Reviewing the latest trends and challenges surrounding LIBOR transition and the adoption of alternative reference rates

By Shannon Harris, Senior Research Executive, CeFPro

The removal of LIBOR from the financial industry is no easy feat, with trillions of contracts and documentation referencing the rate it will be a goliath task to make the transition a reality. Thus far, the path towards conversion and adoption of new reference rates has appeared complex. Although several institutions have begun planning for the subsequent demise of LIBOR there remains many unanswered questions. Many institutions are unsure of when to start adopting new reference rates, initially there has been some take-up from individual firms but most are waiting for a catalyst to jump start the transition. On top of this there are queries on transition plans, customer satisfaction, cross currency operations and the general impacts on wider markets; addressing these challenges now will ultimately prevent future issues and create a smoother transition plan.

In preparation for The Center for Financial Professionals’ upcoming IBOR Europe Forum, we conducted an extensive research study into LIBOR Transition. We conducted multiple interviews, surveys and questionnaires with over 100 industry professionals leading the way. The study allowed us to gain insight into financial institutions across the UK and Europe and find out their key concerns with the removal of LIBOR. After collating the data we identified the top 3 concerns faced by majority of participants, below is an insight into each of these areas.

International variations

One of the leading concerns from survey participants was the global variations in adoption, pace of change and reference rates. Since the announcement of LIBOR phase out the UK, US and EU have all taken different approaches and are set to adopt different replacement rates. Looking at the bigger picture this disconnect between international bodies creates a vast amount of problems for those working across currencies. On an individual level it raises questions on how firms working across multiple jurisdictions can operate efficiently. Below are just a few comments received highlighting financial professionals’ key concerns;

“One thing we are looking into is the different take up pace between the US, UK, EU, Swiss and Japan. You would like to see greater cooperation, an implementation of change globally. We want to see more global cooperation between banks and industry bodies. Ideally, we would only want to make these changes once, it will be incredibly costly and difficult to make these changes in different jurisdictions”

“Another challenge LIBOR transcends across products and regions; SOFR is for the US and SONIA for the UK and €STR for EU. Can anyone actually explain what this all means and how will companies manage multi-currency transactions?”

“There are a lot of different aspects on what the different currency groups are doing, their thoughts, how they differ and how the market will work in a multi rate environment. The market will need to understand the nuances between the different rates and understand what is the most appropriate one to use for different products. If we don’t fully understand the global variations how on earth are we supposed to communicate it to each other?”

Communication

During our research we also touched on upcoming priorities and areas which teams will start dedicating more time to over the coming six months. One such area mentioned by several financial professionals was the process of creating an effective communication plan to relay the changes of LIBOR phase out to internal teams, customer, clients and corporates. Moving onto alternative reference rates is set to bring a large amount of change to the industry, so ensuring you have a strong education and communication plan will largely limit the risks of transition. Highlighted below are a few of the main comments we received relating to communication and education;

“From a front officer perspective you need to make your clients fully aware of what you are selling them. If you’re still selling LIBOR related products you need to make sure they are aware SONIA exists and the market is moving to that. It’s imperative you are transparent about what you are selling and to who. You don’t want someone coming back and say I didn’t know that would change and I am not happy”

“There is a whole education campaign which needs to happen with your client base. They are used to writing loans and doing hedges on IBOR terms, but suddenly you have to do it on these replacement rates which probably don’t look the same or do it to the same level as IBOR. You need to overcome the fact that looks like a more expensive spread that you are charging, so education people on why the numbers are different in the first place” 

“There are some key questions on the education side which need to be answered, for example; What is the right level of information you can pitch to people, how frequently do you update people and what kind of information do they need? You need to better understand the level of knowledge out there and create a base line. Then keep increasing that base and building on the education you have provided”

“An interesting observation is that preparation on communication plans varies depending on the size, scope and nature of the firm. The house hold names are far down the line, but some smaller FIs and boutique asset management firms due to constraints on resources etc. are not that far down the line. There needs to be a hand holding piece from the larger firms to their counterparts or even their clients, so there is this difference stages of preparation which is also a consideration”

Conduct Risk

Following on from the above, another key issue raised was the conduct and reputational risks produced from phasing out LIBOR. Moving onto alternative reference rates could create disgruntled customers and clients if they are miss sold products, miss-treated or not fully informed of the impending changes. In a worst case scenario the removal of LIBOR could generate lawsuits or unfavourable attention for some financial institutions. Throughout our research several professionals agreed that having an effective education campaign could assist in reducing conduct risks. However, at this stage of the process it’s not fully known how customers/clients will react to the changes. Below are a few quotes we received during our study which demonstrate some of the leading questions and concerns around conduct risk;

“A lot of the FIs have been reprimanded as they have been miss selling stuff, so if you continue to miss sell LIBOR products is there a risk you are running as you sold a product knowing it would be discontinued. You also have to consider if there a conduct risk in asking people to move to a new product when it is still settling into normality and the liquidity. They may say I was not aware of all the risks and blame you for that. I think the banks are cautious, you can’t advice people what to do, you need to inform them and let them make their own decision”

“A massive thing we are looking at right now is conduct risk. It’s about demonstrating you have it under control, but how you do that isn’t determined. It would be helpful to know what regulators expect from us and how they will measure if we are treating our clients correctly”

“This is the crunch area where we have a lack of readiness by customers and lack of readiness by banks. You have a space where there are higher conduct implications, there may be negative impacts for some customers and we want to avoid those outcomes. Client outreach could be the key to limiting impacts and making sure people are aware of the change that is happening and the impact on the products they are buying”

To summarise from the above, multiple financial institutions have already begun the painstaking work to prepare for LIBOR phase out. Ahead of 2021, the financial industry will have to adapt to these changes and plan for transition. The adoption of alternative rates raises a number of questions and has several obstacles in terms of infrastructure and re-documentation. Plus we do not fully understand the implications of working cross currency and the influences these changes will have on customers and clients. Thinking forward industry professionals must be aware of the unintended consequences of transition and monitor things such as customer outreach, conduct and reputational risk. The coming twelve months will be a vitally important time to see how financial institutions develop their planning and take the initial steps towards total transition.

In an attempt to generate collaboration and thought sharing The Center for Financial Professionals will be hosting the IBOR Europe Forum on the 5^thof November in London. Throughout the compact gathering handpicked industry professionals will share their insight on various challenges such as global variations, risk free rates, term rates, communication, conduct risk, liquidity, systems and more. The event boasts an exquisite line up of industry speakers and just some of the confirmed institutions presenting at the event include;

NatWest Markets | Goldman Sachs | Lloyds Banking Group | Deutsche Bank | Société Générale | Barclays | Bank of America | SMBC | Wells Fargo | Credit Suisse | JP Morgan and many more