Financial The COVID-19 pandemic: Potential impacts on financial regulation An uncertain future Introduction

The COVID-19 pandemic has swept across the globe driving unprecedented change in a period of time. It has impacted the way we live, work, interact socially, and the way we do business; significantly impacting the dynamics of the global economy. Given the need for businesses and individuals to transact remotely, the lockdowns have accelerated innovation and technology adoption by both financial institutions and their customers. Governments and central responded vigorously from a financial perspective, delivering assistance to individuals and businesses in need, and financing key services that were required to support society during the crisis. Financial regulators have reacted to enable financial institutions to provide and liquidity and to support government stimulus. However, the nature of the assistance and the delivery mechanisms were reactive rather than planned, and there are lessons to be learned and longer-term policy matters to be considered.

2 | The COVID-19 pandemic: Potential impacts on financial regulation In this perspective, we examine the impact the COVID-19 Key expected pandemic may have on the future of regulation and discuss trends and policy the related issues financial institutions will need to address going forward. Clearly, future regulation will be influenced by development other factors that were already underway prior to the onset of the COVID-19 pandemic, including innovation in and technology. Our focus, however, is on pandemic- related drivers. In this paper, we will explore current and future implications as they relate to four themes and speculate on how they will impact the regulatory framework.

Government, central banks and 1 regulatory policy intervention

Operational resilience in the 2 financial sector

Environmental, social and 3 governance (ESG) issues

Customer expectations and 4 requirements

The COVID-19 pandemic: Potential impacts on financial regulation | 3 Government, central banks and regulatory policy Intervention

• In the near-term, expect keen oversight from regulators on provisioning. Stress testing outcomes may result in different capital buffer requirements in various jurisdictions depending on how regulators calibrate these. • Anticipate amendments for conduct guidelines on resolution or restructuring of non-performing (NPL’s), with different strategies expected for NPL’s, and business NPL’s with full or partial government guarantees. • Government will need to work with banks and other lenders on recovery solutions that can be deployed to restructure government guaranteed loans in a sustainable way, benefiting both businesses and government. This may include development of industry utility structures. • Large numbers of retail or non-guaranteed business defaults may lead to banks restructuring balance sheets. • In the next and beyond timeframe, developing a better understanding of contagion among participants in financial markets may lead to either the imposition or increase in regulatory oversight of participants not currently regulated or lightly regulated. • The need to ensure orderly markets and protect non-professional may lead to new rules, appropriate disclosure, and suitability requirements regarding investment funds promising -in availability against potentially volatile or illiquid assets. • Clearer prescription of the role of insurers in protecting against global disasters or pandemics, and development of a framework that works for the insured, insurers and government. • The development of a dual stress-testing framework incorporating the existing macro-economic approach, and a separate approach for acute or chronic-impact global events, such as climate change and epidemics. • Designing a crisis policy framework that identifies the roles of various public bodies and financial institutions, as well as potential tools for dealing with crisis. To the extent that financial institutions are an arm of the policy framework, there will need to be clear understanding of directors’ and executives’ responsibilities and potential conflicts with their responsibilities to shareholders and creditors.

4 | The COVID-19 pandemic: Potential impacts on financial regulation Operational resilience in the Environmental, social and Customer expectations financial sector governance (ESG) issues and requirements

• In the near-term, regulators will want • The commonality of characteristics • In the near-term, conduct regulators to ensure that the original manual between pandemic-related and ESG will focus on the treatment of interventions and amended processes risk has been noted and, given the vulnerable customers that have have been upgraded and embedded impacts of COVID-19, will serve to encountered payment difficulties into a new operating model. The increase the urgency of actions by or suffered losses arising from the working-from-home operating model financial institutions. COVID-19 pandemic, and will require will get close attention, in particular banks to provide adequate time to • In the next and beyond timeframe, the risk governance and controls allow borrowers to recover. we expect regulators to require environment. ESG-like considerations for financial • In the next and beyond timeframe, the • Supervisors will focus on how institutions to reflect lessons learned regulatory and supervisory focus will cybersecurity, and financial from the COVID-19 crisis. In particular, shift to cover the following: controls have been institutions will need to consider: • Risks to customers caused by more implemented. Institutions with • How to make firms more resilient to significant shift to digital channels or trading activities will similar future events need to concentrate on conduct and • Increased cyber risks and potential operational risk oversight. • Future epidemic risk in business theft of data and identity strategy and planning • Assessing third-party outsourcing • Continued ease of access to arrangements that have been forced to • The location of macro-economic banking for customers not digitally change or did not function well during vulnerabilities, and the effect of competent further epidemics on economies the first wave of COVID-19 under a • Focus on the customer journey and given societal structures and GDP global lock-down. Supervisors will be the bundling of product and service constraints very focused on operational resilience offerings in the face of continued disruption, and • Exposure to countries based on their in understanding the longer-term plans social and/or organizational capacity for outsourcing and impacts on the or framework to deal with pandemic- . scale events • In the next and beyond timeframe, we • The ESG performance of third expect regulators to move toward a parties throughout the supply chain more integrated operational resilience framework. • Building flexibility into the crisis or event response framework will enable more agility and repurposing of resources. • Rapid build-out of digital technology and data use will drive more attention to the development of a digital operational resilience framework, including more integrated and digital operational resilience testing. • Increased use of digital technology will drive users to outsourced information and communication technologies (ICT) services, including cloud. Supervisors will expect service-level agreement (SLA) to contain standard contractual clauses and to designate authorities to carry out that oversight.

