2016 ADB TRADE FINANCE GAPS, GROWTH AND JOBS SURVEY

Following ITFA's invitation, earlier on in March, to participate in this year’s annual ADB Trade Finance Gaps Survey, we are pleased to inform you that the results of the survey have been quantified.  In collaboration with the Asian Development Bank, this is ITFA's third year of participation.

This survey quantifies global trade finance gaps and their impact on jobs and growth. The outputs have been used by regulators and financial institutions to understand where and why market gaps remain. This year's resulting report is highly aggregated - see the 2016 report here.

We thank you for taking the time to reply to this survey, which made the results more robust.

CHAIRMAN'S MESSAGE - Sean Edwards, ITFA Chairman / Head of Legal at SMBC

Dear Members and Friends,

The after-glow of a successful conference in Warsaw is still bright on my face as this newsletter reaches you. The event encapsulated all that ITFA is famous for - substantive and relevant education and information, effective networking and camaraderie all enjoyed in a social setting par excellence. The presentations and panels highlighted a number of our achievements throughout the year, the guide to Basel-compliant non-payment insurance policies for example - but also expertly signposted a number of the issues our market will need to face in the coming year.

    

One of these is, of course, Brexit. From the UK to the remainder of the developed world, as well as emerging markets, investors were highly cautious as the long term ramifications of the UK exiting the European Union were yet to be quantified. However, markets and investors were quick to shrug off the short term dent to investor sentiment as markets pared losses and swiftly recovered.

The announcement by the Bank of England of a fresh wave of monetary stimulus bolstered both investor confidence and the continuous global search for yield. With the global commodities market trading sideways for most of the summer months, monies were promptly redeployed into emerging market economies, as the potential for an uptick in economic activity whet investors’ appetite.

With summer out of the way, it is safe to say that all major economies, both developed and EM, have come out of the gruelling summer months relatively unscathed. However, with the European Central Bank falling short of expectations, all eyes are now on the forthcoming US Federal Reserve rate setting meeting, and particularly on how and when the next interest rate increase will impact the US dollar and subsequently the borrowing costs of emerging market economies. Inevitably, I guess we will all be tracking the performance of the dollar as history has taught us not to take movements in the Greenback too lightly.

In this month’s Newsletter, we present a technical paper titled ''Assignment of Proceeds under Letters of Credit - UCP600''. We then invite you to read an interesting article prepared by GTR Editor, Shannon Manders, on how the industry is facing the challenges and risks of the Trade Finance Learning Gap discussed in the session dedicated to Young Professionals during the ITFA conference.  Finally, a short tutorial has been prepared on how to effectively use the Search Function in the ITFA website.

We look forward to hearing from you with any feedback you may want to share with us by sending an email to myself, any of the Board Members or to our general email, info@itfa.org.

Best wishes,

Sean Edwards

TECHNICAL PAPER - ASSIGNMENT OF PROCEEDS UNDER LETTERS OF CREDIT - UCP600 by Lorna Pillow, Senior Vice President, London Forfaiting Company Limited, ITFA Board Member

Introduction and Background

Banks have discounted Documentary Letters of Credit (“Credits”) for many decades, following the first set of uniform rules  published by the ICC (International Chamber of Commerce) in 1933. Yet when the infamous and much quoted case of Banco Santander SA vs Banque Paribas was heard before the  English courts in 1999, it raised serious concerns amongst trade finance practitioners.  Many articles were written at the time, resulting in one of the most important changes in the updated ICC Uniform Customs and Practice for Documentary Credits (‘UCP 600’) regarding the treatment of deferred letters of credit.

The ICC was compelled to ensure that there was consistency between regions on a point so critical  to the survival of secondary market trading. A new Article 12(b) was introduced into UCP 600 as follows: “By nominating a bank to accept a draft or incur a deferred payment undertaking, an Issuing Bank authorizes that Nominated Bank to prepay or purchase a draft accepted or a deferred payment undertaking incurred by that Nominated Bank'' thereby facilitating the fundamental  business need for the discounting of deferred credits.

The provision applies where the Nominated Bank which has incurred a deferred payment undertaking discounts its obligation before maturity and subsequently fraud is discovered. The effect is that the Issuing Bank is not relieved of its obligation to reimburse the Nominated Bank, even if the fraud comes to light before maturity. The terms Issuing Bank and Confirming Bank are used interchangeably in this article mirroring the economic effect of the undertakings in Articles 7 and 8 of UCP 600 relating to Issuing Banks and Confirming Banks respectively.

