Earlier today, the UK Financial Conduct Authority (FCA) formally announced the future cessation and loss of representativeness of LIBOR. The announcement follows the results of a consultation by ICE Benchmark Administration (IBA), LIBOR’s administrator, which confirmed IBA’s plans for the benchmark’s cessation. The FCA statement includes declarations on the future permanent cessation or “loss of representativeness” of all 35 LIBOR settings.
The announcement of non-representativeness for some LIBOR settings, rather than permanent cessation, leaves the door open for their continued publication on a “synthetic” basis. Under the UK Financial Services Bill, which is currently making its way through the UK legislature, the FCA would gain the powers to direct a change in methodology that would allow for the continued publication of a critical benchmark that is no longer representative of its underlying market. The FCA affirmed that any synthetic LIBORs would be based on a calculation-based methodology, ending their reliance on panel bank submissions. The rates would instead be calculated using forward looking term rate versions of LIBOR’s respective risk-free rate (RFR) replacements, plus a spread adjustment to account for the economic differences between LIBOR and its replacements.
The calculation of the spread adjustment is expected to follow the method developed by ISDA as part of its IBOR Fallbacks Protocol for LIBOR-linked derivatives, which is based on the median difference between LIBOR and its respective RFR replacement over the last 5 years. These fallbacks were incorporated into derivatives master contracts for new transactions in January of this year. In addition, market participants have been able to amend their existing trade documentation with these fallbacks by signing up to the ISDA IBOR Fallbacks Protocol, provided that each counterparty to a trade has adhered to the protocol.
While LIBOR will not be replaced in contracts containing the new fallbacks until LIBOR’s actual cessation date, today’s announcement triggered the fixing of ISDA’s spread adjustment for all LIBOR settings, including those USD LIBOR settings expected to be published into June 2023.
We have come a long way since Andrew Bailey, then chief executive of the FCA, gave his first landmark speech announcing that the publication of LIBOR could not be guaranteed beyond the end of 2021. In the nearly four years since the speech took place, market participants, industry groups and regulatory bodies around the globe have been preparing for its cessation. Today, that possibility has finally become certainty.
That said, the end of LIBOR will look quite a bit different from what anybody could have predicted at that time. With respect to GBP and JPY LIBOR, the publication of synthetic rates will provide additional time for market participants to remediate existing LIBOR contracts. The same is true for the most widely used USD LIBOR settings, as panel banks are expected to continue their submissions into June 2023. Somewhat surprisingly, the FCA now suggests that it might consider further extending the publication of some USD LIBOR tenors beyond June 2023 on a synthetic basis as well. The mere prospect of USD LIBOR continuing on not only into 2023, but perhaps even longer, might tempt some market participants to delay efforts to actively transition legacy exposures. They shouldn’t. We expect the push to proactively remediate existing contracts to accelerate now that market participants have clarity around the economics of following a contractual fallback at the time of LIBOR’s cessation. With a known anchor for a conversion price, parties should look to accelerate the proactive transition of legacy cash products in the coming months.
At this time, any organization delaying their efforts to move away from LIBOR is doing so at their own peril. While the continued publication of some LIBOR settings, whether in synthetic form or otherwise, beyond year end 2021 will help organizations manage the risks associated with existing positions that are difficult - or even practically impossible - to remediate, no LIBOR settings will be freely available for use in new products after the end of 2021. Regulators in the US, UK and across the globe remain steadfast in their expectations that market participants end the use of LIBOR in new products after 2021. Today’s announcements will only increase the pressure and expectations for firms to accelerate the shift to alternative reference rates.
Market participants have long been asking for certainty, which has now arrived. Many organizations have long adopted a wait and see approach to the transition away from LIBOR, waiting on others to make the first move. Some have looked to position themselves as fast followers. With today’s announcement, the finish line is clearly in sight.
For more information, read “Six key takeaways from FCA and IBA’s announcements on LIBOR cessation.”
Subscribe to PwC’s LIBOR Transition Market Update here to read more about these and other developments.
On Wednesday, the SEC announced its 2021 examination priorities. They include a number of familiar topics from previous years, including Regulation Best Interest, anti-money laundering (AML) and the LIBOR transition as well as a significant new focus on climate and other environmental, social and governance (ESG) related risks. The climate examination focus is centered on firms’ business continuity plans and whether they are accounting for increasing climate-related physical risks, particularly for systemically important registrants. The SEC will also direct greater scrutiny toward registered investment advisers (RIAs) that offer investment strategies that focus on ESG factors, including their disclosures, advertising, and proxy voting processes and procedures. It also announced the creation of a Climate and ESG Task Force, which will oversee and develop initiatives to proactively identify ESG-related misconduct. The Task Force’s initial focus will be on gaps or misstatements in issuers’ disclosure of climate risks under existing rules. It will also analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies. The announcement also encouraged and committed to following through on whistleblower complaints on ESG-related issues.
