For many banks, 2021 marks the home straight in an endurance race toward IBOR preparedness. The adoption of alternative rates in new products is underway but a lot of work remains to be done. EY’s survey of IBOR program leads found that half of the banks felt there was a high or very high risk from the extent and scale of front-to-back testing required.
By Eveline Hunziker, IBOR Country Leader, EY Switzerland
The IBOR Transition Readiness Banking Survey from EY offers insights into how the global banking community is preparing for the upcoming phase-out. As a major financial hub, Switzerland is significantly affected.
As they navigate tight deadlines and a shortage of resources, banks should focus on technology, client outreach and contract repapering to propel them toward IBOR preparedness by the end of the year.
Where does the Swiss financial sector stand on the IBOR journey?
Switzerland's financial markets regulator Finma has been actively guiding the IBOR transition process for supervised institutions. For 2020, the regulator already made clear its expectations regarding CHF LIBOR cash products, including the aim of substantially reducing CHF LIBOR contracts without robust fallbacks. Although the guidance was targeted at the 26 most-affected institutions, Finma recommends all banks to take note.
The transition roadmap, issued in December 2020, sets out in the detail the steps that supervised institutions and market participants should take to enable a smooth and timely transition. Deadlines are staggered over the course of 2021 to encourage effective use of the remaining time until the end of 2021. Following Finma’s recommendations enables relevant parties to safeguard operational readiness for discontinuation of LIBOR in CHF, EUR, GBP and JPY (in all tenors), and in USD (in the 1W and 2M tenors) across all product types.
What are the biggest issues, risks and challenges?
Unless managed effectively and in a timely manner, discontinuation of the LIBOR could pose a major operational risk for supervised institutions. The main concerns for banks in Switzerland are operational readiness, legal risks and valuation risks.
Finma estimates that even small to medium banks (supervisory category 3 to 5) face complex updates in response to the LIBOR phase-out. For banks of this size, LIBOR feeds on average into two to three internal systems, four to five outsourced systems and 11 reporting areas relying on accurate rates. Without targeted action, IT landscapes – from core banking systems and trading platforms to accounting software – will struggle to cope with alternative reference rates and fallbacks. As a result, banks could struggle post-transition to deliver relevant reporting accurately and on time.
There’s no time to lose in defining strategy, leadership and actions
With technology key to the transition, it’s no surprise that Finma is calling for early action. The regulator has recommended a deadline of 30 June 2021 for system and process changes. A year ago, the challenges were around which systems would be impacted and managing that complexity.
This year, it is scale rather than complexity that is now seen as the biggest risk. Around half of EY’s survey respondents flagged the scale and extent of front-to-back testing as a high or very high risk. Against this background, there’s no time to lose in defining strategy, leadership and actions.
Swiss banks have responded positively
Client outreach still remains sporadic and, according to EY’s global survey, the current rate is running behind expectations. Based on Finma’s timetable of actions, most Swiss banks should by now have ceased concluding new transactions based on CHF or EUR LIBOR that mature after end-2021 (without robust fallback clauses), and – where possible – GBP, JPY or USD LIBOR. Banks should be ready to grant loans that are not based on CHF, EUR, GBP, JPY or USD LIBOR. Swiss banks have responded positively, with many introducing mortgages based on the Swiss Average Rate Overnight (SARON) for the first time in 2020.
Survey Methodology: EY interviewed IBOR program leads at 28 banks, with a multiregional footprint, between November 2020 and January 2021 as part of the third annual survey of banks’ readiness for the IBOR transition. Those surveyed were from both Global Systemically Important Banks (G-SIBs) and local banks operating in the UK, EMEIA and the U.S.
Eveline Hunziker, where does the Swiss market we currently stand with the IBOR transition?
Firms have made significant progress in terms of launching new SARON-based products such as swaps or mortgages. Liquidity is still an issue, however, there’s an expectation that growing volumes of SARON cash products will drive liquidity in SARON derivatives.
The focus now needs to shift from SARON product enablement to transitioning CHF LIBOR legacy contracts.
What are the biggest challenges for firms?
Firms need to tackle two main challenges during 2021. One is to reach out to clients in order to re-negotiate and re-paper legacy CHF LIBOR contracts. Firms need to be able to tailor their communication strategy based on the level of client sophistication and product complexity.
Technology is another challenge as multiple IT systems and models need to be adjusted so they can process the new SARON products.
What steps should firms undertake this year?
2021 is all about execution. In the area of client outreach, it is important that firms are staying close to client feedback so that they can adjust their approach as needed.
