Third, robust fallback language must be introduced for all new transactions referencing IBORs to cap the potential legal and conduct risk that continues to be introduced with each new IBOR-based transaction.
And, finally, firms should systematically capture and store fallback language for all legacy and new transactions and confirm that the fallback language can be used by operational systems in the event of a cessation event (referred to as “operationalizing fallback language”).
Based on the analysis, a global systemically important bank (G-SIB) may have more than 250,000 contracts with references to IBORs that are likely to mature post-2021, in addition to several thousand other contracts with indirect IBOR exposure (e.g., a penalty clause in supplier agreements).1 The volume of documents can increase significantly when considering activities such as servicing, where firms may not have direct financial exposure but play an important operational role in IBOR contracts. It is estimated that legal and contract remediation for IBOR transition may cost more than $50 million and would require enterprise-wide contract discovery, digitization, term extraction, repapering, client outreach and communication capabilities.
Document intelligence solutions may offer a means of conducting this extensive review and cataloguing of contracts in an automated or semi-automated manner via technology such as optical character recognition (OCR) and artificial intelligence/machine learning (AI/ML). Solutions can be deployed to digitize vast numbers of contracts into machine readable formats, extract relevant terms via customizable business logic and interpret those terms into a structured data set for consumption. When faced with thousands or hundreds of thousands of impacted contracts, document intelligence solutions can significantly reduce document review and processing time, resulting in cost savings for firms.
Moreover, capturing fallback language and operationalizing fallback language may require changes across more than 200 internal and vendor applications.
The legal remediation strategy associated with the transition will influence firms’ client outreach and communication approach, operational readiness, and, ultimately, product transition strategy. The inability to address contractual challenges may result in adverse consequences for financial market participants, including financial, legal, conduct and reputation risk.
What can firms do now?
- Actively monitor and participate in fallback language consultations and product conventions led by national and industry working groups
- Implement robust fallback language (transition event, benchmark rate and spread adjustment) in all new cash transactions referencing IBORs and ARRs
- Verify readiness to implement robust fallback language for derivatives based on ISDA’s Benchmark Supplement (EU BMR) and IBOR fallback amendment to the 2006 ISDA Definitions (expected Q4 2019)
- Identify all impacted contracts, develop an inventory of those referencing IBORs, and consolidate impacted contracts to one or more contract repositories for analysis, remediation and repapering (if needed)
- Source a representative sample of contracts referencing IBORs and assess the strength of fallback language in legacy transactions by contract type, product and client segment – assessment should help prioritize remediation efforts
- Assess potential financial, legal and conduct risk due to permanent cessation of IBORs, including non-adherence to the ISDA protocol by specific client segments and the impact of differences in fallback language between cash and derivatives
- Assess the feasibility of leveraging technology solutions to digitize and extract fallback language for all legacy transactions referencing IBORs, thus reducing manual effort up to 75%
- Define a legal remediation, product transition and client outreach and communication strategy based on fallback language and consent provisions, product type and client segment for all legacy transactions maturing post-2021
- Systemically extract and store fallback language at the point of inception (new client or contract) for all new transactions in a legal data repository
- Identify impacted systems (internal and third-party) and develop detailed business requirements for system updates to operationalize fallback language in the event of an IBOR cessation