Financial services organizations, industry working groups and regulators around the globe are working against the clock to successfully replace long-established London Interbank Offered Rates (LIBORs) with alternative risk-free rates (RFRs).
LIBOR's decommission will significantly affect — and pose risks to — a diverse array of business functions being conducted by today's global financial institutions. More than US$370 trillion worth of contracts are said to be tied to LIBOR and other soon-extinct benchmarks such as EURIBOR and TIBOR. RFRs have been designed to overcome the pitfalls of these rates — from minimizing reliance on expert judgement and ensuring a better reflection of the risk-free rate to avoiding past rate-related scandals.
LIBORs currently support a vast range of financial products and valuations across multiple jurisdictions — from loans, mortgages and leases to securitizations, derivatives and more. Global regulators have made it clear the current construct underpinning LIBOR is unsustainable and a threat to global financial stability. The Financial Conduct Authority has gone so far as to no longer compel banks to submit estimates for LIBOR. This shift in attitude towards the prodigious rate has effectively created a deadline of the end of 2021 to implement an alternative. Finance sector players are finding it challenging to navigate an uncertain environment and the transition's potential impact on their products, infrastructure, services, customers — and reputation.
Larger firms, in particular, face the overwhelming challenge of scrutinizing hundreds of thousands — if not millions — of contracts to identify LIBOR-based references, and problematic legal language and develop a solution on time. And beyond how well banks make the transition, how effectively they communicate those changes to the market is deemed critical. Ultimately, we believe financial organizations should be looking at this challenge through four lenses: strategy, legal requirements, operational readiness and client communication.
...automation is being seen as the obvious practical solution, promising huge time and cost savings thanks to a level of speed and accuracy that manual processes simply cannot hope to match.
Given the sheer enormity of the problem, automation is being seen as the obvious practical solution, promising huge time and cost savings thanks to a level of speed and accuracy that manual processes simply cannot hope to match. Ultimately the LIBOR transition opens the door to a fundamental rethink on the use of data and machine-learning techniques to better provide products and services to customers. We are advising clients to viewthe current LIBOR challenge as a 'once-in-a-lifetime' opportunity — a catalyst to making major advances toward innovative digital solutions that will transform their front-to-back infrastructure and processes.
While many firms are taking a 'wait-and-see' approach pending greater transparency from regulators, the good news is that a growing number of smart sector players have begun moving strategically toward artificial intelligence (AI) solutions as the clock ticks down to the transition deadline.
These organizations are structuring LIBOR transition plans that encompass enterprise-wide governance, contract identification, strategic planning, and the inventory of systems, infrastructure and functions that require change. We believe that the use of cognitive technologies — including natural language processing, machine learning and other AI capabilities — will be critical to success.
By automating repetitive, rule-driven processes combined with AI-enabled contract management and workflow, financial firms can quickly unlock an accurate and reliable solution to the transition challenge. Audit trails associated with this process, meanwhile, will provide the starting point to help any organizations facing future claims of misconduct and manipulation.
Beyond making the leap to RFRs successfully, businesses turning to AI will simultaneously position themselves to unlock abilities to streamline documentation making it more consistent, allowing for quicker changes (amendments) and ensuring that documentation and information systems are truly aligned. This will present opportunities to be competitive, significantly reduce costs, enable higher accuracy, faster deployment, improved compliance and risk management. The LIBOR transition presents the opportunity to deliver new functionality transforming a largely manual and error prone process. In addition AI opens up opportunities to better process and analyze data which in turn can translate into competitive advantages.
At KPMG we've brought together two market-leading assets to automate contract analysis and remediation — solving the immediate LIBOR challenge while also creating opportunities for significant future business benefits through transformational digital technology:
KPMG's proprietary Ignite platform is already being used by some organizations to reliably and rapidly extract information and answer specific queries relevant to LIBOR-based contracts, thereby revealing the correct path for a successful RFR-transition journey. The Ignite solution also generates, for customer review and approval, an amended contract based on the AI-based transition path chosen.