The stipulations in Articles 7, 8 and 12 of UCP600 have established the independent rights given to a Nominated Bank to incur a deferred payment undertaking which includes the authorization to a Nominated Bank to prepay. The right to get reimbursed is not affected by the action of such Nominated Bank to actually prepay or discount such letter of credit.

Whilst this treatment of deferred payment credits addresses the main issue raised in Santander, the question as to whether Third Party Banks or forfaiters which further discount such Credits get the same protection as the Nominated Bank has not been resolved or dealt with by the changes made in UCP600.

What is the position, for example, of the Third Party Bank/forfaiter which gets an assignment of proceeds from a Nominated Bank or directly from the beneficiary? Furthermore, if an Issuing Bank gives an undertaking of payment at maturity to a Third Party Bank, and such Third Party Bank then assigns proceeds to another Bank, does this give the same rights to the Third Party Bank as those of the Nominated Bank? What can a Nominated/presenting Bank do if the Issuing Bank refuses to amend reimbursement instructions and insists that its obligations are limited to those set out in UCP600?

Most of the issues in this area relate to the vulnerability of assignees to defects in the rights being ''sold'' by the assignor. Before discussing these issues it is worth noting that these problems can be avoided by ensuring that the financial institution  intending to discount a deferred payment credit is appointed as  the Nominated Bank, either by having the Credit available with them or alternatively, available with any Bank. Needless to say however, this is not always possible.   

Under English law and many other common law legal systems, the basic starting point is that an assignee cannot obtain a better title than his assignor. This is sometimes known as taking “subject to equities” that is, rights which other parties have against the assignor and which the assignee must consequently respect as they existed on or before the date of assignment. Accrued rights to set-off against the transferred debt by the obligor of that debt are one example of such rights. In such circumstances, it would be unfair for the debtor to lose its rights simply because there had been a change of creditor.  

It is perfectly possible for a debtor, say an Issuing Bank, to agree that it will pay an assignee regardless of any defects in the rights which have been acquired from the assignor. In the case of letters of credit, Article 39 of UCP 600 allows for proceeds to be assigned to a Third Party Bank. Such an assignment is, of course, indispensable when a Third Party Bank buys the right to receive payment from either a Nominated Bank or a beneficiary. Such an assignment does not, in and of itself however, cure or resolve the issues relating to defects or adverse claims affecting the assignor’s rights explained above [1] but these can be overcome with a suitably worded acceptance of the notice of assignment by the Issuing Bank. Obtaining an acceptance of assignment of proceeds is, and has been for some time, standard forfaiting practice but care needs to be taken as whilst UCP 600 makes it clear that a beneficiary may assign proceeds, the Issuing Bank is under no obligation to either accept such requests or to acknowledge them. This has become more of an issue with some Banks becoming increasingly wary of accepting such requests from non customers, or in some circumstances where it is claimed that the assignment will result in a conflict with local law. Needless to say this is a barrier to the prepaying/discounting by third party institutions and is therefore to be discouraged.

It is of course at the discretion of every Bank to take into consideration other mitigants and specifics of the transaction that may well allow them to discount a Credit. 

It is good practice however that in all cases any Third Party Bank/forfaiter discounting a Credit advises the Nominated Bank of its intention to do so. 

Apart from ensuring that there has been an assignment of proceeds under Article 39 of UCP 600, the assigning Nominated Bank or beneficiary must ensure that the assignment is valid and has been created before the SWIFT advising such assignment is sent to the Issuing Bank.

Whilst a notice of assignment and acceptance should be obtained in all cases where proceeds due under a Credit are assigned to a Third Party Bank, an endorsement of a draft can in many legal systems provide similar protection under national legislation e.g. under the English Bills of Exchange Act 1882 where an endorsee can benefit from the protection afforded to holders in due course. It is understood by all parties that Issuing Banks can only pay Third Party Banks subject to the satisfaction of their KYC procedures. Whilst many Issuing Banks do not charge assignment fees to encourage trading of their own name, this is not always the case. Where fees are charged it is a matter of commercial negotiation as to the amount that the Issuing Bank will charge for such assignment although one hopes that these are restricted to KYC expenses and changes in payment instructions.

