risk & regulatory academy 2020 · 2020. 12. 3. · © 2020 deloitte central europe © 2020...

Risk & Regulatory Academy 2020

© 2020 Deloitte Central Europe 1© 2020 Deloitte

DAY 4

IRRBB, FRTB, IBOR

1Risk & Regulatory Academy

© 2020 Deloitte 2

Agenda

IRRBB - a new perspective to interest rate risk in the banking book

• IRRBB Regulatory requirements

• IRRBB current market conditions

• IRRBB Survey – Central and Eastern Europe

FRTB - The complexity of market risk in a volatile environment

• Client Survey from 2019: What are the biggest challenges with getting ready for FRTB SA?

• Standardised Readiness for CRR II

• An Holistic Approach to Preparing for SA Go-Live

• Case Study and Capital Allocation

IBOR – transition to a new reality

• Genesis and scope of changes related to the IBOR Reform

• Key results of the IBOR Reform

Alix Tchana TchanaRisk & Regulatory Directorat Deloitte France

Thomas LudsteckRisk & Regulatory Senior Manager at Deloitte UK

Pawel SplawskiRisk & Regulatory Leaderat Deloitte Poland

IRRBBA new perspective to interest rate risk in the banking book

4

IRRBB regulatory requirements

© 2020. For information, contact Deloitte Central Europe 5

Regulatory milestones

IRRBB and Regulatory requirements

2004 2006 2014 2015 2016 2018

BCBS: “IRR Principles” CEBS: “Principles” EBA: SREP EBA: Guideline BCBS: Consultation BCBS: Standards

Jan 1, 2016Implementation of the EBA guidelines

Dec 31, 2017Implementationof BCBS standards

Publication of the results of the BCBS consultation on the revision of the 1997 principles on the treatment of interest rate risks in both the trading and the banking book (based on the consultation of 1993):

• Principles (1 – 13) on interest rate risk management in the two books

• Principles (14 – 15) on interest rate risk management in the banking book

Publication of a technical specification on the IRRBB by CEBS, on the basis of the CEBS guideline of January 2006 on the treatment of Pillar-1 and Pillar-2 risks:

• Principles (1 – 4) for the Institution

• Principles (5 – 9) for Supervisors

Publication of the EBA’s SREP guidelines:

• EBA’s opinion on the treatment of the interest rate risks in the banking book

• National supervisory authorities as primary addresses of regulation

• Institutions to be subject to the EBA requirements through the national supervisors

Publication of two documents on the management of the IRRBB:

• EBA guidelines:

Revision and extension The CEBS “Principles”

• BCBS consultation paper:

• Revision of the IRR principles

• Minimum funding for IRRBB or “hard Pillar 2 approach”

Publication of the final standards for IRRBB:

• Consideration f IRRBB in the framework of the extended Pillar 2 approach (hard pillar 2)

• Specification of Supervisory requirements for the measurement, Management Monitoring as well as controlling of IRRBB

• No explicit coverage of credit spread risks in the banking book (CSRBB) in CRRII, but it is a focus of the BCBS standards on IRRBB

Publication of EBA/GL/2018/02 on IRRBB: updated guidelines on the management of interest rate risk arising from non-trading book activities

Expected implementation

date

June 30 2019


• A robust risk management framework for IRRBB

• IRRBB included in the risk appetite statement and the risk profile

• Policies and procedures for limiting and controlling IRRBB – these to be reviewed at least annually and revised as required

• Specification of delegated powers, line of responsibility and accountability

• Clearly defined limits monitoring function and remediation processes when limits are breached

• Definition of authorised instruments, hedging strategies and risk taking opportunities

• Independent evaluations of internal controls systems and risk management frameworks, including internal or external audit review

• Approval of significant hedging or risk management activities

• Identification of IRRBB in products and activities, particularly in relation to new products or activities

• Integration of IRRBB risk management within the bank’s broader risk management framework

• Measurement of IRRBB should be based on both economic value and earnings-based measures

• Implement effective stress testing framework to assess the impact of IRRBB using a wide range of regulatory prescribed and internally defined historical or hypothetical stress scenarios

• Documentation of key behavioural and modelling assumptions including materiality assessment, testing of assumptions, sensitivity analyses for key assumptions

• Ensure measurement systems and data integrity through identification and quantification of major sources of IRRBB, documented data management and sign-off process, automation where possible to minimise risk of error and robust control framework around processes which are executed manually

• Independent validation and review process of IRRBB models

• Include all material exposure especially non performing exposure

• Documentation of transaction transfer between trading and banking books

• Consider the impact of IRRBB on capital adequacy on a forward looking basis

• Perform reverse stress tests to understand vulnerabilities and scenarios that severely threaten capital and earnings

