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LIBOR and Conduct Risk: When and How Should You Mitigate?

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LIBOR and Conduct Risk: When and How Should You Mitigate?

  1. 1. Don’t get left in the dark when LIBOR is switched off LIBOR and Conduct Risk
  2. 2. CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION THE IMPORTANCE OF ADDRESSING CONDUCT RISKS Copyright © 2020 Accenture. All rights reserved. 2 Conduct risk is particularly relevant to the LIBOR transition as customer perceptions are that the new alternative reference rate (ARR) products and options are not economically equivalent, creating commercial “winners and losers.” The way firms handle client engagement, communication, and understanding can amplify conduct risk. Defining Conduct Risk Ethics, conduct and culture are the foundation of success, serve as the basis for a firm’s reputation and license to operate. Though conduct risk has been a regulatory priority since the global financial crisis; there is no formal unified conduct risk regime in the U.S. Broadly, leading firms consider conduct risk to be an action that could lead to: (a) poor outcomes for clients, or (b) behaviors that prevent, restrict or distort effective competition, or (c) have an adverse effect on market integrity, or (d) extends beyond the U.S. rules for sales and suitability, UDAAP, and fair disclosure, etc. Conduct Risk in LIBOR Transition The roster of U.S. regulators raising preparedness for LIBOR transition continues to grow with the SEC and FINRA joining the ranks of the OCC, the CFTC, and the NYDFS. Key risks related to IBOR transition include: - Misleading clients through client communications regarding the ongoing suitability of IBORs - Negative client outcomes and conflicts of interest driven by the economic inequivalence of IBORs and the ARRs - Anti-competitive practices in RFR or industry working groups - Market abuse, mis-selling and unfair and deceptive practices seeking unfair advantage as a result of the transition - Costly litigation resulting from consumer harm incurred in the transition Change Required to Fallback Provisions Complexity of New ARRs Environment Client Maturity & Awareness Product Complexity Product Maturity IBOR Conduct Risk Drivers Regulators in the U.S., the UK, and the European Union have fined banks more than $9 billion for misconduct related to LIBOR and will expect a focus on good conduct throughout the transition to ARRs. Please see Legend for acronyms Source: https://www.cfr.org/backgrounder/understanding-libor-scandal
  3. 3. Key Conduct Risk Drivers Trade entry/product maturity • Trade entry dates are key in the context of Benchmarks Regulation (BMR) and its requirements for robust fallback plans. • Maturity dates are also important given the target transition date of 2021 set out by regulators. Product complexity • The broad scope of products impacted by the transition implies an equally broad spectrum of complexity. • Complexity drives conduct risk, particularly complex exotic products, which may include direct and indirect reference to IBOR rates and inherent complexities in fallback provisions. Client sophistication/awareness • The broad spectrum of products implies a broad spectrum of impacted clients and counterparties. • The protection afforded to clients against misconduct should be proportional to their sophistication. CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION CONDUCT RISK DRIVERS Copyright © 2020 Accenture. All rights reserved. 3 Productcomplexity Throughout the transition, conduct risk is expected to result from a number of key drivers which should be mitigated through a robust conduct risk framework with targeted management information (MI) that evidences how firms are discharging their duties. These drivers are key considerations in creating and embedding a robust conduct risk framework and risk mitigation methodology with associated MI
  4. 4. CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION CONDUCT RISK EXPECTATIONS Copyright © 2020 Accenture. All rights reserved. 4 What is expected → Demonstrate that a fair price has been established at the moment of signature and that this is fairly applied across like client groups → Analyze risk of misconduct occurences and appropriately plan and manage mitigation → Document and demonstrate → Control framework and governance (1st, 2nd, 3rd LoD) surveillance for mitigation → Qualify, quantify, and report on conduct risk and underlying exposure Reg BI UDAAP CFPB FINRA Conduct Rules Operate within current regulatory frameworks followed today (UDAAP, Sales and Suitability) to include LIBOR specifics Include conduct related activities that are not covered by existing frameworks (e.g., transactions) Although current focus is on LIBOR transition execution, firms should plan ahead to generate evidence demonstrating their fiduciary duties are fulfilled. Please see Legend for acronyms