In addition to the Issuing Bank carrying out KYC on the bank it will pay at maturity, it is also practice for the Third Party Bank (usually not a party to the Credit) to carry out due diligence in relation to the underlying transaction and counterparties. Although this may be no easy task, Uniform Rules for Forfaiting (URF 800) [2], Introduction to the Primary Forfaiting Market and The Forfaiting Money Laundering and KYC checks all published by ITFA and available to its members, give guidance on this issue to Third Party Banks wanting to discount Credits. The Rules and Guidelines take into consideration other measures that banks may take to protect themselves (at least to some extent) on issues that relate to the underlying trade and its counterparties, specifically as they may not be a party to the Credit. It is of course imperative that such an analysis takes place before the discounting of a transaction. Whilst for established clients this process may be one of routine, tools exist to facilitate detailed analysis of the transaction, for example to track vessels and Bills of Lading. The Third Party Bank should insist that although the transaction is being discounted on a ''without recourse basis'', there is an ability to retain recourse in the event of  a breach of any representation and warranty that such Bank may have on the Bank or counterparty selling the asset/transaction.

The other key question is that when a beneficiary presents documents through an Advising Bank (not the Nominated Bank) under the Credit, and the acceptance of documents is sent to such Advising Bank confirming a payment undertaking, could that Advising bank discount the proceeds under the Credit and seek the same remedy as that of a Nominated Bank under UCP 600?  In our opinion when an Issuing Bank gives a reimbursement undertaking to a presenting bank, that presenting bank is effectively authorized to then discount a deferred payment undertaking. It is advisable though that such presenting bank should still advise the Issuing Bank of its intention to discount the proceeds under the Credit before doing so.

Whilst URF 800 allows for specific provisions under Article 4a, 13e and optional clauses to limit the liability of each party, such representations and warranties are as strong as the party you are dealing with. Therefore, the due diligence process including the analysis of the balance sheet of your counterparty to whom you will discount on a ''without recourse'' basis cannot be undermined.  For a Third Party Bank to mitigate the risk of fraud that could happen from the time the documentation is accepted to maturity, the Third Party Bank should insist on having recourse to the Seller whether the Nominated Bank or otherwise together with other representations and warranties [3] set out in the agreement between the two parties.

Disclaimer: This information does not constitute legal advice and is for education purposes only.  You should not rely on this opinion as an alternative to seeking legal advice.

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[1] Note than where the assignor is a Nominated Bank it should not be subject to any defences to payment based on fraud given the changes to UCP mentioned above and so the rights it passes on to an assignee should be similarly unaffected.

[2] Uniform Rules for Forfaiting (URF) 800 is the first standard set of rules for forfaiting transactions by ICC in partnership with International Trade and Forfaiting Association (ITFA).

[3] Refer to Uniform Rules for Forfaiting (URF 800) and Introduction to The Primary Forfaiting Market 

TRADE FINANCE LEARNING GAP PRESENTS RISKS TO INDUSTRY - Shannon Manders, Global Trade Review (GTR) Editor

The trade finance learning gap should be bridged before it’s too late, said speakers at the International Trade & Forfaiting Association’s (ITFA) conference, hosted in Warsaw between 7-9 September.

ITFA formally launched its mentoring programme at the end of last year, and invited some of its mentees to speak at its annual conference. In a session titled “Teaching the next generation”, mentees Asif Dad and Michel Meylacq told the audience that mentoring plays a fundamental role in the careers of young professionals. They called for the industry to assist them in attracting more mentors and mentees to ITFA’s programme.

''Young professionals are the future of the industry, and you can help shape that,” Dad said.

The session addressed the needs of young professionals in the trade finance arena, finding these to chiefly be: access to resources, training and qualifications, and networking.

The speakers highlighted the fact that the trade finance industry is ''skewed towards experienced professionals''. According to a 2014 survey by GTS on global trade and transactional services, only a small minority (2%) of trade professionals currently working in the industry have less than two years of experience in the field.

They recommended that the learning gap within the trade finance industry be tackled ''before it’s too late''.

Speaking on the sidelines of the event, Sean Edwards, ITFA chairman, told GTR there is going to be a ''deficit in the sort of people that understand trade. There are a lot of very experienced people in the industry, which you see if you come to these conferences. But eventually they do retire,'' he said.

Edwards called for those leaving the industry to transfer their know-how, gained through their cumulative experience, to their younger colleagues. ''It’s really important for them to pass on their knowledge: you don’t get that through any training programme or through any textbooks – you can only get it through the one-to-one interchange with people who have been doing this business for a long time.''

As the world of trade evolves, so banks – and their customers – are finding new and different ways of doing business. ''So if we, as an industry, don’t evolve in the same way as our customers, then the industry does run the risk of potentially being not relevant to our customers. And we can’t have that,'' Chris Hall, ITFA board member and head of its Young Professionals network, told GTR at the conference.

NEW ITFA MEMBERS

The ITFA Board is pleased to announce the following three new members.

