Today New City Initiative is comprised of 43 leading independent asset management firms from the UK and the Continent, managing approximately £500 billion and employing several thousand people.
Published by Charles Gubert
From the end of 2021, LIBOR, which benchmarks interest rates for a whole stream of financial products including securitisations, loans and derivatives, will not exist. Admittedly, some large institutional asset managers have spent a lot of their time readying their operations for the imminent move to SONIA (Sterling Overnight Interbank Average Rate), an overnight risk free rate (RFR). However, a lot of the industry is still woefully underprepared.
Conscious that large sections of the asset management community have given little thought to the LIBOR transition, the Financial Conduct Authority (FCA) published yet another uncompromising ‘Dear CEO’ letter reminding investment firms they need to take proactive measures to make sure their businesses are using RFRs to minimise any wider disruption.
So why does the LIBOR transition matter to NCI members? Any boutique firm trading bonds or using derivatives (including for hedging purposes) could find the behaviour, valuations and risk modelling underpinning those instruments changes markedly as a consequence of the shift towards alternative risk free rates. In response, asset managers need to begin identifying any LIBOR-linked exposures in their portfolios and start transitioning to SONIA.
The letter added that firms with material LIBOR exposures should have established transition plans in place signed off by their boards. Such plans should carefully quantify all investments, operations and activities with LIBOR exposure and firms must consider how they will remove or ameliorate existing exposures in a timely fashion. The FCA highlighted fund managers must keep their investors informed about their LIBOR transition programme.
In the case of legacy exposures, firms need to reach out to the relevant counterparties and start repapering their contracts and inserting fall-back provisions. This exercise is likely to be very costly and time-consuming for operations teams. At the same time, many asset managers use benchmarks or performance fees linked to LIBOR. This too will require fund managers to identify replacement benchmarks. Moreover, the FCA – in its letter – has advised investment firms to cease launching any LIBOR-linked products by the end of Q3.
Elsewhere, the FCA’s letter said the risks of LIBOR transition must be quickly identified including any potential conflicts of interest, before adding that clients should be treated fairly during the whole switchover process. The FCA continued: “When changing benchmarks, firms should not misrepresent performance, even if inadvertently. When adjusting performance fees, clients should not be disadvantaged.”
Growing FCA impatience
This letter to asset management CEOs, which is now the second regulatory missive to explicitly reference LIBOR, comes amid growing FCA frustration over what it sees as procrastination by investment firms over their LIBOR transition efforts. Although market users trading derivatives and fixed income instruments are starting to make the switchover to RFRs, those transacting in loans and securitisations appear to be well behind the curve.
Regulators believe the sheer levels of documentation involved in the switchover could be partly to blame for the relative inaction. Nonetheless, the message from the FCA is clear. If markets are to operate smoothly during the LIBOR transition next year, asset managers need to urgently begin integrating the new RFRs into their operating models.