• Implement effective stress testing framework to assess the impact of IRRBB using a wide range of regulatory prescribed and internally defined historical or hypothetical stress scenarios

• Capital adequacy for IRRBB under a wide range of factors and document this in the ICAAP. Key considerations include: capital buffers against loss of earnings, if applicable, assessments of capital associated with lines of business and associated capital allocation

• Implementation of outlier test based on EVE under 6 prescribed scenarios

Key takeaway



• There is a sophistication of risk measurement that should be commensurate with nature and scale of activities

• Measuring impact of IRRBB on both earnings and economic value measures

• Six interest rate shocks scenarios to implement

• Stress tests, EV / NII Simulations, dynamic balance sheet projections are needed in the new IRRBB framework

• IRRBB IT systems need to be enhanced. In particular, external vendor solutions used by many institutions for projections, FTP and NII computation

• Behavioural models need to interest rate sensitive

• The new IRRBB framework heightened scrutiny of behavioural models and IRRBB indicators

• Risk and treasury functions need to be co-ordinated to avoid overlaps since IRRBB is often seen as a risk management technique rather than a “trading” one

• The IRRBB framework increases overheads and pressure on validation functions that are already overstretched. Smaller banks may not have independent model validation or the requisite knowledge

• Introduction of dynamic perspective will require a greater cooperation among Risk Management, ALM and Planning & Forecasting departments on both the definition of a coherent operating model and the implementation of an IT integrated solution.

• Dynamic analyses will require forecasting the future production but also the commercial margin targets, in coherence with the bank’s strategic and business planning. In order to properly analyze all effects of the changes in interest rates and of balance-sheet structure, the granularity of forecasts should be consistent with that of modelling (generally, at product level).

IRRBB implementation challenges


Dynamic Analysis & Stress Scenarios for Models and Methods

Implement robust risk management framework around IRRBB models

New target operating model for ALM functions


Challenges encountered

Focus on ICAAP


Definition

• ICAAP (internal capital adequacy assessment process) is within pillar 2 of Basel regulation.For Credit and market risk, it a complement to pillar 1 requirements.

• For IRRB, Capital requirement is driven by the supervisory outlier test and ICAAP

“Another issue observed concerns the quantification of IRRBB, where one-half of the banks use either a combination of earnings and EVE measures or a pure earnings concept to quantify their IRRBB under the economic perspective.”

“Focusing on single risk categories, the information from the economic to the normative perspective is more often used for certain risks (e.g. credit and market risk) than for others (e.g. operational risk and interest rate risk in the banking book (IRRBB)).”

• Two main issues:

IRRBB measurement Relationship between normative and economic perspective

Source: ECB Source: ECB

Source: ECB


Results

ICAAP – Feedback on ECB survey (1/2)


Context

• The ECB analysis concern ICAAP framework (all risk classes included)• The analysis is performed on 37 financial institutions, all GSIB’s and it is based

on the ICAAP packages submitted in April 2019.

In average three sub-categories of risk are considered by European banks for IRRBB:• Gap risk• Basis risk• Option risk

Few banks integrate a relationship between economic and normative perspective.


Results

• Around one-quarter of the banks in the sample use statistical models that focus on economic value of equity (EVE) measures.

• Overall, one-half of the banks use some kind of combination of EVE and earnings measures for determining risk figures under the economic perspective

• One in ten banks only quantifies earnings measures.

• For IRRBB, the majority of banks use scenario analysis and statistical models.

• One-third of the banks use supervisory outlier test figures, respectively, without any amendments.

• Approximately one in ten banks integrates IRRBB risk in market risk..

ICAAP – Feedback on ECB survey (2/2)


11

IRRBB new challenges

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12

IRRBB within low interest rate context

In the context of low interest rates, European banks profitability has been weakened.

• Transformation margin (short term refinancing vs long term loans) is low since the interest rate curve flattens

• Client behavior is evolving and more and more dynamic

Net Interest Income (NII) has been particularly impacted in this environment.

Consequently, European banks are searching for new rooms of profitability through:

• Projections of NII under multiple business and market scenarios

• Improve the quality of IRRBB measures (accuracy of the indicators and data quality)

• Greater implication of ALM within the sales process and the budget forecasting

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13

IRRBB current challenges

Build more comprehensive behavioral model to capture dependency with interest rate and the structural changes

Behavioral model Data Quality

Exhaustiveness and actuality are the main issues encountered

Dynamic balance sheet and NII projections

Perform in a reasonable timeframe balance sheetand NII projection when making assumptions on new business volume and interest rate scenarios• Banks are facing IT systems limitations and

weakness of the organization (interaction between Management Control department and ALM)

14

IRRBB SurveyCentral and Eastern Europe

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15

Context

Deloitte IRRBB survey – Central and Eastern Europe

In which country is the bank located?

