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How COVID-19 has impacted the financial services sector

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Ralf Heussner, Sebastian Ma’ilei and Stephen Weston explore how the coronavirus pandemic has affected businesses in the financial services sector and consider the transfer pricing (TP) changes for the ‘new normal’.

The human and business impact of the COVID-19 pandemic continues to unfold globally. The rapid pace at which the pandemic is spreading and the global actions taken to curtail it are having an unprecedented impact on the way we live and do business. While it is too early to fully understand the long-term effect of these events, financial institutions across the banking and capital markets, insurance and asset management sectors must prepare for the TP impact of the 'new normal'.

Since the lockdowns began, nearly all financial services companies' employees have been working remotely from their homes, which has involved many individuals working outside the country of their employment. During this time, the OECD released initial guidance suggesting that a home office should not create a permanent establishment (PE) on the basis that any restrictions were likely to be temporary and enforced by governments. However, as lockdowns are being eased at different speeds globally and international travel is resuming, a question remains regarding what this means for business travel. This has created a question of whether a home office may constitute a PE of an enterprise if travel restrictions are lifted but staff continue to work from home voluntarily.

COVID-19 has certainly accelerated the topic of the future of the workplace and what this means for operating models. Groups are reviewing their operating models, particularly where senior executives and key decision-makers previously travelled for business, to establish more centralised models while continuing to serve customers without creating any additional PE exposure. This is a complex task, particularly as tax legislation in this area continues to evolve with the OECD work on Action 1 on the tax challenges arising from digitalisation, and particularly under pillar one.

Financial institutions will need to revisit their TP policies/approaches in the light of potential loss situations and support payments that could be triggered. Market volatility could also invoke the critical assumptions of existing advanced pricing arrangements (APAs) that must be carefully considered and potentially clarified with the relevant tax authorities.

This article explores the impact of the COVID-19 pandemic on the financial services sector, focusing on the key challenges from a TP perspective and the important practical takeaways.

Banking and capital markets

The re-regulation following the 2008 global financial crisis put banks in good stead when entering the COVID-19 pandemic. Compared to banks, households and companies entered the crisis relatively highly leveraged and, therefore, more susceptible to economic shocks.

Banks have been called upon to support government-led schemes that provide emergency funding loans or stand-by liquidity through loan facilities. With corporate and household indebtedness rising further, so too are banking risks, including credit misallocation, credit losses, and possibly banks' own solvency.

The practice of central banks aggressively cutting interest rates even further from previous historic lows has put additional pressure on banks' interest margins. Furthermore, while central banks are focused on funding businesses, they may later choose to stress test banking resolutions developed after the global financial crisis.

While there may be differences between banking profiles, geography or business mix, large declines in bank equity prices may suggest that investors are becoming even more concerned about profitability and prospects for the banking sector. Regulatory edicts preventing share buy-backs and dividends have further reduced the perceived investment case for banks. This may suggest that banks will only be able to replenish their capital buffers through earnings (including bonus restrictions) and retained dividends, rather than through rights issues.

The almost overnight switch to remote working has also highlighted the need for continued investment in IT systems and technology to serve customer needs, as well as publicised pronouncements about banks' real estate footprint. Over time, this may affect the traditional value-driving functions within the banking sector, notably the rise of fintech within the sector.

All these pressures may lead to losses across the banking sector. Booking models may need to be scrutinised to stress test how the credit approval process is working in the COVID-19 environment and whether this affects the location of the key entrepreneurial risk-taking (KERT) function in a corporate lending branch scenario. Likewise, the impact on risk-weighted assets and the knock-on effects for the allocation of capital to branches under the authorised OECD approach (AOA) will need to be carefully considered. Similarly, the way the sector's profit split models will work in loss split situations may need to be revisited and allocation keys reconsidered.

Typical TP models that put a cost-plus floor on the reward to sales branches may need to be retested, either in terms of the 'plus' or their appropriateness in a COVID-19 environment where the bank is sustaining losses as a whole. The 'plus' will also be based on pre-COVID benchmarking searches.

Another area that may require analysis is the impact of a liquidity crunch on banks' fund TP models, and the potential impact for legal entities and branches within a banking group.


