Against this background, boards and executive teams should ask themselves two broad sets of questions. The first concerns what steps are being taken to remain resilient and support customers through near-term economic pressures; and the second, whether their own strategic plans align with medium-term structural changes in their operating environment.

Indeed, a strong grasp of the ever-evolving regulatory environment must inform how financial services firms answer these questions.

Near-term economic pressures

Disruptive economic factors will command attention in the near term. The credit risk outlook is increasingly precarious, and lenders will need to be able to demonstrate to supervisors how they are managing the associated risks. Many insurers and investment funds will also face credit-related pressures in their portfolios and may need to boost their credit teams if the volumes of defaults and corporate restructurings begin to rise.

Where credit risks crystallize, they will feed through to regulatory capital positions. Firms will also need to be vigilant for sudden bouts of volatility within the capital markets.

Central banks and regulators will be working hard to understand market vulnerabilities, with continued stress-testing of individual firms, funds, and the wider system. Margining practices will be under scrutiny.

There is also a major conduct risk component to the current economic situation, with consumers feeling the cost-of-living squeeze. Conduct supervisory standards are substantially higher now than in previous downturns, and firms will rightly be expected to support their customers through a period of economic hardship.

This is a particular dilemma for lenders, who will need to make judgements about when and how to exercise forbearance. It will also be a challenge for insurers, who may see rising numbers of policyholders struggling to cover their premiums, creating the possibility of protection gaps that will draw supervisory attention.

Embedding climate & nature risks

Climate and nature risks will increasingly shape the financial services operating environment. Less advanced firms may find themselves given progressively less leeway for shortcomings in the year ahead.

Efforts are underway in numerous arenas to improve the structure and content of transition plans, and firms will need to shift gears to keep up with new rules, guidelines, and greater supervisory scrutiny.

Firms will also need to keep an eye on the still-evolving nature-related risk disclosure framework being developed by the Taskforce on Nature-Related Financial Disclosures, a financial services industry advisory group whose members represent more than $20 trillion in assets. The Taskforce’s risk disclosure framework is due to be finalized in Fall 2023.

Technology transforming the sector

Technology enables firms to provide new and better products and services, develop deeper insights, and do so ever-more efficiently. However, as supply chains and delivery services models become more complex, both the regulatory regime and firms’ risk management and control frameworks have struggled to maintain pace with technological innovation.

Nowhere is this clearer than in relation to digital (and particularly crypto) assets. Regulated firms have increasingly been engaging with an evolving ecosystem of digital asset technology providers and developing client offerings. The European Union’s Markets in Crypto-Assets framework will enter into force this year, but a further regulatory response may be needed to tackle issues such as leveraged trading and crypto-lending as regulatory uncertainty and gaps will persist.

In the United Kingdom, meanwhile, the Financial Services and Markets Bill, once passed, will give authorities the power to oversee digital assets markets. The secondary legislation that will clarify which activities and market participants they will regulate, however, is yet to emerge.

The transition period for the U.K.’s operational resilience framework will soon enter its second year, and U.K.-based firms need to demonstrate measurable progress with regards to important business services. The 24-month implementation period for the E.U.’s Digital Operational Resilience Act begins this month, and firms within the E.U. will need to begin their work post-haste to be on track for the early 2025 deadline.

The resilience of the delivery of financial services in which third-party suppliers are involved is a major issue. In some cases, firms will need to develop contingency exit strategies and business continuity plans for third-party exposures, including substitute service delivery methods.

Long-standing concerns about model risk management also now have a distinctly technological flavor, with supervisors scrutinizing how firms are deploying artificial intelligence and machine learning. When finalized later this year, the U.K. Prudential Regulation Authority’s (PRA) proposed principles on model risk management will require a large amount of work to catalogue, categorize, and risk-assess models that for some firms could number in the thousands given the PRA’s expansive definition of model.

A general principle will be relevant for firms across all sectors and regions: people, and not models, should be responsible for decision-making. Boards and executive teams should be able to demonstrate that they understand the functioning of their models, including those based on new technologies such as machine learning.

Rising geopolitical tensions

Finally, rising geopolitical tensions will continue to be another feature of the changing risk environment in which financial services firms are operating. International markets are increasingly fragmenting, as nations and business leaders look at how to build supply chain resilience and security through greater localization of production and supply.

Given the volume of alerts generated by transaction monitoring systems, the inherent limitations of legacy systems and data, and strengthened baseline expectations, it is no wonder that some firms feel they are having to run ever-faster just to keep up. The status quo does not appear sustainable, and operating model reform will need to be part of the response, including considering changes to internal structures, resourcing models, and technology strategies.

Resilience and strength

Financial service firms face many headwinds as the new year begins but will do so from a position of resilience and strength, having successfully navigated the vicissitudes of the last three years. The major challenge will be to navigate the choppy near-term waters without losing sight of the medium-term processes of structural change playing out in relation to geopolitics, technology, and sustainability.

Regulation continues to be a major force that will shape the operating environment for financial services, and an integrated view of the regulatory landscape — as well as an ability to connect such a view with business strategy decisions — remain imperative for firms looking to stay at the forefront of the industry.