0

5

10

15

20

0 1 2 3 4 5 6 7

#BA

NK

S

EU SREP CATEGORY

How big are the bank’s total assets and what is the bank’s SREP category?

Poland |15

Serbia |5

Bosnia and Herzegovina |4

Hungary |3

Slovakia |2

Czech Republic |1

Macedonia |1Bulgaria |1

Albania |1

The size of the field reflects the sum of assets in the ranges: EUR 0-1 bn, EUR 1-5 bn, EUR 5-20 bn, EUR 20-45 bn, above EUR 45 bn

In 2019 Deloitte asked Central and Eastern European banks to participate in a survey regarding ALM solutions applied.

The survey consisted of open and closed 53 questions aimed at evaluation of current ALM practices adopted on the market. The questions focused on the following areas:

• Risk estimation and measurement

• Role of ALM units in banks

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Responsibilities around balance sheet forecast


• For the purposes of balance sheet development scenarios, most banks use data prepared by their business units (in particular new sales value and planned margins in all bank groups, or advance payments and client options in non EU banks)

• In all groups of banks risk is the key factor modelling risk related costs. Planning advance payments and client options are next factors considered.

• Finance units usually plan non interest income and expense. Further, they plan the new sales value and margins.

• ALM units participate in the development of market scenarios regarding liquidity and interest rate. This role may be performed by other units, such as risk or finance (for liquidity), or chief economist (for interest rate).

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Results – IRRBB measures


• Most surveyed banks used both measures indicated in the EBA 2018/02 guidelines, i.e. NII and EVE.

• EVE is still less popular, though.

• Along with these two measures, banks continued using more traditional ones to measure IRRBB, such as BPV, VaR or gap modelling.

1

2

2

3

2

2

3

3

3

2

4

5

6

8

7

9

10

12

2

1

7

5

7

9

13

14

18

Contractual interest rate gap in

dynamic terms

Modelled interest rate gap in

dynamic terms

Contractual interest rate gap in

static terms

Modelled interest rate gap in static

terms

VaR

BPV

Economic value of equity (EVE)

simulation

Net interest income (NII) simulation

Number of respondents

Which measures are used to measure interest rate risk:

33

27

25

14

7

18

17

14

5

Other include: client behaviour risk, convexity risk, EVE+NII, EaR/EVE

Leaders Challengers PackCEE

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Results – IRRBB measures


• Conditional cash flow modelling is cash flow modelling under the assumption that the timing and amount of cash flows is dependent on the specific interest rate scenario.

• Unconditional cash flow modelling is cash flow modelling under the assumption that the timing and amount of cash flows is independent of the specific interest rate scenario.

• A majority of banks (19 of 33) participating in the survey used the conditional cash flow modelling.

• In line with EBA/GL/2018/02 guidance, dynamic balance sheet is a balance sheet incorporating future business expectations, adjusted for the relevant scenario in a consistent manner.

• Constant balance sheet is a balance sheet with the constant value and structure of both on and off balance sheet items.

• Survey results indicate that 14 out of 33 banks applied dynamic balance sheet assumptions to estimate IRRBB.

What assumptions related to the balance sheet are included in the IRRBB measures?

2

2

3

3

3

3

4

9

8

12

2

4

2

14

18

Business flows dependent on interest rate environments

Commercial margin consistent with interest rate scenario

Dynamic balance sheet

Static balance sheet


3

3

9

3

12

7

11

18

Partially or fully conditional

Unconditional


Which cash flow modelling approach does the Bank follow?

33

14

19

33

25

14

10

7

Leaders Challengers PackCEE

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Results – Role of ALM units in banks


* The term “Treasury” is vague as it may refer to units operating on its own portfolio (e.g. trading), ones directly cooperating with clients and ALM units managing the banking book portfolios. ** Two banks: one non-universal (Treasury) and the other Non EU (Finance) did not indicate any of the above reporting lines.*** The numbers show how many times each answer was selected.

Where ALM function is located in the organisation structure and what are ALM reporting lines**:

TOP UE AND NON TOP UE

SPEC UE NON UE TOTAL***

Finance 8 5 13

CFO 8 4 12

Treasury 1 1

CEO 1 1

CRO 1 1

Treasury* / Financial markets division

4 7 5 16

CFO 3 4 2 9

Treasury 2 2 2 6

CRO 1 1 2

CEO 1 2 3

CMO 1 1

Other 3 1 4

Total no. banks 15 7 11 33

FRTBThe complexity of market risk in a volatile environment

21

Client Survey from 2019: What are the biggest challenges with

getting ready for FRTB SA?

22

Implementation Challenges

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Clean and consistent static data for bucketing purposes

Mapping instruments to risk factors

Technical challenges with the methodology e.g. index decomp.

