Following 18 months dominated by the Covid-19 pandemic, banks like other businesses might have hoped for some respite. Instead, as we come out of the pandemic banks continue to face a wide and growing range of risks which may well result in the busiest period for banking litigation since the financial crisis. This will likely be combined with increased regulatory activity: the FCA has made clear that it intends to adopt a more assertive approach to enforcement, as well as prioritising customer welfare by introducing a Consumer Duty for financial institutions. We summarise below some of the major trends and risks in this space.
Libor: an orderly wind-down
Since 2017, the FCA has been encouraging firms to transition from Libor to alternative risk-free rates. The discontinuation of the Libor benchmark at the end of 2021 has long been on the regulatory agenda. Yet, the FCA remains concerned that the UK market is underprepared for the transition.
Readiness concerns are not limited to the UK. The Federal Reserve warned US lenders they would have to ‘pick up the pace’ to be ready for the discontinuation of two US Libor settings at the end of 2021. Incredibly, issuances of certain US bank loans in September 2021 continued to reference Libor rates.
Despite the imminent deadline, the FCA continues to consult the market and intends to legislate for the possibility of an unruly transition. In a notable volte-face, the FCA has now acknowledged that it is not practicable to convert all legacy sterling and Japanese yen Libor contracts by the end of 2021. To ensure an ‘orderly wind-down’, the FCA will continue to compel the ICE Benchmark Administration to publish ‘synthetic’ rates for three sterling and three Japanese yen settings for 12 months from 1 January 2022.
The UK government is currently considering legislation that would treat references to Libor in ‘tough legacy’ contracts as referring to the synthetic rate. The proposed legislation is intended to ensure contractual certainty and continuity, deter claims for frustration of contract, and minimise litigation arising out of legacy contracts, which are likely to be the biggest source of Libor claims. However, the provisions fall short of the broader ‘safe harbour’ provisions enacted in US legislation.
Precisely which contracts will fall within scope is also under consultation, with a decision expected early next year. The government has indicated that the scope will be limited to contracts that ‘genuinely have no or inappropriate alternatives and no realistic ability to be renegotiated or amended’. While this may reduce some risks from the transition, a high likelihood of disputes remains.
Increased focus on ESG
One of the most important trends in the financial sector is the acute focus on companies’ environmental, social, and governance (ESG) compliance. ESG issues have long since shifted from an ethical consideration to an economic one. Social awareness of issues such as climate change, inequality, sustainability, and general corporate conduct are becoming increasingly sensitive issues for corporates and stakeholders alike, and banks will need to keep pace.
In June 2021, the European Banking Authority identified five financial risk categories engaged by ESG issues: credit, market, operational, liquidity and funding, and reputational. Each of these could be engaged by a multitude of risk drivers. For example, a counterparty to a financial arrangement could be affected by the physical effects of climate change (eg an extreme weather event), which could hinder the financial performance of that party or their invested assets, and in turn jeopardise a bank’s liquidity or credit. Alternatively, a counterparty could be involved in the production or consumption of fossil fuels, which may ultimately impact the value of a bank’s other investment activities and/or cause reputational damage with customers and investors who are increasingly demanding a greater focus on sustainability. The FCA has also focused on ‘greenwashing’ risks, and how ESG funds are presented to investors.
The diverse nature of ESG risks presents litigation and enforcement risk, where organisations are increasingly likely to be held accountable for ESG issues at a group level. In the past two years, the courts have held that parent companies may be liable for failings at subsidiary level where the parent has presented its group as complying with certain standards. In Vedanta Resources v Lungowe , a group of claimants sued an English parent company for alleged environmental damage caused by an overseas subsidiary, on the basis of corporate disclosures made by the parent company about its environmental compliance within the group. Similarly, in Okpabi v Shell , the claimants alleged that the parent company owed a duty of care to individuals harmed by oil spills allegedly caused by the negligence of its foreign subsidiary, on the grounds that the parent was entrenched in the management of the subsidiary’s business and operations. Both cases found traction with the Supreme Court, which held that each set of claimants had an arguable case, albeit at a procedural stage of proceedings.