The COVID-19 pandemic: Potential impacts on financial regulation | 5 1 Government, central banks and

Theme Theme regulatory policy intervention

Theme background

Governments and central banks responded swiftly to the unfolding COVID-19 crisis with aligned fiscal and monetary policy actions. Critical to the success of the government and policy measures was transmission of these financial support measures to businesses and individuals. The banking sector has been required to play a very significant role in policy delivery and supporting society through business lending, consumer accommodations, providing payment moratoria and foreclosure delays, and executing the Paycheck Protection Program in the US. As a result, banks have substantially increased the risk on their balance sheets, contrary to usual business decision-making imperatives. Both regulators and supervisors have played an important role. Regulators have adjusted policy and regulation to reduce capital and liquidity buffer requirements and offered policy guidance on provisioning requirements. Supervisors have provided operational relief to banks from many normal supervisory activities. Some regulators have also provided temporary relief for certain documentation requirements. These actions were taken to support the banking system’s extension of credit facilities required by businesses and households. Government, central banks and regulatory policy actions were designed to prevent economies and markets from falling into a severe downward spiral, and to curtail the extent of economic damage from lockdown. In effect, by supporting the economy and the financial markets, these actions were also curtailing the extent of the damage to banks. (EU) banks have been encouraged by the European Central

6 | The COVID-19 pandemic: Potential impacts on financial regulation Bank (ECB) supervision division1 to are often concerned that markets will “permitted” to do so. But, in requiring utilize regulatory capital buffers to lend perceive utilization of buffers as a sign banks to significantly increase their into the real economy, making the case of weakness or vulnerability. There is lending exposures, policymakers that banks’ injection of credit is also significant uncertainty regarding the perhaps have played a part in what contributing to economic stimulation extent of loan losses, and banks want is actually the fiduciary duty of boards and, therefore, is self-serving. This has to be in a to begin paying and the responsibility of senior bank not played out as designed, as banks again as soon as they are management.

Likely regulatory responses

The current focus of government, measures. Banks, however, will need guarantees, and corporate NPL or central banks and regulators is to to start planning now to ensure that . In addition to bank lenders, there manage the economic and social impacts they will achieve these timelines, are many jurisdictions with non-bank of the present situation until vaccines considering the significant uncertainty lenders (mostly to the retail sector), are made widely available. At the same in economic forecasting and estimated and these will need to be brought time, they must plan an exit strategy loan losses. into the policy framework from a from the emergency policy framework. conduct perspective (see customers’ • Banks are making changes to However, it could take a couple of years expectations and requirements the provisioning models or, more to fully realize the effect as companies theme). often, making manual overlays to fail or reinvent themselves, markets accrue provision reserves based on • Regulators will be focused on adapt, and labor forces retrain or assumptions and the best available supervisory stress testing and refocus. Continued support to the real evidential data. Although regulators institutions’ own internal stress economy and for vulnerable individuals will not directly impact testing in 2021, as a means of will be unavoidable for some time. The provisions, in many jurisdictions testing the asset quality of banks and immediate regulatory focus will include: they can demand additional capital understanding capital vulnerabilities. • Retaining temporary capital and requirements or drive stress-test Asset management firms will focus on liquidity relief measures. The EU has capital impacts if they feel provisions liquidity stress testing. said they will retain capital relief until are inadequate from a prudential • It is not evident that regulators the end of 2022 and retain temporary perspective. are changing their stress-testing liquidity relief until at least the end • Regulators will expect banks to justify methodologies significantly, but 2021. Similarly, in the US, regulators and document all loan loss levels and banks’ own methods will likely need have provided relief for certain capital the judgmental overlays. to expand to match their evolving and liquidity measures that extend credit review processes to include into 2021. In Asia, indications are • Lenders will require different deeper sectoral and supply-chain that regulators there will continue strategies for retail NPLs, business analysis and focus more on highly to extend temporary capital relief NPLs with full or partial government

1 E CB provides temporary capital and operational relief in reaction to coronavirus 12 March 2020. https://www.bankingsupervision.europa.eu/press/pr/date/2020/html/ssm.pr200312~43351ac3ac.en.html Introductory statement by Andrea Enria, at the virtual meeting of the European CFO Network 12 June 2020 https://www.bankingsupervision.europa.eu/press/speeches/date/2020/html/ssm.sp200612~eae5123290.en.html

