JOINT COMMITTEE ON ECONOMIC REGULATORY AFFAIRS díospóireacht -
Tuesday, 29 Apr 2008

Role and Functions: Discussion with Financial Regulator.

Chairman

I welcome the Mr. Patrick Neary, chief executive, Financial Regulator, Ms Mary O'Dea, consumer director, Financial Regulator, and Ms Mary Sheehy, assistant director general, Central Bank.

I draw attention to the fact that while members of the committee have absolute privilege, the same privilege does not apply to witnesses appearing before the committee. Members are reminded of the long-standing parliamentary practice to the effect that members should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable. Members may ask questions after the briefing.

Mr. Patrick Neary

I wish the committee every success in undertaking its important work.

I will provide an overview of the Financial Regulator, our mandate, our resources, the approach we take to financial regulation, our public accountability arrangements and our continuing efforts to ensure that we operate with the maximum efficiency and effectiveness.

The Financial Regulator is approaching its fifth anniversary, having been established on 1 May 2003 following a Government decision to reconstitute the Central Bank of Ireland as the Central Bank and Financial Services Authority of Ireland. The structure combines two distinct component entities, the Central Bank and the Financial Regulator, each with its own particular set of responsibilities and specific governance structure.

The Central Bank's responsibilities include surveillance of the strengths and vulnerability of the overall economy and financial system. The Financial Regulator's remit includes surveillance of the financial soundness of individual institutions, in addition to wide-ranging consumer protection powers. We adopt a principles-led approach to regulation. This means that responsibility for the proper management and control of a financial service provider rests with the board of directors and its senior management.

The roles of the Financial Regulator and Central Bank are complementary and we enjoy the closest co-operation. Recent market turbulence has reinforced our view that prudential supervision, financial stability and consumer protection are inextricably linked so as to merit the combined approach to supervision that our structure demands.

The overall purpose of the Financial Regulator is to foster sound, growing and solvent financial institutions which give consumers confidence that their deposits and investments are secure and to help consumers to make informed decisions on their financial affairs in a safe and fair market.

The composite structure of the Financial Regulator and Central Bank mandates us to share the corporate resources and other support services of the single legal organisation including manpower, technology, accommodation, corporate services, statistics and internal audit. This sharing of resources and services achieves savings and efficiencies by avoiding unnecessary duplication of support services and corporate infrastructure.

We supervise over 13,000 firms and entities of varying size and nature across the entire financial services spectrum including banking, insurance, funds, intermediaries, credit unions and markets. Our mandate has been significantly expanded in recent times across all these areas as a result of EU regulatory initiatives.

Supervision has both prudential and consumer elements. Prudential supervision involves an assessment of new entities establishing here, and an ongoing programme of surveillance of financial risks and financial soundness. This is done through a combination of off-site and on-site review processes.

In 2007, we authorised over 4,000 financial service providers; received almost 65,000 financial returns for analysis; conducted over 500 on-site inspections and review meetings; and approved over 3,000 prospectuses. Members will have received a copy of our 2007 annual report, published yesterday, which gives a full account of our work in 2007.

On the consumer protection side, we fully implemented the consumer protection code during 2007. The code requires firms to act in the best interests of their customers by selling them products that are suitable, explaining the reason products offered are suitable and treating customers fairly if things go wrong. A key element of the code is the "know the client" and "suitability" provisions designed to minimise the possibility of mis-selling and ensure the consumer gets a product that meets his needs. The code is statutory and therefore firms are required to comply with its provisions. Monitoring and enforcing compliance with our consumer protection requirements is critical in ensuring that the consumer protection framework we have in place is working for the benefit of consumers. A further very significant part of our mandate is providing independent information to consumers on the costs, risks and benefits of financial services and in bringing forward initiatives on the education of consumers of financial services.

The authority is committed to continuous examination and upgrading of our processes and procedures. Following lengthy consultation, we implemented a stakeholder protocol last July. This protocol is a statement describing the targets we aim to deliver on key processes to our stakeholders in accordance with our stated high-level goals. It includes targets for authorisations, inspections, consultation and prospectus approval processes. The industry panel has endorsed the protocol indicating that we are leading the field in having such public commitments in place.

The 2008 budget for the Financial Regulator is €55.8 million. Following a process of consultation with stakeholders, the Minister for Finance agreed in April 2004, that over the three-year period 2004 to 2006, approximately 50% of the total costs of the Financial Regulator would be met by the imposition of levies on the industry. The balance of the total annual costs is absorbed by the Central Bank. In September 2006, the Minister for Finance approved a continuation of this arrangement for the period 2007 to 2009.

Our budget is subject to approval by the Minister for Finance and is the culmination of a rigorous process involving a sub-committee of the authority, the budget and remuneration committee. This committee undertakes a detailed review of the manpower plan, non-pay budget and the budget for shared services before making a recommendation to the authority for its consideration. In approving the regulator's budget, the Minister for Finance is required to consult both the industry and consumer consultative panels — to whose functions I will refer later. Any comments received from the panels are forwarded to us by the Minister for comment. Following approval of its budget, copies are laid before both Houses of the Oireachtas.

We have a current staff of 380. Our actual staff level was 349 at 31 March 2008. It is a significant challenge to recruit and retain staff with the wide range of skills, expertise and experience required to oversee an increasingly sophisticated financial sector. Of our total current staff, 319 hold a third level qualification in a financial discipline. To fulfil the need to keep our staff skills continuously up to date, we engaged consultants in 2007 to review our technical training needs. We have put in place a curriculum-based technical training programme which reflects best regulatory practice tailored to both domestic and international business operations.

