LIBOR to RFR Transition LIBOR to RFR Transition LIBOR to RFR Transition

Managing Conduct Risks in LIBOR Transition – FCA guidance

On the 19 November, the FCA published clear expectations and guidance for firms on managing the prudential, operational and conduct risks arising from the transition away from LIBOR. The scale and the complexity of the transition process have become apparent to both industry and the regulators as the end of 2021 deadline becomes nearer. This guidance is a critical building block for firms in defining their transition plans, timelines and paths. Speeches by the FCA underline how the regulators expect firms to be planning to move swiftly to reduce exposure and reliance on LIBOR and not to be waiting for all issues to be resolved.

The FCA’s overarching expectation is that:

• firms have a strategy in place and take necessary action during LIBOR transition.
• customers are treated fairly by following the FCA’s rules and guidance.

The FCA states that for many firms, LIBOR transition will impact their overall business strategy and front-office client engagement, and should not just be seen as ‘a narrow legal and compliance risk’. Emphasising firms’ existing obligations, the FCA says that firms must have effective processes and controls to identify, manage, monitor and report risks to their business, including risks associated with critical outsourced functions and conflicts of interest.

1. The governance arrangements that firms should have in place.
   The guidance re-iterates that firms’ senior managers and boards are expected to understand the risks associated with LIBOR transition and take appropriate action to move to alternative rates ahead of end-2021. And where appropriate, firms should identify a Senior Manager who is responsible for overseeing the LIBOR transition and detail the responsibility in their Statement of Responsibility. Firms also need to be considering whether their existing conduct risk framework can be used to address LIBOR-related risks or a separate dedicated programme should be established.
   
   
2. Replacing LIBOR with alternative rates in existing contracts/products.
   The FCA’s overarching concern is that firms should take and demonstrate reasonable steps to treat customers fairly. This includes when choosing replacement rates not moving customers to higher rates than what LIBOR would have been or otherwise introducing inferior terms. However, the FCA does state that firms receiving LIBOR-linked interest are not expected to give up the difference between LIBOR and SONIA, which results from the term credit risk premium that is built into the LIBOR rate, but not into SONIA.
   
   The FCA states that firms are more likely to be able to demonstrate they have fulfilled their duty to treat customers fairly where they adopt a replacement rate that aligns with the established market consensus, reached through appropriate consultation, and is recognised by relevant national working groups as an appropriate solution.
   
   However the FCA does emphasis that given that market consensus on how best to transition across the different products is still developing, firms must ultimately exercise their own judgement on when and how to remove LIBOR dependencies in legacy contracts by end-2021. In this context, the FCA also stresses the importance of keeping appropriate records of management meetings or committees that demonstrate they have acted with due skill, care and diligence in both their overall approach to LIBOR transition and when making decisions impacting customers.
   
   
3. Offering new products with RFRs or alternative rates.
   The FCA emphasises that firms should avoid any new LIBOR contracts that mature after end-2021. It supports the target date that the RFR working group has set to stop new LIBOR cash contracts that mature beyond 2021 and the FCA will be monitoring firms’ progress against this end Q3 2020 target over the course of 2020.
   
   
4. Communicating with customers about LIBOR and alternative rates/products.
   The FCA stresses that all communication should be clear, fair and not misleading and that customers should be given enough time to allow them to consider options and make informed decisions before end-2021. Firms should consider the knowledge and experience of the intended audience and ensure relevant client-facing staff have adequate knowledge and competence to understand the implications on their clients of LIBOR ending. The FCA recognises the fine-line between providing information and advice or recommendations but believes firms can present and discuss alternative products, with an objective overview of benefits, costs and risks without inferring a recommendation.
   
   However the FCA does state that is essential that firms who continue to market, sell or distribute LIBOR products that mature beyond end-2021 explain fully what will happen in the event of LIBOR ending and its effect on the customer.
   
   
5. Firms investing on customers’ behalf and LIBOR transition.
   The FCA expects asset managers to be assessing and working to manage their customers’ exposure to LIBOR in a way that protects their customers’ best interests. Asset managers should be engaging with issuers of LIBOR-referencing securities, derivatives and loans counterparties, to convert these instruments and products to alternative reference rates, for example through consent solicitation processes or bond buy-backs, in good time before LIBOR’s likely cessation. They should also be ensuring they assess and manage risks arising from the transition such as impact on contract continuity, expected interest payments, risks of declining liquidity in LIBOR-referencing products.