Regulatory and corporate returns are once again on the regulatory spotlight: What should firms do?

On 7 January 2019 the Bank of England (BoE) published a discussion paper (DP) on the way it collects data from financial institutions in response to the June 2019 Future of Finance report undertaken by Huw Van Steenis and commissioned by Mark Carney. Proposing a number of options to improve the timeliness, flexibility, quality and interpretation of regulatory data and  reduce the burden from data collection on firms, the BoE is set to transform its regulatory approach to collecting, hosting and the interpretation of firms' financial data.

On the same day, the FCA also updated its data strategy, focusing more on responding to how firms are using new technology, data and analysis and how it can apply these as a data-driven regulator to improve its own efficiency and effectiveness. The FCA's data strategy outlines the organisation’s increased focus on the use of advanced analytics and automation techniques to allow the regulator to efficiently predict, monitor and respond to firm and market issues.

At this stage, the BoE's DP is more relevant for firms with important implications. Among a number of options aimed at streamlining regulatory data collection and assessment, the BoE particularly proposes to introduce a new framework where regulators can automatically extract regulatory firm data on demand from firms through Application Programming Interfaces. While this would make the regulatory reporting process more efficient and less expensive, it would also require firms to ensure data accuracy on an ongoing basis.

This is expected to minimise manual processes to collect and interpret supervisory data from firms in the long run. But, moving to a system in which the regulators have direct access to firms data would be a radical departure from current practice and will introduce additional in terms of staffing, expertise, technological infrastructure and internal governance. 

The BoE's DP comes at a time when challenges that financial institutions face in complying with their regulatory reporting obligations is high and the integrity of firms' regulatory reporting is alread on top of the regulatory agenda. For instance, on 31 October 2019, the Prudential Regulation Authority (PRA) issued a “Dear CEO letter” to banks, expressing its concerns about the completeness, timeliness and accuracy of their regulatory returns.

A similar letter was issued by the Financial Conduct Authority (FCA) in February 2018 to the investment firms subject to the Prudential Sourcebook for Investment Firms (‘IFPRU investment firms’) and the firms subject to the Prudential Sourcebook for Banks, Building Societies and Investment Firms (‘BIPRU firms’), which required firms to inspect the appropriateness of their firms’ financial reporting (FINREP) and Common Reporting (COREP) practices.

In addition, the FCA and the BoE had held a two-week TechSprint in 2017 to examine how technology could make the current system of regulatory reporting more accurate, efficient and consistent by making regulatory reporting requirements machine readable and executable. More recently, the FCA, the BoE and seven regulated firms recently completed the second phase of a pilot on Digital Regulatory Reporting (DRR), which run from February 2019 to October 2019 . DRR is an ongoing regulatory initiative intended to allow firms to automatically supply data requested by the regulators in the near future, thereby reducing the cost of collection, improving data quality and reducing the burden of data supply on the industry. 

On the other hand, the Financial Reporting Council (FRC) published a document expressing its concerns with respect to the corporate reporting, quoting examples of basic errors in that it had identified in the cash flow statement of firms and announcing that the thematic reviews that it plans to undertake in 2020-2021 with respect to corporate reporting and audit quality on 16 December 2019. The FRC announced that, in its routine reviews of corporate reporting by firms, it would focus on firms’ disclosures of cash flows and liquidity risks.

These regulatory developments have important implications for firms. Starting with the PRA’s letter, the regulator’s supervisory expectations are threefold. First, the PRA expects firms to be able to “demonstrate how the design and operation of the governance, controls and other processes deliver regulatory reporting of appropriate quality”. Second, it requires them to be ready to “provide details of the key interpretations and judgements made relating to regulatory returns and the governance processes used to validate these. Third, it expects them to report “any material regulatory reporting errors identified, together with an explanation of the actions taken to remediate them”.

Reminding that the production and integrity of a firm’s financial information and its regulatory reporting is a prescribed responsibility, the PRA’s letter also invites firms to take action as necessary to ensure the integrity of their supervisory and financial data, as well as their ability to process them accurately. The regulator expects firms to ensure they are fit for purpose, and to carry out deep dives that look at the accuracy of the returns themselves.

The PRA expects this to be an area of focus for the executive team and the board. In particular, it requires them to undertake a comprehensive review of the effectiveness of the governance controls and other processes around regulatory returns on a regular basis, It also require firms to review their interpretation of the regulatory requirements and their judgements based on these interpretations. This means that firms should undertake a thorough validation of all their current interpretations with respect to the regulatory reporting requirements. As per the FCA’s letter, the same advice applies to FINREP and COREP.

Firms should note that the PRA is minded to commission Section 166 Skilled Persons Reports as per Financial Services and Markets Act 2000 from certain firms, seeking assurance on whether the return reviewed has been properly prepared. These reports may also focus on the firms’ internal governance, controls and other processes. While the focus of these are likely to be on the larger firms all firms should take action to be ready now.

On the other hand, pointing out the common errors in firms’ corporate reporting, the FRC reminds firms that their cash flow statements should follow the treatments prescribed in International Accounting Standards - Statement of Cash Flows (IAS 7) and they should make improvements with respect to disclosure of accounting policies for complex transactions where the cash flow presentation is judgemental and, where relevant, any significant accounting judgements applied in the cash flow statement. In its 2020-2021 thematic reviews the FRC aims to identify how the presentation of firms’ cash flow statement and disclosures can be improved to reflect their capacity to generate cash flows.

Firms should note that the FRC expects company specific disclosures of liquidity risks to be consistent with disclosures given for going concern and the viability statement. It requires firms to ensure they comply with the European Securities and Markets Authority’s Guidelines for cash flow based Alternative Performance Measures. It also require full disclosure of supplier financing arrangements, including the impact on cash flows and the presence of any concentrations of liquidity risk, where this is material. It also expects firms to disclose what constitutes cash and cash equivalents, including any restrictions on the availability of cash.

Intensifying regulatory scrutiny on supervisory and corporate reporting means that firms should undertake infrastructure and technology enhancements to upgrade their data management systems and processes, ensuring that they have in place appropriate data governance policies, control framework and data processing procedures in place to ensure the accuracy, completeness and appropriateness of their regulatory data.

Delivering some of the long-run regulatory objectives could require firms also to make considerable investment in the use of Artificial Intelligence (AI) and Machine Learning (ML) technologies. For instance, during the 2017 TechSprint, the FCA and BoE tested firms' capabilities to map their regulatory requirements directly to the data that they hold, creating the potential for automated, straight-through-processing of regulatory returns, reflecting a regulatory shift towards more automation in supervisory data submission.

Rather than being prescriptive at this stage in terms of its approach to regulatory data collection, the BoE sets out a number of options in its DP to change the way it collects data from firms, which could have important implications on firms. So frms should not only start considering how to adopt AI and ML technologies, they should also engage with the process  by responding to the DP with their comments or suggestions by 7 April 2020 to ensure the approach taken by the BoE is fully informed.

Given advances in technology and improvements in data analytics have already begun to change the way the industry manages, processes and reports data, they should also keep in mind that investing in the AI and ML technologies now to streamline their data processing, governance and control frameworks will not only help them meet the regulators’ expectations but will also give them a competitive edge in the long-run through gains from efficieny.