1. FCA Publishes a Letter regarding LIBOR to Asset Management Firms
On 27 February 2020, the Financial Conduct Authority (FCA) published a letter to all UK registered asset management firms regarding LIBOR transition, urging asset managers to prepare for the end of LIBOR. The FCA mentioned in the letter that the end of LIBOR is a market event and the transition to alternatives is market-led. Firms should not expect or base their transition plans on future regulatory relief or guidance, or on legislative solutions, but to take proactive steps where appropriate. Asset management firms should cease launching new products with benchmarks or performance fees linked to LIBOR and act now if they have LIBOR exposures or dependencies in their fund operations. In addition, a transition plan should be prepared with oversight from the governing body, including specific plans to manage LIBOR transition risks that might involve third-party managers. The FCA expects firms to exercise skill, care and diligence, manage conflicts of interest appropriately, ensure clients are not misled and are treated fairly, and to act in the best interests of clients throughout the LIBOR transition.
KPMG Insight: This is the first Dear CEO Letter issued by the FCA to asset management firms, setting out specific expectations. Similar to the Dear CEO Letter issued to banks in 2019, asset management firms must develop an organised and specific transition from LIBOR to overnight risk-free rates. In particular, they should identify the products, performance fees, existing contracts, and dependencies in fund operating that are linked to LIBOR. Firms should immediately implement transaction activities and embed the principals and expectations of mentioned by the FCA in their transition plans.
27 February 2020 FCA
2. Federal Reserve Bank of New York introduces the SOFR Averages and Index
The Federal Reserve Bank of New York (New York Fed), as an administrator of the Secured Overnight Financing Rate (SOFR) and in cooperation with the Treasury Department’s Office of Financial Research (OFR), announced the publication of three daily compounded SOFR averages: “30-day Average SOFR”, “90-day Average SOFR”, and “180-day Average SOFR”, as well as the SOFR Index, in order to support the USD LIBOR transition. In the production of the SOFR Averages and Index, the New York Fed adopted policies and procedures consistent with best practices for financial benchmarks, including the IOSCO Principles for Financial Benchmarks. Additional information about the policies and procedures related to administration of the SOFR Averages and Index, including the calculation methodology, treatment of non-business days, and revision policy, is available on the New York Fed’s website. In the coming months, the New York Fed intended to update its IOSCO Statement of Compliance to include the SOFR Averages and Index. Tom Wipf, AFFC Chair and Vice Chairman of Institutional Securities at Morgan Stanley, also published a statement to welcome the publication of the SOFR Averages and Index.
KPMG Insight: It is expected that the publication of the SOFR Averages and SOFR Index will further facilitate a smooth LIBOR transition as it provides firms with a redily available, consistent calculation of term rates which can be easily adopted and cited in their contracts. Firms should use the SOFR Averages and index to create new SOFR-based contracts.
2 March 2020 New York Fed
3. Financial Services Agency and Bank of Japan (BOJ) Issues Summary of Survey Results on the Use of LIBOR
The Financial Services Agency and BOJ issued a summary of survey results on the use of LIBOR on 13 March 2020. The survey showed the volume of contracts referencing LIBOR, with approximately JPY164 trillion of assets and notionals of approximately JPY6,300 trillion for derivatives contracts. Most contracts reference USD LIBOR, followed by JPY LIBOR. The survey also found that only a few contracts incorporated fallback provisions. Although most of the entities surveyed had identified business operations affected by the LIBOR transition and had either developed a framework that can continuously track the volume of contracts referencing LIBOR or recognised the approximate volume, the preparedness of business operations for LIBOR transition in Japan, such as IT system updates, is still in early stages.
The survey listed the main actions needed by market participants to prepare for LIBOR transition in terms of customer services and IT systems upgrades. In particular, financial institutions with a large number of contracts maturing beyond end-2021 with no fallback provisions should press ahead with necessary actions for customers and promptly set policies on new products referencing RFR according to the applicable laws of each jurisdiction. Even if the contracts have fallback provisions, financial institutions should also prepare for associated consultations with their customers. They should start employee training and provide communications to customers early to manage conduct risk exposure. Moreover, if financial institutions use LIBOR for their asset and liability management (ALM) and other risk management, they need to consider reviewing their existing management frameworks.
