Why You Need Legal Tech Solutions to Improve Corporate Governance and Compliance in the Face of Change
At any given moment, most Fortune 500 organizations find themselves out of compliance — often with something relatively minor. However, some have found themselves in a similar situation with more serious regulations — and faced far bigger consequences.
Global banks, alone, paid out more than $4 billion in fines for non-compliance in 2020. In February 2020, following a Securities and Exchange Commission (SEC) investigation, a top 5 US bank agreed to pay a $35 million fine for directing clients to risky investments, called inverse exchange-traded funds (ETFs). “As a result of [the bank’s] failure to meet important obligations, some of its employees recommended complex instruments to retail investors who did not understand the risks involved,” Antonia Chion, associate director of the SEC Enforcement Division, told the press.
The most recent penalty against the top 5 US bank came just a week after the bank agreed to pay $3 billion for creating millions of fraudulent accounts — to meet high-pressure sales goals — between 2002 and late 2016. The fine was one of the largest an American bank had to pay since the 2008 financial crisis.
Non-compliant actions, by and large, are like Russian nesting dolls of ‘bad behaviour,’ in the context of corporate governance. It could be said that every function and operation of a company now runs business risks — many of which have a crucial legal and regulatory component. Risks that need to be controlled — or avoided altogether — are related to exposure to litigation, and the policies and procedures around electronic contract management, especially when contracts are more complex and higher in volume. Also, these risks are relevant to the support of legal hold and eDiscovery processes, as well as the precision and quality of contracts, as actually executed.
What is more, the regulatory environment is in a state of flux and yields even more risks of non-compliance, particularly for older agreements that are still in force. The regulatory and legislative requirements for organizations — in many countries — are becoming more stringent. Commercial contracting, meanwhile, is getting more and more complicated. That is because the range of competition has moved to the international market from the domestic market as a result of economic globalization. With their legal risk profile already in jeopardy, companies have witnessed first-hand the impact on contractual relations due to legislation, such as the renegotiation of the North American Free Trade Agreement (NAFTA) — now the United States-Mexico-Canada Agreement (USMCA).
New and ever-changing regulations, at the very least, mean a duty to manage change more effectively, from a contractual standpoint. But this can feel like a constant adjustment — and an ongoing struggle — for legal and compliance departments alike. Meanwhile, contingencies like the COVID-19 crisis have only complicated matters, and regulations related to Brexit and LIBOR have only added to the more than 4,400 regulations impacting companies around the world (The list only continues to grow.). As a matter of consequence, the proverbial stakes could not be any higher; keeping tabs on today’s regulatory landscape and judicial outcomes can be a monumental task.
But although aspects of legal and compliance risk management vary from company to company, there are general principles that corporate counsels, risk officers, and compliance managers would do well to follow. Paramount among them is adopting and implementing legal technology in the form of AI-based legal document management solutions. Such systems help further the corporate values of preparedness, adaptability, and resiliency. They are ideal for risk controls and mitigations, and reduced disputes, not to mention improved customer relationships.
COVID-19 (Coronavirus) Pandemic
In light of the COVID-19 (coronavirus) pandemic — and the subsequent, unprecedented lockdown — corporate counsels, risk officers, and compliance managers have been forced to ponder deeply corporate governance and compliance, let alone contingency planning and preparedness around contract management. After all, due to COVID-19, “legal departments are seeing an increase in their volume of work related to labor and employment activities (44 percent), government affairs and relations (42 percent), and regulatory and compliance matters (39 percent),” according to Gartner. The major negative impact of COVID-19 will be felt by businesses in the foreseeable future, too.
Just think about a commercial party’s inadvertent delay in the carrying out of contractual obligations because of COVID-19. Or their inability to fulfil their contractual obligations altogether. Like COVID-19, itself, this risk is non-discriminatory. Service providers, like construction contractors, may be unable to deliver contracted services within agreed terms, if at all, because their employees — or even those of their customers — have fallen ill and have been quarantined. Manufacturers and processors also face reduced access to raw material or heightened regulatory restrictions, and resulting production delays and slow-downs. These all represent a rather difficult test for leadership and corporate governance structures.