This blog post was taken in part from a recent report written by David Strachan & Suchitra Nair of Deloitte. You can sign up to receive Deloitte’s Financial Markets Regulatory Outlook report, due to be published later in January, here.

Consequently, many corporate law departments (CLDs) will remember these past 12 months as the great pricing reset in which law firms required significantly higher hourly rate increases over and above anything the legal marketplace has seen in at least a decade.

The new year finds both the buyers and sellers of legal services having to grapple with the economic reality of high inflation, increasing labor and infrastructure costs, attrition, labor arbitrage, and major shifts in market demand — all of which will in some way or another impact the cost of legal services into 2023 and beyond.

Using cost control counter-measures

With this reality, many CLDs are not looking forward to a repeat of last year’s rate hikes; however, that is not necessarily a fait accompli for corporate clients. Yet, there are counter-measures that can be deployed to help them mitigate, control, and even create cost savings in the face of such pricing uncertainty.

There are many familiar options that CLDs have at their disposal — such as tiering, RFPs, volume discounts, panel convergence, budget structuring, and in-sourcing — although these approaches, while important considerations for every CLD looking to control their costs, may take time to mitigate the impact of proposed rate increases.

Instead, let’s focus on a few things that might help CLDs achieve tactical and immediate results.

Rebates

Similar to, but distinct from, volume discounts, most rebates exist with those law firms that enjoy large volumes of billing. Rebates are typically negotiated at the start of a calendar year and are contingent on a firm achieving a certain dollar threshold or tier of billings in that year.

Rebates are a good tool for CLDs to utilize during any rate negotiations and especially on large matters or a portfolio of work where a CLD is looking to reduce its legal spend, offset the cost of future work, or simply to mitigate the impact of future rate increases.

Value-added services

Not all clients have sufficient scale with a law firm to entitle them to ancillary benefits with the firm. However, value-added services — such as free legal advice, secondments, market research, access to proprietary technology, education, and training sessions — can be separately negotiated.

If a CLD must accept higher rates, then perhaps trying to negotiate or tie some level of complimentary ancillary services to those rates may help offset the CLD’s legal costs in other areas.

Rate management policy

While many CLDs have billing guidelines in place with their law firms, far fewer have any language in their guidelines that talks specifically about rate management and prescriptive requirements related to how a law firm is to address any proposed rate increases. Consequently, the process becomes much more ad hoc.

A proper rate management policy should address criteria such as when a firm can make a rate increase request, the frequency of a request (e.g., one increase per year rather than two incremental increases), permissible rate increase caps for specific professional groups, and the permissible criteria or reasons that qualify for a rate increase (e.g., merit vs. market pressures). All of these criteria are fundamental to managing expectations up front for both the firm and the CLD and for providing predictability and transparency around rate management.

ALSPs

ALSPs offer CLDs an opportunity to leverage less expensive providers than traditional bricks-and-mortar law firms. Tiering transactional matters or components of a matter away from expensive firms to ALSPs provides CLDs with cost saving and convergence opportunities.

Contingent worker ALSPs are a good example of legal work that typically has been sourced to traditional (and more expensive) law firms. Now, however, CLDs have the option to utilize virtual and less expensive service providers for components of legal matters or other resource needs.

Staffing ratios

As part of rate negotiations, CLDs should consider imposing staffing ratios on firms requiring them to assign a greater percentage of their work to lower cost mid-level associates, rather than expensive partners, thereby offering up potential cost savings for the CLD.

Disbursements & cost recovery

Legal e-billing systems are great for implementing quantifiable rules around non-reimbursable expenses on invoices. However, there are many charges or billing practices that cannot be quantified and corelated to an automated e-billing rule that rejects the proposed expense. Further, there are also other expenses that may be subjective in nature and require more powerful tools to review.

Diving into law firm disbursement data offers a CLD an opportunity to: i) find patterns of billing that are non-compliant with a CLDs billing guidelines; and ii) use the exercise to close any compliance gaps and save money; .

Quick-pay discounts

The importance of timely payment is not lost on a law firm’s management team as tracking outstanding accounts receivable balances is instrumental in measuring productivity and effectiveness of lawyers or identifying servicing issues.

A CLD can utilize quick-pay discounts as a solution to a firm’s balance challenges by providing an incentive for the law firm to lower its rates or offer a discount in exchange for the CLD’s commitment to paying the law firms invoices within a specific time frame.

Alternative fee arrangements (AFAs)

AFAs (e.g., fixed fees, flat fees, contingency, volume discounts, risk collars, etc.) are often touted as the great pricing panacea to hourly rates; however, before accepting any AFA proposal, CLDs should consider asking the law firm to provide quantifiable proof as to the value of the AFA and what if any determination was made to validate that the AFA is a better pricing option for the client. Without any such empirical validation, CLDs risk making costly assumptions around cost savings, when in fact the opposite may be true.

Getting ready to negotiate

Before engaging any law firms in discussions of the above strategies, CLDs need to address two key components that must underlie any of their efforts — billing data and communications.

