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On 16 December 2022, the European Banking Authority (EBA) published its closure report of COVID-19 measures.

The closure report provides an overview of the policy measures taken during the COVID-19 pandemic, their state of play and the path out of policy support.  The closure report is accompanied by an update to the list of public guarantee schemes and general payment moratoria schemes issued in response to the pandemic. The EBA Guidelines on COVID-19 reporting and disclosure have been repealed in response to the decreasing relevance of the related public support measures, and the overall EBA proportionate approach to reporting.

On 30 November 2022, the International Organisation of Securities Commissions published a report, ‘Investor behaviour and investor education in times of turmoil: Recommended framework for regulators based on lessons learned from the COVID- 19 pandemic’.  The final report highlights the research insights and experiences IOSCO members gained during the COVID-19 pandemic. It explores changes in investor behaviour during the pandemic and regulators’ responses worldwide. In particular, the final report provides information on the measures regulators and investor educators took to increase retail investor protection during periods of extreme market volatility and economic turmoil.

The final report shows that the COVID-19 pandemic introduced new challenges and exacerbated some existing issues. It highlights that the COVID-19 period featured:

  • high levels of market volatility;
  • an upward trend in self-directed investing;
  • an increase in gamification of investing and growing investor reliance on social media for advice; and
  • a huge surge in fraud scams in a context of increased retail (and young and democratically diverse) investor participation.

However, the final report also finds that the COVID-19 pandemic did not hinder investor education activities to support investor protection throughout the pandemic. In fact, many regulators continued, expanded and/or adapted their investor education activities to support investor protection throughout the pandemic. Furthermore, the final report finds that it is now easier to participate in the financial market than ever before and retail investors continue trading in riskier investments, while regulators report a higher volume of investor claims and complaints.

On 14 November 2022, the Financial Stability Board (FSB) published ‘Financial policies in the wake of COVID-19: supporting equitable recovery and addressing effects from scarring in the financial sector’.

The final report considers exit strategies through the lens of financial stability and the capacity of the financial system to finance strong and equitable growth. Incorporating feedback from the FSB’s external outreach, the report discusses how the evolution of the pandemic, the Russian invasion of Ukraine and subsequent economic developments have affected the challenges financial authorities face, and how these relate to the COVID-19 related measures taken.

The final report considers specific policy challenges in relation to:

  • Ensuring the effectiveness of domestic policies.
  • Containing cross-border spill overs and preventing scarring by addressing debt overhang issues.
  • The role of international standards.

The report stresses that consideration about adjusting, amending and potentially exiting support measures should take these challenges into account, to support global economic recovery in the near term and prevent financial stability impacts and scarring effects to sustainable growth over the long term.

To this end, authorities should consider:

  • How to ensure the effectiveness of domestic policies to make good use of, and re-gain as appropriate, policy space.
  • How to contain cross-border spill overs.
  • How to address debt overhang issues and other potential vulnerabilities in the non-financial sectors that may create scarring effects on the growth in the longer run.

On 13 July 2022, the Financial Stability Board (FSB) published an interim report on exit strategies to support equitable recovery and address effects from COVID-19 and Russia’s invasion of Ukraine on the financial sector and how the FSB will address these issues going forward. It considers exit strategies in relation to financial stability and the capacity of the financial system to finance strong and equitable growth.

Recovery from the economic impacts of the COVID-19 pandemic has been divergent across jurisdictions. Limited ability to provide additional policy support, in particular in the form of fiscal stimulus, has been a factor behind a relatively weaker recovery in many Emerging Market and Developing Economies than in Advanced Economies. Russia’s invasion of Ukraine has also added to these pre-existing challenges by causing a setback to growth, triggering higher inflation and adding to economic uncertainty.

On 11 July 2022, the International Organization of Securities Commissions (IOSCO) published a final report on the operational resilience of trading venues and market intermediaries during the COVID-19 pandemic & lessons for future disruptions.

In the report IOSCO summarizes some of the existing operational resilience work by IOSCO and other international organizations and outlines how the pandemic impacted regulated entities. IOSCO also examines key operational risks and challenges that regulated entities faced during the pandemic and provides additional observations and lessons learned from the pandemic.

