FCA to monitor whether firms take steps to treat customers fairly when replacing LIBOR

Maria Nikolova

In choosing replacement reference rates, considering the contract as a whole, firms need to ensure the replacement rate is fair, the UK regulator says.

The UK Financial Conduct Authority (FCA) has earlier today elaborated on conduct risk during LIBOR transition.

LIBOR is set to cease after end-2021, when the voluntary agreement of panel banks to continue to submit to LIBOR ends. Firms are expected to find suitable alternatives to LIBOR. The market-led Risk Free Rate Working Group recommends the Sterling Overnight Index Average rate (SONIA) as the preferred risk-free rate (RFR) to replace Sterling LIBOR. The FCA and the Bank of England support transition to SONIA and alternative rates.

“An overarching concern for us will be whether firms have taken reasonable steps to treat customers fairly”, the FCA warns.

In choosing replacement reference rates, considering the contract as a whole, firms have to ensure the replacement rate is fair and should consider that LIBOR discontinuation should not be used to move customers with continuing contracts to replacement rates that are expected to be higher than what LIBOR would have been, or otherwise introduce inferior terms. The FCA will pay close attention to any case where a contract amendment is made in this way as firms may be failing to meet their obligation to treat customers fairly.

When transitioning their existing contracts, firms receiving LIBOR-linked interest are not expected to give up the difference between LIBOR and SONIA, which results from the term credit risk premium that is built into the LIBOR rate, but not into SONIA.

Firms that include fall back provisions in existing contracts to replace LIBOR with a new reference rate, have to ensure they communicate effectively how these fall back provisions are expected to operate (eg whether clauses operate at, or before cessation, and on what basis).

Firms will also need to consider whether any contract term they may rely on to amend a LIBOR-related product is fair under the Consumer Rights Act 2015 (the CRA) in respect of consumer contracts.

Some industry initiatives are still underway and market consensus is still developing in some areas, so the FCA advises firms to exercise their own judgement on when and how to remove LIBOR dependencies in legacy contracts by end-2021.

“The most effective way to avoid LIBOR-related exposure is not to write new LIBOR-referencing business, and to transition to alternative rates”, the FCA says.

Regarding firms that continue to market, distribute and or sell LIBOR products that mature beyond end-2021, the FCA notes that it is essential for them to explain fully what will happen in the event of LIBOR ending and its effect on the customer.

To avoid the risk that customers do not understand how the change will affect them, firms should consider offering alternative products that do not reference LIBOR.

When dealing with existing customers with legacy contracts that need to be amended, firms should communicate in good time to ensure customers can consider all the options available and respond before end-2021.

The FCA will challenge whether firms are treating their customers fairly where:

  • contracts have ‘small print’ resulting in higher costs for the customer (for example by replacing LIBOR with a higher rate);
  • conversations with customers affected by LIBOR are delayed to the point the client is left with insufficient time to understand their options and make informed decisions;
  • firms do not present or discuss alternative products due to unfounded fears of straying into a personal recommendation.

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