Billing data — When leveraged correctly, CLD billing data offers a plethora of opportunities to save money in a runaway market that has pivoted in favor of legal service providers. By mining timekeeper data (e.g., rates, year of call, geographic locations), disbursement charges, invoice line item detail, time allocation, staffing ratios, and more, CLDs may uncover opportunities for savings when comparing billing data between multiple firms and ALSPs.

Communications — Having an open and honest dialogue with their law firms on budget constraints or their companies’ cost saving targets may allow CLDs to obtain voluntary law firm rate freezes or even rate reductions in the interest of building stronger and lasting relationships.

Indeed, holding these candid discussions at an opportune time when a lot of companies are facing financial challenges, may remind law firms that many CLDs are committed to growing lasting partnerships with those firms that understand the client’s budgetary pressures and are willing to help clients meet their cost-saving targets for the greater good of the relationship.

Indeed, “Second Chance” or “Fair Chance” hiring — when done right — is good for business. Companies can fill workforce gaps and reduce turnover, increasing productivity and cutting on-boarding costs. This practice also has community benefits and is a place where corporate value and social values dovetail. When people with criminal records are employed, economic activity and new tax bases are created, and public safety increases.

A 2021 survey of human resources professionals found that 81% believed that the quality of workers with criminal records is generally the same or better than workers without records, with nearly identical hiring costs. Studies have also shown that retention rates are higher, turnover is lower, and employees with criminal records are more loyal to their employers once hired.

Recent job openings reports from the U.S. Bureau of Labor Statistics showed thousands of open positions in accommodation and food services and in manufacturing — just two of the many industries in which talented people who happen to have criminal records could fill the labor gap.

Offering a second chance

Second-chance hiring is good for employers’ bottom lines in whatever industry they operate. Fortunately, many more business leaders are also recognizing the significant value in second-chance hiring. The Second Chance Business Coalition, led by Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co., and Craig Arnold, Chairman and CEO of Eaton, has brought large businesses into the space.  Corporations such as Walmart, McDonalds, Verizon, Accenture, and Koch Industries are among more than three dozen companies that have been brought together by the coalition to work on this issue.

When I was incarcerated, no one asked me for money, but nearly everyone asked me to help them get a job after they were released. Today, I work with businesses to help them develop organizational and risk management strategies to better recruit and retain people with criminal records.

A 2021 report from the Alliance for Safety and Justice estimates that one-third of American adults — roughly 78 million people — have a criminal record. The problem is even worse for Black men. A University of Georgia study found that, as of 2010, 33% of Black men had a felony conviction compared to 8% for all adults.

Unemployment also has been an inescapable by-product of a criminal record. The Prison Policy Initiative calculated that the unemployment rate for people with criminal records is over 27%. By contrast, the country’s overall unemployment rate currently stands at just 3.5%.

Expungement as a risk management tool

Expungement, or record-clearing, is a powerful risk management tool for businesses, but the system can vary drastically among states. For example, a minor drug offense in Florida can stay on a person’s criminal record for life, while a much more serious offense that involved prison time may be expunged in another state. When an employer performs a background check, the Florida person who never served a day in jail will be classified as a “felon” while the person who did years in prison will not.

Fourteen states now broadly allow felonies and misdemeanors to be expunged, while another 23 states have narrower expungement criteria for felonies and misdemeanors. Five other states allow expungement only for pardoned felonies and certain misdemeanors, and three states and the District of Columbia allow only misdemeanor expungement. Five states and the federal system have no expungement law. Without broad record-clearing laws, a person with even a minor criminal conviction will always wear that scarlet letter.

Broader expungement laws have risk management benefits as well. This creates additional issues for chief human resources officers, corporate general counsels, and employment lawyers. Most businesses will never learn of an expunged record, which generally adds additional protections against negligent hiring cases and creates no additional work for corporate staff. In contrast, when a background check has a criminal conviction, the business may have to take additional steps before it can hire the person under the Fair Credit Reporting Act, applicable state laws, and its own risk management strategy.

Without expungement, the risk management landscape is largely governed by state law. For example, Colorado law prohibits an employee’s criminal record from being introduced as evidence in a lawsuit against an employer unless there is a direct relationship between the criminal history and the underlying facts of the claim (Colo. Rev. Stat. Ann. § 8-2-201(2)(a)(I)). Florida — a state without a record-clearing process — protects employers from a negligent-hiring presumption in cases in which the criminal-records check “did not reveal any information that reasonably demonstrated the unsuitability of the prospective employee” (§ 768.096, Fla. Stat.).

Hiring and retention are core business functions and are not an option for companies to achieve success. Unlocking this relatively untapped talent pool can help businesses grow and thrive, creating profits for the business and benefits for its stakeholders, employees, and surrounding community.

Hear more about John’s work, his former legal career, and his journey from prison to expert on re-entry into society after prison on Episode 108 of The Hearing: A Legal Podcast from Thomson Reuters.

As we enter 2023, the specter of a potential recession looms over all budgetary and strategic decisions. Professionals in corporate law and tax departments are already anticipating having to do more with less, which will likely impact how they work with their outside partners over the next 12 months. Add into this a mixture of new governmental regulations, and these next 12 months could start to look less optimistic and more of a trial to overcome.

