LIBOR transition in 2020 proved to be a top priority for financial markets across the globe. Significant progress was made in the markets’ collective effort to move away from the London Interbank Offered Rates (LIBOR), once earmarked as the world’s most important set of numbers. Notwithstanding the work across last year, 2021 looks to be even more challenging, as firms work towards shifting their remaining LIBOR stock to alternative Risk-Free Rates (RFRs) before LIBOR ceases for most currencies and tenors.

This blog examines some important considerations for banks from a conduct risk perspective as client engagement and interaction on the transition increases further in the coming months. Such engagement will now shift away from awareness building and education into actions and client decisions, as firms look to transition their clients to using RFR products and amending or renegotiating sizable volumes of client LIBOR contracts in a safe and orderly manner. Executing the agreed strategy to support good customer outcomes as well as recognising the challenges and considerations of this process will be critical, with regulators’ focus firmly on the fair treatment of clients [1].

2021: Key areas of focus and considerations
As firms face significant pressure to meet regulatory convened working group milestones to offer new RFR products and subsequently cease LIBOR products, there is a risk that firms overlook a number of conduct risks as the transition evolves. We have identified three core areas we believe firms must consider as part of their conduct risk management for 2021:

New products capabilities
In line with regulatory guidelines, most firms should be able to offer a selection of RFR products to meet client needs and continue to develop their suite of RFR products to meet market demand, including both compounding and forward-looking RFRs as and when they become available. With new product offerings, a number of considerations must be assessed such as pricing methodologies, impacts to Funds Transfer Pricing models, product approval, testing and validation, a regular review of client demand for different RFR product-types, and consideration of the suitability of compounded vs term and other rates that provide varying levels of cash flow certainty. Given RFRs are fundamentally different from LIBOR, firms need to consider whether the new pricing methodologies are fair, which may include several components such as the rate itself, a credit adjustment spread and deal specific margins. Firms should also take care in explaining the different market conventions and how the different RFRs are priced, based on the client’s preferred interest rate methodology as there is a risk that clients may not fully understand how the rate will work in practice. This could hamper transition due to the complexity of the new rates or a lack of familiarity with how they are priced. 

Key considerations: Key risks around new product capabilities can be managed by ensuring that all RFR products and pricing methodologies are subject to robust testing, validation and approval via the appropriate governance forums prior to communication with client-facing staff. Consistent with regulatory guidance, it is imperative firms explain, in full, all remediation options, including how the new rate works, key differences from LIBOR and the various components.

Contract remediation
Standardised fallback language and agreed re-pricing methodologies for a variety of LIBOR tenors and currencies are now available. It’s important for firms to consider and incorporate regulatory and market guidance in remediation strategies to help ensure a timely remediation of LIBOR and remove the economic uncertainty which LIBOR may have on their contracts. This is particularly important for firms operating across multiple jurisdictions with large product suites. A holistic remediation strategy, tailored for the nuances of jurisdictional and product characteristics, helps to mitigate the risk of inconsistent messaging and remediation options provided to clients with the same product types, across different jurisdictions or business lines. The risk for firms is how to turn the agreed strategy designed to ensure the fair treatment of clients into successful execution through effective controls and oversight.

Key considerations: Consistent with recent communication from the UK’s Financial Conduct Authority (FCA) “there is no longer any reason for delay” [2]firms should actively seek to transition clients away from LIBOR to alternative rates where possible and in good time, removing any uncertainty of LIBOR’s behaviour on client contracts, ensuring clients have certainty of contract continuity and clarity on next steps. Remediation strategies should align with industry and regulatory guidance on active conversion and contract remediation where possible, justifying any deviations and be flexible enough to cater for different contract types, jurisdictional considerations and client sophistications. Firms should consider how to ensure staff adherence to agreed strategies and the risk that client-facing staff do not adhere to agreed processes and controls. Firms should also consider whether any charges or costs to clients incurred throughout or as a result of the remediation process (if any) are appropriate. Such considerations should be communicated upfront to ensure the client has full information on their remediation options and costs, understand such options and can arrive at their own objective decisions for their LIBOR contracts.

Client outreach
Depending on the range of client sophistication and knowledge of the transition amongst the firm’s client base, the need for a tailored outreach schedule on any contract remediation discussions should be considered. Some clients will need more time than others to (i) process the information, (ii) make their own informed decisions or seek independent legal / financial advice and (iii) assess their own internal operational / system capabilities for any new RFRs or alternative rates. Firms should also expect, and be prepared for, an increase in client queries throughout the year as outreach and engagement increases. Firms who fail to provide adequate information and notice to clients on future contract remediation campaigns may be seen as rushing (or delaying) clients into making their decisions on next steps for their contracts whilst a failure to adequately consider and resource the expected influx of queries may result in additional confusion for clients and may strain or delay the contract remediation process even further. This is also likely to attract regulatory scrutiny and could lead to client complaints.

Key considerations: Firms outreach strategy should be informed by client databases and aligned with their contract remediation strategy, taking into account the differing sophistications, understanding of IBOR, product types and best methods of communications to ensure a holistic and appropriate outreach campaign. If the outreach is decentralised, for example conducted by business line or geographic area, consistent messaging around internal firm timelines for discussions, external market considerations and next steps should be disseminated to the relevant teams. If the outreach is conducted centrally, it is imperative clear communication and escalation channels are established with the relevant business, second line and accountable IBOR programme management to ensure business or region specific nuances are considered. Feedback from client queries on the firm’s client outreach and remediation discussions should be embedded in the firm’s client query management framework and loop back to inform the firm’s IBOR programme regarding any necessary updates to outreach and educational materials for clients. As 2021 will involve further client interaction and negotiations, query support teams should be assessed and resourced on an ongoing basis, with the relevant SMEs and “LIBOR champions” in place to support existing teams on technical topics and areas of focus. Firms with larger footprints should also look to define the responsibilities of central and regional LIBOR support staff and the necessary training / resources requirements, taking into account local and international industry guidance on contract remediation and conduct risk for LIBOR transition. 

2021 will be a year of action when it comes to LIBOR transition. Firms should satisfy themselves they have assessed the key conduct risk challenges and considerations and documented them within their existing conduct risk frameworks. This should be further supported with the necessary governance in place to monitor and review existing processes as staff continue to engage in further client discussions on their LIBOR contracts.

The ability of firms to identify, assess and segment clients, and the impacts to their LIBOR contracts is a crucial prerequisite for any outreach campaign or discussions on contract remediation. Regulators and industry working groups have and will continue to reiterate the key factors for firms to consider as they embark on contract discussions and the different variables which should be considered, such as client sophistication, complexity of products, accounting and hedge effectiveness and further industry guidance among others.

In our view, accounting for the above considerations and the ever-changing LIBOR landscape will support firms in evidencing good conduct throughout 2021 and beyond, as the world’s most important number draws to a close.

Please get in touch with the authors if you are interested in a further discussion on conduct risk and IBOR reform.