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LIBOR Transition readiness: End 2021 - are banks ready?

As we get closer to the end of 2021, banks are focused on contract repapering and client outreach activities, but there are significant resource and operational constraints ahead as banks align their front to back capabilities to accommodate for the differences in market conventions, methodologies, nuances by asset class, and synchronisation of data attributes. Anticipating a significant ramp up of activities over the last two quarters of this year is likely to cause significant capacity constraints and resource challenges across the industry. A lot of work remains to be done.

The latest on LIBOR Transition

Episode 3: End 2021 - are banks ready?

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1. Survey and roundtables - approach

Throughout LIBOR transition, PwC has the opportunity to work with Financial Services firms and official sector organisations across the globe. Through our work we sensed a desire for market participants to understand better their own stage of readiness compared to peers, to exchange ideas on how to accelerate transition, and to have a forum to discuss the impacts of rapidly emerging market developments. In response, PwC conducted an online survey between 20 January and 24 February 2021. We asked participants from 52 global banks involved in the LIBOR transition on contracts and outreach, and systems change activities, to complete the survey. Following the survey, we aggregated the data to form an industry view and this formed the basis of the roundtables we hosted at the beginning of April 2021. The banks that participated in the survey and roundtables were from both Global Systemically Important Banks (G-SIBs) and local banks operating in the EMEA, Americas, and APAC.

2. Key observations from the survey and roundtables

  • The focus is on active transition for GBP LIBOR. Engagement from corporates and counterparties has been lagging but this is expected to shift in Q3 and Q4 2021.
  • No convention has been set in the USD LIBOR lending market. The uncertainty over market conventions and the optionality in rates is causing challenges.
  • There is further education required on the timelines i.e. June 2023 for the legacy book, and new LIBOR and modifications is the end of 2021 for USD. Banks feel not all corporates and counterparties understand this and this is causing the lack of client engagement.
  • Given the flow of industry guidance, consultations, and market standard updates from the Official Sector, there is general recognition that Relationship Managers need to be constantly kept up to date through further support, education and training.
  • There is a strong focus on conduct risk implications and most banks are focused on proactive outreach and are continually engaging, explaining and educating their clients.
  • There is a clear indication that many banks are using LIBOR transition as a launchpad for the optimisation of their legal/contracting operating models to ensure future outreaches are approached more strategically.
  • There is a significant amount of work being done manually, including contract reviews, tracking of fallbacks, implementation of controls as well as performing transitions.
  • In the absence of 3rd party vendors being ready to meet the 2021 deadline, most banks have developed manual workaround solutions. The exception is for 3rd party data vendors where there is a reliance on obtaining comprehensive data for curves and fallback language.
  • Banks with sterling portfolios are planning for some level of capacity pressure in Q3 and Q4 2021 in light of clients engaging much later and all at the same time, resulting in a large volume of contracts requiring repapering and processing of the rate changes via their BAU systems.
  • Banks with USD-based portfolios highlighted, in addition to the challenges already raised, there are complexities of building optionality to “operationalise” a wide variety of rates into their governance processes and policies, as well as changing the pricing, risk management, models, and back office process and systems impacted to reflect this level of flexibility.
  • There is additional complexity to ensure synchronisation of interest rate calculations, payment dates, rollover dates and the transition at the appropriate dates and times, based on all the nuances around asset classes and different conventions.
  • The challenge is the operational readiness of the bank’s infrastructure and how the data attributes for the different term rates, conventions, and various nuances gets captured, and the flexibility built into the downstream systems.
  • Another question is whether the Ops & IT teams understand these requirements and are ready to build in some level of flexibility, especially if there is an ‘uptick’ in activity towards the end of the year. There is likely to be a development squeeze and IT changes get de-prioritised against competing programmes/ projects. This could lead to back-end testing, where testing is done only at the end of the programme, which carries much higher risks. In general, the industry has been trying to “shift testing left” on the plan, so learnings can be fed back into design, well ahead of a ‘go-live’ date.
  • Whether new or repurposed, a critical challenge to technology delivery will be performing full front to back testing to ensure what Relationship Managers and front office developed business requirements are operationalised into the process and back end functional systems build.
  • It is important to see that everything flows through correctly and there are strong feedback loops set-up. Having robust programme governance will be key to ensure full front to back communication, especially during testing, to understand how complexity of LIBOR transition business requirements aligns to the back end functional build, and accurate exposure reporting.