In the most recent Thomson Reuters Institute Insights podcast, available on the Thomson Reuters Institute Insights podcast channel, our team of strategists reveal the trends they’re watching as we enter 2023, and how changes in the overall economy may affect this coming year’s strategic priorities.

Rabihah Butler, Head of Compliance & Government Insights, says that compliance is the name of the game in the risk and fraud space, with the Beneficial Ownership Act, the Enablers Act, crypto-regulation, and ESG compliance all playing their part to make the coming regulatory year a complicated one. And in the event of an economic downturn, there may be questions surrounding who bears the burden of that compliance risk, as well as how government entities and court systems will be able to continue key system reforms that they began during the pandemic.

Natalie Runyon, Head of ESG Insights & an Advisory Services Consultant, believes 2023 may be “a painful year because of multifaceted operational challenges and other headwinds” facing those responsible for ESG within organizations. The Securities and Exchange Commission’s rules on greenhouse gas emissions and the European Union’s new corporate sustainability reporting requirements both will increase work for lawyers and accountants, while certain social aspects of ESG — most significantly, the increased focus on employee well-being as a key performance indicator of organizational well-being — will remain a key priority for boards, especially in a tighter labor market.

Zach Warren, Head of Technology and Innovation Insights, views the tech and innovation landscape as one where next-generation technologies such as artificial intelligence, blockchain, and even ChatGPT may be taking a back seat to tried-and-true standards like business development and security and data protection. Thomson Reuters research has shown that while technology investment has continued thus far in the legal and tax industries alike, a recession may mean scaling back some research and development initiatives.

Bill Josten, Head of Legal Marketplace Innovation Insights, notes that what is top of mind for corporate law department leaders and law firms alike isn’t changing: the volume of matters they’re seeing is increasing. However, flat budgets and a potential down economy may have changed the calculus of how those matters will be tackled. Tighter budgets are forcing corporate law departments to tier their outside work, which could mean a potential rise in utilization of alternative legal services providers. Law firms, meanwhile, also are eyeing what inflation might mean for their realization rates and how to hold onto demand in the face of those tightening corporate purse strings.

Finally, Nadya Britton, Head of Tax and Accounting Insights, explains that small and midsize tax & accounting firms are looking to continue their advisory services expansion, particularly with continued industry automation and a de-emphasis on simple compliance work, while large tax firms are focusing on specialization in specific industry areas. Corporate tax departments, meanwhile, are “all about data, data, data,” Britton says, particularly with trying to better integrate the tax function into their organizations’ wider business initiatives. Even though any economic downtown may not impact tax as strongly as other industries, there are still implications around the industry’s growth plans to be considered.

As our team of strategists describe it in the podcast, 2023 is set to be a complicated year, but research has shown that there can be reason for optimism among all areas of professional services. Even with economic uncertainty looming on the horizon, the next year can prove fruitful with a little strategic planning and care.

Episode transcript.

You can get the whole story on the outlook for 2023 and listen to the most recent Thomson Reuters Institute Insights podcast here.

While talent issues remain high on the board agenda for many companies, organizations need to do more to explicitly tie the well-being of their people and corporate purpose directly to corporate ESG activities on a consistent basis. Indeed, measuring social impact — the S in ESG — through the lens of people’s well-being is not yet mainstream, although it is gaining traction.

Multinational food manufacturing giant the Kellogg Company (Kellogg’s) is among those companies that consistently link their global purpose platform to their sustainability agenda and ensures their purpose is centered on the well-being of their employees and other stakeholders. More specifically, the company, through its Kellogg’s Better Days Promise, aims to advance sustainable and equitable access to food by addressing the intersection of well-being, hunger, sustainability, and equity, diversity & inclusion to create better days for 3 billion people by the end of 2030.

Enacting a multi-pronged stakeholder engagement strategy

Kellogg’s also embeds its corporate purpose into its growth strategy. This definitive integration of purpose and growth dates back a century to its founder and is well entrenched within the organization’s business and culture today, says Stephanie Slingerland, Senior Director of Philanthropy and Social Impact at the Kellogg Company.

The Better Days Promise is a key element of Kellogg’s Deploy for Balanced Growth strategy, which includes consideration of the varying sustainability-related preferences, needs, and desires of the company’s multiple stakeholder groups — employees, customers, consumers, investors, and the communities in which the company is based and operates.

With the recognition that the “company should and can do well by doing good,” Kellogg’s has taken a proactive approach to engaging with stakeholders to communicate how its corporate ESG strategy remains central to its operations and growth strategy through a people well-being lens, Slingerland explains.

