In this chapter of our Annual Insurance Review 2021, we look at the main developments in 2020 and expected issues in 2021 for financial institutions.
Key developments in 2020
The key development in 2020 is again centred upon regulation of the financial services sector. As envisaged in its 19/20 Business Plan, the FCA's focus this year has been upon financial crime controls, in particular anti-money laundering (AML) measures. This has included further consideration of the FCA's oversight of crypto-currencies (the subject of our 2019 key development) given their exposure to money laundering.
In recent years, AML breaches have replaced market misconduct as the driver of the largest fines from regulators. According to a report by consultancy firm Duff & Phelps, global fines for AML breaches in the first half of 2020 are estimated at $706m, which already exceeds the full prior year total of $444m. As at 31 March 2020, 11% of the FCA's open cases related to financial crime, whilst this summer has also seen: (i) the EU adopt its AML Action Plan; (ii) the Financial Action Task Force identify trends increasing the risk of money laundering and terrorist financing due to COVID-19; and (iii) the Government announce a £100m levy on financial institutions to deal with financial crime.
At the time of writing, the FCA is considering proposals to extend its annual financial crime reporting obligation to additional firms irrespective of their total annual revenue. Such additional firms include crypto-asset exchange companies, with the direction of travel (fuelled by AML efforts) suggesting further regulatory requirements being imposed on this sector in the future.
In the words of the Vice President of the EU Commission, Valdis Dombrovskis (as he addressed the European Parliament on 8 July 2020): "Dirty money should have nowhere to hide". The regulation/punishment of financial crime is a unifying cause for international regulators and policymakers such that firms/individuals will be wise to keep on top of their AML obligations to avoid costly sanctions.
What to look out for in 2021
The impact of the COVID-19 pandemic is likely to crystallise for FI Insurers in 2021 in the wake of the delayed discovery of fraudulent/wrongful conduct and the turbulence of global financial markets in 2020.
In particular, we foresee a spike in: (i) instances of employee infidelity, social engineering and accounting fraud (financial engineering of company accounts) due to the impact of remote working on internal controls; (ii) the detection of insider trading and Ponzi schemes (historically more prevalent in the 6-18 month period after a market crash); (iii) claims against investment managers for mandate breaches/negligent investment advice driven by volatile stock performance; and (iv) shareholder claims/securities class actions (especially in the US) following drops in share prices (on the basis of inadequate disclosures concerning the impact of coronavirus). In the regulated sector also, scrutiny is high (for example, the FCA/PRA has issued various Dear CEO letters/guidance notes in relation to COVID-19 related conduct/initiatives) and regulatory/compliance breaches will likely be seized upon by regulators, which continue to introduce stricter requirements while giving little credit to over-stretched in-house compliance and regulatory teams.
Certain industry experts have even predicted a further global banking crisis due to USD 1tn of AAA-rated CLOs containing lower-rated individual leveraged loans to B down to CCC-rated companies. COVID-19, as a global pandemic, is uniquely placed to undermine the risk diversification measures built into such products, leading to significant potential loan defaults and claims/regulatory investigations involving banks and other financial institutions (e.g. in respect of capital inadequacy and/or reckless lending).
Should these COVID-19 triggered events transpire, they will translate to increased crime, PI and D&O exposures, which in turn would likely contribute to the current hard(ening) market. In this respect, the D&O segment is currently recognised as "the hardest of all hard markets" compounded by COVID-19 uncertainty and, as that trend continues, we would expect greater volumes of coverage disputes in the year ahead and measures to limit D&O costs including the use of law firm panels.
Authored by Oliver Knox.
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