Over the last three months, thousands of emergency regulatory measures have been released across the globe in response to the coronavirus pandemic. While some of these measures, which include legislative texts, supervisory statements, formal guidance, No-Action Letters, and various other forms of regulatory relief, have sought to ease the compliance burden of regulated firms, others have ramped it up.
As discussed in FactSet's April 2020 Regulatory Update, numerous law firms and consultancies have responded to this frenzy of activity by producing enormous, panic-inducing checklists of regulatory measures for their clients to survey. This piece takes the opposite approach and looks at developments from a macro and thematic perspective in order to provide some calm and order to the chaos.
Specifically, as set out in the diagram below, we separate the new developments into three groups: international measures, state-level legal and economic measures, and finally, regulatory measures. The regulatory measures are then further broken down thematically into prudential, conduct-based, markets-based, and financial crime-related measures.
Taking this approach leads to the reassuring conclusion that, after having surveyed the legal, economic policy, and regulatory landscape, for the most part, investment firms need not dwell too much on the international, legislative, and economic measures, since they are principally focused on state aid and macro-prudential measures.
Consequently, such firms can instead direct most of their attention toward the regulatory measures, which, as shown below, are largely tweaks to the application of a select body of existing rules rather than a seismic shift in the regulatory landscape.
Before diving into these developments further, we first set the scene and look at the broader context into which these measures have emerged.
The recent burst of regulatory measures is just one of the many species of pandemic-driven developments that senior management and compliance personnel at investment firms are currently having to grapple with. Nevertheless, many of these other issues, such as elevated financial risks, funding pressures, and operational contingencies, frequently overlap or intersect with the new regulatory measures. As such, a firm's commercial and regulatory response can and should be conflated into a broader overarching strategy to manage the fallout of the pandemic.
By way of example, consider the various statutory risk assessments regulators have been forced to update in response to the coronavirus. These have identified numerous non-regulatory risks that firms will have to address from both a commercial and a compliance perspective.
The European Securities and Markets Authority (ESMA) Risk Dashboard, updated on April 2, 2020, is a case in point. It identifies several operational, commercial, and markets-based pressures currently impacting firms that need to be managed in their own right as well as from a compliance perspective, including liquidity and funding pressures, increased AUM outflows, falling asset prices, narrowing spreads in some markets (e.g., high yield bonds), and unprecedented trade volumes and volatility in others (e.g., equities).
In addition to these operational and market risk-based considerations, firms are also having to manage economic and credit risk developments identified by regulatory authorities, again from both a commercial and a compliance perspective. Uncertainty around the likelihood and scale of looming defaults is one of the most pressing examples. The theoretical prospect of negative interest rates emerging, as recently discussed by the St. Louis Federal Reserve, is another.
These pandemic-driven regulatory risk assessments are not exclusively confined to financial and economic considerations. For instance, the European Banking Authority (EBA) announced on March 31, 2020 that it had updated its financial crime risk assessment, which identified pandemic-linked elevated levels of fraud, money laundering, and terrorist financing risk. This in turn triggered an automatic obligation on regulated firms to re-evaluate and enhance their AML/CFT controls.
These regulatory risk assessments highlight the additional pressures facing senior management from a compliance perspective over and above the spate of recent regulatory developments.
Despite these bandwidth-sapping additional pressures, the flow of "regular" regulatory developments has shown little signs of slowing. Some new measures have been delayed, such as the new EU Securities Financing Transactions Regulation (SFTR) transaction reporting regime. However, many others remain extant. For instance, in the EU, the sector is still gearing up for an enormous suite of new ESG regulatory measures that are just beginning to enter into force, while the European Commission have just announced a new Action Plan to overhaul the EU AML/CFT regime once again in the coming year, just months after AMLD5 went live and six months before AMLD6 comes into force. Meanwhile, EU exposed firms are also having to contend with the outcome of Brexit negotiations and the increasing prospects of a "Hard Brexit."
The pandemic-driven measures are thus arriving at a time when markets are distressed, and workforces are already stretched and are further complicating already complex and critical business decisions. In summary, the new measures are adding an additional burden in an already-stressed business environment.