Kellogg’s has seen positive implications by intentionally collaborating with stakeholders to integrate the organization’s corporate purpose and social impact into its ESG strategy in a variety of ways, including:

• • • Cross-stakeholder ESG initiatives — Honoring World Food Day is a month-long event at Kellogg’s. It is an opportunity for the company to engage with many of its stakeholders, including food banks, retail partners, and employees, through workplace and community volunteering opportunities, donation drives, communications, and events.
    • Employees — Kellogg’s employees regularly engage with ESG initiatives over the course of the year. Indeed, cultivating employees as ambassadors through the promotion of the Better Days Promise to employees’ networks, customers, and partners enables a multiplier effect on the company’s ESG communications and social impact.
    • Consumers & community — Kellogg’s has a long history of involving consumers in its philanthropic activities. In the summer of 2022, for example, the company’s launch of the Build for Better program and competition, executed in partnership with Minecraft and the nonprofit KABOOM!, allowed consumers to design a virtual playground on Minecraft and submit it for the chance to see it built in real life. The winning design was built at a Boys and Girl Club of America in Marietta, Georgia in November 2022.
    • Customers — Likewise, the company’s retail customers recognize the importance of ESG initiatives and are eager to partner on Better Days Promise. For example, Kellogg’s collaborated with a retailer to launch Kellogg’s InGrained, a program that helps rice farmers reduce climate impact. Another retail partner, recognized Kellogg’s commitment, investment, and partnership on philanthropic, sustainability, and well-being initiatives, named the company the first-ever ESG Supplier of the Year.

Storytelling & data are essential

Data and storytelling are key to executing holistic, multi-pronged communications to a wide variety of stakeholders. While it is sometimes tricky to address all audiences’ preferences and expectations, “sharing stories about the people behind our strategy who have such a passion for their work, or the people that the initiative impacts, resonates the most,” Slingerland says. “Data helps to contextualize the impact of the stories.”

One of the most common challenges in implementing an ESG engagement strategy is how to influence late-comers or those who question the validity of the widespread attention that ESG is receiving. To make progress, companies should stay focused and highlight the positive impact company initiatives can have on the surrounding communities, and how these initiatives help drive company’s growth, Slingerland advises.

The hearing exposed some partisan differences even as broad agreement emerged on what needs to be done to reduce risks for crypto investors. Republicans and Democrats remained apart in their views of the future of a digital-asset world shaken by the swift collapse of a firm regarded as one of the safest bets in the industry. Indeed, the FTX failure showed basic concerns that must be resolved before mainstream firms can assure regulators that investor protections are in place.

Republicans who have been ardent advocates of deregulation used the hearing to slam U.S. agencies for failing to act sooner to halt fraud at FTX and for going too slow in drafting rules. Numerous Democrats argued against taking hasty actions until more is known about the FTX failure, which led to Bankman-Fried’s recent arrest and indictment on multiple criminal charges.

Garden of Eden full of snakes

“My fear is that we will view Sam Bankman-Fried as just one big snake in a crypto Garden of Eden,” U.S. Rep. Brad Sherman (D-Calif.) told the hearing of the U.S. House Financial Services Committee. “The fact is, crypto is a garden of snakes.” Sherman has been a persistent critic of cryptocurrency, which he sees as mainly a tool for tax evasion, funding for illicit activities, money laundering and sanctions evasion.

Republican legislators at the hearing argued against curbs that discourage innovation and argued for moving more quickly to put basic rules in place.

Despite testy exchanges and finger-pointing across the aisle, the hearing showed bipartisan consensus that the industry needs to assure transparency, asset custody, and governance that curbs conflicts of interest and self-dealing.

The FTX case also illustrates the challenging complexities in resolving a digital-asset bankruptcy, Ray said during the hearing. But the process was the same that he followed while overseeing the collapsed energy trading firm Enron, he said. “You follow the money.”

The FTX event could lead to “information being gathered that will inform legislation in a positive way,” said Sarah Riddell, a Morgan Lewis lawyer who worked for the Commodity Futures Trading Commission (CFTC) and participated in drafting the Dodd-Frank legislation.

Riddell compared the job ahead to the post-financial crash rulemaking that required a multi-faced, complicated process. The industry firms that have put compliance in place in their crypto practices could emerge intact, she said. “The firms with good tires will survive the heightened attention this has brought.”

AML as a unifier

U.S. Senators Elizabeth Warren (D-Mass.) and Roger Marshall (R-Kansas) recently introduced bipartisan legislation aimed at mitigating risks that digital assets pose to U.S. national security by closing “loopholes” that enable money laundering using cryptocurrencies. The introduction of the Digital Asset Anti-Money Laundering Act of 2022 comes in the wake of a number of high-profile government actions and scandals in the crypto sector, including the Treasury Department’s blacklisting of the cryptocurrency “mixer” Tornado Cash in August as well as the FTX bankruptcy and founder Bankman-Fried’s subsequent indictment. Amid these scandals, pressure on legislators and regulators to rein in the sector and strengthen anti-money laundering (AML) activities has only mounted.

Among other things, the Digital Asset Anti-Money Laundering Act of 2022 would extend AML obligations to a much broader spectrum of cryptocurrency players. For example, it would require such crypto entities as digital asset wallet providers, miners, validators, and other network participants to comply with portions of the Bank Secrecy Act, including know-your-customer requirements. The Act would also prohibit financial institutions from using or transacting with digital asset mixers and other anonymity-enhancing technologies and from handling, using, or transacting with digital assets that have been anonymized using these technologies.