The announcements follow last Friday’s SEC risk alert, which provided observations around digital asset securities from past examinations and foreshadowed cryptocurrency-related focus areas going forward. For investment advisers, exams will focus on a number of topics including portfolio management, recordkeeping, custody control assessments, disclosures, pricing of client portfolios and registration issues. For broker-dealers, exams will scrutinize areas including the safekeeping of funds, registration requirements of affiliates, AML, due diligence, disclosures of conflicts of interest and outside business activities of registered representatives. Securities exchanges and alternative trading systems will be examined to ensure compliance with registration requirements, timely reporting and necessary system safeguards. The SEC will also review whether registered transfer agents servicing digital asset securities are in compliance with transfer agent rules that include shareholder administrative functions and the recording of ownership in the issuance of securities.
The SEC is demonstrating how it can materialize its ESG focus through the evolution of existing requirements, such as by expecting business continuity and disaster recovery plans to reflect the potential for disruption from more frequent and more intense climate-related events. In response, organizations should ensure that they have considered all climate-related risks in their contingency planning efforts, including potential impacts to data centers and employees’ home locations in the current work-from-home environment. In addition, the SEC’s longstanding expectation for truth in advertising has now evolved to cover investment advisors and funds’ ESG strategies. Given the relatively early state of standards for such offerings, institutions need to have high-quality data to demonstrate that investments advertised as meeting ESG criteria truly reflect the impact of the companies comprising that portfolio.
Meanwhile, the digital assets risk alert comes on the heels of the release of the highly anticipated initial registration filing from one of the largest US crypto asset exchanges prior to its direct listing. As institutional interest in digital assets picks up, the SEC is making it clear that the relatively nascent nature of the industry does not excuse non-compliance. At his confirmation hearing this week, SEC Chair nominee Gary Gensler indicated that he intends to work to promote innovation while ensuring consumer protection. In its risk alert, the SEC is doing exactly that - providing guidance and a warning to bad actors while not going so far as to limit the development and growth of digital assets. Considering Gensler’s recent focus on digital assets in his role in academia, expect this to be a priority during his tenure as Chair.
On February 26, the Fed issued final supervisory guidance for effective oversight by boards of directors - also known as Board Effectiveness guidance. First proposed in August 2017, the guidance aims to consolidate supervisory expectations for boards and provide a principles-based view of what the Fed considers in its evaluations of board effectiveness.
The guidance outlines board expectations across five key attributes: (1) overseeing the development of and approving the firm’s strategy and risk appetite; (2) directing senior management to provide sufficient information; (3) holding senior management accountable with respect to risk management; (4) supporting independent risk management and internal audit through risk and audit committees; and (5) maintaining a capable and appropriate board composition and governance structure. Relative to the proposed guidance, the final version further clarifies the five attributes to emphasize where the board should take an active oversight role and provide direction or support to management rather than actively engaging in management activities. In addition, the final guidance no longer suggests that boards provide the results of their self assessments to the Fed and removes a recommendation that board risk committees be involved in determining the membership of management committees.
The guidance will inform the Fed’s assessment of the Governance and Controls component included in its large financial institution (LFI) rating system, which went into effect last year for banks with over $100b in total consolidated assets. The Fed has not yet finalized its complementary risk management guidance for senior management, independent risk management, and internal audit, which was proposed in January 2018 and would also form part of the Fed’s governance and control expectations under the LFI rating system. In addition, although the proposal stated that there would be similar guidance proposed for the intermediate holding companies (IHCs) of foreign banks, that has not yet been introduced by the Fed and the final Board Effectiveness guidance does not apply to IHCs.
The long-awaited final guidance makes few significant changes from the proposal, which should come as a relief to banks that have spent the last three years taking steps to align with the proposed expectations. Banks will also appreciate the removal of the suggestion to provide the results of self assessments as this could have resulted in reticence around the level of candor and comprehensiveness boards would include. Clarifying board expectations will allow them to sharpen their focus on the execution of their duties, which has been challenging given the expansion of scope for board oversight over the last decade and increasing difficulty of distinguishing board and management responsibilities. Given the Fed’s position on the role of supervisory guidance, it is not surprising that this document is written more as a set of principles and effective practices rather than as prescriptive requirements. That said, it is still worth carefully reviewing as it reflects the Fed’s experience with a wide variety of boards and its observations of the practices that contribute to effective board oversight.
These notable developments hit our radar over the past week:
Financial Services Leader, PwC US