The insurance industry is by its very nature generally well prepared to deal with significant industry loss events, such as the COVID-19 pandemic. Several insurers learned lessons from the SARS outbreak of 2003 and introduced exclusion clauses for communicable diseases and epidemics/pandemics into most non-life products, such as business interruption (BI) and travel insurance. However, there is still uncertainty associated with the full extent of claims for life and health insurers and the timing of those claims, as the impact will vary country by country. The industry is closely monitoring the effect on mortality rates and life insurers are also expecting to be severely affected by the financial markets (e.g. life investment bonds).

As business interruption and contingency claims (e.g. event cancellations) continue to unfold for general insurers, which could potentially result in a reduced capacity (i.e. available capital) in the market. With a trend towards higher combined ratios and decreasing levels of return on equity because of COVID-19 losses, insurers will need to increase rates, which will result in higher premiums. This has led to some insurers raising additional capital in the market, in anticipation of a 'hardening market' in early 2021.

As a consequence, multinational insurance groups are assessing how potential COVID-19 claims may affect their solvency capital requirements from a regulatory perspective, and whether they need to amend the terms of their existing inter-company reinsurance programmes (e.g. tighten the exclusion wording to exclude further pandemics) or increase the level of cover as the 2021 renewal season approaches.

From a TP perspective, multinational insurance groups, which are looking to increase their intra-group reinsurance cession levels or put in place additional contracts to better manage volatility, should maintain adequate documentation to support the commerciality of the arrangements, in particular why the new contracts were introduced or changes to the terms have been made, to ensure that the arrangements are commercially rational.

In addition, insurance groups should analyse the impact that increased cession levels may have on the pricing of the ceding and profit commissions for proportional reinsurance and the premium costs in case of non-proportional reinsurance. In an environment where there is increased scrutiny and pressure on cost bases, profit-based contingent commissions may become more common for proportional reinsurance such that ceding companies are rewarded based on the overall profitability of the business reinsured.

Where the ceding company uses the net cost-plus method to test whether the ceding commission appropriately covers its production costs with an appropriate mark-up, consideration must be given to whether the net cost-plus method is still sustainable if the reinsurer is making losses and, therefore, may not be willing to pay additional commissions to cover the cedant's costs. In addition, from the reinsurer's standpoint, multinational insurance groups should consider revisiting their return on capital benchmarking to ensure that the comparables reflect market conditions and take into account the impact of losses.

Hub-and-spoke underwriting models may need to be scrutinised to stress test how the underwriting approval process has worked in the COVID-19 environment, and whether this affects the location of the KERT functions in an underwriting branch scenario. Likewise, the knock-on effects for the allocation of investment assets and capital to branches under the AOA will need to be carefully considered. Similarly, the way that KERT profit split models will work in underwriting and investment loss split situations may need to be revisited and allocation keys reconsidered.

Asset management

As the COVID-19 pandemic continues to create uncertainty, asset managers in the traditional and alternative sectors are under stress on several fronts. These challenges affect both regulated and unregulated funds at both the fund and investment levels.

The sector has witnessed the combined impact of massive outflows of assets, as investors focused on liquidity as well as lower asset valuations eroding the stream of management fees. In addition, lower asset valuations are likely to also reduce the level of performance fees available, if any, which have become an important source of income also for traditional funds.

Certain funds have been facing difficulties in meeting investor redemptions. As such, the initial response was focused on complying with regulatory requirements and avoiding a liquidity crunch for the funds, respectively for the management companies (ManCos) or alternative investment fund managers (AIFMs) managing these funds. Financial regulators were already focused on fund liquidity before the COVID-19 outbreak, and given these fresh risks, the management of liquidity has become even more important for the asset management sector.

For alternative funds, the COVID-19 pandemic will also likely affect the quality of investment assets (e.g. considering the broader impact of the COVID-19 pandemic on the commercial real estate sector with outstanding rents, debt relief, etc.) and trigger questions around the underlying financing arrangements that are inherently linked to the quality of the assets being financed.

The practical challenge is how to treat potential loss situations for regulated entities (especially ManCos and AIFMs) and group internal service providers where potential floors (minimum compensation clauses), support payments, or liquidity injections may be triggered/required to stabilise the profit, liquidity or capital positions. Other questions relate to potential fee waivers and to what extent these should be shared.

The focus is shifting to assessing the potential impact of the 'new normal' on existing TP models to remunerate the key functions across the value chain covering ManCos/AIFMs, fund administration, portfolio management, and capital raising/distribution. The key question for TP purposes is how existing TP models can appropriately deal with implied loss situations (e.g. where the shares determined under fee splits are insufficient to cover the costs of local distribution operations) or actual loss splits (e.g. where a profit split model turns into a loss split model). Here, the clear recommendation is to actively monitor the effective distribution of profits or losses by combining existing price setting with outcome testing approaches to corroborate actual results.