In undertaking all our work, we believe a regulatory approach grounded in broad consensus amongst all stakeholders is the best way. For this reason, we operate a consultative and collaborative approach. To support this approach, the consultative consumer and industry panels were established in late 2004 as a co-ordinating mechanism for ensuring that the consultative process with our stakeholders is efficient and effective. The Act permits both panels to comment on our draft statements of estimated income and expenditure, our strategic plan and to provide comments on regulatory proposals when we request them to do so. In addition, the consultative consumer panel has a specific function to comment on our performance. The Minister for Finance appoints the members of both panels. We work closely with both consultative panels and with the credit union advisory committee in many areas of our work. This engagement is positive and constructive.

We are one of a small number of financial regulators internationally who commit to developing our mandate in a strategic way. We publish a three-year rolling strategic plan, which clearly sets out our purpose, values and goals and converts these into a series of divisional strategies and actions in a transparent and measurable way. While this process involves extensive consultation, it gives all stakeholders a high degree of certainty of what to expect in their relations with us. Having defined our commitments and deliverables in our strategy, we are publicly accountable for our performance, measured against the objectives we have set for ourselves.

Mindful that our regulatory requirements would not become a barrier to competitiveness and growth, we apply the Government's better regulation principles when introducing new requirements. One of these principles is regulatory impact analysis, RIA. RIA is a tool used to assess the likely effects of a proposed new regulation. It looks at whether a proposed regulation will have the desired impact and what are the associated costs and benefits. We recognize the value of RIA for significant regulatory proposals and have actively participated in developing an RIA model specifically for financial services regulation with the committee of European securities regulators, CESR.

Operational efficiency, effectiveness and value for money are issues of particular interest for this committee. The Financial Regulator has had several external independent examinations which examined these areas, including the Comptroller and Auditor General report, the international monetary fund or IMF-World Bank assessment, the financial action task force examination, an IMF research paper in 2007 and a recent OECD report on Ireland's financial stability.

In July 2007, the Comptroller and Auditor General published its report on a value for money examination of the Financial Regulator. The report highlights the progress we have made since our establishment. Overall the results of the study are favourable. In particular, the conclusions of that report indicated that: we have generally been prompt in issuing associated rules and guidance for financial services providers; in developing standards, regulatory policies and administrative procedures, we systematically consult stakeholders and publish related documentation; since our establishment, we have devoted considerable effort to developing a formal risk-rating model, and significant progress in achieving risk-based supervision has been made; and we have developed our capacity to assess the relative costs and benefits of new regulation where we have discretion in how legislation is to be implemented. The value for money examination also recommended a number of areas where we could improve our efficiency. These recommendations are now included in our latest strategic plan and include the re-development of our corporate website and making more use of information technology systems to enhance our effectiveness.

Two weeks ago the OECD published its economic survey of Ireland which examined the area of financial stability. In the report, the OECD said the Central Bank and Financial Services Authority of Ireland is a highly respected institution that has well identified the major financial stability issues and has urged borrowers and lenders to behave in a prudent way. The OECD also recognised the following forward-looking actions taken by the Financial Regulator in advance of the market turmoil in the latter part of 2007: increasing the risk weighting on high loan-to-value mortgages for owner occupiers to increase the capital cushion; the imposition of new liquidity requirements for credit institutions; and the introduction of a new consumer protection code and minimum competency requirements. It also acknowledges the passing of new legislation so that non-deposit taking sub-prime market lenders and firms providing home reversion loans are covered by the new consumer protection code and the minimum competency requirements.

The International Monetary Fund and the World Bank in their assessment of the stability of Ireland's financial system commented very favourably on the progress achieved in strengthening the regulatory and supervisory framework. The financial action task force of the OECD, which reviewed Ireland's system to combat money laundering and terrorist financing also said that we apply a strict authorisation process and actively monitor the fitness and probity of those who manage financial institutions. Their examination also concluded that we have sufficient operational independence and autonomy to ensure freedom from undue influence or interference.

The establishment of the Financial Regulator in 2003 was itself an action of efficiency and better regulation in merging the regulatory functions of four existing regulatory agencies — the Central Bank, Department of Enterprise, Trade and Employment, Office of the Director of Consumer Affairs, and Registrar of Friendly Societies — and creating a single regulator. The new structure of financial regulation provides for a more accountable system of financial regulation. An IMF research paper, published in February 2007, ranks the Irish system and structure of financial regulation first in the world in terms of its accountability and independence arrangements as compared with other international single financial regulators.

We are currently being assisted by external consultants in a systematic review of our key business processes and benchmarking them against comparable financial regulators and other similar businesses. The project will examine and assess whether the current activities, processes, organisational structure, resource utilisation and risk management model in place support us in the execution of our mandate. This is a very significant project for us, the outcome of which will have a big influence in the development of our next strategic plan. We have invited the two statutory consultative panels to identify and prioritise regulatory requirements that are open to amendment by us and to identify specifically what they consider to be redundant requirements no longer fit for purpose. The Department of Finance has stated it will consider the impact of regulation on the financial services sector as part of its initiative to modernise and consolidate the existing body of legislation, a project currently under way.

I hope I have given committee members a good overview of the operation of the Financial Regulator and our efforts to operate an open, effective, efficient and accountable organisation. We strive continuously for improvement and have many initiatives under way. Clearly, the events in the financial markets in recent months have given rise to many fresh challenges to be considered and addressed. However, any response to these must be made in an open and collaborative way and in the best interests of consumers and safe and sound financial institutions. My colleagues and I will be happy to answer committee members' questions.

Deputy Seán Ardagh

I thank Mr. Neary for his exposition of current events. It is welcome that Ms Sheehy from the Central Bank and Ms O'Dea, the Financial Regulator's consumer director, are present because a number of questions to be asked will be relevant to those areas. It was my understanding that Mr. Brian Patterson would be in attendance, but I wish him well. According to newspapers, he will stand down as chairman in the near future. He has done a superb job in all of the offices he has taken in the public service and during his business life. I hope our guests will pass on my good wishes.

