Federal Reserve: innovation and risk in financial services
Michael S Gibson, the Director of Supervision and Regulation at the Board of Governors of the Federal Reserve System, made a statement on innovation in the financial system and its commitment to responsible supervision and regulation at the Subcommittee on Digital Assets, Financial Technology, and Inclusion of the Committee on Financial Services.
Gibson began by stressing the Federal Reserve’s commitment to responsible innovation within the financial system. He acknowledged the potential benefits of innovation, such as reinforcing the safety and soundness of banks, improving operational efficiencies, reducing costs, and increasing opportunities for financial inclusion. However, whilst acknowledging the positive aspects of innovation, Gibson emphasized too the need to address associated risks. He highlighted the Federal Reserve’s commitment to supervising banks to ensure they operate in a safe and sound manner and in compliance with applicable laws.
Gibson then outlined four overarching principles guiding the Federal Reserve’s approach to supervising and regulating innovation in banking:
- Same risks, same regulation: Activities presenting fundamentally the same risks should be regulated similarly, regardless of the technology or terminology used.
- Noninterference in service offerings: The Federal Reserve does not dictate which customer classes banks can serve, emphasizing compliance with the law rather than restricting specific customer types.
- Transparency in expectations: The Federal Reserve aims to be transparent about its expectations and approaches to novel activity supervision and regulation through various channels including guidance and statements.
- Continuous learning: Regular outreach and engagement with banks, nonbank fintechs, academics, and other stakeholders help the Federal Reserve stay informed about evolving technologies and their impact on the banking sector.
Gibson then covered the recently established novel activities supervision program, which focuses on the risks associated with novel, technology-driven activities at banks. This includes activities involving crypto-assets, distributed ledger technology, and complex partnerships between banks and nonbank fintechs. The program is designed to provide clarity and relevant feedback to institutions to encourage responsible innovation.
Gibson delved into specific areas of focus of the program, including distributed ledger technology, crypto-assets, stablecoins, and complex technology-driven partnerships. He stressed the potential benefits of these technologies while acknowledging associated risks, such as those related to governance, risk management, legal uncertainties, and illicit finance.
He also discussed the Federal Reserve’s guidance on the supervisory non-objection process for banks which will allow the Federal Reserve to verify that a bank has appropriate risk management systems in place to identify and control potential risks with respect to engaging with dollar tokens, or stablecoins. Additionally, Gibson highlighted recent guidance on third-party risk management, emphasizing the importance of managing risks associated with relationships with financial technology companies.
Gibson also acknowledged the growing use of artificial intelligence (AI) in banking for applications like fraud monitoring and customer service. He emphasized the importance of using AI in a safe, sound, and compliant manner, addressing potential risks such as data challenges, explainability, bias, cybersecurity, and consumer protection. He added that the Federal Reserve itself was evaluating technology to enhance its supervision processes.
In concluding, Gibson noted the key balancing act of supporting responsible innovation with all of its benefits whilst remaining “focused on ensuring that any risks associated with novel financial products and services are properly managed.”
ESAs propose amendments to the SFDR draft RTS
The European Supervisory Authorities (ESAs) have released their Final Report, which proposes amendments to the draft Regulatory Technical Standards (RTS) for the Delegated Regulation supplementing the Sustainable Finance Disclosure Regulation (SFDR).
The ESAs have made several adjustments to the draft RTS, including:
- Extending the social principal adverse impact (PAI) indicators and modifying the PAI disclosure framework.
- Introducing a new financial product disclosure of greenhouse gas (GHG) emission reduction targets.
- Improving and simplifying the financial product templates in Annexes II-V of the SFDR Delegated Regulation, including a new “dashboard” with a simple summary of key information.
- Enhancing the disclosure of how sustainable investments comply with the “do not significantly harm” (DNSH) principle.
- Revising the provisions for products with investment options such as multi-option products (MOPs).
- Other technical changes, including harmonizing the calculation of sustainable investments and requiring the disclosures to be produced in a machine-readable format.
The European Commission will review the draft RTS and decide whether to endorse them within three months of the ESAs’ publication. These draft RTS will be applied independently of the comprehensive assessment of SFDR announced by the European Commission in September 2023, and any changes resulting from that assessment will be introduced later.
