LIBOR transition: managing the conduct risk
Vice President - Compliance
Monday 20 April 2020
Regulatory Reporting and Outreach
LIBOR (London Interbank Offered Rate) is a widely used benchmark that aims to be representative of the interest rates at which large global banks lend to one another in the wholesale, unsecured funding markets, in particular currencies, for certain term periods.
After 2021, reliance on LIBOR will no longer be assured by the FCA  and it is envisaged that banks will have transitioned to alternative overnight risk-free rates (RFRs)  as recommended by the Financial Stability Board . Overnight RFRs are more robust because they are anchored in active, liquid underlying markets. This contrasts with the scarcity of underlying transactions in the short-term interbank and wholesale unsecured markets from which LIBOR and some other Interbank Offered Rates (IBORs) are constructed.
Scope of use
Used globally, LIBOR and IBORs are often referenced in derivative, bond and loan documentation, and in a range of consumer lending instruments such as mortgages and student loans. For banks and financial institutions, the transition away from LIBOR and other IBORs to RFRs is expected to impact existing and future transactions across several contract types and client segments.
The transition presents significant challenges with the potential for severe negative impacts across multiple business lines, operational areas and geographical regions. For many firms the transition will impact their overall business and sales strategy as well as their client engagement model. It is important that risks are identified, considered and managed in an effective and coordinated manner that meets the expectations of regulatory authorities.
While the required outcome (transition from LIBOR to a RFR) and the timeframe (end-2021) is not set out in legislation, the FCA has clearly and repeatedly stated its expectation that firms need to find suitable alternatives to LIBOR, preferably based on market-driven consensus. As recently as 16th January 2020, in a joint FCA/PRA letter to Senior Managers of major banks and insurers, it was stressed that “the intention is that sterling LIBOR will cease to exist after the end of 2021. No firm should plan otherwise.” However, the lack of legislative underpinning may act to restrict market-wide and cross-jurisdictional coordination, which in turn could enhance the risk of divergent market approaches emerging.
Governance and accountability
LIBOR migration presents a risk that the conduct of a firm and/or its employees could be perceived as unfairly impacting clients or counterparties, thus undermining the integrity of the financial system and potentially impairing effective competition to the detriment of consumers. 
The FCA expects firms to consider whether any LIBOR-related risks are best addressed within existing conduct risk frameworks or if a separate, dedicated programme is required. For many regulated firms, LIBOR transition will impact their overall business strategy and front-office client engagement rather than simply being a narrow legal and compliance risk.
Potential risk impact will therefore need to be considered and addressed in a coordinated manner through enhancements to governance, controls and conduct risk procedures. This will likely involve specific project working groups being established to manage and drive the transition across all functions and areas of the business with appropriate accountability upwards to a Steering Committee and onwards to the Board or a Board Committee.
A central LIBOR transition programme should be sufficiently resourced and appropriately scoped to engage proactively across all business divisions within a firm or Group. Inadequate structuring or preparation for the transition may negatively impact the robustness and stability of firms and undermine their ability to meet the challenges that the transition brings.
Treating customers fairly (TCF)
Firms will, in negotiation with their customers, need to amend contracts for LIBOR-linked products that mature beyond end-2021 to ensure the product continues to operate effectively. This may include inserting robust fall-back provisions in existing contracts (taking effect before or at the time of LIBOR cessation) and/or converting the contract to reference an alternative rate. In choosing replacement reference rates firms need to do so fairly and consider the following:
LIBOR discontinuation should not be used to move customers with continuing contracts to replacement rates that are expected to be higher than LIBOR would have been, or otherwise introduce inferior terms
When transitioning their existing contracts, firms receiving LIBOR-linked interest are not expected to give up the difference between LIBOR and a replacement RFR, which results from the term credit risk premium that is built into the LIBOR rate, but not into an RFR
The FCA has been clear in its view that the most effective way to avoid LIBOR-related exposure is not to write new LIBOR-referencing business, and to transition to a fair replacement rate.
Firms that insert fall-back provisions in existing contracts to replace LIBOR with a new reference rate should ensure they communicate effectively with clients regarding how these fall-back provisions are expected to operate in practice (e.g. whether clauses operate at, or before cessation, and on what basis).