Several issues are to the fore. The Comptroller and Auditor General's report was critical of the website to the effect that it was not of the type of leading edge design one would expect. For him to make this statement means there is a question of what and how has something been done. Another question Mr. Neary has answered to some extent is that of the commissioning of an independent review of the adequacy of the current prudential processes, inspection visits, on-site checks and follow-up. I would appreciate more information in this respect.

Some matters in the public domain are of interest, share dealings on the Stock Exchange in particular. Given insider dealing, the small scale of the market and the few dealers therein, the punter who invests is at a loss. There is an asymmetry in information, namely, the dealers and company executives, operating in a small market, have so much information that the person without such information is placed at a disadvantage and can only lose money on his or her investments. This has been shown recently, particularly in respect of insider trading. Is the Financial Regulator taking the action expected of him by the public? Lester Piggott was given a jail term for evading tax. When people who use insider information to benefit themselves or their companies to a significant degree one wonders why firm action is not taken.

In terms of St. Patrick's weekend and the release of false information so that share prices would fall and people buying short would be able to benefit, how far has the Financial Regulator progressed? Does any area appear suspect and has the issue been halted? Regarding the confidence of international bankers, pension funds and insurance companies in the Stock Exchange, it appears from the Central Bank's graphs that the ISEQ index has fallen in value considerably more than the FTSE, Xetra-DAX and other indices in the past six-eight months. Is this due to a lack of confidence in the Stock Exchange and, if so, is it the case that there are not sufficient reprimands and actions being taken by the authority?

Contracts for differences, CFDs, may have been more in vogue at the end of last year, but several people have suffered significantly due to the downturn in the stock market. Ordinary members of the public do not buy short — it occurs more in the cases of hedge funds and other bodies. Particular stockbroking firms were regularly churning out products for sale, making commissions and making interest on the difference between the amount put up and the stocks' costs. On an amount of €1,000 of ordinary punter's money, the broker was making ten times the commission he or she would have ordinarily made. The turnover was so quick that brokers were making whammy after whammy. Brokers' websites are still pushing CFDs and there is still spread-betting on financial stocks. The idea of a stock exchange, that it be used for the funding of businesses so that employment and the economy can develop in a sustainable way, is being undermined. What is the authority doing in this respect?

Last weekend, three strong and large financial institutions announced simultaneously in what had the appearance of collusion — I am not saying that it was collusion — that they were increasing mortgage interest rates even though the euro interest rate had not increased. The main banks are either substantial in size or are owned by substantial bodies in the United Kingdom, Australia or elsewhere. That they announced interest rate increases simultaneously appears questionable.

I understand the new subprime lenders are now coming under the Financial Regulator's wing. How will the question of stress testing of rates for the people who sign up to these mortgages be addressed? It appears that most of the recent cases in the Commercial Court were taken by a certain company which is particularly involved in sub-prime mortgages.

Chart No. 10 on page 29 of the Central Bank quarterly bulletin sets out data on access to wholesale funding from banks. Banks were asked about their access to wholesale funding and the chart indicates they were either somewhat or considerably hampered by securitisation in various forms, whether mortgages, commercial and corporate loans or long-term debt securities. Difficulties have arisen in respect of funding. In Dublin alone, at least seven developments are at the €500 million range or above and it appears from newspaper reports that they are highly leveraged. If one of these developments ran into trouble, what effect would it have on the banking system? Could it mean that international banks would note the significant weaknesses that exist here and turn off the tap, thereby putting our banking system into disarray?

The final sentences of the domestic prices, costs and competitiveness section of the Central Bank's report state:

This suggests that the economy's competitiveness position is not too unfavourable, and this is supported by the recovery in export growth in 2007 and continuing inflows of foreign direct investment. Nevertheless, given the current strength of the exchange rate and the uncertain outlook for the global economy, it is important that further competitiveness loss should be avoided.

That appears to be an optimistic statement from the Central Bank, which is normally quite conservative in its views. Does it imply that room exists within the partnership negotiations for agreement between Government, employers and trade unions?

Senator Paul Coghlan

I join in the committee's welcome to Mr. Neary, Ms Sheehy and Ms O'Dea. In terms of assessing the effectiveness of the Financial Regulator, one is often left with the impression that the regulatory authorities arrive late and somewhat breathless at each new scandal and they are only catching up rather than taking proper measures that would prevent adverse consequences for consumers. Would Mr. Neary agree? He spoke about a consultative and collaborative approach. Am I correct in believing the model of financial regulation here is based on consensus and, therefore, the desire exists to engage with financial institutions rather than compel or direct them to take specific actions? If that is the case, is it not a rather cosy set-up and does it not create certain conflicts? What steps should be taken to ensure the authority is not susceptible to capture by the bodies it regulates?

In regard to share dealings and insider trading, of which there has perhaps been too much in this society, is this only a matter for the Office of the Director of Corporate Enforcement or can the Financial Regulator have a role in the maintenance of proper corporate governance standards?

Deputy Leo Varadkar

I join my colleagues in thanking the delegation for coming before the committee. I ask forgiveness if my questions are obvious or stupid because I do not have much expertise in this area.

I understand IFSRA has responsibility for regulating the insurance industry but not health insurance, which is under the regulatory authority of the Health Insurance Authority. With VHI becoming a normal insurer under recent legislation, there is no longer a case to be made for a separate authority in health insurance. Given the proliferation of State agencies, of which approximately 1,000 exist at present, what are the delegates' views on the Financial Regulator taking over the role of regulating health insurance?

