Analysis of $1 billion of insurance industry claims show cyber incidents, including crime, is the top cause of loss - AGCS

Financial institutions and their directors have to navigate a rapidly changing world, marked by new and emerging risks driven by cyber exposures based on the sector’s reliance on technology, a growing burden of compliance, and the turbulence of Covid-19, according to a report from Allianz Global Corporate & Specialty (AGCS).

At the same time, the behaviour and culture of financial institutions is under growing scrutiny from a wide range of stakeholders in areas such as sustainability, employment practices, diversity and inclusion and executive pay.

“The financial services sector faces a period of heightened risks. Covid-19 has caused one of the largest ever shocks to the global economy, triggering unprecedented economic and fiscal stimulus and record levels of government debt,” says Paul Schiavone, Global Industry Solutions director, Financial Services at AGCS.

“Despite an improved economic outlook, considerable uncertainty remains. The threat of economic and market volatility still lies ahead while the sector is also increasingly needing to focus on so-called ‘non-financial’ risks such as cyber resilience, management of third parties and supply chains, as well as the impact of climate change and other Environmental Social and Governance (ESG) trends.”

Covid 19 impact

Financial institutions are alive to the potential ramifications of government and central bank responses to the pandemic, such as low interest rates, rising government debt and the winding down of support and grants and loans to businesses. Large corrections or adjustments in markets – such as in equities, bonds or credit – could result in potential litigation from investors and shareholders, while an increase in insolvencies could also put some institutions’ own balance sheets under additional strain.

“Claims may be brought against directors and officers in the financial services industry where there has been a perceived failure to foresee, disclose or manage or prepare for Covid-19 related risks,” says Shanil Williams, global head of Financial Lines at AGCS.

Cyber – highly exposed despite high level of security spend

The Covid-19 environment is also providing fertile ground for criminals seeking to exploit the crisis as the pandemic led to a rapid and largely unplanned increase in homeworking, electronic trading and a rapid acceleration in digitalisation.

Despite significant cyber security spend, financial services companies are an attractive target and face a wide range of cyber threats including business email compromise attacks, ransomware campaigns, ATM “jackpotting” – where criminals take control of cash machines through network servers – or supply chain attacks.

The SolarWinds Sunburst hack targeted banks and regulatory agencies, demonstrating the potential vulnerabilities of the sector to outages via their reliance on third-party service providers.

Most financial institutions are now making use of cloud services-run software, which comes with a growing reliance on a relatively small number of providers. Institutions face sizable business interruption exposures, as well as third party liabilities, when things go wrong.

“Third-party service providers can be the weak link in the cyber security chain,” says Thomas Kang, head of Cyber, Tech and Media, North America at AGCS. “We recently had a bank client suffer a large data breach after a third-party vendor failed to delete personal information when decommissioning hardware. How financial institutions manage risks presented by the cloud will be critical going forward.

“They are effectively offloading a significant portion of cyber security responsibilities to a third-party. However, by partnering with the right cloud service provider, companies can also leverage the cloud as a way to manage their overall cyber exposure.”

Compliance challenges 

Compliance is one of the biggest challenges for the financial services industry, with legislation and regulation around cyber, new technologies and climate change and ESG factors constantly evolving and increasing.

Indeed, the report notes that there has been a seismic shift in the regulatory view of privacy and cyber security in recent years with firms facing a growing bank of requirements. The consequences of data breaches are far-reaching, with more aggressive enforcement, higher fines and regulatory costs, and growing third party liability, followed by litigation.

Regulators are increasingly focusing on business continuity, operational resilience and the management of third party risk following a number of major outages at banks and payment processing companies. Companies need to operationalise their response to regulation and privacy rights, not just look at cyber security.

Applications of new technologies such as Artificial Intelligence (AI), biometrics and virtual currencies will likely raise new risks and liabilities in future, in large part from compliance and regulation as well. 

ESG factors taking centre stage

Financial institutions and capital markets are seen as an important facilitator of the change needed to tackle climate change and encourage sustainability. Again, regulation is setting the pace. There have been over 170 ESG regulatory measures introduced globally since 2018, with Europe leading the way.

The surge in regulation, in combination with inconsistent approaches across jurisdictions and a lack of data availability, represents significant operational and compliance challenges for financial service providers.

“Financial services may be ahead of many other sectors when it comes to addressing ESG topics, but it will still be an important factor shaping risk for years to come,” says David Van den Berghe, Global Head of Financial Institutions at AGCS. “Social and environmental trends are increasingly sources of regulatory change and liability, while increased disclosure and reporting will make it much easier to hold companies and their boards to account.”

At the same time, activist shareholders or stakeholders increasingly focus on ESG topics. Climate change litigation, in particular, is beginning to include financial institutions.

“Companies that commit to addressing climate change and diversity and inclusion will need to follow through. For those that do not, it will come back to haunt them,” says Van den Berghe.