The COVID-19 pandemic: Potential impacts on financial regulation | 7 leveraged borrowers. Given some authorities’ pronouncements on the use of buffers,2 further guidance will likely be needed regarding stress test outcomes, the use and adequacy of buffers, the level of downturn that institutions can withstand, the impact of reverse stress testing and what would trigger recovery actions. • In the EU, the ECB has stated that it will monitor loan deterioration and management strategies closely and maintain its engagement with banks to devise ways of swiftly disposing of impaired bank assets. This is a clear indication that its policy position during this crisis will be different from the previous crisis, with NPLs still on balance sheets from almost 10 years ago. • In the UK, the Prudential Regulation Authority (PRA) is being less explicit. However, an independent industry body (TheCityUK) formed a Recapitalisation Group to help consider the post-pandemic COVID-19 may well be indicative of the type of may be the best way for the state recapitalization challenge. They have integrated approach between banks to recover value in the -term. issued a report3 proposing various and government that is required Beyond loan workout and capital recovery solutions that can be in the development of appropriate repair, governments, central banks and deployed to restructure guaranteed exit strategies. regulators will need to reflect on lessons loans in a sustainable way, benefiting • In the US, regulators have encouraged learned and consider amendments to both businesses and government banks to work with borrowers and the framework going forward. Some of and providing banks with a clear provide appropriate accommodations; these may include: roadmap of how to deal with the they will evaluate bank performance in potentially large number of small- and • New approaches to understanding the light of current events. medium-sized enterprise (SME) loans effects of contagion in financial markets that will face difficulties. Another • Establishment of state-owned asset • Regulation of markets and participants independent industry body, UK management vehicles or utilities to Finance, is designing a utility structure manage the collection and/or recovery • Approach to stress testing, reflecting to operationalize the collections and of state guaranteed loans are also a the speed, breadth, and depth of the recovery of government guaranteed possibility and would support policies economic impacts loans in a consistent way across the that seek to remove NPLs quickly from • Changes to the policy framework for banking sector. These initiatives bank balance sheets. This structure responding to similar future events

2 Media briefing July 28, 2020 Andrea Enria (ECB) confirms buffers can be utilized to at least the end of 2022. Stress testing goes beyond this date. BIS Newsletter on buffer usability (Oct 2019) states supervisors have discretion to impose time limits. https://www.bankingsupervision.europa.eu/press/speeches/date/2020/html/ssm. sp200729~4177c94f5b.en.html and https://www.bis.org/publ/bcbs_nl22.html 3 Supporting UK : recapitalising businesses post Covid-19 — July 2020 https://www.thecityuk.com/research/supporting-uk-economic-recovery-recapitalising- businesses-post-covid-19/

8 | The COVID-19 pandemic: Potential impacts on financial regulation Understanding contagion Regulation of markets it necessary to extend their oversight and ensure current non-regulated To better understand the impact of and participants participants have sufficient liquidity significant global events, central bank Some of the contagion effects in financial to manage their own stresses. and regulatory policymakers require a markets impact either non-regulated better understanding of the contagion Additionally, the need to ensure the or significantly less regulated entities. effects in markets, particularly for functioning of orderly markets also calls Some of these entities may be driving liquidity impacts across the various into question again the appropriateness or amplifying market stress, benefiting segments. Understanding contagion of funds promising deposit-like stability, from central bank market intervention will lead to a greater recognition of or cash-in availability against volatile or activities and/or causing stress on more the roles that various participants play illiquid assets or, in the case of money significantly regulated elements of in crisis situations and allow macro- market funds, against commercial the core funding markets. An example and micro-prudential regulators to paper markets that froze under stress. appears to be highly-leveraged re-evaluate . It will be We would expect consideration of funds that hold large arbitrage positions important to develop data and models changes to fund structures, in particular in government bonds which they were for testing this in a wider stress asset mismatches and price stability forced to sell, causing further price falls test and vulnerability assessment promises. In addition, we expect in government bonds, and generating framework in order to better further stress-testing requirements significant calls on determine the vulnerabilities, identify for market . These all will companies and funds.4 If these potential systemic changes, and the need to be explained to customers are coming under pressure from forces cause-and-effect relationships. and incorporated into product design, outside the regulated entities in the suitability and disclosures. market, then regulators may consider

4 Financial System Resilience: Lessons from a real stress - speech by Jon Cunliffe, , June 2020 https://www.bankofengland.co.uk/speech/2020/jon-cunliffe- speech-at-investment-association

