CHAIRMAN'S STATEMENT
The Malta Financial Services Authority is pleased to present this report of its activities in 2013.
I am pleased to report that the industry in Malta enjoyed a successful 2013, with activity recorded in all sectors of the finance industry as trading conditions eased and signs of growth began to appear in the larger economies. The detail of the MFSA's work in 2013 is contained in sections of the report produced by senior staff and units of the Authority.
This year, in a departure from the established custom, my statement will focus primarily on the immediate future and, most notably, on the new EU regulatory requirements as they affect each key part of the industry. The new approach presents significant challenges to the industry and regulators alike. They aim to lay the foundations for a more stable, robust and competitive finance industry in the future. In addition to the new structures, legislation and regulations emanating from the EU, the world's two largest financial services economies, the USA and the UK, have also carried out reforms in their regulatory structures, philosophy and legislation. Other high quality jurisdictions around the world have made or are implementing adjustments as to how the finance sector is regulated. Taken as a whole, there is no doubt that we are experiencing the biggest changes to financial regulation the world has known and all this is happening at unprecedented speed.
Nearly five years after the 2008 shocks to the global finance system, the full extent of the regulatory changes brought in by European Union have become clear. The implementation of some changes, most notably in banking supervision, is already underway, and over the course of the next few years it is probable that every part of the mainstream finance industry will be included in the new approach. What is common across all the changes already in place or coming into force are the objectives of minimising threats to the stability of the financial system and strengthening consumer and public confidence in the finance sector. Confidence is the critical element and fundamental to the EU's ability to remain globally competitive in financial services, attract corporate and private capital, develop products that meet market needs and enhance the industry's ability to sustain healthy profit margins.
This is a challenging time for the finance sector in Europe and North America. Asia, Africa and South America are producing new corporate and private wealth and the finance industry, both local and international, is establishing a broad range of services and expertise to assist customers in emerging markets. In the mature, mainly Western economies, governments are having to tackle high levels of national debt, a decrease in the numbers of economically active people as the aged become the largest group in society and escalating costs for public health and social care. These changes are creating new product openings for the finance sector, though in these politically delicate areas consumer and political confidence, value for money and clear customer benefits will be fundamental to success.
The digital world is forecast to be on the verge of being an even more significant force in finance. The internet has spawned new venture capital vehicles such as crowd-funding, new consumer advice and guidance investment software and new currencies. Some commentators believe that the giant global technology companies that own social media and search engine platforms are themselves looking to develop financial products.
Existing and emerging software and hardware developers also present the industry with unprecedented opportunities to capture market segments in existing territories, enter new geographic markets, reduce marketing and operations costs, improve the quality of information, analysis and compliance and offer products and services more exactly tailored to the circumstances of individual customers. Regulatory bodies can also secure large benefits from advanced technology, including real time information, higher quality statistical and market data, quicker administration and more comprehensive and efficient collation of documents in dispute resolution. Brands and firms from trusted domiciles that have established track records of solid performance and good customer service should be able to command a premium place in the digital market, where a proven record of trust, service and expertise are central to differentiating the good from the mediocre and, as is too often the case on the internet, the criminal. For serious and careful digital and foreign consumers, place of domicile will be particularly important. Jurisdiction will emerge as a matter of equal consequence to consumers as it has historically been to promoters.
Technological advances have particular resonance for the funds management industry, as technology can open up new markets and greatly reduce costs. The fund management industry is evolving rapidly across the globe. The lines of demarcation between traditional fund managers and the alternative investment sector are beginning to blur as businesses compete for profitable business worldwide, develop similar ranges of products and use similar techniques. In Europe, UCITS lV makes it easier to do pan-EU business, and should make it significantly cheaper to do cross-border business.
Working across borders presents a number of operational challenges, including language, time zone, reporting and regulatory issues. Indeed, regulatory changes are seeing some fund managers look to create new business models that strengthen competitiveness while mitigating cost burdens through outsourcing, merger or deeper market penetration. Malta has proven itself attractive to the funds industry because it offers the range of skills and benefits the industry needs. It is well placed to continue to grow as a funds domicile. At this time, we are witnessing the convergence of regulatory approaches and requirements. While structure and details will vary across the globe, in high quality jurisdictions broadly similar philosophies, rules and procedures will apply. In banking, insurance, fund management and investment services the same patterns are apparent worldwide; convergence on consumer protection, corporate governance and regulation and centred on transparency, high standards of personal and corporate conduct and fit for purpose people. Regulators and the regulated have to respond to new levels of complexity and legally codified standards of corporate and individual behaviour.
All sectors of the finance industry now have to comply with new requirements in liquidity, corporate governance, consumer protection, transparency, conduct of business rules and with tighter laws and obligations regarding preventing market abuse, money laundering and corruption.
