Who should read this article?
Board members and senior executives across the insurance, asset management, banking and capital markets sectors in the Nordics, including for example CEO, CRO, CFO, CCO, Head of Regulatory Affairs or Head of Compliance.
At a glance:
- Supervisory priorities have evolved following the COVID-19 disruption, including for example financial and operational resilience, good customer outcomes and digitisation.
- Banks should conduct stress and scenario testing to assess their ongoing financial and operational resilience in the rapidly changing circumstances, while also demonstrating fairness and flexibility when dealing with customers throughout the COVID-19 pandemic.
- The pandemic has been a profound and searching “stress test” of the regulatory framework created in response to the financial crisis a decade ago. The lessons from the pandemic experience will strongly influence the future direction of travel for financial services regulatory policy and supervisory practice over the next decade.
Introduction
Darkening economic prospects set the backdrop for our Financial Markets Regulatory Outlook 2020 (RO20) published in January, but for reasons then entirely unforeseen we are now in the midst of a global economic downturn. COVID-19 has crystallised and massively exacerbated multiple downside economic risks that were already present in the fragile global economy, prompting exceptional measures from authorities in the Nordics and worldwide to try to offset near-term damage.
Although the financial system held up well during the height of the pandemic, the outlook remains highly uncertain, with the potential for further financial stresses to come as the scale of the COVID-19-induced economic contraction becomes clearer. For an industry already feeling the squeeze at the start of the year, this is likely to prompt some difficult decisions about cost-cutting and consolidation for banks.
Our Interim Regulatory Outlook 2020 reflects on the progression of the regulatory themes identified in the RO20 and outlines our views on what remains in store for the rest of the year. We see five key themes as we look forward. All of these themes are as relevant in the Nordics as they are across Europe and in the EU.
Full steam ahead
Due to COVID-19 pressures, a number of the issues that we identified at the start of the year have taken on even greater importance. We expect several major regulatory initiatives, notably sustainability and IBOR transition, to continue apace, and banks should therefore continue to allocate resource and investment into their regulatory change programmes.
Sustainability has remained a key priority in the Nordics despite the disruption caused by COVID-19. In Denmark, the FSA joined the global Network for Greening the Financial System in June. Over the summer, the Danish FSA also engaged the industry on public consultations regarding the EU regulations on sustainability-related disclosures, i.e. regarding its supervisory and enforcement powers (a legislative proposal has since been tabled in parliament), and on related proposed amendments to the EU Non-Financial Reporting Directive.
Although in the Nordic region typically only larger banks have material exposure to LIBOR, IBOR transition more generally remains an important issue. In Norway, the topic is particularly relevant for a number of Norwegian banks with financing and products denominated in currencies other than NOK. In addition, while there is no formal legal obligation to replace CIBOR since it is not considered a ‘critical’ benchmark rate, it is still widely expected that Danish authorities will track closely developments for EURIBOR.
Near-term supervisory focus
Ensuring banks’ financial resilience following the COVID-19 pandemic has been a key priority for Nordic supervisors. They were quick to implement a number of measures to ease the immediate supervisory burden on banks. Supervisory focus is now shifting to banks’ medium-term financial resilience.
Banks’ provisioning for expected credit losses under IFRS 9 will be a key area of focus going forward, albeit with impairments increasing from relatively low levels compared to some other countries. The Danish FSA has said that it will focus on ensuring that expected credit losses are adequately addressed given increased default risk.
Banks should produce a broad range of different stress scenarios to test their financial resilience in the rapidly changing circumstances. The Norwegian FSA has, for example, stressed that banks need to base their loss provisions on new scenarios and assumptions following COVID-19.
Operational resilience in the new normal
We expect greater supervisory scrutiny of any new operational or control risks arising from the mass shift towards patterns of remote working, in relation to which regulatory changes could follow. In light of this, banks should revisit and update their business continuity and disaster recovery plans to reflect the new normal.
In Norway, the FSA has stressed that cyber security and IT compliance should be a key focus for boards and management going forward. In Denmark, the FSA similarly views cyber and operational resilience as key strategic issue to be dealt with at board level as well as with systemic providers of critical IT-infrastructure which are directly supervised by the FSA.
Supervisors have also warned about the possibility of increased or new types of financial crime as a result of the new remote working environment, and are increasing their monitoring in this area. In addition to the repeated instances of severe failings in the AML/CTF area that keep surfacing within its jurisdiction, this has provided additional impetus for action by the Danish FSA. It indicated in the summer its intention to conduct as many as 40 on-site inspections in the AML/CTF area in the remainder of 2020. Banks should prepare for increased supervisory scrutiny with regards to their financial crime monitoring and control frameworks.
Good customer outcomes
Nordic countries, as was also the case across the EU, implemented extensive measures to provide relief to customers experiencing financial hardship due to COVID-19. In Finland, for example, banks were required to provide customers with support in order to prevent payment difficulties and insolvencies caused by the pandemic, including by granting grace periods. In Sweden, the FSA considered the loss of income associated with COVID-19 to qualify as special grounds for reduced or suspended amortisation payments for a limited period of time.
How banks respond to these measures and ensure good customer outcomes will inform supervisors’ evaluations of banks’ cultures. Banks will need to demonstrate fairness and flexibility in addressing the challenges that COVID-19 continues to pose to customers.
Banks will now start to transition back to standard forbearance approaches in preparation for expected higher levels of non-performing loans from Q4 2020. Banks should have a clear transition plan in place for customers, but also update contingency plans in case there is a significant further deterioration during a second wave of the pandemic.
Digitisation: its necessity and its challenges
The pandemic has placed a premium on digitisation, although it is also clear that some of the existing challenges of digitisation are accentuated in the current environment. Banks should be able to demonstrate that they are doing all they can to support customers, including by applying technological solutions.
Although generally already more advanced than many other regions, digitisation has picked up pace in the Nordics and regulators have continued to push for banks to adapt to the changing environment. The Finnish FSA has, for example, provided instructions on how to detect fraud and scam attempts as a new wave of virtual asset and investment frauds has emerged following the COVID-19 pandemic.
Looking beyond immediate COVID-19 challenges, Denmark has adopted a comply-or-explain legal framework that mandates the disclosure of large corporate firms’ data ethics policies starting 2021 (which may include AI and algorithmic transparency, model data management, and data protection), which will also be expanded to include the financial sector. In addition, the regulatory framework for outsourcing was updated in July 2020 with the specific purpose of removing legal barriers to the adoption of cloud services in the financial sector.
Looking forward: reflecting on regulatory reform
COVID-19 can be seen as a “stress test” of the financial services regulatory system built over the last decade. The lessons learnt during the pandemic are likely to influence the longer-term future of financial services regulation, as regulators and policymakers reflect on the resilience of the current framework and banks’ responses, and reach judgements on whether, or to what extent, the regulatory framework has passed its first major test. In the Nordics, as elsewhere, it is still too early though to tell where and to what extent regulators may want to enhance or re-shape the regulatory framework.
