service, and to provide that service to the highest possible standard.

The five principles I have outlined above should guide firms in doing this.

Nevertheless, it is fair to say that regulation has had a greater role to play in shaping the infrastructure that supports securities markets in the years since the financial crisis than it may have done in the past. If we take for example MiFID II’s abolition of broker crossing networks, limitations on dark pool trading and the trading obligations, we see EU regulation intervening to bring the majority of trading across Europe on-venue. These rules are altering the very structure of securities markets in Europe (Grant Thornton,2017).

As the Chair of ESMA recently remarked, the MiFID II transparency regime is about providing the right amount of transparency which contributes to efficient price formation and to a level-playing field between the different types of trading venues while avoiding adverse market impact (Maijoor, 2018).

Regulation is also changing the breadth and nature of regulators’ scope of responsibility. To take just one example in our own case in Ireland, the ability of firms to opt into the systematic internaliser regime has resulted in Ireland moving from a position where we had no systematic internalisers under MiFID I to a position where we now have nine systematic internalisers notified to us. We have had to evolve our own expertise and supervisory approach in the face of these developments and also as we see new types of MTF and OTF venue establish in our jurisdiction.

We also see the extent to which regulation has sought to bring greater transparency to securities markets by requiring ever more trading data to be reported to regulators. Indeed, we see provisions of the regulatory framework which are based directly off the back of such reporting – such as the double volume cap. Requirements such as the EU trading obligations and the double volume cap can be seen as examples where regulation itself has come to form a part of the day-to-day trading ‘infrastructure’ within which firms operate.

And the scale of this regulatory intervention continues to grow, as we look ahead to the forthcoming reporting obligations of SFTR and as we both embed and evolve the EMIR regime.

EMIR

Following on from the original regulation in 2012, EMIR 2.1 and 2.2 are key pieces of legislation which will have a significant impact on financial conduct and market infrastructure arrangements on the international stage. Particularly, the implementation of EMIR 2.2 will impose new rules on the classification and supervision of CCPs, and it will establish the CCP Supervisory Committee to manage the new tiering system of classification for third country CCPs and promote supervisory convergence.

Discussions are ongoing to develop more stringent regulations to promote financial stability in the event of a CCP failure, and overall transparency in the market. And it is not just legislators or regulators who see the need for enhancement here. Last month, a review by several major firms (BlackRock et al, 2019) identified that, while CCPs have undoubtedly played an important role in protecting market participants from counterparty losses in the face of market shocks, issues remain in terms of resilience, recovery and resolution.

At the same time as we evolve the EMIR regime, we continue of course to supervise compliance with its existing requirements. In our EMIR Letter to Industry earlier this year, the Central Bank of Ireland provided feedback on the main issues identified from a review of EMIR data quality we undertook in 2018. This has given opportunity for appropriate actions to be taken to ensure complete, accurate and timely reporting going forward. The letter was the culmination of a series of data quality checks on reported EMIR data focused on the extent to which reporting complies with EMIR and related implementing and technical regulations and guidance. Key takeaways of general relevance include the need for boards to focus on oversight of reporting, especially where the reporting tasks have been delegated to third parties. This includes making reporting a standing agenda item at board meetings.

Supervisory Convergence

Even as we concluded our own review of EMIR data quality, together with other National Competent Authorities and ESMA, we also continued our work to achieve a more coordinated approach to EMIR supervision at an EU level. This culminated with the publication last month of the outcome of the ESMA peer review into supervisory actions aimed at enhancing the quality of data reported under EMIR (ESMA, 2019). The insights from this review will inform our continued development of a more consistent and coordinated EU supervisory approach.

Indeed, whether it be data quality under EMIR or any other topic, there is now a concerted momentum to put in place more structured and targeted mechanisms to raise supervisory standards, and to drive EU supervisory convergence in securities markets. At the Central Bank of Ireland, we consider this work essential to the delivery of our mandate in a context where we are seeing a European securities market emerge that is more fragmented and has more complex interconnections, with a corresponding need for greater cooperation amongst EU competent authorities in order to avoid regulatory arbitrage.

