The Swiss Financial Market Supervisory Authority (FINMA) on Monday published guidance regarding the potential replacement of the London Inter-bank Offered Rate (LIBOR), highlighting the risks of such a move.
The report follows on from the Financial Conduct Authority (FCA) announcing in July of last year that it no longer plans to support the benchmark from 2021 onwards. This is because the regulator believes the benchmark is based on too few actual underlying transactions and is therefore vulnerable to manipulation.
As a result, alternative reference rates are now being discussed. However, FINMA warns that because many financial products and contracts are dependent on LIBOR benchmark interest rates, such a move is not without its risks – namely, legal risks, valuation risks, and operational readiness risks.
According to the report, a substantial contract volume is tied to LIBOR in Switzerland. This mainly consists of mortgages and derivatives contracts. The National Working Group on Swiss Franc Reference Rates (NWG) is the main forum for considering alternative options for LIBOR.
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In order to avoid potential legal risks, the financial regulator advises: “Numerous contracts for financial products that reference LIBOR have a final maturity date after 2021. Amending these contracts to include practicable fallback clauses could help minimise potential legal risks.”
Furthermore, the Swiss watchdog suggests firms should adopt a clear communication strategy for their customers and counterparties, to reduce the chance of legal conflicts.
To ensure companies are ready for this change, FINMA states that “proper valuation, pricing and adequate risk management with regard to alternative reference rates are key.” However, this could be costly and could require the replacement of technical infrastructure and data management.
In order to stay on top of this change, FINMA advises supervised firms to address the challenges they might face in the wake of a potential replacement of the LIBOR benchmark “in good time.” You can read the full report here.