Appointment of members to the authority is done more or less by ministerial diktat. Fine Gael has proposed to follow the practice of other countries by having prospective chairpersons and, perhaps, members of the authority interviewed by a committee that would decide their appropriateness for the job and their attitudes to consumers. Do the delegates regard that as a practical proposal or do they have objections to it?

Under the terms of the Consumer Protection Act 2007, which was passed before I became a Deputy, the power exists to make it illegal for retailers to impose additional charges on people who pay by credit card or direct debit, which Quinn Insurance does at present. That legislation has not been brought into effect by the Minister for Enterprise, Trade and Employment, Deputy Martin, because of his general decision making problems. What are delegates' views on the measure and would the Financial Regulator have a role in enforcing it?

In respect of regulatory impact assessments, the Government has agreed to reduce the cost of the administrative burden of regulation on businesses by 25% by 2012. Essentially, that entails adopting the Lisbon Agenda target at national level. In terms of the financial regulations imposed by the Financial Regulator, what model is used to assess the baseline for regulation? Is a standards cost model, which I prefer, or some alternative model used? If the latter is the case, why is the standards cost model not used?

In regard to high loan-to-value mortgages and as somebody who is suffering the consequences of a 100% mortgage, does the Financial Regulator feel any guilt for allowing that situation to arise? We have discussed in detail the impact of the international credit crunch on the Irish economy but I do not think we will feel the pain from America for another two quarters. Our suffering in Ireland is largely of our own creation, as was the debt fuelled property boom. Does the Financial Regulator accept some responsibility for the unsustainable increases in house prices, which were due to the excessive ease of access to credit among other reasons?

Deputy Seán Sherlock

I apologise for missing the initial contribution. I join members in welcoming the delegation before the committee. I, too, am on a steep learning curve. Generally speaking, there is confidence in the system of regulation while there is a lack of confidence in the market mechanisms. It is important to make that distinction.

My questions are predicated on practical matters, for instance, the high degree to which the banking sector has issued loans on foot of what is effectively property speculation. I do not know the percentage but I wonder if the downturn in that sector has left the banking sector vulnerable to a situation similar to that of Northern Rock and other institutions. I realise we make the distinction between the sub-prime market and the position as it relates to Ireland in that Ireland would not have been a victim of the sub-prime lending scenario, so to speak, but it appears a great deal of money is tied up in property. If a downturn occurs in the construction sector and there is potential for defaulting on loans, does that leave the banking sector vulnerable? Is there a role for the regulator in that regard in seeking to modify the behaviour of banks in terms of the way they loan to their customers in the future? I am sure there has not been much lending to other sectors with growth potential within the economy, and perhaps that is something that should be examined. In agriculture, for example, only 2% of all lending relates to agricultural output but I would like to hear the representatives' view on that.

In terms of the potential for a banking crisis, I imagine the risk to be low but it always exists. In regard to the amount of money on deposit by individual citizens, do the representatives believe there is enough protection in place to ensure that if one or two banks go bust, the money they have on deposit is adequately protected? I understand there is a mechanism in place and a fund with the Central Bank for depositors but in the current climate, and given what has happened abroad, are there grounds for enhancing that provision?

With regard to the European Union financial services action plan, the first question is a practical one. Is it a binding action plan on all member states and, if so, what percentage of that action plan has been transposed into law? How are the representatives monitoring the transposition of those laws and regulations? Is there scope for better legislation, given that the Lamfalussy report in 2001 instigated the financial services action plan? Is there scope for a review of that or could we have better regulation to achieve the maximum amount of output in the economy, which is what we are talking about?

I am heartened that the organisations have put themselves up for external review. That is always a good benchmark because self-regulation is not always the most effective. The fact that they constantly review their operations would give some grounds for confidence also.

Chairman

In the past two or three years some financial institutions offered easy to access mortgages to people in financial difficulty with other companies. Now that those people are in financial difficulty it appears those financial institutions, rather than organising a reloan schedule, are more interested in acquiring the property within six or eight weeks of defaulting. I am aware that one financial institution had a large number of cases before the courts. From having discussions with other people working within the sector it appears they are more interested in acquiring property than providing a mortgage. They give the mortgage on easy terms but are now claiming back on it. The representatives might comment on those points. We may come back to the members subsequently.

Mr. Patrick Neary

I thank the members for their questions. I have noted the questions and will try to deal with them seriatim. I will ask my colleagues to help me at various stages. Ms O’Dea might assist with the sub-prime question and might also have some views on the process surrounding the regulatory impact analysis, RIA.

The first question concerned the Comptroller and Auditor General's report. Two issues were brought to light in that regard, the first of which was the website. We have two main corporate websites. The first to which we devoted all our resources, which we felt was the more urgent to get right, was the consumer facing website called itsyourmoney.ie. We put a great deal of work into that. The website was completely revamped last year. We have had more than 500,000 visits to it since it was set up. Live on-line are all our cost surveys and we have won an EU award for that website. There is a certain pride attaching to that achievement.

Work remains to be done on the corporate website, which is currently financialregulator.ie. It is not as cohesive as we would wish. We have a team working on that currently, assisted by consultants, and the time line for delivery is later this year. It is hoped that by the end of this year that corporate website, which will be up to the standard of itsyourmoney.ie, will be in place. I hope the members are satisfied with that response.

We have appointed consultants to help us with the business process review. The authority has asked us to quality assure our structure and all our essential processes to ensure we have the right resources in place, including staffing skills and expertise, the IT resources and so forth, ensure our processes tie in with our model of risk based supervision and that the outcomes are delivered in the most optimum and efficient way. That work is ongoing. The target date for the finalisation of that project is the end of August this year. At that stage, we will seek to implement any recommendations and incorporate them in our strategic plan for next year. That work is ongoing.