In summary, IOSCO sets out the following lessons learned on operational resilience during the pandemic:

  • Operational resilience means more than just technological solutions – the operational resilience of a regulated entity depends as much on the regulated entity’s processes, premises and personnel as its technology when faced with a significant disruption.
  • Consider dependencies and interconnectivity – full business processes and all dependencies and interconnections are important to consider before and after a disruption to adequately assess potential risks and changes to controls. Critical to this is consideration of the role of service providers and off-shore services, whether intra-group or third parties.
  • Review, update and test business continuity plans (BCP) – BCP (including scenario planning) are important to review and consider whether updates are appropriate to reflect lessons learned from the pandemic. For example, pre-pandemic operations may not be restored for a prolonged period, a disruption may impact all or multiple locations at the same time and a broad range of scenarios (even those that are unlikely) may be appropriate to be tested. The pandemic highlighted the importance of communication channels between regulators, key authorities, regulated entities, and third-party service providers to help understand any impacts on operational resilience.
  • Effective governance frameworks – the pandemic highlighted the importance of an entity’s effective governance framework to facilitate and support operational resilience due to potentially novel and fast-paced situations or changes that might arise. Decisions made under pressure may need to be revisited and tested if they impact the business beyond the period of disruption.
  • Compliance and supervisory processes – greater automation and less dependence on physical documents and manual processes by regulated entities may better accommodate a remote workforce. A review of monitoring and supervision arrangements by regulated entities for remote workforces may be appropriate to help ensure continued effectiveness in a remote or hybrid environment.
  • Information security risk – decentralized and remote work may increase the importance of monitoring processes to help ensure information security, and in particular, to prevent cyber-attacks.

On 21 June 2022, the European Banking Authority (EBA) published four draft principles to support supervisory efforts in assessing the representativeness of COVID-19–impacted data for banks, using internal ratings based (IRB) models. These principles will be part of a supervisory handbook, which the EBA will publish later this year, with the objective to ensure a harmonised approach in the use of COVID-19 data, especially where the use of moratoria and other public measures may have led to changes in default rates.

The draft principles are based, in part, on the EBA guidelines on probability of default (PD) and loss given default (LGD), are as follows:

  • Principle 1: Clarifies that the guidance on the assessment of data representativeness laid down in the EBA guidelines on PD and LGD should be applied also in the case of COVID-19-impacted data.
  • Principle 2: Clarifies that a significant decrease in applied IRB risk parameters compared to the pre-crisis levels indicates a potential lack of representativeness and should be analysed in more depth.
  • Principle 3: Deals with the default and loss rates observed during the COVID-19  pandemic and clarified that in case of non-representativeness of such rates, a recalibration should be postponed to lower long run averages.
  • Principle 4: Tackles the validation and recalibration of downturn LGD in the context of the COBID-19 pandemic. The EBA recommends that potential recalibrations be postponed at least until the effects of the crisis have fully materialised in the observed loss rates.

 

The sequel to the business interruption second test case is now here. On Monday, the Full Federal Court handed down its decision in the second business interruption test case appeal.  The decision is an appeal from the judgment of Justice Jagot in relation to various business interruption insurance claims. The Full Federal Court also handed down its decision in the appeal of the Star case, Star Entertainment Group Ltd v Chubb Insurance Australia Ltd [2021] FCA 907, at the same time.

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The appeal case largely upholds the decision of Justice Jagot that the primary cause of any loss was government action in response to the wider Covid-19 crisis rather than the outbreak of Covid-19 at any particular premises or within a particular geographical area. The appeal was allowed in part, mainly in relation to adjustment for government payments and the payment of interest under s57 of the Insurance Contracts Act 1984 (Cth).

A special leave application has now been made to the High Court.

What was the appeal all about?

In the appeal, LCA Marrickville Pty Ltd v Swiss Re International SE [2022] FCAFC 17, the Full Federal Court considered the construction of various business interruption insurance policies and whether they responded to losses sustained by a number of small businesses.  The initial case dealt with ten small businesses and was conducted with the co‑operation of insurers and the Australian Financial Complaints Authority.  The appeal considers a subset of these cases delving into detail in relation to five of the ten initial cases.

The appeals were allowed in part, however insurers were largely successful in terms of the overall outcome.  Similarly to the decision at first instance, the UK Supreme Court decision in FCA v Arch Insurance (UK) Ltd and others [2021] UKSC 1 was noted and influential; however the Full Court commented that caution should be adopted when reviewing it because of the significantly different experiences of COVID‑19 in the UK compared to Australia.

