Realising opportunities while managing conduct risk

As efforts to transition from Libor to risk-free rates (RFRs) ramp up, Maria Blanco and Nassim Daneshzadeh, partners in PwC’s US and UK financial services practices, discuss two critical and interconnected strategies that are front and centre for PwC clients

 

Client strategy – Making Libor transition an example of putting your customer first

One of the first questions PwC asks when speaking to Libor transition programme heads is: ‘How does your programme address the needs of clients?’

At the heart of any Libor transition programme should be a thoughtful approach on how to best serve the client base, not only in migrating the back book to alternate reference rate solutions, but also by addressing emerging needs during this historic market event. This can be achieved by rotating the traditional programme structure onto its side and taking a strategic client view that:

• Creates customer profiles across positions, exposures and behaviours to support need- and risk-based segmentation.
• Drives prioritisation of client-related activities – client utility (contract and communication) set-up, marketing and educational planning, as well as new product development.
• Links client and product exposures to get a more insightful view of the balance sheet, and potential impacts from remediation efforts and market events.

In doing so, firms can realise a number of benefits, such as:

• More efficient use of resources with greater impact as a result of more informed decisions. Knowing what type of exposures clients have across all of their activities allows you to design the client utility more efficiently, prioritise which relationships should be remediated as a relationship versus as individual products, and prepare the organisation for the new types of products that will be required in an alternate reference rate world.
• Better risk management. By having client exposures and behaviours quantified and tied to the balance sheet, scenario analysis and changes to the balance sheet caused by remediation can be tracked and managed more easily.
• Most importantly, the ability to provide distinctive service – always a commercially sound idea. A strategic view of your client base allows you to design transition plans tailored to the customer, manage communications in a seamless, co-ordinated manner and identify and create impactful client solutions.

 

Conduct risk – The elephant in the room of Libor transition

The follow-up question PwC asks when speaking to Libor transition programme heads is: ‘How are you mitigating conduct risk?’

Libor transition is fraught with potential conduct risk, which, if mismanaged, can become an expensive and reputationally corrosive event. Five distinct features heighten conduct risk during Libor transition:

• Information asymmetries between industry working group participants and their clients – who are privy to less information – increase the possibility of actual and/or perceived unfair treatment of clients, mis-selling and collusion.
• Economic value transfer from moving to alternative RFRs can create ‘winners and losers’ and result in disputes.
• Uncertainty in the evolving RFR market structure – and the resulting open question of when interbank offered rates will actually cease to be published – makes it difficult for firms to know the ‘right’ thing to do and when to do it; for example, when to transition back-book clients.
• Conflicts of interest resulting from the multiple business and economic outcomes that can arise through the transition process.
• Regulatory scrutiny resulting from historical misconduct events – such as swaps mis-selling or payment protection insurance – has heightened the focus on conduct controls from global regulators.

To help firms proactively mitigate conduct risk, PwC created a Libor transition conduct risk framework. The three elements of the framework are:

1. Identifying types of conduct risks. Not all conduct risks are the same for every institution. Libor transition-specific conduct risks span from information asymmetries and economic value transfer to conflicts of interest and market disruption. Identifying them upfront is the foundation for managing them. 

2. Defining programme-level conduct risk principles. Expectations for conduct risk mitigation have to be digestible for the entire organisation. Hence, PwC encourages the use of conduct risk principles to communicate how the firm approaches conduct risk, as well as its risk appetite. 

3. Identifying conduct risk scenarios and creating mitigating actions for each risk. Guided by conduct risk principles, firms can design the necessary governance, controls and processes to mitigate firm-specific conduct risks across transition scenarios.

Conclusion

You cannot create an effective Libor transition client strategy without considering the closely intertwined conduct risk implications. Not every client and product has the same type or levels of conduct risk. Client strategy must not only be rooted in the opportunity to create new products and services, but should also weigh potential conduct risks embedded within each relationship and action. For example, serving a sophisticated hedge fund client that has set up a Libor-based opportunity fund will bring different types and levels of conduct risk than serving a public pension plan or a small commercial client. By pairing Libor-specific client strategies and conduct risk frameworks, firms can seize a unique opportunity to provide distinctive service while mitigating conduct risk during Libor transition.

 

Libor transition and implementation – Special report 2019
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