The rapid and catastrophic onset of COVID-19 has resulted in significant strain and difficulty for every firm. It is expected that many firms would have either already invoked their Recovery Plan or will need to in the short term.
It is therefore important that firms utilise their recovery plans and continue to evolve and update them to ensure the firm’s viability remains intact.
Firms have developed and prepared recovery plans to provide a blueprint and a sound and comprehensive approach to follow in the event of a significant crisis. An integral part of these plans is selecting and calibrating a suite of Early Warning Indicators (EWIs) to provide sufficient warning of potential issues and to provide adequate time to determine whether activation and implementation of recovery options are warranted. Most firms developed indicators in line with the EBA’s Guidelines on the minimum list of qualitative and quantitative recovery plan indicators. These indicators cover different types of risks including capital, liquidity, profitability, asset quality, market-based and macroeconomic indicators. It is evident that the experiences of the past and scenarios that at the time were plausible were key in the calibration of these EWIs. However, the swiftness and cliff-effect impact of the current pandemic illustrate that the breadth of indicators utilised within firms’ recovery plans could be further broadened.
Market-based indicators such as stock price or CDS spreads would be considered leading indicators which have now become more important to understand and include within recovery plans. Many firms when calibrating these metrics found it somewhat more difficult to link specific movements in share prices or spreads to potential financial distress within the firm. Therefore, firms tended to calibrate these based on historical performance and linked to previous stressed periods. These metrics have been key in the current crisis as they would have been the first indicators to be triggered in a lot of instances.
Many firms have utilised ‘common’ Recovery Plan EWIs of financial distress which are typically linked to disruptive financial cycles and the build-up of ‘risk’ in the system. These EWIs and their trajectories are monitored carefully. However, given the speed and impact of the current pandemic, these common EWIs have not detected these issues early enough which has left firms in a potentially vulnerable state. The lessons of the past few weeks illustrate that we collectively need to think outside of the box and develop recovery plans and EWIs to consider other indicators not normally associated with typical financial metrics.
Risk horizon scanning and critical thinking of the risks and issues that could be faced by firms needs to be incorporated into recovery plans. ‘Black Swan’ events do occur more often than expected and therefore nothing should be off the table when defining, selecting and calibrating a suite of EWIs to help protect and manage risks within a firm.
As part of developing their recovery plans, firms test the responsiveness of their EWIs and the viability and feasibility of their recovery options by defining a set of hypothetical scenarios. It is important to note that recovery plans are not designed to ‘predict’ the factors that could prompt a crisis but rather they test the resilience of the firm to high impact events. These scenarios are severe in nature and designed to threaten the viability of the firm should no action be completed. These scenarios should be idiosyncratic, systemic and a combination of both. These scenarios should be based on events that are exceptional but plausible. However, there is a somewhat subjective view on what is ‘plausible’ outside what firms have experienced from the past. Therefore, many firms have looked at more ‘normal’ systemic events such as the last financial crisis. Many firms could argue that the current pandemic and its impact (including the speed of the impact) would be a less plausible event based on their past experiences. However, it is now clear that firms should be thinking about the most extreme types of scenarios, which may seem implausible now but could become plausible in the future. These scenarios need not be specifically financial in the first instance, rather, scenarios that could lead to a financial impact should be tested more often.
In addition to the use of Recovery Planning, the current pandemic has illustrated the importance of firms having robust and comprehensive Business Continuity Plans (BCP) by creating a system of prevention and recovery from crises. It is now clear that firms need to ensure that not only that their recovery plans are interlinked with their strategy, risk appetite and risk management framework, but they are also integral and reliant on a complete BCP. Utilising other non-financial EWIs that could be considered as part of regular updates to the BCP would enhance recovery plans significantly and allow for a more dynamic and comprehensive view of risks faced by the firm.
Firms should be actively reviewing their recovery plans as well as their BCPs. It is expected that firms’ boards and senior management need to actively monitor their current circumstances in order to be in the best position to respond to a rapidly changing environment.
Specifically, firms should consider expanding their Recovery Plans, BCPs and associated EWIs to cover the following:
It is important that firms fully understand their risk profile and potential vulnerabilities to drive their decisions for recovery planning and associated business continuity plans.
There are several steps firms should consider implementing in the short term. Any firm without a recovery plan should develop one immediately. For those firms who have a recovery plan in place:
KPMG’s experienced teams across member firms have a strong understanding of developing and implementing recovery plans by supporting a broad range of financial and non-financial institutions, and significant and non-significant institutions in the development of their recovery plans.
KPMG’s industry expertise and well-founded experience in recovery planning as well as building operational resilience enables the firm to work with clients to assist in times of stress.