On 21 January, AFME and Simmons & Simmons hosted a panel session with the FCA to discuss in more detail some of the themes raised in our paper LIBOR Transition: Managing the Conduct and Compliance Risks.
The session began with an audience survey, which concluded that 60% of attendees considered litigation risk to be the biggest compliance risk facing firms. Much of this relates to the challenge of identifying and transferring clients to replacement rates, particularly given the FCA’s statement that firms must not “move customers with continuing contracts to replacement rates that are expected to be higher than what LIBOR would have been, or otherwise introduce inferior terms”.
The panel discussed the tension between the desire to pursue a broadly consistent approach and the complexities of meeting individual clients’ needs. No matter what a firm’s core market, their client base will contain a range of businesses, from sophisticated to simple, multinational to local, multi-banked to single-banked. Some clients are already well-sighted on their LIBOR exposure, others less so. Firms need to understand not only what products each client holds, but the underlying financing or investment need, in order to propose a suitable transition plan. As an example, the FCA was clear that LIBOR transition is an opportunity for firms to move customers to rates that are simpler and easier to explain. As such, firms will be coming under increasing pressure from the regulators if they continue to issue LIBOR linked products for new business.
The timing of that transition is also key. Considering the size and scale of the project, it might be seen as prudent to begin transitioning continuing contracts as soon as possible, particularly as this approach offers transparency to clients. However, while LIBOR continues to exist, it is possible that client contracts that have already been transitioned may reference a rate which turns out to be higher than LIBOR. While noting the FCA’s recent letter to ISDA on the subject, it is also not certain at this stage whether LIBOR will promptly cease to exist at the end of 2021, or tail off as individual submitters withdraw. In the latter scenario, firms would be exposed to the risk of comparison between old and new rates beyond 2021 – compounded by the potential for LIBOR to become more volatile and potentially unrepresentative as the LIBOR panel shrinks. The FCA was clear that firms would need to make reasonable judgements in ensuring a replacement rate for LIBOR was expected to be as economically equivalent as possible at the time a decision was made. While a short-run risk of comparison was acknowledged, the FCA noted that firms would also need to consider the risks if client engagement and transition away from LIBOR is left very late and rushed through, or some clients remain exposed to a LIBOR rate that ceases to be representative after 2021.
Over the last few years, industry groups, including ISDA and the Working Group on Sterling Risk-Free Reference Rates (RFRWG), have been engaged in helping to build market consensus on how individual asset classes can transition away from LIBOR. The FCA acknowledged the efforts of these UK working groups and encouraged firms to align with the market consensus to agree suitable alternative rates where appropriate. It was clear from the discussion that the ongoing nature of these important efforts makes the compliance challenges more complex – firms cannot wait for these discussions to conclude before acting. The FCA has also been clear that firms are not beholden to these market recommendations and are free to make their own commercial decisions about how and when to transition, although a departure from a ‘market consensus’ approach will need to be justified.
More broadly, the FCA called upon firms to ensure that they have a comprehensive plan with intermediate deadlines throughout 2020-2021 – leaving too many key milestones until the end of the transition period will not be viewed well by supervisors. The panel also discussed the FCA’s expectations regarding firms’ communications with clients in relation to transition. Firms should expect the FCA to be looking for them to have produced clear communication strategies, which take into account different client and product types.
System readiness was raised as a key dependency for firms’ transition plans, particularly against the backdrop of a market concern that system updates may not be ready in time to meet regulatory expectations on transition timeframes. The FCA encouraged firms to start preparing for the integration of system updates and clarified that a lack of system readiness should not be a reason for firms to delay LIBOR transition.
Finally, the level of industry support for a legislative solution was discussed. While many in the room felt this would be helpful, the panel cautioned that it would be a complex process that might not bring the promised benefits. For instance, without a globally coordinated approach, firms would be under different legal obligations in each jurisdiction, meaning a ‘safe harbour’ in one might be outlawed in another. Legislators would also be faced with creating a solution tailored to the individual needs of each market and asset class, a tall order in the time left.
The FCA’s parting message was that it expects to see an increase in the use of SONIA in the sterling derivatives market post March 2020, and will continue to monitor this closely.
Evidently, the challenge facing compliance teams is huge and multi-faceted. The conduct issues discussed by our panel were only a few of those that firms need to consider and there are significant dependencies on the work being undertaken by market experts on the legalities and practicalities of the transition. The message, though, was clear: the danger of waiting is too great and firms need to start engaging with clients and mitigating the conduct risks now.
AFME Contacts
Richard Middleton
Managing Director, Head of Policy
[email protected]
+44 (0)20 3828 2709
Fiona Willis
Associate Director, Policy
[email protected]
+44 (0)20 3828 2739