3. Contract remediation and client outreach readiness

3.1 Contract remediation approaches

59% of respondents expected to rely on Fallbacks for Derivatives. Repricing is the most expected remediation approach across all cash products.

  • The focus is on active transition for GBP LIBOR for 2021 - new products and legacy remediation. The UK seems to have a clearer path given the recent FCA/ IBA announcements, Dear CEO Letter, and regulators making it clear that Senior Managers could have their bonuses affected if they fail to meet the end of the year deadline. It is clear that all the guidance and protocols are now out there, and the focus is on the banks to further communicate this to their clients.
  • The survey confirmed that there has been a broad and timely adherence to the ISDA IBOR fallback protocol for derivatives, and that firms will be agreeing the transition of the excluded trades bilaterally with counterparties starting at the end of Q1 2021.
  • For the transition of bilateral and syndicated loans the majority of banks demonstrated a preference to leverage industry standard templates but acknowledge that it is not possible for a proportion of their bilateral loans, where the banks will need to draft their own fallback language, and in some cases for syndicated facilities as well.
  • For syndicated loans, where the bank is the participant or minority lender, most respondents stated they are waiting for the agent or majority lender to reach out to the syndicate members.
  • No convention has been set in the USD LIBOR lending market. The uncertainty in SOFR daily vs SOFR compounded and the variations in credit sensitive rates (i.e. Ameribor by AFX, BSBY from Bloomberg, the Bank Yield Index published by ICE and IHS Markit’s USD CSA) is causing challenges. Some clients may adhere to the protocol with the assumption of proactive repapering and make modifications now. The challenge will be how banks can operationalise (extract and manage) this.
  • Relatively low reliance on Tough Legacy/Legislative Solutions across all products. Bonds and Securitisations anticipate largest use of Tough Legacy solutions.

3.2 Client Outreach

As of January 2021, half or fewer than half of the respondents had begun client outreach at scale across the different assets classes.

  • Most banks have started their client outreach with their derivative products. By April 2021 it was expected that derivatives outreach would have been underway for 93%. Banks have started moving core lending/ debt products and by April 2021, 75% is expected to be underway.
  • Email communications has played a large role in banks’ communication to clients, across the different asset classes. Letters, though less than email, still account for 13-40% of respondents. However, 1:1 client engagement, by face, phone or video conference call, was preferred for derivatives and core lending/debt products.The Front Office (Relationship Manager/Sales) are largely (83%) responsible for outreach and negotiation with clients.
  • Given the continuous flow of industry guidance, consultations, and market standard updates from the Official Sector, there is general recognition that there is increasing pressure on Relationship Managers and Sales teams to be trained and educated on all the LIBOR transition changes that would impact client communications and negotiations.
  • It is expected there will be an 'uptick' in activity in H2 2021 as clients understand their options, form their evaluations and seek approvals from their Boards (tends to happen on a quarterly basis), and this is what is taking time. So the question is more about when the clients do respond, and likely to do this at the same time, how are banks prepared to manage the volume, complexity and operational challenges that lie ahead.
  • Given the timeline shift for certain USD LIBOR tenors to June 2023, the market is heavily focussed on new product development and developing liquidity. With the added complexity of multiple conventions i.e. three term SOFR rates, multiple credit sensitive rates - there seems to be no general consensus of which rates to use. For syndicated loans, most banks are offering multiple methods of communication to their clients either bilaterals on the adoption of fallbacks or variations of alternative rates. There is a wide range of readiness amongst the FIs.
  • Remediation has slowed down and most banks have rebaseline their plans, with the intent to outreach early in 2022. Most banks are also seeking to transition their LIBOR transition change programmes into BAU by Q1 2022.

3.3 Incentives versus Conduct Risk

All respondents agreed Relationship Manager education and clarity in communications on key features is how conduct risk is predominantly managed when transitioning clients. Other areas that scored highly included having a strong conduct risk framework, actions and metrics.

  • Most banks are feeling the pressure to move their clients into active transition, in particular for GBP LIBOR. Some banks are driving home the message by informing their clients there will be a backlog in contract remediation activity towards the back end of 2021, hoping that this would encourage them to move now as there is likely to be significant resource constraint across the industry. This is being used as an incentive to get clients to transition now rather than later.
  • Some banks are encouraging more proactiveness from their clients by explaining ‘contract frustrations’ in the hope this encourages clients to transition now i.e. what would be the consequences of doing nothing and fallback is implemented.
  • In general banks are cognascient of conduct risk implications and are aware of the risks of providing guidance or seen to be providing guidance on re-pricing strategies. Most banks are taking the approach of being transparent and overly communicating on the options available to clients.
  • Respondents felt the need to continually engage, explain and educate. 88% of the respondents outlined where clients or counterparties with approved/active OTC uncleared derivative exposure had not signed the ISDA protocol and had not agreed to alternative remediation, a more focused and proactive outreach via the Relationship Managers was how they plan to engage prior to cessation.