The Act would also direct the U.S. Treasury Department to establish an AML/counter-terror finance compliance examination and review process for money services firms and directing the U.S. Securities and Exchange Commission and CFTC to establish similar compliance examination and review processes for the entities those agencies regulate.

“Rogue nations, oligarchs, drug lords, and human traffickers are using digital assets to launder billions in stolen funds, evade sanctions, and finance terrorism,” Sen. Warren said in a written statement. “The crypto industry should follow common-sense rules like banks, brokers, and Western Union, and this legislation would ensure the same standards apply across similar financial transactions. The bipartisan bill will help close crypto money laundering loopholes and strengthen enforcement to better safeguard U.S. national security.”

The senators noted that the Treasury Department, U.S. Justice Department and other national security and financial crime experts “have warned that digital assets are increasingly being used for money laundering, theft and fraud schemes, terrorist financing, and other crimes.”

In fact, rogue nations have used digital assets to launder stolen funds, evade American and international sanctions, and fund illegal weapons programs, the statement noted, adding that in 2021, cybercriminals raked in at least $14 billion in digital assets — an all-time high.

Further, Binance, the world’s-largest crypto platform, was reported to have laundered more than $10 billion for criminals and sanctions evaders over the last few years. However, splits among Justice Department prosecutors are delaying the conclusion of a long-running criminal investigation into Binance, it was recently reported. A Binance spokesperson declined comment.

Whatever the ESG concerns that emerge, both say, they are among an already full plate of work for corporate tax teams in 2023.

Readiness to take on ESG responsibilities

The extent to which corporate tax functions will be prepared to take on upcoming regulatory requirements around ESG will be a key factor in 2023. At the same time, tax leaders don’t seem too worried. The infrastructure upon which most tax teams can lean are the processes and governance already in place to meet current financial disclosure requirements, explains Sturgis. Indeed, corporate tax functions have solid protocols and procedures in place to comply with existing regulations, and they already have experience with calculating how much the company contributes to local economies in which the company operates.

Sturgis offers these essential actions that can help determine if the current process framework is adequate to absorb ESG requirements:

• • • Make sure tax leaders are able to articulate how the tax function is reducing risk.
    • Evaluate how the tax function is grasping the company’s current tax liabilities, which includes income tax, payroll tax, personal property tax, and value-added tax. In addition, a detailed understanding of those liabilities from state, local, federal, and international perspectives also is important.
    • Assess the tax compliance process and conduct a gap analysis against best-in-class practices.
    • Review processes to understand how new tax laws are being identified and evaluated.
    • Analyze how adding technology to processes might help reduce that risk.

Evaluation of IRA tax incentive opportunities

The full implementation of the IRA could reduce the domestic greenhouse gas footprint in the U.S. by as much as 40%, given that there is more than $300 billion of climate-related and clean energy investment incentives from solar wind energy storage, hydrogen, carbon sequestration, clean aviation fuel, and charging stations for electric vehicles, says Hall. Because of the expansive incentives related to the IRA, any corporate tax function can be a vital and valuable contributor to a company’s ESG strategy execution around climate and the environment in 2023.

What is interesting about the IRA is its supercharge tax credits, which actually have been on the books for years. In addition, the law also offers extensive opportunities to enhance social initiatives — the “S” in ESG — which include: i) a low-income area provision that allows a company to leverage additional incentives if a company’s energy project is in a low-income community that is below or near the poverty line; and ii) an “energy community” special rule that encourages investment in communities that have historically been negatively impact by fossil fuel industries, while at the same time, are in need of economic revitalization.

ESG-infused cross-border tax regulations

In addition to the issues on the horizon around tax in the U.S., there are tax concerns related to ESG in other jurisdictions. Two notable ones, according to Sturgis and Hall, are the potential for a carbon border tax and IRA-like legislation in other countries. Indeed, they could increase the difficulty of the work by corporate tax teams, if passed.

For example, the implications of the European Union (EU) enacting a carbon border tax could be significant, notes Sturgis. The EU is already taxing carbon, but the carbon-based border tax complicates the incentives to keep the production of goods sourced and manufactured within national borders because these goods would be at a price disadvantage. Also, more jurisdictions passing their own IRA-type legislation to incentivize domestic investments would also have an impact. “A headwind on the IRA legislation in the U.S. is that our friends over in Europe were not too happy about it,” Hall says.

ESG here to stay in 2023

Political and financial headwinds are likely to slow progress around ESG in 2023. Sturgis and Hall point to the divided U.S. Congress and the high cost of capital that are likely to both slow companies’ efforts to take advantage of IRA incentives.

However, both anticipate progress over the long term because of ongoing rulemaking and the staying power of the importance of ESG among the public, investors, employees, consumers, and other stakeholders. As a result, corporate tax teams as well as their outside tax & accounting firms are likely to stay busy in 2023.

“Whenever [ESG] rules come out, they need to be implemented via controls and audited,” Hall states. “As accountants and CPAs, that is where we can help.”