The COVID-19 pandemic: Potential impacts on financial regulation | 9 Stress testing scenario-driven framework, similar to Crisis policy framework current models; and (ii) a broader and During this crisis, it was clear that far-reaching events-driven framework The COVID-19 pandemic has had, current scenario-based stress testing similar to what the Bank of England among other things, an immense was insufficient to estimate the impact (BOE) (UK), the Authorité de Contrôle impact on the economy, businesses on loan books. A more detailed and Prudential et de Résolution (ACPR) and individuals’ financial welfare. The granular understanding of exposures () and Australian Prudential financial sector has had to play a very based on sectors, sub-sectors and Regulatory Authority (APRA) are significant role in ensuring people, information on obligors’ exposures to discussing with respect to climate their employment, businesses and supply chains (production inputs) and change testing that can be adapted production of goods and food were demand chains (sales) is critical. for a wide-range of non-economic supported from a financial perspective. Although most governments, central Many of these data points are similar derived events. banks and financial regulators to those for climate change (e.g., The need to model contagion in responded appropriately during this understanding supply chains, and client/ financial markets and in the supply/ crisis, it would be folly not to review asset exposures to physical risks). All demand chains of borrowers across the responses, identify lessons learned, of this means a big data agenda re: sectors, sub-sectors and geographies look forward to potential future obligors (for financial resilience) and will drive an even greater need for events, and establish a crisis policy suppliers (for operational resilience), comprehensive data, data labeling framework now that incorporates a and an amended modeling approach and data management. When coupled financial markets response. This may that can accommodate these inputs and with ESG requirements, and the digital be aligned with, or include, elements of estimate the financial impacts on bank agenda being driven by customer climate change or environmental risk and insurance balance sheets. demand, this points to more urgent framework responses. We see a dual stress-testing framework technology re-platforming demands as the norm: (i) a macro-economic from regulators.

10 | The COVID-19 pandemic: Potential impacts on financial regulation etc). It should outline the extent or boundary on the level of loss that may occur before backstops or government guarantees kick-in. • During the current COVID-19 crisis regulators expected banks to support the real economy by utilizing their regulatory capital and liquidity buffers to lend more, dampen the shock and, in theory, protect their balance sheets. In practice this did not happen as banks realized the risks of lending in uncertainty were far greater than the potential macro-economic benefits. The crisis framework, therefore, will have to consider how stimulus will work in practice through the banking system and the infrastructure that can be deployed subsequently to recover and restructure loans in a manner that benefits the economy as a whole. • Such measures may need to be role- played in system-wide scenario testing with bodies akin to resolution-based crises management groups but with system-wide set up. The framework may include: as part of the solution. It will provide clarity to boards, senior management The policy response may also address • Given the reach of policy response and investors in these institutions as the importance of the insurers’ role in in the current crisis and the need to their roles and the responsibilities the framework and look to engage them to encompass various market of the various players in the policy more comprehensively. The pandemic participants in the delivery and risk- framework vis-a-vis the institutions. has raised questions about taking aspects of the various support It will need to consider the legal and whether insurers are legally measures, there is clearly a need obligation of directors and required to cover business interruptions to formalize such arrangements for management and formally recognize caused by pandemics, the breadth of future events. We see the need for that these will change when they are coverage, and their civic responsibilities a separate crisis policy framework acting jointly with government and to be inclusive and good corporate that will be implemented when central banks in responding under the citizens. While insurers will want to certain environmental, epidemic crisis framework. There may be “best protect themselves in the future from or similar events occur that have efforts” and “hold harmless” clauses liability arising from similar events, this far-reaching impacts on people’s in the protocol, and expectations may not be the view of policy-setters. lives, the operation of economies that regulators and supervisors will They may need to consider what and functioning of the financial not subsequently seek to hold an coverage insurers must offer as part of system. The playbook would delineate institution responsible for unintended their licensing conditions and place a cap what systemic measures might be consequences of actions taken in on both the premium and the liability. taken, the expected role of players good faith (e.g., the extension of This way businesses will be paying for at in implementing them, and relevant credit to entities that in a more normal least part of the cost of protection and regulatory modifications needed. scenario may not benefit from such recovery and government and insurers • A crisis policy framework will need decisions; the rapid transmission of acting in concert building off models to include the financial institutions economic stimulus with reduced fraud that currently exist in some countries that will be expected to participate controls to speed up transmission; for flood-damage or terrorism.

The COVID-19 pandemic: Potential impacts on financial regulation | 11 2 Operational resilience in

Theme Theme the financial sector

Theme background

The approach to operational resilience differs slightly among global regulators, some taking a more integrated approach and others taking a risk element approach. However, the principles of operational resilience and the risk elements are very similar. The primary concern of regulators at the start of the crisis was ensuring that institutions were able to stay open for business — delivering products and services to customers. Regulators and supervisors have been satisfied with how financial institutions’ operational resilience frameworks managed to transition from business as usual to business continuity operations and then to a remote work-from- home environment. There were delays in getting operational, concerns about controls on trading and other activities, and the effects on outsourced activities in offshore jurisdictions due to local lockdowns. However, institutions managed to operate effectively and recover these services reasonably promptly, in some cases re-onshoring the activities.

