This article is an extract from GTDT Financial Services Litigation 2023. Click here for the full guide.
Financial services litigation trends in 2023
The combination of the war in Ukraine and high inflation did not help to restore the global financial markets in a post-covid-19 economic world. With its high interest rates and increased debts, 2022 contributed to the volatility of the markets, making them more sensitive to the various changes and thus harder to predict. The beginning of 2023 was marked by a major event for financial institutions; after a constantly increasing loss of confidence in 2022, in the first quarter of 2023 Credit Suisse finally merged with UBS, Switzerland’s only remaining big bank. In this context, Switzerland was the first country to deal with the practical application of the ‘too big to fail’ international legislation, testing it for the first time. While the impact of this merger on financial services litigation is yet to be defined, we provide below a brief overview of other, ever-developing, areas of financial services litigation and identify a global attempt to fight economic instability with ever-increasing surveillance and regulation – for better or for worse.
Increased litigation due to economic volatility
One of the biggest risks for financial services providers in 2023 pertains to the volatility of markets. The uncertainty of the markets increases the likelihood of civil, criminal and supervisory litigations for financial services providers. An environment characterised by high inflation, falling growth and restrictive monetary policy usually leads to an increase in defaults, both that of individuals and corporations, and thus of recovery civil actions, notably in the field of asset management where the environment will likely lead to an increase in client dissatisfaction. Indeed, financial service providers, while encountering difficulties in assessing the value of assets in a volatile market, might be increasingly held liable for their customers’ investment losses. In this context, the recently adopted national legislations, such as the Federal Act on Financial Institutions in Switzerland, define more clearly liability for the quality and the quantity of information a financial service provider must disclose to its customers, creating additional grounds for financial service-related civil litigation. Moreover, unstable markets cause the augmentation of fraud and misconduct of financial services providers, which in turn augments criminal and supervisory authorities’ enforcement activities, and thus potential litigation in these fields. Finally, the war in Ukraine continuously influences the sanctions domain and its pending criminal and supervisory litigation.
Operational resilience: a way to prevent data-related litigation
With a global rise of operational risks arising, for example, from the misuse of data or the outsourcing of internal resources by financial institutions, litigation surrounding these issues is likely to increase in the next few years. Indeed, financial service providers adapt to the need for digitalisation by developing new client-service models and turning to an increasing number of digital solutions. Automation, on the one hand, helps to streamline and speed up the onboarding of customers and their overall experience, while on the other hand assists financial service providers in the assessment of performance and risks. In addition, the increasing number of cross-partnerships between financial service providers and large tech companies also favours the use of automation. This progress, however, does not come without a price – these processes result in enormous data flows, which make safety protocols and sensitive data storage measures crucial for financial service providers. Emerging regulations on these topics around the world, such as currently in the US or in Switzerland, enhance financial losses due to compliance and litigation.
Environmental, social and governance-linked litigation on a predicted and predictable rise
Even despite the global rise of energy prices, the majority of financial service providers now consider that having strong environmental, social and governance (ESG) competencies is a competitive advantage on the market. However, successful ESG investments and strategies must be disclosed mindfully by financial service providers, especially in light of global regulations imposing more transparency and disclosure obligations. An increase in the information made available to the public may lead to increased litigation – from both shareholders and stakeholders. While shareholders could argue that their investment was based on false information on ESG aspects, stakeholders, such as non-governmental organisations, will generally be more prone to litigate against financial service providers after scrutinising their ESG compliance through the information made available to them. In this context, actions condemning greenwashing or claims for director’s duties will likely see an increase, potentially also in the financial sector. Moreover, if until recently stakeholders’ claims have focused on the disclosure of environment-related information, the trend is now moving to more specific and proactive claims for prudent financial management with regard to ESG norms.
Decentralised finance and cryptocurrencies in an ever-increasing need for regulation
Since their appearance in 2020, decentralised finance applications now occupy an established place in the financial services area, while fundamentally impacting the area’s traditional structures. Therefore, global regulators are searching for ways to remedy, for example, the lack of transparency of both decentralised finance applications and the crypto market. Currently, on the one hand, the anonymity of these markets enhances the risk of breach of anti-money laundering provisions. On the other hand, the civil and supervisory regulation currently in force, which relies on an identifiable financial service provider, also proves inapplicable because liability cannot be assigned. This exposes the users to great risks in navigating a system without proper consumer protection – and thus being exposed to the loss of assets, errors in the use of the application and hacking, when their possibilities to litigate are, for now, limited. Contrary to individuals, financial service providers that are active on decentralised finance or on cryptocurrency market applications directly engage their civil and criminal liability.
Last year saw the highly publicised collapse of FTX, which made global regulators aware, once again, of the necessity to better regulate the cryptocurrency market. Until now, the crypto market seems to have been able to circumvent most tax compliance, anti-money laundering and consumer protection regulations. This trend is however coming to an end, as shown, for example, in the shutting down of the Dohrnii Foundation in Switzerland. Therefore, with increasing regulation in the fields of decentralised finance and cryptocurrency, we will also see an increase in proceedings against financial service providers active in these fields. Moreover, users of crashing cryptocurrency platforms, such as FTX, will be eager to start proceedings in an attempt to recover their lost investments.
Conclusion: should an increase in regulation always mean an increase in litigation?
Surveys worldwide show that financial service providers anticipate an increase in regulation, which is also the easily identifiable common point in all the fields outlined above. Increased regulation of financial institutions imposes new obligations, be it in the handling of data or in the implementation of ESG norms, all the while enhancing transparency and the disclosure of activities. In this context, in order to prevent, or at least mitigate, the related litigation increase and the rise in claims by different stakeholders, financial service providers should focus on compliance and develop organisational processes to meet the various new compliance requirements – whether through different audit systems or through data analysis systems.
Finally, this brief overview of recent litigation trends would be incomplete without mentioning reputational risks. We observe that the handling of the media coverage of financial litigation is crucial, as reputation has rapidly become one of the most important competitive advantages, or disadvantages, in the financial services market. In the courtrooms, live feeds, tweets and live transmissions on YouTube mean that financial litigation is even more accessible and public than it has ever been. Credit Suisse is one of the best examples of reputational costs: the company struggled, in the years before its recent merger with UBS, with a variety of publicised scandals that affected its situation on the market in the most severe way. Therefore, while technological developments overwhelm financial services regulators and consumers, providers should, as always, pay special attention to technology surrounding the media and the reputational risks linked to it.