A call to action for Asset Management firms.
As part of the continued regulatory scrutiny and oversight of the transition away from LIBOR, on 27th February 2020 the FCA published another Dear CEO letter addressed to all UK‑regulated asset managers. The FCA makes clear it is essential for asset managers to reflect on the points raised in the letter and to take appropriate action.
It is an indication of the importance that the FCA attaches to LIBOR transition for the sector that it has chosen to write again to asset managers, having covered this topic as recently as 20th January in its letter to CEOs setting out its asset management supervision strategy.
The letter encourages firms to “prepare now for the end of LIBOR” and be “in no doubt” of their responsibility to facilitate and contribute to an orderly transition. The letter sets out clear expectations as to the specific actions asset managers should be taking in terms of their:
- governance and oversight;
- transition plans;
- products and services; and
- mitigation of conduct risks and conflicts of interest.
- Firms are expected to take all reasonable steps to ensure that the end of LIBOR does not lead to market disruption or consumer harm, and to support industry initiatives to ensure a smooth transition.
- Asset managers should be in no doubt that they have a responsibility to facilitate and contribute to an orderly end to LIBOR. They should take pro-active steps, not wait for instructions from clients nor expect or base their transition plans on future regulatory relief or guidance, or on legislative solutions.
Further insights and requirements are grouped below, by area of focus:
Transition governance and oversight
- The Board should have oversight of the transition process, and seek support and challenge from second and third lines of defence.
- Senior managers need to be aware of the risks of LIBOR transition and there should be clear lines of accountability for managing each aspect of transition - Statements of Responsibility should include any responsibilities arising from LIBOR transition plans.
- Asset managers with material exposure to or dependencies on LIBOR should have established proportionate transition plans agreed with their Boards. Those with little or no LIBOR exposures or dependencies should test this view periodically with oversight from the Board.
- Where the Board decides that no LIBOR transition plan is needed, the FCA may challenge this.
- If the Board decides that a barrier to transition is insurmountable or the transition preparations will not be completed in time, the firm must inform the FCA immediately.
The LIBOR transition plans asset managers have in place are expected to:
- span all business functions and be devised holistically;
- consider both how existing exposures will be removed/ameliorated in a timely manner and how new ones will be prevented;
- carefully quantify all investments, operations and activities with LIBOR exposures/dependencies;
- include a strategy for keeping clients appropriately informed of such changes as they develop and are implemented;
- consider the risks arising from the LIBOR transition and identify appropriate mitigations; and
- include appropriate milestones, be resourced adequately and be monitored to ensure progress at an appropriate rate.
Effective transition plans will likely align with priorities and milestones outlined by the FCA and industry initiatives such as ISDA’s work on benchmark fall-back adjustments where appropriate.
Products and services
- Asset managers offering products/services that are exposed to or dependent on LIBOR must consider carefully whether these will meet the needs of clients and perform in the expected manner after 2021.
- Where firms are issuing new products with LIBOR exposure beyond 2021, they will need to consider whether such products comply with product governance rules.
- Where asset managers operate funds, CIS and/or segregated mandates with objectives and other features that reference LIBOR, they might have transition plans that involve developing and offering new products that reference alternative rates and might amend the constitutional documents of existing products either to include fall-back provisions or to replace LIBOR with alternative rates.
- All obligations relevant to making changes to product documents should be considered.
- Asset managers investing on behalf of clients in instruments which reference LIBOR such as bonds, loans, swaps and structured products may want to, in order to avoid or manage the risks of LIBOR transition, invest in instruments that reference alternative rates or have fall-back provisions.
- They should also engage with issuers and counterparties to convert outstanding instruments to alternative rates or to add fall-back provisions.
Mitigating conduct risk and conflicts of interest
- The FCA points to the expectation that firms will align with their overarching principles for business in: exercising skill, care and diligence; managing conflicts of interest appropriately; ensuring clients are not misled and are treated fairly; and act in the best interests of clients.
- It reminds firms of its statement from November 2019 Q&A for firms about conduct risk during LIBOR transition and also stresses the following specific expectations for asset managers:
- Clients must not be exposed to unpredictable or unreasonable costs, losses or risks.
- All clients must be treated fairly and their interests should be upheld throughout the LIBOR transition.
- When changing benchmarks, asset managers should not misrepresent performance, even if inadvertently.
- Clients should not be disadvantaged when adjusting performance fees.
- Any conflicts of interests arising from LIBOR transition must be mitigated or, where that is not possible, managed appropriately.
There are some key priority actions asset managers should have already taken or, if not, need to immediately:
- secure senior level understanding, support and sponsorship;
- shape and mobilise the delivery programme for transition;
- complete an impact analysis;
- stop the problem getting worse (in terms of existing LIBOR usage); and
- external engagement, monitoring industry developments and the response of clients and competitors.
Furthermore, we expect that FCA supervisory teams will focus on understanding how asset managers have factored this Dear CEO letter into LIBOR transition programmes, and action plans, throughout 2020 and beyond.