Banks will need to devote increasing attention to monitoring ESG risks in their risk management framework, both in relation to their own businesses and the businesses of their clients and counterparties.
Held to ransom
In June 2021, the head of the National Cyber Security Centre (NCSC) described the threat of ransomware attacks as ‘the most insidious cyber security risk’ to businesses in the UK. This year alone, there have been a substantial number of high-profile victims of ransomware attacks.
Covid-19 has compounded the issue, with businesses relying on digitisation of services, and the move to a remote working model has tested IT infrastructure and exposed new vulnerabilities. Banks have been disproportionately targeted, due to the nature of their operations and the value of their assets. In the first half of 2021, the banking industry experienced an increase of 1,318% in ransomware attacks, compared to the same period in 2020 (Trend Micro, 2021).
Ransomware is prevalent because it is profitable; payment is becoming more common, as companies seek to minimise business interruption and avoid the potential ramifications occasioned by data breaches. Alongside the potential reputational harm, affected companies could be exposed to regulatory investigations, fines, and private claims brought by data subjects.
Official advice by the NCSC continues to be that companies should not pay ransoms. Irrespective of potential reputational harm, payment could constitute a criminal offence. As attacks become more prevalent, more voluminous, and more sophisticated, banks should, at the very least, ensure that they are maintaining up-to-date, robust cyber-security systems, detailed crisis management plans, and evaluate whether the risks warrant investing in a cyber-insurance policy.
The growth of group litigation
The recent growth of group litigation can be attributed in part to the simplified regime for collective actions introduced under the Consumer Rights Act 2015, as there has been a greater willingness by the courts to allow group actions to proceed using previously little-used procedures. Litigation funding has also had a considerable impact in this area, since group claims against large institutions have a number of features that can be attractive to funders.
Indeed, the Competition Appeal Tribunal (CAT) recently described the collective proceedings regime as ‘dependent’1 on third party funding and the High Court commented that it was ‘obviously intended to facilitate a means of redress which could attract and be facilitated by litigation funding’.2
The CAT regime deals exclusively with claims arising out of antitrust infringements, and financial institutions already represent a significant proportion of defendants across these claims. Two claims are proceeding in relation to alleged forex failings between 2008 and 2014, against eight leading financial institutions3. A separate claim against Mastercard has just passed the certification stage, in relation to multilateral interchange fees paid on transactions.4
There has also been a recent influx of High Court claims arising out of personal data breaches, using one of two legal avenues under the Civil Procedure Rules:
- Representative actions. Since 2020, claims have been commenced against Facebook and Marriott, among others. However, all claims have been stayed pending Supreme Court judgment in Lloyd v Google (see below).
- Group litigation orders (GLOs). This year, GLO claims were commenced against Virgin Media and EasyJet. In July 2021, British Airways reached a settlement with claimants in respect of a mass data breach in 2018.
The primary difference between the two is that claimants must opt in to GLO claims, whereas representative actions are opt out, although the proposed class must have the ‘same interest’ in the claim. The ‘same interest’ test has, for many years, acted as a highly-restrictive gatekeeper for representative actions.
However, the Supreme Court is reconsidering the scope of the test in Lloyd v Google, to determine whether: (i) four million affected users can share the same interest; and (ii) damages are recoverable for loss of control of data, even where there is no pecuniary loss. Judgment is expected to be handed down by the end of 2021 and will have wide-reaching implications, including for financial services firms which will inevitably hold and process customer data.
In December 2020, the Supreme Court confirmed in the Mastercard case that a lower threshold ought to be applied when certifying claims to proceed as collective actions in the CAT. A successful Supreme Court outcome for the claimants in Lloyd v Google, would likely signal a significant pro-consumer shift in group action litigation. In turn, this would almost inevitably trigger group action claims targeting financial institutions.
