The Commission de Surveillance du Secteur Financier (CSSF) yesterday published its annual report for 2018, revealing key figures of the financial centre, as well as major events that marked the different areas of supervision over the past year, challenges and solutions and the future of prudential supervision in the context of a changing industry.

A healthy financial sector

As regards the banking sector, the CSSF highlighted the good quality of assets, the strong capitalisation of the supervised institutions and an appropriate liquidity situation. Even though the banking sector recorded a sustained activity – the balance sheet increased by 3% in 2018 compared to the previous year – some significant trends appeared. The number of banks dropped marginally (-4 entities) with an increasing number of banks changing into branches. Their net result slightly decreased by 3.2%. This loss in profitability is linked to the ongoing rise in general expenses, as a result of the need for significant technological investments, on the one hand, and greater regulatory pressure with which the banks must comply, on the other. A similar situation was observed with respect to the other players of the financial centre, in particular investment funds, PFS and payment or electronic money institutions. The profitability of the supervised entities thus remained one of the main focus points for the CSSF. 

In the field of investment funds, Luxembourg secured its leadership at the European level with respect to Undertakings for Collective Investment in Transferable Securities (UCITS). The number of authorised management companies of investment funds rose from 306 in 2017 to 314 in 2018. The total number of Undertakings for Collective Investment (UCIs) registered on the official list slightly fell to 3,908, whereas the number of sub-funds slightly increased to 14,898. Meanwhile, the total net assets of Luxembourg UCIs dropped by 2.3% to €4,065 billion at the end of 2018 compared to 2017, due to a negative market effect which was greater than the positive inflow of new capital.

Positive results were also recorded for payment institutions, the number of which grew by one entity and the balance sheet of which by 37.65% to €819 million. Similarly, the number of electronic money institutions increased by one entity and the balance sheet by 40.65% to €1.3 billion.

The CSSF: between continuity and constant adaptations

The CSSF continued to pay particular attention to the resilience of the financial system, compliance with the laws and regulations in force and governance issues. This was particularly the case for real estate.

In view of the sharp rise in prices of real estate in the Grand Duchy (+9.3% in 2018) and the lower standards for granting credits, household debt is on the rise. For Claude Wampach, Director, in charge of banking supervision, “The role of the CSSF as the macroprudential authority is to ensure, together with its partners within the Systemic Risk Board, that this risk is contained”.

In addition, the CSSF continued to be particularly watchful towards the non-compliance risk and the related legal and reputational risks. The number of off-site inspections as well as on-site controls was enhanced. These controls revealed that non-compliance is mainly linked to the absence of appropriate governance or of a clear definition of risk appetite by the board of directors and the management’s failure to implement the principles of governance, as well as to internal control and compliance functions which are inappropriate or sometimes too dependent on the management.

As regards governance, 2018 was also marked by the publication of the Circular CSSF 18/698 on the authorisation and organisation of Luxembourg investment fund managers. The text also included specific provisions with respect to the fight against money laundering and terrorist financing.

The fast and ongoing development of technology has created new types of services impacting all the activities of the financial sector, as well as more complex operational models. Françoise Kauthen, member of the Executive Committee, explained: “On the one hand, we observe that these trends expose the traditional players to new threats, like rising cybercrime. On the other hand, we notice that the risks related to these models also include known conventional hazards, like money laundering”.

The CSSF also dealt with the increasing use of technology by the supervised entities - about 260 requests for advice or authorisation of off-site IT projects, in addition to the growing number of on-site inspections. Considering these figures, the CSSF has focused more on material IT systems according to a risk-based approach and has shared its considerations on the use of artificial intelligence in a white paper.

With respect to cryptoassets, the CSSF intends to continue and accelerate its reflection process regarding the regulation of some players concerned. It has three objectives: protect consumers, in particular, from risks inherent to IT system security, allow new players to provide services in an adapted and clear regulatory framework and anticipate new FATF recommendations.

“New ways of working”

In order to assist the financial sector in a context of growing regulatory requirements, as well as products and services which are more and more innovative and complex, the CSSF increased its staff and launched an important reflection on the modernisation of its work methods. Almost 200 agents were recruited these last two years with the staff number reaching 845 as at 31 December 2018.

The use of the latest generation of technological tools has been extended in keeping with the implementation of the CSSF 4.0 strategy. They will allow the CSSF to reproduce proactively, via a portal, information that the supervised entities can update. Moreover, the application of control algorithms will enhance the granular update of risks reported via the regular reporting already in place. Finally, the CSSF envisages to apply machine learning methods to the authorisation process.

In the framework of the review of the organisation of its work and collaboration methods, the CSSF applies, among others, the Lean Management methodology in order to optimise its internal organisational processes, such as the interaction with the financial centre.

A challenge: the dual digital and ecological transition

The CSSF noted that whilst clients of financial institutions, as well as the regulator, will never fully trust robotics, they should not fear digitalisation. On the contrary, if used intelligently, it will contribute to build a financial system that is more efficient, cheaper, less vulnerable and more inclusive. 

Claude Marx highlighted: “With respect to digitalisation, there are two certainties: The first is that there will be a deep transformation in the business areas of the Luxembourg financial sector. The second is that computers will not replace human beings.” He added, however, that: “the digital transition will also lead to changes of some employee profiles necessary for the financial centre, and not all existing profiles will be converted into professions of tomorrow. Consequently, there will be, at first, a negative impact on employment in the financial sector which is and will remain one of the driving forces of the Luxembourg economy in the coming years”. Another collateral impact of digitalisation will be the decrease in tax revenue generated by the financial sector which will have to be offset by other income sources. 

Finally, the CSSF reflected on the urgency of the ecological transformation, which must be part of the realisation of the COP21 goals, on the one hand, and the 17 UN Sustainable Development Goals, on the other. In March 2018, the European Commission presented an ambitious strategy regarding sustainable finance. According to Claude Marx: “The transition to a low-carbon economy cannot be achieved without private sector financing”. The relevant roadmap includes a unified classification system for ‘sustainable’ investments, EU labels, the obligation for asset managers and institutional investors to take into account sustainability in the investment process, the integration of sustainability in the prudential requirements and the disclosure of non-financial information on climate. He concluded: “The Grand Duchy, with some 4,500 billion of assets under management, should aspire to have at least 10% of these assets invested in short-term sustainable investments and become the leader in this area”.