Greensill Capital (UK) Limited (Greensill Capital) is an independent financial services firm specialising in origination and syndication of supply chain finance, structured trade finance and working capital optimisation solutions globally. Greensill Capital was founded in 2011 by a seasoned team of trade and supply chain finance specialists. Headquartered in London, Greensill Capital has grown to over 140 professionals worldwide with offices in New York, Chicago, Frankfurt and Sydney. Greensill Capital is the majority owner and bank holding company of Greensill Bank AG, a regulated German private bank.

Greensill Capital is one of the leading originators of supply chain finance and account receivables based assets, utilising its own balance sheet, as well as that of its subsidiary bank. In addition to its own hold position, Greensill Capital partners with a wide range of banks and institutional investors to provide the stable funding streams underpinning the process. Since launch, the company has completed over 100 Supply Chain Finance programmes, extends facilities of over $9bn to customers across Europe, North America, Latin America, Africa and Asia, and works with more than 75 different banks and institutional partners.

Mr. Wasif Raza will be the main contact for all ITFA related matters.

The Export and Import Bank of China was founded in 1994 and is a state bank solely owned by the Chinese Government and under the direct leadership of the State Council. Its international credit ratings are the same as China's sovereign ratings.

The Bank is headquartered in Beijing. It has more than 20 business branches inside China, one branch and two representative offices outside China, namely the Paris branch, the Representative Office for Southern and Eastern Africa and St. Petersburg Representative Office. It has established correspondent banking relationship with more than 1,000 banks.

The Bank's main mandate is to facilitate the export and import of Chinese mechanical and electronic products, complete sets of equipment and new high-end products, assist Chinese companies with comparative advantages in their offshore project contracting and outbound investment, and promote international economic cooperation and trade.

Guo Jing will be the main contact for all ITFA related matters.

As a financial services provider independent of any specific bank, AIC Finanz GmbH has been a dependable and creative partner to the international business community since 1991. They are specialists in trading and recovering receivables from international trade transactions, living up to the highest industry standards.

The focus of their activities is on emerging markets. Their highly skilled team offers financing solutions to customers that are individually tailored to their needs. AIC Finanz GmbH buy and sell receivables from international trade transactions on a non-recourse basis (forfaiting).

In addition to this, they operate an international receivables collection agency and are active around the globe in both fields. SMEs who intend to structure their exports in accordance with the requirements of the forfaiting markets may also obtain advisory services from AIC Finanz GmbH.

Christiane Heldermann will be the main contact for all ITFA related matters.

UPCOMING EVENTS - SAVE THE DATE

We wish to take the time to remind our readers of the upcoming ITFA events.

Firstly, the Southern European Regional Committee (SERC), is organising an Education Seminar for its ITFA members, which will be held on Monday, 31 October 2016 in Italy. The seminar will be held in both English and Italian. The event will commence at 2:30pm and will be held at the premises of Banco Popolare Headquarters, Verona, and will be followed by drinks. Since access will be restricted to confirmed guests only, you are kindly requested to send an email confirming your attendance to Barbara Salazer by latest Friday 21 October 2016.

Another upcoming ITFA event is the GRC Fall workshop which is being held on November 23, 2016 in Frankfurt am Main. The event is for ITFA members only. The workshop will be held in German. As is customary, the workshop will be followed by the traditional Christmas Dinner which will be sponsored by ITFA. The seminar (14:00 – 17:00 hrs) including refreshments will be hosted by Helaba Landesbank Hessen-Thüringen Girozentrale, MAIN TOWER, Neue Mainzer Str. 52-58, 60311 Frankfurt am Main. The ITFA Christmas Dinner, which is sponsored by ITFA, will be held at 17:30 hrs.

May we also take the opportunity to remind you all about ICC Academy’s first Regulation and Compliance in Trade Finance Conference, which is being held on 26 October 2016 in Singapore. This high-level event will gather some of the trade finance industry’s leading professionals to discuss regulatory trends - both in the regulatory capital and financial crime fields - which have had a major impact on the financing of trade in recent years. The conference will include practical sessions on how banks and corporates can best manage increasing regulatory compliance risks.

Another upcoming event is the Accuity AML, Risk Reduction and Compliance Asia Conference which is being held between 3-4 November in Hong Kong. This conference brings together experts from North America, Europe and Asia and offers the opportunity for you to learn about the latest trends in fighting financial crime globally. Please click the link above for further details.

