Since 2017, regulators such as the FCA and PRA, alongside the Financial Policy Committee, have been highlighting the need to move away from relying on LIBOR, the benchmark rate used for around $170tn of derivatives contracts, along with loans, notes and securitised products such as mortgage-backed securities.
Whilst the approach taken so far has been one of encouragement for a “market-led” solution, the relative lack of progress to date has prompted the Financial Conduct Authority and the Prudential Regulation Authority to issue letters to the CEOs of large banks and insurance companies, requiring them to submit risk assessments as related to LIBOR retirement. Plans must have board approval and a nominated senior manager with oversight and are due by 14th December 2018.
Stay current on your favourite topics
Pressure is building, partly due to the removal of banks’ need to contribute to the daily LIBOR rate submission beyond the end of 2021 – which many posit as the “death of LIBOR” – but also due to the complexity of the solution; no single rate is being sought to replace LIBOR, but rather multiple solutions depending on currencies and asset type.
Most organisations are already swamped with regulatory programmes such as MiFID II, SFTR, and FRTB. In addition, the pressure and uncertainty around Brexit is presenting significant resourcing and thought leadership challenges to departments already decimated and under-resourced from a decade of post-financial crisis cost cutting.
However, all is not lost. There are a number of preparatory steps large financial institutions can take to establish coherent and co-ordinated programmes of work to address the LIBOR issue:
- Establish a firm-wide programme with representation from front-to-back impacted functional areas;
- Create a trade catalogue of live instruments, trades and packages impacted by the changes, enriched and mapped to likely end state scenarios;
- Identify technology systems impacted, for example those with hardcoded LIBOR references or with single curve dependencies. For many organisations this will commence with a review of risk engines and the risk curves associated with the different LIBORs ;
- Perform a contract discovery exercise to discover the legal impact of potential changes.
As the landscape changes, and increased certainty about the target state is known through industry bodies and working groups, it is important to develop and maintain agile impact analysis tooling to provide “what-if” simulation modelling. The seeds of this tooling can be put in place now, alongside the trade catalogue mentioned above.
Once the target state is known, a series of migration projects must be established and delivery teams formed to execute the realignment. This is likely to incorporate new processes, reporting, risk modelling, and market data and controls to name a few. Trade migration events will need to be planned and executed, combining input and co-ordination across all impacted functions. Most FS organisations have experience of this activity, but this time around the scale and co-ordination is likely to be an order of magnitude bigger than previously experienced.
Whilst the end state for the replacement of LIBOR is not yet fully understood, by acting now, firms can be prepared for the inevitable rush in the lead-up to the expected 2021 target date.
Citihub Consulting specialises in the delivery of strategic change for our financial services clients. Our team of experienced industry practitioners create, manage and execute effective programmes of work across the front-to-back business and technology stack, either embedded within or working alongside clients’ teams.