Eva Dauberton
News Editor
ESMA issues May newsletter
The European Securities and Markets Authority (ESMA) has released the latest edition of its ‘Spotlight on Markets’ newsletter. The newsletter contains factsheets highlighting key events during the month, including:
- Position Paper on building more effective and attractive capital markets in the EU.
- Statement providing initial guidance to firms using Artificial Intelligence technologies (AI) when they provide investment services to retail clients.
- Final report containing Guidelines on funds’ names using ESG or sustainability-related terms.
- Final report on the rules on conflicts of interests of crypto-asset service providers (CASP) under the Markets in Crypto Assets Regulation (MiCA).
- Combined report on 2023 Common Supervisory Action (CSA) and the accompanying Mystery Shopping Exercise on marketing disclosure rules under MiFID II.
- Statement reminding issuers about the applicable legislative framework to “pre-close calls”.
- Statistics on Securities and Markets (ESSM) Report
- MiFIR review consultation package
- Call for evidence on the review of the Undertakings for Collective Investment in Transferable Securities (UCITS) Eligible Assets Directive (EAD).
The newsletter also includes a factsheet on "Discontinuation of ratings: What ESMA expects from Credit Rating Agencies”.
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US Treasury seeks input on AI use in the financial sector
The US Department of the Treasury (Treasury) has issued a request for information (RFI) regarding the development and application of artificial intelligence (AI) in the financial sector. The aim of this RFI is to better understand the current use of AI in financial services, its impact, and potential challenges. Additionally, the Treasury is seeking recommendations on how to improve legislative, regulatory, and supervisory frameworks related to AI in financial services.
This initiative builds on the Treasury's previous efforts in this area. Earlier this year, they released a report on AI and cybersecurity and issued their 2024 National Illicit Finance Strategy, which highlighted the potential of AI in strengthening anti-money laundering and countering the financing of terrorism compliance.
Various agencies are also working together to stay ahead of AI's evolving use. In January 2024, the Commodity Futures Trading Commission (CFTC) sought feedback on the current and potential uses and risks of AI in CFTC-regulated derivatives markets. Similarly, in July 2023, the Securities and Exchange Commission (SEC) proposed a rule to address conflicts of interest related to the utilisation of predictive data analytics and AI by broker-dealers and investment advisers.
Janet L Yellen, the Secretary of the Treasury, provided insight into the Treasury work at the Financial Stability Oversight Council Conference on Artificial Intelligence and Financial Stability. She acknowledged the challenges ahead, stating, “As we look to address AI-related risks, we are not starting from scratch or seeking to reinvent the wheel. [..] That said, there are also new issues to confront, and this is a rapidly evolving field. We have our work cut out for us and are pursuing a variety of initiatives to identify and address emerging risks.”
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APRA releases final prudential practice guide for operational risk management
The Australian Prudential Regulation Authority (APRA) has released its final prudential practice guide: CPG 230 Operational Risk Management (CPG 230). This guide is intended to support banks, insurers, and superannuation trustees in implementing the new cross-industry prudential standard CPS 230 Operational Risk Management (CPS 230).
Some context
CPS 230 outlines the minimum standards for managing operational risk, including updated requirements for business continuity and service provider management. These baseline expectations apply to all entities, and it is expected that firms will continuously improve their practices as their business operations expand, aligning them with the scale of their risks and their role in the financial system.
Key takeaways
CPG 230 provides guidance to meet CPS 230 enforceable requirements and is aligned with the sections set out in the standard.
APRA has made several changes since the consultation on the guidance. These include:
- Shortening of the guidance and greater focus on meeting expectations set by the standard.
- Non-significant financial institutions have an additional 12 months to comply with certain requirements in CPS 230 relating to business continuity and scenario analysis.
- Inclusion of a “day one” checklist for entities to assist in their implementation of the standard.
- Providing a three-year forward plan of its intended approach to supervising the standard to assist the industry with implementation and planning.
Next steps
CPS 230 will come into effect on 1 July 2025.