Other

The DRC calculation

Mapping instruments to the various components of SA

% of Respondents

Source: Deloitte survey among eight clients in Northern Europe from 2019

Survey Results (1/3)

Comments

• An ECB survey from 2019 among ~70 European banks found that 15% of the smaller or medium sized banks have made negligible progress in implementing the new rules. Furthermore, 10% already admit facing delays in meeting the 2021 reporting requirement.

Which of the following are (or are expected to be) the main challenges with implementing SA?

23

Internal Risk Transfer (IRT)

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Document all IRT Strategies

Process for obtaining supervisiory approval of transfer

Aligning regulatory and ALM mandates

Reclassification of existing instruments prior to 2022

Process for obtaining supervisiory approval of transfer

Ability of the vendor system to include capital add-ons for…

Definition of "extraordinary" circumstances under which…

Maintaining the correct designations

% of Respondents

Which of the following items would be the most challenging to implement?

Source: Deloitte survey among eight clients in in Northern Europe from 2019


Comments

• Internal Risk Transfer is proportionally a more important topic for smaller banks. Smaller banks tend to often use the trading book to hedge risk in the banking book.

24

Adequate

Inadequate and will consequently compel you to pursue IMA

Inadequate, but will not take any measures

Not sure

Do you expect your regulator will find that your using the SA for own funds requirements is:

Source: Deloitte survey among eight clients in Northern Europe from 2019

Yes, we have been doing investigations and have identified opportunities to optimizeNo, we have not done investigations but want to identify opportunities to optimize

Considering the size of your bank's total SA capital charge, have you been investigating and pursuing opportunities to optimisation within the rules?

Capital adequacy and optimization


Comment

• At clients we typically identify several opportunities for optimisation, often around data quality and hedging.

25

Standardised Readiness for CRR II and holistic approach

for Go-Live

26

More than just a number

CRR II reporting requirements for the Standardised Approach are expected to go live as early as 30 September 2021 (in 10 Months)

Most banks can now produce SA capital numbers. But, before go-live, there is a need for:• Testing and Validation: Are the numbers going in correct and complete? Is the output correct?• Analysis: Can the output be explained? Does the business understand the drivers of SA?• Operating Model: Who will run the model? How will errors and exceptions be handled? Who owns remediation?.

SA Calculator Testing and Validation

Although the SA Calculator is up and running in most banks, we have observed major issues in the new data layer for SA.

Before go-live, testing could include:

• Reconciliation between different data sources for SA inputs

• Benchmark with QIS or the Deloitte SA calculator

• Detailed report and remediation actions for data issues

Desk by Desk SA Capital Analysis

To date, banks have focused on producing best efforts draft numbers for regulatory and internal reporting:

However, before go-live, it will be necessary to embed an understanding of capital impact in the firm’s business practices.

• Identify key driver analysis of capital

• Methods to reduce RWA by analysing model limitations, data issues, and trade/hedge strategies

• Implement capital explain approach that allows for ongoing monitoring, trader education, spike remediation etc

SA Target Operating Model

Prior to SA parallel run, the full Front to Back operating model will need to be understood.

• The impact of SA on existing processes, controls, SLAs and CRR II reporting requirements will need to be understood in detail

• Resource forecasts will be needed across different functions over the next 2-3 years,

• Documentation of model policies and controls

• The approach to parallel run will need to be defined.

The launch date for an SA parallel run is not so far away, and producing correct and validated SA numbers, according to a well-defined operating model, is a key priority.

Standardised Readiness for CRR II

27

Data

Quality

An Holistic Approach to Preparing for Your SA Go-liveThe Standardised Approach in FRTB is a relatively simple calculation. The challenges are in getting the data right, coordinating the processes and systems involved, and understanding and managing the capital impact.

In our experience, the output of the standardised calculator is a very useful tool for the identification of data issues.

Capital spikes can be caused by bad data and incorrect bucketing. The testing findings can help identify these problems and ensure that the numbers being analysed in the capital analysis are validated and

correct.

• Review the TOM to ensure it covers all required BAU processes from inputto producing SA numbers from completeness, accuracy, governance and controls perspectives

• Testing should cover all TOM workflows and business requirements

• Deloitte can additionally identify any gaps benchmarked against industry practices

• Validate the capital numbers and drill-down into the underlying drivers

• Use the findings from Capital analysis to determine actions for optimisation / spike remediation

Testing will identify issues with the model, particularly in relation to data quality and

monitoring requirements The TOM informs the capital analysis work of all input data, including the completeness, controls

and governance

Where weaknesses in the model are identified, second line controls may be necessaryTarget Operating Model

SA Calculator Testing and Validation Capital Analysis

Data

Quality

TOM will define key features of the SA build, such as error-handling and processes for dealing with inaccurate

data..

