The transition to LIBOR presents many challenges for large banks (sell-side firms), not the least of which is Legal/Litigation Risk. This risk can present itself to banks in their LIBOR linked financial contracts as counterparties (buy-side asset managers) may choose to litigate over proposed new reference rates if they believe they are not as favorable as LIBOR, raising potential breach of contract claims on impracticality, frustrated purposes or other grounds. Other areas of legal risk include misconduct by banks in setting any alternate reference rate replacing LIBOR, lack of adequate/transparent and/or timely disclosure to clients/counterparties from changes to reference rates and discriminatory treatment/favoritism of clients/counterparties for new rates and spread adjustments.
To mitigate this risk, banks should focus on proactive client outreach campaigns, methodically and timely communicating and negotiating changes to LIBOR with impacted clients/counterparties transparently to get ahead of any potential litigation. Additionally, banks can test their conduct risk controls around e-communications and voice surveillance to /facilitate/assist/ traders are maintaining good faith, fair dealings. Lastly, banks can define a common approach and playbook to remediating LIBOR impacted contracts to /facilitate/support similar treatment and the same alternate reference rate is given to the same class of counterparties/investors in a given widely distributed security (e.g. asset backed securitizations).
LIBOR driven Legal Risks for Banks
Breach of Contract Litigation Risk
Given the myriad of LIBOR referencing financial contracts between banks and client counterparties across many security types such as loans, asset backed securities, derivatives, structured products and the various interests of clients, breach of contract litigation over changes to LIBOR provisions in contracts is to be expected. Banks can mitigate this risk by communicating early and often over changes to contract provisions with client counterparties in a collaborative style versus a take it or leave it approach, akin to a contract of adhesion. It is critical to have a thoughtful, strategic plan to reach out to renegotiate with client counterparties. To do so effectively in a timely and scalable manner requires a programmatic “factory” approach to operationalizing the communications and negotiation process. Outlined below is an overview of a strong practices client communication approach that many leading banks have adopted.
Client Communications “Factory” and “Command Center”
Once contracts requiring remediation have been isolated, they should be grouped by client/counterparty so that program managers can tally up the number of contracts requiring negotiation by a client. At this point, the client outreach and communications plan can be crafted. Typically, internal counsel of a financial institution (lender/agent bank) whose contract the paper is on, works with the business to draft a standard client contract renegotiation outreach message that should contain basic information on the reason for the outreach, actions required and by when, next steps, and the consequences of not amending contracts. The note might have summary statistics referencing how many impacted client contracts have to be negotiated followed by a list of impacted contracts with Contract name, contract ID, date signed, contract/product type (e.g. term loan) and a summary of which provision(s) need to be amended. Lastly, in this planning phase, escalation processes should be documented for cases in which a contract is bespoke (non-standardized) and a standard response cannot be adopted or in cases in which replacing the reference rate would be impractical or uneconomic to the bank. In such cases, review by a bank’s internal and/or external counsel is required for disposition.
Once the communications note and approach is drafted, communications and negotiations can begin. Industry strong practices are for setting up a central Communications/outreach functional team or “Communications Command Center” within the overall LIBOR Program that is adequately staffed with bank legal advisors, communications staffers, business representatives and operations staffers to conduct the outreach, typically external consultants for scale and lower costs. This Client “Command Center” should reach out to impacted client counterparties early in the process and communicate transparently with fulsome disclosures of new rates to mitigate litigation risk around lack of or untimely disclosure of new rates. The Command Center should manage the Communications Factory process consistently and with detailed playbooks to /assist/support/ that clients are being treated uniformly and consistently to mitigate potential litigation risk with aggrieved clients claiming they were discriminated against and received less favorable rates or conditions than others of similar size/stature. The uniformity of negotiations and communications to clients can serve as a strong defense in the event of litigation and interrogatories/subpoenas.
Legal Risk Stemming from Employee Misconduct
Another area of legal risk from LIBOR replacement includes bank employee misconduct. As happened during the setting of LIBOR given its inter-bank rate setting process, bank employees, typically traders, can fairly easily collude with other bank traders to manipulate reference rates for the self-interest of their firm’s proprietary trading to reap ill-gotten gains. Since the LIBOR scandal and consequent regulatory inquiries and hefty fines, banks have re-doubled efforts to mitigate misconduct risk by more extensive and effective use of e-communications and voice communications scanning tools for all front-line, client facing employees. These tools scan emails, instant messages and phone conversations for trigger words or phrases that are then intercepted by compliance officers and further investigated. Banks should continue to expand their use of such tools for client facing staffers and refine their models of key words, phrases to reduce false positive while getting actionable bad activity early on.
Use of Artificial Intelligence Tools
The use of commercially available Artificial Intelligence (AI) based document search tools can help banks mitigate LIBOR driven legal risk by more easily finding LIBOR impacted contracts using search terms. By understanding their exposure and isolating LIBOR impacted contracts and provisions with term extractions, banks can methodically work to remediate these contracts in a wholesale manner (solve for one and many principle) and reduce the risk of unknown legal risks. These AI tools can also identify exception contracts with bespoke non-standard language that are of inherently higher legal risk which /would/could need to be escalated for legal review and negotiated carefully or terminated.
Accenture Contract Remediation Lifecycle
This article covers the Client Communications and Negotiation (3rd) phase of Accenture’s Contract Remediation Lifecyle as shown below (see steps 7-9).
How we can help
In this blog series we have explored legal risks stemming from LIBOR replacement that banks should consider and more importantly, mitigating actions that can be taken to reduce the probability of legal risks materializing. Despite the myriad challenges ahead, banks that think through the LIBOR remediation process thoughtfully, particularly the client communications and negotiations phase, and standardize and scale their contract management process end-to-end should fare well. And Accenture can help with setting up and staffing Client Communications Factories and Command Centers for banks using Consulting and Operations strong practices and playbooks.
To find out more on the topic and how Accenture can support your LIBOR transition please contact the authors.
Newsletter Contact Person: Lisa Bloomberg
This blog is intended for general informational purposes only, does not take into account the reader’s specific circumstances, may not reflect the most current developments, and is not intended to provide advice on specific circumstances. Accenture disclaims, to the fullest extent permitted by applicable law, all liability for the /development and completeness of the information in this blog and for any acts or omissions made based on such information. Accenture does not provide legal, regulatory, audit or tax advice. Readers are responsible for obtaining such advice from their own legal counsel or other licensed professional.
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