Malin Nilsson, Managing Director of Duff & Phelps Channel Islands, weighs up a new approach for a new world
There is much talk of the ‘new normal’ in terms of regulation and ways of working as a result of Covid-19. As some industries and sectors are being fundamentally restructured, we are only starting to scratch the surface of some key regulatory changes.
The longer the consequences of the pandemic continue to have an effect, the greater the impact of shifting working patterns will be.
While I do not have access to a crystal ball, there have been immediate effects, both internationally and in the Channel Islands, for financial services regulation. In many cases, some trends that were already gaining momentum pre-Covid-19 are accelerating.
Fintech and regtech – the winners?
Although fintech has become part of our jargon in recent years, some would say that the pace of change has not been fast enough. Adopting fintech is rapidly becoming a necessity for financial services firms’ survival.
The current conditions have brought its prevalence to the forefront – electronic identification and verification have already received much attention from the JFSC and GFSC, for example.
The pace of advancement will likely accelerate, with fintech and regtech companies well placed to disrupt what are seen as the more ‘high touch’, personalised aspects of the financial services industry.
Some costs go up, some down
Firms will likely see an increase in IT capital expenditure to facilitate remote working. At the same time, they are likely to do away with expensive, unused business continuity offices because the most effective form of business resilience is to ensure that employees can work from home.
While it is clear that a significant proportion of the financial services industry can work from home, this may result in a shift in preferences for the longer term.
If people can work remotely, staff may choose to live further away from key financial centres such as London, New York or Hong Kong. Decreases in living costs may lead to a reduced pressure on salaries and a reduced need for commercial buildings.
This can have many impacts. Will commercial buildings in London be converted into residential homes? If so, how will this impact real estate funds, many of which are administered in Jersey? It may be too soon to tell, but we are witnessing the start of a paradigm shift in how people choose to work and how companies plan for it.
There are risks to working from home as well. For one, it represents an increased risk of cyber attacks as employees access firm systems and client data from their home networks, which are not subject to the same level of surveillance and protection as office networks.
Firms need to ensure that employees are, more than ever, aware of red flags and reporting mechanisms in case of suspicion of cyber-attack attempts. Compliance programmes and monitoring will need to evolve to enable remote oversight of employee data access and use.
Equally, employee fraud will likely increase, as collusion, managing conflicts of interest and monitoring staff behaviours become more difficult. For instance, one household could consist of traders from multiple firms or parties who benefit from sharing information.
Will working from home come at a cost to individual privacy rights? In the age of focus on data privacy, this is difficult to predict. To enable a truly flexible work-from-home environment, firms will need to invest in compliance systems.
For some, however, there is no substitute for physical colocation, and effective monitoring is dependent on mutual trust and setting the cultural tone from the top through observable behaviours rather than a weekly video conference.
The eyes have it
The way regulators supervise and interact with firms has also been disrupted since face-to-face meetings – so often the most important tool of the regulator in being able to look into the whites of someone’s eyes – have been abandoned and replaced with virtual meetings and remote review of documentation.
If the judicial system in Jersey, France, the US and other countries can work via video conference, why not supervision and enforcement? While it is possible, it is not desirable given the loss of human interaction that makes crucial interviews and fact-finding exercises so effective.
Regulators are extremely sensitive to lapses regarding anti-money laundering (AML). During the pandemic, though not always because of it, culprits still need dirty money to move around the financial system. Criminals can find loopholes in firms whose surveillance and monitoring capacity and ability is reduced.
Money laundering reporting officers (MLROs) must consider what new typologies of financial crime may arise as a result of the crisis and how to monitor for them.
The Financial Action Task Force recently issued a statement urging people to remain vigilant in the face of Covid-19-related financial crime, including advertising and trafficking in counterfeit medicines, fraudulent investment opportunities and phishing schemes that prey on virus-related fears.
Government financial support for businesses impacted by Covid-19 will likely lead to an increase in fraud as a result of false claims and misuse, but how this is monitored remains to be seen.
AML is not just the proceeds from arms and drug money, it encompasses ordinary situations such as firms being placed under financial stress in the midst of a crisis.
Offshore and substance complexities
Another area of regulation where Covid-19 has already had an impact is related to substance requirements. Both Jersey and Guernsey have confirmed that where operating practices (for instance, the location of board meetings) have to be adjusted, these do not affect economic substance or tax residency requirements, provided the adjustments mitigate the threats from the outbreak and any changes are temporary.
Similar temporary provisions have been granted in other jurisdictions including Luxembourg and the British Virgin Islands.
However, under the new normal, policymakers may have to make more permanent changes to substance requirements and consider other criteria that do not involve the physical presence of individuals in a certain jurisdiction.
This exposes some fundamental questions – if an individual is allocated to supervise entities in one jurisdiction and is physically located elsewhere, able to perform all duties via connectivity to systems, information and people, what is the justification for that individual to be located in the same jurisdiction as the entity?
Game-changers
We are at an inflexion point now. The effects of Covid-19 will lead to changes, but the magnitude of them remains to be seen. Policy and decision makers in governments and firms will need to strike the right balance between cost reduction and maintaining control and oversight.
Ultimately, the question arises as to whether the focus of regulations – which have been very much based around maintaining local and physical expertise, substance and governance – change in our ability to work remotely.
Has our world changed forever or will we play it safe? This is yet to be seen.
• This sponsored article was first published in Businesslife's Future View supplement in June 2020