Reducing conduct risk in LIBOR transition

As we progress through Q2 of 2021, the 6 month countdown for firms to have completed their LIBOR transition programmes in accordance with timetable set out by the Working Group on Sterling Risk Free Reference Rates has commenced.  As part of that, some firms are still grappling with many of the technical aspects of the transition to Risk Free Rates (RFRs) with, for instance, clarity still awaited on how the FCA will exercise its powers under the Financial Services Bill.  That uncertainty may also have led some to delay the implementation of their communications strategy with their customers.

Customer communications are an important element of how firms can mitigate the conduct risks they face as a result of the Libor transition process and is a key focus of the FCAs expectations for firms.  In this article we look at the guidance available from regulators, along with available market consensus and best practice.  We also provide some top tips for reducing firms’ conduct risk in this complex area. 

Regulator guidance on customer communications

The FCA has included some useful, if fairly brief, guidance on customer communications in its “Questions and answers for firms about conduct risk during LIBOR transition” that was published in November 2019 with an update in November 2020.  Further guidance is contained in the recently joint Dear CEO letter published jointly by the FCA and PRA on 26 March 2021.

The FCA has made it clear that it expects firms to communicate information to customers in a way that is clear, fair and not misleading on the impact of LIBOR cessation. That information should be presented in good time to allow customers to make informed decisions about the relevant products and the risks they may be exposed to. This applies to existing and new financial products and services.

Good practice

Ideally firms should already have started to communicate with customers to raise awareness and educate them on the general implications and timing of the transition.  Further more focused engagement should then be rolled out to discuss new products or solutions that meet the customers’ needs as they take out new facilities, or re-finance or re-paper existing facilities.

How can firms ensure communications are clear, fair and not misleading?

• When offering non-Libor linked products, firms should set out the range of alternatives for customers, including the costs, risks and impact on customers;
• communications should acknowledge the challenges arising out of the transition and any differences in the operation of the new facilities compared to the Libor facilities;
• consider the knowledge and experience of the intended audience (eg firms should assume that retail mortgage borrowers have a lower level of knowledge and understanding of Libor and the implications of the transition for them compared with large corporates); and
• ensure relevant client-facing staff have adequate knowledge and competence to understand the implications of Libor ending and can respond to client queries appropriately, which may require additional training. This should include ensuring staff understand the relevant regulatory obligations, including the boundary between providing information and advice, and that they involve other members of staff where any questions or engagement with customers is outside of their own knowledge or expertise.

Firms risk being challenged on whether they are treating their customers fairly where:

• the replacement rate results in a customer paying more than they would have been paying on their existing Libor facility;
• conversations with customers who have Libor based products that mature after the end of 2021 (or 2023 for some US Dollar tenors) are delayed such that the client is left with insufficient time to understand their options and make informed decisions on how to proceed; and
• firms do not present or discuss alternative products in an attempt to avoid straying into a personal recommendation or advice. Firms can provide an objective overview of the benefits, costs and risks of a range of alternatives to a client’s existing Libor-linked products, without inferring a recommendation or providing advice.

The complexity of the Libor transition landscape and the necessity to tailor communications to individual customers’ sophistication and knowledge base means that firms’ engagement strategy needs to be multifaceted and include segmenting customers by product type, customer sophistication, and risk segment (or other appropriate segment depending on the make-up of the portfolio). Customers in financial distress should also be identified and streamed appropriately to ensure their situation is appropriately managed through the transition.

Top tips for reducing your conduct risk 

Planned client communications and engagement strategy

• Tailored by customer type/product type/risk segment
• Specific strategies for customers in financial difficulty

Content of client communications

• Clear, fair and not misleading
• Content should be appropriate for the customer dependent on their relative sophistication
• The risks and implications of the transition to non-Libor linked products should be clearly explained to the customer

How and when to send communications

• Engage early, allow sufficient time for customer to consider their options
• Education across a variety of mediums
• Consider Covid-19 impact on customers and their timetable for transition

Training for internal staff

• Ensure adequate training and resource is given to frontline staff
• Ensure frontline staff are not giving advice or recommendations
• Ask frontline staff to provide feedback on communications strategy based on their engagement with customers to enable trends to be tracked and processes to be amended as necessary

Monitoring and record keeping

• Put in place mechanisms for customers to confirm their understanding
• Record and retain all engagement with customers