As with all our work of course, we face the challenge of finite resources. This means that, on supervisory convergence as elsewhere, we need to adopt an ever more systematically risk-based approach to how we identify those areas where supervisory convergence is most important.

SFTR

Recently, ESMA published further technical details for the reporting of securities financing transactions as required under SFTR. This includes the validation rules applicable to SFTR reports, and details of the requirement for technical standards as well as a specified trade or position level. It also includes the XML schemas reporting entities should use, including Counterparty and TR data exchange; Intra-TR data exchange; and TR to authority data exchange. As practitioners, we can get caught up in the technical detail of such requirements, and the burden they place on reporting entities and regulatory authorities alike. However, we must always bear in mind the reminder in the Recitals to SFTR itself of the gaps and shortcomings revealed by the global financial crisis, which SFTR seeks to overcome. It is critically important that the SFTR regime is successful in doing so, in what has become such a vital component of international financial markets, providing liquidity and greater flexibility to securities markets and to those who use them.   

While the SFTR transaction reporting regime has yet to go live, the SFTR pillars on collateral reuse, and on disclosure and transparency towards investors, already apply. What we have seen to date shows scope for improvement in order to make disclosures more comprehensive (particularly around costs) and to adopt formatting and content that investors can more easily understand. We have already had cause to engage with a number of firms on this front. Firms should expect greater scrutiny and challenge on the treatment of fees and income received from stock lending activities. 

CSDR

Continuing on the theme of regulation enhancing our oversight of market activity, the CSDR mandated reporting of settlement internalisers, which commenced over the summer, has provided valuable insights into the level of settlement which is occurring outside of securities settlement systems. This now forms yet another component of our understanding of market activity, and how the various aspects of that activity combine to form the infrastructure of securities markets.

The Role of Innovation

I have spoken at some length this morning about the reporting obligations of a number of key pieces of the EU regulatory fabric. This is reflective of the extent to which we are now truly in the age of data driven supervision. In my own area of the Central Bank of Ireland alone for example, we take in more than 6 million reports on trading activity every day. And we are by no means a large regulator.

We depend on technology to take in this data and turn it into visual forms that we can interrogate in order to do our job. Technology and data science are at the core of our basic day-to-day supervisory activity. Moreover, with the rise of algorithmic trading, we are increasingly not only using technology to supervise, but also in fact supervising technology itself – what I have referred to before as supervising not just the conduct of humans but also the conduct of machines.

It is imperative therefore that financial service providers understand the implications of the technology they use, and appreciate that they bear the responsibility for those implications. Effective use of technological innovation can bring benefits, in particular of course to increase transparency for users of securities markets. It can also enable firms to proactively monitor, identify, and correct situations that can lead to poor outcomes. But firms must also ensure they are innovating responsibly and staying alive to any potential risks and downsides when introducing greater levels of technological intervention into the operation of their business (Maijoor, 2019).

Global Standards

Before concluding, I would like to say a few words about the importance of global standards in the securities markets infrastructure and in that regard also the question of equivalence.

I want to start by highlighting the importance of industry initiatives to develop standards at a global level. These initiatives can play a powerful role, as we see in the work of the FICC Market Standards Board (FMSB) and the Global FX Code (FX Global Code, 2018), to name two examples. We also see of course the progress made by bodies such as ISLA and ISDA in securities lending and derivatives markets. In particular, industry standards can get to the heart of day-to-day practical issues in a way that is innovative and agile.

However, public bodies of course have a role to play here also. Indeed, the EU EMIR and SFTR regimes to which I have referred are themselves the implementation of a policy response to work at global forums such as the FSB. As such, they form part of a globally coordinated effort to increase transparency and reduce financial stability risks. It is worth keeping this in mind as we navigate the technical detail of these regimes.

These wider global public policy goals should also be a compass bearing for you when you grapple with questions of interpretation.

The recognition of equivalence

With over 120 EU equivalence decisions in the area of securities markets (Maijoor, 2019) across various legal frameworks and jurisdictions, public authorities in the EU and elsewhere have shown leadership in promoting market access supported by coordinated standards. A large number of third country market participants, like trading venues, CCPs, and CRAs, can do business in the EU while the EU relies on their home country regulation and supervision (Maijoor, 2019). Moreover, the EU continues to evolve its regulatory framework with the global aspect of financial market infrastructure in mind. I have spoken already of the evolution of the EMIR regime for third country CCPs. Also, from a Benchmarks Regulation perspective, ESMA’s duties will be enhanced by the ESAs Review legislative text to include not just the supervision of EU critical benchmarks but also the supervision of third country administrators recognised in the EU (Maijoor, 2019).