  5. 5. • Engage with clients through all communication channels (i.e., verbal, written, social media) • Document contract discovery and assessment criteria • Detail impact analysis and decisioning factors ACT IN THE CLIENT BEST INTEREST PROVIDE TRANSPARENCY AND EFFECTIVE COMMUNICATION OVERSIGHT AND SUPPORT • Review of client outreach • Assess fairness against original impact analysis • Complaint management • Evidence client outreach (verbal and written) at key moments • Document rate and fairness decisions • Consistent and detailed marketing and client communications • Conduct risk MI to identify at risk counterparties and product prioritization MitigantsAction CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION MITIGATING CONDUCT RISK Copyright © 2020 Accenture. All rights reserved. 5 There are key moments when banks should demonstrate they are acting in their clients’ best interests, providing transparency and effectively communicating to mitigate potential misconduct. Discovery Identify all in- scope contracts impacted Digitize Digitize and Store Digitize, store, and extract key metadata from contracts in a secure environment so they are accessible to relevant stakeholders Rebook Contracts Signature Closure Review Client Feedback Update contracts to contain newly agreed upon fallback language Negotiation Discuss and agree on remediation action Client Outreach Implement client strategy for communications, disclosures, and marketing materials Create Contract Amendment Selection of appropriate fallback language / new contract terms for amendment Data Client / Portfolio Assessment Front office review client and portfolio impacts Finance & Risk Review Review for impact on risk and financial measures 1 2 3 4 5 6 7 8 9 10 11 12 13 PHASE 1 – STRATEGIC PLANNING PHASE 2 – IMPLEMENTATION PHASE 3 – POST IMPLEMENTATION Please see Legend for acronyms
  6. 6. CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION 3 LINES OF CONDUCT RISK DEFENSE Copyright © 2020 Accenture. All rights reserved. 6 A three-layered defense with defined roles, responsibilities and authorities to permit comprehensive risk identification and assessment as well as effective risk management supports conduct risk mitigation. Illustrative activities within the lines of defense include: 1st Line Of Defense 2nd Line Of Defense 3rd Line Of Defense Internal audit performs an independent, objective and critical assessment of the design and effectiveness of the governance framework and overall system of controls including 2nd line of defense functions including: • Risk governance framework design and implementation • Business process changes • Technology and data governance • Compliance and risk management monitoring Operational units identify and manage LIBOR risk through predefined policy, controls, and regular monitoring for the functions of the business. • Document contract discovery and assessment • Develop consistent and centralized client engagement and communication models • Assess model pricing and detail impact analysis and decisioning factors • Conduct and evidence client outreach Compliance and Risk develop, implement, and maintain LIBOR risk frameworks and objectively challenge execution of risk and compliance strategies, approaches and related management information. • Check analysis documentation, client engagement, reporting • Independent model governance and communication surveillance • Develop MI to track and report corporate exposures to LIBOR risk, leveraging MI Communication, Collaboration, Reliance Integrated Reporting Board of Directors/ Senior Management • Perform oversight and require client best interests to be central to transition decisions • Establish risk appetite for ARR selection, impact, and strategy • Approve the risk management framework for the transition program Please see Legend for acronyms
  7. 7. CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION MONITORING CONDUCT RISK WITH MI Copyright © 2020 Accenture. All rights reserved. 7 Conduct risk MI plays an important role in helping firms identify, track, mitigate and evidence their conduct risk related to IBOR transition. Reduces the risk of customer detriment Satisfies regulatory requirements and expectations Demonstrates that appropriate and proportionate action is being taken to mitigate conduct risk to management and supervisors Creates cross-applicable data that permits efficient planning and prioritization Streamlines program reporting which can be used to evidence mitigation efforts
  8. 8. CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION KEY ACTIVITIES FOR GREATER EFFECTIVENESS Copyright © 2020 Accenture. All rights reserved. 8 Client Communication and Outreach • Start the client communication plan by defining the timing and nature of communication even if alternatives rates are not yet known • Define communication script for Relationship Managers to engage discussion with key clients • Define the client outreach strategy by type of product and client / counterparty. Start the mobilization plan to anticipate the increasing outreach demand Contract Language and Fallback Adequacy • Identifying legal and contractual impacts, developing a strategy for remediation, assessing readiness to implement more robust fallback language into contracts, and creating both a negotiation strategy and supporting processes • Understand impact from penalty rates and clauses in legacy backbook • Define operational readiness strategy based on the