LIBOR transition Setting your firm up for success - Deloitte
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LIBOR transition Setting your firm up for success
Contents 1. Executive summary1 2. Introduction3 3. Step 1: Mobilise a cross-business unit and geography 5 transition programme with C-level sponsorship 4. Step 2: Set out a transition roadmap 9 5. Step 3: Identify the risks and implement mitigants early12 6. Conclusion17 Appendix A: Overview of the RFRs across jurisdictions 18 Appendix B: Market events 19 Endnotes20 Contacts22 Download a digital copy of this report, and others like it, at Deloitte.co.uk/LIBORtransition
LIBOR transition | Setting your firm up for success
1. Executive summary
Regulators globally have signalled clearly The purpose of this paper 2. Set out a transition roadmap
that firms should transition away from the This paper is intended primarily for all •• LIBOR transition programmes should
London Interbank Offered Rate (LIBOR) to types of financial services firms. However, include the following key blocks of
alternative overnight risk-free rates (RFRs).1 many of the points set out are also relevant activity: (i) identifying financial exposures
to corporates and other end-users of and defining the approach to transition;
LIBOR underpins contracts affecting LIBOR products. This paper is designed (ii) launching RFR-linked products and
banks, asset managers, insurers and to help Board members and executives building RFR volumes; (iii) transitioning
corporates estimated at $350 trillion understand what is needed to drive the back book/legacy trades; and (iv)
globally on a gross notional basis.2 This transition. switching off LIBOR processes and
figure underscores the extent to which infrastructure.
market participants rely on LIBOR Boards should consider the following three
and demonstrates that a sudden and steps for setting up a LIBOR transition •• Identifying key market and regulatory
disorderly discontinuation of the rate could programme: developments and associated milestones
give rise to systemic risk. The rate is so (for example, the identification of term
embedded in the day-to-day activities of 1. Mobilise a cross-business unit and RFRs and developments concerning
providers and users of financial services, geography transition programme fallback language), and continuing to track
both unregulated and regulated, that even with C-level sponsorship these, is crucial. It may not be possible
identifying a firm’s exposures to it – which •• Given the degree of uncertainty and to take certain decisions or actions until
is just one element of what is needed to complexity, LIBOR transition is likely specific developments occur, which will
transition from it successfully – is a highly to be one of the (if not the) biggest affect the pace of transition.
complex task. Against this background, transformation programmes many
many market participants have already firms have undertaken. Boards should 3. I dentify the risks and implement
embarked on transition programmes, but, establish a coordinated, centralised and mitigants early
as some regulators have pointed out, the senior Steering Committee (SteerCo) •• There are significant risks for LIBOR
pace of transition is not yet fast enough.3 to manage and oversee it. Appointing transition that the Board should be
This in part is because of the absence of a senior manager to oversee and take confident are being addressed. An
any formal regulatory or legal mandate. accountability for the programme is early activity is to agree the mitigants to
It is vital that Boards take action now to imperative for firms globally, but UK these risks and, subsequently, ensure
avoid reputational, legal and commercial regulators have specifically asked some that the effectiveness of the mitigants
risk later. firms to do this. is reported to the Board. Delivery risks
include: (i) the creation of “winners and
Given the degree of uncertainty and •• Firms need to clarify the individual losers” which may result in reputational
complexity, LIBOR transition is likely accountabilities for the SteerCo and damage and claims by clients for redress;
to be one of the (if not the) biggest other programme stakeholders from the (ii) clients’ unwillingness to transition,
transformation programmes many outset. In addition to accountabilities for which may result in LIBOR exposures
firms have undertaken. the transition outcomes and activities, continuing to grow; and (iii) the effects on
this should include accountabilities for financial performance which may result in
“The discontinuation of LIBOR decision making; for example, decisions shortfalls against financial plans.
should not be considered a remote on the timing of new product launches,
probability 'black swan' event. Firms or when to engage and transition specific
should treat it is as something that customers.
will happen and which they must
be prepared for. Ensuring that the
transition from LIBOR to alternative
interest rate benchmarks is orderly
will contribute to financial stability.
Misplaced confidence in LIBOR’s
survival will do the opposite.”
Andrew Bailey, Chief Executive, Financial
Conduct Authority (FCA), July 2018 4
1
LIBOR transition | Setting your firm up for success A more imminent deadline of which Boards should be aware Outstanding derivative instruments referencing the Euro Overnight Index Average (EONIA) and the Euro Interbank Offered Rate (Euribor) are valued at approximately €22 trillion and €109 trillion, respectively.5 These benchmarks are not currently compliant with the European Benchmarks Regulation (EU BMR). Compliance will no longer be sought for EONIA and there is uncertainty regarding the future of Euribor.6 Without compliance, from 1 January 2020 onwards, firms will no longer be able to use EONIA or Euribor for new contracts in accordance with the EU BMR. It is still uncertain whether they will be able to use these benchmarks for legacy trades.7 There is also a question as to whether some flexibility may be offered in respect of this deadline – the working group on euro RFRs has discussed the merits of extending the deadline.8 But, for the time being, firms should plan for a 1 January 2020 cut-off. The Euro Short Term Rate (ESTER), which will replace EUR LIBOR, EONIA and Euribor (or will run alongside Euribor), was confirmed as the RFR for the euro in September 2018.9 2
LIBOR transition | Setting your firm up for success
2. Introduction
“Since the financial crisis, Libor We anticipate that regulatory and supervisory
really has become the rate at which scrutiny will grow across jurisdictions, with What’s the problem with LIBOR,
banks don’t lend to each other.” focused intervention in areas where progress and why is transition difficult?