TCF obligations will likely be fulfilled where firms adopt a replacement rate that aligns with the established market consensus reached through appropriate consultation and is recognised by relevant national working groups as an appropriate solution.
The recent ISDA Consultation findings on parameters for the spread and term adjustments in derivatives fallbacks for key IBORs provides an illustrative example . The report recommended the adoption of the market consensus, namely a historical median spread adjustment over a five-year lookback period without including a transition period, without excluding outliers and without excluding negative spreads. The adoption of such an approach by affected firms would likely demonstrate compliance with TCF obligations.
LIBOR-linked products that mature after end-2021 may not perform as customers are led to expect. Depending on the terms of the contract, the uncertainty over LIBOR after this date means the interest rate that borrowers pay and lenders receive is likely to change. In some cases it may not be clear how this rate will be determined. The FCA is encouraging firms to mitigate these risks by taking care in describing to clients the risks associated with LIBOR ending and by being aware that there is a risk that some customers may not fully understand the implications.
It is essential that firms are conducting client contact, discussion and negotiation in line with TCF and conduct risk obligations. The FCA expects firms to keep their customers appropriately informed about the risks and impact of the LIBOR transition on existing and new financial products and services they offer or distribute.
A robust, coordinated and appropriately resourced client outreach strategy will be key in being able to meet these regulatory expectations. Firms must communicate information to customers in a manner that is clear, fair and not misleading. In practice this means:
clearly describing LIBOR discontinuation risks and impacts for existing LIBOR-linked products
where new or alternative product options are presented for existing LIBOR-referencing contracts, the range of options should be reasonable and fairly presented, including the benefits, costs and risks
not disguising, reducing or hiding relevant information
considering the knowledge and experience of the intended audience
Client engagement and clear presentation of relevant information should be initiated as early as possible to raise transition awareness and educate on implications for both new and existing contracts. This will also allow clients to make informed decisions concerning affected products, the risks to which they may be exposed and new products or solutions that may suit their needs.
Where frontline staff lack relevant knowledge or awareness, poor client outreach outcomes will be produced. This in turn may lead to situations where clients are given conflicting messages from different parts of the business. Internal communications strategies should allow sufficient knowledge of the LIBOR transition to filter down to all impacted functions. This may require the roll-out of training programmes and the creation of internal escalation pathways, knowledge libraries and operational playbooks to support efficient and accurate responses to client queries.
Execution of outreach
Client communications linked to the LIBOR transition should be accurately informed and executed in a clear and consistent manner. Robust systems solutions that allow for accurate and timely tracking of all interactions should also be in place. This should include provision for recording all LIBOR-related client communications - particularly important in circumstances where there are multiple open channels of communication between the firm’s stakeholders and the client. It is also of paramount importance that interactions are strictly informative to clients and do not stray across the line into providing advice or recommendations.
While the FCA is strongly encouraging alignment across the industry, regulated firms may reasonably adopt different approaches to what they need to do and by when. It is also more likely that unregulated counterparties not directly subject to any regulatory pressure to renegotiate LIBOR-linked contracts may demonstrate more reluctance, or a greater lack of urgency, to engage.
Client outreach and the subsequent contractual renegotiation process will be complex. Given the number of different relationships that a firm may have with the same client/counterparty (including across multiple products), a single, coordinated approach to contacting each client/counterparty is optimal but may not be possible.
The consequences of a lack of legislative underpinning is that some counterparties or clients may be quicker off the mark and expect answers sooner than a sellside firm is able to provide them. A slow response could therefore affect a firm’s competitive position in the market.
The trigger for the demise of LIBOR was pulled over three years ago and with the end-2021 date now firmly in sight it is incumbent upon stakeholders to heighten their readiness and develop robust plans so that timely, compliant solutions can be agreed and implemented. The FCA is stepping up engagement with firms and has warned that if sufficient progress has not been made by mid-2020, the Bank of England will consider recourse to supervisory tools to ensure a smooth transition .
 The future of LIBOR – speech by Andrew Bailey, Chief Executive of the FCA, Jun-17
 Transition to alternative RFRs, FCA, Dec-19
 RFR statement, Financial Stability Board, Jul-17
 FCA – Next steps on LIBOR transition, Jan-20
 FCA - Conduct Risk during the LIBOR transition
 ISDA LIBOR fallbacks consultation
 FCA –LIBOR transition next steps, Jan-20
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