Regulatory responses

We expect the immediate regulatory • Understanding material operational • Understanding and addressing response will be to focus attention on risks and ensuring these are being cyber, fraud and financial crime lessons learned in the following areas: properly identified, recorded and risks from adapting processes to reported to regulators in the standard support working-from-home, remote • Identifying bottlenecks and manual regulatory returns client interactions, and the rapid intervention challenges during the transmission of economic stimulus transition phases, and establishing • Assessing, monitoring and testing of an understanding of the causes third-party outsourcing and • Developing workforce strategies to (e.g., legacy systems not properly on-offshore concentrations allow people to return to the workplace integrated) as required and in a way that is value-added and for specific purposes

12 | The COVID-19 pandemic: Potential impacts on financial regulation • Planning and implementing enhanced The COVID-19 events will continue service firms can expect more tools for remote operations to drive a host of changes to the way attention on a cross-sectoral basis institutions work, where they work, to their digital operational resilience • Clarifying requirements for physical how they interact with their clients, framework, including; (i) development versus digital documentation the technology they deploy, and of more integrated, consistent and Post-pandemic, Covid-19 regulators how they view the outsourced eco- detailed regulations; (ii) digital will be sensitive to the many problems system. Longer-term policy effects operational resilience testing; and that can prevent banks from fulfilling will likely include: (iii) potential oversight of critical critical roles in the aid transmission third-party providers. • Institutions will continue to make framework. As regulators move far greater use working-from- • Given the level of potential risk posed away from monitoring the immediate home, but will need to implement by a digital environment, we expect responses and vulnerabilities, we expect enhanced controls and resilience while enhanced regulations across all sectors they will require banks to harness the addressing training, development, that will bring stricter enforceability lessons learned from the response to and mentoring needs. Banks will need and the need for clear governance, the COVID-19 pandemic. It is likely that to demonstrate how they are able monitoring and testing. financial institutions will be required to to maintain effective controls in this develop a crisis management framework • Consistent with the interconnectivity environment. incorporating the lessons learned and in the , we expect over that these will become part of a more • Current approaches to managing and time that ICT testing frameworks will coordinated and integrated operational testing operational resilience focus on require the development of common resilience framework. prioritization of key business services standards and approaches, including and ensuring these are defined and assessments and gap analysis, as We have already seen in August 2020 the protected. However, in an external well as actual threat-event testing. A Bank of International Settlements (BIS) event-driven crisis these priorities can common framework would support issue separate consultative documents switch, as in the current COVID-19 reliance and mutual acceptance on Principles for Operational Risk and pandemic. There will probably be a of outcomes across sectors and Principles for Operational Resilience5, new emphasis on building flexibility jurisdictions. clearly messaging that Basel sees them and adaptability into the resilience as separate concepts. • The increased use of digital technology framework so that people, processes, will drive firms further toward the use A more integrated framework will require systems and delivery mechanisms can of outsourced ICT service providers institutions to develop a service-focused be swiftly repurposed. (including cloud), resulting in greater view, map asset interdependencies • Regulators will be even more sensitive risk and more concentration residing extensively while noting manual to the threat of concentration risk in with these providers. Regulators are intervention dependencies, identify the outsourced supply chain. Firms will already considering the design and concentration risks, including single need to re-evaluate the resilience of development of third-party oversight points of failure, and establish impact the current ecosystem and apply the frameworks, including defining tolerance metrics. This implies banks lessons learned to enhance resilience activities and designating the authority establish or enhance the following: and possibly reduce single source or that would be responsible for carrying • Service criteria and location dependency risk. out the oversight. The use of standard contractual clauses, currently being • Asset identification and mapping • The rapidly increasing use of digital considered for cloud arrangements technology and data across the • Risk assessments (e.g., business with financial sector entities, will financial system raise challenges impact assessments (BIAs and BCPs)) possibly also be extended to certain in terms of operational resilience other ICT third-party service activities. • Concentration risk management, and make it particularly vulnerable including back-up strategies to to ICT and risk operational diversify exposure and reliance incidents and cyber-attack. Financial on critical third parties

5 BIS Consultative documents on principles for operational risk and operational resilience https://www.bis.org/bcbs/publ/d509.html

The COVID-19 pandemic: Potential impacts on financial regulation | 13 3 Environmental, social and

Theme Theme governance issues

Theme background

Many of the characteristics of factors common in an ESG framework6 are present in the impact of and the policy response to the COVID-19 pandemic, namely: Non-financial impacts:Financial institutions have been required to consider and incorporate into their actions: support of vulnerable customers; additional lending in a high-risk environment to keep businesses operating; insurance claims that may normally be vigorously defended. Uncertainty: Relating to the timing of events and severity of impacts. Negative externalities: The wider impacts on society and business sectors will impact the activities of financial institutions long after the event. Value chain impacts: The effects on clients’ supply chains and demand for their products and services is significantly impacting the quality and value of financial institutions’ assets and liabilities. Increased sensitivity to changes in : Significant impact to financial institutions from policy responses of government, central banks, regulators and supervisory bodies. Thus, the ESG frameworks provide a useful model for considering regulatory responses to the COVID-19 pandemic.