Mark Carney, Governor, Bank of England, is not happening fast enough. Boards should •• Authorities are concerned about the
May 2018 10 expect questions regarding their timelines, scarcity of underlying transactions.
governance plans, assessment of financial Without sufficient transaction data,
How did we get here? exposures and conduct risks. While initial LIBOR submissions must rely on
Benchmark transition has been on the enquiries might require general responses, expert judgement; this heightens
global agenda since 2014,11 but in July firms should expect regulators’ enquiries the risk of benchmark manipulation.
2017, Andrew Bailey announced that by to become more focused and/or detailed; It is not just the official sector
the end of 2021, the FCA would no longer they should also expect regulators to ask for that is concerned. Panel banks
seek to compel or persuade panel banks accurate quantitative analysis. have expressed discomfort about
to submit quotes for LIBOR, making clear providing submissions “based
that reliance on LIBOR could no longer A further development which may complicate on judgements with little actual
be assured beyond this date. LIBOR is timelines is the risk that the UK exits the borrowing activity against which to
a benchmark which is regulated and European Union with “no deal” in March 2019. validate their judgements” and, as
administered in the UK but used globally. LIBOR is currently authorised under the EU a result, the FCA has “spent a lot
Any discontinuation of LIBOR will therefore BMR. However, in a no deal scenario where of time persuading panel banks to
have a global impact. the UK is deemed a third country with no continue submitting to LIBOR”.15
equivalence, LIBOR could become a third-
What now? country benchmark for the purposes of the •• LIBOR is widely used and the value
2018 has seen regulators turning up the EU BMR. In these circumstances, and in the of outstanding contracts is huge.
pressure by stating that firms should absence of equivalence, the administrator For example, it is estimated that
treat the discontinuation of LIBOR as a of LIBOR would need to re-apply under the contracts referencing USD LIBOR are
certainty and that progress has not yet recognition or endorsement options within valued at $200 trillion, with the vast
been fast enough.12 In the UK, a joint the Regulation, before 1 January 2020 when majority linked to derivatives. Retail
“Dear CEO” letter from the UK Prudential transitional provisions under the EU BMR mortgage contracts which reference
Regulation Authority (PRA) and the FCA, expire. Otherwise, EU-supervised entities USD LIBOR are valued at $1.2 trillion,
was sent to large banks and insurers in could be prohibited from using LIBOR. This with 57% maturing by the end of
September, requiring Boards to sign-off paper does not deal with this issue, but it 2021.16 Contracts maturing beyond
on a comprehensive risk assessment of is highlighted here as something that firms this date should be revised by
LIBOR transition in respect of their firms.13 should monitor and of which they should be incorporating fallback provisions, or
Swiss regulators have also been proactive aware. transitioning to a new RFR.
in reaching out to firms. Further afield, US
regulators are holding bilateral discussions
with firms, and the Bank of Canada has
called on financial institutions to consider
their “readiness” for benchmark reform.14
3
LIBOR transition | Setting your firm up for success
What's the problem with LIBOR and why is transition difficult? Continued
•• RFRs are constructed differently to LIBOR. •• Market-wide and cross-jurisdictional •• The future of LIBOR is uncertain. It is
RFRs are nearly risk-free, whereas coordination might be limited. unclear whether or not LIBOR will
LIBOR reflects perceived credit risk. Regulators want transition to be a be permanently discontinued by
Fixings for RFRs therefore tend to be market-driven outcome. As a result the end of 2021. Firms should plan
lower. This could mean that a trade divergent market approaches could for cessation, but they should also
which transitions from LIBOR to a RFR emerge. For example, for transition consider a scenario where LIBOR in
has a different market value over time to work, the following (among other some form continues post-2021.
than it otherwise would have had. In things) should be in place: (i) fallback
other words, there might be “winners language; (ii) a term structure for In summary, LIBOR transition is a
and losers”. Valuation methodologies certain products; and (iii) solutions complex undertaking. Its success will
should be revised. Liquidity in the to any hedging impacts and hedge depend on active collaboration between
market for RFRs is also likely to be a accounting concerns. To achieve a range of different market participants
restraining factor, certainly early on. this, alignment and coordination and the official sector (see Figure A).
are needed between industry
participants, legal advisors and
accountants. Without coordination,
the risks of transition may increase.
Figure A: Key dependencies
Buyside firms
Demand from buyside firms
is vital to building demand in
RFR-linked products and will
help speed up transition
Banks and Trade associations
sellside firms Will play a key role in the
Will lead the design development
and issuance of of protocols, standards
RFR-linked products, and fallback
enabling liquidity to language
build
where necessary
Regulators Market
Will continue to drive infrastructures
market participation to Need to be ready to
ensure firms do more, support trading and
faster and may use their clearing in all RFR-
powers to drive progress linked products
where necessary
4
LIBOR transition | Setting your firm up for success
3. S
tep 1: Mobilise a cross-business unit and geography
transition programme with C-level sponsorship
Boards should establish a coordinated, While there is no right answer to the
centralised and senior SteerCo to question of which senior manager should
manage and oversee LIBOR transition. UK oversee benchmark transition, we have
regulators have asked the largest banks seen the Chief Financial Officer, the
and insurers to appoint a Senior Manager Chief Risk Officer or, in some cases, a
to be accountable for and oversee LIBOR combination of the Chief Financial Officer
programmes, in accordance with the UK and markets/business leads taking on this
Senior Managers and Certification Regime role. It may be appropriate for sponsorship
(SM&CR).17 This should be documented to change during the programme lifecycle.
in the Senior Manager’s Statement of For example, once the transition plans
Responsibilities and the firm’s Management are set and ready for implementation,
Responsibilities Map. accountability could potentially move to the
Chief Operating Officer.
