Special Report 57 - The Financial Regulator
Published on 31 May 2007
Summary of Findings
The Financial Regulator is the body charged with overseeing the regulation of most forms of financial services provision in Ireland. It was established on a statutory basis in May 2003, and forms part of the Central Bank and Financial Services Authority of Ireland. Its establishment drew together regulatory functions previously carried out by the Central Bank, the Department of Enterprise, Trade and Employment, the Registrar of Friendly Societies and the Director of Consumer Affairs.
The Financial Regulator has a two-part mandate
- a prudential mandate — under which it aims to foster sound, dynamic financial institutions in Ireland by: disseminating guidance and standards to be followed by financial services providers; controlling market entry; ongoing supervision of licensed financial services providers through analysis of periodic returns and selective reviews and inspections of financial service providers; and enforcement of standards, where necessary.
- a consumer mandate — under which it aims to help consumers to make informed financial decisions in a safe and fair market, mainly by: setting business conduct standards and checking they are adhered to; and publishing information to help consumers choose service providers and the services appropriate to their particular circumstances.
This examination looked at all the areas of activity of the Financial Regulator since its establishment. It focused in particular on
- how the Financial Regulator sets standards and provides guidance to financial service providers, particularly in relation to promulgation of EU single market measures
- the operational measures undertaken by the Financial Regulator to monitor compliance by financial service providers with standards
- how the Financial Regulator co-operates with other regulators to efficiently and effectively monitor cross-border financial service providers
- how the Financial Regulator protects and informs the users of financial services in Ireland
- the costs of regulation.
In setting standards for financial services providers, the Financial Regulator tries as far as possible to follow a principles-based approach. This aims to set a limited number of high-level principles to be adhered to, focusing on the behaviour of services providers and the outcomes the Financial Regulator is trying to achieve, rather than on specifying detailed rules to be followed in all conceivable circumstances. In practice, the standards are a combination of principles, rules and guidance.
The EU Financial Services Action Plan (FSAP) was adopted in 2000 with the aim of creating EUwide markets for wholesale and retail financial services. Implementation of FSAP measures (usually by means of EU directives) has substantially changed the standards to which financial services providers are required to adhere. The Department of Finance and the Department of Enterprise, Trade and Employment produced the statutory instruments to transpose relevant FSAP directives into Irish law. The Financial Regulator supported the Departments by providing technical expertise and advice on the development of directives and, subsequently, in providing advice on the preparation of statutory instruments to transpose the directives to Irish law.
While the FSAP is taking longer to implement across the EU than originally envisaged, the directives have generally been transposed into Irish law in a timely fashion. Following the transposition, the Financial Regulator has also generally been prompt in issuing associated rules and guidance for financial services providers.
In developing standards, regulatory policies and administrative procedures, the Financial Regulator systematically consults with stakeholders and publishes related documentation on its website. Greater transparency of the consultation process could be achieved through a simple redesign of the website. The website should also be redesigned to improve access for financial service providers to the most up-to-date information in relation to rules and guidance in operation. The Financial Regulator has identified the redesign of its websites as a key priority by the end of 2007.
Monitoring Compliance with Standards
In a value for money report on financial regulation published by the Comptroller and Auditor General in 1999, it was noted that supervision effort was not based on an assessment of the risk associated with regulated entities. Since its establishment, the Financial Regulator has devoted considerable effort to developing a formal risk rating model, and significant progress in achieving risk-based supervision has been made. The Financial Regulator ranks financial services providers based on their risk rating, taking account of both inherent risk and the impact that failure of the financial services providers would have. The risk ratings are then used to allocate the available resources.
The Financial Regulator could enhance the usefulness of the risk-rating model by formally defining risk categories and the appropriate supervisory stance for each category. This would provide the Financial Regulator with a risk-related basis for identifying the level of resources required for supervision work. As part of the process in determining the appropriate supervisory stance for the various risk categories, the Financial Regulator should commission an independent review (e.g. a peer review) of the adequacy of its current prudential processes including the target frequency and duration of inspection visits, resource level, on-site checks and follow up. It should also seek to benchmark its inspection processes against those of other regulators in the EU with a broadly similar mandate.
The Financial Regulator requires most financial services providers to submit periodic reports about their business — these are referred to as prudential returns. The frequency, type and level of detail required varies from sector to sector. This examination found that the prudential returns system is working broadly as intended, but there is scope to improve efficiency in the receipt, analysis and reporting of returns. On-line submission of returns has been established in a few sectors. Where feasible, this facility should be extended to other sectors, with built-in data validation and checking processes. The Financial Regulator plans to implement such systems by the end of 2007.
The external auditors of financial service providers are legally required to send the Financial Regulator copies of management letters sent to financial services providers at the conclusion of annual audits. Alternatively, the auditors are required to inform the Financial Regulator that no management letter was issued, where that is the case. Analysis of a sample of 80 case files in the course of the study showed that in 2005, the Financial Regulator received all the required auditors’ returns only in relation to credit institutions (i.e. banks and building societies). The Financial Regulator has now updated its procedures for ensuring that auditors’ returns will be received in all sectors.