However, amidst the disruption, some pertinent questions have arisen for legal and compliance departments: Does the COVID-19 crisis constitute a force majeure event under a business agreement? What if there is no force majeure in a contract, and what about an alternative to a force majeure claim? Additionally, what are the costs already incurred or the payments already made under a given agreement?
During any crisis, what should be top of mind is whether — and how —force majeure clauses impact current obligations and contract performance. According to World Commerce and Contracting (World CC), force majeure was the second most negotiated term in contracts during the global financial crisis that lead to the Great Recession of 2008. This may also be true today, given the powerful economic impact of COVID-19.
Naturally, though, it is more than just force majeure. Legal and compliance departments must also think about aspects, such contractual SLA management, liabilities and indemnities, delayed or liquidated damages, and termination provisions.
Without a doubt, corporate governance and compliance matters have been impacted by post-Brexit regulations also.
At the end of 2020, European Union (EU) law ceased to apply to the U.K., as the Brexit transition period between the EU and the U.K. came to an end. To date, industry analysts have mused how the country’s withdrawal from the EU would impact customs readiness, supply chains, and VAT/tax registrations — and rightly so. But the expiry of the Brexit transition period has some corporate compliance implications. Consider U.K.-registered companies that operate in Ireland, for example, and Irish companies with connections to the U.K.
Since January 2021, provisions in the Companies Act 2014 have not been understood to include the U.K either. Simply stated, they make reference to a European Economic Area (“EEA”) member state. So, the U.K. ceasing to be an EEA member state has a number of consequences for statutory exemptions, which are based on an EEA member state connection. That is regardless of the nature and extent of the EU-U.K. trading relationship moving forward. Basically, companies that have taken advantage of these exceptions based on a U.K. connection, in the past, must think twice now. They must review their own corporate affairs, and consider how Brexit will affect their corporate compliance and financial reporting obligations.
This year, hundreds of trillions of dollars of existing financial agreements will need to be amended, too. They make reference to LIBOR (London Inter-Bank Offered Rate), which will be replaced by SOFR (Secured Overnight Financing Rate) as of December 2021. In essence, loans agreed upon in these agreements use LIBOR to calculate agreement-based exchange rates. Although contracts that end before 2021 are safe, those that extend beyond 2021 will need to change to some degree.
“[This] marks the final chapter in the process that began in 2017, to remove reliance on unsustainable LIBOR rates and build a more robust foundation for the financial system,” Bank of England Governor Andrew Bailey said in a March 2021 statement. “With limited time remaining, my message to firms is clear — act now and complete your transition by the end of 2021.”
LIBOR has long been a benchmark for short-term interest rates — whether overnight or over a year —across several different currencies. It has been used to figure out funding costs and investment returns for a slew of financial products — think floating-rate bank loans and adjustable-rate mortgages.
However, LIBOR was discredited after the 2008 financial crisis and has not been considered the “world’s most important number” ever since. That is why the new benchmark for dollar-denominated securities and loans is SOFR. The U.S. Federal Reserve first published SOFR in 2018, as other countries introduced their own local-currency-denominated alternative reference rates for short-term lending. But as ‘the new LIBOR,’ SOFR will soon be the dominant global benchmark rate. First and foremost, it will be based on the average daily volume of transactions in the U.S. instead of daily estimates. It will also depend on transaction data exclusively instead of “expert judgment.”
Though the transition from LIBOR to SOFR is intended to be fairly gradual, it has been framed as the financial market equivalent of the so-called “Millennium bug.” Whether or not it is fair to compare the LIBOR-to-SOFR transition to the Y2K scare (we know how that turned out), more than $370 trillion of existing financial contracts are tied to LIBOR — an estimated $200 trillion of which are denominated in U.S. dollars. That cannot be taken lightly by companies; contracts that extend beyond 2021 will need to be renegotiated altogether.