6 EBA Discussion Paper on management and supervision of ESG risks for credit institutions and investment firms — Oct 2020 https://eba.europa.eu/sites/default/documents/ files/document_library/Publications/Discussions/2021/Discussion%20Paper%20on%20management%20and%20supervision%20of%20ESG%20risks%20for%20credit%20 institutions%20and%20investment%20firms/935496/2020-11-02%20%20ESG%20Discussion%20Paper.pdf

14 | The COVID-19 pandemic: Potential impacts on financial regulation Regulatory responses

Although the COVID-19 pandemic has The impact of the COVID-19 pandemic As with the ESG agenda, we expect these halted much of the normal operational has highlighted the exposure of the matters will require recognition in the supervisory work and redirected much more vulnerable in society to higher following areas of financial institutions of the policy development work, it infection rates. This has coincided with planning and management: has not interrupted the pace of policy international support for the “black • Incorporate future epidemic risk into development of the climate change and lives matter” campaign originating business models and strategies to sustainable finance agenda. If anything, in the US and the general swell of determine industries and sectors most it has refocused minds on the importance opinion highlighting other areas of impacted by lockdowns and supply and urgency of developing a functional social injustice, racism and diversity. chain disruptions. policy framework given the effect of an As a result, governments will likely be acute event like a pandemic. more focused on seriously addressing • Consider vulnerability and the effect of these issues and their domino effect on further epidemics on economies given A key policy response has been assisting regulatory policy. societal structures, the GDP constructs vulnerable customers through financial (industrial/service/agricultural), and difficulties. Showing compassion and The expansion of the social agenda into the impacts on unemployment. understanding in executing workout business strategy would require banks, solutions will be critical during the next investment firms, securities firms, fund • Reassess investments and loans to phase. We expect to see a continuation managers and pension funds to consider businesses or the establishment of conduct regulators’ protection their balance sheet assets from a social of outsourcing arrangements in of vulnerable customers and the agenda perspective in a similar way countries based on their social and/or development and enforcement of to the environmental agenda. Not just organizational capacity or framework standards (see customer expectations “green” investment, but also a socially to deal with pandemic-scale events. and requirements). This will require a supportive agenda. Firms that exploit • Develop policy and approach for careful balancing of customer care, social labor at below minimum wage and run treatment of customers in the event responsibility, and the management of “sweat-shop” environments can prompt of a future epidemic or other acute usual business-decision imperatives. swift customer reaction when exposed health events. and need to consider the reputational In addition to protection, we expect to impacts. The sharp fall in revenues that see further developments in ensuring can ensue produce resultant falls in access to appropriate services for people share value, debt downgrades and higher who are not technologically savvy or probability of on loans. for the financially disadvantaged who cannot easily obtain access to products When firms are re-examining their or services that become a necessity in outsourcing arrangements as described the increasingly digital and non-cash in the Operational Resilience theme in environment. More needs to be done this paper, they will need to consider both to improve digital literacy, improve country and third-party policies toward access to digital identities and mobile individuals. This will include the political and internet services, and address regime, the treatment and payment of biases in data. employees, and the conditions under which they operate.

The COVID-19 pandemic: Potential impacts on financial regulation | 15 4 Customer expectations and

Theme Theme requirements

Theme background

Dealing with customers’ needs and requirements has been at the core of financial institutions’ work during the pandemic. The immediate governmental policy response has been to ensure individuals and households receive income supplements and relief from making debt repayments if their sources of income have ceased or substantially changed. Financial institutions have played a key role in delivering payment holidays to retail clients and lending to many SMEs. The payment holidays were delivered through different mechanisms. Some were established by legislation, others on a voluntary basis by banks acting through banking federations or acting alone. Irrespective of the basis for establishing payment holidays, conduct authorities have been very active in ensuring that banks deliver this assistance to customers without question and without affecting customer credit scores. In the US, regulators placed a temporary moratorium on foreclosures, and stressed the need for banks to work with customers to the greatest extent possible. However, politicians and the media complained that financial institutions favored certain customers in the distribution of benefits to the detriment of the poor. In Asia, banking regulators have also worked with the industry to provide and extend moratoria on loan payments and other flexibilities to customers in financial difficulties. However, there has been little suggestion of inequality in the distribution of assistance. That may come yet.

