After employing the London Interbank Offered Rate (LIBOR) as its primary interest rate benchmark for more than 35 years, the financial services industry is preparing for a critical transition. The United Kingdom’s Financial Conduct Authority is expected to cease publication of LIBOR by Dec. 31, 2021. This pending action is pushing financial institutions to plan and implement modifications as they phase out LIBOR and shift to an alternative reference rate – with legal teams providing essential guidance and expertise along the way.
In this episode of The Robert Half Legal Report, host Charles Volkert, senior district president of Robert Half Legal, is joined by Doug Wilbert, a managing director with Protiviti, to discuss significant legal implications inherent in the benchmark transition. They explore the operational, legal and compliance challenges of replacing LIBOR with an alternative reference rate – and how legal teams are needed to make crucial impact assessments, identify and manage legal and contractual risks, conduct litigation and regulatory reviews, and more.
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Robert Half Legal Report
What Legal Teams Need to Know about the LIBOR Transition
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Charles Volkert: Hello everyone and welcome. I’m Charles Volkert, senior district president of Robert Half Legal and the host of our program. Joining us today is Doug Wilbert. a managing director for Protiviti’s risk and compliance practice. With more than 20 years of experience in the financial services sector, Doug manages large-scale consulting projects. For example, organizational change management and risk assessment programs as well as regulatory compliance and technology initiatives for banks, broker-dealers and custodians. Doug, welcome to the show.
Doug Wilbert: Thanks very much. Appreciate you having me here.
Charles Volkert: Excellent. Well for more than three decades, financial service institutions have primarily looked to the London Interbank offered rate also known as LIBOR for interest rate guidance. They use LIBOR as a benchmark to price or value bonds, derivatives and a wide variety of loans. But that’s changing. The United Kingdom’s financial conduct authority is expected to stop publishing LIBOR by the end of 2021.
This means that firms across the financial service sector need to replace LIBOR with alternative benchmark rates. And as many firms are learning, this is a time-consuming task. One that requires extensive review and may involve major adjustments to systems, networks, products, pricings, contracts and much more. And the legal implications of the LIBOR transition are also extensive which is why legal professionals are being tapped to help with comprehensive and orderly transition. On today’s program, we’re going to discuss the LIBOR transition in much more detail including why it’s being replaced and share strategies to create a sustainable framework to limit conduct and compliance uncertainties. We’ll also explore how legal teams are helping companies to identify legal obligations as well as manage their contractual and litigation risks. So, let’s jump into it.
Doug, to begin, can you explain how LIBOR is used today within the financial services sector and how rates are being determined?
Doug Wilbert: Sure. So, LIBOR is what we’ll call a benchmark rate, sort of a little bit of history, Ice(ph) has been the administrator of LIBOR since 2014 for years and decades in fact. Before that, LIBOR has been used to give a benchmark of which other interest products can align to. LIBOR’s benchmark rate is for five currencies with seven maturities and on a daily basis, a panel between let’s say 11 and 16 contributor banks are asked at what rate would you lend essentially. From there, a LIBOR rate is created and in terms of the size of the market, and this is where a lot of the LIBOR interest is, overall, it’s a 300 trillion dollar plus market. Most of that is in OTC derivatives but LIBOR is used in a number of financial products so besides over-the-counter derivatives including interest rates and cross currency swaps, it’ll be used in loans, syndicated business loans, mortgages, credit cards, you may see LIBOR referenced in overdraft payments or other late payments. It’s referenced in short-term instruments such as repose, time deposits in commercial paper.
So, in terms of its use, it’s quite broad within the financial sector and in just a nominal value, there’s a huge market that has to be moved from LIBOR to something else.
Charles Volkert: So, it sounds like, Doug, a lot of moving pieces in a very important area. So why is LIBOR being phased out and replaced at this point?
Doug Wilbert: So, this goes back — no, about 8, 10 years and ultimately, what it comes down to is a conduct risk issue which is some of the people that helped create the LIBOR rate, were manipulating it for their own good references back to airline miles, if people recall, in the chat features that traders would talk to each other and reference trades in terms of airline miles. What they were really doing is manipulating the rate to their benefit. Because of this, once they got caught, obviously, there was a regulatory concern but there was also a big confidence concern in the rate just by virtue of the way it’s calculated.
It was very susceptible to types of conduct risk fraud and at the time, I don’t think the trade surveillance was sufficient enough to manage LIBOR but because it touches such a large number of products and you know, a 300 trillion dollar plus associated to LIBOR, it has a big impact if the rates are wrong.
So, regulators pushed forward and basically said “Look, we’re going to need to move off LIBOR onto something else where we could have more confidence that the rate is not susceptible to manipulation and then we can use it properly going forward.”
