What does a successful LIBOR transition look like for asset managers?
With the expected LIBOR cessation deadline for the majority of currencies of December 2021 moving ever closer, Shailen Patel (Macfarlanes - Head of CFO Advisory) hosted a panel with Christopher Simon (FCA – Manager, Benchmark Supervision), April Richardson (FCA – Senior Associate, Benchmark Policy), Ben Bullock (Bloomberg – Product Manager, Interest Rate Derivative) and Andrew Henderson (Macfarlanes – Partner, financial services regulation). The panel reviewed what asset managers should do and should avoid to successfully transition their business before the compliance deadlines this year and beyond.
What has happened so far?
The panel reiterated that the FCA Dear CEO letter in 2020, which stated that asset managers should set up programmes and governance to manage the transition from LIBOR, and the Q&As published on their website to help firms manage their transition programmes, remain helpful sources for firms to refer to in managing their obligations in relation to the transition to alternative reference rates. An attendee poll conducted during the session showed 55% of firms had begun their transition, but that 45% had not, and 33% had not even identified a Senior Manager responsible.
The FCA’s consultations on its proposed policy for the use of some of its new powers in respect of LIBOR closed for feedback in January 2021. The Bank of England’s Working Group for Sterling Risk Free Rates (RFRWG) consultation, on a successor rate for GBP LIBOR in legacy bond fallbacks, closed on 16 March 2021.
The RFRWG defined the targets and timeline for transition. New issuance with reference to LIBOR is expected to cease in the UK by 31 December 2021 (this has been confirmed since the panel). RFRWG targets for GBP LIBOR are end Q1 for cash and linear derivatives (with risk management exceptions) and end Q2 for futures and non-linear derivatives (with risk management exceptions). Cessation dates in other jurisdictions are mostly in 2021, however, the US is expected to complete transition by June 2023.
Alternative rates to LIBOR have been developed, including for all five LIBOR currencies. The FCA indicated that some jurisdictions are pursuing multi-rate approaches comprising IBOR plus local RFRs. Ben Bullock agreed, stating that the expectation held by some, of the entire market moving from multiple IBORs to a single rate is unrealistic.
What should asset managers expect over the coming year?
The RFRWG suggested that funds that have performance linked to LIBOR should transition to new target rates by end March 2021. The FCA Dear CEO letter states that the RFRWG milestones apply to asset managers and that firms should consider how they adopt these in their plans. This includes thinking about stopping new products with benchmarks or performance fees linked to LIBOR (which is one of the examples in the letter), but also transitioning existing benchmarks and performance fees away from LIBOR. Many large funds have undertaken the transition.
In order to comply with the cessation date for Sterling-denominated contracts, asset managers can be expected to complete their LIBOR transition projects by Q3 2021 or at least have a clear plan to reach fruition by the end of the year.
The FCA is monitoring and assessing the risks for all regulated firms, including in conjunction with the Prudential Regulatory Authority for dual regulated firms, and will continue to collect and review exposure data. The panel observed that senior managers that have been assigned responsibility by their firms for LIBOR transition under the Senior Managers’ Regime can expect supervisory scrutiny, with close checks on their progress through to the implementation date.
The salient points expected to arise from the Q2 2021 consultations are described in Edwin Schooling Latter’s speech: on synthetic LIBOR, including a power for the regulator to require the benchmark administrator to continue to publish the synthetic rate for up to ten years. The FCA encourages feedback on their proposals and its press release on the LIBOR announcements can be seen online.
What do firms need to do to successfully transition in time?
Andrew Henderson outlined some of the challenges that Macfarlanes has seen in firms’ delivery projects. The fundamental risk is that failure to ensure timely transition will result in problems not only with the FCA, but also with a firm’s own investors who will expect their business to be handled efficiently and effectively.
Among the common challenges experienced by firms is the need to establish effective governance of their programmes, including having sufficient seniority overseeing the projects, requiring the right skills or suitable assistance to enable them to discharge their duties well.
Regardless of the size of a firm’s LIBOR exposure, it is necessary to document and record their exposure and the rationale for decisions that they have taken in relation to those exposures.
There are several dependencies that firms will need to identify and resolve. The dependencies can be internal, such as operations sitting between different parts of the business, or external such as vendors and suppliers. The panel noted that regulated firms retain full responsibility and accountability for discharging all regulatory obligations, regardless of any outsourcing arrangements that may be in place, whether intragroup or to third parties.
Syndicated borrowing poses unique challenges. Borrowing funds will typically have a bank leading migration but fund managers must demonstrate that they are negotiating in the best interests of their investors. Credit funds that are lending will need to consider whether they are "lead" or "junior" in the syndicate and whether they are driving terms.
Review of documents will need to be broad, encompassing not only IMAs but those documents relating to equity, debt, subscription agreements, marketing documents, supplier agreements and remuneration contracts that may contain references to LIBOR.
Technological solutions can help, including using AI. It is important to generate good management information to identify issues, to enable audit and to explain the firm’s decisions. Ben Bullock added that while technology is essential for transition, the solutions can be simple and Bloomberg has had a lot of success with customers in Asia through supporting the various risk-free rate compounding conventions for loans and cash securities across its Multi-Asset Risk System product suite. Technology solutions to facilitate a proposed “big bang” transition for the bilateral derivatives market were never developed by any vendor and were probably never realistic. Given the remaining timelines firms will likely need to proceed with simple technology solutions together with some manual efforts.
Firms will need to make timely sensible communications to their investors. They will also need to consider whether their investors, particularly institutions such as pension schemes, have duties to their underlying clients.
The panel reiterated that asset managers should take a proactive approach to identifying exposures and addressing them, for instance, by adherence with the ISDA Protocol where relevant and checking other fall-back options. Firms should not expect or base their transition plans on future regulatory relief or guidance, or on legislative solutions. The FCA expect firms to exercise due care, skill and diligence.