Other parts of this series:
Throughout 2020 financial services firms have focused on launching new Alternative Reference Rate (ARR) products and their own operational readiness to commence transition. Communication aimed at raising client awareness and educating clients on the impacts of the transition has also been common across the market.
As underlying market liquidity starts to build, the focus is now turning to client readiness for active transition and communication, with corporates and SME (small medium enterprise) being taken to the next level of detail and complexity.
The burden of education and support of SME customers should fall heavily on financial services providers.
Over the last three months we have seen flagship examples of large corporates (such as a global pharmaceutical firm, an energy company and a consumer goods firm) leading the market and actively transitioning and participating in new Risk-Free Rate (RFR) transactions. We have also seen the sterling bond market switch to the Sterling Overnight Index Average (SONIA), and product conventions have quickly converged.
There is broad market support from broker dealers for the switch default pricing convention for Interest Rate Swaps to SONIA from the 27th Oct 2020.1 With the passing of the September 30, 2020 deadline for sterling lenders to offer non-LIBOR linked alternatives, and the mandatory inclusion of contractual conversion mechanisms in new or refinanced LIBOR contracts, momentum should accelerate quickly as the end of Q1 2021 deadline date—to cease all issuance of LIBOR linked loan products (that expire after the end of 2021)—approaches.
What will small and medium enterprises need to do?
Large corporates with experienced treasury teams are aware of the change and commenced planning (and, indeed, the Bank of England is supporting with seminars2 and communications to educate). However, there are concerns for small and medium enterprises, whose demand for credit and liquidity is increasing under COVID 19 but who do not have the time or, potentially, the skill to assess this. The burden of education and support of SME customers should fall heavily on financial services providers.
The range of clients falling under the SME banner—client type, size and sophistication—as well as the level of pressure many of these firms are under, or may experience over the next year as we possibly fall into recession, presents financial services with an array of conduct risk concerns including mis-selling, negligent advice or poor management of conflicts of interest.
To put this into context: Many of these firms are not expected to regularly access financial markets and understand the nuances of an RFR, let alone the new product complexity emerging from some designs. This should make taking out new loans and reviewing options for dealing with legacy exposure particularly challenging.
What the supervisors say
The Financial Conduct Authority (FCA)3 and other supervisors have highlighted their concerns about potential conduct risk, and recent activity from the FCA in particular during the COVID period has shown how keen they are to step in where customers are potentially being harmed (FCA took out a Business Interruption Insurance Test case to support SME policy holders, an action expected to be mirrored by regulators globally4).
Helpfully, both the Association for Financial Markets in Europe (AFME) and The Fixed Income, Currencies and Commodities Markets Standards Board (FMSB) have independently published guidance on how to tackle conduct risk5 in the context of Interbank Offered Rate (IBOR) transition. To market participants, this represents a [small] step towards industry standards that can serve to better protect their clients; as a high-level checklist for their transition; and to generally mitigate conduct/litigation risk resulting from the transition.
Guidance emphasizes communication
In their paper, LIBOR Transition: Managing the Conduct and Compliance Risks,6 AFME guidance is focused almost entirely on communications. Specifically, the five areas of guidance it covers are:
- Establishing a client communications strategy
- Content of client communications
- Methods and timing of client communications
- Training and internal communications
- Monitoring and record keeping
These steps represent a strong and helpful starting point. In the next blog of this two-part series, we will further explore these steps, and offer guidance that reaches beyond the AFME and FMSB papers. We’ll also share how Accenture can help firms as they navigate this challenge.
Please feel free to reach out to us if you would like to discuss further.
- “Sterling Swaps Market To Adopt SONIA For Quotes,” MarketsMedia, 29 September 2020. Access at: https://www.marketsmedia.com/sterling-swaps-market-to-adopt-sonia-for-quotes/.
- “From LIBOR to SONIA: a bridge to the future,” Bank of England, 18 September 2020. Access at: https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/from-libor-to-sonia-a-bridge-to-the-future-speech-by-andrew-hauser.pdf?la=en&hash=BEC85B2C15D4A011C8500C23B6650CA067F5A361.
- “Conduct risk during LIBOR transition: Questions and answers,” Financial Conduct Authority, 19 November 2019. Access at: https://www.fca.org.uk/news/statements/conduct-risk-during-libor-transition-questions-and-answers.
- “Result of FCA’s Business Interruption test case,” Financial Conduct Authority, 15 September 2019. Access at: https://www.fca.org.uk/news/press-releases/result-fca-business-interruption-test-case.
- “LIBOR Transition: Managing the Conduct and Compliance Risks,” Association for Financial Markets in Europe, June 2020. Access at: https://www.afme.eu/Portals/0/DispatchFeaturedImages/20200623%20SS_AFME%20LIBOR%20Transition_Managing%20the%20Conduct%20and%20Compliance%20Risks_client%20communications-2.pdf.
- “LIBOR transition – Case studies for navigating conduct risks,” The Fixed Income, Currencies and Commodities Markets Standards Board, June 2020. Access at: https://fmsb.com/wp-content/uploads/2020/06/libor-transition-case-studies-for-navigating-conduct-risks.pdf.