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Late last year, major banks and insurers were told to convince regulators they had a “robust written plan” to move away from LIBOR. The results of their efforts were deemed to be mixed at best. Now the PRA and FCA are looking much wider. Everyone who uses LIBOR or any other index must make sure their preparations for the demise of LIBOR are underway. They must also demonstrate their obligations under the EU Benchmarks Regulation are met. The regulators have shared what they consider to be best practice in these preparations – and their standards are high.
Following a series of rate-rigging scandals, the EU Benchmarks Regulation was brought in to regulate the management and use of all indices. LIBOR is particularly hard-hit: the Bank of England has stated that it will no longer compel banks and insurers to submit rate estimations for inclusion in the LIBOR benchmark after 2021, and that it expects users to adopt alternative benchmarks based on transaction data. The LIBOR cessation should as treated as “something that will happen and which [firms] must be prepared for”.
If you’re a user of LIBOR or any other index – no matter whatever size as a firm – and unsure of what these changes mean to you then read on.
The complication remains
So, the FCA and PRA are clear that comprehensive preparations must be made for the cessation of LIBOR. Unfortunately, despite the above clear statement, there remains some doubt as to whether LIBOR will in fact be ‘switched off’, as some banks have expressed interest in continuing to provide data to LIBOR. As a result, many LIBOR users are preparing for at least three possible scenarios:
- complete and instant LIBOR cessation
- a transition period (either gradual rollover as contracts expire, or a combination of this and renegotiation with clients)
- LIBOR continuation.
Latest findings, clear directions
The FCA and PRA have now released a summary of the preparations they’ve seen to date, following on from the FCA and PRA ‘Dear CEO’ letter of last September sent to large banks and insurers, requiring them to provide details of risks, mitigating actions and the staff responsible, covering a wide range of scenarios and impacts, and to include a quantification of LIBOR exposures.
They identified eight specific findings, and indicated what they believe represents best practice for firms to which a finding is relevant. In summary:
Key finding 1:
Comprehensive identification of reliance on and use of LIBOR
Beyond the balance sheet to whether LIBOR is present in the pricing, valuation, risk management and booking infrastructure firms use.
Key finding 2:
Quantification of LIBOR exposures
Management information to provide a clear understanding of current LIBOR exposures, including where contracts mature after 2021. Where appropriate, a range of regularly updated quantitative and qualitative tools and metrics to monitor exposure to LIBOR and related risks and facilitate timely decision-making by the relevant governance committee(s).
Key finding 3:
Granularity of transition plans and their governance
“Clear and appropriate governance”, including nominating a senior manager covered by the Senior Manager Regime to be responsible for the transition.
Key finding 4:
Identification and management of prudential risks
Not only the production of a detailed, broad risk assessment of all related risks, but appropriate review and challenge of the assessment, and identified mitigating actions. Evidence that firms were developing or already have the means to track transition risks through time.
Key finding 5:
Identification and management of transition-related conduct risks
Identification and mitigation of a range of conduct risks, including those arising from information asymmetries and conflicts of interest.
Key finding 6:
Scenario planning
Consideration of scenarios including the complete discontinuation of LIBOR in 2021.
Key finding 7:
The role of market participants in supporting transition
Proper awareness of industry initiatives and solutions, and engagement in those initiatives, whilst contingency planning for scenarios where solutions do not materialise from those efforts.
Key finding 8:
Transacting using new risk-free rates and building in fallbacks
Actively seeking to transact in RFRs rather than LIBOR, or incorporating fallback language into transactions.
Conclusion – preparing for all LIBOR scenarios
It appears clear now that for each of the scenarios discussed earlier, most LIBOR users need to undertake a significant piece of work to:
- quantify the extent of exposure
- define and describe the risks resulting from the scenarios above
- define and document their preparation and plans
…and to do so with reference to the clear statement of best practice that has now been released.
To add to the workload, fund managers should be aware of the FCA’s new rules on client communications that reference benchmarks, resulting from their Asset Management Market Study.
How Bovill can help
Bovill can help with all aspects of your preparation. 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.
Get in touch with our benchmarks experts to find out more.