REVAMP OF ITFA WEBSITE - TUTORIAL ON SEARCH FUNCTION

Following the success of this year's ITFA Annual Conference, held in Warsaw at the beginning on this month, we have taken aboard all feedback and suggestions that our valuable ITFA members have put forward. 

One of the issues brought up by those present, was the effectiveness of the search function within the ITFA website. Therefore, following the revamp of the ITFA website earlier this year, we thought it would be a useful exercise to mention a few of the improvements that were implemented, and also specifically illustrate the effective use of the search function.

These include:

1) Interface improvements

2) Images revamp

3) Online banners (sponsorship banners) are now not only visible on the ITFA homepage but also on the inner pages of the website

4) Creation of the ITFA events calendar - please do refer to the Events Calendar from time to time as it is constantly being updated

5) Conversion to responsive website - this was the main task in the website revamp. Responsive Web Design (RWD) refers to a web design that creates websites with an optimal viewing across a wide range of devices including mobile phones.

The ITFA website has been converted to responsive meaning that it works like a mobile app when viewed from a mobile phone. No user installation from the app store is required. This update was quite substantial, but was the next step forward, considering the primary audience of ITFA are mobile executives who probably use their mobile devices for browsing more than their desktops.

6) Keywords update - as much more content has been updated on the website, the status of keywords being used was tested to integrate new keywords or change others to continually optimize drive traffic to the website. This has enabled the search function to be used more effectively. 

For example, if you wish to search for something relating to URF - simply key in URF in the search box at the top right of the webpage.

All posts and documents with the word URF will then show up and by clicking on that particular item, one can then open the article/document.

In addition to the above, another thing we wish to clarify is that as promised during the conference in Warsaw, we are currently discussing, together with our IT consultants, in order to find a solution to speed up the ITFA website. We should have a reply in the coming days and will keep you posted on this issue.

Should you need any further assistance, please do not hesitate to send us an email on info@itfa.org.

CHAIRMAN'S MESSAGE - Sean Edwards, ITFA Chairman / Head of Legal at SMBC

Dear Members and Friends,

It is really difficult to talk about anything else other than the dreaded Brexit and the dire impact it is going to have on the global economy. Global Trading activity heading into the infamous 23 June referendum had been gathering pace since mid-February of this year. Investor sentiment was picking up and this was being reflected in asset prices.

However, closer to the date, investors became jittery and the increased uncertainty over the results of the UK referendum kept the markets on their toes and risk aversion spread quickly only to reverse in the days before the referendum as polls once again indicated a Remain vote might just nudge ahead. However, on 24 June, markets woke up to mayhem, panic last seen in September 2008 (Lehmans'), as the British electorate voted out of the European Union. Clearly, this was not the result many international players were gearing for, and was evidently not the most market-friendly outcome, as all risky assets sold off heavily, with some percentage changes even reaching double digits on the day in major equity indices. It is worth mentioning though that given the large swings, emerging market credit came out relatively unscathed from all happenings in the developed world.

One might argue that, on the positive side, Brexit has brought about interesting opportunities but it would be too premature to estimate the extent of damage and ramifications of the 23 June referendum result, particularly on a global scale. The economic damage could be in its infancy and will only start to show up in statistical economic data in a couple of quarters’ time. The biggest dilemma for investors will be how to tackle this transitory period, as long and even medium-term plays will look more hazy.

Small crises have often been welcomed in our markets but with worries of contagion and central banks having to intervene heavily to steady the ship, this one could well prove just a little bit too big. It is certainly unwelcome.   

On a more reassuring note, we are excited that preparations for the 43rd Annual Trade and Forfaiting Conference are well on track to ensure another memorable ITFA event. To register on-line, to view the conference programme and for any other informative details, please click here. Please bear in mind that since the Early Bird Discount has now expired, we encourage you to register by no later than 31 July in order to avoid incurring the late registration fees. 

In this month’s Newsletter, we present a technical paper titled ''Market Comment on the Repercussions of Negative Reference Rates (for example LIBOR)''. We also invite you to read an interesting article prepared by Marian Boyle (Sullivan & Worcester) on the Insurance Act 2015 - Are you ready? Finally, the ITFA Board is pleased to announce that ITFA is now registered as a non-profit-making association in the Swiss Registry of Commerce.

We look forward to hearing from you with any feedback you may want to share with us by sending an email to myself, any of the Board Members or to our general email, info@itfa.org.

Best wishes,

Sean Edwards

TECHNICAL PAPER - MARKET COMMENT ON THE REPERCUSSIONS OF NEGATIVE REFERENCE RATES (FOR EXAMPLE LIBOR)

Following the recent decisions by several central banks to set negative benchmark interest rates – in addition to Japan, most notably the European Central Bank (ECB) and subsequently Switzerland, Denmark and Sweden – there are some repercussions that need to be considered by Trade Financiers.