On the share dealings on the Irish Stock Exchange and the question of insider dealing, it will not surprise members to hear that we abhor the idea of insider dealing. In the past year or so we have taken over responsibility, under the market abuse directive, for the entire area of market abuse including insider dealing.

A number of players have responsibilities in this area. Companies that are quoted on the stock exchange must have policies and procedures in place to identify insiders, restrict the insider lists and ensure that any information that could facilitate insider dealing is tightly held and accounted for.

Our side of the bargain consists of analysis of trades and trying to marry those trades with any announcements or issues circulating in the market that would suggest that people were trading inappropriately or using information they had in their possession inappropriately, especially information that was not available to the market at large.

This is a complex area. For example, we get 300,000 trade reports every week and it requires a sophisticated IT system to go through those, compare the trades and match them with developments in the market but we are acutely aware of this issue and share members' concerns regarding it.

Deputy Ardagh touched on the next point. On St. Patrick's weekend we commenced an investigation. We spoke yesterday of the rumours in the market then, which reached a crescendo on that particular weekend. We felt there were unjustified stories about a leading financial institution in circulation and we were extremely concerned that well-capitalised, strong, profitable financial institutions could be severely and negatively impacted by unfounded and groundless rumours emanating from unknown sources.

We were anxious to ensure this behaviour was dealt with as we could not have had a case like the one we were experiencing. That was the reason we commenced the investigation at that time, and it is still in progress. We have much information to wade through.

It is a fact of life that what characterise markets, international and otherwise, are rumours. A seasoned professional can identify a rumour, and a rumour can be spread as such. The issue becomes a real problem when rumours are transmitted as facts, and people may have a particular agenda to ensure rumours become facts because it suits what they have in mind. The investigation in progress considers these areas and it will continue to do so.

It is important to maintain confidence in what I would term the regulated market, particularly in terms of the role of the Stock Exchange. As far as the market is concerned, no regulator can influence the value of the market, the view taken about the prospects of any company quoted on the market or the drivers of the performance of a particular share into the future. The reality is the ISEQ has been negatively impacted over recent months. There is a perception that the market is taking the outlook of individual firms in the market into account. There is nothing more to that.

We must bear in mind that over the past five or six years, the ISEQ has outperformed most other indices, so it is not necessarily unusual to see some reversal of that trend in recent months. Over recent years, the ISEQ has performed very well.

There has been much activity in the trading of contracts for difference, CFDs. There is nothing illegal or inappropriate about them and what we require is that any broker or financial institution dealing with consumers or clients in providing CFDs fully discloses the risks. They should be fully satisfied that the people engaging in CFD activities fully understand the risk they are taking on, the scale of charges and other issues which arise. The clients should be alerted to the fact that the value of such instruments can fall as well as rise.

There is also a wider dimension. From an overall perspective of financial stability, we would have a concern shared by other regulators. We will have to discuss this concern with such regulators. The specific concern is the desire for CFDs to be used to take positions in financial institutions without bringing them to public light, and to what extent that may raise a vulnerability within the financial system. CFDs will be high on the regulatory agenda for those kinds of reasons.

A question on interest rate increases was also raised, particularly if there was any collusion on the matter. Everybody in the room would be extremely concerned if there was any evidence of collusion, and if there was, we would certainly alert the Competition Authority as a matter of extreme urgency. ECB base rates have remained unchanged and interest rates transmitted to consumers are increasing. The reality is money costs more in international financial markets, particularly the interbank market, so the cost of funds is more expensive. The consumer director may wish to comment but there is some inevitability that these interest rate increases would transmit to consumers sooner rather than later.

Ms Mary O’Dea

The cost of funding for banks has gone up and, inevitably, that has been passed on to consumers. Something we will consider closely, as we did when we were first established, is to ensure the increase is passed on to the depositor side as well. There should be a gain for deposits where borrowers are paying more.

We still advise consumers that even within that, there is still a market out there and there is not just a single price being charged by a financial institution. All our cost surveys are on-line and we recommend that people look at those when borrowing or placing deposits. They should consider where they can get best value and service.

Mr. Patrick Neary

The next point related to subprime lenders. Tomorrow is the final day for application or authorisation under the new legislation. The issue for subprime lenders is that as soon as we authorise them, it brings them within the scope of the consumer protection code. This requires them to demonstrate suitability, to go through the affordability assessment and stress-test the ability of borrowers to repay. In that sense, the question——

Mr. Mary O’Dea

I could just add to that with regard to a similar remark made by the Chairman on repossessions and policies on arrears. The other impact of the consumer protection code on subprime lenders who will be regulated by us is that they will be required to have a policy on arrears. This relates to the management of paying back the loan rather than immediately moving to repossession.

Mr. Patrick Neary

I note what the Chairman stated. If it were the attitude to put property acquisition at the expense of consumers, the code would take a particularly hostile view of it. I have stated before, and it is no harm to repeat it, that we do not want to be in a position where the first reaction of lenders is to go for the nuclear option of repossession. The code requires that all lenders should treat arrears sympathetically and work out a programme of arrears management with the client. Repossession should be the ultimate and final position, way down the road. That position is covered by the code and we will have another look at it to ensure the case described by the Chairman is not established.

There was a question on wholesale funding in the context of exposures to developers. This goes to the very heart of the lending process. The question relates to the impact of a developer experiencing financial difficulty on individual banks and the stability of the system. We share these concerns.

