A primer for financial services firms for 2022

Quick Take

As 2021 draws to a close, COVID-19's variants and mutations continue to present challenges. This extends both to the medical response as well as the economic outlook for businesses including also for some financial services firms. Just when consensus had largely thought COVID was under control, the Delta variant began to disrupt the outlook. Once Delta was tackled and under control along came Omicron (including sub-variants) to rear its ugly head and present a number of known and unknown unknowns due to its high-level of mutations, which have also led to concerns that conventional vaccines may not work, and the tentative green shoots of the economic recovery could be hampered.

Since the start of the present pandemic and largely regardless of which letter of the Greek alphabet refers to the present threat, firms (and equally their staff) have had to continue to deal with often overlapping and conflicting rules. They have also had to deal with new risks from cyber or more conventional threats and a range of new and very different economic conditions. Some of these challenges and solutions are of a shorter-term nature while others will require longer-term planning with multiple action points, contingency plans and fallbacks during both the worst of the pandemic as well as during the anticipation of the recovery curve that will emerge when COVID-19 and its variations and mutations move from containment to ultimately control and cure.

In this Background Briefing from PwC Legal's RegCORE, we set out a number of considerations financial services firms may wish to adopt. Financial services firms provide critical services to an array of counterparties, clients and customers they serve as well as the communities they operate in. This is ever more critical during the COVID-19 pandemic where households and businesses need access to their deposits as well as funding. While these are certainly by no means a catch-all cure, they may act as a primer for how to deal and adapt to an operating environment under prolonged pandemic conditions.

The key principle of "prudent preparedness prevents paralysis" should be set both as a tone from the top but also from the bottom up and be done so across all business, operational and control functions (legal, risk, compliance, governance and audit). More so than ever before, especially as the pandemic persists, preparedness' objectives and how plans are operationalised needs to be agile.1 They will need to operate on a risk-based approach to identify, mitigate and manage risks to all business operations and to ensure the resilience of both human and financial capital and be applied through adverse market conditions in the midst of the pandemic as well as in the eventual recovery phase, which may be subject to additional volatility. Some of these priorities for firms may include:

  1. ensuring that coordination and teamwork of decentralised resources (including those operating in location-independent working arrangements) have centralised reporting channels and that strategy is set with a sufficient tone from the top to flow throughout the financial services firm as a whole;
  2. periodically reviewing whether preparedness planning is fit for purpose both in design and deployment. This applies to all forms of assets and exposures, including cyber-risks and resilience against a changing regulatory and supervisory environment as well as a host of new bad actors and threats. Plans, assumptions and communication systems (as well as workarounds) should be periodically re-tested to account for unforeseen or threat-based actions that could put pressure on these resources;2
  3. ensuring relevant protocols as well as tolerance for any flexibility are established;
  4. revisiting health & safety arrangements as well as educational and awareness efforts;
  5. managing contractual risks with counterparts, clients and customers as well as suppliers to the firm;
  6. testing resilience of financial arrangements as well as funding channels;
  7. improving monitoring of insolvency risks of counterparties and clients as well as suppliers and having action plans (including as to vendor management) in place in addition to one's own recovery and resolution planning;
  8. considering the adequacy of insurance and re-insurance coverage;
  9. revisiting policies and procedures for dealing with vulnerable customers; and
  10. ensuring early, clear, frequent and consistent internal, external and regulator-facing communication.

Those financial services firms that have done well during the current extent of the pandemic quickly realised that despite having a business continuity and/or pandemic preparedness plan in place, these were designed for shorter term and largely event-driven emergency conditions. Looking over the longer term, prudent firms were quick to put in place a more permanent and centralised pandemic planning coordination team as well as appoint deputies. In order for such teams to perform well, clearly defined responsibilities, powers and resources were allocated to them. This included having sufficient and continued budget access in order to rapidly implement plans, manage preparations in an agile manner and revisit and adapt as necessary to meet rapidly-changing requirements as applicable within individual but equally across borders.3

Firms that have also particularly done well in terms of rolling-out robust resilience measures include those that have taken a 360-degree view of their actions. This means specifically aligning their own actions with those taken by their peers (including competitors) to assess how one's own actions measure up against those of others as well as make up the operating environment as a whole. As has become readily apparent during the pandemic, during a time when people are being asked to self-isolate and distance themselves and do so more frequently, it has never been more important for firms and their staff to be more connected, to communicate and collaborate more with one another but also with the wider markets and communities in which the engage with.

What got us here will not get us there

The various stages of COVID-19 and the continuing evolution of variants and mutations present various threats. They also are reshaping how business is transacted in the EU-27 including after the pandemic eventually subsides. What has become readily apparent is that the pandemic knows no boundaries, no borders and certainly does not discriminate and can certainly resurface in new forms even after the all-clear has been sounded.

The same is also true of the resulting economic pressures and fallouts that have taken aim at public sentiment but also corporate balance sheets. While by and large, e-commerce has boomed, the successive (often rolling) lockdowns have disrupted the real economy. A number of countries experienced economic recessions and in some jurisdictions, financial market crises have followed. Some trading venues have seen the worst crashes since 1987. The pandemic has also put pressure on household finances as well as a looming debt crisis for low- and middle-income but equally for certain more economically developed countries.