There are several basic aims in moving benchmark interest rates into negative territory, predominantly linked to either:

• weakening a currency, thereby making its exports more attractive, and increasing the cost of imports in order to stave off deflation; or
• boosting spending by discouraging savings and promoting borrowing.

The latter is essentially aimed at banks: by making central bank deposits costly, the theory is that they will need to deploy their deposits elsewhere, hopefully in the form of loans which can stimulate an economy.  In turn, the interbank reference rates (such as LIBOR and EURIBOR) reflect the impact of the central bank rates and have consequently also gone negative in a number of cases.

This causes some issues for lines of business that use interest rate benchmarks as a mutually agreeable proxy for the cost of funds for a given period in a specified currency.

Trade Finance is one such line of business, especially since the financing is predominantly risk-based and pricing is typically quoted on a “reference rate plus risk margin” basis, even though the underlying transactions are not deposits.

What are we currently seeing in the market?

Our understanding is that it is becoming commonplace for institutions to set a floor of “zero” for the reference rate in master or transactional agreements, by using wording such as: ''If LIBOR is less than zero at any time of determination, then LIBOR shall be deemed to be zero''.

Why is this a growing trend?

Banks must assess and mitigate risk, in this case interest rate risk.

So what is the issue with setting a zero floor?

Clients may question why the perceived benefit of a negative (i.e. cheaper) rate is not being passed on to them. In reality though, it is not “free money” being provided by the central banks which is then not being passed on to customers; it is a disincentive to holding excess liquidity.

Consider the following related scenarios

LIABILITIES: Clients place funds on deposit with a bank. If the banks receive more deposits than they can redeploy profitably elsewhere (or have to retain some of these funds for regulatory reasons), they typically need to place the excess with a relevant central bank at the prevailing rate. If this rate is negative, the bank is effectively incurring a cost when placing these funds. In turn, these costs are sometimes then reflected in the negative deposit rates charged to clients (although it may not be always the case).

ASSETS: Conversely, if a bank is creating an asset by lending money to a client, it will need to use funds it has obtained from the liabilities side of its balance sheet. As explained above, the cost of obtaining these funds may be impacted by the negative benchmark rates.

What should you do?

In this context, each institution needs to assess how and where it obtains its funding in order to finance assets, and what an appropriate rate may be.

One way of addressing the issue is by using a “cost of funds” rate rather than a benchmark rate, however in practice this also has its challenges as it is harder for a third party (e.g. a borrower) to determine whether the lender’s cost of funds are correct or appropriate.

Any queries emanating from this paper can be addressed to Paul Coles, ITFA Board Member - Market Practice.

Disclaimer: This information does not constitute legal advice and is for educational purposes only.  You should not rely on this opinion as an alternative to seeking legal advice. 

INSURANCE ACT 2015 – ARE YOU READY? By Marian Boyle, Insurance Partner at Sullivan & Worcester, London

On 12 August 2016, the most fundamental reforms of UK insurance contract law for over 100 years will come into force. The reforms are being introduced to redress the imbalance between insurers and policyholders – insurers being perceived as having too much leverage in coverage disputes because the existing law was overly protective of the insurers' position.

For buyers of insurance, the changes are undoubtedly a very positive development. They do, however, significantly change the way UK insurance business will be conducted. Policyholders who want to take advantage of the benefits of the reforms need to understand the changes and adapt their practices accordingly. This article provides a summary of the areas policy holders need to address. 

Why is insurance important?

The UK insurance market (which is the third largest in the world and the largest in Europe), plays a significant role in underpinning global trade by insuring trade related risks.

Physical assets are almost always covered for loss or damage. In trade finance transactions banks may want to be co-assured on the policies that cover the goods, to take an assignment of the proceeds or at the very least be named as loss payees. They may also require cover to be taken out for the premises where goods are produced.

The obligor’s non-payment risk can be insured, as can the borrower's credit risk on financed deals, and the country or political risks that may adversely affect the borrower's ability to service the loan. Over the last ten years these types of credit policies have become increasingly popular, particularly so where the financer can obtain risk capital relief for the insurance. To qualify for the relief, the robustness of risk transfer needs to very clear and confirmation of eligibility supported by legal opinions.

What has changed?