There are similar regimes further afield.
In Australia, the Banking Executive As firms mobilise their LIBOR programmes,
Accountability Regime requires the they should consider its unique
registration of senior executives and characteristics. This analysis will underpin
directors of deposit-taking institutions, as the delivery plan. Overleaf, at Figure B,
well as the development of accountability we set out an illustrative LIBOR transition
maps. In Hong Kong, the Managers- programme governance structure. We
in-Charge framework for all “licensed also provide our view on what makes
corporations” applies; and the Monetary LIBOR transition different and what the
Authority of Singapore has proposed implications are for firms.
guidelines to strengthen the individual
accountability of senior managers and
raise the standards of conduct in financial “We can see it coming, and we know
institutions. The Financial Stability Board the impact of a disorderly transition
(FSB) has also produced a toolkit for would be huge. Therefore, a half-
firms and supervisors to use to manage hearted effort or a failure to act
misconduct risk.18 While regulators in these would be inexcusable, especially
jurisdictions have not specifically linked after all we have learned from the
these regimes to LIBOR transition, they experience of the financial crisis.
might do so in the future. Firms that are Moving this core piece of the global
not subject to these rules should consider financial system to a firm and
whether adopting a similar model would be durable foundation is essential and
beneficial in relation to LIBOR transition. worth the cost.“
William C. Dudley, former President and
Chief Executive, Federal Reserve Bank of
New York, May 2018 19
5LIBOR transition | Setting your firm up for success
Figure B: LIBOR transition programme governance structure
Group Board Programme sponsor:
Should be a Senior Manager (for firms subject to the SM&CR)
and ideally a member of the Executive Committee. If not on
the Executive Committee, the programme sponsor should
report to it regularly (monthly), and should chair the SteerCo.
Board Risk Executive Board Audit The terms of reference of the Group SteerCo should be clearly
Committee Committee Committee defined along with decisions and other matters which are
reserved for the Executive Committee and the Board. The
programme sponsor will be the primary point of contact for
engagement with the firm’s regulators.
Programme Sponsor
(ideally an Executive Committee member) Group Board:
Should receive periodic (quarterly) reports from the
programme sponsor, with the Audit Committee and Risk
Committee considering in more detail those matters
Group SteerCo chaired by programme sponsor (e.g. impact of LIBOR transition on financial statements,
hedge accounting, risk identification and mitigation) that
fall within their respective remits.
Group SteerCo:
LIBOR working group Is the primary decision-taker in relation to the transition
programme. Its membership needs to be sufficiently senior
to enable it to take decisions which commit the business (first
Business units Central functions Control functions line) and engage the control functions, without becoming so
large as to impair its ability to take decisions efficiently and
effectively.
Retail Bank Finance Risk
It is essential that the SteerCo looks across the Group as a
whole so as to be able to identify and deal with situations
in which a decision which is optimal for one business unit is
Commercial sub-optimal for other parts of the Group. Furthermore, where
IT Compliance
Bank there is potential for conflicts of interest, these should be
identified and addressed.
Investment Internal LIBOR working group:
Legal
Bank Audit Should be aware of market and regulatory developments as
well as activities happening within the Group. The working
group should deliver regular, “joined-up” and clear internal
communications (fortnightly). It should meet weekly and report
Insurance Tax to the SteerCo.
Risk and Compliance functions:
Investment Should be engaged at the start, when the programme is
Treasury being mobilised to help identify the key delivery risks and the
Management
potential mitigants early, while also being cognisant of the
firm’s transition strategy.
Business and/or region-specific sub-structures
Role of Internal Audit (IA):
Is to challenge the programme governance design, the
approach to identification of exposures and adequacy of
the data, and the approach to the impact assessment. IA
should also formulate an independent view of risks around
the programme which can be used to challenge the approach
initially and on an ongoing basis.
IA should report to the Audit Committee, senior management
and SteerCo setting out its view of the progress and status of
the LIBOR programme.
6LIBOR transition | Setting your firm up for success
What makes this transition different? Client awareness and contract •• However, one of the challenges is that
renegotiation should be managed exact, fixed dates for these events have
appropriately not yet been set. Firms should identify
I. There is no legal or •• The absence of a legal or regulatory the work and activities that do not
regulatory mandate mandate may make it difficult for the depend on external market events and
transition programme lead to persuade ensure that these are set out in their
stakeholders that they need to act plans, with target delivery dates. It may
The outcome (transition from LIBOR to
now, particularly where there is limited be the case that many of these actions,
a RFR) and the timetable (end-2021) are
buyside demand for RFR-linked products. such as assessing financial exposures
not set out in legislation, even though
The client outreach and renegotiation and operational impacts, could be
regulators have stated their intentions
process will be complex. Given the delivered early in the process.
clearly and repeatedly.
number of different relationships that
a firm may have with the same client/
The only prospective regulatory
counterparty (including products such
intervention to underpin the transition
as loans, deposits, derivatives, securities, II. LIBOR is deep-rooted
that has been mentioned so far is that of
etc.), a single, coordinated approach to
the FCA – or the benchmark administrator
contacting each client/counterparty is
– concluding that LIBOR is no longer
optimal. LIBOR and other benchmarks are deep-
sufficiently representative. In such
rooted in firms’ systems, processes, and
circumstances, LIBOR would no longer •• For some products, renegotiation may
models (among other things). Transition
satisfy the requirements of the EU BMR, not be needed and a change to the
touches almost every part of a financial
and its recognition as a benchmark for terms may only require notification to
services group: banking, capital markets,
use in new contracts would then cease. counterparties or customers. Those
insurance and asset management. Within
contracts that mature beyond 2021 will
the Group it will spread across different
The consequence of this lack of legislative be the focus of renegotiation efforts.