Increasing reach of litigation funding
The market for litigation financing has matured significantly in recent years. The use of third party funding in litigation grew by 105% between 2017 and 2020, and has reached a value of approximately £2bn (Burford Legal Finance Report, 2020) . As litigation funding emerges as a distinct asset class, it is likely that availability of, and reliance upon, third party funding will only become more prevalent in the coming years.
Financial services firms are frequently targeted by funded litigation for a number of reasons. There is often a mismatch in terms of resources between claimants and defendants in financial services cases, which can encourage claimants to seek funding so that they can ‘stay the course’. Financial services firms are also seen by funders as a ‘safe’ defendant, because they do not usually carry any significant enforcement risk. Other factors include a perception that financial institutions may be vulnerable to claims based on legacy industry issues, and that financial institutions may carry greater reputational sensitivity than some other organisations.
Banks and other financial services providers are therefore particularly likely to find themselves facing funded litigation as the litigation funding market continues to develop.
As the impact of the Covid-19 crisis continues to unfold, and companies begin to emerge from lockdown, a swathe of pandemic-related claims is likely. This sentiment appears to be echoed across the market; in April 2021, EY reported that 34% of corporate legal professionals working in-house considered that they were already beginning to see an increase in legal claims resulting from Covid-19.
Some of the mostly likely claims in which firms may be involved include the following.
Breach of contract
Where contractual performance has been prevented for reasons relating to Covid-19, parties may seek to rely on: (i) force majeure clauses (or the doctrine of frustration, where no such clause exists); or (ii) material adverse change clauses. There is considerable scope for development here, since only one relevant case has so far addressed these issues in the context of the pandemic, and it was highly fact-specific.
According to UK Finance, incidences of fraud rose 30% in the first half of 2021, which could give rise to customer claims and possible regulatory investigations. Financial institutions may also have been the victims of fraud in relation to credit extended during the pandemic.
Temporary measures introduced by the Corporate Insolvency and Governance Act 2020 had the intended effect of alleviating pressure on distressed companies during the pandemic. When certain measures expired in June, insolvencies began to return to pre-pandemic levels; The Insolvency Service confirmed that, in August 2021, company insolvencies were 71% higher than in August 2020. While Creditors’ Voluntary Liquidations (CVLs) increased significantly in recent months, compulsory liquidations remain low. Temporary restrictions on statutory demands and winding-up petitions only came to an end on 1 October 2021, so a rise in compulsory liquidations is to be expected over the coming months as well as contentious restructurings.
In January 2021, the Supreme Court handed down judgment in the FCA’s business interruption test case, resolving a number of contested issues between insurers and policyholders5. The key areas of dispute were the scope of ‘disease clauses’ and ‘prevention of access clauses’, which the Court held covered Covid-19. However, the courts have since confirmed that more restrictive disease clauses may not be triggered. In particular, the High Court rejected arguments in Rockliffe Hall v Travelers Insurance Company  that Covid-19 fell within the definition of ‘Plague’. As of 5 September 2021, insurers have paid out £1.02bn in interim and final payments in respect of business interruption claims, but tens of thousands of claims remain to be determined.
These are of course not the only litigation risks facing financial services firms, but they represent some of the major trends we are seeing and expect to see in the coming months. As ever, firms will need to carefully understand the emerging disputes landscape and be prepared for a diverse range of claims spanning different areas of their businesses.
- UK Trucks Claim Ltd v Stellantis NV (formerly Fiat Chrysler Automobiles NV) & ors; Road Haulage Association Ltd v Man SE & ors .
- Walter Hugh Merricks CBE v Mastercard Incorporated & ors .
- Michael O’Higgins FX Class Representative Ltd v Barclays Bank plc & ors; Mr Phillip Evans v Barclays Bank plc & ors.
- Walter Hugh Merricks CBE v Mastercard Incorporated & ors .
- The Financial Conduct Authority v Arch & ors .