target dates when the steady state is anticipated • Translate the steady state into key objectives (product, contract, operations, platforms, etc.) and align LIBOR plan to meet objectives • Execute the chance management and training activity for readiness • Define dynamic pricing strategy by LoB/Product to balance competitive market positions with centralized fairness • Continue to track and remediate misconduct that should arise from IBOR products/contracts negotiation • Credit syndications to invoke multitudes of dates and subscriber tracking Monitoring Approach and Roadmap to 2022Price Discovery and Demonstration of Fairness • Set up a central governance and a process that can help the various stakeholders from the LoB to set up new prices • Define guidelines and fairness principle checklist that can help to capture rate decision making and fairness • Manage duration and term mismatch from Treasury + Market Risk operations • Document and centralize evidences Provides Alternatives • Provide alternatives rates or alternative products and not just rely on fallback terms. Describe and provide justification for every rate conversion • Provide consistent options for alternative rate structures, outreach models and messages are provided to clients to manage potential perceptions due to value transfer Please see Legend for acronyms
  9. 9. CONDUCT RISK ASSOCIATED WITH LIBOR TRANSITION FIVE THINGS TO GET “RIGHT” Copyright © 2020 Accenture. All rights reserved. 9 Start communication early with clients Take a 360 view of the client, to balance the desired outcome for the relationship with the individual products Keep things consistent Align communications internally and externally Keep good records and provide adequate controls and data
  10. 10. BAU: Business as Usual CFPB: Consumer Financial Protection Bureau CFTC: Commodity Futures Trading Commission FCA: Financial Conduct Authority FINRA: Financial Industry Regulatory Authority IBOR: Interbank Offered Rate LIBOR: London Interbank Offered Rate LoD: Lines of Defense NYDFS: New York Department of Financial Services OCC: Office of the Comptroller of the Currency OTC: Over the Counter PRA: Prudential Regulation Authority Regulation BI: Regulation Best Interest RFR: Risk-Free Rate SEC: U.S. Securities and Exchange Commission UDDAP: Unfair or Deceptive Acts or Practices 10Copyright © 2020 Accenture. All rights reserved. LEGEND
  11. 11. www.linkedin.com/showcase/16183502 @AccentureFSRisk Copyright © 2020 Accenture. All rights reserved. TO FIND OUT MORE Samantha Regan Managing Director, Finance & Risk, Accenture Regulatory & Compliance Lead samantha.regan@accenture.com Venetia Woo Director, Finance & Risk NA Regulatory Strategy Lead venetia.w.woo@accenture.com Accenture LIBOR Transition Offering: https://www.accenture.com/us-en/services/financial-services/libor Accenture Finance & Risk: https://www.accenture.com/us-en/financial-services-finance-risk Accenture Finance & Risk LIBOR Blogs: https://financeandriskblog.accenture.com/tag/libor Accenture LIBOR Survey: https://www.accenture.com/us-en/insights/financial-services/libor- transition-survey Joel Kennedy Director, Finance & Risk UK LIBOR Conduct Risk joel.kennedy@accenture.com
  12. 12. Disclaimer This presentation is intended for general informational purposes only and does not take into account the reader’s specific circumstances, and may not reflect the most current developments. Accenture disclaims, to the fullest extent permitted by applicable law, any and all liability for the accuracy and completeness of the information in this presentation and for any acts or omissions made based on such information. Accenture does not provide legal, regulatory, audit, or tax advice. Readers are responsible for obtaining such advice from their own legal counsel or other licensed professionals. About Accenture Accenture is a leading global professional services company, providing a broad range of services in strategy and consulting, interactive, technology and operations, with digital capabilities across all of these services. We combine unmatched experience and specialized capabilities across more than 40 industries – powered by the world’s largest network of Advanced Technology and Intelligent Operations centers. With 509,000 people serving clients in more than 120 countries, Accenture brings continuous innovation to help clients improve their performance and create lasting value across their enterprises. Visit us at www.accenture.com Copyright © 2020 Accenture. All rights reserved. 12 DON’T GET LEFT IN THE DARK WHEN LIBOR IS SWITCHED OFF LIBOR AND CONDUCT RISK
  13. 13. APPENDIX