Cross-border Financial Services Provision
Cross-border financial service provision is increasingly common and has been facilitated by implementation of the FSAP. Co-operation between national financial regulators is required to ensure that all financial service providers are regulated in the first instance by those best positioned to carry out that function. This should aim both to avoid duplication of regulation, and to ensure there are no gaps in supervision. Arrangements agreed at EU level define the responsibilities of regulators in relation to financial services providers operating across national borders, and guidelines and protocols providing for information sharing and collaboration are in place. The Financial Regulator applies the relevant rules and guidelines.
Provision of information to consumers is one of the primary ways that the Financial Regulator seeks to deliver on its consumer mandate. It has published a wide range of advice and guidance material for consumers of financial services, and publishes periodic price surveys on financial services (e.g. cost of personal current accounts and credit cards, cost of motor and house insurance). This information is disseminated in printed form, via a telephone Consumer Helpline, and on the Financial Regulator’s website. Lists of financial services providers are also published on the website, but when it was examined in November 2006, there were gaps in the coverage and information was hard to find. Coverage has since been improved. The Financial Regulator is working to develop the consumer sections of the website to make it clearer and more user-friendly, but there have been delays in the work due to competing demands for IT resources. A revamped website is due to become operational by end-June 2007. This will include a facility for users to search for financial services providers by name and to identify the type of services they are authorised to offer.
Building on existing codes of business conduct, the Financial Regulator has developed a unified Consumer Protection Code. Following a lengthy and detailed consultation process, the Code was formally published in July 2006, and comes into effect on 1 July 2007. Most financial service providers must follow the Code in providing services to retail customers. The Code doesn’t apply to credit unions, except where they are acting as authorised intermediaries or advisors. A separate code, currently issued on an interim basis, applies to moneylenders.
The Financial Regulator carries out consumer-focused inspections designed to establish that financial services providers carry out their dealings with retail customers in line with the relevant conduct of business principles. The scale of the inspection programme is determined by the available resources, rather than by an assessment of the risk that financial services providers may carry out their business in ways that could damage the interests of consumers. The Financial Regulator should develop a systematic risk-based approach to the setting of inspection targets and the selection of financial services providers to inspect. An independent assessment (e.g. a peer review) of the adequacy of the inspection process should also be carried out.
Cost of Regulation
The Financial Regulator was initially staffed by drawing personnel from a range of agencies, but it had significant new functions as well, resulting in a need for additional recruitment and associated accommodation and support services. This, together with increasing costs, is reflected in the Financial Regulator’s operational expenditure, which increased by 15% between 2004 and 2005 and a further 13% in 2006. Total expenditure in 2006 was just under €46 million.
Financial service providers are required to pay annual levies to the Financial Regulator to cover part of the amount it spends on regulation. The levy scheme is subject to the approval of the Minister for Finance, who has set a target for the Financial Regulator to recover 50% of the annual cost of regulation. In order to provide a basis for the levy estimation, the Financial Regulator has developed a financial model to apportion its spending in relation to each of the financial industry sectors. In circumstances where levies are based on estimates, differences can arise between the amount collected and the appropriate share of expenditure. As a result, the amount raised through levies each year has fluctuated around the target level, but the cumulative levies in the period 2004 to 2006 are approaching 50% of expenditure.
Prior to the introduction of the levy system, the Financial Regulator indicated that individual financial services providers would be notified of the levies due each year in advance. In the period 2004 to 2006, the levy notices did not issue before July each year. Because tariff bands changed each year and the impacts of changes in the Financial Regulator’s budget were uncertain, this made it difficult for financial services providers to anticipate the levies they were likely to have to pay when they are doing their own annual budgeting. The Financial Regulator should merge the levy process with its budget estimation process, to provide more timely levy notices to individual financial service providers. The Financial Regulator is working to bring forward the date when levy notices are issued and has stated in its Strategic Plan for 2007 to 2009 that it will review its finance and funding processes.
Financial regulation imposes costs on the financial services industry. In order for financial regulation to be effective it should confer benefits that outweigh the associated costs. However, quantification of the costs and, particularly, of the benefits of regulation is challenging. The Financial Regulator has been developing its capacity to assess the relative costs and benefits of new regulation where it has discretion in how legislation is to be implemented e.g. using regulatory impact assessment techniques to form a judgment on the merits of proposed regulations. This approach provides for a systematic review of costs and benefits, even if a full quantification is not achievable.
The regulatory impact assessment technique can also be used to evaluate the existing body of regulation. The Financial Regulator has invited statutory consultative panels representing financial services providers and consumers to identify and prioritise regulatory requirements that are open to amendment by the Financial Regulator for review. In parallel with that process, the Department of Finance has stated that the impact of regulation on the financial services sector will be considered as part of a process to modernise and consolidate the existing body of legislation, which the Department is currently initiating.
The Financial Regulator avails of a range of services that are shared with the Central Bank. These include information technology development and support. There is a corporate need to focus on delivering information and communications technology improvements in order to keep pace with developments in the sectors under supervision and to improve efficiency and effectiveness. The Financial Regulator has included a number of significant measures in relation to technology development in its Strategic Plan for 2007 to 2009.