subsidiaries, branches and countries. This
underpinning is that different (regulated) Moreover, for derivatives, a market
means that a decision concerning LIBOR
firms could reasonably take different protocol will make contract amendments
transition or, say, the development of a
views as to what actions need to be taken much easier, subject to firms and
new RFR-linked product, which may be
and by when. Furthermore, unregulated counterparties agreeing to sign up to it.
optimal for one part of the business, may
counterparties are not directly subject to Amending bonds, which require majority
have unforeseen negative consequences
any regulatory pressure to renegotiate bondholder consent, will likely be more
for other parts of the Group. For example,
LIBOR-linked contracts and therefore challenging.
this could occur where one part of the
may be slow or reluctant to engage.
business starts to renegotiate a loan
Alternatively, some counterparties or Delivery plans should be flexible
contract and looks to amend its provisions
clients may be quicker off the mark and •• Firms need to understand the
beyond just changing the reference rate
expect answers sooner than a sellside firm implications of different scenarios on
(e.g. following a customer request and/or
is able to provide them. A slow response their financial performance and delivery
commercial opportunity). This could in turn
could therefore affect a firm’s competitive programme; and they should be ready to
compromise the accounting treatment,
position in the market. react to changing market events.
because the contractual change could
•• Project milestones should be regularly be deemed a substantial modification
Implications
reviewed and, if need be, revised in (see Section 5 for further analysis on the
Agree the transition strategy and
the event of delays to the agreement accounting risks).
define programme plans early
of industry standards (e.g. to the
•• The transition strategy should reflect
International Swaps and Derivatives Separately, large-scale operational and
key decisions, for example, whether the
Association (ISDA) Market Protocol IT impacts should be factored into the
firm wants to be a “first mover” in the
and any new standardised fallback overall plan for transformational projects,
transition. A “first mover” is a firm that
terminology across products). recognising that there will be linkages
offers products with the new RFR and
between this work and other major IT and
stops issuing products linked to LIBOR.
operational projects. These dependencies
There have already been instances
will require active, ongoing management
of firms offering RFR-linked products,
and should be visible to the sponsor(s).
but, thus far, we have not seen firms
discontinuing their issuance of LIBOR-
linked products. Key decisions of this
type will inform the timeline, activities
and resourcing requirements.
7LIBOR transition | Setting your firm up for success
Implications Implications Firms should consider the areas on
The programme governance structure Firms should develop sophisticated which they will need MI
should be set up in a way that includes scenario modelling capabilities •• The MI should be actionable. For
all the relevant first, second and third •• Firms should articulate scenarios for example, a firm might identify that
line stakeholders transition. They should update them to a trading desk has increased LIBOR
•• It should allow decisions which affect reflect the latest industry and regulatory exposures in the last month instead
one or more functions or businesses to developments and assess the impact of decreasing them in line with the
be identified quickly and escalated to a on the underlying economics of the SteerCo agreed profile for exposure
senior SteerCo (and in some cases the business. The scenarios may need to reduction. Where this is the case,
Executive Committee and the Board) for be updated and the impacts modelled processes should be in place which allow
decision. regularly. firms to determine whether further
action is needed. More time will be
•• However, it should also strike the right needed upfront to establish the starting
balance between allowing for “business IV. Management information position of financial exposures from
as usual” and ensuring the right degree will be challenging to develop which progress can be tracked. This
of control. While this will always be true will likely require significant resource
for any large-scale programme, our view Management information (MI) and key and will remain a work in progress (in
is that the breadth of business functions performance indicators are essential for terms of increasing levels of confidence
and range of countries affected by LIBOR any programme, but in the case of LIBOR in the data) for the early phases of the
transition mean there will be more of transition will be challenging to develop. programme.
these cross-functional decisions to be This is in part because firms are finding
taken. This should be reflected in the it understandably difficult to identify and
frequency of meetings and time that the quantify the extent of their LIBOR-related “A risk-free rate would help
most senior managers are expected to exposures, embedded within products accomplish two goals. First, it would
spend on programme governance. and documentation. See Figure D for more reduce the dependence on any
detail. individual benchmark. Second, it
•• Given the global scope of the
would allow counterparties to select
programme, clarity of internal Implications benchmarks that might more closely
communications will be key. Resourcing Firms should be satisfied with the match the exposures they want,
for the programme manager, to do the completeness and accuracy of input enabling them to better meet the
“joining-up” across the Group and deliver data needs of some derivatives markets.”
the communications, will also be critical. •• Building confidence in the numbers will Lynn Patterson, Deputy Governor, Bank of
To achieve this, the central programme be an iterative process for firms: they may Canada, June 2018 20
should have the capabilities and channels start off with a financial exposure view
to engage proactively across the business that is a best estimate and then refine it
divisions. over time. Firms will need a clear view of
the completeness and accuracy of the
input data. This may not be as much of an
III. Strategic decision-making issue for smaller firms, as they typically
will be needed against a have fewer data sources.
background of uncertainty
LIBOR transition will affect a firm’s product
mix, the behaviour of its balance sheet, the
economics of the underlying business and
its competitive position in the market. It
will require a series of strategic decisions
to be made by the Executive Committee,
and in some cases the Board, against a
background of continuing uncertainty.
Regulators will want to know how the Board
is apprised of progress.