16 | The COVID-19 pandemic: Potential impacts on financial regulation Regulatory responses

While policymakers are beginning to epidemic and demonstrate flexibility investors. At the same time, they consider their exit strategies, they will to accommodate what customers can will face more scrutiny on how they also need to evaluate the implications actually afford. monitor liquidity and risk for retail customers. Conduct regulators within funds, and help this shape their • Regulators in some jurisdictions will will be focused on protecting the product management and distribution likely require lenders not to foreclose vulnerable and ensuring they gain strategies. on mortgages and to devise alternate access to payment relief while the sustainable restructuring solutions. The nature of the support will probably pandemic is continuing and until more Some structures can involve the differ across jurisdictions as a result normal economic activity resumes. or a government of the local legislation and availability The commencement of rescheduled vehicle taking an interest in of bodies, such as development banks payments at the end of the payment the . There is obviously the and local political realities. In any event, moratoria will likely reveal a significant threat of clients abusing this policy banks will be forced to take appropriate cohort of borrowers that are unable to and adopting a “can pay, won’t pay” loan losses upfront. pay immediately or for an indeterminant approach and using the extended Not only are retail clients vulnerable, period due to employment uncertainty. moratoria to pay-off other debt or but small business owners are as These borrowings will relate to make purchases that otherwise may well, and it is possible that regulators mortgages for family homes, credit not be feasible. extend retail-like protection to a certain cards with high interest rates, and • Regulators, at the same time, cohort of SME clients. Very often SME unsecured personal borrowings. From will have to consider the potential borrowers have their homes committed a societal perspective, there is a need cost of trapping mortgage-holders in as collateral and foreclosure regulations to support people who are genuinely negative equity due to the potential will also apply to these . vulnerable either directly or indirectly as fall in housing prices. a result of the virus. Clearly, government The lockdown forced most policy will seek to protect individuals and • In the case of lenders, communications and transactions into financial institutions will most likely be institutions could be required to digital channels and greatly increased required to participate in this support. reduce interest rates or to settle for the amount of customer business using These expectations, in most cases, will reduced repayment of principle. these modes. It also increased cyber risk and potential theft of data and extend to the not insignificant cohort of • As banks transition from crisis identity, and the risk of transactional non-bank lenders in many countries. management, they should anticipate interference. This is also a heightened The regulatory and supervisory and prepare for an increase in risk on the regulators radar and banks responses are likely to include: complaints, potential legal action, need to address the required internal regulatory and political questions. • Collections and recovery activities controls and provide documentation. It Banks should build the case for how potentially will need to change is important to identify and investigate decisions were or are made on a fair, and those that are outsourced will weakness and potential incidents in equitable, and inclusive basis, and require a revision to the process and data privacy breaches and or data maintain full documentation. the solutions offered to customers. stolen through cyber events, and ensure It will be important for lenders to • Fund managers will find a renewed customers, authorities, and financial understand customers’ personal regulatory and customer focus supervisors are informed. circumstances arising from the on delivering value for money for

The COVID-19 pandemic: Potential impacts on financial regulation | 17 18 | The COVID-19 pandemic: Potential impacts on financial regulation Financial institutions will want to take Accompanying a shift in the technology advantage of the current leap in digital and digital delivery, institutions may engagement and continue to develop begin to shift the nature of offerings transaction execution capabilities on the to an expanded offering and a more back of the gained during bundled delivery of service and the lockdown. This includes a significant product with different pricing structures. switch to a non-cash environment. This will likely bring a suite of other In this context, conduct, customer issues for regulators to consider in terms fair treatment, and data privacy and of fair treatment and transparency. protection need to be a cornerstone of The conduct authorities are also the developments as they loom as a high focused on how insurers are dealing priority on the regulatory agenda. with claims, in particular where insurers Financial inclusion will also be an are interpreting terms and conditions in important consideration for elements what regulators see as a manner unfair of society. Regulators will be aware of to vulnerable groups. Small businesses vulnerable customers whose access and individuals cannot afford to legally to cash continues to be important. challenge such decisions by insurers. Lowering use of physical cash is In UK, the Financial Conduct Authority making ATM machines expensive and (FCA) has taken a number of insurers to further pressure on branch closure court over their failure to meet business programs will make cash less available continuity claims. The detailed judgment to such customers. was substantially in favor of the FCA and the insured, although individual policies Firms will want to invest in digital will stand on their own merits. The US architecture and adoption through insurance industry is closely monitoring marketing to build customer awareness these developments for the potential of the options open to them, share longer-term impacts on the sector. the successful experiences of new digital customers, and offer support for vulnerable customers or those that do not feel at ease using digital channels.