FCA outlines roadmap for financial services firms for next two years
The Financial Conduct Authority (FCA) has published its regulatory initiatives grid for November, which outlines the regulatory roadmap for financial services firms across sectors for the next two years. Some of these initiatives were already included in the February Grid. The review of securitization regulation and Solvency II is still ongoing. The Consumer Duty has been introduced, and work is still in progress to improve depositor outcomes and regulate Buy Now, Pay Later products. The grid also includes changes in the timetable for existing initiatives. One notable change is the amended implementation timetable for Basel 3.1 standards, which has been delayed by six months. A dedicated section has also been included to help firms navigate the Future Regulatory Framework (FRF) and the Government’s plans for repealing and replacing retained EU law (REUL).
Most importantly, the grid includes various new initiatives that are specific to certain sectors or industry-wide, which we will cover below.
It is no surprise that ESG, Consumer Protection, Data Protection, and Financial Resilience are key topics in new multi-sectoral initiatives.
- ESG: the FCA plans to monitor the Task Force on Climate-Related Financial Disclosures (TCFD-aligned disclosures) and publish findings in 2024. The FRC will review the UK policy and regulatory framework for effective stewardship, supported by The Department for Work and Pensions (DWP), FCA, and The Pensions Regulator (TPR). A Discussion Paper is expected to be published in H2 2024.
- Consumer protection: the Treasury is banning cold calling for consumer financial services and products. It will also extend the pensions cold calling ban to cover cold calling for all consumer financial services and products. The FCA will conduct a post-implementation review of the guidance for firms on the fair treatment of vulnerable customers in 2024. The aim is to publish the final report by the end of 2024. The FCA is also developing proposals to improve complaints reporting. This will enable the regulator to better assess whether firms are putting things right themselves, spotting issues earlier, and supporting assertive interventions.
- Data protection: the Information Commissioner’s Office (IOC) will issue guidance to provide an overview of how data protection law applies when using biometric data and biometric technologies. The first phase of the final guidance is due to be published in Spring 2024. This guidance’s second phase, which will focus on biometric classification and data protection, including a call for evidence, will be published in Spring 2024.
- Financial resilience: with the System-Wide Exploratory Scenario Exercise (SWES), the Bank of England aims to investigate the behaviors of banks and non-bank financial institutions under stress. It will also explore how these behaviors can amplify market shocks, potentially bringing risks to UK financial stability. The Bank is working closely with the FCA and TPR on this. Firms will run round 1 of the scenario phase between November 2023 and January 2024. Firms will run round 2 of the scenario phase in mid-2024, with the final results published in H2 2024. BoE, FCA, HMT, and the Prudential Regulation Authority (PRA) will also focus on securing a fair, clear, orderly transition from LIBOR to robust, reliable, and clean alternative risk-free rates. At the end of March 2024, the Synthetic 3-month sterling LIBOR setting is intended to cease. At the end of September 2024, Synthetic 1-, 3-, and 6-month US dollar LIBOR settings are intended to cease. UK authorities will continue to work closely with international counterparts to monitor the transition from synthetic settings in legacy contracts.
The Grid also outlines specific initiatives relating to specific sectors, including banking, credit and lending, payments and crypto assets, insurance and reinsurance, investment management, pensions and retirement income, and wholesale financial markets.
- Banking, credit and lending: there are a number of regulatory revisions, new regimes and perimeter adjustments. The grid includes four new entries, including reviews of the cash savings market and debt advice rules.
- Payments and crypto assets: there are four new initiatives, including reforms to the Payment Services Regulations to strengthen rules on provider-initiated terminations and work to manage the failure of systemic digital settlement assets.
- Insurance and reinsurance: most initiatives are sector reviews to enhance the regulatory framework. This includes work on the authorization and supervision of insurance branches and increasing confidence in solvent exit from the sector.
- Investment management: there are four initiatives, including the ongoing review of the UK’s funds regime and Overseas Funds Regime and a new entry following the establishment of a technology working group looking at fund tokenisation.
- Pensions and retirement income: there are a variety of initiatives amending and consulting on rules, regulations, and codes of practice to ensure that consumers are protected and informed about their pensions.
- Retail investment: there are two initiatives, including reforms to financial promotion exemptions and new work related to the advice guidance boundary review.
- Wholesale financial markets: there are three new initiatives in this section of the Grid on the Intermittent Trading Venue Sandbox, PRA/FCA consultation on margin requirements for non-centrally cleared derivatives and next steps following the recommendations of the Investment Research Review.