The Insurance Act 2015 (the ''Act''):

• radically changes the pre-contractual disclosure process and policyholders' duty;
• introduces a wider range of remedies, which are designed to be more proportionate, in the event of policyholder breach;
• reforms the law relating to insurance warranties;
• codifies the rules that apply if a policyholder makes a fraudulent claim; and
• provides for damages in the event of late payment of claims.

When the Act comes into force on 12 August 2016, it will apply to all contracts of insurance and reinsurance, and to any variations to existing contracts made on or after that date.

This article focuses on the aspects of those changes that require a change of practice by policyholders.

New duty to make fair presentation

Policyholders will be under a duty to disclose material information known to senior management and any individuals responsible for arranging the insurance. Those responsible for the insurance are responsible not only to the internal insurance or risk management team, but also the external insurance broker.

As under the current law, any information is material if it would influence the judgement of a prudent insurer in determining whether or not to take the risk or fix the terms in so doing. Materiality will therefore depend upon the field of activity (e.g. shipping, banking, commodity trading); the nature of the risk; and the relevant class of insurance (e.g. property insurance, credit risk, marine cargo).

Policyholders will also be under a duty to conduct a reasonable search for information that "ought to be known". This includes not only information within the organisation, or its possession and control, but also relevant information held by third parties outside the organisation. 

Presentation needs to be clear and accessible

There is a new standalone duty to present information to insurers in a manner that is ''reasonably clear and accessible". The Law Commissions (which had spent many years working on the reform proposals that culminated in the Act) were critical of the practice of proposed insurers providing large quantities of un-signposted documentation without any indication as its potential relevance. As a result, the last minute "data dumping" of unstructured information will no longer be permitted.

Practical Impact of Fair Presentation Duty

Start Early

Policyholders need to start considering their renewal process and opening the dialogue with placing brokers about what needs to be achieved much earlier. The presentation is now supposed to be an interactive process with insurers asking questions regarding the information provided. The timetable needs to build in this flexibility.

Get advice

Brokers should be able to provide guidance on what information should be considered ‘material’ for any particular type of risk. Part of the long lead-in time permitted between when the Act received Royal Ascent and came into force (18 months), was to enable insurers, brokers and policyholder bodies to work together to develop guidance and protocols setting out what a standard presentation of risk should include for different types of risks.

Organisations, in particular, need to take advice on what should be the ambit of their "reasonable search” and agree that with insurers. The Act provides for a default regime only. Accordingly, if the parties want to agree that the ambit of the relevant search will be narrower than the terms of the Act, they are free to do so.

Who has relevant ''knowledge''?

It will be essential to identify those within the organisation who fall within the definition of "senior management". The Act defines senior management as those individuals who play a significant role in making decisions about how the policyholders' activities are managed/organised. In a corporate context this is likely to extend beyond simply the main Board, and could be a substantial group of people depending on the structure and management arrangements of the organisation.

Policyholders should consider whether the knowledge of such a large group of individuals is really relevant for the purpose of any particular insurance policy. For example, if a commercial bank regularly takes out individual policies covering their clients’ credit risk, is it practical for every individual falling within the definition of senior management to be consulted about whether they have that relevant "knowledge"?  It is much more likely that the transaction team, who have put the deal together, will have the pertinent information and therefore it would be sensible to amend the policy to reflect that fact.

Knowledge also extends to those individuals who are responsible for the policyholders’ insurance. This includes any corporate risk management function but also the placing broker. Policyholders therefore need to liaise closely with their broker and agree what knowledge is relevant and who is responsible for searching for - and in due course storing - the various categories of historical information that might be needed to fulfil the duty.

More onerous obligations

The duty to undertake a reasonable search for information substantially increases the policyholders' obligations.  Remember, a reasonable search will now include relevant information in the hands of third parties – e.g. agents, subcontractors, consultants, professional advisers and those to whom relevant business functions have been outsourced. Policyholders need to make sure they have considered which individuals or organisations are likely to have relevant information and allow enough time to collate it.

Explaining the crucial importance of responding to the information requests in a rigorous manner will also be key.

Explain the risks

Any individual whose knowledge is considered relevant needs to understand the importance of the information gathering exercise, and the likely impact of getting it wrong. A bland enquiry "do you know anything about X" may not result in the appropriate degree of scrutiny, unless it is put in context.

Make it clear, for example, that the organisation is about to insure a physical asset of considerable worth and that the insurance may turn out to be a wasted expense, if relevant information is not disclosed.