8LIBOR transition | Setting your firm up for success
4. Step 2: Set out a transition roadmap
Figure C: The transition roadmap
Programme Strategic Financial risk Product Customer Legal Technology Finance Engagement
delivery and direction management design and comms and and monitoring
Workstreams readiness operations streams
governance
2018 Design, develop Customer Perform Determine
Assessment
and roll-out new comms contract internal and Monitor Monitor
of financial
products (new and review and external and trade
risks and
product awareness decide on system changes analyse associa-
agreement
Establish Assess approvals/ a response Define
on mitigating regulatory tions’ work
programme current model validation per contract Assess accounting, develop- on fallbacks
actions
team and LIBOR exercises) Assess and type impact on
Start tax and ments and and
governance exposures map processes treasury
identifying Agree potential and
engage protocols,
Set financial changes with and RFR
financial Agree risk updated customer controls
Define regulators working
exposures initial appetite product impact
programme and central groups’
and defining plan and transition portfolio
bankers work
approach to identify risk strategy
transition mitigants
Agree
legacy
Identify portfolio
Start internal transition
launching training strategy
requirements/
RFR-linked
awareness
products
2019
and
building RFR Start
volumes Regular Agree and Define bilateral System Design
LIBOR implement Update or customer solution solution
and
discontinue comms
Execute impact controls multilateral design
LIBOR assess- for key existing products outreach negotiations Review
Start transition ments financial strategy
and update
transitioning plan risks policies and
back book/ procedures
legacy trades Under-
take Enhance
Develop customer processes
and refine outreach and control
transition framework
strategy Define and
deliver MI Implement
2020
requirements and test
Complete System
updates to client build, test,
documentation deploy
and feed client
notification /
consent require-
Deliver ments into
training outreach plan
2021
Start Roll-out
switching off Decommission
LIBOR legacy LIBOR
processes and processes,
infrastructure systems and
technology
2022
9LIBOR transition | Setting your firm up for success
Key transition activities Financial risk management: Firms need Engagement and monitoring streams:
Four key blocks of activity will make up the to have a clear idea of how they will manage A key aspect of external engagement will
transition programme: the financial risks created by transition. be with regulators. Given the differing
Some examples include (i) accounting approaches by regulators, an engagement
i. identifying financial exposures and (e.g. effective interest rate calculations strategy that reflects this should be
defining the approach to transition; and impairment analysis); (ii) valuation developed. With the intensity of regulatory
(e.g. mark-to-market on “day 1” of the interest increasing, this workstream will be
ii. launching RFR-linked products and change and who “wins” and who “loses”); valuable in pre-empting and preparing for
building RFR volumes; and (iii) risk management (e.g. model the expected additional level of scrutiny.
changes, curve construction changes and Firms should reach a view on the prudential
iii. t ransitioning the back book/legacy development of new/adaptation of existing and conduct risks and how they will assess
trades; and RFR risk management tools). these under a range of scenarios
(see Section 5 for more information on the
iv. s witching off LIBOR processes and Differences in definition between LIBOR risks associated with transition).
infrastructure. and RFRs mean that firms need to make
changes to the design and calibration of All market participants will be required
At the initial stage of the programme, valuation and risk management models to play key roles in moving this transition
priorities are likely to include the following for contracts. Hedging strategies should forward. There are a range of events which
components: be reviewed alongside hedge accounting will influence transition and determine
impacts. The challenges are compounded when firms can undertake certain activities.
Programme delivery and governance: by the fact that most markets for RFRs are Monitoring these market events from the
See Section 3 of this paper. nascent and therefore relatively illiquid, the outset will be critical so that firms can
absence of term structures in the rates, respond and adapt their plans accordingly.
Strategic direction: Firms should assess the limited availability of historical data,
financial exposures as soon as possible. and the disparate nature of successor
Ideally, firms should have already reached RFR rates across jurisdictions. Depending “The statements by FCA Chief
an initial view on financial exposures and on current capabilities, the changes firms Executive Andrew Bailey that firms
have a clearer view by the end of the year need to make may extend beyond models must end their reliance on LIBOR by
(although, for some firms this may be to valuation and risk management systems the end of 2021 have been clear and
later). They should also understand how and processes. unequivocal. Market Participants
they will manage these exposures and should be under no misconceptions
reduce them over time. Deciding when Product design and readiness: that LIBOR will continue to exist
to introduce new RFR-linked products Generating sufficient demand from after this.”
and when to discontinue the issuance the buyside will be a key driver of the Cathie Armour, Commissioner, Australian
of LIBOR-linked products altogether will achievability of transitioning by the end Securities & Investments Commission,
be important. UK regulators take the of 2021. Firms should consider issuing a October 2018 22
view that transition to new RFR-linked RFR-linked product by H1 2019, (e.g. a bond
products could happen now, and there is to stimulate market activity). There have
evidence of this happening, with increased already been significant developments in
volumes of Sterling Overnight Index some jurisdictions.
Average (SONIA) and Secured Overnight
Financing Rate (SOFR) trades being cleared Customer communications: Customers
(also see Appendix A and B).21 Firms are already asking for information on the
may develop and utilise bespoke tools impact of transition and the approaches
to support program delivery, such as a that firms will take. A coordinated
LIBOR inventory and planning dashboard communication plan across business units
to support various elements of delivery and geographies, which covers the initial
including (but not restricted to) analysis of education through to detailed customer-
financial exposures, contract repapering, specific discussions, is needed. This should
wind-down tracking etc. See Figure D for happen as early as possible.
illustrative Deloitte insights and MI.
10LIBOR transition | Setting your firm up for success
Figure D: Generating insight to drive transition
Deloitte’s specialist Global LIBOR Analytics practice is guiding clients in the development and expression of analytics insights to support
LIBOR programme delivery. Below, we set out illustrative example outputs and MI.
