Wherever you look, you can see experts opining on Interbank Offered Rate (“IBOR”) transition and with good cause, since this is arguably the most significant change in the markets for 30 years and the scale of the undertaking is potentially enormous. Experts are currently discussing many areas, including navigating the new myriad of acronyms – from EONIA to ESTER and LIBOR to SOFR – defining what constitutes acceptable IBOR fallback standards, the remediation of legacy contracts and the preferred Risk Free Rate.
Much of this is known but still, key components are unidentified and yet to be resolved. However, what is clear is that the FCA stated as per its CEO, Andrew Bailey, in July 2017, that it would no longer encourage or compel banks to make LIBOR submissions after 2021. Hence, something needs to happen.
In practice, this means that the industry will need to transition away from IBORs, but to do so it needs to undertake the daunting task of understanding its exposure to this most pervasive group of rates. The sheer scale of the undertaking at hand means that the financial industry has no choice but to proactively embrace more aspects of legal technology than it has done previously. This could become a paradigm leap to a new operating model and create the tipping point for enabling legal technology.
To diagnose exposure to the instruments that reference the IBORs accurately and efficiently as a precursor to the execution of an effective IBOR transition programme, will require the intelligent use of technology to retrieve meaningful data and business context. The keyword is “intelligent”, as the success of this strategy is conditional upon institutions carefully designing and validating how they use that technology; blind adoption will lead to false comfort and problems down the line.
It is key to remember that a fool with a tool is still a fool – you need to use these tools intelligently.
Diagnose and remediate
Each firm needs to identify and assess its exposure to IBORs which are prevalent across derivatives, bonds and loans. However, the scale of this task means that a manual search would potentially be extremely, expensive, unwieldy and prone to operational error. Accordingly, to effectively understand the risk across a large portfolio, the optimal way is to develop an algorithm which can provide scalable review with sample checks. The success of the intelligent algorithmic approach is predicated on a clear, demonstrable methodology to create an effective algorithm. The initial diagnostic and sampling/design phases are critical to the overall portfolio risk analysis.
Organisations will need to assess how they want to amend the contracts and which are the relevant Risk Free Rates to employ, but this work can be done in parallel and should be much easier given the digitisation journey that will have been completed. The digitised contractual data could then be used with document generation platforms to automate the appropriate amendment documentation.
Why digitisation now?
The industry has, for a number of years, discussed the merits of legal technology but the tangible benefits have sometimes remained illusory. As you can see from above, the benefits of IBOR transition are very tangible. In a blockchain world of solutions looking for a problem, the IBOR transition really is the problem looking for a LegalTech solution.
The convergence of factors such as the importance of structured data, utilising efficient technology and processes and the recognition of imperatives to add strategic value, may justify the commitment by firms to invest in a sustainable digitised operating environment that will save time and reduce cost.
Much has been made of blockchain, distributed ledger technology and smart contracts and whilst, in due course, it is inevitable that they will be impactful for legal documentation in the financial markets, in the short term it is anticipated that the immediate opportunities for such technology are likely to be found at the individual transaction level, rather than relationship-level documentation. Leveraging this approach more widely will require legal advisors to understand the various points of connection between each of the documents and take account of legal relationships with third parties; whilst this is happening currently on a small scale, it is still complex and will take time.
However, the time is right for smart firms to embrace certain aspects of legal technology today. Structured data and enabling technology can allow firms to materially enhance their existing contractual framework and can unlock business value through legal change.
This could facilitate a new operating model that enables risk managers and the General Counsel office to have a portfolio understanding of the legal risk contained in the documentation portfolio at their fingertips. This will subsequently equip them to dynamically understand the risk and proactively manage it whilst staying involved in the strategic dialogue.
The IBOR transition is likely to be the tipping point for the industry when the business value of LegalTech is finally realised.
Jason Pugh, Managing Director, D2 Legal Technology