In the EU, there are now a number of pan-EU "super-regulators" with powers of direction and enforcement; the European Central Bank [ECB] will be responsible for banking supervision at top tier level from November 2014 while the European Banking Authority will continue to develop rules for the banking sector. The ECB will have legal responsibility over the entire banking system, though the great majority of EU banks will be supervised by national regulators in the first instance; the European Securities and Markets Authority has been in operation since 2011 and its responsibilities include strengthening the functioning of financial markets and investor protection in Europe, regulating credit rating agencies and enhancing cooperation between national regulators. The third arm of the new European regulatory structure is the European Insurance and Occupational Pensions Authority [EIOPA]. In addition to consumer protection EIOPA's remit also covers the financial stability of its markets and the transparency of financial products under its wing. It also came into being in 2011.
In the years immediately following the crisis is 2008, the European structures set up in the wake of the crash were mainly involved in identifying and minimising further potential shocks to the system and developing policy and legislation for political consideration and eventual approval. An enormous amount of new legislation has now been implemented into EU law and into national law or delegated to national regulators.
National regulators like the MFSA retain all their existing powers and areas of discretion and flexibility but now have additional responsibility to ensure that the new EU requirements are introduced and complied with by financial services firms. The MFSA's obligation is to ensure that Malta is compliant with the new EU regime. Malta is more advanced in enshrining the new EU legislation in law than any other EU nation. For example, Malta was the first jurisdiction to complete the transposition of the Alternative Investment Fund Management [AIFM] Directive. The new legislation and regulations coming into force will, particularly in the early years, put very considerable demands on the people and resources of the MFSA. New systems always take time to be introduced and, in the complex world of financial services, the Authority, industry representative bodies and individual firms will have to reach conclusions on a great many issues of meaning, interpretation and purpose.
Conduct of Business
How financial businesses behave - the behaviour of corporations and of individuals in positions of trust and influence – is now centre stage in the drive to prevent future business failures that threaten stability and weaken public confidence in the financial services sector. Much of the legislation from the EU imposes legally binding conduct of business obligations on businesses. In Malta, the MFSA has decided to review the conduct of business regulatory regime for the investment services sector, with the primary goal of enhancing customer protection. The consultation paper issued to interested parties addressed various issues, such as defining types of customer, measuring risk, the dissemination of information on risk, "know your customer" tests, standards of care, records and disclosures, professional standards, designations, transparency and qualifications for advisory functions, measures on inducements and disclosure of remuneration.
The Authority's proposals have gone out to consultation and the feedback is now being evaluated. The recommendations are entirely in line with EU requirements and aim to ensure that Maltese consumers and investors have acceptable levels of protection and that the rules are applied by firms in Malta in ways that enhance consumer confidence and build on the country's established reputation for business probity and high standards. The Conduct of Business Rules define, in principle, the same standard of behaviour to be expected of any financial business in the post-crisis world.
The EU proposes an even more comprehensive regime on corporate governance and conduct of business and, in January 2013, published an action plan that includes enhancing transparency, increasing shareholder engagement, improving board diversity, non-financial risk disclosure, explanations of non-compliance issues in public reporting, shareholder identification, disclosure of institutional investor voting policies, employee share ownership, and shareholder influence in respect of board remuneration. The plan, if brought into law, will affect publicly listed and private limited liability companies.
All these changes which we hope to implement next year, will have a profound effect on the internal structures within the MFSA.
A Brief Overview of the Main EU Measures
Banking
Some 130 banks in the Eurozone are now under the supervision of the ECB Single Supervisory Mechanism. They account for 85% of banking assets in the Eurozone. What has come to be called "Banking Union" is mainly the supervision of very large Eurozone banks and of any smaller credit institution that is systemically important. None of these is based in Malta. However, the ECB is involved with the MFSA in the supervision of what are called "domestically systemically important banks" and three of these have been selected for Malta. The remaining banks in the Eurozone, around 6,000, will be overseen by national authorities. Only in extreme circumstances, such as potential insolvency, would the ECB become involved on a day to day basis. In extremis the ECB has powers to over-ride national authorities.
The ECB will be responsible for testing the resilience of banks, in a process that has become known as "stress testing." The 2014 programme of stress testing will sample 124 banks across participating EU states, which will cover at least 50% of national banking sectors.
All Maltese banks will have to meet the new capital adequacy rules. A significant demand on Malta's banks and the MFSA will be the implementation and management of CRD IV, which aims to minimise high-risk lending, ensure that banks have sufficient capital "buffers" to withstand future shocks, strengthen corporate governance and control inappropriate remuneration. CRD IV came into operation in January 2014.
The Solvency II Directive
The Solvency ll Directive will impact all insurance companies and is essentially a capital adequacy measure. Its main aim is to reduce the potential for insolvency. It also has an important role to play in developing the single market for insurance products, with similar standards of consumer protection across the market. Currently scheduled to come into force in January 2016, the Directive's risk management objective will need to be implemented with great expertise by the MFSA and Malta's insurance firms, in order to comply with the letter and spirit of the law and allow Malta's insurers the commercial room to compete internationally. It is an area of regulation in which some national governments introduced changes before the EU and thus there is some confusion within Europe and globally.
