FMSB Spotlight Review Checks in on Libor Transition

The FICC Markets Standards Board (FMSB) has published its latest Spotlight Review, this time looking at how market participants may manage potential conduct risks arising in back book transition as part of the broader switch away from Libor to risk-free rates (RFR).

The review aims to provide practical guidance for market participants and builds on a previous review which focused on moving new business off Libor. It has been developed by FMSB’s Libor Transition Working Group, which has representation from a wide range of FMSB member firms.

Back book transition covers long-dated derivative contracts and the need for parties to them to take steps before the end of 2021 to remove their remaining reliance on Libor benchmarks. Until July 2017 when it became clear that Libor would end, few contracts across the cash and derivatives markets envisaged a permanent cessation of Libor settings. Parties to long-dated derivatives contracts as well as borrowers and lenders are therefore exposed to uncertainty on Libor cessation if steps are not taken before the end of 2021. For these older legacy contracts, FMSB says there are four broad transition or fallback options depending on the product and contract in question:

1. Proactively transition Libor-based contracts to alternative benchmark rates in advance of cessation
2. Proactively amend legacy fallback language
3. Rely on legacy fallback terms
4. Rely on a legislative solution for tough legacy contracts

The latest review focuses on the first of these options given the benefits of actively converting contracts to another rate before the end of 2021. In particular, FMSB says, taking an active approach to transition enables market participants to take a degree of control over the impact of the transition on their contracts, reduce uncertainty and operational risk associated with waiting for Libor cessation and helps promote an orderly transition.

Nonetheless, it adds, as with the other transition and fallback options, proactively transitioning away from Libor-based contracts to alternative benchmark rates in advance of Libor cessation gives rise to a number of complexities which firms will need to manage in order to promote a fair and effective transition.

With time fast running out to decide on the most appropriate steps for managing the transition of their back book positions from Libor onto risk free rates, firms must choose their course carefully.

FMSB cites a risk of value transfer depending on the timing of transition and subsequent benchmark rate movements; the possibility of mismatches in fallbacks for underlying cash and associated hedging instruments; and the risk that where firms are required to exercise some discretion, this may give rise to differential client treatment, as examples.

The review examines these complexities through practical case studies and sets out certain key considerations for banks and end users when looking at different transition options and good practice observations for managing the associated risks taking into account the overarching principle, as cited in the FCA Handbook, that firms “must pay due regard to the interests of [their] customers and treat them fairly”.

Martin Pluves, CEO of FMSB, says, “With time fast running out to decide on the most appropriate steps for managing the transition of their back book positions from Libor onto risk free rates, firms must choose their course carefully. I am delighted to announce the timely publication of this Spotlight Review, the second in our series looking at conduct risks that arise in managing Libor transition.”

Chris Salmon, chair of the FMSB Libor Transition Working Group, and chief control officer for markets & securities services at HSBC, adds, “FMSB’s latest Spotlight Review is designed as a guide to help market participants treat customers fairly and support market integrity when they proactively transition their back book trading contracts from Libor to RFR benchmarks. Through FMSB’s Libor Working Group, we have drawn on a wide range of insights and expertise, both from FMSB member firms and the wider industry, to produce this practical Spotlight Review.”