  14. 14. Illustrative post-2021 origination DEEP-DIVE: PRODUCTS AND CONDUCT RISK Copyright © 2020 Accenture. All rights reserved. 14 Complexity and Discretion Typically, the more complex the product and the more discretion in the selection of an ARR the higher the potential for conduct risk: - Exotic derivatives which reference multiple ARRs (i.e. multiple jurisdictions) bring greater inherent complexity - Products with a high number of counterparties such as syndicated loans require coordinated negotiation - Products with a degree of retail exposure present higher levels of conduct risk Timing As products expire, are renewed, or are created, their respective conduct risk levels vary - Products set to expire before end-2021 may not perform as expected due to decreased liquidity (low- med risk) - Products that extend beyond end-2021 or which are renewed, require communication, negotiation, and are subject to multiple economic factors (high risk) - Products originated post-2021 should follow a documented systematic approach to reduce conduct risk, but require communication and acknowledgment of understanding (low-med risk) Product Impact Matrix Timing H M L L M H Complexity and Discretion ETDs Short-term Funding Securitised Products Bonds Loans OTC Derivatives (ISDA) Syndicated Loans OTC Derivatives (NON- ISDA) Retail Loans Pensions Product Creation Confirm rationale for decision: • Evidence analysis • Document sign-off Confirm what would change this decision: • Document change paraments • Evidence communication Log transition trigger event and monitor continuously Select ARR and fallback terms Beyond the mechanics of the instrument, Firms should consider direct and indirect conduct risk resulting from product transitions. Please see Legend for acronyms
  15. 15. • Apply FINRA’s Reg BI and principles of fiduciary duty to clients; assess and manage client exposure to LIBOR to protect their best interests • Manage the impact to management fees resulting from portfolio valuation and benchmarks (i.e., update discounting curve to generate compensating terms) • Legal & portfolio documentation may require client consensus (i.e., bi-lateral agreements) • Centralized / coordinated communication strategy • Migration of OTC contracts by adding an adjustment spread (independently calculated) DEEP-DIVE: LEADING THE RISK CONVERSATION Copyright © 2020 Accenture. All rights reserved. 15 Depending on the institution starting the key activities to mitigate conduct risk with LIBOR transition may vary but in all cases, regulatory expectation is for firms to proactively seek to understand their own and their client exposure. Sell-Side (i.e., Investment Banks) Buy-Side (i.e., Asset & Wealth Managers, Advisors, Brokers Hedge Funds, Mutual Funds) Insurers • Product valuation and discount rate curves require detailed explanation and documentation • Suitability and appropriateness of sold products should be assessed; evidencing considerations of the impacts to clients and clear communication of those is required • The impact of product complexity and client sophistication is magnified • Portfolio analysis and disclosure requirements drive client interactions • Identify the extent to which portfolios, including clients’, have LIBOR exposure • LIBOR transition office coordinates communication across investment teams Client Communication and Outreach Contract Language and Fallback Adequacy Monitoring Approach and Roadmap to 2022 Price Discovery and Demonstration of Fairness Provides Alternatives Primary Key Activities Please see Legend for acronyms
  16. 16. Significant change management required to mitigate conduct risk in all areas of the organization. Copyright © 2020 Accenture. All rights reserved. 16 CONDUCT RISK – IMPACTS • Identify all existing and new contracts impacted by IBOR rates across derivatives, cash products and lending. Identify all fall-back positions • Introduce products based on the new benchmarks demonstrating fairness in the selection of ARRs • Document rationale for rate selection and client impact • Establish ongoing evaluation of client impact of LIBOR transition KEYACTIVITIES • Document contract discovery and assessment criteria • Detail impact analysis and decisioning factors FIRSTSTEPS • Impact assess IBOR exposures and fallback clauses so that customers are not disadvantaged • Revisit client communications and disclosures to provide transparency around future risks and uncertainties • Client outreach and negotiations • Review the clearing, settlement, confirmations, margin calculations, etc. and identify opportunities for revisions • Identify migration approach and tools required for the bulk novation or cancel / re- book of positions maturing post December 2021 • Identify and review contracts and fallback modifications. • Establish central repository of contracts • Define negotiation strategy and oversee contract negotiations including migration approach • Complete new business contract design Operations Legal • Identify the legal implications, e.g. revisions to standard terms and conditions, agreements, and other paper work • Engage with regulators on migration approach and contract language Front Office Business • Update internal and regulatory models for credit risk as IBOR (unsecured) and the alternatives (mix of secured and unsecured) may exclude credit spread related to bank credit risk • Update risk appetite, risk policy, and feed thresholds into risk register; and model validation • Assess impacts on liquidity provisioning process • Submit board approved transition risk assessment to PRA and FCA by 14th Dec • Develop Senior Manager briefings regarding required updates to risk governance (e.g. appetite, policy, and control) • Complete gap analysis of current surveillance parameters against new market abuse scenarios across jurisdictions with differing RFRs • Revise conduct risk surveillance scenarios, triggers and thresholds, and update data parameterization (e.g. transaction eligibility, lexicons, etc) • Update compliance testing and assurance protocols for selected risk controls • Identify regulatory engagement priorities for the bank, engagement schedule, and business advisory approach Reg and ComplianceRisk Please see Legend for acronyms