You can download TRRI’s 7^th report on Fintech, RegTech, and the role of compliance in 2023 here

On the other hand, there are signs of a slowdown in the growth of the fintech sector. In the first half of 2022, for example, the total capital invested in fintech worldwide reached $59 billion, which was flat year-over-year, according to Innovate/Finance’s 2022 Summer Investment Report. What’s more, there were 3,045 deals completed in the fintech sector, fewer than the 3,401 deals in the first half of 2021.

The slowdown is echoed in the findings from this year’s TRRI survey. There was a fall in the number people feeling extremely positive about fintech and regtech. For fintech overall, this year’s survey reported that 15% of respondents were extremely positive compared with 31% last year. For regtech, 15% of respondents felt extremely positive compared with 26% in 2021. What’s more, less than one-in-ten (8%) of respondents from G-SIBs felt extremely positive about fintech.

It may be unsurprising that respondents felt less positive about innovation and digital disruption given the challenges that firms must address across the board. This year, respondents said that the availability of skills (20% fintech, 16% regtech) and regulatory approach (14% fintech, 18% regtech) were the most significant challenges anticipated in the next 12 months. For G-SIBs, concentration risk and third-party providers ranked highest among challenges for fintech (15%), whereas cultural approach (15%) was the biggest challenge facing G-SIB regtech users. Data governance and cyber resilience also feature highly in the list, with other areas including financial crime and operational resilience also prominent.

Regulators are also adopting technological solutions to help with their supervisory roles and the management of large volumes of data. That means, firms need more interaction with regulators on fintech and regtech. More than two-fifths (43%) of G-SIBs reported having spoken to their regulator about fintech and regtech. This contrasts with responses from other financial services firms, nearly 60% of which reported that their regulator had not spoken to them about the use of technological solutions.

Despite this current slowdown and waning of enthusiasm, the future of the fintech market remains optimistic, the report observes, recommending that financial services firms should continue to invest in technology, IT infrastructure, and associated skillsets. To maximize the potential of technological innovation, firms must continually reassess their technological needs and then invest in solutions tailored to the activities of their business.

The Fintech, Regtech, and the role of compliance survey has, in its lifetime, attracted more than 3,000 respondents. Participants from all sectors of financial services — from globally significant banks to technology start-ups — took part in this seventh survey. The survey results are intended to help financial services firms with planning, resourcing, and direction, allowing them to benchmark whether their approach, skills, strategy, and expectations are in line with those of the wider industry. The report specifically focuses on areas that directly affect the compliance function.

The report also assesses the extent to which firms are turning the technological challenges they are now facing into opportunities, embracing new ways of working and navigating the evolving regulatory approach.

A tax department operating efficiently can go beyond providing compliance work and instead make the shift to being a proactive business unit that provides the company with tax and business guidance to mitigate risk and improve profitability. However, leaders and department heads must first understand where their department stands before thinking or wishing to become proactive.

For example, how does a corporate tax department leader know whether the department is proactive or reactive?

Being proactive — creating or controlling a situation by causing something to happen, rather than simply responding to situations after they have happened — means that the department should be organized in such a way that even though all external factors cannot be controlled, the mechanism in place can help plan for the unknown or the out-of-left-field happenstance.

The nature of the types of work done by the corporate tax department and how that work gets done is under almost constant change — the recent local, national, and international regulatory changes is just the latest example. The use of technology also has collapsed borders, allowing individuals and companies alike to traverse with ease. Like the individual, many companies can stretch into parts of the world that would have been only accessible by a few large corporations in the past.

Yet, along with this ease of crossing borders, there is a complexity in navigating it, especially for doing business. Companies can grow by reaching customers across the globe, but the cost of doing business brings challenges, such as having to work within the legal and financial systems in which the customer is located.

Corporate tax department leaders must not only navigate the tax laws of a nation, state, and local government but now increasingly must deal with multi-nation rules, especially if their companies have customers around the globe.

Some corporate tax departments might find it hard to believe that they are not proactive simply because part of the nature of this department is to predict their company’s tax liability and ensure it remains tax compliant while paying the necessary amounts of tax.

Of course, there are some telltale signs that a tax department is not operating efficiently and therefore isn’t proactive. Taking a look at these four areas can help department leaders make a proper assessment.

1. Process management

Departments that use a systematic approach to ensure adequate and efficient business processes are in place are engaging in proper process management to better align business processes with strategic goals. For corporate tax departments, there may be different ways in which data is collected, reports filed, analysis provided, and feedback given back to the business that all may seem to work. However, if they rely primarily on manual work and are multi-stepped (to the point that it takes weeks and months to complete), it may be worth asking some questions of the department’s process management.

Indeed, does process management even exist within the department? Can it be articulated clearly, shown to work repeatedly, and stand on its own? Does it only work for the individuals that helped create it, or can someone new step in and have it work the same way? If the answer to these questions is no, proper process management isn’t in place.

2. Data management

How does the department gather data? Does it feel like a version of the Hunger Games that requires seeking, finding, negotiating, and trying not to step on a land mind? Is this a manual process, collecting various spreadsheets from around the business and then entering the information into the department’s management systems? Or, can the tax department software be integrated to extract data from other part of the business? Is it seamless? Manually processing data significantly increases the chances of error, makes it challenging to verify data sources, potentially creates a tax risk, and is time-consuming.