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Case Study and Capital Allocation

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Case Study: Delivering the Standardised Approach Properly

The Standardised Approach is not too difficult to build, but doing it the right way will have benefits further down the line. The key features of our approach to SA highlight our FO approach in general:

1. Aggregate all the sensitivities by Risk Factor across the desk or bank.

2. Double-loop through all the Risk Factors.

3. Look up the correlation and re-compute correlation sum

4. Compute a final capital charge.

Crude First-pass Implementation:

The crude implementation will:

• Increase computation time, making it harder to run desk-level and what-if scenarios (at least in the Equities / Credit space).

• Output a total number but not show how different components contribute to that number. Analysis is only possible by re-running the mode.

The better approach would:

• Significantly reduce computation time.

• Allow additive decomposition of any one standalone run at any level of granularity (down to trade-level if input data is at trade-level).

• Allow on-the-fly re-computation for different desk structures and for what-if / hedging analysis., e.g. analyse different curves EURIBOR / Reformed EURIBOR for LIBOR reform

A Risk Model that

enables Management

of Risk

There are some areas where Standardised inputs can be challenging, and getting them wrong can lead to distorted results

• Without decomposition, the charge will be grossly exaggerated

Decomposition of Funds and Indices

• The requirements to bump risk factors –one-by-one – by large shocks and re-value can stretch valuation models beyond breaking point (e.g. bumping rates down by 240bps).

Curvature numbers may need validating

• Incorrect reference data can lead to the wrong shock size or bucket being applied.

• Example: Aluminium / Aluminium Alloy

Reference data is key

1. Keep Risk Factors as granular as possible.

2. Single loop through the Risk Factors to reduce computation time.

3. Produce additive contributions per input that sum to the total charge.

4. Present the disaggregated numbers in a pivot so risk can be analysed.

Deloitte Approach:vs

• Unlike the CRR, the CRR 2 has no special treatment for closely correlated currencies, although the CRR 2 gives preferential treatment to ERM II member states

.

Closely correlated currencies

30

Capital Calculators that Allow Drill Down and Analytics - ExampleDeloitte has developed an in-house methodology that we have implemented at three global investment banks. This methodology allows for bank wide capital allocation drill-down to any required level of granularity.

Example

IBORTransition to a new reality

32

Genesis and scope of changes related to the IBOR Reform

33© 2020 Deloitte

What is the interest rate index and the definition of LIBOR

Introduction

For nearly 50 years, IBOR (Inter-bank Offered Reference Rate) has helped determine borrowing costs around the world, from student and mortgage loans to derivatives such as interest rate swaps.

C U R R E N C Y 17.11.2020

EUR 16

USD 16

CHF 12

GBP 16

JPY 16

Benchmark means any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund with the purpose of tracking the return of such index or of defining the asset allocation of a portfolio or of computing the performance fees.

DEFINITIONS ACCORDING TO THE BMR REGULATION:

Index means any figure:

(a) that is published or made available to the public;

(b) that is regularly determined:

(i) entirely or partially by the application of a formula or any other method of calculation, or by an assessment; and

(ii) on the basis of the value of one or more underlying assets or prices, including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys;

BENCHMARKS OF LIBOR BEFORE 2012

Administration: British Bankers' Association

Discretionary system: Interest rate that the contributing bank would pay for a loan from another bank

Scale of instruments basing on LIBOR:

300-350 trillions USD

Number of contributor banks:

8-16

Banks in the panel

Source:https://www.theice.com/iba/libor

34© 2020 Deloitte

IBOR Reform

Source: https://www.ecb.europa.eu/pub/euromoneymarket/html/ecb.euromoneymarket201909_study.en.html#toc4

EUR

tri

llio

ns

Notes: Unsecured, secured, FX swap and OIS market data are based on the EMMS until 2015 and MMSR from mid-2016 onwards. STS data are based on data from Dealogic. Short-term securities include STEP, NEU CP, NEU MTN and certificates of deposit outstanding amount on a quarterly basis. The period under review is indicated by a light grey background.

Turnover in unsecured and secured segments

Money market in euro zone - market share of the cumulative volume per quarter per segment

35© 2020 Deloitte

Results of the 2008 financial crisis

Introduction

2012The beginning of the discussion on departing from IBOR rates in response to irregularities related to the determination of reference interest rates

2021Expected cessation of providing quotes for LIBOR indices and the beginning of the transition plans

2016Preparation and adoption of the BMR Regulation

2018The BMR regulation takes effect

2019Developing a methodology for new reference rates

1 REGULATION (EU) 2016/1011 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014

In response to irregularities related to the setting of LIBOR and EURIBOR reference rates, the European Parliament adopted Regulation 2016/1011 on benchmarks1 ("BMR").

BMR aims to reduce the risk of manipulation of indicators through increased control over their determination and publication, and the identification of conflicts of interest.

