The transition from LIBOR to Risk Free Rates (“RFRs”) has, for the most part, entered its critical year. Regulators have set clear expectations that new issuances of LIBOR linked cash products that mature post 2021 must cease, with new GBP LIBOR issuances to cease by the end of March 2021 
The work to date has largely focused on readiness for the transition, with the market now focused on execution. Whilst there is a stay of execution on the use of USD LIBOR until June 2023 in certain circumstances, it is important that Investment Management firms do not see this a sign to let up on execution activities.
In preparation for the transition, Investment Management firms have been addressing a range of Industry challenges, which we explore further below:
Transition planning: Product Benchmark changes and Portfolio securities
At this stage of the Transition, Investment Management Firms should be seeking to refine their plans for when and how RFRs will be adopted at enterprise, product and portfolio levels. To begin with, based on reliable data showing the firm’s current LIBOR holdings, it’s important to be monitoring overall progress towards meeting the key regulatory transition milestones. Secondly, there should be details plans for the activities required to switch any product benchmark from LIBOR to an appropriate alternative, including specific principles that will guide the decision on selecting the new benchmark. Finally, portfolio level transition plans should be in place with each Investment manager having taken ownership for their move away from LIBOR, tailored to the holdings they are responsible for. This final level of transition planning has proved particularly useful when needing to quickly align with market and/or regulatory driven changes in direction (for example the recent proposals to continue USD LIBOR tenors through to mid-2023).
Operations, systems & third parties
Enabling end-to-end systems and operations to effectively support dealing in new RFR benchmarks remains an industry challenge, and is also felt by Investment Management firms. New market data feeds, interest calculation methods and processes, valuation capabilities and fallback processing are but a few of the operational challenges firms face. Taken collectively, the design, testing and deployment of wide ranging changes to systems, data and processes such as these have required particular care. Furthermore, with external vendors often providing some or all of these transaction services, significant work has been needed to be sure their readiness plans are robust, aligned with the firm’s overall transition roadmap and that their implementation is on track.
A particular challenge for Investment Management firms is the transition of ‘tough-legacy’ contracts, “i.e contracts that genuinely have no or inappropriate alternatives and no realistic ability to be renegotiated or amended) by enabling continued publication of a LIBOR number using a different and more robust methodology and inputs . Some firms have been able to make us of electronic contract databases to scan, analyse and classify contract terms (including fallback language) and understand the nature and scale of their tough legacy and prepare for the consent solicitations that are likely in 2021. However, not all firms have this capability, and hence have had to mobilise and complete labour-intensive projects for fallback language in all LIBOR contracts to be manually read and categorised in readiness for transition. The execution risk of these activities cannot be under estimated. Firms should continue to monitor these activities closely, and focus on the reporting of routine and accurate Management Information and reporting
Managing Conduct Risk
The FCA have demonstrated continued regulatory scrutiny and oversight of the transition away from LIBOR and have been vocal on their expectations for Investment Management firms to identify and manage LIBOR transition conduct risks applicable to their business. Examples of the key considerations include those relating to governance and risk management processes, product and benchmark transitions, legal and contractual provisions, mitigation of conflicts of interest, market conduct and surveillance as well as external communications and the financial sophistication of their client base.
Where Investment Management firms have existing conduct risk frameworks, these have been particularly useful in the identification of specific LIBOR transition conduct risks and existing mechanisms for mitigation. That said, Investment Management firms with a less mature conduct risk framework have more work to do here, notably establishing a standalone set of LIBOR transition conduct risks and mitigation procedures, as well as new ownership, ongoing management and reporting for all the risks during and after the transition.
It is important that firms recognise that the identification and management of LIBOR conduct risks is not a “one time” activity. Close attention is needed to continue to monitor how existing risks crystalise, or new conduct risks emerge, as the transition develops. This ongoing management of LIBOR conduct risks can be more effective if owned by first line of defence functions (as opposed to, second line functions like Compliance).
Client engagement & query management
As the LIBOR transition has progressed, Investment Management firms have been faced with increasing numbers of client queries on the approach the firm has taken to the transition, and what this means for individual investment holdings. In managing these queries, firms have had to ensure that responses provided to clients are consistent, informed, and aligned with the overall transition strategy. Enabling this has presented a number of challenges to work through, including;
- Ensuring that client facing staff have the required knowledge and awareness on the LIBOR transition and the firms’ approach to this in order to respond, through continued training and education exercises;
- Establishing points of contact for managing LIBOR related queries and defining escalation routes to subject matter experts for the more complex queries (something that is notably challenging where there are multiple routes of contact across different customer journeys i.e. retail vs institutional and third party administrators managing queries); and
- Assessing the capabilities of customer relationship management (CRM) tools in ‘tagging’ any LIBOR related client queries to ensure these are appropriately tracked and reported. This has been challenging in firms where standard query management processes are not all routed via CRM tools and additional workarounds have been required.
Key Priorities for Execution
As the year progresses, there are a number of key areas of focus for Investment Managers as they continue to execute against their LIBOR transition Plans:
- Operational Readiness: Investment Management firms need to ensure their systems and operations are ready for dealing in the new RFR linked securities and that there is no disruption to or loss of continuity in end-to-end processing. A key part of this is the need for Investment Management firms to continue to oversee changes to any services provided by third-parties.
- Consent Solicitation and Active Conversion: 2021 will see Investment Management firms subject to a spike in volumes of consent solicitations for their touch legacy LIBOR holdings. With firms having different support teams handling proxy events and others dealing with consent events, it is vital that these teams understand the LIBOR transition events so they are correctly processed and can handle expected spikes in activity.
- Replacement Rates: While firms are cautious in their approach to ensuring they switch to a new benchmark that will is comparable to LIBOR, it is vital to implement the change at a point that ensures clients have sufficient time to make an informed decision about their investments, and communicate changes to clients in a manner which is fair, clear, and not mis-leading.
- Conduct risk management: Even where firms have augmented their existing risk management framework to mitigate conduct risks arising from the LIBOR transition, continued oversight efforts are required. In particular, it is vital to monitor key risk indicators and ensure that mechanisms being relied upon to manage the LIBOR conduct risks continue to be operated effectively by the business.
As we enter the execution phase Investment Management firms need to be focused on these priorities, on delivering the changes necessary to make the transition from LIBOR to the new RFRs successful. Regulators will be paying close attention, and firms regulated by the FCA can expect increased supervisory scrutiny in this area throughout 2021.
 FCA ‘The final countdown: Completing sterling LIBOR transition by end-2021’ 11th January 2021 (noting that this does include an exception for hedging existing positions).
 FCA ‘Benchmarks Regulation – proposed new powers’ 23rd June 2020