New risks in an uncertain market

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New risks in an uncertain market

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This is an excerpt from The Future of Risk Management and Compliance 2023 report.

External global factors continuously have an impact on on the challenges faced by financial institutions around regulation. The last few years have challenged the compliance departments in most financial institutions, but 2022 moving into 2023 has offered a host of new risks for them to contend with.

The aftermath of the pandemic has provided many compliance departments with a stress test for what they can deal with. While there was beginning to be post-pandemic economic recovery, this has dwindled with the rise of increased pressure caused by inflation, the invasion of Ukraine, and increased tensions between China and the US. This year will continue to see these risks develop, while still dealing with the fallout from the pandemic.

With all of these challenges to consider, it is important that all elements of financial institutions, from the executive to the managers, are on the same level about the new risks that are present.

Ukraine invasion and Chinese growth reiterate importance of sanctions

A year on from the Russian invasion of Ukraine, financial institutions have to ensure they are remaining compliant towards the global sanctions in place, which continue to change and develop.

Henry Balani, head of regulations for Encompass comments: “The Russian sanctions have caused a sea change for financial institutions across the world. This is a global issue, the fact that we have all these western nations coordinating their response in terms of the types of sanctions being put in place against Russia is unprecedented.”

As 2023 continues it is likely that these sanctions will change and develop further, creating a difficult environment for compliance departments who have to remain agile. Concerns have also been raised about China helping Russia against western sanctions. There is some speculation that China could provide Russia with arms, and has already been confirmed by the Centre for Advanced Defense Studies have provided evidence that China has already traded sensitive technologies with the Russian defence sector.

This would only lead to increased tensions between China and the US, and the possibility of a more complicated sanctions outlook.

Andrew Davies, global head of regulatory affairs, ComplyAdvantage, told us that their research has already shown companies are taking serious responses to these event and sanctions: “In our recent State of Financial Crime Survey 53% of respondents stated that they have changed their business model in response to Russia’s invasion of Ukraine. This is why it’s critical for organisations to validate the integrity and veracity of the data they use to manage their due diligence.”

Davies further elaborates on how these current circumstances affect financial institutions: “Current geopolitical circumstances also expose organisations to risk. It is critical to leverage technology and data that is up to date and effective. Sanctions can change rapidly so it is imperative to use flexible technology that allows you to react to these changes immediately.

Inflation will result in regulatory risk for financial institutions

Another area which has caused a significant development of new risks for companies is due to the rate of global inflation. In October of 2022 inflation reached 9.6% in the UK according to the Office of National Statistics, the highest it has been in over 20 years. Inflation can increase regulatory risk for financial institutions by increasing the cost of capital, increasing credit risk, and increasing regulatory compliance costs.

In response to these circumstances, Roshni Patel, head of risk solutions, Quantexa, told us: “The ongoing volatile economic, political and social situation is causing regulators, including the European Central Bank (ECB) and Prudential Regulation Authority (PRA), to request financial institutions to start assessing risk mitigation across a broader set of circumstances than they are currently doing.”

Indeed the EBA reported that three European Supervisory Authorities (EBA, EIOPA and ESMA - ESAs) warned of rising risks due to the current state of inflation in Europe in their joint Autumn Statement in 2022.

Matthew Peake, global director of public policy at Onfido, comments on some of the issues which financial institutions are considering under these circumstances: “Amongst the discussion around inflation, economic instability and market fluctuations, privacy and security emerge as consistent themes. These are the principles that underpin trust, build confidence in innovation and will ultimately support growth and stability. It’s little surprise that the vast majority of new UK, EU, and US regulations that we’re following closely, like the AI Act or the AI Bill of Rights, rest upon them. Our focus is firmly on ensuring that these new industry regulations not only adhere to principles of privacy and security, but do not adopt a ‘one size fits all’ model. They need to be comprehensive yet proportionate, and foster a genuine environment for innovation.”

It is more than likely that these conditions will have an impact on the regulatory outlook for 2023. However there are some specific new areas of legislation which financial institutions should look out for. The AI Act is one area of legislation which financial institutions will need to be vigilant of during the course of 2023, but there are other areas of legislation they will need to be aware of such as BNPL legislation, digital asset regulation, and ESG related risks.

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