The lending process requires more than just the value of properties being sustained alone. The way in which these lending relationships are developed means the people involved must first be satisfied there is an underlying cashflow and take-out on the loan, which can be supported by cashflows that are grounded on real planned outcomes, such as sales and building programmes. It should not just be left for the loan to be taken out on the value of the site or unfinished business. Inevitably, one or two examples may end up like that but in the vast majority of cases, lending should be based on the underlying business, cashflow and take-out of a loan. I hope that addresses the question raised.

On competitiveness and room within the current talks for competitiveness, I put my hand up and admit I would be straying into an area which I would not be competent to comment on. I could undertake to reply separately on that issue. If it is acceptable to the committee, I will undertake to do that.

Ms Mary Sheehy

Obviously, we consider the pay agreements an essential element to ensure the country maintains its competitiveness. We are, therefore, extremely supportive of them. We must leave it to the parties involved to work within the parameters set down.

Mr. Patrick Neary

That is a good answer and perhaps I might use it as my response as well.

Senator Coghlan referred to the regulatory model and the extent to which consensus exists. There are two elements to the regulatory model, namely, the prudential side and the consumer side. Ms O'Dea, the consumer director, will discuss the latter.

Due to the fact that we have such a significant financial services sector, it is important that we should set out our stall in clear terms with regard to the relationship that will exist between the regulated entities — in the context of their financial requirements — and the governance and risk management requirements to which we want them to adhere. It is important that financial services companies should know this before they establish operations here. In bringing about change, it is also important that we should do it with buy-in from the industry. In respect, therefore, of capital requirements, liquidity, risk management, credit, market risks, etc., there should be a consensus that works for everyone and supports the financial system in the best way.

We would have a slightly different approach when it comes to the consumer agenda. Perhaps Ms O'Dea will elaborate on the position in that regard.

Ms Mary O’Dea

Our approach is in keeping with the idea of stakeholder engagement. We engage widely with consumers in respect of this issue. In other words, we use the consumer panel and consumer representative bodies — I refer here, for example, to Age Action and those representing minority sectors — and work closely with them in developing our requirements. We also use intelligence from various sources. We obtain information from, for example, the Ombudsman and from our own on-site inspections. When we developed the consumer protection code, the regulatory impact assessment the Government introduced emerged towards the end of the process. Nevertheless, we carried out a regulatory impact assessment in respect of it. We considered what would be the impact on the industry as against what would be the benefit for consumers. We were obliged to tease out what that benefit would be.

On regulatory matters, the benefit often relates to prevention. In other words, one hopefully prevents things happening. One does not demonstrate that there was payback after some large scandal involving mis-selling. One instead tries to demonstrate that this prevents things happening. It is somewhat more tricky to do the latter. We can, however, look to other jurisdictions to see how they dealt with certain matters.

The model we use is extremely transparent. We publish all the requirements we propose and we use consumer research and focus groups in respect of those requirements. When we consider various requirements relating to transparency or information that we wish to impose on firms, we test them on consumers in order to discover if they will work or have the impact we desire. From our point of view, that type of stakeholder engagement shows if we have obtained the right outcome for consumers. The latter is what we really need to measure.

Mr. Patrick Neary

Regulatory capture is an extremely important issue. In my presentation I set out some objective assessments of our transparency, accountability and independence. We are extremely conscious of the fact that it is worth guarding in the context of our reputation. The members of the authority are completely unaligned with any vested interests. None of them has executive or other connections to any regulated entities. The industry contribution to our budget is 50%. This is probably something that would have influenced the Minister in his thinking on our funding arrangements. In that way, they are very practical reflections on regulatory capture. From a staff and executive point of view, we are absolutely prohibited from having connections with financial institutions we regulate. That is part of the staff code of conduct.

Senator Coghlan also raised the question of insider trading. I believe I may already have dealt with that matter.

If an insurance company provides health insurance, we are obliged to regulate it because what is involved constitutes a regulated activity. There is a particular institution we do not regulate, namely, the VHI, which is constituted under different legislation. However, I understand it may come within the Financial Regulator's remit in the not too distant future.

As I understand it — I must engage in a degree of speculation here — the Health Insurance Authority examines community ratings, etc., but is not concerned with the prudential or consumer side of regulation. I am not sufficiently well briefed on its role to answer the question. If the committee feels we should become involved in this area and provide our view, we would be glad to do so in due course.

On the membership of the authority, the appointment of the chairman, etc., I would have no difficulty setting out my stall. I was obliged to do so when I was appointed chief executive. I took part in a competition that was open to both domestic and international applicants. That was a proper process and it is how matters of this nature should be dealt with. Our consumer director took part in a similar process and I am happy to say she will be reappointed with effect from 1 May. I have an open mind as regards the other members of the authority. It is in the gift of the Minister to appoint those members and I understand this matter is due to be considered by him in the context of future appointments.

Ms Mary O’Dea

As regards the legislation that has not yet been enacted and interchange fees, the National Consumer Agency is examining the position and has sought submissions in respect of it. We made a submission. This is not an easy matter to tackle because, somewhere in the system, the consumer ultimately bears the cost. The issue is whether if one uses a card to make one's transaction, one should bear the additional cost attaching to the interchange fee or should this be distributed among all consumers. We have shared with the National Consumer Agency any information we possess as to how that practice operates.

Ultimately, we want to reduce the cost to the system of payment transactions. As we move towards a single European payment area, the Irish Payment Services Organisation, IPSO, has a programme to try to achieve this. In the meantime, the National Consumer Agency has responsibility for making recommendations in respect of the interchange fee.

Deputy Leo Varadkar

The deadline for receipt of submissions was September of last year. It cannot be that difficult to read 50 submissions. I have not, even under the terms of the Freedom of Information Act, been able to obtain details of those submissions because they are classed as top secret. Did the Financial Regulator recommend that the legislation should be commenced, subject to arrangements, or that it should not be commenced?

