I think the Java local development server (java_dev_appserver.cmd) has not been updated to recognise app.yaml and the new Java App Engine runtime. The local development server still insists on a appengine-web.xml file and according to the logs starts a Jetty web server - which is nothing at all like what the documentation at https://cloud.google.com/appengine/docs/standard/java-gen2/runtime says. Basically I am only trying to run the Java example code on that page but the development server takes no notice of it at all - doesn't even matter if there isn't any app.yaml file or any code at all, all it cares about is WEB-INF/appengine-web.xml.
I have given up on this experiment with App Engine Java until the development tools work.
Hope that is clear enough and that someone looks into it.
Thanks
Martin Hodgkins