With the transition from The London Interbank Offered Rate (LIBOR) due to be implemented by 2021 and pressure from regulators, banks have been forced to start developing their plans to identify and mitigate risk associated with the reform. In order to prepare, banks actively are seeking out practical solutions for what to do with dated contracts that refer to the old rate and what steps they can take to ensure data is accurate and compliant.
Synechron’s Roundtable – “Benchmarking EU Regulation” brought together experts Daniel Percy-Hughes, Synechron London’s Head of Regulation and Compliance; Pankaj Gupta, Managing Director of Synechron London Business Consulting; and Haonan Wu, Head of Data Science for Synechron London, to share perspectives with industry stakeholders, on the points of impact and scale of impact of LIBOR. The roundtable discussed the choices banks and other financial services firms are making to transition from LIBOR-like to risk-free rates, as well as how to best navigate these changes alongside Basel III and the Fundamental Review of the Trading Book (FRTB) market risk reform.
The roundtable also discussed and demonstrated how innovative technologies such as Optical Character Recognition (OCR) and Natural Language Processing (NLP) techniques can accelerate a firm’s understanding of LIBOR.
The speakers covered a range of topics, including:
- Points of Impact: Which areas of a financial institution’s business will be impacted, including valuation and risk management at the top of the list, as well as the regulatory, legal, IT landscape and governance as additional points of impact due to be affected by LIBOR reform.
- Scale of Impact: The roundtable reviewed what the quantitative impact of LIBOR reform might be, how valuations across portfolios might be affected and how firms can mitigate this impact and navigate the coming changes.
- State of the Market - An open Q&A was held discussing where each firm thinks the industry currently is with LIBOR, how their firms compare, where they think improvements can be made, and potential solutions to help ease the transition for all financial institutions.
Some of the key takeaways included:
- Buy-side vs. Sell-side: Clients (i.e. Buy-sides) do not widely understand the scope of LIBOR reform or how it might impact them. Sell-sides are thought to have a first-mover advantage; however, the general sentiment around LIBOR reform is that it needs to be an industry-driven journey.
- Collective Effort - Regulators are keen for the industry to work together. There is a common approach being laid out with industry working groups trying to get people together. This includes going back to basics and producing packs on what LIBOR means.
- Data Storage – There is a considerable amount of unknown, ongoing cost associated with storing data. At present, most contracts are stored electronically for the majority of Tier-one banks. For Tier-two banks, most contracts currently are sitting offsite, with institutions not knowing the exact location of the contracts.
- Client Exposure – Buy-sides may not realise the volume of contracts they have on their books. If they do not know what the exposure is, then decisions are not being made based on accurate data, leading to inaccurate reporting.
- E-Storage - The ideal scenario is that the industry will end up in a situation where there is straight through processing and all contracts are e-stored – inclusive of Tier-one and Tier-two banks.
- Regional Approach - The U.S. approach vs. the European approach do not match. The U.S. approach expects that a market solution will materialise and that demand will drive a commercial solution whilst Europe demands more transparency and is placing the responsibility on the industry to create a viable solution. Asia on the other hand, is perceived as being less mature in terms of LIBOR reform than the U.S. or E.U. Key regions will most likely define the outcome. There is also a risk that reform will follow both the U.S. and E.U. approaches simultaneously, requiring harmonization of global approaches. This regional fractionalization would then further be compounded by Brexit where the U.K. and the EU likely will further diverge.
- Business Response - Firms may look to gain first-mover advantage by issuing products featuring new benchmarks (e.g., the Secured Overnight Financing Rate [SOFR]). However, they risk being treated as benchmark administrators if the benchmark is otherwise illiquid, and they are setting forward curves.
- Automation - Smart firms will bring automation into their operational processes beyond LIBOR reform, and would look to extend their technical response to other parts of their business.
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