While this picture looks rather bleak, the following analysis shows that, despite their large number, the new regulatory measures are in substance rather modest. Consequently, if investment firms can just manage to sift through the enormous volume of material, they should find that the burden is manageable.
Having set the scene, let's now turn to the new pandemic-driven developments, starting with international measures.
Just before the pandemic broke, Saudi Arabia took over the G20 presidency with an ambitious cross-sectoral agenda. Within this context, the Kingdom had been hoping to showcase its recent efforts to diversify its economy away from oil dependency and into other sectors such as tourism, in measures which had vacuumed up a large chunk of its budget surplus. Unfortunately, the pandemic changed these plans somewhat, as oil and tourism took a nosedive and the G20 shifted its focus to containing the economic effects of the pandemic.
Kicking off these pandemic-related financial regulatory initiatives for the G20, on March 20, 2020, the G20's Financial Stability Board (FSB) announced it was overseeing coordinated activity between its members (i.e., principally central banks and related international bodies) in response to the pandemic.
On the same day its international twin, the Basel Committee on Banking Supervision (BCBS), also issued a press release in response to the pandemic, announcing the suspension of several of its programs. It also reminded the sector that, from a banking and economic perspective, its prudential framework was specifically designed to manage and prepare the world for crisis situations such as the coronavirus pandemic.
A week later, on March 25, 2020, the International Organization of Securities Commissions (IOSCO) issued a press release stating that it too was overseeing coordinated activity among its members (principally securities and other financial conduct regulators) on the impact of the coronavirus and was, moreover, co-operating with the FSB, BCBS, the Committee on Payments and Market Infrastructures, and the International Association of Insurance Supervisors in this regard.
Then, on April 15, 2020, following a meeting of the G20 Finance Ministers and Central Bank Governors, a G20 Communique and Action Plan was published addressing numerous pandemic-related matters. The document covered healthcare investment, financial support for the World Health Organization (WHO), trade measures, and the fiscal and economic steps countries should take such as the provision of liquidity and funding for businesses, as well as support for employees and households.
The Communique also promised coordination between member states to preserve liquidity between economies through swap line arrangements and, following FSB recommendations, included commitments to encourage the use of flexibility within financial regulation to temporarily reduce the compliance burden on firms and regulators. The Communique further instructed the FSB to continue scanning for vulnerabilities across the financial system while maintaining supervisory oversight and coordination of its members.
Also covered in the Communique was a re-emphasis of the G20's support for measures taken by other international organizations such as the International Monetary Fund, World Bank, and several regional development banks and G20 central banks, which together, the Communique noted, had already provided hundreds of billions of dollars in support for emerging and low-income countries and other economies around the world in response to the pandemic.
Maintaining the existing financial hegemony however, the institutions only offered further credit. So far they have not offered debt relief, save for permission for the poorest countries to "request forbearance" on payments during the crisis, as approved by the Paris Club of major state creditors.
Finally, at the international level, several agencies have used the outbreak as an opportunity to further other, (arguably) less urgent aspects of their regulatory agendas. For instance, several United Nations agencies in conjunction with the International Network of Financial Centres for Sustainability recently published a White Paper together suggesting that the pandemic could be used to "catalyze a durable shift towards an inclusive, low-carbon, and climate-resilient world." The European Commission in its 2020 Sustainable Finance Strategy, published in April, made the same point.
In summary and as expected, the international measures principally direct the efforts of domestic state institutions rather than introducing specific obligations for investment firms. Consequently, while the measures provide important and useful context, investment firms can take a degree of comfort in prioritizing domestic measures over the diktats of the international community of policy drivers. We'll turn to these domestic measures now, starting with executive, legislative, and judicial (i.e., legal) measures.
In jurisdictions around the world, all three branches of state governance have been busy dealing with coronavirus-related matters. Legislative and executive institutions have led the way with measures designed to mitigate the economic consequences of the pandemic, many of which enact the recommendations identified in the international forums discussed above. Several of these measures have varying relevance from a financial regulatory perspective, including:
Somewhat unhelpfully, some federal jurisdictions have also taken action at the state level. This has led to multiple and sometimes significantly divergent versions of the same pandemic-related measures across states (e.g., see the NASAA overview of U.S. state measures).