And yet, even when technology is employed, it’s only as good as its users. Leaders should assess whether current technologies are efficient or actually are creating more work or processes for the department. Often staff — whether incorrectly trained or simply preferring to use their own methods — utilize just certain parts of a software program and rely on manual labor to do other tasks.

In these cases, workers time is not being used efficiently. Further, not having proper data management systems in place also causes bottlenecks in the work flow of department as employees wait for pieces of data in order to move forward. These inefficiencies can create a potential opportunity for risk, such as missing or incorrect data that leads to erroneous results.

3. Compliance & reporting

How long does this process take? Quite often, reporting is the final step in the process and as such, can be significantly impacted by how well or how poorly the previous process were conducted. Again, if there are many manual steps here, it will likely result in wasted time and resources while increasing the chance of risky mistakes.

4. Analysis

Corporate tax departments have always been an advisory to the business by the very nature of their role in providing tax planning. However, this role has increased as departments are now expected to provide insights into tax implications related to deal-making, mergers, business divestitures, and environmental, social & governance (ESG) initiatives to name a few. For departments that aren’t functioning optimally, leaders will find that they cannot provide useful or beneficial advice to the larger businesses because departments themselves lack the bandwidth and resources needed.

Tax departments and their leaders should strive to manage processes and data efficiently and effectively. By utilizing automation and having a clear mindset about the role of the tax department within the organization, a leader can improve the department’s work process, relieve the stress on overworked employees, and provide invaluable information to the business to make it more profitable.

Indeed, this kind of transformation within corporate tax departments has happened, led by leaders who have recognized and adjusted to the new realities of the business and taken advantage of improved technology and process management techniques.

This process then kicked off a volley of communications — internal and external — and necessitated forwarding emails, PDF letters, and spreadsheets for analysis and follow-up. The legal operations team provided some central support, but this was often challenging because data limitations made it difficult to account for past rate increases and freezes across different firms. Overall, the efforts felt somewhat ad hoc and very time-consuming.

“It has always been important to us to get this right,” says Antony Klapper, Deputy General Counsel in Product Liability & Regulatory at VWGoA. “We want to be fair to our law firms, whom we view as trusted partners. At the same time, we must manage our company’s finances responsibly — and execute all of this efficiently with a leanly-staffed team.”

Trisha Fletcher, Legal Operations Specialist at VWGoA, emphasizes these points as well. “Collectively, our team had a strong desire to find a better way to do this.”

Taking a new approach

The VWGoA team launched a new initiative to process rate increase requests more effectively for 2022 and beyond — one that would ultimately win them an ACC Value Champion Award.

The first step, the team decided, was to establish a more centralized, uniform approach. This would be managed by legal operations with strategic guidance from legal leadership. Of course, there would still be coordination with in-house counsel, but in a more efficient way — built around a centralized process, featuring stronger use of data analytics, benchmarking, and core decision governance from leadership.

The next step then, was to improve the in-take process. Outside law firms were asked to submit their rate increases within a designated window of time and through a common portal. This allowed the team to consider them all together, performing side-by-side comparisons of similar firms to ensure more consistent treatment under then-current market conditions. This commonality also enabled the use of greater analytics capabilities to assess past rate increase history, as well as internal and external benchmarking comparisons.

Within this framework, the team also began examining firms’ compound annual growth rate (CAGR). A law firm’s billing rate CAGR shows a multi-year view of the firm’s rate increase history, accounting for past increases and rate freezes. Standardizing the figures this way enabled better side-by-side comparisons across the portfolio, and showed which law firms were high or low outliers based on their multi-year rate history.

The VWGoA team also found it very helpful to use data to model the dollar impact of the requested increases per timekeeper for the coming year. This was instrumental in identifying the most impactful requests in order to focus on managing costs.

Seeing the benefits

Through this new approach, VWGoA legal leadership and legal operations were able to implement more effective governance and decision logic to streamline the rate decisions in light of portfolio metrics and company financial considerations. By streamlining and consolidating the process, they freed up considerable hours that their staff had previously spent responding to rate increase requests as they came in, managing them all through one common workflow. They saved further time be setting auto-approval thresholds for certain rate increase increments.

In the end, the projected savings for the coming year were significant, with rate increases for various timekeepers, for example, trimmed to about one-half of the increment originally sought. The VWGoA team devoted particular attention to adjusting high outliers and managing the impact on budget in a sustainable way.

Beyond time and money savings, the team built a process that leveraged better data to drive better decisions. The result is a strong business case showing how those in legal can use technology and data more effectively to increase productivity and execute against business metrics.

From law firms’ perspective, understanding the data that informs a client’s financial position is a helpful way to focus their rate increase conversations onto a productive end for both sides.

“We recognize that, in this economy, many clients are facing challenging headwinds,” says Susan Vargas, Partner at King and Spalding. “As trusted partners, we are glad to talk about goals and metrics to strengthen our relationship in mutually beneficial ways — and we welcome informative data to help us do that.”