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BIS and MAS unveil platform blueprint to help regulators manage climate risks
The Bank for International Settlements (BIS) and the Monetary Authority of Singapore (MAS) have announced the publication of a platform blueprint as part of Project Viridis. This platform aims to integrate regulatory and climate data to help financial authorities identify, monitor, and manage climate risks in the financial system.
Some context
Project Viridis was first announced in 2022 as part of BIS Innovation Hub’s workplan. It is built on the premise that insights on climate risks could be drawn from existing data sources, providing supervisors with a better understanding of entities exposed to climate-related financial risks and potential systemic exposure to sectors and geographies.
Key takeaways
The Viridis climate risk platform prototypes the development of several features:
- Provision of banking/financial system-wide and financial institution-level views of financed emissions, with breakdowns by countries and industry sectors, and their trajectories under various scenarios.
- Consolidation of reported and modelled emissions of entities that are key financial institutions’ counterparties.
- Mapping of the geographical distribution of entities’ assets to assess their transition risk exposure arising from changes in carbon pricing policies and exposure to different physical hazards.
Next steps
As an exploratory project, Project Viridis serves as a starting point and a foundation for continued intensive development. It could also help supervisors identify their data gaps and explore ways to collect such data from supervised banks.
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HKMA Chief Executive discusses the importance of safeguarding financial security
Eddie Yue, Chief Executive of the Hong Kong Monetary Authority (HKMA), recently delivered a speech at the National Security Legal Forum in Hong Kong. In his address, he emphasised the critical relationship between financial security and the development of the financial sector.
“The financial industry is an important pillar of Hong Kong’s economy.”
Yue highlighted the pivotal role of Hong Kong’s financial industry in the economy, stressing its significance at both local and global levels. He underlined that any instability in Hong Kong’s financial system could have widespread implications, affecting not only the local market but also the international arena.
“At the HKMA, our primary mandate is to maintain the stability and integrity of Hong Kong’s monetary and financial systems.”
He also discussed the HKMA’s essential role in maintaining financial stability and resilience through, among other initiatives, close monitoring of banks’ management of liquidity and market risks and maintaining supervisory efforts on bank lending.
He noted that liquidity and capital ratios well above international standards were a key reason why Hong Kong was unaffected by multiple banking crises taking place elsewhere, including, most recently, the US and European banking turmoil last year.
“If left unchecked, rumours [could] create a favourable backdrop for speculative attacks on our financial system.”
Yue also addressed the importance of confidence in maintaining financial stability, highlighting the need for effective communication with market participants and the public to address potential concerns and misconceptions about Hong Kong’s future as an international financial centre. Reflecting on the social unrest in 2019 and its impact on the financial system, Yue emphasised the significance of legislation such as the National Security Law and the Safeguarding National Security Ordinance in enhancing stability.
“The onus is on us to make the most of it and bring Hong Kong’s financial sector to the next level.”
He also outlined the key factors that contribute to making Hong Kong an international financial centre, including resilience, ecosystem, and opportunity. He highlighted Hong Kong’s strengths, such as its bilingual legal system, independent judiciary, regulatory regime, and talent base. Additionally, he emphasised Hong Kong’s positioning in capturing the growth in emerging areas such as sustainability and FinTech.
In conclusion, Yue stressed the importance of a safe and stable operating environment for businesses in today’s complex global landscape. He reaffirmed the HKMA’s commitment to staying vigilant against potential and emerging risks to financial security and stability and enhancing the regulatory framework to meet evolving market needs and international standards.
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ECB on banking supervision amidst evolving risks
In a speech at the Bundesbank Symposium, Claudia Buch, Chair of the Supervisory Board of the European Central Bank (ECB), spoke of the necessity for supervisory practices to evolve in response to rapidly changing risks in the banking sector.
Evolving risk landscape
Buch began by acknowledging the profound economic and societal impacts of recent major shocks, including the COVID-19 pandemic, the Russian invasion of Ukraine, the energy crisis, rising inflation, and the turbulence in international banking markets during March 2023. These events, she said, have altered the risk environment for banks significantly. Moreover, long-term challenges such as climate change, digitalisation, and heightened geopolitical risks continue to drive structural changes in the real economy and financial system.