Business User Example: Financial Impact Leadership Example: Wind Down MI
By understanding the financial impact of moving to a particular Key metrics will enable the SteerCo and programme manager to
curve (e.g. effects on PV, DV01 and cash flows), mitigation track the progress of their programme deliverables.
strategies can be devised. This will enable business users to
make strategic decisions as they progress with implementing
their transition plans and client outreach.
11LIBOR transition | Setting your firm up for success
5. Step 3: Identify the risks and implement mitigants early
A disorderly transition from LIBOR would Boards and programme managers should
be detrimental to individual firms as well use their understanding of these risks to
as to the market more broadly. There drive the activities or solutions needed to
is, therefore, a strong incentive for each mitigate them. Below, we set out our view
individual firm to identify and manage of some of the top risks that may arise
delivery risks as early and efficiently as as well as how they could potentially be
possible to avoid problems further down mitigated. This is not an exhaustive list, but
the line. rather illustrative of the risks and potential
mitigants that may be considered.
Figure E: Overview of key risks and potential mitigants
Insufficient industry action, Contractual continuity gives rise Accounting implications may
because transition is not to legal risk result in de-recognition of
mandated by regulation or contracts and/or discontinuation
√√ Analyse contractual language and affected
legislation, leads to delays and/or counterparties early of hedge relationships
sanctions √√ Amend contracts to address permanent √√ Identify instruments that might be affected
discontinuation scenario by accounting issues
√√ Educate senior stakeholders on why it is
√√ Ensure compliance with EU BMR √√ Consider whether repapering is needed
essential to mobilise and fund a programme
√√ Engage with industry working groups, central and evaluate how existing hedges might be
banks and regulators affected by it
Lack of awareness of frontline √√ Ensure all staff and customers are aware
√√ Document plans and progress in relation to
transition as part of an engagement strategy staff leads to poor client outreach
outcomes
√√ Implement an internal communications
strategy Amendments to existing contracts
Financial exposures to LIBOR
√√ Consider roll-out of training programmes, may result in potential tax issues
continue to grow and lead to
leading practices and a “red-flag” system,
systemic risk which highlights key issues employees should √√ Identify the instruments that might be
√√ Establish a strategy and target for reducing consider before taking action or a process by affected
LIBOR exposures which to escalate certain issues √√ Review the nature of amendments to
√√ Consider how best to build demand for existing contracts and review intra-group
RFR-linked products arrangements
√√ Put in place the capability to monitor and The broader impacts of transition, √√ Ensure all staff and customers are aware
manage LIBOR exposures including operational issues and
existing regulatory rules, lead to
delays
Firms do not focus sufficiently
Information asymmetries, √√ Ring-fence sufficient time and resource to on the switch from EONIA and
inadequate disclosures and identify and make operational changes Euribor, as well as other global
conflicts of interest give rise to √√ Include broader impacts, and consider wider reform efforts, in 2019 which
rules, such as margin requirements and the
conduct risk results in disorderly transition
Fundamental Review of the Trading Book, in
√√ Establish a clear client communication the initial impact assessment √√ Have a clear view on what is achievable in
strategy time for the 1 January 2020 deadline for EU
√√ Have a system in place to distinguish between BMR
customers e.g. less sophisticated customers Insufficient RFR liquidity makes it √√ Apply lessons learned from the transition of
√√ Ensure disclosures are clear, fair and not difficult to build a curve and price EONIA, and possibly Euribor, to the transition
misleading of LIBOR
√√ Ensure customers understand the risks or
products √√ Monitor benchmark reform efforts across
outcomes they might face from transition √√ Monitor liquidity on legacy LIBOR and new other jurisdictions
RFR-linked products across jurisdictions
√√ Decide whether to contribute to RFR liquidity
by issuing RFR-linked products
√√ Assess whether a term rate is essential for all
parts of the market
12LIBOR transition | Setting your firm up for success
Key risks and potential mitigants
Insufficient industry action,
Information asymmetries,
because transition is not Financial exposures to
inadequate disclosures
mandated by regulation or LIBOR continue to grow
and conflicts of interest
legislation, leads to delays and lead to systemic risk
give rise to conduct risk
and/or sanctions
This puts responsibility for proactive There is a risk that banks continue to issue Moving from legacy products to RFR-linked
engagement on market participants. new LIBOR-linked contracts, which mature products could create winners and losers
Should firms fail to engage, they may miss past the end of 2021, and do not transition – with one party paying or receiving more
key market opportunities, such as building to using RFRs despite this option becoming or less. If the process is not managed
demand for RFR-linked products. They may available. Where this is the case, firms’ appropriately, with the requisite levels
exposures, and associated risks, will grow.
also face regulatory intervention, including of transparency, customers could file
sanctions, if authorities determine that complaints or claims against firms arguing
Potential mitigant: Regulators, such as
they have failed to act in the best interests that they were treated unfairly. This risk
the FCA’s Andrew Bailey, take the view
of their customers or manage risks is heightened by potential information
that “the smoothest and best means for
effectively. asymmetries (e.g. a big bank being on a
this transition is to start moving away
from LIBOR in new contracts”.24 Firms RFR sub-working group and therefore
Potential mitigant: Education of should establish a strategy and target for having more insights than its clients into
senior stakeholders is required to build reducing their LIBOR exposures, which is the advantages and disadvantages of
understanding of why it is essential agreed by the SteerCo and other Executive transition). This could, in turn, lead to
to mobilise and fund a programme. Committees where appropriate. They firms being criticised for failing to manage
The actions and their timing should should consider the ways in which they can conflicts of interest.
be determined by the initial impact build demand in RFR-linked products over
assessment and transition strategy (as the course of the next few years. Processes Potential mitigant: A clear client
and controls will be needed to monitor the
described in Sections 3 and 4 of this paper). communication strategy, underpinned
changes to exposures and allow firms to
Firms should also engage with selected by rigorous programme controls and
take action where progress is not meeting
industry working groups and ensure they documentation, is vital. Firms should have
the milestones set out in firms’ plans.
are “part of the conversation” if they have a system in place to identify and distinguish
not already done so. They should establish certain types of customers which will
a strategy for engagement with central be affected by transition – for example,
banks and regulators and document their identifying the more “vulnerable clients”
plans and progress in relation to transition (e.g. retail clients and small-to-medium
as part of this strategy. sized firms), with weaker bargaining power.