BMR introduces a new standard for the administration of key IBOR rates, which include, among others: LIBOR, EURIBOR, EONIA and WIBOR.

The issue of adjusting money market benchmarks to the requirements of the BMR Regulation was indicated by the Financial Stability Committee (FSC) as a source of systemic risk.

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Regulatory / industry bodies that are guiding IBOR transition

IBOR

The IBOR reform is not introduced by a single regulator, so in order to fully understand its impact, it is necessary to monitor the recommendations of many entities and regulators

The regulatory / industry bodies that are driving transition are defining a set of recommendations oriented to support market participants move away from IBOR across all the key impacted areas

Up to date, there are still some regulatory uncertainties that need to be defined by these regulatory / industry bodies

Buyside firms demand is vital to building liquidity in RFRs

Peers / Market

Lead the design and issuance of RFR-linked products

Bank Associations(ABA, EBF, IIF…)

Development of protocols, standards and fallback language

Market Associations(ISDA, LMA, ICMA…)

Clearing Houses(LCH, EUREX, CME…)

Key role in the settlement of securities and derivatives transactions

IBORtransition guidance

Groups of market participants,central banks and regulators

I n d u s t r y W o r k i n g G r o u p s

Regulators approve the methodology of index estimation and supervise index

administrators

Local regulators(FCA, BaFin, AMF)

Entities supervising administration, calculation and publication of interest rate

indexes

Index administrators

Main working groups

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Industry Working Groups

IBOR Reform

Other Industry Forums

Other industry forums have been established to address IBOR transition: market associations, clearing houses, bank associations, etc.

Alternative Reference Rates

Committee (ARRC)

It was convened in Nov. 2014 to identify a set of RFRs that transaction-based and comply with all the applicable standards

Europe Working Group on RFR

In September 2017, FSMA, ESMA, the ECB and the European Commission announced the establishment of a working group on RFR for the euro area. The working group is composed of representatives of 21 credit institutions with voting rights and representatives of 5 non-voting institutions and 2 guests.

Japan Study Group on RFR

The Group was convened in April 2015 to identify and establish the preferred JPY alternative RFR

Working Group on Sterling RFR

The Group was convened by the Bank of England in March 2015 with the primary focus of identifying and implementing an alternative RFR

National Working Group on Swiss

Franc Reference Rates

The Group NWG is established by the SIX Exchange in June 2013 to reform the TOIS fixing and CHF LIBOR

38© 2020 Deloitte

After December 31, 2021, the FCA will not expect panelist banks to provide further information on the level of LIBOR interest rates, which leads to the real possibility that LIBOR indices may not be available.

As a result, the RFR Working Groups developed, announced and started publishing the overnight interest rate indicators for the major currencies such as USD, GBP, CHF, JPY.

Interest rates indexes are undergoing a modification of the methodology of their estimation to ensure compliance with the requirements of the BMR Regulation. In addition, the ESTR overnight index has been developed for the Euro zone, which replaces the EONIA interest rate.

Main assumptions

IBOR Reform

The financial sector has started to work on replacing the current LIBOR-based rates with alternative risk-free rates (RFRs).

According to the recommendations of the main regulators, by June 30, 2021, financial institutions should introduce offers that include RFR in derivatives, loans and bonds.

Central banks and working groups have not yet developed risk-free forward interest rates. However, the declaration of their development and publication was submitted by index administrators, including Refinitiv and Bloomberg.

39© 2020 Deloitte

Alternative risk free rates

In most cases, administered by central banks

Developed as overnight

Average / compound interest rate indexes

Compiled and published as last

Interest rate indices are based on overnight data

Averages for 30, 90 and 180 days tenors (e.g. SOFR)

Types of interest rates

IBOR Reform

Alternative compounded risk free rates

In most cases, administered by central banks

Based on historical data

Expected and recommended implementation to derivative contracts, bonds and corporate loans

Forward looking term rates

Market participants indicate the need for their development, but at the moment they are not available

Managed by the administrators designated under the BMR Regulation

Reflecting the current approach (forward looking)

40© 2020 Deloitte

Geographical scope of the IBOR reform

Local currencies

Reference rate:CHF LIBOR

Proposed ARFR:Swiss Average Rate Overnight

(SARON)

Administrator:SIX Swiss Exchange

CHF

Reference rate:EURIBOR / EONIA

Proposed ARFR:Euro Short-Term Rate (STR) proposed as a fallback to EURIBOR

Administrator:European Money Markets Institute (EMMI)

EUR

Reference rate:GBP LIBOR

Proposed ARFR:Reformed Sterling Overnight Index Average (SONIA)

Administrator:Bank of England

GBP

Reference rate:USD LIBOR

Proposed ARFR:Secured Overnight Funding Rate (SOFR)

Administrator:New York Fed

USD

e.g. NOK, SEK, PLN, CZK, HUF

41© 2020 Deloitte

NEW RFR/ REFORMED INDEX

APPROACH ADOPTED BY THE ADMINISTRATOR

TYPE ADMINISTRATOR

EONIA€STR(Euro Short-Term Rate)

Switch to € STR. EONIA will continue to exist under the new methodology to allow a smooth transition to the € STR until 3 January 2022.

