Several regulators and central banks have written to the CEOs of firms in their jurisdictions to emphasise the fact that Libor cessation is very real. In most cases (UK, EU, Switzerland and Australia) a written, often board-approved response is required. In other cases, the response is left open (USA, HK and Singapore) and firms were urged to take early and comprehensive action to prepare for a post-Libor world.
You can find some of the letters as follows:
- UK (FCA and PRA released September 2018);
- EU (ECB released July 2019);
- Switzerland (FINMA questionnaire January 2019);
- Australia (ASIC May 2019); and
- Hong Kong (HKMA March 2019).
It is clear that regulators are taking this very seriously and are communicating directly with senior management of firms.
The content of the letters
The common themes of the letters require the firms to:
- Quantify the risks across the entire organisation (e.g. derivatives, loan products, funding requirements and wealth products);
- Describe the governance arrangements (often naming a specific executive) to oversee the transition;
- Describe plans and projects that are either under way or planned;
- Show progress towards internal and external communication of the changes;
- Have a clear understanding of the client impact and how this is being managed; and
- Manage potential impacts on the markets in which they operate.
Firms are currently responding or have responded to the letters and are often accelerating preparations with fully funded projects aimed at transition pre-2021.
Recently the IOSCO Annual meeting was held in Sydney (May 2019) and a panel discussion was held at the RBA (recording is here) including Andrew Bailey of FCA, Cathie Armour of ASIC and Guy Debelle of RBA. There was clear emphasis that 2019 is the ‘pivotal year’ and the end of 2020 should be considered the target for transition from Libor to Risk Free Rates (RFRs).
The FCA has also published a report In June 2019 on the feedback from the letters they sent in 2018: this makes for interesting reading and shows the preparation of the ‘stronger’ firms for transition.
Current state
The markets trading in the Libor replacements (RFRs) have been discussed recently in one of Chris Barnes’ posts and one from myself. These point to an increase in RFR trading but the volumes still remain well below the equivalent Libor in each currency.
I do not intend to speculate as to the reasons for a seemingly slow transition to RFR trading despite the ‘Dear CEO’ letters and the many speeches by regulatory bodies. However, given the shortening timelines (2020 as regulators are recently stating) I expect to see more trading in RFRs over 2019 and 2020.
Point 5 in the content section above is often an area where firms need to devote considerable time and effort. In this blog, I will concentrate more on the client impact in point 5 and how firms might address this important risk.
Client impact
The client impact is one of the more challenging aspects of the Libor transition plan for many firms. Although it is relatively straight forward to identify the clients and the trades, how do firms ensure that the valuation for any prospective change is ‘independent’ and can pass the ‘fairness’ test?
The Clarus CHARM product can be used simply and efficiently to price a client derivative in an independent system. This is often a requirement of jurisdictions to show transparency and a fair outcome for the client.
Clarus Microservices can also be easily incorporated into spreadsheets without the need for on-site installation. Meaning that the price, valuation and risk can all be calculated easily and it is independent of the firm’s systems.
With the potential for asymmetric understanding of the valuations (client may not fully appreciate the change) and the fact that the deal is bilateral (a limited ability of the client to compare prices) there is significant risk to the firm when advising the client. Simple errors or adding spreads may be detrimental to the client and present conduct-related risks to the firm.
There is clearly an imperative to change the trades to avoid significant disruption after 2021 and Clarus’s products can play a role in ensuring an independent price or valuation is provided to the client.
Summary
The ‘Dear CEO’ letters have highlighted the need for firms to make careful plans to transition from Libor in time for the 2021 deadline.
Firms need to look closely at their own risks and also the needs of their clients cannot be overlooked. Clarus CHARM and Microservices can play an important role in ensuring that client needs are appreciated and central to a smooth transition from Libor.