Pillar 2
At the core of Solvency II is the assessment which every insurer and its supervisor must make for a holistic understanding of the company's risks. Pillar 2 details the system of governance required of insurers, and includes the obligations and protocols for a company's assessment of its own risk and solvency and how it manages its capital; risk management strategy, policies and processes and internal reporting procedures; internal controls and compliance and rules about risk management, internal audit, actuarial policies, due diligence of outsourced suppliers and assessment of fit and proper persons.
The MFSA has to satisfy itself that all of these matters are compliant, so markets can more reliably assess the liquidity of a firm and the MFSA has to be satisfied that risk management is fit for purpose, that credit, operational and market risk are credibly quantified and that the potential for regulatory arbitrage is minimised.
EMIR
EMIR is the European Market Infrastructure Regulation on derivatives, central counterparties and trade repositories. The regulation, which affects all EU member states and counterparties worldwide also introduces common standards on the organisation of business, conduct of business, reporting rules and prudential standards for central counterparties and trade repositories. The MFSA has the responsibility for implementing EMIR and its reporting procedures. The Authority has also the role of guiding the industry on EMIR and, as is the case with all the regulatory changes of EU origin, working with the industry, other EU national regulators and international regulators to seek to resolve difficulties, reduce inefficiencies and reduce costs whenever it is prudent, while maintaining public and investor confidence in the structures and processes at work.
EMIR came into force on 16 August 2012. At pan-EU level, EMIR comes under the remit of the European Securities and Markets Authority. EMIR affects any financial counterparties that have entered into a derivatives contract – mainly, though not exclusively, banks, insurers, investment firms, fund managers and pension schemes. EMIR's core objective is to increase transparency and reduce the risk associated with derivatives. Asset classes include Credit, Equity, Rates and Foreign Exchange swaps, options, futures and forwards and Commodities manifested as cash or physically settled swaps, options, futures and forwards. ESMA has created a framework for EMIR, though the detail of much of the regulation will evolve, and some regulation has not yet been created.
The Alternative Investment Fund Managers Directive (AIFMD)
All AIF managers are required to comply with the Directive from 22 July 2014 and it introduces new obligations on disclosure, governance, information flows and oversight. Approval by any EU financial services regulator will be sufficient for all other EU regulators to allow a fund to trade across the EU. Only fully compliant managers will get regulatory approval and thus have open access to all of Europe's 400 million consumers.
Market Abuse Prevention
Maltese and EU law outlawing and penalising market abuse has been in place for many decades. In 2013, the EU Parliament strengthened the existing EU legal framework, including reinforcing administrative sanctions available to regulators. The EU has also taken steps to close pan-EU loopholes and on 4th January 2014, the EU Parliament voted for a new Directive on market abuse. The details of the Directive are being worked on and will include a common definition of market abuse offences, a common set of criminal sanctions, including up to four years imprisonment for insider dealing/market manipulation and up to two years for unlawful disclosure of inside information. Administrative fines may also be imposed by the authorities. Member states will have responsibility for jurisdiction where an offence has taken place in the country or where an offender is a national. The MFSA, in tandem with branches of the Maltese government and in cooperation with other regulators, intelligence agencies and police forces worldwide, uses its existing powers on market abuse and welcomes the new powers granted in EU legislation.
New Rules For Auditors
In December 2013, an EU framework for reform in the auditing market was given political approval. Its key terms affect listed companies and will require a plc to change its auditors every ten years (fourteen years if the audit is shared with another firm), a cap on the provision of non-audit services to audit clients, the strengthening of the independence of auditors, particularly in financial institutions and a ban on auditing firms supplying certain services that might involve decisions that impact on how a business is managed. The EU has created the Committee of European Audit Oversight Bodies (CEAOB) which is tasked with improving pan-EU oversight of auditors.
Consultation, Observation, Participation and Conclusion
The MFSA along with the regulators in all the other EU Eurozone states (and in full cooperation with the regulators in non-Eurozone EU states) is now part of a very well-resourced and greatly strengthened regulatory regime across Europe. There is no doubt that the consumer – the customer – is at the centre of our world more firmly than ever in the past. This is right, but it is also right that the momentous changes in regulation act as a catalyst for a re-emergence of the finance industry in the EU, so that every member state economy is stronger, citizens are better served and Europe is better able to be a competitive force in finance across the world. In Malta, the MFSA has established a tradition of working closely with the industry and that cooperation has, over the years, delivered benefits to all parties. Given the new complexities of the pan-EU regulatory scene, it is more important than ever that the MFSA and industry representatives continue to play an active role in their respective EU consultative and policy fora. It will be a challenge for us all to apply the new regimes and keep an eye open for threats and opportunities that arise from implementation and revision across Europe.
High standards, openness, cooperation, entrepreneurship and nimbleness characterise the Maltese financial services sector. The MFSA is characterised by expertise, knowledge, rigour, impartiality, fairness and a commitment to service. By ensuring that all of these qualities remain strong at the Authority and in the industry the country can continue to reap the benefits for many years to come.
I wish to conclude my statement by thanking all the members of staff at the MFSA and my fellow Governors for their hard work and valuable counsel in 2013.
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