The COVID-19 pandemic: Potential impacts on financial regulation | 19 Conclusion

As we move into 2021, marking 12 months since the Against this backdrop, we have explored a number of themes onset of the COVID-19 pandemic, there is still significant and potential regulatory responses to COVID-19. Some are uncertainty regarding the financial effects on individuals, more obvious than others and some inevitable given the business sectors and financial institutions. The ongoing impact of the epidemic and the existing direction of regulatory experience will likely also bring society a step closer to fully policy. There are others that require reflection and further acknowledging the risks of climate change and environmental analysis in order to develop appropriate responses. One thing risk and drive more urgent responses, while also accepting is clear, we need to be better prepared and have coordinated the risks of similar epidemics or other health threats, such societal, government and financial responses. as antimicrobial resistance. Together with significant concerns regarding societal inequality, social disruption and international geopolitical shifts, these point to further uncertainty and potential disruption.

20 | The COVID-19 pandemic: Potential impacts on financial regulation For more information, contact the authors of this report:

Shane O’Neill Partner, Financial Services Ernst & Young, LLP (UK) +44 20 7951 1170 [email protected]

John Liver Partner, Financial Services Ernst & Young LLP (UK) +44 20 7951 0843 [email protected]

Marc Saidenberg Principal, Financial Services Ernst & Young LLP (US) +1 212 773 9361 [email protected]

Eugène Goyne Associate Partner, Financial Services Ernst & Young Advisory Services Limited +852 2849 9470 [email protected]

The COVID-19 pandemic: Potential impacts on financial regulation | 21 EY Global Regulatory Network executive team previous appointments

Kara Cauter Marie-Hélène Fortésa [email protected] [email protected]

She has over 20 years’ experience working in global Autorité de Contrôle Prudentiel (French Prudential Supervisory professional services firms, advising banking clients on Authority); Association Française des Banques (French Banking the implications of the regulatory agenda and designing Association); and French National Institute for Statistics and approaches to effectively meet those obligations. Economic Studies. WShe has also held senior roles at a global investment bank.

Meena Datwani Eugène Goyne [email protected] [email protected]

She has over 35 years experience in government of which He has over 20 years in government and senior regulatory the last 23 years were in senior regulatory roles. She was the roles. He was previously deputy head of enforcement at Executive Director of Enforcement and Anti Money Laundering the Hong Kong Securities and Futures Commission (SFC). Supervision at the Hong Kong Monetary Authority (HKMA). Prior to the SFC, Eugène worked at the Australian Securities Prior to that she was the Executive Director for Banking and Investments Commission and the Australian Attorney Conduct and Chief Executive Officer of the Hong Kong Deposit General’s Department. Protection Board. She also served as Deputy General Counsel and before that Senior Counsel. Prior to the HKMA she was a Senior Government Counsel with the Department of Justice of the Hong Kong Government.

Mario Delgado Alejandro Latorre [email protected] [email protected]

FROB (Spanish Banking Resolution Authority) Head of Alejandro (Alex) has over 20 years of experience at the Federal International Coordination and EBA and FSB representative; Reserve Bank of New York in monetary policy, capital markets Spanish Ministry of Economy: Director of Office of the and financial supervision and regulation. He was a senior Secretary of State for the Economy in the Economic Affairs; supervisor involved in the oversight of large and systemically Head of the Spanish Delegation Win the Paris Club; Deputy important FBOs in the US. Prior to his role as a senior Head of relations with the IMF. supervisor, he was involved in many of the ’s management efforts.

22 | The COVID-19 pandemic: Potential impacts on financial regulation John Liver Marc Saidenberg [email protected] [email protected]

Divisional Compliance Lead at Barclays; Head of Department, Senior Vice President and Director of Supervisory Policy Investment Firm Supervision and prior roles in enforcement at Federal Reserve Bank of New York; Basel Committee and supervision of investment management, life insurance Member and Liquidity Working Group Co-chair; involved in the and at the UK Financial Services Authority and development of supervisory expectations for capital planning, its’ predecessors. He is currently EY/UK Financial Conduct liquidity risk management and resolution planning. Authority relationship lead.

Shane O’Neill Scott Waterhouse [email protected] [email protected]

He has 20 years experience in banking, capital markets, He was capital markets lead expert for large banks at the asset finance and prudential regulation in a variety of CFO, Office of the Comptroller of the Currency (OCC) and Examiner- COO, strategy and planning, and regulatory roles. Following in-Charge of the OCC’s London Office. He coordinated the the financial crisis, Shane was Head of Banking Supervision supervision of trading, treasury and capital markets activities at a Central Bank for four years, during which he including Dodd-Frank implementation and Basel Committee influenced significant restructuring, recapitalization and requirements. change in the banking sector and in credit institutions, and executed numerous stress tests and asset quality reviews.

Keith Pogson [email protected]

Immediate past President of the Hong Kong Institute of Certified Public Accountants; more than 20 years of experience advising governments and regulators across Asia-Pacific on acquisitions, market-entry strategy and across banking, asset management and securities.

The COVID-19 pandemic: Potential impacts on financial regulation | 23 EY | Building a better working world

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