The impact of the end of LIBOR on retail investors has caught the FCA’s attention. The transition presents clear conduct risk across financial services and – although the timing is unclear – change is coming and smart firms will be planning for the future.
A mountain of retail products such as loans and mortgages are linked to LIBOR. But this is often forgotten in discussions about LIBOR reform, and of the other IBORs. The operation of interest rate benchmarks is an opaque, specialist topic. So the majority of retail investors will have very little understanding of the coming transition and its implications for their savings, loans and mortgages.
The potential impact for retail customers has focussed the FCA’s attention on the potential conduct risks – the risk of adverse client outcomes – associated with LIBOR transition. These sit alongside the many other legal and reputational risks that will be associated with the process. The regulator has said it will take action against firms that do not manage this conduct risk properly. Both regulated and unregulated firms could be impacted: after the RBS GRG scandal, the FCA has made it clear it can take action against SMCR firms, via the conduct rules.
Three questions for those handling retail LIBOR businesses
Amongst a host of questions, three are particularly vital ones for firms dealing with retail LIBOR business:
- When, and to what rate, should retail clients be transitioned?
- When should you start discussing this with clients?
- How can firms demonstrate that clients have been fairly treated, and not disadvantaged, by the transition?
The background on LIBOR reform
The hundreds of trillions of dollars of contracts underpinned by (estimations-based) LIBOR, are likely to have to transition to new transactions-based risk-free rates (RFRs) by the end of 2021. RFRs have advantages: they’re based on concluded trades that are much less open to abuse, and therefore in themselves, they reduce firms’ risk. However:
- Most new long-dated business (past 2021) is still being written on LIBOR – despite European regulators’ clear indication they want its use to cease.
- The transition of legacy business to the new rates will create winners and losers due to:
- The RFR chosen
- The rate of the RFR at the transition
- The transition date chosen
- The chosen transition method
- The likely distinctly different future behaviour of the RFRs.
Clear communications to clients will be a necessity to avoid any perception that customers have been misled or disadvantaged during the transition process. This may be particularly tricky where banks are managing a retail portfolio on one hand, but hedged with derivatives with bank counterparts on the other, and with a clear need not to introduce additional basis risks between the two.
An initial list of considerations
It is clear from the FCA’s recent focus that they believe the transition is a significant conduct risk issue. A quick list of considerations that retail-oriented firms will have to grapple with include:
- How to manage the increasing conduct risk from continuing to write LIBOR-based business.
- How to make customers – especially new customers – aware of the transition and its implications, and the decisions they may need to make.
- How to encourage customers to transition (as desired by the regulators) despite likely inertia and unwillingness to do so, and where a choice of whether or not to do so.
- How to manage the reputational risk from transitioning retail customers, where losers will want to renegotiate and gainers refuse to.
- How to educate employees on the transition implications so they can guide clients transparently and fairly through the process, especially given the company’s likely informational advantage.
- How to ensure customers are treated fairly – “put first” – through the transition, and to be able to demonstrate that they have been.
- How to develop internal governance processes to approve changes to policies, systems, processes and controls. How to get early agreement of processes to implement these, of mitigants to the above risks, and how to give senior management visibility on their effectiveness.
Given the inexorable passage of time towards LIBOR cessation, the clear focus of the FCA / PRA on business’ efforts, and the obvious conduct and other risks to the business, now must be the time to grapple with the transition.
How we can help
Bovill can help with all aspects of your preparation for the transition. Whether you’re a bank, an insurer or an asset manager, we can help – from managing the whole project to supplying additional technical expertise to complement your own or to speed things up. Our extensive experience of benchmarks means we can streamline the process and make sure nothing is overlooked.