Making matters even more complicated, institutions have been encouraged by regulators to include “fallback clauses” in all new agreements. These clauses explain how the significant differences between LIBOR and SOFR will be calculated exactly. Appropriate adjustments need to be made to each agreement, then, and this is no small feet in the absence of legal tech.
Meeting New Governance and Compliance Challenges with Legal Tech Solutions
So clearly, legal and compliance departments need to work across enterprises, identifying and setting the appetite for these risks, and agreeing on the roles and responsibilities for managing each. Equally importantly, they need to develop an effective process framework by designing reliable controls to mitigate the most critical risks. They also need to correctly institutionalize these policies and procedures, not only within legal and compliance departments, but also in other parts of the organization.
In other words, legal and compliance teams have to make risk management a main priority — and a core departmental mandate. Both departments’ value comes from helping companies manage exposure to legal and regulatory risk, and prevent reputational damage, while achieving strategic objectives.
Fortunately, though, the latest legal tech automates the management of legal risk, as it relates to business operations and activities. It helps organizations meet their legal and regulatory requirements, manage their contractual risk, enhance their strategic decision-making, and improve their capability of handling complex legal environments. With advanced platforms, they can streamline and simplify their legal risk management processes, and establish proper legal risk management frameworks — those tailored to their unique situation and needs.
More specifically, corporate counsels, risk officers, and compliance managers can embed artificial intelligence (AI) in their legal document management systems and processes. With an AI-based tool, they can collect the right approved clauses from the library. So they can ‘do the right thing,’ in the contractual sense, upon contract creation. They can either examine individual agreements or systemically measure their risks across their entire inventory, whether they have 1,500 or 150,000 contracts. With the press of a button also, they can find all of the risks and exposures by jurisdiction or by product area, and discover those unique contractual insights — something that is almost humanly impossible to do otherwise.
Partly because it helps improve governance and compliance, and lower risk, AI will create $2.9 trillion in business value and 6.2 billion hours of worker productivity globally in 2021, according to Gartner. In November 2019, the McKinsey Global Survey had already reported “a nearly 25 percent year-over-year increase in the use of AI in standard business processes.” The “transformative power of AI” affects a variety of functions, including operations, brand management, customer service, and — more recently — risk management and compliance.
According to the World Economic Forum (WEF), the rise of AI will enable legal and compliance departments to focus on what they do best: “engage with other colleagues across departments to design and execute a sound risk-management policy.”
When it come down to it, risk management is “a company’s ability to identify, monitor and mitigate potential risks, while compliance processes are meant to ensure that it operates within legal, internal and ethical boundaries,” WEF says. “These are information-intensive activities — they require collecting, recording and especially processing a significant amount of data and as such are particularly suited for deep learning, the dominant paradigm in AI.”
The Inevitability of AI and Automation
In his 2016 book, The Inevitable, Kevin Kelly argues that facts, order, and answers — facilitated by technology — will always be needed and useful. “In fact, like microbial life and concrete materials, facts will continue to underpin the bulk of our civilization,” Kelly writes. “But the most precious aspects, the most dynamic, most valuable, and most productive facets of our lives and new technology will lie in the frontiers, in the edges where uncertainty, chaos, fluidity, and questions dwell. … The technologies of generating answers will continue to be essential, so much that answers will become omnipresent, instant, reliable, and just about free.”
AI-based legal technology has its own utility when it comes to better managing legal risk. Legal document management solutions, in particular, support legal and compliance risk management across organizations. They offer functionalities, like risk identification and assessment, which are no longer only ‘nice-to-haves,’ but also bring some ‘order to the chaos.’ They help corporate counsel, risk officers, and compliance managers meet increased expectations by helping to control legal risk and demonstrating compliance in companies’ entire operations.
Ultimately, organizations can only become more digitally mature by deploying such legal tech solutions. They will be able to structure their business in a more coherent fashion and be prepared for the next change in the world’s financial market, whether it is driven by a global pandemic — or something more akin to Brexit regulations or the big switch from LIBOR to SOFR.