Brexit

One cannot speak about the infrastructure for securities markets in an EU context and not mention the impending change to that infrastructure that will arise from the UK leaving the EU.

An enormous amount of work has been done by public bodies across the EU, including the Central Bank of Ireland, with a view to ensuring that securities markets can continue to operate up to and over the course of the UK leaving the EU – when of course the UK would go from being an EU member at the heart of the EU securities market infrastructure to being a third country. This work includes being prepared for the event of a ‘no deal’ or ‘hard Brexit’, and has ranged from extensive supervisory engagement to ensure regulated financial service providers have the necessary contingency plans in place, to the assessment of applications for authorisation by firms seeking to establish in an EU 27 Member State. It has also involved decisions such as that of European authorities to allow the use of a UK CSD to continue until 29 March 2021, in the event that the UK leaves the EU without a withdrawal agreement.

As Central Bank of Ireland Deputy Governor, Ed Sibley, has noted ‘While we may be reaching the end of the beginning, a ‘hard Brexit’ is still sufficiently plausible to require planning’ (Sibley, 2019). Financial service providers still have a duty of care to their customers and the market as a whole to take advantage of the extra time available now to continue to prepare for the UK’s departure from the EU.

Conclusion

To conclude, there are many ways for a regulator to describe its mission. At the Central Bank of Ireland, we say we are here to serve the public interest, by safeguarding monetary and financial stability and by working to ensure that the financial system operates in the best interests of consumers and the wider economy. This includes having regard to the five principles of a proper and effectively supervised securities market, which I outlined earlier, and working together with other regulatory bodies across the EU and around the world to continue to evolve the rulebook and coordinate how we supervise it. We have made a lot of hard won progress in this regard in the years since the financial crisis. However, it is fair to say that as we are only now starting to see these new legislative regimes take root.

We still have a long way to travel.

I believe our success in the coming years will be marked by the extent to which firms can provide ever more meaningful transparency to investors and market participants. It will also be marked by how well we can make all these various legislative regimes and international standards combine to support one another in creating what you might call the ‘infrastructure’ of securities markets regulation.

I thank you for your attention and, once again, thank the organisers of today’s event for the opportunity to speak to you.

_________

I want to thank Alice Ryan, Stephen Clifford and Cian Congdon for their assistance with these remarks.

Grant Thornton, 2017. MiFID II - Microstructure and trading obligations.

Maijoor, Steven, 2018. The state of implementation of MIFID II and preparing for Brexit. Speech delivered to WFE Annual Meeting 2018. 3 October 2018.

BlackRock, Goldman Sachs, JPMorgan Chase & Co., Allianz, Citi, Societe Generale, State Street, T. Rowe Price, and Vanguard (2019). “A Path Forward for CCP Resilience, Recovery, and Resolution” 24th October 2019.

ESMA (2019). “Final Report: Peer review into supervisory actions aiming at enhancing the quality of data reported under EMIR” 17 October 2019.

Maijoor, Steven, 2019. “Building the EU Capital Markets Union while fostering global financial markets” Speech delivered at ASIFMA Annual Conference, 10 October 2019.

FMSB. “FICC Markets Standards Board”.

FX Global Code, 2018. “A set of global principles of good pracctice in the foreign exchange market” August 2018.

Maijoor, Steven, 2019. “Building the EU Capital Markets Union while fostering global financial markets” Speech delivered at ASIFMA Annual Conference, 10 October 2019.

Ibid.

Maijoor, Steven, 2019. “Ongoing reforms and challenges ahead”. Speech delivered to Conference on adaptation of interest rate benchmarks to the new European regulation on benchmarks, 29 October 2019.

Sibley, Ed, 2019. “Brexit - the end of the beginning?” Speech delivered at DCU Brexit Institute, 30 October 2019.