Unsecured interest rate on overnight wholesale deposit transactions

ECB

EURIBORReformed EURIBOR The EURIBOR reform was completed in 2019.

The new designation rules meet the BMR criteria.

Unsecured interest rate for transactions in the financial market

ECB

GBP LIBORSONIA (Reformed Sterling Overnight Index Average)

Switching to the SONIA index, which is quoted from April 23, 2018.


BoE

USD LIBORSOFR (Secured Overnight Financing Rate)

Transition to the SOFR, which is published from April 2018.

Hedged interest rate that covers many segments of the overnight market

FED

CHF LIBORSARON (Swiss Average Rate Overnight)

Transition to the SARON indicator, recommended in October 2017 as an alternative to CHF LIBOR

Hedged interest rate reflecting the interest payable on the interbank overnight rate

SIX Exchange

STIBORN/A A working group of banks that provide input

data for the STIBOR calculation is in the process of developing an alternative ARR rate.

Unsecured interest rate on overnight transactions SFBF

NIBORNOWA(Norwegian Overnight Weighted Average)

The working group recommended the reformed NOWA rate as an alternative reference rate and is in the process of developing a plan to expand the OIS market based on this rate

Unsecured interest rate on Interbank overnighttransactions

NoRe


IBOR reform on selected markets

42© 2020 Deloitte

STAWKAIBOR

NEW RFR/ REFORMED INDEX

APPROACH ADOPTED BY THE ADMINISTRATOR

TYPE ADMINISTRATOR

WIBOR

N/A

Reformed WIBOR

WKF (Financing Cost Indicator)

Administrator devised a new methodology for fixing the WIBOR, it is currently consulted with the market participants and tested. It was placed to the regulatory authority for approval in Dec 2019.IRF obtained permission to operate as benchmark administrator on 03.11.2020.


Indicator utilizes transactional data for maturity deposits that have been created by panellists

GPW Benchmark

Financial Market Institute (IRF)

PRIBORReformed PRIBOR An administration over the PRIBOR benchmark

has been transferred to an independent entity. Transparency of the used data increased.


Czech Financial Benchmark Facility (CFBF)

BUBORReformed BUBOR Administrator of the index has changed from

Hungarian Forex Association to MNB. Executable quoting system for 1M, 3M and 6M was introduced. Minimum transaction size increased, bid-ask spread declined.


Hungarian National Bank (MNB)

ROBOR

N/A

Reformed ROBOR

IRCC

Changes implemented to market quoting: (bid/ask spreads narrowed, timeslots extended, maximum values of quotations increased)IRCC replaces ROBOR for consumer and mortgage loans to households.For the time being, neither of the two benchmarks is BMR-compliant.


Quarterly index for consumer credit, calculated as an arithmetic mean of the interest rates of the Interbank deposits

Romanian National Bank (BNR)

NationalCommission of Strategy and Prognosis (CNSP)

LEONIALEONIA Plus LEONIA Plus covers more data providers,

including all BNB-licensed banks and branches of foreign banks in the country.SOFIBOR discontinued since 1.07.2018.


Bulgarian National Bank (BNB)


IBOR reform on selected European markets

43© 2020 Deloitte

Calendar of major changes

IBOR Reform

EU

Great Britain

2019 2020 2021

EURIBOR in line with BMR

Q1.2021: new credit products should not be

based on LIBOR

03.01.2022: EONIA will cease to be

published

The FCA has developed guidelines on expected dates for the transition to the reformed indicators

Clear declaration that the final implementation date will not be delayed despite the COVID-19 pandemic, although individual tasks may be postponed

The FCA has developed guidelines on the expected transition dates to the reformed benchmarks.

On November 18, 2020, ICE Benchmark Administration Limited announced that it has initiated consultations on its intention to discontinue publication of all LIBOR quotes for GBP, EUR, CHF and JPY after 12/31/2021.

On November 18, 2020, FCA published a position stating that the publication of LIBOR rates for EUR and CHF will not be continued after the end of December 2021.

