COVID-19: Compliance and Operational Risks for Financial Institutions: EU Financial Authorities Provide Initial Guidance

Financial institutions and market participants are facing operational and compliance risks in the context of COVID-19. Financial authorities are acknowledging these difficulties. For example, last week lawyers in our US offices reported on relief and guidance that the US Securities and Exchange Commission is offering to registered funds and their investment advisers. And, this week, two EU financial authorities have provided initial guidance to ensure continuity of business under financial stress.

The European Banking Authority

On March 12, 2020 the European Banking Authority (“EBA”) published a statement on actions to mitigate the impact of COVID-19 on the EU banking sector¹. The EBA, in seeking to “alleviate the immediate operational burden for banks at this challenging juncture”, recommends that national regulators “make full use, where appropriate, of the flexibility embedded in the regulatory framework to support the banking sector.” The statement addresses the following key points:

• The EU-wide stress test exercise originally planned for 2020 is postponed to 2021 in order for banks “to focus on and ensure continuity of their core operations, including support for their customers”;
  
  
• For 2020, the EBA will carry out an additional EU-wide transparency exercise in order to provide updated information on banks’ exposures and asset quality to market participants;
  
  
• The EBA recommends that national regulators exercise their supervisory activities “in a pragmatic and flexible way, and possibly postpone those deemed non-essential”;
  
  
• The EBA will allow national regulators to “give banks some leeway in the remittance dates for some areas of supervisory reporting, without putting at stake the crucial information needed to monitor closely banks’ financial and prudential situation”;
  
  
• Regarding the regulatory framework, the EBA recommends that banks use the liquidity coverage ratio (LCR) designed to be used under stress. Additionally, the EBA recommends that national regulators should avoid any measures that may lead to the fragmentation of funding markets; and
  
  
• The EBA will allow a flexibility in the implementation of the EBA Guidelines on management of non-performing and forborne exposures.

However, the EBA considers “crucial that the classification of exposures accurately and timely reflects any deterioration of asset quality”. Data quality and reporting accuracy need to be maintained in all circumstances.

European Securities Markets Authority (ESMA)

On March 11, 2020, the European Securities Markets Authority (ESMA) announced the following recommendations to market participants²:

• To be ready to apply their contingency plans, “including deployment of business continuity measures, to ensure operational continuity in line with regulatory obligations”;
  
  
• To immediately disclose relevant significant information regarding the impact of COVID-19 on “their fundamentals, prospects or financial situation in accordance with their transparency obligations under the Market Abuse Regulation”;
  
  
• To transparently report on the actual and potential impact of COVID-19 on business activities, financial situation and economic performance in their 2019 year-end financial report (if not yet finalized in their interim financial disclosures); and
  
  
• (For asset managers) To continue to apply risk management requirements and related obligations.

Key Takeaways

It is imperative that any ad hoc measures to adapt to the current situation—which may include alternative work arrangements (which may affect confidentiality, conflicts of interest, and other financial crime risks) and/or reduced capabilities for monitoring, reporting and controlling operations—are considered in the broader context of the existing compliance framework. In all circumstances, however, data quality and reporting accuracy and timeliness cannot be compromised. Additionally, proper centralized governance procedures should be put into place, including documenting and clearly articulating decisions by authorized personnel if faced with potential derogations from ordinary levels of monitoring and control due to the current situation. Applying a coordinated approach with clearly defined rationales and targeted timelines can be an effective compliance practice for a financial institution, not only in the event of a future audit or regulator inquiry but also for the benefit of its clients and the stability of markets.