The Grid provides much-needed support to firms as the UK revamps its regulatory framework. By improving the accessibility of the Grid, which is available in various formats, regulators are demonstrating their commitment to collaboration with the industry. A dedicated feedback tool on the Grid webpage is also available to improve future editions.
FCA consults on commodity derivatives
The Financial Conduct Authority has published Consultation Paper CP23/27: Reforming the commodity derivatives regulatory framework.
The consultation is part of the broader Wholesale Markets Review (WMR), which is the review of UK wholesale financial markets and sets out the regulator’s proposals concerning the key pillars of the commodity derivatives regulatory regime, which are as follows:
- Setting of position limits by trading venues
- Applying position limits only to certain commodity derivatives contracts
- Enhanced position management controls and reporting
- Exemptions from position limits
- Ancillary activities test (AAT)
The deadline for comments on the CP is 16 February 2024.
FCA publishes final report into credit information market
The Financial Conduct Authority has published Market Study MS19/1.3 Credit Information Market Study Final Report which outlines its plans to improve the current processes by which retail lenders and wider financial services assess consumers’ financial standing, verify identity, reduce financial crime and make informed decisions.
The final report outlines the proposed remedies, grouped into four themes:
- Industry governance – reform of industry governance arrangements to help deliver key measures and provide greater transparency and accountability.
- Data quality – improving the coverage, quality and consistency of credit information to help deliver better outcomes.
- Consumer awareness and engagement – support for consumers to improve awareness of and access to credit information.
- Competition and innovation – potential changes to foster greater competition and innovation.
In order to facilitate the changes required, the FCA is proposing new governance arrangements – the Credit Reporting Governance Body (CRGB) – to oversee the development and implementation of some of the remedies. As a preliminary step to setting up the CRGB, the FCA has formed an Interim Working Group (IWG) under an independent chair which will launch in January 2024 and will run for most of 2024. A number of new consultation papers will be published durting the same time frame which will set out the regulator’s full proposed rules to address the various concerns they have found in the credit information market.
ESAs release interactive factsheet on sustainable finance
The three European Supervisory Authorities (EBA, EIOPA and ESMA – ESAs) have published an interactive factsheet that answers consumers’ most frequently asked questions about sustainable finance. The factsheet provides tips to consumers considering buying financial products with sustainability features, including loans, investments, insurances and pensions.
The factsheet has been translated in all EU languages, and the ESAs are working with national supervisory authorities to help promote it across the EU.
The evolving regulatory landscape in Australia
ASIC chair Joe Longo spoke at the Australasian Investor Relations Association Forum about the evolving regulatory landscape in Australia.
Longo began his speech by emphasizing the importance of maintaining strong relationships with shareholders and potential investors for publicly traded companies. He highlighted the significance of two key tools in investor relations: transparency and engagement and went on to discuss three areas where greater transparency and engagement are needed and useful.
- Continuous disclosure: Longo delved into the critical area of continuous disclosure, stressing its fundamental role in maintaining market integrity and ensuring equal access to information. He provided examples of recent cases, such as the significant penalty against GetSwift Limited and ANZ’s breach of continuous disclosure laws. Longo urged companies to proactively manage information during fundraising and control transactions to prevent leaks or mishandling.
- Sustainable finance: Moving on to sustainable finance, Longo discussed recent developments in standards for sustainability-related disclosures. He mentioned the International Sustainability Standards Board’s (ISSB) standards and the Australian government’s proposed sustainable finance strategy, including the establishment of a framework for sustainability-related financial disclosures. Longo stressed transparency as a key focus in this space and encouraged companies to engage with proposed climate disclosure requirements to build trust. He ended this section by referencing ‘greenwashing’, where the Australian regulator has been particularly active this year with Longo warning “so it’s up to you to make sure you can and do substantiate any and all claims relating to sustainable finance”.
- Stakeholder responsibility and activism: Longo next turned to the role of shareholders and potential investors in holding company boards accountable. He emphasized the importance of transparency and engagement in shareholder-company relationships, pointing to the AGM as a primary formal means for shareholders to engage. Longo also discussed the broader community’s role in making company boards accountable and highlighted the two-strike rule on executive remuneration as an example of shareholder influence.
In his concluding remarks, Longo reiterated the central role of transparency and engagement in business and investor relations. He emphasized the importance of these principles in continuous disclosure obligations, sustainable finance reporting, and shareholder responsibility and activism.
A selected summary of key developments for regulated financial institutions
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