Knowing the history of interbank offered rates
Following the publication of the PRA & FCA’s Feedback on the Dear CEO letter on LIBOR transition, Steve Farrell looks at what conduct risks financial services firms face as they transition away from Interbank Offered Rates and those risks can be managed effectively
As firms transition away from using Interbank Offered Rates (IBORs), familiar risks of market and customer misconduct could resurface.
The risks of misleading clients; market abuse including insider dealing and market manipulation; anti-competitive practices such as collusion and information sharing and risks arising from conflicts of interest could reappear.
Firms should assess conduct risks arising during the transition, using top-down and bottom-up management information (MI). Primary responsibility for this lies with the first point of contact rather than compliance or risk functions. Each firm should consider the interests of individual customers and counterparties.
There are a number of Financial Conduct Authority (FCA) principles that are particularly relevant to where the keys risks are likely to arise, including:
- proper standards of market conduct;
- fair management of conflicts of interests;
- treating customers fairly;
- clear, fair and not misleading communications; and
- the suitability of advice and discretionary decisions.
Lessons from past misconduct cases can provide useful insight, like the FCA’s findings from its Conduct Questions Feedback.
Each firm’s assessment of conduct risks arising during the IBOR transition should be tailored to their business and clients. The table below gives some key considerations by issue. There are a number of key considerations that firms should bear in mind.
Communications
- Make sure you have a plan for internal and external engagement.
- Organise customers based on their needs and financial sophistication.
- Centralise collection and recording of feedback, preferences and responses.
- Financial disclosures should be clear and arranged for each client according to sophistication, and should explain the implications of relying on fallbacks.
- New IBOR referencing business – clients should have a full and clear picture of risks through case-by-case discussions.
Contracts
- Ensure that fallback clauses are fit for purpose and whether value transfer could have a negative effect on them.
- Contracts and other documents should not over-rely on legal disclaimers as a way of managing risks.
Sales process
- Make sure sales staff stick to a compliant script when providing information during a non advised sales process.
- Suitability assessments should be undertaken where needed and as regulation requires.
- Training should be targeted and ongoing for high-exposure staff.
Surveillance
- Consider a continual review of the front office surveillance and control arrangements to make sure they are robust.
- This should be adapted over time to reflect declining IBOR liquidity and increasing RFR liquidity.
Product governance
- Equally assess the performance of RFR products against IBOR products for clients.
- Review continued issuance of current IBOR-linked products that extend beyond the end of 2021 and assess the timing of their transition to RFRs.
- Firms should prioritise financial management of client portfolios on the basis of client types.
- Firms should appropriately manage risks and customer suitability and value for money.
Conflicts
- Internal processes should identify and manage conflicts of interest risks. This includes:
- Where firms manage their own significant benchmarks for IBOR rate-setting and contribution.
- The control of access to any documents showing specific client information.
- Where firms are aware of customer IBORs or RFRs intentions, which could have a negative impact or lend themselves to being exploited to make a profit.
- Identified conflicts should be disclosed.
Governance, culture and controls
- Appropriately assign accountability.
- Senior managers should be able to provide oversight and governance for problem escalation.
- Larger firms are setting up IBOR conduct risk working groups.
- Leadership should encourage staff to escalate conduct concerns or use whistleblowing procedures.
- Firms should identify and establish appropriate controls for transition specific conduct risks.
Rewards and incentives
- The incentive and reward structures for staff involved in transition should take into account their performance in identifying and managing conduct risks.
Management information
- Should highlight top-down and bottom-up insights and help oversight and decision-making.
- Should reflect that conduct risks will continue to evolve.
Record keeping
- Firms should appropriately evidence client actions and decisions.
- For non-advised sales, firms should capture client confirmations and any decisions made to prove these are coming from the client.
Complaints
- IBOR transition related complaints should be identified and addressed in a timely manner.
The verdict
The transition away from IBORs will involve overcoming many challenges including ensuring that market abuse and misconduct which have been seen in the past are not repeated.
Firms should therefore ensure that they robustly identify and mitigate conduct risks arising during the transition, that the first line of defence assesses and tackles them and that the interests of customers remain integral to firms’ decisions and communications.
Transition programmes should also be based on the assumption that LIBOR will end at the end of 2021 and should incorporate communication programmes.
About the author
Steve Farrell, partner, Deloitte