Ms Mary O’Dea

No, we did not make a recommendation one way or the other. We simply shared information relating to our experience with the National Consumer Agency. We stated that, one way or the other, the cost is borne by the consumer. The issue is whether this cost should be borne by a smaller population of consumers or distributed among a larger population of consumers. We would not like there to be a perception that by distributing it over a larger population, it would somehow go away. The cost would still be there and consumers should be aware of that.

Deputy Leo Varadkar

My colleague on the Joint Committee on Enterprise, Trade and Employment, Deputy English, is working on a paper relating to e-payments. I would like Ireland to be a world leader in this area. When I travel to Denmark I see a modern country but when I return to Ireland I am confronted with a country that used to aspire to being modern. If one wishes to advance the e-payment agenda, one must end the disincentives, where they exist, and accept that the cost falls on all consumers but then enable everyone, as should be the case, to use e-payments. That is how savings will eventually be achieved.

Ms Mary O’Dea

We very much support that agenda of moving towards more efficient payment mechanisms, subject to inclusion and financial access and to making sure there is an appropriate programme for consumers, for example, for the unbanked to ensure that consumers are able to have a payment mechanism. There are many other issues wrapped up in it but we support that agenda.

Deputy Leo Varadkar

What percentage of the adult population is unbanked?

Ms Mary O’Dea

We commissioned a report from the Combat Poverty Agency last year and somewhere around 10% of the population did not have access to bank accounts. We examined the implications of that with the agency. In the meantime, we have seen a move towards so-called free banking, but it is really free transactions charges. For people on low incomes the charges that kick in are account maintenance fees. In addition, they do not want to have an overdraft facility but they would like to have a buffer zone because they can only take a €50 note out of the ATM. We believe there is room there for the banking industry to develop products that are particularly targeted at low-income groups, which would facilitate that basic level of banking.

Deputy Leo Varadkar

Does Ms O'Dea have any documentation on that?

Ms Mary O’Dea

The Combat Poverty Agency published the report and I will be glad to send it on to the Deputy.

Senator Paul Coghlan

I thank Mr. Neary for his comments on the question posed by Deputy Ardagh on insider trading. He outlined his ongoing watchfulness but does Mr. Neary have any specific action in mind in regard to known transgressions?

Mr. Patrick Neary

I am trying to interpret the case to which the Senator referred. I think the Senator is referring to a case that came to light because of civil proceedings. That case goes back several years and predates the establishment of the Financial Regulator, so we would not have had any involvement in that case if, as I understand, it is the one to which the Senator refers.

Senator Paul Coghlan

I heard it referred to recently. Perhaps Deputy Ardagh might comment on it.

Deputy Seán Ardagh

It is the same case. Something happened recently but it had a genesis years ago.

Mr. Patrick Neary

That is right. Something happened recently but its genesis predated the Financial Regulator. The Deputy's next question concerned regulatory impact analysis and I will ask Ms O'Dea to comment on that.

Ms Mary O’Dea

Earlier on, I said a little about what we did with the consumer protection code. It is relatively easy to assess the costs — even the indirect costs — of regulation, but the benefits are much trickier from the consumer viewpoint because they are on the prevention side. Therefore one is often looking at that from a qualitative rather than a quantitative point of view. We need to be careful about it. However, with our European colleagues, we are working on a model within Europe that would help us to ascertain how we should approach regulatory impact analysis both from the point of view of costs and benefits.

Deputy Leo Varadkar

What model does the authority use for baseline cost analysis?

Ms Mary O’Dea

Rather than saying what the difference would be in having this consumer protection code, as we had set it out, compared to nothing, we asked what the difference would be between having this consumer protection code and a standard that exists in the industry now. Therefore we did not start from zero. Even if there was no Financial Regulator and no protection in place the industry would compete on the basis of providing a particular level of service, so that service would be there in the first place. That is the way we approached the regulatory impact analysis. We followed the detailed guidelines set out in the better regulations principles.

Deputy Leo Varadkar

Is Ms O'Dea satisfied with that?

Ms O’Dea

Yes, with reservations.

Deputy Leo Varadkar

The authority only calculates a differential, not a baseline first.

Ms Mary O’Dea

No. I should say, however, that it very much depends on what the issue is. For example, a group is currently looking at financial legislation. We have asked the industry panel to examine what parts of financial regulation it believes are redundant. If there was some agreement that parts of legislation no longer served a useful purpose it would probably be better to start by asking "What if we removed legislation?" because the proposition would be to remove the legislation. In the case of the consumer protection code the proposition was to have the market with or without the code. It depends where we are starting from.

Deputy Leo Varadkar

Yes, but the point we are supposed to be starting from is the Government's commitment to reduce regulation by 25% by 2012. Presumably, however, in order to reduce regulation by 25% one must know what the current cost is. Therefore, if it costs €100 figuratively, one has to work that out. How else does one work out what 25% is unless one has a baseline?

Ms Mary O’Dea

Absolutely.

Deputy Leo Varadkar

I think there is no commitment or intention to achieve this target. However, if one was serious about it and we were to do what they have done in the Netherlands and Austria, for example, one would first have to do a baseline analysis of the cost to business of all financial regulations. Then one would have to work out how to bring it down by 25%. If the Department of Enterprise, Trade and Employment is serious about this it should ask the Financial Regulator to do this and to reduce the figure by 25% by 2012, but I do not get the sense that is happening.