Charles Volkert: Understood. So I guess it’s safe to say that based on what started more than 10 years ago with manipulation as the regulators in a number of countries conducted investigations, that led them to criminal charges, fines that you mentioned but ultimately, the financial community no longer trusts LIBOR as an accurate indicator. Widespread discussions about interest rate reform began and about three years ago, the UK’s financial authority announced that LIBOR would be phased out. What do you see, Doug, as the alternatives moving forward as the proper replacement for LIBOR?
Doug Wilbert: Yeah. So, this is the interesting piece, right? So, there’s a number of alternative RFRs that have been quoted. SOFR, SONIA, TONAR, SARON Eurobor, Ameribor — it’s almost like every country had at least a rate that they wanted to reference — or I shouldn’t say every country because the EU under Eurobor, but everybody wanted to create their own reference rate that was acceptable to them
So, in terms of where this is moving from LIBOR, SOFR and SONIA, I think, are the two most popular. On the US, there’s been some push by mid-sized banks to go to Ameribor because it more accurately reflects their products. So we’re going to move away where the volume moves to. I think it’s still a bit to-be-determined but we’re certainly starting to see an uptick in products that, you know, we want to move from LIBOR to. So the CME is seeing an uptick in their SOFR products. So, I think we’re going to start to move along to one of these five or seven different products which also presents a big challenge for organizations. It’s a lot harder to get your systems, your regulatory obligations, your model risk up and running on seven products compared to just one.
Charles Volkert: That’s great background and obviously, still a moving target but maybe you could begin to address the risks as you just brought up that organizations will anticipate as they transition from LIBOR to an alternative rate.
Doug Wilbert: Sure. So, the challenges, if you will, are risks we break up into various categories. Infrastructure, valuation, tax, regulatory governance, accounting liquidity and legal. And these are challenges, right? So, I may have a thousand contracts, I may have 500,000 contracts that reference LIBOR, and if we think about the process, I have to first understand how many contracts I have. I then have to understand the information in those contracts and then I have to actually move them from LIBOR to a new RFR.
In terms of that process alone, there’s a huge risk in my opinion of conduct risk which is if I’m reaching out to clients and I’m changing a component of their contract, I need to be very careful how I do that. I need to make sure I interact with the client appropriately and that I have proper substantiation, that the client understands what they’re converting to and that the client is accepted of it.
So, huge issues with conduct risk in terms of liquidity and infrastructure, I think those are the next two which some organizations have quite a number of contracts in LIBOR that they have to move and it’s a little bit of a challenge to move from such a well-established contract like LIBOR to some of these new RFRs. Finally, with the infrastructure piece, you know, I had LIBOR going into my systems. Now, I might have SONIA, SOFR, Ameribor, Euribor, a host of other RFRs. How do my systems manage them? Is it just an addition of another security or do I require updates? How do my models handle them? How is my risk going to be calculated? How do I transition properly? These are a host of risks that firms need to contemplate. There is no simple way to do this. I give sort of credit to the fed, the ARRC, Alternative Reference Rate Committee, which I believe was established in 2014, has proposed some really solid guidelines and help with project plans and things to think about.
But the reality is this is a very big regulatory change program that carries all the risk of a regulatory change program with a timeline attached to it which originally was the end of 2021 but has been in the most part extended out to 2023.
Charles Volkert: Well, under your point, Doug, even what we’re beginning to see with clients is that a roomful of decision makers really need to be in place to talk about all of the areas that are being impacted that you highlighted, right? Just the need to update, let’s call it 22,000 contracts with a client requires a lot more input and heavy-lifting as far as systems and all of the other things that need to be looked at to make sure, you know, are updated as well. So, that’s great information as you’ve walked us through at least the beginning stages of LIBOR. We have much more to discuss about the transition strategies and risk mitigation but first, it’s time to take a quick break.
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Charles Volkert: Welcome back to the Robert Half Legal Report. I’m Chad Volkert and with me today is Doug Wilbert, managing director with Protiviti’s risk and compliance practice. We’ve been discussing the phase-out of LIBOR and how financial institutions are managing the complex transition process to an alternative reference rate. Doug, can you talk more about the challenges that the LIBOR transition teams are encountering and how you and those teams are addressing those issues?
Doug Wilbert: Sure, you know, one of the biggest challenges that people are having today is it would seem pretty simple as project management and I think that when people start to push forward with LIBOR transition, what they’re recognizing is that these contracts are going to go through various states. It may be in a paper form converted to an electronic document then OCR so that it’s readable. There are various states that the documents go through within the document process. Now, the challenge is if you have whether it’s 10,000 or 300,000 documents, understanding the state of every document is important. So, what you have is a huge project management challenge and that’s just understanding the state of the document. We haven’t integrated in with your contract life cycle management tools. We haven’t integrated with technology. We haven’t integrated with liquidity and valuation and risk management and accounting.