Firms should incorporate appropriate
disclosures which are clear, fair and not
“Firms that we supervise will misleading. For example, many floating
need to be able to demonstrate rate note prospectuses filed with the US
to FCA supervisors and their PRA Securities and Exchange Commission have
counterparts that they have plans included a risk factor on LIBOR reforms.
in place to mitigate the risks, and Firms should set out the risks or outcomes
to reduce dependencies on LIBOR.” that customers might face and have
Andrew Bailey, FCA, July 2018 23 processes in place to ensure customers,
particularly retail clients, understand them.
Moreover, firms should identify, record and
manage conflicts of interest effectively as
disclosures alone may be insufficient.
13LIBOR transition | Setting your firm up for success
The broader impacts of
Lack of awareness of
transition, including
Contractual continuity frontline staff leads to
operational issues and
gives rise to legal risk poor client outreach
existing regulatory rules,
outcomes
lead to delays
The methodologies for calculating LIBOR This could lead to situations in which Boards should reach a clear view on the
and RFRs differ, and therefore amending customers are given conflicting messages extent to which LIBOR is embedded in
legacy contracts to refer to RFRs could from different parts of the business. their systems and processes. The changes
be more financially advantageous for one Further, frontline staff could promote to the operating model are likely to be
party. One of the risks is that contracts products in a way which is not aligned significant and identifying them early
become “frustrated” and are deemed to the wider strategy of the firm, or one will help the programme lead reach a
inoperable and, therefore, are set aside. part of the business could switch to a RFR view on the cost to deliver transition.
Were this to happen on a large scale, it without considering the implications for Furthermore, firms should be aware
would be significantly disruptive. Many another part of the business (e.g. hedge of other areas where there are LIBOR
standard-term legacy contracts contain accounting). dependencies. For example, firms which
fallback provisions which envisage LIBOR have approval to use their own internal
becoming unavailable, but these provisions Potential mitigant: Firms should models to calculate regulatory capital
were not intended to address a permanent implement an internal communications for their trading book exposures will also
discontinuation and cannot be relied upon strategy, ensuring that a baseline level need to consider the interaction between
in the long term should this transpire. of awareness of the wider implications LIBOR transition and the implementation
of transition filters down to the different (scheduled for 2022) of the Fundamental
The courts are usually reluctant to allow functions across the business. This Review of the Trading Book (FRTB). Some
contracts to become frustrated. One may require the roll-out of training firms have identified concerns that a lack
possible outcome is that they look to imply programmes, leading practices and a “red of liquidity and observable transactions in
a term into the contract to fill the LIBOR flag” system, which highlights key issues either the new RFRs or legacy interbank
gap, i.e. one to the effect that if LIBOR employees should consider before taking offered rate benchmarks during the initial
ceased to exist, there would be a substitute action or a process by which to escalate transition phase may cause some risk
rate. 25 certain issues. factors to become “non-modellable”. If
these concerns materialise, the net effect
Potential mitigant: When identifying could be a significant increase in capital
financial exposures, firms should analyse requirements for the firms concerned. It is
the contractual language used and the difficult to imagine that regulators intended
counterparties that will be affected. The transition to have this effect on the FRTB.
vast majority of contracts that run beyond
the end of 2021 will need to be amended Many legacy derivatives contracts
to deal with the permanent discontinuation are currently exempt from certain
scenario. Different approaches can requirements set out in derivatives
be taken across products (e.g. market clearing legislation. It is not clear whether
protocols or incorporating terms which incorporating fallbacks or RFRs into
allow firms to make amendments following these contracts could trigger these
the discontinuation of LIBOR). Appropriate rules. Were this to happen, previously
legal advice should be sought. However, exempt contracts would be subject to
even with voluntary market protocols, all the requirements under the legislation,
firms may not necessarily agree to them. including non-cleared margin rules. In
the US, the Alternative Reference Rates
Firms should note that the EU BMR (Article Committee (ARRC) has sought clarification
28(2)) requires benchmark users to have on this issue. In the UK, the FCA has
robust, written plans in place, setting out suggested that such amendments would
how they would deal with situations where not trigger margin requirements.26
a benchmark is materially changed or
discontinued. Firms should ensure that
they comply with this provision.
