FSB and BCBS Report on Supervisory Issues Associated With Benchmark Transition

Kramer Levin Naftalis & Frankel LLP

On July 9, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) published a report on the findings of surveys on supervisory issues related to LIBOR transition undertaken by the FSB, the BCBS and the International Association of Insurance Supervisors (IAIS). The report includes recommendations for authorities to support financial institutions’ and their clients’ progress in transitioning away from LIBOR. The analysis and the underlying survey were undertaken before the COVID-19 pandemic and don’t reflect any related issues. The report responds to the G20 request to identify remaining challenges to benchmark transition and to explore ways to address them.

Most FSB jurisdictions, including all LIBOR jurisdictions, reported that without adequate preparations, the discontinuation of LIBOR would have a significant negative impact on both financial and nonfinancial institutions (FIs and non-FIs). The report notes that most FSB jurisdictions have a LIBOR transition strategy, while only half of the surveyed non-FSB jurisdictions have a strategy in place. Reported transition plans include, among others, providing guidance to market participants, monitoring transition progress and coordinating national working groups. Most authorities have engaged in forms of supervision and supervisory communication with respect to LIBOR transition issues. LIBOR jurisdictions have taken a systematic approach by collecting information about FIs’ progress on LIBOR transition, while non-LIBOR jurisdiction authorities typically have a more ad hoc approach. Authorities in most jurisdictions have focused their monitoring efforts on major banks and have reported that non-FIs are significantly less likely to be monitored.

Estimated asset and liability exposures to LIBORs are reported to be highest in the LIBOR jurisdictions. Exposures to USD LIBOR are relatively high in the non-LIBOR FSB jurisdictions, and exposures to LIBORs are relatively low outside of the FSB jurisdictions. The derivatives exposures to LIBOR show a similar pattern. The median exposure ratio suggests that roughly 40 to 50 percent of assets and derivatives exposures are expected to mature after 2021, while the maturity structure of liabilities is reported to be shorter in most cases. The importance of incorporating fallback language into existing contracts and the development of products referencing alternative risk-free rates (RFRs) is emphasized by the fact that a considerable portion of the exposures mature after 2021.

The report’s findings illustrate that FIs in LIBOR jurisdictions have shown better progress in transitioning than those in non-LIBOR jurisdictions. In general, transition awareness and preparedness of larger FIs with greater LIBOR exposure are better compared to smaller FIs with less material LIBOR exposures that have adopted a wait-and-see approach. The transition process for FIs with multiple-currency balance sheets or higher exposure to cash products is delayed due to the complexities of such transition process. With respect to types of FIs, banks are more aware and better prepared for the transition than are other types of FIs such as institutional and buy-side investors.

In addition, with respect to transition risks, the report notes that they may arise from operational, legal, prudential, conduct, hedging and accounting perspectives. Major transition challenges that have been identified include the need to develop further products referencing alternative reference rates and to increase liquidity in these products; the dependence on concrete alternatives offered by financial intermediaries; and client willingness to adjust.

With respect to development of fallback language in existing derivatives contracts, FIs are awaiting the finalization of the ISDA amendments and protocols so that the alternative reference rates can be adopted. With respect to development of standardized fallback language in existing cash products, there is less progress, and many jurisdictions have raised concerns about the complexity of incorporating such provisions into existing (legacy) contracts that do not have them and about the required operational readiness to facilitate their use.

The report notes that very few jurisdictions have dedicated roll-off timelines or targets to industry, although several jurisdictions support the private sector in developing their own targets. Authorities in LIBOR jurisdictions and in some FSB jurisdictions are relatively more advanced in taking initiative to facilitate and monitor benchmark transition. The report provides a list of tools available to accelerate transition, including requests to improve operational capabilities, requirements to increase resources, ad hoc regulatory capital add-ons, restriction of activities or curtailing of specific product growth, and administrative sanctions or other legal actions. In addition, the report notes that better cross-border coordination and cooperation could benefit a number of legal, operational and other issues, including the inconsistency in transition timing and approaches across jurisdictions.

Based on the responses received, the report has identified three sets of recommendations with respect to (1) identification of transition risks and challenges, (2) facilitation of LIBOR transition and (3) coordination to support LIBOR transition. In addition, as next steps, FSB, in collaboration with other international bodies and standard-setting bodies, will design metrics or indicators to update the global LIBOR exposures and transition status, will identify a list of qualitative questions to monitor the progress in implementing the above recommendations and will continue to monitor the evolving impact of the COVID-19 pandemic on the ongoing benchmark transition.

The report will be delivered to G20 finance ministers and central bank governors ahead of their virtual meeting on July 18 and can be found here.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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