Meanwhile, the remaining branch of state governance, the judiciary, has also been preoccupied somewhat with COVID-19 related matters. In particular, judges are being called upon to opine on various, principally civil law-related contractual matters, such as the interpretation of transaction, loan and M&A contracts, particularly those with "material adverse effect," "material adverse change," and other types of force majeure clauses.
The extent to which the pandemic constitutes a contractually frustrating event is also tipped to emerge in litigation in due course, while the problem of obtaining "wet ink" over electronic signatures is another pandemic-triggered contractual hot topic. It's also one that has been featured in several recent regulatory communications for funds during the pandemic (e.g., see the FCA's Guidance on the topic).
Outside of classic contractual issues, COVID-19-driven insurance litigation and tortious claims in negligence are also brewing, while insolvency, director and tax fraud, and even "phoenixism" are also expected to emerge in due course as a consequence of the pandemic. It is worth noting that all these contractual and tortious matters overlap with, or at least have a bearing on, financial regulatory considerations.
Competition law matters are also anticipated to appear in the courts eventually as pandemic-driven concerted behavior occurs and market consolidation inevitably follows crisis-driven shakeouts. Nevertheless, in another example of how regulatory matters interface with purely legal matters, the FCA and the UK Payment Services Regulator have issued a Statement welcoming Guidance from the UK Competition and Markets Authority published on March 25, 2020 that permits necessary collaboration between industry participants when taking steps to mitigate the effects of the pandemic.
Like their civil counterparts, the criminal courts are also expected to be called upon to preside over cases involving COVID-19 and financial regulation, especially in relation to market conduct, fraud, and money laundering matters. Indeed, high-ranking members of the U.S. Senate are already under scrutiny for potential insider dealing in relation to material non-public information they received on the economic impact of the pandemic. These members include the Chairman of the U.S. Senate Intelligence Committee, who has had to step down from his position following the launch of a formal FBI investigation into his trading activity.
Despite the importance of these legal developments and their intersection with the financial regulatory arena, they are more focused on emergency state lending and prospective litigation; therefore, they remain either potential or largely tangential to investment firms (at least for the time being).
Together with unprecedented fiscal packages provided by state treasury departments, central banks have deployed all the monetary tools at their disposal to mitigate the negative effects of the pandemic, including the two most obvious: quantitative easing (QE) and interest rate cuts.
For example, in mid-March, the U.S. Federal Reserve announced $700 billion in QE and an interest rate fractionally above 0, while in Europe, the Bank of England took similar measures, cutting its base rate to 0.1%, its lowest level ever, and committing to £645 billion of QE. Meanwhile, the Europe Central Bank (ECB) also announced QE and associated monetary measures, with Christine Lagarde, President of the ECB, emphasizing the provision of "€3 trillion in liquidity through our refinancing operations, including at the lowest interest rate we have ever offered, -0.75%."
Moreover, as dislocation and turmoil hit money market funds putting pressure on bank funding, the Bank of Canada, Bank of England, Bank of Japan, ECB, Federal Reserve, and the Swiss National Bank announced coordinated action to enhance the provision of liquidity by arranging standing U.S.-dollar liquidity swap lines.
Similar to the international and state-level legal measures, these largely non-regulatory monetary actions, though important contextually, have not imposed specific compliance obligations on investment firms; therefore, they do not need to occupy the minds of senior managers and compliance professionals of investment firms too much. However, the prudential regulatory measures taken by some of these agencies have had a specific compliance impact. These are discussed next.
At the macroprudential level, several measures have been taken to ease funding and liquidity pressures and mitigate the risk of systemic risk. For instance, the European Systemic Risk Board (ESRB), published a press release on May 14, 2020, setting out the steps it is taking in response to the pandemic, which include reviewing the macroprudential implications of Member State fiscal measures at the EU level and assessing the prospects of potential large-scale corporate bond credit downgrades.
Other steps the ESRB has taken include overseeing the regulatory response to the potential systemic risk posed by funds exposed to real estate and corporate bonds, as well as overseeing the regulatory response to the risks posed by the high number of margin calls (particularly in oil derivative contracts that have occurred since mid-February), and considering the adverse liquidity impact that these calls may have on bank and non-bank entities.