The main protagonists

The appeal considered 4 types of clauses being:

  • infectious disease clauses, which cover loss from either infectious diseases or the outbreak of an infectious disease at the insured premises or within a specified radius;
  • prevention of access clauses, which cover loss from a competent authority’s order or action that prevents or restricts access to an insured premises because of damage or threat of damage to property. A radius may or may not apply;
  • hybrid clauses, these are a hybrid of categories 1 and 2 and provide cover for loss from a competent authority’s orders or actions which close or restrict access to premises as a result of the presence or outbreak of an infectious disease within a specified radius; and
  • catastrophe clauses, which provide cover for loss resulting from the action of a civil authority during a catastrophe for the purpose of slowing the catastrophe.

The appeal considered more closely the prevention of access, hybrid and catastrophe clauses. At first instance, the infectious disease clause was the only clause found to potentially respond (to Meridian Travel’s claim) and this was upheld on appeal. In relation to the hybrid and prevention of access clauses, the Full Federal Court found the insuring clauses were not enlivened because the government orders did not meet the requirements of the policy. The Full Federal Court also agreed that COVID-19 was not a ‘catastrophe’ within the meaning of the policies.

The appeal provides further guidance on how prevention of access and hybrid clauses should be interpreted.

The prevention of access clause was dealt with in depth in the Education World Travel claim within the appeal.  Education World Travel had attempted to argue that the prevention of access clause was enlivened because of Victorian workplace closure directions.  These directions had required employers to close certain businesses from 6 August to 9 November 2020.  While the Full Court agreed that the Victorian workplace closure orders had the potential to meet the requirements of the prevention of access clause, Education World Travel did not demonstrate that the closure of its premises was because of those directions.  This was because Education World Travel had already closed its businesses at the end of March 2020 due to the overseas travel ban.  The Full Court held that it would be necessary for Education World Travel to show that the closure of its premises was because of the Victorian workplace directions and not because of the overseas travel ban.  Education World Travel had not discharged this burden of proof.

An example of a hybrid clause was the Meridian Travel claim within the appeal.  Meridian, a travel agency, had sought to argue that the hybrid clause responded because of a closure of the business by order of the relevant authority.  Meridian argued that the overseas travel ban closed its business because international travel accounted for approximately 90% of its business. However, the Full Federal Court agreed with the primary judge that cover under the hybrid clause was not available.  This was because the directions did not operate to require the closure of Meridian’s business, rather the restrictions led to the practical consequence that Australians could not make use of Meridian’s business to book international travel.  Furthermore, the Commonwealth Government actions were not consequent upon “the discovery of an organism likely to result in a human infectious or contagious disease of the situation”, as required by the insuring clause.

The impact of trends clauses and government payments

Trends clauses

The appeal also dealt with whether certain adjustments to be made to the business interruption loss calculations due to certain events having the same character or “underlying fortuity” as the insured peril.  The concept of “underlying fortuity” was utilised in the FCA v Arch case. The Court seemed to agree with FCA v Arch and the primary judgment in adopting this test, and not utilising the ‘but for’ approach in the case of Orient-Express Hotels Ltd v Assicurazioni Generali SA [2010] Lloyd’s Rep IR 531, which the UK Supreme Court held was wrongly decided.

In the appeal, Meridian Travel sought to argue the primary judge erred in concluding that the overseas travel ban and the cruise ship ban did not involve the same “underlying fortuity” as the insured peril, being the outbreak of COVID‑19 within 20 km of Meridian’s premises.  This was significant because, if the overseas travel ban and cruise ship ban involved the same “underlying fortuity”, they would not be taken into account in the adjustment of the business interruption losses.  Accordingly, losses resulting from those bans could potentially be paid.

However because the primary judge found that the overseas travel ban and the cruise ship ban did not involve the same “underlying fortuity” as the insured peril, the bans had to be taken into account. The Full Court ultimately agreed with the primary judge.  The reasoning was that Commonwealth Government actions in implementing the overseas travel ban and cruise ship ban were motivated by a desire to control the importation of COVID‑19 to the country.  This was in contrast to the insured peril which was an outbreak of COVID‑19 in the relevant area within Australia.

