IBOR Reform in Switzerland, Part V

Zanders IBOR Assessment

The Financial Conduct Authority (FCA) ensured bank panels support LIBOR, and this is coming to a close at the end of 2021. Currently more than 80% of CHF loans are priced with the CHF LIBOR as a basis. The transition to a new reference rate poses a number of different challenges for the market. This fifth part of our article series presents the checklist of the Swiss National Working Group (NWG) and the Zanders IBOR Assessment.

In the previous articles (IBOR Reform in Switzerland, Part I, II, III and IV), the reasons for a new reference rate, the RFRs compounding techniques and fallbacks were explained. This article presents the checklist proposed by the Swiss National Working Group (NWG) as well as the Zanders view on an effective and efficient IBOR Assessment.

NWG promotion of operational readiness

Financial institutions will be widely affected from the transition to alternative interest rates. This will challenge how contracts are written and priced, as well as how risks managed and IT systems operated. Time and resources are required to amend current operating models. For this reason, it is necessary that financial institutions have an effective and detailed action plan explaining how they will address these challenges. The NWG has developed a comprehensive checklist to help LIBOR users improve their operational soundness (Table 1).

Table 1 Summarized checklist for LIBOR users developed to improve operational readiness.

The NWG states that the setup of an internal IBOR transition project as the first point for an efficient action plan. Zanders believes that an IBOR assessment can provide the institutions with a better understanding of their situation, saving money and time. FINMA also provides guidance on the transition, observing three main risks: legal risk, valuation risk and risks with respect to operational readiness.

With respect to products and contracts, a quantification of the current exposure to LIBOR across business lines and products is necessary. This should encompass on- and off-balance-sheet items linked to LIBOR. Therefore, a transition strategy across business lines and products needs to be set up. The different transition activities need to be prioritized based on the potential impact on P&L, taking into account legal and reputational risks. Moreover, it is necessary to estimate the level of effort and importance of the process while also considering the complexity and requirements of the data and IT systems, respectively.

However, to perform these checks, it is essential to educate the employees on what the IBOR transition means, as well as on the differences among RFRs and between RFRs and LIBOR approaches. Financial institutions should be prepared to inform regulators, rating agencies, public shareholders and stakeholders about the impact of IBOR transition on the company.

From an accounting point of view, it is necessary to assess the consequences of the IBOR transition according to the relevant standards. Moreover, during P&L and liquidity planning, the consequences of modified cash flow projections as a result of the LIBOR transition should be assessed. With respect to the management system, it is important to assess whether the product referencing the RFRs are handled correctly, as well as if the internal valuation and funds transfer pricing (FTP) needs to be adjusted. It might also be necessary to implement valuation procedures and/or models to valuate products referencing new RFRs and to provide the correct valuation to the counterparty. Finally, an assessment of the potential impact of IBOR transition on the hedge accounting is crucial.

On the operational requirements side, the first step is to assess the IT systems and models that are impacted from the transition and ensure that the owners of the systems and models are aware of the changes that are necessary. IT must be able to manage all products based on the new RFRs and understand the differences in time publication. The feed frequency should also be adjusted to a daily update.

Zanders IBOR Assessment

On 2 April 2020, FINMA published its 2019 Annual Report, which stresses that an inadequate preparation by market participants to the discontinuation of the LIBOR is ‘a serious financial market risk’. FINMA also identifies six main impacts for all supervised institutions: (1) High business volumes, (2) Legal risks, (3) Valuation risks for credit, (4) Derivative products, (5) High level of technical dependency, (6) Risks in connection with operational readiness.

In January 2019, FINMA sent a letter to the 43 largest banks addressing the main risk areas and asking institutions to perform a self-assessment of level of preparations to the IBOR transition. In late April 2019, an evaluation of the assessments found there was inadequate preparation among most banks. Zanders offers banks an IBOR Assessment that assesses the bank’s IBOR transition readiness. Based on a review of quantitative information about your ex

osure on LIBOR in terms of contracts and models, and interviews with your bank’s risk specialists, Zanders provides an independent and objective assessment of your bank’s status in the IBOR transition relative to the FINMA expectations and best market practices. After having assessed all guidelines and accompanying requirements, Zanders will deliver a report that states whether your bank’s IBOR transition level is above, at, or below the requirements of FINMA's expectations. For the parts of the IBOR framework that do not meet the guidelines, recommendations will be presented in the report (including a level of priority that accounts for proportionality and materiality).

Zanders can also support your bank with the implementation or enhancement of your (existing) contracts and models in terms of new reference rates. This also includes ensuring operational readiness.

From meeting with banks and multiple publications, Zanders has gained significant knowledge into the challenges of a smooth transition from IBOR to the new reference rates. The Zanders Assessment, which combines our knowledge on best market practices and the latest regulatory developments, will provide your bank with valuable insights in the banks’ transition level and in the further steps needed for a smooth and complete transition.

Conclusions

The transition to alternative reference rates will affect financial institutions on a wide operational perspective. It will challenge how contracts are written and priced, how risks are managed, and how IT systems are operated. Time and resources are required to amend current operating models. For this reason, it is important for banks to develop a detailed action plan explaining how they intend to address these challenges.

The Zanders IBOR Assessment aims to help institutions understand their specific challenges and prepare their business lines to face the transition in an effective and efficient way, creating inventories and assessing exposures.

References: FINMA Guidance 03/2018, LIBOR: risks of potential replacement, December 2018 / FINMA Risk Monitor 2019 Websites: snb.ch / federalreserve.gov / ecb.europa.eu / glkb.ch / finma.ch

Contact

For more information about the Zanders IBOR Assessment, please take contact with Zanders Switzerland. Martijn Wycisk or Davide Mastromarco

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