Ms Mary O’Dea

We have been involved in a number of studies on the general cost of regulation. We are one piece of the regulatory picture. There is corporate enforcement compliance as well as other types of regulation. In the submissions we received when carrying out the regulatory impact analysis on the code, the industry attempted to put figures on how much that type of regulation actually cost although it is difficult. It would require a vast job to examine what the cost is, building it up from the baseline of having no regulation at all. If one looks at a large company like a bank, the shareholders require a certain level of corporate governance and structures to be there even if there was no financial regulation. They would require certain auditing functions and one would have to pull those out of what the additional statutory requirements are. As I think the Deputy is saying himself, it would be quite a significant project.

Deputy Leo Varadkar

It would be a great deal of work, but other countries have done it because the will is there to do it.

Ms Mary O’Dea

Yes.

Mr. Patrick Neary

While Ms O'Dea is on a roll, will she deal with the question about 100% mortgages and debt?

Ms Mary O’Dea

There are a couple of aspects to that. We have no role in regulating products in general. As one can see in the mortgage market, the range of products available to customers is being reduced. While it is obviously difficult to get a 100% mortgage, our view of 100% mortgages at the time was — and still is — that the key issue is whether it is an affordable product for the consumer. The key issue is suitability. A bank should not lend a person a 90% mortgage if he or she cannot afford to pay it back. A person with a large income can quite easily afford repayments on a 100% mortgage. The financial institution must look at a person's individual financial circumstances and see if they can afford to repay the mortgage over the life of the product. We have no control over the cost of houses. Some people find themselves in an unfortunate situation where they might have negative equity. It is equally stressful for a person who saved the 10% and got a 90% mortgage, as for a person who borrowed a 100% mortgage.

As regards debt and mortgages generally, and this picks up on a question Senator Coghlan raised earlier, we have now put in place requirements under the consumer protection code that are as good if not better than those across Europe. I do not know of other good jurisdictions that have suitability requirements for lending practices. Suitability normally applies for investment products. We have applied that to lending products so when a person gets a short or long-term loan, he or she must meet with a suitability requirement. That is a key protection.

If people consolidate debt — and the temptation is to wrap up one's debt into one's mortgage and have a longer term debt — we have requirements in the code that one must point out the additional cost of credit. Having it over a long term makes it much more expensive. We have built a great deal of protection into the consumer protection code which puts us in a much better place. We called for the regulation of equity release and subprime, which were not being regulated at the time. We believed the consumer protection code should be applied to those areas and that is now happening. We are now in a strong position in the protections available to consumers, which is important, given the level of debt in which they now find themselves.

Mr. Patrick Neary

Deputy Sherlock asked about the exposure of banks to speculative property lending and potential vulnerability as a result. We felt concern about the issue, particularly in 2006 when there was a spike in land and other property prices. We felt there was a degree of vulnerability and that it was time to do something about it. Accordingly, we increased the capital cushion to 50% for banks which had exposure to speculative property lending to cover the increased risks.

The Deputy also expressed concern about the possibility of similarities between the vulnerability of Irish banks and the weaknesses which accounted for the problems at Northern Rock. The situations are different in the sense that Northern Rock suffered from a liquidity issue which affected its ability to raise funds using the model it had adopted. It was not as a result of bad debts or default on the part of speculative borrowers.

There is no evidence that lending for speculative property development starved other sectors of resources. I have no sense of that happening but will reflect on the question and, if there is any evidence that it has taken place, I will revert to the Deputy with a reply. He also asked a question about depositor protection. The issue is high on the agenda of the European Council of Finance Ministers, ECOFIN, and it expects to complete a review of the matter this summer. I understand the Department of Finance is participating in the review and its decision on how to move forward on the matter will be informed by the European discussions. We will have to wait and see what emerges.

A huge amount of work went into the financial services action plan. As far as I know, we have transposed everything in the plan. I believe we were ahead of the posse in achieving its implementation in Ireland.

The Deputy also referred to the Lamfalussy report and asked whether we might instigate a review. The model led to separate approaches to securities, banking and insurance and has served us well but the recent turmoil emphasises a need for close regulatory engagement and dialogue among regulators. Our model, involving ourselves and the Central Bank, facilitates that process. It proposes better use of existing recommendations and dialogue to ensure consensus is built much more quickly on regulatory issues. That is the main lesson to emerge from the current review.

Deputy Seán Sherlock

The financial services action plan allows for, say, Bank of Ireland or AIB to set up operations in other countries. In doing so, would they be subject to their host nations' regulatory regimes? Are banks which set up operations in this country subject to our regulatory regime governing, for example, issues relating to liquidity, or are they only subject to the regulatory regime of their home country? It is important to maintain confidence in the system because if confidence fails, it has implications down the line.

Mr. Patrick Neary

Absolutely. An Irish bank, authorised by the Financial Regulator, can establish operations throughout Europe in two ways. It can set up a branch in another member state or it can set up a subsidiary which has a separate authorisation from the one given by that member state. Where branches of entities established in other jurisdictions have been set up in this country, the home country is responsible for them. We are responsible for an Irish bank and its branches wherever they are located around Europe. It is legally impossible to distinguish a branch from the collective; therefore, any liquidity issues arising in our branch will transmit immediately to its head office and the home country. If an Irish bank had a subsidiary in another jurisdiction, it would have access to the regulator in that jurisdiction. The regulator and central bank of that country would have responsibilities to provide liquidity for that subsidiary, as would the group of which the bank was a member. That is why regulators need to talk to one another. It is important that other European countries do not take decisions which conflict with our view of what is appropriate for the group as a whole. The concept of colleges of regulators has been proposed to address the issue. I hope I have answered all the questions asked.

Chairman

On behalf of the joint committee, I thank Mr. Neary, Ms Sheehy and Ms O'Dea for their attendance and the information they have supplied. I look forward to meeting them again in the not too distant future.

The joint committee adjourned at 5.25 p.m. until 4 p.m. on Tuesday, 13 May 2008.