In other words, the Full Federal Court contrasted the Commonwealth Government actions which prevented Australians from leaving Australia and cruise ships from arriving into the country on one hand, with public health orders which prevented citizens from interacting with each other within the country on the other hand. The motivation for the first was the presence of disease overseas and the potential for importing cases, while for the latter the motivation was to minimise domestic transmission.

Government payments

The Full Court arrived at a different answer in relation to government payments.  At first instance, Justice Jagot had held that certain Australian Government payments had to be taken into account when calculating the amount of business interruption loss. In particular, JobKeeper payments were to be taken into account and reduce the amount ultimately payable by the insurers.  However the Full Court took a different view.  It held that JobKeeper payments were not a payment “in consequence of the interruption of interference” and Job Keeper was paid based on a financial test, not whether there was an outbreak nearby.  On this basis, JobKeeper payments were not to be taken into account when calculating the amount of business interruption loss sustained by the insureds.  The Full Court did not alter the position of the primary judge in relation to other payments such as the Federal COVID‑19 Consumer Travel Support Program payments or the Victorian Government’s Support Fund payments.

Interest payments

Although only relevant to LCA Marrickville’s claim within the appeal, the Full Court also departed from the primary judgment in ruling that interest was potentially payable under s 57 of the Insurance Contracts Act 1984 (Cth).  At first instance, Justice Jagot had held it was not unreasonable to withhold payment of the claim until the outcome of the test case and any subsequent appeal. The Full Court held that interest is payable from an earlier point in time, although the period for which interest is payable in this particular case is subject to further submissions from the parties.

What next?

An application for special leave to appeal the decision has been filed in the High Court. If special leave is granted, the matter will proceed to a hearing in the High Court with no further avenues of appeal. In the meantime, by upholding the decision of the primary judge in relation to most of the issues, we now have substantive guidance on how these policies might respond, and this is of use to both policyholders and insurers, subject to any appeal.  The Full Court also suggests that interest may be payable for claims and this could be costly for insurers, although statistics show that fewer than expected claims have been lodged to date. It is also worth noting the decisions were largely dependent on the specific facts faced by each of the insured customers, the timing of certain restrictions and the spread of COVID‑19 within a certain area.  Each case must still be assessed on its merits.

On 21 March 2022, the Financial Stability Board (FSB) published a report regarding FinTech and Market Structure in the COVID-19 pandemic – Implications for financial stability.

The main outcome of the report was that the COVID-19 pandemic has accelerated the trend toward digitalisation of retail financial services. While comprehensive data on the market shares of FinTechs, BigTechs and incumbent financial institutions in retail digital financial services are scarce, proxies suggest that BigTechs and larger FinTechs have further expanded their footprint in financial services.

This expansion can bring benefits such as improved cost efficiencies and wider financial inclusion for previously underserved groups. However, the report cautions over the potential for market dominance. In some markets, concentration measures are high, but there is no evidence of a generalised increase.

There could be negative financial stability implications from dependence on a limited number of BigTech and FinTech providers in some markets. There could also be consumer protection risks from greater dependency on technology and data protection issues.

The report outlines the types of actions taken by authorities during the COVID-19 pandemic that may impact market structure and the role of different firms in providing digital financial services and stresses the importance of cooperation between financial authorities and, where relevant, with competition and data protection authorities.

On 17 January 2022, the European Banking Authority (EBA) issued a press release confirming that the guidelines on the reporting and disclosure of exposures subject to measures applied in response to the COVID-19 crisis adopted on 2 June 2020 continue to apply. Unless instructed otherwise by their relevant Member State competent authorities, credit institutions are expected to continue to report and disclose COVID-19 related data beyond December 2021. The EBA will continue to monitor developments and will consider repealing the guidelines in the future when the COVID-19 situation permits and credit outlook of loans under public support measures improves.

The guidelines on the reporting and disclosure of exposures subject to measures applied in response to the COVID‐19 crisis started applying on 2 June 2020. They established quarterly reporting frequency and semi-annual disclosure of exposures under payment moratoria as well as on exposures under COVD-19-related public guarantee schemes. They were developed as an exceptional measure of a temporary nature, with the EBA expected to communicate in December 2021 on the future application of those COVID-19 reporting and disclosure requirements.