The European Union has published a proposal to amend the BMR Regulation to facilitate the transition to the existing portfolio

02.10.2019 Publication of €STR

10.2019: EURIBOR calculated on the

basis of the modified methodology

22.06.2020: CCPs have started using the € STR for

EUR trades

Q3.2020: introducing provisions to new contracts to enable the

Reform to be carried out

Q1.2020: Introduction of the IRS based on SONIA

03.01.2022: FCA will no longer expect panellists to

submit LIBOR quotes

Changes that have already been applied Expected changes Cut-off dates

PRESENT

C A L E N D A R O F M A I N R E G U L A T O R Y C H A N G E S

ISDA developed and published on October 23, 2020 the Fallback Protocol setting out the transition rules for ISDA-based derivatives

44© 2020 Deloitte

IBOR Reform

USA

SWITZERLAND

2019 2020 2021

PRESENT

The alternative index SARON for the Swiss market has been developed and has been published since 2009.

September 2020:FINMA publishes the self-assessment results: the CHF LIBOR legacy volume value is small and this is not a problemThe SARON compound rate calculator is available on the SIX website:

https://www.six-group.com/en/products-services/the-swiss-stock-exchange/market-data/indices/swiss-reference-rates/saron-calculator.html

The ARRC successively publishes recommendations on the approach to switching to the reformed rates for individual product groups

On November 18, 2020, the ARRC maintained its position regarding the discontinuation of USD LIBOR at the end of 2021.


03.01.2022: assumed date when LIBOR CHF will cease to be available


17.10.2020: CCPs have started using SOFR for USD

transactions


30.06.2021: Expected target date for offering

new products based on the USD RFR

07.05.2020

NWG for CHF RFR

29.09.2020

NWG for CHF RFR


45© 2020 Deloitte

IBOR Reform

USA

SWITZERLAND

2019 2020 2021

PRESENT

The alternative index SARON for the Swiss market has been developed and has been published since 2009.

September 2020:FINMA publishes the self-assessment results: the CHF LIBOR legacy volume value is small and this is not a problemThe SARON compound rate calculator is available on the SIX website:


The ARRC successively publishes recommendations on the approach to switching to the reformed rates for individual product groups

On November 18, 2020, the ARRC maintained its position regarding the discontinuation of USD LIBOR at the end of 2021.


03.01.2022: assumed date when LIBOR CHF will cease to be available


17.10.2020: CCPs have started using SOFR for USD

transactions


30.06.2021: Expected target date for offering

new products based on the USD RFR

07.05.2020

NWG for CHF RFR

29.09.2020

NWG for CHF RFR


46© 2020 Deloitte

IBOR ReformDevelopment of the RFR markets – derivative transactions

H2 2019 H1 2020

Volume(USD billions)

Number of transactions

Volume(USD billions)

Number of transactions

USD LIBOR 53 308. 3 337 734 63 006. 2 393 941

SOFR 272. 5 1 020 488. 9 2 274

GBP LIBOR 4 643. 2 46 576 7 871. 2 65 501

SONIA 4 650. 6 7 139 10 235. 4 13 587

CHF LIBOR 287. 3 4 272 315. 9 6 040

SARON 23. 8 48 20. 0 43

EURIBOR 10 346. 2 106 123 12 507. 3 110 380

€STR 4. 7 11 13. 3 70

Source: ISDA

TRADING VOLUME IN INTEREST RATE DERIVATIVE INSTRUMENTS:

MAIN JURISDICTIONS

In the first half of 2020, the volume of trading in derivatives based on alternative reference rates amounted to 10.9 thousand USD billions, which accounted for 7.6% of the total global trading volume

For comparison, in the first half of 2019, this volume amounted to 5.1 thousand USD billion, which accounted for 4.3% of the global volume of trading in interest rate derivatives

The market trades both swaps that convert alternative reference rates to fixed rates (float-to-fix) and basis swaps that convert IBOR rates to alternative rates (float-to-float)

47© 2020 Deloitte

IBOR ReformDevelopment of the RFR markets – bonds issuances

7

5572

$4.10

$63.70

$100.17

2018 2019 2020Year of issue

Source: Refinitiv. Data in USD billions

ISSUES OF BONDS BASED ON SOFR ISSUES OF BONDS BASED ON ESTR

12

9$5.25

$5.60

2019 2020Year of issue

48

The most important challenges related to the implementation

of the IBOR Reform

49© 2020 Deloitte

Effects of IBOR reform - introduction

Risk management area

The need to develop new forward rate curves

Changing the methods of valuation of financial instruments and their book value

Change in the rules of liquidity management

Accounting area

Change in the valuation of financial instruments and their book value

Modification / adjustment of hedging strategies or hedge accounting policies

Potential reclassification and modification of financial instruments

Legal and tax area

Renegotiation of contracts related to IBOR (e.g. financing agreements, derivative agreements based on ISDA, cash pooling contracts etc.)

Update of transfer pricing documentation

The impact of changes in the valuation of financial instruments on tax, including deferred tax

Operational and system area

Updating IT systems (accounting and ERP systems, transaction platforms, market data providers, etc.)

Change of internal procedures and methodologies

Change in settlement of derivative transactions and potential modifications to collateralisation

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