Meanwhile, following FSB guidance, prudential regulators at state and regional level have emphasized the importance of banks focusing on their core operations and critical functions during the crisis in order to prioritize financial stability and ensure households and businesses get the support they need. This message has been delivered in statements from several prudential regulators including the PRA, EBA, and Federal Reserve.
Prudential regulators have also adopted a pragmatic and more flexible approach to supervision by, amongst other measures, postponing non-essential supervisory activity. For example, the EBA postponed its annual stress testing until 2021 and is permitting the delayed and modified reporting of specified supervisory data.
Similar measures have been adopted in the UK. For instance, the PRA has issued a statement permitting delayed Pillar 3 disclosures and associated reporting, while also publishing a CEO letter to banks on the approach they should be taking in relation to issues such as IFRS 9 accounting and reporting.
As expected, prudential regulators have also introduced measures to loosen bank capital requirements and other related prudential rules during the pandemic. In Europe, the ECB and Bank of England have introduced measures permitting banks to lend through the capital conservation buffer and liquidity coverage ratio, and continue to operate below Pillar 2 requirements. Countercyclical capital buffers have also been relaxed.
The Federal Reserve's prudential measures related to capital requirements are summarized in its dedicated coronavirus FAQ webpage, which also describes some of the other types of technical measures that central banks and prudential regulators have introduced in response to the pandemic.
The PRA and EBA have also prohibited banks from issuing dividends, undertaking share buy-backs, and offering large cash bonuses to senior executives during the pandemic. Other prudential regulators, and notably the U.S. Federal Reserve, have so far resisted taking such measures.
On April 28, 2020, the European Commission also proposed a new regulation temporarily modifying certain aspects of the Capital Requirements Regulations to further enable banks to absorb losses and extend credit during the period of the pandemic. The measures relate to the application of IFRS 9 to bank capital, the process for calculation of the leverage ratio and delayed introduction of the leverage ratio buffer by a year. Among other measures, the proposals also seek to liberalize the application of the non-performing loans backstop. An exceptionally ambitious time frame for enactment of these measures has been proposed in light of the urgency of the situation, with application primed for July 2020.
The Commission simultaneously published an Interpretative Communication document establishing the rationale for the measures in the proposed regulation, providing further guidance on the flexible approach to regulation it recommended on August 28, 2020.
While these are the principal and arguably most impactful measures prudential regulators have introduced since the start of the pandemic, they are not an exhaustive list. Indeed, prudential regulators continue to provide additional guidance as matters unfold. Numerous technical measures on various other matters such as, for example, the EBA's Guidelines on Loan Repayment Moratoria and Statement on Consumer and Payment Issues, have been introduced.
Regulators have collated and summarized all of the measures they have introduced on several dedicated webpages including the EBA, ECB, Federal Reserve, the U.S. Office of the Comptroller of the Currency, the Australian Prudential Regulatory Authority, and the Mexican CNBV to give just a few examples. Given the frequency in which events are occurring, measures and guidance continue to change and as such, regulators are encouraging firms to visit these websites regularly.
As with prudential regulators, conduct regulators have also established dedicated coronavirus webpages and other notification arrangements such as the FCA's coronavirus microsite and daily email, FINRA's coronavirus FAQ webpage, and ESMA’s dedicated webpage. Each collates all relevant press releases, statements, guidance, and new and interim measures that they have published in response to the pandemic.
Prevalent rule sets targeted in these pandemic-driven conduct-based regulatory developments include those governing investor and consumer protection, business continuity and operational resilience, senior management and governance arrangements, trading and risk management, management of client assets, complaints handling, availability of cash, and the provision of access to restricted funds. As the FCA microsite and other regulatory summaries demonstrate, this is by no means an exhaustive list.
In terms of the type of measures that have been introduced, delay has been a common theme, with several regulators pushing back the implementation dates of new requirements, extending the deadlines of existing requirements—including client and regulatory reporting and, as ESMA has, delaying deadlines for responses to consultations.
Some regulators have also modified dates for LIBOR transition arrangements (e.g., the FCA announced modest changes to interim dates, but not to the final transition deadline).
