At the start of 2020, the notion that a due diligence on an agent bank or a market review could be performed remotely by network managers would have been met with incredulity. However, irreversible changes are sweeping through the global custody industry as COVID-19 continues to accelerate a wholesale transformation of market best practices and attitudes.
Margaret Harwood-Jones, co-head of financing and securities services at Standard Chartered, participated on a panel at the inaugural Virtual Summer Meeting of The Network Forum, exploring the tectonic shifts in the custody world that have been precipitated by the pandemic, and its implications for network managers. Here, we share some of the key observations and issues that were surfaced.
Before the COVID-19 pandemic held the world in its grip, most network managers and agent banks were in broad consensus that the due diligence questionnaire (DDQ) devised by the Association for Financial Markets in Europe (AFME) was in a healthy shape1.
Despite the initial protests from agent banks about network managers adding dozens of supplementary questions into the DDQ, the industry collaborated and many of these additional information requests have since been incorporated into the main document.
At the start of 2020, few market participants would have anticipated that the DDQ would require any further substantial change. Fast-forward to 3Q2020, and that view is looking very much out of sync with reality.
While the AFME DDQ had factored in the risk of short-term disruption at a single supplier at a local market level, nobody involved in the drafting of the template could have foreseen the possibility of a global crisis on the scale of COVID-19, let alone its impact on operations.
As such, sections of the AFME DDQ covering business continuity planning (BCP) will require a thorough review and overhaul, as network managers increasingly demand comprehensive answers on whether their agent banks and local market infrastructures have the capability to facilitate remote working and capacity to accommodate surges in transaction volumes.
Other network managers sought assurance, especially at the start of the pandemic, that their agent banks would be able to provide timely service and market information, especially in instances where Internet and electricity bandwidth are constrained.
Outsourcing could be one area of scrutiny in the revised DDQ. Some financial institutions with outsourced operations or centres of excellence in emerging markets found that these services were not automatically treated as “essential services” during lockdown by the authorities, owing to the fact they did not have banking licenses in those countries. “Some of the affected banks carrying out processing activities in several emerging markets were caught out and were instructed to close temporarily,” noted Harwood-Jones. These stress points will need to be referenced in future drafts of the DDQ.
1 Global Custodian (May 15, 2019) AFME’s DDQ appears to have resonated with the industry as alterations lesson
The transition to remote due diligences has exposed some short-term problems. Many banks and regulators do not have joined-up policies on virtual communication platforms, and the industry is currently using a patchwork of different video conferencing apps. For example, Zoom – a popular cloud-based enterprise video conferencing platform – has been banned or restricted in a number of countries due to cybersecurity concerns2.
This is not just a concern for governments but also banks like Standard Chartered3 and a host of organisations, companies and schools4. The establishment of acceptable common standards and principles around video conferencing technology needs to be enacted and soon, if the industry is to operate more efficiently in this remote environment.
2 Cyber-security Insiders (April 15, 2020) Reasons why zoom app is being banned by governments across the world 3 American Banker (April 23, 2020) Banks grow wary of zoom meetings 4 TechRepublic (April 9, 2020) Who has banned zoom ? Google, NASA, and more
In some markets, due diligence practices need to take into account the local sensitivities around data privacy and data protection. According to Harwood-Jones, “The regulations in some of the markets in our network have very strict data sharing rules. For instance, it is prohibited in particular markets – such as Korea – to share certain restricted information outside of the bank’s physical premises. In other words, agent banks are not allowed to share their screens via apps such as Blue Jeans.”
In a few exceptional cases, a handful of banks have warned that video conferencing calls with counterparties’ staff in their places of residence – as opposed to in the office – could be a potential privacy infringement.
To support new ways of working and due diligence in remote environments, it is vital that loopholes in regulations be recognised, addressed and closed to prevent regulatory arbitrage around data regulations.
As virtual due diligence is a fairly recent development, the advantages and disadvantages are yet to be fully understood by the industry. However, as Harwood-Jones pointed out, the growing adoption of video communications – subject to implementation of acceptable common standards and principles on use of such platforms – could result in the rise of virtual due diligences and periodic reviews.
Even as lockdowns lift, some restrictions on international business travel may remain due to concerns over a resurgence of the virus or cost-containment measures. These could also contribute to increased demand for virtual due diligence.
If there is a sustained growth in demand for virtual due diligence from network managers such that what was an exception to the norm becomes mainstream, agent banks will need to review their own operations and resourcing to accommodate the new requirements.
It remains to be seen, however, whether virtual due diligences will supersede on-site due diligence in the longer term. Some network managers are of the view that there is simply no substitute for being able to figuratively ‘kick the tyres’ that an on-site due diligence permits.
Until the industry is fully persuaded that a virtual due diligence can yield the same – if not better – results, there will still be demand for elements of physical due diligence to continue in some shape or form and to the extent permitted by the pandemic.
COVID-19 has redrawn a number of the established boundaries and sped up the pace of change immeasurably. As new risks – such as cyber-crime – become more widespread, and different asset classes – including digital assets and central bank digital currencies – generate interest from investors, network managers will need to adapt and retrain if necessary.
While some network managers are hoping for normal business practices to resume, the industry will be a very different one in 12-24 months’ time. In order to remain relevant, network managers need to understand where the industry is heading and to keep pace with industry developments, nurturing the mindset and skill sets to take them into a new post-pandemic future.