So, the biggest thing we see is organizations underestimating exactly how many project managers they need to move this through. I think the other piece that is challenging is how to manage the outreach to clients and how to manage, you know, BAU, in the legal department with the need for legal guidance within the LIBOR transition. It’s tough to tell your legal department they have a whole new thing to do when they already have their sort of business as usual that they have to go through. So, staffing in and of itself is a big challenge and that’s because at various points in time within the LIBOR process, you’re going to have a big expansion and compression of staff. I would say the final piece is technology. A lot of firms think artificial intelligence software is going to solve their problems. Inevitably what they find out is AI is very good with some contract types. AI does not work very well with other contract types and if you use artificial intelligence software as a way to cure your problems, inevitably, you’re going to just create new challenges and that the software could work so poorly on your contracts that your quality assurance is now expanded.
So, there’s a fine line to walk between using technology and using humans and there’s a fine line to walk on the cost benefit of using technology versus a manual approach.
Charles Volkert: That’s interesting, Doug, and maybe we could pick up and have some dialogue in and around the personnel, if we want to call it that, as to the multi-disciplined team of stakeholders that are driving the transition process to effectively manage those potential risks.
It’s critical that the transition teams possess broad business experience and insights whether that’s financial business operations, to your comment, technology and understanding how that impacts the work as well as the legal expertise. The legal issues involved in replacing LIBOR are substantial and complex. Having legal input and support is an essential factor in the success or failure of the transition process and legal experts are providing input and guidance on a broad range of legal matters addressing and managing those risks. I think you’ve been talking so much about contractual analysis and obligation. How are they moving through those documents, council on appropriate language for new financial contracts based on an alternative model strategy, options for transition and replacement, legal guidance on required client communications back to the other side, so to speak. Certainly, litigation risks to anticipate an increase in litigation, legal teams managing and mitigating those risks, but are there other legal items that you would highlight for our audience to keep in mind?
Doug Wilbert: You hit on a lot of risks there. You know, so one is staying on top of the changes in the different jurisdictions. The Fed’s ARCC committee, like I said, it does a really good job but then you may have state level nuances. For example, NYDFS may get involved there. In terms of I guess you would say overall strategy to mitigate legal risk and conduct risk is I think really where you’re going with this question and one of the things that we’re seeing there is A, staffing with appropriate staff is important. You can’t just put bodies in. People understanding the contracts are important. Whether you bring in lawyers and JD’s is probably preferential than just bringing in someone and to look at a contract.
I think the second big piece here is, is your technology able to monitor and record the different actions that the team is taking? And what I say by that is if I perform outreach to a client for a particular contract, does my software lock that contract? Do I have a unique ID to sign in? Is the substantiation that I reached out recorded? Are all the actions that I put into the system recorded so that if a regulator walks in and says “Client ABC is complaining that you didn’t appropriately interact with them and you transition their contract to a new RFR without talking to them”, do you have the ability to look back and say, “Here’s all the actions associated with the client. Here’s the person who performed the actions and here’s proof that what we did is appropriate.”
That sort of monitoring is key to making sure that should your internal audit come in or regulators come in that you have the substantiation to say that we did things appropriately.
Charles Volkert: Such important points, Doug. Appreciate that. And I’d like to underscore that if they are not already doing so, in-house legal teams should be working with other departments within the organization to develop customized strategies to successfully navigate the LIBOR transition as you can hear from Doug, so many moving pieces. If you’re not working as a unified team, there’s going to be issues and it’s important to recognize that each company has a unique set of products, services, contracts and customers. There’s not a single easy roadmap to replacing LIBOR.
So, the transition requires guidance, actions and modifications that are tailored to the particular legal risks and requirements of an organization with a thought-out plan. With that said, we’ve reached the end of the program for today and that was certainly a great discussion with Doug. Many thanks to you, Doug, for joining me today and sharing important guidance on this topic with our audience and before we close, how can our listeners contact you and where can they obtain more information about LIBOR?
Doug Wilbert: Sure. Thanks. Yeah, you can go to protivity.com. We have blogs and various papers on LIBOR transition there. To reach me directly, my email is [email protected]. That’s d-o-u-g-l-a-s period w-i-l-b-e-r-t @protivity.com. More than happy to answer any questions or address any concerns that people in the audience have.
Charles Volkert: Excellent, Doug. And I certainly encourage our listeners or our listeners’ colleagues to reach out to you for more information. Our listeners can also contact me at charles.volkert. That’s v as in Victor, o-l-k-e-r-t @roberthalf.com and you can visit the Robert Half Legal’s website for additional information on legal career and management resources including our latest salary guide for legal professionals and that address is roberthalflegal.com.
Thanks again, Doug, and to our audience for listening today. Join us next time on the Robert Half Legal Report as we discuss important trends impacting the legal field and legal careers.
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