  17. 17. Evidencing answers to these questions and remediating any inconsistencies or gaps is critical in managing conduct risk appropriately 1. Have you identified the risks? - Is there a comprehensive client suitability and appropriateness matrix reflective of the current product suite? - Have you clearly identified all conduct risks related to the transition? - Is there a process for the identification and assessment of all product-specific conduct risks? - Has scenario analysis been performed to capture all transition outcomes? - Are all potential risks captured within the conduct risk taxonomy? - Have you clearly articulated your conduct risk definition, appetite, taxonomy, outcomes, measures, testing, tolerances and strategy? 2. Have you allocated responsibility? - Is there adequate governance in place for the review, challenge and approval of all IBOR-specific programs? - Is there adequate representation of the compliance function within all LIBOR program related governance - Are there adequate information flows between product, model and LIBOR change governance - Are the roles allocated to Lines of Defence Committees and clearly articulated in governance forum documentation? - Is each conduct risk owned by the 1LoD embedded in senior manager statements of responsibilities? 3. Have you identified support mechanisms? - Is there a client support and outreach mechanism in place to deal with LIBOR queries and disputes? - Do conduct risks related to LIBOR transition and client outcomes align to business values / codes of conduct / product design? - Are all such conduct risks mitigated properly by policies, procedures, processes, surveillance, monitoring and controls? - How would breaches, risk issues and control failures be identified, measured, mitigated and monitored? - Is there LIBOR -specific training, supervision and performance / breach management to encourage LoD-appropriate behaviors for all staff? 4. Have you identified conduct MI? - How does conduct MI align to business / product goals and conduct risks / outcomes? - Is there a delineation between the LIBOR -transition change risk MI for new or modified products, post-launch and BAU product MI? - How would the conduct MI be designed to be concise and fit for purpose? Will it inform senior management whether they are within risk appetite, show trends, root cause analysis and identify ‘read across’? - How does the conduct MI inform reallocation of resource to remediate ‘out of appetite’ conduct? - Is data analytics used sufficiently, accurately and consistently? 5. Have you identified undermining factors? - Are there any conflicts between customer communications and the wider conduct agenda? - Is there a 3LoD assurance process in place for the LIBOR program? - How do 2LoD assurance and 3LoD audit align to conduct risk appetite and identify behaviors or culture that undermine stated expectations? - How do governance, control, training, performance management and remuneration processes support the LIBOR conduct agenda? - How are negative behavioral economics biases (both customer and employee) identified and mitigated sufficiently? The 5 FCA questions drive a more detailed set of LIBOR-specific questions which serve as a checklist for your conduct risk framework. Copyright © 2020 Accenture. All rights reserved. 17 ANSWERING THE FCA’S FIVE QUESTIONS ON CONDUCT RISK Source: “Progress and challenges” 5 Conduct Questions – Industry Feedback for 2018/19 Wholesale Banking Supervision, Financial Conduct Authority, May 2019 Please see Legend for acronyms
  18. 18. CONDUCT RISK DASHBOARD Copyright © 2020 Accenture. All rights reserved. 18 Identify the most vulnerable Counterparties (factoring in sophistication, conflicts of interest and anti-trust) Identify the Products which should be prioritized (factoring in complexity, maturity date, notional, trade count, fallbacks) Use the Conduct Risk Radar to quantify and categorize the risk across the program Identify the internal Owners of the products / relationships with the highest risk Conduct risk MI dashboard maps conduct risk across the LIBOR program through a customizable scoring methodology driven by exposures, products and counterparty profiles. Please see Legend for acronyms
  19. 19. DATA THAT PERMITS ACTION Copyright © 2020 Accenture. All rights reserved. 19 Identify distribution of LIBOR transition conduct risk across the firm… … and drill into the data to see the relevant associated products and counterparties to help plan and prioritize a firm’s transition. The dashboard allows firms to identify ownership of the high risk products and counterparty relationships and drill into the underlying data to focus efforts to mitigate risk. Please see Legend for acronyms

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