3.4 Stepping back - Lessons Learnt & Creating Reusable Assets

Nearly 50% of respondents have used the LIBOR contract remediation opportunity as a catalyst to develop a digitised contract inventory or standardise their legal documentation.

  • There is a clear indication that many are using LIBOR transition as a launchpad for optimisation of their legal/contracting operating models to ensure future outreaches (of which there will be many) are approached more strategically. The critical areas have been mass digitisation of documents, capturing legal information as structured data and leveraging technology (e.g. CLM) to undertake re-negotiations, streamlining contract repositories, and updating contact databases. These are assets firms are ensuring are not lost once the LIBOR transition challenge has been dealt with.
  • When looking at where banks have adopted new technology tools and systems, there is a clear distinction between which processes can be repurposed and where more bespoke solutions are needed. Exposure monitoring and contract digitization and re-booking were the top two areas identified as needing new tooling. These are processes that are more nuanced in and less suitable for BAU processes and established technologies. For processes such as product approval and profit and loss (P&L) monitoring, participants, either used repurposed or tactical tooling or resorted to manual processes.
  • LIBOR transition has required organisations to interact front to back across all functions. Collaboration has become critical especially as heavily centralised programmes have become more federated into the business/ functions during 2021, as the focus shifted to operationalising the changes. Banks have acknowledged the greater levels of collaboration shown across the organisation especially during the pandemic and the altered ways of working.

4. Systems change readiness

4.1 Overall stage of readiness

  • In February 2021, we saw banks had the fewest responses in terms of the remediation stage considered ‘completed’ across asset classes (20 - 34%) .
  • Most banks were in the ‘implementation and testing’ stage across the different asset classes.
  • Over 70% of banks outlined there is more reliance on 3rd party vendor solutions/ some sort of combined solutions for Loans and Derivatives vs Securitisations and FRNs, where 36 - 45% responded they rely on ‘in-house’ systems.

4.2 3rd Party Vendor readiness

  • There are some big 3rd party vendors that are lagging behind and have delayed providing release updates and patches. In general banks felt these providers will eventually get there but are currently hampered by the different market conventions out there, and have been taking a ‘wait and see’ approach to determine whether there would be some industry convergence and hence having to avoid building out too many options. They want to build once with limited variations. Most banks seem to have addressed this issue as they have developed manual workaround solutions but there are questions about how robust the controls are around these solutions to address all the nuances we discussed earlier.
  • For products like 3rd party securities and FRNs, banks are being constrained by 3rd party data providers where the data is not comprehensive in terms of curves and fallback language. Therefore, a big issue is the readiness of the 3rd party data providers and understanding how the vendors will get a comprehensive view of what fallbacks are for each of these securities, and when and how they plan to communicate this to banks.

4.3 Operationalising the changes

A significant amount of work being done is manual - from contract review, the implementation of controls to prevent new LIBOR, and the tracking of fallbacks in legacy contracts.

