Financial institutions

In this chapter of our Annual Insurance Review 2023, we look at the main developments in 2022 and expected issues in 2023 for financial institutions.

Key developments in 2022

As we predicted last year, Environmental, Social and Governance (ESG) matters continued to set the agenda for financial institutions and their insurers in 2022.

"Greenwashing" remains a focus of global regulators. One hindrance to effective regulation has been the lack of a universal definition of ESG, which has led to rating agencies and other market participants using their own (often inconsistent) methodologies. In a June 2022 feedback statement, the FCA noted that the Treasury was considering bringing ESG data and rating providers within the regulatory perimeter, subject to which the FCA will develop a regulatory regime for such providers with a focus on transparency and good governance. The FCA has made clear that it will scrutinise, and challenge regulated firms on their fund strategies and disclosures pertaining to ESG, and we expect that increasing standardisation will bolster regulators' efforts in this respect.

Other jurisdictions also continued to develop their regulatory frameworks for ESG matters. In May 2022, the United States Securities and Exchange Commission (SEC) proposed rules which, if adopted, will require firms to make enhanced ESG disclosures in fund prospectuses and similar documents.

The focus on ESG-related misconduct is already driving claims activity, with the United States leading the way. In April 2022, the SEC brought enforcement action against a mining company alleging misleading statements in ESG disclosures, and in May 2022, the SEC brought a further action against an investment adviser for failing to act consistently with ESG disclosures when making investment choices for mutual funds. 

Faced with the maturing regulatory environment, allied with the potential for civil claims by aggrieved investors, financial institutions will wish to ensure that their words and actions continue to be aligned on matters pertaining to ESG.   

What to look out for in 2023

Whilst punctuated by the COVID-19 pandemic, recent years have seen relatively benign economic conditions, characterised by rising markets and ultra-low interest rates. That cycle has now emphatically ended. With the war in Ukraine and increasing economic headwinds vexing global policymakers, volatility promises to be the "new normal" for financial institutions in 2023.

Sanctions have been a mainstay of policymakers' response to the Russian invasion of Ukraine, and with the conflict becoming increasingly attritional, we expect that to continue in 2023. Banks and other financial institutions will continue to be on the sanctions frontline. The core risks include: (i) ensuring compliance with complex and rapidly evolving packages of sanctions (especially in cross-border transactions, where the laws of involved jurisdictions may conflict); and (ii) the possibility of claims (e.g. for breach of contract) where the bank has been required to cease dealings due to sanctions risk.

Speaking more broadly, economic downturns often drive claims activity, and that pattern may repeat itself if the world's leading economies tip into recession in 2023. Whilst many financial institutions may welcome the return of higher interest rates, they also carry risks. The abrupt increase in rates can be expected to dampen inflation, but the effect will not be instant, and the two factors combined will in the meantime place borrowers under pressure and may cause a deterioration in credit quality.

A consequence of the 2007-08 financial crisis is that banks are well capitalised and better equipped to withstand systemic risk. Newer market participants, including fintechs and challenger banks, may however face unique challenges in adverse market conditions.

Written by Matthew Wood.

Download our full Annual Insurance Review 2023 for more insights.