14LIBOR transition | Setting your firm up for success
Separately, Solvency II regulations currently
require insurers to value assets and Accounting implications may
liabilities using “risk-free” discount rates Insufficient RFR liquidity result in de-recognition
(calculated by the European Insurance and makes it difficult to build a of contracts and/or
Occupational Pensions Authority (EIOPA)) curve and price products discontinuation of hedge
based on LIBOR and other relevant rates.27 relationships
Potential mitigant: Firms should identify A lack of liquidity may mean that firms are If the benchmark interest rate in a
and include all relevant broader impacts unable to build a curve and price products legacy contract is replaced with a RFR,
in the initial impact assessment that is effectively. This could give rise to client and counterparties will need to assess whether
undertaken and ensure that the relevant counterparty complaints in the future and, this constitutes a substantial modification
stakeholders identify the full extent in addition, to issues for the firm itself in and therefore “de-recognition” for the
of the changes required. Firms should relation to appropriate hedging. purposes of International Financial
ring-fence enough time and resource Reporting Standards.
in their transition plans to address Potential mitigant: Firms should monitor
operational issues and the ways in which liquidity in both legacy LIBOR and new The continuity of hedge relationships,
LIBOR may be integrated into other RFR-linked products across jurisdictions. once benchmark interest rates are
processes. Furthermore, where there are For example, the ARRC estimated in its replaced with the new RFR, will depend
uncertainties or conflicts with existing paced transition that it would need three on various factors. For example, whether
rules, these issues need to be addressed years to develop a liquid derivative market the change in terms of the hedging
by firms (and their trade associations) based on SOFR from the start of its daily instrument leads to a discontinuation of
as part of their regulatory engagement publication.28 There is also a strategic the hedging relationship. There may also
strategies. decision to be taken by the Board, with be implications prior to transition, for
financial and balance sheet implications, on example, for designated cash flow hedges
whether the firm is going to contribute to that hedge LIBOR cash flows beyond the
the liquidity of RFRs by issuing RFR-linked transition date.
products.
Potential mitigant: Firms should identify
Firms should assess whether a term rate instruments that might be affected by
is essential for all parts of the market; for accounting issues. For example, they
example, the FSB has noted that in some should identify their LIBOR exposures and
markets, notably the largest part of the outstanding hedge relationships, consider
interest rate derivatives markets, it will be whether repapering is needed and, if it is,
important that transition is to RFRs rather evaluate how their existing hedges might
than term RFRs.29 Firms could consider be affected by it. Appropriate staff and
whether other changes could be made customer engagement and education, as
to ensure that corporates are still given well as discussions with auditors, should
visibility of cash flow, without a full curve be considered as part of this process.
being required to provide this information.
They should monitor developments from
the RFR working groups, which might
provide further clarity in respect of these
issues. As noted above, some firms are
already testing the market by issuing RFR-
linked debt products.
15LIBOR transition | Setting your firm up for success
Firms should also consider whether there
are implications for other areas of the tax
Firms do not focus sufficiently
Amendments to existing on the switch from EONIA
code in the particular jurisdiction – for
contracts may result in and Euribor, as well as
example, hybrid rules, corporate interest
potential tax issues other global reform efforts,
restriction rules, transfer pricing and thin
capitalisation rules. Where intra-group
in 2019 which results in
LIBOR funding is being replaced, firms
disorderly transition
Before amendments are made to existing should check that the new method of
contracts (loans, derivatives, etc.), firms pricing is on an arm’s length basis in If firms are not ready in time for EONIA
should consider whether this could give accordance with transfer pricing rules, and Euribor transition, this could lead to
rise to a disposal of the existing contract so as to ensure there are no tax return a significant loss in business and major
for tax purposes. If amendments are adjustments to deny the deductibility reputational damage if contracts become
considered material, this may constitute inoperable. Firms should continue to
of financing expenses. Firms should
a disposal of the existing contract and monitor developments regarding possible
also ensure that the new RFR basis is an
amendments to EU BMR transitional
entering into of a new contract for appropriate return such that, inter alia, it is provisions.
corporation tax purposes in certain not capable of being re-characterised as a
jurisdictions. non-deductible distribution or subject to Furthermore, firms should monitor global
stamp duty on transfer (which may apply efforts to reform interest rate benchmarks
A disposal of intra-group contracts may to returns dependent on the results of a more generally. They will need to be
be treated differently to third party business and returns that exceed a normal aware of regulatory frameworks across
contracts. For intra-group contracts, a commercial return). jurisdictions and understand whether
deemed market value disposal rule in the these might affect them – for example
tax code could crystallise a tax charge if Potential mitigant: Firms should identify the EU BMR includes a third-country
tax neutral grouping provisions are not instruments that might be affected by regime which affects non-EU entities
available. However, third party contracts that administer benchmarks used by EU
these tax issues. Where repapering of
may crystallise a tax charge (for the firm or supervised entities.
contracts is needed, a tax advisor should
its customer counterparty) where tax law review the nature of the amendments to
follows the accounting treatment and there Potential mitigant: Firms should be
the existing contract, together with the
clear on what they need to do to meet
is a profit and loss (P&L) impact arising in envisaged accounting treatment. Existing the current deadline of 1 January 2020
respect of the transition (taxable credit or contracts should be reviewed generally for EONIA and possibly Euribor transition.
deductible debit), which may be the case to consider whether any tax events are Moreover, given the timelines, they should
where there is a “substantial modification” triggered in the terms and conditions consider how any lessons learned from
of the contract for accounting purposes. of the instruments. Firms should also EONIA and Euribor transition might be
This should be considered in conjunction consider the impact from the perspective applied to LIBOR transition.
with the accounting considerations. If a tax of the client counterparty and address
event is expected to be material, a change potential obstacles. Transfer pricing Firms should be clear on how other
of tax law could be proposed to spread specialists should review any new intra- benchmark reform efforts might affect
the effect of the P&L impact over several group arrangements. Appropriate staff their businesses. Bespoke LIBOR tools and
tax years (there are precedents for such dashboards may be developed by firms
and customer engagement and education
transition adjustments). to track exposures and the timelines by
should be considered as part of this
which they need to make changes across
process. jurisdictions. The FSB publishes annual
progress reports which outline global
developments.
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