  • When asked the question how banks were implementing controls to prevent new LIBOR i.e., whether they were building new systems functionality or amending existing functionality, most answered this was being done manually - 61% banks answered manual.
  • When asked the question how banks were monitoring and tracking fallbacks in their legacy contracts i.e., whether there was some degree of automation/ tech solution used, over 80% of the banks outlined they have comprehensive fallback tracking but it was being done manually.
  • In addition to a lot of manual work being done, banks highlighted the big challenge they face is in ‘operationalising’ fallbacks. This varies product by product. For Derivatives, this is managed more centrally but for bilateral loans where a lot of contracts do not have fallbacks there is more of a need for banks to reach out and negotiate the arrangement with their clients. Banks acknowledged there are nuances of clients adhering/ not adhering to the ISDA protocol and banks face challenges on how to automate and implement these nuances for bespoke contracts.
  • There are also challenges with operationalising 3rd party securities as there is a big reliance on 3rd party data providers and there was general consensus that banks were not receiving accurate and comprehensive curve data and fallback language information from the data providers. There were big questions about the readiness of these data providers and how they would be able to provide a comprehensive view, and when and how they would communicate this to the banks. Banks recognise the need to provide market data providers with more structure on what they need so they can work on a solution that meets their needs. The challenge is the lead time it will take to make these changes as it could go beyond the end of year deadline. Banks can only rely on the data fields out there and in the meantime put tactical solutions in place to see what to report on.
  • Banks' systems need to be flexible enough to manage at least 2-3 market conventions. A big challenge however is the USD LIBOR market and building optionality to “operationalise” a wide variety of rates into their governance processes and policies as well as changing the pricing, risk management, models, and back office processes and systems impacted to reflect this level of flexibility. As well as operationalising the data attributes, triggers and conventions related to the different asset classes, there is also the additional challenge to ensure synchronisation of interest rate calculations, payment dates, rollover dates and the transition at the appropriate dates and times.
  • In terms of challenges across products and jurisdictions taking loans as an example, where there are recommendations and the differences are not too large, if there was a counterparty where they are not allowed to add any mismatches to their books this would become difficult and the systems change effort would be significant.
  • When asked the question about how banks plan to implement client driven changes in bulk ahead of cessation e.g. when a large asset manager or lender requests a remediation of their whole portfolio
    • Most banks acknowledged that mass collection and distribution of data attributes to Ops teams could not be done for loans especially where bilaterals need to be done to migrate legacy trades.
    • Another challenge is that a lot of lending have switch clauses that operate on future date prior to cessation. Banks acknowledged that to operationalise these, they would need to capture all their contracts that will move ahead of cessation, which is a challenge.
    • At the moment, for bulk migration most banks have limited tooling to do this, although this varies by product area, but most agreed this was being done manually by the Operations teams. Currently due to the lack of engagement with clients, the Operations teams have the capacity to do this. However, for GBP LIBOR banks foresee an 'uptick' happening in client engagement over Q3/ Q4 2021, especially as there has been a lot more guidance from the Official Sector and there is nothing more to wait for given the year end deadlines. The focus now is very much on the banks educating and reaching out to clients. They also foresee the magnitude of the work increasing in Q3/ Q4 2021 and there being some significant resource challenges. All banks agreed this is going to be an industry issue. Some banks are using this message as an incentive to get clients to move earlier.

4.4 Shifting complex front to back testing to the left

  • A challenge is whether the Ops & IT teams understand the complex requirements discussed in the previous sections, and are ready to build in some level of flexibility, especially if there is an 'uptick' in activity towards the end of the year. There is likely to be a development squeeze and IT changes get de-prioritised against competing programmes/ projects. This could lead to back-end testing, where testing is done only at the end of the programme, which carries much higher risks. It also limits testing to the actual system versus looking at whether it meets the actual business requirements expected to be delivered. In general, the industry has been trying to “shift testing left” on the plan, so learnings can be fed back into design, well ahead of a go-live date. Whether new or repurposed, a critical challenge to technology delivery will be performing full front to back testing to ensure what Relationship Managers and front office developed business requirements are operationalised into the process and back end functional systems build. This would require centralised coordination to bring all parties to the table and strong governance to ensure full front to back alignment in testing.

EMEA

Karyn Daud

Partner, UK LIBOR Contracts & Client Outreach Lead, PwC United Kingdom

+44 (0)7795 617469

Email

Akhilesh Khera

Partner, UK LIBOR Systems Change Lead, PwC United Kingdom

+44 (0)7483 374074

Email

Lisa Dhanani

Director, UK LIBOR Transition COO, PwC United Kingdom

+44 (0)7740 241313

Email

Heiko Christmann

Senior Manager, Germany LIBOR SME, PwC Germany

+49 211 9815402

Email

Americas

Chris Kontaridis

Partner, US LIBOR Contracts & Client Outreach Lead, PwC United States

+1 404-384-0931

Email

Paul Chew

Partner, US LIBOR Systems Change Lead, PwC United States

+1 917-865-4634

Email

Gaurav Shukla

Partner, US LIBOR Transition Lead, PwC United States

+1 646-581-7830

Email

Justin Keane

Partner, US LIBOR Transition Lead, PwC United States

+1 917-514-6286

Email

APAC

Sergey Volkov

Partner, APAC LIBOR Transition Lead, PwC Japan

+81 (0) 90 9850 6016

Email

Yura Mahindroo

Partner, Singapore LIBOR Transition Lead, PwC Singapore

+65 8182 5177

Email

Asim Parashar

Partner, India LIBOR Transition Lead, PwC India

+91 98 3314 1065

Email

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