She proposed that these evolving risks necessitate a parallel evolution in supervisory practices to maintain the resilience and stability of the banking sector.
Achievements and challenges in European banking supervision
Marking the tenth anniversary of the European banking supervision system, Buch reflected on the achievements of the Single Supervisory Mechanism (SSM). Established in response to the global financial crisis and the European sovereign debt crisis, the SSM has harmonised supervision across Europe, delivering effective oversight through a consistent framework built on national best practices.
Using Germany as an example, Buch noted that the ECB directly supervises 25 significant banks, while the Federal Financial Supervisory Authority (BaFin) and the Deutsche Bundesbank oversee more than 1,000 less significant institutions (LSIs), accounting for 40% of the domestic market. This collaborative supervision model, involving Joint Supervisory Teams (JSTs) led by the ECB, underscores the importance of robust national supervision.
Resilience in the European banking sector
Buch outlined several factors she felt had contributed to the increased resilience of European banks over the past decade:
- Reduction of legacy risks: Non-performing loans (NPLs) have declined significantly, from more than 7% in 2015 to less than 2% in 2023, due to better macroeconomic conditions, supervision, regulatory frameworks, and loan workouts. These had been “the bane of the European banking system”.
- Improved capitalisation: The aggregate Common Equity Tier 1 (CET1) ratio for banks increased from 12.7% in 2015 to 15.6% in 2023, driven by post-crisis regulatory strengthening. However, the leverage ratio increased marginally from 5.3% in 2016 to 5.6% in 2023.
- Robust liquidity: Banks' liquidity coverage ratio improved from 138% in 2015 to 158% in 2023, emphasising the importance of effective liquidity risk management in the current environment of monetary tightening and geopolitical uncertainties.
- Enhanced governance and risk management: Despite progress, Buch stressed that more needs to be done to improve internal governance and strategic steering, which remain top supervisory priorities.
Adapting to new risks
Buch also highlighted the necessity for banks to focus on forward-looking risk assessments and sustained resilience, including capital, liquidity, and operational resilience. She identified several evolving risks:
- IT and cyber risks: Reported cyber incidents at European banks doubled from 2022 to 2023, with increasingly sophisticated attacks posing significant financial, reputational, and legal implications. The ECB has prioritised this area, and results from the 2024 cyber resilience stress test will be published later this summer.
- Climate change: Achieving climate neutrality requires structural changes in the economy, affecting CO2-intensive activities and the financial sector. Banks need to adapt to these changes, which include the growing importance of non-bank financial intermediaries and digitalisation.
- Emerging NPLs: New non-performing loans are materialising slowly, with visible increases in commercial real estate and loans to small and medium-sized enterprises (SMEs). Banks must account for this emerging deterioration in asset quality and increase their provisioning flows.
Reforming ECB banking supervision
To enhance the efficiency and effectiveness of supervision, the ECB's Supervisory Board has implemented several reforms, which Buch outlined as follows:
- Focusing risk assessments: A multi-year approach allows for assessments to be spread over a four-year cycle, making supervision more proportionate and targeted.
- Integrating supervisory activities: Improved coordination of supervisory activities, such as on-site inspections and thematic reviews, ensures a comprehensive assessment of bank risks.
- Utilising the full supervisory toolkit: A more effective and intrusive use of supervisory tools will ensure that risks are mitigated promptly. This includes issuing binding qualitative requirements and enforcement measures when necessary.
- Enhancing communication: Clear and concise communication with banks, including focused Supervisory Review and Evaluation Process (SREP) decisions and executive letters, will outline supervisory expectations and necessary remedial actions.
- Stabilising methodologies: Simplifying and stabilising existing methodologies will enable supervisors to focus on novel risks, ensuring consistent and robust supervision.
- Leveraging IT systems and analytics: Continued investment in IT systems and data analytics will improve supervisory efficiency and quality.
Buch concluded that while the risk environment is evolving, supervision must evolve in tandem. The ECB's reformed SREP aims to make supervision more efficient, effective, and intrusive, without compromising its core objective of ensuring banks remain safe and sound.
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