Evaluating the impact

There are several consistent market and knock-on TP themes across the financial services sector.

In practice, all financial services institutions (banking and capital markets, insurance and asset management) should monitor the effective distribution of profits or losses by combining existing price setting with outcome testing approaches (especially for fee split arrangements in the asset management sector, or profit split models in the banking sector) to monitor the effective distribution of profits/losses across the group's different entities/branches and jurisdictions.

Relevant benchmarking studies should be revisited to reflect the updated market/economic environment, e.g. to assess the impact of COVID-19 on the return on equity targeted by reinsurance vehicles, cost-plus routine services, and funds TP.

The potential corporate tax PE consequences of remote working may have been softened at present by tax authorities' COVID-specific relaxations. However, how long this will continue is up for debate. Likewise, tax audits were in many cases put on hold. Government finances across the globe have been significantly stretched by funding furlough schemes and the like. At some point, they are likely to look at ways of replenishing government funds. We have already witnessed audit activity recommencing.

TP documentation should also be produced or updated contemporaneously, potentially including additional qualitative or quantitative analyses to support loss situations, support payments, etc. It is expected that both tax authorities and financial regulators will increasingly focus on TP as an indicator of proper management, by examining the appropriateness of TP policies, intercompany agreements and TP documentation. The potential long-term impact of the COVID-19 pandemic on the TP dimension is still to be seen but TP models will need to accommodate the 'new normal'.

Click here to read the entire 2020 Deloitte/ITR Financial Services Guide

Ralf Heussner



Deloitte Luxembourg

T: +352 45145 3313

Ralf Heussner is a partner with Deloitte based in Luxembourg. He specialises in the financial services sector and is part of Deloitte's global financial services leadership team. He has worked for many of the key players in the asset management industry (ranging from the traditional sector to private equity, real estate, and hedge funds), banking, and insurance during his prior tenure in Tokyo, Hong Kong SAR and Frankfurt.

Over the past 18 years, Ralf gained extensive experience advising clients on a range of tax, TP, valuations, and controversy-related engagements. His experience covers TP planning and policy setting, risk reviews, operationalisation, documentation, restructurings, and dispute resolution engagements. He has worked on more than 35 APAs and numerous high-profile controversies on both the local and competent authority levels with authorities in China, the EU, Japan, the US, and other key jurisdictions.

Ralf is a frequent speaker at tax seminars, has participated in consultation projects with various governments about tax reform, and has contributed to thought leadership on TP issues in various publications.

Sebastian Ma’ilei



Deloitte UK

T: +44 20 7007 1596

Sebastian Ma'ilei is Deloitte's global head of insurance TP and has 15 years of experience in dealing with TP issues for direct insurance, captives of non-insurance groups, brokers and reinsurance clients (covering both property and casualty, and life and health). He has advised clients on key issues such as testing the arm's-length nature of premium on captive contracts, intellectual property (IP) planning for data/placement analytics, intra-group reinsurance/retrocession (covering proportional and non-proportional treaties, stop-loss, XL, fees and facultative covers) fronting, intra-group financing, guarantee fees and attribution of profits to permanent establishments.

Sebastian has extensive APA and mutual agreement procedure (MAP) experience and was involved in the first unilateral UK reinsurance APA and the first bilateral UK/German APA for a large multinational insurer in respect of its branch profit allocation to its European branch. More recently, he has been involved in a MAP covering brand royalties for a major insurance group. He has experience in dealing with tax authorities on inquiries on issues such as substance and functional capability and diverted profit tax (DPT) associated with captives of multinational groups.

Stephen Weston



Deloitte UK

T: +44 20 7007 4568

Stephen Weston is a partner in Deloitte UK's financial services tax group, and leads the financial services TP team. Over a career spanning 30 years, he has advised a number of multinational corporate and financial institutions on the taxation of international finance and treasury and TP matters. He also has tax audit, direct tax litigation and APA experience in these areas.

Stephen's financial services sector clients include global banks and insurance groups. He is the Deloitte global lead for banking TP. He also leads the firm's approach to significant people functions (SPFs) in the context of the UK controlled foreign company (CFC) state aid case.

Stephen is a qualified chartered accountant and a full member of the Association of Corporate Treasurers.

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