KPMG Insight: In light of the survey results, the Financial Services Agency and BOJ are expected to heighten monitoring of the preparedness of financial institutions in Japan for the LIBOR transition. Financial institutions in Hong Kong can also make reference to the survey results and key action items suggested by the BOJ, such as introducing fallback provisions in new/existing contracts, introducing new RFRs, enhancing employee training and communication with customers, upgrading IT systems, setting up/revising policies, internal indicators for progress management.
March 2020 BOJ
4. FCA issues a statement on the Impact of the Coronavirus on firms’ LIBOR transition plans
The FCA, Bank of England (BOE), and member of the Working Group on Sterling Risk-Free Reference Rates have discussed the impact of the coronavirus on firms’ LIBOR transition plans over the coming months. In a statement on 25 March 2020, the FCA mentioned that the target end date of LIBOR by the end of 2021 remains unchanged, although the FCA sees that some of the interim transition milestones of firms are likely to be affected by the Coronavirus. Alongside other international authorities, the BOE, FCA, and Working Group will continue to monitor and assess the impact on transition timelines and will update the market as soon as possible.
KPMG Insight: Many financial institutions around the globe were expecting a delay to the LIBOR end date beyond 2021, but the FCA statement reaffirms that firms need to completely move away from LIBOR by the end of next year. We have seen widespread disruptions to bank operations amid COVID-19 and many of them have not put LIBOR transition as a priority for the next few months. We recommend all financial institutions in Hong Kong to evaluate their current LIBOR transition plans to ensure that all planned actions can still be completed within the next 20 months.
25 March 2020 FCA
1. ICMA publishes a quick guide to RFR transition in the international bond market
On 27 February 2020, the International Capital Market Association (ICMA) issued guidance on the transition to risk-free rates (RFR) in the international bond market. The guidance summarised the alternative RFRs over five LIBOR currencies. It also provided guidance on the two IBORs, EURIOBR and EONIA, that are not planned to be discontinued.
The guidance outlined several key areas, including the progress in new issues of RFR-linked floating rate notes and securitisations, the differences between LIBOR and RFRs, a summary of RFR bond market conventions, information of the use and availability of term RFRs, information on fallbacks in IBOR bonds, information on the issues surrounding bonds which already reference LIBOR and which are due to mature beyond the end of 2021, and details of different spread adjustment options.
KPMG Insight: The transition to RFRs is a global issue requiring coordination across different products and markets. Firms engaging in the international bond markets should observe the guidance provided by the ICMA to continuously monitor progress in key transition areas of planning and preparation, in particular, the change in methodology for constructing bond coupons with the use of new RFRs, the implementation of fallbacks, and the spread adjustment applied in relation to legacy LIBOR bonds.
27 February 2020 ICMA
2. FASB Issues Guidance to Assist in Transition Away from Interbank Offered Rates to New Reference Rates
On 13 March 2020, the Financial Accounting Standards Board (FASB) released the Accounting Standards Update that provides temporary optional guidance to ease the burden in accounting for reference rate reform. The Accounting Standards Update aims to address the operational challenges raised by stakeholders and to simplify the process of migrating to new reference rates, as well as to reduce transition-related costs. The new guidance provides certain optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate that is expected to be discontinued.
However, the expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after 31 December 2022, except for hedging relationships existing as of 31 December 2022, where an entity has elected certain optional expedients for and are retained through the end of the hedging relationship.
KPMG Insight: The new FASB guidance provides additional information to address potential accounting challenges expected to arise from the transition in respect of contract modifications and hedging relationships which could result in significant P&L impact. The release of the new guidance can be observed as a positive indicator that proposed accounting amendments have been generally well-received by industry players. Firms must consistently follow the latest accounting developments to ensure that they apply the appropriate changes for all contracts and correctly reflect related downstream accounting and reporting impacts.
March 2020 FASB
1. KPMG is featured in LIBOR Risk Quarterly Report
The report provides an overview as at the end of Q1 2020 the progress of LIBOR transition in the market and initiatives undertaken by regulators and industry bodies across different jurisdictions. It also presents analyses of associated risks and market impacts from different aspects such as pre-cessation of LIBOR, adoption of alternative risk-free rates, fallback protocol and language for LIBOR linked contracts, viability of synthetic LIBOR, hedging accounting, operational uncertainties, cost of transition and the risk of delay. KPMG is featured in the report where Chris Dias, the global co-lead of LIBOR solution at KPMG, discusses the operational uncertainty and challenges in the transition.