The impact from these concerns is being felt by various types of financial services and non-financial services both large and small (collectively "firms"). Corporate credit ratings downgrades across "real economy" industries such as energy/oil, entertainment, retail, travel/leisure but also banking were most heavily impacted by the pandemic as certain corporates failed to adapt or provide an outlook on how they might do so. The largest credit rating agencies had initiated as many credit rating downgrades in 2020 as during the start of the 2008 Global Financial Crisis (GFC).

As a result, some of these more general factors and thus pressures on firms include:

  1. Shifts and changes to how business is conducted across different sectors or how supply and delivery chains operate prior to and since the onset of the COVID-19 pandemic. Some business and operating models may have been or are still yet to be altered completely by what is turning out to be a very different set of stresses, shortages and uncertainty as to what they had been used to – including during and following the GFC. Consequently, if this time is different, then some firms may need to look at operational as well as funding resilience quite differently as well as to cope with shortages of various goods and services;
  2. A more fundamental shift to and thus greater reliance on internet-, virtual and metaverse-based infrastructure. This presents new commercial opportunities but also exposure to a range of cyber- and conventional risks;
  3. Concern that mutations and variants may cease to be capable of being curtailed and combatted by current vaccinations and medical responses being administered as timely as before. Ultimately this could translate into large-scale absenteeism of employees across firm's own business operations but equally across those of their clients as well as suppliers whether due to illness, caring for relatives, home-schooling or a host of other issues;
  4. Continued pressures on economic sentiment plus a subdued outlook that may be jolted by more frequent sectoral shocks and disruptions have persisted and thus drive greater uncertainty on the length and extent of downturns and the prospective paths for recovery;4 and
  5. Uncertainty on adequacy of insurance coverage during rapidly changing events.

Given the above, extraordinary central bank-led as well as governmental fiscal and other public-sector-led support measures have and may likely continue on for much longer with a larger pool available than during the GFC. This may also include a greater role for public-private sector partnerships along with possible support as a result of fiscal stimulus packages along with tax reliefs for businesses but also (perhaps more importantly) the human capital that work and buy from those businesses. Crucially, fiscal stimulus may take longer than monetary policy measures to affect change and improve the outlook.

Not all of these support measures are able to reach companies, their clients and the broader "real economy" at the same time. This too may continue to impact the recovery prospects, especially since Delta and Omicron and any other further variants could cause delay and at points derail green shoots taking hold. Such delays may also, certainly over the longer-term, cause challenges in how to refinance the extraordinary support that has been provided to date and how to drive the recovery as well as who will pay for it. This future financing effort risks causing challenges for some companies right now unless they can update their business models.

All of this has put pressure on financial services firms who, for the moment, will be expected to extend support to such firms during the pandemic and its economic impact but also in order to drive the first tentative green shoots of recovery in what across many industries may be a very different operating model. Financial services firms have had to both during the (prolonged) pandemic but also with a view to a new economic and business operating model had to adapt their risk tolerance and how they measure their exposures.

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Footnotes

1. The European Central Bank (ECB) in its oversight role of financial market infrastructures (FMI) as opposed to its Banking Union role at the head of the Single Supervisory Mechanism (SSM) set out best practices for overseers of FMIs and their business continuity plans. This publication is available here. In this publication the ECB observed that for FMIs "Different approaches have been noted, ranging from more standardised step-by-step pandemic-specific business continuity plans to more flexible arrangements entailing ad hoc decision-making." While the ECB's own proposals for FMIs to link up their actions (at least those expectations that are set out by the ECB) with the six risk levels set by the WHO in respect of pandemics is welcome, these may be eclipsed by more stringent restrictions and conduct expectations set by health and other public authorities that quickly eclipse what is required or seen as best practice by financial services policymakers and supervisors.

Equally on 3 March 2020, the ECB-SSM sent a letter to SSM direct supervised institutions (banks and investment firms) requesting that they at both group and individual legal entity level consider contingencies where operations are dependent on their staff remaining healthy and available to work as well as having access to the suitable systems and processes. Crucially, the ECB-SSM calls on firms to:

  1. Establish adequate measures of infection control in the workplace, including systems to reduce infection transmission and worker education;
  2. Assess their contingency plans, in particular, to ensure that the plans include a pandemic scenario and provide for scaling measures appropriate for the firm's geographic footprint and business risk, taking into account the stages of a pandemic outbreak;
  3. Assess how quickly measures could be implemented and how long operations could be sustained in a pandemic scenario;
  4. Assess whether alternative and sufficient back-up sites can be established;
  5. Assess and test the firm's capabilities for large scale remote working;
  6. Assess and test the capacity of existing IT infrastructure;
  7. Assess the risks of increased cyber-security related fraud; and
  8. Assess the ability of their critical service providers to ensure continuity of services.

2. Temporary relaxation of regulatory standards may provide some firms with necessary flexibility but also carries with it new risks and vulnerabilities to business operations in addition to wide-spread and prolonged remote working. Personnel of all levels of seniority need to be aware to these risks and that often humans are often the weakest link. For dedicated Background Briefings from PwC Legal's RegCORE on both location-independent working as well three lines of defence during location independent working arrangements please see our dedicated Thought Leadership section.

3. COVID-19 restrictions have been and remain an area of uncoordinated and fast-paced change. This has and continues to lead to confusion and concern given that restrictions can affect the freedom of movement of persons as well as availability of goods within but also across judications.

4. Which may mutate into widespread financial pressures on meeting or receiving obligations when due, concerns on insolvency risks more generally.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.