This is presenting increasing challenges to the industry in terms of
maintaining required levels of transparency, notably where
institutions serve as intermediaries. Developments around digital
assets and currencies, notably the role of stablecoins and central
bank digital currencies, have continued at pace, with an increasing
regulatory and enforcement focus on the financial crimes linked to
these types of assets.
Expectations with respect to the intersection of ESG issues and
financial crime as our organisation, customers and suppliers
transition to net zero, are increasing, not least with respect to
potential ‘greenwashing’. Companies also face a heightened
regulatory focus on both human rights issues and environmental
crimes, from a financial crime perspective. We also continue to
face increasing challenges presented by national data privacy
requirements, which may affect our ability to manage financial
crime risks holistically and effectively.
Mitigating actions
•We are strengthening our fraud and surveillance controls, and
investing in next generation capabilities to fight financial crime
through the application of advanced analytics and artificial
intelligence.
•We are looking at the impact of a rapidly changing payments
ecosystem to ensure our financial crime controls remain
appropriate for changes in customer behaviour and gaps in
regulatory coverage, including the development of procedures
and controls to manage the risks associated with direct and
indirect exposure to digital assets and currencies.
•We are assessing our existing policies and control framework
to ensure that developments in the ESG space are considered
and the risks mitigated.
•We work with jurisdictions and relevant international bodies to
address data privacy challenges through international
standards, guidance, and legislation to help enable effective
management of financial crime risk.
•We work closely with our regulators and engage in public-
private partnerships, playing an active role in shaping the
industry’s financial crime controls for the future, notably with
respect to the enhanced, and transparent, use of technology.
Ibor transition
Interbank offered rates (‘Ibors’) have historically been used
extensively to set interest rates on different types of financial
transactions and for valuation purposes, risk measurement and
performance benchmarking.
Following the UK’s Financial Conduct Authority (‘FCA’)
announcement in July 2017 that it would no longer continue to
persuade or require panel banks to submit rates for the London
interbank offered rate (‘Libor’) after 2021, we have been actively
working to transition legacy contracts from Ibors to products
linked to near risk-free replacement rates (‘RFRs’) or alternative
reference rates. In March 2021, in accordance with the 2017 FCA
announcement, ICE Benchmark Administration Limited (‘IBA’)
announced that it would cease publication of 24 of the 35 main
Libor currency interest rate benchmark settings from the end of
2021, and that the most widely used US dollar Libor settings
would cease from 30 June 2023. The FCA subsequently used its
regulatory powers to compel IBA to publish the remaining six
sterling and Japanese yen settings, from 1 January 2022, under an
amended methodology, commonly known as 'synthetic' Libor. As
a result, our focus during 2021 was on the transition of legacy
contracts referencing the Euro Overnight Index average (‘Eonia’)
and the Libor settings that demised from the end of 2021,
including those settings subsequently being published on a
'synthetic' basis.
During 2021, we continued the development of IT and RFR
product capabilities, implemented supporting operational
processes, and engaged with our clients to discuss options for the
transition of their legacy contracts. The successful implementation
of new processes and controls, as well as the transition of
contracts away from Ibors, reduced the heightened financial and
non-financial risks to which we were exposed. However, while all
but exceptional Libor contract issuance ceased in 2021, or from
the end of 2021 for US dollar Libor, we remain exposed to material
risks. These include, from so-called ‘tough legacy’ contracts, that
have not been able to be transition to a new rate and will use a
'synthetic' Libor or a contractual fallback rate, and from legacy
contracts that reference US dollar Libor, which are expected to
demise from June 2023.
Financial risks have been largely mitigated as a result of the
implementation of model and pricing changes. However,
differences in US dollar Libor and its replacement RFR, Secured
Overnight Funding Rate (‘SOFR’), create a basis risk in the trading
book and banking book due to the asymmetric adoption of SOFR
across assets, liabilities and products that we need to actively
manage through appropriate financial hedging. Additionally, the
comparatively limited use of SOFR for new RFR products to date
and lack of alignment around conventions could potentially delay
transition of some US dollar Libor contracts into 2023. This would
compress the amount of time to transition these contracts, which
could lead to heightened operational and conduct-related risk as a
result.
Additional non-financial risks, including regulatory compliance
risk, resilience risk, financial reporting risk, and legal risk also
remain for ‘tough legacy’ contracts, and the US dollar legacy
portfolio. These risks continue to be actively managed and
mitigated with a focus on ensuring that fair outcomes for our
clients are achieved.
These risks are present in different degrees across our product
offering.
Transition of Legacy contracts
During 2021, we successfully transitioned over 90% of legacy Ibor
lending contracts in sterling, Swiss franc, euro and Japanese yen
Libor interest rates, as well as Eonia, directly or via appropriate
fallback mechanisms. The majority of the remaining contracts will
transition in advance of their next interest payment date, with only
a small proportion of ‘tough legacy’ contracts remaining. We
expect that out of approximately 1000 lending contracts there will
be less than 20 ‘tough legacy’ contracts, the majority of which will
be transitioned to alternative rates during 2022. Our approach to
transition ‘tough legacy’ and US dollar legacy Ibor contracts will
differ by product and business area, but will be based on the
lessons learned from the successful transition of contracts during
2021. We will continue to communicate with our clients and
investors in a structured manner and be client led in the timing
and nature of the transition.
For derivatives, approximately 99% of our sterling, Swiss franc,
euro and Japanese yen Libor interest rate exposures at the end of
2021 had successfully transitioned directly or via appropriate
fallback mechanisms, leaving a small number of ‘tough legacy’
contracts. There are expected to be less than 20 bilateral
derivatives trades that remain ‘tough legacy,’ the majority of
which are expected to mature or transition in 2022. We anticipate
our ‘tough legacy’ and US dollar exposure will continue to reduce
through 2022 as a result of contract maturities, and active
transition. We will continue to look to actively reduce our US dollar
exposure by transitioning trades ahead of the demise date of 30
June 2023, by working with our clients to determine their needs
and how we transition their contracts. Additionally, we are
working with market participants, including clearing houses, to
ensure we are able to transition our cleared derivative contracts as
the US dollar Libor benchmark demise date approaches.
For our loan book, approximately 85% of our reported exposure at
the end of 2021 linked to sterling, Swiss franc, euro and Japanese
yen Libor interest rate contracts that required no further client
negotiation but remained drawn on Libor as they have yet to reach
their next interest payment date. The majority of the remaining
exposure linked to benchmarks that demised from the end of 2021
relates to contracts where discussions with our clients and other
market participants, for syndicated transactions, have continued in
early 2022, in advance of their next scheduled interest payment
date, and this has led to further transitions being completed.