Blind Eye Knowledge

When requesting information, whether from senior management or as part of the "reasonable search" obligations, individuals need to be reminded that knowledge under the terms of the Act is not limited to that which an individual actually knows. Knowledge extends to matters which an individual suspected, and of which he or she would have had knowledge, had they not deliberately refrained from confirming or enquiring about them. This is concept is often expressed by the shorthand term of "blind eye" knowledge. Once again, however, parties are free to agree that knowledge, for the purpose of any particular policy, should be limited to actual knowledge.

Keep records updated

Policyholders need to make and retain detailed records as to the searches they have undertaken and received. Do not assume that the list of individuals relevant for the purpose of the "reasonable search" enquiry will stay static. The commercial activities of an organisation can change radically during the course of a year and the question of what constitutes a reasonable search needs to be revisited at every renewal, and every time a request is made to insurers to amend the policy.

Reforms of the law on Warranties

Under the current law it is open to insurers to add a declaration to insurance proposal forms or policies stating that the policyholder is warranting the accuracy of all the answers given, or their answers form the "basis of the contract". This has the legal effect of warranting the truth of every piece of information given in the proposal. Any inaccuracy, however immaterial, can entitle insurers to treat themselves as discharged from liability automatically.

The Act abolishes clauses of this type and, if included, they will no longer be given effect to.

The Act also replaces the existing remedy for breach of any warranty and provides instead for more proportional remedies. The policy might provide, for example, that the insured warrants that a particular physical commodity will be stored in a secure warehouse protected with 24-hour security personnel. If the relevant storage warehouse is left unattended, the warranty will be breached. The Act provides that for any loss occurring during the period of the breach, insurers will have no liability. If, however, the breach is remedied, and the security arrangements become fully effective, again insurers will become liable for any loss arising after the breach has been remedied.

Practical Implications

Going forward, any ‘basis of contract’ clauses in policies or proposal forms should be struck out. They will no longer be effective in any event, so why keep them?

Policyholders should continue to take insurance warranties extremely seriously. Even though the new remedies will now be proportionate, insurers will still be able to escape liability for any loss that happens during the period of breach.

Make a careful note of any warranties that have been given, consider how compliance is monitored and put in place reporting procedures to keep tracking compliance. Any inadvertent breach must be quickly remedied if remedy is possible. Evidence as to the date and times that breaches are remedied must be retained so that this can be provided to insurers in the event of a loss. If the breach cannot be remedied, get advice promptly on what options might be available e.g. getting insurers to waive breach.

Fraudulent Claims

Under the new Act, if the policyholder makes a fraudulent claim, the insurer is not liable to pay that claim, even it would seem (although this is not beyond doubt) those parts of the claim that are entirely honest. The insurer may also give notice to the policyholder to terminate the contract and may retain the premium.

The Act does not define what is fraud or what amounts to a fraudulent claim. That is left for the courts to interpret that as a matter of common law.

Practical Implications

Everyone involved in an insurance claim needs to be clear that absolute and scrupulous honesty is required. Exaggerating any aspect of a claim, or providing insurers with any documents in support of a claim where there are suspicions as to their authenticity, can lead to serious problems.

The second practical step is to consider whether the fraud clause in your policy appears more onerous than the Act. If so, the justification for including it should be discussed.

Damages for Late Payment of Claim

A late amendment inserted into the Act by the Enterprise Act 2015 introduces an implied term into insurance contracts that the insurer will pay claims within a ‘reasonable period of time’. Breach of that implied term entitles the insured to a claim in damages. This new provision comes into force on 4 May 2017. Under the old rule, even if an insured had suffered significant losses as a result of insurers delaying a claim payment, the insured had no remedy.

Insurers will have a defence under the Act if they had reasonable grounds for disputing the validity or quantum of the claim. It remains to be seen how the Courts will interpret the test of reasonableness, but the introduction of an implied term will undoubtedly give policyholders more leverage if insurers are obviously dragging their feet without any apparent justification.

Practical Implications

The time limit for bringing a claim for damages for late payment of claim is extremely tight. The insured will only have one year from the date insurers paid the claim and this deadline need to be carefully noted.

Conclusion

Changes introduced by the Act undoubtedly place policyholders in a significantly better position.

This is good news for trade finance parties where there has been some scepticism about the value of insurance owing to concerns that insurers would find reasons not to pay. Achieving more certainty about the effectiveness of insurance as a risk transfer or mitigation tool, in a trade finance context, will increase its attractiveness.

However, if policyholders want to take advantage of the benefits that the Act was designed to confer, they need to understand the changes and adapt their practices accordingly.  The manner in which insurance risks need to be presented going forward has changed radically.  Carrying on with "business as usual" could result in claims being denied or policy proceeds being significantly reduced.