LIBOR Transition: Focus on Conduct Risk

December 10, 2019

On 19 November 2019, the UK Financial Conduct Authority published “Questions and answers for firms about conduct risk during LIBOR transition” to remind firms of the conduct risks associated with entering into LIBOR-referencing transactions that endure beyond end-2021.

It is now well-known that LIBOR is expected to cease after end-2021, when the voluntary agreement of panel banks to continue to submit to LIBOR ends.  Firms and other market participants need to have removed dependencies on LIBOR by this date to avoid disruption when publication of LIBOR ceases.  In anticipation of firms increasing their efforts to transition away from the use of LIBOR, the FCA has published the Q&As to identify potential conduct issues arising from this transition under the following key themes: (1) governance and accountability; (2) replacing LIBOR with alternative rates in existing agreements and offering new products based on risk free rates; (3) communicating with customers; and (4) investing on customers’ behalf. In this alert memorandum, we set out the key points from the Q&As including a checklist for conduct risk management, and an update on the LIBOR transition process.

Key Points from the Q&As

  • Buy-side as well as sell-side firms should be preparing for LIBOR transition.
  • LIBOR transition should not be viewed as a narrow legal and compliance task.
  • The FCA does not take a position on whether to replace LIBOR in legacy contracts by inserting “robust fall-back provisions” or by converting to alternative rates. However, the transition should not be used to move clients to rates that are “expected to be higher than what LIBOR would have been”. We do not think the FCA requires firms to accurately predict whether a rate will be higher than LIBOR. The point is to be fair, clear and not misleading to customers.
  • The Q&As offer a simple method of demonstrating that customers have been treated fairly: adopting a replacement rate that aligns with the established market consensus, and is recognised by relevant national working groups.
  • Firms are not expected to give up the difference between LIBOR and SONIA resulting from the term credit risk premium built into LIBOR.
  • The FCA will monitor firms’ progress on ceasing new LIBOR cash contracts that mature beyond 2021 against the target date of end-third quarter 2020 set by the market-led Risk Free Rate (“RFR”) Working Group.
  • Firms can provide an objective overview of the benefits, costs and risks of a range of alternatives to a client’s existing LIBOR-linked exposure, without inferring investment advice.

Please click here to read the full alert memorandum.