Automation as a solution to the LIBOR challenge, as noted, promises ongoing business benefits and advantages that go beyond identifying contracts and needed changes. Going forward, digital capabilities unlocked by a smart LIBOR solution will enable financial institutions to access applicability of AI in key areas such as risk management, compliance, operational resilience and more. Being more data-enabled, for example, will create additional capabilities that could prompt the creation of new products or services for finance-sector clients.
Smart, forward-looking banks are already recognizing this broader reality and avoiding the temptation to let their LIBOR transition unfold in isolation. Some are realizing, for example, the connection between the LIBOR challenge and the Fundamental Review of the Trading Book (FRTB) — essentially a new market-risk rulebook developed by the Basel Committee on Banking Supervision to be applied to banks' wholesale trading activities. Banks are looking hard at the crossroads they now face and whether the time is right to do something fundamentally different in this area and far beyond.
Automation as a solution to the LIBOR challenge, as noted, promises ongoing business benefits and advantages that go beyond identifying contracts and needed changes.
Experience tells us that we are not seeing what we would consider an appropriate sense of urgency in the global financial services sector despite the formidable task ahead and its tight timeline. UK financial regulators recently noted their surprise over the "very different states of readiness for dealing with the transition and associated risks demonstrated by plans submitted." They also urged against firms taking a "wait-and-see" approach.
But sector players are not entirely to blame for being slow off the mark on this complex journey. As noted, they unfortunately also face a troubling reality amid the number of dependencies associated with the transition, the need of clarifying guidance from standard setters and the potential intervention from both regulators and legislative bodies to pave over some seemingly insurmountable hurdles.
Until banks and financial businesses know more regarding the fundamental 'building blocks' that will be instrumental to their success, we may see a continued reluctance to accelerate investment in solutions. But firms cannot simply sit idle pending more action from industry bodies and other key player. There is no time to lose and tapping into AI will give organizations the fastest and most-reliable solution to today's — and tomorrow's — business challenges.
Several leading organizations in the global financial services sector are discovering— with KPMG professionals' insights and guidance — the immense impact that a strategic, AI-enabled transition to LIBOR can have on their efficiency and competitive edge. Tasks that would typically take up untold hours — if not days — of human productivity are being reduced to seconds thanks to AI's remarkable capabilities.
One major global bank recently turned to a KPMG firm and our Ignite AI platform to assess more than 25,000 contracts representing billions of dollars in exposure — a formidable task that would have required an estimated 15,000 hours of manual work equivalent to four paralegals or lawyers working full time for about 22 months.
Much of the key information was typically buried across a huge array of PDFs and simple text documents that would have been almost humanly impossible to track down manually in advance of the 2021 RFR-transition deadline. We were able to successfully identify and extract all relevant contract details in a fraction of the time for a fraction of the cost, creating a comprehensive new database that will enable the banking giant's LIBOR transition. Automation typically completed within seconds a huge array of contract identification and analysis tasks that each would have taken humans hours upon hours to complete. Beyond the remarkable time savings, the automated LIBOR solution boasted an accuracy rate of up to 98 percent — versus about 85 percent for manual processes.
We recently completed another successful transition for a global banking giant that needed to identify, analyze and convert to machine readable format thousands of loan contracts — each up to several hundred pages long. The bank had previously done similar proof-of-concept work with about 20 other consulting firms, technology vendors and AI boutique shops and was pleased to note that Ignite proved to be the only comprehensive solution that fully met its needs.
As many financial firms are discovering, the transition is too complicated to be tackled merely with software tools, given the complexity of working with unstructured data and converting countless complicated text documents to a machine-readable format. We've kept Ignite in a much more open format that makes it unique in the market — letting us achieve very high results across a range of use cases. Beyond LIBOR, our approach provides crucial new capabilities and advantages for future success thanks to the digital transformation being implemented as we convert key text documents to machine-readable forms.