Importantly, ESMA announced a delay on March 26, 2020 in a revised public statement together with regulatory forbearance in relation to compliance with the new SFTR reporting regime, noting that it "expects competent authorities not to prioritize their supervisory actions towards counterparties, entities responsible for reporting, and investment firms in respect of their reporting obligations pursuant to SFTR or MIFIR, regarding SFTs concluded between April 13, 2020 and July 13, 2020, and SFTs subject to backloading under SFTR." ESMA further stated that it will not be available to record the details of SFTs reported and, as a result, counterparties, entities responsible for reporting, and report-submitting entities will be unable to report by the reporting start date."
In respect of SFTR Trade Repositories (TR), ESMA stated that it "does not consider it necessary to register any TR ahead of April 13, 2020," which was the original SFTR reporting go-live date for the first set of in-scope firms. Instead, ESMA stated that it expected TRs to be registered sufficiently ahead of the next phase of the reporting regime (i.e., starting on July 13, 2020), when credit institutions, investment firms, central counterparties, central securities depositories, and relevant third-country entities are due to start reporting.
On March 26, 2020, the FCA also published a statement on its supervisory approach to SFTR implementation, mirroring ESMA's position.
As seen in relation to the SFTR developments, pandemic-related delays have often been accompanied by "regulatory forbearance" whereby regulators announce that the supervision or enforcement of a specific obligation will not be a priority during the pandemic. This position is typically applied to measures that firms will clearly struggle to achieve compliance with under the present circumstances, or where the matter is otherwise not a priority.
Other examples of pandemic-triggered regulatory forbearance include ESMA's approach to the new tick-size regime for MiFIR systematic internalisers and its position on MiFID II RTS 27 and 28 best execution reports.
In addition to forbearance and delay, some regulators have also liberalized certain measures to ease the compliance burden on firms where appropriate. For example, despite the current elevated AML/CFT threat, the German regulator BaFin announced a temporary liberalization of client due diligence measures when granting COVID-19-related emergency state loans.
While most of the pandemic-related conduct measures apply to all regulated firms, targeted guidance for specific firm types has also been published. These include the SEC's press release on relief for investment advisors, ESMA's announcement of a six-month delay to the first money market funds reports deadline, and the FCA's Guidance for Funds, which emphasizes compliance with Value at Risk (VAR) limits, addresses the topic of virtual general meetings, warns against improper use of repos, and outlines expectations for client and fund reporting, with annual and half-yearly fund reporting delays permitted.
Measures such as delay, regulatory forbearance, and rule liberalization have not been restricted to "core" conduct matters either. For instance, in a series of statements on financial reporting and accounting, ESMA and the EBA have announced regulatory forbearance for delayed publication of financial reports by listed issuers under the Transparency Directive together with Guidance on how to classify default, treat loan moratoria, and more generally on how to approach calculations made pursuant to IFRS 9 during the pandemic (see for example, the March 25, 2020 collaborative statements of ESMA, as well as the EBA and ESMA statement of March 27, 2020).
The FCA, in a Statement of Policy on March 26, 2020, also announced that annual company accounts could be reported up to two months late during the pandemic. This is further outlined in a joint statement by the FCA, PRA, and Financial Reporting Council that was released on the same day and provides additional support, guidance, and measures.
On the same topic but not related to delay, ESMA published Guidelines on Alternative Performance Measures (APMs) on April 17, 2020. They establish a harmonized approach to reporting APMs under the Transparency Directive and Market Abuse Regulation and include a dedicated section on using APMs during the pandemic.
In several jurisdictions, market-based interventions, such as the deployment of circuit breakers and restrictions on short-selling activity, were undertaken at the start of the pandemic.
On March 16, 2020, for instance, ESMA published a Decision reducing the short-selling notification threshold for issued share capital from 0.2 to 0.1%. It followed several ESMA-approved decisions to restrict short selling in Italy, France, Belgium, Greece, and Austria. On April 15, 2020, ESMA issued several more Opinions supporting Member State short-selling measures. All of these measures have since expired aside from the lowered reporting threshold, which currently extends until June 16, 2020.
In a Statement on March 23, 2020, the FCA confirmed that it was not introducing a wider short-selling ban in the same way as other EU Member States. However, on March 31, 2020, the FCA declared that it would follow ESMA's approach and reduce the short-selling notification threshold from 0.2 to 0.1%.
In relation to derivatives markets, on May 4, 2020, the European Supervisory Authorities published an updated version of the Draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a central counterparty (i.e., the EMIR Margin RTS) in response to the pandemic. The draft proposes a deferral of the implementation phases of the initial margining requirements by a year, as agreed by IOSCO and the BCBS on April 3, 2020.
Other markets-related regulatory measures have involved listing-rule relief as seen, for example, with the SEC approval of several exchange compliance tolling periods such as for the NYSE, among others. Meanwhile, in the UK, the FCA announced assistance to firms in seeking to raise capital.
On a more somber note, on April 23, 2020, the SEC published a "Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Modify Its Application of the Proxy Delivery Requirements of NYSE Rule 451(b)(1) Through and Including May 31, 2020." In a nutshell, the change permits exchange members to vote uninstructed shares so long as proxy materials were transmitted to beneficial owners up to 10 days prior to the shareholder meeting, rather than the 15-day period required by the rule. Press reports have stated the change was prompted by a COVID-19 outbreak and fatalities affecting the warehouse where much of the printing and distribution of proxy materials is undertaken.
Finally, segueing into the final topic of financial crime measures, in May 2020, the FCA published Market Watch 63, on "Market Conduct and Discipline in the Context of Coronavirus." This note reiterates inside information management obligations in anticipation of a spike in capital raising in response to the pandemic, and also in relation to the novel types of inside information the pandemic has produced (e.g., eligibility for state funding support, exercise of force majeure terms or termination rights within contracts, and decisions to suspend usual patterns of corporate activity, such as dividend distributions and share buy-backs). Market Watch 63 was published alongside Primary Market Bulletin 28, which provides an update on the recent timetable extension for publication of half-yearly financial reports.
As the European Banking Authority (EBA) noted in its recent update to its financial crime risk assessment on March 31, 2020, pandemic-linked elevated levels of fraud, money laundering, and terrorist financing risk have emerged. This has triggered an obligation on regulated firms to re-evaluate and enhance their AML/CFT controls in response. This was expected; criminals often seek to take advantage of financial institutions when they are distracted by other events. The announcements from the EBA and the consequent compliance outcomes flowing from them mirror the situation in other jurisdictions across the world.
Regulators have also been reminding issuers of their obligation to promptly and accurately disclose any significant price sensitive/material non-public information regarding their business in accordance with market abuse laws, including sufficiently impactful pandemic-related matters (see for instance, ESMA's statement on financial reporting and markets announcements under the Market Abuse Regulation).
In terms of financial reporting, regulators have stressed that issuers must disclose the actual and potential impacts of the pandemic on their business in their 2019 year-end financial report if they have not yet been finalized or otherwise include them in their interim financial reporting disclosures.
As noted earlier, other types of financial crime that are expected to arise in relation to the pandemic include insolvency and tax fraud and insider dealing. Section 4108 of the U.S. CARES Act also establishes a Special Inspector General to oversee potential fraud claims. While the appointment of a Special Inspector General has been rather controversial, the purpose behind it is simple enough: to investigate cases of suspected fraud that are (1) under the False Claims Act and (2) related to business loans made under the CARES Act and report them to the Department of Justice.
The pandemic has left few places in the financial regulatory arena untouched, and the sheer volume of measures published over the last few months has been overwhelming. While some of the measures have eased the compliance burden, others have ramped it up.
Unfortunately for investment firms, adequate business continuity and operational resilience arrangements are a fundamental requirement of any financial regulatory regime and regulators expect firms to be fully prepared for economic crises. Therefore, there will be very little sympathy from regulators presented with pandemic-driven enforcement-level incidents of non-compliance.
Nevertheless, the above survey shows that the new rules, when viewed holistically, really amount to a few tweaks to existing measures and in many cases ease the regulatory burden. This is not a MiFID II type of affair where entirely new systems and controls, data, and infrastructure need to be developed. Consequently, as long as investment firms can track, prioritize, and take the typically modest steps required in this game of regulatory "whack a mole," there is no need to panic.
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